What is the major problem with using coinage as a currency system?

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.

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.

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.

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