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4. Early Banking
Questions:
4. Discuss how the Italian money changers allowed payments to be made "on the books" and describe how paper currency developed from the practices of goldsmiths. (receipts, endorsements, banknotes)
T-Accounts:
5. Use T-accounts to show the effects of the deposit or withdrawal of currency into a checkable deposit.
6. Use T-accounts to show a payment by check assuming the buyer and seller use the same bank.
7. Use Taccounts to show a payment made by check assuming that buyer and seller use different banks and that the check clears through the Federal Reserve.
The Money Changer
The first banks evolved in the city states of Italy: Venice, Genoa, and Florence. These cities were heavily involved in international trade, so the money changers had a thriving business. Money changers bought and sold different sorts of coins. The word "bank" comes from the name of the tables the money changers stood behind.
Deposit banking first existed when a money changer accepted the deposit of coins by a merchant, promising to pay on demand coins of equal value. These money changers invented double entry bookkeeping. They would note the value of the coins deposited and the amount owed the merchant making the deposit.
The money changer and the merchants were involved in a credit relationship. The money changer promised to pay money to the merchant on demand. The word "bankruptcy" comes from a tradition of breaking the money changer's table
if he failed to pay out the coins when they were demanded by his depositors.
In the beginning, a buyer had to go to his money changer, withdraw gold or silver coins, and pay them over to the seller. The seller often would then deposit the coins at his money changer. To avoid carrying coins a long distance, buyers and sellers would meet at the money changer's table to make their payments.
Rather than counting out coins to the buyer and then receiving them back from the seller, money changers began to allow merchants to make payments by making changes in their book entries. If one merchant owed another merchant money, the money changer would debit the buyer's (debtor's) account and credit the sellers (creditor's) account. That way payment was made without coins changing hands.
Banking in England
The modern banking business in England started when the goldsmiths began to rent space in their vaults. A person would take his coins to a goldsmith and in return receive a receipt noting the amount deposited, the name of the depositor, and the name of the goldsmith. The depositor paid a small fee.
The goldsmiths had developed what is called 100% reserve banking. Reserves are money a bank keeps in its vault or deposits with another bank or government agency. When the goldsmiths stored all the money deposited, they were holding a 100% reserve.
Early Paper Currency: Goldsmith Receipts and Banknotes
Paper currency gradually evolved from the receiptsdepositors received when they left gold and silver coins with the goldsmith. To begin with, a buyer would have to take his receipt to the goldsmith, obtain coins, and pay them over to the seller.
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The seller would often take the coins to a goldsmith and deposit them in return for a receipt.
Before long, many people were using the receipts to make payments. When this practice began, the buyer would endorse his receipt and give it to the seller. The seller would then take the receipt to the buyer's goldsmith and obtain gold. The seller sometimes would deposit the gold in return for a new reciept.
Eventually, receipts came to change hands many times. The first buyer would endorse the receipt and then give it to a seller. Then that seller would endorse the receipt as well and use it to buy something, and so on. The goldsmith receipts would circulate.
By the time the goldsmith called his side business a bank, he was issuing banknotes. A banknoteis a promise to pay money on demand to the bearer, usually printed in convenient standard amounts. Banknotes are almost exactly like modern paper currency, except that they have the name of a bank on them, and the bank is obligated to pay gold or silver coins on demand. Soon payments were made by banknote, without the buyer endorsing the banknotes. Some payments were made without any coins changing hands.
Checkable Deposits
The early banks sometimes issued book deposits. A book deposit is a deposit that is noted on the bank's books payable on demand without a receipt. By the late eighteenth century, banks began to allow merchants and wealthy customers make payments by check. A check is an order that asks the bank to pay a specific sum out of a book deposit to the person designated on the check. A checkable deposit is a book deposit that checks can be written against. If payment is made by check and the check is deposited, changes are made in the entries on the bank's books and no coins need to change hands.
T-Account Problems
Harris Teeter deposits $5,000 of currency into its checkable deposit at Nationsbank.
HT NB
A L A L
______
Mon. Res. Ch.Dep.
Cur. V.C. HT +5k
-5k +5k
Ch.Dep. ______
+5k +5k +5k
______
0 0
Piggly Wiggly withdraws $6,000 of currency from its checkable deposit at First Union.
PW FU
A L A L
______
Mon. Res. Ch.Dep.
Cur. V.C. PW -5k
+5k -5k
Ch.Dep. ______
-5k -5k -5k
______
0 0
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General Motors uses a check to purchase $400,000 of Steel from USX.
Both have checkable depostis at NationsBank.
GM USX NB
A L A L A L
______
Mon. Mon. Ch.Dep.
Ch.Dep. Ch.Dep. GM +400k
-400k +400k USX -400k
Goods Goods ______
+400k -400k 0 0
______
0 0 0 0
The Clearinghouse Association
Many banks issued banknotes and checkable deposits. Each bank would accept banknotes and checks drawn on other banks and then collect currency. Eventually, the banks formed a clearinghouse association. The banks would send the checks and banknotes they received in deposit to an office owned by the clearinghouse. Further, the banks kept funds in a book deposit at the clearinghouse. When a bank deposited checks and banknotes drawn on other banks, the clearinghouse employees would credit its book deposit. The clearinghouse employees would debit the book deposits of the banks on which the notes and checks were drawn. After the clearinghouse association opened, payments could be made by banknotes and checks issued by many different banks without any gold or silver coins changing hands. Today, the Federal Reserve banks play the role of the clearinghouse association.
More T-Accounts
John buys $50 worth of hardware from True Value using a check drawn on his account at NationsBAnk. True Value deposits the check into its account at First Union. The check clears through the Fed.
John TV FU
A L A L A L
______
Mon. Mon. Res. Ch.Dep.
Ch.Dep. Ch.Dep. Res.Ac. TV+50
-50 +50 +50
Goods Goods ______
+50 -50 +50 +50
______
0 0 0 0
Fed NB
A L A L
______
Res.Ac Res. Ch.Dep.
FU +50 Res.Ac. John -50
NB -50 -50
______
0 0 -50 -50