Transcript Principles of Economics

Principles of Economics
Power Point Presentation
Chapter 10
Money
• March 20, 2007
© J. Patrick Gunning
What Is Money?
• A definition: money is
the medium of
exchange. It is the
item or promise that is
generally accepted in
exchange even though
no one ever expects to
use the item in any
other way than to buy
something in a market.
Topics Discussed in This Chapter
• 1. The different types of money.
• 2. Money in the modern economy.
• 3. The marvel of money (appendix).
The Four Different Types of
Money
• 1. Commodity Money
• 2. Representative Money
• 3. Credit Money
• 4. Government Money
First Type of Money: Commodity
Money
• Commodity: a material good or resource.
• Commodity money: a material good or
resource that not only has value in exchange
but also has value in use.
• Example: a gold coin. If a gold coin was
melted down, a grocer would trade almost
the same amount of groceries for the gold
metal as he would trade for the coin.
Gold Coins and The Mint
• Why a gold coin is worth more than the
same weight of gold: it contains a stamp
from a mint, which informs the user of its
weight and purity.
• Mint: an organization that smelts metal ore
into uniform coins or bars of fixed purity,
size and weight. It then stamps them to
signify their purity and weight.
Examples of Gold Coins and
Bullion
• $5
•
$20
Gold Bar &
Silver Ingot
Primitive Forms of Money
Practical or ornamental items such as salt,
tea, shells, weapons, tools, and jewelry
served as humankind's earliest monies. The
use of commodities as media of exchange
persisted in some societies for hundreds of
years after the invention of coinage.
Cowrie Shell Money
• Porcelain-like shells from mollusks found
mainly in Indochina-Pacific Region were the
first kind of money to circulate freely in trade
in the ancient world.
Ghost Face Money
• Kuei T'ou C'ien (Ghost Face
Money)
Ch'ing (Bridge Money)
Bronze cast in the shape of miniature household tools
and farm implements became a widely accepted form of
Chinese currency as early as the 10th century BC. Some
of these metallic pieces were still in use in the 2nd
century AD.
Tea Brick Money
• Bricks of pressed tea
leaves served as
currency in Tibet,
Mongolia, Siberia, and
Northern China during
the 19th and early 20th
centuries. Pieces were
cut from large bricks for
use as small change.
Pan-Liang (221-118 BC) Money
• This is the famous coin of Emperor Shih
Tuang Ti, builder of the Great Wall of China.
The Pan Liang was the standard money of
China for more than a century.
One Man Economy
• No need for
exchange
• No need for money
Money As a Medium of
Exchange: Barter Society (1)
• People who obtain goods in trade expect to
consume them. Example: fish for a blanket.
Money As a Medium of
Exchange: Barter Society (2)
• People who obtain goods in trade may expect to
trade them for other goods.
• A good that is acquired in order to trade for other
goods functions as a medium of exchange.
• Example: in order to obtain nails, a person may
first produce apples and then trade them for
potatoes. Later, he trades the potatoes for nails.
• The potatoes function as media of exchange. But
they are not generally accepted in exchange.
How A Money Economy Differs
From A Barter Society
• At least one class of commodities is accepted in
exchange by practically everyone in practically all
circumstances.
• The class become generally accepted in exchange.
• It has value in exchange, regardless of its value in
use.
• The use of a single class as money reduced the
costs of making exchanges.
Barter in Colonial America
• Coins were scarce during the early colonial
period, and much of the meager supply
available went to pay for imported goods.
Short of cash to spend at home, the settlers
used tobacco, rice, corn, and numerous
other commodities to buy goods and
services and to pay debts.
Farm Products
Corn and tobacco
were the most
important of the farm
products that came
into use as money
substitutes. Both
were declared legal
tender and could be
used to pay taxes and
other debts.
Pelts
• Beaver pelts were used to pay court fines
and debts and to buy goods. Sought after by
fashionable Europeans, the skins became
important export items.
Iron Nails
•
Even such important objects as nails
occasionally served as substitutes for scarce
coins.
Wampum
American Indians traded with strings and
belts of polished beads known as wampum.
Colonies soon adopted wampum as a
commodity currency.
A Money Economy
• How a money economy differs from a barter
economy: at least one class of commodity
continues to be used as a medium of exchange by
practically everyone.
• That is, practically everyone is willing to trade his
commodities for the same commodity.
• Some amount of the commodity used as money is
also used as a good or resource.
Advantages of Gold Over Other
Commodities As a Medium of Exchange
•
•
•
•
•
•
1. Its enduring market value as an ornament
2. Its physical durability.
3. Its high value in relation to its bulk.
4. Its divisibility.
5. Its capacity to be cheaply assayed.
6. Its high cost of production.
Second Type of Money:
Representative Money
• Representative money: certificates of ownership to
commodity money.
