Chapter 7Money and banking
Think it over
What is money? What are its uses?
What services does a bank provide?
What is a financial centre? Is Hong Kong a financial centre?
a.Why is exchange the precondition for specialisation?
b.How can specialisation improve labour productivity?
Are dating and marriage examples of barter? Do they require double coincidence of wants? Is it difficult to have dating and marriage?
a.Are the following items regarded as a medium of exchange, a store of value and a means of payment in Hong Kong? Fill in the table below with ‘’ and ‘’.
A medium of exchange
A store of value
A means of payment
i.A HK$100 banknote
ii.A US$100 note
iii.A credit card
b.With reference to the table in (a), what are the relations among medium of exchange, store of value and means of payment?
In a barter economy, people can store their wealth only in the form of resources and goods. In a monetary economy, people can also store their wealth in the form of money. What are the advantages of storing wealth in the form of money?
Compared with barter, what are the advantages of having money as a common measure of value?
In barter, without money as the standard of deferred payments, how were future payments expressed? What were the difficulties involved? What are the advantages of using money as a standard of deferred payments?
a.Do the following goods have the desirable properties of money? Fill in the table below with ‘’ and ‘’.
Limited and stable in supply
Tokens in Jumpin GYM U.S.A.
b.Which of the above performs the best as money in Hong Kong?
Credit money has little intrinsic value and is not backed by valuable goods. Why is credit money commonly accepted in exchange?
Cheques are not legal tender. Why are cheques widely accepted in exchange? What are the advantages and disadvantages of using cheques over legal tender in settling payments?
a.What would happen if the intrinsic value of metallic money (e.g. coins) were much larger than its face value? b.What would happen if the intrinsic value of metallic money were much smaller than its face value? pp.31-33
Multiple Choice Questions
Which of the following descriptions about barter is INCORRECT? A.Barter is the exchange of goods directly for other goods. B.A person’s buying and selling occurs at the same time.
C.Barter requires double coincidence of wants.
D.Barter does not exist in societies with a medium of exchange.
A.a medium commonly accepted for the exchange of goods.
B.an asset to store unrealised purchasing power.
C.a unit to express prices, incomes and expenditures.
D.All of the above
To serve as a store of value, money has to be
D.All of the above
Cheques are sometimes preferred to banknotes as a means of payment because the former are more A.portable.
A credit card is not money because it CANNOT perform the functions of (1)a medium of exchange.
(2)a store of value.
(3)a unit of account.
(4)a standard of deferred payments.
A.(1) and (2) only
B.(3) and (4) only
C.(2), (3) and (4) only
D.All of the above
Which of the following financial institutions in Hong Kong can accept demand deposits? A.Licensed banks
B.Restricted licence banks
D.All of the above
Isabella wants to deposit $200,000 for half a year in Hong Kong. Which of the following financial institutions can accept her deposit? (1)Licensed banks
(2)Restricted licence banks
B.(1) and (3) only
C.(2) and (3) only
D.All of the above
Which of the following is NOT a central bank function?
A.As a lender of last resort
B.As a clearing house
C.As a banker for the public
D.To manage the country’s official reserves
Which of the following is NOT a major factor contributing to Hong Kong’s development as a financial centre? A.Hong Kong has one of the finest deep-water ports in the world. B.Hong Kong has an adequate supply of financial professionals. C.There is a strong local and regional demand for Hong Kong’s financial services. D.Hong Kong has a stable government which imposes no foreign exchange control and maintains a low tax rate.
The general function of a financial market is
A.to accept deposits and offer loans.
B.to channel money from sources with money to sources in need of money. C.to supply money to facilitate exchange.
D.to raise capital for firms.
Barter involves one transaction but monetary exchange involves two transactions. But why is it easier to have monetary exchange than barter? (8 marks)
a.Must a medium of exchange be a means of payment? Must a means of payment be a medium of exchange? Explain.(6 marks) b.Must a medium of exchange be a store of value? Must a store of value be a medium of exchange? Explain. (6 marks)
Can the following fulfil the four functions of money? Explain. a.Cash coupons of a supermarket (4 marks)
b.Octopus cards (4 marks)
c.Payment by Phone Service (PPS) (4 marks)
List FOUR central bank functions performed by the Hong Kong Monetary Authority.
