Renovatio monetae

This silver pfennig from the Archbishopric of Magdeburg (1152-1192) was subject to a policy of renovatio monetae. Twice a year whoever held it had to bring it in to be changed for new coins at a rate of four old coins to three new coins. That suggests an annualized tax rate on coinage of 44%. Image source: British Museum

This is another post in a series that explores how European monarchs harnessed the minting of coins to earn revenues for their coffers. 

A king or queen generally resorted to two different strategies for profiting from the mints. The first was to mint long-lived coinage. The second involved issuing short-lived coinage subject to a policy of renovatio monetae, which is the topic of this post. These aren't mutually exclusive buckets. It's possible for elements of both policies to be blended together.

Almost everything I've written about medieval coinage on this blog has been about the long-lived sort, because that was the dominant pattern in Europe. Under a long-lived coinage system, once a coin had been minted it remained in permanent legal circulation. For example, England's long-lived coinage policy meant that an English penny produced in 1600 would have been just as valid a hundred years later, in 1700, as a penny produced in 1699.

The monarch earned a one-time fee from the original minting of the coin. More specifically, a citizen who brought raw silver to the royal mint left with that same amount of silver now transformed into coin form, less a small part going to the crown. This profit was known as seigniorage. In England, the seigniorage rate on silver typically hovered around 5%, my source for this number being The Debasement Puzzle by economists Rolnick, Velde, and Weber. Once a particular coin was produced, however, the king or queen no longer earned revenue from it.

As society grew and more coins were needed, raw silver was constantly brought to the royal mints by the public in order to be coined, the monarch earning a steady stream of income. This was known as free coinage, since everyone had the right to access the royal mints.

Short-lived coinage subject to a policy of renovatio monetae was an entirely different manner. Under this model, coins didn't circulate permanently. When a king or queen announced what was known as a renovatio monetae, or a renewal of the coinage, all existing coins had to be brought back to the mint to be recoined into new coins. The monarch collected a fee upon each renovatio monetae. 

To help reinforce the monarch's ability to collect a profit, only the most recent coin was allowed to be used within the monarch's domain. Older local coins and coins from other realms were illegal. To distinguish the new version from the outgoing version, the new type was stamped with a different pattern. The penalties for not obeying the rules of renovatio could be harsh. According to Philip Grierson, a numismatist, anyone caught using expired coinage could face imprisonment, a fine, or have their face branded with the old pattern of coin.

Source: Svensson

The period of time between one renovatio monetae and the next varied widely. In England, the monarch initially adopted an interval of nine years, beginning in 973 AD with Edgar. Later on, this was shortened to just three years. In many parts of Germany and Poland, renovatio monetae occurred yearly, as recounted by economist Roger Svensson in his wide-ranging book on the topic. In the Archbishopric of Magdeburg it was carried out twice a year, coinciding with important market days in the spring and autumn. The Teutonic order in Prussia used a much slower ten-year cycle, according to Svensson. 

The date for the switch was often chosen to occur just prior to annual tax payment day or, as in the case of Magdeburg, ahead of a regularly occurring market or festival (see figure above). Requiring that all tax payments or market transactions be conducted with new coins reinforced the necessity of  bringing in old coinage to be melted down into new coinage, thus guaranteeing a boost to the monarch's revenues.

The coinage that prevailed in Poland and Germany from the 12th century almost seems to have been designed with a short lifespan in mind, since it is leaf-thin and fragile. Coins minted in this style are known as bracteates, one of which can be seen below. Svensson speculates that the bracteate format was better suited for the purposes of renovatio monetae than standard coins since the costs of periodically reforming silver into thin and pliable coin would have been lower than heavier coins. 

Leaf-thin bracteates from Frankenhausen. Source: Svensson

 

How much profit did the monarch collect from renovatio monetae? 

For many years the Teutonic order in Prussia used a conversion rate of seven old coins to six new ones, says Svensson. Combined with the fact that renovatio only occurred every ten years, the effective tax rate was relatively light. According to Christine Desan, a law professor, English royal profits amounted to 25% of the metal minted (she cites Spufford), but recall that this tax was levied only every three years so that works out to a yearly tax of around 8%. (Some people may notice the similarity of renovatio monetae to ideas promulgated by Silvio Gesell, who came up with the idea of stamped scrip—money that depreciates.)

