Dual currency problem in Boston during 1800s.
Country banks' notes are redeemed at a discount due to the cost and inability for them to redeem the notes. Merchants face trouble because they have both country banks notes and Boston bank notes that are of good quality. They have to bear the full cost of any possible fluctuation of the redemption rate changes.
But Gresham's Law didn't kick in this situation.
(1) The notes of Boston Banks didn't disappear though diminished relative to those of country banks in response to the growing reliance on demand deposits and to the increasing competition of country banks agents in Boston.
(2) The value of "bad" notes are changing and the "good" notes are redeemed constantly at par. The purchasing power of the bad notes changed constantly. There is no incentive for arbitrager to drive good notes out of circulation.
A rising preference for deposit banking tends to diminish the importance of city bank notes. The existence of large deposits in city banks restricted the ability of these institutions to increase their issuance of notes.
The fundamental plan of Suffolk System
(1) each country bank was required to maintain a permanent deposit at Suffolk Bank of 2000 bucks or more depending on their sizes, plus an added deposit sufficient to redeem all its notes that were received by the Suffolk Bank
(2) Boston banks were required only to maintain permanent deposits
(3) no interest was paid on any of these deposits
(4) in return the Suffolk Bank agreed to accept at par from depositor banks all the bank notes they received from other New England banks in good standing and to credit such deposits to the account to the depositor bank on the day following receipt.
The principal motive was the desire of Boston banks to increase their bank note circulation.
The Suffolk System increased the acceptablity of the country notes by making them acceptable at par.
The most striking achievement of the Suffolk System for Boston was the ultimate elimination of the discount on country banknotes.
Membership in the Suffolk System was restricted to banks whose notes could be accepted safely by the public.
Although the Suffolk could not prevent the undesirable newcomer from issuing notes, it could prevent the wayward bank notes from getting extensive circulation, by withholding membership in the Suffolk System.16 This acted as an effective safeguard when State legislatures were extremely lenient in granting bank charters and when State banking legislation was inadequate.
By requiring that members' deposits represent reserves against their notes in circulation, the Suffolk Bank centralized the reserves of the system.
There is some evidence that the Suffolk System contributed to banking stability; at least it served to avert greater disaster to New England banks during economic panics.
How, then, did a system that seemed so entrenched in 1851, collapse seven years later? This end was, to a considerable extent, due to the populous desire of country banks for over–expansion of their notes.
Within a banking system where every bank possesses the ability to issue notes which circulate as money there is a tendency for over–issue by many individual banks, leading to discounting of bank notes and a general deterioration of sound credit.
Systems of bank note clearing and redemption are a necessity for the smooth operation of relatively free banking with a gold coin standard, whether the system is privately operated as with the Suffolk System or governmentally operated as the Safety Fund System in New York.
4/11/2013
4/09/2013
Banking history
The Civil War brought four major pieces of monetary legislation: the legal-tender laws, in 1862; the National BankingAct, in 1863; an act outlawing private coinage, in 1864; and an act imposing a prohibitive 10 percent tax on state-banknote issues, in 1865. The combined effect of the last three acts was to place the entire currency supply under federaljurisdiction. Together with the legal-tender laws, these acts comprised a program for securing means other than directtaxation to pay for the war against the South.
Free banking overview
Historically, even some of the staunchest proponents of laissezfaire have viewed banking as inherently unstable and so requiring government intervention. According to this view, left to unfettered market forces, banks are prone to periodic runs and failures simply because of unpredictable private decisions about the form in which individuals hold their money.
In particular, the Free Banking Era (1837—63) is often cited as an example of what would happen if banking were unregulated. It was a period when banks were subject to few restrictions, fewer than any other period in U.S. banking history. And it has often been characterized as chaotic, with many different kinds of paper money, with numerous bank runs and failures, and with substantial losses and inconvenience to holders of bank notes.
problems were caused by economic shocks that caused many banks to fail but did not lead to bank runs or panics.
Before 1837, all new U.S. banks had to be chartered by a state legislature. In practice, the chartering system was a cumbersome and very political process that severely limited the number of banks opened.
