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| Hand operated rolling mill, for putting the edge impression on to coins |
I've been reading about the medieval monetary system lately. What a fascinating and complex mechanism, and a good reminder that we should not be using the word medieval as a synonym for primitive or unenlightened. Medieval coinage, I've come to discover, is also a highly confusing subject. A quote that John Munro attributes to Karl Helleiner seems apropos: "There are two fundamental causes of madness amongst students: sexual frustration and the study of coinage."
Studying odd, imaginary, or historical monetary systems is rewarding not only because of the aha! moment that understanding provides, but also because of what these systems reveal about our modern one. Readers may have noticed that for the last two months I've been posting rather obsessively on monetary policy, a topic I've typically avoided. Here's my attempt to combine monetary policy and medieval coinage into one post, hopefully as a useful way to consolidate all my points in an interesting way.
In medieval days, mints were generally owned by a prince. A mint-master was put in charge of coining silver bullion into coin (gold and copper were also coined, but for simplicity I'll focus on silver). The prince set the official rate at which the mint-master could convert raw silver into a specific coin. For instance, one pound-weight of silver might be coined into 240 silver pennies, each with 1/240th a pound-weight of silver in them. Under the principle of free coinage, anyone could bring raw bullion, plate, jewelry, and foreign coin to the mint to be converted into coin of the realm.
Coins were far more convenient in trade than raw silver because they saved transactors from the laborious process of weighing and assaying silver powder or ingots. Because of this superior marketability, coins usually traded at a premium to an equivalent amount of raw silver. A coin with 1 gram of silver therein, for instance, might exchange in the market at a price of 1.1 grams of pure silver bullion. Munro refers to this premium as the agio.
The existence of an agio represented a potential arbitrage opportunity for the public. A merchant need only buy raw silver, bring it to the mint to be coined, and leave with the same weight of silver, but now in coin form and capable of purchasing, say, 10% more goods. He could then buy more bullion with this new coins, repeating the process and earning a 10% risk-free return each time.
While coinage was free, it was not gratuitous. The mint-master required a certain amount of silver as payment for the use of his time, minting tools, and wages for his employees. Since silver was usually mixed with base metals like copper to produce the final coin, the mint-master also required compensation for supplying the baser metals. This fee was called brassage. The prince exacted a fee too, or a tax. This was called seigniorage.
These costs restricted the opportunities for arbitrage. If the brassage and seigniorage costs were higher than the agio, the public would avoid the mint altogether since the transaction would result in a loss in purchasing power. Better to keep their silver in bullion form or search for a mint that produced identical coin at less cost.
However, as long as the agio was more than brassage and seigniorage, citizens would continue to bring bullion to the mint and enjoy a small return.
This process had a natural limit. Much like the water-diamond paradox (which tells us that the usefulness of something does not necessarily equate to a higher price) the fact that coins were more useful than raw bullion in transactions didn't mean that people would always pay to enjoy that benefit. As the public flocked to the mint, a coin glut would develop. The marginal value that the market placed on coin-as-transactions-medium would deteriorate, driving the agio down to the twin costs of brassage and seigniorage. Put differently, an increase in coin supply would push the marginal value of coin towards the cost of production. Just as water is extremely useful but essentially free, the marketability value of coins -- though still useful -- could be had at no cost once the quantity of coin was sufficiently plentiful.
Let's bring this back to monetary policy. The initial agio of coin over silver is very much akin to the liquidity premium I've mentioned in previous posts. The existence of an agio, or liquidity premium, is justified by the convenience, moneyness, or non-pecuniary return on a medium-of-exchange. As the supply of coin is allowed to increase, all other things staying the same the market's marginal valuation of this non-pecuniary return will fall, as will the associated agio/liquidity premium.
A modern central bank keeps the supply of reserves artificially tight and restricts competition. In doing so, it creates a positive marginal non-pecuniary return on reserves (or a convenience yield, see here). This drives the market value of reserves above the price at which they would otherwise trade were they subject to competition. In other words, a central bank creates a permanent agio.
In order to execute monetary policy, central banks will typically massage this agio. By emitting a small amount of reserves or sucking them in, a central banker can alter the marginal valuation that the market places on the convenience of reserves. This pushes the agio higher or lower. Any change in the agio translates into an economy-wide change in the price level.
