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Alan Cring Productions in association with Emergent Light Studio presents

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the Illinois State Collegiate Compendium, Academic Lecture in Business and Economics.

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This is Business Finance, FIL 240 for autumn semester 2023.

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Special Topics

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Today, special topics, second part, and then after that you will have a surprise quiz.

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And then that will be it for today. And then on Monday, again, it is a Zoom class.

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And it will be the first day of review for the final exam.

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The first round is mainly me telling you what the structure of the exam is

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and going through some of the more of the definitional conceptual topics that I will be asking or I may be asking about.

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And I did, you have that sheet of definitions that's available in Canvas for you.

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I strongly encourage you to have a real thorough walk through that.

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And by all means, if there are one or two or a few that you don't have a good handle on what the definition is,

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by all means, that would be a great topic for the question and answer periods of the reviews next week.

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But again, on Monday, the class will be by Zoom and then on Wednesday we'll be back together.

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We'll review, you'll do your course evaluations, and that will be how we get to the finals week.

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And then it will be all over for you.

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I'll look at the numbers just to start this happy day going forward.

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Now, the interesting thing is that we have clear indication now that we have gotten a really good handle on the inflation.

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And so there is very little reason for the Fed to increase the discount rate or put pressure on other interest rates any further than they have.

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Now, that should get the markets all kinds of happy, big day up.

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Well, it's not a big day. It is actually a quiet day.

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That's because we already knew that this was going to happen.

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The markets had the expectation that the inflation numbers would come in attractive, at least good.

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And so there was already that news had been impounded.

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So the story today was of new expectations that are forming, and there isn't anything much to talk about.

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As you can see, the Dow was up a lousy 19 hundredths of a percent, and the S&P 500 was up an even lousier 7 percent.

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And the NASDAQ pulled up the rear end at.01 percent.

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So it was sort of the reverse. Usually, the Dow is the least active, the S&P 500 is more, and the NASDAQ is the most.

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But here you see just the reverse of it, just because there is very little excitement in the markets.

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Not really much of a direction.

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Yeah, we knew that inflation was getting under control, so we knew that the Fed was not going to raise interest rates anymore.

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And we know that the economic activity is looking good going into the Christmas season.

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And so there's very little news that is new that could propel the market one way or the other.

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And one little note, and I said this on Monday, and there's more confirmation, the Black Friday sales were record sales.

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So there is some clear, obvious, positive news that, yes, we are coming from a recovery into a possible expansion starting next semester.

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Well, next semester, next year. So that's good news for you.

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And as far as how crude actually has risen, it's still in that trading band, the one from 72 to 79 right now.

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It's a little bit up. It's mostly just on general, a little bit of concern about supply conditions and the possibilities of the supply disruptions.

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There's not much in that, but a few concerns are still swirling around.

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I think the oil traders kind of jump every time a little bit happens over in the Middle East or in Eastern Asia.

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But I mean, Russia yesterday, I believe it was yesterday or the day before yesterday,

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their foreign minister threatened to blockade the entirety of the European Union,

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put a naval blockade on the entirety of the European Union, which of course is laughable. That's not going to happen.

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But anyway, going over here quickly, having a look at some other things.

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Gold is showing peculiar activity.

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And I was trying to find out from some of the people that are connected to the gold markets, what's up?

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And they seem to be, I don't worry about it, but I mean, it's gotten well above that resistance level of $2,000 an ounce.

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And when it does that, that means that the gold freaks are thinking that the end of the world is coming.

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And so I don't know what's going on with them. Do they know something that everyone else doesn't?

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But there you go. I mean, I just kind of keep a little bit of an eye on it.

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Anyway, bonds. There you go. The bond yields are sliding.

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That means interest rates overall will be coming down as they have been showing. Mortgage rates are down and other rates are starting to slip.

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Car loan. I've seen a couple of car loan ads that are offering rates that are still ridiculous, but they're lower than they were even a month ago.

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To give you an example, one of the big car dealerships in the United States was offering almost a month ago 11.99% APR financing, which is stupidly high, insanely high.

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Well, last week, good news. We brought our interest rate for financing on 60-month car loans down to a low, low 10.49%.

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Well, that still sucks, but they're coming down.

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But like I had said earlier in the semester, the era of really low interest rates that you guys saw in the earlier part of your lives, that's probably history now.

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We're probably not going to see rates that low for a long, long time, but they will come down from where they are now, if that's any good news.

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But anyway, bond yields are down, which means bond prices are up, which means investors are buying bonds.

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Nothing spectacular about that. It's great news, though.

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And interestingly, this is kind of an odd thing because they're actually pretty flat.

