Download Finance and Trade

Finance and Trade
Money in Early National Period
• Bimetallic Standard
– Set up by Alexander Hamilton first Secretary
of Treasury
– Justification is to increase the money supply
– Foreign silver and gold coins accepted
• Silver content of Spanish dollar is unit of account
• Equal weight of gold = 15 time weight of silver
Bimetallic Standard does not work
• Why? Value of gold to silver is fixed
• Market value fluctuates
• Once market value moves away from fixed
ratio, anyone can make money buying up
one or the other currency, only one will
circulate
• Gresham’s Law
• As supply of gold increased after gold rush
in 1840 most silver disappeared from
circulation
• Was Bimetallic standard necessary to
increase money supply?
• No, Banks create money
Banks in Early National Period
• Financial Intermediaries are financial
institutions through which savers can
indirectly provide funds to borrowers.
Banks
– take deposits from people who want to save
and use the deposits to make loans to people
who want to borrow.
– pay depositors interest on their deposits and
charge borrowers slightly higher interest on
their loans.
Bank notes
• Banks also had the right to issue bank
notes or bank money
• Promise to pay the holder specie on
demand
• By 1860 there were more than 9,000
different kinds of bank notes circulating
• Personal checks were rare
Two Types of Banks
• State Chartered Banks
– Chartered by State legislatures
– Private investors provide assets
– Make loans in form of bank notes
• National Bank
– First National Bank 1791
• Set up Alexander Hamilton
• 20 year charter, not renewed
– Second National Bank 1816
• Also 20 year charter
How do banks create money?
• Reserves are deposits that banks have
received but have not loaned out.
• In a fractional-reserve banking system,
banks hold a fraction of the money
deposited as reserves and lend out the
rest.
Banks and Money Supply
• Bank A receives
a $100 gold as
deposit
• Recorded as an
asset and liability
in T account
Assets
Liabilities
gold $100
D $100
Banks and Money supply
• Banks make money by loaning some of
this deposit to others
• The fraction of total deposits that a bank
keeps as reserves is called the reserve
ratio.
• Banks decides how much to keep as
reserves
• What happens when bank makes a loan?
Banks and Money Supply
• Assume RR=10%
• Bank A makes a
90$ loan
• Bank makes no
money on deposit
• Created $90 in
Bank notes, Money
supply has
increased by $90
Assets
Liabilities
gold $100
deposit $100
Loan $90
Bank
notes $90
Banks and Money Supply
• What happens
when person
receiving the loan
spends it and it is
deposited in
another bank?
• gold and notes
go down in bank
A
Assets
Liabilities
gold $100
deposit
$100
- $90=$10
Loan $90
Bank
notes $90
-90=0
• Bank notes are used and deposited in
another bank which may redeem notes
and then make more loans
• What limits the amount of notes created?
– No Fed, no reserve requirement
– Bank may go under
– More notes issued, value of notes decrease
Value of Bank Notes
• Depends on a number of factors
– Distance from Bank
– Reliability of Bank
• Amount of Reserves and number of notes issued
– Banks determine the amount of reserves they
keep
Money Multiplier
• The money multiplier is the reciprocal of
the reserve ratio:
M = 1/R
• With a reserve requirement, R = 10% or .1
or 1/10,
• The multiplier is 10.
• The initial $100 deposit increases MS by $
1000.
Problems with Fractional
Reserve Banking
• If reserves are less the deposits, banks
could not have enough cash to pay all
depositors even if bank is solvent.
• Banks the issue too many notes are even
more vulnerable.
• Rumors can lead to runs on banks and
banking panics
• Bank of US
What was the role of 1st Bank of
US?
• Modeled after Bank of England
– Public and Private
• Accepted Deposits, printed notes that
were redeemed for specie, made loans
• Served as a fiscal agent for Federal Gov
– Held tax receipts, tariffs, made loans to gov,
paid gov bills
– Allowed to have branches in all states
Advantages over State Banks
•
•
•
•
Large Gov deposits
Lots of Branches
Notes were more useful than state bank notes
Held more state bank notes than state banks
held BUS notes
– Could redeem them faster
• Demand for state bank notes reduced
• Charter was not renewed in 1811 due to political
pressure
What happened?
