A
banknote (often known as a
bill,
paper money or simply a
note) is a kind of
negotiable instrument, a
promissory note made by a
bank payable to the bearer on demand, used as
money, and in many jurisdictions is
legal tender. Along with
coins, banknotes make up the cash or bearer forms of
all modern
money. With the exception of
non-circulating high-value or precious metal commemorative issues,
coins are used for lower valued monetary units, while banknotes are
used for higher values. However some coins may have a significant
value depending on the condition and worth.
Advantages
Originally, precious and semi-precious metals were made into coins
and were used to negotiate and settle trades. Banknotes offer an
alternative bearer form of money, but the advantages and
disadvantages between the two forms of bearer money are complex and
so in different circumstances the overall advantage can lie with
either form.
The costs of using bearer money include:
- Manufacturing or issue costs. Coins are produced by industrial
manufacturing methods that process the precious or semi-precious
metals, and require additions of alloy for hardness and wear
resistance. By contrast bank notes are printed paper (or polymer),
and typically have a lower cost of issue, especially in larger
denominations, compared to coin of the same value.
- Wear costs. Coins wear and lose mass over their economic life,
and eventually are scrapped. Banknotes do not lose economic value
by wear, since, even if they are in poor condition, they are still
a legally valid claim on the issuing bank. However, banks of issue
do have to pay the cost of replacing banknotes in poor condition
and paper notes wear out much faster than coins.
- Opportunity cost of capital. Coins have economic value and are
a form of non-financial capital, however they do not pay interest.
Banknotes have economic value but are a form of financial capital,
a loan to the issuing bank. The issuing bank invests its assets
primarily in interest bearing loans and securities, but also needs
to hold metallic reserves. Thus banknotes indirectly earn interest
through the investments made by the issuing bank, but coins do not
pay interest to anyone. This foregone interest is the most
important economic advantage of banknotes over coins.
- Cost of transport. Coins can be expensive to transport for high
value transactions, but banknotes can be issued in large
denominations that are lighter than the equivalent value in
coins.
- Cost of acceptance. Coins can be checked for authenticity by
weighing and other forms of examination and testing. These costs
can be significant, but good quality coin design and manufacturing
can help reduce these costs. Banknotes also have an acceptance
cost, the costs of checking the banknote's security features and
confirming acceptability of the issuing bank.
- Security. Counterfeiting paper
notes is easier than forging coins, especially true given the
proliferation of color photocopiers and
computer image scanners. Numerous
banks and nations have incorporated many types of countermeasures
in order to keep the money secure.
The different advantages and disadvantages between coins and
banknotes imply that there may be an ongoing role for both forms of
bearer money, each being used where its advantages outweigh its
disadvantages.
Convertibility
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 on 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 physically
inconvertible is necessarily unbacked. Most of the confusion
centers around the failure to distinguish between two types of
convertibility:
- Physical convertibility, where a unit of currency can be
exchanged at the issuing bank for a given physical amount of
something, and
- Financial convertibility, where a unit of currency can be
exchanged at the issuing bank for a unit'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 main
shopping season has ended. If the paper currency is physically
convertible (for one ounce of silver, let us suppose), people will
return the unwanted paper currency 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 currency. For example, if the community has 100 units of
unwanted paper money, and if people intend to redeem the unwanted
100 units for silver at the bank, the bank could simply sell 100
units worth of bonds or other assets in exchange for 100 units of
its own paper currency. This will soak up the unwanted paper and
head off people's desire to redeem the 100 units 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 paper currency
at one ounce of silver without ever redeeming any paper currency
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 argument against fiat paper currency is a practical one, with
the best example being the US dollar, which has lost 95% of its
value since 1913. This should be compared with the period of the
Gold Standard, which began in the UK in 1717 and lasted until 1931,
when there was essentially no inflation over the period. The
entitlement to redeem banknotes in gold (which the bank cannot
print) means that if a bank prints more paper money than it has
gold in its vaults it runs the risk of a run on the bank, when the
only mechanism available to stop the run is to raise interest rates
without limit until the note holders stop redeeming their
paper.
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.
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 in precious metal on
presentation (see
representative
money). With the gradual removal of precious metals from the
monetary system, banknotes evolved to represent
credit money, or (if backed by the credit of a
government) also
fiat money.
