The Monetary System

1 What is money?
Gold? Cows? Snails? Cigs? Rum? Bitcoins? Salt?

All of these in some point in time has been used as money

Money is a medium of exchange, i.e., any medium people have agreed upon/generally accept in
exchange for goods and services.

It solves this fundamental problem of “Double coincidence of wants”: You want something that I
can’t offer, etc. This is seen in the barter system.

2 Characteristics of good money

 Scarce*
 Divisible
 Portable
 Hide able
 Durable
 Low maintenance

*You want the money to be relatively scarce, because there is the value.

All of those characteristics leaves only gold and bitcoin, but bitcoin is still questionable because
something about magnetism or something I blacked out.

3 Functions of money
 Medium of exchange
 Unit of account  creates this complex economy, used to compare costs and benefits
 Store of value  measure inflation; gold is technically a better function of money because
paper money is subject to inflation (more)
Liquidity is the characteristic how much it takes to turn goods into money. Money is the most
liquid asset (paper money/gold)

4 Evolution of money: from commodity to fiat

Commodity money  intrinsic value, can be used in other way. Ex: Gold, platinum, silver, cows

Fiat money  no intrinsic value, only for medium of exchange. Ex: paper money.
5 Evolution of coins
From barter, where we would have a mini auction, we notice that for a particular good, everyone
wants gold and silver, and from that starting point, we started with:

Gold nuggets  standardization of coin sizes, with the merchant’s face on it  control of the mints
(they could control things and people didn’t like it)  coin clipping/debasement (to fight scarcity) 
inflation (for the same coins, you get less goods and services)

6 Evolution of banking
Onset of warehouses (I take your coins and give you a receipt: you have __ gold coins of this weight
and we’re going to hold them in our vault and keep them secure, but every time we need to make a
purchase w have to go to the bank)  issuance of banknotes (we’ll give you something like a
checkbook: this is worth __ gold go to warehouse xyz)  fractional reserve banking (bank starts to
give out loans. They issue more notes than how much is deposit  inflation)  nationalization of
banks (now the Federal Reserve System, a central bank of the nation)  bank we know now 
paper money

If your checking account is free, the bank is loaning out money

7 Backed by?
 Gold
I issue this much bank note because you have this much gold. This is the gold standards. In
1913 when we get a federal reserve, we were still on gold standards (some ratio of dollars to
gold)
 Trust

8 Fractional Reserve Banking

10% reserve ratio: reserves 10% (in bank vaults) and loans 90%

Money multiplier = 1/R (ratio) = 10

Money Supply = 10 x 100 = 1000

Because after you loan $90, they would put it in the bank again, and you get another $81 (90%)….
etc.

Increase money supply, lower reserve ratio and vice versa  inflation  decreases value of each
dollar

9 Some issues with paper money

Not as scarce as gold, not so durable, but the most dangerous is that you can counterfeit paper
money.
10 The Phillips Curve
You want low unemployment and low inflation, but hat’s impossible, you have to give up something