Thursday, May 10, 2012

Updated 14.2

Section 2: The Development of Modern Banking

The United States experimented with many different kinds of money and faced many issues with it before it created the Federal Reserve System. Initially, each bank printed its own currency in different sizes, colors, and denominations. As a result, there were hundreds of different kinds of notes in circulation. Another issue was banks were tempted to print too much money because they could simply print more. Finally, counterfeiting became a concern. In 1861, the government printed greenbacks to finance the Civil War. In 1863, the National Banking System (NBS) was established which issued its own currency called National Bank notes. Other currencies of the period included gold certificates and silver certificates. The Federal Reserve System (Fed) was established in 1913 in order to assist with modern banking.
Content Vocabulary
state bank
A state bank is generally a financial institution that is chartered by a state. It differs from a reserve bank in that it does not necessarily control monetary policy (indeed, the state in question may have no legal capacity to create monetary policy), but instead usually offers only retail and commercial services.
A state bank that has been in operation for five years or less is called a de novo bank.[1]
In the United States the term "state bank" is used in contradistinction to "national bank." All national banks are chartered and regulated by the Office of the Comptroller of the Currency. State banks are chartered and regulated by a state agency (often called the Department of Financial Institutions) in the state in which its headquarters are located. In addition, state banks that are members of the Federal Reserve are regulated by the Federal Reserve; state banks that are not members of the Federal Reserve are regulated by the Federal Deposit Insurance Corporation (FDIC). Therefore, almost every state bank has both a state and federal regulator. There are a handful of state banks which do not have FDIC insurance.
An Introduction to State Banks (In Context), 7:43
How can state banks grow the economy?
What is the one state that has a state bank?
Is the unemployment rate high or low in this state?
Have they balanced their budget?
What early American founder encouraged these banks?
What could improve economic productivity?
What will they produce?
What is the relationship between commercial banks and state banks?
How does it actually work?
How does the state profit from this system, as opposed to how the Fed benefits?
How many states are proposing these banks?
Summarize the state bank system.
Is there accountability, as opposed to the Fed, in this banking system?

State public banks, an old American tradition, may provide an important tool to pull states out of the current economic slump. The concept is simple: The public bank uses state funds on deposit as bank reserves for making loans for infrastructure and other projects to Improve the state's economy and grow jobs.

Ben Franklin argued that colonial Pennsylvania's public bank was the key to the colony's 18th century prosperity. North Dakota, whose public bank has operated since 1919, boasts the lowest unemployment rate in the country and is the only state to have a balanced budget in each of the last three years.

In this video we highlight the research and efforts of Ellen Brown, the author of "Web of Debt" and others at the Public Banking Institute. Ellen was a guest on our radio show, In Context which is archived at our website, For more information on the public banking institute see their website at

This program is an edition of the series In Context produced by MDR Productions, Inc. In Context is a live, call-in show that originates at Pacifica affiliate WPKN 89.5 FM, Bridgeport, CT whose signal reaches most of Connecticut and parts of New York.

