tag:blogger.com,1999:blog-72534942106932394122024-02-06T17:48:53.220-08:00Encyclopedia of MoneyAnastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comBlogger324125tag:blogger.com,1999:blog-7253494210693239412.post-70594925134731728622022-09-11T07:27:00.003-07:002022-09-11T07:27:48.470-07:00TROUBLED ASSET RELIEF PROGRAM<p style="text-align: justify;"> The Troubled Asset Relief Program, known as TARP, was the cornerstone of the United States program to address the U.S. financial crisis that began in 2008. It came into being in October 2008 with the enactment of the Emergency Economic Stabilization Act of 2008. The legislation was commonly billed as a $700 billion bailout for banks.</p><p style="text-align: justify;">The TARP plan evolved over time but originally its purpose was to buy bad loans, mortgage-backed securities, and collateralized debt obligations from banks. These assets went by the term “toxic assets” because they had no market value, and amounted to a severe threat to solvency of the banking system. At first it was thought that the government might be able to recover its investment because it would be purchasing these assets at bargain basement prices, and selling them for a profit later when the financial crisis had passed. Further consideration brought the realization that purchasing these assets at low prices undercut the capitalization of the banking system. Two weeks after the program’s enactment, the secretary of treasury shifted the focus of the program to emphasize the purchase of preferred stock in banks and guaranteeing troubled assets. If a bank recovers with the benefit of the government’s help, and its stock climbs, the government can sell its stake and recover at least some of the taxpayers’ investment.</p><p style="text-align: justify;">Citigroup was one of the large banks that benefited from the program. The United States Treasury first purchased $25 billion in preferred stock in Citigroup, and later another $20 billion. The United States government in addition guaranteed troubled loans and securities on Citigroup’s balance sheet on the order of $306 billion. In return for the guarantees, the government received another $7 billion stake in Citigroup (Curran, November 25, 2008). The government forced the top banks to participate in the government bailout. Otherwise, banks that elected not to participate would appear financially stronger, which might give a competitive advantage over the banks that did participate. For smaller banks, participation was voluntary. In the beginning, many smaller banks worried that participation in the program was equivalent to a confession of financial weakness. Once the government let it be known that it would not let banks that were fundamentally unhealthy participate in the program, perceptions changed. Banks began to fear that not applying for participation might be regarded as financial weakness.</p><p style="text-align: justify;">TARP drew criticism from the outset.</p><p style="text-align: justify;">The government did not seem to be doing enough to track how banks were using the infusions of government capital. Homeowners facing foreclosures received no relief from TARP funds. People wondered why it was more important to bail out Wall Street than to bail out families facing bankruptcy and home foreclosure. None of the TARP funds helped homeowners refinance mortgages that they could not pay. In December 2008, President Bush used his executive authority to make TARP funds available to U.S. automobile manufacturers. Both General Motors and Chrysler received TARP funds. The most controversial beneficiary of TARP funds was American International Group, a large insurance company. In January 2009, the new administration of President Obama vowed to revise the TARP plan to alleviate the rate of home foreclosures.</p><p style="text-align: justify;">Bank bailouts became a global phenomenon in 2008. The United Kingdom established a plan similar in strategy and scale to the one in the United States. The Royal Bank of Scotland was the largest beneficiary of government bailout money in the United Kingdom. In 2008, Sweden announced a sweeping bailout plan to save its banking system. Belgium bailed out a large bank in October 2008. Germany and Iceland both bailed out financial institutions. Switzerland, eager to protect its status as global banking center, put together a massive recapitalization of the United Bank of Switzerland.</p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2011/10/savings-and-loan-bailout-united-states.html">Savings and Loan Bailout</a></p><p style="text-align: justify;">References</p><p style="text-align: justify;">Cimilluca, Dana. “The Financial Crisis: Swiss Move to Back Troubled UBS; Under Plan, as Much as $60 Billion in Toxic Assets to be Taken Off Balance Sheet.” Wall Street Journal (Eastern Edition), October 17, 2008, p. A3.</p><p style="text-align: justify;">Curran, Rob. “Large Stock Focus: Citi Jumps on Bailout; B of A, Goldman Follow”, Wall Street Journal (Eastern Edition) November 25, 2008, p. C6.</p><p style="text-align: justify;">Kessler, Andy. “What Paulson Is Trying to Do.” Wall Street Journal (Eastern Edition) October 15, 2008, p. A19.</p><p style="text-align: justify;">Solomon, Deborah. “U.S. News: Obama Works to Overhaul TARP—Team Tries to Meld Some Paulson Ideas with Aid to Borrowers Facing Foreclosure.” Wall Street Journal (Eastern Edition), December 17, 2008, p. A3.</p><p style="text-align: justify;">Williamson, Elizabeth. “U.S. News: Rescue Cash Lures Thousand of Banks.” Wall Street Journal (Eastern Edition), November 3, 2008, p. A3.</p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-85584980693092493552022-09-11T07:20:00.001-07:002022-09-11T07:20:56.543-07:00UNIVERSAL BANKS<p style="text-align: justify;"> In addition to the traditional commercial banking activities of holding deposits and extending loans, universal banks offer a full range of financial services, including underwriting, issuing new offerings of stocks and bonds, and brokering stocks and bonds. Some universal banks provide insurance. Banks that only engage in underwriting new securities, floating new offers of securities, and brokering securities are called “investment banks.” Universal banks combine deposit banking of traditional commercial banking with investment banking.</p><p style="text-align: justify;">In the 1800s, banks in continental Europe and Germany in particular developed along the lines of universal banks, whereas in Britain deposit banking and investment banking tended to remain separate. In the United States, financier moguls such as J. P. Morgan introduced universal banking in the United States in the last decades leading up to World War I. Congress cut short the development of universal banking in the United States with the enactment of the Glass–Steagall Banking Act of 1933. Aimed at restoring public confidence in banks, this act prohibited commercial banks from investing in the stock market or providing investment bank services. In the German model of the 19th century, universal banks purchased corporate stock for customers. In exchange, customers yielded to banks proxies entitling banks to vote the customers’ shares in shareholder votes. The banks also purchased corporate stock on their own accounts. The control of a large piece of shareholder power ensured that the banks held positions on corporate boards of directors. The universal banks were also lenders to corporations. By holding seats on boards of directors, the banks had a voice in the management of companies that owed them money. In addition, they had an incentive to watch out for mismanagement at the expense of stockholders and creditors. It was an arrangement that put a large amount of power in the hands of banks.</p><p style="text-align: justify;">In the post–World War II era, universal banks enjoyed the greatest legal acceptance and experienced the fullest development in Germany. German universal banks hold large equity positions in corporations, have representatives on their boards, and exercise proxy votes for customer shareholders. Japan and Switzerland also followed the universal banking model. The economic success of these countries, and particularly the rapid economic growth in Germany and Japan, began to restore confidence in universal banking. Banks in these countries help to minimize conflicts between debt and equity holders and keep corporate management under tighter rein. By ensuring access to long-term financing, universal banks shield corporate managers from short pressures from fluctuations in stock market prices.</p><p style="text-align: justify;">Particularly in Germany, critics raised the issue of universal banks dominating the German stock market. It is said that rather than earning high dividends, banks were more interested in making loans to corporations on whose boards they had representation. In the 1990s, Germany experienced several corporate failures. In 1998, the German government enacted the Control and Transparency in Corporate Field Act. This act prohibits a bank holding more than 5 percent of a company’s shares from controlling the proxy voting rights for its bank customers who also own shares in the company.</p><p style="text-align: justify;">In the 1990s, momentum began to build to approve universal banking in the United States. Critics worried that universal banks would choose riskier investments because under a system of FDIC insurance the cost of funds to a bank does not vary with the riskiness of its investments.</p><p style="text-align: justify;">In 1999, the U.S. Congress lifted the ban on universal banking with the passage of the Financial Services Modernization Act of 1999. Replacing the Glass–Steagall Act of 1933, this act allowed the integration of banking, insurance, and stock-trading. By 2007, the United States boasted three large universal banks, Citigroup Inc., JPMorgan Chase & Co., and Bank of America Corp (Wall Street Journal, September 6, 2007). As the subprime financial crisis of 2008 unfolded in the United States, some observers felt the financial woes stemmed directly from dismantling the wall between deposit banking and investment banking. They were referring to the repeal of the Glass–Steagall Act. At first, the universal banks seemed to fare better than the investment banks. The financial crisis could be interpreted as a symptom of the shake-out and consolidation that analysts expected from the enactment of the Financial Services Modernization Act of 1999. As the financial crisis widened, however, the stock values of Citigroup, JPMorgan Chase, and Bank of America crashed, and the future of the institutions was very much in doubt. All three of the banks received large infusions of preferred stock investments from the United States Treasury.</p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2010/03/glass-steagall-banking-act-of-1933.html">Glass–Steagall Banking Act of 1933</a>, Troubled Asset Relief Program</p><p style="text-align: justify;">References</p><p style="text-align: justify;">Esen, Rita. “The Transition of German Universal Banks.” Journal of International Banking Regulation, vol. 2, no. 4 (2001): 50–57.</p><p style="text-align: justify;">Fohlin, Caroline. “Relationship Banking, Liquidity, and Investment in the German Industrialization.” Journal of Finance, vol. 53, no. 5 (October 1998): 1737–1758.</p><p style="text-align: justify;">Sidel, Robin. “Do-It-All Banks’ Big Test; Universal Model So Far Weathers Credit Crunch, Remains Controversial.”</p><p style="text-align: justify;">Wall Street Journal (Eastern Edition, New York) September 6, 2007, p. C1. Wall Street Journal (Eastern Edition). “Glass and Steagall Had a Point.” May 31, 2008, p. A10.</p><div style="text-align: justify;"><br /></div>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-69179700817916102152022-08-29T05:16:00.003-07:002022-08-29T05:18:04.902-07:00FEDERAL OPEN MARKET COMMITTEE (FOMC)<p style="text-align: justify;"> The Federal Open Market Committee (FOMC) is the chief policy-making group within the Federal Reserve System. It makes the key decisions for monetary policy in the United States. Monetary policy has to do with interest rates, credit conditions, and growth in the money supply.</p><p style="text-align: justify;">The FOMC consists of 12 members. All seven members of the board of governors of the Federal Reserve System serve on the FOMC. The president of the Federal Reserve Bank of New York is also a permanent member of the FOMC.</p><p style="text-align: justify;">The presidents of the 11 other regional Federal Reserve Banks hold the remaining four seats on a rotating basis. The seven presidents of regional Federal Reserve Banks who do not hold a seat attend meetings of the FOMC as nonvoting members. The chair of the board of governors of the Federal Reserve System also serves as chair of the FOMC. The president of the Federal Reserve Bank of New York serves as vice-chair. The seven members of the board of governors wield a powerful sway over monetary policy. They hold the majority of the voting seats on the FOMC and are permanent members. FOMC decisions are made either by consensus or near consensus. The president of the Federal Reserve Bank of New York owes his precedence over the other presidents to the special role played by the Federal Reserve Bank of New York. The Trading Desk at this bank carries out the day-to-day operations required to implement the policies decided by the FOMC. The account manager for the FOMC is the chief supervisor of the New York bank’s Trading Desk. That person is in daily contact with members of FOMC subcommittees. Normally, the FOMC meets eight times per year to assess monetary policy and make adjustments. If developments in the economy warrant quicker action, the FOMC holds additional meetings either in person or by conference call. Immediately after a meeting, the FOMC announces its decisions to an eagerly awaiting Wall Street and financial media. Financial markets often react within minutes of an announcement from the FOMC. Financial markets may react right before a meeting as speculators try to make money by betting on what action the FOMC will take.</p><p style="text-align: justify;">The wording of the formal instructions to the New York Trading Desk is decided at the FOMC meeting. Once the FOMC decides to change policy, the new policy is implemented immediately. The policies are implemented through the purchase and sale of U. S government securities. The Federal Reserve’s trading in U.S. government securities are called “open-market operations.” The New York Trading Desk decides the amount of securities to buy or sell to carry out the instructions handed down by the FOMC.</p><p style="text-align: justify;">The main interest rate the FOMC aims to influence is the Federal Funds Rate, which is the rate of interest commercial banks charge each other for overnight loans. The FOMC decides on a target for the Federal Funds Rate and instructs the New York Trading Desk to conduct the open-market operations necessary to maintain the targeted rate. To ease monetary policy, the FOMC lowers the targeted rate, and to tighten monetary policy, the FOMC raises the targeted rate.</p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2022/08/announcement-effect.html">Announcement Effect</a>, <a href="https://encyclopedia-of-money.blogspot.com/2011/10/open-market-operations.html">Open Market Operations</a></p><p style="text-align: justify;">References</p><p style="text-align: justify;">Meade, Ellen E. “The FOMC: Preferences, Voting, and Consensus.” Review, Federal Reserve Bank of St. Louis, March 2005, pp. 93–101.</p><p style="text-align: justify;">Thornton, Daniel L. “When Did the FOMC Begin Targeting the Federal Funds Rate? What the Verbatim Transcript Tells Us.” Working Papers, 2004-015, Federal Reserve Bank of St. Louis, 2005.