Chapters 10 and 15
Money, Banking, and Fiscal Policy
KEY IDEAS TO KNOW:
Define money and describe its principal characteristics-stability, portability, durability, uniformity, divisibility, and recognizability.
Describe the various forms money takes in the United States.
List common services banks and other financial institutions provide.
Explain how banks “create” money.
Describe the principal roles and responsibilities of the Federal Reserve System.
Define inflation and explain how it impacts businesses and consumers.
What is Money?
What do the following items have in common? Bronze knives, farm tools, cacao beans, salt chunks, stone disks, fish hooks, beaver pelts, musket balls, nails and cigarettes. Well the answer is that all of these items have been used as money! Money you say oh wise one? Yes, money. Not money in the sense that you know it today but yes, money.
Lets think about what money really is:
Money: Anything accepted as payment for goods and services by most people in an area at a given time.
Think about it, if most of the people in a region are willing to accept a certain item as payment for goods and services then that item has a use as money. It is sort of like the way cigarettes are portrayed as money in the movies. Now the reality is that these types of money, informal money that has another basic use if you will, are not money as you normally have thought of it. This type of money is called commodity money. The origins of money can be traced back to ancient times. Then commodity money, money that has an alternative use, was used. In the South Pacific and Africa, cowrie shells were the common forms of currency while in New Guinea, it was dog teeth that were used. At Santa Cruz, the feathers of hundreds of honey-eating birds were attached to short sticks to make feather-stick money while in the Marshall Islands, fishhooks were commonly used. In ancient China tea leaves were compressed into "bricks" while the Russians used compressed cheese as their currency. Commodity money was still present during the colonial age when many products such as gunpowder, musket balls, corn, and hemp were commonly used.
In 1618 tobacco became the most famous type of colonial money because the governor of colonial Virginia gave it a monetary value of three English shillings per pound. However, fiat money, money by government decree, has come to replace commodity money. In 1645 Connecticut established a monetary value for wampum, a form of currency that the Narragansett made out of white conch and black mussel shells. Because the Narragansett and the settlers used wampum in trade, certain shells were made equal to 1 English penny. In the 1700's the Governor of the then territory of Tennessee was paid a salary of 1000 deerskins a year! His secretary of state was paid 500 raccoon skins. Quite a salary huh!
As time progressed, other forms of money were used. In some states, laws were passed allowing citizens to print their own paper currency. Backed by gold and silver deposits in banks, it served as currency for the immediate area. Some states passed tax-anticipation notes that could be redeemed at the end of the year. The governments printed the notes, which were used to pay salaries, buy supplies, and meet other expenditures until taxes were received and the notes redeemed. The taxes though, were collected in coins.
Paper money was really first seen around the time of the Revolution. In 1775 the Continental Congress authorized the printing of Continental Currency which had no gold or silver backing. By the end of the war nearly $250 million had been printed and spent.
Representative money is money backed by-exchangeable for-some commodity, such as gold or silver. It is not in itself valuable for non-money uses, but it can be exchanged for some valuable item. Like commodity money, the amount of representative money in circulation, or in use by people, is limited because it is linked to some scarce good, such as gold. At one time, the United States government issued representative money in the form of gold and silver certificates. In addition, private banks accepted deposits of gold and silver and issued paper money, called bank notes. These were a promise to convert the paper money into coin or bullion on demand. These banks were supposed to keep enough gold or silver in reserve-on hand-to redeem their bank notes. Often they did not.
Money as you know it today is not commodity money. Today most money is what we call fiat money. Fiat money is money by government decree. Wampum was the first fiat money used in the America's. It had a set value, equal to a certain amount of gold, established by Connecticut in 1645. Since the government of Connecticut established it as official money it is fiat money.
The concept of paper currency was not well regarded early on. Most Americans, indeed most people world wide, felt that paper currency was risky since it had no inherent value. As a result most fiat money was in the form of coins. This coined money is known as specie. Specie was well regarded because it some metallic content, either gold or silver. Due to scarcity this then had some inherent value of its own. In fact paper currency was not even issued until 1775 when the Continental Congress printed a very small amount of paper currency to pay its debts.
