Credit events vs. liquidity events
In my view, global markets are current facing a credit event, not a liquidity event; that distinction is important. A credit event results in severe distress but ultimately transfers good assets from weak hands to strong ones. A liquidity event, on the other hand, is what Walter Bagehot and Henry Thornton described as a reduction of money stock, which has a pernicious deflationary impact. I presume that lessons from letting Lehman fail are now front and centre of mind for the Federal Reserve. I expect to see liquidity measures being proposed if there's even a whiff of a problem. If the event I envisage remains confined to a credit event, long-term investors like us should be eagerly awaiting its onset. I am by no means a sadist. Every such prior financial event has inflicted distress and pain on all of us and will usually hit us from quarters we would least imagine. But it is a necessary condition to correct the distortions in the cost of capital. (VIEW LINK)
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