BANK PRACTICE & PROCEDURE

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CHAPTER ONE

MONEY: EVOLUTION AND FUNCTIONS

Introduction

The importance of money for the smooth functioning of the modern complex economies can hardly be
exaggerated. The importance of money for modern economics is known by the functions that it performs.
True, those more primitive societies of the past were able to function without it; it is difficult to visualize
today an economic system, be it free-economic system or command-economic system, which can function
without money. How money reached to this stage is quite interesting to know. It was not invented overnight.
It is the result of a process of evolution through several hundred years.

This chapter explores questions such as what it is money? How money was invented? What are the
functions of money? , beginning with the oldest forms of money and describing how new forms developed.
It describes how early banks sprung up to store money, and how other financial intermediaries were
established to transfer money from savers to spenders. It also identifies that an efficient financial system
helped provide the resources for investment in new capital, promoting economic growth and rising living
standards. Finally, we will discuss how new ways to borrow and lend continue to fuel our nation's prosperity
and raise questions about maintaining stable economic growth.

1.1 The Definition of Money

It is not easy to define money. Even economist of repute stood bothered at this issue. Consequently, there
are many definitions of money as there are economists. But, experts agree on one definition of money,
money is anything that behaves like money and performs the functions of money. Beyond that simple
definition, there are little agreements. The reason is the many new forms of money takes in our modem,
complex economy. Defining and measuring money is no longer as simple as counting and weighing coins
or even balancing checkbooks.

New forms of money have been a response to the changing needs of our economy. We have found new
ways that money can work for us new ways to stimulate production and exchange, new ways to allocate
resources toward future production, and new ways to store wealth. But like most change, changes in money
require new ways of managing money. Policy makers must understand how money works in all its new
forms and decide on policies for helping money serve us better.

2.2 The Origin of Money: The Barter System and Its defects

A system of exchanging good and services directly for goods and services was known as barter.

In the most primitive forms of societies, man procured goods not produced by him through forces. He did
not need money. Furthermore, the absence of money keeps them primitive. This is because primitive
societies are generally self-sufficient. They managed to survive only on the meager production that is
carried on within the small community itself. When a primitive tribe can satisfy all its own needs for food,
clothing tools, and shelter, there is no need for exchange and no need for money.

Eventually, there may be some specialization among subgroups within a developing tribe. Persons with
particular physical attributes or mental abilities begin to perform appropriate jobs and develop skills for
doing them better. Primitive engineers build the roads and bridges; strong, athletic persons capture the
game; and careful artisans do work requiring meticulous detail. Many of our names are a result of our
family's specialization as carpenter, fisher, miller, tailor, or goldsmith in some primitive community. With
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some degree of specialization within the tribe, exchange can take place through barter. Barter is the
exchange of some goods and services for goods and services of another type. When there are old,
established patterns of production and consumption within a small, closely knit community, barter is fairly
simple. Engineers, hunters and artisans can freely share the products of their work.

Things are not so simple when the society expands. Specialist develops new techniques of production,
which open up opportunities for even finer specialization. A broader market area covering greater distances
makes such techniques worthwhile. Old patterns of production and consumption constantly break down
and are rebuilt in entirely new ways. Barter is not as convenient as before. To depend on direct exchange
of what one has for what one wants would become so complicated that all exchange and all production
would slow down. What is needed is a symbol to represent value in exchange and to entitle the holder to
equivalent value for purchasing precisely what he or she wants, in a word: money.

The availability of money encourages producers to increase their special output of particular goods. Then
the receipt of money enables consumers to spend for a wider variety of the things they need. When money
replaces barter for making trades, both production and consumption can grow.

