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
International trade is the exchange of capital, goods, and services across international borders or territories because there is a need or want of goods or services. (see: World economy)
In most countries, such trade represents a significant ...
, where instruments valued in different
currencies
A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins.
A more general def ...
must be exchanged.
Currency trading
Freely convertible currencies have immediate value on the
foreign exchange market, 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
In macroeconomics, hard currency, safe-haven currency, or strong currency is any globally traded currency that serves as a reliable and stable store of value. Factors contributing to a currency's ''hard'' status might include the stability and ...
.
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
The Korean People's won, sometimes known as the North Korean won (Symbol: ₩; Code: KPW; Korean: ) or Democratic People's Republic of Korea won ( Korean: ), is the official currency of North Korea. It is subdivided into 100 ''chon''. The cur ...
, the
Transnistrian ruble
The rubla ( ro, рублэ, rublă, , plural ruble; russian: рубль) is the currency of Transnistria and is divided into 100 ''kopecks''. It is also known as the rouble in Commonwealth English or ruble in American English. Since Transnistria ...
, and the
Cuban national peso, are officially nonconvertible and can only be exchanged 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 is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often a ...
. For example, restrictions on the
Argentine peso
The peso (established as the ''peso convertible'') is the currency of Argentina, identified by the symbol $ preceding the amount in the same way as many countries using peso or dollar currencies. It is subdivided into 100 ''centavos''. Its ISO 4 ...
were introduced during
an economic crisis in the 1990s and scrapped in 2002 during a subsequent crisis.
Commodity money
Convertibility first became an issue of significance during the time
banknote
A banknote—also called a bill (North American English), paper money, or simply a note—is a type of negotiable promissory note, made by a bank or other licensed authority, payable to the bearer on demand.
Banknotes were originally issued ...
s began to replace
commodity money
Commodity money is money whose value comes from a commodity of which it is made. Commodity money consists of objects having value or use in themselves (intrinsic value) as well as their value in buying goods.
This is in contrast to representat ...
in the
money supply
In macroeconomics, the money supply (or money stock) refers to the total volume of currency held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circul ...
. Under the
gold
Gold is a chemical element with the symbol Au (from la, aurum) and atomic number 79. This makes it one of the higher atomic number elements that occur naturally. It is a bright, slightly orange-yellow, dense, soft, malleable, and ductile me ...
and
silver standard
The silver standard is a monetary system in which the standard economic unit of account is a fixed weight of silver. Silver was far more widespread than gold as the monetary standard worldwide, from the Sumerians 3000 BC until 1873. Following ...
s, notes were redeemable for
coin
A coin is a small, flat (usually depending on the country or value), round piece of metal or plastic used primarily as a medium of exchange or legal tender. They are standardized in weight, and produced in large quantities at a mint in order t ...
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 principle that the banknote was merely a substitute for the real commodity money (gold and silver) was gradually abandoned.
Under the
gold exchange standard, for example the
Bretton Woods Institutions
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the United States, Canada, Western European countries, Australia, and Japan after the 1944 Bretton Woods Agreement. The Bretto ...
, 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 per
troy ounce
Troy weight is a system of units of mass that originated in 15th-century England, and is primarily used in the precious metals industry. The troy weight units are the grain, the pennyweight (24 grains), the troy ounce (20 pennyweights), and th ...
. 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, currencies are issued on the
fiat of the issuer (a government or central bank), and carry no guarantee of convertibility to a tangible asset.
See also
*
Convertible security A convertible security is a financial instrument whose holder has the right to convert it into another security of the same issuer. Most convertible securities are convertible bonds or preferred stocks that pay regular interest and can be converted ...
*
Virtual currency
Virtual currency, or virtual money, is a digital currency that is largely unregulated and issued and usually controlled by its developers and used and accepted electronically among the members of a specific virtual community. In 2014, the Europ ...
References
{{Authority control
Foreign exchange market
Metallism