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The “Kipper- und Wipperzeit” and the Foundation of Public Deposit Banks∗

Isabel Schnabel Max Planck Institute, Bonn

Hyun Song Shin Princeton University

November 2006

Abstract

The “Kipper- und Wipperzeit”, one of the most severe hyperinßa- tions in the time of commodity money, gave rise to the foundation of the famous public deposit banks, such as the Bank of Amsterdam and the Bank of Hamburg. We show that the combination of asymmetric information between trading parties about coin values and imperfectly ßexible exchange rates promotes Gresham’s Law and helps to explain the spread of debasements across the regions of the Holy Roman Em- pire, following trade itineraries. We then argue that the deposit banks mitigated monetary disturbances by making the value of money com- mon knowledge. In this sense, the banks may be thought of as early precursors of modern central banks. JEL: E42, E58, N13. Keywords: Gresham’s Law; debase-

ment; common knowledge; central banks.

1 Introduction

Shortly after the beginning of the Thirty Years War (1618—1648), the small

German states and neighboring principalities that comprised the Holy Ro-

man Empire experienced one of the most severe economic crises ever recorded,

∗We thank Charles Goodhart, Timothy Guinnane, and Hendrik Hakenes for useful discussions.

with rampant hyperinßation and the breakdown of trade and economic ac-

tivity. The crisis became known as the “Kipper- und Wipperzeit” (i.e., the

clipping and culling times), named after the practice of clipping good coins

and sorting good coins from bad.

Episodes of currency debasement are common throughout history, but

the Kipper- und Wipperzeit stands out for two reasons. The Þrst is the

severity of the crisis and its regional spread. The debasement proceeded at

such a pace that the public authorities quickly lost control of the downward

spiral. Unlike many episodes of currency debasement in which the sovereign

engineers a controlled debasement so as to generate revenue, the Kipper-

und Wipperzeit gives all the impressions of an uncontrolled “race to the

bottom” in which the debasement gathers momentum and takes on a life of

its own. The crisis spread from one state to another, and even spilled over

to neighboring states such as Poland.

The second reason why the Kipper- undWipperzeit stands out from other

episodes is because it coincided with the establishment of some of the most

important public deposit banks. The famous deposit bank of Amsterdam

was established already in 1609 when the currency debasement was still mild,

compared to later years. The German deposit banks, the bank of Hamburg

(founded in 1619) and the Banco Publico of Nuremberg (1621), were estab-

lished at the height of the crisis. The public deposit banks issued a notional

currency called “bank money” that was backed by holdings of gold and silver

coins, and set up a cashless payments system in which transactions between

account holders were settled by transfers from one account to another in

terms of the notional currency.

The potential relationship between the currency disturbances and the

foundation of deposit banks has been remarked upon by Adam Smith in

his Wealth of Nations. He argued that the foundation of deposit banks

was a response to the monetary disturbances of the time (see his “Digression

concerning Banks of Deposits, particularly concerning that of Amsterdam”):

“Before 1609 the great quantity of clipt and worn foreign coin,

which the extensive trade of Amsterdam brought from all parts

of Europe, reduced the value of its currency about nine per cent

below that of good money fresh from the mint. Such money no

sooner appeared than it was melted down or carried away, as

it always is in such circumstances. The merchants, with plenty

of currency, could not always Þnd a sufficient quantity of good

money to pay their bills of exchange; and the value of those bills,

in spite of several regulations which were made to prevent it,

became in a great measure uncertain.

...

In order to remedy these inconveniences, a bank was established

in 1609 under the guarantee of the city.”

To the extent that public deposit banks succeeded in maintaining the

soundness of the currency, they have a good claim to being the early precur-

sors of the modern central banks.1 In seeing the origin of central banks in

these early public deposit banks, our view differs from the conventional view

(as argued, for instance, by Charles Goodhart (1988)) that central banks

were established as a way for the state to Þnance wars. Hence, the ability to

lend is typically seen as the crucial characteristic of central banks. Goodhart

1This view is in line with other research that has pointed to early deposit banks as precursors of modern central banks. For example, Kohn (1999) and Fratianni and Spinelli (2006) have pointed to the Venetian public deposit banks as predecessors to the Bank of England.

also argues that central banks initially did not play a catalytic role in the

development of the Þnancial system and the economy more broadly.

In contrast, the public deposit banks of the early 17th century initially

were not supposed to engage in lending; their main function was to provide for

a payment and clearing system. In fact, the banks did also engage in lending

to the state, although to different degrees. However, this was against the

ideas of the original founders, and conßicted with the banks’ other functions.

One extreme example was the Banco Publico of Nuremberg, which engaged

in lending to the City from the very beginning even though this was against

the bank charter. Interestingly, this bank was also far less successful than

the banks of Amsterdam and Hamburg. Due to its meagre deposit base, it

never managed to establish its bank money as a major means of payment.

Besides preserving the soundness of the currency, the Banks of Amsterdam

and Hamburg played crucial roles in promoting the institutions that underpin

Þnancial innovation and economic development (see, for instance, Schnabel

and Shin (2004) on the role of the public deposit banks in promoting trade

and credit).

Indeed, the economic performance during the Kipper- und Wipperzeit

of those regions that successfully established public deposit banks, namely

Hamburg and the Netherlands, appears to have been much better than that

of other regions. One may even speculate that the following rise of Amster-

dam and Hamburg as the economic and trade centers of Northern Europe

may have been related at least partly to innovations in the Þnancial sector,

stimulated by the foundation of public deposit banks. In this respect, our

paper has some bearing to the debate on the relationship between Þnancial

institutions and growth.

The precise manner in which the public deposit banks were successful in

accomplishing this stabilizing role is a matter that deserves further study,

since it gives valuable insights both into the way in which currency debase-

ments take place, and how public deposit banks may arrest such debasements.

Kindleberger (1991, 1999) is one of the few scholars who have commented on

the potential relationship between the currency disturbances and the foun-

dation of public deposit banks, an aspect neglected in much of the historical

literature on the “Kipper- undWipperzeit.” However, even Kindleberger does

not explain the mechanism by which the deposit banks were able to solve the

problems of the time. The existing literature on deposit banks mentions the

inßation only incidentally.

In this paper, we will argue that public deposit banks played a key role

in establishing common knowledge in monetary transactions. Commodity

money (typiÞed by coins minted from precious metals) is a prime example

of an asset plagued by problems of informational asymmetries, especially

in times of frequent devaluations. Such informational problems constitute

a severe impediment to the efficiency of exchange. Hence, our paper is

related to the theoretical literature dealing with the question of how trade can

be facilitated in the presence of informational asymmetries regarding asset

values. Our argument rests on the potentially corrosive effects of incremental

erosion of the precious metal content of circulating coinage when two parties

to a transaction do not have common knowledge of the values underpinning

an exchange.