There have been almost as many different symbols used as money as there have been societies using them.
The most familiar in our history books are animal bones and giraffe

The invention of Money

It is thus clear that the use of money arose out of the inconveniences of barter; although in the international
sphere barter continued to practice for a long time. A feature of transaction involving money is that direct
exchange gives way to indirect exchange. In a barter transaction giving and taking are both comprised in a
single act; the use of money separates these two processes, since first a commodity is sold out for money
and subsequently, at a later time the money so obtained is used to make the desired purchase. Let us add
a word about the way money has been invented. As soon as people realized the difficulty of double
coincidence of wants and that exchanging commodities, which if divided would lose their quality, they first
used a commodity as a unit of account of as a standard of value.

In the earlier stage, as already stated, commodities were used as standard of values and unit of account; in
the second stage metallic money was used and in the final stage, the paper money is in use. Now with the
help of this unit of account values of different goods and services could be expressed and compared. This
led to the extension of area of exchange and to the emergency of the pricing system. Economic calculations
became more rational and individual choice making became easier. This also extended the scope of
markets, and provided ample opportunities for speculation and division of labor. Now goods came to be
brought and sold independently. At the same time the dependence of one person on the other wants
completely done away with.

The availability of money encourages producers to increase their special output of particular goods. Then
the receipt of money enables consumers to spend for a wider variety of the things they need. When money
replaces barter for making trades, both production and consumption can grow.

There have been almost as many different symbols used as money as there have been societies using them.
The most familiar in our history books are animal bones and giraffe tails, gunpowder and salt, and stones
and strings of shells. In colonial America there was not much money, so Virginia tobacco was used in
exchange for more years than gold was standard money. Some of these primitive forms of money are still
used. In fact, in some islands of the South Pacific stone disks measuring four feet across still function as
money.

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What do all these symbols have in common? Certain characteristics are common to all money in some
degree. For a substance to serve as money it must be relatively rare; it should be easily carried and stored
without spoiling; and it should be divisible into smaller portions for making small payments. The
commodity that best exemplifies these characteristics is precious metal. Gold and silver are rare relative to
their demand for ornamental or industrial purposes. Their rarity makes them highly valuable per unit of
weight, so that they are easily carried. Both are fairly durable, subject to very little deterioration over long
time and much use. They are easily fashioned into small shapes and easily stamped with identifying marks.
Furthermore, badly worn metal coins can be melted down and made into fresh new ones.

The first use of precious metals as money was probably in southern Asia about ten thousand years ago.
Nuggets circulated as money around the Persian Gulf and in trading settlements along the China coast.
Exchange using precious metals was difficult at first because the metal had to be assayed to determine its
value. Assayers would weigh and test a magnet for purity each time it changed hands. Eventually assayers
began to stamp their special mark and the certified weight on each nugget so that it would not have to be
weighed and tested over and over again. This worked rather well except for the common practice of
chipping or shaving small pieces from the edge of some nuggets and combining them to produce another
one. To reduce the value of money is called debasing the currency. Authorities tried to prevent debasement
by flattening nuggets, making them round, and seriating the edges. Coins of this kind began to be used
9,000 years ago in eastern Mediterranean countries. By the time of Christ there were mints operating in
cities along the Mediterranean coast.

The arrival of money into medieval Europe helped destroy the old feudal society and made way for
development of a commercial and, finally, an industrial economy. The old system of feudalism had been
based on strong ties of dependency between land-owning lords and serfs, or slaves who worked the land.
Barter worked well in such a closely-knit society, where serfs turned over their surplus crops to the lord
who, in turn, provided them protection against marauding tribes. Money changed all this. Serfs could sell
their grain and wine to traveling merchants and use the money to buy their freedom from the lord. Then
the freed serfs moved to newly developing towns to become merchants themselves or, eventually, small
manufactures. Many lords were eager to sell their land and free their serfs so as to acquire money of buying
silks and spices brought from the orient.

1.2 The Importance of Money

The importance of money for modern economies is known by the functions that it performs. As a matter of
fact, it is difficult to think of an economy these days which may work without the use of money. Most
money in itself is worthless; its value is derived from it use. Money is used as a link between the world's
producers and the world's consumers. It enables people to consumer or own things they did not produce,
and it encourages people to produce things they do not intend to consume.

