What is (and was) money? Week 2

Learning Objectives Know the definition of money. Be able to discuss the four different types of money. Be able to list the four functions of money. Know how the money supply is measured in the U.S. Be familiar with the history of the gold standard in the U.S.

Definition Money is anything generally accepted in payment for goods and services or in the repayment of debts. Money = Wealth? Money = Income?

Problems with barter Double coincidence of wants is rare. No standard in which prices can be compared.

Functions of Money Medium of exchange Unit of account Store of value Standard of deferred payment

Four classes of money

1. Commodity Money A medium of exchange that has other uses.

Example of commodity money Manillas are ornamental metallic objects worn as jewelry in west Africa Bronze bracelets.

Other Examples Amber, beads, cowries, drums, eggs, feathers, gongs, hoes, ivory, jade, kettles, leather, mats, nails, oxen, pigs, quartz, rice, salt, thimbles, umiacs, vodka, wampum, yarns, and zappozats (decorated axes).

Commodity Money: Desirable Characteristics Authentication Uniformity Divisibility Durability Portability Scarce … but not too scarce (elasticity of supply)

Cattle Paradox “When cattle are regarded as a form of money, not only healthy cattle but also scrawny ones will be valued to the detriment of the environment supporting them and their owners.”

Linguistic Links Capital, cattle, chattels have a common root. Pecuniary comes from the Latin word for cattle pecus. In Welsh da as an adjective means good but as a noun means both cattle and goods.

First Coins Cowrie shells used throughout the world before metal coins came into existence.

2. Representative money A claim to a commodity money. For example, tobacco certificates used in Colonial times.

Metallic coins: commodity or representative money?

An unusual coin Big stones of Yap Caroline Islands German rule—stones marked with X’s indicating the government was claiming them as a fine.

Government Minted Coins Advantage to the public: standardization Advantage to the government: seigniorage

Gresham’s Law: bad money drives out good money Queen Elizabeth I wanted to stop debasement of the currency so began minting high purity coins. Her economic advisor Gresham told her the plan was flawed.

What about the dollar coin? Why has it not been successful in U.S. when all other countries use coins for denomination of the same and even greater value?

Clues The Bureau of Engraving and Printing produces 37 million notes a day with a face value of approximately $696 million. 95% of the notes printed each year are used to replace notes already in circulation. 45% of the notes printed are $1 notes. Between the Fort Worth, Texas and the Washington, DC Facilities approximately 18 tons of ink per day are used.

Paper Money Banks store coins and issue receipts. If receipts can be transferred, they can serve as money. Receipts are call “bank notes”

Problem with privately issued bank notes Counterfeiting is difficult to control because each bank’s notes would look different. Solution: government central bank issues bank notes.

3. Credit Money A promise to pay commodity or representative money used as medium of exchange. Late middle ages bills of exchange circulated as money. Similar to commercial paper.

Early bankers: the goldsmiths In 17th century England, savers deposited valuables in the goldsmith’s safes. Receipts could be used as evidence of one’s ability to pay a debt. Eventually receipts were used as bank notes.

Credit Money What if banker issues “receipts” to more precious metal than he has on deposit?

Instability with credit money If depositors worry about the soundness of the banks they will “run” on the bank. Solution: government regulation of banks to ensure soundness.

4. Fiat Money When the government obtains a monopoly and can suspend redeemability, the link with commodity money is easily broken. When redeemability is permanently suspended the result is FIAT MONEY. Fiat money is government issued money with no intrinsic value.

Seigniorage under fiat money Consider what happens when money leaves the country. Money supply contracts. Fed buys Treasury securities and returns interest to the Treasury. The U.S. public save on interest they would otherwise have to pay on their debt.

Electronic Payment Systems Electronic payment systems are one of the early applications of computer systems but they were used for large size transactions. Recently with reduction in computing costs, they have been used for small size transactions. Cost savings for every bill paid electroncially: $1

Dangers with fiat money Inflation. Hyperinflation. Fear of inflation.

Measuring the money supply Currency: 1.056 trillion M1 = checkable deposits + currency = 2.307 trillion M2 = M1 + savings deposits = 10.03 trillion

In sum: four types of money Commodity Representative Credit Fiat

The Gold Standard

Mint Act of 1792

Bimetallism Using both gold and silver as money. In 1792 the ratio was set at 1:15 but fluctuating market prices made it difficult to maintain.

Demonetization of silver in 1873 “Crime of 73”

William Jennings Bryan 1896 “I will not help to crucify mankind upon a cross of gold.”

Political satire of populist movement?

1933 End of gold standard for U.S. citizens.

Bretton Woods Era 1944-1971 US$ exchanged for gold at a rate of $35/oz but only central banks could exchange their dollars for gold.