Demand Notes

Demand Notes, famously nicknamed “Greenbacks”, were the very first paper money issued by the United States government. Rolled out in 1861 to finance the colossal costs of the American Civil War, these notes were revolutionary. Unlike the gold and silver coins of the era, their value was not derived from precious metal but from the faith and credit of the U.S. Treasury. This made them a pioneering form of fiat money in America and earned them their iconic nickname from the green ink used on the back to deter counterfeiters. In today's financial world, a demand note is a type of debt instrument where the lender can request, or “demand,” full repayment from the borrower at any time. There is no fixed maturity date; the loan is due whenever the lender says so. This provides incredible flexibility for the lender but creates significant uncertainty for the borrower.

Imagine you're President Abraham Lincoln. The Civil War is raging, and the Union is running out of money to pay its soldiers and buy supplies. Gold and silver are scarce. The government's solution, championed by Treasury Secretary Salmon P. Chase, was radical: print paper money. These Demand Notes were initially authorized to be paid “on demand” in coin at certain Treasury facilities. However, as the war drained the government's metallic reserves, this promise became difficult to keep. The government soon suspended coin payments, and subsequent versions of the Greenbacks were issued as pure fiat currency, legal tender by law but not redeemable for gold. This was a bold, controversial move that fundamentally changed the American financial system and enabled the Union to fund its path to victory. The public was skeptical at first, but the Greenbacks eventually became an accepted part of economic life.

While the original Greenbacks are now valuable collector's items, the concept of a loan payable on demand is very much alive. Modern demand notes are essentially a form of promissory note with a special, powerful feature for the lender.

Today's demand notes are not typically investments you'll find on the New York Stock Exchange. They are more common in private lending arrangements, between businesses, or within families. Their main features are:

• Payable on Demand: This is the defining trait. The lender can call the loan at any time, for any reason, and the borrower must repay the principal and any accrued interest immediately.
• High Liquidity (for the lender): For the person or entity that extended the loan, a demand note is almost like cash. They can convert the loan back into money whenever they need to.
• High Risk (for the borrower): A business using a demand note for funding operates under the constant threat that its financing could disappear overnight. This makes it a precarious way to fund long-term projects.
• Variable Interest Rates: The interest rate on a demand note is often variable, tied to a benchmark like the prime rate, though it can also be fixed. The rates are typically lower than those for a term loan with a fixed maturity, as the borrower isn't getting the security of a long-term commitment.

From a value investing perspective, participating in a demand note—either as lender or borrower—is an exercise in risk assessment. For the average investor, demand notes are an uncommon and generally unsuitable investment. If you are ever in a position to lend money via a demand note (for example, to a small business or an individual), your focus must be entirely on the borrower's credit risk. Ask yourself: “If I demand this money back tomorrow, does this person or business have the cash to pay me?” You must compare the interest offered with what you could get from far safer, highly liquid alternatives. Is the extra 2% you might earn worth the risk that the borrower defaults? For most investors, the answer is a clear no. Instruments like Treasury Bills or a high-quality money market fund offer excellent liquidity with minimal risk, making them superior places to park short-term cash. The bottom line: Demand Notes are a fascinating piece of financial history that played a crucial role in shaping the United States. In modern practice, they are a specialized tool for lenders who prioritize absolute liquidity above all else. For the ordinary value investor, they are a curiosity to understand, not an asset to pursue.