</p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-6009843758386088652022-08-29T05:11:00.003-07:002022-08-29T05:16:53.382-07:00ANNOUNCEMENT EFFECT<p style="text-align: justify;"> Central banks publically announce intentions of maintaining a key policy interest rate at a certain level called the “target rate.” The practice of announcing targets is relatively recent, and represents a sharp departure from the confidentiality and secretiveness that was once thought to be a necessary part of monetary policy and open market operations. The “announcement effect” refers to a central bank’s ability to control a key interest rate merely by announcing its intentions.</p><p style="text-align: justify;">In the United States, the key policy interest rate targeted by the central bank is the federal funds rate, and the central bank is the Federal Reserve System. The federal funds rate is the interest rate at which commercial banks can borrow funds from each other overnight. The federal funds rate reflects the market tightness for these funds. The Federal Reserve can ease tightness in this market by purchasing U.S. government bonds, and can tighten this market by selling U.S. government securities. Buying U.S. government securities injects additional funds into the banking system, allowing banks to increase lending and enlarge the money supply in the process. Central bank purchases and sales of government securities are called “open market operations.” In the Federal Reserve System, a policy-making group called the Federal Open Market Committee (FOMC) formulates the policy for open market operations.</p><p style="text-align: justify;">Until 1994, the Federal Reserve kept directives involving open market operations a secret until 45 days after an FOMC meeting, keeping current financial market participants unaware of the Federal Reserve’s policy stance at a given point in time. In 1976, the Federal Reserve successfully defended itself against an inquiry filed under the Freedom of Information Act to obtain copies of the minutes of FOMC meetings without the 45-day delay. Federal Reserve cited an “announcement effect” that might lead to volatility and uncertainty in financial markets, and maintained that secrecy was a necessary part of monetary policy.</p><p style="text-align: justify;">On 4 February 1994, the FOMC, amidst a two-day meeting, announced that it planned to apply slight pressure to commercial bank reserve positions, and that short-term interest rates could be expected to rise, breaking the Federal Reserve’s long stance policy of secrecy in these matters. It was an experiment in clearly communicating policy decisions to financial markets, and using public announcements as a method of communication. The experiment had none of the dire consequences that the Federal Reserve cited in its 1976 defense against a Freedom of Information inquiry. The practice of publically announcing policy decisions and targets became a standard part of central banking in the United States and in numerous other countries. What became known as the “announcement effect” enabled central banks to control a targeted interest rate with fewer interventions in the open market. It gave central banks the ability to control a targeted interest rate merely by announcing its intentions and taking little or no immediate action.</p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2022/08/federal-open-market-committee-fomc.html">Federal Open Market Committee</a>, <a href="https://encyclopedia-of-money.blogspot.com/2011/10/open-market-operations.html">Open Market Operations</a></p><p style="text-align: justify;">References</p><p style="text-align: justify;">Belongia, Michael T., and Kevin Kliesen. “Effects on Interest Rates of Immediately Releasing FOMC Directives.” Contemporary Economic Policy, vol. 12, no. 4: 79–91.</p><p style="text-align: justify;">Demiralp, Selva, and Oscar Jorda. “The Response of Term Rates to Fed Announcements.” Journal of Money, Credit, and Banking, vol. 36, no. 3 (June 2004, part 1): 387–405.</p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-24605282999493319072022-08-18T08:49:00.006-07:002022-08-18T08:52:05.800-07:00LIQUIDITY TRAP<p style="text-align: justify;"> A liquidity trap is a macroeconomic condition in which injecting additional money and liquidity into an economy exerts very little impact on overall price levels, output, or employment. It is a macroeconomic phenomenon, meaning that it applies to the economy as a whole and not to industries individually. Only an economy at a low point in a business cycle is at risk of developing a liquidity trap. During a recession, a liquidity trap can become a major hindrance to economic recovery, considerably complicating the task of designing an effective economic policy.</p><p style="text-align: justify;">The liquidity trap at first seems more of a puzzle than a trap. It seems paradoxical that the money stock can grow without commiserate growth in spending. Theories of inflation assume that money stock growth does lead to comparable growth in spending, and the growth in spending drives inflation. Only economies experiencing deflation or near deflation seem to be at risk of developing a liquidity trap.</p><p style="text-align: justify;">A liquidity trap becomes possible because money, particularly bank balances, can act as a substitute for stocks and bonds, and may even become an attractive substitute if interest rates drop to very low levels. Money pays little or no interest, but it is the most liquid of all financial assets. Liquidity confers certain advantages. It puts one in a position to exploit speculative opportunities or handle financial emergencies. To offset the advantages of liquidity, stocks and bonds pay dividends and higher interest. The danger of a liquidity trap occurs when interest rates reach very low levels, probably lower than 1 percent. Unusually low interest rates of this order occurred in the United States during the 1930s, and again in Japan in the 1990s. Extremely low interest rates, coupled with fear of deflation, makes bank balances a highly attractive financial asset compared to much less liquid stocks and bonds. Low interest rates involve the expectation that interest rates will be higher in the future. Investors do not want to lock in a low interest rate by purchasing longer term financial assets when interest rates are low.</p><p style="text-align: justify;">The practical significance of a liquidity trap is that it leaves the monetary authority powerless to stimulate the economy by increasing the money supply. The main ingredient of a monetary stimulus is the purchase of government bonds with newly printed money. Called “open-market operations,” this action makes the bond market more of a seller’s market, meaning bond sellers can sell bonds at lower expected yields. In other words, interest rates fall. In a liquidity trap, the preference for holding bank balances over bonds becomes so strong that open-market operations can no longer reduce interest rates. Falling interest rates no longer accompany above average growth in the money supply.</p><p style="text-align: justify;">As a recession unfolds, the market for used capital goods is likely to see severe deflation, which will undercut the prices of new capital goods. Businesses become hesitant to purchase capital goods if they come to expect that capital goods can be purchased at lower prices in the future. Falling demand for finished goods further undermines the willingness to purchase capital goods. With the liquidity trap acting as a floor under interest rates, openmarket operations cannot push interest rates low enough to stem the tide of falling investment spending. The economy sinks deeper into recession.</p><p style="text-align: justify;">The cure for a liquidity trap involves a high level of government deficit spending to compensate for the absence of business investment spending. In the 1990s, the Japanese government baulked at enlarging the public debt on the scale needed to lift Japan out of the liquidity trap. The Japanese economy languished in recession during much of the 1990s.</p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2011/10/open-market-operations.html">Open Market Operations</a></p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-65808860102319736652022-08-18T08:44:00.007-07:002022-08-18T08:50:25.093-07:00U.S. FINANCIAL CRISIS OF 2008–2009<p style="text-align: justify;">The U.S. financial crisis of 2008–2009 owed its origins to a failure of institutions to adjust to rapid innovation in the home mortgage industry. The size and importance of the United States in the global economic and financial system left little doubt that the outcome would take on global dimensions.</p><p style="text-align: justify;">The roots of the U.S. financial crisis go back to the aftermath of the 1990s economic prosperity. The 1990s saw the longest economic expansion recorded in U.S. history. The long expansion received its thrust from an investment boom in information technology industries. Easy credit fed the investment boom for a time. When the United States started tightening credit, a high-tech stock bubble burst, the investment boom ended, and the United States entered into recession. In a bid to resuscitate the United States economy, the government again turned to easy credit and bargain basement interest rates.</p><p style="text-align: justify;">Low interest rates and easy credit between 2002 and 2005 sparked a boom in housing, creating a housing bubble comparable to the high-tech stock bubble of the 1990s. A housing bubble posed special risk to the financial system because houses are one asset that can be purchased with small down payments. Compared to purchasers of corporate stock, purchasers of houses can put in a much smaller share of their own money.</p><p style="text-align: justify;">Dodd and Mills (June 2008) lay out every step in the development of the crisis. A long upswing in house prices had put creditors at ease about the risk of home mortgages. A house seemed to be bullet-proof collateral. Lenders began granting riskier loans and being less thorough in verifying the income, jobs, and assets of borrowers. Some mortgage originators went so far as to offer interest-only loans and negative amortization payment options. Negative amortization meant the borrower’s monthly payment was not even covering all the interest charges, much less paying down the principal. Lenders felt that escalation in house prices assured that a house could always be refinanced for larger amounts, or sold to pay off a mortgage. Rising house prices should translate into falling loan-to-value ratios for creditors.</p><p style="text-align: justify;">Another weak link in the stability of the financial situation was in the process of packaging home mortgages into financial securities. Investors buying these mortgage-backed securities had to rely on the same credit rating agencies that rated bonds. Well-established and reputable rating agencies such as Standard and Poor’s and Moody’s had performed well in rating bonds but had little knowledge or experience in mortgage-backed securities. Since mortgage-backed securities were new, no historical data existed to estimate past performance and risk. These agencies awarded top ratings of AAA to over 90 percent of the mortgage-backed securities based on subprime loans (Dodd and Mills, June 2008).</p><p style="text-align: justify;">Investors purchased mortgage-backed securities with borrowed funds and counted on being able to trade out of these investments in a hurry to cut losses. Mortgage-backed securities, however, were sold in an over-thecounter market, and no dealers committed themselves to making a market for them. As the poor quality of the mortgages became evident, no dealers came forward willing to maintain an inventory of these securities. The market for mortgage-backed securities became a market where everybody wanted to sell and nobody wanted to buy.</p><p style="text-align: justify;">The magnitude of investor losses from mortgage-backed securities would have been easily manageable if the problem had not had wider implications. Mortgage delinquencies and home foreclosures began to mount in 2006 and 2007 amid an otherwise expanding economy. It became clear that many homeowners could only make their mortgage payments if home prices continued to escalate, allowing them to refinance their homes before the teaser interest rates on their existing home mortgages expired. It was equally obvious that many loan applications had inflated measures of borrowers’ income and house appraisal values. Falling home prices triggered a wave of foreclosures. Upward interest rate adjustments on adjustable-rate mortgages worsened an already bad situation.</p><p style="text-align: justify;">A related casualty of the mortgagebacked securities market debacle was investor confidence in the credit ratings agencies such as Standard and Poor’s and Moody’s. These agencies were forced to downgrade the credit ratings of mortgage-backed securities at a much faster pace than had ever been seen for corporate bonds.</p><p style="text-align: justify;">The month of July 2007 saw a significant round of ratings downgrades for mortgage-backed securities. Wall Street hedge funds began trying to liquidate large positions in these securities. In August 2007, the French bank BNP Paribas suspended withdrawals from some money market funds that were heavily invested in U.S. mortgage-backed securities. The bank claimed it had no way of putting a value on these assets. Expecting a wave of customer cash withdrawals, other money market fund managers shifted these portfolios from medium- and long-term bank deposits and commercial paper to overnight deposits. The strong demand for liquidity drained the supply of funds for short-term commercial credit instruments. The market for what was called “asset-backed commercial paper” collapsed.</p><p style="text-align: justify;">The collapse of the asset-backed commercial paper market brought to the surface the role of the structured investment vehicles that a number of banks sponsored as off-balance sheet entities. Banks sponsored these off-balance sheet entities to skirt banking regulations. They amounted to a hidden banking system. These structured investment vehicles raised funds by selling asset-backed commercial paper and invested the funds in longer-term assets that paid higher interest rates. Part of the arrangement was that the sponsoring banks were obligated to provide credit to the structured investment vehicle when necessary. When the market for asset-backed commercial paper collapsed, sponsoring banks had to meet unwanted and inconvenient loan commitments.</p><p style="text-align: justify;">Banks, unable to raise funds by selling loans and fearful of depositor withdrawals, set to hoarding liquidity. They were caught in a squeeze between keeping loans on their books that they had planned on selling, and honoring loan commitments to hedge funds and corporate entities, commitments that they wished they had not made.</p><p style="text-align: justify;">In March 2008, the Wall Street firm of Bear Stearns saw a run on its deposits that would have ended in bankruptcy if the Federal Reserve had not assisted in its acquisition by JPMorgan Chase. In September, the United States government announced a takeover of Fannie Mae and Freddie Mac, two government-sponsored enterprises concerned exclusively with the home mortgage market. Later in September, the Wall Street firm Lehman Brothers failed. The United States Treasury refused to bail out Lehman Brothers but did encourage other firms to acquire it. When no buyers appeared, Lehman Brothers went into liquidation.</p><p style="text-align: justify;">Another important industry found itself drawn in to the mortgage-backed security debacle. Bond insurers usually provided investors with default insurance against municipal and infrastructure bonds. The firms had begun selling default insurance for the mortgagebacked securities. Rising mortgage delinquencies and foreclosures hammered the stocks and credit ratings of bond-insuring companies and left in doubt the ability of these companies to honor default insurance claims in the municipal bond market and the student loan market, making these investments much less attractive.