Monetary system and its evolution in globe

Fundamentals of Financial Planning

1. BI METALLION: Bimetallic standard is a monetary system under which the monetary unit of the country is expressed by law in terms of two metals, usually gold and silver, in specific ratio. In other words under bimetallic both silver and gold silver circulate simultaneously within the country. They are unlimited legal tender. Characteristics of BI Metallion: Both coins are full bodied coins further both the coins are unlimited legal tender. The government fixes in advance the rate of which tow coins will exchange for each other. There is free and unlimited coinage of both the metals into standard monetary units. There is no restriction on import and export of these metals. Merits: Adequate supply of money Price stability Stable price of silver Encouragement to foreign trade Easy to keep cash reserve Encouragement to production Demerits: Inequality of market ratio and mint ratio Operation of gresham’s law Not successful internationally No price stability Encourages speculation Little stimulus to foreign trade.

2. In the 20 th century, both silver and gold lost their former importance within monetary systems, and monometallic system was abandoned by all nations. It was set up in 1976 at the Conference in Kingston (Jamaica), when the gold lost its role of monetary standard: Under this system, the currency of the country is made of paper. Generally, the currency system is managed by the CB of the country. Today, almost all countries in the world have managed currency standard systems. The paper currency standard system is a fiat system: does not allow free convertibility of the currency into a metallic standard; money is given value by government fiat (is intrinsically useless) The value of the money is set by the supply and demand for money and by the supply and demand for other goods and services in the country. The value of the money depends on its purchasing power. Paper currency standard system (Managed currency standard)

3. Paper money is economical. Its cost of production is negligible. It is convenient to handle and it is easily portable. It is homogeneous. Its supply can be made elastic. Its value can be kept stable by proper management. Paper currency can function very effectively as money, provided, there is proper control of it by the managing authority. It is ideal for internal trade. But for international trade and payments, gold is still found necessary. Advantages of paper currency system

4. First important disadvantage: There is the danger of over-issue of paper money by the managing authorities: Over-issue of currency will result in a rise in prices, adverse foreign exchange rates and many other evils. The over-issue of paper money has ruined many countries in the past. Second important disadvantage: It will not have universal acceptance: It is recognized as money only in the country where it is issued. For others, paper money is just bits of paper. Gold, on the other hand, has universal acceptance. Disadvantages of paper currency system

5. Principles and Methods of note issue: The central bank of a country is responsible for issuing currency notes for it. Principles of note issue: 1:Currency principle 2:Banking Principle On the bases of these principles different methods or tools can be adopted by central bank to issue note.

6. 1:Currency principle THEORY: The currency principle is based on 100% gold backing. According to this principle central bank must keep 100% reserves against each and every note issued. So there will be full convertibility under such system. Merits Full safety Ensures public confidence There is no loss of bullion No danger of inflation No danger of over issue Demerits: Inelasticity Bullion lies, inactive Unnecessary expenditure in mining Poor countries cannot follow Lack of economy Need for precious metals

7. 2: BANKING PRINCIPLE THEORY: Banking principle lies on the other end. This principle says that note issuance should be dealt independently by central bank and it shall be allowed to issue notes according to the ongoing circumstances. Also there is no need of full backing of gold under this principle. Only a percentage of issued notes are backed by gold. However all the notes are issued with the guarantee of convertibility into gold. Merits: Elastic system Government needs Popularity Surety Economics Demerits: Over issue Economic crises Balance of payment Lack of security Less of confidence of people

8. Methods of Note Issue Fixed fiduciary system Fixed maximum fiduciary system Proportional reserve system Minimum reserve system Percentage system Simple deposit system Government bond deposit system

9. Fixed fiduciary system Under this system the central bank of country is permitted to issue a fixed amount of notes without keeping any metallic reserves. This portion is called fiduciary issue and is blocked by government securities. This system first adopted in England in he year 1844. In India this system worked from 1861 to 1920. Merits: Check on excessive issue of notes Public confidence Safety Demerits: In elasticity: additional notes cannot be issued Costly: need to maintain gold reserve

10. 2. Fixed Maximum Fiduciary System A maximum amount is fixed upon which the bank can issue-notes without any gold reserve and this maximum limit is generally well-above the average annual circulation of notes. Merits: Economy No risk of over issue Applicable to all the countries Elasticity Demerits: Rigidity No guarantee against inflation

11. 3. Proportional reserve system Required to keep a certain percentage generally varying from 25 to 40% of gold against the note-issue is covered by securities. First adopted in France after 1928 and several other countries after first world war. Merits Simplicity Elasticity No fear of excessive issue Convertibility assured. Demerits: Uneconomical Difficulty in contraction of currency Bullion and gold lie idle in the reserve Imaginary convertibility of the paper notes.

12. 4. Percentage system: While fixing the portion of metallic reserves with the paper currency the minimum metallic cover was also laid down. The minimum metallic cover comprised not only gold and silver also foreign securities. Merits: Gold savings Elasticity, economy, and convertibility Demerits: Uneconomical Difficulty in contraction of currency Bullion and gold lie idle in the reserve Imaginary convertibility of the paper notes.

13. 5. Simple deposit system: Metallic reserve equal to the amount of note issue.(USA) Merits: Elasticity Public confidence No fear of over issue Demerits Lack of economy Lack of elasticity Difficulty in foreign payment

14. 6. Government bond deposit system The notes issues are backed up by an equivalent amount of government bonds or treasury bills. Used by USA. Merits: No danger of over –issue Full converitbility

15. 7. Minimum reserve system: Keep a metallic reserve equal to the amount of note issue. There is principle of note issue. Merits: Full convertibility, no danger of over issue Demerits: No economy of precious metal No elasticity of paper currency. Not popular. 8. Simple deposit system: The note issuing authority keeps and equal quantity of gold and silver in the metallic reserves as a cover against note issue.