Currency stabilisation and asset-price anchors: An examination of medieval monetary practices with some implications for modern policy

Anthony Hotson, 23 April 2013

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Mints as off-balance-sheet intermediaries

Mints can be viewed as off-balance-sheet banks. Instead of holding bullion and issuing redeemable notes, they issued coins embedded with bullion, and took a fee (mintage and seigniorage) based on throughput. English silver coins had a (nominal) face value and a collateral value (that is, intrinsic worth), and medieval monetary policy revolved around the alignment of these two values. The crisis of the pound sterling in the 1540s arose from Henry VIII’s debasement of the currency, resulting in collateral values being reduced to half their face values (Spufford 2012). The opposite problem arose in the 1690s when collateral values rose above face values, and full-weight coins were hoarded or melted down (Horsefield 1960).

Currency crises tend to receive more press than periods of stability, and it is noteworthy that the English Mint was able to maintain a reasonable degree of stability over many centuries. It did this by posting a Mint price expressed in terms of the face value of specie (that is, precious metal coins) it was willing to offer against delivery of bullion of a certain weight and fineness. Provided the Mint stood ready to mint bullion at its posted price, there was no need for holders to accept a lower price, and the Mint therefore established a floor for the sterling price of bullion. Demand for bullion from Asia, foreign mints and for the production of domestic plate could give rise to upward pressure on prices, but a premium over the Mint’s posted price could trigger an increased supply from the melting down of specie. As a result the Mint system set a reasonably firm floor and a partial cap (resistance points) to bullion-price fluctuations. Bullion prices were anchored.

Figure 1. English Mint prices, 12th century to 18th century: Face value of coin offered against bullion delivered

Source: Mayhew 1992, 1999, 2011; Feaveryear 1963; Gould 1970; Challis 1992.

Periodic step-devaluations and Mint-price rises

Roughly once a generation, the Mint would exchange worn coins for new ones. The terms of exchange during re-coinages could vary, but a commonly adopted practice was to reduce (devalue) the weight of newly minted coins by an amount commensurate with the deterioration (reduced weight) of the old ones. This would mean that newly minted coins would weigh the same as averagely worn old ones, and the aggregate face value of the coin stock would remain the same.

Broadly speaking, the English Mint offered the same terms for unminted bullion as old specie, so a devaluation of the coinage implied a rise in the Mint price, i.e. an offer of more face value of specie against delivery of a given weight and fineness of bullion. As a result, the English coinage underwent a series of step-devaluations between the 12th and 18th centuries so the coinage could be renewed without most holders being penalised for under-weight coins. The only other option would have been for the Exchequer to subsidise the purchase of new bullion to make up for the lost weight of worn and clipped coins. Over six centuries the face value of sterling increased by a multiple of three times relative to its bullion weight.

Henry VIII’s debasement of the currency (reduced fineness) was corrected, although the episode did result in a permanent devaluation (reduced weight) of the currency. On occasion, upward pressure on the price of bullion due to strong demand from other users – in particular Asia, foreign mints or domestic plate – led to a diminution in the stock of sterling specie and eventually a pragmatic increase in the Mint price.

Mint, sound money and price stability

At its best, the Mint system managed to reconcile a number of conflicting objectives:

  • It maintained confidence in its currency (specie) by protecting its collateral value by way of a cap and collar.
  • At the same time, step-devaluations facilitated the replacement of deteriorated coins without the deflationary consequences of a reduction in the nominal value of the coin stock.
  • A normally cautious approach to Mint-price increases avoided imparting unduly inflationary shocks to the sterling prices of staple goods and other ordinary commodities.
  • But (and this is an important but), inflation or deflation of ordinary commodity prices was tolerated as a by-product of keeping bullion prices pegged.

Price stability of bullion rather than ordinary commodities

There was no parallel in medieval monetary policy to the modern preoccupation with the price of ordinary commodities, as measured by consumer price indices. Indeed, when faced with a change in the relative price of bullion and ordinary commodities, the authorities would resolutely keep bullion prices pegged and allow ordinary commodity prices to adjust. Relative price changes could be significant, not least as a result of new mining discoveries in the Spanish Americas.

Figure 2. London silver/wheat exchange ratio: Pennyweights of silver per bushel of wheat

Source: Clark 2004; Lindert 2006.