In some cases, though, the conversion rate bordered on exploitative. Svensson says that a common exchange rate in Germany was four old bracteates for three new ones. Given two renovatio per year in places like Magdeburg, that works out to a yearly tax rate on coinage of 44%! If a citizen of Magdeburg started the year with 16 bracteates in their stash, and they complied with both renovatio, by year-end target would only have nine bracteates.

This may have created a very weird effect whereby coins became "cheaper and cheaper" over the course of the year in anticipation of the inevitable withdrawal day, according to historian Sture Bolin. Since everyone would have known ahead of time that there was to be a 4:3 conversion on a fixed date, and no one wanted to be stuck holding coins and bearing the conversion tax, sellers would only accept coins at a discount to compensate them for conversion. That discount varied with time. As the final day approached, it would have got progressively wider.

In modern times we don't have to deal with the hassles of renovatio monetae. The coins and banknotes we use are long-lasting: a nickel from 1956 is just as valid as one from 2022. Or consider that while the $1 note is no longer printed in Canada, anyone can still bring them to a bank to be deposited for free. If a policy of renovatio monetae were to be announced by the Bank of Canada in 2025, and Canadians were required to bring our coins and banknotes in each year to be exchanged for new ones, there would probably be a revolt against the inconvenience of it, especially if the fee was high.

This combination of exploitation and inconvenience may explain why the English abandoned renovatio monetae in the middle of the 12th century in favor of permanent coinage. "The renovatio monetae witnessed to the extent of royal control and suggests that coining was routinely coercive," writes Desan. "This new system reduced the burdens placed on people required so frequently to remint their money at a cost."   

However, if renovatio monetae was inconvenient (and frequently exploitative), it also had a key benefit. As silver coins passed from hand to hand, they suffered from natural wear and tear. On top of that, bad actors regularly clipped off their edges, keeping the silver shavings for themselves. By renewing the coinage every year or two, the monarch ensured that the coinage was kept in relatively good condition.

Alas, the same can't be said for long-lived coinage systems, which were particularly prone to the wear and tear problem. After a decade or two of circulating, a typical coin would have lost a significant amount of its original silver content, at which point it would no longer be equal in weight to new coins. This meant that the realm's coins were no longer fungible, or interchangeable, with each other. The familiar problem of Gresham's law would now begin to plague the monetary system, whereby the "bad" coins, which meant the old underweight coins, drove out the "good" coins, the new full-weighted ones. With only shabby coins being used in trade, the money supply was more prone to counterfeiting and clipping, leading to an even shabbier coin supply, and more counterfeiting and clipping. 

Mind you, there were ways to defend against the inevitable downward spiral of long-lived coinage. By adopting a policy of defensive debasements, which I've written about before, the fungibility of coins could be restored.

Nor were long-lived coinage systems spared from being exploitative in nature. The method of abuse was different than that used to exploit short-lived coinage, involving a policy of repetitive debasements in the silver content of coinage.

As an example of this, I wrote a post last year exploring how Henry VIII financed his wars in France using debasement of his long-lived coinage. Do read it, but in short the trick was to increase the number of people visiting the royal mints to convert raw silver into new coins. This would in turn boost the monarch's profits. After all, he or she earned a 5% cut from each new coin produced.  The rush to the mint was linked to the fact that, post-debasement, the public could now get more silver pennies from the mint than before for a given quantity of silver, which in turn allowed them to buy more goods and services than they would have otherwise been able to purchase.

After a series of such debasements, Henry VIII was much richer, but the coinage was debauched. Going into 1542, for instance, the English penny contained 92.5% silver. Nine years later its purity stood at just 25% silver, the majority being base metal such as copper. 

To sum up, short-lived coinage issued under a policy of renovatio monetae was one of several ways to administer the monetary system. It had some advantages over other methods, but was also easily abused. This abuse was linked to the fact that coinage was simultaneously a crucial tool for day-to-day commerce, both as a medium of exchange and a unit of account, and also a way for the monarch to fund itself. Maximizing its latter role by relying on frequent and onerous renovatio may have done severe damage to money's capacity to perform the former role. 

This tension was not necessarily resolved with the move towards long-lived coinage, as Henry VIII demonstrates. And while we may think we have left these these medieval issues behind in the 21st century, I don't think that we can ever fully escape the tensions embodied in money's dual roles as crucial tool of commerce and source of government funding.

The credit theory of money

 
Over on the discussion board, Oliver and Antti suggest that I read two essays from Alfred Mitchell-Innes. Here are a few thoughts. 

