PAPER CURRENCY STANDARD

SOWMYA G S

ASSISTANT PROFESSOR

VIVEKANANDA DEGREE COLLEGE

PAPER STANDARD REFERS TO A MONETARY STANDARD IN WHICH INCONVERTIBLE PAPER MONEY CIRCULATES AS UNLIMITED LEGAL TENDER.

THE STANDARD MONEY IS MADE OF PAPER, BOTH CURRENCY AND COINS SERVE AS STANDARD MONEY FOR PURPOSE OF PAYMENT.

NO GOLD RESERVES ARE REQUIRED EITHER TO BACK DOMESTIC PAPER CURRENCY OR TO FACILITATE FOREIGN PAYMENTS.

THE STANDARD IS KNOWN AS MANAGED STANDARD BECAUSE THE QUANTITY OF MONEY IN CIRCULATION IS CONTROLLED AND MANAGED BY THE MONETARY AUTHORITY WITH A VIEW TO MAINTAIN STABILITY IN PRICES AND INCOMES WITHIN THE COUNTRY.

IT IS ALSO CALLED FIAT STANDARD BECAUSE PAPER MONEY IS INCONVERTIBLE IN GOLD AND STILL REGARDED AS FULL LEGAL TENDER.

FEATURES• PAPER NOTES AND TOKEN COINS CIRCULATES AS

STANDARD MONEY AND ACCEPTED AS UNLIMITED LEGAL TENDER IN THE DISCHARGE OF OBLIGATIONS.

• PAPER MONEY IS NOT CONVERTIBLE INTO ANY COMMODITY OR GOLD.

• THE UNIT OF MONEY IS NOT DEFINED IN TERMS OF COMMODITY.

• PAPER STANDARD IS NATIONAL IN CHARACTER. THERE IS NO LINK BETWEEN THE DIFFERENT PAPER CURRENCY SYSTEMS.

• THE FOREIGN RATE OF EXCHANGE IS DETERMINED ON THE BASIS OF THE PARITY OF PURCHASING POWERS OF THE CURRENCIES OF DIFFERENT COUNTRIES.

MERITS OF PAPER STANDARD

ECONOMICAL:

THE PAPER STANDARD IS CHEAPER THAN GOLD

OR SILVER STANDARD. IF A COUNTRY USES PAPER

MONEY, IT NEED NOT SPEND ANYTHING ON THE

PURCHASE OF GOLD OR SILVER FOR MINTING

COINS. THE LOSS WHICH A COUNTRY SUFFERS

FROM THE WEAR AND TEAR OF METALLIC COINS

ARE ALSO AVOIDED.

ELASTIC:

THE PAPER STANDARD IS A HIGHLY USEFUL IN

MONETARY SYSTEM BECAUSE IT POSSESSES GREAT

ELASTICITY. THE MONETARY AUTHORITY CAN EASILY

ADJUST THE MONEY SUPPLY IN ACCORDANCE WITH

THE REQUIREMENTS OF THE ECONOMY. THE SUPPLY

OF MONEY CAN BE INCREASED BY PRINTING MORE

NOTES IN TIMES OF FINANCIAL EMERGENCY, WAR

AND FOR ECONOMIC DEVELOPMENT. IT CAN ALSO BE

REDUCED WHEN THE ECONOMIC SITUATION SO

DEMANDS.

STABILITY IN INTERNAL PRICE LEVEL:

THE PAPER STANDARD ENSURES PRICE STABILITY IN THE

COUNTRY. THE MONETARY AUTHORITY CAN STABILIZE

THE PRICE LEVEL BY MAINTAINING EQUILIBRIUM

BETWEEN DEMAND AND SUPPLY OF MONEY BY AN

APPROPRIATE MONETARY POLICY. FOR EXAMPLE: IF AS A

RESULT OF THE DEVELOPMENT OF TRADE AND

COMMERCE, THE DEMAND FOR MONEY INCREASES, THE

MONETARY AUTHORITY WILL INCREASE THE SUPPLY OF

MONEY WITHOUT THE NECESSITY OF INCREASING ITS

METALLIC RESERVES.

