Complexities of U.S. Financial System
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U.S. Financial System
U.S. Financial System is made up of numerous different markets for diverse products offered on a various trading platforms and exchanges. Among the many products traded are stocks or equities, fixed income securities, foreign exchange, commodities, derivatives etc. Financial market helps to keep the wheels of the economy moving by allowing individuals and businesses either to invest their excess funds in different products or to sell their products to raise cash when they want to. That is the market offers liquidity- the ease of buying and selling without any loss of value- to buyers and sellers. Some intermediaries such as banks, investment banks, insurance companies, pension funds, and asset management companies- may be involved in between buying and selling.
Role of US Federal Reserve: Federal Reserve System is the central banking system of U.S.A. The main roles of U.S. Federal Reserve are to manage the monetary policy for maximizing employment and for keeping inflation stable, to supervise and regulate banking institutions, to maintain the stability of financial system, and to provide financial services to depository institutions, government, and foreign official institutions.
Federal Reserve System’s structure is made up of Board of Governors or Federal Reserve Board – Washington D.C, and twelve regional Federal Reserve Banks. A major part of the system is the Federal Open Market Committee (FOMC)- which consists the Board of Governors, the president of Federal Reserve Bank in New York, and Presidents of four other Federal Reserve Banks, who serve on a rotating basis.
Under the Chairman’s Leadership, the 7-member Board of Governors of the Federal Reserve plays important role in all the activities of the Federal Reserve System. Apart from its supervisory role, the board plays active role using the monetary policy and influencing money supply by changing federal funds rate- the overnight rate at which depository institutions trade funds among them. This federal funds rate is targeted to impact the interest rate at which businesses and general public borrow money. The Board can also set the reserve requirement rate on transaction deposits and sets the discount rate at which Federal Reserve Banks provide short-term loans to depository institutions. It also supervises activities of regional reserve banks. As Federal Reserve is subject to congressional oversight, by law, the Chairman reports to Congress twice annually on the Federal Reserve’s activities and monetary policy and testifies before Congress on numerous other financial issues.
Complexities: But Federal Reserve’s role as a central bank has become questionable- mainly because of the mistakes it made in managing monetary policy. Critics point out that the Fed was partly responsible for global financial crisis of 2008 was because it maintained low interest rate in the economy leading to the housing bubble; also it was late in admitting that a crisis existed even at the close hours of credit crunch. Also it has been ineffective in its role as regulator and supervisor of depository institutions. Its policy of printing money without keeping any asset base like gold or silver is inflationary. Also such rising inflation is having a negative impact on the value of dollar. The weaker dollar would have been good if USA was a net exporting country, but it is a net importer i.e. its import costs are higher export earnings. Oppositely, higher net imports give rise to more inflation. Additionally, as US sovereign rating is high, a weaker dollar does attract foreign creditors or investors with excess funds, who have investments in US treasury bills, treasury bonds and other corporate assets. But debt servicing or interest payments to those creditors mean more dollars is going out of the country. But as economy slows down, employment generation gets main focus, thus more money supply is required. So a cycle has been created which is leading to weaker US economy- for which Federal Reserve and its policies are largely blamed.
Interest Rate Impact: Interest rate affects the economy in stock and bond prices and yields, consumer and business spending, inflation etc. As U.S. economy is well connected to the outside world, interest rate on U.S. does impact global financial market to some extent. Economy assigns an equilibrium interest rate to every market. For example- interest rate and bond prices have inverse relationships. If interest rate is high, bond prices will be low, which will attract domestic and foreign investors to invest in those treasury and corporate bonds and vice versa. Rising interest rate causes the consumers and businesses to save more and cut back spending. This will reduce business earnings and stock prices will fall.
Exchange Rate Decision: A business’s decision whether to operate in foreign environment varies according to situations in exchange rate. If a country’s currency is undervalued compared to business’s native currency, then it makes investment in that country, ceteris paribus. Similarly, when looking to take profit or cash out of the country, businesses want that country’s currency to be stronger than its native currency. So because of the risks of see-saw effect of exchange rate, businesses look for stable exchange rate in a country to decide on foreign operation. In U.S. case, as dollar depreciates, it will become attractive for new foreign investors to invest in U.S. for long term, but businesses may find it more profitable to reinvest profits in the country, rather than take profits out.
Conclusion: Complexity of the U.S. Financial is immense given the debt-based nature of the economy and lack of oversight from regulators. Though not feasible in globalization age, efforts should be made to make economy self-sustaining and less indebted.
References
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Financial Markets of the United States. (2010). Retrieved 11 01, 2013, from U.S. Department of Treasury: http://www.treasury.gov/resource-center/faqs/Markets/Pages/finmarketsfaq.aspx
2. Federal Reserve System. Retrieved 11 01 13, from Wikipedia: http://en.wikipedia.org/wiki/Federal_Reserve_System
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4. Board of the Governors of the Federal Reserve System. (2008). Retrieved 10 31 13, from Federal Reserve Bank of New York: http://newyorkfed.org/aboutthefed/fedpoint/fed46.html
5. What Is the Role of the Chair of the Federal Reserve System?, Retrieved 11 01 13, from For Dummies: a Wiley brand: http://www.dummies.com/how-to/content/what-is-the-role-of-the-chair-of-the-federal-reser.html
6. Criticism of the Federal Reserve. Retrieved 11 02 13, from Wikipedia: http://en.wikipedia.org/wiki/Criticism_of_the_Federal_Reserve
7. A Weak US Dollar: How Does that Impact You?. (2007) Retrieved 11 02 13, from Daily FX:http://www.dailyfx.com/story/topheadline/2007/09/27/A_Weak_US_Dollar__How_1190910183231.html
8. How Interest Rates Affect Market. Retrieved 11 02 13, from Investopedia: http://www.investopedia.com/articles/stocks/09/how-interest-rates-affect-markets.asp
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