BIS Working Papers

No 698
Money and trust: lessons
from the 1620s for
money in the digital age
by Isabel Schnabel and Hyun Song Shin

Monetary and Economic Department

February 2018

JEL classification: E42, E58, N13.

Keywords: Gresham’s Law; debasement; common

knowledge; central banks
BIS Working Papers are written by members of the Monetary and Economic
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economists, and are published by the Bank. The papers are on subjects of topical
interest and are technical in character. The views expressed in them are those of their
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This publication is available on the BIS website (www.bis.org).

© Bank for International Settlements 2018. All rights reserved. Brief excerpts may be
reproduced or translated provided the source is stated.

ISSN 1020-0959 (print)

ISSN 1682-7678 (online)
 Money and trust: lessons from the 1620s
for money in the digital age
Isabel Schnabel Hyun Song Shin
University of Bonn Bank for International Settlements
February 5, 2018

Abstract
Money is a social convention where one party accepts it as payment
in the expectation that others will do so too. Over the ages, various
forms of private money have come and gone, giving way to central
bank money. The reasons for the resilience of central bank money are
of particular interest given current debates about cryptocurrencies and
how far they will supplant central bank money. We draw lessons from
the role of public deposit banks in the 1600s, which quelled the hyper-
in‡ation in Europe during the Thirty Years War (1618-1648). As the
precursors of modern central banks, public deposit banks established
trust in monetary exchange by making the value of money common
knowledge.

JEL codes: E42, E58, N13.

Keywords: Gresham’s Law; debasement; common knowledge; central

banks.

An earlier version of this paper was circulated under the title “The Kipper- und Wip-
perzeit and the foundation of public deposit banks”. We thank Morten Bech, Vincent
Bignon, Forrest Capie, Stijn Claessens, Piet Clement, Marc Flandreau, Charles Good-
hart, Timothy Guinnane, Hendrik Hakenes, Stephen Morris, Larry Neal, Stephen Quinn,
Will Roberds and Nathan Sussman for comments. The views expressed here are those of
the authors and not necessarily those of the Bank for International Settlements.

1
1 Introduction
Money as a means of exchange is a social convention. One party accepts
money as payment in the expectation that others will do so. This bare
de…nition does not leave much room for the special role of central banks.
Over the ages, various forms of private money have come and gone. Some
have lasted longer than others, but they have given way to central bank
money. The reasons for this resilience of central bank money are of particular
interest given current debates about cryptocurrencies and how far they will
supplant central bank money.
We draw lessons on the nature of money by examining the role of pub-
lic deposit banks established in the early 1600s, which quelled the hyperin-
‡ation in Europe during the Thirty Years War (1618-1648). The Bank of
Amsterdam, famously discussed at length in Adam Smith’s (1776) Wealth of
Nations, is perhaps the best known of these public deposit banks. We argue
that the public deposit banks were early precursors of modern central banks,
and that they were able to establish trust in monetary exchange by making
the value of money common knowledge. The lessons resonate through the
intervening years to current debates about cryptocurrencies and the nature
of money.
The Thirty Years War involving the small German states and neighbour-
ing regional powers was associated with one of the most severe economic
crises ever recorded, with rampant hyperin‡ation and the breakdown of trade
and economic activity. The crisis became known as the Kipper- und Wip-
perzeit (the clipping and culling times), after the practice of clipping coins
and sorting good coins from bad.
Episodes of currency debasement have occurred throughout history, but
the Kipper- und Wipperzeit stands out for two reasons. The …rst is the
severity of the crisis and its rapid regional spread. Currency debasement
proceeded at such a pace that the public authorities quickly lost control of
the downward spiral.
The second reason why the Kipper- und Wipperzeit stands out is the
manner in which debasement was brought under control. A key step was the
standardisation of wholesale payments through public deposit banks. The
Bank of Amsterdam was the …rst, established in 1609. The German deposit
banks, the Bank of Hamburg (founded in 1619) and the Banco Publico of
Nuremberg (1621), were established at the height of the crisis.
Public deposit banks share with modern central banks the feature that
their deposits served as a platform for a cashless payment system in which
transactions between account holders were settled by transfers from one ac-
count to another. However, unlike with modern central banks, new deposits

2
could be created only by holders surrendering gold and silver coins. In this
sense, bank money re‡ected the value of underlying coins, but the conve-
nience of bank money for settlement of transactions meant that bank money
traded at a premium (agio) to the underlying coins, with the premium re-
‡ecting the value to account holders of the convenience of bank money for
settlement. The agio was substantial. Adam Smith reports that the typical
agio in Amsterdam was between 2 and 5 percent, and much higher else-
where.1 Quinn and Roberds (2007, 2014) provide a detailed picture of the
operation of the Bank of Amsterdam and its subsequent development as an
early precursor of modern central banks.
In seeing the origin of central bank money in terms of these early public
deposit banks, our view (and that of Quinn and Roberds) di¤ers from the
conventional view, as argued for instance by Charles Goodhart (1988), that
central banks were established primarily as a way for the state to …nance
wars. The ability to lend is typically seen as the crucial characteristic of
central banks. In contrast, the public deposit banks of the early 17th century
initially were not designed to engage in lending; their main function was to
provide a payment and clearing system.
In practice, however, the deposit banks also engaged in lending, although
to di¤ering degrees. One example was the Banco Publico of Nuremberg,
which engaged in substantial lending to the City of Nuremberg, contrary to
its charter. Perhaps for this reason, this bank was far less successful than the
Banks of Amsterdam and Hamburg (Kindleberger (1991, 1999)). It ended
up with a meagre deposit base and never managed to establish itself as a
major giro bank - a bank whose deposits serve as a means of payment. Be-
sides preserving the soundness of the currency, the Banks of Amsterdam and
Hamburg played crucial roles in promoting the institutions that underpin …-
nancial innovation and economic development through settlement of …nancial
claims and bills of exchange.2
We argue that the source of the success of public deposit banks was their
role in instilling common knowledge in monetary transactions by establishing
a platform for standardised settlement of transactions, both for goods and
for …nancial instruments.
Common knowledge refers to not only the fact that everyone knows, but
also that this knowledge is transparent to all concerned. The philosopher
David Lewis (1969) provided a celebrated analysis of why common knowledge
is key to social conventions, and common knowledge is also the cornerstone
1
Wealth of Nations (1776), p. 421 of 1991 printing.
2
See Schnabel and Shin (2004) for an account of the role of bills of exchange and the
crisis of 1763.