In order to argue for a rationale for public deposit banks, we Þrst provide

a formal model of the incremental debasement of currency, and provide an

analysis of the circumstances that validate “Gresham’s Law.” Gresham’s

Law is commonly stated as the principle that bad money drives out good:

When two similar commodity monies circulate concurrently, and one is infe-

rior to the other in terms of intrinsic value (e.g., in metallic content), then

the inferior money will continue to circulate, but the superior money will be

gradually withdrawn from circulation, and hoarded for melting down or for

export. However, the simple statement of Gresham’s Law begs a number of

questions.

One important question is why the market rate of exchange between the

inferior and superior monies does not adjust so as to take into account the

different intrinsic value of the two currencies. Once the prices adjust in this

way, and a fair rate of exchange is established, then both currencies would

circulate, but at prices that reßect the fair premium or discount. Indeed,

Rolnick and Weber (1986) cite several historical episodes from the United

States and Britain where precisely such an adjustment happened. An un-

resolved question in the literature is why there are episodes where currency

debasements lead to a “race to the bottom” (such as in the Kipper- und

Wipperzeit) and others where the currencies of different qualities circulate

concurrently at fair rates of exchange.

Our model of the Kipper- und Wipperzeit stresses several features of the

political and institutional landscape of the time that we believe proved to be

a fertile environment for the “race to the bottom.” Two key features stand

out:

• the political fragmentation of the states within the Holy Roman Em- pire, and the associated fragmentation of minting activities across the

states, and

• the “international” nature of the trade within the Holy Roman Empire, where the trade in goods and money were conducted across jurisdic-

tions.

The Þrst bullet point refers to the fact that, in spite of the attempts

to harmonize minting across the Empire, it remained in the realm of the

regional princes to mint their own coins.2 The minting of coins was not only

an element of sovereignty, but also an important part of the states’ revenues

in the form of seignorage. The fragmentation of minting was responsible

for the large variety of coins circulating within the Empire. Through trade,

the different coins would spread across regions. In our model, we assume

that traders within a particular jurisdiction would be more familiar with

the differing qualities of coins produced within their own jurisdiction, but

would have less familiarity with the heterogeneity of coinage produced in

other regions. In this sense asymmetric information lies at the heart of our

story, akin to Akerlof’s (1970) “lemons” problem. However, the nature of

the asymmetric information differs from the original “lemons” problem in

that the asymmetric information would apply equally to both sides of the

transaction. That is to say, one side has better information about his own

coins than the other side; but no one has an absolute advantage over the

others. In this sense, the asymmetric information applies “symmetrically.”3

We argue that public deposit banks removed monetary uncertainty and,

hence, enhanced the efficiency of trade. The role of monetary uncertainty

in trade has already been analyzed by Chwe (1999). He argued that the

expected utility from trade may be maximized by making the value of money

common knowledge. As an example, he mentions the introduction of “reeded

edges,” which prevented the “clipping” of coins and made their value publicly

2A similar problem existed in the United Provinces, although to a lesser extent (van Dillen 1934, p. 81).

3Of course, we are not the Þrst to provide an explanation for Gresham’s Law based on asymmetric information. As well as Akerlof’s (1970) original contribution, Aiyagari (1989), Banerjee and Maskin (1996), and Velde et al. (1999) have presented asymmetric information models of Gresham’s Law.

veriÞable. However, the technological prerequisites for the production of such

coins were quite high and became common only towards the end of the 17th

century, i.e., well after the foundation of the deposit banks (Sargent and Velde

2002, p. 270).4 The foundation of deposit banks in the beginning of the 17th

century may have been another way of making the value of money common

knowledge. By pooling good coins and creating a notional currency, these

banks created common knowledge among traders about the value of coins.

One interesting question concerns the role of the government in this process.

In the model by Gorton and Penacchi (1990), banks mitigate inefficiencies

by making asset values informationally insensitive; however, under certain

conditions, the government has to intervene to ensure efficient trading. The

public guarantee of the early deposit banks may have played a similar role.

The paper proceeds as follows: After brießy summarizing the existing lit-

erature on the Kipper- und Wipperzeit, we describe the history of the crisis.

Then we present the institutional details on the deposit banks founded in

Amsterdam and Hamburg. In the subsequent section, we present a theoret-

ical model that describes how two-sided asymmetric information about coin

values promoted Gresham’s Law and the spread of the debasements across

regional borders; we then show how a public deposit bank could increase the

efficiency of trade by reducing informational asymmetries and making the

value of coins common knowledge. Finally, we draw some comparisons to

modern economic issues, such as the role of central banks in stabilizing the

currency, and the relationship between Þnancial institutions and growth.

4The common technology used for coin production at the time in Germany was the cylinder press (“Walzenprägewerk”). The screw press (“Spindelpresse”), with which milled edges could easily be produced, had already been invented, but was not in use at the time due to the opposition of the mint masters (von Schrötter 1930).

2 Existing literature

There is an extensive historical literature on the “Kipper- und Wipperzeit”

(mostly in Dutch or German), whereas the economic aspects of the crisis

have hardly been analyzed. A notable exception are two insightful papers by

Kindleberger (1991, 1999), who was the Þrst to stress the regional spread of

the crisis across different regions. He argues that the simultaneous severe

debasements in many states could not be considered as independent events,

but that the crisis propagated from one region to another. In contrast, the

historical literature has tended to focus on those regions or towns that were

affected most by the crisis and has neglected the potential propagation across

regional borders; there is no comprehensive analysis comparing the evolution

of different regions of the Empire.5 Kindleberger (1991) argues that the

crisis spread through Gresham’s Law. However, most of the theoretical

literature on Gresham’s Law focuses on gradual erosion of coin values within

one country. We have not found any article dealing with the spread of a

devaluation across regions.

There also is an extensive literature on public deposit banks whose institu-

tional features are well-documented. Van Dillen (1934) and Soetbeer (1866,

1867) have authoritative treatments of the foundation and institutional de-

tails of the Bank of Amsterdam and the Bank of Hamburg, respectively.6

Poschinger (1875) describes the foundation of the Bank of Nuremberg in

5See Wuttke (1894) on Saxony (Kursachsen), Schöttle (1921) on Upper Swabia, Wagner (1940) on Erfurt, Ernstberger (1954) on Bohemia, Gaettens on Lower and Upper Saxony, Bogucka (1975) on Poland, Altmann (1976) on Bavaria, Schneider (1981) on Hamburg, Schneider (1991) on Frankfurt, and Weisenstein (1991) on Trier. For more general treat- ments, see Opel (1866), Freytag (1888), Gaettens (1955), Redlich (1972), Rittmann (1975), North (1994), and Sargent and Velde (2003).

6See also Adam Smith (1776 [1991]) and Baasch (1927) on the Bank of Amsterdam, and Büsch (1790), Levy von Halle (1891), Sieveking (1934), and Pohl (1986) on the Bank of Hamburg.

great detail. Interestingly, the literature on deposit banks is largely discon-

nected from the literature on the crisis. While stating that the foundation of

deposit banks was a response to the monetary disturbances of the time (e.g.,

van Dillen 1933, p. 80), none of the sources tries to explain the economic

rationale for the bank foundations. Again it was Kindleberger (1991, 1999)

who Þrst analyzed the potential relationship between the currency distur-

bances and the foundation of public deposit banks. But even Kindleberger

is largely silent on the mechanism by which public deposit banks were able

to deal with the monetary disturbances.

