Chapter 20

Learning Objectives

  • After you have read and studied this chapter, you should be able to:
    • LO 20-1: Explain what money is and what makes money useful.
    • LO 20-2: Describe how the Federal Reserve controls the money supply.
    • LO 20-3: Trace the history of banking and the Federal Reserve System.
    • LO 20-4: Classify the various institutions in the US banking system.
    • LO 20-5: Briefly trace the causes of the banking crisis of 2008 and explain how the government protects your funds during such crises.
    • LO 20-6: Describe how technology helps make banking more efficient.
    • LO 20-7: Evaluate the role and importance of international banking, the World Bank, and the International Monetary Fund.

The Importance of Money

  • Introduction to Money:
    • The Federal Reserve (or the Fed) is the organization responsible for managing money in the United States.
    • Current Chair: Jay Powell.
  • Economic Growth and Job Creation:
    • Availability of money is critical for economic growth and job creation.
    • That is why various institutions have evolved to manage money and make it accessible.
  • Modern Transaction Methods:
    • Cash can be withdrawn from an Automated Teller Machine (ATM), which are widely available.
    • Various payment methods include checks, credit cards, debit cards, smart cards, and even cryptocurrencies like Bitcoin.
  • Global Currency Exchange:
    • Daily, over $5 trillion is exchanged in global currency markets.
    • The economic status of any major country impacts the US economy.

Defining Money

What is Money?

  • Definition:
    • Money is anything generally accepted as payment for goods and services.
  • Historical Forms of Money:
    • Historically, money has included items such as salt, feathers, fur pelts, stones, rare shells, tea, and horses.
    • Example: Cowrie shells were a popular currency until the 1880s.

Characteristics of Money

  • Five Standards for Useful Money:
    1. Portability:
    • Money should be easy to carry.
    • Example: Coins and paper money are more practical than bulky goods.
    1. Divisibility:
    • The ability to be divided into smaller units.
    • Example: Various coin sizes (quarters, dimes, etc.) represent distinct values.
    1. Stability:
    • The shared agreement on the value of money contributes to economic stability.
    • Example: The US dollar is seen as a stable measure of value globally.
    1. Durability:
    • Money must withstand physical wear and tear.
    • Example: Coins can last thousands of years.
    1. Uniqueness:
    • Money should be easily recognizable to avoid counterfeiting.
    • Features like watermarks and intricate designs help prevent fraud.

The Evolution of Money

  • Barter System:
    • Barter is the direct exchange of goods and services.
    • Example: An entrepreneur bartered services worth $50,000 for graphic design.
    • Drawbacks of barter include portability and efficiency.

Technology in Modern Banking

## Electronic Money

  • E-Money:
    • Online payments facilitated through platforms like PayPal and Google Wallet.
    • Uses smart technology for easier transactions.
  • Cryptocurrencies:
    • Example: Bitcoin, launched in 2009, has been subject to significant thefts.

The Federal Reserve and the Money Supply

  • Definition of Money Supply:
    • The amount of money the Federal Reserve makes available for purchasing goods and services.
  • Controlling Money Supply:
    • The Fed controls the money supply through monetary policy tools.
  • Quantitative Easing:
    • This is a method to create more money and increase economic activity, especially during recessions.

Categories of Money Supply

  • M1:
    • Includes coins, bills, demand deposits, and traveler's checks (liquid money).
  • M2:
    • M1 plus savings accounts and other time deposits.
  • M3:
    • M2 plus large time deposits.

Economic Implications of Money Supply Changes

  • Inflation:
    • Occurs when there's excessive money chasing too few goods, raising prices.
  • Deflation:
    • Results from a contraction in the money supply, leading to lowered prices.

The Structure of the Federal Reserve System

  • Major Components:
    1. Board of Governors.
    2. Federal Open Market Committee (FOMC).
    3. 12 Regional Federal Reserve Banks.
    4. Advisory Councils.
    5. Member Banks.
  • Independence:
    • The Fed is a private institution and is not funded by taxpayer dollars.

Tools of the Fed to Control Money Supply

  1. Reserve Requirements:
    • Minimum reserves banks must keep.
  2. Open Market Operations:
    • Buying/selling government bonds to control the money flow.
  3. Discount Rate:
    • Interest rate charged to member banks for borrowing from the Fed.

Creating a Secure Banking Environment

Causes of the 2008 Banking Crisis

  • Factors contributing to the crisis included:
    • Low-interest rates encouraging excessive borrowing.
    • Pressure on banks to make risky loans (e.g., Community Reinvestment Act).
    • Selling of mortgage-backed securities (MBS).
  • Resulting Events:
    • Housing bubble burst caused significant foreclosures, impacting millions of families.

Government Protections for Funds

  • Key Organizations:
    • Federal Deposit Insurance Corporation (FDIC).
    • Savings Association Insurance Fund (SAIF).
    • National Credit Union Administration (NCUA).
  • Insurance Coverage:
    • Up to $250,000 per depositor per institution.

Contemporary Banking Institutions

Types of Institutions

  1. Commercial Banks:
    • Profit-seeking institutions; serve depositors and borrowers.
    • Offer checking accounts, savings accounts, loans, and other financial services.
  2. Savings and Loan Associations (S&L):
    • Accept deposits and provide home mortgage loans; originally promoted thrift.
  3. Credit Unions:
    • Non-profit, member-owned cooperatives providing similar services to banks but often offering better rates.
  4. Nonbanks:
    • Institutions that don’t accept deposits (e.g., insurance companies, pension funds).

Role of International Banking

  • Global Economic Impact:
    • Banking is increasingly interlinked; decisions made by international banks affect domestic economies.
  • World Bank:
    • Provides funding for development projects and aims to improve living standards in developing nations, while facing criticism for its methodologies.
  • International Monetary Fund (IMF):
    • Facilitates monetary cooperation; aids countries in financial distress and stabilizes world markets.

Summary of Key Learning Points

  • What is money?: Money is generally accepted as a medium for goods and services, characterized by five standards: portability, divisibility, stability, durability, and uniqueness.
  • Federal Reserve Role: The Fed controls the money supply through set reserve requirements, open market operations, and discount rates to stabilize the economy.
  • Banking System Evolution: Banking in the US has evolved from barter systems to modern banks, involving legislation influencing its structure and turbulent economic events shaping regulations.
  • Technological Advances: Technology promotes banking efficiency with online banking services and electronic funds transfers, adapting to consumer needs.