Working Paper nr.

Rejoinder to :

"The Debasement Puzzle of the Middle Ages"

December 2011

For:

New Austrian School of Economics - NASE

JEL Classification number: E42, E43, E44, G1, G12

Keywords: Discount rate, Asset returns, Arbitrage, Bimetallism, Coinage, Commodity Standard, Currencies, Dual Currency, Gold Standard, Monetary Regime, Monetary Standard, Monetary System, Seigniorage, Brassage, Silver Standard

Author: Peter M. Van Coppenolle

Rejoinder to "The Debasement Puzzle"

According to established facts as summarized by a paper entitled "The Debasement Puzzle" first published in the Journal of Economic History of December 1996, vol. 56, no. 4, pp. 789-808, the monetary debasement in the mediaeval period of Western Europe poses a challenge to monetary theory. The challenge is to explain why, in the face of increased seigniorage, people would voluntarily bring unusual large volumes of precious metal to the mints. The same unusual volume occured even after the inverse operation of a reinforcement of the coin. How to explain the unusual volume in the absence of a logical incentive.

In solving the puzzle, I posit that there clearly was an incentive. But it can not be explained by modern monetary theory. To solve it, one has to fall back on the workings of the bill discounting practise. A bill originates with the payee as it is drawn on the payer, who accepts it in order to give it legal standing in the mercantile circles in which it originated. Contrast this with a note or loan which originates with the payer. A bill is therefore evidence of value added, whereas a note or loan is evidence of debt. It is a well established fact that bills were the preferred instruments of exchange between merchants at e.g. the fairs of Champagne or later in merchant cities like Bruges.The bill, as an instrumentum of value added, has little problem in circulating. Contrast this with an instrumentum of debt, such as present day fiat currency, which did not start circulating spontaneously.

It is also established fact that the going rate in discounting a bill is lower then the rate on notes or loans. It is commonly argued that the risk factor is different. The latter is entirely true in that it is clear that bills are drawn on existing goods which will hit the markets within a season or 90 days. The underlying consumer goods were real and rolling a bill would harm if not ruin the merchant's reputation. Discount rates are therefore a function of the propensity to consume, while interest rates are a function of saving. (Fekete, 2005). Both rates are as distinct as chalk and cheese and may even go in opposite directions. Despite this important distinction, not very well understood by modern monetary theory, the discount rate is commonly referred to as a "short commercial loan" in some textbooks. I deplore the use of the word "loan".

The direct sources of the discount rate ("short commercial loan") are not within my reach, but as an approximation I suggest to use "commercial rates" as given by Homer & Sylla. (2005:104) They report that a 5-8% rate was regarded as fair in the fourteenth century. This 8% rate is not annualised. Knowing that a sum of say 100 units could be applied profitably in discounting a bill for 108, maturing in maximum 90 days (and in the case of the Champagne Fairs, only 6 weeks later at the next fair) it stands to reason that the proceeds could be reused to discount another bill. Depending on the maturity dates, a sum of 100 could be invested in low risk high yielding bills. The annualized profits would far exceed the loss by debasement.

There is a link between the bill discounting practise and the activity of the mints. Bruges is claimed to be the more commercialised town of the fourteenth century. It stands to reason that discounting bills in Bruges was easier and common practise and its profitability would therefore attract spontaneously precious metals to the mint. Even from tableware or jewellery, if necessary. The flow of metal, be it existing high value coin or other coin, attracts the attention of the sovereign, who wishes to tax this flow with a seigniorage. This seigniorage is in no material aspect different from the likes of e.g. modern day VAT or GST or any other indirect taxation. As long as the "tax" is lower than the annualized profit, the "debasement tax" is inconsequential. This alone would explain the higher volumes of metal flowing to the mint in Bruges and the consistently larger debasements in towns, like Bruges, where it would still be profitable to keep discounting bills in spite of the ongoing debasement tax.

Discounting bills would be logically preferred over investing in loans, even if the latter were at higher rates. Bills, circulating on their own steam as instruments of added value are materially different from loans, which are instruments of debt. Besides being a superior instrument over a debt based instrument, the bills' maturities differed materially from loans. Bills typically mature within a quarter whereas a loan regularly does have a longer maturity which would overlap recurring annual debasements, potentially exposing the loan instrument to repayment in debased coin.

The data provided suggests a strong correlation between debasement and increased flows of metal to the mints. However, this correlation is likely due to opportunism of the sovereign. I suggest that the increased flow of metal to the mints is highly correlated to opportunity in the discounting market. The sovereign only opportunistically profited from the flow, not because he was a trader, but because he could and did control the mints. The fact that new metal from South America found its way to Europe during the fourteenth century, opening up new mercantile opportunities, which called in turn for discounting, supports the point.

Modern monetary theory would assert that an influx of new precious metal would be (price)inflationary. This conclusion does not necessarily follow, as the inlfux of new precious metal compared to existing precious metal stock already circulating or at any rate above ground, may be an insignificant fraction. But it would allow new mercantile or industrial opportunities. The discounting practise amounts in fact to profit sharing. The foundations for a legal corporation with share capital were inconceivable then, as yet. But discounting a bill amounts to taking a share in the added value. The inflationary price-pressures in mediaeval times can be attributed to debasements, to which prices and remunerations responded fairly quickly (Chilosi & Volckart, 2010). The new capital that was drawn to the mints was drawn there because of the fact that new capital provided new opportunities, including a share for the sovereign. The debasements by the sovereign therefore resulted in price and wage inflation, but not necessarily in a linear fashion.

Debasements were and are still a strong armed instrument to disenfrenchise creditors. Where renegotiating a debt after a debasement would be a function of the balance of power, engaging in the discounting bill practise attracted less risk, because of a. its nature as a superior (value added) instrument and b. the very short maturity compared to an annual debasement cycle. It could also be argued that the balance of power between merchants who rely on each other to discount each others bills may be the subject of another investigation. Merchants engaging in bill discounting are more comparable to business venture partners then to debtors and creditors, precisely because the different nature of their relationship. The face value of the bill does not relate to debt and the discount rate does not relate to interest. (Fekete, 2010).

The flow of metal to the mints continued in unusual amounts even after a reinforcement of the coin. The reinforcement of the coin was the outcome of a power struggle between debtors and creditors. But the flow of precious metals to the mint is not of a monetary nature, but of a commercial nature. Because if one is not hit with a debasement tax, there is an even stronger reason to partake in discounting bills.

Conclusion: the flow of metal to the mints is not related to the debasement practise. It is a consequence of profit opportunity in mercantile practise, followed by an opportunistic tax in the form of a monetary debasement on the flow of metal to the mints of the sovereign.

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References

Chilosi, David & Volckart Oliver, "Good or Bad Money? Debasement, Society and the State in the Late Middle Ages", LSE, WP 140/10, May 2010

Fekete, Antal, "Interest and Discount and the continental divide between them", www.professorfekete.com, 2007

Homer, Sidney & Sylla, Richard, A history of Interest Rates, Fourth Edition, Wiley Finance, 2005