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Alan Cring Productions in association with Emergent Light Studio presents the Illinois

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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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Okay special topics continued.

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I will go through this, what I didn't do on Thursday, or rather on Monday and then we

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will have a surprise quiz for the remainder of the time together and then you're done

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for the day.

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And then next week on Monday again, that's a Zoom session, first day of review and the

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first day I'll lay out for you on the Zoom session, the structure of the final.

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And then I'll go through some of the details.

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I'll focus more on Monday on definitions, concepts and go through a few of some of those

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terms if you want to ask me can you give me a definition of this or that, I can do that

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as long as you don't go like 10 or more definitions but that will be Monday, a Zoom session, the

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link will be in your canvas for that session.

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So and it will start at regular class time and go as long as you have questions.

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Real quick here, quick just a brief look at the numbers.

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It wasn't a spectacular day at all.

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As you can see it was an utterly uninspiring day.

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The Dow oddly enough was up 0.04% and then the S&P 500 was down 0.09% and the NASDAQ

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was down a little more at 0.16%.

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Nothing really, that's trivial.

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That's basically a flat day.

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But you'll see that that was actually kind of globally what was going on.

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An important part of that is that we now have the data as of today that inflation has been

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brought under control.

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It is coming down.

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It is going to not be the job of the Fed to raise the discount rate anymore.

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No longer slowing, trying to slow down the economy by draining liquidity.

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Well you would think that would make the markets happy.

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Yay, interest rates going down.

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Well why didn't the markets react that way?

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It's because they already knew that this was what was going to happen.

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The expectation had already been impounded in securities prices a few days previously.

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So there was no new expectations formed today.

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So there wasn't really any reason for the markets to move very much today.

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Just a quiet day.

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Now crude oil is still in its trading band 72 to 79.

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It did come up.

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It had kind of a wild day.

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It went up and then down and then up.

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And fortunately it leveled off there at the end of the day.

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So it's still in that 72 to 79 trading band.

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But it seems to be kind of volatile right now.

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With lots of rumors flying around as always is the case.

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The traders are reacting to the best guesses they have of what's about to come about.

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But there's not really any thought that there's going to be any supply disruptions from the

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Middle East or from Eastern Europe.

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But still the rumors are there.

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Now over here the odd thing was gold was roaring its way.

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It had completely broken through that $2,000 per ounce resistance level.

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And it was on its way up.

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And then there at the last it began to drop hard as you can see.

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And it seems in the aftermarket it's still pulling downward.

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So the gold bugs were excited because they thought there was some reason to see the end

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of the world coming.

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So they were buying their gold.

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But something cooled them off there by the end of the day today.

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So that's good news.

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They'll be quiet we hope.

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Now the 10-year bond dropped.

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The yield is going down.

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It went down.

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Let's see if I can read that, about six and a half basis points.

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Interest rates, the discount rates going down.

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Interest rates in general are going to go down.

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It's not going to be a spectacular drop.

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The interest rates that we had there for four or five years, they are no longer going to

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happen.

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Not for a long, long time.

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However, at least they're easing up from where they were even a few months ago.

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Home mortgage rates are sliding.

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They're still ridiculously high compared to what they were a few years ago.

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And you're even seeing auto loans, the interest rate coming down.

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But still, I got an ad from one of the major auto companies about a month ago.

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7.99% financing.

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Wow, isn't that incredible?

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Geez, that's an awful interest rate.

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Well I just got an ad yesterday.

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New interest rates now for six-year loans are 10.49%.

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Yes, that's a drop.

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But that's still a very high interest rate for an auto loan, historically speaking.

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So we are getting the interest rates down.

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That's going to keep the economy on the expansion path.

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We're moving from a recovery toward an expansion.

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More good news was that the numbers are coming in on Black Friday and sales were record.

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It was record sales.

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So clearly consumer confidence is high enough that people are opening their wallets to buy

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for the Christmas season for gifts.

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And that's always good news.

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Consumer confidence goes up, buying goes up, more jobs, more production, the whole nine

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yards.

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Great news.

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Okay, now oddly enough, the euro and the pound both just wobbled.

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It looks like it was down a little bit, but not much.

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Well if our interest rates are going down, that should weaken the dollar and that should

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cause other currencies to appreciate against the dollar.

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So why isn't that happening here?

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Most likely it's just because their interest rates are easing up too, and so it's kind

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of a wash right now.

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The euro was pretty much flat, a little depreciation the dollar had.

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The pound just barely a little bit.

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And the Japanese yen was about flat.

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So there you are.

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And if you look over here, the Nikkei finished down a lousy little bit, about a quarter of

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a percent.

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No spectacular movements in there.

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And the London was down a little more.

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And if you look, that's kind of the story over here.

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So in other words, the world's economies, or at least the financial markets, are in

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a wait and see attitude right now.

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It's sort of sitting back.

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If you look at volume on the Standard & Poor's 500, it's still pretty lousy against its 52

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week average.

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3.4 billion shares today against 3.7 on an average day over the past year.