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But with interest rates in the United States going down, you would expect the euro and the British pound to be appreciating, but they're not.

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They're just kind of sitting there looking stupid right now.

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See what Japan was doing. Yep, Japan's about the same way. There's not a lot of activity.

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Like I said, if U.S. interest rates are going down, that means the dollar should be weakening against other currencies.

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So those currencies should be appreciating, unless their interest rates are weakening too, in which case it's just sort of like a wash.

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So that might be part of what's going on there.

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All in all, I keep doing this with you, and it sounds like I'm just kind of babbling,

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but I'm just getting you into that thinking, those chains of logic and reasoning and knowledge of how the markets of the world and the economies work.

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And this helps you begin to formulate informed judgments instead of baseless opinions.

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That's what we want out of leaders, and that's what we are creating here as leaders for the future.

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Looking over here, well, the D.K. just sort of rolled up and then rolled back over into bed, ended down just a little bit,

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so nothing exciting in Tokyo, go over to London, and they rolled up a little bit, but then they rolled down more and then went to bed too.

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Wasn't much activity over there. Notice that that's about what happened over here.

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So this kind of like a little bit of a malaise is sort of a global thing right now.

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We're all kind of sitting around waiting for some great new news or some great new bad news, something like that.

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It's not happening right now. So in a way, that's not the worst thing in the world.

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We're on a path of growth. We have overcome the difficulty, at least for the time being, of inflation.

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We've got a decent jobs market out there. Industrial production is decent, and we're showing consumer confidence, which is huge.

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When consumers are spending money, that means that they're confident about the future.

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They're not holding their money back for some apocalypse.

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So when Black Friday is a record sales event, that shows that the consumers are willing to open their wallets and buy stuff.

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And if you're looking, I do have a wish list on Amazon. Anyway, you know, okay.

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Now just a quick look at what I'm not I won't beat you up with it much, but I thought I'd look at one that I had looked at myself earlier today.

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It didn't have a good day, but I want to show you about this one. Well, let's try that again.

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My keyboard is dead. And why is it dead? Because I kicked the keyboard USB port out.

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I mean, seriously, why do I do that?

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Oh, God. Oh, I'm going to electrocute myself doing this. Great.

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Good God. Yeah, I think they hired me because they had this policy, hire the idiot. He's fun to watch.

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Don't just sit there. Someone help me.

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Nobody going to help you.

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Okay. No.

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Here.

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Plug that in. See?

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I know, right?

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Oh, I see.

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Oh.

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What's in there?

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There's a disk in there.

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Yeah.

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It got a battery caught in it.

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That's what I thought.

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Oh, God.

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Don't.

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Okay.

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Nothing metal.

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Yeah, it's metal and I'm playing with electricity.

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Okay.

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Boopie Boopie.

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This is killing my lecture today.

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You're scaring me. You're going to get electrocuted right now.

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I'm not as good as I am.

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Screw this.

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Stupid thing.

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Yeah, thank you, thank you, yeah.

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Where the hell? Okay.

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Let me try something.

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I need this only for a little longer.

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Okay.

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Never mind that. I'll just go on to the lecture for today.

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Oh, I get it.

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There was another little thing that that thing got stuck in.

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Oh, hell.

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Maybe if I put on these glasses. They're not mine, but God, I look stupid.

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Okay.

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Anyway, let me finish up a topic.

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I left one part for today from the discussion of the Federal Reserve.

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Let me cover that with you here very quickly.

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Okay. Now remember that the Federal Reserve regulates and supervises the banks.

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And then that's one of its duties. These are the duties of the Fed.

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And these are of the Fed.

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And then it also serves as a bank for banks.

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And I went through those two in detail on Monday.

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Now three is an interesting one.

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It's the one where the Fed conducts monetary policy.

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And I went through two of the ways.

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One way is through the required reserve ratio or the fractional.

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It can up or increase or decrease the amount of money the banks have to keep on reserve, reserve ratio.

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Okay. The second one I went through was the use of the discount rate.

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The rate at which the Fed will lend money to banks.

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Now again, the discount rate is set by the Fed.

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That's their signal of what they think the economy needs.

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Like right now, the Fed, we now see that the inflation numbers are cooling off very well.

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So we are now in a position to predict that the Fed at its next meeting will not further increase the discount rate.

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It's got it under control.

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And if my numbers are correct, just as a reference point, right now the discount rate is at 5.50%.

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But also, if banks don't want to borrow from the Fed at the discount rate, they can go to the federal funds market,

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which is where banks keep their money.

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And so banks will charge an interest rate to other banks to borrow some money.

