Ch 11 Money / Banking
During the "free banking era" who issued their own currency?
"Wildcats", state chartered banks
Continental dollar
- paper currency issued by the Continental Congress to finance the Revolutionary War; lack of any gold or silver to· support paper money, plus the uncontrolled printing of money, led to its declining value; "not worth a Continental" was a common slogan at the end of the Revolution
4-5 major types of money used in early societies
1. commodity money (ex. tea leaves) 2. fiat money (has value due to govt decree) 3. paper currency includes: - tax anticipation note: paper money printed by states that could be redeemed with interest at the end of the year - Continental dollars: form of fiat paper currency that were printed by the Continental Congress to finance the Revolutionary War 4. specie: money in the form of coins made from silver or gold
currency problems
1. each bank issued its own currency in different sizes, colors, denominations - very inconsistent 2. a bank could print more money whenever it wanted 3. counterfeiting 4. not all were broadly accepted by every bank
2 banking trends emerged in the 1990s
1. improving health of all financial institutions 2. continued erosion of historical difference between commercial banks, savings banks, S&Ls and credit unions
3 functions of money
1. medium of exchange 2. unit of account 3. store of value
2 services of a bank
1. safe place to put money 2. lend money
Gold Standard: advantages
1. some people feel more secure about their money if they know it can be converted into gold 2. supposed to prevent the government from printing too much paper currency (only supposed to print enough that can be exchanged into gold - doesn't typically happen in reality so govts just maintain "appearance" that they can convert)
The "federal reserve system" created ___ regional banks all ____ by the federal government
12, chartered
Savings and Loan Crisis (1980s)
1300 failed banks, cost the FDIC over $300 Billion due to: 1. deregulation - S&L's unprepared to compete without govt setting their interest rates and determining loan types 2. High interest rates - S&Ls had made longterm low interest loans but when interest rates peaked in the 1980s recession, S&Ls were paying more on funds deposited with them than they earned on the loans they already made (negative cash flow) 3. Small capital reserves kept by S&Ls - bad loans forced S&Ls out of business b/c they didn't have funds to absorb
When did the Bank of the US cease to exist? Why?
1811, Alexander Hamilton died, the bank lost it's main backer
FIRREA (Financial Institutions Reform, Recovery, and Enforcement Act of 1989)
A federal law passed in 1989 in response to the crisis in the savings and loan industry. It revised the regulation of thrifts (S & Ls) and created several new agencies, such as Office of Thrift Supervision (OTS) and Resolution Trust Corporation (RTC). The overall impact was taking away S&L's independence and bringing them under the same rules as other banks. This reform made all banks safer.
commercial bank
A for-profit financial institution that accepts demand deposits and makes loans and provides a full range of other services for the public They were once the only banks to issue chaecking accounts that were called demand deposit accounts (DDAs)
gold standard
A monetary system in which paper money and coins are equal to the value of a certain amount of gold
credit union
A nonprofit financial institution that is owned by its members and organized for their benefit.
Why did the Federalist, led by ______ _____ believe that the country needed a strong "central bank"?
Alexander Hamilton, so the US can develop healthy industries and trade
wildcat bank
An unregulated, unstable, speculative bank that issues paper bank notes without sufficient capital (gold or silver) to back them
Money
Anything that serves as a medium of exchange, a unit of account, and a store of value
Which articles prevented the government from printing paper money and instead left that power to private banks?
Article 1 Section 8, Article 1 Section 10
paper currency
Backed by gold and silver in banks. After the Revolution, Americans hotly debated the issue of paper currency because it had resulted in inflation during the war, when the government used it to pay for goods and services. Many farmers favored issuing paper currency through a land office, which would provide capital based on the value of their land.
Bank
Bank an institution for receiving, keeping, and lending money
The first centralized bank in America established by the federalist
Bank of the United States
4 problems that arose from free banking era
Bank runs and panics, wildcat banks, fraud, many different currencies
3 factors of the Great Depression
Bank runs, stock market crashed, unpaid loans
wampum
Belts or strings of polished seashells that were used for trading gift-giving by Iroquois & other Native Americans
The federal reserve banks were the ___ banks for the 12 regional districts
Central
Which war forced politically powerful local bankers to comply with changes concerning banking?
