Gresham's Law
Encyclopedia
Gresham's law is an economic
principle that states: "When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation." It is commonly stated as: "Bad money drives out good", but is more accurately stated: "Bad money drives out good if their exchange rate is set by law."
This law applies specifically when there are two forms of commodity money
in circulation which are required by legal-tender
laws to be accepted as having similar face value
s for economic transactions. The artificially overvalued money tends to drive an artificially undervalued money out of circulation and is a consequence of price control.
Gresham's law is named after Sir Thomas Gresham
(1519–1579), who was an English financier
during the Tudor dynasty
. However, the law had been stated forty years earlier by Nicolaus Copernicus
. In Poland it is known as the Copernicus-Gresham Law. The phenomenon had been noted even earlier, in the 14th century, by Nicole Oresme. The fact of bad money being used in preference to good money is also noted by Aristophanes
in his play The Frogs
, which dates from around the end of the 5th century BC.
(the value of the metal of which it is made, often precious metal
s, nickel
, or copper
.)
In the absence of legal-tender
laws, metal coin money will freely exchange at somewhat above bullion market value
. This is not a purely theoretical result but may instead be observed today in bullion coin
s such as the South Africa
n Krugerrand
, the American Gold Eagle
, or even the silver Maria Theresa thaler
(Austria
). Coins of this type are of a known purity and are in a convenient form to handle. People prefer trading in coins rather than in anonymous hunks of precious metal, so they attribute more value to the coins of equal weight.
The price spread between face value
and commodity value is called seigniorage
. Since some coins do not circulate, remaining in the possession of coin collectors, this can increase demand for coinage.
On the other hand, "bad" money is money that has a commodity value considerably lower than its face value and is in circulation along with good money, where both forms are required to be accepted at equal value as legal tender.
In Gresham's day, bad money included any coin
that had been debased. Debasement was often done by the issuing body, where less than the officially specified amount of precious metal was contained in an issue of coinage, usually by alloy
ing it with a base metal
. The public could also debase coins, usually by clipping
or scraping off small portions of the precious metal. Other examples of "bad" money include counterfeit
coins made from base metal.
In the case of clipped, scraped, or counterfeit coins, the commodity value was reduced by fraud, as the face value remains at the previous higher level. On the other hand, with a coinage debased by a government issuer, the commodity value of the coinage was often reduced quite openly, while the face value of the debased coins was held at the higher level by legal tender laws.
coins were widely circulated in Canada (until 1968) and in the United States (until 1965 for dimes
and quarters
and 1971 for half-dollars
). However, these countries debased
their coins by switching to cheaper metals as the market value of silver rose above that of the face value. The silver coins disappeared from circulation as citizens retained them to capture the higher current or perceived future intrinsic value of the metal content over their face value, using the newer coins in daily transactions. In the late 1970s, the Hunt brothers attempted to corner
the worldwide silver market but failed, temporarily driving the price far above its historic levels and intensifying the extraction of silver coins from circulation. The same process occurs today with the copper content of coins such as the pre-1997 Canadian penny
, the U.S. one-cent coin
and the pre-1992 UK copper pennies and halfpence.
This also occurred even with coins made of less expensive metals such as steel
in India.
Legal tender laws act as a form of price control. In such a case, the artificially overvalued money is preferred in exchange, because people prefer to save rather than exchange the artificially demoted one (which they actually value higher).
Consider a customer purchasing an item which costs five pence, who possesses several silver sixpence coins. Some of these coins are more debased, while others are less so—but legally, they are all mandated to be of equal value. The customer would prefer to retain the better coins, and so offers the shopkeeper the most debased one. In turn, the shopkeeper must give one penny in change, and has every reason to give the most debased penny. Thus, the coins that circulate in the transaction will tend to be of the most debased sort available to the parties.
If "good" coins have a face value below that of their metallic content, individuals may be motivated to melt them down and sell the metal for its higher intrinsic value, even if such destruction is illegal. As an example, consider the 1965 United States half dollar coins, which contained 40% silver
. In previous years, these coins were 90% silver. With the release of the 1965 half dollar, which was legally required to be accepted at the same value as the earlier 90% halves, the older 90% silver coinage quickly disappeared from circulation, while the newer debased coins remained in use. As the price of bullion silver continued to rise above the face value of the coins, many of the older half dollars were melted down. Beginning in 1971, the U.S. government gave up on including any silver in the half dollars, as even the metal value of the 40% silver coins began to exceed their face value.
