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Liquidity is also a matter of trust to some degree. But liquidity
has another feature that few people notice. Liquidity is a function
of laziness. By this I mean that liquidity is an inverse function
of the amount of research required to understand the character of a
financial instrument. A dollar bill requires no research. A bank draft
requires less research than my personal check. Commercial paper issued
by JP Morgan requires less research than paper issued by a bank in the
boondocks. Buying shares of GE requires less research than buying
shares of a start-up high-tech company. A bond without an MBIA
(once-upon-a-time anyway) guarantee or a high S&P/Moody’s rating
requires less research than a bond without a guarantee or lacking a
set of letters beginning with “A” from the rating agencies. The less
research we are required to perform, the more liquid the instrument –
the more rapidly that instrument can change hands and the lower the
risk premium in its expected returns.

The root of today’s problems in the financial markets and in the economy as a whole is the household sector. The point needs no elaboration, but its significance cannot be minimized. As we have argued on more than one occasion, the shrinkage in the personal savings rate is not the result of consumer profligacy, as other commentators persist in describing it. Rather, the savings rate has been suppressed by a slowdown in the growth of household incomes. The shortfall between income and outlay has been met by borrowing, and in particular by borrowing against the family real estate. Now the opportunity to borrow has shrunk dramatically, an outcome that will profoundly change the household’s spending power and spending patterns. But the impact is not just on the household. A slowdown in the growth of consumer spending has ominous implications for the entire global economy – and, along the way, the U. S. federal deficit, soon to be overburdened by spiraling benefit obligations. This predicament is not a short-run matter, unless home prices abruptly reverse themselves and head back into the stratosphere – which is hardly likely.

Zimbabwe, a South African nation with 12 million inhabitants, is battling rampant hyperinflation to the tune of 100,000% per year. The International Monetary Fund puts the rate even higher, at a whopping 150,000% as of December, 2007. The Christian Science Monitor reports that a sausage sandwich in Zimbabwe costs 30,000,000 local dollars, which translates into just $1.25. In fact, prices are rising so quickly, some storekeepers—for lack of clients—are buying sacks of grain to turn around and sell at a profit a couple of weeks later.