3
of the analysis of equilibrium in economics and game theory.
The importance of common knowledge is especially relevant in monetary
economics in the age of distributed ledger technology (DLT) and Bitcoin,
as one interpretation of money is as a score-keeping device on the history
of past transactions. The analysis of money as a score-keeping device was
given emphasis by the paper by Kocherlakota (1998), whose title is “Money
is memory”. In the setting of Kocherlakota’s analysis, a costless, publicly ac-
cessible record of all past transactions that is common knowledge can achieve
the allocation with money, and sometimes more. On the other hand, Bhaskar
(1998) and Bhaskar, Mailath and Morris (2012) show that such results are
not robust to small departures from the common knowledge of in…nite his-
tories of transactions. This is so even if the record-keeping device is costless.
The current debates about the role of DLT and whether it will displace cen-
tral bank money thus crucially depend on how important common knowledge
is for monetary exchange and how well DLT can recreate the pre-conditions
for common knowledge. We return to this issue below.
Commodity money is vulnerable to problems of informational asymme-
tries and adverse selection, especially in times of frequent devaluations. We
present a theoretical model in the spirit of Shin (1996) and Chwe (1999)
where such informational problems reverberate through mutual distrust so
as to constitute a severe impediment to the e¢ ciency of exchange. To the
extent that …nancial instruments such as bills of exchange are settled using
coins of uncertain quality, the standardisation necessary for contractual cer-
tainty will also be undermined by the uncertainties in the value of commodity
money. The seed of uncertainty can feed and amplify the potentially corro-
sive e¤ects 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.
Currency debasement has occurred on numerous occasions throughout
history, but the Kipper- und Wipperzeit raises a number of important ques-
tions. The …rst is why the exchange rate between inferior and superior monies
does not adjust to re‡ect the di¤erent intrinsic value of the two currencies.
Once the prices adjust in this way, and a fair rate of exchange is estab-
lished, then both currencies would circulate, but at prices that re‡ect the
fair premium or discount. Rolnick and Weber (1986) cite several historical
episodes from the United States and Great Britain, where precisely such an
adjustment happened.
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.” We build on two features
in particular:

4
 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 was conducted across jurisdictions.

The …rst bullet point refers to the fact that, in spite of the attempts to
harmonise minting across the Empire, it remained in the realm of the regional
princes to mint their own coins.3 The minting of coins was an important part
of the states’revenues through seignorage. The fragmentation of minting was
responsible for the large variety of coins that circulated. Through trade, the
di¤erent coins would spread across regions. Our model builds on the feature
that (at least some) traders within a particular jurisdiction would be more
familiar with the average quality of coins produced within their own juris-
diction, but would have less familiarity with the average quality 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 di¤ers from the original lemons
problem in that the asymmetric information would apply symmetrically to
both sides of the transaction. One side has better information about his own
coins than the other side; but no one has an absolute advantage over the
other. In this sense, the asymmetric information applies “symmetrically.”4
The establishment of public deposit banks secured standardisation of the
units of settlement by replacing the direct exchange of coins (which is beset
with problems of adverse selection) with the balance transfers across accounts
in the deposit bank. Even if the coins backing the deposits were of uncertain
quality, such uncertainty a¤ects all account holders equally and symmetri-
cally. The fundamentals would be uncertain, but the uncertainty is common
knowledge. The advantage of payment via the deposit bank would be rein-
forced if the quality of coins at the deposit banks were of higher quality.
In our model, the standardisation of contracts enables traders to enter
the market with less fear of expoitation, reinforcing the pool of potential
trading counterparties when entering the market. So, the more traders that
enter as potential buyers, the more will potential sellers too be attracted to
3
A similar problem existed in the United Provinces, although to a lesser extent (van
Dillen (1934, p. 81)).
4
We are not the …rst 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 adverse selection models of
Gresham’s Law. Our incremental contribution is to show the importance of common
knowledge.

5
enter the market, which in turn reinforces the incentives for other buyers to
enter. Thus, the initial “seed”of standardisation of units of settlement sets
o¤ a virtuous circle of greater market participation, thicker markets and the
greater capacity of the …nancial system to facilitate the consummation of real
economic transactions.
The outline of our paper is as follows. After setting the stage with a
brief description of the history of the crisis, we present institutional details on
the deposit banks founded in Amsterdam and Hamburg, and compare their
performance with other, less successful deposit banks of the era. We then
sketch the theoretical arguments on how two-sided asymmetric information
about coin values could make the system vulnerable to Gresham’s Law and
the spread of the debasements across regional borders; the role of the public
deposit bank stemming the crisis builds on the theoretical arguments. Our
formal model is presented in the appendix.

2 Historical background
2.1 The Augsburg imperial mint ordinance
In 1559, the Holy Roman Empire sought to harmonise its coinage system
by issuing the Augsburg imperial mint ordinance (“Reichsmünzordnung”).5
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
or leased. The export of domestic money or silver was prohibited, and the
amount of foreign coins limited. The intrinsic content of coins was to be …xed
throughout the denomination structure; even small coins were full-bodied.
The alteration of coins was to be punishable by death. The supervision
of minting was delegated to the Imperial Circles, which employed coin in-
spectors (“Kreiswardeine”) and organised regular “probation days” where
inferior coins were declared void. Mint masters who were responsible for the
production of inferior coins were to be punished.
The ordinance put the Empire on a bimetallic standard. The largest
coins (Dukaten) were gold, whereas all the other coins were silver. Although
there were regional variations, the Reichstaler underpinned the silver coinage.
By decree, 9 Reichstaler were to be minted from 1 Mark silver of Cologne
(approximately 234 grams). In southern Germany, the Gulden played a com-
parable role. Smaller-denomination coins were the Kreuzer and Groschen,
5
Note that the mint ordinance did not apply to the Netherlands, Switzerland, and some
of the Western border regions (Schneider (1981, p. 48)).

6
although there was great regional variation in the names.6
However, the mint ordinance was ‡awed in its implementation. Given
the higher costs of producing subsidiary coins, the minting of small coins
proved to be unpro…table. The o¢ cial mints stopped producing small coins,
which led to a shortage of small change. As small coins were needed for daily
transactions, some unauthorised mints (so-called “Heck(en)münzen”) started
to mint inferior coins which allowed for at least some seignorage pro…t. 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 o¢ cial mints started to take part in the coin-making business.
Coin supervision proved to be ine¤ective (Schneider (1981, pp. 48–49)), and
the prohibition of coin adulteration was not enforced.