A British diplomat, Mitchell-Innes was appointed financial advisor to King Chulalongkorn of Siam in the 1890s as well as serving in Cairo. He eventually ended up in the British Embassy in Washington where he penned his two essays on money. The first, What is Money, attracted the attention of John Maynard Keynes, while the second essay, The Credit Theory of Money—which was written in 1914—expounded on his views.

Both are interesting essays and worth your time. One of Mitchell-Innes's main points is that all money is credit. This may have been a controversial stance back in 1914, when people were still very much focused on metallic money, but I don't think anyone would find it terribly controversial today. If we look at the instruments that currently function as money, all of them are forms of credit, that is, they are obligations or "credits on a banker" as Mitchell-Innes puts it.

Having established his credit theory at the outset of his 1914 essay, Mitchell-Innes devotes much ink to patching up its weakest point: coins. Any critic will be quick to point out that the historical circulation of coins contradicts his claim that all money is credit. Coins, especially gold ones, were valued as commodities, not credit.

To protect his credit theory from this criticism, Mitchell-Innes downplays the role played by coins. So in What is Money he claims that for large chunks of history, the "principal instrument of commerce" wasn't the coin, but the medieval tally stick. These ingenious objects look like this:

Medieval tally sticks, an early example of public/private key technology https://t.co/DG1p5Sn399 pic.twitter.com/cOAz2PoiRZ

— JP Koning (@jp_koning) November 8, 2016

While I certainly like the idea of tally sticks, to claim that they were the main way of engaging in hand-to-hand trade during medieval times doesn't seem likely. Long and awkwardly shaped, tally stick are not nearly as convenient as coins. It's hard to see why anyone would prefer them. Just like the sleek US$1 bill has driven the bulky $1 coin out of circulation, one would expect coins to push bulky tally sticks out of general usage.

Alfred Mitchell-Innes once claimed that tally sticks—not coins—were the dominant medieval instrument of commerce: https://t.co/o4qimrRdGT

Seems unlikely, no? Why lug a bundle of heavy 8-inch long sticks in your pocket for making payments when coins took up much less space? pic.twitter.com/aIRW9Eghr3

— JP Koning (@jp_koning) October 30, 2018

Mitchell-Innes's second, and more radical, line of defence is to claim that coins themselves are a form of credit. "A government coin is a "promise to pay," just like a private bill or note," he says. Elsewhere he writes: "A coin is an instrument of credit or token of indebtedness identical in its nature with a tally or with any other form of money, by whomsoever issued."

This is a strange idea. Why would anyone issue a financial promise encoded on gold? For instance, imagine that I owe you some money. To give physical form to my debt, you ask me to write out an IOU which you will keep in your pocket. But why would I inscribe my promise on something expensive like a gold disc, especially when I could simply record it on a cheap and lightweight piece of paper? Larry White puts it better here:

"This account fails to explain, however, why governments chose bits of gold or silver as the material for these tokens, rather than something cheaper, say bits of iron or copper or paper impressed with sovereign emblems. In the market-evolutionary account, preciousness is advantageous in a medium of exchange by lowering the costs of transporting any given value. In a Cartalist pay-token account, preciousness is disadvantageous — it raises the costs of the fiscal operation — and therefore baffling. Issuing tokens made of something cheaper would accomplish the same end at lower cost to the sovereign."

Mitchell-Innes doesn't make much of an effort to explain why gold might have been selected as a medium for inscribing IOUs. But on the discussion board, Antti has a provocative theory. Credit is often collateralized, an asset being pledged by a borrower to a lender in order to reduce the risk of the loan. If a gold coin is a form of credit, then maybe the gold embodied in the coin is serving as collateral.

Think about it this way. While it would certainly be cheaper for me to record my IOU on paper, if I welch on my promise then the person who holds my IOU is left with nothing but a worthless note. But if I welch on an IOU that is encoded on a gold disc, at least the person who has my IOU is left with some gold (albeit of lower worth than the face value of the original IOU).

According to Antti's theory, a gold coin is therefore a more solid form of credit than a note, since it provides recourse in the form of precious metals collateral. If my credit is bad, the only way I may be able to get a loan is to issue gold IOUs, my paper ones being too risky for people to accept.

It's an interesting theory, but the problem with inscribing my IOUs on gold is that it is a terribly insecure way for me to conduct my business. Gold is highly malleable. Bite a gold coin between your canines and you'll leave a mark on its surface (trust me, I've done it). So if I pay you with my coin IOU, you could clip a tiny bit off the edge and keep it for yourself, passing the rest of the coin off at a store. That store owner could in turn pay it away to a supplier. Unaware that it has been clipped, the supplier returns the coin to me for redemption. I am obligated to accept the clipped coin at full value since it is my IOU. However, I've had a chunk of my collateral stolen somewhere along the transactions chain—and there's nothing I can do about it.

