Money and Banking - Dr. D. Foster Money Basics & Measuring Money.

Money and Banking - Dr. D. Foster

Money BasicsMoney Basics

& Measuring Money& Measuring Money


The functions of moneyThe functions of money

The functions money serves:The functions money serves:– medium of exchange.– unit of account.– store of value.– std. of deferred value.

Need money serve all these functions?To be money, the object must To be money, the object must

serve as a final means of serve as a final means of payment.payment.


What isn’t money?What isn’t money?

Wealth is not money …Wealth is not money … Income is not money.Income is not money. A credit card is not money.A credit card is not money.

What about . . .• Stored value cards?Stored value cards?• Electronic money?Electronic money?• ““Local” currencies?Local” currencies?

To be money, the To be money, the object must be object must be redeemable on redeemable on demand at face demand at face

value.value.


HistoryHistory

Favorable characteristics– portable, durable, recognizable, scarce, commodity– wheat, shells, precious metals– Yap stone wheels

How do we get to paper?– commodity, representative, fiat– U.S. and the “gold standard.”– Deciding on denominations and coins vs. paper.– Evolution to e-money.


The G-manThe G-man

Mint coins to create standards of purity.– Revenue source.

[Seignorage]– Beware of “debasing.”

Bank issued “notes” as money. U.S. government - “greenbacks.” Gold standard - 1879 to 1933/1971. Created Federal Reserve in 1913.


The Continental StoryThe Continental Story June, 1775 – 2 million Spanish dollars in bills of credit authorized.

12 colonies pledged to redeem from 1779 to 1782.Total money supply est. at 12 million Spanish dollars.End of 1775 – 6 million Continentals issued.End of 1779 – 242 million issued!! [26C=$1]British added counterfeits.End of 1781, 168C = $1.

“A wagon load of money will scarcely purchase a wagon load of provisions”.


MeasurementMeasurement

How? - Liquidity of financial assets.

M1 = [Coins and] currency in circulation (C) + “transactions deposits” (D) + TC

M2 = M1 + SDS +TDS + MMMFIndividual

M3 = M2 + TDL + MMMFInstitutional + Euro$ + RPFed Regulation Fed Regulation

DD

Liquidity – how fast, at full market value, an Liquidity – how fast, at full market value, an asset can be converted into a means of asset can be converted into a means of payment.payment.


The Monetary BaseThe Monetary Base

Monetary Base (MB) = C + bank reserves (R)Federal Reserve has perfect control over MB:– Prints currency.– All reserves are currency or deposits at the Fed.

M1/M2 is highly correlated to MB … or, was?or, was?M1 relates to economy [M*V=P*Y].MB plays a role in the government’s budget: G = T + Bonds + MB


Monetary Data - CurrencyMonetary Data - Currency


Monetary Data – M1Monetary Data – M1


Monetary Data – Travelers ChecksMonetary Data – Travelers Checks


Monetary Data – Demand Monetary Data – Demand DepositsDeposits


Monetary Data – DD and OCDMonetary Data – DD and OCD


Monetary Data – OCD (banks & Monetary Data – OCD (banks & tot.)tot.)


Monetary Data – DD, OCD, TotalMonetary Data – DD, OCD, Total


Monetary Data – M2Monetary Data – M2


Monetary Data – MZMMonetary Data – MZM


Monetary Data – M2 and MZMMonetary Data – M2 and MZM


Monetary Data – Monetary BaseMonetary Data – Monetary Base

Sweep Programs and M1Sweep Programs and M1

Sweep programsSweep programs - the shifting of checking deposits to MMDAs to …– avoid reserve requirements.– provide additional income to customer.

The Fed allowed sweeps beginning in 1994.

Sweep programs have distorted the meaning of the M1 measure of money.


Monetary Data – M1 and SweepsMonetary Data – M1 and Sweeps

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

1.00

.95


Rothbard on Money

•Money is different than coal …• What is true if the supply of coal rises?

• What is true if the supply of money rises?

• Is there a right amount of money?• What if the money supply doubled?

• Are there economic interests “agitating” for a decline in the money supply?

• Is it wasteful to mine for gold and silver?• What is the significance of a commodity as money?


Rothbard on Money

•What about counterfeiting money?• Harms those with “real” money.

• Hard to do with commodity like gold.

• Easy to do with paper/fiat money.

• And, if the government has a monopoly?

• What has the government done to our money?• We’ve forgotten that the name meant a weight.

• Gov’t force through “legal tender” laws.

• Now, gov’t can finance spending withoutraising taxes or borrowing funds!


The end of gold

• The gold standard and wartime.• Suspensions to keep banks afloat & gov’t financing

going.

• Wartime inflation only occurs in paper, not in gold!!

• For U.S. – Revolutionary War, War of 1812, Civil War.

• Gold coins and paper circulated until 1933.• This provided some limit on arbitrary money creation.

• Gold contracts (or, clauses) thwart government.• Specify payment in $ equivalent of some amount of

gold.

• FDR cancels all gold clauses; the case of the Halle Building.

The end of order The end of truth

Need a National Currency?Need a National Currency? DollarizationDollarization - Use another country’s currency as your medium of exchange.$ - Ecuador, El Salvador, Timor, British Virgin Islands, Panama

€ - Vatican City, Monaco, Andorra

Currency boardCurrency board - the national currency is backed by an equal amount of a foreign currency.$ - Hong Kong, Bermuda, East Caribbean $

€ - Bulgaria, Estonia, Lithuania

Currency unionCurrency union - A group of countries adopt a common currency. Euro/West Africa/Caribbean


Money BasicsMoney Basics

& Measuring Money& Measuring Money

Yap Stone WheelsYap Stone Wheels


Money and Banking - Dr. D. Foster Money Basics & Measuring Money.

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