Convertibility
Encyclopedia
Convertibility is the quality that allows money
or other financial instruments to be converted into other liquid
stores of value
. Convertibility is an important factor in international trade
, where instruments valued in different currencies
must be exchanged.
, and few restrictions on the manner and amount that can be traded for another currency. Free convertibility is a major feature of a hard currency
.
Some countries pass laws restricting the legal exchange rates of their currencies, or requiring permits to exchange more than a certain amount. Some currencies, such as the North Korean won
and the Cuban national peso
, are officially nonconvertible and can only be exchanged from on the black market. If an official exchange rate is set, its value on the black market is often lower.
Convertibility controls may be introduced as part of an overall monetary policy
. For example, restrictions on the Argentine peso
were introduced during an economic crisis in the 1990s
, and scrapped in 2002 during a subsequent crisis.
s began to replace commodity money
in the money supply
. Under the gold
and silver standard
s, notes were redeemable for coin
at face value, though often failing banks and governments would overextend their reserves.
Historically, the banknote has followed a common or very similar pattern in the western nations. Originally decentralized and issued from various independent banks, it was gradually brought under state control and became a monopoly privilege of the central banks. In the process, the fact that the banknote was merely a substitute for the real commodity money (gold and silver) was gradually lost sight of.
Under the gold exchange standard
, for example the Bretton Woods Institutions, banks of issue were obliged to redeem their currencies in gold bullion, or in United States Dollar
s- which in turn were redeemable in gold bullion at an official rate of $35/troy ounce
. Due to limited growth in the supply of gold reserves, during a time of great inflation of the dollar supply, the United States
eventually abandoned the gold exchange standard and thus bullion convertibility in 1974.
Under the contemporary international currency regimes
, all currencies' inherent value derives from fiat
, thus there is no longer any thing (gold or other tangible store of value
) for which paper notes can be redeemed.
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
or other financial instruments to be converted into other liquid
Market liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
stores of value
Store of value
A recognized form of exchange can be a form of money or currency, a commodity like gold, or financial capital. To act as a store of value, these forms must be able to be saved and retrieved at a later time, and be predictably useful when retrieved....
. Convertibility is an important factor in international trade
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...
, where instruments valued in different currencies
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
must be exchanged.
Currency trading
Freely convertible currencies have immediate value on the foreign exchange marketForeign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...
, and few restrictions on the manner and amount that can be traded for another currency. Free convertibility is a major feature of a hard currency
Hard currency
Hard currency , in economics, refers to a globally traded currency that is expected to serve as a reliable and stable store of value...
.
Some countries pass laws restricting the legal exchange rates of their currencies, or requiring permits to exchange more than a certain amount. Some currencies, such as the North Korean won
North Korean won
The won is the currency of North Korea . It is subdivided into 100 chon. The won is issued by the Central Bank of the Democratic People's Republic of Korea...
and the Cuban national peso
Cuban peso
The peso is one of two official currencies in use in Cuba, the other being the convertible peso...
, are officially nonconvertible and can only be exchanged from on the black market. If an official exchange rate is set, its value on the black market is often lower.
Convertibility controls may be introduced as part of an overall monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
. For example, restrictions on the Argentine peso
Argentine peso
The peso is the currency of Argentina, identified by the symbol $ preceding the amount in the same way as many countries using dollar currencies. It is subdivided into 100 centavos. Its ISO 4217 code is ARS...
were introduced during an economic crisis in the 1990s
1990s
File:1990s decade montage.png|From left, clockwise: The Hubble Space Telescope floats in space after it was taken up in 1990; American F-16s and F-15s fly over burning oil fields and the USA Lexie in Operation Desert Storm, also known as the 1991 Gulf War; The signing of the Oslo Accords on...
, and scrapped in 2002 during a subsequent crisis.
Commodity money
Convertibility first became an issue of significance during the time banknoteBanknote
A banknote is a kind of negotiable instrument, a promissory note made by a bank payable to the bearer on demand, used as money, and in many jurisdictions is legal tender. In addition to coins, banknotes make up the cash or bearer forms of all modern fiat money...
s began to replace commodity money
Commodity money
Commodity money is money whose value comes from a commodity out of which it is made. It is objects that have value in themselves as well as for use as money....
in the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
. Under the gold
Gold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
and silver standard
Silver standard
The silver standard is a monetary system in which the standard economic unit of account is a fixed weight of silver. The silver specie standard was widespread from the fall of the Byzantine Empire until the 19th century...
s, notes were redeemable for coin
Coin
A coin is a piece of hard material that is standardized in weight, is produced in large quantities in order to facilitate trade, and primarily can be used as a legal tender token for commerce in the designated country, region, or territory....
at face value, though often failing banks and governments would overextend their reserves.
Historically, the banknote has followed a common or very similar pattern in the western nations. Originally decentralized and issued from various independent banks, it was gradually brought under state control and became a monopoly privilege of the central banks. In the process, the fact that the banknote was merely a substitute for the real commodity money (gold and silver) was gradually lost sight of.
Under the gold exchange standard
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
, for example the Bretton Woods Institutions, banks of issue were obliged to redeem their currencies in gold bullion, or in United States Dollar
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
s- which in turn were redeemable in gold bullion at an official rate of $35/troy ounce
Troy ounce
The troy ounce is a unit of imperial measure. In the present day it is most commonly used to gauge the weight of precious metals. One troy ounce is nowadays defined as exactly 0.0311034768 kg = 31.1034768 g. There are approximately 32.1507466 troy oz in 1 kg...
. Due to limited growth in the supply of gold reserves, during a time of great inflation of the dollar supply, the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
eventually abandoned the gold exchange standard and thus bullion convertibility in 1974.
Under the contemporary international currency regimes
Exchange rate regime
The exchange-rate regime is the way a country manages its currency in relation to other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many of the same factors....
, all currencies' inherent value derives from fiat
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...
, thus there is no longer any thing (gold or other tangible store of value
Store of value
A recognized form of exchange can be a form of money or currency, a commodity like gold, or financial capital. To act as a store of value, these forms must be able to be saved and retrieved at a later time, and be predictably useful when retrieved....
) for which paper notes can be redeemed.