Introduction to Money, Banking, & Financial Markets
Introduction to Money, Banking, & Financial Markets Part Two
Ch. 1 Why Study Money, Banking and Financial Markets?
Ch. 2 An Overview of the Financial System
Ch. 3. What is Money?
Money and Banks
Definition of money:
–Money is anything
Evolution of money:
–Self-sufficient
–Improvement: Barter
•
•
Problems with barter
1.Many Prices
–4 goods; pianos, ducks, Frisbees & boots
•Piano: duck/piano, Frisbee/piano, boot/piano
•Duck: Frisbee/duck, boot/duck
•Frisbee: boot/Frisbee
•Boot:
Formula: # prices = n(n-1)/2 n = number of goods
with 5,000 items =>
2.Double Coincidence of Wants
–
The Development of Money
Under barter some goods stood out as ones in constant demand.
Commodity Money
–Examples:
•Gold & Silver
Functions of Money
Medium of Exchange
–commonly accepted
Unit of Account
–standard measure of the value of goods and services
Store of Value
–hold and use later
Other examples of money
Money on Yap
2,000 year old tradition
most 2 ½ - 5 feet
some 12 feet across
worthless when broken
used for big ticket items, property
Pros and Cons of Commodity Money
Pro:
–value
•
Con:
–
–
Solutions to these problems
Warehouse banking
–Gold Certificates
•
U.S. Dollar
–What commodity is backing the dollar ?
•Fiat Money
–
–“THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE”
Governments love fiat money
Seigniorage
–
Debasing a gold coin
–add lead or other cheap metals
–Clipping a coin
•why coins look the way they do
The Economics of One Dollar
Aside
Total currency
–June 30, 2007
–$812,760,000,000
–per capita
$2,688
Pro
–
•$1.64 vs. $22 / $1000
–
•30 years vs. 18 months
Con
–
•8¢ vs. 4¢
–
•$75 per machine
–Higher transportation costs
Susan B. Anthony Dollar
Why did it fail?
–
–
The New Dollar Coin
Importance of Network Externalities
Value is determined by the number of other people using the good.
–Physical payments infrastructure
–Familiarity
What would convince consumers to carry the dollar coin?
What would induce vending machine operators to convert their machines?
Congress Tries Again for a Dollar Coin
Odd motivations
–
•
•
–
Will “augment – not replace – paper currency.”
–Guarantees will not be widely used
Money Supply
M1
currency outside the banking system + demand deposits + traveler’s checks + other checkable deposits
M2
Less liquid than M1
M3
Less liquid than M2
How banks make money
Gold Certificates
–Bank Notes
Example: T-account / Balance sheet
What is the current money supply?
$100
Banker decides to loan out some money.
–Allow gold to leave.
–Print more bank notes.
What happens to the money supply?
Fractional Reserve Banking System
Modern day equivalent
–Gold
•currency and deposits at the Fed
–DD
•checking accounts
Fractional reserve banking
Concern
–more DD than reserves
What if everyone wants their gold or currency?
–Bank is illiquid
Insufficient reserves to cover DD.
–Not necessarily insolvent
Importance of banks
Creation of money
Financial Intermediaries
In their absence => direct financing
Financial Intermediaries
Problems with direct financing
–I have an extra $20,000.
–Place an ad in the paper
•“Investor has $20,000. Looking for potential new car buyer in need of a loan.”
•What should I do before I lend out this money?
–
–
–
A better way: Give my money to a bank, they find the borrowers.
–Benefits:
•cheaper
–
•less risk
–
Additional benefit of Financial Intermediaries
–Ability to pool small, short-term investments and make large, long-term loans.
•mortgages
•college loans
•car loans
How does this work?
Day 1: $10,000
Day 2: $10,000 + 10,000 = $20,000
Day 3: $20,000 + 10,000 = $30,000
Day 4: $30,000 + 10,000 = $40,000
Day 5: $40,000 + 10,000 = $50,000
Day 6: $50,000 + 10,000 = $60,000
Day 7: $60,000 + 10,000 = $70,000
Day 8: $70,000 + 10,000 - 10,000 = $70,000
Day 9: $70,000 + 10,000 - 10,000 = $70,000
Day 10: $70,000 + 10,000 - 10,000 = $70,000
Day 11: $70,000 + 10,000 - 10,000 = $70,000
Day 12: $70,000 + 10,000 - 10,000 = $70,000 ..