Friday, March 17, 2006

Liquidity - Is It Really Your Money

The most commonly recognized sign of massive illiquidity is a run on the banks.

may not happen again in most western countries - anytime soon. It will happen again however.

Each market has their own liquidity issues - peculiar to that market.

One aspect of wealth retention is diversifying your speculations into markets with low correlation to each other.

This starts on the simplest level - don't count on a company you work for to provide your retirement - and also own that companies stock. The correlation of the value of those two positions with each other and the companies long term future is way too close.

Fortune 500 and Dow 30 companies can and have imploded and disappeared.

The currency of the USA has visited worthless a couple of times before. Both the continental dollar and the civil war greenback dollar were sold at huge discounts - or refused acceptance entirely.

We know that today's dollar is being discounted for inflation - with the Federal Reserve printing huge amounts of them for decades - they are not a safe bet to store value.

If everything you own is in USA dollars - you may continue to lose money to the printing presses of the Fed. You are likely over correlated in US dollar exposures.

If you are in another nation - they are certainly going along and following the Fed's lead - you are probably over correlated in currencies for your entire portfolio. A side bet on resources may reduce that correlation.

Banks fail - nations fail - companies fail or have courts reverse their commitments - nothing in our world beyond personal relationships has eternal value. God is only taking one thing off this planet - that is people. All temporal assets are therefore fully correlated at this extreme.

What you can do now if you have wealth to protect - is seek to diversify.

Also important in the long run is not to use leverage in markets where there may be a liquidity surprise. I'll write more on that latter.

For now - just think of how your overall net worth would be impacted if all world markets shut down for the next month. Perhaps only your country's markets and currency no longer trade - will you be left with anything?

A speculation rule:

Wealth is made through concentration - wealth is preserved through diversification.

If there are no markets - is your money really your money?



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