When issued by the Government or by authorized banks whose solvency is unquestioned, it is accepted as freely as coin, and if not so accepted, cannot be considered good money. We shall consider only the case where it is generally accepted.
Being usually a promise to pay coin, on demand, it can, in one sense, be considered honest only when the promise is kept. If the issues are excessive,—that is, if by increasing the volume of the money as a whole its value is lowered so that the coin is worth more in some other country than as a part of that money system,—the coin will leave the country, as has been explained in regard to gold. The paper simply acts as so much gold or silver would act if added to the currency, forcing out a certain amount of coin. Where both metals are used with the paper, the one to go would depend on which was worth the most, relatively, in other countries. If the issues of paper are continued long enough, all the coin will leave the country, and, if still continued, the value of the money will sink below that of the coin, as the paper will not leave the country, but will accumulate, lowering the value with each new issue. The system will then have changed to an inconvertible paper system, the value of the money being no longer dependent on the value of the coin on which it is based, and no longer affected by changes of money value in other countries, but determined wholly by the amount issued, relative to the demands of business in the country of issue.
If the issues continue in excess of demand, the value will lower, even to the point of utter worthlessness; but if properly controlled and limited, the value of the money can be maintained at any point desired far more readily and easily than in the case of a convertible paper and coin system, since many variable forces are excluded when the convertibility is dropped.
The amount of paper money that can be kept at par with coin under a convertible system bears no fixed relation to the amount of the coin. By a proper control of the volume of paper issues their value can be kept equal to coin value, with almost no coin in circulation, or in reserve. An excessive issue of the paper will cause coin to be exported, but this export may be checked, and an import produced by withdrawing some of the paper.
Some control, therefore, may be exercised over the value of money under a convertible system, to make such value constant, but this is evidently limited. If the value of the money is falling, the decline can be checked, and its value made to rise, by withdrawing some of the paper issues; but this will cause an importation of coin, partly offsetting the reduction and checking such rise, and when all the paper has been withdrawn, the power of control by this method ceases. If the money value is rising, an increase of paper issues will stop such rise, but it will cause the exportation of coin; and when all the coin has been exported, the money will cease to be convertible, and the system will have changed to an inconvertible one,—the money still possessing the same qualifications as a measure of value that it possessed in the former case. The only difference is, that in the convertible system the money value is partly determined by the natural causes affecting the supply of coin, partly by the laws and conditions of business in foreign countries, and partly by the legislation at home, restricting the coinage or the issue of paper; while in the inconvertible system it is determined wholly by the control of the issues relative to the demand for money.
This difference may constitute either a merit or a defect, according as the control is intelligent and honest or otherwise.
The disastrous consequences that have resulted at various times from the use of inconvertible paper money, have, in every case, been due to a lack of proper control and to excessive issues, caused generally by the want of a reliable gauge by which to determine the amount that should be issued, and by a misunderstanding of the principles involved.
While paper money, though a promise to pay coin, cannot, in one sense, be called honest, unless the promise is kept; in a larger sense the test of its honesty is its invariability of value.
John Stuart Mill says of inconvertible paper money:—
"In the case supposed, the functions of money are performed by a thing which derives its power of performing them solely from convention; but convention is quite sufficient to confer the power; since nothing more is needful to make a person accept anything as money, and even at any arbitrary value, than the persuasion that it will be taken from them on the same terms by others. The only question is, what determines the value of such a currency; since it cannot be, as in the case of gold and silver (or paper exchangeable for them at pleasure), the cost of production. We have seen, however, that even in the case of metallic currency, the immediate agency in determining its value is its quantity. If the quantity, instead of depending on the ordinary mercantile motives of profit and loss, could be arbitrarily fixed by authority, the value would depend on the fiat of that authority, not on the cost of production.