The need for liquidity is a mantra among those who organise and regulate the financial system. To say that a proposal will damage liquidity more or less stops further discussion.
But what is liquidity? When I reviewed UK equity markets for the government last year, most participants told me liquidity was best judged by the spread – the difference between what it would cost to buy and sell the same share simultaneously. But since this is not a transaction anyone is likely to make, this indicator made little sense. Others regarded the volume of trading as a measure of liquidity; but this led to the circular argument that trading was good because it encouraged trading, a perspective relevant for those who own exchanges but not for anyone else.
The quest for liquidity rests on an illusion. Banks tell their customers they can have their deposits back immediately, even though they could not if all did so at once. It is often suggested that this confidence trick makes banking unique – banks have a mysterious capacity to “create money”. But the same device is used in many other markets to create an appearance of availability that exceeds the underlying reality.