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We like to think that when we deposit a dollar at the bank, it goes into a big vault and we can pull out that same dollar at any time. But that¿s not how the U.S. banking system works. Banks take that money and invest it to make money themselves, so cash gets spread around. This, naturally, leads to a big risk: What happens if those investments go sour? Well, you¿d be out of luck. You can¿t get your dollar back.
The Federal Reserve doesn¿t like that scenario, so it prohibits banks from putting all the cash it has on deposit on the line. In fact, the Fed forces banks to keep a portion of their assets at the Federal Reserve itself, to make sure that some of your assets won¿t get squandered if the bank¿s bets go south. These are called ¿reserves,¿ (hence, Federal Reserve. Got it? Good), and usually amount to 10% of the total cash kept in checking accounts.
These reserves are never exactly 10%, and banks like to keep a little extra in reserve ¿ not, as you might think, to make you more comfortable that they¿re in good financial shape, but rather so they can take that excess and lend it to other banks and make money off it. (They¿re banks, they can¿t help themselves.) The rate at which they make these loans is called the Federal Funds rate, which is set by the Federal Reserve¿s Federal Open Market Committee.
When you hear people chattering about how the Fed cut or hiked interest rates, this is what they¿re talking about: the interest rate banks can charge for lending money from their reserves. This begs the question: If these are essentially loans between banks, why is the Fed Funds rate so important for the rest of the economy?
Well, simply put, because loans make the financial world go round. Bank A lends Bank B $10,000 at a Fed Funds rate of 5%. Bank B then lends out $10,000 to a small business at 7%. The small business then takes that money and expands the business and hires new workers. Now someone is employed, Bank B has made interest off the loan, and Bank A is the richer for making it all happen. It¿s perhaps overly simplistic, but you get the idea. When you want the economy to thrive, you make lending cheaper.
Of course, sometimes you don¿t want the economy to thrive. In fact, you might want it to cool down, mostly to avoid money flooding the system and causing inflation. In that case, the Fed raises interest rates, making it difficult to lend or borrow.
Home / Markets / Industries / Finance
Monday, May 05, 2008
Where Warren Buffett is Looking to Invest
FOXBusiness
Warren Buffett would consider a $40 or $50 billion deal within the next year, according to an exclusive interview Buffett gave Fox Business Monday morning.
When asked if he would engage in a $40 or $50 billion deal before this time next year, Buffett said, “If it was a good one, I’d figure out a way to do it, yeah.”
Within the next year, Buffett said he hopes to find “another company or two to buy. Big ones, absolutely, elephants,” he said. “We’ll keep trying to do more of the same, and we do have the best board in the country. And we have a company that has the resources to do big deals, and I just want to be on the radar screen so when big deals occur, my phone rings.”
Buffett also said he would consider increasing his stake in the Pohang Iron and Steel Company, South Korea-based POSCO (PKX)
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| Exclusive Interview With Warren Buffett and Bill Gates |
“Yeah, I think about increasing the stake in Posco, based on price and what other things we are doing, but Posco is a terrific steel company, and it’s priced pretty reasonably," Buffett said.
Asked what he might do with one million dollars to invest, Buffett said, “I could find better things to do with a million dollars probably in Korea than I could probably find in this market.”
Bill Gates, who joined Buffett in the interview, commented on the Yahoo deal.
“We, Steve Ballmer the CEO, announced on Saturday in his letter that we walked away and that we’re pursuing an independent strategy so that’s where the focus is and obviously we have a strong competitor in that category so we need to do breakthrough software,” said Gates.
“Steve [Ballmer] has done a fantastic job. If you take what’s happened to the earnings and sales since he’s been CEO, its well more than doubled. It’s phenomenal. If you do a comparison back to that period, where all the tech stocks, even Microsoft, even though we said, ‘hey this all seems very wild to us and crazy,’ you know, that’s a comparison, but in fact, the strength of the company has never been greater. And what a management does, is they just build that strength, they don’t let the volatility of the market determine how they’re making good business decisions. And so, you know, we’re being rewarded, relative to say, three years ago for the good work we’ve done."
With regard to the international economy, Buffett said he is a supporter of free trade.
“I believe in … as much free trade as possible. I do think we have a problem in a large trade deficit that has to be addressed at some point. But I would not address it in any way by penalizing specific countries, specific products, and in the end, you really do want countries to do what they do best and encourage as much possible free trade,” he said.
Gates agreed that “the benefits of free trade to consumers of all countries are pretty phenomenal.” “There’s rarely a thing that’s a clear win-win, and for countries that engage in trade, it’s a win-win, and it’s a little scary to see that we’re not articulating to the public the fact that trade is a key reason why the United States and its economy has been able to do so well,” Gates said.
Gates said that Microsoft was not immune to the recession.
“So far the Microsoft numbers have been very healthy, but in no way can the technology sector be immune if the economy is slowing down. In fact, technology spending is often the thing that goes up the most as the economy grows, and goes down the most as people are seeing the economy contract. We are seeing good numbers so far, but you know, all the discussion may put people in a more conservative mode, so we’re trying to make sure we’ve got our bases covered.”
Buffet spoke a bit about sustainable energy, and said he not think that ethanol was the panacea to the nation’s energy plans.
“My gut reaction just from listening to everything is that it is not. That doesn’t mean that other bio fuels might not be of interest, but I have not been impressed with the case for ethanol,” Buffett said. He added that he was not a supporter of tax-free gas this summer.
“I don’t think it makes sense to take off the gas tax for a certain period during the summer. We probably should have been taxing gas more over the years… The idea that you take a gas tax away for three months doesn’t make much sense to me.”
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