Notes or bills were often referred to in 18th century novels and
were often a key part of the plot such as a "note drawn by Lord X
for £100 which becomes due in 3 months time"
Song Dynasty
Jiaozi, the
world's earliest paper money
First banknotes in the world
The use of paper money as a circulating medium is intimately
related to shortages of metal for coins. In
ancient China coins were circular with a
rectangular hole in the middle. Several coins could be strung
together on a rope. Merchants in China, if they became rich enough,
found that their strings of coins were too heavy to carry around
easily. To solve this problem, coins were often left with a
trustworthy person, and the merchant was given a slip of paper
recording how much money he had with that person. If he showed the
paper to that person he could regain his money. Eventually, the
paper money called "
jiaozi"
originated from these
promissory
notes.
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 jiaozi nevertheless did not replace
coins during the Song Dynasty; paper money was used alongside the
coins.
The
successive Yuan
Dynasty
was the first dynasty in China to use paper
currency as the predominant circulating medium. The founder
of the Yuan Dynasty,
Kublai Khan, issued
paper money known as
Chao in his
reign. The original notes during the Yuan Dynasty were restricted
in area and duration as in the Song Dynasty, but in the later
course of the dynasty, facing massive shortages of specie to fund
their ruling in 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 the Indian sub-continent a similar system evolved called the
hundi system. The history of these instruments has not been widely
studied but it is quite likely that these were in common use
hundreds of years ago, being designed to assist in Indian trade,
which was extensively practiced across the world in the past. A
Hundi is basically an unconditional order in writing made by a
person directing another to pay a certain sum of money to a person
named in the order. Hundis, similar to paper notes, were issued by
indigenous bankers and used in trade and credit transactions and to
transfer funds from one place to another, a kind of travellers
cheque. They were also used as credit instruments for borrowing and
as bills of exchange for trade transactions.
Banknotes in Europe
In
Europe the first paper money consisted of
paper 'coins' issued in Protestant Leyden (today, Leiden
) in the
Netherlands
during the Spanish siege
of 1574. Over 5000 of the estimated 14,000 residents of
Leyden died, mostly due to starvation. Even leather (often used to
create emergency currency) was boiled and used to feed the people.
So to create currency, the residents took covers and paper from
hymnals and church missals and created paper planchets, which were
struck using the same dies that were previously used to mint
coins.
The first
proper European 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.
Until Louis XIV, banknotes were issued by small creditors, had
limited circulation, and were not backed by the authority of the
state. Economist
John Law
helped establish banknotes as formal currency, backed by capital
consisting of French government bills and government accepted
notes.
Banknotes in the United States
In the early 1690s, the
Massachusetts Bay Colony was the
first of the
Thirteen Colonies to
issue permanently circulating banknotes. The use of fixed
denominations and printed banknotes came into use in the
18th century.
In the early
1700s each of the thirteen
colonies issued their own banknotes, called
colonial scrip. Later, the
Continental Congress issued
continental currency to support the
Revolutionary War. The
federal government of
the United States did not print banknotes until 1862.
However,
almost immediately after adoption of the United States Constitution in
1789, the United States
Congress chartered the First Bank of
the United States
and authorized it to issue banknotes.
The bank
served as quasi-central bank of the
United
States
. The bank closed in 1811 when Congress
failed to renew its charter.
In 1816, Congress chartered the Second Bank of
the United States
. When its charter expired in 1836, the bank
continued to operate under a charter granted by the Commonwealth of
Pennsylvania until 1841.
In the United States, public acceptance of banknotes in replacement
of precious metals was hastened in part by
Executive Order 6102 in 1933. 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 banknotes.
Issue of banknotes
Generally, a
central bank or treasury
is solely responsible within a state or
currency union for the issue of banknotes.
However, this is not always the case, and historically the paper
currency of countries was often handled entirely by private banks.
Thus, many different banks or institutions may have issued
banknotes in a given country. In the United States, commercial
banks were authorized to issue banknotes from 1863 to 1935. In the
last of these series, the issuing bank would stamp its name and
promise to pay, along with the signatures of its president and
cashier on a preprinted note. By this time, the notes were
standardized in appearance and not too different from the Federal
Reserve Notes that circulated for most of the 20th century.
In a small number of countries, private banknote issue continues to
this day.
For example, by virtue of the complex
constitutional setup in the United Kingdom
, certain commercial banks in two of the union's
four constituent countries
(Scotland
and Northern Ireland
) continue to print their own banknotes for domestic
circulation, even though they are not fiat
money or declared in law as legal
tender anywhere. The UK's central bank, the Bank of
England
, prints notes which are legal tender in England and Wales; these notes are also
usable as money (but not legal tender) in the rest of the UK (see
Banknotes of the pound
sterling).
