chapter 11 money. money (def): any commodity or token that is generally acceptable as a means of...

Chapter 11

Money

Money

MONEY (def): any commodity or token that is generally acceptable as a means of payment

What are the functions of money What does money do?

What are the characteristics of money? What can be used as money?

What’s it worth? Yasin’s Shirt?

Sammy’s Shoes?

Grace’s watch?

Taylor’s Phone?

The 3 Functions of money

Medium of Exchange Measure of value Store of value

Medium of Exchange

Before, money economies worked on a barter system (trading)

Barter system works on double coincidence of wants – seller and buyer must both be willing

In Medium of Exchange Money acts as a lubricant that smoothes the

mechanism of exchange Everybody wants currency because they can use it

to get what they want

Medium of Exchange

Saves time over bartering When you barter it takes time to find someone

that has what you wanted and wanted what you have.

With medium of exchange – you sell to any willing buyer and buy from any willing seller for currency

Purchasing Power: The amount of goods or services that can be bought with a unit of currency

Measure of value or Unit of Account

Allows Prices Standard prices allow commerce to move

faster haggling

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Measure of value or Unit of Account

Allows Price comparison, which allows decisions In the barter system the value of a good is worth the

value of many other goods. 1 chicken equals so many loaves of bread, so many litres of milk,

pounds of cheese etc.

In a money system, there is a unit of currency that acts as the “standard” that can be used to measure against.

Money makes comparison easy An Ipad = $600 and a PS4 = $600 therefore they are the

same price and are of equal value. A movie is $10 and an DQ blizzard is $5. A DQ blizzard is half

the price of a movie.

Store of Value

In the barter system one good is sold in place of another good.

Money however, can be held (saved) to delay consumption Money as well as other assets such a jewellery, real estate,

antiques. However money has the greatest level of liquidity. Purchasing power in the future should be close to the

purchasing power today Inflation is the rate by which money looses its purchasing

power How leaky is the batery

Canada has established a policy to control inflation to approximately 2%. This assists in the control of purchasing power.

Store of Value

Store of value is very important in international trade

People will look for safe harbours currencies during times of political or economic turmoil

Traditional Safe Currencies USD Euro CAD

The Big FIVE characteristics of money:

1) generally acceptable 2) portable 3) divisible 4) hard to duplicate or counterfeit 5) uniform in value

1) generally acceptable

Older forms of money was generally acceptable because it had some form of underlying value i.e. Gold Coins

Fiat (let it be so) money is declared by government to be considered legal tender

2) Portable Money should be easy to carry Gold other precious metals were

heavy and dangerous to carry Led to the creation of paper money http://player.discoveryeducation.com/index.cfm?guidAssetId

=E09A70EE-C52E-43E7-9736-6FD5B7B6CA0C&blnFromSearch=1&productcode=US

3) Divisible• Making Change back

in the day

3) Divisible• In order for currency to be useful it had to be divisible to

reflect a range of valuesCanada• 1 dollar = 100 centsBritain• 1 pound = 20 shillings = 240 pence = 960 farthingIndia• 1 gold mohur = 15 silver rupees • 1 ruppee = 16 annas = 64 paise = 192 pies,

4) Hard to Counterfeit Rare It’s a simple tool to help you

remember how to check bills: Touch, Tilt, Look through, Look at.

http://videos.howstuffworks.com/howstuffworks/54-how-money-is-made-video.htm

5) Uniform Value Durable Does not loose it’s value

Inflation

Meet Cupad, Cupid's greedy cousin Counterfeit Uniform in value Portable Acceptable Divisible

Classwork P251 1-4

Fake Money http://bankofcanada.ca/en/

video_corp/videos.html

Measuring the money supply Money: Medium of Exchange Near Money: Deposits or other

assets that act as a store of value but are not themselves a medium of exchange

Components of the Money Supply Demand Deposits

Money will be transferred “on demand”1. Chequing Accounts2. Current Accounts (chequing account for

business)3. Savings Accounts

Term Deposits Lender agrees to lend money for a fixed

amount of time At maturity holder will receive money plus

interest Ex Bonds and GIC (Guaranteed Investment

Certificate)

Components of the Money Supply Notice Accounts

Require notice to the bank before given withdraw

Used primarily by business Some interest paid

Calculating the money supply There are many different measures of Canada’s

money supply Definitions go from narrow (M1) to broad (M2) The narrowest definition is most easily affected

by monetary policy and assets are most liquid The broadest definition is the least affected by

monetary policy and assets are least liquid There is not correct measure of money supply

Definition of the Money Supply Bank of Canada (BOC) has a range of definitions of money

supply ranging from very specific to broad (M1-M3)

M1: Narrowest definition of money – medium of exchange More easily controlled by monetary policy Most liquid

All currency in circulation outside of banks Chequing Accounts and Current Accounts Money in banks and ATMS are not counted because??

