Money and Banking

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Money and Banking

• Week 2
• Introduction continued,
• What is money?

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• Exchanges e.g., NYSE

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OTC markets e.g.,NASDAQ
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• money market instruments short-term maturity,
  low risk, high denomination debt instruments.
• Examples Treasury bills, commercial paper,
  repos, bankers acceptances.

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Equity

• Issuers
• Low riskis never paid back.
• Level of dividend payments can be decided by
  managers.
• Dilution of earnings for existing shareholders.

• Investors
• Higher risk than bonds from same firm. Investors
  are residual claimants.
• Higher return, on average.

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Debt

• Issuers
• Risk of being forced into bankruptcy if firm
  cannot meet debt obligations.
• Interest payments on bonds must be made every six
  months.
• Tax advantage of interest payments.
• Return paid on bonds lower than on stock. Its a
  cheaper form of finance.

• Investors
• Lower risk than equityeven if firm fails bond
  investors are first in line.
• Return is lower, on average.
• Cash flows every six monthsgood for retirees.

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• Fiscal Policy
• Taxing spending.
• Borrow if spending exceeds tax revenue.
• Responsibility of the Treasury.

• Monetary Policy
• Affecting money supply and interest rates.
• Responsibility of central bankthe Federal
  Reserve.

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Federal Funds Rate
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• Fed funds rate rate of interest that large banks
  charge one another for short-term loans.
  Transactions flow through their accounts at the
  Fedhence the term.
• Determined by supply and demand.
• Target is 5.25

• Discount rate rate of interest that the Fed
  charges banks for short-term loans.
• Currently 6.25.

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Definition

• Money is anything generally accepted in payment
  for goods and services or in the repayment of
  debts.
• Money Wealth?
• Money Income?

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Functions of Money

• Medium of exchange
• Unit of account
• Store of value

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Early forms of money

• Big stones of Yap

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• Manillas were ornamental metallic objects worn as
  jewelry in west Africa
• Bronze bracelets.

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Commodity Money

• Intrinsically valuable
• Divisible
• Homogeneous
• Scarce
• Portable
• Durable

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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).

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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.

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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.

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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.

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First Coins

• Cowrie shells used throughout the world before
  metal coins came into existence.

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Government Minted Coins

• Advantage to the public standardization
• Advantage to the government seigniorage

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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.

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Greshams 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.

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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?

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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.

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• 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 Years100 .............. 8.5
  Years

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Paper Money

• Banks store coins and issue receipts.
• If receipts can be transferred, they can serve as
  money.
• Receipts are call bank notes

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Early bankers the goldsmiths

• In 17th century England, savers deposited
  valuables in the goldsmiths safes.
• Receipts could be used as evidence of ones
  ability to pay a debt.
• Eventually receipts were used as bank notes.

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Credit Money

• What if banker issues receipts to more precious
  metal than he has on deposit?

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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.

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Problem with privately issued bank notes

• Counterfeiting is difficult to control because
  each banks notes would look different.
• Solution government central bank issues bank
  notes.

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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.

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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.

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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

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Federal Reserves Monetary Aggregates
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Growth Rates of Feds Monetary Aggregates