The currency principle is advocated by the ‘currency school’ comprising Robert Torrens, Lord Overstone, G.W. Norman and William Ward. Currency principle is based on the assumption that a sound system of note issue should command the greatest public confidence.
This requires that the note issue should be backed by 100 per cent gold or silver reserves. Or in other words, paper currency should be fully convertible into gold or silver.
Thus, according to the currency principle, the supply of paper currency is subjected to the availability of metallic reserves and varies directly with the variations in the metallic reserves.
The currency principle has the following advantages;
(i) Since, according to this principle, the paper currency is fully convertible into gold and silver, it inspires maximum confidence of the public.
(ii) There is no danger of note issue of the paper currency leading to the inflationary pressures.
(iii) It makes the paper currency system automatic and leaves nothing to the will of the monetary authority.
The currency principle has the following drawbacks:
(i) The currency principle makes the monetary system inelastic because it does not allow the monetary authority to expand the money supply according to the needs of the country.
(ii) It requires full backing of gold reserves for note issue. Thus, it makes the monetary system expensive and uneconomical.
(iii) This principle is not practical for all countries because gold and silver are unevenly distributed among countries.