The principles of note issue are classified into two classes. One opinion says that complete conversion of notes into gold bars is known as the “Currency Principle”. The second advocates the elasticity in the supply of money according to the needs of trade and commerce, known as “Banking Principle”. These two theories are discussed below in detail:-
Principles of Note Issue
Currency Principle
According to these principles of note issue, notes are issued against gold reserve. The paper money is an reasonable substitute for metallic money. The paper money should have backing hundred percent of gold reserve. If there is lack of gold reserve against paper money. People will lose confidence in such notes. Hence, notes issued should be limited to the limit and quantity of notes issued will automatically expand or contract according to the inflow and outflow of gold into and out of the country concerned. The advantages claimed for this principal is that there is full care and protection to the paper currency. Moreover, excess issuance of currency in this principle is no danger. In this case, issue of currency depends on the availability of gold.
Banking Principle
Under banking principles of note issue, there is no requirement for backing of paper money by law. Notes issued should entirely on the discretion and necessity of the bank and trade. Bank will sustain sufficient reserve to honor the notes in their own interest. Under this principal, the surplus money should be routinely offered for cash payment, if there is an excess of notes issued and thus the appropriate ratio will be sustain between gold reserve and supply of money. This system is faced with the danger of over issue and as a result public confidence is lacking in this system.
After reading the above mentioned principles of note issue, now we can easily arrive at a conclusion that both these systems of note issue are defective. One scarifies elasticity and other security. These days, a certain percentage of notes issued by the central bank backed by gold or silver.
Methods of Note Issue
Notes are issued in almost all the countries according to the “Banking Principal”, but the reserve varies from country to country. According to the reserve, several countries methods of note issued have been evolved which are as under;
- Fixed Fiduciary System
- Maximum Fiduciary System
- Proportional Reserve System
- The Minimum Reserve System
- Fixed Fiduciary System
Under this method of note issue, central bank of the country is allowed to issue currency notes of a specified amount without presenting gold and silver to cover it. Once this limit is reached, additional amount of notes can be issued by hundred percent backed by gold. The advantages claimed for this method is that it gives elasticity in the money supply. It also grant maximum care due to the excess issuance of notes of the “Fiduciary Limit” except they are sheltered by hundred percent of gold. The possibility of inflation is effectively checked. However, this system is objected on the ground that judiciary limit is open to change by amendment in the Act and is raised will lose the confidence of the people.
- Maximum Fiduciary System
According to this method of note issue, the fiduciary system’s limit is fixed above the normal requirements of the country. Beyond the maximum no note is issued without legal sanction. This system is defective in the sense that, if the limit is too low, the currency system becomes inelastic and if the limit is too high, there is danger of over issue of notes.
- Proportional Reserve System
Under this method of note issue, the central bank is mandatory by law to maintain a permanent percentage from 25% to 40% adjacent to issuance of notes. It is often called percentage system. The remainder of the notes is to be covered by trade bills and government securities. This system is easily operated and it gives needed elasticity to the currency note system. But the system is uneconomic as huge amount of gold is kept idle as reserve. Moreover, the value of money is not stable, but this system is elastic up to a certain limit.
- Minimum Reserve System
Under this method of note issue, the reserve limit is permanently fixed and the volume of the notes has no connection with the amount of the reserve. To meet the ever- increasing demand for currency, government can issue notes up to any amount against the reserve but it is faced with the danger of the inflation.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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