M2: Includes all of M1 plus Savings accounts Term Deposits

Definition of the Money Supply M2++: Includes all of M2 plus – store

of value Deposits at non-bank deposit-taking

institutions (credit union, caisse populaires)

Annuities at life insurance companies (Annuities is a mortgage in reverse)

All of these assets can be turned into cash in two business days

Definition of the Money Supply M3: Includes all of M2++ - store of

value Least controlled by monetary policy Least liquid

Large term deposits Foreign Reserves Funds that are used as a Store of value but

can be converted into cash

Why do we care about money supply? Knowing the money supply

Helps BOC determine interest rates and other financial policies

How much money is in Canada?

Money Supply In Canada$Millions

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

2004 2005 2006 2007 2008

M3

M2

M1

Banking System Unit Banking: Many independent

banks limited number of branches US has over 14 000 banks

Branch Banking: Limited number of banks with unlimited number of branches Canada has 13

Branch Banking SystemAdvantages

• Safe – less risk of a run on the bank

Disadvantage

• Highly concentrated in few hands

• Little competition

• Higher costs for consumers

Run on the Bank Occurs when a large

number of customers withdraw their deposits because they believe that the bank might become insolvent (go out of business)

Driven by fear and panic

Canada’s Banks 6 banks control over 90% of the

banking assets

Legal Classification Schedule I banks: Domestic Banks

The 13 Chartered Banks Schedule II Banks: Canadian Banks that

are subsidiaries of foreign Banks HSBC Canada Citibank Canada

Schedule III Banks: Foreign Banks with branches in Canada Deutsche Bank

MAGIC or COUNTERFEIT?

How does a Bank turn $100 into $1000?

Reserve Ratio

Reserve requirement is a regulation that sets the minimum reserves each bank must hold to customer deposits and notes Ex. The reserve ratio is 5% A deposit of $100

$5 Reserve $95 Can be loaned out

Reserve Ratio Ex Reserve Ratio: 10% Tarek deposits $100 in the bank The bank keeps $10 and lends out $90 to Thea Thea uses the $90 to pay her employee Sammi who then

deposits the money in the bank The bank keeps $9 and lends out $81 to Sandra who

purchases supplies from Eric for supplies for her new fashion boutique

Eric deposits the $81 in the bank The bank keeps $8.10 and lends out $72.9 to Saheel who

buys books for school from Casey’s Book Store Casey deposits the $72.9 in the bank The bank keeps $7.29 in reserve and lends out $65.61 to

Gordon to help him pay to record his new country song "your love hurts like a broken toe"

Reserve Ratio Ex

$100 Could result in a maximum of $1000

in new money

Reserve Ratios around the world India: 5% China: 15.5% United States: 10% Chile: 4.5% South Africa: 2.5% Canada: ?

260 Example 1

Change in Deposits =

1_____________________________

Reserve Ratio

x Change in Reserves

Change in Deposits =

1_____________________________

0.1x 100

Change in Deposits = 1000

Change in Money Supply

= 900

260 Example 2

Change in Deposits =

1_____________________________

Reserve Ratio

x Change in Reserves

Change in Deposits =

1_____________________________

0.05x 500

Change in Deposits = 10 000

Change in Money Supply

= $9 500

In Class work Do Questions 1-3 (don’t do #4) on

page 260

260 1

Change in Deposits =

1_____________________________

Reserve Ratio

x Change in Reserves

Change in Deposits =

1_____________________________

0.1x 5 000

Change in Deposits = 50 000

Change in Money Supply

= 50 000 – 5 000 = 45 000

260 2

Change in Deposits =

1_____________________________

Reserve Ratio

x Change in Reserves

Change in Deposits =

1_____________________________

0.08x 10 000

Change in Deposits = 125 000

Change in Money Supply

= 125 000 – 10 000 = 115 000

P260 3

Change in Deposits =

1_____________________________

Reserve Ratio

x Change in Reserves

Change in Deposits =

1_____________________________

0.20x 1000

Change in Deposits = 5 000

Change in Money Supply

= 1000 – 5000 = - 4000

Assets and Liability A deposit in the bank is both:

Asset (something of value) Liability (a debt that has to be repaid)

Assets always equal liabilities (+ owner’s equity)

