Money and Banking Chapter 10

Bell Ringer 11/28 What are the major problems with the barter system of exchange? What are 4 characteristics of money? What does it mean to be “on the gold standard”? What president took us off? What are the 3 types of financial institutions?

Before Money Barter system Means through which good and services are exchanged Barter=trading objects directly for other objects Major problem: ??????

Money Money makes trading easier for everyone, it is a symbol of value Money can be any substance that serves as a medium of exchange, a measure of value, and a store of value Started in Italy by the Medici Family, as a way of trade exchange.

Functions of Money If money satisfies these 3 functions, it will be accepted and used by everyone in society 1. medium of exchange-something or anything accepted by all parties as payment for goods

Functions of Money 2. measure or standard of value—common denominator that can be used to express worth in terms most individuals understand In the U.S. our measure or standard of value is expressed in dollars and cents

Functions of Money 3. Store of value—the property that allows purchasing power to be saved until needed Money enables a period of time to pass between earning and spending

Characteristics of Money 1. Durable 2. Portable 3. Divisible-makes it easy to measure the value of goods exactly 4. Stable 5. Hard to counterfeit (duplicate) Limited availability (for money to be successful)

Different kinds of money 1. Commodity Money- object used for money is valuable in itself (example: salt, tobacco) 2. Representative money- object used for money stands for something else of value (example: checks) 3. Fiat money- the gov’t says the object used for money is valuable (example: coins, bills)

Credit Cards They are not money because: 1. They have no fixed value 2. They are not exchanged

Money in early societies Money came in many different forms Many used commodity money (cheese, tea leaves, salt) Others used fiat money

Colonial America Commodity money – salt, tobacco, livestock, finished lumber, GUNPOWDER, corn, WHISKEY Wampum – shells that were given value as fiat money by the Connecticut government in 1600’s Paper Currency – backed by gold and silver Specie – money in the form of coins, usually gold or silver

Money in America In colonial America, some money was commodity and some fiat Products like gunpowder, corn, and tobacco used as money

Money in America Modest amount of specie was used in colonies Specie is hard money – coins Coins were the most desirable form of money in colonial America -- Hard

Money in America Paper money first issued in Revolutionary War called “continentals” Was not backed by gold or silver and was worthless by end of the war, 250 million was printed(Congress redeemed them at 1/100th or original value) FUNDING BILL part of Hamilton’s Plan

Origins of the Dollar George Washington became president in 1789, one of his challenges was to establish a money supply..task given to Alexander Hamilton and Ben Franklin The most plentiful coin in circulation was the Spanish peso and - introduced in America because of foreign trade

Origins of the Dollar Pesos resembled the Austrian talers, which sounds like “dollars”…Franklin/Hamilton decided to make the dollar the basic monetary unit They divided the dollar into tenths, easier to understand

The Greenback Standard The Constitution gave the federal gov’t power to mint coins, not print money Banks were allowed to issue their own paper money Many problems with currency developed – trust / no standard looking currency / individual banks might go bankrupt By 1860, 1,600 banks were issuing more than 10,000 kinds of paper currency

The Greenback Standard When the Civil War erupted, both gov’ts needed to raise money to finance the war Congress decided to print money for the first time since Constitution was adopted --- INFLATION!

The Greenback Standard Congress printed $60 million demand notes..nicknamed greenbacks, printed with green ink to distinguish them from state notes Greenbacks not backed by gold/silver…people feared they would be worthless, avoided them..lost value

National Currency From 1861-1900, the U.S. had 5 types of currency in circulation Greenbacks – to help fund the Civil War (Confederacy had it too) National Bank Notes – issued by national banks, backed by gov’t bonds Gold certificates – eventually a $20 gold coin is used (double eagle) Silver certificates – alternative to silver dollars, backed by silver Treasury Coin Notes – paper currency redeemable in gold and silver In 1900, Congress passed the Gold Standard Act…. put U.S. on the gold standard

Advantages of a Gold Standard 1. People more secure about their money if it can be converted into gold 2. Prevents gov’t from printing too much paper currency. In theory, a county will only print the amount of money it can back

Disadvantages of a Gold Standard 1. Gold stock may not grow fast enough to support a growing economy…… new gold supplies have to be found to be able to expand economic growth 2. People may suddenly decided to convert their currency into gold, draining gov’t supply Difficulty in solving an economic recession according to citizens and some economic theorists like John Maynard Keynes -- DEPRESSION 3. Price of gold changes dramatically

Abandoning the Gold Standard U.S. abandoned it in 1933, during the Great Depression people began to cash their money for gold– NOT!! Could not possess gold – illegal for more than $100

The inconvertible fiat money standard Since 1934, the U.S. has been on an inconvertible fiat money standard (can not convert dollars into gold) The gov’t controls the money supply The Federal Reserve System issues a single currency

Financial Institutions A business that offers financial services (lends money, stores money) to customers Functions: 1. provides services to depositors and borrowers 2. makes a profit

Financial Institutions Earns money by: 1. charging interest on loans 2. earning interest from investments 3. charging a fee for storing money

