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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.
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