A similar situation occurred in 2007 in the United States with the rising price of copper
and zinc
, which led the U.S. government to ban the melting or mass exportation of one-cent
and five-cent
coins, respectively.
In addition to being melted down for its bullion value, money that is considered to be "good" tends to leave an economy through international trade. International traders are not bound by legal tender laws as citizens of the issuing country are, so they will offer higher value for good coins than bad ones. The good coins may leave their country of origin to become part of international trade, escaping that country's legal tender laws and leaving the "bad" money behind. This occurred in Britain during the period of the gold standard
.
what was happening to the English shilling. Her father, Henry VIII
, had replaced 40 percent of the silver in the coin with base metals, to increase the government’s income without raising taxes. Astute English merchants and even ordinary subjects would save the good shillings from pure silver and circulate the bad ones; hence, the bad money would be used whenever possible, and the good coinage would be saved and disappear from circulation.
Gresham was not the first to state the law which took his name. The phenomenon had been noted much earlier, in the 14th century, by Nicole Oresme. In the year that Gresham was born, 1519, it was described by Nicolaus Copernicus
in a treatise
called Monetae cudendae ratio
: "bad (debased) coinage drives good (un-debased) coinage out of circulation." Copernicus was aware of the practice of exchanging bad coins for good ones and melting down the latter or sending them abroad, and he seems to have drawn up some notes on this subject while he was at Olsztyn
in 1519. He made them the basis of a report in German
which he presented to the Prussian Diet held in 1522 at Grudziądz
, attending the session with his friend Tiedemann Giese
to represent his chapter. Copernicus's Monetae cudendae ratio was an enlarged, Latin
version of that report, setting forth a general theory of money for the 1528 diet. He also formulated a version of the quantity theory of money.
According to the economist George Selgin
in his paper "Gresham's Law":
Gresham made his observations of good and bad money while in the service of Queen Elizabeth, with respect only to the observed poor quality of British coinage. The earlier monarchs, Henry VIII and Edward VI, had forced the people to accept debased coinage by means of their legal tender laws. Gresham also made his comparison of good and bad money where the precious metal in the money was the same metal, but of different weight. He did not compare silver to gold, or gold to paper.
The referenced passage from The Frogs
is as follows (usually dated at 405 BCE):
The currency devaluation phenomenon was already stated in ancient sources. Following are a few examples:
The Bible
1. Machpela Cave transaction:
Genesis 23:16:
Abraham weighed to Ephron the silver… four hundred shekels of silver, according to the current merchants' standard.
According to Gresham’s law, one can understand that Abraham, who promised Ephron (in Genesis 23:9) full payment, gave him good money - in market and wallet altogether. Not only did Abraham agree to pay the price Ephron had set, he even paid it with good money, for the market and the wallet altogether.
2. The building of the Temple
Kings I 10:21
All King Solomon's drinking vessels were of gold, and all the vessels of the house of the forest of Lebanon were of pure gold; none were of silver; it was nothing accounted of in the days of Solomon.
The fact that silver metal was used as a method of payment in ancient Israel, one can learn from this verse and from the double meaning of the word kesef (in Hebrew: money, silver). In the days of Solomon there was high inflation as far as this metal (silver) was concerned. The balance between the metals - silver and gold, which were used among other things as means of payment, was broken so bad against the silver metal until It was nothing accounted of.
Silver was nothing accounted of indicates a situation of hyper-inflation (in terms of silver metal) in the days of King Solomon, and can shed light on the background to the division of the kingdom after him. Since under these conditions, the distribution of the nation’s resources and wealth changes radically, the people become impoverished, and the kingdom crumbles down, just like a disease or a fire which damages are felt only after they have occurred.
One should note that throughout generations and transcripts of the bible, the words according to the current commercial standard and Nothing were never dropped, although seemingly, they do not contain any additional information.
The Mishna
3. The Mishna Bava Metzia
Bava Metzia 4:1
Bad coins acquire good coins, but good coins do not acquire bad coins;
This source describes the same phenomenon described by the Gresham law, though no explanation is given to this phenomenon. The writers of Mishnva have probably not fully grasped the dynamics behind the phenomenon, but merely stated it.
Notably this passage mentions only the flight of good money abroad and says nothing of its disappearance due to hoarding or melting.
