Financialization and Macro-Liquidity Risk

FINACIALIZATION AND
MACRO-LIQUIDITY RISK
LI BAOWEI
ZHANG YUN
XIE RUOQING
25/9/2014
1

ABSTRACT
Background: Recent financial crisis and macroeconomic volatility show us excess
liquidity and liquidity crunch are alternate in China. This paper considers that it is
rooted in three reasons:
 Firstly, in the main developed countries, financial development has become increasingly
independent from the development of the real economy. Increased finance separate from
the real economy investment brings about new financial instruments and transactions which
are get rid of the shackles of traditional finance, resulting in a significant change in the
macroeconomic structure;
 Secondly, high liquidity assets with low risk and other financial assets are complexly
alternative in financialization process;
 Thirdly, lever mechanism is widely used, leading to increasingly significant financial
instability.
2
Macro-Liquidity; Financialization; Monetary; credit

CONTENT
1. Introduction
2. Review
2.1 Theoretical Studies of Macro Liquidity
2.2 Definitions of Liquidity
3. Money, Credit and the Nature of Liquidity
4. Financialization and the Produce of Macro Liquidity Risk
4.1 Definitions of Financialization
4.2 The produce of Macro Liquidity Risk
5. Study of Liquidity Measurement
5.1 Review of Measurement Methods
5.2 An Empirical Analysis of China’s Monetary Market
6. Policy Recommendations of Liquidity
6.1 Monetary Policy
6.2 Macro Prudential
7. Main Conclusions
3

1. INTRODUCTION
• June 2013, a "money shortage" reproduction hit China money market. Under the impact of reserve
repayment, expectation of foreign exchange holding decline, greater regulation on bond market, money of
payment and other factors, the interbank offered rate was climbing, which means short-term liquidity
crunch. June 8, Shanghai interbank offered rates rose 231.2 basis points to 8.294%.
• We study the logic of the monetary and credit capital theory from Marx in the development of the
foundation, absorb and learn from Minsky's financial instability theory to analyze the current
macroeconomic liquidity risk. In this paper, we consider that the national currency is the credit support of
the M1 and M2 with deposit insurance protection and other supported by national credit debt assets,
equity and financial derivatives markets, such as credit belongs to the support of financial credit assets.
• This is not just arising from a single financial institution but rather reflects the overall financial markets.
This paper is intended to depart from the functional currency, study the nature of the mechanism of
liquidity, and why liquidity generated in the process of the financial supplemented by empirical analysis
to propose appropriate policy recommendations for macroeconomic liquidity risk.
4

2. REVIEW
2.1 Theoretical Studies of Macro Liquidity
For monetary liquidity stage research and focused on Keynesian
and neo-classical economic theory, research scholars around the
world in this regard is quite mature.
•Keynes (1936); Tobin (1958) and Kahn (1972);
Minsky (1963); Stanfield (1986)
•Wray(2012)
•Nobuhiro Kiyotaki and John Moore(2002)
•Friedman (1968) and Bruner (1968); Stanfield (1986)
5

2. REVIEW
2.2 Definitions of Liquidity.
• The most common is the use of financial deepening McKinnon indicator,
M2 / GDP measure of liquidity, the index reflects the interaction between
the real economy and the financial market level and did not consider the
process of money between financial and non-monetary financial assets
alternative relationships.
• Kramp define the “liquidity” from three aspects: First, from the due date of
assets to define "liquidity", while money is a kind of maturity zero assets,
so the money the most, "liquidity" of nature; Second, convenience, the
proportion of the stock of money balances and output flows, "liquidity" of
the ratio between the size of output; third is the "financial strength" him
from the balance sheet of the economy starting to define the "liquidity",
namely financial strength is that people hold on government debt and other
private sector entities in the market value of debt measure, that "liquidity"
is make a financial product conveniently converted to another financial
product tools. Definition Kramp to maturity to define liquidity, liquidity is
to explain the concept of repetition, does not have real meaning.
6

2. REVIEW
We summarized in the definition of the various liquidity that there are three
aspects of liquidity meaning that monetary liquidity, institutional liquidity and
market liquidity. We believe that monetary liquidity means investors will
credit the lower currency conversion process for a higher credit non-monetary
financial assets arising from liquidity, when the economy in which people are
expected to rise in interest rates, tend to hold money instead of bonds , the
greater the demand for money speculative motive, resulting in excess
liquidity. Liquidity refers to the institutional bodies prefer to non-monetary
financial assets into monetary assets, resulting in conversion value of assets
between agencies or institutions and individuals, resulting in liquidity, when
lack of funds between institutions, the formation of the money shortage,
liquidity risk is generated. Market liquidity is a measure in markets monetary
financial assets and monetary assets transaction activity, if market liquidity is
high, then the more active trading between assets.
7

