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170
weight of the pure metal was credited to his account. This
deposit was a highly reliable form of money. A merchant could
transfer it to the account of another merchant. Payments through
the bank commanded a premium.
Then came the second Amsterdam discovery. The deposits
so created did not need to be left idle in the bank. They could
be lent. The bank then got interest. The borrower then had a
deposit that he could spend. But the original deposit still stood
to the credit of the original depositor. That too could be spent.
Money, spendable money had been created. The important thing,
obviously, is that the original depositor and the borrower must
never come at the same time for their deposits — their money.
If they do, they cannot be paid.
Unit Five
to sweat [swet] coins стирать золото с монет; to antedate [!enti!deit] ïðåä
шествовать; wretched [!ret
бездействующие, неиспользуемые деньги; to stand to the credit of the
original depositor быть записанным на первоначального вкладчика.
Questions.
1. What role did Amsterdam play in the economic life of Europe at the
beginning of the 17th century and why did its role decline?
2. What was typical of coined money circulation in European countries at
that time?
3. How was the problem of the quality of coins solved by the bank
of Amsterdam?
4. How were deposits created and what do you think was necessary for
a normal money circulation when banking was just developing?
ʃid] coins неполноценные монеты; idle money
***
On the Continent John Law was engaged in selling an idea
for a new kind of bank, the deposits of which would be secured
by land rather than by silver or gold. In Paris in 1716, he got
permission from the Regent to establish a bank, the Bank
Royale. As part of the bargain the bank took over the debts of
the Regent and of the realm.
Then in 1717, Law organized the Company of the West, later
known as the Mississippi Company. It held absolute title to the
lands in the northern and eastern parts in America. The nonexistent
metal in the imaginary mines of that area was the backing for
the notes.
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MONEY AND BANKING
Parisians, hearing of these conceptual riches and that colonization
was under way to get them, rushed to buy the stock of the
Company of the West. The stock boomed. By 1719, the boom
had become a wild speculation. The price of the stock went up,
sometimes by the hour. Law’s notes went out by the hundreds
of millions. It is to that year that we owe the useful French word
“millionaire”.
There was no way to go but down, and presently this became
evident. Doubts began to develop about the notes. So people
started bringing them to the bank for the silver and gold that
were still in Louisiana, and also not there. Paying off the notes
in gold and silver was suspended; in modern terms, the Banque
Royale went off the gold (and silver) standard. Nothing could
disguise the elementary fact that the bank could not pay, that
the notes were now worthless. Like the deposits in Amsterdam,
Law’s notes were money created by a bank. Issued in excess,
the notes clearly were a disaster.
to secure deposits by land (silver, gold) гарантировать над¸жность вкладов земл¸й (серебром, золотом); regent [!ri:d
королевство; to hold absolute title to the lands иметь абсолютное право собственности на земли; backing for the notes обеспечение банкнот;
Louisiana [!luizi!
золотого стандарта.
nə] Луизиана; to go off the gold standard отказаться от
ənt] регент; realm [relm]
171
Questions.
1. How did John Law establish a new kind of bank?
2. What was the backing for his notes?
3. Why did the Banque Royale crash?
4. What important law of money circulation was neglected by the bank?
***
In 1694, the Bank of England was formed; its founders
subscribed the money the King needed. In return, they were given
the right to make loans to others with newly issued notes backed
by the King’s promise to pay. The Bank became an accomplished
instrument for regulating the creation of money by lesser banks —
in placing limits on lending and consequent deposit expansion
and note issue. In London in the 18th century the goldsmiths
made loans in notes against the holdings of gold and silver coin.
The Bank of England, when it received these notes, returned
172
them for collection in gold or silver. This required the banks
to maintain reasonable reserves of cash against their note issues.
They could not be reckless in the issue of notes as was Law.
Later the Bank acquired for itself a monopoly of note issue, first
in London, then throughout the country.
