We have been mulling about why Soros (as we reported) expects the credit crisis to have real bad effects on the economy, and in his view, house prices have much further to fall, yet he thinks the worst is over for the stock markets. He didn’t give an explanation for that seeming anomaly, but there must be some ‘wall of money’ involved…

As people who experienced the financial markets in the 1980s, we remember that reassuring expression that popped up with almost predictable regularity, “a Japanese wall of money” would soon visit this or that asset class.

And, for numerous years, it did. The hay-days of those iconoclastic Japanese walls of money were the second half of the 1980s, when Japanese money bought up everything in sight, and 8 of the worlds top 10 banks were Japanese.

The Japanese wall of money actually continued until recently, which might surprise a few, since Japanese economic might certainly doesn’t look as impressive (or even intimidating, according to some) as it did back then. Those were the days when you could buy books called “Japan as No.1.” in airport bookshops.

That Japanese wall of money morphed into the ‘carry-trade‘, super low Japanese interest rates to deal with the aftermath of the popping of multiple bubbles (shares, real-estate, land) in Japan at the end of the 1980s fueled borrowing in Yen and moving the proceeds into higher yielding currencies and assets.

Now, with interest spreads between the US and Japan dwindling, that carry-trade has dwindled with as well. But there actually is a new wall of money. It’s created in the US (mainly).

The Fed has created something like $900B in new liquidity to keep the financial system from melt-down. Since banks have not been terribly eager to loan out to even the most creditworthy customers, that money has to go somewhere.

It also fits nicely with another article we published about the American bubble cycle replacing the business cycle. A pending bubble in stocks? Well, we had a feeling when we wrote a couple of articles here titled “Looking for cheap stocks in an expensive market”..

In the meantime, the Fed is pondering whether to move to a more active policy to prevent bubbles from forming, according to an article in the Financial Times. But, we fear it’s dealing with the aftermath of imploding bubbles that provides most of the fuel for the next one..

As regular readers will recognize, we have been rather sanguine about the markets, liquidity is indeed the best explanation of the divergence between a bad economy and stock prices being less than 10% away from their highs, unless you believe the economy is on the mend.

Here is a quote from another good article arguing the recent market rally might be overdone.

The fundamentals of the economy – particularly the inflation problem, the pressures on consumer spending, and the de-leveraging process at work following a decade-long credit bubble – are troubling and do not appear to be adequately reflected in stock prices or market psychology.

We couldn’t agree more.