</p><p style="text-align: justify;">The outcome of these developments was a banking system less willing and able to make loans and demanding U.S. Financial Crisis of 2008–2009 | 415 Media and pedestrians gather in front of the Lehman Brothers headquarters in New York on September 15, 2008, the day the 158-year-old financial firm filed for bankruptcy. (AP Photo/ Louis Lanzano) tighter criteria of credit worthiness. A seizing of credit markets hobbled private initiative among producers and consumers. The forces of recession gathered strength as firms across industries reported falling earnings. October 2008, stock markets around the world entered a steep slide. The world braced for a global recession. Economic policy makers assumed that the economic situation in the United States was developing along the lines of a liquidity trap. The Federal Reserve System, the central bank of the United States, pushed its policy interest rate to near zero and allowed banks to use a wider range of assets to borrow funds. The U.S. government met the crisis with plans for massive increases in deficit spending. In a liquidity trap, massive government spending is needed to offset the combined effects of strong liquidity preference and pessimistic expectations.</p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2022/08/liquidity-trap.html">Liquidity Trap</a></p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-22614929460150470522022-08-18T08:38:00.003-07:002022-08-18T08:45:18.339-07:00ADJUSTABLE-RATE MORTGAGES<p style="text-align: justify;">An adjustable-rate mortgage (ARM) provides for varying interest rates over the life of the mortgage. It forces the borrower to shoulder some of the risks that fixed-rate loans place on the lender. Key to the rationale for ARMs is the almost one-to-one relationship between short-term interest rates and inflation rates. Over the life of a 30-year, fixedrate mortgage, inflation ranks among the biggest enemies that a lender faces. Increases in the inflation rate reduce the real (inflation-adjusted) rate of interest that a mortgage pays to a lender. Higher inflation reduces the real purchasing power of each monthly payment while pushing up the real operating cost of a lender. If the inflation rate happens to rise above a mortgage interest rate, the lender ends up earning a negative real interest rate.</p><p style="text-align: justify;">The high inflation rates of the 1970s taught lenders the damage that inflation can wreak on the interest income earned from mortgages. Lenders began demanding higher interest rates on 30-year mortgages as insurance against a wave of inflation wiping out the profits and capital of mortgage holders. Adjustable-rate mortgages developed as a way to get home buyers into houses without paying the high interest rates attached to 30-year, fixed-rate mortgages.</p><p style="text-align: justify;">Under an ARM, the mortgage interest rate at any given time is linked or indexed to a short-term interest rate. Two short-term, benchmark interest rates commonly used for setting ARM interest rates are the London Interbank Offered Rate (LIBOR) and the one-year, constant maturity treasury bond rate. The interest rate on an ARM is adjusted periodically to reflect changes in a benchmark interest rate. The home buyer benefits because short-term interest rates are usually lower than long-term interest rates, since short-term rates have less inflation risk. The disadvantage to the home buyer lies in the risk that short-term interest rates go up, probably because of rising inflation or anti-inflation policies. If short-term interest rates go up, the monthly payments on ARMs go up. With ARMs, the burden of accelerated inflation is born by the borrower instead of the lender. In turn for bearing the risk of accelerated future inflation, the home buyer stands a chance getting by with lower interest rates. If inflation never drives up short-term interest rates over the life of the loan, the home buyer comes out ahead.</p><p style="text-align: justify;">Adjustable-rate mortgages come in several varieties. In some mortgages, the monthly payment can change every month, depending on the benchmark interest rate. Other mortgages allow changes in monthly payments as infrequently as every five years. The time frame between rate changes is called the “adjustment period.” A mortgage with a one-year adjustment period is called a one-year ARM.</p><p style="text-align: justify;">Many ARMs put a cap on the amount that a mortgage interest rate can change from one adjustment period to the next. This provision protects home buyers from large jumps in interest rates and monthly payments. Other contracts put a limit on the amount that monthly payments can increase from one adjustment period to the next. If interest rate adjustments call for a 10 percent increase in monthly payments, but the contract only allows monthly payments to go up 5 percent, then the unpaid interest will be added to the balance of the mortgage. By law, nearly all ARMs have a cap on how high interest rates can go over the life of a mortgage.</p><p style="text-align: justify;">One version of the ARM allows the home buyer to pay an initial interest rate well below the benchmark interest rate used for setting an ARM interest rate. The home buyer enjoys the low interest rate, often called a teaser rate, for an initial period, such as a year. Then the interest rate is adjusted upward according to the indexing formula tied to the benchmark interest rate. If shortterm interest rates happen to be rising at the same time that a homeowner is transitioning from the teaser rate to the fully indexed, benchmark rate, then the home owner may experience “payment shock.” The large increase in monthly payment may leave a home owner unable to make a house payment. The practice of offering teaser rates contributed to the severity of the subprime mortgage crisis in the United States. </p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2022/08/us-financial-crisis-of-20082009.html">U.S. Financial Crisis of 2008–2009</a></p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-71491714235664088892022-04-06T07:08:00.005-07:002022-04-06T07:09:20.311-07:00Mexican peso crisis of 1994<p style="text-align: justify;">The sharp depreciation of the Mexican peso in December 1994 marked one of the swiftest macroeconomic reversals in the history of developing economies and currency crises. President Ernesto Zedillo had barely been in office three weeks when, on December 19, 1994, his administration asked the Banco de Mexico to undertake roughly 15 percent devaluation of the peso, adjusting the pegged exchange rate from 3.45 pesos per dollar to 4.00 pesos per dollar (Sharma, 2001). It was a modest devaluation, but it undercut the confidence of foreign investors and touched off a wild speculative run against the peso. On December 22, 1994, the Banco of Mexico, unable to defend the peso against stampeding, panic-stricken foreign investors, allowed the peso to float. The peso immediately sank another 15 percent (Sharma, 2001). By February 16, 1995, the peso had depreciated 42 percent against the U.S. dollar (Torres, February 1995). The peso reached its nadir at 7.65 pesos per U.S. dollar (Sharma, 2001).</p><p style="text-align: justify;">The outgoing President Carlos Salinas and the soon-to-be President Zedillo met on November 20, 1994, to discuss the currency situation. The Friday before, Mexico had lost $1.7 billion in a run on the peso. The two leaders agreed that devaluation on the order of 10 percent was needed, but the outgoing officials refused to devalue the currency on their watch (Wessel, July 1995).</p><p style="text-align: justify;">The peso crisis caught many observers and investors by surprise. Mexico had become the darling of Wall Street. Mexico’s economic policy seemed to have all the right ingredients. It emphasized privatization and deregulation of state-owned enterprises, restrictive monetary and fiscal policies, and a pegged exchange rate relative to the U.S. dollar. The ratification of the North American Free Trade Agreement (NAFTA) in January 1994 opened Mexico’s economy to the largest consumer market in the world. Between 1989 and 1994, Mexico’s gross domestic product (GDP) growth averaged 3.9 percent (Sharma, 2001). Mexico’s inflation rate, which raged as high as 160 percent in 1987, sank to single-digit territory in 1993 (Sharma, 2001). Government indebtedness as a percent of GDP shrank from 15 percent in 1987 to 1 percent in 1992 and 1993 (Sharma, 2001). Between 1987 and 1994, government spending as a percent of GDP shriveled from 44 percent to 24.6 per cent (Sharma, 2001). In February 1994, Mexico’s foreign exchange reserves stood at $28 billion, well above the $6.3 billion level held in 1989 (Sharma, 2001). With the dawn of NAFTA, Wall Street saw no limits to Mexico’s potential.</p><p style="text-align: justify;">In hindsight, one economic statistic signaled trouble. Mexico’s current account deficit steadily climbed from $6 billion in 1989 to $20 billion by the end of 1993 (Sharma, 2001). Mexico’s imports were growing much faster than its exports. Current account deficits reflect either a high level of government deficit spending, high levels of private investment spending relative to savings, or some combination. In 1994, government deficit spending in Mexico was minimal, and the high level of private investment spending seemed to reflect Mexico’s bright future under NAFTA. Foreign portfolio investments in Mexican stocks and short-term bonds made possible the high level of investment spending. It also left Mexico vulnerable to a sudden outflow of foreign capital.</p><p style="text-align: justify;">In 1994, foreign investors began to get jittery over the size of Mexico’s current account deficit. Mexico tamed inflation, but did not eradicate it. Under a pegged exchange rate, inflation increases the prices of domestic goods, but does not affect the price of imported foreign goods unless the peg is adjusted. Mexico failed to adjust the pegged exchange rate to compensate for domestic inflation, encouraging Mexico’s consumers to purchase more imported goods at the expense of domestically produced goods. As long as foreigners exhibited a strong appetite for Mexican stocks and bonds, the Mexican government felt no pressure to devalue its currency. The peso appeared to be in high demand at the current exchange rate.</p><p style="text-align: justify;">In 1994, the strong foreign demand for portfolio investments in Mexico began to diminish over worries about Mexico’s rising current account deficit. Rising current account deficits often lead to a devaluation of a currency. If a currency depreciates 25 percent, foreign investors immediately see the value of their investment depreciate by 25 percent.</p><p style="text-align: justify;">Part of the attraction of Mexican stocks and bonds had to do with low interest rates in the United States. Throughout 1993, the U.S. federal funds rate remained at 3 percent. In 1994, the Federal Reserve System started raising the federal funds rate, pushing it up to 5.5 percent by November 1994 (Sharma, 2001). As interest rates rose in the United States, investors became less willing to chase higher interest rates in developing countries and emerging markets. When the Mexican government announced a devaluation of the peso in December 1994, foreign investors decided it was time to get out of Mexico.</p><p style="text-align: justify;">After the peso crisis, Mexico’s economy sank into steep recession. Inflation soared as devaluation lifted the prices of imported goods. In the United States, President Bill Clinton put together a nearly $50 billion rescue package (Greenwald and Carney, 1995). Without the rescue package, the Mexican government would have defaulted on a large amount of dollar-denominated government bonds. (In 1994, the Mexican government had started issuing dollar-denomniated bonds to ease investor fears about devaluation of the peso.) The rescue package helped calm markets and limited the damage inflicted on other Latin American countries.</p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2022/04/east-asian-financial-crisis.html">East Asian Financial Crisis</a>, <a href="https://encyclopedia-of-money.blogspot.com/2022/04/currency-crises.html">Currency Crises</a></p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-8471280834384424802022-04-06T07:00:00.002-07:002022-04-06T07:03:34.782-07:00Current account<p style="text-align: justify;">The current account summarizes transactions that fall within the categories of imports or exports of good and services, income earned abroad, domestically generated income belonging to foreigners, and unilateral transfers. The common denominator behind all these transactions is the involvement of an inflow or outflow of currency. Unilateral transfers include foreign aid and gifts of money from residents of one country to family members living in another country. Cross-country investments, such as buying and selling foreign stocks and bonds, also involve currency inflows and outflows, but are summarized in another account called the capital account. A third account, the official reserves transactions account, summarizes central bank transactions that involve an inflow or outflow of currency and that change official reserve holdings. A Federal Reserve purchase of gold with dollars is an example of the type of transaction covered by the official reserves transactions account. These three accounts make up the balance of payments.</p><p style="text-align: justify;">The current account balance is considered a significant indicator of the economic and monetary health of a country. It is among the handful of indicators that the Economist magazine reports for major countries of the world. The Economist reports the current account balance both in absolute numbers and as a percent of gross domestic product (GDP).</p><p style="text-align: justify;">On the current account, transactions that involve an outflow of currency are a debit item, and transactions that involve an inflow of currency are a credit item. Exports of goods and services are a credit and imports are a debit. The foreign expenditures of a U.S. family visiting Greece count as an export on the U.S. current account. The interest income that a resident earns on a foreign bond counts as a credit. The interest income that a domestic bond pays to a foreign owner is a debit. Money residents send to family members living abroad counts as a debit. If the money value of the debits outweighs the money value of the credits, then the outflow of currency outruns the inflow of currency, and a country has a current account deficit. If the credits exceed the debits, the country has a current account surplus.</p><p style="text-align: justify;">Persistent current account deficits is often regarded as an indication that a currency is overvalued and therefore faces a heightened risk of future depreciation. The largest component in the current account balance is net exports (exports minus imports). A current account deficit is nearly always an indication that imports exceed exports. As the value of a country’s currency goes up in foreign exchange markets, foreign imports into that country become less costly while exports from that country become costlier in foreign markets. An excess of imports over exports suggests that a domestic currency is too strong and likely to weaken in the future. A current account deficit indicates that the currency outflow on the current account exceeds the inflow. If the excess outflow of currency from a current account deficit is not offset by an excess inflow on a capital account surplus, a currency will depreciate unless a government is able and willing to take action. Governments usually hold sufficient official reserves to defend domestic currencies against speculative attacks, but not against long-term downward trends driven by market forces.</p><p style="text-align: justify;">Currencies can remain strong in foreign exchange markets for extended periods of time in situations where a large current account deficit is offset by a large capital account surplus. A capital account surplus indicates that the inflow of foreign capital exceeds the outflow of domestic capital to foreign countries. A net inflow of capital equates to a net inflow of currency. Countries with persistent current account deficits often maintain elevated interest rates. The high interest rates encourage the inflow of foreign capital, offsetting the tendency of a current account deficit to undermine the value of a currency.