It is broadcast on the first Sunday of the month at 10pm and first Wednesday of the month at 6:30pm and is streamed live at For further information, please visit
legal tender
Legal tender is a medium of payment allowed by law or recognized by a legal system to be valid for meeting a financial obligation.[1] Paper currency is a common form of legal tender in many countries.
For instance, if an individual owes someone US$100 in the United States, he or she can try to pay the debt in Mexican Pesos or valuable jewelry or gold metal, or even a cheque or a charge card, but the creditor is not required to accept any of those as payment. The creditor must accept US $20 dollar bills, however, because that is legal tender in the United States. An individual can try to sell his or her pesos or gold to someone else in exchange for some US legal tender, and pay the debt with that money, but the creditor cannot force any specific person to satisfy a debt with pesos or gold. In Mexico, however, pesos are legal tender, and US dollars are not. So, by Mexican law, the creditor must accept pesos as payment, whereas the creditor can refuse US dollars or gold.
The origin of the term "legal tender" is from Middle English tendren, French tendre (verb form), meaning to offer. The Latin root is tendere (to stretch out), and the sense of tender as an offer is related to the etymology of the English word extend (to hold outward).[2] The noun form of a tender as an offering is a back-formation of the noun from the verb.[]
Legal tender is variously defined in different jurisdictions. Formally, it is anything which when offered in payment extinguishes the debt. Thus, personal cheques, credit cards, debit cards, and similar non-cash methods of payment are not usually legal tender. The law does not relieve the obligation until payment is accepted. Coins and notes are usually defined as legal tender. Some jurisdictions may forbid or restrict payment made other than by legal tender. For example, such a law might outlaw the use of foreign coins and bank notes, or require a license to perform financial transactions in a foreign currency.
In some jurisdictions legal tender can be refused as payment if no debt exists prior to the time of payment (where the obligation to pay may arise at the same time as the offer of payment). For example vending machines and transport staff do not have to accept the largest denomination of banknote. Shopkeepers can reject large banknotes — this is covered by the legal concept known as invitation to treat. However, restaurants that do not collect payment until after a meal is served would have to accept that legal tender for the debt incurred in purchasing the meal.
The right, in many jurisdictions, of a trader to refuse to do business with any person means a purchaser cannot demand to make a purchase, and so declaring a legal tender in law, as anything other than an offered payment for debts already incurred, would not be effective.
Constitution Lecture Extra: Coining Money and Legal Tender, 4:37
Where is the legal tender power not given in the Constitution?
What is the best argument in granting the power to coin money?
Section 8 gives Congress what power?
The Federal government has no power to do what according to the Constitution?
The power to coin money and the power to establish legal tender are two different things.

Not a part of the normal lecture series, but an applied exercise. This deals with Congress's power to coin money, and whether or not it includes the power to establish a legal tender.

This is made in response to a video by Dr. Tom Woods, who in turn was responding to people criticizing Ron Paul for saying that the Federal government has no power to establish a fiat money as legal tender. You can see his video here:
national bank
To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;
1. William Blackstone, Commentaries 1:264--68, 1765
2.Robert Morris to President of Congress, 15 Jan. 1782
3.Robert Morris to Thomas Jefferson, 1 May 1784

4.Wharton v. Morris
5.Thomas Jefferson, Propositions respecting Coinage, 13 May 1785

6.Records of the Federal Convention
7.James Madison, Federalist, no. 42, 285, 22 Jan. 1788
8.John Jay to George Washington, 13 Nov. 1790
9.St. George Tucker, Blackstone's Commentaries 1:App. 261--62, 1803
10.Joseph Story, Commentaries on the Constitution 3:§§ 1112--17, 1833
In banking, the term national bank carries several meanings:
  • especially in developing countries, a bank owned by the state
  • an ordinary private bank which operates nationally (as opposed to regionally or locally or even internationally)
  • in the United States, an ordinary private bank operating within a specific regulatory structure, which may or may not operate nationally, under the supervision of the Office of the Comptroller of the Currency.
In the past, the term "national bank" has been used synonymously with "central bank", but it is no longer used in this sense today. Some central banks may have the words "National Bank" in their name; conversely if a bank is named in this way, it is not automatically considered a central bank. For example, National-Bank AG in Essen, Germany is a privately owned commercial bank, just like National Bank of Canada of Montreal, Canada. On the other side, National Bank of Ethiopia is the central bank of Ethiopia and National Bank of Cambodia is the central bank of Cambodia.
Alexander Hamilton on a National Bank, 4:34
Why did Alexander Hamilton argue in favor of a national bank?
What had the individual states incurred?
How is the power of the central government increased?
How does this result in a Revolution fought in vain?
Why did the Founders limit the power of the central government?
How did the first President limit himself?