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So there is still a lot of weakness in buying activity, especially by the big dogs.

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So there you are.

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There's where we're sitting.

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And you can look around at some of the markets, show you one right now.

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I pulled up Bristol Myers here, just to show where we could be over the next year or so.

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Now Bristol Myers, as you can see, it's a very safe company, beta.37, low risk investment.

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PE ratio at 12.37 indicates that it is undervalued, possibly.

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It is a profitable company with $3.94 per share, and it pays a little bit of a dividend.

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So just to keep you in the mood of doing these, we'll look at the one year holding period

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return on this company.

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And we would have in one year projected $57.70 against the purchase price one year earlier

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today of about $48.72 and minus one, and then you take the result times 100.

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Your cap, well, let's try that one more time.

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$57.70 divided by the current price one year earlier, $48.72 minus one.

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So the capital gain yield is 18%.

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Now if you add in the dividend yield, 4.66%, look at that.

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I got to multiply that by 100 first, and then add the 4.66.

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A total holding period, one year holding period return of 23.09%, and this is on a really

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low beta stock.

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So this gives you an indication that, doing some more research obviously, but it looks

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like this is a definite buy, a good stock to have in a well diversified portfolio.

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With a beta that low and returning 23.09% annual, you can't beat that.

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Bristol Myers is one of those old stable companies that sells basic products and all that.

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So even if the economy went to hell, it's not going to go down that much, but it looks

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like that's a heck of a winner at that low risk level, and it's undervalued right now,

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so this would be a good time to buy.

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So as I've always said, of course, don't trust anything I tell you as far as investments

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go, because I wouldn't be giving investment advice if I were good at this.

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If I were good at this, I wouldn't be here.

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Anyway, enough of that.

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Let me tell you, I'm going to finish up, I'm not going to do the second topic, I'm just

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going to finish up the Federal Reserve today, make sure you've got all that down.

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Now be sure, at least listen to watch that video, I gave you the link to that video on,

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it's called In Plain English, it's about the operations of the Federal Reserve.

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That goes through the whole thing pretty well, but just to remind you, I had one tale that

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I hadn't shown you.

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This was, remember, the tools of monetary policy.

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Well first of all, duties of the Fed, just to get a running start, duties of the Fed,

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well the first duty was that it regulates and supervises the banks, the governors regulate,

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and the district banks supervise the banks.

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Two, the Fed serves as a bank for banks.

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And the third one was the one where I cut off near the end, conducts monetary policy.

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This is the big one.

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Now I gave you the three different tools, the least used would be the required reserve

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ratio, sometimes called the fractional reserve ratio.

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And this I gave you last time, like I said, I'm just getting a running start.

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The second tool to conduct monetary policy would be the discount rate.

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Now that's a rate at which the Fed would lend money to banks.

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If your bank needs $10 million, the Fed will lend it to you, and it will charge you this

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rate that it sets.

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This discount rate is set by the Fed.

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It also serves as a signal that, well, okay, the Federal Reserve raised the discount rate

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by 25 basis points,.25%.

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Well that would mean that the Fed is saying that it wants the economy to slow down, so

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it wants interest rates to go up.

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Or the Fed lowered the discount rate.

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That would mean that the Fed thinks the economy is going a little too slowly, so it wants

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to juice the economy a little bit.

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It wants lower interest rates.

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Now what's the expectation now?

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The Fed had been, every meeting it was raising the discount rate up, up, up, signaling slow

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down economy, we've got to kill inflation.

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But now we are pretty much assured that the Fed may actually be completely finished with

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those incremental increases in the discount rate.

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That's good news.

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That's great news.

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Happy news.

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Okay.

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Good news.

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Now however, banks don't have to go to the discount window at the Fed.

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They can borrow from each other in the federal funds market and they will pay the federal

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funds rate.

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This is not set by the Fed.

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It's set by the supply of money and demand for money in this vast pool of bank funds.

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So it is set by market forces.

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However the Fed will give a target what it wants it to be.

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And the Fed has this last tool that I'm going to tell you about that it uses to push that

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federal funds rate to where they want it.

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Now again, just to emphasize this, the federal funds market is this vast pool of the money

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of banks.

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That's kind of oversimplifying it, but it does it pretty well.

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So there's this ginormous pool of trillions of dollars.

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This is the federal funds market.

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And it's just all this money that's swirling in the banking system.

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Now it might sound kind of paradoxical.

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It's very real, but it's kind of diffused.

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It's sort of like air.

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Well we know it's there, but it's here, here, it's everywhere.

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And for the Fed to add money to it or drain money from it, it's sort of like breathe,

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blow it over here.

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That's kind of what the Fed does with this last operation that it does.

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It's called open market operations.

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OMOs.

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Now I'm going to juice your thinking a little bit here just for a minute.

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Either or not, you're going to be the leaders of the free world someday, pretty much every

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one of you.

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You're going to know things that hardly anyone else knows.

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Some people just don't want to know this.

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Some people can't understand it.

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But that's where we come in.

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We know about this.