2.2 Creeping debasement of small coins

The increasing circulation of debased subsidiary coins implied a creeping
increase in the price of large coins (which were still largely full-bodied) in
terms of small coins. Averaged over the Empire, the Reichstaler increased
between 1582 and 1609 from 68 to 84 Kreuzer, a devaluation of the Kreuzer of
one …fth (Shaw (1895, p. 103)). The process was fuelled by the looming war,
which induced the princes to prepare a war chest by increasing seignorage
revenues and set the stage for the ensuing hyperin‡ation. One well-studied
case was that of the Duke of Braunschweig–Wolfenbüttel. In 1617, he ordered
the coining 210 Groschen from 1 Mark silver compared with 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 imperial 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.

2.3 Hyperin‡ation and the “Kipper- und Wipperzeit”

(1619-1623)
The Defenestration of Prague in 1618 marked the beginning of the Thirty
Years War. The war increased further still the princes’ need for revenues,
setting the stage for the ensuing hyperin‡ation. By 1621, the coin standard
had been decreased from 9.5 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
6
http://pierre-marteau.com/wiki/index.php?title=Money_(Holy_Roman_Empire)

7
including such famous people as Albrecht von Wallenstein, 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 Gulden
per Mark, which was well above the existing standard (46 Gulden). In fact,
the consortium diluted the standard even more. Wallenstein and the other
members of the consortium bene…ted from this deal, which allowed him to
…nance his own army during the war. In addition, the Emperor himself
earned an amount of 6 million Gulden 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.”7 To provide for a
su¢ cient supply of silver, the mints employed subcontractors who went about
buying old coins with higher silver content (paying with debased money at
increasing prices) to bring them to the mint to receive larger amounts of
debased coins bearing the same nominal values. These people were later
called the “Kipper und Wipper”.
The initial e¤ect of the enormous monetary expansion was an economic
boom. However, eventually, prices started to increase rapidly, and the initial
boom turned into hyperin‡ation and crisis. By this stage, many of the new
coins were made almost entirely of copper. Redlich (1972, pp. 11) claims that
the Empire was by this time on a de facto copper standard. The increasing
scarcity of copper even led people to bring their pots and pans to the mints.
More and more often, trade and business came to a standstill. Craftsmen and
farmers were no longer willing to sell their services and products for worth-
less money. Tax revenues also ran dry, as taxes were paid in copper money.
Rising prices were followed by riots in many big cities including Erfurt, Hal-
berstadt and Kassel, often directed against the money changers rather than
the sovereigns (Scheinder 1981, p. 72). As the debasement spiralled out of
control and people were no longer willing to accept the worthless money, one
mint after another ceased its operations.

2.4 Public deposit banks and stabilisation

The monetary crisis led to the foundation of the major deposit banks of
northern Europe. The Bank of Amsterdam pre-dated the crisis, having been
founded in 1609. Other deposit banks followed in Middelburg (1616), Ham-
burg (1619), Delft and Nuremberg (both 1621). The Banks of Amsterdam
and Hamburg are the best known, and were to play an important role in
7
Langer (1978, p. 30) as cited in Kindleberger (1991, p. 160).

8
subsequent centuries (see Schnabel and Shin (2004)). The Bank of Amster-
dam was modelled on the Venetian Banco della Piazza di Rialto (founded
in 1587), but the goal was quite di¤erent. In Venice, the bankruptcy of the
private deposit banks caused by excessive lending had led to the establish-
ment of a public bank; in Amsterdam, the purpose was to quell monetary
disorder.8
The Bank of Amsterdam functioned as follows. Coins could be deposited,
and the respective amount would be credited in a notional 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 typically bore a premium (called agio) compared
with the circulating money. One reason for this was the quality di¤erences
between deposited and circulating coins, but also a reduction in uncertainty,
which made the bank money more valuable for the merchants - akin to the
liquidity premium we see in modern …nancial assets.9
Deposit banks evolved in the major tradings centres 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 payment system among the participating merchants. However,
such activities were soon prohibited; the fear was that good coins would
be withdrawn from circulation, thereby accelerating the depreciation of the
currency (Soetbeer 1866, p. 24)). At …rst, the idea of a bank was looked
upon with the same suspicion by the general public, and it was only at the
merchants’insistence that the bank came into existence.
Originally, the Bank of Amsterdam 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 diluting the
value of the bank money. The bank bene…ted from a government guarantee,
and it was controlled by the merchants themselves, who had a collective
8
See van Dillen (1934, pp. 80, 85), Kohn (1999) and Fratianni and Spinelli (2006).
9
According to Adam Smith (1776 [1991], pp. 421, 426), the typical agio was around 5
percent in Amsterdam and 14 percent in Hamburg.

9
interest in monetary stability.
The credibility was eroded somewhat by the creation of a lending bank
in 1614, which was established primarily to extend loans to the public au-
thorities, 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 settled 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 …nance.The legendary reputa-
tion of Amsterdam bank money was fostered by the large stocks of precious
metals in Amsterdam, which arose from the city’s dominating position in the
bullion trade (Baasch (1927, pp. 2150). The stability of the bank money was
rarely questioned.
Similar institutions developed elsewhere, most notably in Hamburg whose
…nancial institutions were almost one-to-one copies of the ones in Amster-
dam (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 were initially 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 once more it was the merchants
who pleaded that it be established. 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 discontinued, it undermined the bank’s credibility from the outset.
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, the bank extended loans to the public authorities from the

10
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 worsened in later years when the
bank’s vault was virtually plundered by the city’s o¢ cials 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, the bank’s total
assets decreased sharply in the early years after its 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.
Early writers like Adam Smith appear to have admired institutions such
as the Bank of Amsterdam. Kindleberger (1991) also describes the banks
as having been a success. In contrast, van Dillen (1934) provides a more
nuanced assessment regarding the ability of the banks to mitigate the mone-
tary 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 devaluation of the currency was not stopped completely.
On the other hand, given that bank money was used only in wholesale trans-
actions, 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 mone-
tary stability. Arguably, this stemmed from the serious ‡aws in the bank’s
organisation: First, the deposit of coins had not been limited to full-bodied
coins; and second, the bank was not able to escape the grasp of the public
authorities on its vault, which diminished its credibility. The same prob-
lem 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 recurred in the later
history of the banks, and were countered by the banks’ temporary closure
(similarly to the “suspension of convertibility”discussed in the bank run lit-
erature; see Diamond and Dybvig (1983)). Also, similarly to the Bank of
Nuremberg, the Bank of Hamburg was repeatedly abused as …nancier of the
state –though not to the same extent.

