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Just to see the difference between these last two borrowing options.

I'd like you to kind of look at this, this diagram

and see if it, if it makes sense to you.

The last option we talked about was where governments

borrow in their own currency on the domestic market, primarily.

And this is the way it works.

So, let's just kind of walk through it, because it helps us

to understand some of the terms that we read in the papers.

Over on the left, we see the government is issuing bonds,

like we just said in their own currency domestically, all right.

And the first transaction is between the government

and these market makers or these primary market dealers.

We call this, these first two boxes here, are the primary market.

And normally what happens is the government

has auctions scheduled throughout the year, all right.

They may happen every couple of weeks.

All right.

They're scheduled.

Shortly, before the auction, the government

will say, okay, we're going to need

to borrow x amount at the next option, at the next auction.

And so, the primary dealers are ready with the bid.

All right.

They're saying, I'm willing to lend you money, government.

I'm thinking about this interest rate.

And so, the auction takes place on the scheduled date.

And, that's a transaction between those first two

boxes there, the government and these primary dealers.

And, an interest rate is set on those bonds, all right?

The government gets its money and it goes back home.

And goes about its business, all right?

The government has its money and it has it at a set interest rate.

It's the interest rate set in that auction, all right?

But that's not the end of the picture.

Then what happens is that those primary dealers turn around and they sell,

they resell those bonds to other institutions, other individuals.

And those bonds then go to live out there

in that third box, which is the secondary market.

And they live there in a sense, until the day of their maturity.

So if it's a ten year bond, imagine the

government prints the paper, sells it to the primary dealer.

The government has their money for ten years, they

know how much they have to pay for their money.

All right?

And the government goes and spends it.

They don't have to think about that bond again for ten years.

When somebody will present it to the

government and the government will pay them.

Okay?

But that bond then is resold by the primary

dealer and goes to live in that secondary market.

Where it may be bought and sold dozens of times until the day of its maturity.

Well who buys and sells these bonds in the secondary market?

There are a lot of people.

So we've got financial institutions, we've got pension funds, insurance funds, banks.

That what they do is they have some savings, they have

some cash, and they want to earn some interest on it.

Well a very safe way to earn your interest is to buy a government bond.

Because you know, number one, that the

government won't default, we're crossing our fingers.

We know the government will not default on that bond,

you will get the money back when the maturity date comes.

And second you know, that a lot of other people want those bonds.

So if I decide that I need my money before ten

years are up, I can turn around and resell it to somebody.

And they'll give me the equivalent of what that bond is worth before ten years.

So financial institutions are very active.

And then households and firms are out there.

Corporations will have savings and they'll say we'll let's see what should I

do with my savings leave it in the bank at very low interest.

Or get no interest at all put it in the vault.

Or should I go and buy some bonds.

Which is a very safe way to get some earnings.

So they'll buy bonds and sell bonds when they need them.

Households do this.

You know, you may have, you may own

some U.S. Savings Bonds, some U.S. Treasury Bonds.

You may have some of your savings in a mutual fund that puts

some of their money into U.S. Bonds for you, so you earn interest.

Governments buy these bonds.

So that's kind of funny to think about.

Why would a government buy its own bonds?

But when you realize that governments also have savings.

They are collecting money from us that they

have to pay us someday in pensions, all right?

And we hope they will.

So they have this cash sitting there and they need to earn some interest on it.

What safer place to put the cash than in their own bonds.

There's no currency risk.

It's not like a stock market where actually you could lose the

initial value of your, of your investment if things go very badly.

It's a bond.

You know you'll pay yourself, so governments buy their own bonds back.

In fact you'll see a lot of times that statistics will refer

to Gross Public Debt and Net Public Debt.

Net Public Debt is just all the money the

government owes minus the money it actually owes to itself.

Okay.

So governments will buy bonds and central banks will buy them.

And we'll talk about this in the next session, but

I want you to be aware that they are there.

And then another group that will come in there and buy those bonds are foreigners.

Foreigners will come and say, you know I really like to have some dollar assets.

Or I've earned all of these extra dollars from exporting to the United States, I

think what I will do is buy bonds with them so that I earn some interest.