A decrease in the silver/wheat exchange ratio could either have been reflected in a decrease in the sterling price of silver, or an increase in the sterling price of wheat, or a mixture of the two. In the event, the Mint system pegged the sterling price of silver and allowed the sterling price of wheat to rise. Increased supplies of silver bullion would be converted into silver specie at the Mint price and, as David Hume noted, an increased stock of specie would tend to bid up the prices of ordinary commodities (Hume 1752). A rise in the sterling prices of ordinary commodities acted as a safety value to protect the coinage from a fall in its collateral value. The idea that ordinary commodity prices should be stabilised and that bullion prices should be allowed to let rip would have been regarded as perverse and incomprehensible.

Bank of England’s enhanced bullion-price cap

During the 18th century, the Bank of England replaced the Mint as the country’s leading monetary institution and the bullion market dealt with the Bank rather than the Mint. Bank notes were redeemable in current coin at face value, but not necessarily in full-weight coins. As a result, an ordinary Bank note did not confer a right on the holder to receive a particular weight of bullion (commensurate with that in a mint-condition coin). However, the currency reforms completed in 1776 meant that notes could be redeemed in passable (nearly mint condition) coins and this had the effect of aligning the sterling price of bullion closely to the Mint price (Hotson 2012). The suspension of note convertibility into specie in 1797 resulted in the removal of the cap and a dramatic rise in the sterling bullion price, but the resumption of convertibility in 1821 led to the effective re-imposition of a bullion-price cap. The Mint price continued to act as a price floor.

Figure 3. Start of sterling's gold standard: Newton's devaluation (1718), suspension (1797), resumption (1821)

Source: Challis pp440, 449; Castaign et seq.

Currency School critics chided the Bank for holding insufficient bullion reserves (liquidity) to meet potential note redemptions, and the 1844 Act resulted in substantially larger holdings of bullion (Ricardo 1809-11).

Figure 4. Bank of England's notes in circulation and bullion reserves: Currency School critics and 1844 Act

Source: BEQB, June 1967, Appendix cited on pp 159, Table A.

By the end of the 19th century the Bank was holding twice its capital in bullion. This improved its liquidity position, but left it potentially exposed to a heroic basis mismatch between its sterling liabilities and bullion assets. A halving of the sterling price of bullion would have wiped out the Bank’s capital and left it insolvent. The continued effectiveness of the Mint price floor nevertheless meant that the Bank’s balance sheet remained protected. The price of silver bullion did subsequently fall once the Mint price for silver was abolished in 1816 (Challis 1992).

Figure 5. Bank of England's bullion leverage: Mismatch of commodity asset against sterling liabilities

Source: BEQB, June 1967, Appendix cited on pp 159, Table A.

Mint price and asset-price anchors

For centuries, monetary systems have been stabilised by anchoring the price of some of the asset counterparts of money and allowing other (consumer) prices to vary. In recent decades, we have turned this approach on its head, targeting the consumer price index and allowing asset-counterpart prices – mainly property prices – to let rip. Our focus is on requiring banks to adjust their capital to reflect the risk of asset-price impairments (and other exposures), rather than to stabilise the prices of their assets. The two approaches are not mutually exclusive, but it is curious that so little attention is paid to the other approach with its long historical pedigree. Subsequent columns will consider how a modern system of asset-price stabilisation might be devised.

References

Challis, Christopher E (1992), New History of the Royal Mint, Cambridge.

Feavearyear, Albert E (1931), The Pound Sterling: A History of English Money, Oxford.

Horsefield, J Keith (1960), British Monetary Experiments, 1650-1710, Cambridge, Mass.

Hotson, Anthony (2012), “Stabilizing Monetary Systems: Sterling’s Currency and Credit Markets from the 12th to the 21st C”, University of Cambridge Working Papers in Economic and Social History, No. 11, September.

Hume, David (1752 [1987]), “Of Money”, pt. II, essay III, I, in Eugene F Miller (ed.) Essays: Moral, Political, and Literary, Liberty Fund, Indianapolis, revised edn.

Mayhew, Nicholas J (2012), “English Mint Price Data”, Winton Institute for Monetary History.

Ricardo, David (1951-1973), “Bullion essays’, in Piero Sraffa and M H Dobb (ed.) The Works and Correspondence of David Ricardo, Pamphlets and Papers 1809-11, 11 volumes, Cambridge.

Spufford, Peter (2012), “Debasement of the Coinage and its Effects on Exchange Rates and the Economy: in England in the 1540s, and in the Burgundian-Habsburg Netherlands in the 1480s”, in John H Munro (ed.) Money in the Pre-Industrial World: Bullion, Debasements and Coin Substitutes, Pickering & Chatto.

Topics: Economic history
Tags: Bank of England, bullion, consumer price index, gold standard, Mint

Research Fellow at the Winton Institute for Monetary History, Ashmolean Museum, University of Oxford

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