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And so the federal funds rate, whereas the discount rate is set by the Fed,

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the federal funds rate is determined by market forces, supply and demand of money.

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If there's a lot of money in the federal funds pool, then the federal funds rate will be low.

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If there isn't a lot of money in the federal funds pool, then the federal funds rate would be higher, supply low, federal funds rate higher.

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The Fed cannot set the federal funds rate, that's the supply and demand.

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They can set a target for the federal funds rate.

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They'll say, well, we would like it to be.

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And if I read the numbers correctly, just last night, they are setting a target for the federal funds rate of between 5.25% and 5.75%, if I read the numbers correctly.

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Now they can't say, you will be this number, but they can set a range that they would like to see it.

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And they can actually move it toward what their target is.

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They can't just say, the federal funds rate will be, but they have tools that they can make it move toward where they want it to be.

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And that's where we get into the third of the three tools of monetary policy.

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The third tool of monetary policy is what are called open market operations, OMOs.

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This is how the Fed actually pushes money into the economy or sucks money out.

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These OMOs, they happen every day and we're talking about hundreds of billions of dollars every day.

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This is happening.

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This is again one of those things that is happening all around the world, all around the United States, all around everyone, every business, every family, every household.

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And yet almost no one knows that this is happening.

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That's where I talk about how you future leaders will know this.

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You will know what the average person doesn't know, doesn't want to know, and might not even have the intellectual capacity to understand.

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And that's why you are separate now.

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You are the ones who have to take care of these things and make sure that we know what they are, how they work, and where they're going at any given time,

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and to some extent, what's going on.

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Sometimes they get out of hand.

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They go, these forces move in ways that are not desirable.

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And I'm going to show you that here in a little while.

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But first, let me explain.

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I'm not going to go through the details I would in a macroeconomics class or in an upper level finance class.

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But it's pretty easy on a basic level to do this, to explain it.

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Remember that the open market operations, their purpose is to drain liquidity, pull money out of the economy, or, on the other hand,

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to increase liquidity, money in the economy.

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So if I thought the economy wasn't doing very well, I would see the Fed probably trying to push money into the economy,

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add liquidity, as we say.

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If I thought that the economy was running too hot, inflation was starting to pick up steam, then I would do the opposite.

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I would drain liquidity.

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I would pull money out of the economy.

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Now, the place where the money is showing up in the economy, where it actually shows up, is, well, for the most part,

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is in that giant pool that I mentioned before, the federal funds market.

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This is where all the banks have their money.

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In a way, it's a very real thing, but in a way, it's one of the things that, well, show me where the federal funds market is.

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I couldn't exactly do that.

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It's the composition of all of the banks and all of their money that they have.

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And so in a way, yeah, it's there, but it is like a diffuse thing, which makes it a little trickier to handle it,

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because it's sort of like air.

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It's everywhere.

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We know it's there, but come here.

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Come here, air.

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Let me take some of you out of the room.

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It's kind of like that.

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Now, the Fed is going to push money into the economy and drain money out of the economy using the federal funds market.

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In other words, all these banks, bank, bank, bank, bank, bank, all over the world, all over the country.

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Okay.

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Now, here's how a federal fund, here's how the Fed would conduct an open market operation.

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Now, here is the Federal Reserve over here.

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Now, there's a special place at the Federal Reserve.

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It's called the Domestic Trading Desk.

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It is at the Federal Reserve Bank in New York.

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And when I say desk, I'm referring to floor after floor of traders at the DTT, at the DTD.

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Okay.

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Now, these traders are going to sit there.

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Let's say you are a trader on the Domestic Trading Desk.

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Okay.

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You're just sitting there, wish I had something to do today.

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Okay.

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Now, the Federal Reserve has a special committee, the Federal Open Market Committee, the FOMC.

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Now, in that video that I gave you the link to, they show this, they talk about this.

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And they probably do it with the cartoon characters.

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They probably do it better than I do.

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But there you are.

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Now, this Federal Open Market Committee comprises the seven governors and five of the district bank presidents.

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They meet officially eight times a year.

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Now, the seven governors are permanent.

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They're always there.

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Four of these serve two-year rotating terms.

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So, in other words, you might be the bank president of the district bank of Atlanta.

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And she is the district bank president of Cleveland.

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So you finish your two-year term.

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And so you leave the FOMC and she takes your seat.

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But there is one of those district bank presidents that is permanent.

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District bank president.

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That is the president of the New York bank.

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Why is he permanent?

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Because it is his bank that has the desk.

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We call the New York district bank the Empire Bank.

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Partly because the Empire State Building and all that.

