Ch. 10: Money and Banking

1. Ch. 10: Money and Banking

2. Sec. 1: Money: Its Function and Properties

3. Functions of Money Money – is anything that people will accept as payment for goods and services -must perform 3 functions

4. Function 1: Medium of Exchange • Medium of exchange – the means through which goods and services can be exchanged • Barter – exchanging goods and services for other goods and services • is cumbersome and inefficient b/c 2 people who want to barter must at the same time want what the other has to offer • Money allows for the precise and flexible pricing of goods and services – convenient

5. Function 2: Standard of Value • Standard of value – the yardstick of economic worth in the exchange process • allows people to measure the relative costs of goods and services

6. Function 3: Store of Value • Store of value – something that holds its value over time • do not need to spend all money at once or at one time – can put aside for later • know it will be accepted wherever and whenever it is presented • When money does not function well as a store of value when economy experiences significant inflation – sustained rise in the general level of prices

7. Properties of Money -to perform 3 functions – an item must possess certain physical & economic properties

8. Property 1: Physical DURABILITY PORTABILITY • should be durable or sturdy enough to last throughout many transactions • if it falls apart when handled or spoils quickly – not good • needs to be small, light, and easy to carry

9. Property 1: Physical UNIFORMITY DIVISIBILITY • must be uniform – having features and markings that make it recognizable • coins look different from other flat metal disks • paper is a consistent size and uses special symbols & printing techniques • distinctive characteristics that ID value & make more difficult to counterfeit • should be divisible so change can be made • also allows for flexible pricing

10. Property 2: Economic • purchasing power or value should be relatively stable • amount that you can purchase with a certain amount should not change quickly • if it does – not good • must be scarce to have any value • when supply of money outstrips demand – money loses power or purchasing power

11. Property 2: Economic • People who use it – • they will accept money in payment for goods & services

12. Types of Money

13. Type 1: Commodity Money • Has value for what it is • items used have value in and of themselves – apart from their value as money • ex – • Most common form of commodity money throughout history are coins made from precious metal • coins contain enough of precious metal that if melted – would be face value • Problem -

14. Type 2: Representative Money • Is paper money that can be exchanged for something else of value • earliest –Middle Ages – receipts to pay a certain amount of gold or silver • why – not safe to transport large amounts of those precious metals • beginning of widespread modern use of paper money • Govt. involvement – • problem – • can cause problems of inflation or deflation in the general level of prices

15. Type 3: Fiat Money • Have • dollar linked to gold until 1971 – cannot be exchanged for gold anymore • only converted into other combinations of US currency • In fiat money – • worth far less than face value • Paper money has no intrinsic value – • only has value b/c govt. says so and people accept it • Crucial role of govt. with fiat money –

16. Money in the United States • Money consists of what can be used immediately for transactions – currency, demand deposits, and other checkable deposits • Currency – • Demand deposits – funds in checking accounts can be converted into currency “on demand” • Near money –

17. Money in the Narrowest Sense • Money is what can be immediately used for transactions • transactions money • this is what most people spend • about half of this is currency (paper or coins) – used by individuals or businesses • Most demand deposits are noninterest-bearing checking accounts that can be converted into currency by writing a check • traveler’s checks – represent a small share • others – negotiable order of withdrawal (NOW) – interest-bearing accounts against which drafts may be written

18. Are Saving Accounts Money? • Near money – cannot be used directly to make transactions • ex – savings accounts & other interest-bearing accounts • money in a saving account can be transferred into a checking account or removed directly • Other forms – • Time deposits – funds placed in a financial institution for a specific period of time in return for a higher interest rate • Often placed in certificates of deposit (CDs) • Money market accounts – place restrictions on the # of transactions that can be made in a month & require to maintain a certain balance in the account in order to receive a higher interest rate

19. How Much Money?

20. Sec. 2: The Development of US Banking

21. The Origins of Banking • Modern banking rose in Middle Ages in Italy • It. merchants stored valuables/money for wealthy people & issued receipts that promised to return on demand • figured out - • beginning of fractional reserve banking • practice of

22. The Origins of Banking • Colonial America – same practice – but banks were not as secure • if merchant’s business failed – depositors lost all savings • State banks – banks chartered or licensed by state govt. were established • After Revolutionary war • some followed practices that tended to create instability and disorder • issued own currency that not linked to reserves of gold or silver held by bank