• The commodity money warehouse: a business that
stores the money commodity.
• When a customer stores his commodity money,
the warehouse manager gives her an ownership
certificate.
• The certificate implies a promise by the
warehouse manager to redeem the certificate.
– Redeem: to exchange the certificate for the item that is
stored.
Example of Representative
Money Issued by Government
• Note that it is a promise to pay gold coin to the bearer.
Four Characteristics of
Representative Money
• 1. It is issued by a commodity money warehouse.
• 2. It is a credible promise to turn over a given
quantity of the commodity it represents.
• 3. The materials from which it is made have
practically no value as commodities (e.g., paper).
• 4. There is a sufficient amount of the commodity
in the warehouse vaults for the warehouse
manager to keep all his promises to redeem the
certificates for the promised commodity.
The Emergence of Representative
Money
• Representative money has often been issued
by a government.
• Sometimes, it has been issued by private
commodity money warehouses, however.
• Question: how could representative money
emerge in a society if a government did not
issue it?
A Representative Money
Scenario (1)
• 1. If people used gold coins as the only kind
of money, they would keep some coins on
hand in order to make future transactions
and in order to save.
• 2. Storing coins is costly because:
– 1. They occupy space.
– 2. They can be stolen.
A Representative Money
Scenario (2)
• 3. Costs of storage is lower for a warehouse that
stores the gold of many people in the same place.
• 4. A warehouse business would be profitable
because the price people would pay for storage of
their savings is greater that the cost of providing
the storage service.
• 5. Warehouses would issue deposit receipts, or
gold certificates.
A Representative Money
Scenario (3)
• 6. Warehouses agree to redeem the certificates for
gold during the ordinary hours of business,
regardless of who presents them. At this stage the
certificates are not yet money because they are not
generally acceptable in exchange.
– Right to redeem representative money on demand: the
right to withdraw the commodity that backs the money
at any time during the normal hours of business simply
by presenting the representative money.
A Representative Money
Scenario (4)
• 7. But sellers would be willing to accept the certificates in
exchange because they could redeem them.
– They might charge a premium at first. But later they might prefer
the certificates over gold coins.
– The cost to a seller of redeeming a large number of certificates is
practically the same as the cost of redeeming one.
• 8. As more and more sellers began to accept them, people
would come to prefer the certificates to the gold because of
the lower cost of using paper in exchange.
– The representative money replaces the gold coins in exchange; but
there is no increase in the total quantity of money.
Two Steps in the Emergence of
Representative Money
• 1. A gold storage warehouse must emerge.
– A. People must have a demand for gold storage.
– B. The sum of costs of storing gold must be lower when
owners join together and store it in a single place than
when they store it separately.
• 2. Certificates issued by the gold storage
warehouse must become acceptable in exchange.
– This is more likely if the warehouse manager agrees to
redeem them for gold to anyone who presents a
certificate to him.
Third Type of Money:
Paper Credit Money
• Definition: items similar to
representative money but
which are not certificates
of ownership and cannot be
redeemed for any
commodities.
Characteristics of Credit Money
• May be identical in appearance to
representative money.
• Issued by a banker, who creates money.
Unlike a commodity warehouse, the banker
does not have the commodities needed to
redeem the certificates.
• Definition of a banker: a producer of credit
money; a creator of money.
The Emergence of
Credit Money (1)
• Assume at first that gold certificates are
widely used in exchange.
• The commodity warehouse manager is not
ordinarily required to redeem the
certificates because people are happy to use
representative money.
The Emergence of
Credit Money (2)
• The warehouse manager issues certificates that are
not backed by gold in the warehouse.
– He may use them to buy goods for himself.
– He may lend them out in order to earn interest.
• These certificates are credit money. The
warehouse manager becomes partly a banker.
• Sellers accept the unbacked certificates in
exchange because they expect other sellers to
accept them.
The Emergence of
Credit Money (3)
• An example:
• The warehouse manager issues 1000 kilograms
worth of gold certificates. These are backed by
gold and are commodity money.
• He later issues 100 kilograms worth of certificates.
These are not backed by gold and are not
commodity money.
• By issuing the unbacked certificates, he becomes
partly a banker.
Question 1
• Why does the warehouse manager issue
credit money (and, therefore, become a
banker)? Two answers:
• 1. To get money for his personal use.
• 2. To earn money by making loans.
Question 2
• How does the banker's action of creating money
affect people?
• People who receive the new money compete with
holders of the existing money for goods and
resources. They bid up the prices higher than they
otherwise would be.
