money and banking

1. Module: Money and Banking
Topic: Paper Money and Evaluation of Fiat
Money
Week 3
Mr. Aamir waheed
Department of Commerce

2. Lecturer Objectives
This lecturer aims:
 To Understand What is Paper Money?
 To Understand the types of Paper Money
 To Understand Merits and Demerits of Paper
Money
Ch 1 -2

3. Lecturer Objectives (Cont’d…)
 To Understand the Characteristics of Good
Money
 To Understand the Evaluation of Fiat Money
Ch 1 -3

4. Paper Money
 Paper money are the money which are
issued by the central bank of a country in
form of paper that acts as an unlimited
legal tender in the economy.
 Unlimited legal tender mean money that a
person has to accept without any limit of
amount.
 E.g: All currency notes of 100 are
unlimited legal tender money
Ch 1 -4

5. Paper Money
 In words of Hanson:
Paper money means the paper instruments
such as bank notes, cheque, bills of exchange
and other forms that take the place of money
and act as currency or circulating medium.
Ch 1 -5

6. Kinds of Paper Money
There are three types of paper money:
1) Representative paper money
2) Convertible paper money
3) Inconvertible/Fiat paper money
Ch 1 -6

7. Representative paper Money
Representative paper money is the paper
money which is fully backed by gold and
silver reserves. Under the monetary system
of representative money, the quantity of
gold and silver which is equal to the value
of paper currency issued are kept in the
reserves by the monetary authority.
e.g: normal paper money, Credit cards,
cheque
Ch 1 -7

8. Convertible paper money
Convertible paper money refers to the paper
money which is easily convertible into
standard coins or metals. These are
maintained as reserves with the monetary
authority.
e.g: US dollar, Euro, Japanese Yen, Pound
Ch 1 -8

9. Inconvertible paper money
Inconvertible paper money refers to the
paper money which is not convertible into
standard coins or valuable metals. Under
the system of inconvertible paper money,
the monetary authority maintains no
metallic reserves against paper currency
like in case of representative and
convertible paper money.
Ch 1 -9

10. Inconvertible paper money
The issuing authority is not responsible to
convert the paper notes into gold or gold
coins.
Ch 1 -10

11. Merits of paper money
1. Cheap and Economical
Normally paper money is much easier to issue.
Practically it cost nothing to government.
Printing of paper currency is requires certain
special types of paper, ink, and printing
technology. These things no doubt are costly
but overall printing cost is quite low.
Ch 1 -11

12. Merits of paper money (Cont’d.)
2. Convenience
Paper money is convenient to transfer and
carry. It can be easily kept in pocket. Further it
can also be readily converted into cheques,
and drafts, etc.
3. Copying
The design of paper money is very difficult to
copy. Further special type of paper and ink is
used in paper money that makes it quite
impossible to copy.
Ch 1 -12

13. Merits of paper money (Cont’d.)
4. Homogeneous (Uniform quality)
The paper money has another advantage that it
has uniform quality and the holder does not
bother for possession of new or old money.
5. Ease of Counting
Paper money is much easer to count than
metallic money.
Ch 1 -13

14. Merits of paper money (Cont’d.)
6. Useful in Emergency
The paper money can be used in emergency
life war and floods. The government can meet
the expenses by printing notes in shorter time.
But metallic money takes long time period for
mining, refining and minting the metals.
Ch 1 -14

15. Merits of paper money (Cont’d.)
7. Easily Portable
Paper money is portable i.e. it can easily be
transferred from one place to another as
compared to metallic money. The cost of
transferring paper money is quite low and it can
be transferred in a very short time period.
Ch 1 -15

16. Demerits of paper money
1. Demonetization
The demerit of paper money is that the holder
may have to suffer loss. The paper money is
fiat money. It is issued by fiat(order) of the
government. In case the government cancels
the currency notes the holder has to bear full
loss.
Ch 1 -16

17. Demerits of paper money (Contd.)
2. Exchange Rate Instability
The value of paper money is instable and is
subject to fluctuations in the exchange rates.
The fluctuations in the exchange rate market
also produce serious effects on the price level
in the economy.
Ch 1 -17