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These open market operations are to the tune of hundreds of billions of dollars every day

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swirling back and forth through the economy, through the banks, even through our own bank

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accounts.

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And hardly anyone knows this is happening.

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And it is the force that is maintaining control of the economy in the short run.

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So you're going to know about something, even to try to explain it.

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You might get someone to kind of get how they work, but would they know how incredibly forceful

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this is?

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Probably not.

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So that's where we come in.

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We have to know this.

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We have to understand it because we are the ones who will be trying to know what it's

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going to do to our companies, know what it's going to do to the economy, and all that kind

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of stuff.

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Okay.

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Now, I'm going to go away from the federal funds market here for a minute.

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And I want to give you one last part about the Federal Reserve.

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Now the Federal Reserve, remember, there are seven governors and 12 district bank presidents.

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One of those districts is kind of more important than the other ones.

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It's the Empire Bank, the Federal District Bank of New York.

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It has kind of a pivotal role in the machinery that I'm going to show you here.

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But the Federal Reserve has a special committee.

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It's called the Federal Open Market Committee, the FOMC.

239
00:20:50,180 --> 00:20:59,980
In fact, that little cheesy animated video talks quite a bit about this.

240
00:20:59,980 --> 00:21:07,700
And they do a really good job, maybe even better than I do, because it's kind of a

241
00:21:07,700 --> 00:21:10,340
summary, but they got it.

242
00:21:10,340 --> 00:21:11,340
Okay.

243
00:21:11,340 --> 00:21:22,900
Now, the Federal Open Market Committee, all seven governors are on this committee plus

244
00:21:22,900 --> 00:21:31,340
five district bank presidents.

245
00:21:31,340 --> 00:21:47,020
Four of those district bank presidents serve rotating two-year terms.

246
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Okay.

247
00:21:51,420 --> 00:21:58,660
So in other words, you're the president of the District Bank of Atlanta, and you've just

248
00:21:58,660 --> 00:22:00,340
done your two years.

249
00:22:00,340 --> 00:22:03,300
So I'm the president of the District Bank of Cleveland.

250
00:22:03,300 --> 00:22:04,900
I might be the one.

251
00:22:04,900 --> 00:22:11,340
You're done with your term, and then I step in, and it's my turn to be on the FOMC.

252
00:22:11,340 --> 00:22:12,660
And that rolls around.

253
00:22:12,660 --> 00:22:18,500
Now there's one permanent member.

254
00:22:18,500 --> 00:22:22,660
That's the Empire Bank president.

255
00:22:22,660 --> 00:22:30,140
And there's a reason.

256
00:22:30,140 --> 00:22:32,140
That one is...

257
00:22:32,140 --> 00:22:35,980
There's a reason.

258
00:22:35,980 --> 00:22:40,220
That's the New York Fed District Bank.

259
00:22:40,220 --> 00:22:46,260
That president is always going to be on the Federal Open Market Committee.

260
00:22:46,260 --> 00:22:53,140
He or she is going to be a fixed thing like the seven governors are.

261
00:22:53,140 --> 00:23:07,500
Now, this FOMC meets formally and officially eight times a year.

262
00:23:07,500 --> 00:23:12,660
And they make a decision.

263
00:23:12,660 --> 00:23:16,240
Are we going to add liquidity to the economy?

264
00:23:16,240 --> 00:23:22,820
Are we going to leave the liquidity growth rate alone, or are we going to drain liquidity?

265
00:23:22,820 --> 00:23:28,780
They meet and they make this decision eight times a year.

266
00:23:28,780 --> 00:23:32,580
And they kind of hint at it even in that video.

267
00:23:32,580 --> 00:23:36,860
This is not a, oh, everyone agrees.

268
00:23:36,860 --> 00:23:41,820
It can get fierce in those meetings.

269
00:23:41,820 --> 00:23:47,460
You have the inflation hawks, cut the money supply to zero, and you have the inflation

270
00:23:47,460 --> 00:23:48,460
doves.

271
00:23:48,460 --> 00:23:50,300
The economy needs help for God's sake.

272
00:23:50,300 --> 00:23:52,020
Put some money into it.

273
00:23:52,020 --> 00:24:01,100
And as a matter of fact, just this week that disagreement has rolled out and two of the

274
00:24:01,100 --> 00:24:05,740
bank presidents are arguing in the news media for God's sake.

275
00:24:05,740 --> 00:24:11,540
I mean, usually they're quiet and they have their differences when the door is locked,

276
00:24:11,540 --> 00:24:15,780
but when they open the door, everyone's like, they're fighting it out.

277
00:24:15,780 --> 00:24:24,860
They're duking out with competing interviews on news sites now, which is, yeah, that's

278
00:24:24,860 --> 00:24:29,320
a little bit crazy that it gets to that point.

279
00:24:29,320 --> 00:24:31,920
But there is often disagreement.

280
00:24:31,920 --> 00:24:37,100
You have those who want to cut the money supply because they're still afraid that inflation,

281
00:24:37,100 --> 00:24:39,660
the embers are just waiting to burst back out.