Its function as a "link" makes money a medium of exchange. It is a means of exchanging the things we
have produced for the things we want to consume. The availability of money simplifies the process of
production and exchange. The more developed our money system, the more we are encouraged to produce
and the greater becomes our desire to consume exotic things. We are encouraged to specialize in the
production of cotton cloth, kitchen tables, and haircuts so that we can enjoy oranges, tape players, and sport
events. Through specialization, we each become more productive. Without money to link producers with
consumers, we would be more limited to the self sufficient production of our own hands; or we would
spend much of our energy bartering our production for the things we want.

If money is to be a medium of exchange, it must also be a standard of value. It must provide a medium of
exchange for evaluating all items in exchange. Under barter, evaluating goods is enormously complex. One
goat (female) may be worth four clay bowls or two cutting tools. A cutting tool may exchange for a jug of

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oil, which in turn is worth six animal pelts or tow goat (female) may be worth four clay bowls or two cutting
tools. A cutting tool may exchange for a jug of oil, which in turn is worth six animal pelts or two goats
(male). Just making all the necessary calculation for trade can become tiresome, using time that could be
better spent in real production.

A uniform symbol of value measures all these items by a single language and simplifies trade. It ensures
that producers of, say, clay bowls are rewarded fully for their contribution to world output. Increasing world
output by some known value entitles producers to an equal of goods for their own consumption.

In money is to serve as a reliable measure of production and consumption, it must not change in value. This
is particularly true when production and consumption take place in two different time periods. Some
producers of goods or services intend to store the value of their work as a basis for consuming other goods
at some future time. When their own production cannot be stored for later sale, they will sell it today and
save a portion of their earnings. In this sense, money is used as a store of value. Most of us store a part of
our earnings regularly to provide for our consumption needs at some future time.

1.3 Functions of Money

Money performs a number of primary, secondary, contingent or other functions which not only remove the
difficulties of barter but also lubricate the wheel of trade and industry in the present day world.

A) Primary Functions

There are two types of primary functions. They are to act as a medium of exchange and as a unit of value.

Money as a Medium of Exchange: By serving as a medium of exchange, money removes the need for
double coincidence of wants and the inconveniences and difficulties associated with barter. The
introduction of money as a medium of exchange decomposes the single transaction of barter into separate
transactions of sale and purchase there by eliminating the double coincidence of wants.

When money acts as a medium of exchange, it means that it is generally acceptable. In therefore, affords
the freedom of choice. With money we can buy the best and also bargain in the market. Thus money gives
us a good deal of economic independence and also perfects the market mechanism by increasing
competition and widening the market. As a medium of exchange, money acts as an intermediary, it
facilitates exchange. It helps production indirectly through specialization and division of laborer, which, in
turn increase efficiency and output. According to Prof. Walters, money, therefore, serves as a factor of
production enabling output to increase and diversify.

In the last analysis money facilitates trade. When acting as the intermediary, it helps one good or service
to be traded indirectly for others.

Money as Unit of Value: The second primary function of money is to act as a unit of value; Under barter
one would have to resort to some standard of measurement, such as a length of string or a piece of wood.
Since one would have to use a standard to measure the length or height of any object, it is only sensible
that one particular standard should be accepted as the standard. Money is the standard for value just as the
yard or metro is the standard for measuring length. The monetary unit measures and expresses the values
of goods and services. In fact, the monetary unit expresses the value of each good or service in terms of
price. There can be no pricing process without a measure of value. Unlike barter, the prices of all
commodities are expressed in terms of dollars, birr and pounds, etc. depending on the nature of the
monetary unit in the country.

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Money as a unit value also facilitates accounting. Assets of all kinds, liabilities of all kinds, income of all
kinds, and expenses of all kinds can be stated in terms of common monetary unit is to be added or
subtracted.

B) Secondary Functions

Money performs three secondary functions: as a standard of deferred payments, as a store of value, and as
a transfer of value.

