Separating the functions of money—the case of Medieval coinage

Florentine florin

Last year Scott Sumner introduced the econ blogosphere to what he likes to call the medium-of-account function of money, or MOA, defined as the sign in which an economy's sticker prices and debts are expressed. Here and here are recent posts of his on the subject.

I think Scott's posts on this subject have added a lot of depth to the interblog monetary debates. However, I've never been a big fan of Scott's terminology. As I've pointed out before, what Scott calls MOA, most modern economists would call the unit-of-account function of money. Older economists like Jevons and Keynes[1] referred to the unit-of-account as the money-of-account, and modern economic historians also prefer money-of-account. Terminological differences aside, in today's post I want to focus on what I'll call from here on in the unit-of-account function of money.

Scott's UOA posts often emphasize the idea of separating the unit-of-account function from the medium-of-exchange. This isn't a new approach. Back in the 1980s, a trend in monetary economics began whereby economists began to dissociate the various bundled functions of money into constituent components. In fact, a few contributors to the modern econ blogosphere were participants in what was then called "New Monetary Economics", or NME, including Tyler Cowen, Bill Woolsey (pdf), Scott, and Lawrence White (pdf). White, it should be noted, was a critic. Cowen doesn't blog much about NME these days, his last post on the subject was in 2011, but I'm sure every time he goes to a restaurant he can't help but wonder what the world might be like if the menu prices were in different units than the media he expected to pay with. Here is an old Cowen paper (with Krozner) on NME that is worth reading, as well as the bibliography which serves as a good jumping off point to understand more about NME.

But let's turn to an actual example. The separation of the medium-of-exchange from the unit-of-account envisioned by NME isn't mere speculation. Indeed, such a separation has been very much the norm over the last thousand years or so. The medieval monetary system operated with what was essentially a number of heterogeneous media of exchange and an independent unit of account.

Medieval Europe was politically fragmented and many different mints issued coins. Einaudi (pdf) tells us that some 22 gold coins and 29 silver coins (most of them foreign) circulated in the Duchy of Milan alone in the 18th century. This does not include the many varieties of copper coins that would also have been current. Weber (pdf) describes Basel in the 1400s, which had a heterogeneous coinage acquired through trade that included florin and ducats from Italy, and German rhinegulden, along with the local silver penny.

Because most of these coins had different metallic content, and the market value of coins was determined to a large extent by the quantity of metal therein, would this not have caused a terrific amount of confusion? Silver and gold traded at a constantly fluctuating ratios, contributing to the calculational morass. How could shopkeepers and shoppers keep track of the prices at which transactions were to be consummated with such an incredible variety of ever changing units?

The answer is that prices were expressed in terms of a universal unit of account. The name for this unit was the pound, or in French, the livre. The pound (and livre) were further divisible into 20 shillings (sous) and each shilling into 12 pence (deniers). A pound was therefore divisible into 240 pence. Prices and debts were recorded not in terms of individual circulating coins, but in terms of this pound unit of account. Indeed, pound coins never actually existed in Medieval Europe, the pound being a purely abstract accounting unit.

According to Einaudi, local mint officials maintained a list of coin ratings whereby each coin in local circulation was rated at a certain amount of £/s/d. Officials determined the rating by assaying the quantity of gold or silver in each coin. Thus a shopkeeper need only list the price for, say, a horse in terms of the universal unit of account, say 1 pound 6 shillings. A buyer need only look at the 1£ 6s sticker price, determine what sorts of coins he had in his pocket, refer to their public ratings, and compute the proper number of coins to hand over as payment.

Over time, the precious metals content of coins would deteriorate as people 'sweated' coins, filed them, clipped them, or bathed them in aquafortis [2]. The price ratio of gold to silver would often change subject to the whims of market demand as well as mine supply. Sometimes a sovereign might call in an existing issue of coins and reissue them with more or less precious metals therein. When the metallic content of a given coin was changed, or when the market silver-to-gold ratio fluctuated, local mint officials would quickly account for this change by re-rating the altered coin in terms of the £/s/d unit of account.

The advantage to shopkeepers with this system is that they needn't update their sticker prices. After all, via constant re-ratings, the prices of coins were made to fluctuate around the unit of account. For example, if the Spanish doubloon was re-rated due to a debasement in its gold content, our horse-seller could keep his 1 pound 6 shilling price constant, and need simply ask for more doubloons [3]. In this way, the chaos of the medieval coinage system was rendered orderly by a universal £/s/d unit of account.

