The Big Problem of Small Change

Thomas J. Sargent, François R. Velde

• Publisher: Princeton University Press
• Year: 2014
• Print ISBN: 9780691116358, 9780691029320
• eBook ISBN: 9781400851621
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

The Big Problem of Small Change offers the first credible and analytically sound explanation of how a problem that dogged monetary authorities for hundreds of years was finally solved. Two leading economists, Thomas Sargent and François Velde, examine the evolution of Western European economies through the lens of one of the classic problems of monetary history--the recurring scarcity and depreciation of small change. Through penetrating and clearly worded analysis, they tell the story of how monetary technologies, doctrines, and practices evolved from 1300 to 1850; of how the "standard formula" was devised to address an age-old dilemma without causing inflation.


One big problem had long plagued commodity money (that is, money literally worth its weight in gold): governments were hard-pressed to provide a steady supply of small change because of its high costs of production. The ensuing shortages hampered trade and, paradoxically, resulted in inflation and depreciation of small change. After centuries of technological progress that limited counterfeiting, in the nineteenth century governments replaced the small change in use until then with fiat money (money not literally equal to the value claimed for it)--ensuring a secure flow of small change. But this was not all. By solving this problem, suggest Sargent and Velde, modern European states laid the intellectual and practical basis for the diverse forms of money that make the world go round today.


This keenly argued, richly imaginative, and attractively illustrated study presents a comprehensive history and theory of small change. The authors skillfully convey the intuition that underlies their rigorous analysis. All those intrigued by monetary history will recognize this book for the standard that it is.

Part I

A Problemand Its Cure

CHAPTER 1

Introduction

Paper and gold

A remarkable switch in monetary standards

A century ago few would have foretold the kind of money we use today. In 1873, the U.S. Congress had passed a law, section 14 of which states: “the gold coins of the U.S. shall be a one-dollar piece, which, at the standard weight of 25.8 grains, shall be the unit of value” (Statutes at Large of USA 17:427). Section 14 thus defined the American unit of account,¹ the dollar, as a specified quantity of a particular metal. In doing so, it embodied a shared wisdom accumulated from centuries of experience. And, while some countries did not adhere to the gold standard in 1900, relying instead on some type of inconvertible paper money, they were regarded as backward by the “advanced nations.” Today, the definition of the dollar as an amount of gold is gone and long forgotten. The “advanced nations” now all rely on inconvertible paper money.²

How can we explain this remarkable reversal? With hindsight, can we detect groundwork laid in earlier times for the universal replacement of gold by fiat?

The 1873 arrangement for small coins prefigured a new monetary standard.

On closer inspection, ancillary sections of the 1873 U.S. law portend the monetary developments of the twentieth century. Sections 15 and 16 prescribed that smaller denominations, from 50¢ to 1¢, were to be made in metals other than gold. An act of 1879 (Statutes at Large 1879, 7) made these subsidiary coins convertible, in sums of $20 or more, into “lawful money” (i.e., gold) on demand at the Treasury. Subsidiary coins were tokens: their value came not from metal within but from trust in the government’s promise to convert them into gold (dollars) upon demand.

In 1900, sections 15 and 16 were thought unremarkable, dealing as they did with a matter of subsidiary importance, a technical issue much like minting charges or employee salaries. Indeed, similar provisions for small change could be found in the monetary laws of other advanced countries, and monetary textbooks of the time routinely described what had become by then a “standard formula” for managing the supply of small change.

Yet it took centuries to devise the formula. And until it was devised, the supply of small change was an important and persistent problem. Furthermore, from our vantage one hundred and twenty-five years later, the more enduring features of the act of 1873 are sections 15 and 16: for today all parts of our money, not just small change, have now become “tokens,” convertible only into other tokens.

