How interesting to see that brokers' wisdom continues to prove a superb lagging indicator. With the Hang Seng Index 4,000 points off its bottom they are all changing their bearish tune. Their tardy acceptance of the fact that there is real underlying strength in the market still leaves many of them puzzled as to what exactly is driving the rally and so they fall back on that catch-all explanation - liquidity. This, they sagely warn in their weekly and monthly reports to clients, cannot last for long so keep your 'sell' slips at hand for the inevitable correction. On one level they are probably right. Liquidity does drive markets and Hong Kong's more than others. This is inherent in the peg to the US dollar. Even under the modified currency board system now in place, monetary discipline is primarily maintained through inflows and outflows of capital. Money supply, the best measure of liquidity, responds to it quickly and the evidence of the impact this has on the stock market is easily presented. Look at the accompanying chart at on the year-on-year rates of change in the Hong Kong dollar M1 measure of the money supply and the Hang Seng Index. The two are obviously closely linked. The paradox is that the September data on M1, the latest available, shows it declining by 16 per cent year-on-year on a six-month average basis. The M2 measure, which takes in savings and term deposits with banks, shows positive growth at 3 per cent on a six-month average basis but this is still far below the 24 per cent of a year earlier. At these levels it would appear rather difficult to claim that liquidity is driving the market. Such low growth rates should have the index teetering on the brink of 6,000. The index's higher showing is a strong indication that money supply figures for last month and this will show a vast improvement when they are published. But will this make the improvement a short-lived anomaly as so many brokers still seem to believe? Their caution will certainly prove justified if interest rates again rise above the levels of equivalent rates in the United States. However, this is increasingly unlikely to happen. The peg to the US dollar not only links money supply directly to capital flows across Hong Kong's borders but also links interest rates directly to US rates except in times when people worry that the peg will be broken. We have lived through one of those times since summer last year and have emerged on the other side with the peg intact and interest rates once again tracking US rates. This has, if anything, made the peg stronger than before. Any real attack on it would have to be greater than the one it has withstood and there is little threat of this at present. Thus, if money supply shows high growth rates, it will only mark a recovery back to levels consistent with the economy's normal requirements. Yes, liquidity may be driving this rally - and a good thing too.