Debasement

Debasement refers to the practice of lowering the purchasing power of money. The notion of debasement is much easier to understand in the case of commodity money; that is, when the means of payment has its own intrinsic value such as silver or gold coins. History is replete with examples of various kinds of debasement. The first, and the most natural and innocent of all, takes place when coins lose part of their weight, and therefore value, during their circulation just from frictions. There are also less natural and therefore less innocent "frictions" such as those described as "sweating"; that is, putting many coins together in the same (usually leather) bag and shaking them so that the dust worn off could be used as metal.

These methods of debasement, along with many similar ones, were not as effective as the practice of "shaving", that is, shaving off parts of the periphery of the coins (a job done usually by artists) and reducing their precious metal content, using the removed metal to construct new coins or simply to produce luxury goods. This is one of the reasons why ancient coins rarely remained exactly rounded. Modern coins, by contrast, have a peripheral ring around their edges, reminiscent of the efforts to avoid the old practices of shaving or clipping off the coins at their edges. The peripheral ring of the coins, today, serves other more noble purposes, enabling their recognition by people with impaired visibility.

So far we dealt with the private sector of the economy, but a great deal of debasement occurred in the public sector of the economy as well, where there was a lowering of the precious metal content of the coins with the purpose again of constructing new coins from the removed quantity of the precious metal of the old ones.

The often-cited example is the denarius, the official coin of ancient Rome. The value of the denarius decreased over time as the government reduced its silver content. The immediate result of the debasement of the currency in ancient Rome was inflation, which reduced the purchasing power of the people's currency and, at the same time, made it possible for the government to carry out its expenses at a much lower cost.

Another famous instance of debasement took place in the United Kingdom during the 1540s. The face value of the pound in 1551 represented only one-fourth of the pre- cious metal (silver) content it had in 1542. The difference, or the financial gain, between the face (or official) value of the coined money and its actual production cost was called seigniorage, and helped the UK government to defray its expenditures.

It is interesting to note that in periods of debasement the so-called Gresham's law comes into play. Gresham's law is sometimes expressed as "bad money drives out of circulation good money". Simply put, the public will tend to hoard the good (or unde- based) money, and use the debased money for its payments. As a consequence, the bad (or debased) money remains in circulation, and the good money goes into hoarding.

Debasement is a practice easily recognizable in the case of commodity money. However, we cannot say the same thing in the case of a fiduciary or fiat monetary system, which is not directly backed by a commodity: the money in circulation is instituted as such by government. The altering of value in a fiat money system is a much more difficult practice and occurs when the money supply exceeds its demand. In this as in all cases, where supply exceeds demand, the price or (effectively the same thing) the purchasing power of money declines. In other words, the excess supply of money gives rise to an inflationary process, which, by and large, is in favour of debtors and against creditors. Since govern- ments are usually debtors, debasement might be a method for redeeming public debt.

Potentially, the process of inflation can also be set off by the fractional reserve system characterizing the operation of financial institutions. Under fractional reserves, banks can lend out more money than they have in reserves. Money supply therefore increases in a multiple way and this contains the potential for inflation, and thereby debasement. There might also be a less frequent case of debasement, namely as a result of currency redenomination, when a new unit of currency is introduced to replace an old one.

See also:

Commodity money; Fiat money; Fractional reserve banking; Gresham's law.