MONEY and BANKING

Chapter 13

MONEY

How is Money different from Barter?

Money is anything that people commonly accept in exchange for goods and services.

Money was developed to overcome problems associated with bartering.

Example

Suppose that you go shopping and decide to buy a jacket.

When you pay for the jacket you hand the clerk a chicken.

The clerk refuses to accept the chicken, so you offer him 12 oranges, a picture of your mother and a coffee mug.

The clerk refuses all of these as well. Finally, you open your wallet and offer

the clerk several pieces of paper with a picture of an 18th century politician and the number 10 printed in green.

The clerk accepts these pieces of paper because they have a guaranteed standard of value in the U.S.

In the U.S., money has 3 basic functions which make it a more efficient system than barter.

Medium of Exchange

Any item that sellers accept as payment for goods and services

Ex. – If you have a part time job in a restaurant, you will be paid in money rather than in barbeque sauce. You then can use the money to buy anything you want. (Including barbeque sauce.)

Standard of Value

A measure of the relative value of goods and services

Ex. – People can compare the worth of items such as a CD and a pizza. If the CD cost $10 and a pizza cost $5, a consumer knows that the relative value of the CD is twice that of the pizza.

Store of Value

Money can be saved or stored for later use.

For money to serve as a store of value, 2 conditions must be met• Must be non-perishable – can’t rot over time

while being saved.

• Must keep its value over time.

5 Major Characteristics of Money

Durability Portability Divisibility Stability Acceptability

Durability

Refers to money’s ability to be used over and over again.

Portability

The ability to be carried from one place to another.

Divisibility

Refers to money’s ability to be divided into smaller units.

Stability

In value Money must be stable in value. Encourages saving and maintains

money’s purchasing power.

Acceptability

Means that people are willing to accept money in exchange for their goods and services.

Once Again…

Money must have and must retain it’s value.

How does money get its value?

Economists have identified 3 sources of value for money.• Commodity Money

• Representative Money

• Fiat Money

Commodity Money

An item that has value of its own and is used as money.• Ex. – Precious metals, gems, salt in ancient

Rome, tobacco and beaver pelts in early America.

Representative Money

An item that has value because it can be exchanged for something valuable.• Ex. – During the American Revolution the

Continental Congress issued representative money, called Continentals, to finance the war for independence against Great Britain. Merchants accepted these and would trade them in to the government for gold or silver later.

This is a Continental

Fiat Money

An item that has value because a government fiat, or decree, says that it has value.• Ex. – The majority of nations today use a form

of fiat money called currency (paper bills and coins) for money.

The U.S. Relies on Fiat Money

It’s money takes on the form of coins, paper money, and checks.

Coins are made by the U.S. mint. Paper money is printed by the Bureau of

Engraving and Printing in Washington D.C.

Checking accounts make up th largest segment of U.S. money supply.

History of U.S. Banking

Pre-Civil War (1780’s-1860)

This was the time of experimentation and debate in U.S. Banking

Some wanted a national banking system and some wanted states to regulate banks within their borders.

2 National Banks were formed, one in 1791 and the other in 1816. (Both eventually failed.

The major problem with banking during this period was that states issued their own currency and some states used pieces of dollar bills to represent fractional amounts.• Ex. – if you visited a store in the 1830’s and

paid for a 25 cent item with a $1 bill, the clerk might cut the bill into 4 pieces and return 3 of them to you as change.

Civil War to WWI (1860-1913)

The federal government created a dual banking system made up of state and national banks

During the Civil War, Congress issued currency to pay for the North’s war expenses

This new currency was called greenbacks or U.S. notes and was not backed by gold or silver

The Confederate States also issued their own money, which was worthless by the end of the war.

WWI to the Present (1913 – present)

In 1913 Congress passed the Federal Reserve Act, establishing the Federal Reserve System (commonly called the “Fed”)

The Fed became the nation’s central bank, and all nationally chartered banks were required to join.

State chartered banks could choose to join or not.

During the 1920’s about 7,000 banks closed because they were poorly managed.

At the time if a bank closed the people who had money in the bank lost all of their money (people lost confidence in banks)

When Franklin D. Roosevelt was elected in 1932, he issued a “Bank Holiday” in which he closed down every bank in the U.S. for 4 days.

FDR then sent out inspectors to determine which banks were strong enough to reopen.

Almost all were reopened, and people began to put their money back into the banks

FDR also created the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits up to $5,000 ( today = $100,000)

U.S. Banking Today

3 major type of financial institutions have emerged as the U.S. banking system has evolved.

Commercial Banks

Nearly 10,000 commercial banks exist in the U.S.

Their main functions are to lend money, accept deposits, and transfer funds

Saving and Loans Associations (S&L’s)

Established to lend money and accept deposits.

Mutual Savings Banks

Set up to serve people who whished to make small deposits that large commercial banks did not want to handle.