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Why is liquidity so important to business markets around the world?

The last 12 months has seen major changes in financial markets around the world but there is one element which keeps hitting the headlines which is liquidity. So what exactly does this entail and how is it so vital to the worldwide economy?

In simple terms liquidity is the money which is made available on the money market for companies to cover short term obligations and running costs for their business, whether it is associated with the financing of debts or the funding of mortgage agreements or any other matter associated with business. In short it is the life blood of any industry, any economy and any individual business.

The reason why money market finance is so important is because as well as giving companies the means by which to borrow money on a short term basis it also gives cash rich companies the opportunity to lend money to third parties and receive interest at an agreed rate - i.e. it allows them to make their money work for the business.

You can have the largest asset base in the world, the best run business but if you need short term finance and are not able to lend against or liquidate any of your assets then you are in trouble. We saw this scenario with AIG in the US whereby the group had literally billions of dollars of assets but required short term funding to cover liabilities. As the money markets stalled and finance was not available the company could not borrow against its asset base and hit short term difficulties - resulting in the US government bailout.

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