Bringing this back to a medieval setting, imagine that the prince ceases free coinage (much like how a modern central banker would restrict reserve supply and competition). From time to time the public might be allowed access to the mint, and in limited numbers, but usually the mint would be closed to business. The supply of coin, therefore, is henceforth restricted. The ensuing lack of transactions media will cause a large agio to emerge as the market value of coin rises relative to bullion. I'm assuming here that counterfeiting is too dangerous to justify. If not, counterfeiters will be motivated to establish black market mints once the agio significantly exceeds brassage.
The prince is now in the same position as a modern central banker. By bringing a bit of silver bullion to the mint, turning it into coin, and spending it, he can increase the quantity of coin in the economy and thereby decrease the marginal non-pecuniary return on coin. The agio would thereby shrink, pushing the market value of coin down, or the price level up. After all, the economy's unit of account in the medieval period was determined by a given link coin, usually the penny, so any change in the penny's value resulted in an economy-wide change in prices.
Both the prince and a central banker face a limit to the effectiveness of expansionary monetary policy. Once a prince has issued enough coin to drive the agio down to zero via mass "coin quantitative easing", further coin emissions will have no effect on the price level. A coin will now be worth no more than its intrinsic silver value. Nor can it fall to a discount to its silver content, since the public would simply buy coin and melt it into bullion until the discount has been removed. As for a modern central banker, once QE has reduced the convenience yield provided by reserves across the entire curve to zero, then further reserve emission cannot push the price level down any further. The agio has disappeared. In the same way that coin falls to its silver content, reserves will have fallen to their intrinsic "backing" value -- and will go no lower.
The prince still has an alternative. He can engage in outright debasement. By reducing the intrinsic silver content in coin, the price level will once again start to rise. Likewise, a central banker might attack the intrinsic value of central bank liabilities by destroying assets, or purchasing assets at bloated prices, or engaging in helicopter drops. Princes did in fact tend to reduce the price level via debasement and not by manipulating the agio, although they usually did so as a way to earn higher revenue, not to help the economy. No doubt due to the irresponsibility of the prince's who preceded them, modern central bankers are legally prohibited from outright debasement. Manipulating the agio on reserves, or playing with the interest rate on reserves, are the only tools left to them.
Most of the actual facts about medieval coinage in this post come from John Munro's Warfare, Liquidity Crises, and Coinage Debasements in Burgundian Flanders, 1384 - 1482 (RePEc) and The Coinages and Monetary Policies of Henry VIII (RePEc), among other papers. Munro shouldn't be blamed for mistakes in my theorizing, nor the analogy to modern central bank QE.
"By emitting a small amount of reserves or sucking them in, a central banker can alter the marginal valuation that the market places on the convenience of reserves. This pushes the agio higher or lower. Any change in the agio translates into an economy-wide change in the price level"
ReplyDeleteYou seem to be saying that savers immediately turn into spenders, and spenders immediately turn into savers, whenever the base interest rate goes up or down. I'm not sure why you believe that this is always the case.
"The prince is now in the same position as a modern central banker. By bringing a bit of silver bullion to the mint, turning it into coin, and spending it, he can increase the quantity of coin in the economy"
The prince is not like a central banker in this example. He is like a fiscal authority that prints its own money to finance its spending. This is quite different.
"Both the prince and a central banker face a limit to the effectiveness of expansionary monetary policy"
You mean expansionary fiscal policy (in the former case).
"You seem to be saying that savers immediately turn into spenders, and spenders immediately turn into savers, whenever the base interest rate goes up or down. I'm not sure why you believe that this is always the case."
DeleteEvery one who holds, or saves reserves, immediately turns into a spender upon the central bank taking expansionary action. There is no buyer, or saver, who steps forward, so the price level must rise until buyers are tempted back into the market.
"The prince is not like a central banker in this example."
The prince is like a central banker because he's in a privileged position to manipulate the agio on the economy's medium of account -- in the prince's case the silver penny, in the banker's case reserves. I'm not sure about the relevance of fiscal policy.
When I read about monetary history I am struck by how often people complained about money shortages, and the resulting recessions. The best explanation I can think of is that as coins wear down, and the economy grows, a shortage of coins develops. The light coins circulate while the heavy coins are hoarded. The mint might try to relieve the money shortage by minting more coins, but the new, heavy coins are hoarded. Thus the mint fails to perform its service of providing more coins when needed. A good solution is for the mint to devalue the coins and make the new coins just as light as the old, circulating coins. Now the new coins will circulate and the mint can relieve the coin shortage.
