SAVINGS, INVESTMENT, AND THE FINANCIAL SYSTEM Modules 22 & 23

The Financial Sector  Economic Growth and Investment Spending  Two instruments of growth: Human capital – public education, universities, experience Physical capital – public, but mostly private industry  How do we pay for this investment spending? Savings-investment spending identity Savings = investment…always Economics fact: all money saved is invested

The Financial Sector  Financing money – obtaining loans, borrowing funds  Gov’t and private firms borrow Surpluses and deficits (gov’t)  Interest rate – the price of borrowing money Today’s avg. home rate = 4.37% (30 yr), 3.39% (15 yr) Today’s avg. car = 2.57%, student = 4.66% So if you buy a house for $300,000, you’re actually paying $313,110

The Financial Sector  Savings: Who is saving?  Households – private savings  Gov’t Budget surplus –or– exceeding revenue = deficit (dissaving)  National Savings = private savings + budget balance  Capital inflow/outflow – foreign savings, spending in the US from people in other nations Concept from the formation of a truly global economy Can be +/- 2012: inflow of $800 billion This has continued to climb

The Financial Sector  Savings from capital inflow is not the same as national savings

The Financial Sector  Recent Numbers  Gov’t deficit - $474 Billion (according to useconomy.com) Spending: $3,999 trillion with a revenue of $3,525 trillion Lowest deficit since the recession  Capital Inflow/Outflow balance -$110.3 B (tradingeconomics.com)

The Financial Sector  The Financial System  Markets where households can invest wealth, by purchasing financial assets Financial assets Paper claim that entitles buyer to future income from the seller Bonds, stocks, and bank deposits Physical assets Pre-existing house, equipment Can use as you wish (rent, sell, etc) Liability A future payment (ex. Loan)

The Financial Sector  Three tasks of the financial system  Reduce transaction costs Ex – business wants a $1 billion loan  Reduce risk Most individuals are risk-averse Financial systems reduce exposure to risk Diversification – invest in multiple areas, business, limits risk and still allows full investment of funds

Liquid assets – money is the most liquid, it’s the reason why every spy has a crap ton of money in their go bag…

The Financial Sector  Provide liquidity  Cash is the most liquid form of exchange  Liquidity means flexibility and speed Liquid Assets – can be sold quickly to attain cash Illiquid Assets – can not sell quickly  Financial markets provide liquidity for business (through loans, etc) and cash for investors on demand, through the sale of financial assets

The Financial Sector  Financial assets  Book examples: loans bonds, loan-backed securities, stocks Why did Facebook go public? Traded on stock market – prestige Safer for employees – they can start to cash out their shares to cash in on the money they wanted when they started the company SEC rule – If you have more than 500 “shareholders of record” you have to adhere to the same financial disclosure as public companies All the burdens with none of the perks  Financial intermediaries  Transform funds from many different individuals into financial assets Mutual funds, pensions, life insurance, and banks Ex: banks – deposits turned into loans

CURRENCY AND THE CONCEPT OF MONEY Module 23

Settlers of the classroom  In your teams, you each have a number of goods that you produce each turn, your goal is to produce the most homes, businesses, and markets as you can by the end of 5 rounds of the game  Home = 2 wood, 2 brick  Business = 2 wood, 2 brick, 1 sheep, 1 wheat, 1 fish  Market = 3 wood, 3 brick, 2 sheep OR 2 wheat OR 2 fish  For each round, your team gets more of the resources that are on the sheets as well as additional materials and you have to decide what you are going to build  You may also trade for each of your turns, if you feel the need to do so

Stalag 17 currency cigarettes-in-stalag-17/view

The Financial Sector  What is Money?  An asset that can be easily used to purchase goods (def: liquid)  Currency in circulation, checkable bank deposits, traveler’s checks = money  Creates gains from trade because it makes indirect exchange possible  Roles of Money Medium of exchange – trade for goods and services Store of value – holds purchase power over time Unit of account - measurement

The Financial Sector  Types of Money  Commodity Money A good used for exchange Ex: gold and silver  Commodity – Backed Money No intrinsic value for the money, BUT value was guaranteed by the fact money could be converted into a commodity  Fiat Money Value derives

The Financial Sector  Measuring Money  Money Aggregates Measures the money supply  M1 (“Monetary base”) and M2 M1 – measures only money in circulation and demand deposits (checking) M2 – M1 + “near-moneys” Ex: not quite liquid (savings accounts, CDs)  Today’s M1 number: $2.85 trillion  Today’s M2 number: $ trillion

The Financial Sector  Time value of money and finance  Borrowing, lending, and interest Present and future value