Kinds, Merits and Demerits Kinds, Merits and Demerits of Paper Moneyof Paper Money

Chapter #3Chapter #3

Kinds of Paper MoneyKinds of Paper Money

There are three kinds of Paper There are three kinds of Paper money:money:

Representative paper moneyRepresentative paper money Convertible paper moneyConvertible paper money Fiat paper moneyFiat paper money

Representative paper moneyRepresentative paper money

It is that money which is fully backed It is that money which is fully backed by equivalent metallic reserves.by equivalent metallic reserves.

The holder of the bank note can The holder of the bank note can easily get it converted into the easily get it converted into the metallic money on demand.metallic money on demand.

Goldsmith receipt is an example of Goldsmith receipt is an example of representative money.representative money.

Up to 1933 America was issuing Up to 1933 America was issuing representative dollars and up to representative dollars and up to 1925 UK was issuing representative 1925 UK was issuing representative pounds.pounds.

Reason of shiftReason of shift

Because of limited resources of gold Because of limited resources of gold and silver, the country can not issue and silver, the country can not issue representative paper money.representative paper money.

Fluctuations in the prices of gold and Fluctuations in the prices of gold and silver was also the reason.silver was also the reason.

For example; If America issue the dollar For example; If America issue the dollar that $100 will be converted into 10gm of that $100 will be converted into 10gm of gold and in the market, the value of gold and in the market, the value of 10gm gold is either $80 or $120. So this 10gm gold is either $80 or $120. So this fluctuations arise problems.fluctuations arise problems.

Convertible paper moneyConvertible paper money

Paper money which is easily Paper money which is easily convertible into coins on demand is convertible into coins on demand is called convertible paper money.called convertible paper money.

The state or the public authority The state or the public authority which issues convertible paper which issues convertible paper currency does not keep an equal currency does not keep an equal value of metallic reserve behind it.value of metallic reserve behind it.

Because they knows it that all the Because they knows it that all the notes are not generally presented for notes are not generally presented for conversion at the same time.conversion at the same time.

Reason of shiftReason of shift

Just like representative money, Just like representative money, this money is also having the this money is also having the same problem.same problem.

But the only difference was that But the only difference was that for this money, the Govt does for this money, the Govt does not keep 100 % reserves of gold not keep 100 % reserves of gold and silver.and silver.

Fiat paper moneyFiat paper money

It is that money which is not It is that money which is not redeemable or convertible into gold or redeemable or convertible into gold or silver on demand.silver on demand.

It is accepted because it has been It is accepted because it has been declared legal tender by the issuing declared legal tender by the issuing authority and has general acceptance authority and has general acceptance as a medium of exchange.as a medium of exchange.

The intrinsic value of fiat money is nil The intrinsic value of fiat money is nil because its not convertible in gold & because its not convertible in gold & silver on demand.silver on demand.

Example; The currency that which we Example; The currency that which we are using now-a-days are fiat money.are using now-a-days are fiat money.

Fiat money in the words of Fiat money in the words of Keynes is that which is created Keynes is that which is created and issued by the state but is and issued by the state but is not convertible by law into any not convertible by law into any thing other than itself and has thing other than itself and has no fixed value in terms of an no fixed value in terms of an objective standard.objective standard.

Merits of Paper MoneyMerits of Paper Money

EconomicalEconomical Elasticity of money supplyElasticity of money supply Promotes economic growthPromotes economic growth Internal price stability Internal price stability Helpful in emergency Helpful in emergency Regulation of exchange ratesRegulation of exchange rates Uniform qualityUniform quality

EconomicalEconomical

Under paper standard, the Under paper standard, the central bank of any country has central bank of any country has not to keep gold or silver for not to keep gold or silver for issuing of the paper notes.issuing of the paper notes.

The cost of printing paper notes The cost of printing paper notes is also very small.is also very small.

It is thus, most economical form It is thus, most economical form of monetary standard. of monetary standard.

Elasticity of money supplyElasticity of money supply

As the money supply is not As the money supply is not backed with gold or silver, backed with gold or silver, therefore, the monetary therefore, the monetary authority can easily manage its authority can easily manage its supply according to the supply according to the requirements of trade and requirements of trade and industry in the country.industry in the country.

Promotes economic growthPromotes economic growth

Under paper standard, the Under paper standard, the monetary authority is free to monetary authority is free to determine its monetary policy.determine its monetary policy.