Suggest FOUR factors that contribute to Hong Kong’s development as a financial centre.
a.What are the four functions of money? (4 marks)
b*.What essential properties should money have to perform each of the four functions? List TWO of them for each function. (8 marks) c*.How are the functions of money affected by inflation? (8 marks)
a*.Rice was used as a medium of exchange in the past. Explain why it is no longer used.
b**.Explain why paper money is a better form of money than gold in peace time but the opposite occurs in wartime. (6 marks)
Think it over
1.Money is a medium that we use to buy things and to store wealth. 2.The primary function of a (private) bank is to accept deposits and provide loans. Examples of other services are listed on p.19. 3.Answers may refer to pp.25-28.
a.With specialisation, people concentrate on the production of certain types of goods. Their specialised output cannot satisfy their diverse wants. If they cannot exchange their output for other goods, they have to produce themselves whatever goods they want to consume. In other words, without exchange, they have to be self-sufficient and cannot specialise in production. b.Specialisation can improve labour productivity because
the right person can be assigned to do the right job;
practice makes perfect;
training time can be saved for production;
the time spent having the same person switch from doing one part of the job to another can be saved for production; as fewer capital goods are needed in production, firms can afford to provide sufficient tools for their workers; mechanisation is stimulated.
Barter is a direct exchange of goods and services for other goods and services. Most dating and marriage involve a ‘direct exchange’ of love and care. All direct exchange requires double coincidence of wants. Since it is difficult for people’s wants to coincide (i.e. to meet someone whom you love and who loves you at the same time), it is not easy for dating and marriage to take place. (How many of you are presently dating someone?)
b.Only if an item can function as both a medium of exchange and a store of value (with purchasing power) can it be a means of payment (accepted in exchange and for settling payments), e.g., coins and notes. If an item cannot perform either of the two functions, it cannot be a means of payment, e.g., US$100 note and credit card.
Firstly, money is commonly accepted for settling payments in transactions but most resources and goods are not. If people store their wealth in the form of non-money resources and goods, they have to transform them into money for transactions in future. Transaction costs are involved. Moreover, the prices of individual resources or goods (e.g. oil, properties) can fluctuate greatly relative to the general price level. If their prices drop significantly in future, their owners can suffer a great loss. It is riskier to store wealth in the form of non-money resources or goods than in the form of money. Secondly, resources and goods may have some characteristics that hinder their accumulation, e.g., houses and tables are bulky (involve a high storage cost) while cows and crops are perishable (values drop significantly after a certain period). Since money (a medium) can be anything, money can be made from materials which have desirable qualities, e.g., gold and silver are durable and precious (a small amount can buy a lot of things). Money facilitates exchange as well as wealth accumulation. Hence, wealth can be accumulated quickly in a monetary economy.
With barter, specialised producers have to exchange their goods for other goods. However, in monetary exchange, all goods are exchanged for money. Thus, the number of exchange ratios drops tremendously. Exchange ratios are costly to determine and tedious to memorise. Transaction costs can be greatly reduced in a monetary economy. p.9
With barter, deferred payments are expressed in terms of goods and services. It is difficult for goods offered by future payment providers (e.g. crops offered by farmers) to match the goods asked for by future payment receivers (e.g. wood requested by hut builders). Moreover, goods and services have some characteristics that hinder transactions (e.g. low durability and heterogeneity). Thus, the volume of transactions involving future payments is low. With money as the standard of deferred payments, transactions involving future payments no longer require double coincidence of wants. Hence, transactions involving future payments are facilitated and greatly increased.
Test Yourself 7.2
Limited and stable in supply
(can be evaporated)
(with low purchasing power → bulky)
(with low purchasing power)
(with high purchasing power)
Tokens in Jumpin GYM U.S.A.
(with low purchasing power)
(Accept other conclusion with reasonable arguments.)
