Economics Reflections

Chapter 10: Money and Banking

Money
Money is defined in terms of its three uses. Money can be a medium of exchange, which is
anything that is used to determine value in the exchange of goods, a unit of account, where it is
used to compare the value of goods, or a store of value, meaning that money keeps its value even
if it is not spent. This is different from barter where people would exchange goods for another
good directly. In the U.S. economy, barter would not provide an effective means of trade as the
economy is complicated and large and barter works better in smaller, more traditional markets. I
think that the paper money and coins are the best type of currency to use as they are lightweight,
uniform, portable, durable, and easily divided. Economists use six characteristics to determine
how well an item serves as currency. They are durability, portability, divisibility, uniformity,
acceptability, and limited supply. Since money may be needed at any given time it is beneficial to
a person if they can carry some with them at all times. This also means that money must
withstand many uses. Additionally, money must be uniform for people to measure and compare
the values of goods as well as being easily divisible so that people only have to use as much as
necessary. Money is also no longer useful if the are not in limited supply and if the society does
not accept it as a type of currency. I think it is important that people accept money as an item that
has value and can be used to exchange goods as this ensures that people can exchange goods for
money. If people did not accept it people would have to find a new way to exchange goods.
Finally, money gets its value depending on whether the money is commodity money,
representative money, or fiat money. Commodity money is money that consists of objects that
have value in themselves and are also used as money such as cattle, salt, and precious stones.
Representative money is money that the holder can exchange for something else of value. Then,
fiat money is money that has value because the government decrees it is an acceptable means to
pay debts. Today, the U.S. currency is considered fiat money.
The History of American Banking
Early in the nation's history, many people did not support a national bank. However, the first
national bank gave stability to American banking and helped manage the country's finances.
When the Bank's charter expired, many states chartered banks without any supervision or
regulation. This lead to financial chaos and the Second Bank of the U.S. was chartered until its
renewal was vetoed by President Jackson. This lead to the free banking era where there were
many bank runs and panics, wildcat banks, fraud, and many different currencies. I think that the
lack of uniformity and a centralized system allowed for the wide variations between banking
systems which were incompatible with one another and the for the high levels of fraud and abuse
of power. The Civil War then prompted the government to pass the National Banking Acts of
1863 and 1864 and adopt a gold standard which lead to a new national currency, the power to
charter banks, the power to require banks to hold adequate gold and silver reserves to cover bank
notes, and establish a definite value for the dollar. I think that the country needs a strong
centralized bank to unite the country's currency and monetary system. This helps the U.S.
currency fulfill the some of the six characteristics of money such as uniformity and acceptability.
The Federal Reserve System serves as the nation's central bank today and consists of member
banks and the Federal Reserve Board and gives out short-term loans and makes Federal Reserve
notes. Trust in banks has wavered with the ups and downs of the economy and I think that it will

continue to do so as people want to make sure that they do not lose money in economic
downturns.
Banking Today
Today the money supply consist of money that is divided into two categories: M1 and M2.
M1 is the money that is easily and immediately accessible for payment of goods and services. In
other words, it is assets that have liquidity or can be directly converted to cash. Checking
accounts are considered part of M1. M2 consists of M1 and additional assets such as savings
accounts and money market mutual funds. Banks also allow people to safely store their money in
a secure place using savings accounts, checking accounts, money market accounts, and
certificates of deposit. I think this helps take away some stress on people since they know that
their money is safely stored away and not easily accessible to others. Banks can also help people
in need of some money to start businesses or pay for goods and services by giving them loans.
This helps people in the short-term while ensuring that the bank makes some profit by charging
interest. However, I think that loans are risky as borrowers may default and not be able to pay
back their loans causing the bank to lose money and many loans take years to pay back. The
amount that is borrowed is called the principal and the price paid for borrowing the money is the
interest. One of the most common loans given is a mortgage. Credit and debit cards have made it
even easier to pay for goods as they represent a promise that a person will pay the bank back
later for the money they use. I think that credit and debit cards have made it easier to carry
around currency, however they have also made it easier for people to go into debt as they may
spend more money using a card than they have and tangible money can help people spend less.
ATMs have also made banks more efficient and I think that they have made it easier for people to
access their money quickly at any time.