The experiences of dollarization
in countries with weak economies and currencies (for example Israel
in the 1980s, Eastern Europe
and countries in the period immediately after the collapse of the Soviet bloc
, or South America
n countries throughout the late 20th and early 21st century) may be seen as Gresham's Law operating in its reverse form (Guidotti & Rodriguez, 1992), since in general the dollar has not been legal tender in such situations, and in some cases its use has been illegal.
Adam Fergusson
pointed out that in 1923 during the great Inflation in the Weimar Republic
Gresham's Law began to work in reverse, since the official money became so worthless that virtually nobody would take it. This was particularly serious since farmers began to hoard food. Accordingly, any currencies backed by any sorts of value became the circulating mediums of exchange. In 2009 Hyperinflation in Zimbabwe
began to show similar characteristics.
These examples show that in the absence of effective legal tender laws, Gresham's Law works in reverse. If given the choice of what money to accept, people will transact with money they believe to be of highest long-term value. However, if not given the choice, and required to accept all money, good and bad, they will tend to keep the money of greater perceived value in their possession, and pass on the bad money to someone else. In short, in the absence of legal tender laws, the seller will not accept anything but money of certain value (good money), while the existence of legal tender laws will cause the buyer to offer only money with the lowest commodity value (bad money) as the creditor must accept such money at face value.
The Nobel prize-winner Robert Mundell
believes that Gresham's Law could be more accurately rendered, taking care of the reverse, if it were expressed as, "Bad money drives out good if they exchange for the same price."
The reverse of Gresham's Law, that good money drives out bad money whenever the bad money becomes nearly worthless, has been named "Thiers' Law" by economist Peter Bernholz, in honor of French politician and historian Adolphe Thiers
. "Thiers' Law will only operate later [in the inflation] when the increase of the new flexible exchange rate and of the rate of inflation lower the real demand for the inflating money."
In the market for used cars, lemon automobiles
(analogous to bad currency) will drive out the good cars. The problem is one of asymmetry of information. Sellers have a strong financial incentive to pass all used cars off as "good" cars, especially lemons. This makes it difficult to buy a good car at a fair price, as the buyer risks overpaying for a lemon. The result is that buyers will only pay the fair price of a lemon, so at least they reduce the risk of overpaying. High-quality cars tend to be pushed out of the market, because there is no good way to establish that they really are worth more. Certified pre-owned
programs are an attempt to mitigate this problem by providing a warranty
and other guarantees of quality. "The Market for Lemons
" is a work that examines this problem in more detail.
Some also use an explanation of Gresham's Law as "The more efficient you become, the less effective you get"; i.e. "when you try to go on the cheap, you will stop selling" or "the less you invest in your non-tangible services, the fewer sales you will get".
Vice President Spiro Agnew
, used Gresham's law in describing American news media
, stating that "Bad news drives out good news," although his argument was closer to that of a race to the bottom
for higher ratings rather than over and undervaluing certain kinds of news.
Gresham's law has been cited as "Silver currency will inevitably force gold currency out of circulation" (L. Pyenson, Servants of Nature (W.W. Norton, 1999) p. 21); this suggests a fundamental misinterpretation, cf. Mundell (above).
in the 14th century also mentioned that bad money drives away the good money from the market, because people tend to use bad money for transactions and save the good money. Al-Maqrizi found this happening in Egypt and analysed the phenomenon.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
principle that states: "When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation." It is commonly stated as: "Bad money drives out good", but is more accurately stated: "Bad money drives out good if their exchange rate is set by law."
This law applies specifically when there are two forms of commodity money
Commodity money
Commodity money is money whose value comes from a commodity out of which it is made. It is objects that have value in themselves as well as for use as money....
in circulation which are required by legal-tender
Legal tender
Legal tender is a medium of payment allowed by law or recognized by a legal system to be valid for meeting a financial obligation. Paper currency is a common form of legal tender in many countries....
laws to be accepted as having similar face value
Face value
The Face value is the value of a coin, stamp or paper money, as printed on the coin, stamp or bill itself by the minting authority. While the face value usually refers to the true value of the coin, stamp or bill in question it can sometimes be largely symbolic, as is often the case with bullion...
s for economic transactions. The artificially overvalued money tends to drive an artificially undervalued money out of circulation and is a consequence of price control.
Gresham's law is named after Sir Thomas Gresham
Thomas Gresham
Sir Thomas Gresham was an English merchant and financier who worked for King Edward VI of England and for Edward's half-sisters, Queens Mary I and Elizabeth I.-Family and childhood:...
