What Is a Banknote?
A banknote is a negotiable promissory note which one party can use to pay another party a specific amount of money. A banknote is payable to the bearer on demand, and the amount payable is apparent on the face of the note. Banknotes are considered legal tender; along with coins, they make up the bearer forms of all modern money.
A banknote is known as a "bill" or a "note."
Key Takeaways
- A banknote is a "bill" or form of currency that one party can use to pay another party.
- In the U.S., only the Federal Reserve Bank is allowed to print banknotes for money.
- While banknotes used to be backed by precious metals such as gold and silver, in 1971, the United States government went off the gold standard, making American banknotes a fiat currency that is backed instead by good faith.
How Banknotes Work
Before modern societies and financial systems were set up, people used valuable objects, such as gold and silver, to pay for goods and services through bartering. Eventually, paper money and coins replaced these physical assets as representative currency. When this happened, precious metals backed the new currencies to give it credibility.
At present,only the government backs banknotes. Although in earlier times commercial banks could issue banknotes, the Federal Reserve is now the only bank in the United States thatcan create banknotes and mint money. Worldwide, billions of financial transactions use banknotes every day.
Historically, U.S. citizens could exchange U.S. government-issued paper money for gold or silver. This bimetallic standard system consisted of paper currency in a fixed ratio with gold and/or silver. However, in 1964, the U.S. government gradually began to halt the bimetallic standard; in 1971, the U.S. went off the gold standard altogether. The decision created a pure fiat currency, which the government supported only with its good faith in its ability to pay off any debts.
Fiat money derives its value from the relationship between supply and demand,not the value of the currency’s physical material. Since fiat money is not linked to physical reserves, it risks becoming worthless, due to hyperinflation. For example, if in a distant future U.S. citizens lose faith in the U.S. dollar bill, this paper currency will no longer hold value. Luckily, the likelihood of the U.S. dollar collapsing is very low.
Many use the terms banknotes, currency notes, and bills interchangeably. While both are promissory notes, many use currency notes more frequently for common dealings.
While it is common in some cultures to keep one's savings in the form of banknotes, this poses inflationary risk because cash loses buying power over time. If you have a large amount of cash on hand, a savings account or certificate of deposit can help you earn a small amount of interest.
Polymer Banknotes and the Bank of England
In 2013 the Bank of England considered introducing polymer banknotes. These plastic-like banknotes, which Canada and many other nations also use, are easier to clean and harder to counterfeit than paper notes.
The pros of introducing polymer banknotes also include their enhanced security features, reduced replacement costs (as polymer lasts two and a half times longer than paper), waterproofing, dirt-resistance, and overall lower negative environmental impacts.
Cons to introducing polymer banknotes into Britain’s monetary system included a higher upfront manufacturing cost, counting difficulties –given that the material is slipperierthan paper —challenges in folding the new material, and questionable compatibility with existing vending machines and auto-payment systems.
What Is the Difference Between a Banknote and Regular Money?
Today, there is little difference between the term "banknote" and other types of currency. Historically, the term "bank note" originated from the historical period when banks could issue their own paper currency, backed by the value of their gold and silver deposits. Today, the right to print notes is usually reserved to a country's central bank, although there are some countries that delegate that authority to commercial banks.
How Do You Tell if a Banknote Is Real?
Most central banks implement a combination of anti-counterfeiting measures in printed notes, such as raised type, watermarks, and threaded paper. These will vary depending on the currency and the date of issue. For U.S. currency, the Secret Service provides a helpful list of existing security measures.
How Can I Replace a Damaged Banknote?
If you have mutilated U.S. currency, you can freely redeem your notes by sending them to the Bureau of Engraving and Printing.
The Bottom Line
Banknotes are paper bills that are used as currency. The first banknotes were promissory notes, backed by the gold and silver in the bank's vaults. Today, banknotes are the main manifestation of physical currency, although they may eventually be replaced by digital payment systems.
