Bernholz, Monetary Regimes and Inflation, 3

20 Jun 2010 by Jim Fickett.

Inflation can occur even under a precious metal standard, either by influx of more of the metal from abroad or, more usually, by debasement of the currency. Debasement has been accompanied, for thousands of years, by price and exchange controls. These never prevent inflation and hoarding, but do cause market disruption and considerable suffering. A precious metal standard can be introduced, and maintained for long periods, if it is in the economic interest of a government. The merchant city-states of Venice and Florence provide an example.


In Chapter 3 Bernholz considers “Inflation under metallic monetary regimes”. Inflation can happen under a gold or silver standard, most notably if the government changes the content of coins. Bernholz describes a number of interesting historical examples of such. He also considers some important related topics: how a metallic standard comes to be introduced and maintained, and what means a government may use to try to forcefully preserve the nominal value of a debased currency.

The less important case of inflation under a metallic standard occurs when the supply of the monetary metal increases.

We know that general but limited price increases occurred several times in antiquity because captured foreign treasures were put into circulation. So it seems that a doubling of prices took place after Alexander the Great had coined the treasures won after the defeat of Persia

The more important case is debasement of the currency.

the debasement of the Roman silver currency, the denarius, became important under Septimius Severus and his successors and accelerated during the course of the third and fourth centuries AD. In the latter century the denarius had totally lost its silver content and had become a pure copper coin…

Scholars agree that a pronounced inflation took place during the third and fourth (Bagnall 1985) centuries AD. 'Between the reigns of Emperors Claudius (AD 41-54) and Constantius (AD 337-361), the price of wheat on the open market in Egypt, expressed in drachmas, increased more than a million-fold. Dramatic inflation of prices is one the the central economic facts of the third and fourth centuries AD' (Lendon 1990, p106).

But this development is less dramatic than it sounds, for it amounts to an average annual rate of inflation of 4.4 per cent.

Bernholz is nothing if not fair and thorough, and points out that in some cases it was not government spending that drove a reduction in the precious metal content of the coinage.

The value of coins deteriorated because of wear and tear and monetary authorities did not exchange old coins at their face value for new ones. As a consequence, when they issued new coins with full metallic value, Gresham's Law worked: the bad old money drove out the good new coins. This led to a scarcity of circulating money, which the authorities sought to overcome by issuing the new coins with a metal content corresponding to that of the old coins. In this way a slight debasement of the currency took place with a positive fiscal side-effect, but not necessarily with fiscal considerations as its prime cause.

Gresham's law is that when two versions of the currency with the same face value but different real value circulate, people will hoard the more valuable one and only the poorer one will remain in circulation. Or, concisely, bad money drives out good. An interesting point is that Gresham's law often delays the consequences of debasing the currency:

Inflation will remain rather limited as long as bad money … is still driving out the good … For this means that the total money supply is scarcely changing.

Given the tendency of governments to inflate, how can good money come about? In some cases, at least, it can be in the economic interest of the government to maintain a solid currency.

In 1192, Doge Henry Dandolo of Venice issued a new silver coin, the gros or matapan … This new money was soon used internationally and imitated in other European countries. A few decades later, in 1252, Florence issued its first gold coins, the florins … The florin was widely used in Western Europe as unit of account and in international transactions, presumably because of its stability in terms of other currencies, which was maintained for more than 300 years. …

What were the reasons for these developments? Venice and later Florence were centres of international commerce. Their merchants and rulers, because of the tax revenues resulting from a flourishing commerce, were strongly interested in an international currency accepted everywhere which reduced transaction costs and thus widened international trade.

This chapter contains a very depressing section on the futile actions of governments – via price and exchange controls – to try to avoid the natural consequences of debasing the currency. Considerable suffering is the usual result.

Diocletian and his co-regents introduced maximum prices for 1200 products and services … through an edict issued in 301 AD …

The death penalty was introduced for asking higher prices than set in the edict. But like all such measures taken later in history, the introduction of price controls proved to be a failure. Until 305, when Diocletian abdicated and the price decree was no longer in effect, numerous death penalties, the disappearance of goods from the market and disturbances in the labour market were the consequences

It was even worse at other times.

On February 2, 1627, jurisdiction in the trials of vellon [the currency at the time] smugglers was transferred to the courts of the inquisition, and on September 13, 1628, the ordinary death penalty was replaced by burning at the stake.

People do not, however, give up their livelihood easily, even with such penalties.

'On November 11, 1651 His Majesty ordered that all pieces of 2 maravedis be carried to the mints within thirty days for restamping to quadruple their tale [their nominal face value]. The possession of unstamped coins after the expiration of the period of grace was declared illegal, and their expenditure was subject to a penalty of death and the loss of one's goods.'

But in spite of these stern sanctions only small quantities of coins were surrendered.