Deck 14: Money

Question 1

Money gets a lot of attention, but tends to have a bad press. Are the authors of the following statements talking about money as we have defined it? Or are they using money as a synonym or symbol for something else? What is that "something else" in each case where you conclude that money is not really the subject of discussion?
(a) "The love of money is the root of all evil." (Often misquoted as "Money is the root of all evil.")
(b) "Health is a blessing that money cannot buy."
(c) "If this be not love, it is madness, and then it is pardonable. Nay, yet a more certain sign than all this: I give thee my money."
(d) "Wine maketh merry; but money answereth all things."
(e) "Words are the tokens current and accepted for conceits, as moneys are for values."
(f) "Money speaks sense in a language all nations understand."
(g) "Americans are too interested in money."
(h) "Protecting our natural environment is more important than making money."

Answer 1

The money as the medium of exchange has been used since long to provide the standardization of exchange in the market economy. The evolution of money from the earlier system of barter exchange has been now widely preferred as the medium of exchange.
People in the economy use money as the way of self- aggrandizement that is the amount being owned by the people. The money thus becomes the way of social exchange, increased status and providing all sorts of the attitudes or the practices that the people have usually failed to examine with sufficient care.The insertion of the various phrases expresses the author's long- felt frustration at this kind of foolish irresponsibility. The discussion in all parts relates with the measuring money and exaggerating the notion of the money as medium of exchange.

Question 2

For almost 2000 years, people on the Island of Yap in Micronesia have used circular stones as money, though more recently they are more of a symbol than a general medium of exchange. Various people own portions of the stones.
(a) Because the stones are worthless when broken and also heavy, People leave the larger ones where they are and simply take note of the fact that ownership has changed. How is this similar to paying by check?
(b) Some of the stones are propped up in rows in village "banks." Suppose that the person who lives next door to the "bank" is entrusted with the responsibility of keeping track of who owns what portion of each stone. How could this person use his position to make loans and thereby expand the quantity of money in Yap?

Answer 2

The medium of exchange in the island Y has different medium of exchange in terms of the stones and that is used in circulation as the form of currency of island Y. the condition can be contrasted with the use of paper currency in various ways.
a)The condition described above relates to the fact that the cheque very easy in terms of carrying. This is similar to the fact that larger stones are bit difficult to carry in terms of small stones. There is no major change but only the title changes in the medium of exchange.b)The keeper of the stones can lend the money by loaning temporary ownership of some portion of the stones to the borrowers. The keeper might just be able to increase the money supply indefinitely under such kind of arrangement.

Question 3

In 1945, economist R. A. Radford published an article, "The Economic Organization of a P.O.W. Camp" describing the economy inside a World War 2 prisoner of war camp. Cigarettes were used to trade various items out of Red Cross parcels and rations.
(a) Why did cigarettes quickly become acceptable as a medium of exchange in Radford's prison camp even for people who did not smoke? Can you think of any other item that might have become money in the prison camp if cigarettes had not been available?
(b) Suppose one of the camp residents had run out of cigarettes, but wanted to buy a jar of jam from another camp resident, and that the owner of the jam agreed to turn over his jam if the buyer gave him a promissory note for eight cigarettes. How could that promissory note become money within the prison camp?

Answer 3

The money as medium of exchange has been serving as the best sort of exchange measures and this is one of the finest ways to fulfill the condition of double coincidence of wants in the market. The cigarettes' use can also be attributed to the exchange medium of prisoners' of war in World War 2 as it suited that condition.
a)The cigarette use in terms of exchange increased in World War 2 as cigarette had the requisite value for the many camp residents apart from their value as medium of exchange and was reasonably uniform in quality. The cigarette could easily be exchanged in smaller amounts and moreover can be stored for more times.
We cannot think of any other significant item that might serve the purpose well as compared to the cigarette. There cannot be other medium keeping the mental acumen of prisoners in mind.
b)The problem in this case relates to the promise and recognition of the person who signed the promissory note in order to make it genuine. Then it could be widely made available and added to the stock of the existing form of currency.
There can be one possible alternative to the cigarette in the camp is the issuing authority and the money now has been widely signed and monitored under the institution of issuing authority. The prisoners had the trust factor and this is the reason why cigarette was widely prevalent.

Question 4

The term fiat money is sometimes used to describe paper money that is not backed by gold or anything else, and that consequently seems to have value merely because some authority has declared, "Let it become money."
(a) Is fiat money any less money than gold coins are? What kind of "authority" does it take to turn a "worthless piece of paper" into money?
(b) Are U.S. dollars money in Canada? Are Canadian dollars money in the United States? Why are U.S. dollars warmly welcomed by retailers in many countries of the world? Can you think of circumstances in which the people of a country would refuse to accept their own national currency in payment, but would welcome payments made in U.S. dollars? What does all this indicate about the "authority" of governments that try to create fiat money?

