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Tuesday, 22 November 2011

What are the different principles and methods of note issue Discuss their advantages and disadvantages

There are two principles of note issue. First is the currency principle and the second is banking principle. There are different views about these principles. One school of thought says that there should be full convertibility of notes into gold bullion. The second gives importance to the elasticity of supply. Now we discuss these two principle.

The lover of this principle say that paper money is better than the metallic money but there should be 100% backing of gold reserves. They say that in order to maintain the prestige of paper money gold should be available for the conversion of notes when presented.

i. Safety And Security :-
The advantage of this system is that it gives full safety and security to the paper currency.

ii. No Danger Of Over Issue :-
There is no danger of over issue of the currency. So it is an effective check on inflation.

i. Inelastic :-
The disadvantage of this principle is that it makes the supply of money inelastic. According to this principle paper currency can only be printed and issued if there is a 100% gold cover available against it. So this system can not meet the requirement of trade and industry.

ii. Lock Up Of Gold :-
A huge amount of gold is unnecessarily locked up which can be used in other productive projects.

According to this principle there is no need of reserve requirements of gold and silver for the notes issued. The banks are authorized to regulate the note issue keeping in view the need of the business in the country. The banks themselves will maintain adequate reserves of gold for meeting their obligations of note. If there is an over issue of notes, the excess money will be automatically presented for cash payment and proper ratio will be maintained between the supply of money and the gold reserves.

The merit of this principle is that it secures elasticity in the issue of currency.

Not Safe :-
The demerits of this principle is that it is not a safe. In the history of England banking, many times over issuance of money created problems for the economy.

Conclusion :-
After discussing both the principles we can say that both are defective. For a sound system of not issue security and elasticity must go side by side. Keeping in view the above defects modern world have devised new methods of regulating note issue.

Fixed Fiduciary System :-
Under this system the central bank of the country is permitted to issue bank notes of a given amount without giving gold and silver cover. The fixed quantity of notes allowed by law to be issued is to be backed by Govt. securities only. This is named the fiduciary limit. The amounts of notes circulated in excess of the fiduciary limit must be 100% backed by gold.

1. Elastic System :-
The first advantage of this system is that it makes the supply of money elastic.

2. Safety :-
It also gives maximum safety because notes can not be issued in excess of the fiduciary limit unless they are 100% covered by gold.

3. Check On Inflation :-
The inflation can be effectively checked.

1. High Fiduciary Limit :-
If fiduciary limit is high or it has been increased with the passage of time then people will loose confidence in the currency.

1. Great Britain is considered the home of this system of note issue and it has successfully survived since 1844.

2. Japan and Norway are also practicing this system of note issue even today.

According to this system the central bank is required by law to keep a fixed percentage varying from 25 to 40 percent against the note issue. The essential feature of this system is the provision of proportional metallic reserves against the notes in circulation. The reserve ratio may be allowed to drop below the legal minimum.

1. It was adopted by France and reserve ratio was 30%.

2. Germany adopted it keeping 40% of gold against the note issue.

3. The federal reserve Bank of U.S.A has also adopted it with slight modification.

1. Elastic System :-
The main advantage of this system is that it makes the supply of money elastic.

2. Lock Up Of Gold :-
The defect with this system is that it locks up the gold reserves unnecessarily. So we cannot use it for other purpose.

3. Exchange Management or Modified Proportional Reserve System :-
J.M. Keynes has suggested modified form of proportional reserve system and calls it exchange management. According to this system the central bank is required by law to keep the percentage required against the note issue in the form of gold, foreign bills or cash at some foreign banks where gold standard prevails.

This method is followed in India, Pakistan and in many European Countries. The state bank of Pakistan has to keep 30% of gold silver or approved foreign exchange against the note issue. This method of note issue economies the use of gold and also makes the currency system elastic.


Anonymous,  27 January 2014 at 09:36  

very nice info

Unknown 6 December 2015 at 08:21  

which system prevailed in Pakistan?

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