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Money today is fiat money—legal tender not redeemable in gold or any other specie by the government that has issued it. The Federal Reserve System and other central banks may still carry entries on their balance sheets for gold valued at a fixed price, but such an entry is “simply the smile of a vanished Cheshire cat.”6
In Western Europe, a single monetary system is now in place for 11 countries, marking the first time these Europeans have
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shared a payment system since the fall of the Western Roman Empire approximately 1,500 years ago. On January 1, 1999, the
11 European countries tied their exchange rates to the Euro and gave to the new European Central Bank the power to establish interest rates and dictate monetary policy.
The ubiquitous check has a long history, and a lot of machinery and technology has been invented for processing checks. The paper check is the oldest and most frequently used noncash payment instrument in the United States.
The legal rules that govern the rights and obligations of drawers, drawees, and holders of checks today are essentially the same as those that applied in earlier periods to bills of exchange. Chapter 3, about check systems and the Uniform Commercial Code (U.C.C.), discusses the operation, the governing law, and the risks of check systems.
In the United States, before the automation of proof machines and clearing systems, checks were processed manually. Many banks would honor “counter checks,” checks that did not have preprinted customer account data but carried only the name and address of the bank. Counter checks were available at merchants’ counters in the community for the use of bank customers. Mechanical “proof” machines were used to sort the checks into bins for “drawn on us” and ”drawn on other” banks and, for bin categories, listed amounts and total.
Each bank prepared remittance letters containing checks drawn on other banks that its customers had deposited. These remittance letters were mailed to the bank’s “correspondent bank” in each geographic location; the letters requested payment for the checks contained therein. Upon receipt of funding from the correspondent bank, the bank credited its customers’ accounts with “good” or “collected” funds and then permitted the customers to withdraw such funds. Today’s check processing
systems are all high-speed versions of these basic processes. The premise of the depository bank’s time delay for collection of funds is still embedded in the automated interbank clearing systems of today.
As the Federal Reserve System developed so that each depository was assigned a unique identification number, each customer’s account also was so identified; magnetic ink character recognition (MICR, pronounced “mike-er”) was introduced, and the basis for high-speed electronic check processing systems was established. The new high-speed electronic reading proof machines replaced their older mechanical ancestors. Electronic check presentment, by which the MICR encoding is sent electronically to paying banks, is a major technological benefit of MICR. Yet despite years of promoting electronic payment and bill presentment systems, checks are still being used for most consumer-to-business payments.
ELECTRONIC PAYMENTS Fedwire
The unique feature of Fedwire7 is immediate finality of payment. This immediate settlement is, at present, different from any other payment system in the United States. The Federal Reserve System (the “Fed”) guarantees (under Regulation J) payment to the receiving bank and assumes the credit risk of the sending bank’s insufficiency of funds. The Fed mitigates that risk by delaying the execution of payment orders sent by banks that are thought to be among those that are less stable.
Since 1918, the Fed has moved funds through electronic communication systems. When the Fed changed from weekly to daily settlements, the Federal Reserve Banks installed a private telegraph system among themselves to process transfers of funds. In the 1920s, United States Treasury securities became transferable by telegraph. The nation’s funds and securities transfer system remained largely telegraphic until the early 1970s. New
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computer technologies then became available. The Fedwire electronic transfer system was developed and is operated by the Federal Reserve System. Until 1980, Fedwire services were offered without explicit cost to Federal Reserve member commercial banks. The Depository Institutions Deregulation and Monetary Control Act of 1980 (also requiring the pricing of Fed services, including funds and securities transfers) gave nonmember depository institutions direct access to the transfer system.
The Fedwire system connects Federal Reserve Banks and Branches, the Treasury and other government agencies, and more than 9,000 on-line and off-line depository institutions. Fedwire and CHIPS (Clearing House Interbank Payment System) handle most large-dollar transfers involving the United States. Fedwire plays a key role in the nation’s payments and government securities transfer mechanisms. Depository institutions use Fedwire to transfer funds to correspondent banks and to send wire transfers of their customers’ funds to other institutions. Transfers on behalf of bank customers include funds used in the purchase or sale of government securities, deposits, and other large, time-sensitive payments. The Treasury and other federal agencies use Fedwire extensively to disburse and collect funds.