Industry sign banking missouri rfp simple
you so today what we want to do is talk about interest rates you remember what we've done up to now is we've calculated interest rates here's how well you know how to interpret here's how to calculate an interest rate but as I said before what we want to do is we want to talk about why why are interest rates whatever they are and this is our next topic for discussion what we have and I referred to it before is supply and demand but there is a model known as the loanable funds model of interest rates loanable funds another term for that is just credit and so this is a model of the credit market and we're gonna talk about a lot of detail but basically what it comes down to is a supply and demand model and we've seen supply and demand and other economics classes there's always a quantity down here on the horizontal axis when we draw supplying a man and there's always a price on the vertical axis but here is the quantity of credit and then on the vertical axis it's the price of credit which is the interest rate and so that really and I mean that's a very simple model but it gets a job done and it accurately depicts what takes place in the credit markets so anyway that's going to be what we present if that's all there were to it then we'd be done but there are a lot of details that go in that for us to understand it first of all let's talk about the demand for credit the demand for credit is also refers to borrowing okay people who demand credit this is not demand like give it to me or else that kind of a demand this is a need for credit or request for credit right okay and the people who demand credit or need credit those are borrowers okay now if we just said who borrows the answer is pretty much everybody and so that's not going to be an adequate way of attacking this what we want to do when we talk about the demand for credit or borrowers is we want to talk about the groups that are net borrowers if we say everybody borrows it and well then okay that's not really what we want we want to know who borrows more than they lend who on balance borrows funds okay I borrow I'll and I put money in the bank I have savings and so forth I put money away for retirement those are funds that are supplied in credit markets and I also borrow which group am I in am i a borrower and my lender and the answer is for me or for you or for anybody your net position depends on which one of those you do more up are you borrowing more than your linear' you lend you more than you borrow it okay well once we get away from the individuals and just talk about groups there are two groups that are net borrowers in the US credit markets that borrow more than they lend and the first group is businesses and the second group is government and so we want to talk about their behavior and how they demand credit how they do why they do and so forth what motivates them what that relationship looks like let's first of all talk about businesses business demand for credit most all borrowing done by businesses is to finance an investment in capital goods and inventories okay now when I use this term investment here's what I don't mean I don't mean it like the man or woman on the street means that term investment I do not be buying stocks and bonds when we talk about businesses investing in capital goods what we mean is by these capital goods these would be tools equipment structures software and I'll say etc stuff that can be used to make other stuff okay and inventories sometimes businesses borrow to purchase inventories and these inventories are either materials or finished goods General Motors has inventories of materials they may have some inventories of steel for example they may have inventories of tires on hand to put on cars and then they also have some finished goods some inventories of just cars sitting out here waiting to be sold and I don't know about General Motors operations but they any other business may go up borrow some money in order to finance these inventories right you don't just have a car set in here and say then hey that costs nothing somebody's got to pay for all the stuff that went into that car in order to produce it in order for it to just sit there waiting to be sold so anyway so this is the motive why business would demand credit I've never seen that formula before this is a formula for present value if you'll go back in your notes and you don't actually have to do this because you'll probably remember but what I told you is that when people invest when they make investment decisions this is a formula they use to evaluate those investments and so if you were gonna go out let's see you're running some business and you say gosh I'm thinking about buying I don't know I'm thinking about buying some kind of a tractor a backhoe or I'm thinking about buying a delivery truck I'm thinking about buying a dump truck or I'm thinking about buying you know some piece of equipment which you would have in mind is if I get that equipment that will increase my future profits I can go out and do more work now I can charge for more work and so there's future money that will come back from that tractor or whatever it is that you're thinking about buying and the same thing would be true if you said here's structures if you say oh we're gonna build a new warehouse out here then hey now that we have a bigger warehouse we can store more stuff we can sell more stuff profits go up so there'd be the future returns but then what we'd have to do is reduce those future returns to present value and we've got this formula when do we get the returned obviously I don't have the Sigma sign up here and that would be relevant in virtually every case where there'd be a stream of future profits from this capital investment but I just want to slim this discussion down as much as possible so we've got these future profits from the capital good the same thing would be true from the inventories okay and then we want to see on does that future profit when we bring it back to present value what's it worth okay and we do that and we can just make up some hypothetical number here's a hundred thousand dollars is the future money that we're gonna get from this $27,000 tractor $84,000 tractor or whatever we calculate we do the division present value and maybe that we come up with some number here's a hundred thousand dollars we're reducing it back to present value and let's say it's worth $75,000 and so now what we're thinking is this I'm ready to go shopping for a tractor I've done all my due diligence I've done all my projections out here