This book is about the “big problem of small change”: what the problem was, how it was solved and why it took so long, and what was learned in the process about broader monetary and fiscal affairs. A long struggle with the problem of small change eventually produced a practical solution. It also produced a monetary theory that was able to extend token coinage to the entire denomination structure and found the comprehensive fiat money system that prevails today.³

The enduring problem of small change

Western Europeans long struggled to sustain a proper mix of large and small denomination coins, and to free themselves of the belief that coins of all denominations should be full-bodied.

Commodity money prevailed.

The monetary system begun by Charlemagne about A.D. 800 had only one coin, the silver penny. From the end of the twelfth century, various states introduced larger denominations. To do so, they established a monetary system that embodied the prevailing views about money. At the time, European monetary authorities did not think of money as something whose value emerges from its role as medium of exchange. Instead, they shared a conception of money that ignored its moneyness and focused solely on the substance it contained, namely silver. Therefore, in their view, coins of all denominations should be full-bodied, and rates of exchange of coins of different denominations should reflect their relative metal contents. They understood how a commodity money anchored nominal prices, and they sought to maintain that anchor throughout the denomination structure. So they set up a system in which supplies of coins of all denominations were chosen by private citizens, who decided if and when to use metal to purchase new coins from the mint at prices set by the government.

Shortages and depreciations

In the following centuries, that system produced intermittent shortages of small denomination coins, persistent depreciations of small coins relative to large ones, and recurrent debasements of the small coins. Cipolla (1956, 31) stated that “Mediterranean Europe failed to discover a good and automatic device to control the quantity of petty coins to be left in circulation,” a failure that extended across Europe. He called this failure the “big problem of small change.”

A standard formula

By the middle of the nineteenth century, the mechanics of a sound system were well understood, thoroughly accepted, and widely implemented. According to Cipolla (1956, 27):

Every elementary textbook of economics gives the standard formula for maintaining a sound system of fractional money: to issue on government account small coins having a commodity value lower than their monetary value; to limit the quantity of these small coins in circulation; to provide convertibility with unit money.… Simple as this formula may seem, it took centuries to work it out. In England it was not applied until 1816, and in the United States it was not accepted before 1853.

The standard formula avoided shortages and depreciations of small denomination coins without causing inflation. It retained a commodity money anchor but did not impose it coin by coin. Instead, it made the smaller denominations into token coins, convertible into gold.

In 1900, J. Laurence Laughlin (1900, 113–14) described the standard formula and added: “As a matter of course, countries have not always had clear conceptions regarding this kind of money, so that the principles just enumerated have come forth only by a process of evolution out of experience.”

The standard formula evolved from experience.

Thus, Cipolla, Laughlin, and others⁴ have highlighted the discrepancy between the formula’s simplicity and the time required to devise it. The aim of our book is to understand the sources of this discrepancy. We retrace events from 1200 to 1850, following three strands.

First, important ideas about money had to be discovered and others discarded. It took a long time before theorists recognized the superiority of tokens over full bodied coins. ⁵ Second, technologies that made it possible to issue token coinage had to be developed. Third, by trial and error, policy makers had to learn the properties of new institutions.

The long process of evolution out of experience provides a fascinating perspective on the growth of monetary theories and institutions, with many interactions among the three strands of theories, technologies, and experiments. Commentators tried to make sense of their observations, building monetary theory in the process. Governments ran diverse experiments, sometimes in response to commentators’ advice. Technical innovations in metal working altered the relative costs of legal and illegal suppliers of small change, and made new monetary policies feasible.

Governments had long experimented with issuing token coinage themselves and sometimes allowed private agents to issue it, before they discovered, or accepted, that, as in Cipolla’s standard formula, small change should be tokens backed by a government standing ready to exchange them for full-bodied large denomination coins or currency. In the process, they di...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Dedication Page
• Contents
• List of Illustrations
• List of Tables
• Preface
• Acknowledgments
• Part I: A Problem and Its Cure
• Part II: Ideas and Technologies
• Part III: Endemic Shortages and “Natural Experiments”
• Part IV: Cures and Side-effects
• Part V: A Formal Theory
• Glossary
• References
• Legal Citations Index
• Author Index
• Subject Index