The first thing I think needs to be said about The Global Economic System is that the title by itself isn’t a very good one. The book isn’t really about the global economic system. Now the subtitle, which is “How Liquidity Shocks Affect Financial Institutions and Lead to Economic Crises” does an excellent job of getting to the crux of what the book’s about. It very much focuses on how negative shifts in liquidity can produce cascading effects through the financial system and beyond into the economy.
From the perspective of traders and investors, I think the first part of the book in particular is extremely valuable. That’s where the author’s discuss the dynamics of the bid/ask spread – where it comes from on the base level and what causes it to expand and contract and move. The bid/ask idea is one that trips up a lot of folks in the exchange-traded markets, because they tend to see traded prices as the primary piece of information (this is something I wrote about in Misunderstanding the Bid/Ask Spread in Stock Trading, which is among the most commonly read posts on this site). The language the author’s use may be a bit challenging at times (two of the authors are university professors), but visuals are included to make the point about what can happen when liquidity in the market shifts.
The other really interesting thing (at least I thought so) from the early part of the book is a look at the liquidity risk premium. The authors model a portfolio that is basically long liquidity risk (meaning long low liquidity bonds and short high liquidity ones) and demonstrate the returns that can accrue, as well as the impact of market liquidity shocks.
The bid/ask and liquidity risk discussions sets up the rest of the book in terms of laying the market dynamics foundation for the bigger picture ideas it focuses on from that point forward. What the authors do from there is to put forward what they view to be the stages of a liquidity shock, from trigger all the way through to eventual transmission from Wall Street to Main Street.
Three examples of this liquidity shock progression are included. The first is the Great Depression. Second is the Japanese “Lost Decade”. Naturally, the so-called “Great Recession” we’ve just gone through is the third. The authors walk through the triggers and stages of these periods in a very detailed fashion with loads of market and economic data (lots of charts and graphs) to highlight there points. It’s well done.
In general terms, The Global Economic System is a book more likely to be of use to fundamentally oriented traders and investors since it tends to focus on bigger macro level events and effects. I do think, however, the early discussion on the big/ask spread and market liquidity is of use to all kinds of market participants. For those who really want to get into the liquidity risk research, an article by one of the authors which clearly was foundational to the book can be found here.
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