282
00:24:39,660 --> 00:24:42,500
And then you have the other ones say enough is enough.

283
00:24:42,500 --> 00:24:49,300
We have raised the discount rate more times than we ever did in history and the inflation

284
00:24:49,300 --> 00:24:55,120
numbers are dead, so why are we still trying to cut the money supply?

285
00:24:55,120 --> 00:24:58,700
So they can get really fierce.

286
00:24:58,700 --> 00:25:01,260
However, there is a vote.

287
00:25:01,260 --> 00:25:06,340
And once that vote is done, those 19 votes are counted, I'm sorry, those 12 votes are

288
00:25:06,340 --> 00:25:11,020
counted and a decision is made.

289
00:25:11,020 --> 00:25:18,620
Now if I understand, if I remember it right, if it's a 50-50 vote, the chairman decides

290
00:25:18,620 --> 00:25:20,580
who's going to go.

291
00:25:20,580 --> 00:25:21,580
Okay.

292
00:25:21,580 --> 00:25:34,140
So whatever they decide, the district bank president of the Empire Bank sends a message

293
00:25:34,140 --> 00:25:41,380
to the Empire Bank in New York.

294
00:25:41,380 --> 00:25:56,260
And the message he sends, or she sends, goes to what is called the domestic trading desk.

295
00:25:56,260 --> 00:26:04,660
The domestic trading desk, the DTD, is in the Empire Bank.

296
00:26:04,660 --> 00:26:06,180
It's there.

297
00:26:06,180 --> 00:26:10,460
That's why that one is more important than the others because whatever the Fed decides

298
00:26:10,460 --> 00:26:18,980
at the FOMC meeting, it will be executed at the domestic trading desk in New York City.

299
00:26:18,980 --> 00:26:26,980
Now this is not, when I say desk, the word desk in corporate, in corporate and government

300
00:26:26,980 --> 00:26:31,920
lingo is not, you know, wow, I got a nice desk right here.

301
00:26:31,920 --> 00:26:36,540
The desk is an official thing.

302
00:26:36,540 --> 00:26:45,060
And this desk has many, many, I think hundreds of traders.

303
00:26:45,060 --> 00:26:51,380
The manager of the desk gets the message from the FOMC.

304
00:26:51,380 --> 00:26:58,660
Add liquidity or drain liquidity or leave the liquidity growth rate where it is.

305
00:26:58,660 --> 00:27:08,460
That's what the domestic trading desk does is execute the orders of the FOMC conveyed

306
00:27:08,460 --> 00:27:16,380
to them through the Empire Bank president to the desk.

307
00:27:16,380 --> 00:27:26,020
Now if you follow that, the rest of it is kind of just that story of that swirling billions

308
00:27:26,020 --> 00:27:30,780
and billions of dollars every day just like that all through the economy.

309
00:27:30,780 --> 00:27:32,780
This is where it's happening.

310
00:27:32,780 --> 00:27:33,780
Watch.

311
00:27:33,780 --> 00:27:39,180
I'm trying to think, who looks like a desk trader?

312
00:27:39,180 --> 00:27:42,860
Oh, no actually some of you do.

313
00:27:42,860 --> 00:27:44,940
I can see you in New York City doing it.

314
00:27:44,940 --> 00:27:45,940
Let's say you.

315
00:27:45,940 --> 00:27:48,580
You're a desk trader.

316
00:27:48,580 --> 00:27:53,340
Now the desk manager has given the orders.

317
00:27:53,340 --> 00:27:59,100
He or she got it from her boss, the New York bank president.

318
00:27:59,100 --> 00:28:07,100
Let's say drain liquidity from the economy and that message is sent to all the traders.

319
00:28:07,100 --> 00:28:08,580
Do it.

320
00:28:08,580 --> 00:28:10,740
So here's how it works.

321
00:28:10,740 --> 00:28:18,060
You are a desk trader.

322
00:28:18,060 --> 00:28:28,820
In your desk are tons of dollar bills and tons of T-bills.

323
00:28:28,820 --> 00:28:37,620
Now treasury bills and dollar bills are almost exactly the same except for one important

324
00:28:37,620 --> 00:28:39,300
feature.

325
00:28:39,300 --> 00:28:44,700
Both of them are highly liquid and highly safe.

326
00:28:44,700 --> 00:28:50,780
They are both good as gold to a certain extent.

327
00:28:50,780 --> 00:28:59,100
Here is your bank, a normal happy bank.

328
00:28:59,100 --> 00:29:00,900
Right there.

329
00:29:00,900 --> 00:29:10,580
Now a bank will have in its vault dollars and T-bills.

330
00:29:10,580 --> 00:29:12,180
It's the safest capital.

331
00:29:12,180 --> 00:29:18,180
Every bank has to have this super safe capital and dollars and T-bills fill that need, fill

332
00:29:18,180 --> 00:29:20,540
that.

333
00:29:20,540 --> 00:29:26,260
So the bank has sort of a balance of dollars and T-bills and those are tier one capital.

