Banknote - Advantages and Disadvantages

Advantages and Disadvantages

Prior to the introduction of banknotes, precious or semi-precious metals minted into to coins to certify their substance were widely used as a medium of exchange. The value that people attributed to coins was originally based upon the value of the metal, but over time, coins developed a value in their own right which might have differed substantially from the metal from which they were made. Banknotes were originally a claim for the coins or precious metals held by the bank, but due to the ease with which they could be transferred and the confidence that people had in the capacity of the bank to settle the notes in coins if presented, they gradually became a means of exchange in their own right. They now make up a very small proportion of the "money" that people think that they have as demand deposit bank accounts and electronic payments have negated the need to carry notes and coins.

Banknotes have a natural advantage over coins in that they are lighter to carry but are also less durable. Banknotes issued by commercial banks had counterparty risk, meaning that the bank may not be able to make payment when the note was presented. Notes issued by central banks had a theoretical risk when they were backed by gold and silver. Both banknotes and coins are subject to inflation. The durability of coins means that even if metal coins melt in a fire or are submerged under the sea for hundreds of years they still have some value when they are recovered. Gold coins salvaged from shipwrecks retain almost all of their original appearance, but silver coins slowly corrode.

Other costs of using bearer money include:

1. Discounting. Before national currencies and efficient clearing houses, banknotes were only redeemable at face value at the issuing bank. Even a branch bank could discount notes of other branches of the same bank. The discounts usually increased with distance from the issuing bank. The discount also depended on the perceived safety of the bank. When banks failed the notes were usually partly redeemed out of reserves, but sometimes became worthless. The problem of discounting within a country does not exist with national currencies; however, under floating exchange rates currencies are valued relative to one another in the foreign exchange market.
2. Counterfeiting paper notes has always been a problem, especially since the introduction of color photocopiers and computer image scanners. Numerous banks and nations have incorporated many types of countermeasures in order to keep the money secure; however, extremely sophisticated counterfeit notes known as superdollars have been detected in recent years.
3. 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 higher cost of issue, especially in larger denominations, compared with coins of the same value.
4. Wear costs. Banknotes 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.
5. 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.
6. 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.

The different 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.