The subordinate or commercial banks could still lend the
funds of the depositors. This would mean deposits — money —
for those who borrowed. And this money creation could be
carried to excess. The Bank of England developed a method of
preventing this. When the ordinary or common banks seemed
too generous with their loans, the Bank allowed some of their
loans to run out or it sold some of the securities it held. This
is the procedure now celebrated as open market operations.
The commercial banks could replace their depleted reserves by
borrowing from the Bank of England. But that could be restrained
by raising the rate of interest. This charge by the Bank of England
came to be called the Bank Rate or in the USA — the rediscount
rate or, latterly, the discount rate. Such were the regulatory
functions as developed by the Bank of England
to subscribe money жертвовать деньги; an accomplished instrument сформировавшийся аппарат; a goldsmith ювелир, ростовщик; holdings pl
вклады; to make loans against holdings of gold coin предоставлять займы
в банкнотах под вклады золотой монетой (обеспеченные золотом);
to return banknotes for collection in gold разменивать (гасить) банкноты на золото; to run out сокращать (займы); open market operations
операции на открытом рынке (купля-продажа ценных бумаг для воз
действия на процентные ставки); to deplete истощать; rate of interest
ставка процента; charge комиссия, денежный сбор (за услуги); bank
rate, discount rate уч¸тная ставка банка; rediscount rate переуч¸тная
ставка банка.
4
.
Unit Five
-
Questions.
1. What was the principal difference between the Bank of England and those
of Amsterdam and Paris?
2. What mechanism of regulating money circulation did the Bank of
England develop in the 18th century?
3. What changes in monetary regulation were introduced by the Bank later?
Ex. 8. Read the following text and speak on (a) the first American
bank in colonial days and its functions; (b) the reason for the defeat
of its recharter and consequences of that action; (c) the second
bank and its failure; (d) drawbacks of the National Banking
MONEY AND BANKING
System; (e) the gold standard; (f) the establishment of the Federal
Reserve System.
After the War of Independence one might have expected the
newly independent Americans to have welcomed with enthusiasm
their freedom to set up banks but in fact there was a great deal
of opposition to banking in general.
A few banks existed in the United States during colonial days,
but the first real attempt at centralized banking occurred when
the federal government chartered the First Bank of the United
States in 1791. The primary functions of this central bank were
to provide commercial banks services for individuals and business,
to act as a banker’s bank, to serve as a fiscal agent for the
federal government, and to maintain some order in the banking
business by exercising restraints on state banks. Political and
business opposition to the bank led to the defeat of its recharter
in 1811. For the following 5 years only state banks existed.
As a result, when the 1812 War (of Independence) broke out
there was no government bank to exert a restraining hand on the
commercial banks which issued far too many notes backed by far
too little specie and the American financial scene reverted to its
familiar inf lationary pattern.
In 1816, however, the Second Bank of the United States was
chartered for a 20-year period. Although it was designed to
perform functions similar to those of the First Bank, it had
more capital stock and operated on a broader scale. Despite its
efficient operation, many people opposed the Second Bank. Some
opponents disliked the idea of central authority; others objected
to its strict regulations; others were alarmed by the fact that
foreigners owned a certain amount of the Bank’s stock; and still
others thought the bank was unconstitutional. Political tensions
between the bank’s officials and the presidential administration
of Andrew Jackson were instrumental in defeating its recharter
in 1836.
Between 1836 and 1863 — era known as the “wildcat banking
period” — there was no central authority in the U.S. banking
system, and abusive banking practices were prevalent. The civil
war required a rapid transfer of resources from diffused and
decentralized civilian expenditure to concentrated and centrally
controlled military expenditure, by means of some combination
of taxing, borrowing and printing money.
173
174
“Greenbacks” came into existence when, in 1862, the Treasury
was given the right to issue notes that were not convertible into
specie but were authorized as legal tender for most purposes. Very
soon the greenbacks worth in gold fell to half their nominal value.
Their use had in any case only been intended as a temporary
measure and the government started reducing their number in
circulation.