334
00:29:26,260 --> 00:29:31,460
What a bank has to have to show that it can stay in business.

335
00:29:31,460 --> 00:29:36,940
It has other investments too like loans and stuff like that but this is the super safe

336
00:29:36,940 --> 00:29:38,900
stuff the bank has.

337
00:29:38,900 --> 00:29:44,340
So you the desk trader knows that you need to get money away from that bank.

338
00:29:44,340 --> 00:29:46,740
Dollar bills.

339
00:29:46,740 --> 00:29:48,460
You need to drain liquidity.

340
00:29:48,460 --> 00:29:52,460
The way you drain it is to pull these dollar bills which are part of the federal funds

341
00:29:52,460 --> 00:29:54,120
market.

342
00:29:54,120 --> 00:29:57,380
So what you're going to do is I'm a bank president.

343
00:29:57,380 --> 00:30:05,260
You call me ring ring, yellow, Al's bank and all you can eat, cheeseburger bar, may I help

344
00:30:05,260 --> 00:30:06,260
you?

345
00:30:06,260 --> 00:30:12,780
You say hi, you're the desk trader, hi I want to sell you some T-bills.

346
00:30:12,780 --> 00:30:16,860
Oh okay, I guess.

347
00:30:16,860 --> 00:30:30,660
So what you do is you then sell a T-bill to the bank and I, the bank president, send you

348
00:30:30,660 --> 00:30:34,300
a dollar, send you some dollars.

349
00:30:34,300 --> 00:30:38,100
You just drained liquidity from the federal funds market.

350
00:30:38,100 --> 00:30:39,740
That's how it's done.

351
00:30:39,740 --> 00:30:47,700
Now in a more advanced course, I mean I go through these details of these bizarre ways

352
00:30:47,700 --> 00:30:54,420
that they pull this with T-bills, with repos and reverse repos and all this stuff but it

353
00:30:54,420 --> 00:30:56,420
boils down to exactly this.

354
00:30:56,420 --> 00:30:58,780
This is how it's done.

355
00:30:58,780 --> 00:31:08,200
Every day the desk traders are working the banks following the orders of the domestic

356
00:31:08,200 --> 00:31:15,420
trading desk management which got their orders from the Empire Bank president who got his

357
00:31:15,420 --> 00:31:18,900
or her orders from the FOMC.

358
00:31:18,900 --> 00:31:21,520
So there's this chain and it's like a machine.

359
00:31:21,520 --> 00:31:25,500
It's not like something, well how do we do this today?

360
00:31:25,500 --> 00:31:26,820
It's so automatic anymore.

361
00:31:26,820 --> 00:31:29,700
It's just like pushing buttons.

362
00:31:29,700 --> 00:31:38,100
The bank, the Fed just pushes a button and the bank buys a T-bill or something like that.

363
00:31:38,100 --> 00:31:42,500
So that's how you would drain liquidity.

364
00:31:42,500 --> 00:31:46,660
Now let's take it the opposite way.

365
00:31:46,660 --> 00:31:56,900
Let's do it again.

366
00:31:56,900 --> 00:32:04,820
Now remember the trader has dollar bills and T-bills.

367
00:32:04,820 --> 00:32:12,620
The bank has dollar bills and T-bills.

368
00:32:12,620 --> 00:32:17,620
This time your desk manager has said add liquidity to the economy.

369
00:32:17,620 --> 00:32:19,760
Go, do it.

370
00:32:19,760 --> 00:32:26,460
So you call me up, ring ring, hello, Al's Bank and Burrito House of Joy.

371
00:32:26,460 --> 00:32:29,820
You say wait a minute, weren't you something else?

372
00:32:29,820 --> 00:32:31,860
Change your menu.

373
00:32:31,860 --> 00:32:34,660
Okay, try to concentrate.

374
00:32:34,660 --> 00:32:37,860
Okay, here we go.

375
00:32:37,860 --> 00:32:44,060
So what you do is you say I should like to buy some T-bills from you.

376
00:32:44,060 --> 00:32:45,500
Well okay.

377
00:32:45,500 --> 00:32:56,540
So in this case you send, they give up a T-bill and you send them money that goes into the

378
00:32:56,540 --> 00:32:59,500
federal funds market.

379
00:32:59,500 --> 00:33:01,500
That's how LMOs work.

380
00:33:01,500 --> 00:33:08,860
That's how the Fed, its main tool of monetary policy, day in, day out, flowing money back

381
00:33:08,860 --> 00:33:14,100
and forth, T-bills back and forth, exchanging them like this.

382
00:33:14,100 --> 00:33:20,380
And on balance, and interestingly enough, you might want to add liquidity to the economy,

383
00:33:20,380 --> 00:33:22,180
but you know what?

384
00:33:22,180 --> 00:33:28,220
You might once in a while sell a T-bill to a bank.

385
00:33:28,220 --> 00:33:31,180
Well wouldn't that take money out of the economy?