(1519–1579), who was an English financier
Financier
Financier is a term for a person who handles typically large sums of money, usually involving money lending, financing projects, large-scale investing, or large-scale money management. The term is French, and derives from finance or payment...
during the Tudor dynasty
Tudor dynasty
The Tudor dynasty or House of Tudor was a European royal house of Welsh origin that ruled the Kingdom of England and its realms, including the Lordship of Ireland, later the Kingdom of Ireland, from 1485 until 1603. Its first monarch was Henry Tudor, a descendant through his mother of a legitimised...
. However, the law had been stated forty years earlier by Nicolaus Copernicus
Nicolaus Copernicus
Nicolaus Copernicus was a Renaissance astronomer and the first person to formulate a comprehensive heliocentric cosmology which displaced the Earth from the center of the universe....
. In Poland it is known as the Copernicus-Gresham Law. The phenomenon had been noted even earlier, in the 14th century, by Nicole Oresme. The fact of bad money being used in preference to good money is also noted by Aristophanes
Aristophanes
Aristophanes , son of Philippus, of the deme Cydathenaus, was a comic playwright of ancient Athens. Eleven of his forty plays survive virtually complete...
in his play The Frogs
The Frogs
The Frogs is a comedy written by the Ancient Greek playwright Aristophanes. It was performed at the Lenaia, one of the Festivals of Dionysus, in 405 BC, and received first place.-Plot:...
, which dates from around the end of the 5th century BC.
'Good' money and 'bad' money
"Good" money is money that shows little difference between its nominal value (the face value of the coin) and its commodity valueCommodity value
In the field of economics, the commodity value of a good is its free market intrinsic value under optimal use conditions. In a free market, the commodity value of a good will be reflected by its price...
(the value of the metal of which it is made, often precious metal
Precious metal
A precious metal is a rare, naturally occurring metallic chemical element of high economic value.Chemically, the precious metals are less reactive than most elements, have high lustre, are softer or more ductile, and have higher melting points than other metals...
s, nickel
Nickel
Nickel is a chemical element with the chemical symbol Ni and atomic number 28. It is a silvery-white lustrous metal with a slight golden tinge. Nickel belongs to the transition metals and is hard and ductile...
, or copper
Copper
Copper is a chemical element with the symbol Cu and atomic number 29. It is a ductile metal with very high thermal and electrical conductivity. Pure copper is soft and malleable; an exposed surface has a reddish-orange tarnish...
.)
In the absence of legal-tender
Legal tender
Legal tender is a medium of payment allowed by law or recognized by a legal system to be valid for meeting a financial obligation. Paper currency is a common form of legal tender in many countries....
laws, metal coin money will freely exchange at somewhat above bullion market value
Market value
Market value is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value, although these terms have distinct definitions in different standards, and may differ in some...
. This is not a purely theoretical result but may instead be observed today in bullion coin
Bullion coin
A bullion coin is a coin struck from precious metal and kept as a store of value or an investment, rather than used in day-to-day commerce. Investment coins are generally coins that have been minted after 1800, have a purity of not less than 900 thousandths and are or have been a legal tender in...
s such as the South Africa
South Africa
The Republic of South Africa is a country in southern Africa. Located at the southern tip of Africa, it is divided into nine provinces, with of coastline on the Atlantic and Indian oceans...
n Krugerrand
Krugerrand
The Krugerrand is a South African gold coin, first minted in 1967 to help market South African gold. The coin, produced by the South African Mint, proved popular and by 1980 the Krugerrand accounted for 90% of the gold coin market. The name itself is a compound of Kruger and rand, the South...
, the American Gold Eagle
American Gold Eagle
The American Gold Eagle is an official gold bullion coin of the United States. Authorized under the Gold Bullion Coin Act of 1985, it was first released by the United States Mint in 1986.- Details :...
, or even the silver Maria Theresa thaler
Maria Theresa thaler
The Maria Theresa thaler is a silver bullion-coin that has been used in world trade continuously. Maria Theresa Thalers were first minted in 1741, using the then Reichsthaler standard of 9 thalers to the Vienna mark. In 1750 the thaler was debased to 10 thalers to the Vienna Mark...
(Austria
Austria
Austria , officially the Republic of Austria , is a landlocked country of roughly 8.4 million people in Central Europe. It is bordered by the Czech Republic and Germany to the north, Slovakia and Hungary to the east, Slovenia and Italy to the south, and Switzerland and Liechtenstein to the...
