Comprehensive US Banking and Money System: Definitions & Functions

Double Coincidence of Wants

Two traders are willing to exchange their products directly.

Money

Anything that is generally accepted in exchange for goods and services.

Medium of Exchange

Anything that facilitates trade by being generally accepted by all parties in payment for goods or services.

Commodity Money

Anything that serves both as money and as a commodity; money that has intrinsic value.

Unit of Account

A common unit for measuring the value of each good or service.

Store of Value

Anything that retains its purchasing power over time.

Gresham's Law

People tend to trade away inferior money and hoard the best.

Seigniorage

The difference between the face value of money and the cost of supplying it: the 'profit' from issuing money.

Token Money

Money whose face value exceeds its cost of production.

Check

A written order instructing the bank to pay someone from an amount deposited.

Transactions Account

A bank account that permits direct payment to a third party.

Fractional Reserve Banking System

Only a portion of bank deposits are backed by reserves.

Bank Notes

Originally, papers promising a specific amount of gold and silver to anyone who presented them to issuing banks for redemption; today, Federal Reserve Notes are mere paper money

Representative Money

Bank notes that exchange for a specific commodity, such as gold or silver.

Fiat Money

Money not redeemable for any commodity; its status as money is conferred initially by the government.

Legal Tender

U.S. currency that constitutes a valid and legal offer of payment of debt.

Financial Intermediaries

Institutions that serve as go-betweens, accepting funds from savers and lending them to borrowers.

Depository Institutions

Commercial banks and thrift institutions; financial institutions that accept deposits from the public.

Commercial Banks

Depository institutions that historically make short-term loans, primarily to businesses.

Thrift Institutions

Savings banks and credit unions; depository institutions that historically lent money to households.

The National Banking Act of 1863

Created a new system of federally chartered banks called national banks.

Federal Reserve System (The Fed)

Became the central bank and monetary authority of the United States.

Objectives of the Fed

To serve as the central bank and monetary authority of the US.

Banking During the Great Depression

During this time period, 1/3 of the banks failed in the US.

FOMC (Federal Open Market Committee)

12 Board members, 7 Board of Governors + 5 of the 12 Presidents from the US Reserve Banks.

Overall Objectives of the FED

To maintain high levels of employment, economic growth, price stability, interest rate stability, financial market stability, and exchange rate stability.

Bank Holding Company

Corporation that owns banks.

Money Market Mutual Funds

A collection of short-term interest-earning assets purchased with funds collected from many shareholders.

Moral Hazard

Banks continued to take bigger risks, since they felt their depositors would be protected by the Federal Deposit Insurance Corporation (FDIC).

S&L Crisis (Savings and Loans)

A growing number of banks either collapsing, or declaring insolvency.

Mortgage-Backed Securities

Considered a safe investment.

3 Important Functions of Money

a medium of exchange, a unit of account, and a store of value

US Coin Production

A quarter (25 cents) costs 3 cents to produce

The US Mint Made...

$165 Million in 2024 ($304 million in 2023, and $337 million in 2022)

The Birth of the Fed

Before 1864, banks were charted by the states in which they operated, thus known as "state banks"

Each bank issued notes and they were redeemable for gold

National Banks

-they issued notes

-they are regulated by the Comptroller of the Currency

-state notes were all taxed out of existence

-state banks survived by creating checking accounts

-thus, we have the dual banking system today

Led to the Creation of the FED System in 1913

During the latter part of the 19th century, there were panic runs on Banks. In 1907, the Knickerbocker Trust Company failed

Objectives of the Fed (more)

-to serve as the central bank and monetary authority of the US

-all banks were required to join the Fed (except state banks)

-it now issued all notes

-to buy and sell government securities

-to extend loans to member banks

-to clear checks

-to require that member banks pull reserves equal to at least some specified fraction of their deposits

Lender of Last Resort

During the Great Depression, the Fed considered itself the...

Fed's Board of Governors

were now responsible for setting and implementing the nation's monetary policy. 12 Reserve Banks were moved under the Board of Governors. The ________ consists of 7 members appointed by the President and confirmed by the Senate

Those 7 ________ appointed by the President, through Congress, serve a 14-year, non-renewable term. Their terms are staggered, so that a new one is appointed every 2 years. It is set up this way to protect the FED Board from political pressure

One governor is appointed by the President to serve as Chairman of the Board of Governors for a 4-year term (renewable)

Jerome Powell

The current Fed Chairman is....

The Fed maintained.....

To maintain:

-high levels of employment

-economic growth

-price stability

-interest rate stability

-financial market stability

-exchange rate stability

Introduced Money Market Mutual Funds

Merrill-Lynch in 1972, became competition for banks

Attraction of Money Market Mutual Funds

-People were attracted to this type of investment because of the inflation (stagflation era) of the 1970s). Banks had a limit on the interest they could pay on deposits, making it more difficult to compete with money market mutual funds

-To help banks compete with investment firms, Congress tried to ease banking regulations in 1982

-Banks now began to involve themselves in risk-taking, by making commercial loans, credit cards, and other devises to attract savers

1989 Congress Banking Industry Bailout

-eventually costing $180 billion dollars)

-Money was used to close failing banks

-Paid off insured depositors

-Find healthier banks to take over the deposit accounts

-About 3000 banks failed between the early 1980s and the early 90s

-During the 90s, banks recovered, and their profits grew fourfold (Decade of the tech revolution)