Free entry meant that a legislative charter was no longer required for a bank to be established. The free banking laws essentially allowed anyone to open a bank, issue their own currency (bank notes), take deposits, and make loans. The Free Banking Era was not a period of laissez-faire banking, however, since banks established under the free banking laws were subject to certain restrictions.
State governments were jealous of the financial favors they had garnered from their banking systems. In order to retain these favors while allowing freedom of entry into the banking business, they supported the inclusion of "bond deposit" provisions in the laws regulating bank-note issues.
• Free banks had to deposit designated state bonds with the state banking authority (state auditor or treasurer) as security for all notes issued. (Some states also allowed federal bonds.)
• Free banks had to pay specie (gold or silver) for notes on demand. Failure to redeem even one note meant that the state banking authority would close the bank and sell all of the assets deposited with it to pay off note holders. Further, in many states, note holders had preference over other bank creditors in terms of legal claims on the remaining assets of the bank.
• In general, free bank stockholders were liable for bank losses in an amount up to the value of their stock even though free banks were limited liability companies. This double liability provision meant that, if a bank failed, someone with, say, $25,000 of free bank stock not only might lose this investment, but also would be liable for an additional $25,000 of personal wealth to cover bank losses (including those on notes).
• Very few free bank closings involved losses to note holders; that is, by our definition, very few failed. Between 1838 and 1863, 709 free banks operated in the four states and 48 percent of them
closed. However, only about one-third of the closings resulted in any losses to note holders.
• Free bank notes were quite safe. For most years and most states, the expected loss from holding a randomly selected bank note for one year was zero. Further, when noteholders suffered losses, they ranged from an average of about 25 cents on the dollar in New York and Wisconsin to an average between 10 and 15 cents on the dollar in Indiana.
• Most of the free banks were not short-lived. Between 1838 and 1863, New York, Wisconsin, and Indiana free banks were in business a mean of 6.3 years.
for a banking system to be inherently unstable, a run on one or more banks and their subsequent
failure must lead to the failure of other banks.
Why were free bank failures not contagious? That is, why did the bank failures in one state not spread to other states? A possible explanation is that the requirement that free banks keep a reserve of state bonds behind their notes provided some public information about free bank portfolios which helped note holders distinguish good banks from bad ones when local real shocks occurred.
In particular, the Free Banking Era (1837—63) is often cited as an example of what would happen if banking were unregulated. It was a period when banks were subject to few restrictions, fewer than any other period in U.S. banking history. And it has often been characterized as chaotic, with many different kinds of paper money, with numerous bank runs and failures, and with substantial losses and inconvenience to holders of bank notes.
problems were caused by economic shocks that caused many banks to fail but did not lead to bank runs or panics.
Before 1837, all new U.S. banks had to be chartered by a state legislature. In practice, the chartering system was a cumbersome and very political process that severely limited the number of banks opened.
Free entry meant that a legislative charter was no longer required for a bank to be established. The free banking laws essentially allowed anyone to open a bank, issue their own currency (bank notes), take deposits, and make loans. The Free Banking Era was not a period of laissez-faire banking, however, since banks established under the free banking laws were subject to certain restrictions.
State governments were jealous of the financial favors they had garnered from their banking systems. In order to retain these favors while allowing freedom of entry into the banking business, they supported the inclusion of "bond deposit" provisions in the laws regulating bank-note issues.
• Free banks had to deposit designated state bonds with the state banking authority (state auditor or treasurer) as security for all notes issued. (Some states also allowed federal bonds.)
• Free banks had to pay specie (gold or silver) for notes on demand. Failure to redeem even one note meant that the state banking authority would close the bank and sell all of the assets deposited with it to pay off note holders. Further, in many states, note holders had preference over other bank creditors in terms of legal claims on the remaining assets of the bank.
• In general, free bank stockholders were liable for bank losses in an amount up to the value of their stock even though free banks were limited liability companies. This double liability provision meant that, if a bank failed, someone with, say, $25,000 of free bank stock not only might lose this investment, but also would be liable for an additional $25,000 of personal wealth to cover bank losses (including those on notes).
• Very few free bank closings involved losses to note holders; that is, by our definition, very few failed. Between 1838 and 1863, 709 free banks operated in the four states and 48 percent of them
closed. However, only about one-third of the closings resulted in any losses to note holders.