2.5 Issues to be addressed

The applicability of the simple version of Gresham’s Law –that bad money
drives out good – needs to be quali…ed. One important question is why
di¤erent types of coins would not circulate at an exchange rate re‡ecting

11
their intrinsinc values (what is called “circulation by weight”). One strand
of the literature argues that the exchange rate between the two monies is
…xed (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, from both an institutional
and an empirical point of view. Indeed, Rolnick and Weber cite several
comparatively recent historical episodes from the United States and Great
Britain where di¤erent types of coins circulated side by side at a ‡oating
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, 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 understanding 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 et al (1999)). Commodity money has always been
plagued by problems of asymmetric information because the intrinsic value
of coins, and especially their …neness, could be checked only at relatively
high costs. The technologies used to assay the …neness of coins have been
described in some detail by Gandal and Sussman (1997, pp. 443–444): The
most common, but relatively crude technology was the “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 …neness. A higher precision could be ob-
tained only by assaying by …re (essentially the melting-down of the coin),
which was much more costly and implied a loss of the coin itself.
The monetary system worked on the principle that individuals could bring
metal to the mint (controlled or authorised 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) and 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
takes place by setting the mint equivalent and the seignorage rate (see Redish
(1990), Sussman (1993) and 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

12
metal, on their …neness and 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 source of …scal 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 di¤erent 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 …nally, by changing the coins’ …neness, the detection of
which required rather sophisticated technologies, as 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’ …neness, even though other kinds of debasements were
observed in the considered time period.
The new (debased) coins could enter circulation not only when fresh bul-
lion was minted, but also when old coins were re-minted. Rolnick et al (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, government 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 in both 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 according
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, at the other ex-
treme, coins circulated by tale, re-minting would always be pro…table if the
new mint price exceeded the old mint equivalent (Sussman (1993)).
Summing up, a satisfactory theoretical account of the events surround-
ing the Kipper- und Wipperzeit should address how the debasements could
spread across regional borders and why there was so much re-minting in

13
spite of the substantial seignorage tax. Based on our historical account,
the following important features …gure in one version of our model: 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.

3 Elements of a theory
The Kipper- und Wipperzeit stands out from other episodes of currency de-
basement in that the debasement was not limited to a single state, but spread
from one state to another. Kindleberger (1991, p. 149) writes 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.”
One version of our formal model builds on the following features:

the double-sided asymmetric information concerning the quality of coins,

and the attendant adverse selection problems;

the interaction of the “seed” of adverse selection and the mutually

reinforcing nature of market participation;

the fragmented and decentralised nature of minting activity and the

incentives facing an individual state when faced with debasement in
surrounding states; and

the importance of common knowledge in transactions, and how deposit

banks restored the standardisation necessary to underpin e¢ cient ex-
change.

We take each of these features in turn, and explain how the pieces …t
together in the overall explanation of the Kipper- und Wipperzeit.

3.1 Adverse selection

In order to set the framework of our argument, consider a simpli…ed setting
with two jurisdictions, overseen by a central authority. Both jurisdictions
use silver money, and are on the same o¢ cial coin standard. However, the
central authority is too weak to enforce the standard and cannot prevent the
debasement of coins by the regional sovereigns. The decentralised nature of
the o¢ cial interventions is important for our argument. Denote the quality
of coins in the two jurisdictions by v1 and v2 , respectively, where we may think

14
of vi as the relative silver content of the coins in jurisdiction i relative to the
full-bodied ones. When the quality of coins is not uniform, vi should be
considered a random variable, with an associated distribution over qualities
in i.
The merchants in country i can a¤ect the overall density of vi by with-
drawing existing coins from circulation and re-minting them. The regional
sovereign can a¤ect the density of vi by determining the minting standards in
i. The quality of coins cannot be easily determined without their undergoing
costly examination, such as assaying by …re. Hence, most traders cannot
make …ne distinctions between coins of similar quality. However, it would
be reasonable to assume that merchants in one jurisdiction have better in-
formation concerning the quality of the coins circulating in their own region,
compared with coins circulating in the other region. For our argument to
be valid, it su¢ ces to make the moderate assumption that proportion of
the merchants in region 1 know what the true average quality of the coins in
circulation in their own region is, but are uncertain about the average qual-
ity of coins predominating in the neighbouring region. The rest (proportion
1 ) do not even have this modest information.
Consider a mechant from country 1 who would like to buy goods from
country 2. He would pay for the goods by shipping coins from country 1
to the sellers in country 2. Alternatively, the merchant from 1 can issue a
bill of exchange that is redeemable in the coins of 1 at the maturity date.
Either way, the merchant from 1 who knows the true average quality of coins
in 1 has an advantage in the transaction. Relative to trade in terms of full-
bodied coins, the informed buyer from country 1 knows the (expected) gain
by paying for the goods in terms of debased coins. The situation is exactly
symmetrical from the point of view of merchants from country 2. Let us
apply the same assumptions for country 2. Proportion of merchants in 2
know the true average quality of coins circulating in 2, and the rest (1 )
do not.
The sellers of goods in countries 1 and 2 face a dilemma. The goods they
are giving up to buyers from the other region are of known consumption value
(for the sake of argument, we may assume identical, risk-neutral preferences).
However, they receive in return coins of uncertain value. More importantly,
they realise that the buyers who are most keen to purchase the goods are
those who know that the coins they are using to purchase the goods are of
low quality. In this sense, the keener the buyer to buy a good, the more wary
should the seller be. In the extreme case where the adverse selection is severe,
the sellers would be better o¤ refusing to trade with any buyer, since only
the buyers who o¤er debased coins will o¤er to trade with them. This is the
well-known “Groucho Marx”problem in trade with asymmetric information,

15
with reference to the Marx Brothers’…lm where Groucho famously announces
that “I refuse to join any club that would have me as a member.”
The adverse selection problem described above is a variation on the
lemons problem described by Akerlof (1970), except that the asymmetric
information a- icts both sides along two dimensions. By this, we mean that
country 1’s merchants have an advantage in buying goods from country 2,
while they are at a disadvantage when they are sellers of goods to buyers from
country 2. Thus, neither group has an absolute advantage over the other
group. Instead, they each have a relative advantage along one dimension.

