The Role of Money

The Three Uses of Money Money as a Medium of Exchange Determine value of a good or service Money as a Unit of Account Compare the value of goods Money as a Store of Value Value even when stored/saved

The Three Uses of Money Money has three main functions. Why is it important to have a means of exchange that is a stable, consistent unit of account?

Characteristics of Money To be successful money must be: PORTABLE DURABLE DIVISIBLE LIMITED IN SUPPLY

Portability Easily transferred from one person to another

Durability Needs to be able to last when handled and does not deteriorate when being held as a store of value (savings)

Divisibility Money must be easily divisible into smaller units, so that people can use only as much as needed

Limited Availability Money loses its value whenever there is too much of it

Sources of Money’s Value Commodity Money- Objects that have value in and of themselves: Cattle, Gems, Tobacco

Representative Money Objects that have value solely because the holder can exchange them for something else: IOU, Cashier’s Check or Money Order

Fiat Money Dollars, Pesos, Franks, Euros “Legal Tender”-Has value because a government has declared that it is acceptable means to pay debts. Dollars, Pesos, Franks, Euros

Sources of Money’s Value

The Gold Standard

Advantages Limits the power of the government and banks to cause price inflation by excessive use issue of paper money Creates certainty in international trade by providing a fixed patter of exchange rates Gold backs up paper currency in circulation

Disadvantages May not provide sufficient flexibility in the supply of money needed A country cannot isolate its economy from depression or inflation going on in the world

Disadvantages Con’t The price of gold can change dramatically over time Increased unemployment or decline in economic expansion can make adjustments hard

Changes in American Banking

American Banking Before the Civil War Opposing Views of Banking The First Bank of the United States Financial Chaos in America: Panics The Second Bank of the United States The Free Banking Era: State Chartered Banks Could not back up the money they printed

Alexander Hamilton, a Federalist, was a staunch supporter of a strong federal government and, therefore, of a strong central bank.

Stability in the Later 1800s By 1860, an estimated 8,000 different banks were circulating currency. To add to the confusion, the federal government played no role in providing paper currency or regulating reserves of gold or silver. The Civil War, which erupted in 1861, made existing problems worse.

During the Civil War, the Confederate government issued currency such as this bill. After the Confederacy lost the war, this currency became worthless.

American Banking

Banking in the Early 1900s The Federal Reserve System Created by President Wilson to ensure a stable flow of money through the economy Banking and the Great Depression The Federal Deposit Insurance Corporation (FDIC) was created to protect the money people put in the bank FDR Reforms: The New Deal Created a safer and more effective use of assets by the banks

The Panic of 1907, illustrated here on a magazine cover at the time, contributed to many people’s belief that the nation needed a central banking system.

Two Crises for Banking As a result of the many bank failures of the Great Depression, banks were closely regulated from 1933 through the 1960s. The government restricted the interest rates banks could pay depositors and the rates that banks could charge consumers for loans. By the 1970s, bankers were eager for relief from federal regulation.

Two Crises for Banking The Savings and Loan Crisis: Volatile interest rate climate of the 1970s depositors removed their money from banks and deposited it in money market funds. This increased interest rates, because the funds were not governed by Regulation. More than 1,000 S&Ls failed by 1989, essentially ending one of the most secure sources of home mortgages

Financial “Meltdown,” Bailout, and “Recovery” Meltdown: the value of financial institutions or assets drops rapidly Bailout: financial support to a company or country which faces serious financial difficulty or bankruptcy. It may also be used to allow a failing entity to fail gracefully without spreading contagion. A bailout can, but does not necessarily, avoid an insolvency process.

The Federal Reserve System

A Review of U.S. Banking History

One reason why the United States established a central banking system was to avoid financial speculation and panics.

Janet Yellen succeeded Ben Bernanke as Chairman of the Fed in 2014.

The 12 District Banks are different sizes as measured by their assets The 12 District Banks are different sizes as measured by their assets. The New York Reserve Bank has a small geographic area but the largest number of assets.