Financial Institutions There are several different kinds of financial institutions. The 3 main kinds are: 1. Banks 2. Savings and Loan Associations 3. Credit Unions

1. Banks Also called commercial banks 2 banking systems in U.S. (national and state) All banks must have charter from either state or national gov’t. Whichever charters the bank, makes rules to regulate it Offer both checking and savings accounts to depositors

2. Savings and Loan Associations Accepts savings deposits from customers and makes loans to home buyers

3. Credit Unions Like a private bank Set up by a large group of people who are employees of a certain organization or a certain group Is owned by its depositors and only people who are part of the group can become members

3. Credit Unions Members may open savings, checking accounts and take loans Profits earned by the credit union are paid to its members as interest in their savings deposits which are called shares

The Federal Reserve System Est. in 1913 Created to control the money supply The Fed is the nation’s central bank Made up of 12 regional banks across the nation Board of Governors (located in Washington, D.C.) supervises the Fed, appointed by the President and approved by the Senate The Fed’s customers are local banks

The Federal Reserve System Main Jobs: 1. Supervise and regulate banks 2. Maintain currency (replaced worn out currency with new currency) 3. Clear checks 4. Regulate the nation’s money supply

Actuality of the Federal Reserve? It actually exacerbated (made bigger) the Great Depression in America because of its restrictive monetary policy The Fed refused to help out smaller banks that were going bankrupt (which is actually its job) The Fed aggressively pursued tightening the money supply of the US thereby making the Great Depression worse (citizens kept what money they had and wouldn’t spend it – while citizens who had no money to begin with couldn’t get their hands on any to spend)

4. Regulates the money supply Most important job of the Fed Helps to maintain price stability – but it doesn’t do this – it has actually served to INCREASE INFLATION

The Federal Reserve System Federal Deposit Insurance Corporation (FDIC) passed in 1933 to insure deposits in banks Originally protected up to $2,500, now protects up to $100,000 an account FDIC provided security

Savings Only 2 things people can do with their income…spend it or save it Saving—the absence of spending Savings—refers to the dollars that become available when people abstain from consumption

Savings Saving makes economic growth possible When people save, they make money available for businesses and gov’t so they can produce new goods and create more jobs

Investment Considerations Before you invest in a financial asset, it is important to consider several factors

Investment Considerations 1. Risk-Return Relationship: Risk—situation in which the outcome is not certain As an investor, your first consideration should be the level of risk you can tolerate 2. Investment Objective Consider the reason for investing The investor’s knowledge of his/her own needs is important What is your goal, save for retirement? Make additional money for vacation?

Investment Considerations 3. Simplicity Stay with what you know If it is too complicated, then ignore it If it seems too good to be true, then it probably is 4. Consistency Most successful investors invest consistently In many cases, the amount invested is not as important as investing on a regular basis

401(k) Plans Have become popular among investors (60% of U.S. households have one), considered one of the safest investments Employees authorize payroll deductions, which are invested in mutual funds or other investments approved by the company You don’t have to pay income tax on the money you contribute

401(k) Plans Many employers match an employee’s contributions by at least 25% (immediate return) Can take with you if you change jobs, can borrow $ before you retire Must pay taxes on earnings when you withdraw it

Individual Retirement Accounts (IRA) Long-term, tax-sheltered time deposits that an employee can set up as part of a retirement plan If worker’s spouse does not work outside the home, up to $3,000 per year can be deposited in a separate account for each spouse $3,000 will not be taxed, until worker takes it out after retirement….will not pay as much taxes on it, because worker will be in a lower tax bracket

Roth IRA Contributions are made after taxes, so that no taxes will be taken out when investor is ready to withdraw it Will work well for someone who plans to retire in a high tax bracket

Certificates of Deposit (CDs) One of the most common forms of investment available They are actually loans investors make to financial institutions Issued mostly by banks Attractive because they can cost as little as $100 and investors select the length of maturity CDs issued by banks are protected by the FDIC

Certificates of Deposit (CDs) Because banks/others count on the use of this money, penalties are usually imposed if money is withdrawn early

Bonds as Financial Assets When the gov’t or a firm needs to borrow funds for long periods, they often issue bonds Bonds---long-term obligations that pay a stated rate of interest for a specified number of years

Bonds as Financial Assets 3 components of a bond: 1. coupon—stated interest on the debt 2. maturity—life of the bond 3. per value—the principal or total amount borrowed that must be repaid to the leader at maturity

Bonds as Financial Assets Bonds are not insured No guarantee that the issuer will be around in 20 years to redeem the bond Examples of bonds: corporate bonds, municipal bonds, government savings bonds

Bonds as Financial Assets Treasury bills (T-bill) are regarded as the safest investment Short-term obligation with a maturity of 13,26, or 52 weeks with a minimum denomination of $1,000

Bond Ratings Investors have a way to check the quality of bonds Standard & Poor’s and Moody’s publish bond ratings Rating based on a number of factors, including the basic financial health and past credit history of the issuer

Bond Ratings Ratings use letters scaled from AAA (highest investment grade) to D (stands for default) Bonds with high ratings sell at higher prices than bonds do with lower ratings “Junk bonds”—risky bonds with low ratings, but carry a high rate of return