Money and Banking Chapter 1 Money, Banking, and Your World

Chapter Money , Banking , and Your World CHAPTER OBJECTIVES By the end of this chapter , students should be able to . Describe how ignorance of the principles of money and banking has injured the lives of everyday people . Describe how understanding the principles of money and banking has enhanced the lives of everyday people . Explain how bankers can simultaneously be entrepreneurs and lend to entrepreneurs . URL books

Dreams Dashed LEARNING OBJECTIVE . How can ignorance of the principles of money and banking destroy your dreams ?

At 28 , Ben is in his prime . Although tall , dark , and handsome enough to be a movie star , Ben real passion is culinary , not thespian . Nothing pleases him more than applying what he learned earning his degrees in hospitality and nutrition to prepare delicious yet healthy appetizers , entrees , and desserts for . He chafes , therefore , when the owner of the restaurant for which he works forces him to use cheaper , but less nutritional , ingredients in his recipes . Ben wants to be his own boss and thinks he sees a demand for his style of tasty , healthy cuisine . Trouble is , Ben , like most people , came from humble roots . He doesn have enough money to start his own restaurant , and he having difficulty borrowing what he needs because of some youthful indiscretions concerning money . If Ben is right , and he can obtain financing , his restaurant could become a chain that might revolutionize America eating habits , rendering Eric expose of the retail food industry , Fast Food Nation ( 2001 ) as obsolete as The Jungle ( 1901 ) Sinclair infamous description of the disgusting side of the early meatpacking industry . If Ben can get some financial help but is wrong about Americans preferring natural ingredients to this and that , he will have wasted his time and his backers may lose some money . Ifhe can not , however , the world will never know whether his idea was a good one or not . Ben a good guy , so he probably won turn to drugs and crime but his life will be less fulfilling , and Americans less healthy , if he never has a chance to pursue his dream . Married for a decade , Rose and Joe also had a dream , the American Dream , a huge house with a big , beautiful yard in a great neighborhood . The couple could not really afford such a home , but they found a lender that offered them low monthly payments . It seemed too good to be true because it was . Rose and Joe unwittingly agreed to a negative amortization mortgage with payment . Their monthly payments were so low because they paid just part of the interest due each year and none of the ( growing ) principal . When housing prices in their area began to slide downward , the lender foreclosed , although they had never missed a payment . They lost their home and , worse , their credit . The couple now rents a small apartment and harbors a deep mistrust of the financial system . URL books

Rob and Barb had a more modest dream of a nice house in a good location with many conveniences , a low crime rate , and a decent public school system . They found a suitable home , had their offer accepted , and obtained a conventional mortgage . But they too discovered that their ignorance of the financial system came with a price when they had selling their old house . They put it up for sale just as the Federal Reserve , America central bank ( monetary authority ) decided to raise the interest rate because the economy , including the housing market , was too hot ( growing too quickly ) a higher price level across the economy ( Higher interest meant it was more expensive to borrow money to buy a house ( or anything else for that matter ) To compensate , buyers decreased the amount they were willing to offer and in some cases stopped looking for a new home entirely . Unable to pay the mortgage on both houses , Rob and Barb eventually sold their old house for much less than they had hoped . The plasma , new carpeting , playground set in the yard , mower , and other goods they planned to buy evaporated . That may have been goodfor the economy by keeping in check , but Rob and Barb , like Rose , Joe , and Ben , wished they knew more about the economics ofmoney , banking , and interest ( Samantha too wished that she knew more about the system , particularly foreign exchange . Sam , as her friends called her , had grown up in Indiana , where she developed a vague sense that people in other countries use money that is somehow different from the dollar . But she never gave the matter much thought , until she spent a year in France as an exchange student . With only in her budget , she knew that things would be tight . As the dollar ( lost value ) France currency , the euro , she found that she had to pay more and more dollars to buy each euro . Poor Sam ran through her budget in six months . Unable to obtain employment in France , she returned home embittered , her still vibrating with her Indiana twang . Jorge would have been a rich man today had not invested his inheritance in government bonds in the late . The Treasury promptly paid the interest contractually due on those bonds , but high rates of and interest in the and early reduced their prices and wiped out most of their purchasing power . Instead of inheriting a fortune , Jorge received barely enough to buy a midsized automobile . That his father had worked so long and so hard for so little saddened Jorge . If only his father had understood a few simple facts when the supply of money increases faster than the demand URL books

