1. Money and Banking
Chapter 10

2. 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?

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

4. 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.

5. 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

6. 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

7. 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

8. 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)

9. 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)

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

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

12. 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

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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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!

20. 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

21. National Currency
From , 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

22. 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

23. 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

24. 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

25. 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

26. 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

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

28. 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

29. 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

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

31. 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

32. 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

33. 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

35. 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

36. 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)

37. 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

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

39. 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

40. 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

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

42. 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?

43. 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

44. 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

45. 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

46. 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

48. 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

49. 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

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

52. 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

53. 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

54. 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

55. 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

56. 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

57. 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