Chapter 10

Money anything that serves as a medium of exchange, a unit of account, and a store of value

3 Uses of Money 1. Medium of exchange - anything that is used to determine value during the exchange of goods and services Barter - direct exchange of one set of goods/services for another  Still used in many parts of the world  Informally in the U.S.  More specialized economies makes it harder to barter  Money makes exchanges much easier

3 Uses of Money 2. Unit of account - a means for comparing the value of goods and services Can tell a good price because you see other prices for similar things Standard across the board Priceline, Hotels, etc.

3 Uses of Money 3. Store of value - something that keeps its value if it is stored rather than used Good store of value – money Sometimes economies experience rapid inflation - money has less buying power

6 Characteristics Currency - coins and paper bills used as money Different people used different items: tulip bulbs, gold, silver, shells, rice, salt, etc.

6 Characteristics Durability - must withstand the wear and tear of being used. If it can't then its not a good store of value

6 Characteristics Portability - able to take money as you go about daily routine Easy to transfer money from one person to another

6 Characteristics Divisibility - must be easily divided into smaller pieces. 16th and 17th century coins could be divided into 8 pieces U.S , 50, 20

6 Characteristics Uniformity - count and measure money accurately Always know what a dollar will buy Dried fish were used as money; large + small fish worth different (how do you tell)

6 Characteristics Limited supply - federal reserve controls the supply of money Keeps the right amount of money available Pebbles or other natural items

6 Characteristics Acceptability - everyone must be able to exchange the objects that serve as money Accepted everywhere because it can be spent everywhere

Commodity Money Commodity money - objects that have value in themselves and that are also used as money Salt, cattle, precious stones - used in different societies Have other used other than money

Representative Money Object that have value because the holder can exchange them for something else of value Early forms - paper receipts for gold and silver; heavy to carry, had to be weighed and tested then left in safes IOU - promise of something in the future

Fiat Money Money that has value because the government has ordered that it is an acceptable means to pay debt “Legal tender” Limited supply

Section 2

Banks Bank – an institution for receiving, keeping, and lending money developed over the course of history 1 st part of U.S. history banks were informal Managed by merchants on top of regular trade Charged to keep money safe or to loan money Problems: went out of business or untrustworthy - lose money

Two Views Founders agreed they needed a safe, stable, banking system Federalists – Alexander Hamilton – centralized banking system needed to develop healthy industries and trade Anti-Federalists – Thomas Jefferson – decentralized banking – states establish and regulate banks within their borders National Bank – bank chartered by the national government; issue single currency, manage federal funds and other banks

First Bank 1791 – Bank of the United States with 20 year charter 1) Hold the money the government collects in taxes 2) Help the government carry out power to tax, borrow, money and regulate interstate and foreign commerce 3) Representative money – bank notes in gold and silver 4) Make sure banks held enough gold and silver to exchange for notes

Jefferson – constitution does not give Congress the power to create a national bank Feared that it would only lend to the wealthy and large businesses Creation of national bank was unconstitutional Hamilton died in a duel bank lost main supporter – lasted until charter expired in 1811

Chaos After it expired state banks issued notes they couldn’t back Chartered many banks without knowing if they were trustworthy Prices rose rapidly – merchants and customers had no confidence Different banks issued different currencies Not all redeemable by gold

Second Bank 1816 – 2 nd Bank of the United States – 20 year charter Helped restore confidence – opposed by Andrew Jackson Bank president surprised banks with large numbers of notes to check reserves 1819 – national bank constitutional 1832 – vetoed renewal of bank

Free Banking 1837 – 1863 Free Banking or “Wildcat” Era 1830 – 1837 number of state chartered banks tripled Problems: 1. Bank runs and panic – state banks did not keep enough gold and silver to back paper money Bank runs – widespread panic in which great numbers of people try to redeem their paper money 2. Wildcat banks – banks located on edge of settled areas. Not enough people living in remote areas

Problems 3. Fraud – issued bank notes, collected gold and silver and then disappeared 4. Different currencies – state chartered, cities, private, banks, railroads, stores, churches, and individuals were allowed to issue currency Many were counterfeit Had different values $1 in New York not the same as $1 in Atlanta

Later 1800s 1860 – 8,000 banks circulating currency; federal gov not involved Civil War added to the problems

Union and Confederacy needed money 1861 – U.S. Treasury issued the Continental – 1 st paper currency “greenbacks” printed in green ink South issued currency backed by cotton; victory = value Eventually became worthless

Unifying Banks National Banking Acts 1863 and 1864 – restore confidence in paper money 1) Power to charter banks 2) Power to require banks to hold adequate gold and silver reserves to cover their bank notes 3) Power to issue a single national currency Eliminated many state currencies and stabilized the money supply

The Gold Standard 1870s - gold standard adopted Gold standard – monetary system in which paper money and coins are equal to a certain amount of gold 1) Set a definite value for the dollar. 1 ounce = $20; people became more confident in paper money 2) Government could issue money only if it had gold in the treasury

Single national currency and gold standard helped stabilize the banking system Did not provide a central decision making authority Panic of 1907 –  banks stopped exchanging gold for paper money  banks failed  people lost jobs

Federal Reserve System 1913 – Federal Reserve Act Federal Reserve System – nation’s central banking system 1 st true central bank Central bank – bank that can lend to other banks in times of need

Member Banks created 12 regional Fed banks All banks chartered required to become members of the Fed Member Banks – banks that belongs to the Federal Reserve System Stored some of their cash at the Fed Bank Fed Bank was the main bank in that district

Federal Reserve Board Supervised by a board appointed by the President of the U.S.

