Speculative Motive For Money Demand In The News

See Americans Chasing High Interest Rates Risk Falling Into a ‘Cash Trap’: Investors must decide whether to sit on their cash or redistribute it ahead of expected rate cuts by Vicky Ge Huang of The WSJ. Excerpts:

"Bob McGovern is in no rush to move his cash.

The 66-year-old retired banker and his wife have about 60% of their nonretirement assets in Treasury bills and money-market funds that are paying yields of around 5%. With plans to buy a second home in a warmer area, they expect to keep it there until the Federal Reserve cuts short-term interest rates to 4% or below.

“Until then, I’m just going to keep it in cash. I like the safety,” said McGovern, of Grosse Pointe Woods, Mich.

Americans have poured money into cash-like investments since the Fed began raising interest rates, driving assets in money-market funds to a record $6.12 trillion earlier this month, according to the Investment Company Institute. Now, Wall Street traders are betting rates have peaked and those investors face a choice: keep sitting on their cash as interest payments shrink, or figure out how to redeploy the money."

"staying on the sidelines risks missing out on years of potential gains from holding a broad portfolio of stocks, bonds and other riskier investments.

J.P. Morgan Asset Management calls it the “cash trap.”"

"Some investors cite reasons other than attractive interest rates for sticking to cash. Frank Hammond, a 72-year-old retiree in Pittsburgh, said he is nervous about November’s presidential rematch between President Biden and former President Donald Trump. Geopolitical tensions, including escalating conflicts in the Middle East, are another reason for worry."

Money Demand: How much of your wealth you wish to hold as cash. 

The article mentions "cash-like investments." An example would be your money in a money market account. It earns interest but it is very easy to get your hands on it. You can usually just call your fund or go online to get money transferred into your checking account. But it probably earns less interest than, say, the stock market (which is riskier). And it won't be as easy to convert your stocks to cash.

We all have assets. Our cars, clothes, other possessions, money in savings, stocks, etc. But we hold some as cash. The amount we wish to hold as cash is called Money Demand.

Why do people hold money if interest income has to be given up?

This leads us to the money demand motives.

Money Demand Motives

1. Transactions Motive-We hold some cash (or money in a non-interest paying checking account) to pay bills, like food, rent, etc. These are regular payments.

2. Precautionary Motive-We hold some cash (or money in a non-interest paying checking account) for emergencies like car repairs.

3. Speculative Motive-This is when you hold cash waiting for the interest rate to rise on an investment (like a CD or certificate of deposit) so you don’t get locked in to a low interest rate.

Example: Suppose a 1-year CD pays 4% right now (this means that you give the bank $1,000 today and a year from now they give you $1,040). But if you think the interest rate will rise to 5% next week, you wait and hold some extra cash now.

In the article Bob McGovern is holding cash waiting for interest rates to fall. He is speculating that they will fall so he is holding cash for the time being.