3.2 Ampli…cation through market participation

The adverse selection e¤ect is the “seed”. The large economic damage comes
through the ampli…cation e¤ect of withdrawal from market participation.
One of the important functions of markets is to match buyers with sellers, so
that they can consummate trade on mutually bene…cial terms and thereby
realise the potential economic surplus. In doing so, the market mechanism
relies on the mutually reinforcing e¤ect of market participation.
Take a simple hypothetical example. When a seller contemplates whether
to take his produce to the market, he weighs up the pros and cons. By taking
his produce to the market, he will lose a day’s work, and therefore incur cost.
Thus, he will only choose to take his produce to the market if he believes
that there are su¢ cient potential buyers at the market to make it worthwhile.
The more potential buyers there are, the more worthwhile it is to incur the
cost and participate as a seller.
The situation is exactly symmetric from the point of view of the buyer.
The buyer will go to the market only when there is su¢ cient likelihood of
sellers turning up with goods for sale. Thus, from the point of view of the
buyer, the incentive to participate is greater when the expected seller partic-
ipation is greater. The mutually reinforcing e¤ect of seller/buyer participa-
tion has been much discussed in the literature on thick market externalities
(Diamond (1982), Pagano (1989) and Shin (1996), among others), and the
design of trading platforms in …nancial exchanges and the rules governing
them have been shown to depend sensitively on the strength of such exter-
nalities. When markets work well, the externalities operate in a virtuous
way. Because buyers believe that sellers will participate actively, they are
happy to submit aggressive (i.e. large) bids without worrying that such ac-
tion will simply result in the price being bid up in a thin market. The
sellers, for their part, anticipate such behaviour, and are happy to submit
large quantities without fearing that this will simply drive down the price in
a thin market. The virtuous circle of beliefs results in the desirable outcome

16
where transactions are large and there are large gains from trade.
However, a seed of doubt is planted by adverse selection, the externalities
that led to the virtuous circle can work in reverse, and the market may spiral
down to a very di¤erent outcome. When the seller fears that his goods
will be paid for with debased coins, he will be wary of how much the buyer
knows about the quality of the coins he is carrying (or will be released at
the time of redemption of the bill of exchange). In particular, the greater
the probability that the buyer is bringing debased coins, the more reluctant
the seller is to part with his goods. This is the Groucho Marx phenomenon
alluded to above.
However, if this is the reaction that a potential purchaser is likely to face,
then the buyer will think twice before setting o¤ to market. Even those
buyers who do not have privileged information will be cold-shouldered by the
sellers. Thus, the uninformed buyers are the …rst group to be discouraged
from going to market. The result is that the pool of potential buyers is
weighted heavily in favour of those buyers who know that the currency they
are carrying is debased. The sellers can anticipate all this, and so are fully
justi…ed in their wariness when facing a buyer. Trade therefore is much less
likely to take place, and so sellers are much less likely to take the trouble to
come to market in the …rst place.
This is a classic example of an ine¢ cient equilibrium. The actions of each
individual are rational given the circumstances that he faces, but the resulting
aggregate outcome is undesirable from a welfare point of view. There are
large potential gains from trade that are left unexploited. The main losers
are those uninformed traders who would ideally have traded with each other,
but are unable to do so in equilibrium due to the unravelling e¤ect imparted
by the “seed”of adverse selection.

3.3 Incentives of the sovereign

A key feature of the propagation of the currency debasement is the frag-
mented and decentralised nature of the minting activity. We go back to
our simplifed two-country setting with countries 1 and 2. We noted above
Kindleberger’s (1991, p. 149) argument that “bad money was taken by de-
basing states to their neighbors and exchanged for good. The neighbor
typically defended itself by debasing its own coin.” It is important to under-
stand why debasing one’s own coins could be seen as “defending”the country
from the onslaught from the neighbouring country.
First, it is worth asking what motivates the sovereign. It would be reason-
able to suppose that the sovereign has a …scal incentive towards debasement
arising from the revenues raised through seigniorage. Indeed, such a motive

17
lies at the heart of episodes of “controlled”debasement where the sovereign
deliberately engineers the debasement of a …xed size so as to raise revenue.
However, even if the sovereign did not have such motives, there are good
reasons to “defend”the currency through a matching debasement when faced
with a ‡ood of debased coins from neighbouring regions. The motive is
closely related to the competitive devaluations that occur in modern times.
Suppose, for the sake of argument, that the sovereign in country 1 does not
have a …scal motive to debase the currency in 1. However, when debased
currency from 2 is exchanged for the full-bodied coins from 1, the full-bodied
coins will be withdrawn from circulation or exported to be melted down.
The result would be a lowering of the money supply in 1, and the associated
economic e¤ects of tight money. A matching debasement by 1 remedies the
situation by removing the margin of pro…t for those who seek to exchange
bad money for good.
Of course, if the sovereign also had a motive to raise revenue, then the
argument for a matching deviation would be even stronger. In this sense, the
sovereign would need very little encouragement to follow the path of matching
debasement. Indeed, there would be a strong argument for selecting a level of
debasement that slightly exceeds the debasement in the neighbouring region,
since this would be the prudent strategy in a world where the exact quality
of coins is uncertain, and the onus is on pre-emptive action in a world of
fast-moving events.
The “race to the bottom”comes when the competitive debasements reach
such a pace that one country races to keep up with the debasement from the
other country as the best response, and in turn the other country’s rapid
debasement is its own best response. In a decentralised setting where the
actions of the sovereigns do not come under strong central control, the indi-
vidually prudent actions of individual sovereigns would lead to the collectively
disastrous outcome of a race to the bottom. As with traders, the sovereigns
themselves face a collective action problem, and the spread of debasement
is the outcome of that problem. The fragmented nature of the Holy Ro-
man Empire during the Kipper- und Wipperzeit is therefore an important
ingredient of our scenario of events.

3.4 Deposit banks

We have argued 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’pro…ts and
social welfare. Crucial to our argument has been the combination of (i) the
fragmented nature of the institutions that allow the incremental debasements

18
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 veri…ed.

