Monday, May 16, 2016

Aggressive vs defensive debasement

COINING IN PARIS c. 1500 (From a French print c. 1755)

Not all debasements, or reductions of the precious metals content of coins, are equal. Among scholars of medieval coinage, there is an interesting distinction between aggressive, or bad debasement, and defensive, or good debasement.

Let's take defensive debasements first.

In medieval times, the minting of coins was usually the prerogative of the monarch. Any member of the public could bring their silver bullion or plate to the mint where the monarch's agents would strike a fixed amount of coins from that silver, returning the appropriate number of coins to the owner but taking a small commission for their pains.

A decline in the quality of coin was a fairly natural feature of medieval societies. As silver pennies passed from hand to hand, oil and sweat would remove small flecks of metal.  Compounding this deterioration were less honest methods of removing small bits from each coin, like clipping. Nicholas Mayhew, a numismatist, estimated that each year 0.2% of the coinage's silver content was lost; more colourfully, 'seven tons of silver vanished into thin air' during every decade in the fourteenth century. Less conservative estimates go as high as 1% per year.*

Using Mayhew's 0.2% rate of decline, if the king or queen's mints manufactured pennies that contained 2 grams of silver in 1400, these 1400-vintage pennies might contain just 1.81 grams by 1450, fifty years later.

This created a huge problem. Long before 1450 people would have lost their incentive to bring raw silver to the mint to be made into new coins. Let's say a merchant in 1450 owed 10 pence to his supplier. One option was for the merchant to bring enough silver to the mint to get ten new pennies and then pay off his debt. With the king maintaining his fifty year-old policy of turning two grams of silver into a new penny, that meant the merchant had to bring 20 grams to be minted.

But the merchant had a better alternative; buy ten pennies of the 1400-vintage that together contained just 18.1 grams of silver (1.81 x 21) and then pay off the supplier. The key here is that all pennies, whether they be 1400-vintage or 1450-vintage pennies, passed at face value as legal tender. Thus the merchant's creditor had to accept any penny to settle the debt, bad or good. The merchant's decision was therefore a simple one. Far cheaper to pay off the debt with ten 1400-vintage pennies, the equivalent of 18.1 grams of silver, than ten new pennies, which contained 20 grams.

Because the king's mint was effectively providing too few new pennies for a given quantity of silver, no one would ever bring silver to the mint. (If you work it out, you'll see this is in instance of Gresham's law.) And with no new coins, coin shortages emerged. The legacy coinage had to circulate ever faster to meet society's demand for a medium of exchange, and this would have only increased its rate of depreciation. And a faster decline in the quality of the coinage made them more susceptible to counterfeiters, which only reduced their legitimacy. An inflationary spiral emerged.

The way to simultaneously halt inflation and encourage the creation of new pennies was to introduce a defensive debasement. If, in 1451, the royal family announced a debasement of the coinage so that its mint now struck pennies that contained, say, 1.75 grams of silver rather than 2.0 grams, then people would start bringing silver to the mint again. After all, our merchant could take ten worn-out 1400-vintage pennies that contained 1.81 grams to the mint, have them recoined into ten new pennies with 1.75 grams of silver, pay his debt, and still have some silver left over. The entire generation of old worn out coins would be brought to the mint to be replaced with a new generation of harder-to-counterfeit and clip pennies.

In sum, to ensure a steady supply of new coins the king or queen had to debase the coinage ever few decades. Meir Kohn calls this a ratification of the natural deterioration in the silver content of coins; "defensive debasements did not cause the gradual inflation that took place so much as ratify it." This was sound monetary policy.

Aggressive debasements, one the other hand, were unsound monetary policy.

You may have noticed that by debasing the penny from 2.0 to 1.75 grams, the monarch would be drawing large amounts of silver and old pennies into his or her mint to be turned into new pennies. After all, why would anyone pay debts with pennies that contain 1.81 grams when they can bring them to the mint to be recoined into pennies that contain just 1.75 grams? Another way to think about it is this: if a horse is selling for a pound (where a pound was defined as 240 pennies), why pay for it with 240 pennies minted in 1400 containing a total of 434 grams when they can be first reminted into 240 new pennies that contain just 420 grams, these new pennies being just as acceptable in trade as the old ones? In other words, better to buy a horse for 420 grams of silver than 434.

Debasements were profitable for the monarch. As I mentioned earlier, the royal family levied a fee on all silver brought to his mint. This fee is referred to as seigniorage. In more modern terms, think of a mint as a pipeline where the owner takes a cut on throughput. So by debasing the coinage, the monarch would dramatically increase mint throughput and therefore boost seigniorage revenues.

