(I am an occasional contributor to roundtables of economists in the magazine The International Economy. This month’s topic was the possible dangers of “today’s giant swirling ocean of liquidity”.)
Imagine a city that experiences a miraculous improvement in its transit system. Thanks to some mix of new technologies and organizational improvements, the subways and buses are now able to carry far more passengers at lower cost and the same level of service. Would we see that as good news, or as bad? It’s true that Uber drivers and gas station owners would be unhappy as abundant public transportation reduced demand for their services. And retailers and restaurants might face challenges in managing a sudden flood of new customers. But no one, presumably, would think the city should deliberately give up the improvements and return transit service back to its old level.
The point of this little fable should be obvious: liquidity, like transportations services, is useful. Having more of it is better than having less.
What liquidity is useful for, fundamentally, is making promises. It functions as a kind of collective trust. The world is full of socially useful projects that can’t be carried out because even a well-grounded expectation of future benefits can’t be turned into a claim on resources today. Liquidity is the fuel for these transactions. In a world of abundant credit and low interest rates, it’s easier for me to turn my future income into ownership of a home, or a business to turn future profits into new plant and equipment, or a government to turn future revenue into improved public services.
Someone with a great business plan but no capital of their own might try to get the labor and inputs they need to bring it about by promising workers and vendors a share in the profits. Unless the business can be launched with just the resources of immediate family and friends, though, it’s not likely to get off the ground this way. The role of the bank is to allow strangers, and not just those who already know and trust each other, to contribute to the plan, by accepting — after appropriate scrutiny — the entrepreneur’s promise, and offering its own generally-negotiable promise to the suppliers of labor and other resources.
Yes, when you make it easier to make promises, some of them won’t pan out. But we would like people to make more provision for future needs, not less, even if our knowledge of those needs is less than perfect. The most dynamic parts of the economy are the ones where there are the most risky projects, some of which inevitably fail.
Of course asset owners are unhappy about lower yields. But that’s no different from the complaints we always hear from incumbents when production improvements make something cheaper. Asset owners’ complaints are no more reason to deny us the socially useful services of liquidity than those of the proverbial buggy-whip makers were to deny us the services of cars. (Less reason, actually, given the concentration of financial wealth among the wealthiest families and institutions.)
Interest rates today are lower than at almost any time in history. So are the prices of food or clothing. We should see abundant liquidity the same way we see these other forms of abundance — as the fruit of the technological and institutional that has made us so much materially richer than our ancestors.