In this paper, we will try to Þll these gaps in the literature by

1. proposing a stylized model of the process by which the devaluation of

coins spread across regions, and

2. explaining how the public deposit banks were able to mitigate the mon-

etary disturbances.

We will start by describing the major features of the crisis, as well as the

major characteristics of deposit banks.

3 History of the crisis

3.1 The Augsburg imperial mint ordinance

In 1559, the Holy Roman Empire sought to harmonize its coinage system

by issuing the Augsburg imperial mint ordinance (“Reichsmünzordnung”).7

According to this decree, minting was to be carried out by a selected group

of princes maintaining a limited number of mints. Mints could not be sold

7Note that the mint ordinance did not apply to the Netherlands, Switzerland, and some of the Western border regions (Schneider 1981, p. 48).

or leased. The export of domestic money or silver was prohibited, and the

amount of foreign coins limited. The intrinsic content of coins was Þxed

throughout the denomination structure; even small coins were full-bodied.

The alteration of coins was to be punished by the death penalty. The super-

vision of minting was delegated to the Imperial Circles who employed coin

inspectors (“Kreiswardeine”) and who organized regular “probation days”

where inferior coins were declared void. The mint masters who were respon-

sible for the production of inferior coins were to be punished. The ordinance

put the Empire on a bimetallic standard: The largest coins (“Dukaten”) were

in gold, whereas all the other coins were in silver.

However, the mint ordinance was inherently ßawed. Given the higher

costs of producing subsidiary coins, the minting of small coins proved to

be unproÞtable. The official mints stopped producing small coins, which

led to a shortage of small change. As small coins were needed for daily

transactions, some unauthorized mints (so-called “Heck(en)münzen”) started

to mint inferior coins which allowed for at least some seignorage proÞt. The

strong increase in the number of mints put pressure on the price of silver,

which induced the mints to reduce the silver content of coins even further.

Later even the official mints started to take part in the coins business. The

coin supervision proved to be little effective (Schneider 1981, pp. 48—49),

and the prohibition of coin adulteration does not seem to have been enforced

at any time.

3.2 Creeping debasement of small coins

The increasing circulation of debased subsidiary coins implied a creeping in-

crease in the price of large coins (which still largely were full-bodied) in terms

of small coins. Average over the Empire, the Reichstaler increased between

1582 and 1609 from 68 to 84 Kreuzer, a devaluation of the Kreuzer of one

Þfth (Shaw 1895, p. 103). The process was fueled by the looming war, which

induced the princes to prepare a war chest by increasing seignorage revenues

and set the stage for the following hyperinßation. One of the extreme cases

was the Duke of Braunschweig—Wolfenbüttel. In 1617, he ordered to coin 210

Groschen from one Mark silver compared to 110 according to the ordinance.

By 1621, this number went up to 330 Groschen, implying a decrease of the

silver content by two thirds. More and more states started to violate the im-

perial mint ordinance. The bad money also spilled over to regions not issuing

adulterated coins, not only within the Empire, but also across its borders,

e.g., to the Netherlands.

3.3 Hyperinßation and the “Kipper- und Wipperzeit” (1619-1623)

In 1618, the defenestration at Prague marked the beginning of the Thirty

Years War. The war still increased the princes’ need for revenues, setting

the stage for the following hyperinßation. By 1621, the coin standard had

been decreased from 9 1/2 Gulden per Mark silver (as prescribed by the mint

ordinance) to 46. The most spectacular deal was concluded in 1622 when a

coin consortium led by the banker Hans de Witte from Prague, and including

such famous people as Albrecht vonWallenstein, leased all mints in Bohemia,

Moravia, and Lower Austria from the Emperor. At the same time, they were

granted a monopoly for silver purchases and coin production in those areas.

This silver was to be coined at a standard of 79 ß. (Gulden) per Mark, which

was way above the current standard (46 ß.). In fact, the consortium diluted

the standard even more. Wallenstein and the other members of the consor-

tium are said to have become rich by this deal, which allowed Wallenstein

to Þnance its own army during the war without any problems. In addition,

the Emperor himself earned an amount of 6 million ß. from the lease, which

was six times his former revenue from Bohemia, including the revenue from

minting.

Similar actions were observed in other parts of the Empire, where new

mints sprang up “like mushrooms after a warm rain”.8 To provide for a suf-

Þcient supply of silver, the mints employed subcontractors who went buying

old coins with higher silver contents (paying with debased money at increas-

ing prices) to bring them to the mint to receive larger amounts of debased

coins, bearing the same nominal values. These people were later to be called

the “Kipper und Wipper”.

The initial effect of the enormous monetary expansion was an economic

boom. However, eventually, prices started to increase rapidly, and the initial

boom turned into a crisis. By now, many of the new coins were made almost

entirely of copper.9 The increasing scarcity of copper even led people to

bring their pots and pans to the mints. At some point, trade and business

stagnated almost completely. Craftsmen and farmers were no longer willing

to sell their services and products for worthless money. Tax revenues also

ran dry, as taxes were paid in copper money. The skyrocketing of prices was

followed by riots in many big cities, which were often directed against the

money changers rather than the sovereigns who were often just as responsible

for the depreciation. At the beginning of 1623, when people were no longer

willing to accept the worthless money, one mint after the other ceased its

operations. This also slowed down the inßation.

8Langer (1978, p. 30) as cited in Kindleberger (1991, p.160). 9Redlich (1972, pp. 11) claims that the Empire was de facto on a copper standard.

3.4 Stabilization

Since 1622, the authorities tried to reorganize the coinage system. One state

after the other returned to the old mint ordinance. The Kipper coins were

invalidated and could be sold at a price corresponding to their silver con-

tent, which often was negligible. This price was between 75 and 100 percent

below the nominal value. The old coins were melted and recoined, often at

a substantial loss for the public authorities (who had to bear the minting

costs). The economic consequences of the inßation have not been explored

satisfactorily. However, there seems to be a consensus that the performance

of states was very heterogenous.10 In particular, the depreciation in the

Northern states, especially in the Hanseatic cities and also in the Nether-

lands, appears to have been much lower than in the Southern and Eastern

states.11 The course of the Reichstaler rose from 1 ß. 32 Kr. in 1618 to 6

ß. in 1622 (i.e., the value quadrupled) when averaged over different states of

the Empire (Shaw 1895, p. 103).12 A much larger increase was observed in

speciÞc regions: For example, the Reichstaler climbed to 7 ß. in Frankfurt,

10 ß. in Southern Germany, 11 ß. 15 Kr. in Bohemia, and 15 ß. in Electoral

Saxony (“Kursachsen”) and Nuremberg, compared to the official standard

of 4 ß. 30 Kr. (North 1994, pp. 104, 106, Kindleberger 1991, p. 158). In

contrast, in Hamburg the course of the Reichstaler started from 44 schilling

in 1618, reached its peak at 54.5 in 1621, and then dropped to 48 in 1622

(Soetbeer 1866, p. 28); this amounts to an increase of “only” 24 percent

up to the peak. Interestingly, the depreciation before the foundation of the

deposit bank had been higher than average: 33 percent in Hamburg versus

10 percent averaged over the Empire. North (1994, p. 106) has argued that

10See, e.g., North (1994, pp.101, 106). 11Schneider (1981). 12Note that 1 ßorin equals 60 Kreutzers.

the geographical proximity to strongly or weakly affected areas was one im-

portant determinant of the degree of the depreciation. If we believe in the

gravity formulation of international trade, then trade ßows among geograph-

ically close areas would have been larger than among distant ones. Hence,

the observation that geographically close regions had similar depreciation

rates may be seen as evidence that the depreciation spread through trade.