• Free bank notes were quite safe. For most years and most states, the expected loss from holding a randomly selected bank note for one year was zero. Further, when noteholders suffered losses, they ranged from an average of about 25 cents on the dollar in New York and Wisconsin to an average between 10 and 15 cents on the dollar in Indiana.
• Most of the free banks were not short-lived. Between 1838 and 1863, New York, Wisconsin, and Indiana free banks were in business a mean of 6.3 years.
for a banking system to be inherently unstable, a run on one or more banks and their subsequent
failure must lead to the failure of other banks.
Why were free bank failures not contagious? That is, why did the bank failures in one state not spread to other states? A possible explanation is that the requirement that free banks keep a reserve of state bonds behind their notes provided some public information about free bank portfolios which helped note holders distinguish good banks from bad ones when local real shocks occurred.
4/9/2013 Banking notes
The origin of the First Bank of United States
It wasn't a central bank.
Wasn't granted monopoly privileges to issue notes
No regulatory power on commercial banking system
But it was the only bank exempt from tax imposed on other banks which do business in different states. It also had a large amount of reserves, which implied its strong influence in the financial market.
Second Bank of United States
Mission is to bring order to banking system by restoring specie payment by state chartered banks. (socialize depositor losses)
It didn't regulate banks and it didn't act as lender of last resort, but it was big and conducted monetary policies.
Did these banks serve to improve the quality of the US means of payment or not?
Favorable view: they served to discipline and restrain state banks by actively redeeming their notes.
Unfavorable view: rather than restraint, they often encouraged state banks to expand by reissuing bank notes.
Free banking
States (not federal) charters
No federal law governing banking system
Freer entry
No note issue without discretionary approval
Myths about state banking
(1) state banks are free
(2) wildcat banks are ubiquitous
(3) poor quality of state banks and banknotes is a result of lax regulation and oversight
How to open a bank
(1) meet the capital requirement
Asset Liabilities
Bonds deposited with Notes
state banking authority $50000
$50000
Loans to stockholders Equity
15000 $50000
specie
5000
loans
30000
have to buy bonds from state you live (collateral)
pay-in capital : 50000-15000=35000
Note issuance
Banks are allowed to issue their own notes, but have to make security deposit with the state banking authority. (Typically in the form of state bonds)
Notes should be issued up to face value of the deposit
States can close banks if the deposit values fall below the value of notes outstanding
Panics in2007
Repo market (regulation Q and restriction on interstate branching)
Par conversion
Banks are not allowed to make arrangement with customers on how much to redeem. The legislation makes bank runs possible.
State chartering restricted entry and competition of banks. Banks are small and undiversified.
Wildcat banking is exaggerated. Most banks were honest.
It wasn't a central bank.
Wasn't granted monopoly privileges to issue notes
No regulatory power on commercial banking system
But it was the only bank exempt from tax imposed on other banks which do business in different states. It also had a large amount of reserves, which implied its strong influence in the financial market.
Second Bank of United States
Mission is to bring order to banking system by restoring specie payment by state chartered banks. (socialize depositor losses)
It didn't regulate banks and it didn't act as lender of last resort, but it was big and conducted monetary policies.
Did these banks serve to improve the quality of the US means of payment or not?
Favorable view: they served to discipline and restrain state banks by actively redeeming their notes.
Unfavorable view: rather than restraint, they often encouraged state banks to expand by reissuing bank notes.
Free banking
States (not federal) charters
No federal law governing banking system
Freer entry
No note issue without discretionary approval
Myths about state banking
(1) state banks are free
(2) wildcat banks are ubiquitous
(3) poor quality of state banks and banknotes is a result of lax regulation and oversight
How to open a bank
(1) meet the capital requirement
Asset Liabilities
Bonds deposited with Notes
state banking authority $50000
$50000
Loans to stockholders Equity
15000 $50000
specie
5000
loans
30000
have to buy bonds from state you live (collateral)
pay-in capital : 50000-15000=35000
Note issuance
Banks are allowed to issue their own notes, but have to make security deposit with the state banking authority. (Typically in the form of state bonds)
Notes should be issued up to face value of the deposit
States can close banks if the deposit values fall below the value of notes outstanding
Panics in2007
Repo market (regulation Q and restriction on interstate branching)
Par conversion
Banks are not allowed to make arrangement with customers on how much to redeem. The legislation makes bank runs possible.
