If nations traded item for item, such as one automobile for 10,000 bags of coffee, foreign trade would be cumbersome and restrictive.
But instead of barter, which is the trade of goods without an exchange of money, all countries receive money in payment for what they sell. The United States pays for Brazilian coffee with dollars, which Brazil can then use the wool from Australia, which in turn can buy textiles from Great Britain, which can then buy tobacco from the United States.
Foreign trade, the exchange of goods between nations, takes place for many reasons such as: no nation has all the commodities that it needs, a country often does not have enough of a particular item to meet its needs, and one country can sell some items at a lower cost than other countries.
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FOR BANKING OPERATIONS
Seventeenth-century English goldsmiths provided the model for contemporary banking. Gold stored with these artisans for safekeeping was expected to be returned to the owners on demand. The goldsmiths soon discovered that the amount of gold actually removed by owners was only a fraction of the total stored. Thus, they could temporarily lend out some of this gold to others, obtaining a promissory note for principal and interest In time, paper certificates redeemable in gold coin were circulated instead of gold. Consequently, the total value of these banknotes in circulation exceeded the value of the gold that was exchangeable for the notes.
Two characteristics of this fractional reserve banking remain the basis for present-day operations. First, the banking system's monetary liabilities exceed its reserves. This feature was responsible in part for Western industrialization, and it still remains important for economic expansion. The excessive creation of money, however, may lead to inflation. Second, liabilities of the banks (deposits and borrowed money) are more liquid — that is, more readily convertible to cash-than are the assets (loans and investments) included on the banks' balance sheets. This characteristic enables consumers, businesses, and governments to finance activities that otherwise would be deferred or cancelled; however, it underlies banking's recurrent liquidity crises. When too many depositors request payment, the banking system is unable to respond because it lacks sufficient liquidity. The lack of liquidity means that banks must either abandon their promises to pay depositors or pay depositors until the bank runs out of money and fails. The advent of deposit insurance in the United States in 1935 did much to alleviate the fear of deposit losses due to bank failure and has been primarily responsible for the virtual absence of runs on US banks.
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COMMERCIAL BANKING IN THE USA
Commercial banks are the most significant of the financial intermediaries, accounting for some 60 percent of the nation's deposits and loans. The first bank to be chartered by the new federal government was the Bank of the United States, established in Philadelphia in 1791. By 1805 it had eight branches and served as the government's banker as well as the recipient of private and business deposits. The bank was authorized to issue as legal tender banknotes exchangeable for gold.
In the next three decades the number of banks grew rapidly in response to the flourishing economy and to the system of "free banking", that is, the granting of a bank charter to any group that fulfilled stated statutory conditions. Government fiscal operations were handled initially by private bankers and later (after 1846) by the Independent Treasury System, a network of government collecting and disbursing offices. The National Bank Act (1864) established the office of the comptroller of the currency to charter national banks that could issue national banknotes (this authority was not revoked until 1932). A uniform currency was achieved only after a tax on nonnational banknotes (1865) made their issuance unprofitable for the state-chartered banks. State banks survived by expanding their deposit-transfer function, continuing to this day a unique dual banking system, whereby a bank may obtain either a national or a state charter.
The stability hoped for by the framers of the National Bank Act was not achieved; banking crises occurred in 1873, 1883, 1893, and 1907, with bank runs and systemic bank failures. The Federal Reserve Act (1913) created a centralized reserve system that would act as a lender of last resort to forestall bank crises and would permit a more elastic currency to meet the needs of the economy. Reserve authorities, however, could not prevent massive bank failures during the 1920s and early 1930s.
The Banking Acts of 1933 and 1935 introduced major reforms into the system and its regulatory mechanism. Deposit banking was separated from investment banking; the monetary controls of the Federal Reserve were expanded, and its powers were centralized in its Board of Governors; and the Federal Deposit Insurance Corporation was created.
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BANKS AND BANK ACCOUNTS
Banks and bank accounts are regulated by both state and federal statutory law. Bank accounts may be established by national and state chartered banks, and savings associations. All are regulated by the law under which they were established.