what I can generate in the future I've reduced those numbers to present value a new tractor be worth $75,000 from here a new truck so now we go and we start pricing these when we start getting some bids on it and so what will happen maybe somebody says hey here's the price of the truck the price of let's say capital equipment and they may give us a quote and they say something like this seventy thousand dollars and so now we say hey this is pretty good it's the best price I can get on this equipment I've been looking at I can buy that for seventy thousand dollars all those future profits hundred thousand dollars and it generates in the future I reduced that the present value and those are were seventy five thousand dollars I'm gonna do it so we buy that capital equipment we make the investment okay now what was the interest rate I used here I didn't tell you okay because this is a hypothetical example let's say it was I don't know six percent hypothetically and and that all worked out we buy the equipment now what happens if interest rates rise in the marketplace and now we can't borrow money at 6% now a reasonable discount rates not 6% now at 7% and we go through we've got the same hundred thousand dollars in the future we calculate present value and now it comes out to sixty eight thousand five hundred dollars do we make that investment do we buy that piece of equipment no why because I don't spend seventy thousand dollars to get back sixty-eight thousand five hundred that's a loser and so what we have let's draw a little bit of a graph here what we have is something like this business investment in capital goods and inventory I won't write all that out this is a dollar amount there's an interest rate and what we've got is a relationship that looks like this and what that relationship says is at lower interest rates there are more of these yes answers yes I will buy that capital equipment and when these discount rates go up and we do the same calculation then there are more of those investment opportunities where we say no okay and so in the first answer and this was just one investment decision among not only what this one company faces a company might be thinking hey should we get some new desks for the employees shall we get some new computers should we get some new software should we build onto the side of this building and should we get some tractors and delivery trucks and so forth or a wide range of investment decisions that a single company makes and then throughout the economy there are more and more of those and so what happens is it doesn't go from 6% yes the 7% know for everybody at the same time even within one firm some projects at that point become noes and others still are good investments but the relationship is this every time that interest rate gets higher in this formula we have present value goes down this is this inverse relationship we talked about before every time interest rates go up the present value of capital projects go down and we say no to more of those projects and so higher interest rates are associated with less and less investment and vice versa during those times when interest rates are going down present value of these projects is going up and then there will be lower interest rates more investment and those periods when we have we haven't gotten to a check but expansionary monetary policy it's pushing interest rates down low interest rates business are saying hey this would be a great time for us to add on to our factory this would be a great time for us to get that new robot this would be a great time for us to do whatever and so lower interest rates more investment in capital goods okay what we're interested in here is business borrowing and so some businesses pay for their investment capital goods pay for it out of their own cash flow what they're generating out of their profits some companies will sell stock some companies will borrow the money and we're not interested in the companies that do this through their cash flow we're not interested in the companies that pay for these capital goods by selling stock these are issues that come up in the field of corporate finance how are we gonna finance our business okay but we are interested in those capital projects that are financed by borrowing and so basically what we're saying is this is they'll lower the interest rate the more we will go out and borrow to finance capital projects and also to hold inventories now what inventories are we talking about I gave a couple of broad examples here but truthfully you go around town you go to a car dealership most car dealerships are holding finished goods cars out there on the showroom either on the showroom floor or out in a lot they have behind that with the high fence they borrow the money to finance those inventories if you go to a lot of drug stores or grocery stores or clothing stores a lot of those borrow the money in order to buy the inventory to set it out here and put it on display then you buy that merchandise and then they take the receipts from the sale and pay off the bank loan and not all on the same day but that's the idea city utilities that sells us this power to light up the room they buy materials city utilities will buy coal and that train comes in there might be a hundred cars of coal and they dump that coal and now city utilities has an inventory of coal and then they will burn that and turn that into power and sell it to us we send our a check in at the end of the month to pay the bill and now city utilities has the money coming in to pay off that bank loan okay so this is just ordinary business and so the utilities just to take as an example will have a bigger sort of inventory of that material if they can borrow that money more cheaply and when they have to pay more to borrow that money if interest rates are 10 or 12 percent they might have a much smaller inventory of that coal why well because if that hill of coal out there cost them 10 million dollars and they're paying 10 percent to borrow the money at 10 million dollar inventory of coal 10 percent interest were paying a million dollars a year to have that cold piled up out there if interest rate went down to 5 percent it only cost us a half a million dollars a year to keep that inventory of coal out there and so we'll have a bigger inventory same theories any questions about this this is a demand curve I'm gonna put a D next to it and I'll put a B next to that with its business demand for credit questions about this a demand for what just it's the demand for credit by these two groups the businesses are