ENSURES FULL EMPLOYMENT OF RESOURCES:

THE GOLD STANDARD HAD A DEFLATIONARY BIAS

WHEREBY THE RESOURCES OF THE COUNTRY

REMAINED UNUTILIZED. BUT UNDER PAPER CURRENCY

STANDARD EACH COUNTRY MANAGES ITS CURRENCY

IN SUCH A MANNER AS TO ENSURE FULL EMPLOYMENT

OF ITS PRODUCTIVE RESOURCES.

MORE CONDUCIVE TO ECONOMIC

DEVELOPMENT:

THE PAPER CURRENCY STANDARD IS BEST SUITED

TO AN UNDERDEVELOPED, BACKWARD COUNTRY

BECAUSE IT ENABLES TO DEVELOP ITSELF SPEEDILY

THROUGH DEFICIT FINANCING INSTEAD OF LOOKING

FOR FINANCIAL RESOURCES THROUGH TAXATION

AND PUBLIC BORROWINGS.

MORE SUITABLE FOR NATIONAL

EMERGENCIES:

THE PAPER CURRENCY STANDARD ENABLES A COUNTRY

TO MEET NATIONAL EMERGENCIES LIKE WAR AND OTHER

NATURAL CALAMITIES IN A BETTER AND MORE EFFECTIVE

MANNER THAN ANY OTHER METALLIC STANDARD.

DEMERITS OF PAPER STANDARD

DANGER OF INFLATION:

THE GREATEST DEFECT OF THIS STANDARD IS THAT THE DANGER

OF INFLATION IS ALMOST IN-BUILT IN IT, THE REASON BEING THAT

THE CURRENCY OF THE COUNTRY IS NOT LINKED WITH ANY

METAL. HENCE IT IS EASIER TO INCREASE THE SUPPLY OF PAPER

MONEY WITHOUT KEEPING ADDITIONAL METALLIC RESERVES.

GOVERNMENTS ARE OFTEN TEMPTED TO MEET THEIR INCREASED

EXPENDITURE AT A TIME OF WAR BY PUTTING THE PRINTING

PRESS INTO MOTION. THIS OFTEN RESULTS IN A STATE OF

INFLATION.

INSTABILITY IN INTERNATIONAL PRICES:

THERE ARE VIOLENT FLUCTUATIONS IN INTERNATIONAL

PRICES UNDER THIS SYSTEM. SINCE THE INTRINSIC

VALUE OF PAPER CURRENCY IS ZERO, THERE IS IN FACT

NO LOWER LIMIT TO FALL IN ITS VALUE. IN OTHER

WORDS, THE VALUE OF PAPER MONEY CANNOT FALL TO

ZERO UNDER METALLIC STANDARD BECAUSE THE VALUE

OF METALLIC COINS CANNOT FALL BELOW THEIR

INTRINSIC VALUE. THE PRICES CAN RISE TO ANY HEIGHT

UNDER PAPER CURRENCY STANDARD.

INSTABILITY OF EXCHANGE RATES:

SINCE THE CURRENCY HAS NO LINK WITH ANY METAL UNDER

PAPER CURRENCY STANDARD THERE ARE WIDE FLUCTUATIONS IN

FOREIGN EXCHANGE RATES WITH ADVERSE EFFECTS ON

COUNTRY’S FOREIGN TRADE. EXCHANGE INSTABILITY DOES NOT

TAKE PLACE UNDER GOLD STANDARD BECAUSE UNDER THIS

SYSTEM THE CURRENCY OF EVERY COUNTRY IS LINKED WITH

GOLD. SINCE FREQUENT CHANGES DO NOT TAKE PLACE IN PRICE

OF GOLD, THE EXCHANGE RATES OF DIFFERENT CURRENCIES

REMAIN STABLE. BUT UNDER PAPER CURRENCY STANDARD THERE

ARE WIDE FLUCTUATIONS IN EXCHANGE RATES OF DIFFERENT

CURRENCIES. TO REMOVE THIS DRAWBACK THE COUNTRIES HAVE

COME UP WITH THE TECHNIQUE OF EXCHANGE CONTROL.

