ALEXANDRIA, VA (Mar. 19, 1998) -- Money fulfills three functions: It is used as a medium of exchange, a store of value, and a unit of account. For many innovations that are hallmarks of human progress (I won't deal with the neo-Malthusians and Luddites here, thanks), money was a necessary component. Money is anything from wampum to shells, but I take this from the Euro-centric perspective of innovation in commercial ventures such as international trade, capitalism, and the evolution of a complex society.
As a unit of account and medium of exchange, money allows for contracts to be drawn up in very specific terms that leave no chance to the vagaries of the kind of wheat I might trade you for your horses or the exact amount of spices you might bring back from the Indies on your next voyage. As a mechanism for commercial interaction, money allows for the expression of all goods in units of account and allows for more specialization in producers. The merchant of spices doesn't need know about a customer's ability to pay in labor or the quality of chickens the customer may be offering as payment -- he only needs to price his goods in terms of coins and only needs to know that the coins being offered have a standard gold or silver content. As a store of value, it is a convenient mechanism for saving the accumulated product of a human's or a business commercial organization's toils. Money doesn't need to be fed and coins are easy to store.
The Origins and Functions of Banks
With the need to store value came banks, and with stored value came the question of making use of that stored value. In the European experience, a number of events came together to answer this question of what to do with the accumulation of wealth and storage of value. The Renaissance would not have found its legs except for the patronage of banking families such as the de Medicis and Borgias, whose influence led to the Church dropping its restriction on usury, or the charging of interest on loans. It is no coincidence that a lift in a Church ban on money lending would coincide with a flourishing in technological innovation, the arts, and creation of wealth.
Scholars disagree on the origins of the modern bank, arguing for different models such as those established by the Babylonians, Greeks, and Venetians. The urge to provide for the safekeeping of gold, or specie, for a mutually agreeable intermediary for commercial transactions and for trade financing has existed for ages. Each society's model for banking has features resembling basic features of what we know as "banks."
There is still a major demarcation point in the way we look at banks and financial institutions in the U.S. The term "bank" in many cases applies to a financial institution that takes in deposits insured by state and federal governments. That insurance represents a retail marketing advantage banks and savings an loans (S&Ls) have over non-regulated institutions. The operators of that bank or S&L can treat it like a casino and the government entities that insure the institution (such as the Federal Deposit Insurance Corporation) will still pay back depositors for their losses up to $100,000. Given the competitiveness of money markets and the desire for higher yields by holders of cash, the marketing edge banks have is slipping.
A consumer who can earn 50-200 basis points more (one basis point equals one one-hundredth of a percentage point) on ready cash-like assets in a brokerage account rather than in a bank account will likely forgo the desire for deposit insurance. That decline in marketing advantage and the maturation of money markets is where we'll pick this up next time.