the first ones that we're talking about but they are borrowing money for these purposes to invest in capital goods or and structures or inventories by those the first group we talked about just businesses okay any questions about this any other questions okay let's talk about the second group government oh people say so much about the government okay government who makes decisions by government on borrowing money an answer is they don't do it that way here's what happens is here's government spending and then we subtract government tax collections and then the borrowing is the difference right I'm gonna put a turnip here that we'll discuss so if we have a situation where and we'll just pick out hypothetical numbers let's say the government spends three trillion dollars nah they could never do that yes it could let's say government spends three trillion dollars and then collects and taxes two trillion dollars and by the way the government does have a little bit of revenue over and above taxes okay there are some fees that are charged and so forth but for the most part taxes we're talking about revenues coming in but if the government spends three trillion writes checks for it and gives those checks to people or transfers it in their accounts and so forth and collects two trillion dollars hey there's a shortfall how can you spend three trillion and only have to coming in an answer is or the difference so one trillion dollars is the budget deficit this is kind of like if let's say you're running the government and you wanted to go out and buy three trillion dollars of stuff and you only had to treating come in then you get your credit card out and use the credit card for the other one trillion that's a big credit card balance you'd be carrying now a few notes about this one of them is this budget deficit all of these numbers that we're talking about here three trillion to try and one trillion and so forth these are annual one year twelve months so when you hear somebody talk about the government's deficit that's an annual figure okay now suppose you've got a credit card you went out and borrowed a trillion dollars this year and then you got your statement at the end of the year would it just say one trillion dollars and that's it an answer is well it would be what the balance was before the Year started and another trillion right so if you have borrowed in the past like several trillion dollars and then this year another trillion then the balance on that statement wouldn't be one trillion the one year figure it would be the amount accumulated over the years and so what we have is another concept of national debt and that is accumulated deficits over all time Oh - surpluses we don't have a lot of those but we don't want to forget about the theoretical possibility that there's a surplus and so when would these have started a long time ago there we go that is the that's the easy answer that will not get you through a test a long time ago what happened 1789 that is when the United States was created right before that way there were the the colonies of the English colonies and
then those colonies became independent not only of England but of each other and there was a confederation just a bunch of really what would be independent nations thirteen of them they all threw end together throw off the yoke of oppression fought that out war ended when it started in 1776 right when did that war in Boyde this stuff is hard didn't it I mean how long you been living in the United States most of you you know there's gonna be a foreign student get an answer to this right 1783 war was over okay and then what 13 countries knock County in Alaska in Hawaii thirteen independent you know New York and New Jersey in Virginia and Massachusetts in blah blah blah blah blah blah was the last three and then they went along here said okay we got what we wanted then after a few years they said boy this is not so good we could do better and then they all got together and said hey you know what we ought to do yeah just like all of us get together in one big country US Constitution 1789 so at that point we had a going Enterprise 1789 that's when the Constitution was ratified these thirteen states got together thirteen countries got together and filled out this this constitution made it all up send it back to the individual states individual states ratified it and when they ratified it in 1789 then we had the United States and at that point the government said okay we're in business let's get a credit card and you know they did not charge much on the credit card in those early years and they also didn't collect much in taxes those numbers are pretty small back in the old days and over the years they've grown so anyway today the national debt is it's all the deficits these are annual put that again the annual deficits and then the annual surpluses well over the years every year there's either a deficit or a surplus it could be the exactly imbalance exactly a zero there but boy that's hard to do you know if you had a bunch of those balances somebody just said here's a dollar the budgets out of balance so in terms of it being exactly balanced that's not a realistic possibility but anyway every year a deficit or a surplus and then the deficits are causing that credit card balance to go up and the surpluses that's when you're paying it off and we haven't been paying off much lately for a long time we paid off a little bit in mid to late 90s not much I think what we had was two years I'm gonna say a paying off a little bit a little bit of a surplus in the late 90s President Clinton was in office then we had wound down the Cold War a lot of military spending was no longer occurring he kind of makes me smile and then public policymakers of Congress the Federal Reserve the US Treasury Department some economists you know what they were sitting around their sin oh boy what happens if we pay off all the debt and they started like getting worried about that anyway that passed after I two years and so anyway then we went back to everyone in deficits before that and I don't know the exact date but let's say 1998 just to put a number on it I can look these numbers up and so could you anyway had a couple years of modest surpluses before that you had to go back to 1969 to find a surplus so we're talking about 30 years in between surpluses then since then we've been talking about deficits and so now the national debt is ballpark figure 10 I'm gonna put a plus trillion dollars and very recently the Congressional Budget Office Congressional Budget Office is it sounds like a