Money as Standard of Deferred Payments: The third function of money is that it acts s a standard of
deferred or postponed payments. All debts are taken in money. It was easy under barter to take loans in
goats or grains but difficult to make repayments in the same form. Money has simplified both the taking
and repayment of loans because the unit of account is durable. Money links the present values with those
of the future. It simplifies credit transactions. It makes possible contracts for the supply of goods in the
future for an agreed payment of money-the buying and selling of securities, debentures and shares.

But there is the danger of changes in the value of money overtime which harms or benefits the creditors
and debtors. To overcome this problem, some of countries fixed debt contracts in terms of a price index,
which measures changes in the value of money. Such contract overtime guarantees the future payment of
debt by compensating the loser by the same amount of purchasing price at the time of entry of contract.

Money as a Store of Value: Another function of money is that it acts as a store of value. It is a form in
which wealth can be kept infact from one year to the next.

Money is a bridge between present and future. Money as a store of value is meant to meet unforeseen
contingencies and to pay debts. One can store value for the future by holding short/terms promissory notes,
bonds, mortgages, preferred stocks, household furniture, houses or any other kind of valuable goods.

Money as a Transfer of Value: As money is generally acceptable means of payment and acts as a store of
value, it keeps on transferring values form person to person and to place to place.

C) Contingent Functions

Money also can perform some incidental or contingent factions. They are:

Money as the most liquid of all liquid assets: Money is the most liquid of all liquid assets in which wealth
is held. Individuals and firms may hold wealth in infinitely varied forms. They may be chosen between
holding wealth in currency, demand deposits, time deposits, saving deposits, bonds, treasury bills, short
terms government securities, long terms government securities, debentures and product equipment.

Basis of credit systems: Money is the basis of the credit systems. Credit economizes the use of money. But
money is at the back of all credit. A commercial bank cannot create credit without having sufficient money
in reserve.

Equalizers of marginal utilities and productivities: Money acts as an equalizer of marginal utilities for
consumer. The main aim of consumer is to maximize his/her satisfaction by spending a given sum of money
on various goods, which he/she wants to purchase. The main aim of producer is to maximize his profits.
For this, it equalizes the marginal productivity of each factor with its price.

Measurement and distribution of net income: it was not possible to measure and distribute the national
income under the barter system. It is not only helps in measuring national income but also in its distribution.

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This is done when the various good and services produced in a country are assessed in money terms and
the factors are paid wages, interest, profits and rent in terms of money.

1.4 Desirable Properties of Money

At minimum, money has five requisite properties: They are
1. Portability: Money must be easy to carry around and easy to transfer in order to make purchases in
different locations.
2. Durability: Money that does not have the quality of physical durability will lose its value as money.
For example chips could be money, but it would be difficult to keep it in current form of it. Would
become sale and wear out.
3. Divisibility: We must be able to divide money easily into equal parts to allow fort purchase of
smaller units some monies, however, have been indivisible.
4. Standard ability: We must be able to standardize money if money is to be useful. Its units should
be of equal quality and physically indistinguishable. Only if we can standardize money can
individuals be certain of what they are receiving when they make economic exchanges.

1.5 Kinds of Money

Money can be classified on the following different bases: 1) the physical characteristics of the materials of
which money is made; 2) the nature of the issuer such as a government, central bank, commercial bank or
other, and 3) the relationship between the value of money as money and the value of money as commodity.

On the basis of material used, money can be classified into metallic money and paper money.

1. Metallic Money: Money made of any metal such as gold, silver, nickel, copper, etc is called metallic
money. Metallic money is further divided into standard money, token money and subsidiary money.

a) Standard money: Standard money is money whose values as a commodity for non-monetary purposes is
as great as its value as money. Such money is made of coins whose face value equal their intrinsic or
metallic value. The holder of such coins may use them as metal by melting them or as money, because the
value of the metal in the coins is the same as their monetary value. Standard money is, therefore, known as
full bodied money.

b) Token money: Token money is representative money whose intrinsic value of the metal is less than its
face value. The fifty-cent coin in circulation in Ethiopia is a token coin, if it is melted, its metal will not be
sold worth fifty cent.

c) Subsidiary money: Subsidiary money is to assist the token money. All coins of the denomination from 1
cent to 25 cents in Ethiopia are subsidiary money.

