Ch. 18
Money and Banking
Ch. 18.1
Origins of Money
(Learning Objective- discover the evolution from Barter to Money)
Money has not always existed! Early Families were self-sufficient. There was no need for exchange. Over time,
specialization caused exchange. (Some hunted, some farmed) These exchanges were done by Barter (trading goods
or services for other goods or services)
Problems of Barter
Inefficient, Time consuming, difficult to determine value of goods or services.
Specialization makes Barter difficult. How does a Brain Surgeon trade for his services?
The Birth of Money
Money- anything that is widely accepted in exchange for goods or services. We don’t know exactly when money was
first used. Anything could be used as money as long as it is widely accepted.
3 Functions of Money
1. Medium of Exchange- (most important)
2. Unit of Account
3. Store of Value
Medium of Exchange
Anything that is widely accepted as payment for a good or service. Could you use Corn as a Medium?
Commodity Money- The earliest form of Money. Corn was accepted as Money because it could be used later to
purchase something else. Gold and Silver are early forms of Commodity Money. Cattle and Salt also!
Problem- Counterfeiting.
Unit of Account
A standard on which to base all Prices. A way to determine value. A bushel of Corn is worth a Pair of Shoes, or a Cast
Iron Pot, or a Cow Hide. This gave buyer and seller a common measure of value. An ounce of Gold is worth……….?
Store of Value
Money serves to store value over time when it retains purchasing power.
MONEY = VALUE or WORTH
Money is a measurement of STOCK – an amount measured at a particular point in time.
FLOW- an amount received or expended during a period of time.
Money is a stock measurement.
Income is a Flow measurement.
Commodity Money
The introduction of Commodity Money made exchanges easier! It is not perfect though!
Limitations1. Durable- Some Commodities don’t last very long.
2. Portable- some are bulky and difficult to exchange.
3. Divisible- not easily divided. Can you buy a fraction of a cow?
4. Uniform Quality- Some bushels of Corn may not be as good as others.
5. Low Opportunity Costs- If you are using corn as money, you shouldn’t eat it.
6. Supply and Demand must not Fluctuate- What if there was a record Corn crop? How would that affect the
value of corn?
7. Limited Supply- The ideas money should be limited. Can you use leaves as Money?
(*See Chart pg. 568- 7 desirable qualities of Money)
Coins
Commodity Money has always had Quantity and Quality problems. (How much? How Good?)
Turning Gold or Silver into Coins solved these problems.
Coins first used in Asia in about 600BC. Coins were Durable, Portable, Uniform and Limited.
The power to Coin. This was originally vested in the King or Feudal Lord.
Token Money- money whose exchange value exceeds its production cost. Today we use bills and coins that cost much
less to make than they are worth. (A quarter cost the US Mint about 10 cents to make.) Paper Money costs even less.
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Ch. 18.2
Origins of Banking
(Learning Objective- understand why banks were created)
The Earliest Banks
Keeping coins on your person or at home was unsafe. People used Goldsmiths to keep their gold for them.
The Goldsmith would make coins on request for their customers. A farmer might visit the Goldsmith to withdraw
money to go buy a horse. The horse trader would then take the gold to the Goldsmith for deposit (safekeeping).
This became a nuisance for some. They instead would write a note to the Goldsmith instructing him to transfer Gold
from their account into the horse trader’s account. These notes became the first Checks.
Check- written order instructing the bank to pay money from an account.
Bank Loans
People have confidence that Banks will honor deposits and checks. So, Banks rely on the idea that there are more
deposits in the Ledger than actual Gold (Money) in the vault. A Check is a Medium of Exchange. No actual money
exchanges hands. It is simply an entry in a bank ledger. Banks do have simple rules- you can’t withdraw more then
you deposit.
Fractional Reserve Banking System- only a portion of bank deposits is backed by reserves.
Bank Notes
A piece of paper promising the bearer a specific amount of Gold when the note was redeemed at the issuing Bank.
Difference between a Check and a note?
-Checks could be redeemed for gold only if endorsed by the payee.
-Bank notes could be redeemed for gold by anyone who presented them to the issuing ban
These were more convenient than carrying cash and are examples of Representative Money.
Representative Money- Bank notes that exchange for a specific commodity, such as Gold.
