Money and Banking Evolution of Money

Functions of Money Barter Economy –Moneyless economy that relies on trade –Hindered b/c some products offered may be undesirable Life is simpler in an economy WITH money

Three Functions Medium of Exchange: –Accepted by all parties as payments for goods and services –Gold, silver, salt Measure of Value –Common denominator that can be used to express worth in terms that most individuals understand –Price Tag : dollar and cents

Store of Value –Property that allows purchasing power to be saved until needed –Goods and services can be converted into money –Enables a period of time to pass between earning and spending an income Three Functions

Money in Early Society Use of money was developed in ancient times –Made life easier Commodity money: –Money that has an alternative use as an economic good or commodity Fiat money –Money by government decree –Coins, dollar bill –Served as money b/c government said they were money

Money in Colonial America Tobacco and wampum once accepted currencies States passed laws to print paper currency –Backed by local banks with gold and silver American revolution –Continental dollars (w/o gold and silver backing) ; worthless at end of the war Colonies used –Specie, gold and silver coins (limited in supply) –Worth more

Origins of the Dollar Spanish Peso –Formed in Mexico from silver –Ships became victims of Caribbean pirates –Known as “pieces of eight” Divided into 8 sub parts known as bits –Talers = name of Austrian money Franklin and Hamilton liked how talers sounded (dollars)

Dollar –Basic monetary unit (or standard unit of currency) –Divided into tenths (different form the peso) Origins of the Dollar: Franklin and Hamilton

Characteristics of Money Must be portable –Easily transferred from one person to another Must be durable –Lasts when handled or store for long periods Must be divisible –Facilitate all transactions Must be limited in supply –Retain its value

Early Banking and Monetary Standards

Privately Issued Bank notes Monetary standard –The mechanism designed to keep money supply portable, durable, divisible and limited in supply Continental currency was worthless –Only trusted coins –Congress has the power to coin money; prevented states from “coining” money –Private banks printed paper money

Growth of State Banking 1811 the nation had 100 state banks –Banks that receive a charter to operate from a state government –Exchange paper notes for gold and silver

Abuses in Banking Banks only printed amount of currency they could back with gold and silver Wildcat banks (dishonest/fraudulent banks) –Printed larger amounts of currency in remote areas –Made redemption of currency difficult

Problems with Currency First, each bank issued its own currency –Different color, size, denominations –100’s different notes Second, bank could print money whenever it wanted –Issue too many notes Third, counterfeiting became a major problem –Just made their own up By Civil war, 1600 banks issued 10,000 different kinds of currency Merchants were worried about backing of money

The Greenback Standard Civil War Congress authorized (1861) printing of $60 million of demand notes –Did not have gold and silver to backing –Government declared them legal tender 1862: new federal currency –Called Greenbacks b/c of green ink –Did not have gold and silver backing

National Currency People feared greenbacks and avoided using them NC: Paper currency of uniform appearance that was backed by United States government bonds Congress created the National Banking System (NBS) –Banks privately owned but chartered by the Federal Government –Issues national bank notes –Backed by US bonds –State banks withdrew their notes

1863: Fed Gov’t issued gold certificates backed by gold –At first they were printed in large denominations for banks 1886: issued silver certificates –Printed in smaller denominations for public use National Currency

Gold certificates: paper currency backed by gold placed on deposit with the United States Treasury Silver certificates: paper currency backed by silver dollars and bullion placed on reserve with the treasury Treasury Coin notes: paper currency issued by the Treasury that was redeemable in both gold and silver National Currency

Gold Standard Defined as the dollar being worth a set amount of gold. Gold certificates could be exchanged for an equivalent amount of gold.

1900: Congressed passed –Basic unit = dollar –Equivalent to specific amount of gold –Did not change the use of greenbacks or notes –Americans could exchange them for gold Remained in effect until the Great Depression Gold Standard

Advantages –Security Americans felt about their money –It prevents the government from printing too much paper currency Disadvantages –Gold stock may not grow fast enough to support a growing economy –People may decide to convert their paper money to gold –Price of gold will respond to the market and lose substantial value –Political risk of failure

Abandoning the Gold Standard Gold Reserve Act of 1934: Removed the U.S. from the Gold Standard We moved to Managed Money Supply, using an inconvertible fiat money standard Fiat Money (legal tender): anything the government decrees is valuable

The Inconvertible Fiat Money Standard 1934: US has been on an inconvertible fiat money standard –Money standard under which the fiat money supply cannot be converted into gold or silver by its citizens Money supply of the US is managed by the Federal Government

Characteristics of Modern Money Tangible component of modern money –Coins –Federal Reserve notes Intangible component –Traveler’s checks – checking accounts –Savings accounts

Portable Durable Divisible Characteristics of Modern Money