So today we began the fourth section of the course which extends the money view to capital markets and asset prices. I should begin by saying that this is a very new fangled way of teaching money and banking. that it's still the case. That, that these two subjects capitol markets and money markets are typically in separate courses. Okay, if you took a course in financial markets, that's, that's capital markets. And you're learning cap m, you're learning stuff about securities, security prices and so forth. And you don't hear anything about money markets. Okay? And if you take a money and banking course, typically you might learn IXLM or, or something like that. And you never hear anything about financial markets. Typically their in seperate, seperate courses. And they're, they're often even in separate parts of the University. Finance courses are in the business school and banking cour-, money banking courses are in the Economics department. So there's a sort of intellectual disjuncture there. capitol, between the period capital markets. Which is the province of finance. And money markets, which is the province of banking and economics. As you can see, with shadow banking, this intellectual separation is not in line with the real world. Okay. In the real world, these things are intertwined. Intertwined, and more so today than really, really, certainly since World War II. Maybe since World War I. very much intertwined, so we have to be thinking of them in the same, in the, in, in, we have to, we have to combine intellectually as well, but the, but the barriers, the reason why these things are in separate boxes, has a historical origin. and I think it's helpful to, to build that up, okay. And, and understand why people thought you could separate the capital markets from the money markets. and in fact, the point, the point is that in Bagehot's day they were kind of separate, okay. They were, they were more separate than they are, they are today. So let's just say, in Bagehot's world we know how banking worked in Bagehot's world. We've talked about that a couple of times, okay? That this was about discounting of short term bills. Bills that were issued by firms to finance goods on their way toward final sale. banks discounted these things and, and would, would hold a portfolio of them that matured at various dates, and the liquidity of a bank was, was ensured by that, that, the maturation of these bills, that when they came due there would be a cash inflow. So the banks would have lined up plans for cash inflow by having all these bills. Okay. So we had a bank, here okay. That had bills on one side, discounted bills, and we'll say deposits on the other side. Okay. And these [COUGH] these deposits we'll say are the assets of the primary lender I'm introducing here now, maybe the household. We've never seen the household in this course before, okay, which is interested in holding deposits in order to make payments and so forth. And the issuer of the bills is some primary borrower. Say a business, which is using these bills in order to finance part of its working capital here, okay. So, the bank, from this point of view, is serving the Bagehot bank. Is a kind of intermediary, okay? And we're going to be work, a lot of what we're going to be doing in this next section of the course is thinking of banking as intermediation. Okay? And there's inter-mediation that, that this, these loans essentially to the, these are essentially loans to the bank, to, to the borrower. and it's the deposits that are funding those loans. That's the, that's the idea there. This is a little bit of a different perspective than we've had up til now. This is what we call, indirect finance. And in the Bagehot world, it's in the money market. This is, this is the money market we're talking about. Now, in Bagehot's day. There was also capital market, okay? The government issues bonds. in fact, there were, there, these were, were bonds without any maturity. They were they just paid a coupon forever. and they also issued short term stuff, and corporations sometimes issued bonds, too. They were, they were bond to finance, various kinds of, of large scale projects. and there's equity. Okay. These bond and these equity, were held by, rich people. This was a form of, a form of wealth. And they are held directly, bonds and equity [SOUND]. We might call that direct finance, there's no intermediary in between. There's no other financial institution there. It's just the bonds are being held by, by the primary lender. This is the capital market, okay? Now, these markets were, are linked, everyone appreciates, because when the household is buying these assets, what are they buying them with? They're buying them with their deposit. Okay so they're transferring some of those deposits to the firm, which then uses it to, to, to pay its vendors or to build its machine or its factory or whatever, you know. So that's, that's what the firm is borrowing at the bond, the bond is, the, the, the borrower is issuing a bond The primary is buying it by transferring through deposits to the primary borrower, which is then spending those deposits, to make an investment of some kind. Okay. So there is an interlink between the money market and the capital market there. Okay. But that's just at the moment of issuing bonds. Once the bonds are issued its like all over and is a separate little market. and there are prices these bonds that fluctuate and, and there might be a secondary market and so forth. but it seems like they're, they're kind of separate. The liquidity issue They comes these bills, these staggered timing, okay, isn't an issue so much for the bonds, because no one is making any promise that these things are going to, are going to turn into cash. They're making a promise in the bonds that they'll pay certain coupons, maybe bi-annually or something, but those coupons are small potatoes compared to the, the value of the bonds. Most of the principle of the bond is never, is not promised to be paid until maturity which may be 30 years from now or something like that. Okay, so it's very different kind of instrument than a bill. Some people have argued, the economic historians have argued, some of my professors have argued that the fact that in Britain, this short term money market thing was very highly developed, because Britain was the center of the world economy. You know, the bank of England was the Central Bank for the whole world. This is where world finance, world trade got finance, in the British money market. Okay so this is a sort of hyper developed money market. And they and, and economic historians suggest sometimes that one of the reasons for, for Britain's sort of lagging behind the development of much of the rest of the world after the industrial revolution was because they didn't have as well developed systems of long-term finance. Okay, and in particular, they're banks, the notion that banks might do long-term finance was completely verboten. You know, it had to be, the banks, banks had to keep liquid. There was this cult of liquidity that, that prevented banks from going into the development finance business. You know, if you wanted to borrow long-term, you had to issue a bond or something like that. There was no long-term bank lending. and, now, I don't know if that's true or not. I'm not an expert on Britain, but what I will tell you, is that in the United States, it was a very different situation. Okay, the new world, was different than the old world.
