Kinds, Merits and Demerits
of Paper Money
Chapter #3
Kinds of Paper Money
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There are three kinds of Paper
money:
Representative paper money
Convertible paper money
Fiat paper money
Representative paper money
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It is that money which is fully backed
by equivalent metallic reserves.
The holder of the bank note can
easily get it converted into the
metallic money on demand.
Goldsmith receipt is an example of
representative money.
Up to 1933 America was issuing
representative dollars and up to
1925 UK was issuing representative
pounds.
Reason of shift
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Because of limited resources of gold
and silver, the country can not issue
representative paper money.
Fluctuations in the prices of gold and
silver was also the reason.
For example; If America issue the
dollar that $100 will be converted
into 10gm of gold and in the market,
the value of 10gm gold is either $80
or $120. So this fluctuations arise
problems.
Convertible paper money
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Paper money which is easily
convertible into coins on demand is
called convertible paper money.
The state or the public authority
which issues convertible paper
currency does not keep an equal
value of metallic reserve behind it.
Because they knows it that all the
notes are not generally presented for
conversion at the same time.
Reason of shift
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Just like representative money,
this money is also having the
same problem.
But the only difference was that
for this money, the Govt does
not keep 100 % reserves of gold
and silver.
Fiat paper money
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It is that money which is not
redeemable or convertible into gold
or silver on demand.
It is accepted because it has been
declared legal tender by the issuing
authority and has general
acceptance as a medium of
exchange.
The intrinsic value of fiat money is nil
because its not convertible in gold &
silver on demand.
Example; The currency that which
we are using now-a-days are fiat
money.
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Fiat money in the words of
Keynes is that which is created
and issued by the state but is
not convertible by law into any
thing other than itself and has
no fixed value in terms of an
objective standard.
Merits of Paper Money
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Economical
Elasticity of money supply
Promotes economic growth
Internal price stability
Helpful in emergency
Regulation of exchange rates
Uniform quality
Economical
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Under paper standard, the
central bank of any country has
not to keep gold or silver for
issuing of the paper notes.
The cost of printing paper notes
is also very small.
It is thus, most economical form
of monetary standard.
Elasticity of money supply
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As the money supply is not
backed with gold or silver,
therefore, the monetary
authority can easily manage its
supply according to the
requirements of trade and
industry in the country.
Promotes economic growth
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Under paper standard, the
monetary authority is free to
determine its monetary policy.
It therefore regulates the money
supply in such a way that
productive resources of the
country are utilized to their
maximum and greater economic
growth achieved.
Internal price stability
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Under paper standard, the
monetary authority can maintain
stability in internal price level by
making necessary expansion or
contraction in money supply
according to the economic
conditions.
Helpful in emergency
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Paper money is also useful in
times of war when huge funds
are needed to finance it.
It is also helpful to meet any
financial crises.
The monetary authority by
expanding or contracting the
money supply achieve this
objective.
Regulation of exchange rates
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Under paper standard, the
international exchange rates are
fixed by purchasing power of the
respective countries.
Paper currency is an effective
and automatic regulator of
exchange rates between the
countries.
Uniform quality
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The paper money has a uniform
quality and the holder least
bothers for possession of new
money coins.
With the use of paper money,
the loss of precious metals due
to wear and tear is also solved.
Demerits of Paper money
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Danger of inflation
Internal price instability
Exchange rate instability
Dangers of mismanagement
Fear of demonetization
Use within the country
Danger of inflation
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Under paper money, the
increase in money supply is not
difficult because it requires no
backing of gold or silver.
The government of the country,
to cover the deficit financing,
over issues paper currency.
This results in inflationary rise in
prices with all its evil effects.
Internal price instability
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All the countries of the world are
now on paper standard.
They have not achieved
domestic price stability in reality.
There are violent fluctuations in
internal prices under this
system.
Exchange rates instability
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Under paper standard, there are
also wide fluctuations in the
foreign exchange rates.
The internal prices do not move
in line with the external prices.
As such external instability
arises which directly effects the
foreign trade.
Dangers of mismanagement
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Paper standard is useful only
when it is efficiently managed.
If the monetary authority is not
vigilant and does not issue the
paper currency as required, it
often leads to inflation or
deflation.
Fear of demonetization
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The paper money has no intrinsic
value of its own.
The monetary authority also does
not promise to convert it into
precious metal.
If the government at any time orders
the demonetization of the currency,
And the holders of the demonetized
notes fail to deposit these notes in
times, they have then no value.
Use within the country
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As the intrinsic value of paper
money is zero, it can only be
used in the country issuing it.
Outside the country only stable
paper money has the value.
Conclusion
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Paper money is a source of
blessing for mankind.
However, when it is not properly
managed, it becomes source of
risk and confusion.