Good Money Drives out Bad
A Note on Free Coinage and Gresham’s Law in Chinese Han Dynasty
Abstract
Gresham’s law has one precondition: If there is a fixed rate of exchange between bad and good money, then bad money will drive out good. We argue that when (1) there is no fixed exchange rate between bad and good money, and (2) when the government encourages free coinage, then there is a possibility for good money driving out bad. We use these two preconditions to explain why the “Sizhu” coins were successful during the reign of Emperor Wen (179-157 BC) under his free coinage policy. The analysis of metallic composition and their weights confirms that the Sizhu coins minted under a free coinage policy had better metal content than those Sizhu coins under a central minting policy.
Keywords: Gresham’s law, Sizhu coins, monetary scale, the Money Weighing Law, Emperor Wen (179-158 BC), Chinese Han Dynasty
JEL: E52, N15, N25, N45
|
Yen-liang Chen
Assistant Professor of History
National Dong Hwa University
Hualian 974, Taiwan
陳彥良harold@mail.ndhu.edu.tw |
Cheng-chung Lai (corresponding author)
Professor of Economics
National Tsing Hua University
Sinchu 30013, Taiwan
賴建誠lai@mx.nthu.edu.tw |
*This English version is based on two much longer and detailed Chinese papers, available upon request.
March 2008
1 Overview
The politically confusing Warring State Era in North China was unified by the Qin Empire (221-206 BC, 15 years) and began to be administered by a centralized bureaucratic government. The Qin Empire was more bureaucratic than any other state or empire prior to the 17th century, but it was far from completely bureaucratic—the persistence of monitoring problems prevented its full development. The monetary system was also rather unstable in this short-lived dynasty, with this chaotic situation continuing into the succeeding Han Dynasty (206 BC-221 AD).
Our story focuses on the first half of the Han Dynasty. Several emperors following Qin issued various sorts of currency, but all failed, and mainly due to counterfeiting and serious debasements in weight and fineness. To restructure the monetary problems, in April of 175 BC, the fifth year of Emperor Wen, the emperor declared two new policies: (1) a new coin named Sizhu (it means 4 zhu, where 1 zhu = 0.651 grams) to be minted; (2) the right of coinage is open to all people. This policy is called “let minting” or free coinage (“all counterfeiting crimes will be forgiven”). This successful free coinage policy during the reign of Emperor Wen set the foundation for the flourishing Wen-Jing (179-141 BC) era in the Han Dynasty.
This free coinage policy is the first and the only case in Chinese history and ran from 175 BC to 144 BC (about 30 years), before seeing a return to the conventional “central (or national) minting” policy. The Sizhu coins which were created during the free coinage period continued to be minted and circulated throughout China until 119 BC (about 55 years in total).
The analysis of the Sizhu coins’ metallic composition and their weights confirms that they were the best quality currency during the Han period. We also show that the Sizhu coins under the free coinage policy had better metal content than those under the central coinage policy. The evidence illustrated in this paper is useful to reject an old belief among Chinese historians that Emperor Wen’s free coinage policy caused monetary confusion until the central minting policy was recovered.
Why do Sizhu coins play a central role in this story? It is because Sizhu coins were issued side-by-side with the free coinage policy and continued to be minted during the period of central coinage. Hence, Sizhu coins are important samples to compare the quality of currency under two regimes. Two arguments are offered in this paper. (1) We present archeological evidence to show that the quality of Sizhu coins minted during the free coinage period is much superior to that minted during the central coinage period. (2) The successfulness of the Emperor Wen’s free coinage policy and the superiority of Sizhu coins can be explained by Gresham’s Law: when there is no fixed exchange rate among circulating coins, good money drives out bad.
In other words, when coins are free to compete, bad money will be driven out. The free coinage policy has, however, an obvious disadvantage: the government sees no important seigniorage profits. Few governments are willing to adopt free coinage mainly to due state revenue considerations.
Free coinage does not mean that anyone can mint any form of coin in any weight and fineness. The government provides standard samples for minters to follow and leaves a certain margin of profit (seigniorage) to encourage them to coin. Coiners are motivated to produce high quality products in order to “sell” more. On the one hand, if the profits are high and competition becomes knee, then the quality of products will become better and better, resulting in turn for the seigniorage profits to be less and less. On the other hand, as basic economic theory tells us, money supply will also increase until equilibrium is reached. Stated differently, under free coinage the government “sacrifices” its seigniorage profits in the hopes of seeing currencies with better quality in circulation. The government thus is freed from minting responsibility and related costs.
