quence the bank would go bankrupt and close. People ready to rush armoured cars full of cash to banks suffer- who had not been able to withdraw the raw their money in time ing from a bank run, people had more confidence that lost their savings. This happened most recently in their deposits were safe, which made bank runs a thing Canada during the Great Depression. of the past. In response to such bank failures, the Bank of Canada The rules of fractional reserve banking govern was established in 1935 and became a Crown Canada's commercial banks. Banks accept deposits, and Corporation, wholly owned by the Canadian govern- must, by law, keep a portion of these deposits as ment, in 1938. Besides being granted a monopoly on reserves. However, they are free to lend out the remain- the issuance of banknotes in Canada, the Bank was also der. As these loans may in turn re-enter the banking given responsibility for monetary policy and was to be system, much of the money (in terms of account bal- the lender of last resort to the commercial banks. It was ances) created in the Canadian economy is created by in this last role that it has been most useful. Once the the banks despite the Bank of Canada being the sole banks had the backing of the Bank of Canada, ever issuer of banknotes and other currency. Exercise 48 1. Define: a) STORE OF VALUE b) MEDIUM OF EXCHANGE c) UNIT OF ACCOUNT d) FRACTIONAL RESERVE BANKING 2. Why would people be unlikely to use fresh fish or mangoes as money? By contrast, what chemical property of gold has made it a preferred form of money for thousands of years? 3. a) If banks are required to keep 10% of deposits as reserves, how much can they lend out from an initial deposit of $1000? b) Say that amount loaned in 'a' is spent by the borrower, and then deposited in another bank by the merchant who sold the borrower goods and services. How much of this subsequent deposit must be kept and how much can be loaned out? c) Continue this process 5 or 6 times. How much money could conceivably be created by the banking system from that initial $1000 deposit? 172 Economics for CanadiansLesson 48 Money and Banking Money is an important part of the e system, As anyone who has played Monopoly knows, often wh want anything you have to offer offer in which case altrade is not possible. M his difficult Money has taken various forms throughout history. In locks to protect their own gold supplies, began to look the past, pressed clay tokens representing livestock or after the gold and other precious metals belonging to grain, ingots or coins made of metal, beaver pelts, other people (for a fee, or course). Over time, though, cowrie shells, playing cards and paper promissory notes the goldsmiths noticed that once people had entrusted (promising to pay gold or silver) have all been used. their metals to them, they rarely asked to see them or to Today most money is fiat money, which, in either its get them back. So, the goldsmiths began to lend their paper or electronic form, derives its value solely from depositor's gold and silver out to others, again in the willingness of other people to accept it in exchange exchange for a fee (which was not called interest as the for goods and services. The general tendency of money charging of interest (usury) was illegal under Church to, over time, become less physical and (and therefore law). However, they were careful to keep enough gold more convenient) reflects an increase in the level of and silver on hand to make sure that if some of their rust in the monetary system. Where once people need- depositors did come to take their precious metals back, ed money to have intrinsic value (metals, pelts), we that they would be able to provide it. how are quite used to and comfortable with money that, in and of itself, is really just paper or electrons. Eventually, as people began to feel more confident that their money was safe with the goldsmith/banker, they What then defines money as money is not its form, no longer felt a need to use their precious metals in hen, but rather its function. All monies have had to sat- transactions at all, preferring instead to use notes prom- sfy three main functions. First, they have had to serve ising to pay the bearer some of their precious metals. s a store of value. Money, be it beaver pelts, coins or People preferred these so called 'promissory notes' or ny bank balance as told to me by the ATM, should not 'letters of credit' as they were easier to carry around and se value ( or at least, not lose significant value) over were not as vulnerable to theft as the precious metals me. If it can store value reasonably well, then others themselves. Eventually, banks themselves began to issue ill be willing to accept it. Thus, it can serve as a banknotes, promising to pay the bearer gold (and edium of exchange - people can use it to acquire sometimes silver) 'upon demand' or upon presentation pods and services from others. If it is accepted as a of the banknote at the bank. So long as everyone had edium of exchange and a store of value, it then confidence that there was plenty of gold in the bank to comes a unit of account. If a certain form of money cover the notes, no one would seek to convert their widely accepted and used, then the value of goods notes to gold. d services in an economy will be measured in terms units of that money, making economic decision mak- However, periodically people would lose their confi- g easier. dence and the result would be a 'run on the bank'. Of course, there was rarely enough gold (or in later times, unking began when goldsmiths, who had quite strong notes) to satisfy all of the depositors and as a conse- 171