The old water-bucket-over-the-door prank. Classic liquidity trap. [cue: Three Stooges clip]
In any investment, the choice basically comes down to holding onto a pile of cash, or handing that cash to someone else for the promise of a bigger pile later. An investor has to get something in return for letting the money out of their grasp. That something is known as a return.
However, if the economic situation gets bad enough, the return on an investment can be so small that investors just say “screw this” and squirrel their cash under their mattresses.
That situation describes a liquidity trap. Basically, interest rates are so low that investors have no incentive to let go of their money. The concept, laid out by legendary economist John Maynard Keynes, states that "liquidity preference" gets to the point that almost everybody would rather keep their money than invest it.
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Finance: What is liquidity preference?27 Views
finance a la shmoop. what is liquidity preference?
yeah well liquidity is a good thing you want it. being liquid means that you have
cash which gives you options to you know buy stuff. and yeah even the Amazon River [money leaves a wallet in the grocery store]
shops at Amazon. all right so if your flavor of
investment has a liquidity preference over someone else's then your investment
all else being equal is preferable. see the liquidity preference . specifically if
you have liquidity preference and usually this is found in the form of
early stage of venture capital investor term sheets for investing in companies
in the form of convertible preferred stock- like it converts into common at
the IPO or something like that- then you get paid before everyone else
gets paid -at least in this form of stock- if the company gets sold.
all right well technically that is, but the company is sold and your convertible
preferred hasn't converted into common shares yet this company didn't go public. [convertible stock made into common stock]
but so like let's think about the example where if the company raised
twelve million bucks in preferred stock, which all had a liquidity preference
over and above common ,and then the whole company was sold for just fifteen
million dollars. well then those with liquidity preference would get liquid
first .ie they get their twelve million bucks. then the remaining three million
would be sprinkled around everyone else who was do the dough. plus any dividends
or accrued assets that have come our way otherwise. and yes technically debt
holders get paid ahead of the various series preferred investors who then get [list of who gets paid first]
paid ahead of the common shareholder but that's a different video. all right so
when it comes down to it you want to have liquidity preference. clearly I
prefer to be liquid myself. [man floats in lake in an inner tube]
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A liquid market is a market featuring high trading volumes, i.e. investors actually want to put their cash to work.