Civil War
Historical periods of types of money/banking (see also paper currency)
Colonial 1607-1776: - continental dollar - specie Pre-Civil War (1789 - 1861): mutual savings bank national bank savings and loan Civil War-Pre-Depression 1861-1929: United States Note Commercial Bank Federal Reserve System gold certificate gold standard legal tender mutual savings bank national bank savings and loan association silver certificate treasury coin note Depression 1929-1939: commercial bank federal reserve system in-convertible fiat money standard mutual savings bank national bank savings and loan association World War II-FIRREA - 1940-1989 commercial bank deregulation federal reserve system inconvertible fiat money standard mutual savings bank national bank NOW account savings and loan association 1989-Present commercial bank federal reserve system inconvertible fiat money standard mutual savings bank national bank NOW account savings and loan association
5 types of Financial Institutions
Commercial banks, savings and loans, savings banks, credit unions, finance compAnies
Objects that have value in themselves and that are also used as money
Commodity money
printed during the Revolutionary War, but became too abundant and caused people to distrust the government's money unless it was coin
Continental dollars
A card entitling it's holder to buy goods and services based on the holders promise to pay for these goods and services
Credit card
A person or institution to whom money is owed
Creditor
Coins and paper bills used as money
Currency
A card used to withdraw money
Debit card
Failure to pay back a loan
Default
The money in checking accounts
Demand deposit
3 transactions you perform for ATM
Deposit money, withdraw cash, obtain account info
To be a successful medium of exchange
Durability, portability, divisibility, uniformity, limited supply, acceptability
how did Congress prevent greenbacks from becoming worthless like the continental dollars?
Establishing the national banking system
All the federal reserve banks were supervised by a _____ ____ ___ appointed by the president of the US
Federal reserve board
The system also created the national currency we use today called
Federal reserve notes
As a result of the 1907 banking crisis the government plans to reinstate a central bank called
Federal reserve system
Money that has value because the government had ordered that is an acceptable means to pay debts
Fiat money
The name of the Act passed by congress in 1989 to abolish the independence of the S&L industry?
Financial institution reform, recovery, and enforcement act (FIRREA)
Gold Standard: Disadvantages
Four disadvantages of a gold standard are that: 1. the gold stock may not grow fast enough to support a growing economy - if new gold supplies cannot be found, the money supply may not be able to expand; 2. people may suddenly decide to convert their currency into gold, thereby draining the government's gold reserves; 3. the price of gold is likely to change dramatically over time if it is not fixed; and 4. there is the political risk of failure based on the fixed price if too outside of the market
Keeps only a fraction of funds on hand and lends out the remainder
Fractional reserve banking
Paper currency: revolution to civil war
From the period of the American Revolution to the time of the Civil War, the paper currencies that were used were privately issued bank notes. The Constitution prohibited the federal government from producing paper currency, so the paper money supply was left for private banks to produce. Each bank issued its own currency in different sizes, colors, and denominations, and by the Civil War there were more than 1,600 banks issuing 10,000 kinds of paper currency. All of these banks were supposed to have backing in the form of gold or silver, but this was rarely the case because the temptation to issue too many notes always existed and counterfeiting became a major problem.
required citizens, banks, and businesses to turn in their gold and gold certificates over to the US government
Gold Reserve Act
A monetary system in which paper money and coins are equal to the value of a certain amount of gold
Gold standard
monetary standard under which the basic currency unit is equal to and can be exchanged for a specific amount of gold
Gold standard
fixed the price of gold at $20.67 per ounce
Gold standard act
Paper currency issued during the civil war
Greenback
The currency that was issued by the US treasury in 1861
Greenbacks
3 reasons for the S&L crisis
High interest rates and deregulation, bad loans, fraud
Federal reserve notes allowed "fed" to ___ or ___ the money in circulation according to business needs
Increase,decrease
The price paid for the use if borrowed money
Interest
why is it important for money to be both portable and divisible?
It must be both portable and divisible for it to be used practically. Portable: able to be carried Divisible: able to be broken into smaller denominations
2 advantages of the "gold standard"
It set a definite value for the dollar, the government could issue currency
passed in 1862, authorized the Union government to print United States notes
Legal Tender Act
The ability to be used or directly converted to cash
Liquidity
Currency, travelers checks, demand deposit
M1
Difference between M1 and M2
M1 can be converted to cash directly
All of M1 plus more
M2
Great Depression banking
Many banks failed (didn't have the cash to give to depositors) during the Great Depression because the banking industry was overextended and none of the banks had deposit insurance for their customers. The resulting concern about the safety of bank deposits caused a run on the bank in which depositors rush to withdraw their funds from a bank before it failed, often making the situation even worse and causing more banks to fail.
