Chapter 10 – Money and Banking

Money is a “medium of exchange,” a store of value and a Money is a “medium of exchange,” a store of value and a unit of accountunit of account

Qualities of money

DurabilityDurability: Tobacco is a poor money because it deteriorates over time: Tobacco is a poor money because it deteriorates over time DivisibilityDivisibility: A house is a poor money because it can't be broken up into : A house is a poor money because it can't be broken up into

small, equal unitssmall, equal units PortabilityPortability: A house generally can't be moved, so it's a poor choice of : A house generally can't be moved, so it's a poor choice of

moneymoney UniformityUniformity: Paintings are a poor choice of money because they have : Paintings are a poor choice of money because they have

different values for paintings, and different values to different peopledifferent values for paintings, and different values to different people Limited Supply/ScarcityLimited Supply/Scarcity: Sand dollars (sea shells) are poor choices of : Sand dollars (sea shells) are poor choices of

money, because anyone can go to to the seashore and pick them up.money, because anyone can go to to the seashore and pick them up. Acceptability/Intrinsic ValueAcceptability/Intrinsic Value: Ordinary paper is a poor choice of : Ordinary paper is a poor choice of

money because it doesn't represent any value to most consumers.money because it doesn't represent any value to most consumers.

Kinds of money

Commodity Money/SpecieCommodity Money/Specie: Money that is an object : Money that is an object of some value to consumers and is traded as such. of some value to consumers and is traded as such. Examples include: Gold, silver, copper coins, Examples include: Gold, silver, copper coins, tobacco, whiskey, cotton, corn, etc.tobacco, whiskey, cotton, corn, etc.

Representative MoneyRepresentative Money: Money (usually paper) that : Money (usually paper) that can be traded for a commodity or something of can be traded for a commodity or something of value. Ex. U.S. Silver certificates, U.S. “greenback” value. Ex. U.S. Silver certificates, U.S. “greenback” dollars, etc.dollars, etc.

Fiat MoneyFiat Money: Money that has no value other than : Money that has no value other than the demand of government. Ex: U.S. dollar today, the demand of government. Ex: U.S. dollar today, most global currencies. most global currencies.

U.S. Banking History

1791: Congress charters the First Bank of U.S. 1791: Congress charters the First Bank of U.S. championed by Alexander Hamilton (lasts 20 years). championed by Alexander Hamilton (lasts 20 years). Opposed by Jefferson and MadisonOpposed by Jefferson and Madison

1816: Madison signs 20 year charter for Second Bank 1816: Madison signs 20 year charter for Second Bank of U.S. to cover war debt from War of 1812of U.S. to cover war debt from War of 1812

1836: Andrew Jackson vetoes bill to renew corrupt 1836: Andrew Jackson vetoes bill to renew corrupt Second Bank of U.S., despite bank's bribery of Daniel Second Bank of U.S., despite bank's bribery of Daniel Webster and multi-million dollar lobbying campaign.Webster and multi-million dollar lobbying campaign.

U.S. Banking History, cont'd

1836-1862: Free banking era, where Congress mints 1836-1862: Free banking era, where Congress mints only gold and silver (lots of bank fraud, failures, but only gold and silver (lots of bank fraud, failures, but also low taxes and no national debt). States regulate also low taxes and no national debt). States regulate banks, except for a few national banks approved to banks, except for a few national banks approved to circulate federal government specie.circulate federal government specie.

1862: Federal government issues “greenbacks” to 1862: Federal government issues “greenbacks” to float Civil War debt, charters national banks. State float Civil War debt, charters national banks. State chartered banks continue to exist in large numbers. chartered banks continue to exist in large numbers.

