Convertibility - Commodity Money

Commodity Money

Convertibility first became an issue of significance during the time banknotes began to replace commodity money in the money supply. Under the gold and silver standards, 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 Dollars- 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.