Budget Office reporting to Congress that's what it is the Congressional Budget Office has a bunch of economists and accountants and different people working form staff members and they made a forecast and here's what they're and nobody knows but they said this we forecast over the next ten years that we're gonna run deficits year after year after year and those will acute and not any surpluses and those deficits over the next ten years will be nine trillion dollars and so if they are right then you add another nine to this and this will be approaching 20 trillion dollars when we all get back together for our ten-year reunion here in this room I've already put in a reservation for it okay so anyway what I'm saying to you is huh if it took us 200 in what would be 20 years more or less to run up ten trillion dollars worth of debt it's gonna take us ten years to run up not quite see the thing is I'm really not optimistic so I probably think this will be more than nine but anyway we're just about gonna double this in a 10-year period the good news is this I am gonna die and not pet thing off on this and I will leave that to you yes sir oh we know what the national debt is that's accurate this number is the one that's you know we won't know until after the fact how much debt accumulates because the thing is this doesn't take into account what's gonna happen with new laws being passed and things like that but in terms of how much is the debt accumulated right now yeah pretty accurate and you could get on your iPhone or whatever and find that out and just know do you do that 11.8 no that couldn't be once you here's the thing that's wrong with those numbers I'm not saying it's not actors as far as it goes some of that is government owing money to other government agencies some of that is governmental money the Federal Reserve and so then we started saying hey or you know as the Federal Reserve gonna make us pay that back that sort of thing so anyway 1012 I think it's not that high really in terms of the number that Congress worries about which is what we're coming back to here in a moment anyway but anyway so what we're gonna do is add another nine trillion dollars worth of debt my guess is more over the next decade Wow but the good thing is that's a record nobody's ever done that before not in the whole solar system I mean this is not just for the United States this is a record for our solar system but per and possibly for the galaxy the Milky Way galaxy they make good candy bars back to our story what was our story we want to understand this why is this one trillion or two trillion or whatever the numbers are going to be who makes the decision who makes a decision on how much government is going to spend because nobody makes a decision on the deficit okay they make a decision how much to spin they make a decision how much they collect in taxes and then the deficit is the difference okay so who makes these decisions anybody Congress Congress with presidential approval and it's the same thing with taxes right our tax laws are passed by Congress and the president signs it I'll put this formula back up here for present value can you kind of see this I mean you can watch c-span and see how this all works in action have you ever seen any of these people in Congress safe huh what would be the present value of that highway how much does it cost to build that highway you know I don't think that highway is gonna produce enough future revenues or benefits to justify that the present value of that and highway you know its value as an asset is let's say 1 billion dollars it cost us 1.5 billion dollars to make it know do they do that no no they don't do that so they don't really go about it you know here we had businesses they don't really go about it that way how do they go about it like if you're in Congress and you're sitting on a committee and maybe it's a committee that considers highways what you're thinking be hey we need a highway to come to this town that's in my district I'm representing the whatever the 48th congressional district in Missouri Missouri doesn't have 48th district I'm representing this district we need better highways here and somebody says we need better highways in Iowa and you say no you don't oh you've got an Iowa's corn corn doesn't drive you don't need highways Missouri we need highways right and then the guy from Iowa or gal the member of Congress says hey I'm not gonna go along with you having a highway if we don't get one I didn't say okay well I'll go along with yours you go along with mine and so everybody gets a highway and did they ever go hey the present value of that mmm no let's don't do it you don't hear that term tossed around a lot these are political decisions is that bad no that is not bad if I were running for office from Missouri's 48th district and I've got to have votes and I'm on the committee that build highways I'm thinking what am I gonna do to get reelected am I gonna jump up and say that is a total waste of money you're not building a new highway through my district because you know what's gonna happen if I say that the person I run against the next race is gonna get a video of this videotape and they're gonna give it to all the TV news stations in town and I'm gonna be standing up there and saying present value and I am gonna lose the next race right so this is not really the way the calculations done and there's another problem with this what are those benefits these hi let's say this highway is gonna be built through here or let's say that there's gonna be a dam built or a bridge or anything like that my time horizon is different than the time horizon of that project I'm thinking about the next election two years if I'm gonna send it it could be two years or four years or six years but if I'm a president four years or no time horizon because there's no more reelection but the time horizon of the decision-maker in Congress tends to be whatever the political cycle tells them and these projects don't have that same time horizon and so there's kind of a mismatch now what about that for businesses if you're a business the business has an infinite life the people who buying stock in it now I don't mean to say that the people who are running a business have infinite tenure in their jobs as a CEO or something like that but the people who are buying stock in a business are thinking hey what's that company worth and so then they are buying stock and a company that can generate profits this year next year two years five years ten years twenty years thirty years from now here's a business