How Money Markets Operate? Essay

Money markets refer to a subsection of the fixed-income industry where short-term financial instruments of high liquidity are sold and bought. The money market includes several short-term trading instruments such as commercial papers, treasury bills, and bankers’ acceptances. The main purpose of any money market is to fill the void in any economy’s short-term credit needs. Nevertheless, the money market differs from the capital market because most of the former’s instruments mature after only a short time.

The money market is not limited to physical currency trading but it also encompasses trade in other short-term instruments that are either sold in wholesale or retail terms. For example, in most countries money market occur in terms of commercial papers and treasury bills among other non-currency tools. The overall goal of money markets is “to facilitate the efficient transfer of short-term funds between holders and borrowers of cash assets”¹.

This paper aims to assess money markets as well as how they operate including their context within international economies. Money markets developed to their current states when it became clear that money was a major tool in the global financial system². Currently, most money market instruments have a maturity period that is less than one year. Although, money markets are often confused with bond markets, the latter is distinguished by its short maturity periods.

In the global context, money markets are part of vast and distinguished international monetary systems. All economies around the world use money markets to fulfill their short-term lending and borrowing needs. Money markets were a replacement for commodity markets that were fairly common in the previous centuries. Gold is still a preferred trading commodity in modern markets and it is also one of the earliest.

For example, in the 1600s France had the biggest gold reserve for trading purposes in the whole of Europe³. Maintaining a balance in the money markets can determine the fate of an entire economy. Furthermore, only free markets have shown the resilience that is necessary to accompany the fluctuations in demand and supply of the money markets. After the Dutch economy collapsed in the late 1700s due to demand and supply uncertainties, the government took charge whilst upholding the spirit of the free market⁴.

Capital markets serve a purpose that goes beyond the short-term lending and borrowing needs. Furthermore, individuals rarely feature in the money markets although they are well represented in the capital markets. Large economies have subsequently big money markets and vice versa. The demand and supply of money market instruments is subject to normal market forces. It is also important to note that money markets are part of both capitalist and socialist systems. Nevertheless, their modes or regulation and presentation in these two systems are different.

Access to money markets in various economies around the world is limited to local institutions. The use of middlemen in these markets is also common especially in capitalist economies. Other than economic players, money markets are also subject to political influences. Political stability is synonymous with health money market environments and vice versa. All governments endeavor to use their money markets to create harmonious investment tools that can bring together financial institutions, citizens, and government policies.

The main distinction of money markets is their short-term assets. These assets can be bought or sold and have a maturity period that can range from twenty-four hours to one year. Furthermore, all these instruments of exchange can be easily converted into cash-based currencies at the convenience of their holders. All money markets have ready facilitation/disposals for “bank accounts, certificates of deposit, interbank loans, money market mutual funds, commercial paper, treasury bills, repurchase agreements, and securities lending”⁵.

In modern economies, the money markets make up a significant share of the entire financial system. For instance, money markets account for at least thirty-five percent of the entire United States’ economy according to recent statistics. The only unique factor about most money market instruments is their maturity periods. In addition, most of these instruments are issued under different sets of guidelines and regulations.

Fannie Mae and Freddie Mac are two institutions that are tasked with the distribution of money market securities. However, these two institutions operate under regulations that seek to oversee the best interests of both the government and the populous. In 2008, the interests of the money market consumers were overlooked when Freddie Mac and Fannie Mae gave subprime mortgage money to retail banks and who in turn made quick and cheap loans to people to finance homes without telling them that interest was going to go up quickly as a result”⁶.

Fig 1. Table showing trends of March 2012 sales of short-term securities over periods of fifteen years and thirty years⁷. The trade indicates the interest rates of most securities remain stagnant over the short-term and keep adjusting over the long-term.

Money markets are universal and they can be found in any country across the world. In socialist economies, there are limitations to the diversity of money market instruments. For instance, both Singapore and Qatar have money market instruments⁸. However, as a capitalist hub Singapore offers a wide range of market instruments than Qatar, which is a socialist economy. Nevertheless, it is important to note that both of these countries have similar economic dynamics.

Liberal markets are the hallmark of money markets because economic policy makers rely on them to effect the distribution of funds to the parties that need it at any given times. In lecture 1 on “Origins of a Political Economy”, it is noted that President Roosevelt used the money market skills of Lord Keynes to save America from slipping into another financial depression. Keynes advised Roosevelt to “to pump money into states and regional government…and once states and regional governments had access to that revenue money, it became their responsibility to create banks”⁹. Banks are important agents in money markets and they can use the instruments of this trade to stimulate growth in any section of the economy.

Commercial banks are the main facilitators of money markets. Most money market instruments are distributed through the commercial-bank networks. Consequently, in any given country commercial banks act as suppliers and consumers of money market products. The market dynamics that are subject to the operations of commercial banks are expected to create a viable balance in this market. First, commercial banks are surcharged with the distribution and collection of currency.

This process often relies on the millions of citizen-operated checking accounts that are held through various commercial banks. These accounts are responsible for movement of market instruments from wholesalers to retailers and then to individuals who act as consumers. In instances where money markets prove hard to regulate, commercial banks are often used by governments to correct any imbalances. In the history of the United States, commercial banks have been used to correct money markets. For example, in the Lectures on “Political Economies” we encountered incidences where both Franklin Roosevelt and Bill Clinton influenced money market dynamics during their presidencies¹⁰.

