Liquidity vs. Solvency
Liquidity vs. Solvency is probably a good subject at this point, and one that brings a certain confusion to this humble layman.
Now, as I understand it, liquidity is (at its most basic) the ability to move around assets. For example, having cash on hand means that you have a certain amount of liquidity. You can spend/trade it for a wide variety of goods, from a can of Coke at Family Dollar to a new car or house, if you have enough. Seems simple enough, right?
Solvency, then, is your basic balance sheet: Do you have more assets than debts? In a strictly budgeted scenario, if you have more debts than assets, you are not (very) solvent; all your income goes to servicing those debts. You can't move around assets easily because everything is tied to a debt (or the Repo Man is knocking on your door.) You are insolvent, frozen, unable to move through the tides of money.
You have a neighbor named John. He's a cattle farmer. Beef prices have been going up, and for the last few years, he's managed to keep ahead of the debts. It's mid-winter, and he's got hay in the barn, feed-corn seed in the shed, and 1,000 pregnant cows. Because he's has more unencumbered assets than debts, he's solvent. However, none of those assets can be quickly turned into cash (hay might sell to other farmers, but the corn has to grow, and the calves are still only en potentia.) He can have $1 million in assets, with the potential to make $500,000 in the coming year, but he can't move it around. Therefore, he has very little liquidity.
Your other neighbor, Bill, has had a run of bad years, and he sold all his cattle to pay off debts, feed his family, and pay his taxes. He has just walked out of the bank with a $500,000 cash loan, mortgaged on his land. (The banker, a friend and a business man, decided that it was worth the risk.) Bill has very few assets, but a lot of cash. He's very liquid, but practically insolvent.
Which one would you rather be? John, who might have to starve a little now, but reap the rewards in a few months; or Bill, who can spend his money on anything, but has a 30-year mortgage hanging over his every move?The Problem
So here's where I get confused. Today, the Fed announced that they are putting out $200 billion to help ease liquidity problems with major banks and lenders. Markets were overjoyed! Brokers cheered!
But why the celebration? Helping liquidity doesn't mean the debt has gone away. It simply means that you can now shuffle around money to keep the banks open. If banks start closing, it will directly hurt the consumers and the economy. But if a bank stays open by tap-dancing on the waves, its fall could be that much harder when it finally comes.
The basic, fundamental problem is still there--production is off; spending is high; and many of the supposed assets our economy has have been over-valued. To be incredibly simplistic, too much money has been floating around. Everyone has tried to get a piece of it (or had to without realizing it).
CAPS, for example, illustrates this perfectly. How do you get a high score in the CAPS system? By beating the market! If the market rises 10% in a year, and your picks have only risen 9%, you're losing! Likewise, if there is more money in the economy, you have to get a larger volume of it just to stay even.
On the other hand, if the market drops 10% in a year, and your picks only drop 8%, you're winning! Not because you have more, but because you have more relative to the market.
Simplistically, this is how the money supply works.
Here's some math: If the Fed pumps in $200 billion into the market, and there are about 350 million people in the US, every man, woman and child has to come out of the year with at least $571 more dollars than they would normally have...to stay even! If you have a family of four, and only one bread winner, then he/she has to come out with $2,280 more dollars out of thin air. Every single person who doesn't have that extra money is at least that much poorer than before, even if they show a perfectly balanced budget.
So, John and Bill?
With the Feds action today, John's real profits are going to get cut. Since everyone is going to working to get their $571 to stay even, John's going to pay more at the pump, the feed store, the grocery store, and the tax office.
Bill, on the other hand, has it much worse. That 30-year mortgage has just gotten a little steeper, and he's going to have to work harder and harder to just stay even. Like sand in the gears, this will wear a little faster, run a little rougher, and make it that much easier to simply collapse under the weight of it all.
My Magic 8-Ball prediction is that this is just a band-aid. The underlying problems of the economy are only going to get worse, and, in a fit of economic Darwinism, over-priced and over-extended businesses are going to come tumbling down like, well, the legendary brokers of the Great Depression.