Credit money is commonly accepted in exchange because people believe it is commonly accepted in future transactions. Credit money has little intrinsic value and is not backed by anything of value. However, provided that people believe that credit money is commonly accepted for the purchase of goods they desire, people are willing to accept it for the sale of the goods they own. If people do not accept credit money when selling their goods, it is difficult for them to exchange their goods for others’ goods since barter requires double coincidence of wants.
Cheques are widely accepted because payments by cheque have some advantages over payments by legal tender. Firstly, a cheque payment can be drawn for the exact amount, and hence no counting or making change is needed. Secondly, cheques are more portable and even if they are stolen, the cost is relatively small. However, cheques cannot replace legal tender because payments by cheque have some disadvantages over payments by legal tender. Firstly, cheques are accepted only if the payee (收款人) trusts that the payer’s cheque can be cashed. Secondly, cashing a cheque involves costs. Therefore, payments by cheque are commonly accepted in transactions among trading partners who are acquainted (認識) with each other, and in situations when sellers do not want to handle a large amount of cash which involves counting, making change and running the risk of theft.
a.If the intrinsic value of metallic money were much larger than its face value, people would exchange for coins (with a lower face value) in transactions and sell the metal (which has a higher intrinsic value) illegally for profit. Most coins would disappear. b.If the intrinsic value of metallic money were much smaller than its face value, people would use the metal (with a lower intrinsic value) to produce coins (with a higher face value) illegally to make a profit. Counterfeit money might appear.
Multiple Choice Questions
Barter may still exist in a monetary economy, e.g., direct exchange of stamps, food and toys.
To retain purchasing power for future use, money has to be durable (as a store of value).
Option A is correct. Provided that one has enough money in one’s current account, a cheque can be used to settle a transaction of any amount. Hence, one does not have to carry a large amount of cash to settle large payments. Cheques are more portable than banknotes. Options B and D are incorrect. Acceptance of a cheque is based on whether a payee trusts a payer. Since payments by cheque are less reliable than payments by banknotes, they are not as widely accepted as banknotes. Option C is incorrect. Both cheques and banknotes are scarce.
For details, please refer to Learning Tips 7.1.
Restricted licence banks and deposit-taking companies can accept time deposits only.
Restricted licence banks can accept time deposits for any maturity, but the amount must be HK$500,000 or above.
A central bank does not serve individuals or firms.
This factor contributes to Hong Kong’s development as a trading and logistics centre.
1.Barter involves a transaction in which buying and selling occur simultaneously. The buyer has to find a seller who has the good the buyer wants and a seller who simultaneously wants the good the buyer has. In other words, barter requires double coincidence of wants. Since it is difficult for people’s wants to coincide, barter is difficult to arrange. (4 marks) Monetary exchange involves two transactions in which buying and selling are separated. People sell their goods for money first and then they use the money to buy the goods they desire. Since money is commonly accepted by sellers of all goods, only the wants of buyers who use money to buy goods are satisfied in each transaction. Therefore, double coincidence of wants is not required in monetary exchange. Monetary exchange can take place more easily than barter. (4 marks)
a.The answer to the first question is ‘no’. A medium of exchange may not be a means of payment, e.g., credit card. This is because if a medium of exchange is not a store of value (with purchasing power), despite its acceptance in exchange for goods, payment is merely deferred and not settled. (3 marks) The answer to the second question is ‘yes’. A means of payment must be a medium of exchange, e.g., money. Since a means of payment can settle payments for goods, it must be accepted as a medium of exchange. (3 marks) b.The answer to the first question is ‘no’. A medium of exchange may not be a store of value (i.e. it does not have purchasing power), e.g., credit card. Provided that the seller trusts that the payment will be settled in future (e.g. the guarantee of the credit card issuer), the seller may accept the use of a medium of exchange which has no purchasing power in exchange for his/her good. (3 marks) The answer to the second question is ‘no’. A store of value may not be a medium of exchange, e.g., jewellery. Although a store of value may be accepted by someone (as it retains purchasing power, it can be exchanged for some goods), it may not be commonly accepted by all people in exchange for all goods. So a store of value may not be a medium of exchange. (3 marks)
