Friday, 1 June 2012

The curious case of the Canadian penny

The inflation squid finally took its toll on the Canadian one penny coin. Due to increasing metal prices the cost of minting and distributing the coin reached 1.6 cents and the Central Bank of Canada decided in May to discontinue its production. Its purchasing power dropped by a staggering 96% since the coin was first introduced in 1908. The Central Bank of Canada reckons that the move will save $11 million a year, while Bloomberg estimates that banks will save $20 million per year from not having to deal with small change. Not worth a penny ?

Metal Prices and Inflation

The Canadian penny is primarily made out of steel (approximately 94%) and nickel (1.5%) with copper as plating. From 1982 to 1996 the base metal from which it was minted was copper and from 1997 to 1999, it was zinc, two metals considerably more expensive than the ubiquitous steel. This practice of changing the composition of a  metal coin is not as new as one might think. 

It dates from ancient times when coins were minted out of precious metals such as gold or silver and if the ruling establishment wanted to devalue the currency, they would literally diminish the quantity of gold or silver per coin. For example, the Roman silver Denarius when it was first minted close to 269BC, it contained a quantity of 6.8 grammes of silver. In 211BC, the standardised Denarius contained only 4.5 grammes on average, while under the rule of the mad emperor of Rome, Nero it had reached 3.4 grammes. It was ultimately replaced in the mid 3rd century by the Antonianus, a coin which was initially minted out of silver, but was slowly debased into bronze. 

The previous copper composition of the Canadian penny made it economically unfeasible to create it since it  ended up costing more than it was legally worth. A big emphasis on "legally" since melting coins for their metal content is strictly forbidden in most states. But this does not prevent entrepreneurial minds to hoard the coins and wait until they are taken out of circulation and subsequently extract the metal content. Since the metal content is higher than its face value it makes sense to hoard it. Nobody sane would sell the 1oz American Gold Eagle, which contains 33.930 grams of gold at its 50$ face value. Copper chart from Trading Economics:

The situation is more extreme in the United States where it costs the US mint 2.41 cents to market a single penny and a whopping 11.2 cents for a nickel. Nevertheless, the losses on putting these coins or market are more than offset by the profits from selling coins with a face value considerably higher than its cost of production, profits known as seigniorage.

The important lesson here is that inflation has not only propped up asset prices to record high levels, thereby creating artificial bubbles and increasing the cost of money, but has also managed to literally increase the cost of money, by making it more expensive to mint and market low value coins.

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