A brief summary is useful before going to examine archeological evidence. When private minting under a free coinage policy is legal and encouraged, the quality of money is better (due to competition), and this drives out bad money. When private minting under a central coinage policy is illegal (counterfeiting), the quality of money tends to be lower, which drives out good money and probably causes inflation. If so, then why do governments seldom adopt a free coinage policy? A simple answer: seigniorage profits will become null, and seignorage profits are too fat to let go.
2 Archeological Evidence
Table 1 is a summary from Zhou Weiron (2004): Metallic Contents of Ancient Chinese Coins. Column (a) indicates the officially “claimed” weight of coin when minted, where the basic unit is zhu (= 0.651 grams). Column (b) is the average weight of coins found in archeological sites. Column (c) is the ratio of the “actual” weight and the “claimed” weight, and it shows the degree of debasement: below 100% means the quality of coins is degraded; over 100% means the quality of coins is higher than the official standard. Column (d) is the copper content of the coin (fineness), as reported from laboratory analysis.
Column (e) is an indicator to show the cooper content of “each standardized zhu”. Table 1 compares several kinds of coin, where Column (e) is useful to compare the cooper content of each zhu in various coins. Its usefulness is shown in the last Column (f). We use the value of the first coin in Column (e) 0.43g as the base (= 100) in order to see the relative quality of other coins.
It is evident that the coins minted under Emperor Wen and Emperor Jing (179-141 BC) have the highest quality (index = 205). This confirms our claim that coin quality was significantly better under the free coinage regime, and that good money did drive out bad. Stated differently, Column (e) shows that the copper contents of coins were obviously lower under the central coinage regime. For example, the 4 zhu (Shizhu) minted during the Emperor Wen and Emperor Jing (179-141 BC) period contains 0.88g of copper, while the same 4 zhu coin minted during the Emperor Wu (140-88 BC) period contains only 0.73g of copper.
Table 1. Quality of Coins in Qin and Han Dynasties, 221 BC-221 AD
|
Date |
Official / standard weight
(a) |
Average weight of coins found
(b) |
Percentage of real weight
(c) = (b)/(a) |
Fineness of copper
(d) |
Cooper content of “each zhu”
(e)=(c) x (d) |
Index
(f) |
|
Qin (221-206 BC) |
12 Zhu
(7.81g) |
4.78g |
61.20% |
71.02% |
0.43g |
100 |
|
Early Han Dynasty
(206-188 BC) |
3 zhu
(1.95g) |
2.21g |
113.33% |
75.33% |
0.85g |
198 |
|
Empress Lü
(188-180 BC) |
8 zhu
(5.21g) |
3.85g |
73.90% |
74.12% |
0.55g |
128 |
|
Emperor Wen and Emperor Jing
(179-141 BC) |
4 zhu
(2.60g) |
2.89g |
111.15% |
79.51% |
0.88g |
205 |
|
Emperor Wu
(140-88 BC) |
4 zhu
(2.60g) |
2.33g |
89.62% |
80.94% |
0.73g |
170 |
|
Emperor Wu (118 BC) until the end of Western Han (8 AD) |
5 zhu
(3.26g) |
3.10g |
95.09% |
82.62% |
0.79g |
184 |
|
Eastern Han
(26-221 AD) |
5 zhu
(3.26g) |
2.79g |
85.58% |
84.56% |
0.72g |
167 |
Source: Zhou Weiron (2004): Metallic Contents of Ancient Chinese Coins, Beijing: Chung Hua Books (in Chinese).
We have more Sizhu (4 zhu) samples to compare their quality. First, 430 Sizhu coins minted during the reigns of Emperor Wen and Emperor Jing (179-141 BC, free coinage) were found in archeological sites, with a total weight of 1,223.15g and an average weight of each coin at 2.84g. Second, 75 Sizhu coins minted under Emperor Wu (140-88 BC, central coinage) had a total weight of 174.3g, with an average weight of each coin at 2.32g. The quality of coins again is proven to be better under the free coinage regime. Sizhu coins found in other scattered archeological sites repeat the same conclusion.
