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.

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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.

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* 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.