The First Bank of the United States was needed because the government had a debt from the Revolutionary War, and each state had a different form of currency. It was built while Philadelphia was still the nation's capital. Alexander Hamilton conceived of the bank to handle the colossal war debt — and to create a standard form of currency.
Thomas Jefferson, George Washington, and John Adams are also in this video.
national currency
Fiat money is money that derives its value from government regulation or law. The term derives from the Latin fiat, meaning "let it be done" or "it shall be," as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.
Fiat money originated in 11th century China,[1] and its use became widespread during the Yuan and Ming dynasties.[2] The Nixon Shock of 1971 ended the direct convertibility of the United States dollar to gold. Since then all reserve currencies have been fiat currencies, including the US dollar and the euro.[3]
gold certificate
A gold certificate in general is a certificate of ownership that gold owners hold instead of storing the actual gold. It has both a historic meaning as a US paper currency (1882–1933) and a current meaning as a way to invest in gold.
Banks may issue gold certificates for gold which is allocated (non-fungible) or unallocated (fungible or pooled). Unallocated gold certificates are a form of fractional reserve banking and do not guarantee an equal exchange for metal in the event of a run on the issuing bank's gold on deposit.[1] Allocated gold certificates should be correlated with specific numbered bars, although it is difficult to determine whether a bank is improperly allocating a single bar to more than one party.[2]
silver certificate
Silver Certificates are a type of representative money printed from 1878 to 1964 in the United States as part of its circulation of paper currency.[1] They were produced in response to silver agitation by citizens who were angered by the Fourth Coinage Act, which had effectively placed the United States on a gold standard. The certificates were initially redeemable in the same face value of silver dollar coins, and later in raw silver bullion. Since 1968 they have been redeemable only in Federal Reserve Notes and are thus obsolete, but are still valid legal tender.
central bank
A central bank, reserve bank, or monetary authority is an institution that manages a nation's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the nation's monetary base, and usually also prints the national currency, which usually serves as the nation's legal tender.[1][2] Examples include the European Central Bank (ECB), the Federal Reserve of the United States, and the People's Bank of China.[3]
The primary function of a central bank is to manage the nation's money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as alender of last resort to the banking sector during times of bank insolvency or financial crisis. Central banks usually also have supervisory powers, intended to prevent commercial banks and other financial institutions from reckless or fraudulent behavior. Central banks in most developed nations are institutionally designed to be independent from political interference.
What is a Central Bank? 3:38
What is a central bank?
What two powers do they have?
How is money regulated?
What does it produce in the long run?
Where does the money come from?
Were the Founders aware of the problem?
When was the Founder's system changed?
What is important to understand about the Fed?
Does it operate transparently?

Description of a Central Bank and the Federal Reserve Act. Where most of our income tax dollars go.
bank run
A bank run (also known as a run on the bank) occurs when a large number of customers withdraw their deposits because they believe the bank is, or might become, insolvent. As a bank run progresses, it generates its own momentum, in a kind of self-fulfilling prophecy (or positive feedback): as more people withdraw their deposits, the likelihood of default increases, and this encourages further withdrawals. This can destabilize the bank to the point where it faces bankruptcy.[1]
A banking panic or bank panic is a financial crisis that occurs when many banks suffer runs at the same time. A systemic banking crisis is one where all or almost all of the banking capital in a country is wiped out.[2] The resulting chain of bankruptcies can cause a long economic recession.[3] Much of the Great Depression's economic damage was caused directly by bank runs.[4] The cost of cleaning up a systemic banking crisis can be huge, with fiscal costs averaging 13% of GDP and economic output losses averaging 20% of GDP for important crises from 1970 to 2007.[2]
Several techniques can help to prevent bank runs. They include temporary suspension of withdrawals, the organization of central banks that act as a lender of last resort, the protection of deposit insurance systems such as the U.S. Federal Deposit Insurance Corporation,[1] and governmental bank regulation.[5] These techniques do not always work: for example, even with deposit insurance, depositors may still be motivated by beliefs they may lack immediate access to deposits during a bank reorganization.[6]
Bonus video: The Bank run, 7:00

A clip from the 1946 film It's A Wonderful Life.
13 July 1931, Run on bank, Berlin

EXCLUSIVE: Bank Run, Food Shortage, Riots, and Worldwide Collapse, 2:48
With a bank run, what results?
On a global basis, what might happen?

he Money GPS by David Quintieri prepares the reader to avoid certain collapse that is spreading worldwide. It features Bob Chapman, James Turk, and David Morgan.