Another main participant in the money-market field is the central bank. Central banks act as the regulators of commercial banks in any country¹¹. Consequently, central banks have a huge stake in the control of money markets as well. In liberal economies, central banks act as overall bankers for the commercial banks as the latter deposits their money into these organizations¹². On the other hand, central banks hold cash reserves on behalf of countries and their financial institutions. In regards to money markets, central banks have the ability to issue out these reserves to financial institutions if a need for them arises.

International money markets are often subject to the control of central banks. These institutions act as gateways to all international monetary transactions as well as rates of exchange. One of the purposes of the monetary reserves that are held within central banks is to ensure that the demand for national currencies does not outstrip supply at any given time. To correct these monetary imbalances, central banks sometimes use other forms of exchange such as gold standards.

In addition, globally accepted currencies such as the Euro and the dollar are a common fixture in the international money markets. It is important to note that the currency exchange markets are subject to both internal and external factors. For example, if a country produces less than average it often relies on imports. Consequently, the country’s currency will be less valuable if other countries are not interested in its domestic products.

There are various categories of money market instruments and they are all aimed to satisfy certain market segments. Bank deposits make up the majority of the market but they are only considered as legitimate instruments when ‘certificates of deposit’ are issued along with them. Bank deposits are mainly influenced by an institution’s creditworthiness or government’s policies in regards to these instruments. At times banks receive loans from other banks and this scenario creates another form of money markets.

Commercial paper is another form of money market instrument and it acts as an acknowledgement of any debt that is unsecured. Only large and reputable organizations are in a position to trade in commercial paper¹³. The creditworthiness of any financial organization is subject close scrutiny when it is offering these promissory notes. Treasury bills are among the most common money market instruments. Treasury bills are often given out by governments and their maturity periods range from a month to a year.

The buying and selling of treasury bills is subject to a fixed interest rate. In modern economies, treasury bills are also issued electronically and traded as such. Repos represent a late entrant into the money market and they are characterized by their relatively short maturity periods. Repos are issued on “short-term basis…usually no more than two weeks…where a borrower sells a security it owns for cash and agrees to buy it back from the purchaser at an agreed time and with interest”¹⁴.

Money markets are characterized by their trade in short-term securities that have maturity periods of less than twelve months. The money market instruments are subject to short-term factors and this minimizes their risk by a significant margin. The main actors in the money markets are commercial banks, central banks, governments, individuals, and other financial institutions. Political climates have a lot of influence on money markets. Most money market instruments are reliant on the creditworthiness of the institutions that issue them. Money markets are continually evolving in line with the needs of the population.

Fig 1. Table showing daily Treasury bill rates data¹⁵

The table above indicates the yield rates of treasury bills that have different maturity levels. It is important to note that although the treasury bills are issued exclusively by the United States Treasury Department, they can be sold as various money market instruments. Consequently, “The ‘Bank Discount’ rate is the rate at which a Bill is quoted in the secondary market and is based on the par value…and the Coupon Equivalent, also called the Bond Equivalent, or the Investment Yield, is the bill’s yield based on the purchase price”¹⁶. It is also evident that instruments with shorter maturity rates (4 weeks) yield lower returns than those with higher ones.

Reference List

Amico, Stefania. “The Federal Reserve’s Large‐scale Asset Purchase Programmes: Rationale and Effects.” The Economic Journal 122, no. 564 (2012): 415-446.

Balaam, David. Introduction to International Political Economy. Upper Saddle River, NJ: Prentice Hall, 2012.

Department of Treasury. “Resource Centre.” Open Government. 2015. Web.

Ehrmann, Michael and Marcel Fratzscher. “Monetary Policy Announcements and Money Markets: A Transatlantic Perspective.” International Finance 6, no. 3 (2003): 309-328.

Goodfriend, Marvin. “Monetary mystique: Secrecy and Central Banking.” Journal of Monetary Economics 17, no. 1 (2006): 63-92.

Lecturer’s Last Name, First Name. “Political Economic Notes.” Lectures, 2015.

McKinnon, Ronald. Money and Capital in Economic Development. New York: Brookings Institution Press, 2013.

Melvin, Michael. International Money and Finance. London: Academic Press, 2012.

Footnotes

1. Michael Melvin, International Money and Finance (London: Academic Press, 2012), 17.
2. Lecturer’s First Name Last Name, “Political Economic Notes” (Lectures, 2015).
3. Lecturer’s First Name Last Name, “Political Economic Notes” (Lectures, 2015).
4. Lecturer’s Last Name, “Political Economic Notes”.
5. Lecturer’s First Name Last Name, “Political Economic Notes” (Lectures, 2015).
6. Lecturer’s Last Name, “Political Economic Notes”.
7. Stefania Amico, “The Federal Reserve’s Large‐scale Asset Purchase Programmes: Rationale and Effects,” The Economic Journal 122, no. 564 (2012): 426.
8. Lecturer’s First Name Last Name, “Political Economic Notes” (Lectures, 2015).
9. Lecturer’s Last Name, “Political Economic Notes”.
10. Lecturer’s First Name Last Name, “Political Economic Notes” (Lectures,2015).
11. Michael Ehrmann and Marcel Fratzscher, “Monetary Policy Announcements and Money Markets: A Transatlantic Perspective,” International Finance 6, no. 3 (2003): 310.
12. Marvin Goodfriend, “Monetary mystique: Secrecy and Central Banking,” Journal of Monetary Economics 17, no. 1 (2006): 69.
13. Ronald McKinnon, Money and Capital in Economic Development (New York: Brookings Institution Press, 2013), 59.
14. David Balaam, Introduction to International Political Economy (Upper Saddle River, NJ: Prentice Hall, 2012), 43.
15. Department of Treasury, “Resource Centre,” Open Government. Web.
16. Department of Treasury, “Resource Centre,”.