Financial Markets
What’s the Role of Financial Markets?
Companies, real estate, and commodities are traded in financial markets, including the stock market, bond market, foreign exchange (currency) market, and others. These financial markets play a crucial role in the economy. They serve as intermediaries between businesses and investors and help businesses raise money to expand. Values are set by the markets and those who trade in them.
What Can You Learn from Monitoring the Market?
By monitoring financial markets and looking at the stocks included in them, you can get a sense of what’s important to producers and consumers. This can also give you some indication of the state of health of the macroeconomy.
The use of computers and technology has reduced the costs of and removed the barriers once associated with buying or selling stock on the actual floor of the New York Stock Exchange and other exchanges. Today, most trading is online.
Numerous brokerage firms and app companies have even made investing a possibility for minors. With the help of a trusted guardian, online brokerage firms, such as Stockpile, let adults buy gift cards that allow you, as a minor, to buy fractions of shares of stock with as little as $5, $25, $50, or $100. Owning even a fraction of a share of Disney, McDonald’s, Microsoft, Apple, or another stock could inspire you to learn more about the goods produced and the services offered by the company.
Bull and Bear Markets
As stock prices change, the financial markets rise and fall. These movements are called changes in “the market.” At the beginning of the 1950s, the Dow stood at 200. It reached 1,000 in 1982, 5,000 in 1995, over 11,000 in 2006, and more than 26,000 in 2018. Historically, investments tied to the Dow earn about 7 percent over long periods.
When “the market” rises for months and stock prices are rising, on average, people are motivated to buy. This trend is called a “bull market.” In contrast, the “bear market” indicates a continuous drop in financial markets. “Bears” sell their stock shares and go into hibernation because they expect stock prices to continue to fall.
You need to know that there are risks associated with stock investments. Knowledge and research, possibly provided by financial experts, will help you in making strategic stock decisions.
Government and Financial Markets
Having explored how businesses can raise money to invest in themselves and how creditors lend with the hopes of receiving a return, you may be asking, what does this have to do with the role government plays in the financial markets?
Big Idea
The government’s role in the financial markets is to protect their integrity and efficiency. Government is needed to protect integrity and efficiency when people and businesses invest for growth.
With respect to financial markets, the federal government has taken numerous steps to ensure the banking system remains competitive and efficient. This is important if businesses are going to be able to identify productive capital projects and successfully secure financing for them. The federal government is also responsible for addressing system-wide failures in markets.
FDIC
In 1933, the United States Congress created an independent agency called the Federal Deposit Insurance Corporation (FDIC). In response to a historic number of depositors with checking and savings accounts withdrawing their bank deposits during the panics of the early 20th century, the FDIC began to insure customers’ checking and savings deposits. In doing so, the federal government minimized concern that the banking system would fail. The reduced risk motivated depositors to return to banking, increasing the amount of loanable funds for businesses and expanding opportunities for savers and investors to benefit from the power of compound interest.
SEC
In 1933, the United States Congress also created the Securities and Exchange Commission (SEC). The SEC protects the buyers of stocks, bonds, and other securities from fraud, deceit, and misrepresentation. It does so by requiring corporations to provide the public with the same financial information that is available to corporate insiders, including risk factors.
The next year, Congress passed the Securities Exchange Act of 1934. It prohibits insider trading, which occurs when confidential information about securities—hidden from the general public, especially stockholders—is misused by people who work at a company.
Think About It
If you were given $1,000 today to invest in stocks or bonds, which would you choose and why? How would you make your decisions?
If the government wasn’t playing the role of referee in these savings and investing institutions, do you think people would risk their money, feeling safe that they would get it back in the future?
The Effect of COVID-19 on Financial Markets
Because the COVID-19 pandemic had an immediate and significant effect on consumer and business demand and supply, it also affected the financial markets. Three major U.S. exchanges, the Dow Jones Industrial Average, the NASDAQ Composite, and the S&P 500, all closed at new record highs on February 12, 2020 prior to an understanding of the COVID-19 crisis as a pandemic.
Then on February 24, 2020, the Dow dropped more than 3 percent as the spread of coronavirus extended outside China, where it was first detected in November 2019. Subsequently, the financial markets continued to fall, and, on March 9, the Dow had its largest drop in a day, more than 2,000 points. Panicked investors sought to sell, triggering multiple "circuit breakers," required halts of sales, that paused the market. That same day, the S&P 500 fell by 7.6 percent and oil prices fell by 22 percent. The losses kept coming. An even greater drop occurred three days later, March 12, and another the following week.
Massive corrections intermingled with these drops, causing bounces in the markets. According to CNBC, the Dow jumped 6.4% on March 12 for a more than 20 percent increase, the best three-day move since 1931. The S&P 500 was at 2,630, up more than 20% from its low of 2,191 earlier that week.
According to the Wall Street Journal, In March 2020, many Americans were sheltering in place and cut retail spending by a seasonally adjusted 8.7%, a record amount. The country’s industrial production plunged at the steepest rate in more than 70 years.
What caused these significant declines? Investor fears of a recession that would be caused by prolonged months of reduced activity.
Governments around the world took action, announcing interest rate cuts, loan programs, stimulus packages, and various other actions designed to signal stability and raise investor confidence. By mid-April, financial markets, while below their February highs, were well above their March lows.
It’s worth noting that individual companies seen as having solutions and thriving despite the crisis (for example, certain technology and pharmaceutical companies) saw their stock prices soar, even during the greatest downturns.
Crises don’t last forever, and they provide opportunities as well as challenges.
Summary: The Role of Financial Markets
In order to have a healthy economy, we need our businesses to grow and our consumers’ money to grow. This happens when individuals save and then use those savings to invest in businesses through loans, stocks, and bonds. These transactions happen in financial markets. Businesses take this money and invest it in their businesses, meaning that they make long-term choices to grow the businesses. They then pay their investors back, plus interest.
This helps answer an important question: how can government in a mixed market economy help consumers and businesses prosper, even in times of crisis? Even in a limited government, it is necessary for the government to play referee to keep these financial markets fair and efficient, and to step in when there in a market failure.