lecture20_312_Banks&Finance_SP11_overheads

lecture20_312_Banks&Finance_SP11_overheads -...

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Lecture #20 April 11, 2011 Financial Capital and the push for a central bank.
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For most of the semester we have been talking about the increasing integration of the national economy, and its effects, primarily in geographic terms. This week I want to talk about increasing integration in functional terms, particularly through the development of financial markets. We need to return to banks for a bit, and then to the expansion of other elements of the financial system.
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Financial Panics: There were serious financial panics in 1873, 1893, and 1907 with milder panics in 1884, 1890, and 1896 All of these crises had elements of banking panics, where people lost confidence in the banking systems ability to convert bank liabilities, either bank notes or deposits, into currency on demand. The economy had shifted toward deposit banking with the reaction of the state banks to the National Banking Act.
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The circulating medium, gold coins and other forms of paper money, came to be dominated by coins or paper money that was directly convertible into coins in the form of gold certificates and silver certificates.
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Remember our description of fractional reserve banking from earlier in the semester. Investors in banks paid in capital, usually in the form of specie (gold and silver coins), which the bank held in reserve. Most banks were commercial banks because their primary line of business was buying and selling bills of exchange. When a bank made a loan, it bought a bill. Before the Civil War the bank would issue bank notes (the liabilities of the bank) when it made a loan. After the National Banking Act, states banks would make loans in the form of deposits (usually checking account deposits), so a typical bank would have a balance sheet that looked like:
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Reserves Gold Coins Deposits Loans (Assets) (Liabilities) (Assets) $100 $100 $80 $80 $64 $64 $52 .. $500 $400
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In the late 19 th century, the form that “high powered money” could take was primarily gold and silver coins, and gold and silver certificates. Most of the “money” in the economy was in the form of deposits, rather than in a physical form of money. The problem for the banking system is that for every $20 in reserves, they had roughly $80 in deposit liabilities outstanding.
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When people lost confidence in the banking system’s ability to convert deposits into currency (coins, certificate, greenbacks, or national bank notes) depositors would panic and run on the banks. This occurred in each of the financial panics. As a result, banks had to curtail their loans in order to build up liquidity. On any given amount of high powered money, they made fewer loans:
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Reserves Gold Coins Deposits Loans (Assets) (Liabilities) (Assets) $100 $100 $75 $75 $56 $56 $42 ..
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lecture20_312_Banks&Finance_SP11_overheads -...

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