Money and Banking • What is currency?

– Coins and paper money

– Ea. nation has its own currency, but all currencies have 3 things in common:• Easy to carry• Durable • Has standard form & considered

legal tender by govt. that issues it

– Only way we can be sure the currency will be accepted by others in exchange for goods and services

3.635 Malaysian Ringgitt = $1 U.S.

1.2036 Swiss Franc = $1 American

0.77 Euros = $1 U.S.

Currency of the Past Cowrie shells are considered the most widely and longest used currency in history. Cowrie shells were the earliest form of money used in China and are still used as money in some parts of Africa.

Salt was used as currency since ancient times.

Coins made from salt. Salt cakes were also traded. The American colonies depended on England for salt. During and after the Revolution, saltworks were opened along the East Coast to meet the colonists needs to preserve food.

Cacao seeds were used as currency in the 16th century by Mexico's Aztec culture. The Aztecs also used cotton cloaks and gold dust for money.

Functions of Money• Store of Value (you can keep it for

a long time & it still has value)– You can keep your wealth in money

instead of animal hides• It’s easy to carry around, etc.

• Measure of Value (a.k.a. unit of account – a common measure of the value of goods & services)– A pack of gum is worth about $1.29

• Medium of Exchange– Others will accept it as payment for

G&S’s

Why Money has Value• B/C we’re

confident someone else will recognize its value & accept it as pmt.

Currency in U.S. History• A weakness of

A.O.C. – no standard currency– Each state issued

its own money– Made trade very

difficult b/c there were different values and exchange rates from state to state

Georgia colonial currency

Massachusetts Currency

Above, a Massachusetts dollar; left, a Pennsylvania “farthing”

Financial Institutions• $$ put into banks,

etc. is loaned out to others– Interest charged for

loans = bank profits

• Commercial banks offer full banking services– Checking & savings

accts. found here

Financial Institutions, Cont’d.

• Credit Unions– Non-profit– Serve only members

• Savings & Loans– Full banking services– Used to only make home loans

Financial Institutions, Cont’d.

• All financial institutions are supposed to follow rules & accounting practices that minimize risk– Depending on

who is running the fed. govt., regulation of banks can be strict or very lenient

Federal Deposit Insurance Corp.

• FDIC– Fed. Corp. that

insures our accounts in Finan. Inst’s.

• If bank fails, FDIC up to max. of $100,000.

Federal Reserve System

• a.k.a. “the Fed” is our nation’s central bank

• Fed is THE bank to U.S. banks– When banks need $$, they

borrow from the Fed.

• 12 Fed. Reserve districts in U.S.– Ea. district has one main fed.

reserve bank. Most have smaller Fed. branch banks as well

• The Federal Reserve officially identifies Districts by number and Reserve Bank city.• In the 12th District, the Seattle Branch serves Alaska, and the San Francisco Bank

serves Hawaii. The System serves commonwealths and territories as follows: the New York Bank serves the Commonwealth of Puerto Rico and the U.S. Virgin Islands; the San Francisco Bank serves American Samoa, Guam, and the Commonwealth of the Northern Mariana Islands. The Board of Governors revised the branch boundaries of the System in February 1996.

The Fed, Cont’d.• Nat’l. banks w/

federal charters must be members of The Fed– They own stock in

the Fed. & earn dividends from it

The Fed., Cont’d.

• 7 members (i.e. bankers) of Fed. Board of Governors

• 1 Chairman (4-year term)

• Board of Gov’s. makes econ. decisions independent from the POTUS and Congress– Avoids political pressure

by staying independent

The Fed., Cont’d.

• Fed. Res. district bank officials serve on advisory committees and report economic conditions from their district and on issues relating to consumer loans to the Board of Gov’s.

• FOMC (Federal Open Market Committee) makes most of the U.S. policy

A meeting of the Federal Open Market Committee in Philadelphia. FOMC's decisions to change the growth of the nation's money supply affect the availability of credit and the level of interest rates that businesses and consumers pay. Those changes in money supply and interest rates, in turn, influence the nation's economic growth and employment in the short run and the general level of prices in the long run.

The Fed., Cont’d.• FOMC

manipulates U.S. $$$ supply as economic conditions change

• To change the U.S. money supply, the Fed. can:

• 1) Lower or increase the “discount (interest) rate” for banks

– Lowering the Discount Rate means banks can borrow more $$ from the Fed. b/c interest rate is lower

– Banks are more willing to loan money to consumers at a lower rate. People are more likely to borrow $$ at lower interest rates.

Changing the Money Supply

Changing the $$ Supply, Cont’d.

• 2) Lower or increase the “reserve requirement” for banks– Amt. of $$ banks are

required to keep in reserve at Fed. Res. district bank (they cannot loan it or spend it – keep it in the “vault”)• If it’s lowered, banks have

more money to loan out, so $ supply increases

Increasing the $$ Supply, Cont’d.

• 3) Through open market operations– a) Purchase or sale of U.S.

govt. bonds or Treasury bills

• Treasury Bills (a.k.a. T-Bills):– Debt issued by U.S. govt.– Must be repaid in 1 year or

less

• Govt. Bonds:– U.S. Treasury loan to fed.

govt. w/ promise to pay principal & interest in certain # of years.

Changing the Money Supply, Cont’d.

• When Fed. buys bonds & T-Bills from investors, $$ supply goes up

– Fed. pays investors cash for them, so the $$ supply increases

– When $$ supply increases, interest rates decrease, so people borrow more & spend more

How the Fed. Res. Changes the $$ Supply, Cont’d.

• When the Fed sells bonds & T-Bills

– This takes cash OUT of investors’ hands, so there is less $$ in the economy

Changes in the banking industry

• 1st attempt at a bank for fed. govt. was First Bank of the United States:

• Only served U.S. govt.

• Lasted for 20 years (1791-1811) (until charter lapsed)

• Biggest supporter was Alex Hamilton, the nation’s first Secretary of the Treasury

• It collected fees and made payments on behalf of the federal government.

• The charter was allowed to lapse in 1811, partly because of opposition from state banks.

Alexander Hamilton, left, and below, the building that housed our federal govt’s. first bank still stands in Philadelphia

Changes in Banking Industry, Cont’d.

• The Second Bank of the United States– Chartered in 1816

• Charter lapsed, so only state banks remained (w/ no fed. regulation).

• State banks issued their own $$$ – Made up most of U.S. $$

supply until fed. govt. began printing $$ during Civil War.

Changes in Banking , Cont’d.• Nat’l. Banking Act (1863) created a dual-system of

banking that allowed for:

– Nationally chartered banks, AND– State chartered banks

Changes in Banking Industry, Cont’d.

• Several major bank crises in U.S. betw. 1873 & 1907

• Panic of 1907 resulted in the Federal Reserve Act of 1913.

• Fed. Res. began issuing Federal Reserve notes (dollars) in 1914– Has been our main form

of currency since then.

Crash of 1907

Problem:A series of bank runs, a stock market crash, and deep recession. Banker J.P. Morgan finally brought together financial leaders to halt the panic.Outcome: Congress established America's first true central bank, the Federal Reserve System, in 1913 in the hope of preventing such panics