What Is Near Money?
Let me explain near money to you directly: it's a term in financial economics for non-cash assets that are highly liquid and can be easily turned into cash. You might hear it called quasi-money or cash equivalents.
Key Takeaways
- Near money refers to non-cash assets that can be easily converted to cash.
- Financial analysts view near money as an important concept for testing liquidity.
- Central banks utilize the concept of near money in classifying assets as either M1, M2, or M3.
Understanding Near Money
As an analyst, I use near money to understand and quantify the liquidity of financial assets and how close they are to being cash. You should know that near money comes into play in various market scenarios. It's essential for analyzing corporate financial statements and managing the money supply. In wealth management of all kinds, near money acts as a gauge for cash liquidity, converting to cash equivalents, and assessing risk.
Near money and near moneys have been shaping financial analysis and economic thinking for decades. I see it as key for testing liquidity. Central banks and economists use it to determine money supply levels, with the 'nearness' factor deciding if assets fall into M1 or M2.
When we talk about near moneys, we're referring to all of an entity's near money assets together. The nearness varies based on how long it takes to convert to cash. Other factors like transaction fees or withdrawal penalties can affect it too.
Examples of near money assets include savings accounts, certificates of deposit (CDs), foreign currencies, money market accounts, marketable securities, and Treasury bills (T-bills). Keep in mind that what counts as near money can differ depending on the analysis you're doing.
Personal Wealth Management
In your personal wealth management, near money is a big factor in determining your risk tolerance. It typically includes assets you can convert to cash in a few days or months. If you rely on high liquidity, you'll go for low-risk, short-term options like high-yield savings accounts, money market accounts, six-month CDs, and T-bills—these give low returns but minimal risk of loss.
If you have more cash built up, you can extend the nearness to get better returns. For instance, a two-year CD has a longer maturity and higher expected return, placing it farther on the spectrum than a six-month one.
Beyond those low-risk choices, you have higher-risk options like stocks. These can be sold and converted to cash in a few days via market trading, so they have short-term nearness. But their volatility means you might end up with less cash when you need it immediately.
Corporate Liquidity
For businesses, near money and its nearness are central to financial statement analysis, especially balance sheet liquidity. This shows up in key ratios: the quick ratio and the current ratio.
The quick ratio focuses on assets with the shortest nearness, usually within 90 days. These include cash equivalents, marketable securities, and accounts receivable. You calculate it by dividing these quick assets by current liabilities, showing how well a company can cover liabilities with its most liquid assets. Generally, a higher quick ratio means better capability to handle current liabilities.
The current ratio goes a bit further, including assets convertible to cash within a year. It divides all current assets by current liabilities to assess liquidity over that one-year period.
The Money Supply
Economists build on the near money concept by dividing assets into tiers like M1 and M2 for money supply analysis.
The Federal Reserve has three main tools to influence money supply: open market operations, the federal funds rate, and bank reserve requirements. Adjusting these affects the money supply tiers, which is crucial for central bank policy.
When deciding policy, Federal economists look at M1 and M2. M1 is narrow money, focusing on cash—it includes coins, demand deposits, and checking accounts, excluding near money. M2 includes near money with intermediate nearness, adding savings deposits, time deposits under $100,000, and retail money market funds to everything in M1.
In the U.S., the Fed uses M1 and M2 for policy, and it stopped reporting M3 in 2006. Remember, near money is part of M2.
Money vs. Near Money
In any near money assessment, you need to distinguish between money and near money. Money is cash in hand or in the bank that you can access on demand for transactions. Near money takes some time to convert to cash.
You and businesses need actual money for immediate obligations. In central bank terms, M1 is mostly real money. Near money isn't cash but assets easily turned into it. The specific assets and their nearness will vary by analysis, and it's a factor in all financial decisions.
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