Sri Lanka sees Gresham's Law come alive amid high inflation

[Pat McCotter]

Sri Lanka sees Gresham's Law come alive amid high inflation
By Asantha Sirimanne

Aug 11, 2008 (LBO) - Sri Lanka is melting its coinage and minting less valuable coins amidst booming commodity prices and rising inflation at home, continuing a tradition of monetary debasement that dates back to ancient monarchies.

Central Bank Governor Nivard Cabraal says the monetary authority is cutting the cost of the coin issue by melting existing coins and re-striking new and lightweight ones.
Starting from 2006 Sri Lanka has minted a series of smaller coins out of cheaper metals with the new one rupee coin weighing 3.65 grams compared to the older one weighing 7.13 grams.

The new 50 cents coin has a diameter of 18.0 millimetres, slightly smaller than the older 25 cent coin of 18.03 millimetres.

The new five rupee coin made of brass plated steel is replacing an older more valuable whole Nickel/brass coin. The new two rupee coin of nickel plated steel is also replacing a whole Cupro/Nickel coin.

Unlike printing paper money, which has almost no intrinsic value, supplying coins is no longer a profitable business for most central banks, as the seigniorage (or profits of issuing money) is harder to come by with coins unless they are debased with cheaper alloys.

Sri Lanka's central bank together with the ministry of finance has also carried on a campaign to collect coins which were in children's piggy banks. When money is stuck in piggy banks the central bank is forced to issue more coins at additional expense.

Governor Cabraal says the campaign helped reduce the costs of the coin issue and save money that would have otherwise flowed out of the country to mint new coins.

By collecting the Nickel/brass and Cupro/Nickel coins in circulation and shipping them to the minter for melting and re-striking, Sri Lanka could now debase the coins with less valuable plated steel coins.

Base metal and precious metals and most commodities have been booming amidst unprecedented money printing in the United States, though the bubble is now running out of steam after the underlying credit bubble collapsed in August 2007.

Debasing coins has been a traditional tactic of monarchs to steal from the population secretly, before the advent of paper money central banking gave rulers an even better weapon to create inflation and impoverish the population.

The process has been formalized in monetary economics famously as Gresham's Law, named after Sir Thomas Gresham who advised Queen Elizabeth I in 1558 about the bad effects of debasing coins.

Gresham's Law which says "bad money drives out good" underscores the tendency of people to hoard good coins, and give to others in payment coins that are either damaged, officially debased, or chipped illegally and in the process driving 'good' money out of circulation.

It is also applied to the tendency to keep coins with intrinsic commodity value and to give to others paper money.

Gresham was prompted to raise the issue after the loss of confidence in British money and inflation due to the rapid debasement of coins with cheaper alloys especially during the time of Queen Elizabeth I's father, Henry VIII and half brother Edward VI.

During the time of King Edward I the English penny was reputed to have had 22 grains of troy silver. By the time of Henry VIII it was down to 10. During Elizabeth I's reign it fell to 7.8 grains, according to published data.

Food prices were said to have rocketed 75 percent at the time.

But debasement of silver coinage in particular was practiced even in Nero's time, usually to finance wars. The 100 percent silver denarius of Augustus's time was reported to have fallen to 94 percent by the time of Nero.

About 200 years later there was hardly any silver in the denarius.

In 1694 the creation of the Bank of England to finance a military adventure of King William III gave rulers the ultimate method of impoverishment and secret taxation of ordinary citizens by the creation of 'perpetual debt' backed paper money or central bank credit.

Sri Lanka's inflation hit 29.9 percent in April 2008. Sri Lanka's previous highest inflation of 26 percent, reached in 1980, when the central bank printed money to finance the biggest budget deficits in the island's history, also saw massive debasement of coins.

At the time Sri Lankan metal workers melted brass 5 and 10 cent coins, to make screws and other hardware as Sri Lankan money lost value from inflation, prompting the central bank to issue aluminum coins instead.

Sri Lanka also printed a 1,000 rupee note at the time. In the current inflation bout Sri Lanka has issued a 2,000 rupee note.

In the last twenty years many countries have brought in inflation targeting laws, restraining the monetary instruments that central banks have to inflate economies and outlawing high inflation.