"The central banks of the world have largely lost the ability to control the money supply, other than by the narrowest of measures, which are increasingly less meaningful." -John Mauldin, Apr 28 newsletter.

It took me a while to start thinking this was the case. The Fed somewhat mysteriously retired the M3 money supply metric (often considered the broadest measure) late in 2005. I took this to mean that they had given up pretending they were exercising fiscal discipline and had moved on to covering up their mismanagement. While that might be the case, I'm now wondering if they were trying just as hard to hide how little control they now have over US liquidity.

The Economist helps explain it in their recent articles on derivatives. Investment banks and public markets now offer many ways to make highly leveraged bets on many financial instruments. This has the effect of requiring investors to use less money to get the same result (good or bad). Put another way, this means investors can make a many times larger bet with the same money. Which means that, without the Fed doing anything, liquidity has increased. In the same way, now that investors can buy securities that assume the risk of mortgage loans, the banks that made the loans can free up cash for other purposes.

Mortgage-backed securities (MBS) and the like increase liquidity, but the Fed gets the blame for lowering interest rates to the point where it becomes attractive for hedge funds to borrow money to buy many of these securities.

For me, all this still points to the increasing stock market indexes showing us only that the game of "last liar" continues for now.