In
Hong
Kong
, three commercial banks are licenced to issue
Hong Kong dollar
notes. As well as commercial issuers, other
organizations may have note-issuing powers; for example, until 2002
the
Singapore dollar was issued by
the
Board
of Commissioners of Currency Singapore, a government agency
which was later taken over by the
Monetary Authority of
Singapore.
Materials used for banknotes
Paper banknotes
Most banknotes are made of dense 80 to 90 grams per square meter
starch paper (see also
paper), sometimes mixed with
linen, abaca, 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.
Early Chinese banknotes were printed on paper made of
mulberry bark and this fibre is used in Japanese
banknote paper today.
Unlike most printing and writing paper, banknote paper is infused
with polyvinyl alcohol or gelatin to give it extra strength.
Most banknotes are made using the mould made process in which a
watermark and thread is incorporated during the paper forming
process.
The thread is a simple looking security component found in most
banknotes. It is however often rather complex in construction
comprising fluorescent, magnetic, metallic and micro print
elements. By combining it with watermarking technology the thread
can be made to surface periodically on one side only. This is known
as windowed thread and further increases the counterfeit resistance
of the banknote paper. This process was invented by Portals, part
of the
De La Rue group in the UK.
Other related methods include watermarking to reduce the number of
corner folds by strengthening this part of the note, coatings to
reduce the accumulation of dirt on the note, and plastic windows in
the paper that make it very hard to copy.
Durable banknote papers
Banknote paper with enhanced durability is a recent development,
designed to meet the growing need for popular low-denomination
banknotes to withstand extreme wear.
Improved protection against dirt: Manufacturers of
banknote paper were quick to recognize the problems associated with
dirt and developed a special paper with a thin layer of varnish on
the surface to repel soiling. This layer is applied directly to the
substrate. The thickness and structure of the paper remain
unchanged, thereby preserving the natural feel. The so-called
Durable Banknote Papers, which are available in
the global banknote market under brand names, such as
LongLife,
Platinum, Marathon Coated, Diamone, and
Flesure,
protect banknotes from soiling and environmental influences, making
it possible for them to remain in circulation for longer.
Increased mechanical stability: With new products,
such as
Synthec and
Diamone Composite, banknote
manufacturers have gone a step further and responded to the growing
demand for higher mechanical stability of the paper—because the
longer a banknote stays in circulation, the limper it becomes and
the more easily it tears.
Synthec substrate, for example,
consists of 80 percent cotton fiber and 20 percent synthetic fiber,
with the latter being longer and more flexible than the former. The
synthetic fibers constitute a dense network within the cotton fiber
structure, supporting the banknote like a kind of corset and
increasing its mechanical stability. This practically doubles the
useful life of the product.
Synthec is much less sensitive
to climate fluctuations than standard banknote paper. The synthetic
fibers are incorporated in the banknote substrate at the sheet
formation stage. This has the advantage that all established
security features—such as three dimensional watermarks, fluorescent
fibers, security threads, or the innovative new
varifeye
see-through window—can be integrated into the new
Synthec
substrate, just as they would be with the standard cotton
substrate. Optically variable effect inks and foil elements, such
as holograms, can be applied to this substrate in the same way as
with traditional banknote paper. Public confidence in the
established security features, built up over decades, remains
intact. To ensure that the banknotes are also protected against
dirt, they are given a standard coating of varnish. By the end of
2007,
Synthec banknotes will be circulating in three
countries, including an African country with different climate
zones that has chosen
Synthec as a substrate for its
lowest-denomination note. In the south of the country conditions
are tropical, with a rainy season that lasts for eight months,
while the north is very arid and extremely hot, with temperatures
reaching 41 degrees Celsius. Today, most bank notes are made from
cotton to prevent easy rips.
Counterfeiting and security measures on paper banknotes
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
and the
Individual
States of the Confederate States of America, the financing of
World War I 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.
In 1988,
Austria
produced the 5000 Schilling banknote (Mozart),
which is the first foil application (Kinegram) to a paper banknote in the history of
banknote printing. The application of optical features is
now in common use throughout the world.
Many countries' banknotes now have embedded
holograms.
