A banknote (more commonly known as a bill in the United States and Canada) is a kind of negotiable instrument, a promissory note made by a bank payable to bearer on demand, used as money, and under many jurisdictions is used as legal tender. With coins, banknotes make up the cash forms of all modern money. With the exception of non-circulating high-value or precious metal commemorative issues, coins are generally used for lower valued monetary units, while banknotes are used for higher values.
Originally, the value of money was determined by the intrinsic value of the material the money was made of, such as silver or gold. However, carrying around a lot of precious metal was cumbersome and often dangerous. As an alternative, banknotes would be issued. In financial terms, a note is a promise to pay someone money. Banknotes were originally a promise to pay the bearer an amount of precious metal stored in a vault somewhere. In this way the stored value (usually in gold or silver coins) backing the banknote could transfer ownership in exchange for goods or services.
The ability to exchange a note for some other kind of value is called "convertibility". For example a US silver certificate was "payable in silver on demand" from the Treasury until 1965. If a note is payable in demand for a fixed unit, it is said to be fully convertible to that unit. Limited convertibility occurs when there are restrictions in the time, place, manner or amount of exchange.
A common misconception is that a bank note that is inconvertible is necessarily unbacked (so-called "fiat money"). Most of the confusion centers around the failure to distinguish between two types of convertibility: 1) Physical convertibility, where a unit of currency (a dollar) can be exchanged at the issuing bank for a given physical amount of something, and 2) Financial convertibility, where a dollar can be exchanged at the issuing bank for a dollar's worth of the bank's assets. The importance of financial convertibility can be seen by imagining that people in a community one day find themselves with more paper currency than they wish to hold — for example, when the Christmas shopping season has ended. If the dollar is physically convertible (for one ounce of silver, let us suppose), people will return the unwanted dollars to the bank in exchange for silver, but the bank could head off this demand for silver by selling some of its own bonds to the public in exchange for its own paper dollars. For example, if the community has $100 of unwanted paper money, and if people intend to redeem the unwanted $100 for silver at the bank, the bank could simply sell $100 worth of bonds or other assets in exchange for $100 of its own paper dollars. This will soak up the unwanted paper and head off peoples’ desire to redeem the $100 for silver.
Thus, by conducting this type of open market operation — selling bonds when there is excess currency and buying bonds when there is too little — the bank can maintain the value of the dollar at one ounce of silver without ever redeeming any paper dollars for silver. In fact, this is essentially what all modern central banks do, and the fact that their currencies might be physically inconvertible is made irrelevant by the maintenance of financial convertibility. Note that financial convertibility cannot be maintained unless the bank has sufficient assets to back the currency it has issued. Thus, it is an illusion that any physically inconvertible currency is necessarily also unbacked.
The perception of banknotes as money has evolved over time. Originally, money was based on precious metals. Banknotes were seen as essentially an I.O.U. or promissory note: a promise to pay someone money, but not actual money. As banknotes became more widely used, they became more accepted as equivalent to precious metal. With the gradual removal of precious metals from the monetary system, banknotes evolved to represent fiat money.
In the United States, public acceptance of banknotes in replacement of precious metals was hastened in part by Executive Order 6102. This order carried the threat of a maximum $10,000 fine and a maximum of ten years in prison for anyone who kept more than $100 of gold in preference to bank notes. Similar measures were taken worldwide, with similar results.
History
Paper money originated in two forms: drafts, which are receipts for value held on account, and "bills", which were issued with a promise to convert at a later date.
Money is based on the coming to pre-eminence of some commodity as payment. The oldest monetary basis was for agricultural capital: cattle and grain. In Ancient Mesopotamia, drafts were issued against stored grain as a unit of account. A "drachma" was a weight of grain. Japan's feudal system was based on rice per year – koku. At the same time, legal codes enforced the payment for injury in a standardized form, usually in precious metals. The development of money then comes from the role of agricultural capital and precious metals having a privileged place in the economy.