The National Banking Act of 1864 brought some order to
the chaos by creating a National Banking System. Its stringent
requirements and provisions for note security ended many unsound
operations of private commercial banks. The system had several
noticeable weaknesses, however, such as the perverse elasticity of
the money supply, the gravitation of reserves toward the money
centre, and the lack of assistance to the farm sector of the economy
because real estate could not be used as collateral for loans.
When, by 1873, the silver dollar ceased to be the standard of
value, America was virtually on the gold standard. New discoveries
in Alaska, Africa and Australia led to an enormous increase in
gold supplies, stimulating the world economy, and in 1900 America
officially accepted the gold standard. Meanwhile banking was
becoming increasingly important. Already by 1890 over 90 percent
in value terms of all transactions were carried out by cheque.
After a series of bank failures in New York and after several
years of research and study of foreign central banks such as the
Bank of England and the Bank of France, lawmakers replaced
the National Banking system with the Federal Reserve System
(Fed) to provide more effective supervision of banking. By passing
the Federal Reserve Act in 1913, they established a central-type
bank for the United States
5
.
Unit Five
to charter учреждать, создавать (на основе устава); recharter повторное
учреждение; to exert a restraining hand on the banks прилагать усилия
для ограничения (сдерживания) деятельности банков; specie [!spi:
singl. металлические деньги (золотые и серебряные), звонкая моне
та; wildcat banking period период рискованных банковских спекуля
ций; abusive banking practices практика банковских злоупотреблений;
évalent распростран¸нный, общепринятый; convertible (into) конвер
pr
тируемый (в); note security обеспечение банкнот; unsound operations
ненад¸жные операции; perverse elasticity неправильная, ошибочная
эластичность (отражает характер зависимости двух факторов, напр.
спроса и предложения); the Federal Reserve System (Fed) Федеральная
резервная система (США).
ʃi:]
-
-
-
MONEY AND BANKING
Ex. 9. Read the text about the Federal Reserve System, discuss its
functions and compare it with the monetary management in any
other country.
For many years the banks themselves decided what reserve
ratio constituted a safe proportion of currency to hold against their
demand deposits. Today, however, most large banks are members
of the Federal Reserve, a central banking system established in
1913 to strengthen the banking activities of the nation. Under
the Federal Reserve System, the nation is divided into twelve
districts, each with a Federal Reserve Bank owned by the member
banks of its district. In turn, the twelve Reserve Banks are
themselves coordinated by a seven-member Federal Reserve Board
in Washington. Since the President, with the advice and consent
of the Senate, appoints members of the board for fourteen-year
terms, they constitute a body that has been purposely established
as an independent monetary authority.
One of the most important functions of the Federal Reserve
Board is to establish reserve ratios for different categories of banks,
within limits set by Congress. Historically these reserve ratios
have ranged between 13 and 26 percent of demand deposits for
city banks, with a somewhat smaller reserve ratio for country
banks. Today, reserve ratios are determined by size of bank and
by kind of deposit, and they vary between 18 percent for the
largest banks and 8 percent for the smallest. The Federal Reserve
Board also sets reserve requirements for time deposits (or savings
deposits). These range from 1 to 6 percent, depending on the ease
of withdrawal.
A second vital function performed by the Federal Reserve
banks is that they serve their member banks in exactly the same
way as member banks serve the public. Member banks automatically
deposit in their Federal Reserve accounts all checks they get
from other banks. As a result, banks are constantly clearing their
checks with one another through the Federal Reserve System,
because their depositors are constantly writing checks payable
to someone who banks elsewhere. Meanwhile, the balance that
each member bank maintains at the Federal Reserve — its
“checking accounts” there — counts as part of its reserves against
deposits, just like the currency in its tills.
Thus banks operate on what is called a fractional reserve system.
That is, a certain specified fraction of all demand deposits must
be kept on hand at all times in cash or at the Fed (as economists
175
176
and bankers call the Federal Reserve). The size of the minimum
fraction is determined by the Federal Reserve, for reasons of control.
