Money & Banking

AlMoatassem Mostafa

Lecture Outline

• The Evolution of the Payment System– Fiat Money– Checks– E-Banking & E-Money

• Functions of Money– Medium of Exchange– Unit of Account– Store of Value

Learning Objectives

At the end of the lecture, students should be able to understand:• How fiat money appeared.• How checks represent a new and efficient

form of money.• How money acts as a medium exchange, unit

of account, and store of value.

The Evolution of the Payment SystemFiat Money

• Fiat money appeared as a new type of money that could overcome the difficulties associated with metallic money.

• Initially, paper money was fully backed by and convertible to metal (like gold).

• Banks issued fiat money that represented a certain amount of metal. Fiat money could be exchanged at any time for this amount.

• This system was known as the Gold Standard and it lasted between 1879 and 1934.

• Each dollar used to represent a specific amount of gold.

• The Gold Standard collapsed because it was basically based on the fact that fiat money represented gold. This led to major economic problems.

• In a later stage, money became inconvertible to metal.• Fiat money is now issued by a government decree as a

legal tender.• People are now under legal obligation to accept

money as a means of payment.• Fiat money is basically a valueless piece of paper; It

does not have intrinsic value and it derives its value from the government decree.

• Advantages of fiat money include:– Solved the problem of carrying heavy metals and

coins for large transactions– Less cost of production as compared to

commodity money that involves the search and refinement of metals.

• Disadvantages of fiat money include:– The hardship and cost of transporting fiat money

in case of large transactions– Loss, theft, and money counterfeiting.

Checks

• A check is a written order to your bank to pay a specific sum of money from your account to the person who deposits the check.

• Checks are usually linked to checking accounts.• A checking account is a much more flexible

account that allows its owner to withdraw and deposit money frequently.

• Advantages of checks include:– Brilliant innovation that improved the efficiency of

the payment system– Overcame the complications associated with fiat

money, including large transactions, transportation cost, and theft.

– Enabled people to settle large transactions without the need to transport large amount of currencies.

– Reduced the risk of theft and fraud.– Represent receipts for payments once they

returned to their owner.

• Disadvantages of checks include:– Payment for someone in a different place, which

would involve delays to transport the check from one place to another.

– Banks do not work on weekends; payment for a transaction using a check would not be settled until the first business day.

E-Banking & E-Money

• Influenced by the dominance of computers and technology.

• Most banks will provide you a username and password to access your account online. Through such login credentials, you have full access through which you can monitor and conduct different operations and transactions on your account.

• E-banking is regarded as a highly efficient method of payment. It enables people to settle their transactions and pay their bills conveniently and instantly.

• You can also settle a transaction with people in any part of the world instantly without any delays.

• E-Money is a natural consequence of the development of E-Banking.

• A debit card is one form of E-Money. Most banks provide its customers debit cards once they setup an account. A debit card enables its holder to make purchases by transferring funds electronically from his/her account to a merchant’s account.

• Most supermarkets and stores offer their customers the option to pay for their purchases using debit cards at the points of sale. You can easily swipe your debit card through the card reader followed by entering your pin number, and the payment is done in seconds.

• Other forms of E-Money include stored-value cards like prepaid cards and gift cards; these cards are purchased for certain amount money paid upfront by the customer. The customer can then use these cards to make purchases.

• These forms of E-Money collectively contribute to facilitating payments and transactions. They save time and cost of transactions. They also overcome the dangers of theft and loss as you cannot use these cards unless you have the pin number.

• Drawbacks of E-Banking and E-Money include:– Vulnerability to what is known as online banking

theft and Internet fraud. – Hackers could steal millions and even billions of

dollars through online bank thefts. Hackers could steal your debit card data and pin number or your online accounts credentials and use it to steal funds from your account. This is known as identity theft.

– Card Skimming: installing certain parts on the ATM that could steal your debit/credit card data.

Functions of MoneyMedium of Exchange

• Any indirect exchange must involve a medium of exchange, namely an item through which an exchange takes place. This medium of exchange will not be used directly by the person who receives, but he rather saves it for a future exchange.

• Money as a medium of exchange, consequently, facilitates the exchange of goods and services by reducing transaction cost and time. It overcomes the problem of “double coincidence of wants” associated with the barter system.

• Money contributes to improving economic efficiency through supporting specialization and division of labour.

• For an item to serve as a medium of exchange, it must be universally accepted, durable, divisible, and easy to transport.

Unit of Account

• Money is the unit through which we can measure the prices of goods and services.

• All the prices of goods and services are expressed in terms of money.

• Wages, incomes, costs, and wealth are all measured in terms of money

• Unit of account is, therefore, regarded as the valuation and calculation function of money.

• Money serves best as a unit of account if its value is stable and not subject to fluctuations.

• Fluctuations of the value of money generally result in fluctuations in the prices of goods and services, which make it very hard to maintain a price level for goods and services in the economy.

• Money becomes an inefficient unit of account for the prices of goods and services in case of inflation.

Store of Value

• Money is used as a store of value because it is durable. It could be saved for future purchases. This is one feature that distinguishes indirect exchange from direct exchange in the barter system.

• Another feature of money that contributes to its success as a store of value is the purchasing power of money.

• The purchasing power of money lasts from the time we earn our income until the time we spend it as we normally do not spend our income once we earn it.

• Store of value is not an exclusive function of money; assets and precious metals could also be used as a store value.

• However, what sometimes makes money a more successful store of value is liquidity. Liquidity is how fast an asset can be converted into a medium of exchange to make purchases. Money is the most liquid asset as compared to other assets.

• The success of money as a store of value depends on maintaining its value and purchasing power. If the value of money deteriorates, its purchasing power decreases, and people prefers other assets as a store value because they pay higher interest as compared with money.

Practice Questions

1. Define the following terms: Medium of Exchange, Unit of Account, Store of Value, Liquidity.

2. Explain the advantages and disadvantages of fiat money. 3. Checks have overcome many problems associated with

fiat money. Explain.4. Talk about E-Banking and E-Money.5. Explain the function of money as a medium of exchange

(or as a unit of account or store of value)6. Explain why money is generally a better store of value

than other assets, including gold.

Office Hours and Contact Details

Office: Office 401, Faculty of law main building, fourth floor.E-mail: al_moatassem@mans.edu.egOffice hours: Saturdays 11:00 am-12:30 pm.

Mondays 12:30 pm- 2:30 pm.