ABSENCE OF AUTOMATIC WORKING :

LIKE THE GOLD STANDARD, THE PAPER CURRENCY STANDARD

DOES NOT WORK AUTOMATICALLY. TO MAKE IT WORK, THE

GOVERNMENT HAS TO INTERVENE FROM TIME TO TIME.

PRINCIPLES OF NOTE ISSUE

THERE ARE TWO PRINCIPLES OF NOTE ISSUE. THEY ARE:

• CURRENCY PRINCIPLE

• BANKING PRINCIPLE

BOTH THESE PRINCIPLES ARE CONTRADICTORY TO EACH OTHER.

CURRENCY PRINCIPLEACCORDING TO THE CURRENCY PRINCIPLE, THE CENTRAL BANK OF THE COUNTRY SHOULD KEEP 100% GOLD FOR EVERY NOTE ISSUED. IN OTHER WORDS THEIR SHOULD BE FULL CONVERTIBILITY FOR THE AMOUNT OF LEGAL TENDER CURRENCY IT ASSUMES FULL CONVERTIBILITY OF NOTES.

THE ADVOCATES OF THIS PRINCIPLE OF NOTE ISSUE ARE OF THE VIEW THAT THE CURRENCY UNDER THIS SYSTEM WILL EXPAND OR CONTRACT AS IT WOULD HAVE EXPANDED OR CONTRACTED UNDER THE METALLIC MONEY. THE CURRENCY PRINCIPLE ASSURES MAXIMUM SAFETY FOR THE NOTES. THOSE WHO OPPOSE THIS PRINCIPLE ASSERT THAT THE SYSTEM NO DOUBT GIVES SAFETY TO THE CURRENCY BUT IT LACKS ELASTICITY. THE SUPPLY OF NOTES IS TIED DOWN TO THE SUPPLY GOLD AVAILABLE IN THE COUNTRY.

MERITS OF CURRENCY PRINCIPLE

• IT GIVES FULL SAFETY AND SECURITY TO THE PAPER

CURRENCY.

• THERE IS NO DANGER OF OVER-ISSUE OF THE CURRENCY,

WHICH IS AN EFFECTIVE CHECK TO THE POSSIBILITIES OF

INFLATION.

• THE CURRENCY PRINCIPLE PROVIDES GREATER

CONFIDENCE TO THE PUBLIC, BECAUSE IT PROVIDES

ASSURANCE IN EASE OF CONVERTIBILITY OF NOTES.

DEMERITS

• IT MAKES THE SUPPLY OF MONEY HIGHLY INELASTIC, BECAUSE THE ISSUANCE OF NOTES IS ONLY POSSIBLE ON THE AVAILABILITY OF GOLD. SO, THE GOVERNMENT CANNOT ISSUE NOTES IN CASE OF EMERGENCY.

• ACCORDING TO THIS PRINCIPLE, PAPER CURRENCY CAN ONLY BE PRIMED AND ISSUED IF THERE IS 100% GOLD COVER AVAILABLE AGAINST IT. THE ISSUANCE OF CURRENCY THUS COMPLETELY DEPENDS UPON THE AVAILABILITY OF GOLD RATHER THAN THE TRADE AND INDUSTRY NEED.

• THERE IS UNNECESSARY LOCK UP OF GOLD FOR THE CURRENCY, WHICH MAY BE USED FOR SOME OTHER PURPOSES.

• IT IS NOT ACCEPTABLE IN THE REAL WORLD AND HAS NO SUPPORT FROM ALL OVER THE WORLD.

