Transcript Chapter 10 - Groupfusion.net

CHAPTER 10
Money and Banking
10.1 MONEY

Money has three purposes: medium of exchange,
a unit of account and a store of value
Medium of exchange: anything that is used to
determine value during the exchange of goods
and services
 Without money people would need to barter
(some traditional economies still do)
 Money is much easier to exchange than haggling
over which good is equal to the good you want

Unit of exchange: money provides a means for
comparing the values of goods and services
 All jackets you want to purchase are listed in
terms of dollars and so it makes deciding which
to purchase a little easier

Store of value: money keeps its value if you
decide to hold on to it
 It will be recognized as a medium of exchange for
weeks and months from now
 Inflation might alter the value
 When an economy is suffering from inflation –
money doesn’t hold its value for very long

SIX CHARACTERISTICS
OF MONEY
Many items have been used as currency in the
past and yet none have all six characteristics
found in money
 1. Durability
 Money can withstand wear and tear
 Can last for years before replacing

2. Portability
 People can take their money where thy go
 Easily transferable to another person

3. Divisibility
 Money can be easily divided up into smaller
dominations

4. Uniformity
 Money is only valuable with two units are able to
buy the same thing
 If we priced everything in fish then what would a
small fish buy vs. a large?
 A dollar can always get you a dollars worth of
something









5. Limited Supply
Anything too available is no longer valuable
The Federal Reserve Systems controls our money
supply
Its action keeps the right amount of money out in the
system
6. Acceptability
People will take your money always
May not take an alternative good that you want to
barter
Only if the nation lost confidence in our currency’s
value would money not be accepted
SOURCES OF MONEY’S VALUE
What makes money valuable?
 Commodity money consists of objects that have
value in and of themselves and that are also used
as money
 Ex: cattle and precious gems
 These items have other uses in addition to
currency
 Commodity money lacks some of the necessary
characteristics of money

Representative money – makes use of objects
have value because the holder can exchange
them for something else of value (like gold)
 Ex: IOU notes exchanged for goods at a store
 Early rep money took the form of paper receipts
for gold and silver and since gold and silver was
difficult to carry…people would just exchange the
promise note
 Early US money was backed by gold

Fiat money has value because the government
has decreed that it is acceptable means to pay
debts
 The govt is ensuring that the money will remain
in limited supply and therefore, is valuable
 This is done via the Federal Reserve Board
 Our govt is valuable because the govt says it is

10.2 THE HISTORY OF AMERICAN
BANKING
Modern history ….
 The Federal Reserve Act passed in 1913 created
the Fed
 This was the nation’s 1st true central bank
 A central bank is a bank that can lend to other
banks in times of need
 12 regional Fed Reserve Banks (member banks)
 National govt stores its reserve money in
member banks
 Each can loan out money to their regional banks
to help with short term demand








This helps prevent bank failures
The act also created the national currency that we
use today– Federal Reserve note
It allows the federal govt can increase or decrease the
amount of money in circulation at any given time
The Fed helped restore confidence to the nation’s
banking system
It was unable to prevent the Great Depression
During the 1920s too many banks gave out risky
loans to businesses
Paid investments coupled with depositors demanding
deposits back led to a HUGE emergency
The Federal Deposit Insurance Corp was formed
in o 1933
 FDIC will cover up to $100,000 of depositors
money
 Federal legislation was also passed that limited a
person’s ability to redeem dollars for gold.
 Eventually all money became fiat based (govt
decree that guarantees the value of money)








In the 1970s banks began requesting deregulation
(removal of govt restrictions)
This deregulation contributed to a huge saving and
loans scandal in the 1980s
S&L failed one after another due to…
1. Deregulation – businesses were unprepared for
competition post regulation
2. High interest rates – low rates were being paid
back from loans taken out during the 70s while at the
same time higher rates needed to be out to depositors
3. Bad loans to people and businesses who shouldn’t
have qualified
4. Fraud
In 1999, Congress repealed the 1933 GlassSteagall Act
 This act allowed banks to sell financial assets
such as stocks and bonds

10.3
BANKING TODAY
The money supply is all the money available in
the US economy
 It is divided up into two categories: M1 and M2
 M1 is money that people can easily gain to pay
for good and services
 All assets have liguidity (the ability to be
converted into cash quickly)
 This includes money held by the public, money in
checking accounts M2 consists of all assets in M1
plus other assets
 M2 funds cannot be used as cash directly
 You cannot hand someone a deposit slip from
your saving account

FUNCTIONS OF FINANCIAL INSTITUTIONS

Money market mutual funds CDs are included in
this category
1. They store money in a safe environment
 2. They help people save their money (while
making money)

Savings accounts
 Checking accounts
 Money market accounts
 Certificates of deposits (CDs)

FUNCTIONS OF FINANCIAL INSTITUTIONS







CDs pay a higher rate of interest on deposit than
savings or checking
But …money is locked in for a longer amount and if
you need withdraw it early there are penalities
3. They issue loans
Banks only keep a fraction of their deposits at any
one time
The rest is loaned out to early interest
This is how banks make their money
The more money that a bank lends out and the higher
interest rate that they charge to its borrower, the
more profit a bank is able to make
If a borrower defaults (fails to pay back their
loan), the banks loses money
 If they make too many bad decisions…the bank
may go out of business all together
 Mortgages are loans to buy real estate
 Mortgages last from 15-30 years
 Many banks issue out credit cards too
 Any credit card will charge interest for any
balance that is not paid in full at the end of the
billing cycle
 Careful because this interest will add up quickly

Interest is the price paid for the use of borrowed
money
 The amount borrowed is the principal
 The largest source of income for banks is the
interest they receive from customers who have
taken out loans