2. Paper Money: Paper money refers to notes of different denominations made of paper and issued by
central bank and/or the government of the county paper money can be classified into representative paper
money, convertible paper money, inconvertible paper money and fiat money

a) Representative paper money: Representative paper money is in effect a circulating warehouse receipt
for full-bodied coins or their equivalent in bullion. It is also known as representative full-bodied money
because it is fully backed by gold coins or gold bullion held by the treasury.

b) Convertible paper money: It is money, which does not have 100 percent backing in the form of standard
coins or billion. But the holder of paper money can get it converted into bullion or coins on demand. The

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only difference between representative and convertible money is that the former is fully backed by standard
coins or bullion while the latter is not fully backed by them.

c) Inconvertible paper money: The paper money which does not have pay backing of standard coins or
bullion and is also not convertible into them is known as inconvertible paper money. Notes issued by central
banks of all countries represent inconvertible paper money.

d) Fiat money: Paper money which circulates on the authority of the government is fiat money. Keynes
defined fiat money issued during the special purpose war or emergency.

1.6 Monetary Standards

Monetary standard refers to the overall set of laws and practices which control the quality and
quantity of money in a country.

Monetary standard is a system of note issue-a system of issuing metal or paper currency. The form of
standard money used in a country determines the type of monetary system or the standard. If for example,
standard money is of metal the system is known as mutualism and the monetary standard is known as
metallic standard; if the standard money is of paper the system is known paper currency system and the
monetary standard as the paper standard. Thus, the term ‘monetary standard’ essentially refers to the form
or type of standard money used in an economy. It is, in fact, the standard money of goods and services. A
monetary standard aims at maintaining stability in the internal as well as external value of the currency.
There are many types of monetary standard in the evolution of money. But only two types of monetary
standards have been popular with nations in the world are metallic or commodity standard and paper or fiat
standard. The metallic standard refers to monetary system in which the value of the monetary unit
expressed in terms of a fixed quantity of some melts. The monetary system is related to one metal it is
known as monometallic. Monometallic may refer to the gold standard if the metal is gold, and to silver
standard if the metalic silver. If the monetary unit is made of two metals, the monetary standard is known
bimetallism. '

Gold Standard

The gold standard is a monometallic standard in which the value of monetary unit is fixed in terms of
specific weight and purity. Gold standard is s state of affairs in which a country keeps the value of its
monetary and the value of a defined weight of gold at equality with one another. Coulborn's definition, the
gold standard is an arrangement whereby the chief piece of money of a country is exchangeable with a
fixed quantity of gold of a specified quality.

Rules of the Gold standard

The following are general principle for the successful working of the international gold standard. The gold
standard functioned before the First World War in order to study its working, it is essential to analyze the
conditions for its success. These conditions have come to be known as the "rules of the game". But it
recommended the following general principle for the successful working of the international gold standard.
1. It should involve a common agreement among nations as to the objectives for which it existed.
2. It should bring stability of prices and guarantees stability of exchange.
3. Individual central banks should avoid such actions, which might endanger stability of prices through
their effects on the policy of the central banks.

