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First, you have to really understand what liquidity is. Liquidity isn't cash, or value per say, but rather a measure of how easy something is to trade. Cash just happens to be the most liquid thing because it is the most actively traded thing. For example, it's not like everyone trades for cars directly using chickens, but both chickens and cars are directly traded for cash, so cash is more liquid (ie easy to trade with) than either cars or chickens. Next, excess liquidity can disappear by market participants simply refusing to do trade (ie a drop in demand). For example, if I have a house, which many people would be willing to trade for me today, tomorrow they could all change their minds and wouldn't even trade me a spoonful of dirt for it. In which case, the liquidity of my house (easiness to trade it), dried up by simply a change in market demand. Now here's the best part, while every transaction has a buyer and seller, every transaction has two supplies and two demands. For example, person A may be willing to trade his supply of cars, but demands X dollars in exchange for any one of them, and person B is willing to trade his supply of dollars, but demands a car of certain condition for them. In this case, there are two supplies (dollars, and cars) and two demands (again dollars, and a car of a certain condition). If the supplies of each participant, meets the demands of the opposing participant, the transaction happens, and the trade is settled between the two parties. So to address your questions. It's entirely possible for something that was easy to trade (cash), was traded for [houses/stocks/commodities/etc], and afterwards, no one is willing to trade things anymore. Which includes people with houses who are not willing to trade them for cash, and people with cash no longer willing to trade them for houses. Liquidity disappeared simply by a change in market demand. But you're not necessarily wrong, as if demand doesn't change, then it doesn't really dry up. |