3 How to Implement a Free Coinage Policy?
In 1975 a scale for weighing money was found in a very old Han Dynasty tomb in Hubei Province, central China. According to its inscription, this scale was made in 165 BC, the 15th year of Wen Emperor. Although brief in length, the inscription reveals an important law about money-weighing. We call this the Money Weighing Law (MWL). MWL stipulated that all circulating coins should be checked with an official money scale; otherwise the user would be punished for ten days of forced labor. MWL warranted that all circulating money will be scrutinized and the consequence is clear: the bad will be separated from the good.
We have no detailed information about how the scale works, but we do know how MWL was practiced, according to a Han Dynasty document. By using the money scale, when buyers use bad money to purchase commodities, sellers will ask for more money to compensate for the unqualified coins. On the contrary, when buyers pay with good money, sellers will be asked to give more commodities to compensate for the buyers’ overqualified coins. In other words, when the money scale was backed up by MWL, there was no fixed exchange rate between good and bad money, and people had to “compensate” each other according to the quality of coins judged by the money scale. The next question is how wide or how “deep” this method was practiced in daily life. Written documents confirm that it was practiced down through the li level (a unit representing 100 households), meaning MWL was widely and daily practiced throughout the empire.
MWL is an important device for Emperor Wen’s free coinage policy. Under the first step, the government provided a standard form of money with a specified metallic content (fineness). The second step encouraged people to mint coins which must meet the minimum requirements as specified. The third step used the standard money scale as a public arbitrator, to distinguish good money from bad.
How did such a loose policy improve the quality of coins? Here, competition or the mechanism of market indeed works. As explained earlier, coiners seek the seigniorage profits that the government chose to release. As the number of competitor increase, in order to sell more coins, the quality of the coin will improve and excess profits will decrease until equilibrium reached. On the other hand, the scale for weighing money warrants that the newly minted coins must meet or exceed the minimum requirements.
4 Why Gresham’s Law Does Not Work?
Every economist knows that Gresham’s Law means “Bad money drives out good,” but this is as simple minded as everyone knows that Say’s Law means “Supply creates its own demand.” Over the past decades there have been many important journal papers reporting historical experiences of Gresham’s law in various countries, as well as debating its theoretical implications.[1]
In this section we would like to justify the theoretical possibility of “Good money drives out bad” in order to support our case. We argue that under free coinage policy and under MWL, Emperor Wen’s monetary reform was highly probable in producing high quality coins that drove out the bad ones. Limited by space, we confine ourselves to the ideas of Milton Friedman and Robert Mundell.
“Gresham’s law, … applies only when there is a fixed rate of exchange between the two. … Gresham’s law is often misunderstood and therefore misused, especially when it is applied by analogy in nonmonetary contexts, because the requirement that there be a fixed rate of exchange is forgotten.” (Friedman and Schwartz: A Monetary History of the United States, p. 27 footnote 16). In other words, the oft-observed historical experience that “Bad money drives out good” is mainly due to the existence of a precondition: the governments had fixed and enforced the exchange rates among the circulating coins, i.e. bad money should be accepted at the same value as the good.
Emperor Wen’s free coinage policy and MWL are two effective weapons to invalidate Gresham’s law. Under MWL, good coins were separated from bad, and hence there is no fixed rate of exchange. According to Friedman, therefore, bad money will not drive out good. On the contrary, good money will drive out bad, because under free coinage policy, better coins will be produced by competition among coiners, and people like to hold quality coins.
The notion that good money drives out bad has been well argued by Mundell (1998), and two passages are particularly relevant.
(1) “The usual expression of the law ‘bad money drives out good’ is a mistake. Schumpeter refers to this common definition as ‘not quite correct.’ However, as the statement stands, it is not just ‘not quite correct;’ it is quite false, but the opposite is in fact true! Standing by itself, the general statement of ‘good money drives out bad’ is the more correct empirical proposition. Historically, it has been good, strong currencies that have driven out bad, weak currencies.” (Section 2: Faulty Renderings).
(2) “Gresham’s Law, properly understood, can be a powerful tool in the hands of historians for the study of monetary history. The catchy phrase ‘bad money drives out good’ is not a correct statement of Gresham’s Law, nor is it a correct empirical assertion. Throughout history, the opposite has been the case.” (Section 12: Conclusions).
5 Bad Money Did Drive out Good Money in the Qin Empire (221-206 BC)
We have reported a counterexample of Gresham’s law in Han China, but it seems this is the only exceptional case. The “normal” version of Gresham’s law prevailed throughout the Chinese history, with the case of the ancient Qin Empire as a good example. The basic principles are similar and simple: the Qin Emperor forced people to accept all kinds of money in circulation, disregarding their quality variations. This means the state had fixed the exchange rate between bad and good money. In this case, as Friedman explained, Gresham’s law would be in operation. Moreover, the Qin Emperor had adopted a policy of central coinage, where private minting was a crime.
