Convertibility is the quality that allows money or other financial instruments to be converted into otherliquidstores of value. Convertibility is an important factor ininternational trade, where instruments valued in differentcurrencies must be exchanged.[1]
Freely convertible currencies have immediate value on the different international markets, and few restrictions on the manner and amount that can be traded for another currency. Free convertibility is a major feature of ahard currency.[citation needed]
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 theNorth Korean won, theTransnistrian ruble, and theCuban national peso, are officially nonconvertible and can only be exchanged on theblack market. If an official exchange rate is set, its value on theblack market is often lower.[2]
Convertibility controls may be introduced as part of an overallmonetary policy. For example, restrictions on theArgentine peso were introduced duringan economic crisis in the 1990s and scrapped in 2002 during a subsequent crisis.[3]
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Convertibility first became an issue of significance during the timebanknotes began to replacecommodity money in themoney supply. Under thegold andsilver standards, notes were redeemable forcoin 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 thegold exchange standard, for example theBretton Woods Institutions, banks of issue were obliged to redeem their currencies ingold bullion, or in United States dollars, which in turn were redeemable in gold bullion at an official rate of $35 pertroy 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 contemporaryinternational currency regimes, currencies are issued on thefiat of the issuer (a government or central bank), and carry no guarantee of convertibility to a tangible asset.