ReplyDeleteIn this case it's not that the prince is being irresponsible or trying to profit at the public's expense. He's just acting to relieve the money shortage.
"In this case it's not that the prince is being irresponsible or trying to profit at the public's expense. He's just acting to relieve the money shortage."
DeleteWhen I was writing the post, the same thing came to my mind. I think that it's a really neat observation since I'd been conditioned (by mises.com) to think that medieval debasement was always bad. Which, as you point out, isn't necessarily the case. The prince is playing catch-up to debasement initiated by the private sector.
You might like the Munro papers at bottom. He draws the opposite conclusion -- that debasements were often initiated for princely gain.
I think debasement often had unintentionally beneficial consequences. As the medieval economy grew, there was a greater need for MOE. Also, the threat of debasement caused sellers to raise prices, reversing the long deflationary trend, and induced holders of money to spend it quickly, leading to a faster transition from payment in kind to a monetized economy.
DeleteStill, I hope readers will take a look at George Selgin's research in Good Money which shows how private mints in England actually produced coinage which was far superior compared to that of the Royal Mint at the dawn of the Industrial Revolution:
http://www.youtube.com/watch?v=-gn55fTRXZw
Yep, Selgin's is an excellent book.
Delete"Debasement," in the sense of declining precious metal content, would be part of the natural evolution of private, competitive coinage. The trick, as shown by Selgin's research, is to issue base metal coins which derive their value from being claims on precious metal. Thus the Parys Mine Druids, which had a face value twice that of their copper content, were accepted by merchants because 252 pennies could be redeemed for a gold guinea.
DeleteLarry White described minting operations with the following accounting identity:
M = PQ + C + S
M: nominal face value of a batch of coins
P: nominal price paid per ounce of precious metal
Q: ounces of precious metal
C: operating costs (brassage)
S: seigniorage (or for private mints, profit)
Private mints would profit from "debasement" by steadily reducing Q to produce a given M (which would then be used to pay workers or obtain more precious metal). Eventually, C would be minimized by substituting paper for base metal.
Monarchs might have been consciously addressing exchange media shortages through debasement (that seems to be the conclusion of Angela Redish here: http://www.minneapolisfed.org/research/sr/sr460.pdf ). But this was at best a clumsy way of solving a problem that they had created in the first place via prohibitions on transactions in, and private possession of, bullion (Munro, 3) and competitors in the market for coinage ("counterfeiters").
"Private mints would profit from "debasement" by steadily reducing Q to produce a given M (which would then be used to pay workers or obtain more precious metal)."
DeleteMy understanding of coinage is that the mints were like pipelines. Much like a pipeline doesn't own the oil or gas that passes through, it just charges a tariff, the mint didn't own its own gold or silver, it simply set a tariff on the bullion that people brought to it to be coined. It therefore didn't need to "obtain" more precious metals. The main way for a mint-master to increase profits was by increasing the brassage rate or raising throughput, much like how a pipeline will try to drive through tariff hikes or increase gas flow through its network in order to increase profits. Debasement increased profits because it caused a temporary rise in throughput, not because the mint's own stock of bullion (it didn't have any) could suddenly be turned into more coin.
[Preface: I realize your original post was intended mainly as a parable, not an exhaustive historical account. However, like you, I also find medieval money fascinating in its own right, and I like thinking about these topics. I don't mean to come off as a pedant or nitpicker.]
DeleteI should have been more clear. I was referring to truly competitive private mints (of the type described by Selgin), not private moneyers working to produce the feudal lord's monopoly coinage. Assuming they hit upon the idea (and I think the profit motive would have guided them), truly private coin issuers would use their redeemable token money (essentially metal banknotes) to pay workers and cover operating costs, including obtaining more base metal (to make more coins) and more precious metal (such as guineas to fractionally-back those coins) to repeat the process. They would be similar to banks, except their liabilities would be coins only, not deposits (had private coinage been allowed to continue, I'm sure the Soho Mint and the Parys Mine Company would eventually have gotten into deposit banking, too).