</p><p style="text-align: justify;">Even with strong capital inflows, a current account deficit is regarded as a risk factor in foreign exchange markets. The components in the current account are not tightly linked to the volatility and varying psychology of financial markets whereas capital flows are tightly linked to conditions in financial markets. Capital flows are much more sensitive than exports and imports to changes in expectations, and can therefore be more volatile. A net capital inflow can quickly change to net capital outflow, leading to almost certain currency depreciation and crashing financial markets for a country with a current account deficit. Currency speculators are always closely watching countries using elevated interest rates to sustain current account deficits offset by capital account surpluses. If these speculators see signs that elevated interest rates are pushing a country with a current account deficit into recession, they will dump the currency of that country. The value of the currency will crash in foreign exchange markets, domestic financial markets will crash, and the country will likely undergo a full-blown economic collapse.</p><p style="text-align: justify;">For several years, the United States has been able sustain current account deficits with little difficultly. That is because the United States holds a reputation as a safe haven for foreign capital. United States’ investments are considered among the safest in the world. Over the last 30 years, however, the Japanese yen has gained strength relative to the dollar, reflecting the fact that Japan usually has current account surpluses and the United States usually has current account deficits.</p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2010/01/balance-of-payments.html">Balance of Payments</a>, <a href="https://encyclopedia-of-money.blogspot.com/2022/04/currency-crises.html">Currency Crises</a>, <a href="https://encyclopedia-of-money.blogspot.com/2010/02/foreign-exchange-markets.html">Foreign Exchange Markets</a></p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-45742634855620243442022-04-05T04:20:00.004-07:002022-04-05T04:20:56.670-07:00East asian financial crisis<p style="text-align: justify;"> n 1997, a financial crisis threw the East Asian economies into a financial chaos that threatened to derail the East Asian economic miracle and engulf the global financial system. In the 1990s, East Asia had become the scene of a new group of economic miracles. From the mid1990s until the outbreak of financial crisis, East Asian countries such as Thailand, Singapore, Indonesia, South Korea, and Malaysia posted real gross domestic product (GDP) growth rates in the 8 percent range or higher (International Monetary Fund, 1997).</p><p style="text-align: justify;">Until the East Asian financial crisis, currency crises were often the domain of countries suffering from high inflation, slow growth, large government budget deficits, low savings, and political instability. Unlike the usual candidates for currency crises, the East Asian countries had what economists call “sound macroeconomic fundamentals.” They had high savings rates, low public debts, fast growth and low inflation—the very qualities that win the confidence of foreign investors.</p><p style="text-align: justify;">One crack in the foundation involved the structure of corporate finance. Enterprises had relied too heavily on debt financing as opposed to stock issuance. Enterprises do not face bankruptcy when the value of company stock plunges, but they do face bankruptcy when they cannot pay debts. An equally important vulnerability stemmed from the balance sheets of East Asian banks. These banks borrowed foreign capital on a short-term basis to underwrite long-term loans. The short-term nature of the foreign capital inflows left these banks open to a sudden and unexpected reversal from a foreign capital inflow to a foreign capital outflow. A sudden reversal of foreign capital flows made these banks and enterprises illiquid. Much of the foreign debt was denominated in dollars. When the exchange rates of local currencies fell, the real value of foreign debt in local currencies skyrocketed.</p><p style="text-align: justify;">The East Asian countries practiced an economic policy that pegged the value of their local currencies to a basket of currencies in which the U.S. dollar played a highly dominate role. The rate at which a local currency could be converted into dollars remained almost constant. This policy shared in making East Asia an attractive haven for foreign capital, but it also was the undoing of these economies. In the late 1990s, the value of the U. S dollar went up, probably because of strong global demand for U.S. financial assets. As the value of the dollar climbed, the values of currencies linked to the dollar, such as the East Asian currencies, also climbed. The appreciation of a country’s currency leaves the exports of that country more expensive in foreign markets. It also makes foreign imports into that country less costly. Falling exports and rising imports left the East Asian economies with current account deficits that needed to be financed by an inflow of foreign capital. East Asian companies began to feel the pain as sales fell off in foreign markets, and domestic sales faced greater completion from imports. In addition, East Asian central banks raised interest rates to increase the attraction for foreign capital. The policy of keeping the local currency exchange rates pegged to the dollar required that current account deficits be financed by foreign capital inflows. Otherwise, the value of the local currency relative to the dollar would sink.</p><p style="text-align: justify;">The economic and financial situation in Thailand sparked the crisis. Many currency traders believed that the baht, Thailand’s currency, traded too high, higher than the central bank of Thailand could support.</p><p style="text-align: justify;">Thailand’s economy was already suffering from double-digit interest rates and depressed stock prices. Currency traders launched billions of dollars of sell contracts on the baht. Fears of currency depreciation excited a broad outflow of foreign capital, putting more pressure on foreign exchange reserves. In a single day, the central bank spent $500 million dollars of its dollar reserves to keep the baht from falling below its pegged level (Daniels and VanHoose, 1999, 441). In 1997, Thailand’s central bank let the baht float, free to depreciate, which it did.</p><p style="text-align: justify;">The depreciation of the baht triggered foreign capital outflows from other East Asian economies. By the end of 1997, Thailand, Indonesia, and South Korea had watched local currencies depreciate about 40 percent relative to the U.S. dollar (Daniels and VanHoose, 1999, 36). </p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2022/04/currency-crises.html">Currency Crises</a></p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-58558829554676076912022-04-05T04:13:00.005-07:002022-04-05T04:13:40.799-07:00Foreign debt crises<p style="text-align: justify;"> Economies and governments can accumulate debt to external creditors, meaning creditors from other parts of the world. External financing for productive investments can expand opportunities for economic development and accelerate economic growth. Just as households and businesses can sink too deeply into debt, countries and individual economies can accumulate debt to the point that external debt obligations cannot be met. Measures of indebtedness compare the amount of debt with income. A household with a moderate amount of debt can double its debt if its income doubles and remain only moderately in debt. If a country’s gross domestic product (GDP) doubles, it can double its external debt without increasing its debt burden. A country that is able to meet its external debt obligations is said to be able to “service” its debt.</p><p style="text-align: justify;">Analysis of an individual country’s debt to the rest of the world takes on a macroeconomic perspective because it involves converting one currency into another currency. In addition to an individual borrower’s ability to repay, in the case of foreign borrowing there are aggregate credit conditions that must be met by the whole economy. Exceeding aggregate credit limitations can lead to sharp adjustments in domestic interest rates or exchange rates. Often a foreign debt is denominated in a foreign currency. In that case, a country must be able earn enough foreign currency in exports and capital inflows to service the debt. If a country’s debt is denominated in its own currency, it still needs to service its debt without upsetting exchange rates. A country can in effect default on its external or foreign debt by suspending convertibility of its domestic currency into foreign currencies. If a country is unable to earn sufficient foreign currency from exports and capital inflows to service its foreign debt, it can increase capital inflows by increasing domestic interest rates. These higher interest rates will be a burden on the economy and can force an economy into recession.</p><p style="text-align: justify;">The debt that a sovereign government owes to external creditors is called “sovereign debt.” When a government defaults on obligations to external creditors, it is called a “sovereign debt crisis.” Russia, Ecuador, and Argentina furnish examples of outright debt default. Ukraine, Pakistan, and Uruguay avoided outright default through debt restructuring. Mexico, Brazil, and Turkey averted default with the help of large-scale support from the International Monetary Fund. Some debtor governments are more cooperative than others in resolving default situations. Uncooperative governments can harm the ability of private domestic corporations to access international debt markets. Risk of foreign debt default or restructuring appears to be lowest when total external debt as a percent of GDP is less than 49.7 percent, short-term debt as a percent of foreign currency holdings is less than 130 percent, public external debt is less than 214 percent of fiscal revenue, and the exchange rate not over appreciated above 48 percent (Manasse and Roubini, 2005, p. 40).</p><p style="text-align: justify;">Economists have developed indicators to measure a degree of a country’s indebtedness. For poor, debt-laden countries, some type of debt restructuring is likely to occur when net present value of debt exceeds 200 percent of exports. For other, nonindustrial countries, it appears that the risk of debt exposure starts to rise when external debt as a percent of GDP rises above 40 percent (Daseking, December 2002). Countries can sustain higher debt ratios if exports are growing rapidly, or if exports represent a large proportion of GDP, or if a large share of external debt is denominated in domestic currency.</p><p style="text-align: justify;">The United States is a debtor nation, but its debt ratios are well below the threshold levels that signal a possible foreign debt crisis. Given the role of the U.S. dollar as a world currency, it is not clear if the same debt–ratio threshold levels apply to the United States. The rise of foreign debt in the United States is worrisome to some observers. Easy access to foreign credit sometimes allows countries to delay painful but inevitable reforms.</p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-70615021506803813712022-04-04T09:05:00.002-07:002022-04-06T07:00:57.864-07:00Currency crises<p style="text-align: justify;">A currency crisis occurs when the value of a currency crashes in foreign exchange markets, when holders of a currency stampede to sell it in foreign exchange markets out of fear that the currency is headed for lower values in the future. Foreign exchange markets determine the rate or price at which one currency can be purchased with another currency. An exchange rate of $1 per 10 Mexican pesos tells how many pesos it takes to purchase a dollar and how many dollars it takes to purchase a peso. While exchange rates are subject to market forces, certain groups have vested interests in exchange rate stability. One such group would be U.S. investors who have purchased Mexican peso bonds issued by the Mexican government. Bondholders who purchased Mexican bonds with dollars when the exchange rate stood at 10 pesos per $1 will experience a windfall loss if the Mexican peso depreciates to 20 pesos per $1. When they sell the Mexican bonds and convert the pesos back into dollars, they will receive roughly half as many dollars as they originally invested. Therefore, if holders of Mexican bonds expect the peso to depreciate in the future, they will try to sell their Mexican bonds for pesos, and convert the pesos back into dollars before the depreciation occurs. If large numbers of investors try to sell pesos for dollars all at once, the value of the peso in the foreign exchange market will crash.</p><p style="text-align: justify;">Speculators may trigger a currency crisis if they think a currency is vulnerable to a sudden crash. If speculators think the peso may deprecate in the future, they will borrow pesos and sell them for dollars. If speculators borrow pesos to buy dollars when the exchange rate is 10 pesos per $1, then they can repay their loans and reap a profit if the peso depreciates to 20 pesos per $1. Speculative attacks can turn mere expectations that a currency will depreciate into a self-fulfilling prophecy.</p><p style="text-align: justify;">The common denominator behind all currency crises is a current account deficit. A current account deficit most likely indicates that outflows of domestic currency from imports exceed inflows of domestic currency from exports. As long as outflows of domestic currency approximately balance inflows of domestic currency, the foreign exchange rate tends to remain stable. If the outflow of currency outruns the inflow of currency on the current account, then foreign investors must either be willing to hold financial assets denominated in the domestic currency, or the central bank responsible for the domestic currency must buy back the excess outflow with its holdings of other foreign currencies. Central bank holdings of other foreign currencies are called foreign exchange reserves. The more foreign exchange reserves a central bank holds, the less likely a domestic currency will suffer a currency crisis. A current account deficit and the associated excess outflow of currency lead to currency depreciation if the central bank does not buy back the excess currency outflow and if foreign investors do not find financial assets denominated in the domestic currency attractive. If, for instance, Mexico has a currency account deficit and the Banco de Mexico does not hold sufficient reserves of U.S. dollars to buy back the excess outflow of pesos, then excess supply of pesos will build up in foreign exchange markets and one of two possibilities are left. One possibility is that foreign investors will purchase the excess supply of pesos and use the pesos to purchase bonds and other investments in Mexico. If foreign investors are afraid of investing in Mexico, or find Mexican interest rates too low, then there will be pesos in foreign exchange markets that nobody wants, and the Mexican peso will depreciate.</p><p style="text-align: justify;">Countries that run persistent current account deficits tend to run out of foreign exchange reserves. Speculators are prone to launch speculative attacks on countries with current account deficits and low foreign exchange reserves. If the attack is successful, the currency crashes.