The Wall Street Journal Guide to Understanding Money and Investing initiates you into the mysteries of the financial pages-buying stocks, bonds, mutual funds, futures and options, spotting trends and evaluating companies. For those who are curious but intimidated by everyday financial jargon, this guide offers a literate, forthright and lively alternative.
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Wall Street Journal Guide to Understanding Money and Investing
By Kenneth M. Morris
Rebound by SagebrushCopyright ©1999 Kenneth M. Morris
All right reserved.
The History of Money
Most money doesn't have any value of its own. It's worth what it can buy at any given time.
The history of money begins with people learning to trade the things they had for the things they wanted. If they wanted an ax, they had to find someone who had one and was willing to exchange it for something of theirs. The system works the same way today, with one variation: now you can give the seller money in exchange for the item you want, and the seller can use the money to buy something else.
IN THE BEGINNING WAS BARTER
Our earliest ancestors were self-sufficient, providing their own food, clothing and shelter from their surroundings. There was rarely anything extra - and nothing much to trade it for.
But as communities formed, hunting and gathering became more efficient. Occasionally there were surpluses of one commodity or another. A people with extra animal skins but not enough grain could exchange its surplus with another people with plenty of food but no skins. Barter was born.
As societies grew more complex, barter flourished. The most famous example may be Peter Minuit's swap in 1626 of $24 in beads andtrinkets for the island of Manhattan. Its property value in 1998 was assessed at $23.4 billion.
MONEY FILLS THE BILL
It takes time and energy to find someone with exactly what you want who's also willing to take what you have to offer. And it isn't always easy to agree on what things are worth. How many skins is a basket of grain worth? What happens if the plow you want is worth a cow and a half?.
As trade flourished, money came into use. Once buyers and sellers agreed what was acceptable as a means of payment, they could establish a system that assigned different values to coins or other durable and easily transportable items. The term currency, another word for money, means anything that's actually used as a means of exchange.
Using money also meant that buying and selling didn't have to happen at the same time. Sellers could wait until they were ready to make a purchase to spend the money they had received. What's more, they could accumulate money from a number of sales to give them more buying power.
Money has taken many different forms over the years. In Rome, for example, soldiers were often paid with sacks of salt - that's sal in Latin, the root of salary - and salt was also used in ancient China to pay for small purchases.
METAL BECOMES THE STANDARD
As early as 2500 B.C. various precious metals - gold, silver and copper - were used to pay for goods and services in Egypt and Asia Minor. By 700 B.C. the kingdom of Lydia was minting coins made of electrum, a pale yellow alloy of gold and silver. The coins were valuable, durable and portable. Better yet, they couldn't die or rot on the way to market. In addition, using coins permitted payments by tale, or counting out the right amount, rather than weighing it. That simplified the exchange process even more. For a long time, the relative value of currencies was usually gold or silver. That's where terms like pound sterling and gold standard originated. In modern times, though, national economies have moved away from basing their currency on metal reserves. Gold hasn't been a universal yardstick since 1971, when the U.S. stopped redeeming its paper currency with gold.
MONEY BY FIAT
When money was made of gold or silver - or could he exchanged for one of them - it was commodity currency. But money that has no intrinsic value and can't be redeemed for precious metal is fiat currency. Most currency circulating today is fiat money, created and authorized by various governments as their official currency.
Bills come in different sizes, colors and denominations, but their real value is based on the economic strength of the country that issues them.
THE ORIGINS OF PAPER MONEY
Although the idea of paper money can be found in bills and receipts recorded by the Babylonians as early as 2500 B.C., the earliest bills can be traced to China. In 1282, Kubla Khan issued paper notes made of mulberry bark bearing his seal and his treasurers' signatures. The Kuan is the oldest surviving paper money. The currency - about 8 1/2 x 11 inches - was issued in China by the Ming dynasty between 1368 and 1399.
The first European bank notes were printed in Sweden in 1661, and France put paper money into wide circulation in the 18th century.
The first paper money in the British Empire was in the form of promissory notes given to Massachusetts soldiers in 1690, when their siege of Quebec failed and there was no booty to pay them with. The idea became popular with the other colonies, if not with the soldiers who were paid that way.