So putting one's gold collateral into circulation is an open invitation for thieves, which is why Antti's collateral theory of coins doesn't seem very realistic to me.

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The idea that coins circulated at more than their precious metals content, or intrinsic value, can be found throughout Mitchell-Innes's two essays. He uses the existence of this premium as proof that the metal content of a coin is not relevant to its value, its credit value being the sole remaining explanation.

To some extent, I agree with Mitchell-Innes. Over the course of history coins have often circulated above their intrinsic value, and from time-to-time this premium has been due to their value as credit. The merchants' counterstamps below are great examples. By adding a stamp to a government coin, these merchants have elevated the coin's value from one cent to five or ten cents.

Redenominated coins are IOUs printed on metal.

"The practice of elevating the denomination of circulating cents seems to have been an early Civil War era phenomenon, given the shortage of then circulating coins." Source: https://t.co/OIMMt2CBVj pic.twitter.com/UiXSBKpk7u

— JP Koning (@jp_koning) October 29, 2018

These three coins are straight out of Mitchell-Innes two essays. As I say in the tweet, counterstamped coins effectively functioned as an IOU of the merchant. For instance, take the five cent Cameron House token, on the right. This token was issued by a Pennsylvania-based hotel—Cameron House.  Its intrinsic value was one cent, but Cameron House's owner promised to take the coin back at five cents, presumably in payment for a room. The sole driver of the coin's value was the reliability of Cameron House's promise, the amount of metal in the token having no bearing whatsoever on its purchasing power.

While Cameron House's stamp turned metal into a much more valuable form of credit, not all stamps do this. Last week I wrote about coin regulators who regulated gold coins and shroffs who chopped coins. Both functioned as assayers, weighing a coin and determining its fineness. If the coin was up to standard, the regulator or shroff stamped their brand onto its face and pushed it back into circulation. Below is a chopmarked U.S. trade dollar:

Chopped 1880 U.S. trade dollar (source)

But unlike the Cameron House stamp, the regulation or chopping of coins didn't turn them into a credit of the regulator or shroff. The marks were simply indicators that the coin had been audited and had passed the test, and nothing more.

Both the Cameron House coin and the chopped U.S. trade dollar would have traded at a premium to the intrinsic value of the metal that each contained. But for different reasons. As I wrote above, the Cameron House coin was a form of credit, like a paper IOU, and thus its value derived from Cameron House's credit quality, not the material in the token. But not so the chopped U.S. trade dollar. Precious metals are always more useful in assayed form than as raw bullion. While it is simple to test the weight of a quantity of precious metals, it is much harder to verify its fineness. This is why chopmarks would have been helpful. Anyone coming into possession of the chopmarked coin could be sure that its fineness had been validated by an expert shroff. And thus it was more trustworthy than silver that had no chopmark. People would have been willing to pay a bit extra, a premium, for this guarantee.

Remember that a decline in the amount of metal in a five-cent Cameron House token would not have changed its purchasing power. With a chopmarked trade dollar, however, any reduction in its metal content flowed through directly to its exchange value. This is because a chopmarked dollar was nothing more than verified raw silver. And just as the value of raw gold or silver is determined by how many grams are being exchanged, the same goes for a chopmarked trade dollar.

And so whereas Mitchell-Innes has a single theory of money, we've arrived at two reasons for why coins might trade at a premium to intrinsic value, and why their purchasing power might change over time. The Cameron House theory, which also happens to be Mitchell-Innes's theory, and the chopmarked trade dollar theory, which is completely contrary to Mitchell-Innes's essays.

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I've used private coinage for my examples, but these principles apply just as well to government coinage. Our modern government-issued coins are very similar to the Cameron House tokens. They are a type of IOU (as I wrote here). In the same way that trimming away 10% from the edge of a $5 note won't reduce that note's purchasing power one bit, clipping some of the metal off of a toonie (a $2 Canadian coin) won't alter its market value. The metal content of a modern coin is (almost always) irrelevant.

But whereas modern government coins operate on Cameron House principals, medieval government coins operated on the same principals as chopmarked traded dollars. In England, a merchant who wanted coins would bring raw gold or silver to a mint to be converted into coin. But the merchant had to pay the mint master a fee. The amount by which a coin's market value exceeded its intrinsic value depended on the size of the mint's fee.

