1. C HAPTER 10 Money and Banking

2. 10.1 M ONEY Money has three purposes: medium of exchange, a unit of account and a store of value Medium of exchange: anything that is used to determine value during the exchange of goods and services Without money people would need to barter (some traditional economies still do) Money is much easier to exchange than haggling over which good is equal to the good you want

3. Unit of exchange: money provides a means for comparing the values of goods and services All jackets you want to purchase are listed in terms of dollars and so it makes deciding which to purchase a little easier Store of value: money keeps its value if you decide to hold on to it It will be recognized as a medium of exchange for weeks and months from now Inflation might alter the value When an economy is suffering from inflation – money doesn’t hold its value for very long

4. S IX CHARACTERISTICS OF MONEY Many items have been used as currency in the past and yet none have all six characteristics found in money 1. Durability Money can withstand wear and tear Can last for years before replacing 2. Portability People can take their money where thy go Easily transferable to another person

5. 3. Divisibility Money can be easily divided up into smaller dominations 4. Uniformity Money is only valuable with two units are able to buy the same thing If we priced everything in fish then what would a small fish buy vs. a large? A dollar can always get you a dollars worth of something

6. 5. Limited Supply Anything too available is no longer valuable The Federal Reserve Systems controls our money supply Its action keeps the right amount of money out in the system 6. Acceptability People will take your money always May not take an alternative good that you want to barter Only if the nation lost confidence in our currency’s value would money not be accepted

7. S OURCES OF MONEY ’ S VALUE What makes money valuable? Commodity money consists of objects that have value in and of themselves and that are also used as money Ex: cattle and precious gems These items have other uses in addition to currency Commodity money lacks some of the necessary characteristics of money

8. Representative money – makes use of objects have value because the holder can exchange them for something else of value (like gold) Ex: IOU notes exchanged for goods at a store Early rep money took the form of paper receipts for gold and silver and since gold and silver was difficult to carry…people would just exchange the promise note Early US money was backed by gold

9. Fiat money has value because the government has decreed that it is acceptable means to pay debts The govt is ensuring that the money will remain in limited supply and therefore, is valuable This is done via the Federal Reserve Board Our govt is valuable because the govt says it is

10. 10.2 T HE H ISTORY OF A MERICAN BANKING Modern history …. The Federal Reserve Act passed in 1913 created the Fed This was the nation’s 1 st true central bank A central bank is a bank that can lend to other banks in times of need 12 regional Fed Reserve Banks (member banks) National govt stores its reserve money in member banks Each can loan out money to their regional banks to help with short term demand

11. This helps prevent bank failures The act also created the national currency that we use today– Federal Reserve note It allows the federal govt can increase or decrease the amount of money in circulation at any given time The Fed helped restore confidence to the nation’s banking system It was unable to prevent the Great Depression During the 1920s too many banks gave out risky loans to businesses Paid investments coupled with depositors demanding deposits back led to a HUGE emergency

12. The Federal Deposit Insurance Corp was formed in o 1933 FDIC will cover up to $100,000 of depositors money Federal legislation was also passed that limited a person’s ability to redeem dollars for gold. Eventually all money became fiat based (govt decree that guarantees the value of money)

13. In the 1970s banks began requesting deregulation (removal of govt restrictions) This deregulation contributed to a huge saving and loans scandal in the 1980s S&L failed one after another due to… 1. Deregulation – businesses were unprepared for competition post regulation 2. High interest rates – low rates were being paid back from loans taken out during the 70s while at the same time higher rates needed to be out to depositors 3. Bad loans to people and businesses who shouldn’t have qualified 4. Fraud

14. In 1999, Congress repealed the 1933 Glass- Steagall Act This act allowed banks to sell financial assets such as stocks and bonds

15. 10.3 B ANKING T ODAY The money supply is all the money available in the US economy It is divided up into two categories: M1 and M2 M1 is money that people can easily gain to pay for good and services All assets have liguidity (the ability to be converted into cash quickly) This includes money held by the public, money in checking accounts M2 consists of all assets in M1 plus other assets M2 funds cannot be used as cash directly You cannot hand someone a deposit slip from your saving account

16. F UNCTIONS OF FINANCIAL INSTITUTIONS Money market mutual funds CDs are included in this category 1. They store money in a safe environment 2. They help people save their money (while making money) Savings accounts Checking accounts Money market accounts Certificates of deposits (CDs)

17. F UNCTIONS OF F INANCIAL I NSTITUTIONS CDs pay a higher rate of interest on deposit than savings or checking But …money is locked in for a longer amount and if you need withdraw it early there are penalities 3. They issue loans Banks only keep a fraction of their deposits at any one time The rest is loaned out to early interest This is how banks make their money The more money that a bank lends out and the higher interest rate that they charge to its borrower, the more profit a bank is able to make

18. If a borrower defaults (fails to pay back their loan), the banks loses money If they make too many bad decisions…the bank may go out of business all together Mortgages are loans to buy real estate Mortgages last from 15-30 years Many banks issue out credit cards too Any credit card will charge interest for any balance that is not paid in full at the end of the billing cycle Careful because this interest will add up quickly

19. Interest is the price paid for the use of borrowed money The amount borrowed is the principal The largest source of income for banks is the interest they receive from customers who have taken out loans