What Is Paper Money? Explain Its Types in Detail.

There are different types of paper money, which uses commonly nowadays all over the world. But before going towards the types of paper money, let’s talk about paper money. What is paper money?

Generally the term “paper money” refers to banknotes issued by the central bank of the country. Bill of exchange and cheque are also considered as paper money. Paper Money is generally accepted in daily transactions as a medium of exchange.

Paper currency is defined by F. Perry as “Paper money is documented representing money, such as banknotes, bill of exchange, promissory notes and postal orders”

Types of Paper Money

There are basically four different types of paper money, which is using all over the world:

• Representative Money
• Convertible paper money
• Inconvertible paper money
• Fiat money

1. Representative Money

The representative paper money is that money which has a hundred per cent metallic reserves behind it. The government keeps such reserves for the holders of paper money when they demand it. The example of representative paper money is American gold and silver certificates, which are guaranteed gold and silver deposits in treasury. Another example is Indian gold bullion certificates which were issued in 1927.

2. Convertible Paper Money

Convertible paper money is also from one of the types of paper money. The convertible paper money can be exchanged for full-bodied money or standard money upon demand of the holder of money. The government does not maintain a hundred per cent reserves against such money.

A fractional reserve of full-bodied money is kept as a guarantee for repayment. All paper money is not presented for repayment at a time, a nominal pan of full-bodied money is sufficient to meet the demand. The convertible paper money is issued against gold, silver and securities.

The money issued on the basis of securities is known as a fiduciary issue. The government cannot maintain hundred per cent reserves for issuing money but it is convertible into gold, silver of full-bodied coins.

3. Inconvertible Paper Money

The inconvertible paper money cannot be exchanged for full-bodied money or standard money. The gold or silver reserves are not kept by the monetary authority. The money is issued on the written promise of the government. The gold, silver or currency of other countries can be kept for issue paper money.

But such reserves are not maintained for holders of inconvertible paper money. The government may want to take back its securities or written promises. The money equal to its security is to the cancelled by the central bank. The example of inconvertible paper money is German mark during the First World War. In the same way, dollars were inconvertible during the American Civil War. Moreover in France currency was not convertible during the French revolution.

4. Fiat Money

The fourth and last types of paper money are Fiat money. The fiat money is that money which has face value more than its real value. The actual value of money is worthless. It is accepted by the people on the order of government. The face value is fixed by the government and this money is not exchanged into standard money.

This is actually fiat money. It is used as a medium of exchange and as a standard of value. The fiat money may be paper money or any other commodity. The real value is not equal to face value. Fiat money is issued all over the world.

Advantages

The main advantages of paper money are as under:-

• Economical

Paper money practically costs nothing to the government. Currency notes, therefore, are the cheapest media of exchange. If a country uses paper money. It need not spend anything on the purchase of gold for minting coins. The loss which a country suffers from the wear and fear of metallic money is also avoided.

• Convenient

Paper money is the most convenient form of money. A large amount can be carried conveniently in the pocket without anybody knowing it. It is very risky to carry on one’s person Rs.5000 in coins, but not in cash notes. It possesses, in a very large measure, the quality of portability which a money material should have. In a very small bulk, it can contain a very large value. Think of a currency note of Rs.1000.

• Homogenous

One essential quality of money is that it must be exactly of the same type. Even among the coins, there are good and bad coins, but currency notes are exactly similar. It is, therefore, a very suitable medium of exchange.

• Elasticity

Paper money is absolutely elastic. Its quantity can be increased or decreased at the will of the currency authority.

• Cheap remittance

Money in the form of currency notes can be cheaply remitted from one place to another in an insured cover.

• Advantages to banks

Paper money is of very great advantages to the banks. They can keep their cash reserves against liabilities in this form, for currency notes are full-length tender.

• Fiscal advantages

Fiscal advantages to the government of the paper currency are undoubtedly very great, especially in times of national emergencies like a war. Modern war cannot be prosecuted by taxes or loans alone. All government have to resort to the printing press. These above advantages also indicate the Importance of Money for us today.

Disadvantages 

The disadvantages of paper money are as follow”-

1. Paper Money is of no value outside the country of issue, gold and silver coins are accepted even by foreigners, as they have got some intrinsic value.
2. Paper currency may result in instability of foreign exchange rates when the domestic prices and external prices do not move in harmony.
3. There is a possibility of damage to the paper. Fire may burn it if the place is flooded, it is gone, and it may also be eaten up by white ants.
4. A serious disadvantage in paper currency is the case with which it can be issued. There is always a danger of its over-issue when the government is in financial difficulties. The temptation is too great to be resisted. Once this course is adopted, however, it gathers momentum and leads to a further note –printing and this goes on till the paper currency loses all value.