| The Function of Liquidity |
| Liquidity
, in this reference, is the amount of money available to an economic or market system. In reference to the economy, this amount is typically referred to as the Money Supply (M2). It measures the total amount of currency, checking account deposits, savings deposits, and Certificates of Deposit (CD's) that are less than $100,000. The Federal Reserve Bank manages the supply of money for our economy. Visit our Federal Reserve Section for more information on America's Central Bank. Like any other product or commodity, there is a supply and demand relationship for money. As in any supply/demand equation, the supply is determined by "sellers" and the demand is determined by "buyers." In this case it is "sellers" and "buyers" of money. How does one buy money? Answer: by taking out a loan (or even by exchanging a foreign currency for the U.S. dollar). The prevailing interest rate of a bond, a mortgage, a loan, etc. is the "cost" of obtaining money. The supply of money interacts with current demand to determine a "price." If there is a greater demand to borrow money, the interest rate (price of money) is rising. Hence, you pay more for the money. If the demand lessens, you pay less; that is, lower interest rates prevail. If the supply of money increases, the price (interest rate) decreases. If the supply decreases, the price increases. |
 |
|
| Note: If this discussion of supply and demand characteristics of money feels foreign to you, please consider the numerous price fluctuations that we encounter everyday. Popular commodities fluctuate in price for the same reasons. Gasoline prices increase during summer months as a result of more people driving; that is, more demand for gasoline. If there also is a shortage from the refineries (decreased supply), the price will go even higher. Stock price fluctuations follow the same principles. When a stock is in demand, the price will continue to rise until that current demand is exhausted. Understanding these principles will, undoubtedly, improve your return in stock market trading or investing. |
|
|
| The supply of money is a major factor in determining prices of shares in the stock market. When the money supply is increasing, shares usually follow with higher prices. Conversely, if the money supply is decreasing, share prices typically decline. For addition information on the relationship between share prices and the supply of money (i.e., interest rates), visit The Stock Market and The Federal Reserve System. |
 |
| History Dynamics Analytics Home |
|
Copyright © 2001 BoomOnWallSt.com All Rights Reserved |