It is not determined to provide a safe backing for our bank
deposits. Under any fractional system, if all depositors decided
to draw out their accounts in currency and coin from all banks
at the same time, the banks would be unable to meet the demand
for cash and would have to close. We call this a run on the banking
system. Runs have been terrifying and destructive economic
phenomena. Today they no longer pose so dire a threat because
the Federal Reserve Banks can supply their members with vast
amounts of cash.
But why court the risk of runs, however small this risk may
be? What is the benefit of a fractional banking system? To answer
that, it is necessary to know how the bank works.
Suppose the customers of the bank have given it $1 million
in deposits and that the Federal Reserve Board requirements are
20 percent. The bank must at all times keep $200,000 either in
currency in its own till or in its demand deposit at the Federal
Reserve Bank.
But having taken care of that requirement, what does the bank
do with the remaining deposits? If it simply lets them sit, either
as vault cash or as a deposit at the Federal Reserve, the bank will
be very liquid — that is, it will have a great deal of instantly
spendable cash — but it will have no way of making an income.
Unless it charges a very high fee for its checking services, it will
have to go out of business.
And yet there is an obvious way for the bank to make an
income while performing a valuable service. The bank can use all
the cash and check claims it does not need for its reserve to make
loans to businesses or families or to make financial investments
in corporate or government bonds. It will thereby not only earn
an income, but it will assist the process of business investment
and government borrowing.
Thus fractional reserve allows banks to lend or invest part of
the funds that have been deposited with them. But that is not
their only useful purpose. Fractional reserves also give the Fed
a means of regulating how much the banking system can lend or
invest. In other words, fractional reserves are the lever through
which the Federal Reserve authorities can control the quantity of
money in the system
6
.
Unit Five
MONEY AND BANKING
177
reserve ratio резервная норма, норма резервного покрытия (депози
тов); demand deposit депозит до востребования, текущий сч¸т; monetary
authority руководящее денежно-кредитное учреждение (центральный
банк); a Federal Reserve Bank федеральный резервный банк; the Federal
Reserve Board Совет (управляющих) Федеральной резервной систе
мы; reserve requirements резервные требования; till банковская касса;
fractional reserve system система фракционных (частичных) резервов;
to draw out one’s account закрыть сч¸т, снять все деньги со сч¸та;
a run on the banking system «набег, натиск» вкладчиков на банковскую
систему (с требованием возврата депозитов, массовое изъятие депози
тов); vault cash наличность в сейфах банка, наличные деньги в банке;
cash and check claims активы в форме наличных денег и чеков; lever
ə] рычаг.
[!li:v
Ex. 10. Read the following text and explain what is “interest rate” and
“exchange rate”,and what these rates depend on.
The interest rate is the price paid for the use of money. More
precisely, the interest rate is the amount of money one is required
to pay for the use of one, say, dollar for a year.
Interest is typically stated as a percentage of the amount of
money being borrowed rather than as an absolute amount. We
usually say that one is paying 12 percent interest and we practically
never say that interest is $120 per year per $1000.
A Truth in Lending Act was passed in 1968 which requires
lenders to state in concise and uniform language the costs (or the
real cost) and terms of consumer credit. In particular, the act
requires that interest must be stated as an annual rate. Nevertheless,
it is not always a simple matter to determine how much interest
one is being charged.
Money is not an economic resource. As such, money is not
productive; it is incapable of producing goods and services.
However, businesses “buy” the use of money, because money can
be used to acquire capital goods — factory buildings, machinery,
warehouses, and so forth. And these facilities clearly do make
a contribution to production. Thus, in hiring the use of money
capital, business executives are ultimately buying the use of real
capital goods.
Although economists often find it convenient to think in terms
of a single interest rate, in fact there exists a whole range of interest
rates. They may depend on various degrees of risk on loans.
The greater the chance the borrower will not repay the loan,
the more interest the lender will charge to compensate for this
-
-
-
178
risk. The length or maturity of a loan is also very important.
