The Ascent of Money Part 1 to 5
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Transcript of The Ascent of Money Part 1 to 5
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TheAscentofMoneyTheEvolutionofMoneyandtheBanks
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Historical
What the Spaniards in Bolivia did wrong was theyexcavated more and more of silver which they were
using as their currency for money and started using it as
their ,the silver was in such excess that it lost value
In Pisa the problem was there was seven different coins
in circulation.
The roman numerical were very difficult to do complex
calculations for the Europeans and then entered
Fibonacci
.
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Credit&debitsystem
Credit derived from Latin word credo
which means I believe
Since early times the merchants were
charged interest for the money given to
them for voyages
The Church condemned the charging of
interest so taking interested for money
given for credit was prohibited.
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In the early 14th century, Italy was the main financial hub of the
world.
One family, the Mediccis in particular, made a huge impact on theRenaissance. They were foreign exchange dealers who started to
use the Bills of Exchange in a big way.
If a sum could not be paid in cash until the conclusion of a
transaction, the creditors could draw a bill on the debtors. Creditors
could use the bill as a means of payment or obtain cash at a discountfrom a banker willing to act as a broker.
The Church condemned the charging of interest, but accepted bill
discounting transactions. Indeed, bill discounting proved to be a
good source of profit
CONCEPT OF BANKS
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Despite the hostility and resistance the Mediccis rode tosuccess by making their banks bigger and more diversified.
The Italian banking system soon became a model for othercountries in Northern Europe
The next wave of financial innovation occurred inAmsterdam, London and Stockholm. The AmsterdamExchange Bank, set up in 1609, pioneered the system of
cheques and direct debits/transfers. A merchant could make a payment to another simply by
arranging for his account at the bank to be debited and thecounterpartys account to be credited
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The Bank of England was set up in 1694 to assist theBritish government with war finance. The bank had apartial monopoly on the issue of bank notes.
These were promissory notes that did not bear interestand were designed to facilitate payments without the
need for both parties in a transaction to have currentaccounts. The Bank of Englands discount rate soonbecame the benchmark money market interest rate.
With the increasing acceptance of cashless transactions,fractional reserve banking and central bank monopolieson note issue, the nature of money changed as didbanking.
Credit was quite simply the total of the banks assets.Several kinds of banks emerged in Europe. Some bankshelped finance domestic and international trade bydiscounting the bills of exchange drawn by one
merchant on another.
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TheUSdidnothaveacentralbankforalongtime.ThecountryfollowedalaissezfairemodeltilltheFederalReserveSystemwassetupinthe1913.
Thisfragmentedsystemwithlargenumbersofundercapitalizedbankswasarecipeforfinancialinstability.
PanicswerearegularfeatureofAmericaneconomiclife,especiallyintheGreatDepression,whenamajorbankingcrisiswasaggravatedbywrongmonetarypolicy.
Theintroductionofdepositinsurancein1939wentalongwaytowardspreventingbankruns.However,theAmericanbankingsectorremainedfragmentedtill1976wheninterstatebankingwaslegalized.
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Whypeoplestillhavenotlostfaithinmoney It'ssimple:Becausepapermoneyis
soeasytouse.Itgivespeopleanexchangeablecommodityandamathematicalunitthatis
standardizedandgenerallyaccepted.That'ssomethingwe'rewillingtoacceptacertainamountofinflation
for.
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Whynomorerelationbetweengoldandcurrencies Becauseitprovedtobeanextremely
inflexiblesystem.Iftheoverallvolumeofmoneydependsontheavailabilityofpreciousmetals,itcan'tsimplybeincreased.Soashortageofgoldorsilvercanlimiteconomicgrowth.Thelinktogoldbrings
withitadangerofdeflation,inotherwordsaconstantdropinpriceswhichwouldhobbletheeconomy.ThegoldstandardwasoneofthecausesofthedeflationGermanysufferedintheearly1930s,forexample
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TheAscentofMoneyTheBondMarket
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TimetogetintoBOND-AGE Birthofthebondmarket
Todaybondmarketsplayacentralroleinthemanagementoftheeconomy longterminterestratesfortheeconomyasa
whole.
Relativelyliquid SafeOptions
Mostofoursavingslandsupinthebond
market.