This is the trailer to the newly released book by David Quintieri in which several predictions within have already come true.

The free 40-page version of the book is available at

The full version is available on the Createspace eSpace store at:

And also on
bank holiday
A bank holiday is a public holiday in the United Kingdom or a colloquialism for public holiday in Ireland. There is no automatic right to time off on these days, although the majority of the population is granted time off work or extra pay for working on these days, depending on their contract.[1] The first official bank holidays were the four days named in the Bank Holidays Act 1871, but today the term is colloquially (albeit incorrectly) used for public holidays which are not officially bank holidays, for example Good Friday and Christmas Day.
fractional reserve system
Fractional-reserve banking is a form of banking where banks maintain reserves (of cash and coin or deposits at the central bank) that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction (called the reserve ratio) of the quantity of deposits as reserves. Some of the funds lent out are subsequently deposited with another bank, increasing deposits at that second bank and allowing further lending. As most bank deposits are treated as money in their own right, fractional reserve banking increases the money supply, and banks are said to create money. Due to the prevalence of fractional reserve banking, the broad money supply of most countries is a multiple larger than the amount of base money created by the country's central bank. That multiple (called the money multiplier) is determined by the reserve requirement or other financial ratio requirements imposed by financial regulators, and by the excess reserves kept by commercial banks.[1][2]
Central banks generally mandate reserve requirements that require banks to keep a minimum fraction of their demand deposits as cash reserves. This both limits the amount of money creation that occurs in the commercial banking system,[2] and ensures that banks have enough ready cash to meet normal demand for withdrawals. Problems can arise, however, when depositors seek withdrawal of a large proportion of deposits at the same time; this can cause a bank run or, when problems are extreme and widespread, a systemic crisis. To mitigate this risk, the governments of most countries (usually acting through the central bank) regulate and oversee commercial banks, provide deposit insurance and act as lender of last resort to commercial banks.
Fractional-reserve banking is the most common form of banking and is practiced in almost all countries. Although Islamic banking prohibits the making of profit from interest on debt, a form of fractional-reserve banking is still evident in most Islamic countries.
Rothbard on Fractional Reserve Banking, Bank Runs, and the FDIC, 2:35
Bank runs have occurred before such as during the Great Depression.
Do people have to believe the fractional reserve banking system protects their money?
Is your money really held in a bank for you?

Murray N. Rothbard presented this speech at the Michigan Libertarian Party Convention, held in Southfield, Michigan, in May 1989. This is an excerpt where he discusses Banking, FDIC, Fractional-Reserve Banking, Bank Runs, The FDIC and deposit insurance.
legal reserves
The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. It is normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank.
The required reserve ratio is sometimes used as a tool in monetary policy, influencing the country's borrowing and interest rates by changing the amount of funds available for banks to make loans with[1]. Western central banks rarely alter the reserve requirements because it would cause immediate liquidity problems for banks with low excess reserves; they generally prefer to use open market operations (buying and selling government-issued bonds) to implement their monetary policy. ThePeople's Bank of China uses changes in reserve requirements as an inflation-fighting tool,[2] and raised the reserve requirement ten times in 2007 and eleven times since the beginning of 2010. As of 2006 the required reserve ratio in the United States was 10% on transaction deposits and zero on time deposits and all other deposits.
An institution that holds reserves in excess of the required amount is said to hold excess reserves.
reserve requirement
Word of the Day: Reserve Requirements, 2:33
In your own words, what is the reserve requirement?
In plain English, this means what?
When the reserve requirement is increased what results?
If China does this what happens?

