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Chapter 31 Who does capital move for (1)
Mobility Preference: The Economic Consequences of Peace
In 1914, when the First World War broke out, the society was generally worried about a financial crisis. As an expert on monetary issues, Keynes went to the Ministry of Finance to work.His first effort was to persuade Prime Minister Lloyd George to keep gold reserves.By the end of the war, Keynes had established himself in the Treasury and was sent abroad to deal with a series of financial problems.When the peace conference was held in Paris, Keynes represented the British Treasury in the peace talks.

After the peace talks, Keynes resigned from the Treasury to write The Economic Consequences of Peace.This book describes some famous figures and events at that time, including Lloyd George and other figures, as well as the analysis of the society at that time.

Walter Lipman compiled Keynes's writings into a series, Keynes paid for the publication, and Macmillan & Company published them.The book was printed in Edinburgh, and it was transported to London by ship. The ship unfortunately crashed on the way, and 2000 copies of "The Economic Consequences of Peace" were washed up on the beach in Denmark.Under Danish law, books are auctioned locally.The book was finally translated into many languages ​​and sold about 14 copies.

"The Economic Consequences of Peace" is Keynes's famous work.As a world-renowned economist, Keynes' contributions in finance have had a profound impact on later generations.He is most talked about is the famous "liquidity preference theory".

Keynes believed that in the capital market, people have a preference for holding money rather than holding assets such as stocks and bonds that can generate profits but are difficult to realize.Therefore, he put forward the hypothesis of a liquidity trap, which means that when the interest rate level for a certain period of time falls to the lowest level, people will have the expectation that the interest rate will rise and the bond price will fall, and the elasticity of money demand will become infinite. How much currency will be stored by people.When a liquidity trap occurs, no matter how loose the monetary policy is, it cannot change the market interest rate, making the monetary policy ineffective.Keynes believed that when the interest rate fell to a certain level, people's speculative demand for money would become infinitely elastic, that is, people would feel indifferent about holding bonds or money.At this time, even if the money supply increases, the interest rate will not fall again.

The basic point of the resulting liquidity preference theory is to believe that investors do not consider long-term bonds to be ideal substitutes for short-term securities.When an investor accepts a long-term bond, he will demand compensation for the risk associated with the longer repayment period of the bond, which leads to the existence of a liquidity premium.Here, the liquidity premium is the difference between the forward rate and the future expected spot rate.

The liquidity preference theory mainly consists of several parts:
1. Interest rate determination theory: Keynes believed that interest rate is a purely monetary phenomenon.Because currency is the most liquid, it can be converted into any asset at any time.Interest is the reward for giving up liquidity for a certain period of time.The interest rate is thus determined by the supply of money and the demand for money.Keynes assumed that there are two main assets that people can store their wealth in: money and bonds.

2. The movement of the money demand curve: In Keynes’ liquidity preference theory, there are two main factors that lead to the movement of the money demand curve, that is, income growth leads to more value storage, and more commodities are purchased. Changes in income affect people's demand for money.

3. Movement of the money supply curve: Keynes assumes that the money supply is completely controlled by the monetary authorities, and the money supply curve is shown as a vertical line. When the money supply increases, the money supply curve will move to the right, and vice versa, the money supply curve will move to the left.

4. Factors Affecting Changes in Equilibrium Interest Rate: Changes in all of these factors above will cause money supply and demand curves to

The movement of , which in turn causes the fluctuation of the equilibrium interest rate.

