Each post should be relevant to the topic, contain references to economic concepts, and be at least 150 words (each).

Scoring:

The max score for the entire board is 10 points

Each post will have a max score of 5 points

• 5 points = if post is on topic and includes discussion of economic concepts, and is at least 150 words
• 1 - 4 point = if not on topic, not discussing economic concepts, or not 150 words
• 0 points = if not substantial at all (for example just saying something like: that's a good point, I agree with you)

Discussion Question of the week: Incentives to Save

In chapter 9 you learned about some institutions/ rules of the game that are important for maximizing macroeconomic performance, but that are also very important to you on a personal level. They involve financial markets. The "rules of the game" are as such that anyone who chooses to not spend all their money and instead saves some of it, can put that saved money in a variety of markets. These rules allow dollars to move from low valued uses to higher valued uses, including the expansion of the factors of production. That is great for the overall economy. But on a personal level this is great for your household finances. The different financial markets contain people that plan on using your money in a way that benefits them, and thus are willing to compensate you in some way for delaying your utility, giving up liquidity, and taking on some risk. This allows you to create passive income sources and accumulate your wealth in ways other than selling your time for money in the labor market.

Let's briefly look at the places you can put your savings discussed by the book, the implied agreement within, and the risk associated in each.

traditional banks and credit unions

you agree to put money in one of their accounts (savings, cd's, money market deposit accounts), in exchange they will keep your money safe and pay you some interest on your balances. They, in turn, will pool your money with that of other depositors and make loans to people and businesses.

The risk to you is low here because banks and credit unions are required to carry deposit insurance (you'll see FDIC insured and NCUA insured). And what banks are allowed to do with the pooling deposits is regulated. Also, the U.S. has a good track record of not seizing people's personal accounts for government uses (which has happened in some countries). So, the odds of you losing your money if you put it here is essentially zero. That explains why the interest rate you get on money placed here is also really low, normally below inflation.

bond market

A company or government in need of money decides to issue bonds, which are essentially contracts that detail how they will repay any buyers of the bonds. You agree to buy their bonds, thereby lending them money, in exchange for a defined amount of interest over a defined amount of time.

The risk to you here is moderate to high, depending on the type of bonds you buy - but definitely higher than traditional banks. The interest to be paid to you is predefined, so market volatility won't affect that. If the bond contract says you get paid $50 every 6 months, you get that regardless of if it's a booming economy or a recession. That said, there is a risk the issuer could go bankrupt, in which case they may default on their bonds all together. That could cause you to lose your principal (the money you originally gave them) and the promised future interest payments. Bond risk is based on the likelihood of default. Companies with strong financials are low risk. Countries with robust economies and without excessive amounts of debt are low risk. But there are "junk bonds" you could buy that are deemed to have a higher risk of default. Because of competitive markets, those junk bond issuers will need to offer you more compensation (higher interest rates) to convince you to take that extra risk. When you put your money here you get to choose the level of default risk you are willing to accept.

stock market

A company in need of money to grow their business decides to "go public" and sell shares of ownership (i.e. stocks) to anyone willing to buy it. You agree to buy some of the newly created, publicly traded stocks, and in exchange you gain the possibility of earning dividends and the potential for a capital gain if the value of the stock rises in the future.

(note that only the initial public offering connects savers and the actual firms in need of money. Trading of stocks after that are just exchanges between investors, and don't involve the company. Still all that trading between investors is important because that is where the potential capital gains come from. So, we want the "rules of the game" to allow for trading of stocks with other investors, because that increases the expected value of the ipo and thus strengthens the incentive for savers to put their money here.)

The risk to you here is moderate to high, depending on the companies you invest in - but normally the risk level is higher than with bonds. This is because there are no predefined returns and everything is based on how the company does in the future. Companies are not obligated to pay dividends and the market value of your stock could decrease if investor demand falls. Remember possible dividends and/or capital gains is why you put your money here in the first place, and not in the other options listed. There are ways to systematically reduce the risk you are exposed to, like diversification, or buying stocks through mutual funds, but in general there is more risk here. But the potential returns are higher here as well, which is why people are willing to take that extra risk.

shadow banking system

While the term sounds nefarious, the shadow banking system just refers to all the other places you can put your saved money that is not under the same regulation as banks, the stock market, or the bond market.

Somebody has started a fund or company that plans on gathering money from investors and using that money in some lucrative way, generating returns for them and the investors. (examples include a hedge fund, an investment bank, a mortgage company... the key is that the money comes from investors not depositors). You agree to invest in their plan in exchange for the potential returns on your investment.

In general, less regulated markets are riskier than more regulated markets. After all, that is why these options were invented. Someone wanted to create a financial product or service that could make them money. But they felt like the highly regulated options were limiting their profits, so they invented a new option that was outside of current regulation. Now they could engage in riskier profit seeking strategies. And now you could invest in them and try to benefit from their riskier strategies.

microlending

This fifth one wasn't really covered in the book, but I want to highlight it:

Here someone is trying to gather money to lend to an underserved population because the traditional lenders don't see enough profit in lending to them. This idea was popularized by the work ofMuhammad Yunusin Bangledesh (won him the nobel peace prize), and is now used all over the world. It is now even used in advanced economies like the U.S. You agree to invest money into the microlender, they in turn loan the pooled money out to the underserved populations, normally to start or grow a very small business. In exchange you get a rate of return when the borrower pays the money back.

Risk wise, this may sound high risk. After all, the traditional banking sector didn't see fit to lend to them. But usually, the problem is just the loans are so small, that the banks don't see it worth their time. We are talking like $500 loan to buy a sewing machine, or $2,000 for an oven, stuff like that. You can look at the websitekiva.orgto get an idea about the type of loans we are talking about. Also, there is often an issue with the lack of collateral with these poorer populations, which discourages traditional banks from lending to them. But Yunus developed a model of community collateral, where a group of community members agree to pay the loan back if the primary recipient can't. With this model, repayment rates are quite good, about the same as for any other small business loan, sometimes better. So, the risk level to you is not really different, compared other forms of lending.

As you can see, there are a variety of places you can store your saved dollars that will move those dollars to more valued uses for society (i.e. expansion of the factors of production). But it's also in your self-interest to put your money in these places - you can get passive income streams and grow your wealth outside of labor market activity. This makes them "good institutions" because they align the self-interest with the social interest. For this discussion board, talk about which of the 5 listed options you personally use, and your experiences in them. What was the incentive to pick one over the other? How does your risk tolerance level affect your decision? Do you have goals of someday replacing all your labor market activity (active income) with passive income or withdrawals from your wealth? Would you consider funding a microlender? Anything along these lines is open to discuss. The main point is for you to see how the rules of the game that allow these markets to exist can make you better off on a personal level if you use them.

Also if you don't use any of the 5 options because you don't save any money, talk about that. Why aren't you saving any money? What would need to change to get you to start saving?

(note: for this board lets stick to dollars placed in banks, stocks, bonds, the shadow banking system, or microlenders. I know some of you also put dollars in real estate and currency markets, including cryptocurrencies, but those are not connecting savers and borrowers in the same way these 5 are, and that is part the reason for this conversation. So, stick to the given list of 5. We can talk about the rest of this wealth generating strategies in part 7).