The reserve requirements set the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks. The reserve requirement can affect monetary policy, because the higher the reserve requirement is set, the less money banks will have to loan out, leading to lower money creation, and maintaining the purchasing power of the currency previously in use. The effect is exponential, because money that is loaned out can be re-deposited; a portion of that money may again be re-loaned, and so on.
To watch the full episode of Capital Account with Lauren Lyster check out
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member bank reserve (MBR)
excess reserves
In banking, excess reserves are bank reserves in excess of the reserve requirement set by a central bank. They are reserves of cash more than the required amounts.[1] Holding excess reserves has an opportunity cost if higher risk-adjusted interest can be earned by putting the funds elsewhere; the advantage of holding some funds in excess reserves is that doing so may provide enhanced liquidity and therefore flexibility in bank operations.
For banks in the U.S. Federal Reserve System, this is accomplished by making short-term (usually overnight) loans on the federal funds market to banks who may be short of their reserve requirements. However, some banks may choose to hold their excess reserves in order to facilitate upcoming transactions or meet contractual clearing balance requirements.
The minimum reserves and the excess reserves of private (commercial) banks are held as FRB (Federal Reserve Bank) credit in FRB accounts. The total amount of FRB credit held by private banks and the amount of FRB credit that the US government holds in its FRB account, together with all currency and vault cash form the monetary base.

Emergency Economic Stabilization Act of 2008

On October 3, 2008, Section 128 of the Emergency Economic Stabilization Act of 2008 allowed the Fed to begin paying interest on excess reserve balances as well as required reserves. They began doing so three days later.[2] Banks had already begun increasing the amount of their money on deposit with the Fed at the beginning of September, up from about $10 billion total at the end of August, 2008, to $880 billion by the end of the second week of January, 2009.[3][4] In comparison, the increase in reserve balances reached only $65 billion after September 11, 2001 before falling back to normal levels within a month. Former U.S. Treasury Secretary Henry Paulson's original bailout proposal under which the government would acquire up to $700 billion worth of mortgage-backed securities contained no provision to begin paying interest on reserve balances.[5]
The day before the change was announced, on October 7, Fed Chairman Ben Bernanke expressed some confusion about it, saying, "We're not quite sure what we have to pay in order to get the market rate, which includes some credit risk, up to the target. We're going to experiment with this and try to find what the right spread is."[6] The Fed adjusted the rate on October 22, after the initial rate they set October 6 failed to keep the benchmark U.S. overnight interest rate close to their policy target,[6][7] and again on November 5 for the same reason.[8]
The Congressional Budget Office estimated that payment of interest on reserve balances would cost the American taxpayers about one tenth of the present 0.25% interest rate on $800 billion in deposits.

Complete a time line by listing major events in U.S. monetary history in the appropriate spaces. 
14.2 Reading Strategy
Products in the News
New $10 Bills
The Development of Banking in America
Reading Strategy
What happened to currency at the end of the Revolutionary War?

Differentiated Instruction
Advanced Learners
Redesign U.S. currency. Who might be placed on new currency? National leaders, prestigious citizens, or well-known places that should be honored. Student designs can be posted in class.
Privately Issued Bank Notes
Growth of State Banking
Problems With Currency
p. 391
Why did the federal government stop printing paper currency?
p. 392
Private Bank Notes
What were the major problems with such currencies?
Reading Strategy
What major event in U.S. history changed commercial banking forever?

