Problems of Coinage

Now that we’ve been bashing the Mercantilist notion that Britain could have a “shortage of silver,” while France has a surplus, while silver can flow freely between the two, let me stop here and say that there really was a shortage of silver coinage in Britain, before 1700 — and afterwards also, but for a different reason.

February 14, 2016: The Balance of Payments
January 17, 2016: David Hume, “On the Balance of Trade,” 1742

First, let’s assume that silver (or gold, but British preferred silver for their coins before 1700), can flow freely between Britain, France, and elsewhere in Europe. Also, let’s assume that anyone can take foreign silver coins, or raw silver bullion, to the mint and have coins made, with minimal expense.

It would seem that there could be no possible shortage of silver coinage in Britain, unless there were a shortage across the continent and the world, which of course there never was.

But, there were actually a lot of problems with coinage, which we are not familiar with today, and which were not well understood at the time either.

For 2000 years before the invention of coinage in the 8th century BC, people in Mesopotamia and the eastern Mediterranean world used gold and silver as money, trading as raw bullion in any form. This was good, in some ways: you could never have a “devaluation,” and there never was one. A gram (or “mina”) of silver or gold was everywhere the same, unchanging. The problem was that you had to weigh and perhaps assay the silver at every transaction, and the weighing had to be precise.

The advantage of coinage was standardization: no longer did silver have to be weighed at every transaction. You could just count out standardized units.

However, this introduced a new problem: face value versus actual metal content. Standardization required treating every coin the same — the face value. But, the reality was that every coin was different. Often, the difference between face value and reality was small enough that it didn’t matter. But, sometimes the difference was too large to be ignored.

Coins naturally wear down. Or, they could be artificially “worn” via clipping, or even by the government intentionally debasing the coinage by minting new coins with the same face value as existing coins but lower silver content. If a coin was 1% underweight, it maybe didn’t matter. But what about 10%? How about 20%?

Let’s say that the standard for a new silver coin was 10 grams of silver. Coins coming from the mint would weigh 10 grams. You could take 10 grams of silver to the mint and have a coin made.

However, over time, the coin wore down so that it only weighed 8 grams.

Now, people have a choice. They can treat the 8-gram coins as being worth only 0.80 of a full-weight coin. But, now all the coins are treated differently. They lose their standardization. We are back using scales for every transaction, and treating the coinage as raw bullion.

Or, people could accept the lightweight coin, especially if such lightweight coins are very common, such that they are the norm and full-weight coins are a rarity. And, especially if the government is willing to take them in payment of taxes at full value. Now, the 8 gram coin is treated the same as a 10 gram coin.

It doesn’t take long to figure out that, if anyone gets a ten-gram coin in trade, they keep it, and only spend the 8-gram ones. The effective value of the coinage falls from 10 grams to 8 grams. All the 10 gram and 9 gram coins disappear from circulation. This is Gresham’s Law:

Wikipedia on Gresham’s Law

Before long, people figure out that foreigners treat the 10 gram coin as being worth, naturally, 25% more than an 8 gram coin. They only care about bullion weight. The 10-gram coins naturally get used in foreign trade, to pay for imports. They literally disappear from the country. The amount of coins in circulation decreases.

In 1690, William Lowndes, Britain’s secretary to the Treasury, estimated that over £3 million of silver coins had been minted since 1663, but, at that time, virtually none of them were still in circulation. The total silver coinage at the time was about £6 million. This also implies that all the coinage in circulation dated from before 1663, maybe centuries before, which is why they were so worn.

So we see that foreign trade — paying for imports with silver coinage — here actually does reduce the silver coinage of the society, producing a genuine shortage. But, it had nothing to do with the Balance of Payments or a “price-specie flow” mechanism, but rather the problem of face value vs. actual weight of worn coins.

Also, nobody takes ten grams of silver to the mint to make a new 10 gram coin. That would be silly. The standard coin in trade is now 8 grams. A new coin would cost 1.25 old coins, plus a minting charge, and would be worth the same in trade as an 8-gram coin. So, no new coins are made, no matter how available silver bullion might be.

You can see how this can become a problem. It was a big problem in Britain before the Great Recoinage of 1696-1699, when the government took all the worn coins it received in tax payments, melted them down and made new coins. They were, on average, over 20% underweight.

Since the pre-1700 period was also the era of Mercantilist thought in Britain (and elsewhere), we can see how these things can get started.

After the recoinage, the problem of coin wear largely disappeared in Britain. But, it was soon replaced by a different, although similar, problem.

For many centuries, Britain used silver coinage almost exclusively. Other places in the world, notably the Byzantine Empire and the trading states of Italy, were more gold-centric, but Britain was a silver-user. This changed in 1663, with the introduction and widespread use of the gold guinea coin. This new coin was the first example of a die-struck “machined” coin, similar to the way coins are made today, compared to the hand-hammered coins that had been used until that time. So, not only was it a much higher-quality coin than other newly-minted coins of the era, but it was also a vastly better coin than the extremely worn silver coinage in Britain in the 17th century.

This gold guinea coin soon became popular with bankers, who, around that time, were also issuing Britain’s first banknotes. The new banknotes were often based on (and redeemable for) the gold guinea, not the worn silver coinage. However, the silver coinage was still the standard of value and the unit of account in most situations.

After the silver recoinage, gold was “overvalued” in the bimetallic system. The gold guinea then had an official value of 22 shillings, more than the market value of the contained gold, which made it profitable to take gold to the Mint to be coined. (This was a natural consequence of the recoinage. If a high-quality gold guinea had a market value equivalent to 22 worn silver shillings, then, after the recoinage when the shillings were improved to a higher value, the bimetallic ratio would no longer reflect market prices.) From 1700 onwards, the Mint coined gold almost exclusively. The value of the guinea was later reduced to 21.5 and then 21 shillings in 1717, but this still made gold cheaper than silver. What this means is that the market value of a “British pound” of gold coinage was a little less than the market value of a “British pound” of silver coinage. Gold was the cheapest to deliver. Thus, it became the preferred method of payment; and also the standard of value. Put another way, the market value of the silver content of a silver shilling coin was more than a shilling, which would obviously prevent anyone from taking bullion to the mint to be coined. This condition persisted throughout the 18th century, resulting in a chronic shortage of small-value silver coins throughout the century even while silver bullion was exported from Britain. Once again, it would have appeared that silver exports — in the first decades of the 18th century, the East India Company alone was exporting over a million ounces of silver per year — were causing a shortage of silver coinage in Britain. In 1713-1716, 1.2 million ounces of gold were minted into coinage, with much of the gold imported from Brazil.

The eventual solution to this was the token coin, introduced in Britain informally after 1770 and officially after 1816, and based — oddly enough — on the principles of banknotes, which had been developed in Britain since the 1650s. The silver content of Britain’s silver coinage was reduced, such that the value of contained silver was about 90% of face value. However, this required that the supply of coinage be controlled. No longer could silver bullion be freely taken to the Mint to be coined; nor could governments themselves mint coins as they wished. Rather, silver coinage was redeemable, much like banknotes, in gold coin, by this way establishing their value and also limiting their supply. Effective token silver coins were used in the United States from the cessation of “free coinage of silver” in 1873, until the elimination of silver coinage in 1962.