Or a foreign pension fund says I'd to diversify my risk.

I've got some British bonds, I've got

some bonds from the eurozone, from different countries.

I've got some bonds from emerging economies.I'd

also like to have some U.S. bonds.

So that there's the diversification in my portfolio of assets.

And so they'll come in by bonds.

Now, what you need to be aware of is that these

bonds can change hands all the time, but they never change nature.

Right?

They are always in, in the case of the United States, they are in U.S. dollars.

Right?

So if foreigners have bought some of our bonds, that does not

convert it into foreign debt, in the technical sense that we've just defined.

That's not foreign debt.

That's Gross U.S. Public Debt.

And the day that we have to repay it, we

will pay it in dollars, not in foreign currency, okay?

I want you to see the difference between this and

foreign borrowing, which is what we see down here below.

Where the government borrows in a foreign

currency at a spread over foreign interest rates.

So, maybe Brazil needs some money.

Can't raise it all on its domestic market in this first

option we see above in the blue, sort of chain of events.

And so the governm, so the the Brazilian

government says, all right let's borrow some dollars.

Now, they may borrow from foreign banks,

from governments, from multilateral institutions, from financial institutions.

The bond may be bought and sold in a

secondary market, but it says U.S. dollars on it.

All right?

This is what we're calling foreign borrowing and this

is the kind of borrowing that implies risks for governments.

Because the currency value could change.

Now, something that we also need to be

aware of when we think about these bond markets.

Often, you read in the papers that the, the risk

premium on a certain country's debt has risen or has fallen.

We read about this a lot during the eurozone crisis.

When all of a sudden the interest rate that Greece

was paying to borrow went way up into the double digits.

All right?

Where that interest rate comes from, initially is that secondary market.

So out in that secondary market, Greek bonds, maybe ten year bonds

are being bought and sold by people and by institutions all the time.

And maybe one day comes when those buyers and holders and sellers

of bonds say I don't think Greece is going to repay this.

We've seen Greece's debt, it's very high.

I think maybe Greece will leave the eurozone they say to themselves.

Then what happens to these bonds that are in Euros?

Can they repay?

I don't think this is going to be worth anything.

So on that day, beginning on that day, as they become

afraid, they may sell those bonds because they rather have something else.

So they're selling those bondsout there in the secondary market.

What happens?

Well, the price of the bond falls because people are selling them.

There is more supply of them than demand.

The price falls.

Now, implicit in that price is an interest rate.

This is not a course in finance.

But all you have to remember is when the price of the bond falls, then that

interest rate that people will obtain for their

money at maturity, it's fixed on the bond.

But if I pay a low price for it, that interest rate rises by implication.

So whenever bond prices fall because

people don't want them, interest rates rise.

Now, if the rate, the interest rate on

those bonds is rising in the secondary market.

That doesn't mean the Greek government has to

pay bond holders more money for that debt.

That bond tells us how much it's worth on the day

of its maturity when the Greek government turns around and buys it.

But, when the interest rates change out there in that secondary market.

The day the government needs to borrow again in

the primary market it will have to pay more interest.

Because primary dealers know what's happening in the secondary market.

They'll come to the auction and they'll say to the government.

Today, I'm only willing to lend you money at that

rate I'm seeing over there in the secondary market today.

This is why, in the eurozone crisis, and we move onto another chart.

You can see this picture now, these are, we call them spreads.

That's the difference between what intr, whatever interest rate these countries

on the right are paying and some risk free interest rate.

In this case, it's Germany.

So we're looking at the difference between the interest rate Germany pays

on its bonds, and the interest rate these countries had to pay.

And you can see these spreads, they're referred to here.

You can see that after the euro started, these

countries paid about the same interest rate as Germany.

But once fear began in the financial crisis, starting

in 2009, and then as the eurozone crisis gets worse.

Look how the interest rates rise for these countries.

The interest rates that first rose in the secondary

market and then made their way into the primary auction.

And became the interest rate that the government had to pay to finance its debt.

I want you to keep this picture in mind as we

talk about what some of these countries did with their fiscal policy.

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¿Cómo hacen los Gobiernos para Pedir Préstamos? (II)

Analizando las Políticas Económicas

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