Question 5

Adam Smith complained in The Wealth of Nations that many people confused money with wealth. Is this a confusion?
(a) Doesn't everyone's wealth increase when he or she acquires more money?
(b) If any one person's wealth increases when he or she acquires more money, doesn't it follow logically that more money for everyone means more wealth for everyone?
(c) What would happen if the government of India tackled the problem of poverty by printing more rupees and distributing them generously to the poorest people in the country?

Question 6

People usually cannot spend the deposits they hold in commercial-bank savings accounts or savings and loan institutions without first withdrawing the funds-that is, converting them into currency or checkable deposits. But because they're able to do that at almost no cost, these savings deposits are assets that come very close to being money.
(a) Would you expect total spending in the United States over some Period of time to be more closely correlated with M1 or with M2?
(b) Will your answer change if savings and loan institutions allow customers to pay bills through telephone transfers of their deposits to the accounts of others?

Question 7

At any moment some already-printed Federal Reserve notes will be in (a) the wallets of the public, (b) the vaults and tills of commercial banks, and (c) the vaults of Federal Reserve banks. How does each enter into or otherwise affect the total money supply?

Question 8

How does a withdrawal of currency from checking accounts affect the money stock? How does it affect a bank's reserves? How does this affect the bank's ability to extend loans? What effect might this withdrawal consequently have on the money stock?

Question 9

Commercial banks create money by extending loans. The bankers themselves don't see their activities as actually "creating" more money, but that is the effect of their lending activity. It's important that you as a student of economics see exactly why they can do this and why money is ordinarily not created by the lending activities of other institutions.
(a) What is the advantage possessed by commercial banks that enables them to create money when they make loans? Credit unions and consumer credit companies do not have this advantage and consequently do not create money when they extend loans to their customers. What do they lack that commercial banks have?
(b) Would you like to be able to make loans to your friends at will, simply by creating the money you lend them? You could help your friends, increase your popularity, and even earn a little interest if you could learn how to do this. What is the secret?
(c) Suppose everyone in town knows you, knows your signature, and trusts you completely. When a friend asks to borrow $10, you simply write a note saying, "I'll pay $10 to the holder of this note," sign it, and hand it to the friend. Will the friend be able to spend your note, that is, use it as money? Will the merchant who receives the note be able to spend it in turn, perhaps by giving it out in changing a $20 bill? Will you have succeeded in creating money? Would this differ from a situation in which a check you had written, payable to "Cash," circulated from hand to hand without being deposited?
(d) The narrowly defined money stock, or M1, is made up of Federal Reserve notes, checkable deposits, and traveler's checks. All of these are liabilities of trusted financial institutions. What does a person or institution have to do to be able to create money?
(e) At one time in the 1980s, the government of the state of California made plans to begin paying some of its bills with IOUs, because the governor and the legislature were unable to agree on a budget. Could a state IOU function as money? Suppose you were a supplier to the state or someone due a tax refund and you received in the mail an IOU instead of a check. Could you spend it? What might you do if you had to pay the rent and buy groceries and couldn't wait for the governor and legislature to resolve their differences?

Question 10

One way to think about the Fed's ability to change the nation's M1 money supply is by thinking about its effects on the excess reserves within the banking system as a whole. In short, anything that increases excess reserves will tend to increase the money supply; anything that decreases excess reserves will tend to decrease the money supply. With that in mind, what would tend to happen to excess reserves in the banking system, and the M1 money supply, if the Fed
(a) lowers the required reserve ratio.
(b) raises the required reserve ratio.
(c) buys U.S. securities on a mass scale.
(d) sells U.S. securities on a mass scale.

Question 11

Why might the Fed find it significantly easier to expand the money stock in a period of prosperity than in a period of recession? What must the Fed be able to do if it wants the quantity of money in the hands of the public to increase?

Question 12

The textbook says that the paper currency in a society does not have to be "backed" by anything else into which it can be converted on demand in order for it to have value and function as a medium of exchange. The only requirement is that people accept it as a medium of exchange.
(a) Do you think that Federal Reserve notes would ever have acquired acceptability at the time they began to be issued if they had not been redeemable in gold or silver?
(b) What can governments do to make the paper money they want to issue acceptable to the general public, in addition to promising to exchange it on demand for some other asset that people value?
(c) What could cause government-issued paper money that is accepted by everyone in the society as a medium of exchange to lose acceptability and to cease thereby to function as money?

Question 13

If it is not essential that money have "backing" of some kind, why do so many people believe otherwise? Would money backed by bricks be preferred to money backed by no commodity at all?

Question 14

In a related way, congressman and 2012 presidential candidate Ron Paul insisted that "Gold is money." Was he correct in his assertion?