Chapter 14 Money and Banking

MONEY Money must be durable enough to withstand repeated use. Money must be easily divisible into smaller units of value.

Divisible Divisibility means that money can be divided into smaller units. Otherwise, nothing could cost less than one unit of money.

How is money used? UNIT OF ACCOUNT When money is used as a unit of account, it provides a means for comparing the values of goods and services, such as checking the price of similar items at different stores before deciding what to purchase.

Representative Money Representative money is based on the idea that it can be exchanged for something else of value, usually gold or silver. Fiat money has value because a government says it does

Representative Money Representative money makes use of objects that have value solely because the holder can exchange them for something else of value. An IOU has no inherent value apart from the promise of payment.

Fiat Money Fiat money In fiat system paper money, or legal tender, has value because the government has decreed that it is an acceptable way to pay debts. The government limits the money supply, making the money valuable. Too much supply would cause the currency to lose its worth.

History of Banking The Anti -federalists believed that a national bank was not authorized by the Constitution and that the wealthy would gain control of the bank to increase their power over the poor. The Federalists, led by Alexander Hamilton in the late eighteenth century, believed that a centralized banking system was a key to promoting industry and trade.

History of Banking During the Free Banking Era, small state- chartered banks dominated. During the Great Depression, the government restricted individuals’ ability to redeem dollars for gold, eventually making the dollar a fiat currency.

Great Depression Congress created the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits. The Federal Deposit Insurance Corporation (FDIC) offers insurance on bank accounts up to $250,000 to make sure customers do not lose too much money if their bank fails.

Gold Standard The gold standard can slow economic growth by limiting the amount of money in circulation: only as much money as can be backed by gold (which is scarce) can be printed.

Banks failed Many savings and loan banks went out of business due to high interest rates, risky loans, and fraud. The First Bank of the United States was established to bring order to the nation’s confusing banking system. For example, every state had a different form of currency.

Savings and loans crisis One of the causes of the Savings and Loan (S&L) crisis was that S&Ls lost money on risky loans. These losses forced many S&Ls to go out of business.

Here we go again To big to fail? This banking crisis began when mortgage lenders and banks that had issued a large number of sub-prime mortgages found that many of the loans could not be repaid.

2006 Banking crisis In late 2006, a banking crisis occurred. Mortgage lenders and banks that had issued a large number of sub-prime mortgages—loans made to borrowers with bad credit histories— lost money when interest rates climbed and people could not pay their mortgages.

Interest Simple interest is paid only on the money borrowed, while compound interest is paid both on the money borrowed and the interest it earns.

How do Banks make money? How does a bank make money Banks charge more interest on loans than they pay out on customers’ savings. This is their largest source of income. Banks get most of their income from the interest they charge on loans. Banks cover their costs and make a profit by collecting more in interest on loans than they pay out in interest on savings accounts.

Reserve Banking Demand deposits Demand deposits can be paid “on demand,” or at any time. The M1 money supply is liquid, meaning that it can be used as, or directly converted into, cash. In fractional reserve banking, banks keep a fraction of their funds on hand and lend out the rest to their customers.