THE U.S. DOLLAR
The American dollar comes from a silver coin called the Joachimsthaler minted in 1519 in the valley (thal) of St. Joachim in Bohemia (Jachymov in Czech Republic). The coin was widely circulated and called the daalder in Holland, the daler in Scandinavia and the dollar in England. More than two dozen countries besides the U.S. call their currency dollars.
The U.S. dollar's early history was chaotic until the National Banking Act of 1863 established a uniform currency. Before that, banks used paper money (called scrip), but they couldn't always meet their customers' demands for hard currency (gold or silver coins, or specie). Often the dollar could be exchanged for just a fraction of its stated value.
Dollars were once backed by gold and silver reserves. Until 1963, U.S. bills were called silver certificates. Today they are Federal Reserve notes, backed only by the economic integrity of the U.S. You can't exchange them for specie.
THE UPS AND DOWNS OF PAPER MONEY
Paper money has had its ups and downs because its value changes so quickly with changing economic conditions. When there's lots of money in circulation, prices go up and paper money buys less. That's known as inflation.
For example, during the American Revolution paper money dropped in value from $1 to just 2 1/2¢. In Germany in 1923, you needed 726,000,000 marks to buy what you'd been able to get for 1 mark in 1918.
MAKING PAPER MONEY
The Bureau of Engraving and Printing prints money at plants in Washington, D.C., and Fort Worth, Texas. The money is printed in large sheets, stacked into piles of 100 and cut into bills that are bundled into bricks for shipping. The engraved plates, which can be used to produce up to three million impressions before they have to be replaced, are designed with intricate patterns of lines and curves to make the money hard to copy. As an added security measure, several different engravers work on each plate.
The Bureau makes the slightly magnetic ink itself from secret formulas. Special paper, made by Crane and Company, has been used for all U.S. currency since 1879.
The content of the paper is a closely guarded secret, although we know the sheets are now about 75% cotton and 25% linen and contain small, faintly colored nylon threads.
You can get back the full value of a torn bill from the Bureau of Engraving and Printing in Washington, D.C. - as long as you turn in at least 51% of the ripped one.
The U.S. Dollar
In 1862, the U.S. government issued its first paper money. The bills were called greenbacks because the backs were printed in green ink - to distinguish them from gold certificates.
Each U.S. banknote has a distinctively marked green-, black- and cream-colored face. On the dollar bill, a letter within a seal to the left of the portrait identifies the Federal Reserve bank that issued the bill. In this case, it's B for New York. A corresponding number - New York's is 2 - appears four times on the face. On the redesigned bills, the seal of the Federal Reserve system itself appears.
The back of each denomination is different. On the dollar, it's the Great Seal of the United States. Its reverse side, on the right of the bill, features the American eagle and the number 13, representing the country as a whole and the original 13 states. Symbols include: 13 stripes on the eagle's shield, the 13-star constellation above the eagle's head, 13 warlike arrows grasped in one of the eagle's claws the olive branch of peace, with 13 leaves and 13 olives, grasped in the other.
Greenbacks are created in three steps. The black front is printed the first day from the engraved plates. Then the green back is is printed the second day, giving the ink time to dry. Finally, the green serial numbers and Treasury seal are added to the front using a process called COPE, or currency overprinting and processing equipment.
The front of the seal has a 13-letter Latin motto, ANNUIT COEPTIS, which means "He has favored our undertaking," a reference to the blessing of an all-seeing deity whose eye is at the apex of the pyramid. The pyramid itself suggests a strong base for future growth. Underneath, in Roman numerals, is the date 1776, the year the Declaration of Independence was signed. The second motto, NOVUS ORDO SECLORUM, means "New order of the ages."
Legal tender is money a government creates that must - by law - be accepted as payment of debt. A $100 bill is legal tender, for example, but a $100 check isn't. That's because the check is issued by a bank, not the government.
Bills are numbered two ways. The eight-digit serial number is printed on the top right and lower left on the front. The number of every bill of the same denomination in the same series is different. The number begins with a letter (here B) identifying the issuing Federal Reserve Bank.
