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Pumping Money: Financial Market Liquidity Explained

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Pumping Money: Financial Market Liquidity Explained


Pumping Money: Financial Market Liquidity Explained

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  • <iframe src="" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
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On Saturdays we like to help you make sense of events that whizzed past during the busy week.

This week's frantic news from Wall Street sent Central Banks around the world pumping money into the financial system. We were wondering what exactly does this mean.

So, we turn to NPR's Adam Davidson. Adam.

ADAM DAVIDSON: Well, Debbie, it's all about liquidity. Liquidity is basically a way of saying ready cash. Let's say you own a big, beautiful, million-dollar house, but the pizza delivery guy just came with some pizza and you don't have any cash. He doesn't care how valuable your house is, he wants you to give him some money right now. That's liquidity - that ready cash.

And banks, basically, work the same way. Every single day, every afternoon, every bank in the world adds up all the money it owes other people, adds up all the money it has and figures out, do I need money to meet my obligations to pay off the people who I owe, or do I have extra money? And the banks that have extra money lend it to the banks that need money.

This happens every day. These are very short-term loans, just overnight loans, and it's that constant process of lending extra cash that provides the liquidity, the ready cash that funds the entire global economy.

Now, this normally works very fluidly, very easily, but what happened this last week is what's called a liquidity crisis. Basically, a few key banks around the world announced to everyone's surprise that they had a lot of these subprime mortgages. That their assets were worth much less than anyone thought they were. That got banks worried. What if there are other banks that aren't telling us how much their assets have shrunk because panic among banks - they stop lending as much money to each other. And suddenly, other banks that needed the money didn't have the ready cash, that liquid cash, to pay off the people who needed it.

ELLIOTT: So at this point, the Central Bank steps in?

DAVIDSON: Exactly. The Federal Reserve, the European Central Bank, the Japanese Central Bank, the Canadian Central Bank, they all told their banks, hey, don't worry, we will lend you whatever money you need. Now, this is new cash because it's the federal government giving the money. They don't actually print $100 bills. It's all done electronically. But basically, when they lend $30 billion or $70 billion, that's new money entering the system, returning that liquidity, returning that ready cash into the systems. The banks get it. They can give it to people and companies and it allows the market to function again.

ELLIOTT: Can the Central Banks keep doing this forever?

DAVIDSON: Well, they do, do it all the time. What happened this week is they did it more than they usually do. But eventually, the fear is that they would pump so much money into the economy that it would cause inflation.

The Federal Reserve will be very nervous that that might happen. So they'll make sure to stop long before inflation sets in.

ELLIOTT: Well, thanks for the explainer, Adam.

DAVIDSON: Thank you, Debbie.

ELLIOTT: NPR's Adam Davidson.

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