BANKING PRINCIPLEACCORDING TO THIS PRINCIPLE, THERE IS NO NEED TO KEEP 100% GOLD OR SILVER AGAINST NOTES ISSUED. THE NOTES ISSUED SHOULD HAVE A GUARANTEE OF CONVERTIBILITY INTO GOLD. IT IS SUFFICIENT TO KEEP ONLY A CERTAIN PERCENTAGE OF TOTAL PAPER CURRENCY IN THE FORM GOLD AND SILVER RESERVES. THE NOTES ISSUED IN THE COUNTRY SHOULD BE ACCORDING TO THE NEEDS OF TRADE AND INDUSTRY. IF AT ANY TIME THERE IS AN EXCESS OF NOTES ISSUED TO THE REQUIREMENTS OF TRADE AND INDUSTRY, THESE WILL BE RETURNED TO THE BANK OF ISSUE FOR CONVERSION.

THE PRINCIPLE OF NOTE ISSUE HAS THE MERIT THAT IT PROVIDES THE COUNTRY WITH AN ELASTIC CURRENCY. THE GUARANTEE OF CONVERTIBILITY ALSO ACTS AS A REGULATOR OF NOTE ISSUE. SINCE IT DOES NOT REQUIRE 100% METALLIC BACKING AGAINST THE NOTE ISSUE, IT IS THEREFORE MOST ECONOMICAL PRINCIPLE. THE DEMERIT OF THIS PRINCIPLE IS THE DANGER OF OVER ISSUE OF NOTES, POSSIBILITY OF INCONVERTIBILITY OF EXCESS NOTES, LOSS OF PUBLIC CONFIDENCE IN THE CURRENCY AND MONETARY INSTABILITY.

MERITS

• THE BANKING PRINCIPLE IS ELASTIC BECAUSE GOLD IS NOT KEPT FOR CURRENT PERCENT VALUE OF NOTES ISSUED.

• THIS SYSTEM IS FIT FOR MEETING THE GOVERNMENT NEEDS IN CASE OF EMERGENCIES.

• THIS SYSTEM IS POPULAR ALL OVER THE WORLD. EVERY COUNTRY IS ISSUING MONEY UNDER THIS SYSTEM.

• IT ALSO PROVIDES SURETY FOR THE CONVERTIBILITY OF NOTES.

DEMERITS

• IN ORDER TO MEET THE DEMAND FOR MONEY, THERE MAY BE A FURTHER ISSUE OF NOTES BEYOND TO A CERTAIN LIMIT WHICH LEADS TO INFLATION.

• DURING ECONOMIC CRISIS THE CONVERTIBILITY OF NOTES MAY BE REFUSED.

• THIS IS NOT GOOD FOR KEEPING THE STABLE EXCHANGE RATES. WHENEVER THERE IS A CHANGE IN FOREIGN EXCHANGE RATES, THE BALANCE OF PAYMENT POSITION BECOMES MORE UNFAVORABLE.

METHODS OF NOTE ISSUE

THERE ARE DIFFERENT METHODS OF MONEY NOTES ISSUING ADOPTED BY DIFFERENT COUNTRIES OF THE WORLD AT DIFFERENT TIMES. THE MOST IMPORTANT OF THEM ARE:

• FIXED FIDUCIARY SYSTEM

• PROPORTIONAL RESERVE SYSTEM

• MINIMUM RESERVE SYSTEM

FIXED FIDUCIARY SYSTEM

UNDER FIXED FIDUCIARY SYSTEM, THE GOVERNMENT FIXES

A FIXED AMOUNT OF NOTES WITHOUT KEEPING ANY

METALLIC RESERVE. BUT THIS PORTION OF CURRENCY

MUST BE BACKED BY GOVERNMENT SECURITIES, WHICH IS

CALLED FIDUCIARY LIMIT. THE NOTES ISSUED OTHER THAN

FIDUCIARY LIMIT MUST BE FULLY BACKED BY GOLD OR

SILVER RESERVES. THIS SYSTEM WAS INTRODUCED IN

ENGLAND IN1844 IN THE BANK CHARTER ACT OF 1844.