Long-term loans usually command higher rates of interest than
do short-term loans, because the long-term lender suffers the
inconvenience and possible financial sacrifice for forgoing alternative
uses for that money for a greater period of time. The interest rate
is also usually higher on the smaller than on the larger loan
because the administrative costs of a large and a small loan are
about the same absolutely. It depends as well on taxation or the
bank’s monopoly of the local money market.
Borrowing and lending — receiving and granting credit —
are a way of life. Individuals receive credit when they negotiate
a mortgage loan and when they use their credit cards. In some
cases a lender, a bank, may discount the interest payment if the
interest payment is taken in advance, if the bank assumes a 360-day
year (twelve 30-day months), or if a loan is paid in installments.
In the last case interest is paid on the total amount of the loan
rather than on the outstanding balance, making for a much higher
interest rate.
***
Exchange rate is the price at which one currency can be
bought with another. A need to exchange currencies arises when
nations trade. For example, American exporters who sell to Japan
want to be paid in dollars, not yen; but Japanese importers of
American goods possess yen, not dollars. This problem is resolved
by Japanese offering or supplying yen in exchange for dollars.
Conversely, American importers need to pay Japanese exporters
with yen, not dollars. To do so they go to the foreign exchange
market as demanders of yen. In short, we can think of Japanese
importers as suppliers of yen and American importers as demanders
of yen. The interaction of the demand for, and the supply of, yen
will establish the dollar price of yen. Suppose the equilibrium
dollar price of yen, or, in other words, the dollar-yen exchange
rate is $1 = 100 yen. That is, a dollar will buy 100 yen (the “dollar
price” of 1 yen is 1 cent) and therefore 100 yen worth of Japanese
goods. Conversely, 100 yen will buy $1 worth of American goods.
A number of things might occur to increase the demand for —
therefore the dollar price — of yen. For example, incomes might
rise in the United States, causing to buy not only more domestic
goods but also more goods from Japan. Or there may occur a
Unit Five
MONEY AND BANKING
change in American tastes which enhances their preferences for
Japanese gas-efficient compact cars. An increase in the American
demand for Japanese goods will increase the demand for yen and
raise the dollar price of yen. When the dollar price of yen
increases, we say, there has been a depreciation of the dollar
relative to the yen. This means that it takes more dollars to buy
a single unit of a foreign currency (yen). A dollar is now worth
less in that it will now buy fewer yen and therefore a smaller
quantity of Japanese goods.
If the opposite thing happens, if incomes rise in Japan and
Japanese preferences for American goods strengthen — then the
supply of yen in foreign exchange markets would increase. This
increase in the supply of yen relative to demand would cause
the equilibrium dollar price of yen to decrease. This decrease in
the dollar price of yen means there has been an appreciation of
the dollar relative to the yen. It now takes fewer dollars to buy
a single yen than previously. The dollar is worth more because
it is now capable of purchasing more yen and therefore more
Japanese goods
exchange rate валютный (обменный) курс; a Truth in Lending Act Закон
о достоверности информации в кредитовании; to hire money занимать
деньги (под проценты); maturity срок (кредита, погашения платежа);
to forgo отказываться, воздерживаться (от чего-либо); money market
денежный рынок; a mortgage loan ссуда под недвижимость; outstanding
balance невыплаченный остаток; conv
market валютный рынок; equilibrium price равновесная цена; depreciation
обесценение, снижение курса валюты; appreciation повышение курса
валюты.
7
.
érsely наоборот; foreign exchange
179
Ex. 11. Read the following text and think of the dependence of many
countries’ currency on the U.S. dollar. Speak on the reasons for
that phenomenon and possible ways of getting out of it.
The dollar is the world’s dominant currency. Should the world
therefore be worried by its recent plunge against other currencies?
Plenty of people seem to think so. When central bank governors
and finance ministers of the leading countries meet, the fate of
the dollar is always on the agenda. Since 2001 the dollar has
fallen by 33% against the euro and by 15% against the Japanese
yen. Currency traders around the globe scrutinize every word
from the participants of these meetings, looking for a signal that
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