In fact, this will be one idea underlying our theoretical formulation.

4 Public Deposit Banks

The foundation of the major deposit banks of Northern Europe coincided

with the monetary crisis. The Bank of Amsterdam was the Þrst in 1609,

followed by banks in Middelburg (1616), Hamburg (1619), Delft, and Nurem-

berg (both 1621). We are mostly interested in the banks of Amsterdam and

Hamburg because they are the ones that became most famous and inßuen-

tial in the centuries to come. However, we will also consider the Bank of

Nuremberg because it is located in an area that was affected more severely

by the crisis than the other places. Interestingly, the bank was also far less

successful than the others.

4.1 The Bank of Amsterdam

The Bank of Amsterdam was founded in 1609 as a publicly guaranteed de-

posit and giro bank.13 It is well established that the bank was modeled on

the Venetian Banco della Piazza di Rialto (founded in 1587), but the goal of

its establishment was quite different: In Venice, the bankruptcy of the pri-

13The classic description of the functioning of the Bank of Amsterdam is the one by Adam Smith (1776) in his ”Digression Concerning Banks of Deposit, Particularly that of Amsterdam” (pp. 421). A more recent exposition can be found in van Dillen (1934, pp. 79).

vate deposit banks caused by excessive lending had led to the establishment

of a public bank; in Amsterdam, it was the monetary confusion that led to

the bank foundation.14

The Bank of Amsterdam functioned as follows: Coins could be deposited,

and the respective amount would be credited in an imaginary currency, called

bank money. Bank money could be transferred to somebody else’s account

by assignment, avoiding the costs and pain of transferring the coins directly.

Importantly, the quality of coins would be assayed at the time of deposit to

ensure that only full-bodied coins would enter the bank. This was to provide

for a stable relationship between bank money and “good” commodity money.

In contrast, circulating money could be worn, clipped, or debased, implying

a high degree of uncertainty in transactions involving circulating coins. As

a consequence, bank money most of the time bore a premium (called agio)

compared to the circulating money. One reason for this were the quality

differences between deposited and circulating coins, but it was probably also

due to a reduction in uncertainty, which made the bank money very valuable

for the merchants.15

It does not come as a surprise that the deposit banks evolved in the major

trade centers of the time. In trade, monetary uncertainty was particularly

harmful because foreigners would be even more sceptical regarding the value

of coins. In fact, the foundation of the deposit bank in Amsterdam had been

preceded by private initiatives of merchants who deposited full-bodied coins

at cashiers and established a cashless payments system among the participat-

ing merchants. However, such activities were soon prohibited; the fear was

that good coins would be withdrawn from circulation, thereby accelerating

14See van Dillen (1934, pp. 80, 85), Kohn (1999), and Fratianni and Spinelli (2006). 15According to Adam Smith (1776 [1991], pp. 421, 426), the typical agio was around 5

percent in Amsterdam, and 14 percent in Hamburg.

the depreciation of the currency (Soetbeer 1866, p. 24). At Þrst, the idea

of a bank was looked at with the same suspicion by the general public, and

it was only due to the merchants’ insistence that the bank ever came into

existence.

Originally, the Bank was no fractional-reserve bank; the creation of bank

money was, at least de jure, strictly limited by the amount of gold and silver

in the bank’s vaults. The credibility of this arrangement relied substantially

on the ability of the bank to commit to not dilute the value of the bank

money. The bank had several provisions in this respect: First, the bank

beneÞted from a government guarantee. Second, the bank was controlled by

the merchants themselves who had a clear interest in monetary stability.

The credibility was decreased somewhat by the creation of a lending bank

in 1614, which was created primarily to extend loans to the public authorities,

but also to extend lombard loans against collateral, mostly coins and bullion.

Note that the bank also allowed for the creation of money through the

writing of bills of exchange, which were crucial in international payment

transactions. Any account holder could write bills in terms of bank money.

In fact, the bank law prescribed that bills of exchange above a certain amount

had to be paid in bank money. This possibility of money creation provided

an additional threat to the stability of bank money. There was no mechanism

to prevent account holders from writing huge amounts of bills on the basis

of their bank accounts.

However, in spite of these limitations, Amsterdam bank money soon

emerged as the key currency in international Þnance.The legendary repu-

tation of Amsterdam bank money — which was not always justiÞed — was

fostered by the huge stocks of precious metals in Amsterdam, which arose

from the city’s dominating position in the bullion trade (Baasch 1927, pp.

215). Only in very few instances, the stability of the bank money appears to

have been questioned.

4.2 Other deposit banks

Similar institutions developed elsewhere, most notably in Hamburg whose Þ-

nancial institutions were almost one-to-one copies of the ones in Amsterdam

(Soetbeer 1866, p. 23). As in Amsterdam, the giro bank was comple-

mented by a lending bank, and the city became the largest debtor from the

very beginning; in contrast, loans to private agents initially were negligible

(Sieveking 1934, p. 129). However, the bank’s lending activities may not

even have been known to the merchants or the general public as the bank’s

books were kept secret. The bank’s success can be inferred from its rapid

growth: Between 1621 and 1655, the bank’s total assets increased from 832

thousand Marks to 3,506 thousand Marks (Sieveking 1934, pp. 129, 131).

The “Banco Publico” of Nuremberg was the only public deposit bank that

was founded in the southern part of the Empire. Its foundation was again

motivated by the monetary disturbances, and again it was the merchants who

pleaded for the bank’s foundation. Most of its provisions were adopted from

the Bank of Hamburg, with one major exception: Deposits could be made

not only in full-bodied, large coins, but also in current small money, both

domestic and foreign (Poschinger 1875, p. 21). Although this arrangement

was later removed, it reduced the bank’s credibility from the beginning: It

implied that the uncertainty of the value of bank money was not removed

because part of the bank’s coins was possibly less valuable than determined in

the mint decree. In addition, it appears that the bank extended loans to the

public authorities from the very beginning, even though this was prohibited

by the bank’s statutes. In 1623, such loans amounted to almost one third

of the bank’s total assets (Poschinger 1875, p. 36). The abuse became

even worse in later years when the bank’s vault was virtually plundered

by the city’s officials such that the bank was sometimes not even able to

repay deposits on demand (North 1994, p. 117, Poschinger 1875, p. 29).

