Money & banking. Exchange Rates

Money & banking. Exchange Rates Money is an intrinsic part of our life. By money we mean any commodity generally accepted in payment for goods, services, & debts. The main use of money is makes the trading process simpler & more efficient, but actually money has various uses in the modern world & various functions, such as: 1. means of payment 2. medium of exchange 3. standart of value 4. unit of account 5. store of value 6.

standart of deferred payment Money, as the medium of exchange, is used in one-half of almost all exchange. Workers exchange labour services for money. Poeple buy & sell goods in exchange for money. We accept money not to consume it directly but bacause it can subsequently be used to buy things we do wish to consume. Money is the medium through which people exchange goods & services. To see that society benefits from a medium of exchange imagine a barter economy.

A barter economy has no medium of exchange. Goods are traded directly or swapped for other goods. In a barter economy, the seller & the buyer each must want something the other has to offer. Each person is simultaneously a seller & a buyer. In order to see a film, you must hand over in exchange a good or service that the cinema manager wants. There has to be a double coincidence of wants. You have to find a cinema where the manager wants what

you have to offer in exchange. Trading is very expensive in a barter economy. People must spend a lot of time & effort finding others with whom they can make mutually satisfactory swaps. Since time & effort are scarce resources, a barter economy is wastful. Although the crutial feature of money is its acceptance as the means of payment & medium of exchange, other functions are also in great importance. Money can also serve as a standart of value.

Society considers it convenient to use a monetary unit to determine relative costs of different goods & services. In this function money appears as the unit of account, is the unit in which prices & quoted & accounts are kept. In Russia prices are quoted in roubles, in US – dollars, in majority European countries – euros. It is usually convinient to use the units in which the medium of exchange is measured as the unit of

account as well. But let’s turn to the history & see how everything began, what is the background of money & banks. In the past most societies used different objects as money. Some of these were valuable because they were rare & beautiful, others – because they could be eaten or used. Early forms of money like these were used to buy goods. They were also used to pay for marriages, fines & debts.

But although everyday objects were extremely practical kinds of cash in many ways, they had some disadvantages too. For example, it was difficult to measure their value accurately, devide some of them into a wide range of amounts, keep some of them for a long time, use them to make financial plans for the future. For the reasons such as these, some societies began to use another kind of money, that is precious metals. People used gold, gold bullion, as money. Those were dangerous times, & people wanted a

safe place to keep their gold. So they deposited it with goldsmiths, people who worked with gold for jewellery & so on & also had a guarded vault to keep it safe in. & when people wanted some of their gold to pay for things with, they went & fetched it from goldsmith. Two developments turned these goldsmiths into bankers. The first was that people found it a lot easier to give the seller a letter than it was to fetch some

gold & then physically hand it over to him. This letter transferred some of the gold & they had at the goldsmith’s to the seller. This letter we would nowadays call a cheque. &, of course, once these letters or cheques, became acceptable as a way of paying for goods, people felt that the gold they had deposited with the goldsmith, was just as gold as gold in their own pockets. & as letters or cheques were easier to carry around than gold & a lot less dangerous, people started

to say that their money holdings were what they had with them plus their deposits. So a system of deposits was started. The second development was that goldsmiths realized they had a great deal of unused gold lying in their vaults doing nothing. This development was actually of greater importance than the first. Now let’s turn to the first bank loan & see what happened.

A firm asked a goldsmith for a loan. The goldsmith realized that some of the gold in his vault could be lent to the firm, & of course he asked the firm to pay it back later with a little interest. The goldsmith bankers were an early examples of a financial intermediary. A financial intermediary is an institution that specializes in bringing lenders & borrowers together. Banks are not the only financial intermediaries. Insurance companies, pension funds, & building

societies also take money in order to relend it. The crucial feature of banks is that some of their liabilities are used as a means of payment, & are therefore part of the money stock. There can be different types of banks. Central banks supervise the banking system, the fix minimum interest rate, issue bank notes, control the money supply, influence exchange rates, & act as lender of last resort. A commercial banks are businesses that trade in money.

They borrow money from the public, crediting them with a deposit. The deposit is a liability of a bank. It is money owed to depositors. In turn the bank lends money to the firms, households or governments wishing to borrow. Commercial banks are financial intermediaries with a government license to make loans & issue deposits, including deposits against which cheques can be written.

