Originally posted on Tuesday, October 22nd, 2013

The Federal Reserve Bank of New York — the flagship regional Federal Reserve Bank — publishes Liberty Street Economics, featuring “insight and analysis from economists working at the intersection of research and Fed policymaking.”

A recent article there published, by James Narron and David Skeie, Crisis Chronicles: The “Not So Great” Re-Coinage of 1696is a marvel of historical erudition.  Such scholarship is notable and its publication a great credit to the Bank. Some excerpts:

In the late 1600s, England operated a bi-metallic monetary system of high-value gold coins and lower-value silver coins. In the early 1690s, however, the market price of silver began to rise at a time when the mint price of gold was higher than the market price. Thus, gold bullion was flowing to the mint while silver coins were flowing to the commodity markets. By 1695, nearly half of the silver specie was missing from coin in circulation in England as coins were “clipped” (shaved) with the result that their face value no longer reflected the metal content. Ironically, low-weight coin was still accepted for tax payments. In this post, we recount England’s efforts to remedy the “ill state of the coin of the kingdom” during the re-coinage of 1696.

By 1695, high-value gold coins were plentiful in England but there was a notable shortage of small-denomination silver coins, creating a monetary contraction. This led to a dual problem. First, the monetary contraction inhibited the ability to pay the armies engaged in the Nine Years’ War. Second, because silver was used for small-denomination subsidiary coins, the coin shortage impeded everyday transactions between individuals. The Bank of England did not have the authority to intervene in the markets, so a “Commission on the Coinage” was chartered from 1694 to 1695 to deal with the crisis. These developments set the stage for what economist Charles Larkin called “one of the great monetary events in history” in his work The Great Re-Coinage of 1696. During the Commission’s debates, many solutions to the crisis were proposed: Treasury Secretary William Lowndes favored devaluation, Treasury advisor Charles Davenant advocated the expansion of credit, and Royal Mint Master Sir Isaac Newton sought to achieve gold and silver mint price parity. Ultimately, a plan to demonetize the existing clipped coins and issue new, full-weight coins—put forward by Commission member and prominent philosopher John Locke—was approved. The William III silver sixpence shown below was minted in 1696 as part of the great re-coinage. It displays the milled edges introduced around 1662 in an effort to reduce clipping.

In the second half of 1696, England’s economy essentially stopped, and the ensuing monetary contraction led to massive unemployment, poverty, and civil unrest. The smallest gold coin, the golden guinea, and various forms of credit provided the only remaining liquidity in the market, with the Duke of Beaufort famously being forced to pay for a dinner by entering his name in a book at the height of the crisis. The crisis ultimately spurred a new era of economies driven by a broad set of financial instruments, not just specie, and laid the foundations for the later development of “fiat money,” which is backed by full faith and credit in the issuing government, as we’ll explore in a future post on the Continental Currency Crisis.

The views expressed in the Liberty Street Economics post “are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.”

“James Narron is a senior vice president in the Federal Reserve Bank of New York’s Executive Office.”
“David Skeie
 is a senior economist in the Bank’s Research and Statistics Group”

The institution of “a new era of economies driven by a broad set of financial instruments, not just specie” proved, of course, salutary.  The failing grades given to the “Federal Reserve Note Standard” relative both to the classical gold and gold-exchange standards, given by the Bank of England in its December 2011 Financial Stability Paper No. 13 however, clearly demonstrates “fiat money” as an unhealthy alternative to the definition of the currency as a fixed weight of gold.