Introduction to economic activity

Economic activity began with the caveman, who was economically self-sufficient. He did his own hunting found his own shelter, and provided for his own needs. As primitive populations grew and developed, the principle of division of labour evolved. One person was more able to perform an activity than another and therefore each person concentrated on what he did best. While one hunted, another fished. The hunter then traded his surplus to the fisherman, and thus each benefited.

In today's complex economic world, neither individuals nor nations are self-sufficient. Nations have utilized different economic resources; people have developed different skills. This is the foundation of world trade and economic activity. As a result of this trade and activity, international finance and banking have evolved.

For example, the United States is a consumer of coffee, yet it does not have the climate to grow any of its own. Consequently, the United States must import coffee from countries (such as Brazil) that grow coffee. On the other hand, the United States has large industrial plants capable of producing a variety of goods, which can be sold to countries that need them.

If nations traded item for item, such as one automobile for 10,000 bags of coffee, foreign trade would be cumbersome and restrictive.

But instead of barter, which is the trade of goods without an exchange of money, all countries receive money in payment for what they sell. The United States pays for Brazilian coffee with dollars, which Brazil can then use the wool from Australia, which in turn can buy textiles from Great Britain, which can then buy tobacco from the United States.

Foreign trade, the exchange of goods between nations, takes place for many reasons such as: no nation has all the commodities that it needs, a country often does not have enough of a particular item to meet its needs, and one country can sell some items at a lower cost than other countries.

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FOR BANKING OPERATIONS

Seventeenth-century English goldsmiths provided the model for contemporary banking. Gold stored with these artisans for safekeeping was expected to be returned to the owners on demand. The goldsmiths soon discovered that the amount of gold actually removed by owners was only a fraction of the total stored. Thus, they could temporarily lend out some of this gold to others, obtaining a promissory note for principal and interest In time, paper certificates redeemable in gold coin were circulated instead of gold. Consequently, the total value of these banknotes in circulation exceeded the value of the gold that was exchangeable for the notes.

Two characteristics of this fractional reserve banking remain the basis for present-day operations. First, the banking system's monetary liabilities exceed its reserves. This feature was responsible in part for Western industrialization, and it still remains important for economic expansion. The excessive creation of money, however, may lead to inflation. Second, liabilities of the banks (deposits and borrowed money) are more liquid — that is, more readily convertible to cash-than are the assets (loans and investments) included on the banks' balance sheets. This characteristic enables consumers, businesses, and governments to finance activities that otherwise would be deferred or cancelled; however, it underlies banking's recurrent liquidity crises. When too many depositors request payment, the banking system is unable to respond because it lacks sufficient liquidity. The lack of liquidity means that banks must either abandon their promises to pay depositors or pay depositors until the bank runs out of money and fails. The advent of deposit insurance in the United States in 1935 did much to alleviate the fear of deposit losses due to bank failure and has been primarily responsible for the virtual absence of runs on US banks.

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