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 of the value of money, and thereby prevented the socially
ine¢ cient erosion of coin values. We propose two reasons for how the de-
posit banks managed to arrest the erosion of coin values:

better guarantee of the value of the claims underpinning monetary

transactions; and

standardisation of the terms of settlement.

The two reasons, although related, can be taken separately. Indeed,

of the two, the second factor is of potentially greater importance for the
subsequent development of the …nancial system.
The …rst feature (control of the quality of the coins deposited) ensured
that any depositor would be credited the “fair”value of the deposited coins.
The control could take di¤erent forms. One was the restriction of the types
of coins that were accepted for deposit. Indeed, the Banks of Hamburg and
Amsterdam applied 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 su¢ ce 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 relatively cheap tests, such as the use of a scale or
the “touchstone test”, would always have been carried out for that purpose.

19
However, since the quality of coins would have to be veri…ed only once, even
the “assaying by …re” 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.
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 that did not both have an account at the same deposit bank (see
Schnabel 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
jurisdictions 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
centralisation of coins at the deposit bank, thereby ensuring 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 forgo
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 arrange-
ment. 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 government and
the merchants would be much more aligned than in a principality, where the
hunger for seignorage taxes may have outweighed the interest in maximising
social welfare. While the banks were established primarily for the bene…t of
the Amsterdam or Hamburg traders, their establishment also bene…ted their
trading partners. Just as the debasements tended to spread along trade
itineraries, the stabilisation 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 explain why so few deposit banks were created
in the Empire. First, the regional bene…t had to be great enough to make
the costs of establishment worthwhile; this would be true most of all in the
major trading cities like Hamburg and Amsterdam. Second, given the es-
tablishment of banks in 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.
We now turn to the second factor - the standardisation of settlement.

20
By replacing the direct exchange of coins with the balance transfers across
accounts at the deposit bank, the settlement through bank money established
the critical feature of the level playing …eld in information. To explain this
point more fully, it is worth emphasising that the standardisation argument
is logically independent from the argument on the quality of coins backing
the claims at the deposit bank. Even if the coins backing the deposits were
of uncertain quality, such uncertainty a¤ected all account holders equally and
symmetrically.
The agio between bank money and circulating currency can be understood
in those terms. As discussed by Quinn and Roberds (2007, 2014) and by
authors as long ago as Adam Smith, bank money almost invariably traded
at a premium to the circulating currency. The premium ‡uctuated around
a large margin, ranging from less than 2 percent to over 5 percent. Part
of the reason for the agio can no doubt be attributed to the higher absolute
quality of the coins held at the bank to back the deposit claims. However,
even if there were no di¤erence in coin quality, there would still be a good
reason for the existence of the agio.
The most important economic impact of standardisation is the foster-
ing of orderly market transactions that allow economic gains to be realised
through trade. The standardisation of contracts enables traders to enter the
market with less fear of expoitation, reinforcing the pool of potential trad-
ing counterparties that others will look to when entering the market. As
emphasised above, orderly markets allow the virtuous circle of thick market
externalities in which more traders enter as potential buyers believing that
more potential sellers will be attracted to enter the market too. Once these
beliefs have taken hold, self-interested actions reinforce the virtuous circle.
The preconditions of standardisation and common knowledge of units
of settlement lie at the heart of the virtuous circle of greater market par-
ticipation, thicker markets and the greater ability of the …nancial system to
facilitate the consummation of real economic transactions. These factors are
reminiscent of the arguments put forward for the establishment of common
accounting standards and the standardisation of documentation of derivative
contracts that have driven the development of …nancial market institutions
in recent decades. To the extent that the public deposit banks were the
precursors of standard-setters, there can be little doubt that the Bank of
Amsterdam and its imitators such as the Bank of Hamburg kick-started the
…nancial deepening and …nancial innovation that propelled the two cities to
the forefront of global …nance in the subsequent decades.

21
3.5 Common knowledge and money
Common knowledge refers not only to the fact that everyone knows, but that
this knowledge is transparent to all concerned. Another way to state this fea-
ture is that everyone knows, everyone knows that everyone knows, and so on
without limit. The idea is not that individuals hold these in…nite hierarchies
of knowledge in their minds, but rather that they face a very transparent
situation where no doubts exist about such higher orders of knowledge.
The philosopher David Lewis provided a celebrated analysis of why com-
mon knowledge is key to social conventions (Lewis (1969)), and common
knowledge is also the cornerstone of the analysis of equilibrium in economics.
The importance of common knowledge is especially relevant in monetary
economics in the age of DLT, as one interpretation of money is as a score-
keeping device on past transactions. The maxim is “money is memory”.
Indeed, Kocherlakota’s (1998) paper has precisely this title, and in the setting
of his analysis, a costless, publicly accessible record of all past transactions
can achieve the allocation of goods through transfers as would be feasible in
a monetary economy.
The following concrete example illustrates the argument. Suppose that
three individuals, A, B and C, each hold a good that is more valuable to
one of the other two individuals, but there is no double-coincidence of wants
whereby a direct swap between two individuals makes both better o¤. Money
enables the three individuals to trade, and enables them to achieve the ef-
…cient allocation of goods. Generalising such an argument, Kocherlakota
(1998) notes that if a ledger that records all past transactions is common
knowledge, then an impartial referee can keep track of the transfer of goods,
and implement the same allocation of goods to individuals, as is possible
in a monetary economy. The costless ledger of all transactions would open
the possibility of mimicking the allocation of a monetary economy through
a sequence of recorded gifts from one person to another.
This brings us to the topical issue of how Bitcoin and other uses of DLT
technology can be used to implement such a ledger of past transactions with-
out the need for a centralised impartial referee. Kocherlakota’s (1998) maxim
that “money is memory” raises the intriguing question of whether DLT can
substitute for the role of money in providing decentralised social memory.
There are, however, two considerations that give pause for thought. The
…rst concern is the robustness of the argument that memory can substitute
for money. The ledger that keeps score of past transfers must be commonly
shared. Bhaskar (1998) and Bhaskar et al (2012) show that small depar-
tures from the common knowledge of in…nite histories of transactions will
undermine the incentives in such settings, rendering the monetary outcome