I think it's important to think about such hypotheticals. As Selgin recently said, it's important to think about free banking to have a baseline with which to compare other monetary arrangements. I think it's similarly beneficial to think about "free coinage" as a starting point for analyzing medieval coinage.
Another point (sorry, this post provided a lot of food for thought!)--I think it's somewhat problematic to equate the historical agio described by Munro with the superior marketability of coined metal over bullion (let's call it the "coinage premium") that would arise in a free coinage environment. Under free coinage, merchants would likely begin trading with pieces of assayed metal, marked to avoid confusion. Over time, the marks and size of metal would become standardized into coins, which would trade at a premium over raw metal. Possessors of raw metal (such as miners), noting this, would be willing to pay for the service of coinage as long as the cost was less than the coinage premium.
DeleteHowever, as Munro notes, nearly all feudal lords prohibited transactions in bullion, as well as the possession of raw metal (with a few exceptions). This means that the coinage premium for transactions, at least within the realm, was unobservable. Thus I'm having a hard time pinning down exactly how Munro's agio (basically the value of the rulers stamp of approval over unmarked metal) relates to the agio of your post (especially since the public continued to accept debased money by tale, making it hard to draw out a relationship between precious metal content and coin valuation). Furthermore, since feudal lords required all precious metal to be surrendered to the mint (and, as Larry White notes, often formally prohibited sales of bullion to foreign mints), the feudal mints were both monopsonists in the bullion market and monopolists in coin production. These were further distortions away from the free market coinage premium.
On pages 3, Munro claims that even if transactions in bullion had been allowed, the costs of weighing and assaying would have made such transactions "economically unfeasible." Thus, legal tender laws were a necessary cost-saving mechanism. I'm not so sure. I read somewhere (maybe in your Spufford link) that gold dust and silver bars were sometimes used for transactions in the Mediterranean. And if weighing was such a hassle, why did nearly every principality explicitly ban it? John Chown notes that until 1321, weighing coins was common in Venice, but subsequently acceptance at face value was obligatory for coins that were no more than 10 percent underweight. And Larry White, quoting another source, adds that the prohibition on weighing coins and forced acceptance at tale was nearly universal prior to the 16th century.
I suppose I'm splitting hairs, but I sense kind of an implicit "money as a natural monopoly" argument in this section by Munro (in an otherwise fantastic paper). Having been exposed to free banking ideas, I can't help but find it a bit irksome.
Anyway, I look forward to your future coinage posts. The links you've provided have been a treasure trove.
Wow, you've definitely done a lot of reading. (At least as much as me by now?).
DeleteI see what you mean now. Yes, if we're talking about token coins, then a private mint would probably want to reduce its reserve of "backing" metal by spending it away, but not so low that it wouldn't be able to meet request to redeem tokens. As you say, very much like a bank, except metal tokens, not paper chits.
"Thus I'm having a hard time pinning down exactly how Munro's agio (basically the value of the rulers stamp of approval over unmarked metal) relates to the agio of your post (especially since the public continued to accept debased money by tale, making it hard to draw out a relationship between precious metal content and coin valuation)."
Despite limitations on bullion holdings and exchanges, foreign merchants and bankers would have been familiar with the actual metallic content of another realm's coins, nor would they pass foreign coin by tale, but by weight. Jewelers would probably have had the right to hold raw bullion. Somewhere a market price for a coin in terms of bullion would have emerged.
As for weighing coins, I'm sure part of the reason citizens chose to accept by tale and not weight had to do with laws. But part of it was surely convenience -- weighing each half-penny received at peak market time would be costly. Also, weighing a coin is not sufficient to determine its true metallic content of a coin since purity might be the determining factor.
Thanks for the nice compliment, but my reading level is still at yellow-belt level. I'll keep at it, though.
DeleteI have a few more thoughts on this agio/free market bullion stuff, but I'm a bit busy, so I'll comment later. It's related to weed though, so perhaps you might find it amusing.
Once a prince has issued enough coin to drive the agio down to zero via mass "coin quantitative easing"
ReplyDeleteI don't see how this is monetary policy or QE. Since we are still assuming no debasement yet, this seems like a fiscal transfer--a decrease in the prince's net worth (his stock of silver) and an increase in the net worth of whoever gets the coins.
further coin emissions will have no effect on the price level.
