Money and Banking

Evolution of Money

Functions of Money

• Barter Economy– Moneyless economy that relies on

trade – Hindered b/c some products offered

may be undesirable

• Life is simpler in an economy WITH money

Three Functions

• Medium of Exchange:– Accepted by all parties as payments

for goods and services – Gold, silver, salt

• Measure of Value – Common denominator that can be

used to express worth in terms that most individuals understand

– Price Tag : dollar and cents

• Store of Value – Property that allows purchasing

power to be saved until needed – Goods and services can be

converted into money – Enables a period of time to pass

between earning and spending an income

Three Functions

Money in Early Society

• Use of money was developed in ancient times– Made life easier

• Commodity money:– Money that has an alternative use as an

economic good or commodity

• Fiat money– Money by government decree– Coins, dollar bill – Served as money b/c government said they

were money

Money in Colonial America

• Tobacco and wampum once accepted currencies

• States passed laws to print paper currency – Backed by local banks with gold and silver

• American revolution – Continental dollars (w/o gold and silver

backing) ; worthless at end of the war

• Colonies used – Specie, gold and silver coins (limited in

supply) – Worth more

Origins of the Dollar

• Spanish Peso – Formed in Mexico from silver – Ships became victims of Caribbean

pirates – Known as “pieces of eight”

•Divided into 8 sub parts known as bits

– Talers = name of Austrian money

• Franklin and Hamilton liked how talers sounded (dollars)

• Dollar– Basic monetary unit (or standard unit

of currency)– Divided into tenths (different form the

peso)

Origins of the Dollar: Franklin and Hamilton

Characteristics of Money

• Must be portable – Easily transferred from one person to

another

• Must be durable – Lasts when handled or store for long

periods

• Must be divisible – Facilitate all transactions

• Must be limited in supply – Retain its value

Early Banking and Monetary Standards

Privately Issued Bank notes

• Monetary standard – The mechanism designed to keep

money supply portable, durable, divisible and limited in supply

• Continental currency was worthless – Only trusted coins – Congress has the power to coin money;

prevented states from “coining” money – Private banks printed paper money

Growth of State Banking

• 1811 the nation had 100 state banks – Banks that receive a charter to

operate from a state government – Exchange paper notes for gold and

silver

Abuses in Banking

• Banks only printed amount of currency they could back with gold and silver

• Wildcat banks (dishonest/fraudulent banks) – Printed larger amounts of currency

in remote areas– Made redemption of currency

difficult

Problems with Currency • First, each bank issued its own currency

– Different color, size, denominations – 100’s different notes

• Second, bank could print money whenever it wanted – Issue too many notes

• Third, counterfeiting became a major problem – Just made their own up

• By Civil war, 1600 banks issued 10,000 different kinds of currency

• Merchants were worried about backing of money

The Greenback Standard

• Civil War Congress authorized (1861) printing of $60 million of demand notes – Did not have gold and silver to backing – Government declared them legal

tender

• 1862: new federal currency – Called Greenbacks b/c of green ink – Did not have gold and silver backing

National Currency

• People feared greenbacks and avoided using them

• NC: Paper currency of uniform appearance that was backed by United States government bonds

• Congress created the National Banking System (NBS) – Banks privately owned but chartered by

the Federal Government – Issues national bank notes – Backed by US bonds – State banks withdrew their notes

• 1863: Fed Gov’t issued gold certificates backed by gold – At first they were printed in large

denominations for banks

• 1886: issued silver certificates – Printed in smaller denominations

for public use

National Currency

• Gold certificates: paper currency backed by gold placed on deposit with the United States Treasury

• Silver certificates: paper currency backed by silver dollars and bullion placed on reserve with the treasury

• Treasury Coin notes: paper currency issued by the Treasury that was redeemable in both gold and silver

National Currency

Gold Standard

•Defined as the dollar being worth a set amount of gold. Gold certificates could be exchanged for an equivalent amount of gold.

• 1900: Congressed passed – Basic unit = dollar – Equivalent to specific amount of gold – Did not change the use of

greenbacks or notes– Americans could exchange them for

gold

• Remained in effect until the Great Depression

Gold Standard

Gold Standard

• Advantages – Security Americans

felt about their money

– It prevents the government from printing too much paper currency

• Disadvantages – Gold stock may not

grow fast enough to support a growing economy

– People may decide to convert their paper money to gold

– Price of gold will respond to the market and lose substantial value

– Political risk of failure

Abandoning the Gold Standard

• Gold Reserve Act of 1934: Removed the U.S. from the Gold Standard

• We moved to Managed Money Supply, using an inconvertible fiat money standard

• Fiat Money (legal tender): anything the government decrees is valuable

The Inconvertible Fiat Money Standard

• 1934: US has been on an inconvertible fiat money standard – Money standard under which the fiat

money supply cannot be converted into gold or silver by its citizens

• Money supply of the US is managed by the Federal Government

Characteristics of Modern Money

• Tangible component of modern money– Coins – Federal Reserve notes

• Intangible component – Traveler’s checks – checking accounts – Savings accounts

•Portable •Durable •Divisible

Characteristics of Modern Money