When a monarch debased the coinage at a much faster rate than the natural rate of wear and tear, he or she wasn't just playing catch up, this was aggressive debasement. One of the most aggressive debasements of all, that of Henry VIII, involved ten debasements between 1542 and 1551, each in the region of 30-40%. These diminutions were so successful in driving silver to the royal mints that Henry had to erect six new mints just to meet demand, according to Kohn.

The motive for aggressive debasements was almost always the funding of wars. As John Munro points out, securing "additional incomes from taxes, aides, loans, or grants from town assemblies, ‘estates’, or other legislative assemblies was difficult and usually involved unwelcome concessions, and this was not necessarily forthcoming." The mints, however, were firmly under the control of the royal family and were therefore a trustworthy form of revenue.

In Henry VIII's case, his debasement revenues were used to fund wars in the 1540s against Scotland and France. But his debasements were bad monetary policy as they caused rampant inflation, specifically a 123% rise in the English consumer price index from 1541 to 1556.


By the way, it was in response to these aggressive debasements that one of the earliest economic tracts, Nicolas Oresme's de Moneta, was written. Oresme's essay, which dates to 1360, was a response to the aggressive monetary policies of Philip VI and John II. According to Robert Mundell, John II debased the coinage 86 times. Wrote Oresme:
I am of opinion that the main and final cause why the prince pretends to the power of altering the coinage is the profit or gain which he can get from it; it would otherwise be vain to make so many and so great changes.
All monetary policy debates since then, including the explosion of words on the econ blogosphere beginning after the 2008 crisis, are versions of the one that Oresme engaged in: what constitutes good debasement and what constitutes bad? While the content of the debate has changed, the structure is pretty much the same.

* I get this from John Munro.
Note: I have an old post from 2013 on defensive debasement. This post is different because it works out the aggressive side of the debasement equation.


  1. Nice essay -- the tension between bottom-up specie and top-down coinage is a long-lived problem.

    The crux, of course, is simply the "legal tender" law. States have a monopoly on violence that they use to bully and extract resources from the monetary system. Weights and standards are all very well, but standards do not need to be state-sponsored -- private money could solve this coinage problem via multiple-gram standards, with rewards also possibly going to the "most stable" currency. State money is a tragedy of the commons.

    Note that the effect could run the other way. Your neighbor loves to import mulberries from china, loses specie abroad, imports your coinage, which then sells at a premium locally, so everybody melts down their silverware to sell to the mint.

    Your good-versus-bad is misleading, though. There is no good or bad depreciations -- when the state recognizes market reality, how is this supposedly commendably good?! It's largely a question of who got the "clipping vig" -- the state can clip the coins in one big bad depreciation (like FDR and gold), to fund a war, say.

    ...or the vig is lost by thousands of small dealers who accept a small reduction in profit margins in return for immediate cash liquidity, with albeit a clipped coin. Could be a fair trade, perhaps not.

    Also, why wouldn't / couldn't / didn't a private medieval bank solve this problem by storing unclipped coinage and issuing demand notes for circulation? (Too much cash in one place, I guess, which draws the state "attention", likely.)

    1. "The crux, of course, is simply the "legal tender" law."

      Anon, you probably won't like this but I've argued before that legal tender laws could very well be a feature of a free banking system.

      "Weights and standards are all very well, but standards do not need to be state-sponsored -- private money could solve this coinage problem via multiple-gram standards, with rewards also possibly going to the "most stable" currency. "

      Hayekian competing currencies?

      "Your good-versus-bad is misleading, though. There is no good or bad depreciations -- when the state recognizes market reality, how is this supposedly commendably good?!"

      It's better than not recognizing market reality. If the king doesn't debase the currency, the coin shortage gets worse, coins deteriorate faster, and inflation accelerates.

      "It's largely a question of who got the "clipping vig" -- the state can clip the coins in one big bad depreciation."

      Maybe you're only using the word 'clipping' rhetorically, but in its proper sense it is the public that clips (ie uses a scissors to cut off small bits of circulating coins), not the state.

      "Also, why wouldn't / couldn't / didn't a private medieval bank solve this problem by storing unclipped coinage and issuing demand notes for circulation?"

      Go read about the Wisselbank.

  2. Defensive debasement makes perfect sense, and there are many clear examples of it. Aggressive debasement, not so much. It's hard to see how the voluntary operation of a mint could enable the king to steal so much metal from his subjects.