If the total number of silver coins has increased (even if the value of each coin has been driven down to its intrinsic metal value), why wouldn't the overall price level go up?
"turning it into coin, and spending it"
DeleteOk, I see this is related to your "buying up everything" post, so I'll read it again.
"If the total number of silver coins has increased (even if the value of each coin has been driven down to its intrinsic metal value), why wouldn't the overall price level go up?"
DeleteThe price level would go up until the agio disappeared. Any further rise and coin would be worth less than its silver equivalent. Arbitrageurs could buy the coin and melt it into bullion, driving coin prices back up. Their actions set an upward limit to the price level.
" this seems like a fiscal transfer--a decrease in the prince's net worth (his stock of silver) and an increase in the net worth of whoever gets the coins."
I don't think you have to think about it this way. The Prince could be taking his newly minted coins and buying quality financial assets with them, in which case his wealth stays constant. However, the agio will still be driven down.
A coin will now be worth no more than its intrinsic silver value.
DeleteAren't you overlooking one point? In this scenario, the intrinsic value of silver will decrease.
I'm assuming the prince has an effective widow's cruse/vault of silver (perhaps his ancestors were expert raiders of nearby kingdoms). Since I'm still unclear on how increased asset prices translate into higher goods and labor prices, let's say that the prince is getting ready for war and begins to purchase war goods like swords, boots, and armor. As blacksmiths and shoemakers receive payment in coins, their real cash balances will increase. They will start to spend excess balances, which will push up prices, hot potato fashion, throughout the economy.
As the stock of silver coins increases, the purchasing power of silver coins will decline, the agio will shrink, and actors in the economy will start to melt coins and substitute silver (on the margin) for other materials for non-monetary usage (more silver cups, plates, and jewelry). If the prince keeps pumping new coins into the economy through spending, the agio will be restored by the fall in bullion prices, not by the increase in the purchasing power of coins.
Eventually, the stock of non-monetary silver will exceed the demand for its use, and the stock of monetary silver will increase. Actors will pile up excess balances and spend them, increasing prices. If the prince continues to force people to transact only in silver, ever larger amounts of coin will be lugged around to make payments (or perhaps the prince will coin large discs, like Swedish copper).
Am I missing something?
I suppose you're assuming a fixed stock of silver in the economy, so I see how your example works.
DeleteOne question: is there really a difference if the prince buys financial assets or the real output of the economy, as long as it's at market prices? In other words, is there an essential difference between fiscal spending and asset purchases?
"Am I missing something?"
DeleteNo, what you said makes sense. As you said, I'm assuming a fixed stock of silver, your story involves a widow's cruse of silver.
I don't think there is a huge difference between buying financial assets or real output --- as long the real output is invested wisely in infrastructure and such.
Over the next few weeks I'll have another couple of posts on coinage. It's a fascinating subject.
By bringing a bit of silver bullion to the mint, turning it into coin, and spending it
DeleteThis part (and the phrase "massive coin QE") confused me. I was wondering where the prince got the bullion.
Re: buying stuff--I'm still thinking about your "toying with the transmission" post, and I can't help but feel nagging disagreement. Buying bitcoin and buying treasuries might be the "same" in terms of eventually raising the price level, but this seems a bit like saying jumping off a cliff with a hang glider and without are the same in that both will get you to the ground. The endpoint isn't the only relevant point of comparison.
Taken literally, if the Fed did announce that it would stop buying Treasuries & MBS's and exclusively start buying bitcoin, the price of BTC would explode, and there would be other unanticipated effects on the housing and bond markets.
(Btw, it may be time for another BTC post. Baidu, recent run-up to $200, and egifter now selling Walmart giftcards for BTC. This next year will be a big one, I think.)
"As for a modern central banker, once QE has reduced the convenience yield provided by reserves across the entire curve to zero, then further reserve emission cannot push the price level down any further. "
ReplyDeleteThis only can occur if the return on every alternative asset is zero - i.e., the interest rate on every asset is 0% - correct?
If the central bank has reduced the convenience yield provided by reserves across the entire curve to zero, this means by definition that any alternative asset with the same default risk as reserves will yield 0%.* However, riskier assets will still carry a positive yield. On the margin, while investors are now indifferent between the liquidity of reserves and riskier assets, they still need to be compensated for higher default risk.
Delete*This assumes a no interest on reserves policy.