value of money
Measured by the goods, services, and resources that money can purchase. The value of money is determined by the demand for it, just like the value of goods and services. There are three ways to measure the value of the dollar. The first is how much the dollar will buy in foreign currencies. That's what the exchange rate measures. Forex traders on the foreign exchange market determine exchange rates. They take into account supply and demand, and then factor in their expectations for the future. For this reason, the value of money fluctuates throughout the trading day. The second method is the value of Treasury notes. They can be converted easily into dollars through the secondary market for Treasurys. When the demand for Treasurys is high, the value of the U.S. dollar rises. The third way is through foreign exchange reserves. That is the amount of dollars held by foreign governments. The more they hold, the lower the supply. That makes U.S. money more valuable. If foreign governments were to sell all their dollar and Treasury holdings, the dollar would collapse. U.S. money would be worth a lot less. No matter how it's measured, the dollar's value declined from 2000 to 2011. That was due to a relatively low fed funds rate, a high federal debt, and a slow-growth economy. Since 2011, the U.S. dollar has risen in value despite these factors. Why? Most of the economies in the world had even slower growth. That made traders want to invest in the dollar as a safe haven. As a result, the dollar strengthened against the euro. It made travel to Europe very affordable.
Anything that is used to determine value during the exchange of goods and services
Medium of exchange
What are the three functions of money?
Medium of exchange, unit of account, store of value
____ stored some of their cash reserves at the federal reserve bank in their distric
Member banks
In the 1990s banks begin to ___ and sell stocks and bonds
Merge
Pulls money from small savers to purchase short term government and corporate security
Money market mutual funds
All the money available in the US economy
Money supply
A specific type of loan that is used to buy real estate
Mortgage
Greenbacks
Name given to paper money issued by the government during the Civil War, so called because the back side was printed with green ink. They were not redeemable for gold, but $300 million were issued anyway. The greenback was important during the Civil War because it was a new federal fiat currency—the first federal currency since the Constitution was adopted—created by the Union government to fund the Civil War. Farmers hit by the depression wanted to inflate the notes to cover losses, but President Grant vetoed an inflation bill and greenbacks were added to permanent circulation. In 1879 the federal government finally made greenbacks redeemable for gold.
A bank charted or licensed by the national government
National bank
paper currency of uniform appearance that is backed by US government bonds
National bank notes/national currency
privately owned banks that received their operating charters from the federal government
National banks
National Banking System (1863)
Network of member banks that could issue currency against purchased government bonds. Created during the Civil War to establish a stable national currency and stimulate the sale of war bonds.
What did deregulation lead to?
No limits on the interest that could be earned by savings accounts. Any bank could offer NOW accounts All kinds of banks could borrow money from the Federal Reserve System - prior to deregulation, only commercial banks could borrow from the Fed. As a result: S&Ls failed due to deregulation and cheating. Negative cash flow due to having to pay high interest but only earning low interest on long term loans. So Congress pass FIRREA to bring S&Ls under the same rules as all other banks. Now banks fail typically only if they aren't managed properly.
2 disadvantages of commodity money
Not portable or durable
United States note
Paper currency with no backing, first printed by the United States government in 1862 to finance the Civil War.
Continental dollars
Paper money issued by the continental congress to finance the Revolution. Lacking tax revenues or gold or silver in the bank to back it up, this money depreciated rapidly. By mid-1781, it was literally worthless, but it had served its purpose by helping Congress conduct the war for six years
Gold certificates/silver certificates
Paper money that could be exchanged for an equivalent amount of gold and silver, as it was represented by that amount in the United States Treasury
Banking Act of 1933 (Glass-Steagall Act)
Passed after the Depression to strengthen the banking industry. Prohibited commercial banks from selling stock or financing corporations; created FDIC which insures the accounts of depositor of its member banks up to a current limit of $250,000 for one person at one bank
Why did "continentals" become worthless?
People come to believe that they would not be able to redeem their bills for gold and silver
The amount of money borrowed
Principle
Objects that have value because the holder can exchange them for something else of value
Representative money
Deregulation lead to a crisis in hat industry and why?
Savings and loans, previously been protected by government regulation, unprepared for competition
Each of the 12 regional banks allowed member banks to borrow money to meet their ____ demands
Short term
pieces of eight
Spanish coins (pesos) minted from silver from the new world; divided into 8 parts known as "bits"; nicknamed "talers" b/c resembled Austrian talers - sounded like "dollars" so Hamilton and Franklin made dollar basic monetary unit but divided into tenths, not eights like the peso.
Dineh Mohajer
Started nail polish business "hard candy" in 1995 successful because she devised colors (like blue) that hadn't been previously considered and gave them edgy names like "tantrum, greed or dork"
banks that received their charter to operate from the state government. Able to issue their own paper money by printing them in local shops.