There is one important issue I haven't dealt with. What defined the medieval pound unit of account? Anyone who's read my old post will know that this question boils down to this—what was the medieval medium of account? The unit of account is always defined in terms of something else, a medium of account, and it is this MOA (which is different from Sumner's MOA) that anchors the price level.

Although city states never minted pounds (and only rarely shillings), they did mint their own pennies. Weber (pdf)(RePEc) and Spufford hypothesize that these pennies served as a foundation, or "link" coin. The penny unit of account was set equal to the penny coin, either spontaneously or via enactment, and thereafter any alteration in the silver quantity of the penny link coin modified the unit of account.

To illustrate, if the sovereign reduced the amount of silver in the local penny, the penny's linkage to the unit of account meant that the penny-as-unit of account now contained a smaller quantity of silver. The pound unit of account (a multiple of 240 pennies) by definition now also contained less silver. So a debasement of the link penny coin meant that all £/s/d sticker prices would need to be raised by shopkeepers if they desired to preserve real purchasing power [4]. In modern days, we call this inflation. Nor was princely debasement of the link coin the sole cause of medieval unit-of-account inflation. After many years of passing from hand to hand, link coin's naturally wore out, and therefore a steady inflation in prices resulted.

A debasement in a foreign penny circulating locally, however, would have no effect on the local unit of account, insofar as the foreign penny didn't serve as the link coin. Rather, a debasement of a foreign penny would result in that particular coin being re-rated in terms of the unit of account. £/s/d sticker prices would stay constant.

In some cases, however, foreign pennies were the link coin, so changes to the silver content of the local penny would have no effect on the price level. Inflation or deflation were imposed exogenously. Even more interesting, in a few rare cases the precious metal content of a famous coin of a previous era that no longer existed was used as the link coin. Monetary historians such as Munro call these "ghost monies". The advantage of having a ghost link coin rather than a current coin is that the unit-of-account could now stay constant over time, preserving the real value of debts and contracts.

To sum up, the medieval unit of account, as we already know, was £/s/d. We also know that there was no single medium of exchange, but a chaotic mix of coin media of exchange. The MOA was a single "index" coin, usually the locally-coined penny, but at other times a foreign coin or an antiquated "ghost coin". While link coins would come and go over the centuries, the £/s/d unit of account stayed constant.

At what point in history did the unit of account and medium of exchange finally fuse together? Weber (pdf) hypothesizes that the Industrial Revolution brought with it improvements in the quality of coin production. Milled edges prevented filing and clipping. The introduction of steam driven coining reduced minting costs and made it more feasible to replace worn coins. These technological improvements meant that it was now possible for coins to serve as stable units of account. The best evidence that Weber finds for this is the appearance of "value marks", or numbers, on the faces of coins. Medieval coins did not carry numbers on them, only the faces and names of the various personages responsible for their issue. The blank nature of these coins allowed the market to determine their exchange rates in terms of the unit of account. The appearance of value marks in the 19th century indicated that the coinage was now of a high enough quality that a separate unit of account was rendered unnecessary. It was now possible to inscribe the unit of account directly on the coin's face.

As a result of these developments, the modern day individual is incapable of imagining a split between the unit-of-account and the media-of-exchange. But this complex institution is something that our ancestors dealt with on a daily basis. Understanding the medieval monetary system is a great way for us to throw off the cobwebs and understand the difference between media-of-exchange and unit-of-account. After all, who knows what future monetary systems might have in store for us — perhaps another divergence between the two functions? It also crystallizes how important the unit-of-account function is. Whoever controls the unit-of-account controls prices, and therefore monetary policy.

---

[1] The first line of Keynes's Treatise on Money is: "Money-of-account, namely that in which Debts and Prices and General Purchasing Power are expressed, is the primary concept of a Theory of Money.
[2] Sweating coins involved putting many coins in a sack, shaking the sack, and removing the fine metal grains that shaking had dislodged from the coins. Aquafortis is nitric acid, or HNO3.
[3] The doubloons re-rating due to lower metallic content was called a "crying down" the value of the coin. If the doubloon had been reminted to contain more gold,  its value would have been "cried up". [Editor's Note: this is wrong|
[4] When the link coin's metallic content was debased, this was referred to in the medieval literature as an 'augmentation' or 'enhancement' of prices. When link coin's metallic content was rebased (increased), this was referred to as 'diminution', or 'abatement'. 

Update: By coincidence, Nick Rowe has simultaneously posted on the separation of the functions of money.