Until the early 1980's interest rates on bank accounts were regulated and controlled by the national government. A ceiling existed on interest rates for savings accounts. Interest payments on demand deposit accounts were generally prohibited. Banks were also prohibited from offering money market accounts. The Depository Institutions Deregulation Act of 1980 (D1DRA) eliminated the interest rate controls on savings accounts. The restrictions on checking and money market accounts were lifted nationwide.
The operation of checking accounts is governed by state law supplemented by some federal law. Article 4 of the Uniform Commercial Code, which has been adopted at least in part in every state, "defines rights between parties with respect to bank deposits and collections." Part 1 of the Article contains general provisions and definitions. Part 2 governs the actions of the first bank to accept the check (depository bank) and other banks that handle the check but are not responsible for its final payment (collecting banks). Part 3 governs the actions of the bank that is responsible for the payment of the check (payer bank). Part 4 governs the relationship between a payer bank and its customers. Part 5 governs documentary drafts. These are checks or other types of drafts that will only be honored if certain papers are first presented to the payer of the draft.
The banking crisis of the 1930's led to the development of federal insurance for deposits which is currently administered by the Federal Deposit Insurance Corporation. Funding for the program comes from the premiums paid by member institutions. The bank accounts of individuals at institutions which are insured are protected for up to an aggregated total of $100,000.
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INTERNATIONAL TRADE ORGANIZATIONS, CONFERENCES
AND TREATIES
A large number of organizations exist that affect the multinational markets for goods, services, and investments.
GATT 1994 and WTO. The General Agreement on Tariffs and Trade 1994 (GATT 1994) is a multilateral treaty subscribed to by 125 member governments. It consists of the original 1947 GATT, numerous multilateral agreements negotiated since 1947, the Uruguay Round Agreements, and the agreement establishing the World Trade Organization (WTO). On January 1, 1995, the WTO took over responsibility of the former GATT organization. Since 1947 and the end of the World War II era, the goal of the GATT has been to liberalize world trade and make it secure for furthering economic growth and human development.
The GATT is based on the fundamental principles of (1) trade without discrimination and (2) protection through tariffs. The principle of trade without discrimination is embodied in its most favored nation clause. All member countries grant each other equal treatment. All member countries are equal and share the benefits of any moves toward lower trade barriers. Exceptions to this basic rule are allowed in regard to the European Union (EU) and the North American Free Trade Agreement (NAFTA). Special preferences are also granted to developing countries. The second basic principle is protection for domestic industry, which should be extended essentially through a tariff, not through other commercial measures. The aim of this rule is to make the extent of protection clear and to make competition possible.
The new WTO provides a Dispute Settlement Body (DSB) to enable member countries to resolve trade disputes. The DSB appoints panels to hear disputes concerning allegations of GATT agreement violations. If a GATT agreement violation is found and not removed by the offending country, trade sanctions authorized by a panel may be imposed on that country in an amount equal to the economic injury caused by the violation.
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EUROPEAN UNION
The European Economic Community (EEC) was established in 1958 by the Treaty of Rome in order to remove trade and economic barriers between member countries and to unify their economic policies. It changed its name and became the European Union (EU) after the Treaty of Maastricht was ratified on November 1, 1993. The Treaty of Rome contained the governing principles of this regional trading group. The treaty was signed by the original six nations of Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands. Membership expanded by the entry of Denmark, Ireland, and Great Britain in 1973; Greece in 1981; Spain and Portugal in 1986; and Austria. Sweden, and Finland in 1995.
Four main institutions make up the formal structure of the EU. The first, the European Council, consists of the heads of state of the member countries. I he council sets broad policy guidelines tor the EU. The second, the European Commission, implements decisions of the council and initiates actions against individuals, companies, or member states that violate EU law. The third, the European Parliament, has an advisory legislative role with limited veto powers. The fourth, the European Court of Justice (ECJ), is the judicial arm of the EU. The courts of member states may refer cases involving questions on the EU treaty to the ECJ.
The Single European Act eliminated internal barriers to the free movement of goods, persons, services, and capital between EU countries. The Treaty on European Union, signed in Maastricht, Netherlands (the Maastricht Treaty), amended the Treaty of Rome with a focus on monetary and political union. It set goals for the EU of (1) single monetary and fiscal policies, (2) common foreign and security policies, and (3) cooperation in justice and home affairs.