The countries on the gold standard were expected to observe the following rules or condition for the smooth
working.
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a. There should be free and unrestricted export and import of gold between countries.
b. The country-receiving (importing) gold should expand credit within the countryman the gold
exporting country should contrast credit.
c. There should be a high degree of price, wages, income and cash flexibility in countries on the gold
standard so that these change with gold movements. When gold flows into the country, money
supply should increase which should lead to the rise in prices, wages and income, and cost would
be adjusted accordingly. The opposite change would be possible in the situation where gold is going
out of the country.
d. The successful working of the gold standard presupposed the existence of free trade among nations.
e. The country on the gold standard should strictly adhere to the policy of maintaining exchange
stability and other objectives should be subservient to it.
f. There should be no disturbing large capital movements based on speculative activities.
g. Another condition was that the gold value of the domestic currency was to be kept stable. It should
not be overvalued or undervalued
h. Last but not the least, the success of the gold standard working required normal times

Merits of Gold Standard

The international gold standard which operated for more than three decades in different forms had certain
merits.
a. Inspired public confidence: The gold standard inspired public confidence because the domestic
currency was linked with gold. People knew that gold was an internationally accepted medium of
payment and a standard and a store of value.
b. No outside interference: The international gold standard had the merit of working without any
outside interference by any other country.
c. Automatic operation: The gold standard functioned smoothly provided the rules of the game were
observed. These rules were not complex but easy to understand and follow for the countries.
d. Stable exchange rates: Another merit of the gold standard was it maintained stable exchange rates
between countries. The exchange rate was fixed in terms of its mint par or the gold value of its
currency.
e. Stable internal prices: The gold standard secured internal prices. When there was an inflow of gold,
prices rose, and they fall with gold outflow.
f. Check on Inflation: Under the gold standard the currency of a country was linked with gold was
convertible in to it. As the issuing of currency was backed by specific quantity of gold, there was a
limit up to which the authorities could issue currency.

Demerits gold standard

Despite these merits, the actual working of the gold standard revealed a number of disadvantages, which
the countries on the world had to experience.
1. Fair Weather Standard: Critics pointed out that the gold standard acted like a fair weather friend.
It worked smoothly in normal or Pease time but failed during war or economic crises.
2. Not automatic: It is a misnomer to say that the gold standard worded automatically. In fact, all
varieties of it had to be managed by the monetary the central bank. The central bank had to change
the bank rate in accordance with god movements, in order to affect the price level.
3. Exchange stability at the cost of economic stability: one of the priced objectives of the gold standard
was to maintain exchange stability. But this was always attained at the cost of economic stability.
When every time there were gold movements, the internal price level had to be adjusted accordingly
in order to maintain exchange stability.
4. Anarchy in world credit control: Haw trey characterized the gold standard as a state of anarchy in
world credit control. Since the gold standard was a laissez-faire standard and operated only under

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normal times, it failed miserably in condition of severe inflation or deflation. Thus the gold standard
itself is not able to control either inflation or deflation. Rather it had to sacrifice itself at the altars
of inflation and deflation.
5. Deflationary bias: According to Mrs. Joan Robinson, the gold standard had an inherent bias toward
deflation. It was in the interest of the gold losing county to deflate prices.
6. No Independent Policy: a country on the gold standard could not follow an independent policy of
its own; it had to follow that policy which was adopted by all other countries. Failure to follow a
common policy along with other countries means t abandoning the g09dl standard.
7. Costly standard: The gold standard was a costly standard because it was based on gold. Every
country had to circulate god coins or keep gold reserves.
8. Rigid standard: The gold standard was a rigid standard because for its success the rule of the game
had to be observed in letter and spirit. A country could not increase the money supply to finance a
war or development activities or any financial emergency without increasing the gold reserves with
its central bureau
9. Adverse Effects of Interest Rate Changes: Under one of the rules of the gold standard, the central
bank of the country was required to affect changes in the bank rate in keeping with gold movements.
When there was an inflow of gold, the bank rate was lowered, while it was raised with the outflow
of gold.

Bimetallism

Bimetallism, also known as bimetallic standard, is a monetary system under which the monetary unit of
the country is expressed by law in terms of two metals, usually god and silver, in a specific ratio. Both
metals are imported and exported freely. The United States adopted it in 1792, when the mint ratio between
silver and god was fixed at 15:1. France adopted in 1803-followed Belgium, Switzerland and Italy in 1865.
This was abandoned by European countries in 1874.

