Chapter 10 Money, Banking & Finance Section One: Money

Money Three uses of money: Medium of exchange Unit of account Store of value

Medium of Exchange Anything that is used to determine value during the exchange of goods and services In the past most societies used a barter system A barter system is a direct exchange of one set of goods or services for another. Money as a medium of exchange made exchanging goods and services much easier.

Unit of Account Unit of Account is a means for comparing the values of goods and services. You can compare the same or similar items in different markets in the US and they are all priced in dollars. $40 $25

Store of Value Something that keeps its value if it is stored rather than used. This is true with money except in times of rapid inflation.

Six Characteristics of Money Durability: able to withstand wear and tear Portability: easy to hold and transfer Divisibility: easily divided into smaller denominations Uniformity: all the same in terms of what it will buy Limited supply: must be regulated Acceptability: everyone in society must accept it

*A promise of future payment Gov’t has ordered it as acceptable *A promise of future payment *not portable, durable or divisible *control of supply is essential for it to work

Section Two The History of American Banking

Bank: An institution for receiving, keeping and lending money. Early on merchants would hold on to people’s money (keep it safe) for a fee. They would also extend loans to people. Not a very good system; money was not always safe and merchants were not always honest.

Recap of American History Federalists wanted a strong central government to establish economic and social order. Alexander Hamilton believed a strong centralized bank was needed for the US to develop healthy industries and trade. Hamilton proposed a national bank to be chartered, or licensed by the National government. He wanted one currency for the entire nation. The national bank would manage the federal government’s funds and monitor other banks throughout the country.

Recap of American History Anti- Federalists wanted most of the power in the hands of the states. Thomas Jefferson wanted decentralized banks. Individual states would establish and regulate the banks within their borders.

Recap of American History First Bank of the US (1791 – 1811) Had a license to operate for 20 years Objectives: Hold government money (taxes) Help the government carry out its power to tax, borrow money in public interest, regulate interstate and foreign commerce Issue representative money in the form of bank notes (backed by gold and silver) Regulate state- chartered banks Once the Nation’s Bank Charter expired it was shut down. States gave licenses to many banks without considering whether they would be stable or even credit worthy. Corruption and chaos ensued.

Recap of American History Second Bank of the US Another 20 years but charter not renewed. Free Banking or “Wildcat” Era (1836 – 1863) Many problems arose: Bank runs: Widespread panic in which great numbers of people try to redeem their paper money. Wildcat Banks: banks located on the edges of settled areas often times failed. Fraud: Banks would collect gold and silver, issue notes and then run. Different currencies: Each city/state had its own currency. This made trade very hard and counterfeiting easy.

Recap of American History The Civil War made things worse… The US Treasury issued “demand notes”, called “greenbacks”. The South issued currency backed by cotton. By the end of the war, that currency became worthless.

Recap of American History Unifying American Banks (1863 – 1864): Government reforms which gave the federal government three important powers: The power to charter banks The power to require adequate gold and silver reserves The power to issue a single national currency

Recap of American History The Gold Standard is a monetary system in which paper money and coins are equal to the value of a certain amount of gold. Two advantages: Set a definite value for the dollar The government could issue currency only if it had gold in the treasury to back the notes

Recap of American History After the Panic of 1907, the government made plans to reinstate a central bank. In 1913, the Federal Reserve System served as the nation’s first true central bank. A central bank is a bank that can lend to other banks in times of need.

Recap of American History The central bank reorganized the federal banking system as follows: It created twelve regional Federal Reserve Banks Member banks: Banks that belong to the Federal Reserve Banks. Federal Reserve Board: A supervisory board appointed by the President of the US. Short- term loans: Regional Federal Reserve Banks allowed members to borrow money to meet short term needs. It established Federal Reserve Notes – the currency we use today.

Recap of American History The Great Depression: The severe economic decline that began in 1929 and lasted for more than a decade. Franklin D. Roosevelt created the FDIC. Federal Deposit Insurance Corporation insures customer deposits if a bank fails. Banks were highly regulated until the 1970’s and 1980’s. This deregulation paved the way for the next bank crisis.

The Savings and Loans Crisis The causes of the Savings & Loans Crisis: Deregulation High interest rates: Savings & Loans had to pay out high interest rates for depositors but were only charging low rates for loans given out earlier. Bad loans Fraud

Section Three Banking Today

The Money Supply The money supply is all of the money available in the US economy. This includes bills and coins, traveler’s checks, checking account deposits, among others. We track the money supply using TWO categories: M1 M2

The Money Supply, cont. M1 represents money that people have access to easily and immediately OR assets that have liquidity. Liquidity is the ability to be used as or converted to cash. Examples: Currency (almost 50%) Demand deposits (checking accounts) (almost 50%) Traveler’s checks (almost 1%)

The Money Supply, cont. M2 includes all M1 and assets which cannot be used as cash directly but can be easily converted. These assets are also called near money. Examples: Savings account deposits (almost 40%) Small denomination time deposits (20%) Money market mutual funds (a fund that pools money from small savers to purchase short term government and corporate securities) (20%) M1 (22%)

Functions of Financial Institutions Banks and other financial institutions offer many services: Store money Save money Loans Mortgages Credit cards

Functions of Financial Institutions Store money: safe, secure vaults Saving money: Savings accounts low interest rates Checking accounts Money market accounts Certificates of deposits – higher interest rates set term (CDs)

Functions of Financial Institutions Loans: loaning out people’s deposits to make a profit Old days – goldsmith / market Stored money and then lent it out, keeping only a little in reserve. Fractional reserve banking: a banking system that only keeps a fraction of deposits on hand. If a borrower fails to pay back his loan, he is said to be in default.

Functions of Financial Institutions Mortgages: Specific type of loan used to buy real estate. These loans are a major cause of the situation we are in now. Credit Cards: A card entitling its holder to buy goods and services based on the holder’s promise to pay for them. You use your card at a store The bank pays the store Once a month you pay back the bank for your short- term loan

Functions of Financial Institutions Credit Cards, cont. Banks charge interest: price paid for the use of borrowed money or principal. Banks profit by charging more interest on their loans than the interest they pay on their deposits.

Types of Financial Institutions Commercial Banks: most common; provide the most services; play the largest role in the economy. Savings and Loans Associations (S & Ls): 1800s for buying homes now they are like commercial banks

Types of Financial Institutions Savings Banks: (Mutual Savings Banks in 1800s) Bank was owned by the depositors and they shared profits Later, they went public (stock offered) Now, shareholders earn the profit Credit Unions: a cooperative lending association for a certain group.

Types of Financial Institutions Finance Company: Make installment loans to consumers Usually charge high interest rates because of the high level of default.

Electronic Banking Automated Tellers Machines (ATMs): Debit Cards: Uses: Withdraw cash Deposit money Transfer from linked cash Information Debit Cards: Linked to a checking or saving account Money comes directly out of that account when you purchase items

Electronic Banking Home-banking/Internet banking: Further reducing bank costs and making it even more convenient for customers Automatic Clearing Houses (ACHs): Allows customers to pay bills without writing checks ACH transfers funds automatically from customers’ accounts to their creditors’ accounts. Usually used for monthly bills Smart Cards: Similar to debit cards only they are prepaid Some can be “recharged” Some are linked with accounts for record keeping You will probably be issued one at college