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Wed, Nov

Currency Notes | Fixed Fiduciary System | Proportional Reserve System

Business
Typography

There are different methods of money notes issuing adopted by different countries of the world at different times. The most important of them are

Fixed Fiduciary System:

Under fixed fiduciary system, the government fixes a fixed amount of notes without keeping any metallic reserve. But this portion of currency must be backed by government securities, which is called fiduciary Limit.The notes issued other than fiduciary limit must be fully backed by gold or silver reserves. This system was introduced in England in 1844 in the Bank charter Act of 1844. Norway and Japan also adopted this method. This system acted as a brake on the undue expansion of currency and credit in the time of prosperity. This system also provides security for the convertibility of notes.

(Merits)

Safety:

This method of note issue provides safety to notes issued and acts as brake, which also provides safety to currency value.

Stability:

This system not only provides value stability but also provides economic stability, which is helpful for regulating internal prices and exchange rate.

Demerits

Unsuitable for Modern Economy:

In the modem age of ever changing world, the government needs a capital to finance its projects. But this system is unsuitable for a Modern economy in which money needs are often changed.

Metal Drain:

Under this system an internal and external drain of gold or silver cause to decrease in supply of notes even though economic conditions require increase in it.

In-elasticity:

This system is relatively inelastic because under this, notes other than "fiduciary limit can be issued only by increasing gold or silver reserves of the same value. Government can change the fiduciary limit but change in the limit shows weakness of the government.

Lock up of Gold:

This system locks up a fixed quantity of gold, which could otherwise be used for productive purposes.

High Fiduciary Limit:

If fiduciary limit is high or it has been increased with the passage of time then people will loose confidence in the currency.

Unresponsive to the Requirements of Trade:

It is uneconomical and unresponsive to the requirements of trade.

Proportional Reserve System:

Under this system the central bank is required to keep only a certain percentage of notes issued in the form of gold or silver. The reserve proportion is usually from 30% to 40%. It means a central bank can issue Rs. 100 note after keeping gold silver valuing Rs. 30 or 40. This method of currency regulation is the most affordable system of the present time and is widely used in many countries. It was first of all adopted by Germany in 1876 and followed with modifications by U.S.A in 1914.

Merits

Elasticity:

This system is more elastic than fixed Fiduciary system. For example, if bank obtains, Rs. 40 worth of gold, it can issue Rs. 100 note under the proportional Reserve system. Whereas under fixed Fiduciary system the bank can issue note of Rs. 40 only, once the fiduciary limit reached.

Safety:

The reserve maintains in this method serves as a safeguard against excessive note issue and inflation can be checked.

Demerits

Effect on Economy:

This system adversely affects the economy an excessive supply of money in the economy cause to create certain economic problems.

Unable to Control Prices:

Excessive money cause to decrease the purchasing power of the currency, which badly affect the common man.

Lock up of Gold:

The defect with this system is that it locks up the gold reserves unnecessarily. So we cannot use it for other purposes.

Drastic Reduction of Note Issue:

It brings about a drastic reduction of note issue in the event of gold being exported to another country.

Minimum Reserve System:

Fixed minimum reserve system allows the central bank to keep only a fixed amount of reserve against whatever the amount of note issue. The reserve is in the form of gold, silver and-foreign exchange or in the form of any of these types of things. This method-is being used in Pakistan after December 1965. India is also applying it since 1957. South Africa has adopted it in 1930. Holland has been issuing notes under this method for many years.

Merits

Elastic:

This system is much elastic than above stated methods of note issue which can meet the ever-changing needs of the money by the govt.

Economical:

Because a fixed amount of gold, silver or foreign exchange is to be maintained as fixed minimum reserve, therefore it becomes much economical and government can also change the fixed minimum reserve at anytime.

Demerits

Over Issuance of Currency:

Under this method, there is a danger of excessive note issue, which consequently brings inflation. This inflation adversely affects the economy.

Currency Value:

An excessive note issue cause to decrease. in the currency value this decrease in the value of currency cause to contract the purchasing power of the consumers.

Method Of Note Issue Adopted In Pakistan:

Pakistan has used proportional reserve system up to December 1965. Under this method 30% was to be kept as reserve in the form of gold coin, gold, silver bullion and approved foreign exchange. The balance was covered by rupee coin and government security After 1965. State Bank of Pakistan adopted fixed minimum reserve system Under this system the bank has to keep only legally fixed amount of minimum reserve in gold, or silver. Moreover the government in consultation with the State Bank can alter it.



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