386
00:33:31,180 --> 00:33:38,500
Yes, but it would also confuse the speculators who were trying to bet on which way interest

387
00:33:38,500 --> 00:33:40,340
rates were going to go.

388
00:33:40,340 --> 00:33:44,900
Because if you pull the rug out from under them by draining, that would cause interest

389
00:33:44,900 --> 00:33:45,900
rates to go up.

390
00:33:45,900 --> 00:33:51,060
I was expecting you to add liquidity which would make more money and therefore interest

391
00:33:51,060 --> 00:33:53,680
rates in the federal funds market would go down.

392
00:33:53,680 --> 00:33:58,380
So I would be speculating thinking I knew what you were going to do, but you might do

393
00:33:58,380 --> 00:34:03,100
the opposite just to knock me out of the game for a minute.

394
00:34:03,100 --> 00:34:04,100
It happens.

395
00:34:04,100 --> 00:34:10,100
That's why right now you'll see, well if the Fed is going to hold the money, not going

396
00:34:10,100 --> 00:34:17,060
to do anything, why do we see, I can't pull it up right now, but there are actually places

397
00:34:17,060 --> 00:34:22,340
where you can see green arrow, add liquidity, red arrow, drain liquidity.

398
00:34:22,340 --> 00:34:28,260
You can see times when you know damn well the Fed is draining liquidity, but you'll

399
00:34:28,260 --> 00:34:30,580
see a green arrow.

400
00:34:30,580 --> 00:34:31,580
What the heck?

401
00:34:31,580 --> 00:34:32,820
Why are they doing that?

402
00:34:32,820 --> 00:34:34,260
Because they're bluffing the traders.

403
00:34:34,260 --> 00:34:38,740
The traders think that they're draining liquidity which would cause federal funds rate to go

404
00:34:38,740 --> 00:34:43,260
up, other interest rates to go up, but if you add liquidity it will cause interest rates

405
00:34:43,260 --> 00:34:48,100
to turn the other way and it will pull the rug out from under the speculators.

406
00:34:48,100 --> 00:34:49,100
Something that happens.

407
00:34:49,100 --> 00:34:54,220
There's a lot of gamesmanship in this, a lot.

408
00:34:54,220 --> 00:34:55,220
I get confused.

409
00:34:55,220 --> 00:35:00,220
Some of it's really complex strategies and all that, but anyway that's the basic outline

410
00:35:00,220 --> 00:35:09,220
of how the Federal Reserve uses, these are again open market operations, OMOs.

411
00:35:09,220 --> 00:35:17,260
They're done every day, just billions and billions of dollars every day flowing through

412
00:35:17,260 --> 00:35:24,740
the banking system, flowing through the economy in these vast airwaves that almost no one

413
00:35:24,740 --> 00:35:31,740
knows are happening and yet they are affecting our companies, our lives, our economy, and

414
00:35:31,740 --> 00:35:33,380
our nation.

415
00:35:33,380 --> 00:35:38,140
Most people don't have any idea that that's going on.

416
00:35:38,140 --> 00:35:51,340
Now one last thing I want to tell you about, just a little kind of side part to this.

417
00:35:51,340 --> 00:35:58,460
When I say money, money is a little bit more complicated than one might think.

418
00:35:58,460 --> 00:36:07,140
There are actually different monetary aggregates and we divide them up based upon liquidity.

419
00:36:07,140 --> 00:36:13,220
The first level, which almost no one talks about anymore, but it's really there, is this

420
00:36:13,220 --> 00:36:15,240
M sub zero.

421
00:36:15,240 --> 00:36:23,380
This is just the cash and currency in the economy.

422
00:36:23,380 --> 00:36:25,220
Dollars and cents in the economy.

423
00:36:25,220 --> 00:36:35,380
The amount of just pure money that people think of as money.

424
00:36:35,380 --> 00:36:41,860
I think they call this, it used to be called the base, the base money supply, just what

425
00:36:41,860 --> 00:36:43,820
people think money is.

426
00:36:43,820 --> 00:36:50,780
Now the one that you usually see mentioned first though is M1.

427
00:36:50,780 --> 00:36:58,080
This is the cash and currency, M0, plus demand deposits, in other words, checking accounts

428
00:36:58,080 --> 00:37:07,580
at real banks, because that's pretty liquid.

429
00:37:07,580 --> 00:37:13,860
I mean it's almost as good as money, a debit card and all that.

430
00:37:13,860 --> 00:37:18,100
There's also a third one in there, I don't even write it up on the board anymore.

431
00:37:18,100 --> 00:37:25,660
Another kind of very, very liquid money, but I haven't heard anyone use it in years.

432
00:37:25,660 --> 00:37:31,060
Have any of you ever heard of travelers checks?

433
00:37:31,060 --> 00:37:32,860
Don't leave home without them.

434
00:37:32,860 --> 00:37:39,940
They used to be a really big thing, because if you were going overseas, you turn your

435
00:37:39,940 --> 00:37:48,180
say $1,000 into 1,000 travelers checks, and they were accepted all over the world instantly,

436
00:37:48,180 --> 00:37:55,860
and if you lost them or they were stolen, then you were reimbursed very, very quickly.