State chartering restricted entry and competition of banks. Banks are small and undiversified.
Wildcat banking is exaggerated. Most banks were honest.
4/05/2013
Interstate Banking: The Reform That Won’t Go Away
Of the policies that have actually weakened the U.S. banking system,
among the most important are long-standing restrictions against
interstate branching. Its long history of unit banking places the United
States in a unique position among nations with developed banking
systems.
Current law, based on the McFadden Act of 1927, the Banking Act of 1933, and the Bank Holding Company Act of 1956, with their amendments, allows each state to establish its own policies concerning the ability of out-of-state banks to enter the state’s market. Some 30 states and the District of Columbia have reached reciprocal interstate banking agreements with states or other groups of states. Four other states permit banks from any state to operate within their boundaries. Over three-fourths of these 34 states limit such interstate banking to purchases of in-state banks by out-of-state bank holding companies as opposed to allowing out-of-state banks to set up completely new branches. The other one-fourth permit de novo branching. The remaining 16 states allow no interstate banking at all.
After the panic of 1907, branch banking was considered as a means of avoiding future crises, but it lost out in the political battle to the formation of a central bank.
When the banking industry collapsed in the early 1930s, nationwide branch banking wasproposed again but was rejected in favor of federal deposit insurance.
The National Banking Act of 1863 created the national banking system, andwhile it did liberalize many banking laws, it did not form a branch banking system. The states retained control overbranching, and most of them prohibited it. Although branching regulations were subsequently relaxed in many states,they were never made liberal enough to contribute to the national system's stability.
With limited country-bank support, the law approved in 1913 to deal with the recurring panics called for 12 FederalReserve banks, with partial federal government control but with control really based on the New York Fed.
In brief, central banking was a compromise erected in response to theNew York banks' desire for continued hegemony, plus the country bankers' opposition to branch banking.
The establishment of the Federal Deposit Insurance Corporation (FDIC) "weakened theprevious sense of urgency to modify federal statutes regulating branching."
deposit insurance was not new. It had been tried in several states after the panic of 1907, and in each casewhere it was introduced, problems quickly arose. First, by making banks pay into a fund out of their own assets, thestates faced an incentive problem. Because they bore only a fraction of the added risk of failure, banks began to holdmore risky portfolios. Second, deposit insurance could do little to save banks when the economy turned bad. Asagricultural prices fell in the late 1920s, banks in states with insurance plans began to collapse, and the insurancefunds dried up. By early 1930 all eight state funds had gone bankrupt.
The McFadden Act of 1927 and the Banking Act of 1933, which are still in effect, prohibit banks headquartered in onestate from operating additional deposit-taking offices in any other state.
Douglas Amendment to the Bank Holding Company Act of 1956,which prevented holding companies from owning a bank in another state without that state's permission. Until around1980, this legislation effectively checked interstate operation of full-service banks or branches.
Taken together, diverse portfolios and easier funds movement help explain the superiority ofbranch banking in preventing and handling crises and panics. Restrictions on branching kept the bank small and prevented them from adequately diversifying, thereby increasing their risk of failure. In the absence of these restrictions, bank failures in the 1920s and1930s would have been significantly reduced.
thatmonopolization of the banking industry is not a likely outcome of nationwide branching.
Branch banking encourages a higher quality ofmanagement, thereby reducing the risk of crises and failure. In Canada, it should be noted, the Canadian BankersAssociation has historically been ahead of its U.S. counterpart in providing the educational and training programsneeded to develop the qualified bankers necessary for branch banking.
loan decisionsare usually left up to local branch managers and loan officers; only in cases of very risky or large loans do suchdecisions go to the head office
Econometric evidence on market shares in states that permit unrestricted branching indicates that branches do not increase market shares to any potentially troublesome degree. Although the number of firms shrinks, the number of offices increases, and any possible adverse effect on prices is compensated for by increases in services and office hours.
only at market shares and concentration ratios, many of the previously cited studiesunderstate the degree of competition in a branched banking industry.
