Thursday, February 25, 2010

Speculatory Demand for Money

In Tuesday's lecture we talked about the speculatory demand for holding money - where people hold money in order to take advantage of some opportunity for earning a return (interest) on their money.

Greece is a natural target for speculation right now: People hold money looking for opportunities to profit from the country's ills. The standard target in this kind of situation is an ailing country's currency, and indeed the euro has fallen in recent weeks as Greece's problems mount. But the fall has been nothing compared to how the drachma would have fallen, had that still been Greece's currency.

An article in the New York Times discusses the role of particular types of financial assets surrounding Greece, assets called credit-default swaps. These are bits of paper bought and sold by traders in financial markets, with something of a twist - they pay out to the holder if some other company (or even country in Greece's case) suffers some kind of credit event - e.g. a default. So they are a way that concerns investors can hedge themselves against a large loss from a bankruptcy.

Of course, given these types of possible assets to invest in, traders are more likely to invest in them (swaps) than actual Greek government debt, meaning that the supply of funds in the market for Greek government debt is drying up, increasing the price in that market, making Greece's situation even worse.

But, these types of financial dealings were exactly the ones manipulated by the Greek government itself to hide the extent of its debt, and clearly these assets are helpful means of insurance for worried investors, hence some snap decision by politicians to ban them would not necessarily be productive in any way in reducing risks and losses and instabilities in financial markets.

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