437
00:37:55,860 --> 00:38:01,500
So they are technically still part of M1, even though they're hardly ever used.

438
00:38:01,500 --> 00:38:06,500
Have any of you used travelers checks ever?

439
00:38:06,500 --> 00:38:10,060
Like I said, I don't even write it up there, but it is part of M1.

440
00:38:10,060 --> 00:38:13,580
Okay, let me do this.

441
00:38:13,580 --> 00:38:16,060
The next one is M2.

442
00:38:16,060 --> 00:38:21,540
Now remember, as I'm going down, I'm going into more illiquid stuff, more stuff that's

443
00:38:21,540 --> 00:38:24,820
not easily converted to another asset.

444
00:38:24,820 --> 00:38:45,060
M2, that's M1 plus negotiable order of withdrawal accounts plus small time deposits.

445
00:38:45,060 --> 00:38:48,660
Now I mentioned this earlier in the course.

446
00:38:48,660 --> 00:38:52,860
Now accounts are checking accounts at credit unions.

447
00:38:52,860 --> 00:38:55,420
That's mostly what they are.

448
00:38:55,420 --> 00:38:58,040
They actually look like checks.

449
00:38:58,040 --> 00:39:05,740
They're mostly honored like checks, but technically a check from a credit union doesn't have to

450
00:39:05,740 --> 00:39:10,600
be cashed by the credit union immediately.

451
00:39:10,600 --> 00:39:16,540
Now if you go in there with someone's written you a check on a credit union for $100, they'll

452
00:39:16,540 --> 00:39:19,780
say, well, yes, just ID, here it is.

453
00:39:19,780 --> 00:39:26,380
But if you brought in a check for let's say $10,000 that was written on a credit union

454
00:39:26,380 --> 00:39:32,100
and someone who had that credit union account wrote you that check, you go to a credit union,

455
00:39:32,100 --> 00:39:36,040
they don't have to give you that $10,000 on demand.

456
00:39:36,040 --> 00:39:38,500
They could tell you you have to wait.

457
00:39:38,500 --> 00:39:42,100
So in other words, that perfect liquidity isn't there.

458
00:39:42,100 --> 00:39:45,900
That's why now accounts are put in M2.

459
00:39:45,900 --> 00:39:51,780
Now small time deposits, and forgive me if I don't know the exact amount, but I think

460
00:39:51,780 --> 00:40:00,100
it's any CD certificate of deposit or something like that that is for $50 million or less.

461
00:40:00,100 --> 00:40:04,060
So in other words, small time deposit.

462
00:40:04,060 --> 00:40:10,100
Because I mean, if you got a CD, you try to, I want to turn that into cash, they'll charge

463
00:40:10,100 --> 00:40:14,220
you a substantial interest penalty for early withdrawal.

464
00:40:14,220 --> 00:40:15,540
You'll get burned.

465
00:40:15,540 --> 00:40:18,540
So in other words, it's not highly liquid.

466
00:40:18,540 --> 00:40:22,780
That's why it's in M2.

467
00:40:22,780 --> 00:40:30,940
Now the last one is M3.

468
00:40:30,940 --> 00:40:43,500
This is M2 plus large time deposits, these insanely huge things we'll never see, plus

469
00:40:43,500 --> 00:40:46,020
euro money.

470
00:40:46,020 --> 00:40:58,240
Now when I say euro dollars, I am referring to American money in the central banks of

471
00:40:58,240 --> 00:41:00,420
foreign countries.

472
00:41:00,420 --> 00:41:11,320
When you buy a Chinese toaster for $20, that $20 turns into foreign reserve money.

473
00:41:11,320 --> 00:41:17,340
That country has to use that money back here in the United States.

474
00:41:17,340 --> 00:41:22,580
It's highly illiquid, but it is vast.

475
00:41:22,580 --> 00:41:25,040
It is a huge pool.

476
00:41:25,040 --> 00:41:31,700
You buy a barrel of oil for $77, well, that's going to go maybe to some Arab country like

477
00:41:31,700 --> 00:41:41,340
Saudi Arabia, and that's what the oil producing company will get the Riyadh equivalent of

478
00:41:41,340 --> 00:41:43,400
the $70.

479
00:41:43,400 --> 00:41:51,820
And that money in dollars, that $70, is then in the central bank of that country.

480
00:41:51,820 --> 00:41:54,740
Those are called petrodollars, by the way.

481
00:41:54,740 --> 00:42:00,260
But I use the general generic term, euro money or euro dollars.

482
00:42:00,260 --> 00:42:01,260
Highly illiquid.

483
00:42:01,260 --> 00:42:07,900
Let me show you one last thing.

484
00:42:07,900 --> 00:42:17,400
About the crisis of 2008, the Fed's job is to control the growth of the money supply

485
00:42:17,400 --> 00:42:25,060
so that it matches the real growth rate of the economy.