Say it was possible for a merchant to purchase a certain amount of raw gold with gold coins, pay the fee to have the raw gold minted into coins, and end up with more coins than he started with. This would be a risk-free way to make money. Everyone would replicate this transaction—buying raw gold with coins and converting it back into coins—until the gap between the market price of a coin and the market price of an equivalent amount of gold had narrowed to the size of the fee. 

Premia on coins weren't always directly related to mintage fees. English mints usually operated on the principle of free coinage—anyone could bring their gold or silver to the mint to be turned into coin. But sometimes the mint would close to new business. Due to their usefulness and growing scarcity, gold coins would circulate at an ever larger premium to an equivalent amount of raw gold. Since merchants could no longer bring raw gold to the mint and thereby increase the supply of coins, there was no mechanism for reducing this premium.

So as you can see, whether the mint was open and coinage free, or whether it was closed, the premium had nothing to do with the coin's status as a form of credit. It was due to a combination of the superiority of gold in validated form and the availability of validated supply.

In sum, Mitchell-Innes is certainly right that coins have often been a form of credit. A stamp on a piece of metal often elevates it from being a mere commodity to a token of indebtedness. In which case we get Cameron House money. But as often as not, that stamp is little more than an assay mark, a guarantee of fineness. In which case we have chopmarked trade dollars. Both sorts of stamps put a premium on the coin, but for different reasons.

Coming up with grand theories of money is tempting, as Mitchell-Innes has done, but unfortunately these theories sometimes obscure the finer features of monetary instruments. At times, having twenty or thirty bespoke theories may be a better way to understand monetary phenomena than one grand one.

A 21st century U.S. trade dollar

"America's only unwanted, unhonoured coin." 

- John Willem on the silver trade dollar.

The inspiration for this post comes from the old trade dollar, a U.S. silver coin that was minted in the 1870s and 1880s for the sole purpose of circulating in China. Taking the trade dollar as a model, I'm going to discuss the idea of converting the U.S. $100 bill into a trade bill; i.e. to limit it to foreign and not domestic usage.

Why bother modifying the $100 in this way? While not entirely convinced, I do lean towards Ken Rogoff's idea of getting rid of high denomination banknotes like the Canadian $100, the Swiss 1000 franc, and the Europe's €500. These bills are used primarily by criminals and tax evaders; their removal will make these activities more costly. The public's licit demand for a private means of payment can be met by low denomination notes, as can the necessity for a convenient physical payments medium on the part of the unbanked.

But as I wrote here, the Federal Reserve's $100 is categorically different from the above banknotes. The dollar plays a special role as the world's backup medium of exchange and unit of account. Abolish the $100 and not only will those dollarized countries already using U.S. banknotes (many of them poor) be hurt, but so will the desperate citizens of foreign countries who might try to flee to the dollar in the future due to the awful monetary policies of their leaders, usually dictators.*

By converting the $100 into a trade bill, everyone can have their cake and eat it too. Like the old silver trade dollar, the $100 trade bill will be barred from playing a role in the U.S. economy, thus doing damage to the domestic underground economy. But it will be free to be used in places like Venezuela which, thanks to misgovernance, are in urgent need of a better monetary standard.

To help determine the structure of a modern $100 trade bill, let's explore the design of the 19th century silver trade dollar. China had a long history of using silver as money, and as trade with the west grew the Spanish silver dollar—minted in Mexico—had become quite popular with Chinese merchants. U.S. traders were penalized as they had to acquire Mexican dollars at a premium to the coin's intrinsic silver value in order to do business with China. Enter the trade dollar. The idea was to introduce a U.S. equivalent to the Mexican dollar in order to help out U.S. merchants, who would no longer have to pay a premium. The trade dollar would also provide domestic silver producers, an important political constituency, with an outlet for their production.

While U.S. legislators liked the idea of having U.S. silver coins circulate overseas, they did not want the trade dollar to be used in the U.S. After all, the U.S. was in the midst of giving up the old bimetallic standard (silver and gold) in favour of a gold standard, and a new silver coin might interfere with this process.

Thus, we arrive at the Coinage Act of 1873, which simultaneously took the U.S. off of silver (by ending the free coinage of silver) while also introducing the trade dollar. To ensure that the trade dollar would not be "made a part of or be in any way confounded with our monetary system," its legal tender status was limited to $5 i.e. no domestic debt could be extinguished with more than $5 in trade dollars (for a review of legal tender, go here). To further hurt its domestic usefulness, this legal tender status would be completely revoked in 1876.