5. The impact of the liquidity trap on the interest rate: Keynes pointed out that the speculative demand for money is a decreasing function of the interest rate, and further explained that when the interest rate falls to a certain level, the speculative demand for money will tend to infinity.Because the bond price at this time has almost reached the highest point, as long as the interest rate rises slightly, the bond price will fall, and the bond purchase will have a great risk of loss.Thus, no matter how large the central bank's money supply is, people will hold money instead of buying bonds, bond prices will not rise, and interest rates will not fall.This is Keynes' "liquidity trap".In this case, expansionary monetary policy has no effect on investment, employment, or output

Keynes believed that people's money demand behavior is determined by three motives: transaction motive, precautionary motive and speculative motive.The transaction motive refers to the motivation to hold money for the purpose of purchasing goods and services; the precautionary motive refers to the motivation to hold money in order to prevent accidents; the speculative motive refers to the motivation to hold money for speculative activities.The money demand determined by the transaction motive and the precautionary motive depends on the income level; the money demand based on the speculative motive depends on the interest rate level.Keynes's theory had a great inspiration to the world, and this theory still has many adherents.

Capital Market: Demand and Supply of "Money"
As we all know, Wall Street is no longer a simple street or an area, but a synonym for the world's financial center.The average daily capital circulation on this street is 2000 billion US dollars. Nearly a thousand of the world's largest financial institutions are located here. This is the core and most active place in the global capital market.

If you want to understand the weight of the capital market, you can feel it in the beating numbers and hustle and bustle of Wall Street.

But if you want to understand the history of the capital market, you have to start with the Netherlands.

Around 1600, the number of merchant ships in the Netherlands was equivalent to the sum of the number of merchant ships in Britain and France.It can be seen how prosperous the Dutch shipping industry was at that time.

Later, especially in the 17th century, in 1602, the Dutch East India Company was established, and they continued the trade between the Netherlands and Asia.

The Dutch fleet transports the things that are lacking in other countries' markets, and then ships back the things that are lacking in the domestic market, and the profits are very considerable.However, with only a light boat, you have to sail tens of thousands of kilometers on the sea, no matter how impressive the profits ahead are, those unpredictable winds and waves bring huge unavoidable risks to long-distance trade.

Because sailing is very risky, there may be storms, shipwrecks, diseases, etc. at any time, and the food conditions are very bad. These factors make the life of the sailors very difficult. Once an accident occurs on the ship, not only the cargo will be wiped out, but even the lives of the sailors will be lost. I can't keep it.

The excess profits brought by long-distance voyages are what everyone hopes to obtain, but the huge risks that everyone must bear to obtain them cannot be avoided. So, is there a way to obtain sufficient profits while controlling the risks at the same time? To a certain extent?

As a result, joint-stock companies, stocks, and the stock market were born out of people's need for diversification of investment.

The Dutch East India Company was the first company in the world to publicly issue shares. It issued shares worth 650 million Dutch guilders at the time. It set up offices in six seaport cities in the Netherlands, the most important of which was of course Amsterdam. , the number of shares issued here accounts for more than 50% of the total.At that time, almost every Dutchman bought shares in the company, even the servant of the mayor of Amsterdam.

This is the early capital market.After centuries of development.The scale of the capital market has expanded to a global scale, and the capital market has formed a systematic theoretical system, which is probably beyond the imagination of the Dutch in the 17th century.

The capital market, also known as "long-term financial market" and "long-term capital market", includes places for various fund lending and securities trading with a term of more than one year.The trading objects in the capital market are long-term securities of more than one year.Because long-term financial activities involve long-term funds, high risks, and long-term stable income, similar to capital investment, it is called the capital market.

The capital market is one of the three components of the financial market. It is in sharp contrast to the capital market that adjusts the balance of funds of the government, companies or financial institutions.

The suppliers of funds in the capital market are various financial institutions, such as commercial banks, savings banks, life insurance companies, investment companies, trust companies, etc.

The demanders of funds are mainly international financial institutions, government agencies of various countries, industrial and commercial enterprises, real estate operators, and sales finance companies that buy installment contracts from durable consumer retailers.

Compared with the currency market, the main characteristics of the capital market are:
1. The financing period is long.At least for more than 1 year, it can also be as long as several decades, or even no expiration date.

2. Relatively poor liquidity.The funds raised in the capital market are mostly used to solve medium and long-term financing needs, so the liquidity and realizability are relatively weak.