In some European countries, notably Germany, Austria, & Switzerland, there are universal banks which combine deposit & loan banking system with share & bond dealing, investment advice, etc. Yet even universal banks usually forms a subsidiary, known as a financial house money – at several per cent over the base lending rate – for hire purchase or installment credit, that is, loans to consumers that are repaid in regular, equal monthly amounts.

In Britain, the USA & Japan, however, there is, or used to be, a strict separation between commercial banks & banks that do stockbroking or bond dealing. Thus in Britain, merchant banks specialize in raising funds for industry on the various financial markets, financing international trade, issuing & underwriting securities, dealing with takeovers & mergers, issuing government bonds, & so on. They also offer stockbroking & portfolio management

services to rich corporate & individual clients. Investment banks in the USA are similar, but they can only act as intermediaries offering advisory services, & do not offer loans themselves. In Britain there are also building societies that provide mortgages, i. e. they lend money to home-buyers on the security of houses & flats, & attract savers by paying high interest than the banks. The savings & loan associations in the

USA served a similar function, until most of them went spectacularly bankrupt at the end of 1980s. There are also supranational banks such as World Bank or the European Bank for Reconstruction & Development, which are generally concerned with economic development. As we see there are a lot of different types of banks, but also we can talk about different kinds of money. (This classification is mostly based on the functions of money).

In prisoner-of-war camps, cigarettes served as money. In the 19th century money was mainly gold & silver coins. These are examples of commodity money, ordinary goods with industrial uses (gold) & consumption uses (cigarettes), which also serve as a medium of exchange. To use a commodity money, society must either cut back on other uses of that commodity or devote scarce

resources to producing additional quantities of the commodity. But there are less expensive ways for society to produce money. A token money is a means of payment whose value or purchasing power as money greatly exceeds its cost of production or value in uses other than as money. The essential condition for the survival of token money is the restriction of the right to supply it.

Private production is illegal. Society enforces the use of token money by making it legal tender. The law says it must be acceptable as a means of payment. In modern economies, token money is supplemented by IOU money. An IOU money is a medium of exchange based on the debt of a private firm or individual. A bank deposit is IOU money because it is a debt of the bank.

When you have a bank deposit the bank owes money. You can write a cheque to yourself or a third party & the bang is obliged to pay whenever the cheque is presented. Bank deposits are a medium of exchange because they are generally accepted as payment. As you know each country has its own national currency, but there is such a phenomenon as euro – it’s European currency, which is acceptable in the 12 countries of

European Union. On 1 January 2002, the euro, which has been adopted in 1999, started circulating in notes & coins. This was a historical moment in the integration of Europe. From 1 January 2002 the euro existed as cash, but before it it could be used only for banks & financial transaction. What are the advantages of the euro? - the euro is a safe currency against counterfeiting - the euro is based on one of the strongest economies in the world with stable prices

- the euro is business friendly - the euro is convenient & transparent for tourists & the last point I would like to discuss is the banking in Russia. Russian present days banking system features two levels of banking institutions, the Central Bank of Russia (high level) being the regulating body, & commercial banks & credit institutions (lower level) being banking services providers for economic subjects.

Status, responsibilities & jurisdiction of the Central Bank of Russia are outlined in the Federal Law on the Central Bank. The principal purposes of activities of the Central Bank are: - protection of the national currency (Russian ruble) - development & enhancement of national banking system - provision for efficient payment system functioning

Profit derivation is not considered a purpose of the Central bank’s activity. Some of its functions are: - currency issue (monopolized by the Central bank) - payment regulation issue - issue & withdraw banking licenses - regulation of operations in foreign currency The majority transaction in rubles payment in Russia are effected via the Central Bank clearing system – set of arrangements in which debts between

banks are settled by adding up all the transactions in given period & paying only the net amounts needed to balance inter-bank accounts. The Central Bank reports to the Parliament (State Duma). Commercial banks & credit institutions are founded & operated in compliance with the Federal Law on Banks & Banking Activities other applicable law regulations issued by the

Central Bank. Commercial bank is considered founded & regarded as a legal entity after registration of its charter at the Central Bank of Russia. The license, issued in its name by the Central Bank confirms its entitlement to effect banking operations. Exchange Rates There were many system regulating exchange rates, one of which was the Bretton Woods system. The Bretton Woods agreement of 1944 established fixed exchange rates, defined

in terms of gold and the US dollar. Between 1944 and 1971, many currencies were pegged against the US dollar, their parities with the US dollar were fixed. In this period, а US dollar was а promissory note issued by the United States Treasury. If anybody requested it, the Treasury had to exchange the note for 1/35th of an ounce of gold.

