The best things in life are free
But you can give them to the birds and bees
I need money (that's what I want)
That's what I want (that's what I want)
Your love gives me such a thrill
But your love don't pay my bills
I need money (that's what I want)
That's what I want (that's what I want)
Money don't get everything, it's true
But what it don't get, I can't use
I need money (that's what I want)
That's what I want (that's what I want)
“…That’s What I Want!”
Introduction to Money, Banking
and Monetary Policy
The Evolution of Currency
• Currency (aka money) – anything generally
acceptable by society for purchasing goods or
settling debts
1. Commodities as Money
• Commodity: an item used as currency that has
value/usefulness in and of itself
?
About 5000 yrs. Ago…
•
Ingots:
“Worth its weight
in gold”
2. Coinage as Money
• Minting begins in Turkey/Greece 7th C. BCE
• Coins used to represent weight of grain on
scales
BUT
• coins are not used as commodities themselves
(ie. not melted down & put to other uses)
Why the Heads?
3. Paper as Money
• First developed in China in 7th C. CE
History of Money Re-Cap
• 1. Commodity Money (aka Barter, Double
Coincidence of Wants problem)
• 2. Metal by Weight
• 3. Coinage
• 4. Paper
Europe adopts paper money
• 7th-11th C. CE (aka the “Dark Ages” =
insecure)
• Coinage deposited for safekeeping in
monasteries
• monks issue paper receipt for deposited
gold/silver/copper coinage
• receipt then given by “owner” to transfer
ownership of the coinage
• receipt can then be redeemed at the
monastery for the coinage
The “Merchant Princes”
• 13th C. Italy
• condottieri take
over money
deposit power
• first “merchant
bankers”
The Origins of Banking
• Traveling
merchants
deposit coinage in
local goldsmiths’
“vaults”
• paper receipts
issued
(“promissory
note”)
“As good as gold”
• 17th C. paper receipts accepted as possessing
monetary value (they are currency)
• Paper currency used for purchases and given
as change without needing to be immediately
(or ever) redeemed in gold/silver coinage
Enter the Goldsmiths…
• realize that few depositors ever withdrew all of their
deposited coinage at one time – “excess” coinage piling up
in vaults
• goldsmiths could safely “loan” out some of the excess
coinage to others – amount of loan recorded in book
• Interest could be charged on the loan or collateral
demanded as security for loan
• borrowers rarely took full value of their loan with them
either – often took paper receipts instead, leaving more
excess coinage to be loaned out again
Result?
a) more paper “money”/value was in circulation
than there was gold to cover it:
coinage+paper currency+loan accounts >
actual amt. of coinage/gold in vaults
b) goldsmiths had, in effect, created “more” money
(purchasing power) in the form of paper currency
circulating throughout economy
Fractional Reserve Banking
• Only a small fraction of the total money
deposited actually needed to be physically
kept in the bank’s vault (in “reserve”)
• Rest could be loaned out to circulate through
economy, spreading/increasing number of
transactions – “economic growth”, “money
velocity”
BUT what if…?
• … everyone who deposited their money or
had paper receipts for it wanted it ALL back in
GOLD (“hard currency”) at the SAME TIME ???
Financial Collapse
• Financial crises (war, poor harvest, etc.) cause a
“run on the banks”
• Banks unable to pay off all holders’ notes –
fractional reserves used up
• Banks forced to close and declare bankruptcy
• Some depositors lose all of their money
• Bank collapses occurred frequently in 19th and
early 20th Centuries
• 1867:
51 banks in Canada
• by 1900:
17 had failed
• Demand for federal governments to establish
“central” banks to regulate the issue of coins and
paper money
Central Banking
• 1934:
Bank of Canada created
• Purposes: regulate private banks, provide
security for depositors, issue a national
currency
The “Gold Standard”
• Before 1930’s, most national currencies were
convertible back to gold on demand
• Great Depression undermines people’s faith in
paper money – governments fear bankruptcy if
people want all paper converted back to gold
• governments abandon the gold standard for their
currencies
“Fiat Money”
• Money is to be accepted not because it can be
converted into gold
but
• because governments declare it to be the only
“legal tender” and MUST be accepted for
payments
So…
• value of nation’s currency now rests on the
confidence of the people in the relative strength
of their economy and faith in the government’s
stability (remember Zimbabwe?)
• value of currency now “floats” relative to its
strength when compared to other national
currencies/economies AND
• to the laws of supply and demand in currency
markets