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TriggersForEvolutionOfBond Itwaswarsthatfuelledtheriseofbondmarkets
Italiancities14thCentury Financingwarthroughcitizen'smoney
forGovernmentdebt
Bythemid18thcentury,Londonhadathrivingbondmarket
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MR BOND: NATHAN ROTHSCHILD Preferredinvestmentbanktoplacemanybond
issuesofEuropeangovernments
BuyingofatrancheofbondsoutrightfromagovernmentandchargingacommissionfordistributingthesebondstoanetworkofbrokersandinvestorsthroughoutEurope
AnimportantroleindecidingtheoutcomeoftheAmericanCivilWar,bysittingonthesidelinesanddecidingnottobackthesouth
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DoesBondhaspresenceonlyincriticaltimesforGOVT.
NathanRothschild:FundManagerforwarofwaterlooashehadstrongbanknetworkthen
Collectionsofpilesofcash
Ratherthansellinggolddecidedtobuygovernmentbonds
After1yearsoldat40%profit
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DynamicsOfBond ArgentinaCottontradedbondsinmiddleof18th
century
EfforttomanipulatethecostofBondbyrestrictingsupplyofcottontoBritishclothindustry
PressureonBritainonothersideriseinpriceofBonds
DiscoveryofNewcottonmarketsinIndia,Maleshiya
LossofmonopolybyArgentinaandpricefallinBondMarket
HyperInflationinArgentina
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WhatisBond Abondisadebtsecuritywhenyoupurchaseabond,youare
lendingmoneytoagovernment,municipality,corporation,federalagencyorotherentityknownastheissuer.
Theissuer Principalamount Specifiedinterestrate Dateofmaturity
VariablesthatEffectValue
MaturityShortTermandLongTerm RedemptionFeatures-CALLOptionandPUTOption CreditQuality- InterestRate-Fixed,FloatingandPayableatMaturity Price-discountandpremium
Yield-CurrentandYieldtomaturity
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EvolutionofBond
IncertainareaslikeIndiaBand
Marketisnotyetevolved IDBI,InflationBond
SomeotherareaslikeU.S.ithas
evolvedsubstantially.
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Year Event
1963Competitive bidding by syndicates of securities dealers and banks was introduced for Treasury bonds. Only 2 such
syndicate sales were conducted, both in 1963.
1971
Congress provided $10 billion of relief from 4 -1/40 interest rate ceiling on bonds maturing in more than 7 years.
For the first time since 1965, when longer-term market interest rates rose above 4-1/4%, Treasury issued a bond
maturing in more than 7 years. Since then, the bond authority has been increased several times, and an issue of
bonds has been a regular feature of Treasury mid-quarter coupon refunding.
197815-year, 1-month bond issues began at the beginning of each calendar quarter to mature on regular mid-quarterrefunding dates as an alternate for regular quarterly issues of 5-year notes. Depending on market conditions, a 5-
year or a 15-year issue was sold.
198120-year, 1-month bond issues replaced regular issues of 15-year bonds for settlement early in the first month of
each calendar quarter, to mature on mid-quarter refunding dates.
1981Mid-quarter refunding operations were standardized to regular issues of 3, 10, and 30-year area maturities. The 30-
year bonds were callable after 25 years.
1982 Bearer form was eliminated for new Treasury notes and bonds in connection with 1982 changes in the tax law.
1985
Noncallable 30-year bonds, which are more attractive for stripping than callable bonds, became a regular feature
of mid-quarter refunding operations.
1986 Regular quarterly issues of 20-year Treasury bonds were eliminated.
1988Congressional restrictions on the par amount of Treasury bonds held by the public with interest rates exceeding 4-
1/4% were eliminated.
1991 The noncompetitive award limit for Treasury notes and bonds was increased to $5 million from $1 million.
1993May 3, 1993: Offerings of 30-year bonds were pared back to semi-annually from quarterly, with offerings in August
and February, but not in May or November.
1998 April 1998: Begin offering of 30-year inflation indexed bond.
1999August 4, 1999: Treasury announced that the 30-year bond will no longer be issued in November, but will continueto be issued in February and August.
2000 30-year bond issuance was changed. Original issues were offered in February and then later reopened in August.