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Also because it's the center when the Federal Open Market Committee makes a decision to add liquidity, drain liquidity, something like that.

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This president, this bank president, is the one who communicates to the desk.

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Okay, we just voted.

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We're going to decrease the money supply.

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And that comes to the desk.

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And then the manager of the desk tells the traders, drain money out of the economy today, please.

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Okay, now, here you are one of the traders of the many hundreds.

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You will have in your desk, hypothetically, dollars and you will have T-bills.

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They're equally safe, equally liquid, except that T-bills can't be lent.

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They can't be lent to anyone.

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Money can be.

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So here's a bank right here.

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Now the bank has money and it has T-bills.

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Your job, you're a trader.

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I'm the bank.

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Your job is to take my money away from me.

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So what you're going to do is you're going to call me, you the trader, ring, ring, yellow, Al's Bank,

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and Car Wash, and Seventh-day Adventist Baptist Reading Room, side hustle.

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You know, got to make money somewhere.

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Okay, concentrate.

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You want my money.

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You have T-bills.

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You're going to say, Mr. Bank President, I should like to get some of your money and sell you T-bills.

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Okay.

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So what will happen is that I will give you money and you will give me a T-bill.

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With the money, I could have lent that out and put the money in the federal funds market,

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but with a T-bill, I just sit there, what the heck am I going to do with this?

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You see how that's draining liquidity?

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Every time you call a bank and sell them T-bills and they send you money,

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you take that money and you grind it up.

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It's gone.

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You just drained liquidity out of the economy.

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Now, all those traders trading billions of dollars of T-bills for money are acting every day

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on the orders of the Federal Open Market Committee.

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That's how we drain liquidity.

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That's how it's done.

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Every day, if your desk manager says today, drain money,

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you're going to just start calling banks and say, I want to sell you T-bills for your money.

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And the banks give you the money, they get the T-bills, and then the banks say,

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well, we don't have money to lend because it's not in the federal funds market anymore.

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You see how that's going to also, the federal funds market, as you drain liquidity,

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the supply of lendable funds in the federal funds market falls,

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and that makes the federal funds rate go up.

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That's how they move towards the target.

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Now, let's take it the other way.

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Let's take it the other way.

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It's a few months later and the economy is beginning to look a little bit shabby and shaggy and all that.

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So there you are, sitting there waiting for your orders from the desk manager

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who is at the Empire Bank and they got their orders from the Empire Bank president

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who just came out of the meeting of the FLOMC, and the desk manager says, add liquidity to the economy.

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Get dollars into the bank so that they can lend them.

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So in this case, what you're going to do, the bank has dollars in T-bills,

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it's tier one capital, it's safest capital, we always keep that stuff,

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and then you're going to call me, ring, ring, hello, Al's Bank and All You Can Eat Sammits Bar.

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Wait a minute, weren't you something else last night?

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Well, we went into another business.

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Okay, you're going to say, I should like to buy some of your T-bills, Mr. Bank president.

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Wait a minute, last once you wanted to sell me T-bills, now you want to buy them?

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Yes. Okay, sure.

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So in this case, you're going to pay me cash money and I'm going to send you a T-bill.

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Push liquidity into the economy. Grow the money supply.

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That's what was happening from about 2018 to the end of the pandemic.

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Every day, the traders on the desk were buying T-bills from banks.

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They were buying T-bills from banks, which was, and then sending the banks money for what they bought.

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And the liquidity just built up in the economy to keep the economy alive.

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That was how it was done, for the most part.

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It was a day-to-day, week-to-week, month-to-month process.

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And it just, it happens. It's like automatic.

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I teach, one of the courses I teach is cash management, corporate cash management.

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And looking behind the scenes at how that money was getting to the banks, getting to the corporations,

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it was just like, it's complex, but it's just like a machine. It just happens.

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And I found out that the traders actually, they just push buttons.

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They don't even call or talk to anyone anymore. It just happens that they can do this.

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But of course, what the consequence was, the economy built up such a liquidity overhang

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that there was so much money in the federal funds market that it eventually started creating inflation.

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The growth rate of the economy was not as much as the growth rate of the money supply.

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And that's why they had to turn it around and get it going, start draining, clawing back that liquidity.

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And that's why interest rates went up the way they did.

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The supply of money in the federal funds market, therefore the interest rates was going down.

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Therefore, interest rates, I'm sorry, money supply was going down, interest rates were going up.

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And as the federal funds rate went up, as the discount rate went up, all other rates rose on top of them.

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That was how it happened. That's how we got to where we were.

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And now, the Fed has been clawing back that money to the point where it looks like we are now back on track.