Against this background, it is not surprising that the bank’s total assets

decreased sharply in the early years after the bank’s foundation. Other than

in Amsterdam and Hamburg, the volume of the bank’s deposits remained

too small to establish a widely used bank money for trade transactions.

4.3 Performance of public deposit banks

There are different views on the success of the public deposit banks. Early

writers like Adam Smith appear to have admired institutions like the Bank of

Amsterdam. Kindleberger (1991) also describes the banks as having been a

success. In contrast, van Dillen (1934) is more sceptical, especially regarding

the ability of the banks to mitigate the monetary disturbances: “The irony

of history. . . would have it that . . . the world-famous institution [the Bank

of Amsterdam] was not to succeed [in improving monetary conditions].” Van

Dillen’s judgment appears to be based on the observation that the devalua-

tion of the currency was not stopped completely. Given that bank money

was only used in wholesale transactions, this may not come as a surprise.

Also, it should be noted that the debasement in Amsterdam and Hamburg

was much smaller than in other places that did not have a public deposit

bank.

Other than the Banks of Amsterdam and Hamburg, the Banco Publico of

Nuremberg clearly seems to have failed in its goal of establishing monetary

stability. This seems to have been caused by serious ßaws in the bank’s

organization: First, the deposit of coins had not been limited to full-bodied

coins; second, the bank was not able to escape the grasp of the public au-

thorities on its vault, which diminished its credibility. The same problem

also loomed at the other banks when the giro banks were supplemented by

lending banks. Thereby, the banks de facto became fractional-reserve banks

and became vulnerable to bank runs; in fact, such runs occurred recurrently

in the later history of the banks, and were countered by the banks’ temporary

closure (similar to the “suspension of convertibility” discussed in the bank

run literature; see Diamond and Dybvig 1983). Also, similar to the Bank of

Nuremberg, the Bank of Hamburg was repeatedly abused as Þnancier of the

state — though not to the same extent.

5 Toward a Theory

5.1 Issues

In order to show how the public deposit banks removed the uncertainty

regarding coin values and thus arrested the debasement, we need a model

describing how such debasements came about. As we stressed above, the

Kipper- und Wipperzeit was special in that the debasement was not limited

to single states, but spread from one state to another. Kindleberger (1991,

p. 149) argues that “the process spread through Gresham’s Law: bad money

was taken by debasing states to their neighbors and exchanged for good.

The neighbor typically defended itself by debasing its own coin.”

5.1.1 Circulation by weight versus circulation by tale

As was indicated above, the applicability of the simple version of Gresham’s

Law — that bad money drives out good — is, however, a matter of considerable

controversy. The most important question is why different types of coins

would not circulate at an exchange rate reßecting their intrinsinc values (what

is called “circulation by weight”). One strand of the literature argues that

the exchange rate between the two monies is Þxed (so-called “circulation

by tale”), for example, due to legal tender laws, mint exchange policies, or

conventions (see, e.g., Sargent and Wallace 1983, Sargent and Smith 1997,

and Li 2002). However, Rolnick and Weber (1986) argue that such a stance

is untenable, both from an institutional and empirical point of view. Indeed,

Rolnick and Weber cite several comparatively recent historical episodes from

the United States and Britain where different types of coins circulated side

by side at a ßoating exchange rate. For instance, during the early 19th

century in the United States, both the U.S. silver dollar (containing 371.25

grains of silver) and the Spanish milled dollar (with 373.5 grains) circulated

concurrently, with the Spanish dollar circulating at a premium over the U.S.

dollar, with the premium ranging from 0.25 percent to 1 percent. But the

occasional circulation of coins according to their intrinsic values does not

exclude the possibility that there were deviations from the circulation by

weight at other times. In fact, we will see that such deviations are important

to understand the observed spread of debasements across regions.

The other strand of the literature on Gresham’s Law is based on the as-

sumption of asymmetric information about coin values, generating a problem

akin to Akerlof’s lemons problem (see, e.g., Aiyagari (1989), Banerjee and

Maskin (1996), and Velde, Weber and Wright (1999)). Commodity money

has always been plagued by problems of asymmetric information because

the intrinsic value of coins, and especially their Þneness, could be checked

only at relatively high costs. The technologies used to assay the Þneness

of coins have been described in some detail by Gandal and Sussman (1997,

pp. 443—444):16 The most common, but relatively crude technology was the

16See also the relevant entries in von Schrötter’s coin dictionary (“Strichprobe,” “Kup- pellenprobe”).

“touchstone test,” in which the trace from rubbing a coin on a special stone

was compared with that left by a metal of a known Þneness. A higher pre-

cision could be obtained only by the assaying by Þre (essentially the melting

down of the coin), which was much more costly and implied a loss of the coin

itself.

In our model, we will follow the literature in assuming that traders are

imperfectly informed about the quality of coins offered to them in an ex-

change. In contrast to the existing literature, we consider a situation of

two-sided asymmetric information where each side has better information

about its own coins than the other side, but no one has an absolute advan-

tage over the other. More precisely, we assume that money traders within

a particular jurisdiction can perfectly observe the quality of coins produced

within their own jurisdiction, while they can make only coarse distinctions

between foreign coins of differing qualities. The idea is that foreign mer-

chants have to rely on something like the touchstone test, while domestic

merchants are more familiar with the quality of coins, due, for example, to

the ßow of information from near-by merchants who have conducted the more

rigorous “assaying by Þre.” This informational assumption Þts nicely a situ-

ation where minting activities are fragmented across states, as was the case

in the Holy Roman Empire, and will help to explain how the debasement in

one state could spread to other states.

5.1.2 Debasements

The monetary system worked on the principle that individuals could bring

metal to the mint (controlled or authorized by the sovereign) to be made into

new coins; this is often referred to as “free minting” or “free coinage” (see,

e.g., Redish 1990, Sargent and Velde 2003). In such a system, the quantity

of coins minted is determined by the public’s decision to bring silver or gold

to the mint. The sovereign determines the prices at which minting is taking

place by setting the mint equivalent and the seignorage rate (see Redish 1990,

Sussman 1993, Sargent and Velde 2003): The mint equivalent (or mint par)

was the value of a given weight of precious metal in terms of the numeraire

currency; it depended on the number of coins struck from the metal, on their

Þneness, as well as on their nominal value. A certain fraction of the minted

coins — the (gross) seignorage rate — was kept by the mint to cover minting

costs (brassage) and the seignorage tax. The seignorage tax went to the

sovereign and constituted an important Þscal revenue, especially in times of

war. Hence, the price at which precious metal could be sold at the mint —

the mint price — was below the mint equivalent, implying that the minting of

new coins was a costly activity for the individual who brought in the metal.

The sovereign could debase his coinage in three different ways (see Suss-

man 1993): First, by increasing the number of coins struck from the alloy,

which would alter the coins’ weight and could, therefore, be detected with a

scale; second, by increasing the coins’ nominal value, which was even more

transparent; and Þnally, by changing the coins’ Þneness, the detection of

which required rather sophisticated technologies, as was described above. In

addition, coins could be clipped by the general public, which would again

change the coins’ weight and could, therefore, be detected by using a scale.