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THE FUNCTION OF BANKS IN NATIONAL ECONOMY
To be able to understand the role and the work of banks properly, we must first say what the term 'national economy' means. It covers three principal fields: industry, commerce and direct services.
Industry provides energy, raw materials and goods. The extractive industry produces coal, oil, gas, iron ore and a number of other metals and minerals from the ground or seabed. These are needed by the manufacturing industry for the production of machines and all those goods, which the customers buy: the car, the TV set, furniture, the dishwasher in the kitchen etc.
However, we do not get these goods direct from the factory but buy them in a shop or a department store. They are transported there and delivered to our homes by railroad, sometimes by ship or air, especially if they have been imported.
This brings us to another field of economy, commerce, which can be divided into trade and the service industries.
Trade is the buying and selling of any commodity. It can be divided into home trade and foreign trade.
A television set is transported several times before we can switch it on in our living room. Transport is, of course, a service which industry, trade and the consumer make use of. But it is only one of the service industries.
If the television set is damaged or gets lost while being transported, the insurance pays for this. Insurance is a service industry that specialises in covering risks of all kinds: damage, loss, fire, accidents - to give just a few examples.
Industry and commerce depend on precise, up-to-date information, which could not be provided, if we did not have our highly developed communication services like the telephone, telex and the post.
You may have noticed that banks have not been mentioned yet. Where does banking link up with the other sectors of a national economy? The simple answer is everywhere.
Banking:
• collects money from its clients in small or large amounts
• provides efficient means and methods of payment for goods and services
• finances industry, commerce and direct services
• grants credits to consumers for the purchase of consumer goods
• sells foreign currencies
• has contacts with all important national and international money and capital markets, etc.
Text 18
MONEY
Money is anything that is in general use in the purchase of goods and services and in the discharge of debts. Money may also be defined as an evidence of debt owed by society. The money supply in the US consists of currency (paper money), coins, and demand deposits (checking accounts). Currency and coins are government-created money, whereas demand deposits are bank-created money. Of these three components of the money supply, demand deposits are by far the most important. Thus, most of the money supply is invisible, intangible, and abstract.
The two most important inherent attributes that money must possess in a modern credit economy are acceptability and stability. In earlier times in the evolution of money and monetary institutions in the United States, the attributes of divisibility, portability, and visibility were important. The two legal attributes of 'legal tender' and 'standard money' are not of as much importance today as in the past.
The four functions that money often performs are (1) standard of value, (2) medium of exchange, (3) store of value, and (4) standard of deferred payment. In a modern specialized economy, (2) and, most especially, (1) are the most important of these.
Although it is agreed that the value of money has fallen in the US over time, there are three in part conflicting theories of value that have been advanced to explain this phenomenon: the commodity, quantity, and income theories. Most economists today espouse either the second or, more typically, the third of these. Any money can retain its value as long as its issuance is limited; it need not have a commodity backing. Inflation or rising prices have been explained by demand and/or supply theories in recent years, although historically the former has been thought to provide the more satisfactory explanation.
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MONEY AND ITS FUNCTIONS
All values in the economic system are measured in terms of money. Our goods and services are sold for money, and that money is in turn exchanged for other goods and services. Coins are adequate for small transactions, while paper notes are used for general business. There is additionally a wider sense of the word 'money', covering anything, which is used as a means of exchange, whatever form it may take. Originally, a valuable metal (gold, silver or copper) served as a constant store of value, and even today the American dollar is technically 'backed' by the store of gold which the US government maintains. Because gold has been universally regarded as a very valuable metal, national currencies were for many years judged in terms of the so-called 'gold standard'.
Nowadays however valuable metal has generally been replaced by paper notes. National currencies are considered to be as strong as the national economies, which support them. Paper notes are issued by governments and authorized banks, and are known as 'legal tender'.
The value of money is basically its value as a medium of exchange, or as economists put it, its 'purchasing power'. This purchasing power is dependent on supply and demand. If too much money is available, its value decreases, and it does not buy as much as it did, say five years earlier. This condition is known as 'inflation'.