U.S. Banking History, cont'd

1913: Federal Reserve Bank created (Third National 1913: Federal Reserve Bank created (Third National Bank)Bank)

Reaction to the Panic of 1907Reaction to the Panic of 1907

Jekyll Island meeting

Organized at 1910 secret meeting at Jekyll Island, Georgia Organized at 1910 secret meeting at Jekyll Island, Georgia attended by: attended by:

Connecticut Senator Nelson W. Aldrich Connecticut Senator Nelson W. Aldrich Assistant Secretary of the Treasury Department A. Piatt Assistant Secretary of the Treasury Department A. Piatt

AndrewAndrew Paul Warburg (“Daddy Warbucks” in Annie), Kuhn, Loeb, Paul Warburg (“Daddy Warbucks” in Annie), Kuhn, Loeb,

and Co. partnerand Co. partner Senator Nelson Aldrich's his personal secretary Arthur Senator Nelson Aldrich's his personal secretary Arthur

SheltonShelton J.P. Morgan & Co. partner Henry P. Davison (Morgan was J.P. Morgan & Co. partner Henry P. Davison (Morgan was

the money guy in Monopoly)the money guy in Monopoly) National City Bank president Frank A. Vanderlip National City Bank president Frank A. Vanderlip

Federal Reserve System

One central bank with an Open Market Committee, One central bank with an Open Market Committee, appointed by President and confirmed by Senateappointed by President and confirmed by Senate

12 member branches in various parts of the country 12 member branches in various parts of the country (including Boston), NY most powerful(including Boston), NY most powerful

Private banks can buy “stock” to become members of Private banks can buy “stock” to become members of the system that pays a fixed interest rate on the stock the system that pays a fixed interest rate on the stock determined by law (additional Fed profits revert to determined by law (additional Fed profits revert to U.S. Treasury) and borrow from discount window at U.S. Treasury) and borrow from discount window at reduced interest rates, the “Federal Funds Rate”reduced interest rates, the “Federal Funds Rate”

Powers of the Federal Reserve Bank

Loans to banks and foreign central banks at discount Loans to banks and foreign central banks at discount rates (to corporations in the last two years)rates (to corporations in the last two years)

Can inflate currency through purchase of Can inflate currency through purchase of government debtgovernment debt

Can Can notnot print money (job of U.S. Treasury) print money (job of U.S. Treasury)

FDIC

Federal Deposit Insurance CorporationFederal Deposit Insurance Corporation: Requires all : Requires all federal banks to pay a subscription and insures federal banks to pay a subscription and insures depositors of those banks up to $25,000 (in 1936), depositors of those banks up to $25,000 (in 1936), $250,000 today.$250,000 today.

Inflation of Dollar

Supply and Demand work on currencies too

Is inflation coming?

Kinds of banking institutions

Commercial banks: loans to a variety of businesses, Commercial banks: loans to a variety of businesses, takes in standard savings, Certificates of Deposit.takes in standard savings, Certificates of Deposit.

Savings and Loan: Mostly real estate loansSavings and Loan: Mostly real estate loans Resolution Trust Corporation: Bailed out S&Ls in Resolution Trust Corporation: Bailed out S&Ls in

1980s1980s Credit Union: Members (depositers) own bank Credit Union: Members (depositers) own bank

Designed to keep larger part of profit for depositersDesigned to keep larger part of profit for depositers Investment bank: Capital investment, regulated by Investment bank: Capital investment, regulated by

Securities and Exchange AdministrationSecurities and Exchange Administration

Banking

Fractional Reserve SystemFractional Reserve System: The system of banking The system of banking where banks hold only a fraction (usually 1/10) of where banks hold only a fraction (usually 1/10) of the money deposited is lent out for interest.the money deposited is lent out for interest.

Money

Money definition: a store of value that is Money definition: a store of value that is exchangeableexchangeable

Money supplyMoney supply: The amount of all money in the : The amount of all money in the (U.S.) economy(U.S.) economy

Measures of Money

M1

Definition: The amount of money in circulation Definition: The amount of money in circulation or in demand deposits, such as checking accountsor in demand deposits, such as checking accounts

M2

Definition: M1, plus savings accounts and money market funds

Other terms

LiquidityLiquidity: Cash on hand, or readily accessible funds : Cash on hand, or readily accessible funds (Banks can have trouble raising liquidity during (Banks can have trouble raising liquidity during recessions/depressions)recessions/depressions)

MortgageMortgage: loan for purchase of a property (usually a : loan for purchase of a property (usually a house) paid off at interest over a fixed interval of house) paid off at interest over a fixed interval of time.time.