Advantages of Banknotes
Originally, precious and semi-precious metals were formed
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.
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.
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.
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