Chapter 11 Money
Money • MONEY (def): any commodity or token that is generally acceptable as a means of payment • What are the functions of money • What does money do? • What are the characteristics of money? • What can be used as money?
What’s it worth? • Yasin’s Shirt? • Sammy’s Shoes? • Grace’s watch? • Taylor’s Phone?
The 3 Functions of money • Medium of Exchange • Measure of value • Store of value
Medium of Exchange • Before, money economies worked on a barter system (trading) • Barter system works on double coincidence of wants – seller and buyer must both be willing • In Medium of Exchange • Money acts as a lubricant that smoothes the mechanism of exchange • Everybody wants currency because they can use it to get what they want
Medium of Exchange Saves time over bartering When you barter it takes time to find someone that has what you wanted and wanted what you have. With medium of exchange – you sell to any willing buyer and buy from any willing seller for currency Purchasing Power: The amount of goods or services that can be bought with a unit of currency
Measure of value or Unit of Account • Allows Prices • Standard prices allow commerce to move faster haggling http://video.google.ca/videoplay?docid=8650971429469030558&ei=2yIVS9vVJ4f6lAeilYy_Dg&q=montey+python+haggle+-site%3Ayoutube.com&hl=en#
Measure of value or Unit of Account Allows Price comparison, which allows decisions In the barter system the value of a good is worth the value of many other goods. 1 chicken equals so many loaves of bread, so many litres of milk, pounds of cheese etc. In a money system, there is a unit of currency that acts as the “standard” that can be used to measure against. Money makes comparison easy An Ipad = $600 and a PS4 = $600 therefore they are the same price and are of equal value. A movie is $10 and an DQ blizzard is $5. A DQ blizzard is half the price of a movie.
Store of Value • In the barter system one good is sold in place of another good. • Money however, can be held (saved) to delay consumption • Money as well as other assets such a jewellery, real estate, antiques. However money has the greatest level of liquidity. • Purchasing power in the future should be close to the purchasing power today • Inflation is the rate by which money looses its purchasing power • How leaky is the batery • Canada has established a policy to control inflation to approximately 2%. This assists in the control of purchasing power.
Store of Value • Store of value is very important in international trade • People will look for safe harbours currencies during times of political or economic turmoil • Traditional Safe Currencies • USD • Euro • CAD
TheBig FIVEcharacteristics of money: • 1) generally acceptable • 2) portable • 3) divisible • 4) hard to duplicate or counterfeit • 5) uniform in value
1) generally acceptable • Older forms of money was generally acceptable because it had some form of underlying value i.e. Gold Coins • Fiat (let it be so) money is declared by government to be considered legal tender
2) Portable • Money should be easy to carry • Gold other precious metals were heavy and dangerous to carry • Led to the creation of paper money • http://player.discoveryeducation.com/index.cfm?guidAssetId=E09A70EE-C52E-43E7-9736-6FD5B7B6CA0C&blnFromSearch=1&productcode=US
3) Divisible • Making Change back in the day
3) Divisible • In order for currency to be useful it had to be divisible to reflect a range of values Canada • 1 dollar = 100 cents Britain • 1 pound = 20 shillings = 240 pence = 960 farthing India • 1 gold mohur = 15 silver rupees • 1 ruppee = 16 annas = 64 paise = 192 pies,
4) Hard to Counterfeit • Rare • It’s a simple tool to help you remember how to check bills: Touch, Tilt, Look through, Look at. • http://videos.howstuffworks.com/howstuffworks/54-how-money-is-made-video.htm
5) Uniform Value • Durable • Does not loose it’s value • Inflation
Meet Cupad, Cupid's greedy cousin • Counterfeit • Uniform in value • Portable • Acceptable • Divisible
Fake Money • http://bankofcanada.ca/en/video_corp/videos.html
Measuring the money supply • Money: Medium of Exchange • Near Money: Deposits or other assets that act as a store of value but are not themselves a medium of exchange
Components of the Money Supply • Demand Deposits • Money will be transferred “on demand” • Chequing Accounts • Current Accounts (chequing account for business) • Savings Accounts • Term Deposits • Lender agrees to lend money for a fixed amount of time • At maturity holder will receive money plus interest • Ex Bonds and GIC (Guaranteed Investment Certificate)
Components of the Money Supply • Notice Accounts • Require notice to the bank before given withdraw • Used primarily by business • Some interest paid
Calculating the money supply • There are many different measures of Canada’s money supply • Definitions go from narrow (M1) to broad (M2) • The narrowest definition is most easily affected by monetary policy and assets are most liquid • The broadest definition is the least affected by monetary policy and assets are least liquid • There is not correct measure of money supply
Definition of the Money Supply • Bank of Canada (BOC) has a range of definitions of money supply ranging from very specific to broad (M1-M3) • M1: Narrowest definition of money – medium of exchange • More easily controlled by monetary policy • Most liquid • All currency in circulation outside of banks • Chequing Accounts and Current Accounts • Money in banks and ATMS are not counted because?? • M2: Includes all of M1 plus • Savings accounts • Term Deposits
Definition of the Money Supply • M2++: Includes all of M2 plus – store of value • Deposits at non-bank deposit-taking institutions (credit union, caisse populaires) • Annuities at life insurance companies (Annuities is a mortgage in reverse) • All of these assets can be turned into cash in two business days
Definition of the Money Supply • M3: Includes all of M2++ - store of value • Least controlled by monetary policy • Least liquid • Large term deposits • Foreign Reserves • Funds that are used as a Store of value but can be converted into cash
Why do we care about money supply? • Knowing the money supply • Helps BOC determine interest rates and other financial policies
Banking System • Unit Banking: Many independent banks limited number of branches • US has over 14 000 banks • Branch Banking: Limited number of banks with unlimited number of branches • Canada has 13
Advantages Safe – less risk of a run on the bank Disadvantage Highly concentrated in few hands Little competition Higher costs for consumers Branch Banking System
Run on the Bank • Occurs when a large number of customers withdraw their deposits because they believe that the bank might become insolvent (go out of business) • Driven by fear and panic
Canada’s Banks • 6 banks control over 90% of the banking assets
Legal Classification • Schedule I banks: Domestic Banks • The 13 Chartered Banks • Schedule II Banks: Canadian Banks that are subsidiaries of foreign Banks • HSBC Canada • Citibank Canada • Schedule III Banks: Foreign Banks with branches in Canada • Deutsche Bank
MAGIC or COUNTERFEIT? • How does a Bank turn $100 into $1000?
