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)