Liquidity: still loose

Whilst the world's stock markets worry about a credit crunch, the Bank of England this morning released figures showing that, in one important respect, money is still loose. Their figures show that non-bank financial institutions' bank deposits have risen 22.3% in the last 12 months, and by 5.6% in the last three months, although growth in June alone was lower.
This chart shows why this matters. There's a reasonableish tendency for a high ratio of institutions' cash holdings to All-share market capitalization to lead to high returns in the following 12 months.
There are two possible reasons for this:
1. High institutional cash holdings lead to rising share prices, as some of the money is used to buy stocks. (I say some, because non-bank financial institutions include not just pension funds and insurance companies but also things like leasing companies and doorstep lenders).
2. A high ratio of money to share prices means share prices are low. And this can lead to prices rising, either because  markets over-react, or because  low prices mean high risk-aversion and therefore high expected returns; the latter is quite consistent with markets being efficient.
Of course, you can quibble endlessly here. But I'm not making a dogmatic forecast. I'm just saying that not all measures say the sky is falling in for stock markets.

Comments

[Bob B]

But does M4 lending really count as real money??

I am joking, of course. What is amusing for me is that in the regard for an array of close substitutes for money, we have now reverted back in some respects to the analysis of the Radcliffe Report on the Working of the Monetary System, Cmnd.827, published in 1959, which is about where I came in to all this. Sadly, I have been unable to find an accessible online link to the complete text:
http://www.bopcris.ac.uk/bopall/ref10020.html

However, we don't now also follow Radcliffe that “'…. there can be no reliance on this weapon [interest rate policy] as a major short-term stabiliser of demand'. It is now accepted that monetary policy lies at the heart of any attempt to stabilise the economy." - to quote from Mervyn King's Mais lecture of 2005: Monetary Policy - Practice ahead of theory:
http://www.bankofengland.co.uk/publications/speeches/2005/speech245.pdf

But note, the chosen policy instrument is interest rates, not the stock of money, however defined.