State banks
Something that keeps it's value if it's stored rather than used
Store of value
5 functions of Financial Institutions
Storing money, saving money, loans, mortgages, credit cards
Why does US currency have value?
The Federal Reserve controls it's supply
liquid/liquidity
The ability to turn any form of money (asset) into cash
Federal Reserve System
The country's central banking system, which is responsible for the nation's monetary policy by regulating the supply of money and interest rates. Set up in 1913 as nation's first true central bank
Barter System disadvantages
The difficulty with a barter system is that in order to obtain a particular good or service from a supplier, one has to possess a good or service of equal value, which the supplier also desires. In other words, in a barter system, exchange can take place only if there is a double coincidence of wants between two transacting parties. The likelihood of a double coincidence of wants, however, is small and makes the exchange of goods and services rather difficult.
4 characteristics of money
The four characteristics that give money its value are its portability, durability, divisibility, and limited availability. Sometimes also included is uniformity and acceptability.
Federal Reserve System vs. National Banking System
The main difference between the Federal Reserve System and the National Banking System is that the Fed is a true central bank run by government officials while the National Banking System is a system of many banks that buy shares to join the Federal Reserve system and that are nationally chartered and inspected.
3 important powers the national banking act in 1863 and 1864 gave the federal government
The power to charter banks, the power to require banks and hold adequate fold and silver reserves to cover their bank notes, the power to issue a single national currency
Savings banks
Thrift institutions growing out of mutual savings banks
Why was the Second bank of the US established? When?
To eliminate financial chaos, 1816
Why was the FDIC created?
To insure customer deposits if bank fails
Barter
Trade
barter/barter system
Trading good and services without money
paper currency issued by the Treasury that was redeemable in both gold and silver
Treasury coin notes
Means for comparing the values of goods and services
Unit of account (value)
Civil War - Pre-depression (1861-1929)
United States Note Commercial Bank Federal Reserve System gold certificate gold standard legal tender mutual savings bank national bank savings and loan association silver certificate treasury coin note
federal fiat currency that did not have gold or silver backing.
United States notes
Did the bank of the US succeed In bringing order and stability to American banking?
Yes
national bank
a bank chartered, or licensed, by the national government who buys shares to join the federal reserve system
state bank
a commercial bank chartered by the banking authorities in the state in which it operates
bank holiday
a day on which banks are officially closed, observed as a public holiday.
savings and loan association (S&L)
a depository institution that has traditionally obtained most of its funds by accepting savings deposits, which have been used primarily to make mortgage loans
unit of account
a means for comparing the values of goods and services
run on the bank
a rush by depositors to withdraw their funds from a bank before it failed
currency
a system of money in general use in a particular country.
demand deposit accounts (DDAs)
accounts whose funds could be removed by simply writing a check without prior approval from the depository institution. these were the checking accounts set up by commercial banks
FDIC (Federal Deposit Insurance Corporation)
an agency developed by the federal government to regulate banking and and investment activities
barter system
an economic system in which goods or services are traded without the exchange of money
share draft account
an interest-bearing checking account at a credit union
NOW account
an interest-paying checking account; NOW stands for negotiable order of withdrawal
medium of exchange
anything that is used to determine value during the exchange of goods and services
money
anything that serves as a medium of exchange, a unit of account, and a store of value
central bank
bank that can lend to other banks in times of need Federal Reserve System established in 1913 was nation's first true central bank
After selling _____ did not work in order to supply the Civil War, Congress decided to print _____ ________ for the first time since the constitution was adopted.
bonds; paper currency
divisibility
can be made into smaller units so that people can use only as much as needed for any transaction
specie
coined money, usually gold or silver, used to back paper money
World War II-FIRREA (1940-1989)
commercial bank deregulation federal reserve system inconvertible fiat money standard mutual savings bank national bank NOW account savings and loan association
Depression (1929-1939)
commercial bank federal reserve system in-convertible fiat money standard mutual savings bank national bank savings and loan association
1989-present
commercial bank federal reserve system inconvertible fiat money standard mutual savings bank national bank NOW account savings and loan association
Which of the following is omitted in a barter exchange? a. trade b. medium of exchange c. store of value d. money
d. money
Because people felt more secure holding onto gold as opposed to paper currency, what did President Franklin D Roosevelt do?
