Thursday, March 3, 2016

Difference Between Bank Notes and Government Notes

Difference Between Bank Notes and Government Notes
Thomas Allen

    Today, governments notes serve as money. They are issued either directly by governments or, more often, indirectly through their central banks. Notes issued by central banks are often called bank notes, but they are functionally the same as government notes. However, some significant and important differences exist between bank notes under the gold standard and government notes.
    As long as bank notes represent newly manufactured consumer goods (goods expected to be sold in less than 91 days to the final consumer), they are wholly beneficial in their effect. They replace a corresponding amount of gold in the form of coin and reduce the cost of distribution. On the other hand, government notes are wholly maleficent in their effect; they are an unmitigated evil. The worst effect of government notes is that they impoverish the masses by transferring their wealth to the wealthy few resulting in economic stagnation.
    When properly issued, bank notes always evidence capital that provides the means for their retirement. They represent the gold value of merchandise that will be sold in less than 91 days — thus, providing the means for their retirement. They are instruments of distribution and facilitate trade. A person exchanging the bill of exchange for bank notes pays the bank a discount on the bill. Bank notes maintain a direct relationship between money and production and consumption. (Production produces the money needed for consumption of the products produced under the real bills doctrine.) The holder of bank notes can convert them to gold on demand. Thus, bank notes circulate at par with coin. At least two parties, the maker and endorser of the bill discounted, guarantee the notes issued to buy the bill. Bank notes are not legal tender and can circulate without being legal tender. They respond to and serve the needs of the commerce. When their work is done, they are removed from circulation. When the bill representing the merchandise that a bank has converted to bank notes is paid, the payment extinguishes the bank notes. “Their use largely increases the amount of coin in a country, from the powerful influence they exert in enlarging its production and trade, the coin, and paper representing merchandise of equal value, circulating side by side in proportions to suit the public convenience.”[1] Although the quantity of bank notes can fluctuate greatly, their issue and retirement do not lead to price inflation or deflation because they represent new goods being sold in the market. As long as bank notes are issued only for real bills, bank notes can never be over issued. They will not cause prices to rise because they disappear as the merchandise that they represent is sold. They will always remain at par with gold.
    Government notes function entirely differently than bank notes. As government notes do not represent anything being offered for sell, they lose value and raise prices. When used to buy goods, they continue to exist and can be used multiple times to buy consumable goods. They are completely independent of commerce. They do not evidence capital. To the contrary, their purpose is to transfer capital to the issuing government. The government is always a borrower of money and wealth and never a lender. Government notes are not automatically retired; they are retired at the prerogative, whim, and discretion of the issuing government. The government does not issue its notes to discount bills, and they do not represent anything that is immediately available for sale for specie. No interest or discount is connected to the issue of government notes.  Because the government cannot pay its notes in specie on demand, its notes are never made payable on demand. (If it could pay on demand; it would not have to issue notes.) Not representing capital, they become instruments of excess consumption that leads to price inflation. Government notes destroy the relationship between money and production and consumption. Once issued, government notes never disappear until the government decides to retire them. If they were not legal tender, they would have difficulty circulating.
As they are always the last resort of exhaustion and incompetency, they are always made legal tender in the discharge of contracts equally with coin as a necessary condition of getting them into circulation. Otherwise no one would receive them as money. Such provision may for a time give them a high value, but can never raise them to the value of coin, for the reason that they can serve only one function of coin — the payment of debts. . . . They lose a considerable portion of their value so soon as the debts existing at the time of their issue are discharged, as no one will contract to receive them at a future day as the equivalent of coin. Their value, consequently, comes to depend upon the time that, in public opinion, is to elapse before they are paid.[2]
Government notes promise to pay with no provision for payment. They are debt payable at the pleasure of the issuing government. Such payment is almost never made.
    Economics drives the issue of bank notes and determine the quantity in circulation. Politics drives the issue of government notes and determines the quantity in circulation. Government notes are low quality currency. As long as the real bills doctrine is followed and the gold standard is maintained, bank notes are high quality currency.

Endnotes

1.  Henry V. Poor, Resumption and the Silver Question: A Hand-Book for the Times (1878, Rpt. 1969), p. 11.

2. Ibid., p. 12.
Copyright © 2014 by Thomas Coley Allen.

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