While the trade dollar was well-received in China (most of them were chopped), it wasn't entirely successful in staying out of domestic U.S. circulation. According to Garnett, of the $35.9 million in trade dollars coined, $29.4 million were exported. Of this amount, $2.1 million returned to the U.S., joining the $6.6 million that had never left the country.

It's important to understand why trade dollars sometimes stayed in the U.S.—after all, the idea of a trade bill simply won't work if $100 notes continue circulating in the U.S. There seems to be two reasons for this. From 1873 until 1876, trade coins still had a limited value as legal tender. At first, this wasn't an issue. Since the intrinsic value of the coins' silver content exceeded their official legal tender value, it made little sense for Americans to use them to settle local debts—debtors would be effectively overpaying if they did so. However, as silver prices fell through the 1870s the official legal tender value of trade dollars began to exceed their intrinsic value, at which point it was profitable for debtors to pay off their bills in overvalued silver trade dollars. This would have diverted trade dollars from China in order to meet local demand.

Secondly, speculators began to buy trade dollars in China and bring them back home on the expectation that the U.S. government would eventually redeem them at their original value of $1, even as they traded at around 80 cents on the dollar. This belief was eventually realized in 1887 when Congress compelled the government to redeem all trade dollars at par.

So with these design flaws in mind, let's design our $100 trade bill. To begin with, on January 1, 2017 the U.S. government will announce  its intention to rescind the legal tender status of $100 bills. That means the $100 can no longer be used by a debtor to discharge any U.S. debt. Legal tender status must be entirely rescinded to avoid the mistakes of the trade dollar.

Next, the Federal Reserve announces that after a certain date (say January 1, 2019), all domestic deposits and withdrawals of $100 notes will be illegal. Until then, the public enjoys a two-year window for bringing bills into banks or Federal Reserve branches for conversion into $20 bills or deposits. To prevent local hoarding of $100 bills, the domestic closure of the "$100 window" must be perceived to be permanent. Remember that trade dollar inconvertibility was perceived to be temporary, thus encouraging domestic demand. Likewise, if they anticipate a re-opening of the "$100 window," Americans will simply keep their $100s at home.

Banning local redemption will likely force all local retailers, wholesalers, and other businesses to stop accepting $100 bills. A retailer like Walmart that receives a $100 bill during the course of business will have to ship it overseas to be spent or deposited, and that would be quite expensive. Likewise, licit person-to-person exchanges of $100s will be crimped. Lacking domestic acceptance by banks and retailers, the $100 will have no liquidity, and regular people will no longer be willing to accept them.

For these same reasons, illicit domestic usage of $100s will suffer. Since no legitimate businesses will accept them, criminals won't be able to spend $100 notes into the local economy. To launder $100 bills, it will now be necessary to send them overseas for deposit into foreign banks. This will impose significant handling costs on money launderers, especially if the government institutes laws that limit large cash exports. These handling costs will  probably be high enough to force domestic illegal currency users to migrate to $20 bills as their preferred medium.

While domestic usage of $100s will rapidly decline, foreign-based banks will be completely free to allow deposits and withdrawals of $100 banknotes, much as they do now. To get $100 notes shipped from the U.S., foreign banks will have to put in orders with a Federal Reserve bank (they tend to prefer the New York Fed's cash office and, in the West, the San Francisco Fed's Los Angeles cash office). To redeposit $100 bills, they will have to send them by plane back to New York.

This setup should be sufficient to flush most $100 bills out of domestic circulation, forcing U.S.-based criminals and tax evaders to fall back on less convenient $20s. And just as the trade dollar successfully met Chinese demand for silver money, the $100 trade bill will meet Panamanian, Zimbabwean, and other foreign demand for U.S. high denomination cash.

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*Rogoff believes that a policy of removing high denomination notes should only be enacted by developed nations. But since so many undeveloped nations use the dollar, Rogoff is being inconsistent in calling for an end to the $100.

To read more about U.S. trade dollars, here are some good sources:
A Trade Dollar Song and Chorus, 1883 (link)
Collecting Trade Dollars (link)
The History of the Trade Dollar (link)

The British (link), Japanese (link), and French (link) also issued trade dollars

Milton Friedman wrote an excellent account of the switch from bimetallism to the gold standard (pdf).

Medieval QE

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.

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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.