Merits of Bimetallism: Bimetallism as monetary system had the following advantages:

1) Adequate supply of Currency: One of the merits of bimetallism was that it ensured and adequate supply
of currency within the country. As both and silver coins were in circulation and freely minted, there was
no likelihood of both becoming short in supply.

2) Price Stability: It was also argued that the flexibility of money supply assured price stability. The internal
price level was linked with prices of gold and silver. And the prices of gold and silver depended upon their
supply and demand.

3) Stable price of silver: The proponents of bimetallism argued in the lat quarter of 19th century and
twenties of the 20th centuries that bimetallism would stop the fall in the price of silver. In those days, the
price of silver was failing and the silver producing countries were at a disadvantage in trading with god
standard countries. It was therefore felt that the bimetallism would increase the demand increase for silver
and raise its prices.

4) Stable exchange Rates. It was further argued that bimetallism helped to maintain stable exchange rates
between countries. This was because the ration of exchange between god and silver

5) Encouragement to foreign trade: Bimetallism encouraged foreign trade in two ways. First due to
exchange stability between countries, and second, a country on bimetallism could have trade relations with
any country on bimetallism and on silver or gold standard.

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6) Easy to keep cash reserves: As both gold and silver coins were unlimited legal tender, it was convenient
for the commercial banks to keep minimum cash reserves against their liabilities either in god or silver.

7) Encouragement to production: Bimetallism is a monetary systems was superior to the silver or gold
standard because it encouraged production.

Demerits of Bimetallism

The following are the disadvantages of bimetallism.

1. Inequality of Market Ration and Mint ration: - The success of the bimetallic standard depended up
on the maintenance of equality between the market ration and mint ratio of gold and silver. The
metal whose value increased was hoarded by the people.
2. Operation of Gresham's law:- when there was divergence between the mint ratio and market ratio
the Gresham's law would operate and bimetallism would break down. According to this law, cheap
money drives out dear money, or bad money drives out good money. If silver becomes cheaper,
people used this as medium of exchange and hoarded or melted gold coins with the result that god
coins disappeared from the market.
3. Not successful internationally: It was argued that if bimetallism was adopted by many countries, it
would be successful. But it was not possible to expect international cooperation on maintaining
uniform rate in every country.
4. No Price stability: The opponents of bimetallism dispute that flexibility of money led to price
stability.

Thus on all counts, bimetallism was never favored by the nations of the world. For its was a complex and
costly standard which could not work smoothly. They found that a constant supply of money could be
ensured in a much better way by the managed paper standard.

Gresham’s Law

Sir Thomas Gresham concluded in the year 1558 that “bad money drives out good money”. This has come
to be known as Graham's law. Prof. Marshall defined this law as thus, “Whenever the specific value of a
certain class of coins exceeds their currency value, the coins will begin to go into the melting pot or be
exported”. “Bad money” refers to debased or clipped legal tender money such as coins and paper notes.

Thus law operates under the bimetallic standard when gold and silver coins circulate simultaneously and
one metal becomes overvalued relative to the other metal. The metal which is overvalued will drive out
which the metal which is undervalued out of circulation.

Limitations of the Law

There are certain limitations of this law because it can be operated only in the following conditions.
1. I the total money in circulation, including, both good and bad money, exceed s the actual monetary
demand of the public.
2. If the public prepared to accept and circulate bad money.
3. If the gold money is full-bodied legal tender whose face value equals its intrinsic value?
4. If the total supply of bad money is sufficient to meet the total monetary demand of the public.

Paper currency standard

Paper currency standard consists of paper money which is unlimited legal tender and token coins of cheap
metals. Paper money may be either convertible or inconvertible. Convertible proper money is convertible

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into gold or silver coins or bullions of specific with on demand. Paper money which is not convertible into
coins of a precious metal or bullion is known to non-convertible.

Merits of the Paper standard

The following are the merits of the paper standard.