In the model, we will focus on debasements where the sovereign changes the

coins’ Þneness, even though other kinds of debasements were also observed

in the considered time period.

The new (debased) coins could enter the circulation not only when fresh

bullion was minted, but also when old coins were re-minted. Rolnick, Velde,

and Weber (1996) point out some telling empirical regularities associated

with debasements. Seignorage rates tended to be high during episodes

of currency debasement, leading to substantial revenue for the sovereign.

However, these periods also saw very large volumes of (re-)minting activity.

Rolnick et al. (1996) report that, between 1285 and 1490, France had 123

debasements of silver coins, 112 of more than 5%. In normal years, govern-

ment revenue due to seignorage constituted less than 5% of the total, but in

debasement years, it could be as high as 50% due to increases both in the

seignorage rates and mint activity. As discussed above, the same applied

to the Kipper- und Wipperzeit: Seignorage was substantial, and so was the

re-minting activity.

The question is why there was an incentive to engage in the re-minting

of coins in spite of the subtracted seignorage. If coins had circulated ac-

cording to their intrinsic values, there would not have been an incentive for

re-minting older coins due to seignorage. Again, one needs some deviation

from the circulation by weight to explain re-minting activities. If, on the

other extreme, coins circulated by tale, re-minting would always be proÞtable

if the new mint price exceeded the old mint equivalent (Sussman 1993).

Summing up, a satisfactory theoretical account of the events surrounding

the Kipper- und Wipperzeit should be able to explain how the debasements

could spread across regional borders and why there was so much re-minting in

spite of the substantial seignorage tax. Based on our historical account, our

model will incorporate the following important features: The fragmentation

of minting across states, the existence of a seignorage tax, the two-sided

asymmetric information as described above, and the prevalence of trade in

goods and money across jurisdictions.

5.2 A Stylized Model

5.2.1 Assumptions

Consider an economy with two jurisdictions, denoted by 1 and 2. Both

jurisdictions use silver money, and are on the same official coin standard.

However, the central authority is too weak to enforce the standard and cannot

prevent the debasement of coins by the regional sovereigns. Denote the

quality of coins in the two jurisdictions by v1 and v2, respectively. The

quality of coins in region i, vi, can vary between 0 and 1, and should be

thought of as the relative quality of coins compared to full-bodied coins.

According to the coin standard, all coins are full-bodied, i.e., the quality of

both coins is initially equal to 1. vi is then just the share of silver contained

in a given coin (i.e., the coin’s Þneness).17 Assume that in each jurisdiction,

there are mints that offer to mint (or re-mint) coins from the metal brought

in by any individual. The mint equivalent, MEi, and the (gross) seignorage

rate, σi, are set by the regional sovereign in region i, yielding a mint price,

MPi, at which metal can be sold at the mint, of (1−σi)MEi.18 MEi will be inversely related to the coins’ quality, vi. The regional sovereigns can debase

their coins by altering vi. For simplicity, we assume that the precious metal

content of a region’s coins can vary by increments of c > 0, a small positive

constant. We can characterize the distribution of coins in the two regions

in terms of the joint probability p (v1, v2) that the quality of jurisdiction 1’s

coin is v1 and the quality of jurisdiction 2’s coin is v2. In the initial situation

depicted in Figure 1, p (1, 1) = 1, and the probability is zero for any other

pair of coinages.

17We will only consider debasements that reduce the coins’ Þneness. We assume that the weight and the nominal value of coins are kept constant in a debasement. 18We do not consider the potential principal-agent problem between the sovereign and

the mint master. For such a model, see Gandal and Sussman (1997).

1 1 - c

1 - 2c

Figure 1: Initial Situation

We assume that, in each region, there are risk neutral traders who would

like to buy some goods from the other region. Traders differ with respect

to their valuations of the traded goods. Goods prices in terms of silver

are assumed to be exogenous. The sellers of the goods accept only coins

from their own region. Therefore, the buyers have to exchange domestic

coins against foreign ones to be able to trade; one may think of this as a

domestic-cash-in-advance constraint. In our model, we will abstract away

from the trade in goods to focus on the currency exchange between the two

jurisdictions. In a cash-in-advance economy, the trade in goods would be

predicated upon the exchange of currency, and so our abstraction can be seen

as the reduced form of a more elaborate model that involves both the trade

in goods and currency exchange. But one should keep in mind that the

primary motivation of the currency exchange between the two jurisdictions

is the trade in goods, and the volume of the goods trade will be important

for the welfare effects of a currency debasement.

Whether trade is ex-ante beneÞcial for the traders, depends not only

on goods prices (in terms of silver) and on the traders’ valuations for the

goods, but also on the exchange rate between domestic and foreign coins,

and the expected quality of the exchanged coins. We will assume that the

traders strictly prefer to trade if it is known that all coins are full-bodied

(i.e., p (1, 1) = 1) and if the exchange rate between the coins is equal to 1.

Hence, in the initial situation, trade would be welfare-increasing.

We now come to our key informational assumptions. As already ßagged

above, we will make the assumption that traders are better able to distin-

guish the quality of the coins from their own jurisdiction than the quality of

foreign coins. Concretely, we will make the assumption that while traders

can perfectly observe the quality of their domestic coins, they cannot distin-

guish small incremental differences of c in foreign coins. We can formalize

the informational assumption in terms of the information partitions for the

traders from the two jurisdictions. The Þgures below depict the information

partitions of traders from regions 1 and 2, respectively. The ballons indicate

the circumstances that cannot be distinguished by the traders.

1 1 - c

1 - 2c

Partition of trader in 1

1 1 - c

1 - 2c

Partition of trader in 2

This implies that, although the silver price of trading goods is exogenous

and constant, the nominal price of trading goods will depend on the quality

of coins presented in the exchange; in particular, it will be inversely related to

the quality of coins (i.e., it will be equal to the silver price of the good divided

by νi).19 In addition, we assume that traders know the aggregate incidence

of foreign coins (for example, by learning from the aggregate experiences of

all other traders in their region). For example, a trader from region 1 knows

that a certain fraction of coins has been debased, but he cannot observe the

quality of individual coins offered to him in an exchange. Therefore, the

willingness to trade will depend on the aggregate incidence of coinage from

the other region.

Note that, under the given information structure, a debasement cannot

exceed c if it is not to be detected by the other region. Moreover, the re-

minting of good coins into bad coins is never proÞtable if the coins are to be

used domestically where they are valued according to their intrinsic value.

For interregional trade, re-minting can be proÞtable only if the seignorage

rate, σi, is below c.

