The Dollar Quiz: A Hands-On Approach to Monetary Debasement and Inflation

By Watts, Tyler | Journal of Private Enterprise, Fall 2011 | Go to article overview

The Dollar Quiz: A Hands-On Approach to Monetary Debasement and Inflation


Watts, Tyler, Journal of Private Enterprise


I. Introduction

A recurrent theme in monetary history is the debasement of currency by the monetary authority. Debasement is typically sought as a means of inflationary finance - a surreptitious means of raising revenue without directly taxing the citizens or expanding government deficits. Debasement can result in direct seigniorage revenue for the sovereign, who re -mints the coinage at a lighter weight, as well as an increase in the monetary base, such as occurred when President Roosevelt devalued the U.S. dollar in terms of gold, from 23.22 gold grains per dollar ($20.67 per ounce) to 13.71 grains per dollar ($35/ounce) in 1934. A commodity money such as the gold-standard U.S. dollar can only be debased so far, down to zero percent of the original commodity content; once this ultimate debasement occurs, it becomes a pure fiat money. While a fiat money cannot be debased in precisely the same sense as a commodity money can, its value can be diluted in a similar fashion by means of the printing press.

Carl Menger demonstrated clearly that money must start out as a commodity - a physical good that trades readily against all other goods (2007, 257 ff.). The most "saleable" (in modern jargon, most liquid) goods tend to become money-goods, and market competition among various money goods tends to result in those with superior monetary qualities of high value/weight ratio, durability, and divisibility - historically, gold and silver - displacing all others in commerce. All national currencies of our day thus ultimately trace their lineage back to some form of commodity money, a process Ludwig von Mises set out in his monetary regression theorem (1981, pp.129- 31). The U.S. dollar, for instance, is a direct descendant of the Spanish dollar (denominated as ocho Reales or a "piece of eight"), a large silver coin, originally established in the late 15ü century and changed very little thereafter.

The piece of eight, manufactured in Mexico and South America, circulated so widely in the North American colonies that, when it came time for the new U.S. government to set up the country's monetary standard, Congress deemed it appropriate to adopt the monetary standard represented by this ubiquitous and well-respected coin.3 The U.S. Dollar, as initially defined by the Coinage Act of 1792, was in its metallic content identical to the Spanish dollar, with a specified pure silver content of 371.25 grains. Spanish dollars continued to circulate at par with the U.S. Dollar up to 1857 (Nussbaum, 1937, pp.1059- 61), and in the early days of the U.S. republic, Spanish coinage circulated widely, especially in frontier areas.

In order to expand the money supply in a land where "scarcity of money" was a constant complaint, Thomas Jefferson and Alexander Hamilton suggested the United States establish a bimetallic standard consisting of both silver and gold dollar pieces. U.S. dollars would be available in the form of either silver or gold coin; the size of the respective coins was determined by setting the government's "mint ratio" - the relative weights of the two metals that legally constitute a dollar - at the then-current market price of silver in terms of gold, or 15:1. Because the silver dollar was specified at 371.25 grains of pure silver, the gold dollar, then, was specified at one-fifteenth that amount, or 24.75 grains of pure gold. In other words, the silver dollar would contain 1 5 times as much metal as the gold dollar.

As is always the case with a legally fixed bimetallic monetary standard, the operation of Gresham's Law ensured that, as soon as the current market price ratio of silver to gold deviated significantly from the legally fixed mint ratio, one metal would "chase" the other out of circulation. Thus the United States saw the export of its meager gold output, and a de facto silver standard, until 1834, when Congress finally got around to adjusting the mint ratio to 16:1, which was accomplished by a 6.3% debasement of the gold weight of the dollar, to 23. …

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