22
infeasible. This is so even if the record-keeping device is costless.
Bhaskar (1998) cites the example of Samuelson’s (1958) overlapping gen-
erations model. At each date, the young generation have two units of a
perishable consumption good, and the old generation have none. In one al-
location, the young consume both goods, but starve when old. However, a
better outcome is if the young generation transfer one unit of the consump-
tion good to the old, in the expectation that they will receive from the next
generation a similar transfer. Such an allocation is feasible under common
knowledge of histories of in…nite length - for instance, through “punishment”
strategies where a new young generation withhold the transfer of the good
if they …nd that the current old generation that consumes both units. How-
ever, when information is limited to …nite histories, the good outcome may
no longer be feasible through such a strategy as the current old generation
had consumed both units may be doing so purely as part of their own punish-
ment of their predecessors (see Bhaskar (1998)). This is yet another instance
of the observation that higher orders of knowledge of increasing depth do
not approximate the outcome with common knowledge (see Morris and Shin
(1998, 2003) for more details). Bhaskar et al (2012) show that departures
from common knowledge severely restrict the scope of score-keeping devices
to implement cooperative outcomes so that only equilibrium in Markov (that
is, history-independent) strategies can be supported as robust equilibria.
There is a second concern with the “money is memory” maxim. The
argument for this maxim rests on showing that the e¢ cient allocation is only
one possible outcome as an equilibrium. Other, much less desirable outcomes
could also emerge as equilibria. Which outcome emerges will depend on the
robustness of the equilibrium selected.
Although these theoretical debates may seem abstract, they go to the
heart of the current debates about the role of DLT. The theoretical arguments
on money as memory depend sensitively on the common knowledge of the
histories and the unbounded nature of the recorded transactions.
The importance of common knowledge in economics applies to a wide
range of situations. It is worth taking a step back to highlight the abstract
properties of common knowledge so as to better understand the economic
impact of the absence thereof. Consider the following thought experiment.
A large, disparate group of individuals face a collective action problem. Sup-
pose that the preconditions for a successful coordination are in place, and it
is just a matter of conveying the facts of the case to the individuals. Com-
pare three scenarios for conveying this information taken from Morris and
Shin (2007).

Send an email to each individual, stating that the preconditions for a

23
 successful coordination are in place. But each individual recipient does
not know who else has been sent the message.
Send an email to each individual with the same content as above, but
with the recipient list clearly visible.
Rather than relying on email, convene a meeting of all the individ-
uals concerned. Gather everyone in a conference room, where each
individual can clearly see everyone else in the room. Then, make an
announcemement to the gathered group that the pre-conditions for a
successful coordination are in place.

Although the content of the message or announcement is identical in the

three scenarios, they are qualitatively very di¤erent situations in terms of
generating common knowledge of the circumstances. In the …rst scenario,
even if each recipient of the email trusts the sender as to its contents, this
may not be enough to tip the balance towards achieving coordination. The
problem is the uncertainty concerning what other parties will do. Even
if the underlying fundamentals of the problem were known, the uncertainty
about the others’beliefs and actions is still all-pervasive. Douglas Hofstadter
(1985, pp.752-3) coined the term “reverberant doubt”to describe this type of
uncertainty. The idea is that even a small seed of doubt that the players can
close ranks to achieve the good outcome will start to undermine the resolve to
stick to the cooperative strategy. The small seed of doubt “reverberates”to
become a much larger doubt, and when the players catch themselves thinking
this way, it becomes a compelling reason to act unilaterally, and opt out.
The second scenario (of sending an email with the recipient list clearly
visible) may fare much better in generating common knowledge of the under-
lying fundamentals, but there may still be issues with whether the receipients
have actually read the message. The third scenario (of a public announce-
ment to a gathered group) could be considered the most e¤ective means to
generate the common knowledge necessary to achieve the coordinated action.
The email example is intended to emphasise the important distinction be-
tween the quantity of information and the shared nature of that information.
Bank money serves the purpose of the shared nature of the information by
ensuring the standardisation of settlement. Chwe (1999) has noted that the
expected utility from trade may be maximised 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 pub-
licly veri…able. 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

24
and Velde (2002, p. 270)).10 The foundation of deposit banks at the begin-
ning 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 govern-
ment in this process. In the model devised by Gorton and Penacchi (1990),
banks mitigate ine¢ ciencies by making asset values informationally insen-
sitive; however, under certain conditions, the government has to intervene
to ensure e¢ cient trading. The public guarantee of the early deposit banks
may have played a similar role. Dang et al (2015) develop these arguments
to show that debt is the most informationally insensitive security.

4 Conclusion
Our paper has explained how the creation of public deposit banks may have
mitigated the monetary disturbances at the beginning of the 17th century.
For this purpose, we presented a simple model of debasements in a coun-
try 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 cur-
rencies do not fully adjust to relative average coin qualities. It is an open
question for future research whether the assumption of imperfectly ‡exible
exchange rates can also been con…rmed empirically.
Against the background of the theoretical model, we then described how
the institutional arrangements of public deposit banks were able to remove
the existing informational asymmetries and to generate common knowledge
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 veri…ed at the time of deposit. Since
the traders as a group bene…ted 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 institutions
proved to be so successful that Amsterdam bank money (and – to a more
10
The 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)).

25
limited extent – also Hamburg bank money) became the key currency in
international …nance 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 mod-
ern central banks, contrary to the conventional view that such banks were
created much later, mainly with the intention to …nance 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
signi…cance that the foundation of public deposit banks had may be antici-
pated by looking at the rise of Amsterdam and Hamburg to the status of key
trade and …nancial centres. This points to a much greater importance of the
banks than their immediate impact on the monetary situation of the time,
and highlights the signi…cance of …nancial institutions for economic growth.

