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INTRODUCTION
Sections
The Kinds of Money 4
The U. S. Money Supply 6
Velocity of Money 10
Appendix: Money and Gold 13
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
Here, the term bank refers to all financial institutions that offer
transaction accounts ─ accounts from which payments are
made directly using checks or similar instruments. As a result
of the Depository Institutions Deregulation and Monetary
Control Act of 1980, banks now include savings associations
and credit unions as well as traditional commercial banks.
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
Here is why.
2 Technically, negotiable orders of withdrawal and share drafts are not checks, but
they accomplish exactly the same thing ─ only they do so for accounts at savings
associations and credit unions, respectively, rather than at traditional banks. They
are written instructions authorizing institutions that offer transaction accounts to
transfer balances between two of those accounts.
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
4 This measures what is called M1 (we’ll call it M), the supply of immediately
spendable dollars (coins, currency, and checking account balances). Conceptually,
this is the appropriate measure of the money supply. Unfortunately, its actual
measurement leaves much to be desired. As measured, it includes cash that is not
circulating within the economy (as explained later in this chapter), and it fails to
include such checkable accounts as money market deposit accounts.
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
M = CC + CA
$1700 billion = $870 billion + $830 billion
5 One or more days will pass between the time that a check depositor's bank re-
cords an increase in the depositor's account balance and the time that the check
writer's bank learns that the check has been written and reduces the writer's
account balance. During this period, the total of all checking account balances will
rise by the amount of checks that have been deposited but have not yet been
charged against the writers' balances. Hence, to get an accurate measure of the
checking account balances, it is necessary to subtract the dollar amount of checks
that are in the process of collection (and, hence, have not yet "cleared" the writers'
banks) from the total of all checking account balances. Note also that bank reserve
accounts in Federal Reserve Banks and the U. S. Treasury's checking accounts in
the Federal Reserve Banks are excluded from the measure of the money supply.
But, the money supply does include checking account balances held in banks (and
in Federal Reserve Banks) by foreign governments and international organizations.
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
How much they have created is crucial to all the rest of us,
because we must get our hands upon portions of that money in
order to make purchases. So,
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
Velocity of Money
7 The bank also commits to buying them back upon demand ─ paying cash for
checking account balances and paying account balances for cash.
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
9 Similarly, there are checking account balances in banks all over the world that are
denominated in U.S. dollars because of the popular worldwide use of the U.S. dollar
in international trade transactions. Many of those dollars are spent within the United
States, but they are excluded from our measure of the money supply. Hence, as a
measure of our domestically available money supply, the official measure is at best
quite crude (overestimating the cash portion and underestimating the checking
account portion).
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
Many countries "back" their money with gold. That is, for
each Swiss franc (or yen or peso or whatever) issued, the
government holds in its treasury a certain specified amount of
gold. Many people mistakenly believe that it is this backing by
a precious metal that gives money its value. The fact is that
the value of money derives from its scarcity, not from its
backing. If dollars were to become abundant, there would be
inflation. As prices rise, each dollar would buy less. If
abundant, then, dollars would be worth little, whether they are
backed or are not backed by gold. By keeping dollars scarce
enough to avoid inflation, prices will stay relatively low, and
dollars will remain relatively valuable, whether they are backed
or are not backed by gold.
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MONEY MECHANICS Copyright © 1996 – 2009 David B. Ashby All Rights Reserved Chapter 1
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