2. REVIEW
In this paper, a new perspective of Marxist political economics and
Keynesian, Post Keynesian monetary theory is based on three basic
propositions, first, the currency can be exchanged commodities, currencies
can be exchanged, but not the direct exchange of goods commodities,
currencies as medium of exchange, the quest for money because of its ability
to meet the payment means the role of the exchange; Second, money is debt,
record the borrower's debt and lenders as a form of assets, Minsky argued that
anyone can through the issuance of notes in the social accounting system to
create money; Third, the existence of debt default risk, due to both lenders
and borrowers must be willing to "create money" and "holding money" has
generated a lending relationship, which produced a liquidity and default risk.
Therefore, this article is essentially Post-Keynesian perspective of research
money that liquidity is an alternative non-monetary assets and monetary
relationships between assets is determined by the entire financial system has
shown.
8

3. MONEY, CREDIT AND THE NATURE OF LIQUIDITY
• Money supply based on their safety and liquidity in general is divided into four levels of M0, M1, M2,
M3, etc. M0 is cash in circulation, the monetary base; M1 individuals and businesses rely on credit, such
as bank acceptances; credit M2-dependent agencies and organizations, such as time deposits and other
enterprises; M3 institutions in the country and credit support, such as treasury bills, financial bonds,
margin deposits, foreign currency deposits.
9

Table 1 Monetary and non-monetary financial assets safety and liquidity analysis
Monetary Financial Assets Security Liquidity Category
M0 Cash currency Max Max
Security
M1 Bank Savings Higher Higher
M2
Deposits expect of
Demand Deposits
High High
M3
Government Bonds High Low
Corporate Bonds Low Low
Stock Lower Lower Asset
Derivative Min Min
Source: This article is based on hierarchical division of monetary and non-monetary financial assets finishing
10

Figure 1 Figure currency circulation
Monetary Assets
Traditio
nal
Financi
al
Assets
Finan
cial
Deriv
atives
Real Economy
Alter
nativ
e
relati
ons
National Credit Market Credit
Source: This article is based on neo-Marxist political economy and the integration of Keynesian theory carding 11

Based on Post-Keynesian functions for hoarding knowledge, this paper considers that
in the process of development in the current financial and monetary savings had
gradually as residents of non-monetary financial assets have higher credit support,
people chase money that has more value assets resulting liquidity risk. The period of
excess liquidity, which means there are more household savings and cash in
circulation, with the same time is the lack of financial assets, thereby forming a
financial bubble. We believe that the essence of liquidity is the value of a monetary
and non-monetary financial assets between the conversions, credit exchange system.
12

4.1 DEFINITIONS OF FINANCIALIZATION 4. Financialization
and the Produce of
Macro- Liquidity
Risk
Epstein (2001) on the financialization make the following definition:
financialization refers to the domestic and international levels, financial markets,
financial institutions and the financial industry elites importance of economic
performance and economic management system for continuous improvement
process. Paley pointed out the impact of financialization is mainly reflected in the
financial sector relative to the real sector to enhance the importance of the transfer
of income from the real sector to the financial sector, resulting in the distribution of
income. Georgia · R · Kerry Pune (2008) considered an accumulation mode,
Arrighi endorse this model that profit through trade and financial channels rather
than the production of goods produced here in order to obtain financial means and
future interest, dividends and capital gains liquidity supply (or transfer) related
activities (Arrighi, 1994). Goldsmith related to financial ratios (Financial
Interrelations Ratios, FIR) to measure the relative size of the extent of the financial
superstructure and financial deepening. Goldsmith with the "financial
development" to define the changes in the financial structure, with "economic
financialization" to describe the current situation of financial development.
13

4.1 DEFINITIONS OF FINANCIALIZATION 4. Financialization
and the Produce of
Macro- Liquidity
Risk
From an international perspective, we believe that the process of
formation of financial time arises from the financial markets, the
banking industry can be traced back to the United States in the
19th century, large-scale mergers and acquisitions, and in the late
1970s to become a global trend of financialization, 80 stock era in
the United States as the representative of developed countries,
bonds, funds market is gradually improving.
14