• Thus, the creation of credit money harms the
holders of existing money, although they might
not realize it, especially in a growing economy.
Question 3
• What if someone accumulated a large number of
gold certificates and demanded that the issuer
redeem them for commodity money?
• The banker could not redeem all of the certificates.
• Answer depends largely on:
– 1. the organization of the money producing industry.
– 2. the law.
Fourth Type of Money:
Government Money
• Definition: money produced by a
government. It may be commodity,
representative, or credit money.
Government Commodity Money
Government Representative And
Credit Money
The Government Advantage (1)
• A government has an advantage in getting
its paper money accepted in exchange. A
government can achieve acceptability of its
money in exchange by:
– Outlawing or taxing privately issued money
(restricting competition).
– Demanding that taxes be paid in government
money.
The Government Advantage (2)
• In commodity money:
– Debaser: a person who reduces the amount of metal in a
coin by shaving off the edges.
– The government has an advantage over a private issuer
because it can punish debasers.
• In representative and credit money:
– Counterfeiter: someone who produces paper that looks
like representative money.
– The government has an advantage in punishing
counterfeiters
Examples of Government Money (1)
•
1949
Examples of Government Money (2)
• Early Taiwan Money
Examples of Government Money (3)
Examples of Government Money (4)
Commodity Money and Security (1)
• History teaches that the use of commodity money
provides greater security against unexpected
increases in money’s quantity than the use of
credit money. Why? Because additional credit
money can be created so easily and cheaply.
• Anybody who holds the credit money loses
purchasing power compared with what they would
have if the bankers or government did not print so
much.
Commodity Money and Security (2)
• Sometimes both have been used in exchange. Some
financial institutions issued representative money only.
They were gold money warehouses. Others became banks
and issued credit money. In such cases, people tended to
find out about the difference and to prefer the
representative money. They realized that credit money may
suddenly lose value if the bank creates too much of it. At
that stage, the representative money retained its value
because gold and silver could be melted down and sold in
markets for the metals.
• When the two are used together in a competitive situation,
commodity money has ordinarily provides greater security
than paper money.
Commodity Money and Security (3)
• Governments have often interfered with free
competition or given favorable treatment to
financial institutions that have issued credit
money.
• By doing so, the government has promoted
inflation.
• Sometimes it has even caused
hyperinflation.
Commodity Money and Security (4)
• Inflation: An increase in the total price of a basket
of typical consumer goods.
• Hyperinflation: a situation in which the
government prints so much money that average
prices rise very fast.
• Hyperinflation usually occurred during a war or
prior to a revolution, when government leaders
became desperate for resources.
Commodity Money and Security (5)
• The history of commodity shows that the
quantity of commodity money does not
increase unless new deposits of metal are
discovered, mined and minted.
• Even when new gold is discovered, the new
gold is such a small proportion of the total
gold in existence that prices only rise by a
small per cent.
Why the Dollar Replaced Gold
and Silver in the U.S.
• Economic reason: Gold is less convenient
(i.e., more costly) to use than paper money.
• Political reason: Lawmakers in the U.S.
made it unprofitable and, at times, even
illegal to use representative money based on
gold as a medium of exchange.
Private Coins
• In 2002, our Sovereign Elizabeth Regina
will have reigned over us for fifty years,
a truly momentous occasion.
• With this in mind, The Tower Mint, is
offering for sale these magnificent
limited edition, minted products, which
can be personalized with your logo or
message to commemorate the Royal
Golden Jubilee.
Example of a Private Coin
•
New Topic:
Money in Modern Times
• Two types of modern money:
• 1. Currency.
– Central bank notes plus token coins.
– Token coin: a coin for which the value in exchange is
gar greater than its value in use. The copper penny is an
example.
• 2. The transferable deposit.
• Both of these are credit money. There is no
representative money in modern times.
The Central Bank
• Central bank: a government agency that has three
duties:
– 1. To issue paper money and coins.
– 2. To regulate banks.
– 3. To control the quantity of money.
• Central banks are sometimes an arm of the
government and sometimes largely independent,
like the judiciary of the major constitutional
democracies.
The Central Bank Note
• Central bank note: government credit
money, usually issued in several
denominations, made of paper.
Examples of Central Bank Notes
Transferable Deposit
•
•
Definition: a legal right given by a private bank
to a depositor of currency to transfer the
ownership rights to the currency from one bank
to another or to withdraw the currency.
They are accepted in exchange:
A. If sellers believe that the bank will redeem them for
currency on demand or
B. If sellers’ banks are willing to accept them in the
same way as currency.