Each bill also has a series identification number engraved between the portrait and the signature of the Secretary of the Treasury. It gives the year the note's design was introduced, usually when a new Secretary or a new U.S. Treasurer has been appointed.
The Money Cycle
Money is a permanent fixture of modern society, but the bills and coins we use have a limited lifespan.
A major redesign of U.S. currency is underway. The first new bill, the $100, was introduced in 1996, followed by the $50 in 1997 and the $20 in 1998, with the others slated to follow. Their most noticeable features are larger, off-center portraits and even more intricate border designs - both calculated to make the bills more difficult to copy in an era of increasingly sophisticated computer and photocopying equipment.
Since paper bills wear out from changing hands, replacements are printed regularly to maintain a steady supply. Not surprisingly, dollar bills have the shortest life span, about 13 to 18 months. Other countries have successfully introduced durable coins with lifespans of 30 to 40 years to replace their small bills, though so far that approach hasn't worked in the U.S. A new $1 coin is scheduled for release in 2000 to replace the unpopular Susan B. Anthony dollar. Its design should resolve one of the existing coin's major drawbacks: It looks and feels so like the quarter that it's easy to confuse them.
In 1969, bills over $100 in value were eliminated as currency because of declining demand. The faces that disappeared were McKinley on the $500, Cleveland on the $1,000, Madison on the $5,000, Chase on the $10,000 and Wilson on the largest of them all, the $100,000.
HOW COINS COME TO LIFE
In the U.S., new coins are struck at three Bureau of the Mint branches, and each coin carries the mark of the branch where it was minted: D for Denver, S for San Francisco, and P (or no mark at all) for Philadelphia. The process of making coins is called minting, from the Latin word moneta.
The whole process is a modest profitmaker. For example, it costs about 9/10 of a cent to make a penny. That difference - about a dollar for every thousand pennies - is profit. The Mint prefers the term seigniorage. But whatever you call it, it amounts to more than $400 million annually.
Other Forms of Money
Money doesn't always change hands. It's often transferred from one account to another by written or electronic instructions.
Technology has revolutionized the way we use money. The form we're most familiar with - bills and coins - represents only about 8% of the trillions of dollars that circulate in the U.S. economy.
Before 1945, most people paid with cash. By 1990, about $30 trillion was transferred annually by check. Electronic transfers have increased the volume dramatically. In 1998, an average of $1.3 trillion was moved electronically every day through the Federal Reserve System.
NOT CASHLESS - YET
A society that gets along without cash still seems a long way off.
We haven't yet abandoned our pennies, let alone our bills. On the other hand, the money we move with a checkbook, an ATM card, a credit card and a debit card - or a program on a personal computer - suggests that the story of money is still being written.
Increasingly sophisticated smart cards, whose dollar value is imbedded in a microchip that can be debited and replenished electronically, are likely to be part of that tale. For example, they're already replacing tickets and tokens to pay for mass transit, highway and bridge tolls.
HOW CHECKS MOVE MONEY
High-speed electronic equipment reads the sorting and payment instructions, called MICR (Magnetic Image Character Recognition) codes, printed in magnetic ink along the bottom of the check. The money is then debited (subtracted) from the writer's account and credited (added) to the receiver's.
Your bank account number, beginning with the branch number, identifies the account that money will be taken from to pay the check.
The check routing number identifies the bank, its location, and its Federal Reserve district and branch. The coded information explains the arrangement for collecting payment from the bank. The same information, in different format, appears in the upper right of the check, under the check number.
The check number and the amount of the check are printed by the first bank to receive the check when it is deposited or cashed. When you actually write the check, the space under your name is blank.
Information written and stamped on the back of the check shows the account the dollar value was credited to, the bank where it was cashed or deposited and the date, plus the payment stamp from your bank.
MAKING THE MOST OF CREDIT
In 1998, an estimated 70% of all U.S. households had one or more credit cards. And the majority used their cards regularly.
Excerpted from Wall Street Journal Guide to Understanding Money and Investing by Kenneth M. Morris Copyright ©1999 by Kenneth M. Morris. Excerpted by permission.
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