</p><p style="text-align: justify;">A current account deficit usually indicates a large government budget deficit, but it can indicate a high level of domestic investment spending relative to domestic savings. Either way, the country is importing foreign capital. A currency crisis usually occurs when a country that has been experiencing a foreign capital inflow suddenly starts experiencing a foreign capital outflow, perhaps because foreign investors have lost confidence. </p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2022/04/east-asian-financial-crisis.html">East Asian Financial Crisis</a>, <a href="https://encyclopedia-of-money.blogspot.com/2022/04/current-account.html">Current Account</a>, Mexican Peso Crisis of 1994</p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-9105915583167308552022-04-04T08:59:00.003-07:002022-04-05T04:14:28.835-07:00Argentine currency and debt crisis<p style="text-align: justify;">Between 2001 and 2002, Argentina underwent an episode of currency devaluation and debt default that rocked international financial markets and offered fresh evidence of the varied economic trends that can lead to crises. The Argentine crisis has been the topic of wide discussion, partly because it was born of circumstances not normally regarded as fertile ground for currency crises. In the 1990s, Argentina boasted of one of Latin America’s fastest growing economies and one of its staunches devotees to the gospel of free market reform. Part of the credit for economic prosperity seemed to lie with a successful monetary reform that ended the hyperinflation of the 1980s. This monetary reform established a currency board that fixed the value of the Argentine peso at one peso to a U.S. dollar. One Argentine peso, exchangeable into dollars at any time, equaled one U.S. dollar. Argentine inflation subsided to low single-digit levels, output grew at a fast clip, and the economy seemed resilient to external shocks.</p><p style="text-align: justify;">The genesis of the crisis goes back to 1998 when many of Argentina’s trading partners saw their currencies depreciate, perhaps because of fallout to the East Asian Crisis and the retreat of foreign capital. The strong demand for U.S. financial assets keep the U.S. dollar strong, which kept all currencies pegged to the dollar, including the Argentine peso, strong. The strong Argentine peso meant that Argentine exports went at higher prices in foreign markets, while Argentine imports saw falling prices. In summery, Argentina-produced goods grew costlier compared to goods produced by Argentina’s major trading partners. Cheaper imports allowed Argentina to live beyond its means, while its exports were over-priced in foreign markets. To restore balance, Argentina needed to either devalue its currency as its trading partners had done, or undergo domestic deflation. Argentina did experience some deflation, which is a characteristic that distinguishes the Argentine crises from other crises. More often these types of crises occur after government deficits, financed by monetary growth, lead to inflation.</p><p style="text-align: justify;">Government’s budget deficits were modest, but were large enough to force a growing reliance on foreign debt financing. A small financial sector may share the blame for a dependence on foreign capital to finance both private sector and public sector spending. The vulnerability of the system arose from the large share of loans and mortgages denominated in dollars while the income generated to service these debts came in the form of pesos. Once deflationary forces surfaced, output shrank, unemployment spiked, government deficits rose, and the government proceeded to pile up foreign debt. In December 2001, the government of Argentina defaulted on its public debt.</p><p style="text-align: justify;">After more than three years of recession, in January 2002, the Argentine government, running out of credit, devalued the peso relative to the dollar. At the time, 70 percent of all Argentine bank deposits and 79 percent of all loans were denominated in dollars (Economist, March 8, 2003). To avoid throwing many debtors into bankruptcy, the loans were redenominated into pesos at a rate of one peso per dollar, and the bank deposits were redenominated into pesos at the rate of 1.4 pesos per dollar. (Economist, March 8, 2003). The peso deposits quickly dropped in value as the peso plummeted to about four pesos per dollar. The action de-dollarized the Argentine economy.</p><p style="text-align: justify;">Devaluating the peso reduced the cost of Argentine exports in the world economy, making it possible for Argentina to earn foreign exchange and recover from deep recession. Foreign exchange is necessary to repay foreign debts.</p><p style="text-align: justify;">By 2005, the Argentine economy exhibited a strong expansion, helped in part by a worldwide commodity boom, and the government reported budget surpluses. The government offered the holders of defaulted bonds new bonds in a choice of four different currencies. The value of the new bonds equaled about 30 percent of the value of the defaulted bonds (Economist, January 15, 2005). Creditors fumed at the rough treatment and predicted that Argentina would meet with difficulty trying to regain the confidence of foreign investors. </p><p style="text-align: justify;">See also: <a href="https://encyclopedia-of-money.blogspot.com/2022/04/currency-crises.html">Currency Crises</a>, <a href="https://encyclopedia-of-money.blogspot.com/2022/04/foreign-debt-crises.html">Foreign Debt Crises</a></p>Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-32383290149103641952015-09-03T22:47:00.003-07:002021-01-28T01:33:21.307-08:00Yen<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
The <i>yen</i> is the money of account for Japan, comparable
to the dollar for the United States. By the 1990s the Japanese yen had become a
major international currency, sharing the stage with the U.S. dollar, the German
mark, and the ECU as determinants of international monetary values.</div>
<div style="text-align: justify;">
The Shinka Jorei (New Currency Regulations) of 1871 established the yen as
the monetary unit in Japan. The Japanese derived the word <i>yen</i> from the
Chinese word <i>yuan,</i> which meant “round thing,” a reference to the U.S. and
Mexican dollars that dominated East Asian trade at the time. The act set the yen
equal to 0.05 ounces of gold, making the official Japanese price of an ounce of
gold equal to 20 yen. At the time the official United States price of an ounce
of gold was $20.67. The yen was intended to be equivalent to the Mexican dollar,
the standard unit in Asian trade at the time. The yen began life as a
decimalized currency; one-one-hundredth of a yen was called a <i>sen,</i> and
one-tenth of a <i>sen</i> was called a <i>rin.</i></div>
<div style="text-align: justify;">
Officially, Japan was on a bimetallic monetary system, but in practice the
yen was on a silver standard. In 1877 a civil rebellion forced the government to
issue inconvertible paper money to finance military expenditures. Inflation
erupted and in 1882 the government established the Bank of Japan, partly to
replace inconvertible paper money with bank notes convertible into silver.
Following the Sino-Japanese war of 1894–1895, Japanese received in gold a large
war reparation payment from China, providing a gold reserve sufficient for Japan
to establish a <a href="https://encyclopedia-of-money.blogspot.com/2010/03/gold-standard.html">gold standard</a>. In 1887 a new currency law gave the Bank of Japan
a monopoly on the privilege to issue bank notes, and put the yen on the gold
standard.</div>
<div style="text-align: justify;">
At the beginning of World War I most developed countries, including Japan,
abandoned the gold standard and prohibited the export of gold. Following World
War I Japan, beset by economic turmoil, stumbled in its efforts to return to the
gold standard. In 1930, on the eve of the Great Depression, Japan returned to
the gold standard, only to have to abandon it again in 1931. The depression
dealt a serious blow to the gold standard worldwide, and Japan turned to tight
government regulation of its currency, which continued through World War II.</div>
<div style="text-align: justify;">
A wave of inflation engulfed Japan following World War II and the occupation
authorities instituted a currency reform that withdrew old yen notes and issued
new yen notes. In 1949 the exchange rate between the yen and the dollar was set
at 360 yen per dollar. Under the Bretton Woods system, exchange rates were fixed
at official rates, and the ratio of yen to dollars remained at 360 until 1971.
Large trade surpluses enabled Japan to bolster its gold and foreign exchange
reserves, paving the way for lifting all restrictions on foreign exchange
transactions.</div>
<br />
<div style="text-align: justify;">
When a system of floating international exchange rates displaced the fixed-rate Bretton Woods system in 1973, the
yen began an upward career of currency appreciation. In 1970 it had taken 360
yen to purchase a dollar. By 1973 it took only 272 yen, and by the end of the
decade it took only 219 yen to purchase a dollar. As the yen grew stronger, it
took more dollars to purchase a yen, but despite that Japanese goods constituted
a major competitive threat to U.S. industries. In 1984 the world’s major trading
partners agreed to intervene collectively in foreign exchange markets to
appreciate the yen even further. Whereas it took 239 yen to purchase a dollar in
1985, by 1988 that number had fallen to 128 yen, a substantial increase in the
value of the yen.</div>
<div style="text-align: justify;">
In the 1980s Japan took further steps to deregulate its financial system and
to allow foreign firms to participate in Japan’s financial markets. Japanese
banks had become among the largest and most powerful in the world, and the yen
emerged as a major international currency. By 1998 economic depression in Japan
put downward pressure on the yen, and the yen traded at around 140 yen per
dollar.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/02/deutsche-mark.html">Deutsche Mark</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/02/european-currency-unit.html">European Currency Unit</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/02/dollar.html">Dollar</a></div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Davies, Glyn. 1994. <i>A History of Money.</i></div>
<div style="text-align: justify;">
Ohkawa, Kazushi, Miyorhei Shinohara and Larry Meissner, eds. 1979.
<i>Patterns of Japanese Economic Development: A Quantitative Appraisal.</i> </div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-67946481262421535912015-09-03T22:44:00.002-07:002020-12-16T21:13:59.558-08:00Yeltsin’s Monetary Reform in Russia<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
Russia opened the 1990s in monetary chaos, manifested by
soaring inflation, and a currency, the <i>ruble,</i> that had long been shielded
from the free-market forces of foreign exchange markets. In foreign exchange
markets, currencies are bought and sold with other currencies, as when Japanese
yen are purchased with United States dollars.</div>
<div style="text-align: justify;">
Under economic reforms, prices, unfettered from state controls, took off,
creating a ruble shortage that left some workers unpaid for months. Wages and
pensions rose, and the Russian government cranked up the printing presses on a
round-the-clock basis. For the month of July 1992 alone, the government printed
up more rubles than the Soviet Union government had printed up in its last 30
years. To expedite the process, the government increased the largest
denomination of the printed ruble from the 200-ruble note to the 1,000-ruble
note. Coins also became available in higher denominations. Inflation reached its
peak in 1992 when monthly inflation rates ran 15 percent, and prices increased
200 percent over the year.</div>
<div style="text-align: justify;">
In 1993 the government begin to step on the monetary brakes, but in ways that
threw the country into deeper confusion. In July the government invalidated all
rubles issued before 1993, and gave people only a few days to convert the old
rubles into new rubles. It also put a limit on the number of old rubles that
foreigners could convert into new rubles. Citizens could convert up to 35,000
old rubles into new rubles, and if they held additional rubles, these had to be
put into savings accounts for six months. By the end of 1997 annual inflation
had fallen to the 12 percent range, and the government announced a plan to lop
off three zeros from the ruble. Effective 1 January 1998, in what was
essentially an accounting reform, 1,000 rubles became 1 ruble, and all prices,
balance sheets, debts, etc., were adjusted accordingly.</div>
<div style="text-align: justify;">
One legacy of the Soviet regime was tight control over the conversion of
rubles into foreign currencies. Tourists were able to convert foreign currencies
into rubles at a rate close to a black market rate, but set by the Russian
Central Bank. Foreign-owned enterprises earning profits in rubles faced a
special difficulty. If a foreign-owned company wanted to send profits home to
the parent company, those profits had first to be converted from rubles to the
home-country currency at a disadvantageous exchange rate set by the Russian
government. To attract foreign investment, and integrate the Russian economy
into the world economy, Russia had to make the ruble convertible into foreign
currencies at free-market rates.</div>
<br />
<div style="text-align: justify;">
A loan from the <a href="https://encyclopedia-of-money.blogspot.com/2010/03/international-monetary-fund.html">International Monetary Fund</a> helped the Russian government
marshal the foreign exchange reserves needed to establish a convertible ruble.
On 1 July 1992 the Russian government established a single exchange rate between
the dollar and the ruble at an initial rate of 126.5 rubles per dollar. The
responsibility for adjusting the rate fell to the Russian Central Bank, which
planned to set a rate based upon twice-weekly currency auctions. After July 1993 the Russian Central Bank pegged the ruble to the
dollar in a crawling peg system that avoided wild fluctuations but allowed the
ruble to depreciate over time relative to the dollar. In 1996 Russia further
broadened the ruble market by allowing foreigners to buy and sell Russian
government bonds in secondary markets. Russian government bonds, paying over 100
percent interest at times, constitute a major demand for rubles. Rubles must be
purchased first before bonds can be purchased. The astronomical interest rates
on Russian bonds were sometimes necessary to maintain a demand for Russian
rubles. Despite high Russian interest rates, the ruble steadily declined
relative to the dollar, falling to a rate of 6,200 rubles per dollar at the end
of 1997. After three zeros were lopped off, the rate became 6.2 rubles per
dollar.</div>
<div style="text-align: justify;">
In 1998 the Russian government again turned to the printing press to solve
Russia’s problems, putting pressure on the ruble in foreign exchange markets.
The value of the ruble fell sharply in august, and to help cope with the crisis
the government imposed a moratorium on payments on foreign debt, significantly
adding to the severity of a global financial crisis. By the end of the year the
ruble was trading at around 20 rubles per dollar.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/02/foreign-exchange-markets.html">Foreign Exchange Markets</a></div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Hanke, Steve H. 1998. Is the Ruble Next. <i>Forbes</i> (9 March):
64–65.</div>
<div class="bib" style="text-align: justify;">
<i>Wall Street Journal.</i> 1991. “Soviet Printing of Rubles Soared
in 11-Month Period.” 24 December, eastern edition, at A8.</div>
<div class="bib" style="text-align: justify;">
1992. “Russia, Facing Inflation, Plans Bigger Banknotes.” 31
January, eastern edition, at A10.</div>
<div class="bib" style="text-align: justify;">
1992. “Russia Plans to Make Ruble Fully Convertible by August
1.” 6 May, eastern edition, at A3</div>
<div class="bib" style="text-align: justify;">
1993. “Chaos in Russia Mounts.” 26 July, eastern edition, at
A8.</div>
<div style="text-align: justify;">
1997. “Russia’s Overhaul of Ruble Prompts Unease in Nation.”
