MONEY AND BANKING

WHY MONEY – THE “BONANZA” STORY

SO BANKS DEVELOPED AS A SAFE AND EASY PLACE TO STORE “HARD” MONEY

DEPOSIT GOLD – GET A “RECEIPT” THAT WAS THEN ITSELF USED FOR PAYMENTS

NEXT STEP – DEVELOPMENT OF LOANS

BANKS FOUND NOT EVERYONE CAME FOR THEIR GOLD AT ONCE

ALWAYS HAD “EXCESS GOLD” IN VAULT

COULD PRINT MORE RECEIPTS AND MAKE LOANS BASED ON THIS EXCESS GOLD

CHARGE “INTEREST” FOR THE LOANS – NOW PAID FOR DEPOSITS

BANKING TERMS

RESERVES = DEPOSITS

EXCESS RESERVES = “EXTRA” DEPOSITS NOT NEEDED FOR USUAL WITHDRAWALS

FRACTIONAL RESERVE SYSTEM = THE SYSTEM OF HAVING MORE “CLAIMS” ON DEPOSITS IN THE VAULT THAN THERE ARE DEPOSITS

EXAMPLE

$1,000,000 RESERVES (DEPOSITS)

KEEP 10% IN VAULT ($100,000)

MAKE LOANS OF $900,000

TOTAL “CLAIMS” ARE $1,900,000

BENEFITS AND COSTS OF THE BANKING SYSTEM

BENEFIT – LOANS CREATE ECONOMIC DEVELOPMENT

BUT POTENTIAL PROBLEMS:

1. NO COMMON CURRENCY

2. “RUNS” ON BANKS IF EVERYONE WANTED THEIR DEPOSITS AT THE SAME TIME

SO HAD PERIODIC BANK “PANICS”

THE “FEDERAL RESERVE” TO THE RESCUE?

CREATED A “BACKSTOP” TO THE BANKING SYSTEM, CALLED THE “FEDERAL RESERVE”

* CREATED COMMON CURRENCY * CREATED RULES TO ENSURE BANK HONESTY * REGULATES “EXCESS RESERVES”

MORE ON REGULATING EXCESS RESERVES

REQUIRED RESERVE RATIO – % OF RESERVES TO KEEP IN VAULT FED REDUCES IF WANTS MORE LENDING

FED INCREASES IF WANTS LESS LENDING

REGULATING EXCESS RESERVES, CON’T

CONTROL OF INTEREST RATES:

FED CONTROLS TWO SHORT- TERM INTEREST RATES

REDUCE IF WANT MORE LENDING

INCREASE IF WANT LESS LENDING

REGULATING EXCESS RESERVES, CON’T

FED CAN DIRECTLY INCREASE AND DECREASE RESERVES IN THE BANKS VAULTS:CALLED OPEN MARKET OPERATIONS

INCREASE RESERVES (AND LOANS) BY BUYING INVESTMENTS FROM BANKSAND PAYING FOR WITH NEW MONEY

DECREASE RESERVES (AND LOANS) BY SELLING INVESTMENTS TO BANKS AND TAKING MONEY OUT OF THE SYSTEM

PREVENTING BANK RUNS

TO PREVENT A “RUN” BEFORE IT HAPPENS – INCREASE RESERVE REQUIREMENT AND INCREASE INTEREST RATES

TO DEAL WITH A “RUN” ALREADY HAPPENING: INJECT MONEY INTO BANKS’ VAULTS SO CAN MEET WITHDRAWALS OF DEPOSITORS

SIDEBAR ON GOLD

NO LONGER USED AS MONEY – NO “GOLD STANDARD”

BIG DISADVANTAGE – SUPPLY DOESN’T NECESSARILY GROW AS ECONOMY GROWS – CAN LEAD TO DEFLATION

FEDERAL RESERVE NOW CONTROLS THE MONEY SUPPLY THROUGH ITS CONTROL OVER BANK RESERVES

COULD THERE BE OTHER FORMS OF MONEY (LIKE BITCOINS)?

PEOPLE LOOK FOR THREE CHARACTERISTICS OF MONEY:

1. ACCEPTABILITY FOR PAYMENT (MEDIUM OF EXCHANGE)

2. UNIT OF ACCOUNT (CAN BE USED FOR FINANCIAL MEASUREMENT)

3. STORE OF VALUE (HOLDS VALUE AND CAN’T BE STOLEN)