Assume now that the looming war induces the sovereign of region 2 to

debase his coinage by c in order to raise some revenues from seignorage.20 We

will now analyze how such a debasement of coins affects the agents’ decision

to re-mint old coins into new coins and how it inßuences the beneÞts from

trade. We will distinguish two different settings: In the Þrst, we will assume

19Competition among sellers ensures that the nominal price cannot rise above this “fair” price. If a seller tried to fool a buyer by claiming that the offered coins are bad even though they are, in fact, good, other sellers would have the incentive to step in and sell at the fair price in order to reap the beneÞts from the exchange. 20Historically, the increase in seignorage taxes seems to have been the major motivation

for many debasements, especially in times of war (see, e.g., van Werveke 1949, Sussman 1993). This was certainly also true for the Kipper- und Wipperzeit (see, e.g., Ernstberger 1954, pp. 89, 104, Schneider 1979).

that the exchange rate between the coins is determined by the coins’ average

qualities. In the second setting, we will analyze the consequences of “Þxed

exchange rates,” where coins are valuated according to their nominal values

(i.e., “by tale”).

5.2.2 Exchange rates reßect average qualities

Here we assume that the exchange rate between the currencies of the two

jurisdictions reßects the average quality of the coins from the two jurisdic-

tions. Without loss of generality, let us select 1’s currency as the numeraire,

and denote the price of 2’s currency in units of 1’s currency as π. Then, π

is given by the ratio of the average qualities of the two currencies. Hence, in

the initial situation depicted in Figure 1, the exchange rate would be equal

to 1.

Consider now a debasement of the coins in jurisdiction 2, in which the

sovereign modiÞes the mint equivalent in a way that reduces the precious

metal content of coins from 1 to 1− c. Assume that the seignorage rate, σi, is below c, such that there is scope for proÞtable re-minting. If a fraction δ

of the coins is debased, the average quality of coins in jurisdiction 2 is

(1− δ) · 1 + δ · (1− c) = 1− δc

The rate of exchange between coins will reßect the average quality of the

coins, so that π = 1 − δc. Hence, the traders from jurisdiction 1 will be happy to exchange their coins at this rate.

The actual realization of δ depends on whether the traders in jurisdiction

2 decide to have their coins re-minted. In the absence of seignorage, all

traders from region 2 would prefer to have their old coins re-minted and

to use debased coins for the exchange. The exchange rate would drop to

1− c, and trade would remain proÞtable. However, in the presence of non- zero seignorage, re-minting will be beneÞcial only if the beneÞt from trade is

large enough to cover seignorage costs. Those traders for whom re-minting

is not proÞtable will withdraw their good coins from interregional trade. The

average quality of circulating coins will drop to 1− c, and the exchange rate adjusts to 1 − c. Thus, the joint density of coins changes from (1, 1) to (1, 1− c), as depicted in Figure 2. Note that, due to seignorage, the traders from region 2 have to pay more

for the exchange than before (in terms of silver) when using debased coins.

Hence, the beneÞt from trade is smaller than it would be in the absence of

a debasement. The game among the traders in region 2 has the structure

of a prisoners’ dilemma: It would be socially beneÞcial to coordinate on not

re-minting coins (and saving on seignorage), but it is individually proÞtable

to re-mint coins because the externality on the other traders in the form of a

less favorable exchange rate is not taken into account. The only beneÞciary

of the debasement is the sovereign in region 2 who collects the seignorage tax.

In contrast, the traders in region 2 suffer, either because they have to pay

seignorage, or because they cannot trade at all. Some trade will not take

place even though it would be beneÞcial in the absence of the debasement.

This will tend to decrease social welfare, in addition to the social loss in the

form of minting costs (the seignorage tax, in contrast, is welfare-neutral).

If there is no further debasement of jurisdiction 1’s or 2’s coins, this is

the end of the story. In particular, the debasement does not spread to the

other region. For the coin quality to decrease in the other region as well, one

would need a similar debasement in jurisdiction 1, which would then tend

to drive out the good money of jurisdiction 1. It should be stressed that

the reason why Gresham’s Law operates within regions is that the traders in

1 1 - c

1 - 2c

Figure 2:

one region cannot distinguish between the good and bad coins of the other

region, although domestic traders can do so. In this sense, trade promotes

the operation of Gresham’s Law.

5.2.3 Fixed exchange rates

Let us now consider the second setting, where the exchange rate of coins is

determined by their relative nominal values.21 In the model, this would lead

to a Þxed exchange rate equal to 1. Consider again a debasement of region

2’s coins from 1 to 1−c, which induces the traders to re-mint their coins if this is proÞtable. Given the exchange rate of 1 and the average quality of foreign

coins of 1, re-minting will be proÞtable even for those traders for whom re-

minting was not proÞtable in the Þrst setting. Hence, in the absence of a

21This assumption is extreme in that it does not allow for any adjustment of the ex- change rate to a change in the average coin quality. The argument would also go through if the exchange rate did not fully adjust to changes in the average coin quality.

debasement in region 1, the average quality of coins drops to 1− c in region 2.

However, the given exchange rate of 1 does not reßect the average quality

of the coins, which reduces the beneÞts from trade for the traders of juris-

diction 1. The reason is that, in expectation, the traders from region 1

will have to pay higher nominal prices for the goods they want to acquire,

while the exchange rate is not able to adjust to this change in prices. For

some traders, the trade based on good coins is no longer beneÞcial and they

will withdraw their good coins from interregional trade. In contrast to the

Þrst setting, the traders and the sovereign in region 2 will beneÞt from the

debasement, whereas the traders in region 1 will suffer.

So far, we have held the quality of coins in region 1 constant. Assume

now that the sovereign in region 1 may also decide to debase his coinage.

Then the best response of the sovereign in region 1 to the debasement in

region 2 is to debase his coinage as well. This is true even if the sovereign

maximizes regional social welfare, and not seignorage taxes. If the seignorage

rate is not set too high, re-minting will be proÞtable, such that the quality

of circulating coins in region 1 drops to 1− c. As above, some traders may decide to withdraw from interregional trade. Given the reduced coin quality

in region 1, some of the traders in 2 will no longer Þnd it proÞtable to

have their coins re-minted and will withdraw from trade. As illustrated by

Figure 3, the quality of coins presented in exchange will drop from (1, 1) to

(1− c, 1− c). As the proportion of good coins from region 2 falls to 0, all of the good coins from region 1 will be re-minted as well. Thus, we have

p (1, 1) = 0. Welfare is lower in both regions than before the debasement.

The gain of the sovereigns in the form of seignorage taxes is more than

compensated by the loss of the traders.

1 1 - c

1 - 2c

Figure 3: Debasement of 2’s currency in response

The argument can now be iterated. Any joint density of coins presented

for exchange is vulnerable to further erosion provided that one jurisdiction

changes its mint policy to debase its coinage. The coins in the upper end

of the quality distribution are no longer offered in exchange. These “good”

coins will either be re-minted and then reappear in trade with a smaller pre-

cious metal content, or they will be withdrawn from trade altogether. Note

that the effects of a debasement are much more severe in this setting than

in the other one where the exchange rate was determined by average coin

quality. Most importantly, the debasement can spread from one region to

the other. Hence, the inability of the exchange rate to adjust to changes in

aggregate coin quality may help to explain why the crisis spread so widely

across different states, and why so many regions participated in the debase-

ment.