The National Banking System
Reading Strategy
What steps did the National Bank take to create a new banking system and establish its currency?
Other Federal Currencies
Critical Thinking
Create a graphic organizer to list the differences between gold certificates and silver certificates.
Reading Check
Why did the government issue greenbacks in 1861?
The Creation of the Fed
Differentiated Instruction
In the first paragraph, looks for ways that the banking system was showing signs of strain.
The Federal Reserve System
Banking in the Great Depression
Skill Practice
Making Predictions
How do you think that the Great Depression impacted banking?
p. 394
The Great Depression
Why did bank runs occur?
Figure 14.1 State and National Banks
Economic Analysis
What can you infer about the ratio of state banks to national banks?
Questions to audio track:
When did the number of banks peak?
What happened thereafter?
When did more than 31,00 state and national banks exist in the country?
Five years after the Depression, approximately how many banks remained?
Are there fewer or more banks today?
Differentiated Instruction
Songs from the Great Depression touch upon the poverty and misery of the era. Examples include "Brother, Can you Spare a Dime?" by Bing Crosby, "I Ain't Got No Home" by Woody Guthrie, and "Eleven Cent Cotton, Forty Cent Meat" by Bob Miller. Note the subject matter in the songs, especially whom the singers seem to blame for their poor conditions. Write a paragraph summarizing your reaction to the songs.

Brother, Can You Spare A Dime? 3:11

"Brother, Can You Spare a Dime?" lyrics by Yip Harburg, music by Jay Gorney (1931)

They used to tell me I was building a dream, and so I followed the mob, 
When there was earth to plow, or guns to bear, I was always there right on the job. 
They used to tell me I was building a dream, with peace and glory ahead, 
Why should I be standing in line, just waiting for bread?

Once I built a railroad, I made it run, made it race against time. 
Once I built a railroad; now it's done. Brother, can you spare a dime? 
Once I built a tower, up to the sun, brick, and rivet, and lime; 
Once I built a tower, now it's done. Brother, can you spare a dime?

Once in khaki suits, gee we looked swell, 
Full of that Yankee Doodly Dum, 
Half a million boots went slogging through Hell, 
And I was the kid with the drum!

Say, don't you remember, they called me Al; it was Al all the time. 
Why don't you remember, I'm your pal? Buddy, can you spare a dime?

Once in khaki suits, gee we looked swell, 
Full of that Yankee Doodly Dum, 
Half a million boots went slogging through Hell, 
And I was the kid with the drum!

Say, don't you remember, they called me Al; it was Al all the time. 
Say, don't you remember, I'm your pal? Buddy, can you spare a dime?

Woody Guthrie - I Ain't Got No Home, 2:48

From His Record "Dust Bowl Ballads" 1940
Performed by Porter Wagoner - Eleven Cent Cotton, 2:40

Federal Deposit Insurance
Figure 14.2 Fractional Reserves and the Money Supply
Economic Analysis
If the initial reserves were $2,000, how large could the money supply get?
Skill Practice
Using Tables and Charts
What conclusion can you draw from the information in the graph?
What would be the eventual size of the money supply if there was a 25% reserve requirement?
A 15% reserve requirement?

Fractional Reserves and Deposit Expansion
Writing Support
Persuasive Writing
Write a paragraph stating your opinion of the fractional reserve system. Is it a fair or an unfair practice from the point of view of depositors?

Critical Thinking
Explain in your own words how the Fed's policy of fractional reserve banking (set at 20%) can increase the amount of money in the economy by 500%.
Personal Finance Handbook
See pp. R10-15 to learn more about loans.

Reading Check
What is the purpose of the FDIC?

Use a graphic organizer to list the reasons for creating the Federal Reserve System.

14.2 Review
Speculate on what might happen to the U.S. banking system if the government ordered the Fed to stop all its operations.
p. 398
Profiles in Economics
Examining the Profile
1. Contrasting How does Bernanke differ from his predecessor Greenspan?
2. Making Inferences What effect would a more transparent monetary policy have on financial markets?

Ron Paul Hits Ben Bernanke at Hearing, Says Fed Has Destroyed 'Value of Real Money' 4:50

Ben Bernanke Introduced to Andrew Jackson: Hilarious!, 5:46
March 2, 2011
"You are a den of vipers. I intend to rout you out and by the Eternal God I will rout you out. If the people only understood the rank injustice of our money and banking system, there would be a revolution before morning." --Andrew Jackson, 1828 (to a group of investment bankers trying to persuade him to renew their central bank charter)