I have been betting against gloom-mongers on economies and equity markets partly because of the strength of global money supply growth – see here. G7 inflation-adjusted broad money rose by a bumper 7.6% in the year to August.

A useful summary measure of global liquidity conditions is the difference between real money and industrial output growth. A positive gap may imply there is “excess” money available to flow into markets and / or stimulate additional spending. Conversely, major financial crises have usually been signalled by money growth falling below output expansion, indicating deficient liquidity – see chart.

With money supply accelerating but industrial activity slowing, the gap has risen to a five-year high. Tighter credit conditions should constrain bank lending growth over coming months, causing monetary expansion to moderate. Any deceleration is likely to be greater in real terms, with inflation rates set to firm on the back of recent higher energy costs. Even so, the money / output growth gap should remain significantly positive until well into 2008. It is far too early to become bearish on liquidity grounds.

The key near-term risk for equities is not tighter liquidity but economic weakness and a collapse in earnings. Visibility on economic trends is still low but recent news has been generally reassuring.