Current law, based on the McFadden Act of 1927, the Banking Act of 1933, and the Bank Holding Company Act of 1956, with their amendments, allows each state to establish its own policies concerning the ability of out-of-state banks to enter the state’s market. Some 30 states and the District of Columbia have reached reciprocal interstate banking agreements with states or other groups of states. Four other states permit banks from any state to operate within their boundaries. Over three-fourths of these 34 states limit such interstate banking to purchases of in-state banks by out-of-state bank holding companies as opposed to allowing out-of-state banks to set up completely new branches. The other one-fourth permit de novo branching. The remaining 16 states allow no interstate banking at all.
After the panic of 1907, branch banking was considered as a means of avoiding future crises, but it lost out in the political battle to the formation of a central bank.
When the banking industry collapsed in the early 1930s, nationwide branch banking wasproposed again but was rejected in favor of federal deposit insurance.
The National Banking Act of 1863 created the national banking system, andwhile it did liberalize many banking laws, it did not form a branch banking system. The states retained control overbranching, and most of them prohibited it. Although branching regulations were subsequently relaxed in many states,they were never made liberal enough to contribute to the national system's stability.
With limited country-bank support, the law approved in 1913 to deal with the recurring panics called for 12 FederalReserve banks, with partial federal government control but with control really based on the New York Fed.
In brief, central banking was a compromise erected in response to theNew York banks' desire for continued hegemony, plus the country bankers' opposition to branch banking.
The establishment of the Federal Deposit Insurance Corporation (FDIC) "weakened theprevious sense of urgency to modify federal statutes regulating branching."
deposit insurance was not new. It had been tried in several states after the panic of 1907, and in each casewhere it was introduced, problems quickly arose. First, by making banks pay into a fund out of their own assets, thestates faced an incentive problem. Because they bore only a fraction of the added risk of failure, banks began to holdmore risky portfolios. Second, deposit insurance could do little to save banks when the economy turned bad. Asagricultural prices fell in the late 1920s, banks in states with insurance plans began to collapse, and the insurancefunds dried up. By early 1930 all eight state funds had gone bankrupt.
The McFadden Act of 1927 and the Banking Act of 1933, which are still in effect, prohibit banks headquartered in onestate from operating additional deposit-taking offices in any other state.
Douglas Amendment to the Bank Holding Company Act of 1956,which prevented holding companies from owning a bank in another state without that state's permission. Until around1980, this legislation effectively checked interstate operation of full-service banks or branches.
Taken together, diverse portfolios and easier funds movement help explain the superiority ofbranch banking in preventing and handling crises and panics. Restrictions on branching kept the bank small and prevented them from adequately diversifying, thereby increasing their risk of failure. In the absence of these restrictions, bank failures in the 1920s and1930s would have been significantly reduced.
thatmonopolization of the banking industry is not a likely outcome of nationwide branching.
Branch banking encourages a higher quality ofmanagement, thereby reducing the risk of crises and failure. In Canada, it should be noted, the Canadian BankersAssociation has historically been ahead of its U.S. counterpart in providing the educational and training programsneeded to develop the qualified bankers necessary for branch banking.
loan decisionsare usually left up to local branch managers and loan officers; only in cases of very risky or large loans do suchdecisions go to the head office
Econometric evidence on market shares in states that permit unrestricted branching indicates that branches do not increase market shares to any potentially troublesome degree. Although the number of firms shrinks, the number of offices increases, and any possible adverse effect on prices is compensated for by increases in services and office hours.
only at market shares and concentration ratios, many of the previously cited studiesunderstate the degree of competition in a branched banking industry.
4/04/2013
4/4/2013 Banking notes
Classic gold standard:
a monetary system in which the standard economic unit of account is based on the fixed weight of gold.
Redemption pressure stopped countries from printing too much money in gold standard.
A gold standard is a fixed exchanged rate system.
The impossible trinity in international trade
(1) fixed exchanged rate
(2) domestic control of money supply
(3) free trade and capital flows
Why are central banks and gold standard incompatible?
Because the only way for central banks to get around people's redemption of notes for gold is to suspend the redeemibility of their notes into species.
At first, the suspension was only temporary, but during the 1930s, many central banks permanently suspended the redeembility and converted notes into fiat money.
