Financial System Liquidity

Basic monetary liquidity, the most critical element to starting an
economic recovery, remains in growth mode. The large increase in
this composite over the past year brings the 5 year growth up to a
level sufficient to give the economy a fighting chance at expansion.
It also serves as a major positive fundamental for stocks, as rising
real M-1 lets you know you are betting with the Fed.

The broader measure of credit driven liquidity has continued to
decline and is now down about 1.6% yr/yr. The market for financial
company commercial paper outstanding has sunk another 38%
yr/yr or nearly $600 bil. as the shadow banking system continues to
be unwound. Large time deposits at banks have fallen nearly $200
bil. as banks let C&I loans run off and remain with a flat real estate
book. Even the massive M-2 money measure would be down were it
for the large growth of M-1 primary liquidity.

Both retail and institutional money market funds have declined in
2009. Some of this decline is attributable to the purchase of goods
and services by individuals and businesses, but with market short
rates near zero, investors have extended maturities to capture more
yield and have no doubt used funds to fuel the rally in stocks on
expectations of economic recovery.

Individuals have increased savings by over $500 bil. and companies
have added to their liquidity by slashing inventories, capital expend.
and payrolls. So, the economy does not need an ample supply of
private credit to fund economic expansion in the early stages.

Monetary velocity, measured in terms of the cyclical side of the
economy has plunged despite a 1.6% decline in the broad, credit
driven measure of financial liquidity. This has created a large pool
of liquidity that runs over and above the needs of the real economy,
and, as mentioned above, has fuelled the stock and corporate bond
markets.

The Fed and other central banks continue to maintain a network of
large currency swaps to provide liquidity to serve those trapped by
the major decline of global trade. Peak -to-trough, US dollar outflows
have fallen nearly 75% on a monthly basis as the trade deficit has
contracted substantially.

Credit quality spreads have narroweded globally and liquidity appears
sufficient to underwite the initial phase of global economic recovery.
Banking system liquidity is improving as loans run off, but capital is
still not adequate to fund an extended economic expansion.
However, in the US, rising business cash flow and the appearance
of stabilization in home prices will serve to ease the way for banks
to access the capital markets going forward.