26
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32
5 Appendix: model
We illustrate the impact of the erosion of common knowledge through a
simple example, drawing on Shin (1996). The following model assumes only
di¤erential information on the state of the economy and …xed costs to trading.
There are two goods, x and y, and two regions, A and B. In each region,
there are n traders who each have an endowment of one unit of x. In region
A, the preferences of traders are identical, and given by

uA = x + y (1)

Hence, the traders in A consider x and y as perfect substitutes. In region

B, the preferences are given by uB = x. Hence, the traders in B do not care
about consumption of y. However, traders in B can produce good y using
good x as input. The cost (in units of x) of producing y is

x=y = ; > 1: (2)

However, there is a …xed cost of production, F > 0 (measured in units of good

x). Given the preferences and production technology, there is the possibility
of mutually bene…cial trade as long as the marginal cost of producing y is
below the marginal rate of substitution of x against y for region A (which
is 1), provided that F is not too large. The …rst-best solution is when the
marginal cost of production is just equal to 1, which occurs when
1
y =1,y=1 (3)

implying cost of 1= plus …xed costs F . Provided that the …xed cost is not
too large (i.e., F < 1 1 ), the e¢ cient outcome is for traders in region B to
produce, and to trade with those in region A.
The precious metal content of coins from region A is uncertain. Denote
by v the precious metal content relative to full-bodied coins, where v is a
random variable whose realisations are at most 1. There are n possible
realisations of v, and denote by vi the ith lowest realisation of v. Hence

0 < v1 < v2 < < vn 1 (4)

The traders in region A know the realisation of v, but the producers in region
B do not. They have to rely on their signals (described below) to infer v.
We distinguish the real and the nominal price of good y. The real price
of good y in units of good x is
P
di
p = v Pi (5)
i si

33
where di is the amount of money brought to market by buyer i, and si is the
amount of the produced good brought to market by seller i. The nominal
price is P
p di
= Pi (6)
v i si
The …xed cost F is a random variable, and producers in B observe the
realisation of F but the buyers in A do not, and must infer it from their own
signals. Let
0 < F1 < F2 < < Fm (7)
be the possible realisations of F , and suppose that Fm > 1 1 . Thus, for
some realisations, the producers are better o¤ not producing at all.
With common knowledge, we obtain the following …rst-order conditions
for state (i; j) in a symmetric equilibrium:
1
d(i) = s(j) (8)
vi
s(j) = vi d(i); (9)
where the seller’s …rst-order condition applies only if …xed costs are not too
large. Hence, s(j) = 1 and d(i) = v1i for all states where …xed costs are not
too high; otherwise, there will be no production. The real price will be equal
to 1, the nominal price to v1i . Hence, the e¢ cient solution is implemented.
Traders from region A have identical information sets given by fvg. The
traders from region B have identical information sets given by fF g. But v
and F have a joint density g (v; F ). Traders from one region will form beliefs
about traders in the other region from this joint density.
Denote by d (i) the amount of money taken to market by a typical trader
from region A when v = vi , and denote by s (i) the amount of good y
produced by a typical seller from region B when F = Fi . Let the numbers of
traders be large in both regions, so that price e¤ects of imperfect competition
can be neglected.
The …rst-order condition for buyers of y (i.e., traders from region A) is
given by
2 3 32 3
d (1) 2 32 s (1)
6 d (2) 7 1=v1 0
6 7 6 . 76 Q 766 s (2) 7
7
6 .. 7 4 = . . 54 6 7 6 7 (10)
4 . 5 (n m) 5 4 ... 5
0 1=vn
d (n) s (m)
where the matrix Q is the matrix of conditional densities derived from the
joint density over v and F . The optimal decision now depends on the
expected supply instead of the realised supply.

34
 The …rst-order condition for sellers is
2 3 2 32 2 3
s^ (1) 3 d (1)
6 s^ (2) 7 6 v1 0 6 7
6 7 6 (m n) 7 7 6 . .. 7 6 d (2) 7
6 .. 7=4 5 4 5 6 .. 7 (11)
4 . 5 P 4 . 5
0 vn
s^ (m) d (n)

However, note that the optimal production decision for sellers may not co-
incide with the …rst-order condition. A seller from region B will prefer not
to produce if the …xed cost is high relative to gains from trade. From our
assumption on Fm , we know that there is at least one realisation of F for
which it is optimal not to produce. However, if the optimal production
decision is non-zero, then s (i) = s^ (i).
Substituting (10) into (11), we have
2 3 2 32 2 3
s^ (1) 3 d (1)
6 s^ (2) 7 v 6 7
6 7 6 P 76 1 . 7 6 d (2) 7
6 .. 7 = 4 6 7 4 . . 5 6 .. 7
4 . 5 (m n) 5 4 . 5
vn
s^ (m) d (n)
2 32 32 3
s (1)
6 P 76 Q 766 s (2) 7
7
= 4 6 7 6 7 6 7
(m n) 5 4 (n m) 5 4 ... 5
s (m)
2 32 3
s (1)
6 R 7 6 s (2) 7
6
7
= 6 4 (m m) 5 6
7 .. 7
4 . 5
s (m)

Before solving for the equilibrium supplies, let us solve for a related system
2 3 2 32 3
s (1) s (1)
6 s (2) 7 6 76 s (2) 7
6 7 R 76 7
6 .. 7 = 6 6 . 7 (12)
4 . 5 4 (m m) 5 4 .. 5
s (m) s (m)

where we have removed the exponent from the left-hand side. The matrix
R is assumed to be irreducible. We have

Lemma 1 Any solution to (12) is a constant function.

35
 Proof. Since R is irreducible,

s = Rs = R2 s = = R1 s

where R1 is the matrix whose rows are identical, and given by the station-
ary distribution associated with the Markov chain with transition matrix R.
Since each row of R1 is identical, s is constant.

Theorem 2 For any pro…le of …xed costs, there is > 1 such that for
< , the unique equilibrium outcome is
2 3 2 3
s (1) 0
6 s (2) 7 6 0 7
6 7 6 7
6 .. 7 = 6 .. 7
4 . 5 4 . 5
s (m) 0

Proof. First, note that s = 0 is an equilibrium. If no-one produces, then

buyers will not come to market. Conversely, when buyers do not come to
market, no-one produces. We need to show that there is no equilibrium with
positive production. From the benchmark lemma, we know that when = 1,
any solution to equilibrium supply is a constant function. However, since

s (m) = 0

the only solution is the zero function. The equilibrium supply is a continuous
function of . As ! 1 from above, the …rst-order conditions for supply
approach zero from above. For given …xed cost Fi , when the amount of sales
becomes small enough, the seller prefers not to produce at all. Hence, for
close to 1, the only equilibrium is when no-one produces.

In constrast to the drastic, ine¢ cient outcome with decentralised trade,

the existence of a deposit bank will enable e¢ cient production and exchange.
With the deposit bank facilitating payments, the game boils down to one
with common knowledge, and hence there is an equilibrium where producers
produce positive quantities in some states.

36
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