23. Economic Pacesetters: Alexander Hamilton: Shaping a Banking System • 1st Sec. of Treasury (1789 – 1795) – b. Jan 11, 1755 – d. July 12, 1804 • faced banks issuing own currency • The First Bank of the United States • leading Federalist who being in strong central govt. • believed in chartering a privately owned national bank to put govt. on sound financial footing • bank would issue national currency, help control money supply by not accepting money from state banks not backed by gold or silver, lend money to the federal govt., state banks, and businesses

24. Economic Pacesetters: Alexander Hamilton: Shaping a Banking System • Constitution did not authorize govt. to charter a national bank • Jefferson & Madison interpreted Const. strictly and feared putting too much power in hands of central govt. • Hamilton argued Const. implied federal govt. had authority to create national bank & duty to regulate currency • Hamilton won fight & • achieved financial goals Hamilton wanted over time • Congress refused • Hamilton being the architect of the bank was a strike against it – he had many enemies

25. 19th Century Developments Without central bank – States banks returned to old practices – own currency with no link to gold or silver -result –

26. The Second Bank of the US • Congress chartered the • had greater financial resources than the first & succeeded in making money supply more stable • opponents saw bank as too powerful & too closely aligned with wealthy • Pres. Andrew Jackson opposed and

27. Wildcat Banking • Charter for 2nd Bank lapsed in 1836 & • all banks were state banks • each issued own currency – • States passed free banking laws – allowed individuals or groups that met requirements to open banks • some banks in remote locations to keep people from redeeming bank notes – • this and questionable quality of many bank notes that resulted in wildcat banking • such banks susceptible to bank runs when depositors demanded gold or silver for currency • banks often not have sufficient reserves of this – result –

28. The Struggle for Stability • During Civil War – • solution – • US banknote – greenbacks – printed with green ink • 1863 – • national banks – banks chartered by the national govt. • provided for a national currency back by US treasury bonds & regulated the minimum amount of capital required for national banks as well as the amount of necessary reserves to back the currency • Congress taxed bank notes issued after 1865 – helped eliminate them

29. The Struggle for Stability • 1900 – • gold standard – • national currency & gold standard helped bring some stability to banking system • Money now uniform throughout the country – backed by something of intrinsic value and limited by supply of gold

30. 20th Century Developments -economy still experienced periods of inflation and recession and financial panics -due to lack of a central decision making institution to manage money supply in a flexible way to adapt to changes

31. A New Central Bank • 1913 – • a true central bank • 12 regional banks with a central decision making board • provides financial services to the govt., makes loans to banks that serve the public, issues Federal Reserve notes as national currency, regulates money supply to ensure maintaining purchasing power

32. The Great Depression and the New Deal • 1929 – • many banks failed due to bank runs – consumers panic & withdraw money • when banks failed – many more depositors lost their money • Banking Act of 1933 – instituted reforms – • Federal Deposit Insurance Corporation (FDIC) – • set tone for 50 yrs by increasing regulations on banking in the US

33. Deregulation and the S & L Crisis • In 1980 & 1982 – • allowed savings & loan associations (S & Ls) to operate like banks • deregulation encouraged S & Ls to take more risks in type of loans made • result- S & Ls failed and depositors lost money • Govt. agreed to fund the S & Ls restructuring in order to protect consumers • cost taxpayers hundreds of billions

34. Financial Institutions in the US • Bank – • goal of a bank though – earn a profit • All financial institutions receive a charter from the govt. – state or federal • Govt. regulations set amount of money owner must invest in it, size of reserves bank must hold, ways that loans must be made • can refer to commercial bank, savings & loan association, or credit unions • in the past – institutions provided different & distinct services • today –

35. Type 1: Commercial Banks • Privately owned commercial banks are oldest form of banking & most often thought of as banks • initially established to provide loans to businesses • 2003 – • national commercial banks belong to the Federal Reserve System • only about 16% of state chartered banks belong to the Fed • about 1,500 national commercial banks are large one with assets of $300 million + • 2005 –

