Could a lack of liquidity soon cause Asia’s stock markets to crash? That question might seem fanciful at first glance. Central banks in Frankfurt, London, Tokyo and Washington, by keeping policy rates near or below zero, have been responsible for the arrival of unprecedented waves of cash on Asian financial markets. It’s no accident that Shanghai stocks are up 137 percent over the last 12 months even as the Chinese economy has slowed; that the Nikkei stock exchange is up 41 percent surge even as deflation returns to Japan; and that South Korea’s Kospi index is near record highs even as that country’s exports are slumping.
But, as economist Nouriel Roubini recently pointed out, macro liquidity, of the sort created by central banks, can easily be accompanied by illiquidity on financial markets. And when that’s the case, he writes, it creates a “time bomb” by intensifying traders’ tendency toward adopting a herd mentality.
Consider last week’s sudden 6.50 percent drop on the Shanghai stock market. Those panicky hours resembled other “flash crash” moments of recent years: a 10 percent plunge in U.S. stocks in less than one hour in May 2010; the Fed “taper tantrum” in spring 2013; the Oct. 14 jump in U.S. yields; and last month’s mini meltdown in 10-year German bonds. The common thread between each episode was a sudden wave of fear among traders that, even with unprecedented liquidity injections from central banks, markets might still be too illiquid.
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