declared a national emergency that anyone holding more than $100 worth of gold/gold certificates must file a disclosure form with the Treasury
mutual savings bank (MSB)
depositor owned savings institutions operated for the benefit of depositors
problems with currency
each bank issued currency in different sizes, colors, and denominations; temptation to issue too many notes; counterfeiting
portability
easily transferred from one person to another to make the exchange of money for products easier
inconvertible fiat money standard
fiat money that cannot be exchanged for gold or silver; Federal Reserve notes today
Thrift Institutions (Thrifts)
financial institutions that accepted the deposits of small investors but did not have DDAs until the mid-1970s
paper currency backed by gold placed on deposit the the United States Treasury
gold certificates
Disadvantages of gold standard
gold stock may not grow fast enough; lots of people may decide to convert currency into gold, draining reserves; price of gold is not fixed; political risk of failure
5 types of paper currency issued before banking system was overhauled in 1913
greenbacks, national currency, gold certificates, silver certificates, treasury coin notes
origins of the dollar
in 1789 when George Washington became president most plentiful coin in circulation as the Spanish peso Ben Franklin and Alexander Hamilton (Secretary of the Treasury) were tasked with establish a money supply for the new country Pesos were divided into eighths called "bits" (pieces of eight) and were nicknamed "talers" which sounded like "dollars". So Hamilton and Franklin made dollar basic monetary unit but divided into tenths, not eights like the peso. 2 bits = 2/8 or 1/4 of a dollar or 25 cents
US Currency since 1934
inconvertible fiat money
monetary standard under which fiat money supply cannot be converted into silver or gold by its citizens
inconvertible fiat money standard
durability
lasts when handled and does not deteriorate when being held as a store of value
fiat currency that must be accepted in payment for debts. AKA greenbacks
legal tender
government or a designated agent controls the quantity, composition, and quality of the money supply
managed money supply
monetary standard
mechanism that keeps a money supply durable, portable, divisible, and stable in value; gold standard, silver standard, fiat money standard
the mechanism designed to keep money portable, durable, divisible, and limited in supply
monetary standard
legal tender
money that by law must be accepted for payment of public and private debts
commodity money
money that has an alternative use as an economic good, or commodity (ex: ancient china used to use tea leaves compressed into bricks - if not used for trade, it could be used for tea)
fiat money
money without intrinsic value that is used as money because of government decree
Pre-Civil War (1789 - 1861)
mutual savings bank national bank savings and loan
How did state banks assure the public that their money was useful?
notes could be exchanged for gold and silver
gold certificates
paper currency backed by gold; issued in 1863 and popular until recalled in 1934
silver certificate
paper currency backed by, and redeemable for, silver from 1878 to 1968
Federal Reserve notes
paper currency issued by the Fed that eventually replaced all other types of federal currency backed by gold when first issued in 1914 but became inconvertible fiat money after 1934
Treasury coin notes
paper currency issued by the Treasury that was redeemable in both gold and silver
treasury coin notes
paper currency printed from 1890 to 1893, redeemable in both gold and silver
Advantages of gold standard
people more secure about money; prevented overprinting (couldn't print more than they could back in gold)
creditor
person or institution to whom money is owed
store of value
property that allows purchasing power be stored until needed something that keeps its value if it is stored rather than used
interest rates
represent the time value of money. in other words, a dollar today is worth more than a dollar one year from now. To compensate investors for the risks of investment, interest rates must take into account inflation, liquidity, credit and other risks.
paper currency backed by silver dollars and bullion placed on reserve with the Treasury
silver certificates
monetary unit
standard unit of currency in a country's money supply
A 10% tax was issued on all privately issued bank notes in order to force
state chartered banks to join the NBS
Banking in America (graph)
the number of banks in the US grew rapidly after 1880 and peaked in 1921. A period of mergers and consolidations took place from 1921-1929, after which the Great Depression took its toll. The number of banks remained relatively constant from 1933 to 1985 when another wave of mergers took place. 1865: the # of national banks increases as the 10% tax takes effect 1921: more than 31,000 state and national banks exist in the country 1929: about 25,000 banks exist when the Depression starts 1934: 5 years after the depression begins only about 14,100 banks remain 1985: wave of bank mergers and #s drop again
deregulation
the removal or relaxation of government restrictions on business
limited availability
to have value, it must be somewhat scarce. Money loses its value whenever there is too much of it. (so the commodity based money, like tobacco, became useless when everyone began growing their own money)
Colonial Period (1607 - 1776)
types of currency: continental dollar specie
mutual savings bank
was an early kind of thrift institution that is owned by depositors and specializes in savings accounts and mortgage loans, first came about in the late 1700s - did not have demand deposit accounts when they sold stock to raise additional capital they became savings banks b/c they were no longer owned by depositors
fraudulent banks that printed large amounts of currency in remote areas to make currency redemption difficult
wildcat banks
