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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.
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Friday, July 18, 2008
*Revised* Analyst Reports for Allen-Vanguard Corporation, OPTI Canada Inc., EXFO Electro-Optical Engineering Inc., and Trinidad Drilling Ltd.
Comtex
LONDON, Jul 18, 2008 (MARKET WIRE via COMTEX) ----MaybachFinancial.com is one of the fastest growing independent and unbiased research firms in the world. Through our numerous partnerships with many of the top investment minds in the world, we provide research on companies making a move in the markets. Investors seeking genuine analyst opinions on their investments for Allen-Vanguard Corporation (TSX: VRS), OPTI Canada Inc. (TSX: OPC), EXFO Electro-Optical Engineering Inc. (TSX: EXF), and Trinidad Drilling Ltd. (TSX: TDG) should take this opportunity to get free in-depth research by signing up for a free membership at www.maybachfinancial.com. Our coverage of any company will include research in the following areas:
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Copyright 2008 Market Wire, All rights reserved. ********************************************************************** As of Monday, 07-14-2008 23:59, the latest Comtex SmarTrend� Alert, an automated pattern recognition system, indicated a DOWNTREND on 06-12-2008 for EXFO @ $5.18. For more information on SmarTrend, contact your market data provider or go to www.mysmartrend.com SmarTrend is a registered trademark of Comtex News Network, Inc. Copyright � 2004-2008 Comtex News Network, Inc. All rights reserved.
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