18. Demerits of paper money (Cont’d.)
3. Monetary Mismanagement
Purchasing power of paper money is an ever –
changing process. This means that its face
value remains same but its purchasing power
may decline due to monetary mismanagement.
Ch 1 -18

19. Demerits of paper money (Cont’d.)
4. Restricted Acceptability (Limited
Acceptance)/ Use Within the Country
One of the demerits of paper money is that it
has limited acceptance. Its acceptance is
limited within the boundaries of a country. It
cannot be used to make payments to other
countries.
Ch 1 -19

20. Demerits of paper money (Cont’d.)
5. Danger of Inflation
Under Paper money, increase in money supply
is not difficult because it not require backing of
gold. As too much money chasing too few
goods results in inflation.
Ch 1 -20

21. Characteristics of Money
1. Acceptability- in order for you to buy something,
the seller must be willing to accept what you offer as
payment.
2. Scarcity- needs to be scarce enough to be valued
by buyers and sellers
Ch 1 -21

22. Characteristics of Money
(Cont’d..)
4. Durability- if money is
to serve as a store of
value, it must be durable
Ch 1 -22
3. Portability- in order to be
convenient as a medium of
exchange it must be
portable

23. Characteristics of Money
(Cont’d..)
6. Uniformity- a dollar is
a dollar is a dollar. We
take for granted that each
dollar is the same as the
next.
Ch 1 -23
5. Divisibility- to be
useful as a medium of
exchange, money must
be easily divided into
smaller amounts

24. Evolution of Fiat money
 910AD- China is the first country experiments
with the paper money- The fiat money is
nearly used around hundred years but the
paper money is rejected due to the hyper-
inflation as the supply of the money more
than the production.
Ch 1 -24

25. Evolution of Fiat money
(Cont’d..)
1500’S- Spain becoming the richest nation in
the world after collected gold from Mexico and
the new world. After that, Spain spent most of
their resources to extinguish pirates and then
their excessive consumption cause the
shortage of gold hoard. Then, they changed to
financing the war with debt, finally bankrupted.
Ch 1 -25

26. Evolution of Fiat money
(Cont’d..)
1716- John Law persuaded France to use the paper
money in the market and declared all taxes necessary
paid with it gain acceptance. The paper money
becomes more popular than coin and cause to no
limitation in printing, excessive moneymaking and
planning and fraud. Overvalues in printing the
excessive paper money eventually destroyed the
system as well.
Ch 1 -26

27. Evolution of Fiat money
(Cont’d..)
1791-The French Government again tries to use the
paper money as country currency. They eliminated the
gold backing of the currency as fast as possible and
made the franc as the determinate of fiat money in
France. The currency value had dropped 99% during
the past 12 years.
Ch 1 -27

28. Evolution of Fiat money
(Cont’d..)
1862- The 16th President of United States Abraham
Lincoln succeed to pass the Legal Tender Act and
then allowing the United States Government to issue
out their own paper money. The decision was
supported by the government without any of promises
so that a tremendous inflation occurred that caused
the practice fall down rapidly out of grace until year
1913 in which the Federal Reserve System was
developed.
Ch 1 -28

29. Evolution of Fiat money
(Cont’d..)
Since the United States dollar suspension in 1971 of
convertibility of paper currency into any precious
metal, Pakistani rupee is, de facto, fiat money.
Ch 1 -29

30. Evolution of Fiat money
(Cont’d..)
In 1971, the US incurred its first ever current account
deficit of $400 million. Nervousness spread across the
globe and trading partners of the US scrambled to
redeem dollars for gold. As the US did not have
enough gold to pay all claims, on August 15 of 1971,
President Nixon shocked the entire world by
announcing unilaterally that the dollar would no longer
be convertible to gold.
Ch 1 -30

31. Evolution of Fiat money
(Cont’d..)
With millions of dollars held as reserves all over the
world, the international community had no choice but
to accept the dollar as the world’s reserve currency.
This is known as the FIAT monetary system in which
money is established by government decree and is
independent of gold.
Ch 1 -31

32. Any Question?
Ch 1 -32

33. Many Thanks
Ch 1 -33