Creation of money in multi-bank system (p257) Scenario:

Bank A has deposit of $10 000 $1000 Reserve (10%) $9000 Excess

Ms Yeung borrows $9 000 Ms Yeung buys furniture worth $9 000 The store deposits the money Bank B

$900 Reserve (10%) $8100 Excess

Mr Papas borrows $8100 Mr Papas gives that money to another person who

deposits it in bank C $810 Reserve (10%) $7290 Excess

Creation of money in multi-bank system (p257) A multibank system will result in the

same amount of new money creation as a monopoly bank so long as the reserve ratios is the same

Creation of money in multi-bank system (p257) Reserve ratio: 10% Deposit: $10 000 New money: ?

Creation of money in multi-bank system (p257) Reserve ratio: 10% Deposit: $10 000 New money: A MAXIMUM OF $90 000 Why a maximum?

A bank might not lend out all of its excess reserves ( High interest, Prudent lending)

Cash Drain People holding (hoarding) money outside of the banking system

Creation of money in multi-bank system

Bank A

Assets LiabilitiesCash +$10000

(Required 1000

Excess $9000)

Deposit+$10000

Total $10000

Total $10000

Bank A - Loan

Assets Liabilities

Cash $10000

Loan +$9000

Initial $10000

New +$9000

Total $19000

Total $19000

Creation of money in multi-bank systemBank A - Withdrawal

Assets Liabilities

Cash $1000

Loan $9000

Deposit $10000

Total $10000

Total $10000

Bank B - Deposit

Assets LiabilitiesCash $9000

(Required $900

Excess $8100)

Initial $9000

Total $9000

Total $9000

Creation of money in multi-bank system

Bank C - Deposit

Assets LiabilitiesCash $8100

(Required $810

Excess $7290)

Deposit $8100

Total $8100 Total $8100

Bank B - Loan

Assets Liabilities

Cash $9000

Loan $8100

Initial $9000

New +$8100

Total $17100

Total $17100

How banks Destroy “money” The amount of money destroyed is

calculated in the same way as money is created

How banks Destroy “money”

Bank A

Loss of Deposit

Assets Liabilities

Cash -10000

Loan -9000

Deposit -10000

Total -10000 Total -10000

Bank A

Loss of Loan

Assets Liabilities

Loans -9000

Cash +9000

Deposit

Total 0 Total 0

In class work Pg. 260 #4

P260 4Bank A

Assets Liabilities

Cash -2000

Loan -8000

Deposit -10000

Total -10000 Total -10000

Bank B

Assets Liabilities

Cash -1600

Loan -6400

Deposit -8000

Total -8000 Total -8000

How Banks Destroy Money Someone withdraws money

Bank has a shortfall and must find money to complete the withdraw

Bank relies on loans being paid back Banks ceases lending if necessary

This is why banks significantly restricted lending in the US during the 2008 – 2009 recession

Read P249-254

Answer Questions #1-3 on page 251 Answer Questions on page 261

#1,2,3,4a

Answers to p.251 #1-3 1) medium of exchange is the most

important because money does away with barter. It is for this reason that money was developed. The other 2 functions stem from that same essential function: money must be accepted as a medium before it can serve as a measure and a store of value

2) The store value function is undermined most severely by inflation, because money loses its buying power

3 a) Liquidity is the ease with which and asset can be used to make a payment, money being the most liquid of assets

B) Canada Savings Bond; shares in a large corporation. The other three follow in no particular order; they depend upon whether buyers can easily be found who will pay for them.

Pg. 261 #1) U.S is much more limited in the number

of branches they are allowed. In the past Canada’s branch system gave security to the banks, because one branch could support another experiencing difficulties. Today both Canadian and US banks have deposit insurance in case of bank failures, therefore lessening the degree of advantage of security that the Canadian branch system has for depositors.

Pg. 261 #2) The tendancy is that depositors seldom

withdraw the total amount they have deposited, leaving most of their deposits as excess reserves, which can be used for lending

#3) it becomes an asset for the bank because the bank owns it and can use it; it becomes a liability because the bank owe the amount to the depositer

#4 A $5,000 deposit in a monopoly bank allows a loan of $45,000; an $18,000 deposit allows a loan of $162,000

Classwork P251 1-3

1. Most essential function of money?2. Store of value, a lifetime of saving can be

destroyed by inflation1. Diversify your portfolio

3. Liquidity is the ease which an asset can be converted to cash

1. Canada Savings Bond2. Share in a large corporation3. Gold Jewelry4. Diamond ring5. Rare Painting