Three Ways to Use Transferable
Deposits
• 1. Write a check.
• 2. Use a debit card.
• 3. Authorize an electronic transfer.
An Example Of A Checkable Deposit
Check Clearing System
• A system through which the checks written against one
private bank but deposited in a second bank are cleared by
transferring the rights to currency from the first to the
second bank.
• The central bank may act as the banker's bank. It may
accept deposits from banks and other financial institutions.
The deposits are used to clear checks drawn against them.
• The bank depositor’s notion that when he writes a check,
he “transfers funds.” In fact, central bank notes are more
often not transferred. Only the accounting entries are
changed.
Debit Card
• Definition: an electronic checkbook that
allows a depositor of currency to transfer
rights to the currency from his account to
another person by passing a personal
identification card through a recording
machine that is linked to the computers of
the banks of both the giver and receiver of
the rights.
Electronic Transfer Rights
• Definition: an electronic payments system
in which the owner of a bank deposit can
directly and instantaneously transfer rights
to currency from her account at one
institution to someone else's account at
another institution.
Central Bank Regulation
and Money Creation
• To understand how money is created in a
modern market economy, we must first
understand the role of the central bank.
• We discuss this in chapter 11.
• Here we only want to show the difference
between the freedom of a warehouse
manager-turned-banker to create money and
the restrictions on a modern bank.
Transferable Deposit Vs.
Gold Certificate (1)
• A warehouse manager may issue more certificates
than he can redeem in gold. He can issue them for
personal use or to make loans. If he cannot meet
demands to redeem the certificates, he must either
go bankrupt or purchase gold.
• A modern banker may issue more transferable
deposits than she can redeem in currency. But her
uses of them are limited by central bank regulation.
She can only make loans that do not appear to
risky to the central bank’s auditors.
Transferable Deposit Vs.
Gold Certificate (2)
• If a modern banker cannot meet demands to
transfer deposits of currency, she can
borrow from other banks and ask the central
bank to print more and to lend them to her.
• Since her loans are likely to be sound, due
to central bank regulation, borrowing is easy.
Money in International Exchange
• The U.S. dollar is the most prominent
medium of international trade today because:
– 1. The U.S. is the largest buyer and seller of
goods.
– 2. Since 1980, the U.S. has not permitted
increases in the quantity of its credit money to
substantially reduce the dollar's buying power.
• But this can change.
Appendix: The Marvel Of Money
The Evolution of Money
• Money almost certainly came into being step by
step over a long period of time.
• From no trade to gift exchange.
• From gift exchange to barter.
• From a barter to a commodity money economy.
– Metallurgy and minting.
• From a commodity money economy to a credit
money economy.
– First paper money, then transferable deposits.
Learning to Use Money is Easy
• Think about how you first learned to use
money.
• We know that learning to use money is easy
because social scientists have observed
primitive peoples who previously only used
barter. Such people can learn how to use
transferable deposits in a short time.
Inventing Money
• What actions would a person have to take to
introduce money quickly into a society in which it
had never been used.
• Because you have studied the history of money,
you know that the developed trading societies do
not use barter. They use paper money and
transferrable deposits. Could you profit by
introducing paper money? How could you actually
introduce it?
Persuading Sellers To
Accept Your Money
• You must persuade sellers of goods that they can
use your paper (“dollars”) to buy something or to
pay a debt.
• Ways to succeed:
– Align yourself with a well known trader of goods – a
multi-good trader.
– Use your dollars to buy goods from the farmers and
artisans in the community. Then give the goods they
produce to the multi-good trader, who “sells” them for
dollars to the farmers, artisans and others who happen
to acquire money. In this way, each good acquires a
dollar price.
Endorsement and Guaranty
• The whole process could proceed more smoothly
if you also aligned with a wealthy and trustworthy
citizen who agrees to endorse your dollars.
• Such an endorser of notes is called a guarantor.
• Guarantor: a person who agrees to convert what
would otherwise be credit money into a
commodity.
Monetization
• Monetization: the use of promises of goods,
or debts, as a basis for producing money.
The Case of Scrip
• Credit money can easily be created by producers
who are isolated from other parts of the economy.
• Consider an isolated mining town.
• Whether a particular form of money is accepted in
exchange depends on expectations that it can be
exchanged for something else. These expectations
can often be reinforced by promises if the
promisor is trustworthy. Thus the acceptance of an
item as money is based on expectations and trust.
The Advantage of Government
• A government typically has an advantage in
issuing credit money because it can declare
that the money can be used to pay taxes and
institute a legal tender system.
Counterfeiting and Over-issue
• Counterfeiting and over-issue may lead
people to stop using a particular item as
money.