Coin Clipping & Castration

In the centuries before William the Conqueror’s invasion, Anglo-Saxon England had one of the best economies in Europe thanks to the stability of the nation’s coinage. Her prosperity was the envy of the civilized world and this was no doubt a factor in William’s desire to take control.
By the time his descendant Henry II had reached the throne the value of the currency was fading fast. The various Mints across the country were substituting the Silver in the coin with Tin. The base metal was being removed hence the term of the coins being de-based came into being. This is a phrase that is still used for today’s money during a currency crisis.

Up until the last century, coins had a value in their own right thanks to their precious metal content whereas nowadays we simply have promissory notes. Another method of making money illicitly was to clip off the edges of many coins in order to use the silver to produce new ones, hence creating money out of thin air. The inevitable happened and during Henry II’s reign a period of inflation set in as the coins’ value dwindled and hence prices rose. In other words, in order to get the same quantity of silver in exchange for your goods, you needed to receive more coins and charge higher prices. By 1124 Henry had had enough of this abuse and summoned the various Mints to Winchester (then the capital of England) in what was called the ‘Assize of Moneyers’. Two thirds of them were found guilty of debasing the currency and either had their right hands cut off or were castrated. History does not record as to whether they were given a choice between the two options. Even this was not enough to prevent further abuses but later that century all coins were recalled and replaced by the Short Cross penny which lasted nearly 70 years in its true form.

There were effectively two elements to this debasing over the 12th Century. The first was straightforward greed of the coin makers while the second was due to a shortage of precious metals. Numerous Crusades had weakened the country while the ransom for Richard the Lionheart alone amounted to two years of England’s total tax receipts. Although his younger brother King John was later seen as a bad ruler, it was his loss of lands in Normandy 800 years ago which crystallized the decision of our very own Channel Islands to give their loyalty to the English Crown rather than the French. Moving on to modernity it is clear that our behaviour towards money has not changed a great deal. It has taken yet another conflict in the Middle East to remind investors that a modern currency debasement is occurring, this time for the US Dollar. Just as the Pope called Christendom to arms to fight the Infidel, so we now see the American President’s call to fight Worldwide Terrorism. Again, a strong missionary zeal is noticeable, which is not surprising given that the President won the recent election on the back of this traditionalist approach.

Like many other wars in the past, governments lose their financial discipline in order to win at any cost. We saw similar behaviour during the Vietnam War when the restraining influence of America’s Gold standard was abandoned, after which the financial printing presses were left on full. This then enabled them to inflate away the debts created by that conflict. The lesson from this behaviour in the past is that we are likely to see a significant fall in the Dollar in 2006, perhaps as stunning as that seen 20 years ago after the Plaza Accord. The bullish case is being made that a weaker Dollar is good for exports and hence earnings for US companies. However, a devaluation will hurt all foreign countries (other than those in Asia which enjoy the benefit of a currency peg) and will dampen demand in those very markets America is trying to export to. One consequence of similar events during the Great Depression was a round of competitive devaluations which eventually lead to trade tariffs and protectionist behaviour. In other words you would see a reversal of globalization which up until now has helped to smother inflation.

My best take on the near term is that we will see a surge in Gold prices, as the Dollar weakens significantly. As ever, currency devaluation leads to a rise in inflation coupled with a rise in interest rates. Americans will start to save and stop their spending binge, which has effectively kept the world afloat for the last few years. This has significant knock on effects for all of us so we should aim to reduce our investment risk profile over the next 12 months and make capital preservation a priority over capital growth. The good news for investors is that they can make money from Gold which is just entering its intermediate phase of a bull market. They can also look to buy bonds if we see a large rise in yields as these will appreciate significantly if we do indeed enter a period of retrenchment in the USA.

It should be remembered that since the creation of the America’s central bank in 1913 (the US Federal Reserve), the Dollar has lost some 94% of its purchasing power. While we do not have ability to subject today’s central bankers to medieval mutilation, there will no doubt be some kind of retribution for government profligacy and mass production of money. It may have been done with good intentions to stave off the effects of the burst Internet bubble and the shock of 9/11. However, we must learn from history that bankers cannot beat business cycles and attempting to do so will only make matters worse.

Toby Birch
October 2005