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Notes: Chapter 10-Money and Banking I. Money A. Anything that serves as a medium of exchange, a unit of account, and a source of value B. Three uses of money 1. Medium of exchange a. Anything that is used to determine value during exchange of goods and services b. Money replaces barter i. Barter: the direct exchange of one set of goods or services for another ii. Too time consuming and impractical in a modern economy iii. Typically only works in traditional economies c. Currency i. Coins and paper money used as bills ii. Ex: the U.S. dollar, Mexican peso, and Japanese yen 2. Unit of account a. A means of comparing the value of goods and services b. Ex: in a store comparing the cost of two different dresses 3. Store of value a. Something that keeps its value if it is stored rather than used C. Six characteristics of money 1. Durability a. Especially coins vs. paper money 2. Portability a. People need to be able to take their money with them 3. Divisibility a. Ex: different denominations of bills b. $1, $5, $10, $20, etc. 4. Uniformity 5. Limited supply a. Too much money inflation 6. Acceptability D. Sources of money’s value 1. Commodity money a. Objects that have value in themselves and also can be used as money b. Ex: salt c. Often lacks many of the characteristics of money and thus is only used in simple economies 2. Representative money a. Objects that have value because the holder can exchange them for something of value b. Ex: gold or silver or an IOU 1 3. II. Fiat money a. Money that has value because the government has ordered that it is an acceptable means to pay debts b. Also known as legal tender c. Ex: paper money d. The government must control the money supply The History of American Banking A. American Banking before the Civil War 1. Bank: an institution for receiving, keeping, and lending money 2. Two views of banking a. Federalist such as Alexander Hamilton wanted a national bank b. Antifederalists led by Thomas Jefferson wanted banks to be established by the states 3. The First Bank of the United States a. Lasted from 1791-1811 b. Brought order and stability to American banking 4. The Second Bank of the United States a. Lasted from 1816-1836 b. Its constitutionality was upheld in McCulloch v. Maryland (1819) c. Opposed and killed by Andrew Jackson 5. The Free Banking Era (1837-1867) a. No national bank- relied on state-chartered banks b. Problems i. Bank runs: widespread panic in which great numbers of people try to redeem their paper money ii. “Wildcat banks” failed at high rates iii. Fraud iv. Many different currencies B. The Later 1800s 1. During the Civil War a. Greenbacks: paper currency issued during the Civil War b. Widespread inflation in the South because the Confederacy issued too much paper money 2. The National Banking Acts of 1863 and 1864 unified the American banking system 3. Gold standard a. 1870s b. A monetary system in which paper money and coins are equal to the value of a certain amount of gold C. Banking in the early twentieth century 1. The Panic of 1907 showed the need for a central banking system 2. The Federal Reserve System a. Sometimes known simply as the Fed 2 III. IV. b. First true central bank: a bank that can lend to other banks in need c. Member banks: banks that belong to the Federal Reserve System d. Overseen by the Federal Reserve Board e. Federal Reserve notes: the national currency we use today in the United States 3. The Great Depression (1929-1941) a. Severe economic decline during the 1930s b. Numerous bank failures c. Banking reforms i. “Bank holiday”: temporary closure of banks to prevent bank runs ii. Federal Deposit Insurance Corporation (FDIC): government agency that insures customer deposits if a bank fails D. Banking in the later twentieth century 1. Deregulation Savings and Loans Scandal in the 1980s and early 1990s 2. Measuring the Money Supply A. Money supply: all the money available in the United States economy B. M1 1. Can easily be obtained and easily used 2. Liquidity: the ability to be used as, or directly converted to, cash 3. Includes a. Currency b. Demand deposits: the money in checking accounts c. Travelers’ checks C. M2 1. M1 + funds that must be converted to cash (near money) 2. Includes: a. Savings deposits b. Money market mutual fund: a fund that pools money from small savers to purchase short-term and corporate securities Functions of Financial Institutions A. Storing money in a safe place B. Saving money 1. Savings accounts 2. Checking accounts 3. Money market accounts 4. Certificates of deposit (CDs) a. Generally have higher interest rates but you can’t touch the money for a period of time C. Loans 3 1. Factional reserve banking: a banking system that keeps only a fraction of funds on hand and lends out the remainder Default: failure to pay back a loan 2. D. Mortgage 1. A special type of loan that is used to buy real estate E. Credit cards 1. A card entitling its holder to buy goods and services based on the holder’s promise to pay back these goods and services F. Simple and compound interest 1. Interest: the price paid for the use of borrowed money 2. Principal: the amount of money borrowed V. Types of Financial Institutions A. Commercial banks B. Savings and loans associations C. Savings banks D. Credit unions E. Finance companies VI. Electronic Banking A. Automated teller machines (ATM) B. Debit card: a card used to withdraw money C. Home banking D. Automated clearing houses E. Stored value cards 4