1. Economical: The paper standard is cheaper than gold or silver standard. here is no need to waste
god or silver for coinage.
2. Elastic: The Paper standard is a highly useful monetary system because it Possess great elasticity.
The monetary authority can adjust the money supply according to its requirements of the economy.
It was not possible under gold standard.
3. Price stability: The paper standard ensures price stability in the country. The monetary authority
can maintain equilibrium between demand and supply of money by an appropriate monetary policy.
4. Free from cyclical effects: The paper standard is free from the effects of business cycles arising in
other countries- It not available for to her standards especially gold standard.

Demerits of Paper Standard

1. Inflationary Bias: As paper notes are inconvertible, there is every likely hood of the government
printing of excess notes in excess of the requirements.
2. Price stability a Myth: Price stability is myth as has been the experience of the majority of the
countries on the paper standard.
3. Exchange Instability: It leads to instability in exchange rates whenever there is large fluctuation in
external prices as against internal prices.
4. Not Automatic: The paper standard does not operate automatically; rather it is a highly managed
standard, which requires much care and attention on the part of monetary authority. A little
carelessness may bring disaster to the economy.

Systems of note issue

Over the years, different countries have evolved various methods of not issues. The following are the
various methods of note issue.
1. Fixed Fiduciary System: Under this system, a fixed amount of notes is issued by the central bank
against reserves of government securities. Such amount issued on the faith or fiduciary of the central
bank and is called the fiduciary. This system was introduced in England in 1844, in India in 1860,
Followed by Japan and Norway. This system ensures security, inspires public confidence, and is
without any danger of mismanaging the currency through the over issue of notes by the central
bank. It has disadvantages like rigid and inelastic system because in need of financial emergency,
notes cannot be issued without keeping cent percent gold III reserves.
2. Maximum Fiduciary Limit: Under this system, there is a maximum limit up to which the central
bank is authorized to issue not without any gold reserves But there has to be full banking of gold
reserves beyond this limit. The central bank is, however, authorized to raise or lower the maximum
fiduciary limit and to fix the amount of gold reserves.
3. Proportional Reserve System: In this system, a certain percentage of the total notes issued by the
central bank have to be in gold reserves and the remaining in the form of government securities.
This percentage varies from 25 to 40 percent in countries like Switzerland, simple and elastic. The
money supply can be change with changes in percentage food reserves. This system has some
drawbacks. It is uneconomical because large quantities of gold reserves have to be kept which
cannot be issued for productive purposes. Second if the gold reserves fall, the reduction in currency
in circulation may be more than in proportion to the fall in reserves, it may leads to deflationary
tendencies.

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4. Minimum Reserve system: Under the minimum reserve system, the central bank is authorized to
issue notes up to any extent but it must keep a statutory minimum reserve of gold and foreign
securities. This system is useful for the developing countries they can meet their financial
requirements by printing more notes. They can also reduce the money supply to check inflation.
Further it is very required to be kept in reserve.

Summary

Over the centuries, money has undergone substantial change. It has evolved from primitive times to the
present. Increasing use of money provides the basis for economic growth and development, helping to
improve standards of living. Very primitive societies did not need money since they were largely self-
sufficient. The growth of specialization made exchange and money necessary. Nuggets and coins of
precious metal were early forms of money which contributed to broad economic and social change.
Bimetallic money systems were difficult to maintain because of the operation of Gresham's Law.

Representative commodity money was the forerunner of bank notes, which could expand to meet the needs
of trade. The value of early credit money depended on the reputation of the issuing bank or government.
The major credit money used today is checking accounts.

Money links consumers with producers and is thus a medium of exchange. It is a standard of value, a store
of value over time, and a standard for deferred payments. When money functions properly, it promotes the
distribution of goods and services according to each person’s contribution to total production.

Monetary standard can be broadly of two types: (i) metallic standard and (ii) paper standard.

Metallic standard refers to that form of monetary standard in which some metal is taken as a standard of
value. The paper standard refers to paper currency notes as the main currency of the country. Each type of
monetary standard has its own merits and demerits.

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