31 December, eastern edition, at A7. </div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-19395170250116846912015-09-03T22:40:00.003-07:002020-12-16T21:22:45.814-08:00Yap Money<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
The inhabitants of the island of Yap, one of the Caroline
Islands in the central Pacific, adopted large, thick stone wheels for money, a
primitive medium of exchange that survived into the post–World War II era. The
inhabitants called this from of money <i>fei.</i> A study of the operation of
this system of currency reveals interesting insights into the nature of money
that are relevant for modern monetary systems.</div>
<div style="text-align: justify;">
The stone wheels ranged in diameter from a foot to 12 feet and the larger
stones were virtually immovable. The hole in the center of the stone wheels
varied with the diameter of the stone, and the smaller stones could slide over a
pole and be carried. The stones were quarried from Palau, about 260 miles away,
and sometimes from as far away as Guam. Stones could serve as <i>fei</i> only if
they were made of a fine, white, close-grained limestone.</div>
<div style="text-align: justify;">
One of the interesting characteristics of this currency was that the owner
did not have to take possession of it. In transactions involving these large
stones, a buyer would give ownership of the <i>fei</i> to a seller in return for
goods. The seller, however, would not actually take possession of the
<i>fei,</i> but would leave it on the premises of the buyer of the goods. A mere
acknowledgment that the seller owned the <i>fei</i> was all that was needed to
signify its new ownership.</div>
<br />
<div style="text-align: justify;">
The logic of the Yap monetary system went so far as to acknowledge the wealth
of a family on the strength of the ownership of a very large stone that had been
lost at sea for several generations. According to tradition, an ancestor of this
family had secured this <i>fei</i> and was towing it home on a raft when a storm
rose, and the stone ended up at the bottom of the sea. Because all aboard the
ship towing the raft testified to the size and quality of the stone, and that it
was lost at no fault of the owners, the inhabitants of Yap agreed that the stone
belonged to the family that lost it and that its market value remained
unimpaired. Therefore the family enjoyed the purchasing power of this stone just
as if it lay on their own property. </div>
<div style="text-align: justify;">
Another interesting anecdote related to the Yap monetary system occurred
after the German government purchased the Caroline Islands from Spain in 1898.
The German government wanted the natives of Yap to improve the roads and make
them suitable for more modern vehicles. When the natives rather obviously
neglected to improve the roads, the German government was faced with finding a
way to fine the natives. Since removing <i>fei</i> was difficult, and the stones
had no value outside of the island of Yap, the German government hit on the idea
of sending an agent around to paint a black cross on the most valuable stones to
signify a claim of the German government. The natives of Yap immediately set to
work to improve the roads. After the German government was satisfied that the
roads were improved, it sent an agent around to remove the crosses, and a great
rejoicing rose up among the natives.</div>
<div style="text-align: justify;">
The value of the primitive money on the island of Yap depended upon the faith
of its inhabitants. The idea of accepting money on faith must seem ridiculous to
modern-day advocates of a gold standard as the necessary backbone of any
paper-money system. The acceptance of paper money in our modern economies, shorn
of the assurance of the <a href="https://encyclopedia-of-money.blogspot.com/2010/03/gold-standard.html">gold standard</a>, requires that people have faith that
government will not mismanage the money supply, causing it to lose its value
from inflation.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2013/01/spartan-iron-currency.html">Spartan Iron Currency</a></div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Angell, Norman. 1929. <i>The Story of Money.</i></div>
<div class="bib" style="text-align: justify;">
Friedman, Milton. 1992. <i>Monetary Mischief.</i></div>
<br />
<div class="bib" style="text-align: justify;">
Gillilland, Cora Lee C. 1975. The Stone Money of Yap: A Numismatic
Survey. <i>Smithsonian Studies in History and Technology.</i> No. 23.</div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-12393646750616573892015-09-03T22:30:00.004-07:002015-09-03T22:30:55.838-07:00World Bank<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
The World Bank, officially the International Bank for
Reconstruction and Development, is the largest provider of development
assistance to middle-income and low-income countries, directly financing
projects and coordinating development assistance from other agencies. It also
serves as a clearinghouse of ideas for promoting economic development, and
publishes statistical data and research on the state of the world economy.</div>
<div style="text-align: justify;">
Aside from negotiating a fixed exchange rate system for international trade,
the Bretton Woods Conference of 1944 organized the World Bank under the auspices
of the United Nations. The delegates of the Bretton Woods Conference had in mind
financing the reconstruction of war-torn Europe and Japan, and the development
needs of the poorer areas of the world. On 25 June 1946 the World Bank opened
his headquarters in Washington, D.C.</div>
<div style="text-align: justify;">
Member countries, now numbering more than 180, purchase stock in the World
Bank, which also raises capital by selling bonds in private capital markets.
Member governments guarantee the bonds, reducing the interest rate that
investors demand and lowering the cost of capital to the bank. The United States
is the largest shareholder and the president of the World Bank has always been
from the United States.</div>
<div style="text-align: justify;">
The first quarter century of the bank’s existence saw an emphasis on
financing basic economic infrastructure needed to support industry. Between
fiscal years 1961 and 1965 electric power and transportation projects accounted
for 76.8 percent of the bank’s lending. The bank continued to extend substantial
loans to developed countries until 1967. After Robert McNamara assumed the
presidency in 1968, the bank began to channel more resources into projects that
directly relieve poverty, increasing bank lending on agriculture and rural
development projects from 18.1 percent in fiscal year 1968, to 31 percent in
fiscal year 1981.</div>
<div style="text-align: justify;">
In 1960 the International Development Association (IDA) came into being as a
division of the bank that makes soft loans and interest-free loans to the
poorest countries. These countries do not qualify for loans from the World Bank,
whose lending philosophy is more conservative. Also affiliated with the World
Bank is the International Financial Corporation (IFC), created in 1956 to raise
private capital for financing private sector projects. The loans of the IFC are
structured on a commercial basis with maturities ranging from 7 to 12 years.</div>
<div style="text-align: justify;">
The World Bank is perhaps the foremost world leader on economic development
issues. In 1978 the World Bank began publishing the influential <i>World
Development Report,</i> combining articles on current development issues and a
statistical report of economic indicators for the nations of the world.</div>
<div style="text-align: justify;">
Until the 1980s the World Bank mainly financed public enterprises, but since
then the bank has affirmed its commitment to financing private sector projects,
and used its leadership to strengthen the private sector in Third World
countries. The bank promotes reforms conducive to stable macroeconomic
environments, and encourages privatization of public enterprises, environmental
responsibility, and investments in basic health and education.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/01/bretton-woods-system.html">Bretton Woods System</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/03/international-monetary-fund.html">International Monetary Fund</a></div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Ayres, Robert L. 1983. <i>Banking on the Poor: The World Bank and
World Poverty.</i></div>
<br />
<div class="bib" style="text-align: justify;">
Polak, Jacques J. 1994. <i>The World Bank and the International
Monetary Fund: A Changing Relationship.</i></div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-53865303552161065412015-09-03T22:26:00.002-07:002015-09-03T22:29:30.912-07:00Wizard of Oz<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
The book <i>The Wonderful Wizard of Oz,</i> by L. Frank Baum,
is one of the most famous of American children’s stories and the inspiration of
a movie classic that is shown annually on television in the United States. What
is often lost in the movie is that the book, published in 1900, incorporated
allegorically an important monetary debate in the United States in the
1890s.</div>
<div style="text-align: justify;">
The book was written against the background of the free silver movement in
the United States. From 1880 until 1896 the United States saw the average level
of prices fall by 23 percent, a strong downdraft of deflation that worked a
severe hardship on debtors, mostly farmers of the South and West. The bankers
and financiers concentrated in the Northeast benefited from the deflation. One
proposal for mitigating the hardship of deflation was to supplement the money supply, then tied to the gold standard, with silver,
creating a bimetallic standard of gold and silver to replace the gold standard.
Under a bimetallic standard both silver and gold could be minted and circulated
as money. The infusion of silver would put an end to deflation by increasing the
amount of money in circulation.</div>
<div style="text-align: justify;">
The political agitation for a bimetallic standard was called the free silver
movement. Its most memorable spokesman, William Jennings Bryan, four times a
presidential candidate, said in one of the epochal orations in American history:
“You shall not press down upon the brow of labor this crown of thorns, you shall
not crucify mankind upon a cross of gold.” The “cross of gold” referred to the
gold standard.</div>
<div style="text-align: justify;">
In the <i>Wonderful Wizard of Oz,</i> the heroine Dorothy represents
traditional American values—honesty, kindheartedness, and pluck. The cyclone,
representing the free silver agitation, carries Dorothy to the land of “Oz,” as
in ounce (oz) of gold, where the gold standard reigns unchallenged. When
Dorothy’s house lands on the Wicked Witch of the East, the Witch dries up,
leaving only her silver shoes, which become Dorothy’s. The silver shoes (which
were changed to ruby in the movie version) possess a magical power, representing
the magical advantages of adding silver to the money supply.</div>
<div style="text-align: justify;">
Dorothy cannot find out how to return to Kansas, but learns that she should
follow the yellow brick road that leads to the Emerald City. The yellow brick
road represents the gold standard and the Emerald City represents Washington,
D.C. On her journey to the Emerald City Dorothy is joined by the Scarecrow,
representing western farmers, the Tin Woodman, representing the industrial
worker, and the Cowardly Lion, representing William Jennings Bryan. The joints
of the Tin Woodman had become rusty because the depression of the 1890s had put
the industrial workers out of work.</div>
<div style="text-align: justify;">
The Cowardly Lion goes to sleep in the poppy field that represents all the
issues, such as anti-imperialism and antitrust, that threatened to distract
Bryan away from the central issue of the free silver movement in the 1900
presidential election.</div>
<div style="text-align: justify;">
Dorothy’s group reaches the Emerald City, where everyone looks through
green-colored glasses, as in money-colored glasses. Everyone in the city,
including Dorothy’s group, must wear the glasses and they are locked on with a
gold buckle, another reference to the gold standard. In other words, the
financial establishment of the city required that everything be looked at from
the perspective of money.</div>
<div style="text-align: justify;">
Dorothy and her friends reach the Emerald Palace, representing the White
House, and Dorothy is led to her room through seven passages and up three
flights of stairs, a reference to the Crime of ’73, an act of legislation passed
in 1873 that eliminated the coinage of silver. The next day the group meets the
Wizard, who was probably Marcus Alonzo Hanna, the chairman of the Republican
Party and the brains behind President McKinley’s presidency. The Wizard sends
the group to find and destroy the Wicked Witch of the West, which may have been
President McKinley himself. Dorothy’s group finds the Wicked Witch of the West,
who, knowing the magical power of the silver slippers, snatches one of Dorothy’s
slippers in a trick. The separation of the silver slippers, destroying their
magical power, refers to the efforts of the Republican Party to diffuse the
silver issue by calling for an international conference on the subject. Dorothy
angrily pours a bucket of water on the Wicked Witch of the West, destroying her,
and getting back her slipper.</div>
<div style="text-align: justify;">
Dorothy with her friends returns to the Emerald City, expecting the Wizard to
tell her how to return to Kansas. The Wizard turns out to be a fraud and Dorothy
seeks out the Good Witch of the South. The South is ruled by a good witch
because the South was sympathetic with the free silver movement. The Good Witch
of the South tells Dorothy that she can return to Kansas if she clicks her
silver slippers together three times, representing the magical power of silver
to solve the problems of the western farmers, made possible by the support of
the South.</div>
<div style="text-align: justify;">
Despite the agitation for free silver, the United States remained on the gold
standard. Discoveries of gold in Alaska, Australia, and South Africa
substantially increased the world supply of gold, ending the era of tight money.
From 1896 until 1910 prices rose 35 percent in the United States, diffusing the
social protest that found its expression in the <i>Wonderful Wizard of
Oz.</i></div>
<div style="text-align: justify;">
<i><br /></i></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/02/crime-of-73-united-states.html">Crime of ’73</a>, <a href="http://encyclopedia-of-money.blogspot.ru/2010/02/cross-of-gold-speech.html">“Cross of Gold” Speech</a>, <a href="http://encyclopedia-of-money.blogspot.ru/2010/03/free-silver-movement.html">Free Silver Movement</a>, <a href="http://encyclopedia-of-money.blogspot.ru/2010/03/gold-standard-act-of-1900-united-states.html">Gold Standard Act of 1900</a>
</div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div style="text-align: justify;">
Littlefield, Henry M. 1964. The Wizard of Oz: Parable on Populism.
<i>American Quarterly,</i> 16 (Spring): 47–58. </div>
<div class="bib" style="text-align: justify;">
Rockoff, Hugh. 1990. The <i>Wizard of Oz</i> as a Monetary
Allegory. <i>Journal of Political Economy,</i> 98, no. 4: 739–760.</div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-2651967530572761132015-09-03T22:22:00.001-07:002015-09-03T22:22:29.556-07:00Wildcat Banks (United States)<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
During the pre–Civil War era, wildcat banks, although
technically legal, abused the bank note-issuing authority of state banks by
issuing bank notes or paper money under circumstances that discouraged or
rendered impossible conversion into gold and silver specie. The wildcat banks
emerged in a banking system that allowed each bank to issue its own bank notes,
which legitimate banks stood ready to redeem into gold and silver specie. As
security for outstanding bank notes, state banking laws required banks to own
federal or state government bonds, and keep them on file at a state auditor’s
office. The First Bank of the United States and the Second Bank of the United
States had helped maintain an honest currency by forcing western banks and
country banks to redeem their bank notes in specie.</div>
<div style="text-align: justify;">
In 1833 the demise of the Second Bank of the United States left the banking
system without an important safeguard against the temptation of bankers to issue
bank notes in excess of their reserves. Bank notes from distant localities
circulated at varying discounts, depending upon the likelihood of redemption
into specie. Newspapers published lists of good notes and bad notes, and
periodicals appeared that were exclusively devoted to the values of bank
notes.</div>
<div style="text-align: justify;">
Wildcat banks were usually formed without buildings, offices, or furniture,
and required minimal amounts of capital. A group of investors would purchase
bonds, often state bonds selling at a discount, and file the bonds with a state
auditor, who authorized the investors to start a bank. The investors possessed
the engraved plates and dies that were used to print the bank notes, and often
printed bank notes equaling two or three times the amount of the bonds filed
with the state. In practice, the legal requirement that the state auditor
countersign each bill did not act as a brake on the issuance of bank notes.</div>
<div style="text-align: justify;">
Investors were known to start up wildcat banks with only enough money to buy
engraving plates and dies and pay the cost of printing up the bank notes.