Polymer banknotes
In 1983,
Costa
Rica
and Haiti
issued the
first Tyvek and the Isle of Man
issued the first Bradvek
polymer (or plastic) banknotes; these were printed by the American Banknote Company and
developed by DuPont. In 1988, after
significant research and development by the Commonwealth
Scientific and Industrial Research Organisation (CSIRO) and the
Reserve Bank
of Australia
, 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 of all
denominations. Since then, other countries to adopt
circulating polymer banknotes include Bangladesh
, Brazil
, Brunei
, Chile
, Indonesia
, Israel
, Malaysia
, Mexico
, Nepal
, New Zealand
, Papua and New
Guinea, Romania
, Singapore
, the Solomon Islands
, Sri
Lanka
, Thailand
, Viet
Nam
, Western
Samoa
and Zambia
, with other
countries issuing commemorative polymer notes, including China
, Kuwait
, the
Northern Bank of Northern
Ireland, Taiwan
and
Hong
Kong. Other countries indicating plans to issue
polymer banknotes include Nigeria
. In 2005, Bulgaria
issued the world's first hybrid paper-polymer
banknote.
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.
Apart from Australia, other countries such as Vietnam, Brunei, New
Zealand, Papua New Guinea and Romania have all their circulating
banknotes on polymer.
Other materials
Over the years, a number of materials other than paper have been
used to print banknotes. This includes various textiles, including
silk, and materials such as
leather.
Silk and other fibers have been commonly used in the manufacture of
various banknote papers, intended to provide both additional
durability and security.
Crane and Company
patented banknote paper with embedded silk threads
in 1844 and has supplied paper to the United
States Treasury
since 1879. Banknotes printed on pure silk
"paper" include "emergency money" (
Notgeld) issues from a
number of German towns in 1923 during a period of fiscal crisis and
hyperinflation.
Most notoriously,
Bielefeld
produced a number of silk, leather, velvet, linen
and wood issues, and although these issues were produced primarily
for collectors, rather than for circulation, they are in demand by
collectors. Banknotes printed on
cloth
include a number of Communist Revolutionary issues in China from
areas such as
Xinjiang, or Sinkiang, in the
United Islamic Republic of East
Turkestan
in 1933. Emergency money was also printed in 1902 on
khaki shirt fabric during the
Boer War.
Leather banknotes (or coins) were issued in a number of
sieges, as well as in other times of emergency.
During
the Russian administration of Alaska
, banknotes
were printed on sealskin. A number of 19th century issues are known
in Germanic and Baltic states, including the towns of Dorpat
, Pernau,
Reval, Werro and Woisek. In addition to the Bielefeld issues, other
German leather Notgeld from 1923 is known from Borna
,
Osterwieck, Paderborn and Pößneck.
Other
issues from 1923 were printed on wood, which was also used in
Canada
in
1763-1764 during Pontiac's
Rebellion, and by the Hudson's
Bay Company. In 1848, in
Bohemia,
wooden checkerboard pieces were used as money.
Even
playing cards were used for currency
in France in the early 19th Century, and in French Canada from 1685
until 1757, in the Isle of
Man in the beginning of the 19th Century, and again in
Germany after World War I.
Vending machines and banknotes
People are not the only economic actors who are required to accept
banknotes. In the late twentieth century machines were designed to
recognize banknotes of the smaller values long after they were
designed to recognize coins distinct from slugs. This capability
has become inescapable in economies where
inflation has not been followed by introduction of
progressively larger coin denominations (such as the United States,
where several attempts to introduce
dollar coins in general
circulation have largely failed). The existing infrastructure of
such machines presents one of the difficulties in changing the
design of these banknotes to make them less counterfeitable, that
is, by adding additional features so easily discernible by people
that they would immediately reject banknotes of inferior quality,
for every machine in the country would have to be updated.
Destruction
Banknotes have a limited lifetime, after which they are collected
for destruction, usually recycling or shredding. A banknote is
removed from the money supply by banks or other financial
institutions due to everyday
wear and
tear from its handling. Banknote bundles are passed through a
sorting machine that determines whether a particular note needs to
be shredded, or are removed from the supply chain by a human
inspector if they are deemed unfit for continued use – for example,
if they are mutilated or torn. Counterfeit banknotes are destroyed
unless they are needed for evidentiary or forensic purposes.
Contaminated banknotes are also decommissioned. A Canadian
government report indicates:
These are removed from circulation primarily to prevent the spread
of diseases.
When taken out of circulation, Australian bank notes are melted
down and mixed together to form plastic garbage bins.
Paper money collecting as a hobby
Banknote collecting, or
Notaphily, is a
rapidly growing area of
numismatics.
Although generally not as widespread as coin and
stamp collecting , the hobby is
increasingly 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
.
Catalogs
Collectors often use a
banknote
catalog to find information about their banknotes or banknotes
they may be interested in.
Trades
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 . Today,
eBay
has surpassed auctions in terms of highest volume of sales of
banknotes. 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.
There are many different organizations and societies around the
world for the hobby, including the International Bank Note Society
(IBNS).
See also
References
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