for it , prices rise and ensues . When increases , so too do nominal interest rates . And when interest rates rise , the prices of bonds ( and many other types of assets that pay sums ) fall . Jorge father didn lack intelligence , and he wasn even atypical . Many people , even some otherwise ones , do not understand the basics of money , banking , and finance . And they and their loved ones pay for it , sometimes dearly . Madison knows that all too well . Her grandparents didn understand the importance of portfolio diversification ( the rule that you shouldn put all of your eggs in one basket ) so they invested their entire life savings in a single company , They lost everything ( except their Social Security checks ) after that bloated behemoth went bankrupt in December 2001 . Instead of lavishing her with gifts , Madison grandparents drained resources away from their granddaughter by constantly seeking handouts from Madison parents . When the grandparents life insurance , yet another parents had to pay big bucks for their Stop and Think Box History textbooks often portray the American Revolution as a rebellion against unjust taxation , but the colonists of British North America had other , more important grievances . For example , British imperial policies set in London made it difficult for the colonists to control the supply of money or interest rates . When money became scarce , as it often did , interest rates increased dramatically , which in turn caused the value of colonists homes , farms , and other real estate to decrease quickly and steeply . As a consequence , many lost their property in court proceedings and some even ended up in special debtors prisons . Why do history books fail to discuss this important monetary cause of the American Revolution ?

Most historians , like many people , generally do not fully understand the principles of money and banking . KEY TAKEAWAY People who understand the principles of money and banking are more likely to lead happy , successful , fulfilling lives than those who remain ignorant about them . ie books URL books an

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Hope Springs LEARNING OBJECTIVE . How can knowledge of the principles of money and banking help you to achieve your dreams ?

Of course , sometimes things go right , especially when one knows what one is doing . Henry , who as a young Jewish boy Nazi persecution in the , is now a billionaire because he understood what made interest rates ( and as well see , by extension , the prices of all sorts of instruments ) rise and fall . A little later , another immigrant from Central Europe , George , made a large fortune correctly predicting changes in exchange rates . Millions of other individuals have improved their lot in life ( though most not as much as and ! by making astute life decisions informed by knowledge ofthe economics ofmoney and banking . Your instructor and I can not guarantee you riches and fame , but we can assure you that , if you read this book carefully , attend class dutifully , and study hard , your life will be the better for it . The study of money and banking can be a daunting one for students . Seemingly familiar terms here take on new meanings . Derivatives refer not to calculus ( though calculus helps to calculate their value ) but to instruments for trading risks . Interest is not necessarily interesting stocks are not alive nor are they holding places for criminals zeroes can be quite valuable don contain music yield curves are sometimes straight lines and the principal is a sum of money or an owner , not the administrative head of a high school . In , unlike in retail or publishing , returns are a good thing . acronyms also abound , II , CAMELS , IMF , Now , sox , TIPS , TRAPS , and on and on . People who learn this strange new language and who learn to think like a banker ( or other type of ) will be rewarded many times over in their personal lives , business careers , and civic life . They will make better personal decisions , run their businesses or departments more , and be ben citizens . Whether they seek to climb the corporate ladder or start their own companies , they will discover that interest , and foreign exchange rates are as important to success as are cell phones , computers , and soft people skills . And a few will find a career in banking URL books

to be lucrative and fulfilling . Some , eager for a challenging and rewarding career , will try to start their own banks from scratch . And they will be able to do so , provided they are good enough to pass muster with investors and with government regulators charged with keeping the system , one of the most important sectors of the economy , safe and sound . One last thing . This book is about Western financial systems , not Islamic ones . Islamic performs the same functions as Western but tries to do so in a way that is , or , in other words , a way that accords with the teachings of the and its modern interpreters , who frown upon interest . To learn more about Islamic , which is currently growing and developing very rapidly , you can refer to one of the books listed in Suggested Readings . Stop and Think Box Gaining regulatory approval for a new bank has become so treacherous that consulting specializing in helping potential to navigate waters have arisen and some , like , have thrived . Why are regulations so stringent , especially for new banks ?

Why do people bother to form new banks if it is so difficult ?

Banking is such a complex and important part of the economy that the government can not allow anyone to do it . For similar reasons , it can not allow just anyone to perform surgery or a commercial airliner . People run the regulatory gauntlet because establishing a new bank can be extremely and exciting . KEY TAKEAWAY Not everyone will , or can , grow as wealthy as Henry , George , and other storied financiers , but everyone can improve their lives by understanding the financial system and their roles in it . URL books

Suggested Browsing Financial Literacy Foundation The is a organization created to address the growing problem of illiteracy among young Similar organizations include the Community Foundation for Financial Literacy ( and the Institute for Financial Literacy ( Museum of American Finance index In addition to its Web site and its stunning new physical space at the corner of William and Wall in Manhattan financial district , the Museum of American Finance publishes a history magazine . One of this book authors ( Wright ) sits on the editorial board . URL books 10

Suggested Reading , Understanding Islamic Finance . John Wiley and Sons , 2008 . Mahmoud . Islamic Finance Law , Economics , and Practice . New York Cambridge University Press , 2008 . Henry . On Money and Markets A Wall Street Memoir . New York Hill , 2001 , George . on Staying Ahead of the Curve . John Wiley and Sons , 1995 . URL books 11