Forms of Money

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Convertible paper money

Paper money which carries a promise by the issuer that the paper can be converted into the standard money metal at some future date.
The state or the central bank which issues convertible paper currency does not keep 100% of metallic reserve.
Some part of the total supply of convertible paper money is fully backed by the standard metal money is known as Covered issue.

(a) The individuals can get their paper money converted into cash,
(b) The paper money is backed by gold and silver reserves. But, on the assumption that all the currency notes are not simultaneously presented by the public for encashment, the value of metallic reserves is less than the value of the notes issued,
(c) The reserves comprise of (i) metallic portion containing gold, silver and standard coins, (ii) fiduciary portion containing approved securities

It is that money which is not redeemable or convertible into gold or silver on demand.
It is accepted because it has been declared legal tender by the issuing authority and has general acceptance as a medium of exchange.
The intrinsic value of fiat money is nil.

Fiat money in the words of Keynes is that which is created and issued by the state but is not convertible by law into any thing other than itself and has no fixed value in terms of an objective standard.

(a) It has significantly less intrinsic value than its face value,
(b) It is not convertible into any valuable asset,
(c) It is accepted in transactions at face value because it is unlimited legal tender.

a) The danger of over-issue of fiat money (or inflation) is always present in a system of fiat money,
(b) It lacks public confidence as it is not backed by metallic reserves,
(c) Foreign exchange rates are liable to wide fluctuations under fiat money system because fiat money is not linked with other country's money through gold.

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