Under this system, overvalued or undervalued currencies could only be adjusted with the agreement of the International Monetary Fund. Such adjustments are called devaluation and revaluation. The Bretton Woods system of gold convertibility and pegging against the dollar was abandoned in 1971, because following inflation, the Federal Reserve did not have enough gold to guarantee the American currency. Gold convertibility was replaced by а system of floating exchange rates. (Today,

the US dollar - the unofficial world currency - is merely а piece of paper on which is written 'In God We Trust God, not gold!). In the late 1970s and early 1980s, the American, British and other governments deregulated their financial systems, and abolished all exchange controls. Residents in these countries were enabled to exchange any amount of their currency for any other convertible currency. This has led to the current situation in which 95% of the world's currency

transactions are unrelated to transactions in goods but are purely speculative. А freely (or clean) floating exchange rate is determined purely by supply and demand. Theoretically, in the absence of speculation, exchange rates should reflect purchasing power parity - the cost of given selection of goods and services in different countries. Proponents of floating exchange rates, such as Milton

Friedman, argued that currencies would automatically establish stable exchange rates which would reflect economic realities more precisely than calculations by central bank officials. Yet they underestimated the impact of speculation, and the fact that companies and investors frequently follow short-term money market trends even if these are contrary to their own long-term interests. The disadvantage of floating exchange rates is that markets may overreact to the activities of speculators

and this may lead to dramatical appreciation and depreciation of currencies (although markets learned а little at least not to overreact in that way, but it's still not а perfect system). Few governments, however, leave exchange rates wholly at the mercy of market forces. Most of them attempt to influence the level of their currency when necessary. Managed (or dirty) floating exchange rates are more common than freely floating ones.

In 1979, most Western European governments joined the EMS (European Monetary System), with its ERM (Exchange Rate Mechanism). This established parities between member currencies, and a margin of plus or minus 2 1/4%. If the rate diverged by more than this amount from the central parity, governments and central banks had to intervene in exchange markets, buying or selling in order to increase or decrease the value of

their currency. Managed floating system doesn't seem to work well too. The speculators on the market seem to be much stronger than any government or any central bank intervention and government policy can easily be defeated by the combined action of international speculators. For example, on а single day in September 1992 the Bank of England lost five billion pounds in а hopeless attempt to support the pound sterling.

For weeks, аll the world’s financial institutions and rich individuals had been selling their pounds, as everyone except the British Government believed that ever since it joined the ERM in 1990, the pound had been seriously overvalued. When the British central bank ran out of reserves and could no longer buy pounds, the currency was withdrawn from the ERM and allowed to float, instantly losing about 15% of its value against the

D-mark. The next year, speculators attacked the French franc, the Belgian franc, the Danish crone and the Spanish peseta. In August 1993, the European Monetary System was more or less suspended. In this conditions an appropriate system may be half and half system whereby central banks do intervene and try to calm things down, where you may have target zones.

Many manufacturers are in favor of fixed exchange rates, or а single currency. Although it is possible to some extent to hedge against currency fluctuations by way of futures contracts, forward planning is difficult when the price of raw materials bought from abroad, or the price of your products in export markets, can rise or fall by 50% in only а few months. (Since exchange controls were abolished, currencies including the US$ and the pound sterling have in turn appreciated by up to 100%

and then depreciated by more than 50% against the currencies of major trading partners). Other supporters of fixed exchange rates or а single currency include extreme conservatives who want to return to something like the gold standard, as well as people on the left who believe that speculators have too much power. Opponents say that if you have а world currency you have no exchange rates, and that is presumably good for trade and, like under the gold standard, means а very stable and certain

economic environment, but then there is a need for а world central bank, and that’s quite а tall order (difficult to implement). There is also a need to have some kind of world fiscal system to cushion whatever shocks may happen in parts, only in parts of the world - it’s ineffective if there is a global shock. Supporters of flexible rates include monetarists who want countries to follow strict monetary rules, as well as Keynesians who want to be free to devalue in the attempt to reduce unemployment.

The recent event in the world monetary system was the appearance of a new currency - euro. It was introduced in 1998, but went in circulation in 2002. All currencies of european countries were put out of circulation. This allowed European countries to make capital circulation easier and to increase the volume of trade and investment. Besides that, all the countries that make payments with euro, now do not have problems

with exchange rates fluctuations and speculators, thus avoiding financial losses.