Money & Banking: An Historical Perspective

1. Money & Banking: An Historical Perspective Week 12 ECON305, Maclachlan, Spring 2006

2. Definition Money is anything generally accepted in payment for goods and services or in the repayment of debts. Money = Wealth? Money = Income? ECON305, Maclachlan, Spring 2006

3. Functions of Money • Medium of exchange • Unit of account • Store of value ECON305, Maclachlan, Spring 2006

4. Early forms of money Big stones of Yap ECON305, Maclachlan, Spring 2006

5. Manillas were ornamental metallic objects worn as jewelry in west Africa Bronze bracelets. ECON305, Maclachlan, Spring 2006

6. Commodity Money Intrinsically valuable Divisible Homogeneous Scarce Portable Durable ECON305, Maclachlan, Spring 2006

7. Examples Amber, beads, cowries, drums, eggs, feathers, gongs, hoes, ivory, jade, kettles, leather, mats, nails, oxen, pigs, quartz, rice, salt, thimbles, umiacs, vodka, wampum, yarns, and zappozats (decorated axes). ECON305, Maclachlan, Spring 2006

8. Cattle Paradox “When cattle are regarded as a form of money, not only healthy cattle but also scrawny ones will be valued to the detriment of the environment supporting them and their owners.” ECON305, Maclachlan, Spring 2006

9. Linguistic Links • Capital, cattle, chattels have a common root. • Pecuniary comes from the Latin word for cattle pecus. • In Welsh da as an adjective means good but as a noun means both cattle and goods. ECON305, Maclachlan, Spring 2006

10. Origin of Banking • Originated in Ancient Mesopotamia (3500 BC) • Royal palaces and temples for safe keeping grain & other commodities. • In Egypt state warehouses for harvest led to a system of banking. • “Checks” written on deposits. ECON305, Maclachlan, Spring 2006

11. First Coins Cowrie shells used throughout the world before metal coins came into existence. ECON305, Maclachlan, Spring 2006

12. Government Minted Coins • Advantage to the public: standardization • Advantage to the government: seigniorage ECON305, Maclachlan, Spring 2006

13. Coin Crisis in Ancient Greece In 407 BC, Sparta captured Athenian silver mines and released 20,000 slaves. Athens was faced with a silver shortage and started minting silver plated bronze coins. Aristophanses’ The Frogs “the ancient coins are excellent … yet we make no use of them and prefer those bad copper pieces quite recently issued and so wretchedly struck.” ECON305, Maclachlan, Spring 2006

14. Gresham’s Law: bad money drives out good money • Queen Elizabeth I wanted to stop debasement of the currency so began minting high purity coins. • Her economic advisor Gresham told her the plan was flawed. ECON305, Maclachlan, Spring 2006

15. Paper Money • Banks store coins and issue receipts. • If receipts can be transferred, they can serve as money. • Receipts are call “bank notes” ECON305, Maclachlan, Spring 2006

16. Early bankers: the goldsmiths In 17th century England, savers deposited valuables in the goldsmith’s safes. Receipts could be used as evidence of one’s ability to pay a debt. Eventually receipts were used as bank notes. ECON305, Maclachlan, Spring 2006

17. Credit Money What if banker issues “receipts” to more precious metal than he has on deposit? ECON305, Maclachlan, Spring 2006

18. Instability with credit money If depositors worry about the soundness of the banks they will “run” on the bank. Solution: government regulation of banks to ensure soundness. ECON305, Maclachlan, Spring 2006

19. Problem with privately issued bank notes Counterfeiting is difficult to control because each bank’s notes would look different. Solution: government central bank issues bank notes. ECON305, Maclachlan, Spring 2006

20. Origin of Fiat Money When the government obtains a monopoly and can suspend redeemability, the link with commodity money is easily broken. When redeemability is permanently suspended the result is FIAT MONEY. Fiat money is government issued money with no intrinsic value. ECON305, Maclachlan, Spring 2006

21. Seigniorage under fiat money Consider what happens when money leaves the country. Money supply contracts. Fed buys Treasury securities and returns interest to the Treasury. The U.S. public save on interest they would otherwise have to pay on their debt. ECON305, Maclachlan, Spring 2006

22. What about the dollar coin? Why has it not been successful in U.S. when all other countries use coins for denomination of the same and even greater value? ECON305, Maclachlan, Spring 2006

23. Clues The Bureau of Engraving and Printing produces 37 million notes a day with a face value of approximately $696 million. 95% of the notes printed each year are used to replace notes already in circulation. 45% of the notes printed are $1 notes. Between the Fort Worth, Texas and the Washington, DC Facilities approximately 18 tons of ink per day are used. ECON305, Maclachlan, Spring 2006

24. The following information regarding the average life of a Federal Reserve Note was provided by the Federal Reserve System - please note that the life of a note depends on its denomination: $ 1 .............. 22 months$ 5 ................ 16 months$ 10................ 18 months$ 20 ............... 2 Years$ 50 ............... 5 Years$100 .............. 8.5 Years ECON305, Maclachlan, Spring 2006

25. Electronic Payment Systems Electronic payment systems are one of the early applications of computer systems but they were used for large size transactions. Recently with reduction in computing costs, they have been used for small size transactions. Cost savings for every bill paid electroncially: $1 ECON305, Maclachlan, Spring 2006