Morgan Stanley to Buy E-Trade for $13B

Also I don't define front running that way, FINRA does.

https://www.finra.org/rules-guidance/rulebooks/finra-rules/5...

Liquidity is unlike hamburgers in that there is a risk profile associated with it if you sell it to anyone who wants it. Adverse selection happens as detailed elsewhere; you lose money on their custom, potentially a lot of money relative to the margin on your product.

Certain buyers of liquidity are, like essentially all buyers of hamburgers, functionally riskless. You can profitably sell your product to them at a positive margin all day long, at virtually any quantity they could demand.

Payment for order flow is setting up a liquidity stand in a place where you structurally only get the non-risky customers. That liquidity stand is, like a hamburger shop, a cash machine, and justifies CapEx and OpEx to run. Part of the OpEx is paying your landlord for prominent placement of your liquidity stand in front of willing customers who are buying that sweet, sweet liquidity you're selling.

The price of liquidity changes moment-to-moment based on market conditions but is effectively standardized by law nationwide (NBBO). You are not overcharging your customers for liquidity; they pay the same price literally anyone in the country buying it in that instant does and you can, at your option, discount it further to reward them for buying it from you.

You are making superior margins on their custom because you don't inevitably lose lots of money by being in the liquidity business. The liquidity stand down the street is doing the same thing; your vicious competition against each other has caused the prices for your product to crater, to the enduring joy of the people who line up daily to buy your liquidity.

If that economy expands without corresponding increase in the money supply, then prices go down (because there are more stuff, but the same amount of money, so the same amount of money now represent more stuff). But this represents a deflation, which would auto-magically counteract the expansion, because it would incentivize people to wait and spend just at the last minute. (Time value of money and all would revert, wages would fall, fixed amount mortgages would start to spiral out, and all the regular deflation doomsday scenarios.) So the central banks make sure that even in an expanding economy the money supply "stays ahead" of the expansion of the economy. Targeting 2%. (And usually falling short, so inflation is somewhere between 1-2%.)

So holding money did not became worthless, quite the opposite, holding cash is now better than holding it in a bank. But the central bank has only a few policy tools available, and one of them is the interest rate manipulation.

The central banks want to encourage people to make some investments, to take on some risk, or at least spend. Sure, one way is to simply fund the government, as that usually seems the least risky. And it's not like there's nothing to spend on - the Green New Deal and co, but governments are quite reluctant to do so.

Yep, but in the longer term (decades), all other things being equal a country that is saving 2% will have less investment taking place than that same country saving 5%.

> Banks most reliant on retail deposits have the strongest incentive to convert their EL (excess liquidity), created by the APP, into loans - and our results document that they did so.

One problem is we don't have clear insight into how risky these loans are. If a bank is incentivised to give out loans just to avoid having to pay the central bank interest, it may end up taking on riskier loans than it otherwise would have (if it didn't think they were too risky, it would already have made them). And even if this is not the case, and it's only giving loans because now even a low return of e.g. 0.5% looks good, there's a limit on how cheaply it can offer loans because it still has to cover all its own costs.

>Isn't the problem that the market rate would lead us to deflation?

Empirically it's not clear that would definitely lead to worse outcomes. Europe and the US managed to sustain high rates of growth during deflationary times throughout the 19th century, and while there were crashes during that period they weren't as severe as the Great Depression. In the short run it would definitely be painful, as savings rates increased, but there's a hard cap on this. E.g. everybody needs to eat, they're not going to starve themselves for a week just because food will be marginally cheaper next week. Like how people kept buying computers during the 2000s even though the price of compute was halving every year.

There's an interesting argument for why deflation is bad that I read in a labour economics textbook once, termed wage stickiness. Essentially, if there's deflation we might see labour prices falling every year (but falling less than other prices, so purchasing power still increases). Wage floors (minimum wages, inflexible contracts) however prevent this from happening, prevent the market from clearing. This is one reason unemployment was so bad during the great depression: wage floors introduced by the government to stabilise things ended up preventing wages from adjusting to the new price levels, causing unemployment as the value of good produced wasn't enough to pay those wages. Imagine if the price of every good fell by 90% today: suddenly a $10 minimum wage would be the equivalent of a $100 minimum wage in real terms, causing massive unemployment.

Politically, that's a hard problem to solve, so I can see why many people prefer inflation.