NORWAY AND JAPAN ALSO ADOPTED THIS METHOD . THIS

SYSTEM ACTED AS A BRAKE ON THE UNDUE EXPANSION OF

CURRENCY AND CREDIT IN THE TIME OF PROSPERITY. THIS

SYSTEM ALSO PROVIDES SECURITY FOR THE

CONVERTIBILITY OF NOTES

MERITS • SAFETY:

THIS METHOD OF NOTE ISSUE PROVIDES SAFETY TO NOTES ISSUED AND ACTS AS BRAKE, WHICH ALSO PROVIDES SAFETY TO CURRENCY VALUE.

• STABILITY:

THIS SYSTEM NOT ONLY PROVIDES VALUE STABILITY BUT ALSO PROVIDES ECONOMIC STABILITY, WHICH IS HELPFUL FOR REGULATING INTERNAL PRICES AND EXCHANGE RATE.

PROPORTIONAL RESERVE SYSTEM

UNDER THIS SYSTEM THE CENTRAL BANK IS REQUIRED TO KEEP ONLY ASCERTAIN PERCENTAGE OF NOTES ISSUED IN THE FORM OF GOLD OR SILVER. THE RESERVE PROPORTION IS USUALLY FROM 30% TO 40%. IT MEANS A CENTRAL BANK CAN ISSUE RS. 100 NOTE AFTER KEEPING GOLD SILVER VALUING RS. 30 OR 40. THIS METHOD OF CURRENCY REGULATION IS THE MOST AFFORDABLE SYSTEM OF THE PRESENT TIME AND IS WIDELY USED IN MANY COUNTRIES. IT WAS FIRST OF ALL ADOPTED BY GERMANY IN1876 AND FOLLOWED WITH MODIFICATIONS BY U.S.A IN 1914.

MERITS • ELASTICITY:

THIS SYSTEM IS MORE ELASTIC THAN FIXED FIDUCIARY SYSTEM. FOR EXAMPLE, IF BANK OBTAINS, RS. 40 WORTH OF GOLD, IT CAN ISSUE RS. 100 NOTE UNDER THE PROPORTIONAL RESERVE SYSTEM. WHEREAS UNDER FIXED FIDUCIARY SYSTEM THE BANK CAN ISSUE NOTE OF RS. 40 ONLY, ONCE THE FIDUCIARY LIMIT REACHED.

• SAFETY:

THE RESERVE MAINTAINS IN THIS METHOD SERVES AS A SAFEGUARD AGAINST EXCESSIVE NOTE ISSUE AND INFLATION CAN BE CHECKED.

MINIMUM RESERVE SYSTEM

FIXED MINIMUM RESERVE SYSTEM ALLOWS THE CENTRAL

BANK TO KEEP ONLY A FIXED AMOUNT OF RESERVE AGAINST

WHATEVER THE AMOUNT OF NOTE ISSUE. THE RESERVE IS

IN THE FORM OF GOLD, SILVER AND-FOREIGN EXCHANGE OR

IN THE FORM OF ANY OF THESE TYPES OF THINGS. THIS

METHOD -IS BEING USED IN PAKISTAN AFTER DECEMBER

1965. INDIA IS ALSO APPLYING IT SINCE 1957.SOUTH AFRICA

HAS ADOPTED IT IN 1930. HOLLAND HAS BEEN ISSUING

NOTES UNDER THIS METHOD FOR MANY YEARS.

MERITS

• ELASTIC:

THIS SYSTEM IS MUCH ELASTIC THAN ABOVE STATED METHODS OF NOTE ISSUE WHICH CAN MEET THE EVER-CHANGING NEEDS OF THE MONEY BY THE GOVT.

• ECONOMICAL:

BECAUSE A FIXED AMOUNT OF GOLD, SILVER OR FOREIGN EXCHANGE IS TO BE MAINTAINED AS FIXED MINIMUM RESERVE, THEREFORE IT BECOMES MUCH ECONOMICAL AND GOVERNMENT CAN ALSO CHANGE THE FIXED MINIMUM RESERVE AT ANY TIME