Investors arranged through brokers to pay for the bonds after they were
delivered to the state auditor’s office. The investors then brought the freshly
printed bank notes to the auditor’s office, had them countersigned, and used
them to pay for the bonds.</div>
<div style="text-align: justify;">
Although bank notes were theoretically convertible into gold and silver
specie, wildcat banks were put in places difficult to find. In some cases an
Indian guide was necessary to find what was no more than a shanty located on an
Indian reservation. The accessibility of a wildcat bank determined the discount
at which its bank notes traded. Brokers dispatched agents to find remote banks
and demand the redemption of bank notes into specie. Some of the wildcat banks
stationed lookouts that threatened and intimidated strangers who might be
seeking redemption of bank notes.</div>
<div style="text-align: justify;">
In the early days of American capitalism the supply of capital necessarily
fell short of what was needed to exploit the virtually endless supply of natural
resources. The wildcat banks contributed to mobilizing much-needed capital, but
they cost the banking industry a bit of credibility with the public.
Understanding the history that the banking industry has had to live down helps
explain why it remains highly regulated.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/03/free-banking.html">Free Banking</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2011/10/second-bank-of-united-states.html">Second Bank of the United States</a></div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Dillistin, William H. 1949. <i>Bank Note Reporters and Counterfeit
Detectors, 1826–1866.</i></div>
<div class="bib" style="text-align: justify;">
Dowd, Kevin. 1996. <i>Competition and Finance: A Reinterpretation
of Financial and Monetary Economics.</i></div>
<div class="bib" style="text-align: justify;">
Knox, John Jay. 1903. <i>A History of Banking in the United
States.</i></div>
<div class="bib" style="text-align: justify;">
Rockoff, Hugh. 1975. <i>The Free Banking Era: A
Reexamination.</i></div>
<br />
<div class="bib" style="text-align: justify;">
Rolnick, Arthur J., and Warren E. Weber. 1983. New Evidence of the
Free Banking Era. <i>American Economic Review,</i> 73, no. 5 (December):
1080–1091.</div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-72611528536460354662015-09-03T22:18:00.002-07:002015-09-03T22:18:55.093-07:00Whale Tooth Money in Fiji<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
The case of whale tooth money on the island of Fiji shows how
a commodity can become a symbol of wealth in a collectivist society in which
most trade in goods takes the form of gift exchanges, omitting the need for a
common standard of value. To the people of Fiji the polished ivory teeth of the
sperm whale commanded a ceremonial value and sacredness that put them beyond the
realm of a fixed value compared with other goods. The idea of pricing a wide
range of goods in terms of whale teeth would not have occurred to the
Fijians.</div>
<div style="text-align: justify;">
Captain James Cook first set forth the customs surrounding whale teeth in his
<i>Journal</i> describing his voyages through the Fijian and Tongan Islands in
1774. The Fijians called the whale teeth <i>tambua,</i> a word that connoted a
sacred sense of propriety, a positive sense of what was fitting, as well as a
negative sense of what was not fitting. The negative side is captured in the
modern meaning of the word <i>taboo.</i></div>
<div style="text-align: justify;">
Whale teeth served as the principal store of wealth among the Fijians and
were considered precious articles to receive in gift or barter exchanges. No one
left unhappy who received a whale tooth in an exchange, making it a de facto
medium of exchange for large purchases. In the nineteenth century a single whale
tooth commanded sufficient value to barter for a large canoe. It could also
purchase a bride, or serve as blood money in compensation for a murdered person.
To a bride a whale tooth bore the same symbolic significance as an engagement
ring today. According to some reports the power of a whale tooth clenched any
accompanying request, whether it was for a specific gift, an alliance, or a
human life.</div>
<div style="text-align: justify;">
Whale teeth were constantly oiled and polished, and even in the later
nineteenth century were preferred to gold. After Fiji became a British Crown
Colony in 1874 a native Fiji official of the government asked to be paid in
whale teeth, rather than sterling silver or gold sovereigns, citing the added
sense of prestige and authority commanded by the sacred attributes of whale
teeth in the eyes of the Fijians. The ceremonial significance of the whale teeth
survived into recent times. The officials of Fiji made a formal presentation of
a whale tooth to the queen of England and the duke of Edinburgh when they
visited Fiji in 1982.</div>
<div style="text-align: justify;">
The native Fijians were not acquisitive in the modern sense. They traded
their surplus produce for particular things they wanted, and if they did not
have a particular thing in mind, they let their surplus produce rot. Gold and
silver coins held no charm for them when they were first introduced. Fijian
whale teeth reveal possible religious and ceremonial roots to the evolution of
money that precede the need for a convenient medium of exchange to finance
trade.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Davies, Glyn. 1994. <i>A History of Money.</i></div>
<br />
<div class="bib" style="text-align: justify;">
Einzig, Paul. 1966. <i>Primitive Money.</i></div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-73107909007898276172015-09-03T22:17:00.002-07:002015-09-03T22:17:48.310-07:00Wendish Monetary Union<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
From the mid-fourteenth century to the mid-fifteenth century
the Wendish Monetary Union maintained and guarded a common monetary standard for
cities of the Hanseatic League. The Wendish Monetary Union ranks among the first
of the European examples of monetary union, a distant ancestor to the
contemporary European Monetary Union.</div>
<div style="text-align: justify;">
The Hanseatic League was an association of north German towns, mainly
maritime towns and inland towns engaged in foreign trade, that dominated Baltic
trade during the fifteenth century. The league negotiated trade concessions and
monopoly privileges from foreign countries such as England, Norway, and Russia,
often at the expense of local merchants. The league operated self-government
trading compounds, called <i>kontors,</i> at trading centers such as London, and
these kontors were shared by the merchants who were citizens of Hanseatic
towns.</div>
<br />
<div style="text-align: justify;">
The Wendish Monetary Union was formed in 1379 and officially included only
four cities of the Hanseatic League, Lubeck, Hamburg, Wismar, and Luneburg.
Other towns adopted the standard unofficially, making the union influential over
a broad area, including all of Scandinavia. The union regulated the currency of
northern Germany until 1569 and its monetary system was based upon a silver
standard. </div>
<div style="text-align: justify;">
The union struck a silver coin equivalent to the Lubeck mark, containing 18
grams of fine silver, and bearing the coats of arms of the four member towns.
The union purchased the precious metal and supervised its coinage, including the
activities of goldsmiths and the mint’s employees. Compliance with the
regulations of the union was voluntary, and regular reminders issued by the
union suggest that it had a difficult time maintaining cooperation.</div>
<div style="text-align: justify;">
The spread of gold coinage in the fourteenth century was met with a
less-than-hearty reception among the towns of the Hanseatic League. During the
mid-fifteenth century in Wendish towns the penalty for buying goods with gold
was confiscation of the goods. Apparently, the union feared the destabilizing
effects of fluctuating exchange rates between gold and silver, perhaps
reinforced by the union’s own unsuccessful efforts to maintain a fixed ratio
between gold and silver. In 1340 Louis IV, emperor of the Holy Roman Empire,
granted Lubeck the privilege to mint gold coins, leading to the introduction of
the Lubeck gold <i>florin,</i> which was comparable to the Florentine
<i>florin</i> in weight and fineness.</div>
<div style="text-align: justify;">
Unlike many feudal governments the merchants of the Hanseatic League never
sought to profit from currency debasement. Often governments dominated by
merchant princes or commercial classes displayed a strong commitment to currency
integrity, perhaps to help attract commercial activity. Venice, living on an
empire of trade and finance, maintained the value of the <i>ducat</i> for over
500 years, and in the nineteenth century England became the staunch defender of
the gold standard against bimetallism, which would have allowed debtors to
substitute silver for gold in the repayment of debts.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/02/european-currency-unit.html">European Currency Unit</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/03/latin-monetary-union.html">Latin Monetary Union</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/04/monetary-unions-of-ancient-greece.html">Monetary Unions of Ancient Greece</a></div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Dollinger, Phillipe. 1970. <i>The German Hanza.</i></div>
<br />
<div class="bib" style="text-align: justify;">
Williams, Jonathan, ed. 1997. <i>Money: A History.</i></div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-13864240011184592962015-09-03T22:13:00.001-07:002015-09-03T22:13:31.172-07:00Wampumpeag<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
<i>Wampumpeag</i> was a famous currency used by the American
Indians, particularly but not exclusively along the eastern seaboard, and became
widely accepted by the English colonists. The name of the currency, a bit of a
mouthful, was usually shortened to <i>wampum.</i> The <i>peag</i> meant “beads”
in the language of the Indians, and the <i>wampum</i> referred to the white
color of the beads. The most common color was white but some of the beads were
black. Wampum rose to the status of legal-tender currency in 1643 when
Massachusetts set the value of the white beads at eight and the black at four to
the penny for sums no more than 40 shillings. In 1649 Rhode Island set the value
of black beads at four to the penny, but reduced the value in 1658 to eight to
the penny regardless of the color of the beads. White beads, however, were taken
in payment for taxes at six to the penny. As the white man with improved tools
learned to manufacture wampum at a faster rate, the supply increased, and in
1662 Rhode Island ended the acceptance of wampum for payment of taxes.</div>
<div style="text-align: justify;">
The shells of clams and other similar bivalves furnished the raw materials
for the manufacture of wampum. The estuarine rivers of the northeast of America
and Canada made fertile breeding grounds for these clams and bivalves. A typical
piece of wampum was a cylindrical bead about one-half inch in length, and about
one-eighth to one-quarter inch in diameter. The beads were strung through a hole
drilled lengthwise through each bead. The ornamental value of wampum remained an
important part of its attraction as a medium of exchange. Wampum strings that
traded as money were usually either 18 inches or six feet in length. They were
usually counted in cubits and fathoms, but could be divided into smaller values.
The black wampum usually traded at twice the value of the white wampum. Both the
English and the Dutch made use of this currency. In 1644 Peter Stuyvesant,
directory general of New Netherland, negotiated a loan of between 5,000 and
6,000 guilders in wampum, which was used to pay workers who were building a fort
in New York.</div>
<br />
<div style="text-align: justify;">
Several factors caused wampum to gradually lose its value. The Stone Age
technology of some of the tribes known for producing wampum had kept the supply
somewhat in bounds. The colonists brought with them steel drills that
substantially increased wampum production, and the colonists themselves began to manufacture wampum. Also, part of the value of wampum
hinged upon its usefulness in the purchase of beaver skins. As these skins
declined in value, wampum lost some of its value as well. In a matter of a few
years the Indians saw the value of wampum fall by 50 percent, which they
interpreted as efforts of the white man to cheat the Indian.</div>
<div style="text-align: justify;">
Nevertheless, in New England the demand for wampum remained strong into the
eighteenth century. In 1760 J. W. Campbell built a wampum factory in New Jersey
and boasted that one person could manufacture 20 feet of wampum per day. This
factory remained in operation for 100 years. The manufacture of wampum still
contributes to the tourist industry.</div>
<div style="text-align: justify;">
The history of wampum as money among the American colonists shows that
advanced societies will find a medium of exchange when more official supplies of
money are in short supply.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/01/commodity-money-american-colonies.html">Commodity Money</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/04/manilla.html">Manilla</a></div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Hepburn, A. Barton. 1924. <i>A History of Currency in the United
States.</i></div>
<div class="bib" style="text-align: justify;">
Martien, Jerry. 1996. <i>Shell Game: A True Account of Beads and
Money in North America.</i></div>
<div style="text-align: justify;">
Taxay, Don. 1970. <i>Money of the American Indians, and Other
Primitive Currencies of the Americas.</i> </div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-1201303072420650512015-09-03T22:10:00.001-07:002015-09-03T22:10:20.920-07:00Wage and Price Controls<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
Wage and price controls freeze wages and prices at a certain
point in time, and perhaps establish procedures for gradually adjusting wages
and prices. Episodes of hyperinflation and wars have most often laid the
groundwork for the enactment of programs of wage and price controls. Inflation
is rising prices, but also can be defined as a decrease in the purchasing power
of a unit of money.</div>
<div style="text-align: justify;">
In 1793 the government of the French Revolution initiated a system of price
controls that became known as the Law of the Maximum. A decree of 29 September
1793 empowered district administrations with the authority to set commodity
prices at rates one-third higher than the levels of 1790. The decree granted
municipal authorities the responsibility for setting wages at 50 percent higher
than the 1790 level. In 1794 the Committee on Provisions issued an enormous
schedule of the national Maximum, or price list. Each district added
transportation costs, 5 percent profit for the wholesaler and 10 percent for the
retailer, and then published a catalog of prices. Hoarding commodities to avoid
selling at controlled prices was punishable by death. Despite the government’s
involvement in the forcible requisitioning of supplies, the controlled economy
of the Revolution broke down. In December 1794 the government suppressed the Law
of the Maximum.</div>
<div style="text-align: justify;">
The American colonies experimented with wage and price controls to cope with
shortages in commodities and labor. In 1623 the governor of Virginia issued a
proclamation fixing prices and profit rates. The proclamation issued a list of
prices embracing goods ranging from Canadian fish to wine vinegar. A war with
Indians apparently created a shortage of goods that led to the controls. The
colonial government lifted the controls in 1641. In 1630 the Massachusetts Bay
Colony enacted a schedule of wages for skilled workers, coupled with a limit on
the markup for finished goods. In 1633 a law banning all “excessive wages and
prices” displaced the scale of wages and limitation on markups.</div>
<div style="text-align: justify;">
The colonists turned again to wage and price controls to protect themselves
from the wave of hyperinflation that struck the colonial economy during the War
of Independence. The Continental Congress did not have the power to impose wage
and price controls and remained split on the efforts of state governments to
control prices and wages. The New England colonies enacted legislation to
control prices, but the southern colonies demurred. Goods flowed to regions
where prices remained free to rise with market conditions, and state efforts to
control prices failed.</div>
<div style="text-align: justify;">
During the United States Civil War inflation surged in the northern states,
and reached hyperinflation proportions in the Confederacy. Neither the North nor
the South enacted a system of wage and price controls during that conflict,
perhaps reflecting the ascendancy of laissez-faire economics during the
nineteenth century.</div>
<br />
<div style="text-align: justify;">
During World War I virtually all the belligerent powers resorted to systems of wage and price controls. By then
inventions such as the typewriter had increased the administrative efficiency of
governments. In the United States wholesale prices had risen 60 percent above
their 1914 level when Congress declared war on Germany. The United States
government made use of as many as eight government agencies to control prices.