• The BUS could have acted as lender of
last resort but did not
– probably reduced state banks note issue
• After 1811, number of state banks
increased, note issue increased, reserves
decreased
• Panic in 1814
• 2nd BUS chartered in 1816
2nd Bank of US
• Unpopular as the 1st for same reason
• Andrew Jackson elected in 1828 is an
enemy of the bank
• Attempt to recharter bank early in 1832
passes in Congress, Jackson veto bill and
there are not enough votes to over ride
veto
What happens
• Number of Banks
increases at first,
price increase
• Bank panic in 37,
moderate recovery in
38
• Panic in 1939, prices
fall
date
# banks
1819
1830
1834
1840
1841
1844
1850
1860
274
300
506
901
784
696
824
1562
What was cause?
• Soundness school
– Increase in banks and reduction in reserves
increased money supply
– Over issued notes which caused panic
• Not clear this is true. While there was an
increase in notes and price , ratio of bank
reserves to liabilities did not decrease
What caused changes in M ?
• Inflow of silver from Mexico due to political
instability
• Capital inflow from abroad for canal etc
• Chinese trade deficit, meant silver would
flow to China
• but China exchanged US silver for Bills of
exchange on London Banks held in US, so
China could by opium from British
What caused Panic?
• Specie Circular of 1836
– Land payments had to made in specie
– No evidence of reserves going west
• More likely increase in interest rates in
Britain and fall in US commodity prices
• Not clear that the panic had large real
effects GDP continues to grow even with
large fall in prices
Banks and inflation
• Did the Bank of US restrain growth in state
banks and note issue?
– Some evidence that it did
– At same time there was an increase in Bank
of US notes
• What was the effect on price level?
1811
1838
Prices rise
after the first
Bank of US
loses its
charter , but
not after the
second bank
loose its
charter
In spite of
inflation and
deflation during
this period, GDP
growth is
constant.
Changes in
money supply
and prices do not
have real effects.
Trade in Early National Period
• Trade increased from 1793-1807
– American neutrality during Napoleonic wars
– Gdp per capita increased
• Price of exports increased, price of imports fell
due to industrial revolution in Britain
– Terms to trade (Price of exports/ price of imports)
improved
• Trade per capita decreased
– Not evenly distributed
Jeffersonian Embargo
• Jefferson wanted to reverse British
position on controlling neutral shipping
– Attempted to deny British gains from trading
with US
– Was not successful
– War of 1812 further disrupted trade
Gains from Embargo
• Increase in firms producing products that
had been imported from Europe
– Increase in incorporations especially in
textiles
• Firms fail when trade resumes increases
pressure for tariffs to protect textile
industry
Economics of Tarrifs
• Tariffs are an important source of
government revenue
– Some times as high as 90%
• Rates of Tariffs vary but are generally high
• Since volume of trade varies inversely with
tariff rates there is a rate that maximizes
revenue
Tariffs
• Benefits producers and government
• Hurts consumers
Market for jeans Before tariff
S
US consumes Q2
US produces Q5
Imports Q2-Q5
$
P1
Pw+T
Pw
D
Q5 Q4 Q1 Q3
Q2
Q
After
Sf tariff
US consumes Q3
US produces Q4
Imports Q3-Q4
Gov Rev T*(Q4Q3)
B
S
$
a
A
CS abdghcf
abd
PS e
ec
Gov
f
TS abdghcfe abdcfe
P1
Pw+t
Pw
e
b
d
c
f
g
Q2 Q4
h
Sf
D
Q1
Q3 Q5
Q
Benefits of protection
• Are there benefits of protecting an
industry?
• Infant Industry argument
– Depends on presence of learning by doing