Feature – Liquidity
LIQUIDITY: A SHOCK TO THE SYSTEM
How are institutional investors managing liquidity in an era of quantitative tightening? Mona Dohle finds out.
More than 300 years ago, John Law became the economic adviser to the French throne. He rapidly rose to fame for estab- lishing paper money and founding the Banque Générale, the first incarnation of France’s central bank.
In a time of recession and at the height of public distrust in the throne, he famously sold shares in the Mississippi Trading Company, which managed the country’s commercial interests in North America, and used interest rates to stimulate economic demand. While the country was suddenly awash with cash, the prices of futures contracts in the Mississippi Trading Company rose to more than 10,000 francs. But when it became clear that the gains from the exploitation of the new continent were not as easily made as promised by Law, the share price of the company collapsed by more than 70%, leav- ing investors out of pocket.
34 | portfolio institutional | February 2023 | Issue 120
It is no wonder then that parallels are drawn between this famous economic bubble and today’s rapid expansion of mon- etary stimulus. While today’s markets and problems are differ- ent from 18th century France, the experience that assets are easily traded when markets are awash with cash but that liquid- ity can evaporate rapidly is familiar to many investors; last year’s liability-driven investment (LDI) crisis in the UK being a case in point.
Into the shadows While the French regent cranked up the printing press to fund his unsustainable spending habits, in the 21st century central bankers across the globe have injected money into the system through buying government debt in an attempt to dampen the impact of 2008’s financial crisis. This trend was sharply accel-
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