3. High risk and high return.Due to the long financing period, the possibility of major changes is also high, and the market price is prone to fluctuations, so investors need to bear greater risks.At the same time, as a reward for risk, its return is also higher.In the capital market, the suppliers of funds are mainly savings banks, insurance companies, trust and investment companies, various funds and individual investors; while the demanders of funds are mainly enterprises, social groups, government agencies, etc.Its trading objects are mainly medium and long-term credit instruments, such as stocks, bonds and so on.

Four Factors Affecting Capital Needs
wealth
When the wealth in people's hands increases, there are more resources that can be used to buy assets, so the demand for assets naturally increases accordingly.Therefore, assuming other factors remain unchanged, the growth of wealth will increase the demand for assets.

expected rate of return

An asset's rate of return measures the return earned from holding that asset.Therefore, when people make asset purchase decisions, they must consider the pre-return rate of the asset.If the expected rate of return on the bonds of one company is 10%, and that of another company is 5%, then, obviously, the bonds of the first company, which investors are more willing to buy, will naturally increase in demand.Therefore, an increase in the expected rate of return of an asset relative to other alternative assets, other things being equal, increases the demand for that asset.

Risk
The risk or uncertainty of an asset's rate of return program can also affect the demand for that asset.If the return on stock of Company A may be 15%, it may be 5%, and the expected return is 10%; while the stock of Company B has a fixed return of 10%. The rate of return on Company A's stock is uncertain, so its risk is higher than that of Company B, which has a fixed rate of return.

Although both stocks have an expected return of 10%, investors prefer to choose the stock of Company B (safe asset), while the stock of Company A. Most investors prefer to hold less risky assets.Therefore, assuming other factors remain constant, if an asset becomes more risky relative to other alternative assets, there will be a corresponding decrease in the demand for that asset.

fluidity

The liquidity of capital is another factor that affects capital demand. The so-called liquidity refers to the speed at which the relatively low cost of an asset is converted into cash.Liquidity of an asset if there are many sellers and buyers in the market in which it is traded.For example, it is difficult to find a buyer immediately, so it is not a very liquid asset.Treasury bills are a relatively liquid asset because they can be sold in a well-organized market with many buyers, that is, they can be transferred at low cost.So other things being equal, the more liquid an asset is, the more people will favor it, and thus the demand for it will grow.

Market Equilibrium: A Showdown Between Experts
Equilibrium is a term in physics.In the physics class, the teacher hung a stone with a rope and asked the students: "Why does the stone stand still?" The student replied: "Because the stone is affected by two forces, one is the downward gravitational force, The upward pulling force of the string is equal in magnitude and opposite in direction, and the stone is in a balanced state." The teacher said: "If you use your hand to deviate from the equilibrium position and then let go of the hand, what will happen?" The student replied: "The stone will be on the ground. Under the action of gravity, it swings left and right around the equilibrium position, but the swing range will become smaller and smaller, and finally stay at the equilibrium position.” Marshall introduced the concept of equilibrium into economics, mainly referring to various corresponding and changing conditions in the economy. Power is in a state of relative stillness and no change.In the economic system, an economic transaction is in the interaction of various economic forces. If the various forces in various aspects can restrict each other or cancel each other out, then the economic transaction will be in a relatively static state and will remain in this state. change, at which point we say that economic affairs are in equilibrium.

Consumers and producers decide the quantity of goods they are willing and able to buy or provide according to the market price. With their own calculations, consumers and producers enter the market together, and finally determine the equilibrium of the market.If the market is fully competitive, the existence of excess products will inevitably lead to a price drop. As the price falls, the demand will expand and the supply will decrease. Therefore, the price drop can reduce the product backlog in the market and keep supply and demand in balance.At the same time, rising prices can expand the output of production while curbing consumption.So an increase in price can clear the shortage in the market, thus bringing supply and demand into line.

(End of this chapter)