intro RSM part 1

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7 Apr 2011
of 13
RSM Part 1
P. 1-29, 36-49, 140-149, 274-279, 589-600, 603-605, 608-612
1.A (The Origin and Development of Money)
3 functions of money:
1.Method of Exchange
2.Store of Value
3.Unit of Account (common denominator)
Gold worked best in early civilizations because:
4.Stable in quantity (relatively rare)
Otherwise useless (except art) use as money based on trust others would accept
Coinage followed:
Use of metals for money by standardizing purity and weight
Counterfeiting and clipping soon followed
Monarchs debased coinage by melting down existing coins diluting with
other metals reissue  leaving extra for monarch  BUT, often did
prices rise in response (MV=PT)
Money and Prices (Quantity Theory)
M Money supply
V Frequency of money changing hands in a year
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P Prices
T ‘Real transactions (e.g. number of bushels of wheat)
Velocity is generally constant more M may cause more T in short run
(productive resources remain unchanged, thus in long run no more can be
produced) P rises in step with M (debasing causes prices to rise)
Gold from New World would temporarily finance more production, but P
eventually rose
Origins of Banking:
In middle Ages, wealthy would give their gold to goldsmiths or money traders
who had vaults to protect. Will receive paper receipts in return
Easier to pay for soldiers, land, castles by signing over the paper rather than
transferring gold banknotes
Goldsmiths soon realized they could lend some gold out for interest as not
everyone wanted gold back at same time Origin of money multiplier. A
base amount could yield a larger money-supply by re-lending
Interest rates depended on: riskiness + money available to be loaned out
(more bankers had to lend, lower borrowers could bargain down interest)
Interest is price of borrowing
banca - early Italian money traders trust was again key (that gold could
be retrieved when needed). Defaulters would threaten money trade business,
thus other traders would smash up defaulter benches (banca rupta)
Banking families set up banks across the continent so they could respond to
quick needs for money. Banking networks system was ready when industrial
revolution began
Gold and Prices in International Trade
1500s-1700s many nations tried to become Net Exporters so gold would flow
in they were supposedly wealthy; Mercantilism. Idea does NOT work
because of MV=PT (specie-flow mechanism) Gold flowing into a net
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exporter simply causes prices there to rise; prices fall for the net importer as
there is less gold available and buying from the net exporter is no longer
ONLY MUTUAL trade is beneficial
Decline of Gold
1800s huge increase in T; some increase in V with tech, and a bigger
money multiplier But P fell erratically
GOLD RUSHES! Swelled M in random shocks P gyrated Booms and busts!
GOLD STANDARD began to be doubted
The End of Gold for Domestic Money
Disruption of WWI and Great Depression caused most countries to abandon
gold as backing for domestic currency
Instead currency (+ bank deposits) are legal tender: By law, currency or
deposits must be accepted in payments for debts or taxes
The backing for all domestic currencies in modern world is: LAW & TRUST
(NOT gold)
Sometimes trust and law break down: another nations currency or barter is
used great loss of efficiency (e.g. Russia, early 90s)
Without Gold backing currency is easier to debase (printing money, usually
to cover gov payments when taxes are low) risk of hyper-inflation as M and
P skyrocket (Ger, Brazil, Isreal, Argentina)
The End of Gold for International Transactions
Gold remained backing for some international transactions until 1970s
(BoFrance US central B). After, widely criticized WHY tie the supply of
international money to an unstable resource + most new gold came from
Soviet U and South Afr)? Or WHY use a valuable resource for symbolic
purposes?! Inefficient!
At present gold doesnt support domestic or international
Some gold remains in central bank reserves but are slowly being sold off (so
as not too disrupt world gold markets)
Monetary system now depends SOLELY on LAW & TRUST
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