[Public Lecture Series] Economics #9 Finance and Financial Markets

Hello everyone!
Last time, we learned about the nature of economic waves (business cycles) and the importance of identifying price movements.
This time, we will delve into the mechanism of money, which flows incessantly like 'blood' behind those economic waves.
Today's theme is 'The Function of Financial Institutions.' We will uncover exactly what roles banks and securities companies play in our society.
To start the class, let's think about this realistic question you might face in the future.
“Suppose you come up with an idea for a groundbreaking new AI app in the future and think, 'I want to start a business with this!' You absolutely need 10 million yen for development and to rent an office. However, you only have a few tens of thousands of yen in your wallet right now. So, how would you go about raising this 10 million yen? Think of as many concrete methods as you can.
Would you beg your friends or parents? Or would you go to a bank and bow your head? Or perhaps you would raise funds through 'crowdfunding' online.”
In fact, the entire mechanism for exchanging money between 'people (companies) who lack money' and 'people who have surplus money (people with savings)' is called finance.
By taking today's class, you will perfectly understand the mechanism (the current state) of the greatest lubricant of the modern economy: 'Why don't banks just leave the money they receive sleeping in a safe?' and 'Why are the movements of 'interest rates' highlighted in the news every day?' Let's start right away by exposing the true nature of money!

1. What is 'money' in the first place?: Types of currency and money stock
We use money (currency) as a matter of course every day, but why does mere paper or metal grains have value in the first place?
It is because society as a whole trusts that 'this has value.' In economics, this currency is broadly divided into two types.

• Cash currency: This refers to 'banknotes' issued by the Bank of Japan and 'coins' issued by the government; these two combined are called cash currency.

• Deposit currency: In fact, the majority of money used in the modern economy is not in our wallets, but in bank data. It refers to money deposited in bank accounts that can be withdrawn or transferred at any time via cashless payments or account transfers.

Deposits include ordinary deposits that can be withdrawn freely at any time, and interest-free current deposits used for corporate transactions.
And the statistic representing the total amount of money actually used in the entire economy, which combines these cash currencies and deposit currencies, is called money stock.
“If the money stock (total amount of money) of the entire country were to suddenly double, what do you think would happen to prices in the world? Let's think about this by recalling the knowledge from the previous class.”
If the amount of money circulating in the world is too large relative to the amount of goods, the value of money drops, and the prices of goods rise, making inflation more likely to occur. That is why keeping the amount of money in the entire country at just the right balance is extremely important.

2. Finance as a "Lubricant": Two Flows of Funds
The place that connects companies in need of funds with households (individuals) that have accumulated savings is called the financial market. In this market, there are direct finance and indirect finance, which are two completely different flows of funds. This is the biggest highlight of this lecture and the point most frequently targeted in the Common Test.


Differences between direct and indirect financeDirect finance
Route A
A system where companies in need of funds issue
stocks or corporate bonds (IOUs issued by a company) to raise funds directly from investors.

• Features: The securities companies that act as intermediaries are merely a point of contact. If the company goes bankrupt, the investors themselves directly bear the risk that their invested money will not be returned.

• Common Test Preparation: Among the items issued by companies, stocks are funds for operating the company, so they have "no repayment obligation," but corporate bonds are essentially debt, so they "have a repayment obligation." This distinction is very frequently tested!

Indirect finance
Route B
A system where banks pool money deposited by many depositors (households) and lend it to companies based on their own judgment.

• Features: Households and companies are connected indirectly through an institution called a bank. If a company that borrowed money goes bankrupt, your deposits do not disappear; the bank bears the risk. In the history of Japanese finance, this indirect finance has long played the leading role.

3. "Rental Fees" Called Interest Rates
When borrowing money, you must always pay it back with interest (interest rate) added on. In short, an
interest rate is a "rental fee for money." When you rent a car, the rental fee goes up during popular times when everyone wants to rent one (like Golden Week). Money is exactly the same.

• Demand for funds (those who want to borrow) > Supply (those who want to lend): When there are many companies that need to borrow money due to a shortage, interest rates rise.

• Demand for funds (those who want to borrow) < Supply (those who want to lend): During a recession when no one wants to borrow money, lenders lower the rental fee to encourage borrowing, so interest rates fall.

This movement in interest rates influences corporate capital investment and the ease with which we can take out home loans, acting as a powerful lubricant that drives the entire economy.

4. The Gradation of Financial Markets: Short-term and Long-term
The financial markets where money is lent and borrowed are also classified into two types based on the length of the transaction period.

• Short-term financial market: This is a market for trading short-term funds of "less than one year" as an accounting cutoff. A prime example is the call market, where banks lend and borrow ultra-short-term funds on a daily or overnight basis. The name "call market" is said to originate from the practice of calling for funds via telephone to conduct transactions. The interest rates established here serve as the benchmark (indicator) for interest rates in Japan.

• Long-term financial market: This is a market for trading long-term funds of "one year or more." Funds that require a long time to repay, such as those for corporate factory construction or government bonds issued by the state, are traded here.

5. Diverse Financial Institutions: Roles Beyond Just Banks
Finally, let's look at the types of financial institutions around us and their respective professional roles.

• Banks: These are familiar entities to everyone. Beyond collecting deposits and lending them out, they also possess "settlement functions" for handling account transfers and remittances.

• Securities companies: They mainly support direct finance. They help companies raise money directly from the market by issuing stocks or corporate bonds, and act as a gateway for us to buy stocks (securities companies themselves do not lend money to us).

• Insurance companies: They operate a system (mutual aid) where they collect insurance premiums little by little from many people and pay out a lump sum when someone falls ill or has an accident. In fact, because they invest and lend the vast amount of collected premiums as large-scale capital to companies and the government, they are also financial institutions with enormous influence in the financial market.

Today's "Current Location" and Summary
Let's organize the current location of today's lesson. Money is not just used for shopping; it is delivered to the places in society that need it most through routes called
direct finance and indirect finance. Although the types of financial institutions such as banks, securities companies, and insurance companies differ, they all play the role of an important "heart (pump)" to keep the economy running smoothly.

Important points for Common Test preparation!

1. Currency includes "cash currency (banknotes and coins)" in your wallet and "deposit currency" in bank data.

2. The amount of money used throughout the economy, such as cash and deposits, is called money stock.

3. When companies raise money directly through stocks (no repayment obligation) or corporate bonds (with repayment obligation), it is direct finance. When banks pool deposits to lend out, it is indirect finance.

4. The market that handles funds for less than one year is the short-term financial market, and the place for lending and borrowing between banks is called the call market.

Next time, we will learn about the "bank of banks" that controls this flow of money, the super powers of the Bank of Japan (BOJ). The meaning of "rate hikes and rate cuts" you see in the news will make perfect sense!
That's all for today's lesson. Thank you for your hard work!