    Distantly related point: Old-time mercantilists complained a lot about coin shortages, but mistakenly thought they resulted from trade imbalances, so they foolishly railed against imports. The Adam Smith crowd, on the other hand, wrongly thought that the mercantilists were mistaking coins for actual wealth. Smith failed to see that the mercantilists were not motivated so much by "heaping up treasure", but by maintaining an adequate circulation of coins.

    1. "Aggressive debasement, not so much. It's hard to see how the voluntary operation of a mint could enable the king to steal so much metal from his subjects."

      Do you mean that the mint master would not allow an aggressive debasement?

      "Distantly related point: Old-time mercantilists..."

      Good point. As I was writing this post, I got to wondering how much of mercantilist thought is derived from problems related to the coinage; things like Gresham's law, coin shortages etc. Any good links on this?

    2. As usual, I go looking for a quote and it disappears. Anyway, the mercantilism stuff must have been something I read in either Joseph Ernst, Money and Prices in America, Curtis Nettels, The Money Supply of the American Colonies, Andrew McFarland Davis, Colonial Currency Reprints, or Mark Blaug, Economic Theory in retrospect.

      As for aggressive debasement: If old dollar coins contain 1 oz of silver, and the government issues new dollar coins that contain .9 oz, then either the public values the new coins at .9 oz, in which case there is no profit to the government, or else the government declares the new coins to be worth 1 oz., (say, when paying taxes). In that case the government is using its assets to back the extra 0.1 oz worth of the coin. But that's not a profit to the government, since the government's assets and liabilities rise equally as new coins are issued.

    3. I see what you mean. One quibble: in my post I haven't put forth the idea that a monarch profited by issuing less-than full bodied coin. Strictly speaking, in medieval times the monarch didn't "issue new coins," at least not like it does today. The public brought silver to the king's mint and the mint returned that silver to them in the form of newly minted coin, less a commission. In order to earn higher profits, the trick was to increase mint throughput i.e. the amount of silver being brought to the mint so that more commission revenues were earned. And an aggressive debasement i.e. a large decline in the silver content of the penny, was an effective way to do this.

    4. Mike I think you are right, and this is where the point about seignorage enters: the fee that is collected for minting coins becomes part of government assets, and thus backs the coins that are produced with reduced silver content. In principle, the minting fee could be 100% and they could give you copper coins, declaring them legal tender, and FTPL tells us that this wouldn't really change prices. After all, this policy is easy to reverse. On the other hand, if the government spends new coins into the economy, this spending would be financed by the inflation tax as prices rise.

      I'm not sure how to think about aggressive debasements in this framework. They are a bit like forcing people to deposit silver with the government. In the extreme case of 100%, all they get are pieces of paper or copper coins, but these are actually better than coins that contain silver and lose it gradually over the years.

    5. "...and thus backs the coins that are produced with reduced silver content"

      I don't understand how backing or FTPL are relevant to the medieval coinage in my post. The monarch didn't offer to redeem coins for anything. The market value of coins was set (in the long term at least) by the quantity of metal in them. New coins weren't created and spent using the monarch's silver; rather, the public brought their silver to the royal mint to be coined, and then the public spend the new coins.

      Take your example. If the existing silver coin, say the penny, is going to be debased such that it is mixed with large amounts of copper, then prices will begin to rise quite dramatically since merchants realize they will be receiving a smaller quantity of silver every time they accept a penny.

      I think the coins you and Mike are describing are token coins, but these came much later in monetary history.

    6. You're right, when I saw Mike's suggestion above that the government could accept coins at face value for tax purposes, I started thinking in terms of token coins, which is really a tangent that doesn't have much to do with the actual history of coin use during this period.

    7. Another difference is I'm assuming "free minting." That's when the state doesn't provide the material for new coins, the public does. I think you two are also assuming the opposite of free minting, where the state supplies the silver, copper, etc and the mints are closed to the public. All coins are provided on the government's account.

    8. What's puzzling me is that the public tolerated aggressive debasement, even though foreign coins were available. You point out that the coins didn't have any special legal status that was exploited. Perhaps it was simply that access to foreign mints was sufficiently costly that using the local mint was the best way to salvage the silver content of old, unusable coins.

    9. How about this, from Munro:

      "Therefore, to protect their own mints and their coinage supplies, most princes or states responded to foreign debasements by prohibiting the import of foreign coins for domestic circulation, requiring their sale to the state’s mint as bullion, banning the export of bullion – and often, also, by engaging in their own debasements."

    10. Yes, that definitely answers it. This financial repression appears to be a crude way of taxing holdings of silver. Token money has made collection of seigniorage much more efficient.