a.A supermarket’s cash coupons are stores of value (with purchasing power). However, since they are not commonly accepted elsewhere, they are not a medium of exchange or a means of payment. They are neither a unit of account nor a standard of deferred payments as prices and debts are not expressed in terms of the cash coupons. Therefore, cash coupons cannot fulfil all the four functions of money. (4 marks) b.Octopus cards are stores of value since cards with a positive remaining balance have purchasing power. However, Octopus cards are mainly used to settle small-value retail payments and are not a generally accepted medium of exchange. They are neither units of account nor standards of deferred payments as prices and debts are not expressed in terms of Octopus cards. Therefore, they cannot fulfil all the four functions of money. (4 marks)
c.Payment by Phone Service (PPS) is a method of payment. Payment by Phone Service itself is not a medium of exchange, a means of payment, a store of value, a unit of account or a standard of deferred payments. Hence, it cannot fulfil all the four functions of money. (4 marks)
4.The following central bank functions are performed by the Hong Kong Monetary Authority: As an adviser of the government on matters of money, banking and finance Managing official reserves through the Exchange Fund
As a lender of last resort
As a clearing house through the operation of Hong Kong Interbank Clearing Limited, jointly owned by the Hong Kong Monetary Authority and the Hong Kong Association of Banks Supervising financial institutions
Issuing coins and $10 notes
Carrying out monetary policy
(Mark the first FOUR functions only. 1 mark each.)
5.The following factors have contributed to Hong Kong’s development as a financial centre: A favourable time zone location, enabling financial dealings to be carried out continuously almost 24 hours a day around the world A strong local and regional demand for financial services, e.g., from the mainland of China and Southeast Asia Favourable government policies such as a stable and efficient government, the rule of law, minimal government intervention in the market, no foreign exchange controls, no restrictions on capital flows, substantial foreign exchange reserves and fiscal reserves, a fully convertible and stable currency, a simple tax system and low tax rate An excellent financial infrastructure supported by efficient transport and communications services An adequate supply of financial professionals
(Mark the first FOUR factors only. 1 mark each.)
a.The four functions of money are a medium of exchange and means of payment, a store of value, a unit of account and a standard of deferred payments. (4 marks) b.To be a medium of exchange, money should be generally acceptable, limited and stable in supply, divisible, portable, homogeneous and having denominations. To be a store of value, money should be generally acceptable, limited and stable in supply and durable. To be a unit of account, money should be generally acceptable, limited and stable in supply, divisible, homogeneous and having denominations. To be a standard of deferred payments, money should be generally acceptable, limited and stable in supply, divisible, durable, portable, homogeneous and having denominations. (Mark the first TWO properties only for each function. 1 mark for each property.)
c.During inflation, the purchasing power of money drops continuously. Hence, money may not be generally accepted as a medium of exchange. (2 marks) With a fixed face value and bearing no interest, money is not a good store of value during inflation. (2 marks) During hyperinflation, if money is no longer commonly accepted as a medium of exchange, it cannot perform the function of being a unit of account. The value and price of some goods may not be measured in terms of money. (2 marks) During inflation, as the purchasing power of money drops continuously, people may not use it as the standard of deferred payments unless the payments are indexed. (2 marks)
a.Though rice is commonly accepted and divisible, it does not have the following properties and hence it is not a good form of money. The supply of rice is significantly affected by the weather. Thus, its value fluctuates greatly. Rice is not durable and its value falls continuously.
Rice has low purchasing power and hence rice is not portable. A large quantity of rice is needed to settle large transactions. Huge transport costs are involved. Rice is heterogeneous in quality and disputes may arise over its value and exchange ratio. (Mark the first THREE reasons only. 2 marks each.)
b.During times of peace, paper money, not gold, is the legal tender as declared by a government. Thus, paper money is considered money and is commonly accepted in exchange, but gold is not. (2 marks) During a war, a country may be conquered and the government may be overthrown or its people may flee to another country. Paper money issued by the central bank may not be accepted to settle payments. Since paper money is credit money without intrinsic value, and gold is a store of value with high intrinsic value, gold may be exchanged for goods or services, but paper money may not. So gold is a better form of money than paper money during a war. (4 marks)