4.2 THE PRODUCE OF MACRO LIQUIDITY RISK 4. Financialization
and the Produce of
Macro- Liquidity
Risk
Since the 1990s, increasing the degree of financial deepening, lack of supervision
caused serious consequences in the 2008 financial crisis. In response to the financial
crisis, the Fed lender of last resort to save the city's identity, non-performing assets
acquired companies, the introduction of credit facilities, direct way to supplement the
lack of liquidity. Former financial regulatory reform, like CDO (bonds backed
securities) and CDS (credit default swaps) such complex financial derivatives and hedge
funds are not subject to regulation. And later in 2009, the United States launched a
comprehensive reorganization of financial markets, 2012 Financial Supervisory
Authority referred 692 cases involving potential financial fraud to the United States
Securities and Exchange Commission and other law enforcement agencies, including
347 with insider trading related to a strong complement to the Government supervision
of the securities industry.
15

and the Produce of
Macro- Liquidity
Risk
Stage Process Impact Characteristics
1929
-1938
1929 -1938 Establish Federal Home Loan Bank Committee
(FHLBB)
the Federal Home Loan Bank membership organization
established
to strengthen the
supervision system
And promote the
development
1933 promulgated the "Glass - Steagall Banking Act"
prohibits the payment of interest to banks, demand
deposits, prohibiting commercial banks underwriting
securities company
1940
-1979
1940 Enacted "Investment Company Act" (ICA) and the
"Investment Advisers Act" (IAA) regulate investment
securities and
investment banking
business regulation
Early
80-90s
982 Securities and Exchange Commission allows
companies to provisions in Section 415 "Securities Act" for
all securities under a one-time two years after the issuance
of the registration program
to improve the efficiency of the stock and bond registration
process, the formation of the shelf registration system, to
facilitate the issuance and investment bankers tender
deregulation
Since
the
1990s
1999, pass "Financial Services Modernization Act,"
allows the bank holding company operating a variety of
financial services, including deposits and loans, securities
brokerage, underwriting, advisory and other
Financialization and
greater financial
regulation
Table 2 U.S. Financial Policy Act process of sorting table
Source: Based on [America] Alan • Stuttgart forward, Chen Yulu, Wang Zhijie, Cai Ling translation: "Control, relax
and re-regulation", Economic Science Press, 1999 edition and U.S. recently news 16

and the Produce of
Macro- Liquidity
Risk
Table 3 China's financial institutions and interest rate liberalization bill
Stag
e Process of financialization Features
1992-
2001
1995 "Banking Law" was promulgated on the People's Bank of
duties and obligations of commercial banks, responsibility, business
rules, financial regulation financial accounting
system
requirements.
Financial regulation
is becoming
systematic, mixed.
1995 pass the "Commercial Bank Law" and other conditions for the
establishment of commercial banks and business to regulate.
1995 promulgated the "Insurance Law", 2002 amended 2009
amendments.
1995 promulgated the "law", provides a ticket, bill of rights and
obligations of people and transfer.
Since
2001
to
now
2001 the "Trust Law" on the subject of rights and obligations, such
as the termination of the Trust to change the trust industry norms.
Financial markets
while strengthening
security in the open
financial markets,
better adapted to
China's national
conditions and
systematic
development.
2003 "Securities Investment Fund Law" was promulgated on closed-end
funds and open-end funds to regulate, fund manager duties,
fund raising, supervision and management regulations; small foreign
currency deposit interest rate controls to reduce currency, interest
rate floor open.
Source: Beijing University Legal Information Network
17

5. STUDY OF LIQUIDITY MEASUREMENT
5.1 Review of Measurement
Methods
a. Balance Sheet Analysis
b. Spread volatility analysis
c. Scenario analysis and stress
testing
18

our empirical analysis of this paper, money market as an object, examine the
performance of the macro liquidity risk result that the volatility of the overnight
interest rate that results from the start, through the analysis and indicators of the
monetary authorities and other depository institutions balance sheets observations,
to explore the reasons behind volatility liquidity risk generated by the current
balance sheet structure within a reasonable forecast range for the foreseeable
future.
19

A. measure of liquidity fluctuations in the currency market
Interbank lending rate refers to the short-term inter-bank lending rate is used, the reflection of the
degree of market shortage and excess liquidity, Shibor by China 16 commercial banks offer, as
China's interbank lending market benchmark interest rate . Paper selected since October 8, 2006,
since Shibor started running to date data March 31, 2014, the establishment of ARCH models to
measure fluctuations Shibor, thus reflecting the tightness of the liquidity situation.
Figure 2 is October 8, 2006 to March 31, 2014 Overnight Shibor fluctuations, we can see the
interest rates have smooth, and therefore do Shibor time sequence diagram.
20

