CH. 10: MONEY AND BANKING

SEC. 1: MONEY: ITS FUNCTION AND PROPERTIES

FUNCTIONS OF MONEY

Money – is anything that people will accept as payment for goods and services

-must perform 3 functions

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

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

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

PROPERTIES OF MONEY

-to perform 3 functions – an item must possess certain physical & economic properties

PROPERTY 1: PHYSICAL

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

DURABILITY PORTABILITY

PROPERTY 1: PHYSICAL

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

UNIFORMITY DIVISIBILITY

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

PROPERTY 2: ECONOMIC

People who use it – they will accept

money in payment for goods & services

TYPES OF MONEY

•derives its value from the type of material from which it is composed

•is paper money backed by something tangible – gold or silver – that gives it value

•has no tangible backing – but it is declared by the govt. that issues it, and accepted by citizens who use it, to have worth

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 -

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

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 –

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 –

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

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

HOW MUCH MONEY?various

instruments to measure the

money supply

is the narrowest measure of the money supply, consisting of currency, demand deposits, and other checkable deposits

synonymous with transaction money

elements are called liquid assets – are or can easily become

currency

is a broader measure of the money supply

consists of M1 plus various kinds of near

money

includes – savings accounts, other small

denomination time deposits, money

market mutual funds

SEC. 2: THE DEVELOPMENT OF US BANKING

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

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

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

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

19TH CENTURY DEVELOPMENTS

Without central bank –

States banks returned to old practices – own currency with no link to gold or silver

-result –

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

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 –

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

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

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

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

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

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

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 –

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 –

TYPE 1: COMMERCIAL BANKS

-today – wide range of services

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

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

SEC. 3: INNOVATIONS IN MODERN BANKING

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

Service 1: Customers Can Store Money

-customers deposit money, bank stores

currency in vaults & is insured against theft &

loss

safe place to store important papers &

valuables – safe deposit boxes

Service 2: Customers Can Earn Money

-customers deposit money in bank

accounts – can earn money on their

deposits

-

-banks offer other accounts – money

market accounts and certificates of deposit

(CDs)

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 –

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

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

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

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

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

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

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

DEBIT CARDS

Similar to ATM cards – can be used to

withdraw cash & make other transactions at ATMs

called check cards b/c linked to bank accounts & can be used like checks for purchases

Retailers prefer debit cards rather than checks –

DEBIT CARDS

Often look like credit cards & although credit

cards involve getting a loan

debit cards important to keep

track of purchases to know how much money is available

Often seen as a safer way to handle money than credit cards with credit cards – with debit cards –

STORED VALUE CARDS

Stored value cards represent money that the holder has on deposit with the card issuer called prepaid cards – ex – cards are convenient b/c do not need exact

change when using something 2004 –

expected to grow to 49 million by 2008 $42 billion in transactions in 2003

STORED VALUE CARDS

Multi-purpose stored-value cards – may take the place of a checking account convenient for purchases & paying bills

Need to evaluate fees – money paid into these cards is not always

covered by the FDIC

ELECTRONIC BANKING

Allows customers who have an account with a bank to perform practically every transaction without going to the bank itself through the internet – most bank websites allow customers to review

recent transactions, viewed canceled checks, print periodic statements

with electronic fund transfers –

ELECTRONIC BANKING

Recurring bills – mortgages – several challenges – electronic banking allows banks to amass large

amounts of info about people banks say to provide better service

Laws require banks to make customers aware of privacy policies & concerns have led to development of increasing

sophisticated information security systems