So, why do we use money at all? Well the reality is that the use of money is very much tied to the Industrial Revolution. As the world grew increasingly modern money became needed. Before money was used the world was primarily agricultural. People living in traditional economies used barter as a means of exchanging goods and services. Barter presented great difficulty in completing transactions and in fixing value. With the Crusades and the corresponding growth of towns and villages and increased trade money became a necessity. Industrialization would have been impossible without money.
Money serves, therefore, three essential functions:
· It is a Medium of Exchange - money is used so we can exchange goods and services easily. In barter this is very difficult because transfer of large items and perishable goods makes moving around a little tough.
· It is a Measure of Value - money is used so we can assess fairly and consistently the comparative worth of items. In barter this could not occur because it is impossible to compare the value of different commodities consistently. For example, trading two cows for a goat and a three legged dog. Whose to say what is worth more??
· It is a Store of Value - money is used so that we can save our earning for a later date In barter this cannot occur because often items might die or rot!
Money also has eight essential characteristics.
· Portability - Money is small and transportable. Imagine using certain types of commodity money. What if Cows where accepted as commodity money. Can you imagine walking around with a cow in your pocket??? A little difficult huh?
· Divisibility - Money can be broken down into smaller or larger units of measure to make transactions easier. Can you imagine the cow scenario? Its not like you can rip of a leg if the whole cow wasn't necessary as payment!
· Durability - Money lasts. Specie lasts forever and even paper currency is pretty durable. In class Iripped a twenty dollar bill in half once and then taped it back together. It was still worth the same wasn't it? Imagine trying that with a cow! Eventually even an un dismembered cow would die, rot and stink. Not too durable.
· Stability of Value - Money, despite the influences of inflation and deflation remains fairly stable in value. Money is not subjected to the natural forces of weather as much early commodity was. In traditional economies when one needed goods he would trade crops. If there was a drought, however, the value of said crops would shoot way up. Since most money is in one way shape or form tied to known gold reserves, it is stable in value.
· Considered scarce - because people believe there is not enough cash to satisfy their wants, it's scarceness helps give money it's value
· Accepted - Whatever is used as money must be accepted as a medium of exchange in payment for debts.
· Easily recognizable - People must be able to identify the different denominations of currency.
· Tamper proof - This stops counterfeiting
Federal Reserve Notes
Denomination / Portrait on Bill$1 / George Washington
$2 / Thomas Jefferson
$5 / Abraham Lincoln
$10 / Alexander Hamilton
$20 / Andrew Jackson
$50 / Ulysses S. Grant
$100 / Benjamin Franklin
$500 / William McKinley
$1000 / Grover Cleveland
$5000 / James Madison
$10000 / Salmon P. Chase
$100000 / Woodrow Wilson
DID YOU KNOW?
Source: US Treasury Department
Life span of dollars
Money will be changed to foil counterfeiters constantly. But new bills won't last any longer than what we use now. How long bills circulate before they are withdrawn:
$1 / 18 months
$5 / 20 months
$10 / 31 months
$20 / 45 months
$50 / 112 months
$100 / 102 months
The cost of making money
Penny / 0.8 cents
Nickel / 2.9 cents
Dime / 1.7 cents
Quarter / 3.7 cents
Half Dollar / 7.8 cents
Dollar Bill / 3.0 cents
Pocket Money
The amount of coins and currency in circulation per person in actual dollars and actual money (adjusted for inflation)
1960 / $177.47 / ($883.75)
1970 / $265.39 / ($1,008.21)
1980 / $581.48 / ($1,040.17)
1990 / $1,105.14 / ($1,246.35)
2000 / $1,404.29 / ($1,404.29)
Number of Lincoln pennies in circulation:
106 billion
Total number of nickels, dimes, quartersand dollar coins in circulation:
52.7 billion
Real value of an 1800 penny in year 2000 dollars:
10.2 cents
Estimated value of a pristine, uncirculated 1800 penny:
$50,000
Percentage of Americans with household income above $50,000 who want to abolish the penny:
31
Percentage with household income less than $15,000 who want the same:
18
Total lobbying by the pro-penny Americans for Common Cents in 1998:
$60,000
Total for the American Red Cross:
$60,000 /
HISTORY OF AMERICAN MONEY AND BANKING
Serving the Nation’s Financial Needs
During the colonial period, England did not permit the American colonies to print or mint their own money. Bartering was common. Colonists used various goods in place of coins and paper money. In Massachusetts Bay for a time, colonists used Native American wampum as a medium of exchange. In the Virginia Colony, tobacco became commodity money. Though scarce, some European gold and silver coins also circulated in the colonies. The Spanish dolár, later called dollar by colonists, was one of the more common coins.
