Previous articles in this series discussed Barter Systems and Commodity Money. This article will discuss an important development in money, namely the difference in the value of the metal used in commodity money to that of the face value assigned by the Government. Read on for details…
The Value of the Metal vs. the Value of the Coin
Consider the Canadian gold coin from the previous post in this series. This coin costs $5,200 CAD to purchase, yet it only has a face value of $250 CAD. There are a few interesting observations that can be made about this. From a pure commodity perspective, we could look at the “melt value” of the coin, namely, if we were to melt it down into a lump of solid gold, how much might it sell for? The coin is noted to be 99.99% pure gold and is 62.34 grams, or 2.20 ounces. The price of gold at the time of writing is about $1,200 USD/ounce, or about $1,400 CAD/ounce. Assuming that the coin is 100% pure gold for simplicity, the melt value of the coin would be $1,400 CAD/ounce * 2.20 ounces = $3,080 CAD.
This brings us to the first pricing distinction, namely the fact that the selling price of the coin is not the same as the melt (commodity) value. The coin sells for about $2,000 CAD more than its melt value. This can be explained due to the fact that the coin is rare (only 300 will be made), has a beautiful and detailed design, and comes in a storage box.
The other pricing distinction is that the face value of the coin is listed as $250 CAD. However, we have already indicated that depending on who would be buying the coin (collector or someone that wants melted down gold), the value is somewhere between $3,000 CAD and $5,200 CAD! The face value is the value of the coin that the Government has assigned to it. Namely, you could use the Canadian gold coin as legal tender and it would be valued at $250 CAD. Notably though, not all financial institutions may honor the coin as legal tender, as in Canadian law, only circulating legal tender can be readily used at banks. Collectible coins are classified as non-circulating legal tender and so banks and business can accept them at their discretion.
In the United States, the face value of coins is set by laws passed by the US Congress. There are many theories/explanations as to why the face value is set so low compared to the actual value of the coin. Some theories explain that the face value is set low to prevent the coin from being used in circulation and instead encourages use of Government currency. For example, if the price of gold fell to say $125 CAD/ounce, people that owned the Canadian gold coin may start using it on everyday purchases. This difference between commodity value and face value can also be viewed as Seigniorage.
Seigniorage
Seigniorage is the difference between the face value of money and the cost for a mint to produce and distribute it. Consider the British sterling silver coin, which in the 12th century was standardized by Henry the II as having 92.5% silver and 7.5% copper. If the face value of the coin was set by the Government to be the same as a 100% silver coin of the same weight, the Government would receive a Seigniorage profit of 7.5%, less the cost of the copper and costs to manufacture and distribute the coin.
Seigniorage can also occur indirectly in a modern financial system. If the Government prints and distributes cash, it can use the revenue generated from issuing the cash to purchase Government bonds. In this case, seigniorage would be defined as the interest on the bonds less the cost to produce and distribute the cash. The Government can thus influence this mechanism by adjusting the face value and amount of cash to be printed, as well as the interest rates on the bonds.
The difference in the face value and commodity value of money is an important concept as it effectively allows the Government to set the value of the money independent of its intrinsic value. Future articles will discuss how this concept evolved towards modern day fiat currency.
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