Money and Banking Chapter 10

Money Chapter 10, Section 1

Money…What is it?  Medium of exchange...used to determine value during the exchange of goods  Easier and more useful to exchange money than goods straight up  If there is no money, people barter  Unit of Account...serves as a unit of measure  This allows us a means to compare goods  Store of value...assuming there is no inflation, money keeps it’s value

Characteristics of Money  Currency...coins and paper bills that we use  Durability...must withstand wear & tear  Portability...must be easy to carry (small)  Divisibility...can be broken into smaller units  Uniformity...has consistent value (can count)  Limited Supply...why it keeps its value  Acceptability...recognized by all to have value

Sources of Money’s Value  Something must back money to make it valuable  Commodity money...an object that has value in itself and used as money (not portable or divisible)  Diamonds, cattle  Representative Money...represents something of value...can be exchanged for something of value  IOU, Checks, silver or gold certificates  Fiat Money...money that has value because the government says so (our currency)

Review 1. Two units of the same type of money must be the same in terms of what they will buy, that is, they must be (a) divisible. (b) portable. (c) acceptable. (d) uniform. 2. What is the source of fiat money’s value? (a) it represents the value of another item (b) government decree (c) presidential pardon (d) it is equal to the value of the stock market

History of American Banking Chapter 10, Section 2

Banks  Institutions for receiving, keeping, and lending money  Banks also function as a business  They look to make money  They do so by using your money  You are investing in the bank when you deposit money  American banking has developed over our history to meet the needs of our population

History of Banks  At first, merchants may have held people’s money  Easy to lose your money (not safe at all)  Federalist vs. Anti-federalists  Federalist (Hamilton) wanted a strong central bank or a national bank  Would be able to issue a single currency  Anti-federalists (Jefferson) wanted to leave it to the states

First Bank of the US  Bank of the United States (1791)  Granted a 20 year charter – license to operate  Hold government funds  Borrow money for the government  Issue money  Watch over state chartered banks (watched their reserves of gold and silver)  Provided stability but charter was not renewed  Only lasted until 1811

State Banks  Resulted in Chaos  Printed more money than there was value to back it (leads to high inflation)  People lost confidence in the value of money  States issued charters w/out considering if they would be stable  Banks created their own money  Did not have acceptability, limited stock, or uniformity

Second Bank of the US  similar to the first  20 year charter – slowly rebuilt the public’s confidence in national banking system  Many people still opposed the nat’l bank  Surprised state banks by asking for gold and silver to represent their currency’s value  Put many out of business  State banks started to limit the notes (loans) they issued

Free Banking Era  After the closing of the Second Bank of the US, state chartered banks began  Bank Runs...many people demanded backing for their currency  People wanted the gold or silver  Wildcat banks...ma and pa banks  increased instability (high rate of failure)  Fraud...”made up” that they were banks  Different currencies – state, city, private, etc.

Civil War Banking  National Banking Acts of 1863, 1864  Gave banking powers to the federal government...looked to stabilize currency  Power to charter banks  Require banks to hold reserves  Power to issue a single currency  Later (1900’s) adopted the gold standard  Before this, there was about 8,000 different banks circulating currency

Gold Standard  Money represented a certain amount of gold  Set a definite value for the dollar  Currency could only be issued if there was gold to back it (gave people confidence)  Abandoned in 1971  Why abandon the gold standard?  We turned to use Fiat Money (gov’t decree)

The FED (Federal Reserve)  1913 Federal Reserve Act…established the Federal Reserve  Nation’s first true central bank  bank that could lend to other banks  12 Regional Banks throughout the country that oversee member banks  Member banks are banks that belong to the federal reserve system

Federal Reserve  Supervised by a Federal Reserve Board (Board of Governors…appointed by the Pres.)  Loan money to banks in times of demand  This helps prevent bank failure  Create Federal Reserve notes (our currency)  Will increase or decrease $ in circulation  Today…has huge influence on the economy by controlling the money supply and setting interest rates

FDIC  Federal Deposit Insurance Corporation  Established as a result of Great Depression  Act passed in 1933  Insures people’s money up to $250,000  This started at $2,500  Restricts people ability to redeem $ for gold  because we use Fiat Money

Review 1. During the Free Banking Era between 1837 and 1863, banking in the United States was dominated by which of the following? (a) small, independent banks with no charters (b) the Bank of the United States (c) state-chartered banks (d) savings and loans banks 2. After the Civil War, the National Banking Acts gave the federal government the power to do all of the following EXCEPT: (a) insure banks against failure (b) charter banks (c) require banks to hold adequate gold and silver reserves (d) issue a single national currency

Banking Today Chapter 10, Section 3

Money Supply  All the money available in the US Economy  Divided in M1 & M2  These are the two main categories  Money in the United States also consists of checks, checking accounts, deposits, etc.

M1  Assets that are liquid (directly converted into cash)  Currency (bills and coins) that are held by people outside of bank vaults  Demand Deposits (checking accounts…non interest and interest bearing)  Traveler’s checks  Any transaction that can be made on demand (debit cards, ATM machines, etc.)

M2  M1 + those that can’t be used directly as cash  M2 is also known as “near money”  Savings (you have to withdraw this $ and then use it)  Mutual Funds (funds that pool $ from small savers to purchase short term gov’t and corporate securities)

Functions of Financial Institutions  Store money…protected from loss  Saving Money  Saving accounts – small interest  Checking accounts – frequent withdrawals  Money Markets – more interest than savings  CD’s (certificate of deposit) - higher interest for a certain amount of time but cannot withdraw until the time has passed

Functions of Financial Institutions  Loans  Lend money (new businesses)  Fractional reserve banking (banks only keep a fraction of $ on hand and lend out the rest)  Default…failure to pay back loans by people  This will cause a bank to fail or close  Mortgage  Loans for real estate (15, 25, or 30 years)  Must pay back the principal plus interest  Long term, lower interest

Functions of Financial Institutions  Credit Cards  Essentially, banks are loaning you money on the spot  High interest, short term  Interest…price paid to borrow money  Principal…amount borrowed  Simple interest…interest paid on principal alone  Compound Interest…interest paid on principal and interest