5.3 Deposit Banks

Our model has shown how trade and the associated information problems can

give rise to a variant of Gresham’s Law where good coins are re-minted or

withdrawn, even though, in equilibrium, this reduces the traders’ proÞts and

social welfare. We have seen that the inability of exchange rates to adjust

to changes in the average coin quality seems to be necessary to explain how

the crisis spread across regional borders. Crucial to our argument is the

combination of (i) the fragmented nature of the institutions that allow the

incremental debasements to take place, and (ii) the two-sided asymmetric

information that follows from cross-border trade. We will now discuss how

the public deposit banks may have served to remedy these problems.

Let us consider the following features of an “ideal” public deposit bank,

abstracting from the weaknesses observed in practice:

1. Coins could be deposited at the bank only after the quality of the coins

had been veriÞed.

2. The banks created a notional currency (“bank money”) to be used for

payments.

3. All bills beyond a certain amount had to be paid at the bank.

4. Banks were publicly guaranteed.

We want to argue that the combination of these features generated com-

mon knowledge about the value of money, and thereby prevented the socially

inefficient erosion of coin values. The Þrst feature was the control of the

deposited coins’ quality, which made sure that any depositor would be cred-

ited the “fair” value of the deposited coins. Otherwise, the holders of good

coins would not have been willing to deposit their coins. The control could

take different forms. One was the restriction of the types of coins that were

accepted for deposit. Indeed, the Banks of Hamburg and Amsterdam had

such restrictions. For example, coins that were known to have been subject

to serious debasements were not accepted. In the framework of our model,

it would suffice to allow only for the deposit of domestic coins, the quality

of which could easily be checked by domestic traders (and, hence, by the

bank). In contrast, the lack of such restrictions at the Bank of Nuremberg

may explain its limited success. The quality of coins could also be checked

by using the assaying technologies described above. It is likely that the rel-

atively cheap tests, such as the use of a scale or the “touchstone test,” would

always have been carried out for that purpose. However, since the quality

of coins would have to be veriÞed only once, even the “assaying by Þre” may

have been worthwhile, given that it would have to be carried out only at the

time of deposit. Hence, the costs would be negligible, relative to the total

circulation of money. Ideally, the controls would ensure that the value of

coins in the bank’s vault — and hence the value of the notional currency —

would correspond to that prescribed in the Mint Ordinance.

By depositing the coins at the bank, the traders could commit to not

debasing them. The coins were stored in the bank’s vault, and payments

were carried out in terms of a notional currency, which was backed by the

holding of coins in the deposit bank. But how could the deposit bank commit

to not debasing the coins, once they were deposited? Here, it is crucial that

the traders themselves beneÞted from not being able to debase their coins.

There was no beneÞt from collectively debasing the coins in the bank’s vault.

Therefore, the bank’s promise not to debase the coinage would be credible,

and the asymmetry of information between domestic and foreign traders was

eliminated. When using “bank money” in international transactions, there

was no informational advantage that one trader has with respect to another.

The observed agio of bank money compared to the circulating money can be

seen as evidence of the credibility of the banks’ arrangement.

Payments would be executed through cashless transfers or, alternatively,

through bills of exchange, denominated in the notional currency. Bills of

exchange were particularly important in international transactions between

parties who did not both have an account at the same deposit bank (see Schn-

abel and Shin 2004 for the use of bills of exchange in international trade). In

fact, in Amsterdam and Hamburg, only merchants from the bank’s jurisdic-

tions were allowed to open an account at the bank. The provision that all

bills of exchange above a certain amount had to be paid at the bank implicitly

forced all merchants to open a bank account. It provided for a centraliza-

tion of coins at the deposit bank, and thereby ensured that the network of

merchants making use of the bank money was large enough; this raised the

bank money’s attractiveness due to the existing network externalities in the

use of money. Moreover, the willingness of the domestic traders to forego the

option to write bills outside the bank was a signal to foreign traders that the

payment mechanism was reliable.

The guarantee of the City lent some additional credibility to these ar-

rangement. In fact, it is quite striking that the banks were founded in free

cities, rather than principalities. In a free city, the interests of the govern-

ment and the merchants would be much more aligned than in a principality

where the hunger for seignorage taxes may have dominated the interest in

maximizing social welfare. While the banks were established primarily to

the beneÞt of the Amsterdam or Hamburg traders, their establishment also

beneÞted their trading partners. Just as the debasements tended to spread

along trade itineraries, the stabilization would spread along the same routes.

Hence, the creation of public deposit banks had the character of a public

good. At the same time, this may help to explain why there were so few

deposit banks created in the Empire. First, the regional beneÞt had to

be large enough to make the costs of establishment worthwhile; this would

be true most of all in the major trading cities like Hamburg and Amster-

dam. Second, given the establishment of banks at other places, the other

regions could free-ride on the stability provided by these banks. However,

these other places may have underestimated the impact that the creation of

the banks would have on the future economic development of the respective

regions.

6 Conclusion

Our paper has tried to explain how the creation of public deposit banks may

have mitigated the monetary disturbances at the beginning of the seventeenth

century. For this purpose, we presented a simple model of debasements in a

country with a uniform coin standard, but fragmented minting activities. We

have argued that asymmetric information about coin values between trading

partners promoted the working of Gresham’s Law within regions. However,

asymmetric information alone is not able to explain why the debasements

spread across regions. In the framework of our model, the progagation

of debasements can only be explained if exchange rates between regional

currencies do not fully adjust to relative average coin qualities. It is an open

question for future research whether the assumption of imperfectly ßexible

exchange rates can also been conÞrmed empirically.

Against the background of the theoretical model, we have then described

how the institutional arrangements of public deposit banks were able to re-

move the existing informational asymmetries and to generate common knowl-

edge about the value of the money used in exchanges. The mechanism

worked as follows: The banks created a notional currency, which was backed

by the holding of coins, whose quality had been veriÞed at the time of de-

posit. Since the traders as a group beneÞted from not debasing their coinage,

the bank could credibly commit to not debasing the stored coins. Public

guarantees lent some additional credibility to these arrangements. The in-

stitutions proved to be so successful that Amsterdam bank money (and — to

a more limited extent — also Hamburg bank money) became the key currency

in international Þnance for almost two centuries.

The role we ascribe to the public deposit banks is akin to the functions

typically conducted by central banks. Therefore, our analysis suggests that

the early deposit banks should be thought of as early precursors of modern

central banks, contrary to the conventional view that such banks were cre-

ated much later, mainly with the intention to Þnance wars. At places where

the banks were used to this end, such as Nuremberg, they were never able to

establish bank money as a key currency for trade transactions. The signif-

icance that the foundation of public deposit banks had may be anticipated

by looking at the rise of Amsterdam and Hamburg to key trade and Þnancial

centers. This points towards a much larger importance of the banks than

their immediate impact on the monetary situation of the time, and highlights

the importance of Þnancial institutions for economic growth.

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