and so there is a way in the stock market for us to take all those future profits and bring them back to the present and that's how much we are willing to pay for that share of stock but there is not a way for all these future benefits of projects to be brought back to the present in the political world and so it just ends up being done at the polls and the elections and so then it's kind of like put a high priority on now yeah I'm gonna build a highway it's gonna cost a billion I don't know it's gonna provide a billion dollars with the benefits it costs a billion and a half dollars but you know what a billion and a half dollars gonna be paid in the future we're gonna borrow the money and maybe borrow it on a 30-year bond and then somebody else can worry about paying for it you don't look like a free highway we're gonna borrow the money on our credit card we'll pay it off in 30 years and by 30 years from now I'll be dead the politician says 30 years from now I'll be out of office I'm not gonna worry about the cost I don't worry about the benefit so anyway I don't mean to say there's something bad about these people in Congress because that would be the position you or I would be in if we were running for Congress to our incentives would be the same we'd be in a bind so anyway when we start talking in about the analysis it'll be something like this the Congress will get together and they'll negotiate with the president and so forth but they'll get together and they say we need this highway we need that aircraft carrier we need this new hospital veteran's hospital we need to do this or that with Social Security and they'll say what we need to do to spend money at the state and local levels they have their own needs we need a new prison we need a new Elementary School we need to fix the potholes in the roads but they'll go out and I say we need these things and they're being influenced by voters by the public and then they'll say well let's go out and borrow some tax people up to the point where we can and they've done all these things based not on the economic calculations but on some other basis and then they come up with numbers and then I've written down three Trey and two trillion and so when we draw a graph of what looks like here's what credit needed to finance the deficit there's a demand for funds by government and it is based on all of these political calculations political is not a dirty word it's just not an economic calculation so it's different in nature but this is the spending minus the taxes and that's how much we need to borrow you have you ever heard on c-span or something like that at congressmen say you know interest rates are pretty high let's just don't build these highways no I've never heard it I've paid a lot of tension over the years to c-span and I'm not saying they're wrong I'm saying they don't consider things that way because they have different things that influence their behavior so they don't take a business approach they're not supposed to if it were business we'd have businesses run the government and we don't so I mean we intentionally take certain things activities out of the business world and hand it over to government so we shouldn't I'm not trying to evaluate them like this is a lousy business you're running I'm just saying it's not run like a business okay so anyway now here's what we do we've got to demand curves that we've talked about I'll put the other one right here here's the quantity of borrowing by businesses and we had this demand curve DB and so what we want to do is add these up how do you add two curves together it's like this watch just put a plus sign in the middle hmm what do you think that's the add sign equal of course we draw another graph over here in theory what we would do is we'd have the bottom axis the horizontal axis lined up all the way across here interest rate quantity of credit and then we would just pick some interest rate like let's say three percent I put a horizontal line across here and we've got the government borrowing a certain amount let's just put a number down here doesn't make any difference how much it is 50 dollars and we've got businesses barring a certain amount let's say three hundred dollars and then what we would do is say hey 350 plus 300 is unless I'm mistaken 350 and that's when the interest rates three percent we've got it dot well then I guess that's time to do that again let's say the interest rate is 6% dot dot horizontal line all the way across we're gonna add along that horizontal line hey we've got still fifty billion dollars or $50 I should say by government the business sector now 200 so 50 and 200 is these are just too easy aren't they 250 now in theory we do this at every possible interest rate three point one percent three point two percent three point three and so then we would just generate a whole series of dots over here and though it's a whole series of dots would trace out a curve no my hands left would trace out a curve that's a downward sloping curve and it would go through these dots that we made and this is the total demand for credit this process is called horizontal summation horizontal summation of the curves okay questions on the other side of the market we had three groups I said we're going to talk about the sectors the groups that are net borrowers on the supply side of the market we have the lenders there are three groups that are net lenders that lend more than they borrow the first group households people most of the households that are comprised of students borrow a lot more than they lend and so most of the student households will be on the other side of the market but when we take all households together we've got a lot of people who have their life savings people who are retirees have their life savings and they got most of them have their houses paid off we put all households together households are net lenders to the extent of trillions of dollars a second group of lenders banks and the Federal Reserve and we'll talk about how but they are working together in this process that we will discuss and the third group of lenders that will consider our foreign lenders people o
erseas save money and they want to loan that money out to somebody to get interest and they'll own a lot of it the people just down the street from where they live but some of their savings works our way to the United States okay what we're gonna do is have a curve that is associated with each one of those groups of savers we will add those three curves to get it we get a total supply curve and that will be next time so long