*Today- paper money represents Gold in a Bank’s vault. (Fiat Money)
Fiat Money
Over time, Representative Money became more popular. Governments began issuing Fiat Money.
Fiat Money- has no value in itself; it is declared money by a Gov. Decree.
Fiat Money has value because the Gov. says so. People accept it because they believe that others will accept it as
well. It is mere paper or pieces of metal that the Gov. says has value. Most people use Fiat Money today.
Depository Institutions
Banks today evolved from Goldsmiths. They are known as Depository Institutions.
They accept deposits and make Loans or Checks from these Deposits. 2 Types
Commercial Banks
Historically they lent to Commercial ventures (Businesses) rather than individuals.
There are 6,500 Commercial Banks in the US.
Today they loans to general public.
Thrifts (Savings and Loans, Savings Banks, Credit Unions)
Usually they specialize in loaning to their members for Mortgages, Car loans or major commercial purchases.
*Both of these were regulated by state governments.
National Bank Act of 1863
Created- National Banks. National Banks are regulated by the Fed. Gov. (US Treasury) and are federally insured.
US Treasury Building in DC
*Today- we have both state and federal banks.
The Federal Reserve System
A times Banks experience “Panics” where people lose confidence and want to withdraw $.
This could cause the Bank to fail. After several banks failed during the Panic of 1907, the Gov. took action.
1913- The Federal Reserve System- The Central Bank and monetary authority of the US.
Nearly all industrialize nations have done the same.
Federal Reserve in DC
Powers of the Fed
-Supervise monetary system (sets Monetary policy)
-issue national currency
-Bank for Banks (reserve only deals with banks, not the public)
-insures Banks
-Holds reserves (Fiat $ must be “backed up” by Gold reserves to give it value)
-sets rates for loaning money (Fed loans $ to banks which determines the interest rate of bank loans)
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Ch. 18.3
Money, Near Money and Credit Cards
(Learning Objective- Describe the Definition of Money)
Definition of MONEY
When you think of Money, you probably think of Currency- Notes and Coins. These are just a small part of Money.
If you make a Deposit into a Bank, the amount in the account is also Money. Both currency and checking accounts
can be used for exchanges, and have value. This is usually called M1.
Narrow Definition of Money (M1) - currency, checkable deposits and traveler’s checks.
Currency
Bills and Coins in circulation are part of the Money supply. Money in Bank vaults or on Deposit are not in circulation.
Currency is about ½ of M1.
Paper currency (notes) is issued by the Federal Reserve System. Coins are minted by the Gov. and with Paper
currency are considered Fiat Money.
US Currency Abroad
About ½ of all US Currency is held by foreigners. Many foreigners rely on the stability of the US dollar. Many don’t
trust the stability of their own currency. Some foreign nations will use the Dollar as their currency. (Panama, Ecuador,
El Salvador)
Traveler’s Checks
Less than 1% of M1. Safer than cash since they can be replaced if lost or stolen.
Broader Definition of Money: M2
M2 includes M1 plus Savings Deposits, Time Deposits, and Mutual Funds.
Savings Deposits
An account that earns interest but has not specific maturity date. This means you can withdraw any time with no
penalty. Most banks allow you to have a savings and a checking account. Savings accounts can also shift funds into
Checking. Savings accounts are about 3 times the size of M1.
Time Deposits
These earn a fixed rate of return if help for a specific period. (Months to years) Early withdrawal = penalty.
Time deposits of less than $100,000 are part of M2.
Mutual Funds
An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in
securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money
managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors.
Advantage- allows you to pool your money with a group of investors and have a professional manage your
investment.
M1 compared to M2
See pg. 584
Credit Cards are NOT Money!
You can make purchases but they are not considered part of the Money supply.
A credit card is a way to borrow money. You are only delaying payment. You have to eventually pay your credit card
bill.
Evolution of MoneyCommodity Money
Then
Paper Money- representing a claim to some commodity (gold)
Then
Paper Money- with not value in itself.
Then
Electronic Entries to a bank
*Most Money today doesn’t change hands; it changes computer accounts via electronic funds transfers.
Electronic Money
Computerized Funds transfers between banks.
Debit Cards are so popular today that people carry less cash, so less is being printed.
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