History of American Banking
The Revolutionary War brought even more confusion to the already haphazard colonial money system. To help pay for the war, the Continental Congress issued bills of credit, called Continentals, that could be used to pay debts. So many of these notes were issued that people often refused to accept them. The money became so worthless that the phrase “not worth a Continental” was used to describe something of little value.
After the war, establishing a reliable medium of exchange became a major concern for the new nation. The Constitution, ratified in 1788, gave Congress sole power to mint coins, although private banks were still allowed to print bank notes representing gold and silver on deposit. Because the history of money in the United States is so closely tied to the development of the banking system we’ll examine both simultaneously. Before we do, here is a little trivia for you. In technical terms, a "bank" is an institution that loans money only to businesses and the government, such as the Federal Reserve Banks. What we consider a bank is actually called a "thrift institution." We have become lazy and call all loaning bodies banks.
Banking Services
Banks and savings institutions today offer a wide variety of services, including checking accounts, interest on checking, automatic deposit and payment, storage of valuables, transfer of money from one person to another, and overdraft checking. Overdraft checking allows customers to write a check for more money than exists in his or her account. The bank “loans” the needed amount and the customer pays the money back, usually at a relatively high rate of interest. In general, the type of services are the same across the country. The exact conditions of the services, however, vary from state to state according to
each state’s banking laws.
In choosing a bank or savings institution for a checking account, you should consider the service charges. service charges on checking accounts vary from bank to bank and with the type of account. You may be charged from $.25 to $.50 for each check you write. Some institutions offer “free checking”-no per check fee or month fee-providing the balance in the account remains above a certain minimum. If it drops below this minimum, a service charge of about $4 to $6 is collected. The minimum balance generally ranges from $100 to $500
Electronic Banking
One of the most important changes in banking began in the late 1970s with the introduction of the computer. With it came electronic funds transfer (EFT), a system of putting onto computers all the various banking functions that in the past had to be handled on paper.
One of the most common features of EFT is automated teller machines (ATMs). These units let customers do their banking without the help of a teller. A few banks have authorized customers with home computers to use them for banking transactions. If problems with security can be resolved, many people may one day bank by computer from home.
EFT Concerns
Although EFT can save time, trouble, and costs in making transactions, it does have some drawbacks. The possibility of tampering and lack of privacy are increased because all records are stored in a computer. A person on a computer terminal could call and read or even alter the account files of a bank customer in any city, if he or she knew how to get around the safeguards built into the system. Another problem for customers-but a benefit for banking institutions-is the loss of “float,” or the time between when you write a check and when the sum of the check is deducted from your account.
In response to these and other concerns, the Electronic Fund Transfer Act of 1978 describes the rights and responsibilities of participants in EFT systems. For example, EFT customers are responsible for only $50 in losses when someone illegally uses their card, if they report the card missing within two days. If they wait more than two days, they could be responsible for as much as $500. Users are also protected against computer foul-ups. If the balance appearing on a person’s statement or given out by an automated or human teller is less than the customer believes it should be, the bank must investigate and straighten out the problem within a certain period of time