36. Type 1: Commercial Banks

37. Type 2: Savings Institutions • Saving & loans associations began I US in 1830s • originally chartered by states as mutual societies for 2 purpose • 1. Take savings deposits • 2. Provide home mortgage loans • Basically – people pooled savings in a safe place & have a source of financing for families who wanted to buy homes • S & Ls still do this – but also more – like a commercial bank • since 1933 – govt. may charter S & Ls • since 1982- federally chartered S & Ls call themselves savings banks • Many savings institutions are financed through the sale of stocks • in 2003 – 800 federally chartered saving institutions & 600 state chartered institutions • insured under a specific fund of the FDIC as part of reform that followed the S & L crisis of the 1980s

38. Type 3: Credit Unions • Are cooperative savings and lending institutions – like early S & Ls • offer services similar to commercial banks and S & Ls, but specialize in mortgages & auto loans • 1st credit union in US chartered in 1909 • Federal Credit Union Act of 1934 created a system of federally chartered credit unions • 2003 – about 5,800 federally chartered credit unions, 3,600 state chartered • most have deposit insurance through National Credit Union Association (NCUA) • Credit unions have membership requirements • to be a member – must work for a particular company, belong to a particular organization, be part of a community affiliated with the credit union • are cooperatives - nonprofit organizations owned by and operated for members • more than 80 million members nationwide in 2003

39. Sec. 3: Innovations in Modern Banking

40. What Services Do Banks Provide? Banks act like money stores – Customers able to do 3 things: Banks are businesses that earn money by charging interest or fees on these services

43. Service 3: Customers Can Borrow Money • Banks allow customers to borrow money thorough fractional reserve banking • banks provide customers (must be approved) with different loans for different circumstances • Mortgage loan – • lender and borrower agree on time period (usually 30 yrs) & interest rate • monthly mortgage payment amount is settled • real estate property act as collateral • if borrow defaults (stops payment) lender take property • property would then be sold to cover balance of mortgage • purchase on credit card is a loan • credit cards issued by banks to users who are borrowers • when you purchase – • when you pay back the bank –

44. Banking Deregulation • Pre-1980s – • also – prevented banks from operating in more than one state • states had limitations on # of branches a bank could have in one state • deregulation in 1980s & 1990s brought this to an end & other changes

45. Bank Mergers • End of regulations on interest banking led to a large # of mergers • Larger banks acquired smaller and smaller banks joined together to enter different geographic regions • # of mergers has declined since 1998 – 500 then, to less than 200 in 2005 • although mergers creating very large banking organizations continued • Bank of America Investment Services, Inc. & J.P. Morgan Chase & Co. • 2 of the largest in Am., with assets around $1 trillion each • 95% of most commercial banks have assets of $1 billion or less

46. Bank Mergers • Mergers have increased competition to keep interest rates low & more consumer services • increase in # of bank branches – even while # of banks declines • larger banks & more branches offer customers greater availability of services • also cite economics of scale – can spread costs of new technology over more customers • Potential problems – • increased competition but fewer banks to choose from • larger banks may show less interest in smaller customers & local community issues

47. Banking Services • Financial Services Act of 1999 – • change allows banks to sell stocks, bonds, & insurance & some investment companies can offer traditional banking services • changed based on idea that consumers would prefer to have a single source for financial services • A financial supermarket • banks have not always been able to realize benefits from offering this array of services • have not • people still look to • insurance companies, investment brokers & mutual fund companies

48. Technology and Banking • Technology as changed (computer technology) the way customers use banks – electronic banking • Automated teller machines (ATMs) – • Debit cards – cards that can be used like an ATM card to withdraw cash or like a check make a purchase • Stored value cards – • cards allow customers to use money in their accounts more conveniently

49. Automated Teller Machines • ATMs make it easy to • began to be widely used in the 1970s – and today are located airports, workplaces… • basically a data terminal linked to a central computer linked to an individual banks computer • bank provides a plastic ATM card with a magnetic strip that contains account info • insert card – enter personal identification # & follow instructions • Can

50. Automated Teller Machines • All ATM networks are connected so consumers can use ATM cards at any machine • Some banks charge a fee – • people can use ATMs when banks are closed or from cars • ATMs save banks money – • also allow banks to have more locations without having a complete branch office