10. The Liquidity Transmission Mechanism: Understanding Future Macro-valuation Shifts

Concept of an active financial cycle introduced. This can amplify macro-economic dislocations. Global Liquidity is shown to determine World financial asset prices, including real estate values. Global Liquidity leads movements in the real economy by up to 20 months. Transmission occurs through portfolio rebalancing using the concept of the price-to-money ratio (P/M), which parallels the traditional price-earnings ratio. Treasury bond term premia are positively determined (Granger caused) by the overall flow of liquidity, in contrast to the conclusions from narrower Central Bank and academic event studies. Exchange rates are determined by the quality mix of liquidity between private and public sources. Equity returns depend on the positioning of liquidity within portfolios. We evidence that large holdings of liquidity are associated with greater future equity returns.