The War Industries Board controlled the prices of many basic raw materials. The
Food Administration set the prices for many staple foods, such as wheat and
livestock. Inflation slowed substantially, contributing to a general feeling
that the controls were a success. The controls were lifted at the end of the war
amid some talk that the controls should be extended to the peacetime
economy.</div>
<div style="text-align: justify;">
In 1936 Germany imposed a comprehensive system of wage and price controls
that remained in effect for 12 years. This system of controls was part of
Germany’s centrally planned economy that was directed toward military
mobilization. When the Allied occupation governments kept the controls in place
at the end of World War II, black markets sprang up to meet the needs for
certain supplies. Germany’s rapid economic growth began after the controls were
lifted in 1948.</div>
<div style="text-align: justify;">
During World War II many countries established some form of wage and price
controls to contain inflation. The United States went to a comprehensive system
of wage and price regulation in 1942. The Office of Price Administration had to
approve of price increases and a National War Labor Board approved of wage
increases. The main effect of the controls in the United States lay in the
postponement of inflation until after the war. The United States briefly turned
again to wage and price controls during the Vietnam War.</div>
<div style="text-align: justify;">
The use of wage and price controls to suppress inflation runs the risk that
black markets will emerge, and that producers will secretly reduce the quality
of products to save money. The reduction in the quality of products, which
forces consumers to buy them more frequently, defeats the purpose of the
controls.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/01/american-revolution-hyperinflation.html">American Revolution Hyperinflation</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/03/french-revolution-hyperinflation.html">French Revolution Hyperinflation</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/03/inflation-and-deflation.html">Inflation and Deflation</a></div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Blinder, Alan S. 1979. <i>Economic Policy and the Great
Stagflation.</i></div>
<div class="bib" style="text-align: justify;">
Rockoff, Hugh. 1984. <i>Drastic Measures: A History of Wage and
Price Controls in the United States.</i></div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-12807351569722038592015-09-03T21:56:00.001-07:002015-09-03T21:56:20.821-07:00Virginia Tobacco Act of 1713<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent" style="text-align: justify;">
The Virginia Tobacco Act of 1713 created the most advanced
form of a commodity monetary standard found in the American colonies. Under the
provisions of the act planters brought their tobacco to public warehouses, where
it was weighed, graded, and stored. The planters received paper notes that were
titles of ownership to the tobacco, and these notes circulated as money. Any
recipient of these tobacco notes had the option of claiming the tobacco and
taking possession of it.</div>
<div style="text-align: justify;">
The American colonies, struggling with a shortage of precious metal specie
for transacting business, turned to several expedients, including allowing
certain commodities to be acceptable in the payment of debts. Several of the
northern and middle colonies had a whole list of commodities that could be used
in the payment of debts at prices mandated by the government. The colony of
Virginia, however, relied almost exclusively on tobacco as a medium of exchange
to compensate for the shortage of specie. The government accepted tobacco in the
payment of taxes and government officials and the Anglican clergy received
payment in tobacco.</div>
<br />
<div style="text-align: justify;">
Tobacco as a medium of exchange, however, shared many of the defects of other
commodities used for that purpose. For one thing, the quality of tobacco varied
substantially and debtors always wanted to pay off debts with the lowest grade
possible. Owners of tobacco also found ways to pass off lower grades of tobacco for higher grades. In 1705 the Virginia
House of Burgesses enacted a law against passing off hogsheads of tobacco that
had trashy tobacco packed underneath a top layer of quality tobacco. Another
disadvantage of tobacco lay in its bulk and weight, which made it difficult to
transport for the purposes of exchanging ownership.</div>
<div style="text-align: justify;">
The Tobacco Act of 1713 called for the construction of a number of public
warehouses for the storage of tobacco. Each warehouse employed agents who
weighed and graded the tobacco that a planter brought in for storage. The agents
then issued to the planter notes or warehouse receipts vouching for the grade
and quantity of the tobacco. These tobacco notes allowed the ownership of the
tobacco to change hands without removing the tobacco. This form of tobacco money
resolved many of the difficulties with the tobacco standard and decreased the
inconvenience to those who received tobacco in payment of debts, effectively
increasing the value of tobacco money.</div>
<div style="text-align: justify;">
The act drew strong protest from critics who were against any sort of cheap
money or paper-money plan. Because of vehement opposition, the House of
Burgesses was later forced to pass a law assessing penalties for burning the
newly built tobacco warehouses. In 1730 the House of Burgesses enacted
additional legislation that further strengthened the government’s system for
inspecting and grading tobacco and providing for the rejection of tobacco that
failed to meet certain quality standards. This act made Virginian tobacco more
attractive in export markets.</div>
<div style="text-align: justify;">
The system of tobacco notes worked sufficiently well to delay the
introduction of real paper money in Virginia until 1755, making Virginia one of
the last colonies to adopt paper money. Virginia’s experience with the tobacco
standard demonstrates that gold is not the only commodity that may serve as a
monetary standard. Any commodity that is universally in demand and acceptable in
trade can serve as a standard to support paper money.</div>
<div style="text-align: justify;">
<br /></div>
<div class="Seetitle" style="text-align: justify;">
See also: </div>
<div style="text-align: justify;">
<a href="http://encyclopedia-of-money.blogspot.ru/2010/01/commodity-monetary-standard.html">Commodity Monetary Standard</a>, <a href="http://encyclopedia-of-money.blogspot.ru/2010/01/commodity-money-american-colonies.html">Commodity Money</a>, <a href="http://encyclopedia-of-money.blogspot.ru/2011/10/rice-currency.html">Rice Currency</a>,
<a href="http://encyclopedia-of-money.blogspot.ru/2015/09/virginia-colonial-paper-currency.html">Virginia Colonial Paper Currency</a> </div>
<div style="text-align: justify;">
<br /></div>
<div class="Bibtitle" style="text-align: justify;">
References:</div>
<div class="bib" style="text-align: justify;">
Brock, Leslie V. 1975. <i>The Currency of the American Colonies,
1700–1764.</i></div>
<div class="bib" style="text-align: justify;">
Galbraith, John Kenneth. 1975. <i>Money: Whence it Came, Where It
Went.</i></div>
<div style="text-align: justify;">
Nettels, Curtis P. 1934. <i>The Money Supply of the American
Colonies before 1720.</i> </div>
</div>
Anastasiyahttp://www.blogger.com/profile/01732747442400305230noreply@blogger.comtag:blogger.com,1999:blog-7253494210693239412.post-43414876147917667822015-09-03T21:53:00.002-07:002015-09-03T21:56:46.106-07:00Virginia Colonial Paper Currency<div dir="ltr" style="text-align: left;" trbidi="on">
<div class="noindent">
<div style="text-align: justify;">
In the last half of the eighteenth century the colonial
government of Virginia was the last of the colonial governments to have recourse
to paper currency. Paper money was not completely new to Virginia because
tobacco notes, essentially warehouse receipts for stored tobacco, had circulated
as money since early in the eighteenth century. Later, however, the Virginia
colonial government issued fiat paper currency that was declared legal
tender.</div>
</div>
<div style="text-align: justify;">
The circumstances that pushed Virginia to the paper currency brink were
hardly rare in the history of paper money. Robert Carter Nicholas, a member of
the House of Burgesses at the time but not a friend of paper money, explained
the rationale as follows:</div>
<div style="text-align: justify;">
<br /></div>
<blockquote>
<div class="noindent">
<div style="text-align: justify;">
Money, the acknowledged Sinews of War was necessary,
immediately necessary; Troops could not be levied and supported without it; of
Gold and Silver, there Was indeed some, what Quantity I do not know, in the Hands of Individuals, but The
Publick could not command it. Did there not result from hence a Necessity Of our
having Recourse to a Paper Currency, as the only Resource from which we Could
draw Relief?</div>
</div>
</blockquote>
<blockquote>
<div class="noindent">
<div style="text-align: justify;">
(Brock, 1975)</div>
</div>
</blockquote>
<div style="text-align: justify;">
<br /></div>
<div class="source">
<div style="text-align: justify;">
The crisis that led to the issuance of paper currency was the encroachment of the French in what is now western Pennsylvania. After Major General George Washington returned from an expedition against the French and reported to the colonial governor about the military situation, the Virginia House of Burgesses in February 1754 authorized the treasurer to borrow 10,000 pounds at 6 percent interest. The treasurer reported back that there was no money to be had or borrowed. Metallic coinage, flowing out to Europe to pay for imports faster than it flowed in, was hard to come by in colonial Virginia.</div>
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At first the House of Burgesses balked at the issuance of paper money, but in May 1755 the Burgesses authorized the issuance of 20,000 pounds of legal-tender treasury notes for the use of General Edward Braddock. When Braddock’s expedition met with disaster shortly thereafter, the Burgesses authorized another 40,000 pounds. Further issues were made in 1756. The legal-tender status of these notes drew protests, at first ineffective, from British merchants not wanting to accept depreciated paper money in payment of debts.</div>
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In 1757 the Burgesses seized upon the idea of slashing government expenditures by exchanging interest-bearing treasury notes for noninterest-bearing notes. It voted to issue 100,000 pounds in noninterest-bearing notes to retire the interest-bearing notes still in circulation. To attract additional support for the idea of noninterest-bearing notes, the Burgesses authorized the issuance of an additional 80,000 pounds in noninterest-bearing notes to aid in the war effort. Although not paying interest, these notes were legal tender and were to be retired in the payment of taxes.</div>
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After 1762 the exchange rate between Virginia’s paper currency and the British pound began to rise significantly, meaning that more of Virginia’s paper currency was needed to buy British currency, usually about 40 percent more. Thus, 140 pounds of Virginia paper currency was needed to buy 100 British pounds. This currency depreciation forced British creditors to accept cheap paper, which was legal tender, in payment of debts owed by Virginia’s colonists. As Virginia’s paper currency was convertible into ever fewer British pounds, British merchants became more impatient with their losses. Parliament finally passed the Currency Act of 1764, which banned paper money as legal tender in private and public debts. The act applied only to the colonies south of New England because the Currency Act of 1751 had applied similar principles to New England. Virginia continued to issue paper money until the Constitution of the United States put the authority to issue money with the federal government.</div>
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See also:</div>
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<a href="http://encyclopedia-of-money.blogspot.ru/2010/02/currency-act-of-1751-england.html">Currency Act of 1751</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2010/02/currency-act-of-1764-england.html">Currency Act of 1764</a>,<a href="http://encyclopedia-of-money.blogspot.ru/2015/09/virginia-tobacco-act-of-1713.html">Virginia Tobacco Act of 1713</a></div>
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References:</div>
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Brock, Leslie V. 1975 <i>The Currency of the American Colonies: 1700–1764.</i></div>
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Ernst, Joseph Albert. 1973. <i>Money and Politics in America, 1755–1775.</i> </div>
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