486
00:42:25,060 --> 00:42:36,580
Now some years ago, I was one of the relatively popular bloggers on financial and economic

487
00:42:36,580 --> 00:42:40,700
news on the internet.

488
00:42:40,700 --> 00:42:51,620
And at that time, in 2000, about, started in about 2006, 2005, I was writing articles

489
00:42:51,620 --> 00:42:56,140
warning that something very bad was going to happen to the economy because the Federal

490
00:42:56,140 --> 00:43:00,420
Reserve, here's what was happening.

491
00:43:00,420 --> 00:43:04,420
M3 was out of control.

492
00:43:04,420 --> 00:43:05,700
The Fed can't control it.

493
00:43:05,700 --> 00:43:11,620
That's just people buying and companies buying foreign stuff and sending our dollars to their

494
00:43:11,620 --> 00:43:13,060
central banks.

495
00:43:13,060 --> 00:43:15,420
So this thing was spiraling out of control.

496
00:43:15,420 --> 00:43:21,220
It was so bad the Fed stopped publishing M3 in 2006.

497
00:43:21,220 --> 00:43:26,220
They were so freaked out they didn't want everyone going crazy about how insane the

498
00:43:26,220 --> 00:43:28,380
growth rate of M3 was.

499
00:43:28,380 --> 00:43:34,520
And it was all because of the euro dollars, the money in other foreign banks, because

500
00:43:34,520 --> 00:43:41,780
we were buying foreign cars, foreign oil, we were buying everything, so M3 was skyrocketing.

501
00:43:41,780 --> 00:43:44,780
Even M2 was getting ridiculous.

502
00:43:44,780 --> 00:43:47,300
So how did the Fed deal with it?

503
00:43:47,300 --> 00:43:54,820
They cut the growth rate of M1, the money that households and businesses use every day.

504
00:43:54,820 --> 00:43:59,440
They cut the growth rate of it down to zero.

505
00:43:59,440 --> 00:44:02,180
So in other words, the economy was cruising along at about 2.5%.

506
00:44:02,180 --> 00:44:07,540
Just like a car driving along at 25 miles an hour.

507
00:44:07,540 --> 00:44:16,180
And then all of a sudden the liquidity, the M1, was cut to zero growth rate.

508
00:44:16,180 --> 00:44:22,180
And of course, by September 15th, the economy collapsed.

509
00:44:22,180 --> 00:44:23,180
It just buckled.

510
00:44:23,180 --> 00:44:26,400
The entire banking system just buckled.

511
00:44:26,400 --> 00:44:28,980
That was what caused the Great Recession.

512
00:44:28,980 --> 00:44:34,980
There are all these talking heads, well, it was the housing market bubble, some bubble

513
00:44:34,980 --> 00:44:36,280
crap again.

514
00:44:36,280 --> 00:44:39,800
Or we were giving home loans to high-risk people.

515
00:44:39,800 --> 00:44:43,260
How dare those poor people want to live in a house they own?

516
00:44:43,260 --> 00:44:44,560
All kinds of excuses.

517
00:44:44,560 --> 00:44:46,740
You look right here, there it was.

518
00:44:46,740 --> 00:44:53,140
The growth rate of the money supply had been cut, of the M1 had been cut to zero even though

519
00:44:53,140 --> 00:44:55,040
the economy was growing.

520
00:44:55,040 --> 00:45:00,180
It didn't have enough lubrication, but liquidity to do that.

521
00:45:00,180 --> 00:45:03,180
And finally it cracked.

522
00:45:03,180 --> 00:45:10,060
On September 15th of 2008, we came within two hours, and I'll tell you about that maybe

523
00:45:10,060 --> 00:45:12,400
next week if I have a minute.

524
00:45:12,400 --> 00:45:17,900
We came within two hours of a financial apocalypse of the entire world.

525
00:45:17,900 --> 00:45:19,580
ATMs wouldn't work.

526
00:45:19,580 --> 00:45:23,780
You couldn't get your money out of banks because they had no money to give.

527
00:45:23,780 --> 00:45:26,980
It was nearly a disaster.

528
00:45:26,980 --> 00:45:33,300
It was enough of a disaster because we had, this led to the worst recession since the

529
00:45:33,300 --> 00:45:35,100
Great Depression.

530
00:45:35,100 --> 00:45:45,420
And the Fed has quietly made sure that hardly anyone knows that it was their inappropriate

531
00:45:45,420 --> 00:45:51,460
reaction to the growth rate of M3 by using M1 to try to drag it down that caused it to

532
00:45:51,460 --> 00:45:52,740
happen.

533
00:45:52,740 --> 00:46:00,220
Notice that when the growth rate of M1 was above zero, the M3 was still skyrocketing

534
00:46:00,220 --> 00:46:08,940
so by cutting M1 down to zero, they were barely denting M3's rapid growth rate.

535
00:46:08,940 --> 00:46:10,540
That's how it worked.

536
00:46:10,540 --> 00:46:16,700
Anyway, you have a quiz to take and then once you finish that, that will be all I have for

537
00:46:16,700 --> 00:46:23,700
you today and I thank you.