Such drafts were used for giro systems of banking as early as Ptolemaic Egypt in the first century BC.
However the use of paper money as a circulating medium is intimately related to shortages of metal for coins. In the 600s there were local issues of paper currency in China and by 960 the Song Dynasty, short of copper for striking coins, issued the first generally circulating notes. A note is a promise to redeem later for some other object of value, usually specie. The issue of credit notes is often for a limited duration, and at some discount to the promised amount later. The original notes were restricted in area and duration, but the Yuan Dynasty, facing massive shortages of specie to fund their occupation of China, began printing paper money without restrictions on duration. By 1455, in an effort to rein in economic expansion and end hyperinflation, the new Ming Dynasty ended paper money, and closed much of Chinese trade.
In Europe the first banknotes were issued by Stockholms Banco, a predecessor of the Bank of Sweden, in 1660, although the bank ran out of coins to redeem its notes in 1664 and ceased operating in that year. It was in the early 1690's when the Massachusetts Bay Colony issued the first permanently circulating banknotes. The use of fixed denominations and printed banknotes came into use in the 18th century.
The ease with which paper money can be created, by both legitimate authorities and counterfeiters, has led both to a temptation in times of crisis such as war or revolution to produce paper money which was not supported by precious metal or other goods, thus leading to hyperinflation and a loss of faith in the value of paper money, e.g. the Continental Currency produced by the Continental Congress during the American Revolution, the Assignats produced during the French Revolution, the paper currency produced by the Confederate States of America, the financing of the First World War by the Central Powers (by 1922 1 gold Austro-Hungarian krone of 1914 was worth 14,400 paper Kronen), the devaluation of the Yugoslav Dinar in the 1990s, etc. Banknotes may also be overprinted to reflect political changes that occur faster than new currency can be printed.
Most banknotes are made of heavy paper, sometimes mixed with linen, cotton, or other textile fibres. Generally, the paper used is different from ordinary paper: it is much more resilient, resists wear and tear, and also does not contain the usual agents that make ordinary paper glow slightly under ultraviolet light.
In 1988, Australia produced the first polymer banknote, made from biaxially-oriented polypropylene (plastic), and in 1996 became the first country to have a full set of circulating polymer banknotes. Since then, other countries to adopt polymer banknotes include New Zealand, Romania, Brazil and Mexico, with many others issuing commemorative polymer notes. Polymer banknotes were developed to improve durability and prevent counterfeiting through incorporated security features, such as optically variable devices that are extremely difficult to reproduce.
In 1988, Austria produced the 5000 Schilling banknote (Mozart), which is the first foil application (Kinegram®) to a paper bank note in the history of bank note printing. The application of optical features is now in common use throughout the world.
Paper money collecting as a hobby
Banknote collecting is a rapidly growing area of numismatics. Although generally not as widespread as coin and stamp collecting, the hobby is expanding. Prior to the 1990s, currency collecting was a relatively small adjunct to coin collecting, but the practice of currency auctions, combined with larger public awareness of paper money have caused a boom in interest and values of rare banknotes.
In the 1950s, Robert Friedberg published the landmark book Paper Money of the United States. Friedberg devised an organizing number system of all types of U.S. banknotes; the system is widely accepted among collectors and dealers to this day, and the volume has been regularly updated.
For years, the mode of collecting banknotes was through a handful of mail order dealers who issued price lists and catalogs. In the early 1990s, it became more common for rare notes to be sold at various coin and currency shows via auction. The illustrated catalogs and "event nature" of the auction practice seemed to fuel a sharp rise in overall awareness of paper money in the numismatic community. Entire advanced collections are often sold at one time, and to this day single auctions can generate well in excess of $1 million dollars in gross sales. However, as of 2005, rare banknotes still sell for much less than comparable rare coins. There is wide consensus in the paper money collecting arena that this disparity is diminishing as paper money prices continue to rise at a rapid rate.
There are many different organisations and societies around the world for the hobby including the International Banknote Society (IBNS).
See also
External links