Banking, Finance, And Economics #2

The banking industry has been around for some two thousand years and unless the world dissolves into into dust, mud, and dirty liquids, will be with us until the death of all mankind. The Panic of 1907: Lessons Learned from the Market's Perfect Storm by Robert F. Bruner and Sean D. Carr  | Aug 31, 2007

is a very good place to start when trying to understand the interactions of banking, finance, and economics. This would lead one to read would be by G. Edward Griffin, The Creature From Jekyll Island. There are other sources by which the reader may gain a better perspective of the problems we will discuss in general as this post is not an attempt to be very technical. Like my four part post of corporations, it is an attempt to get you, the reader to question what you know or think what you know while providing a general guide for possible answers.

Banks provide a useful service, they handle our money. Back before the days of standardized monetary units (money, both coin of the realm and bank or other minter of coin) the bank would keep your gold or silver “safe” in return for a fee. Then bankers got the bright idea of lending your gold or silver by way of certificates or the real item. After all, what's the good of having all that gold and silver laying about if it was not earning a profit. Bankers had been financing local trade through the use of their own capital so why not expand the money supply. The economic consequence is that when the money supply is increased the rate of inflation may be increased correspondingly and the rate of interest suffers a decline. The theory of money and interest rates then govern how an economy expands or contracts. At least in theory but many are not so sure. So the bankers and the local government or regional government mints coins, writes contracts, and so forth. The local merchants may write their own script, that practice was still being used even through the great depression of 1929, by the way. Later the merchants would issue their own consumer charge cards for customers who met the credit standards. This practice dates back to before the turn of last century. We can see that attempts by the central governments have not been successful in controlling the money supply. The creation of the Federal Reserve Bank was a bold attempt to do just that but has had little success in doing so.

Banks have two main requirements in their chartered life as corporations. The first is the capital requirements, how much in the way of capital (not talking about buildings and machinery) is necessary to open any particular bank, and what are the reserve requirements – the amount that can be loaned out at any one time, also know as a liquidity ratio. Oh yes, we have a ton of regulations about who and who is not credit worthy, who may open an account, and much more, but all of that is minor annoyances. The two main requirements have an effect of the stability of the bank and the safety of its deposits.

Central banks, that is, the creations of governments that essentially do the government's business, this is a slightly different animal. You see, as I outline in the last post we had a number of banking forms, from state chartered to national chartered to commercial banks and private consumer banks to savings and loans to credit unions, and the like. Now the distinctions are almost irrelevant sine we tend to treat all banks the same so that the differences between them are very minor. But the central government bank is a horse of another color. I pulled this general outline off the Wikipedia site:

The Federal Reserve Banks offer various services to the federal government and the private sector:[14][15]
Acting as depositories for bank reserves
Lending to banks to cover short-term fund deficits, seasonal business cycles, or extraordinary liquidity demands (i.e. runs)
Collecting and clearing payments between banks
Issuing bank notes for general circulation as currency
Administering the deposit accounts of the federal government
Conducting auctions and buybacks of federal debt
Historically the Federal Reserve Banks compensated member banks for keeping reserves on deposit (and therefore unavailable for lending) by paying them a dividend out of the Federal Reserve Banks' earnings, limited by law to 6%. The Emergency Economic Stabilization Act (EESA) of 2008 additionally authorized the Federal Reserve Banks to pay interest on member bank reserves.

All nationally chartered banks must become members of the Federal Reserve Bank. In the next post we will talk about the Fed's open market operations, the setting of reserve requirements, the inter bank lending rates, and so forth.