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The supply of money is growing at approximately the real growth rate of the economy.

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And that is a good thing. That is a very good thing.

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You see, the Fed is in the business of maintaining, one of its big things that it's supposed to do

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is maintain the stability of the aggregate price level.

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In other words, no deflation, no inflation. Keep the money supply growing at the appropriate rate.

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And so this is how it's done.

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It's the FOMC, it meets officially eight times a year, but I should mention that it can have emergency meetings.

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But it looks like right now we're at the point where we have got it back stable.

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It's like if you're driving a car and you start swerving, it might take you a while to get it back on the right side of the road.

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And that's essentially what was happening there for a while.

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We were just having to force the money supply down. Now we're good.

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I want to show you something.

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We hear all kinds of stories about, well, what happened in 2008?

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You hear all kinds of different theories.

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Well, it was because of the housing market bubble, or it was because of the low quality home mortgages

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that were being given to those damn poor people so they could live in places that they own.

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It was this, that, and the other thing.

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It was the aliens from another planet, or the Freemasons, or whatever.

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Let me show you the numbers.

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These were happening back at the time when I was an active, one of the early active bloggers on financial matters.

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And I had been flagging that there was, in early 2008, that there was a serious chance of a major economic catastrophe coming.

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And let me show you what I was doing.

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Now, to put the background on this, monetary aggregates.

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These are measures. I keep talking about the money supply.

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Well, we break it down.

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The first one is M0. You hear hardly anyone talk about M0.

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It's actually kind of important, but people don't talk about it.

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It is purely just cash and currency.

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In other words, the physical stuff itself.

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That's the first money supply that, and most people would think that, actually most people think of that as the money supply.

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Dollar bills and coins in circulation.

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The one above it, and that's extremely liquid.

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The one above it is almost as liquid. It's called M1.

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M1 is the cash and currency plus demand deposits.

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In other words, checking accounts.

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Because they are so liquid.

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There's also, oddly enough, they include travelers checks in M1.

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Just out of curiosity, does anyone use travelers checks anymore?

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Have you ever, have you heard of them?

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They used to be really popular.

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Don't leave home without them.

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You could carry travelers checks overseas, and if someone stole them or you lost them, you get your money back right away.

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That's why they were included, is because they were so liquid.

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And they were accepted everywhere.

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Back in my time.

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Now, M2 is all of the M1 money plus now accounts and small time deposits.

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Now, I think I said something about now accounts earlier.

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Now accounts are checking accounts at credit unions.

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Now stands for negotiable order of withdrawal.

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These are not as liquid as bank checks, demand deposits.

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Now they seem to be, but actually if you have a check, someone's written you a check from a credit union,

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you can go to the credit union, usually they will honor it on site.

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But they don't have to.

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Now accounts don't have to be honored on demand.

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Now, small time deposits.

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That would be things like CDs for less than, I don't know what it is, like $10 million or something like that.

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Not nearly as liquid.

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Substantial interest penalty for early withdrawal.

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The money isn't right away to you.

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So M2 has less liquidity overall.

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And finally, you have M3, which is M2 plus large time deposits plus Euro dollars.

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Now I'm using this term very loosely.

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Euro dollars are American money somewhere else in the world.

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Like for example, you madam buy a barrel of oil from Saudi Arabia.

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That, those American dollars, you paid let's say $70 a barrel for it.

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That $70 you give it to me.

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I'm an Arab.

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That's going to go into the Saudi central bank and the central bank will give me the equivalent in Riyadh.

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But that, those Euro dollars are the money that we have sent to other countries to buy their stuff.

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And it is staggering in how much it is.

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But it is highly illiquid.

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When those countries want to use those dollars, they have to use them for big capital projects.

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Lend our government money.

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Lend a corporation long term debt.

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Buy stock in an American corporation.

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Remember those Euro dollars have to be spent in the United States or in a country that accepts dollars.

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Now let me show you something here.

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Look what happened to M1.

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It died.

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In the year 2006, the Fed cut the growth rate of the M1 to an average of 0.

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Why did they do that?

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Because M3 and even M2 were so out of control.

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So they just cut off the money that was supposed to be for the economy.

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They just stopped growing.

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Even though our economy kept growing, they cut off, they stopped growing the money supply that businesses and households use, M1.

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And so by the time we get to September of 2008, the economy just buckled.

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In other words, it wasn't getting enough oil to run the machine.

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That was why the Great Recession happened.

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It crashed because of a Fed effort to control this vast M3 by using paltry M1, which everyone needs.

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Anyway, I'll talk about that a little more next week.

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I'm going to take a quiz now.