Let us explain its historical background. When the Warring State Era in North China was unified by the Qin Empire around 221 BC, the monetary system was in a chaotic state. Currencies issued by previous Warring States were circulating and the new empire was unable to issue a sufficient quantity of money in good quality in the near term. Under such constraints, the state stipulated that all the existing coins were legal and usable if they satisfied the following four conditions: (1) they are not seriously damaged; (2) not made with lead; (3) the inscription is identifiable; (4) the diameter is greater than 1.8 centimeters.
This is a very loose definition of currency. Moreover, nobody was allowed to refuse any money that met these requirements: “Who dares to accept money selectively will be fined for four ounces of gold.” This means the state fixed exchange rates among many kinds of coins issued by previous warring states, and of course private minting is illegal. This is an ideal environment for Gresham’s law to operate, and the result is predictable: “counterfeiting prevailed, inferior coins flooded” the nation. We have good reasons to say that Gresham’s law contributed greatly to the short-lived Qin Empire (221-206 BC).
6 Returned to Central Coinage Policy in 144 BC (Emperor Jing)
Let us come back to our Han Dynasty story. In 144 BC, Emperor Jing adopted the central coinage policy, which ended the first and only free coinage golden age in Chinese history, practiced from 175 BC to 144 BC (about 30 years). The key coin, Sizhu (4 zhu), remained the same as before. Under the pressure of state finance, the monetary system became less stable in weight and fineness: in 140 BC, the 4 zhu coin was changed to 3 zhu (less heavy); returned back to 4 zhu in 136 BC; changed back to 3 zhu again in 119 BC; and a new 5 zhu coin was minted in 118 BC. In 113 BC, Emperor Wu prohibited local governments to mint, and the right to coin by then was totally monopolized.
These quick changes and restructuring within such a short time span (140-113 BC) caused many troubles, and the quality of coins also deteriorated. In 1957-8, 10,436 pieces of 5 zhu coins were found, and many of them are still in good condition. The average weight of these 5 zhu coins decreased from 3.35g (minted under Emperor Wu, 140-88 BC), to 3.26g (minted under Emperor Zhao, 87-75 BC), and then to 3.07g (minted under Emperor Xuan, 74-50 BC, and Emperor Ping, 1-5 AD). The average weight of 5 zhu coins continued to decrease to 2.86g in the Eastern Han Dynasty. The message is clear: the quality of coins was continuously downgraded under a central coinage regime, mainly due to the pressure of state finance.
7 Concluding Remarks
We have learned of many stories about debasement under a central minting regime, and it seems that central minting is the main cause of Gresham’s law. Under public financial pressure, governments are seduced to maximize their seigniorage profits by continuous debasements, resulting in coins of various qualities. To sustain the whole monetary system, the government has to force people to accept bad and good money by fixing their exchange rates. As Friedman explained, this is the precondition for Gresham’s law to work.
On the other hand, Mundell stated: “Historically, it has been good, strong currencies that have driven out bad, weak currencies.” In this article we confirm such a view by offering a case in ancient Chinese Han Dynasty and explain why Gresham’s law did not work then. (1) Emperor Wen used the Money Weighing Law (MWL) to separate good money from bad, i.e. the government did not fix the exchange rates between bad and good coins. (2) A free coinage policy allowed coiners to compete and improve the quality of coins. This once and only free coinage era (about 30s years) set the foundation for the flourishing Wen-Jing (179-141 BC) era in the Han Dynasty.
References
Friedman, Milton and Anna Schwartz (1963): A Monetary History of the United States, 1867-1960, Princeton University Press.
Mundell, Robert (1998): “Uses and abuses of Gresham’s law in the history of money”, Zagreb Journal of Economics, 2(2):3-38. (http://www.columbia.edu/~ram15/grash.html)
Peng, Hsin-wei (1965): A Monetary History of China, Bellingham: Western Washington, 1994 (translated by Edward Kaplan, 2 volumes).
Wang, Yu-chuan (1951): Early Chinese Coins, New York: The American Numismatic Society.
Zhou, Weiron (2004): Metallic Contents of Ancient Chinese Coins, Beijing: Chung Hua Books (in Chinese).