2001 October 2001: Treasury announces discontinuance of 30-year bondsboth nominal and inflation-adjusted.
2009March 2009: Reopening of the 30-year bond announced at February quarterly with the fi rst auction taking place in
March.
2009
July 2009: Additional reopening of the 30-year bond announced during the May quarterly. 30 year bonds were now
issued quarterly with one reopening taking place one month after the original issue and the second reopening
taking place two months after the original issue.
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TheAscentofMoneyTheStockMarketBubbles
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Aftertheadventofbankingandthebirthofthebondmarket,thenextstepinthestory
oftheascentofmoneywastheriseofthejoint-stock,limited-liabilitycorporation.
Enablesthousandsofindividualstopool
theirresourcesforrisky,long-termprojectsthatrequiretheinvestmentofvastsumsofcapitalbeforeprofitscanberealized.
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PatternofFinancialBubbles1. Displacement:Somechangeineconomiccircumstancescreatesnewandprofitableopportunitiesforcertain
companies.
2. Euphoria or overtrading: Afeedbackprocesssetsinwherebyrisingexpectedprofitsleadtorapidgrowthinshareprices.
3. Mania or bubble: Theprospectofeasycapitalgainsattractsfirst-timeinvestorsandswindlerseagertomulctthemoftheir
money.4. Distress:Theinsidersdiscernthatexpectedprofitscannotpossiblyjustifythenowexorbitantpriceofthesharesand
begintotakeprofitsbyselling.
5. Revulsion or discredit:Assharepricesfall,theoutsidersallstampedefortheexits,causingthebubbletoburstaltogether
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TheAdventofCompany
JohnLawofEdinburgh
TheDutchEastIndiaCompany
Issueofshares
TheworldsfirstStockExchange
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TheOldestShare
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TheFirstBubble
FrenchGovernmentonthebrinkof
bankruptcyforthethirdtimeinacentury.
ThebirthoftheMississippiCompany.
TherunuptotheFrenchRevolution.
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May1719-Nov17201,500,000,001,000,000,0
1,500,000,001,000,000,00
500,000,000
12,00010,0008,000
6,0004000
2,000
May 1719 to November 1720
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TheGreatDepressionof1930 Outputcollapsedbyathird.
Employmentreachedaquarter.
Over10,000banksfailed.
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TheEnronBubble
KennethLay,chiefexecutiveof
Enron.
Thoughtofcreatinganenergybank.
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TheRecessionof2008
Overlendingbybanks.
Thehousingbubble.
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The Bombay Stock Exchange
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TheAscentofMoneyRiskManagement:Insurance,Welfare
StateandHedgeFunds
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Risk Themostbasicfinancialimpulse
WrongPlace:NewOrleans
WrongTime:hurricaneKatrina
AreyouInsured?
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RiskManagementincaseofdisaster
St.Bernard
Bluecollarcommunity
Allhomesinsured
Refusaltopayevengenuineclaims
Limitsofprivateinsuranceexposed
No Home
Insurance zone
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RootsofInsurance
1744:Settingupof1stInsuranceFunds
2MinistersoftheScotlandChurch RobertWallaceandAlexanderWebster
Unhappyonseeingthestateofwidowsandchildrenofthefellowclergymen
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ThePlan
Hugeamountofcalculations
CarefulAssumptions
Maxnumberofwidowsandorphans
TheKeyPoint:
Notjustthemoneyin-outconcept
PremiumtocreateaFund Investthefunds
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Whatwasrequiredforthisschemetowork?
AccurateProjections
ScottishMinistersWidowsFund-AmilestoneinFinancialHistory
SizeMatters
Easiertopredictpayoutsforeachyear
Precisecalculationoflife-expectancy
CalltheActuarists!!!
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TheWelfareState
Japan
Nationalizetherisk
October1947:Britisheconomist,WilliamBeveridgesIdea
Governmentwillprovide
By1970:Amiracleofeffectiveness
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TheDownside
FatalFlawindesign:
1976:MiltonFriedman
NobelPrizeinEconomics
Chile:outputcollapsing,inflationrising Welfarestatebankrupt
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TheConservativeEconomicRevolution
FriedmanandChilesEconomists
Cutgovernmentspendingby27%
BalancetheBudget
Tightenmoneysupply
LiberalizeTrade
ThePensionScheme
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Isthereanyotherway
HedgeFunds
Futures
Options
Size:$598trillion
Downside
ORInvestinahouse?