Central bank is a central bank because it monopolizes note issuance.
Fiat money
(1) inflation is more common after the abandonment of gold standard
(2) cheaper to produce
(3) senioriage accrues to government
Article 1 section 10 denies states from issuing fiat money. But it doesn't specify whether Congress could do so. In this way does the government inverts section 10.
a monetary system in which the standard economic unit of account is based on the fixed weight of gold.
Redemption pressure stopped countries from printing too much money in gold standard.
A gold standard is a fixed exchanged rate system.
The impossible trinity in international trade
(1) fixed exchanged rate
(2) domestic control of money supply
(3) free trade and capital flows
Why are central banks and gold standard incompatible?
Because the only way for central banks to get around people's redemption of notes for gold is to suspend the redeemibility of their notes into species.
At first, the suspension was only temporary, but during the 1930s, many central banks permanently suspended the redeembility and converted notes into fiat money.
Central bank is a central bank because it monopolizes note issuance.
Fiat money
(1) inflation is more common after the abandonment of gold standard
(2) cheaper to produce
(3) senioriage accrues to government
Article 1 section 10 denies states from issuing fiat money. But it doesn't specify whether Congress could do so. In this way does the government inverts section 10.
4/02/2013
4/2 Banking notes
Self regulation of private banking system
(1) consumers will redeem deposits and notes, imposing pressure on banks to be more prudent in their daily operations
(2) Other banks can redeem deposits and notes, either because of strategic or profit reason.
(3) To lower transaction costs, banks come up with the institution of clearinghouse, which functions like like central bank and imposes regulation among member banks.
(4) ownership. Typically the private banking the ownership is partnership. The bankers are the people that work there. And they share something in the bank. Doubly liable.
Why is it that the banks in the clearinghouses never thought it make sense to take all the golds that are each in their own bank, and deposit them in one larger bank and thus have on their balance sheet reserve credits?
Local bank Regional Bank
A L
Gold Notes & Checks
Local bank deposits some gold in the regional bank, in return it gets a reserve balance. Regional bank deposits some gold in the reserve bank in return for some reserve balance. The reason is to lower the reliance on gold in transaction.
What characteristics does a stylized freely evolved monetary system look like?
(1) Competition reduces natural monopoly in private banking sectors. There was a concentration in clearinghouse system.
(2) Inside money at that time was of good quality and reputation.
(3) Interest rate tended not to be paid on banknotes
(4) Commodity money is driven out of circulation. But international trades still need commodity money to make payments.
(5) Commodity money and bank reserve end up consisting of only a small fraction of the deposits. The reserve ratio is low. (2%)
(6) What assets does an unregulated bank hold? Short-term commercial paper, large amount in their balance sheets are bonds of governments and corporations, smaller loans that are collateralized.
(7) What liabilities does it hold? Deposits.
(8) Banks are involved in related business.
Why don't reserve disappear in the free banking system?
(1) Existence of liabilities presupposes something promised
(2) Banks have a competitive incentive to redeem others' liabilities
(3) reserves are scarce
There isn't much evidence showing that market forces will lead to the spontaneous emergence of a central bank.
How do banks today issue banknotes?
What is a Central Bank?
Functional definitions
(1) lender of last resort
Central bank Commercial bank
A L A L
Gold 40 M 10
Long term 160 R 10
notes 100
capital 40
Now investors want to redeem 60$, the commercial bank doesn't have that many cashes.
The bank will turn to the central bank, the central bank will take gold 20, issue reserve note or reserve credit, and give it to the bank.
For the central bank, asset is loan to the bank, and the liab is the deposit account for the bank
For commercial bank, gold 20 is added on their asset, and loan from Fed 20 is added on their liab. The equity is not changed. Later the commercial bank will return the money and interest to the Fed. The Fed will lend money at a penalty rate
(a) the only banks that can afford higher interest rate are good banks
(b) You don't want banks to come to Fed for daily borrowing. The Fed is an emergency window.
(2) controller of money supply
Confused with positive and normative description of central banks' duty
Evidence shows that Fed fails to manage money supply and credit supply.
A structural definition:
A bank that enjoys government privileges, generally including a monopoly of paper currency.
