Why is a strong banking system essential to a prosperous society?

Mark 12:15-17

• “…he said to them, “Why put me to the test? Bring me a denarius and let me look at it.” 16 And they brought one. And he said to them, “Whose likeness and inscription is this?” They said to him, “Caesar's.” 17 Jesus said to them, “Render to Caesar the things that are Caesar's, and to God the things that are God's.” And they marveled at him.

Money and the Banking System

Is money wealth??

Is money wealth??

• No

Is money wealth??

• No• Money is just a way to transfer wealth or to

give people incentives to produce wealth

Is money wealth??

• No• Money is just a way to transfer wealth or to

give people incentives to produce wealth• All people have to do is agree on something as

an intermediary means of exchange and bingo, money!

Money, money, money

• Money only works because other individuals will supply real goods and services in exchange for that money

Money, money, money


• History of money?

Money, money, money


• History of money?• So... The definition of Money: Something

generally accepted as a medium of exchange

Alternate money

Alternate money

• Credit cards, debit cards, checks, IOUs, gold

Alternate money

• Credit cards, debit cards, checks, IOUs, gold• Barter: lots of this going on at Craigslist

Alternate money

• Credit cards, debit cards, checks, IOUs, gold• Barter: lots of this going on at Craigslist• “2006 Fender Telecaster Deluxe FMT HH, will

trade for clean Lamborghini or Ferrari.”

Alternate money

• Credit cards, debit cards, checks, IOUs, gold• Barter: lots of this going on at Craigslist• “2006 Fender Telecaster Deluxe FMT HH, will

trade for clean Lamborghini or Ferrari.”• Bitcoin

When money goes bad

Inflation

Inflation

• Inflation is a general rise in prices

Inflation

• Inflation is a general rise in prices• Prices rise when there is more demanded than

supplied at a given price

Inflation

• Inflation is a general rise in prices• Prices rise when there is more demanded than

supplied at a given price• So when there is more money, people tend to

spend more. Without increase in output, prices simply rise

Inflation

• Inflation can be viewed as general decline in the real value of money, loss of purchasing power

Inflation

• Inflation can be viewed as general decline in the real value of money, loss of purchasing power

• Rule: more money in society means higher prices

Inflation

• “The big problem with money created by the government is that those who run the government face the temptation to create more money and spend it”

$787 billion “porkulus” bill signed by POTUS in 2009

Inflation at work

• What was inflation for the last 10 years?

Inflation at work

• What was inflation for the last 10 years? 24.3%

Inflation at work


• What was inflation for the last 20 years?

Inflation at work



Inflation in real life

• Inflation over last 50 years (1964-2014): 657%• I.e., if I bought an item for $10,000 in 1964 it

would cost $75,735 today

Now that’s inflation

• Inflation in Zimbabwe in 2008: 79 million%


• Inflation in Zimbabwe in 2008: 79 million% per month!


• Inflation in Zimbabwe in 2008: 79 million% per month!

• Annual rate in 2008….. 89,700,000,000,000,000,000,000%

How do politicians use inflation?


• Because raising taxes can be political danger, politicians print more money



• Result: prices rise, eroding purchasing power



• Result: prices rise, eroding purchasing power• Inflation is in effect a hidden tax… the money

that people saved is robbed of purchasing power which is transferred to the government issuing the money

“Our economic problems worry me much less than our political solutions, which have a far worse track record.” Dr. Sowell

Deflation

Deflation

• Persistent decrease in the general prices of goods and services

Deflation


• Can be disastrous: people hold onto money, creating less demand, prices continue to drop

Deflation


• Can be disastrous: people hold onto money, creating less demand, prices continue to drop

• Raises fears of the Great Depression

The Banking System

Why have banks at all?


• Safety… economies of scale in guarding money


• Safety… economies of scale in guarding money• Enable business to achieve economy of scale

by financing much more than individual businesses could on their own


• Safety… economies of scale in guarding money• Enable business to achieve economy of scale

by financing much more than individual businesses could on their own

• And you can make money from a bank: people acting in their own self interest lead to a more prosperous society

What is the U.S. banking system??


• A group of private institutions that transfer savings from people to others who want to borrow



• There are about 7,042 FDIC-insured banks and S&Ls in the U.S.



• There are about 7,042 FDIC-insured banks and S&Ls in the U.S.

• That’s down from about 8,430 in ‘08

Top U.S. banks

• JP Morgan Chase• Bank of America• Citi Group• Wells Fargo• Goldman Sachs• Honest George’s Bank, Used Car Parts and Pet

Boutique


• Banking system enables millions of people to spend money belonging to millions of other people for purchases and investments


• Banking system enables millions of people to spend money belonging to millions of other people for purchases and investments

• Banking system affects total demand in the economy as a whole by adding to the money supply through “fractional reserve banking”

So, how do banks work?

Fractional Reserve Banking

• A system that enables banks to only have on hand a fraction of the total reserves needed to cover all deposits



• Since all depositors won’t demand their money at once, banks lend out the rest and earn interest and fees



• Since all depositors won’t demand their money at once, banks lend out the rest and earn interest and fees

• Fractional reserve banking creates “new” money to create wealth


• U.S. Required Reserve Ratio is 10% on demand deposits (all deposits except savings accounts and CDs), above $79.5 million

• Down from 12.3% in 1968


• U.S. Required Reserve Ratio is 10% on demand deposits (all deposits except savings accounts and CDs), above $79.5 million

• Down from 12.3% in 1968• So if a bank has $500 million in deposits, it

must maintain $50 million in cash in its vaults or in a Federal Reserve Bank

What economics looks like in college

• M1= Mb*mm• mm= (1+c)/c+R• M1 is money supply; Mb is monetary base;

mm is money multiplier; c is currency ratio; R is reserve ratio

Fractional reserve banking

• Ratio varies by country


• Ratio varies by country• 0% in Australia, Canada, Mexico to 19.5% in

China, to 30% in Lebanon


• Ratio varies by country• 0% in Australia, Canada, Mexico to 19.5% in

China, to 30% in Lebanon• Enough!!! How exactly does fractional reserve

banking create wealth???????

Federal Reserve System

• A central bank created in 1913 by Congress to control all private banks



• Role is to prevent banking panics… runs on the bank




• Tells banks what reserves they can hold




• Tells banks what reserves they can hold• Insure deposits through the FDIC (Federal

Deposit Insurance Corp.)... thus prevent “runs” on banks

The Fed

• Sets interest rates on loans to banks, thus indirectly controlling interest rates throughout the banking system

The Fed

• Sets interest rates on loans to banks, thus indirectly controlling interest rates throughout the banking system

• Operates 12 Federal Reserve Banks throughout the country that work with private banks to distribute funds, extend credit, process U.S. money, etc.

Assignment for April 1

• Read and study Chapter 17 of Basic Economics: “Government Functions”

Why is a strong banking system essential to a prosperous society?

Documents

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