Reserve Ratio • Reserve requirement is a regulation that sets the minimum reserves each bank must hold to customer deposits and notes • Ex. The reserve ratio is 5% • A deposit of $100 • $5 Reserve • $95 Can be loaned out
Reserve Ratio Ex • Reserve Ratio: 10% • Tarek deposits $100 in the bank • The bank keeps $10 and lends out $90 to Thea • Thea uses the $90 to pay her employee Sammi who then deposits the money in the bank • The bank keeps $9 and lends out $81 to Sandra who purchases supplies from Eric for supplies for her new fashion boutique • Eric deposits the $81 in the bank • The bank keeps $8.10 and lends out $72.9 to Saheel who buys books for school from Casey’s Book Store • Casey deposits the $72.9 in the bank • The bank keeps $7.29 in reserve and lends out $65.61 to Gordon to help him pay to record his new country song "your love hurts like a broken toe"
Reserve Ratio Ex • $100 • Could result in a maximum of $1000 in new money
Reserve Ratios around the world • India: 5% • China: 15.5% • United States: 10% • Chile: 4.5% • South Africa: 2.5% • Canada: ?
260 Example 1 1 _____________________________ Reserve Ratio Change in Deposits Change in Reserves x = 1 _____________________________ 0.1 Change in Deposits 100 x = Change in Deposits 1000 = Change in Money Supply 900 =
260 Example 2 1 _____________________________ Reserve Ratio Change in Deposits Change in Reserves x = 1 _____________________________ 0.05 Change in Deposits 500 x = Change in Deposits 10 000 = Change in Money Supply $9 500 =
In Class work • Do Questions 1-3 (don’t do #4) on page 260
260 1 1 _____________________________ Reserve Ratio Change in Deposits Change in Reserves x = 1 _____________________________ 0.1 Change in Deposits 5 000 x = Change in Deposits 50 000 = Change in Money Supply 50 000 – 5 000 = 45 000 =
260 2 1 _____________________________ Reserve Ratio Change in Deposits Change in Reserves x = 1 _____________________________ 0.08 Change in Deposits 10 000 x = Change in Deposits 125 000 = Change in Money Supply 125 000 – 10 000 = 115 000 =
P260 3 1 _____________________________ Reserve Ratio Change in Deposits Change in Reserves x = 1 _____________________________ 0.20 Change in Deposits 1000 x = Change in Deposits 5 000 = Change in Money Supply 1000 – 5000 = - 4000 =
Assets and Liability • A deposit in the bank is both: • Asset (something of value) • Liability (a debt that has to be repaid) • Assets always equal liabilities (+ owner’s equity)
Creation of money in multi-bank system (p257) • Scenario: • Bank A has deposit of $10 000 • $1000 Reserve (10%) • $9000 Excess • Ms Yeung borrows $9 000 • Ms Yeung buys furniture worth $9 000 • The store deposits the money Bank B • $900 Reserve (10%) • $8100 Excess • Mr Papas borrows $8100 • Mr Papas gives that money to another person who deposits it in bank C • $810 Reserve (10%) • $7290 Excess
Creation of money in multi-bank system (p257) • A multibank system will result in the same amount of new money creation as a monopoly bank so long as the reserve ratios is the same
Creation of money in multi-bank system (p257) • Reserve ratio: 10% • Deposit: $10 000 • New money: ?
Creation of money in multi-bank system (p257) • Reserve ratio: 10% • Deposit: $10 000 • New money: A MAXIMUM OF $90 000 • Why a maximum? • A bank might not lend out all of its excess reserves ( High interest, Prudent lending) • Cash Drain People holding (hoarding) money outside of the banking system