Why is it good to have monopoly power on paper currency?
(1) central bank doesn't face the competition from other banks of note redemption.
(2) monetary policy
(3) Seiniorage
(4) short-run lending power
Central bank will suppress private inside money by either banning them or prohibiting payment of interest. Central bank can also tax the bank (reserve ratio)
Why do government favor central banks?
(1) For poor countries, central bank is the only way to generate the revenues.
(2) Fiscal reasons. To get senioriage and for government to gain loans of favorite terms that otherwise wouldn't be got naturally.
Banking let people escape risks of holding debased government coins.
Some banks were involved in debasement business too.
Banks took step to get profit from government debasement
The rest read the ppt
(1) consumers will redeem deposits and notes, imposing pressure on banks to be more prudent in their daily operations
(2) Other banks can redeem deposits and notes, either because of strategic or profit reason.
(3) To lower transaction costs, banks come up with the institution of clearinghouse, which functions like like central bank and imposes regulation among member banks.
(4) ownership. Typically the private banking the ownership is partnership. The bankers are the people that work there. And they share something in the bank. Doubly liable.
Why is it that the banks in the clearinghouses never thought it make sense to take all the golds that are each in their own bank, and deposit them in one larger bank and thus have on their balance sheet reserve credits?
Local bank Regional Bank
A L
Gold Notes & Checks
Local bank deposits some gold in the regional bank, in return it gets a reserve balance. Regional bank deposits some gold in the reserve bank in return for some reserve balance. The reason is to lower the reliance on gold in transaction.
What characteristics does a stylized freely evolved monetary system look like?
(1) Competition reduces natural monopoly in private banking sectors. There was a concentration in clearinghouse system.
(2) Inside money at that time was of good quality and reputation.
(3) Interest rate tended not to be paid on banknotes
(4) Commodity money is driven out of circulation. But international trades still need commodity money to make payments.
(5) Commodity money and bank reserve end up consisting of only a small fraction of the deposits. The reserve ratio is low. (2%)
(6) What assets does an unregulated bank hold? Short-term commercial paper, large amount in their balance sheets are bonds of governments and corporations, smaller loans that are collateralized.
(7) What liabilities does it hold? Deposits.
(8) Banks are involved in related business.
Why don't reserve disappear in the free banking system?
(1) Existence of liabilities presupposes something promised
(2) Banks have a competitive incentive to redeem others' liabilities
(3) reserves are scarce
There isn't much evidence showing that market forces will lead to the spontaneous emergence of a central bank.
How do banks today issue banknotes?
What is a Central Bank?
Functional definitions
(1) lender of last resort
Central bank Commercial bank
A L A L
Gold 40 M 10
Long term 160 R 10
notes 100
capital 40
Now investors want to redeem 60$, the commercial bank doesn't have that many cashes.
The bank will turn to the central bank, the central bank will take gold 20, issue reserve note or reserve credit, and give it to the bank.
For the central bank, asset is loan to the bank, and the liab is the deposit account for the bank
For commercial bank, gold 20 is added on their asset, and loan from Fed 20 is added on their liab. The equity is not changed. Later the commercial bank will return the money and interest to the Fed. The Fed will lend money at a penalty rate
(a) the only banks that can afford higher interest rate are good banks
(b) You don't want banks to come to Fed for daily borrowing. The Fed is an emergency window.
(2) controller of money supply
Confused with positive and normative description of central banks' duty
Evidence shows that Fed fails to manage money supply and credit supply.
A structural definition:
A bank that enjoys government privileges, generally including a monopoly of paper currency.
Why is it good to have monopoly power on paper currency?
(1) central bank doesn't face the competition from other banks of note redemption.
(2) monetary policy
(3) Seiniorage
(4) short-run lending power
Central bank will suppress private inside money by either banning them or prohibiting payment of interest. Central bank can also tax the bank (reserve ratio)
Why do government favor central banks?
(1) For poor countries, central bank is the only way to generate the revenues.
(2) Fiscal reasons. To get senioriage and for government to gain loans of favorite terms that otherwise wouldn't be got naturally.
Banking let people escape risks of holding debased government coins.
Some banks were involved in debasement business too.
Banks took step to get profit from government debasement
The rest read the ppt
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