Short-term loans Regional Fed allowed members to borrow money to meet short term demands Prevents bank failures

Federal Reserve Notes Created national currency used today - Federal Reserve Note Increase or decrease amount of money in circulation

Great Depression Fed restored confidence but unable to prevent the Great Depression Great Depression – the severe economic decline that began in 1929 and lasted for more than a decade 1920s – banks loaned a lot of money to high risk businesses - Unable to pay back loans Farmers unable to pay loans because of crop failures 1929 stock market crash – bank runs Failed loans + bank runs = bank failures Black Tuesday

Banking Reforms 1933 – FDR closed the banks. Only reopened the stable ones Federal Deposit Insurance Corporation – government agency that insures customer deposits if banks fail Original amount of $2,500 per account Book written - $100,000 Limited ability to redeem dollars for gold Eventually became fiat money – no more gold standard

Banking in the 20 th Century 1933 – 1960s banks heavily regulated: interest rates and qualifications Late 1970s and 80s Congress passed laws to deregulate several industries – caused Savings and Loan Crisis

Savings and Loan Crisis Deregulation Previously been protected by regulation Not prepared for competition after deregulation

Savings and Loan Crisis High Interest Rates 1970s long term loans at low rates 1980s rates skyrocketed – high payouts to depositors Still receiving low rates on money lent in the 1970s

Savings and Loan Crisis Bad Loans Risky loans in the early 1980s hit the S&L industry forcing many out of business

Savings and Loan Crisis Fraud Some made large loans to businesses with little chance of succeeding Businesses failed large drain on FSLIC (insurance for S&L) 1989 – Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). Abolished independence of S&L and gave insurance responsibility to FDIC

Recent Trends 1999 – abolished Glass-Steagall Act  separation of commercial and investment banking Banks could now sell financial assets – stocks and bonds Privacy rules for customer data

Section 3

Money supply – all the money available in the United States economy  Currency  Traveler’s checks  Checking account deposits  etc

M1 Money that people can gain access to easily and immediately to pay for goods and services Liquidity – the ability to be used as or directly converted to cash 48% of M1 is made up of currency held by the public Checking accounts make up a large part too Demand deposits – the money in checking account

M2 Everything in M1 plus assets funds that cannot be used as cash directly – but converted pretty easily (near money) Money market mutual funds – pools money from small savers to purchase short term government and corporate  Saving accounts

Functions Offer a variety of ways for people to save money  Saving accounts  Checking accounts  Money market accounts  Certificates of Deposits

Savings and checking are the most common – liquid pay interest Money markets and CDs are types of savings accounts that pay higher rate of interest  MM – write a limited number of checks, varying interest rates  CDs – fixed interest rate over a period of time, money is locked in

Loans Goldsmiths held gold for a fee Always kept the same amount of gold as notes issued Eventually realized that people didn’t ask for it all at once Could lend out 50% – 75% and still have enough for customers

Fractional reserve banking – banking system that keeps only a fraction of funds on hand and lends out the remainder Today’s banks operate like this Loans are the way banks make money Help industries grow Default – failure to pay back a loan

Mortgages Mortgage – specific type of loan that is used to buy real estate Usually last 15, 25, or 30 years Usually requires a down payment

Credit Cards Credit card –a card entitling its holder to buy goods and services based on the holder’s promise to pay for these goods and services

Simple and Compound Interest Interest – price paid for the use of borrowed money Principal – the amount of money borrowed Simple interest – interest paid only on principal  $100 at 5% = $105 Compound – interest paid on both principal and accumulated interest  $105 at 5% = $110.25

Banks and Profits Largest source of income is interest received from customer loans Amount of interest paid out is less than what they charge on loans

Commercial Banks Traditionally provided services to businesses Checking services Some are chartered by states and regulated by state authorities and FDIC 1/3 are national banks and part of the Fed Largest role in the economy

Savings and Loans Originally chartered to lend money for building homes mid 1800s Over time started doing the same things as commercial banks

Saving Banks Early 1800s to serve people who made smaller deposits and transactions than commercial banks wanted to handle Negotiable Order of Withdrawal (NOW) accounts started in saving banks – interest checking

Credit Unions Cooperative lending associations for particular groups – specific firm or gov agency Specialize in home mortgages and car loans Some provide checking accounts

Finance Companies Make installment loans to consumers Spread cost of larger purchases over months Charge higher interest rates than banks – high risk

Electronic Banking 1970s banks start to use computers

ATM Computers used to deposit money, withdraw, and get account information Available 24/7 Reduce labor costs

Debit cards Used to withdraw money at ATMs Use a pin for protection

Home Banking Online banking Check accounts, transfer money, pay bill

Automatic Clearing Houses ACH Allows customers to pay bills without writing checks Transfers funds automatically Pay regular monthly bills Convenience factor

Stored Value Cards Also called Smart cards Similar to debit cards Mix between debit card and cash Refillable balances