It therefore regulates the money It therefore regulates the money supply in such a way that supply in such a way that productive resources of the productive resources of the country are utilized to their country are utilized to their maximum and greater economic maximum and greater economic growth achieved. growth achieved.

Internal price stabilityInternal price stability

Under paper standard, the Under paper standard, the monetary authority can maintain monetary authority can maintain stability in internal price level by stability in internal price level by making necessary expansion or making necessary expansion or contraction in money supply contraction in money supply according to the economic according to the economic conditions. conditions.

Helpful in emergencyHelpful in emergency

Paper money is also useful in Paper money is also useful in times of war when huge funds times of war when huge funds are needed to finance it.are needed to finance it.

It is also helpful to meet any It is also helpful to meet any financial crises.financial crises.

The monetary authority by The monetary authority by expanding or contracting the expanding or contracting the money supply achieve this money supply achieve this objective.objective.

Regulation of exchange ratesRegulation of exchange rates

Under paper standard, the Under paper standard, the international exchange rates are international exchange rates are fixed by purchasing power of the fixed by purchasing power of the respective countries.respective countries.

Paper currency is an effective Paper currency is an effective and automatic regulator of and automatic regulator of exchange rates between the exchange rates between the countries.countries.

Uniform qualityUniform quality

The paper money has a uniform The paper money has a uniform quality and the holder least quality and the holder least bothers for possession of new bothers for possession of new money coins.money coins.

With the use of paper money, With the use of paper money, the loss of precious metals due the loss of precious metals due to wear and tear is also solved.to wear and tear is also solved.

Demerits of Paper moneyDemerits of Paper money

Danger of inflationDanger of inflation Internal price instabilityInternal price instability Exchange rate instabilityExchange rate instability Dangers of mismanagementDangers of mismanagement Fear of demonetizationFear of demonetization Use within the countryUse within the country

Danger of inflationDanger of inflation

Under paper money, the Under paper money, the increase in money supply is not increase in money supply is not difficult because it requires no difficult because it requires no backing of gold or silver.backing of gold or silver.

The government of the country, The government of the country, to cover the deficit financing, to cover the deficit financing, over issues paper currency.over issues paper currency.

This results in inflationary rise in This results in inflationary rise in prices with all its evil effects.prices with all its evil effects.

Internal price instabilityInternal price instability

All the countries of the world are All the countries of the world are now on paper standard.now on paper standard.

They have not achieved They have not achieved domestic price stability in reality.domestic price stability in reality.

There are violent fluctuations in There are violent fluctuations in internal prices under this internal prices under this system.system.

Exchange rates instabilityExchange rates instability

Under paper standard, there are Under paper standard, there are also wide fluctuations in the also wide fluctuations in the foreign exchange rates.foreign exchange rates.

The internal prices do not move The internal prices do not move in line with the external prices.in line with the external prices.

As such external instability As such external instability arises which directly effects the arises which directly effects the foreign trade.foreign trade.

Dangers of mismanagementDangers of mismanagement

Paper standard is useful only Paper standard is useful only when it is efficiently managed.when it is efficiently managed.

If the monetary authority is not If the monetary authority is not vigilant and does not issue the vigilant and does not issue the paper currency as required, it paper currency as required, it often leads to inflation or often leads to inflation or deflation.deflation.

Fear of demonetizationFear of demonetization

The paper money has no intrinsic The paper money has no intrinsic value of its own.value of its own.

The monetary authority also does The monetary authority also does not promise to convert it into not promise to convert it into precious metal.precious metal.

If the government at any time orders If the government at any time orders the demonetization of the currency, the demonetization of the currency, And the holders of the demonetized And the holders of the demonetized notes fail to deposit these notes in notes fail to deposit these notes in times, they have then no value. times, they have then no value.

Use within the countryUse within the country

As the intrinsic value of paper As the intrinsic value of paper money is zero, it can only be money is zero, it can only be used in the country issuing it.used in the country issuing it.

Outside the country only stable Outside the country only stable paper money has the value. paper money has the value.

ConclusionConclusion

Paper money is a source of Paper money is a source of blessing for mankind.blessing for mankind.

However, when it is not properly However, when it is not properly managed, it becomes source of managed, it becomes source of risk and confusion.risk and confusion.