14
12
10
8
6
4
2
0
IR
2006 2007 2008 2009 2010 2011 2012 2013 2014
Figure 2 2006.10.8-2014.03.31Shibor overnight call rate fluctuations map
Source: People's Bank of China statistics
21

Through the overnight lending rate of the
relevant diagrams and partial correlation
chart analysis, we have established three
AR lag time series models are as follows:
we can get the LM test result is greater than
253.25, P (F (2,2724) ) = 0.0000, so we come
to the square of the residual presence of two
order autocorrelation sequence, that sequence
is present regression model error conditional
heteroskedasticity:
22

Both test results are considered models exist autoregressive
conditional heteroskedasticity should be established in AR
GARCH basis (3) mean equation on (1,1) model.
Mean equation is:
After ARCH LM Test test results are as follows in table:
23

Table 3 GARCH (1,1) model ARCH LM test results table
F-statistic 3.14833
3
Prob. F(1,2726) 0.0761
Obs*R-squared 3.147008 Prob. Chi-Square(1) 0.0761
Source: EViews 7.0 software fitting results
Description Value statistics fall null hypothesis accepted domain, there is no autoregressive
conditional heteroskedasticity in the error term, the prediction of IR, get the overnight lending rate
March 31, 2014 was (1.29-1.51,1.29 + 1.51 ).
24

B. Spread volatility analysRiEsSID
10
8
6
4
2
0
-2
-4
-6
2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: People's Bank of China overnight lending rate data processing
We can observe fluctuations in interest rates four
large range of overnight disassemble: October
2007, February 2011, July 2011 and June 2013.
We can observe Correspondingly, 2008 financial
crisis occurred in 2007 within a certain time
after fluctuations in liquidity indicators, the
paper from October 2006 to February 2014 the
monetary authorities and other depository
institutions' balance sheets analysis were
calculated monthly security assets, or assets and
liabilities of safety, or the ratio between debt.
25

Table 4 monetary authorities and other depository institutions' balance sheets multivariate analysis
Sample Mean
Standa
rd
Deviati
on
Min Max
Monetar
y
authoriti
es
illiquid assets / liabilities security 89 1.27 0.16 1.04 1.52
Security Assets / Total Liabilities 89 0.90 0.06 0.73 0.95
Safety Assets / Assets 89 11.35 4.44 2.76 18.13
Source: People's Bank of China Monthly Data Report
Other
deposito
illiquid assets / liabilities security 89 1.18 0.03 1.12 1.25
Security Assets / Total Liabilities 89 0.25 0.03 0.20 0.29
26

Table 5 monetary authorities assets and other depository institutions balance sheet variables of relevance compared
with Shibor
Monetary authorities other depository institutions
Illiquid
assets /
liabilities
safe assets /
total liabilities
security
assets /
liabilities
illiquid
assets /
liabilities
security safe
assets / total
liabilities
security assets
/ liabilities
The
correlatio
n
coefficie
nt
-0.68 0.36 0.53 0.09 -0.56 -0.56
27

Set monetary authorities than illiquid assets and liabilities of safety, other depository institutions than
illiquid assets and liabilities of safety, y = the last day of each month Shibor rates for regression of y
resulting regression equation as follows:
28

6. Policy
Recommendatio
ns of Liquidity
Figure 4 monetary policy interaction with macro-prudential policy
Monetary Policy
Macro-prudential Policy
Market Rate
Credit
Mortgage Rates
Risk of Banks’
Balance Sheets
Price Stability
Financial Stability
Source: Grant Spencer: <Coordination of monetary policy and macro-prudential policy>,
at the Credit Suisse Asian Investment Conference, HongKong, 27 March 2014. 29

7. Main
Conclusions
In this paper, starting from the functional currency, liquidity is to explore the
nature of the monetary deemed credit assets in the financial trend, investors
are more willing to higher levels of credit held by non-monetary financial
assets, resulting liquidity risk. It is liquidity risk and excessive amplification
alternating the role of credit in which reflects financial leverage played, when
credit expansion bubble burst, then there was an economic crisis. Based on
empirical analysis of China's currency market, the use of time-series model
and balance sheet analysis, results in the future China will be in for some
period of illiquidity, which made policy recommendations, by establishing a
broader currency policies to control the flow of the system and the
establishment of macro-prudential regulatory framework to strengthen
liquidity management, and promote economic stability and development.
30

THE END
LI BAOWEI
ZHANG YUN
XIE RUOQING
25/9/2014
31

Financialization and Macro-Liquidity Risk

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