The Fed’s Roles: Serving the Government Acting as the Government’s Banker and Agent Issuing Currency for the Government

Mobile banking has become increasingly popular in recent years Mobile banking has become increasingly popular in recent years. One of the Fed role’s is to process electronic transactions.

The Fed’s Roles: Serving the Government Federal Reserve Notes have various codes and markings that help identify the bill and the issuing bank.

The Fed’s Roles: Serving and Regulating Banks Clearing Checks Supervising Banking Practices Acting as Lender of Last Resort Monitoring Reserves Conducting Bank Examinations

Between 2000 and 2009, consumers’ use of checks decreased while most other types of noncash transactions increased. Analyze Charts What technological developments occurred during these years that made the changes in non-cash transactions possible?

Regulating the Money Supply The Federal Reserve is best known for its role in regulating the nation’s money supply. setting the discount rate, setting reserve requirements, setting the federal funds rate target, Using open market operations to meet that target. Economists and the Fed watch several indicators of the money supply. M1 is a measure of the funds that are easily accessible or in circulation. M2 includes the funds counted in M1 as well as money market accounts and savings instruments The Fed compares various measures of the money supply with the likely demand for money to determine when and how to use these tools.

The Money Supply M1 consists of cash and assets that can be directly converted into cash. The term demand deposits refers to money in checking accounts.

The Fed requires banks to keep a fraction of their funds on hand and lend the remainder to customers.

The Functions of Modern Banks

Functions of Financial Institutions Storing Money Saving Money Making Loans Mortgages Credit Cards Interest Making a Profit

Types of Financial Institutions Commercial Banks Savings and Loan Associations Savings Banks Credit Unions Finance Companies

Electronic Banking Automated Teller Machines Debit Cards Home Banking Stored-Value Cards

Investing

Investment and Free Enterprise Capital projects, such as putting solar panels on the roof of a school, can be worthwhile but require an initial investment.

The Financial System In order for investment to take place, an economy must have a financial system. A financial system is the network of structures and mechanisms that allows the transfer of money between savers and borrowers.

The Financial System Financial Assets Savers and Borrowers a tangible asset whose value is derived from a contractual claim, such as bank deposits, bonds, and stocks Savers and Borrowers Suppliers and Consumers of Capital

The Financial System Individuals' savings is one important part of our financial system.

The Financial System

Liquidity, Return, and Risk Used as or converted into Cash Return Money an investor receives above the initial investments

Liquidity, Return, and Risk Investors need to think carefully about the level of risk that is right for them. Lower risk investments typically have low rewards. As risk increases however, so does potential reward.

Bonds and Other Financial Assets

Bonds as Financial Assets Posters such as this one encouraged Americans to purchase war bonds to help the United States government pay for World War II.

Bonds as Financial Assets Investors can earn money by buying bonds at a discount, called discount from par.

Types of Bonds Savings Bonds: Low denomination; issued by USA Treasury Bonds, Bills, and Notes: issued by US Treasury; no credit risk Municipal Bonds: issued by State/local govt; finance public project Corporate Bonds: issued by Corporation for expansion Junk Bonds: a high-yield, high-risk security; issued by a company seeking to raise capital quickly in order to finance a takeover

Types of Bonds Treasury bonds, notes, and bills represent debt that the government must repay the investor.

Other Types of Financial Assets Certificates of Deposit savings certificate with a fixed maturity date, specified fixed interest rate A CD restricts access to the funds until the maturity date of the investment Money Market Mutual Funds Funds pool money from small savers to purchase short-term govt or corporate securities

Other Types of Financial Assets Investments with lower risk usually have lower reward as well. Bonds issued by the government are generally less risky than bonds issues by corporations.

Stocks

A stock split doubles the amount of shares that a stockholder owns.

Tracking Stock Performance Bull Markets Steady rise in Stock prices in general over a period of time Bear Markets A steady drop or stagnation in stock prices in general over a period of time