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TheAscentofMoneyThe Real Estate Market
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Infinance,theconventionalwisdomisthatthereisnothingsaferthanlendingmoneytopeoplewithproperty.
Bytheendof2006,Americanowneroccupiersowedasumequalto99%ofUSGDP,comparedto38%,about50yearsback.
Beforethe1930s,onlyabout40%ofAmericanhouseholdsbelongedtoowneroccupiers.
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ROOSEVELTS NEW DEAL AnewHomeOwnersLoanCorporationwassetupto
refinancemortgageonlongertermsupto15years.
AFederalHomeLoanbankBoard,setupinthe1932. ThisgavebirthtoanewbreedofinstitutionscalledSavings
andLoansthattookdepositsandlenttohomebuyers.
FederalHousingAdministration(FHA)soughttoencourage
largefullyamortizedandlowinterestloanswhichlaidthefoundationforanationalsecondarymarket.
Astheaveragemonthlypaymentonamortgagereduced,homeownershipbecamearealizabledreamformany
Americans.
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CONTINUING REFORMS GovernmentSponsoredEnterprises(GSE)wassetup.
AsapertofGSE,FannieMaewassetuptoissuebonds
andusetheproceedstobuymortgagesfromSavingsandLoans.In1968,FannieMaewassplitinto:-
GinniMaetoservepoorborrowerslikemilitaryveterans.
RedefinedFannieMaewhichcouldbuyconventionalaswellasgovernmentguaranteedmortgages .
In1970,theFederalHomeLoanMortgageCorporation(FreddieMac)wassetup.
CommunityReinvestmentActof1977putAmericanbanksundergovernmentpressuretolendtothepoorerminority
communities.
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FALLOF S&LS UnderPaulVolcker,inabidtocutinflation,theS&Lswere
atthereceivingend.
Startedlosingmoneyonlongtermfixedmortgages. Startedlosingfixeddepositstohigherinterestpaying
moneymarketfunds.
ManyS&Lscollapsedbecauseofrecklesslending.
ThefinalcostoftheS&Lcrisisbetween1986and1995was$153billionor3%ofGDPofwhichtaxpayershadtofoot$124billion.
Thiswasthemostexpensivefinancialcrisissincethe
Depression.
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SECURITIZATION LewisRanieriofSalomonBrotherspioneeredtheconceptby
bundlingthousandsofmortgagestogetherasthebackingfornewsecuritiesthatcouldbesoldasalternativestogovernmentandcorporatebonds.
SinceamajorityofthemortgagesenjoyedanimplicitguaranteefromFannieMae,FreddieMacandGinnieMae,thebondsusedtosecuritizewereperceivedasgovernmentorinvestmentgrade
bonds. Between1980and2007,thevolumeofGSEbackedmortgage
backedsecuritiesgrewfrom$200millionto$4trillion.
In1980,only10%ofthehomemortgagemarkethadbeensecuritized.By2007,thishadrisento56%.
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ROLEOF POLITICS PresidentGeorgeBushsignedtheAmericanDreamDown
paymentActof2003tosubsidisefirsttimehousepurchasesbylowerincomegroups.
Lenderswereencouragednottopressborrowersforfulldocumentation.
PressurewasalsoputonFannieMaeandFraddieMactosupportthesubprimemarket.
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THE FINAL WORDS Itlookedasthoughsecuritizationwasallocatingrisktothose
bestabletobearit.Butactually,itwasbeingpassedontopeoplewhounderstoodtheleastaboutit.
Therealestatemarketsawabigbubblewhichhadtoburstatsomepointoftime.
Incitiesallovertheworld,housepricessoaredabovelevelsandpoliticiansfuelledtheboombyencouraginghome
ownershipandintroducingsuitablepolicymeasures. Thetendencyofmanymiddleclasshouseholdstoputvirtually
alltheirincomeintoahighlyleveragedinvestmentdefiesthebasicprinciplesofriskmanagement.
Thekeytofinancialsecurityshouldbeaproperlydiversified