). Coins of this type are of a known purity and are in a convenient form to handle. People prefer trading in coins rather than in anonymous hunks of precious metal, so they attribute more value to the coins of equal weight.
The price spread between face value
Face value
The Face value is the value of a coin, stamp or paper money, as printed on the coin, stamp or bill itself by the minting authority. While the face value usually refers to the true value of the coin, stamp or bill in question it can sometimes be largely symbolic, as is often the case with bullion...
and commodity value is called seigniorage
Seigniorage
Seigniorage can have the following two meanings:* Seigniorage derived from specie—metal coins, is a tax, added to the total price of a coin , that a customer of the mint had to pay to the mint, and that was sent to the sovereign of the political area.* Seigniorage derived from notes is more...
. Since some coins do not circulate, remaining in the possession of coin collectors, this can increase demand for coinage.
On the other hand, "bad" money is money that has a commodity value considerably lower than its face value and is in circulation along with good money, where both forms are required to be accepted at equal value as legal tender.
In Gresham's day, bad money included any coin
Coin
A coin is a piece of hard material that is standardized in weight, is produced in large quantities in order to facilitate trade, and primarily can be used as a legal tender token for commerce in the designated country, region, or territory....
that had been debased. Debasement was often done by the issuing body, where less than the officially specified amount of precious metal was contained in an issue of coinage, usually by alloy
Alloy
An alloy is a mixture or metallic solid solution composed of two or more elements. Complete solid solution alloys give single solid phase microstructure, while partial solutions give two or more phases that may or may not be homogeneous in distribution, depending on thermal history...
ing it with a base metal
Base metal
In chemistry, the term base metal is used informally to refer to a metal that oxidizes or corrodes relatively easily, and reacts variably with diluted hydrochloric acid to form hydrogen. Examples include iron, nickel, lead and zinc...
. The public could also debase coins, usually by clipping
Coin clipping
Coin debasement is the act of decreasing the amount of precious metal in a coin, while continuing to circulate it at face value. This was frequently done by governments in order to inflate the amount of currency in circulation; typically, some of the precious metal was replaced by a cheaper metal...
or scraping off small portions of the precious metal. Other examples of "bad" money include counterfeit
Counterfeit
To counterfeit means to illegally imitate something. Counterfeit products are often produced with the intent to take advantage of the superior value of the imitated product...
coins made from base metal.
In the case of clipped, scraped, or counterfeit coins, the commodity value was reduced by fraud, as the face value remains at the previous higher level. On the other hand, with a coinage debased by a government issuer, the commodity value of the coinage was often reduced quite openly, while the face value of the debased coins was held at the higher level by legal tender laws.
Examples
SilverSilver
Silver is a metallic chemical element with the chemical symbol Ag and atomic number 47. A soft, white, lustrous transition metal, it has the highest electrical conductivity of any element and the highest thermal conductivity of any metal...
coins were widely circulated in Canada (until 1968) and in the United States (until 1965 for dimes
Dime (United States coin)
The dime is a coin 10 cents, one tenth of a United States dollar, labeled formally as "one dime". The denomination was first authorized by the Coinage Act of 1792. The dime is the smallest in diameter and is the thinnest of all U.S...
and quarters
Quarter (United States coin)
A quarter dollar, commonly shortened to quarter, is a coin worth ¼ of a United States dollar, or 25 cents. The quarter has been produced since 1796. The choice of 25¢ as a denomination, as opposed to 20¢ which is more common in other parts of the world, originated with the practice of dividing...
and 1971 for half-dollars
Half dollar (United States coin)
Half dollar coins have been produced nearly every year since the inception of the United States Mint in 1794. Sometimes referred to as the fifty-cent piece, the only U.S. coin that has been minted more consistently is the cent.-Circulation:...
). However, these countries debased
Debasement
Debasement is the practice of lowering the value of currency. It is particularly used in connection with commodity money such as gold or silver coins...
their coins by switching to cheaper metals as the market value of silver rose above that of the face value. The silver coins disappeared from circulation as citizens retained them to capture the higher current or perceived future intrinsic value of the metal content over their face value, using the newer coins in daily transactions. In the late 1970s, the Hunt brothers attempted to corner
Cornering the market
In finance, to corner the market is to get sufficient control of a particular stock, commodity, or other asset to allow the price to be manipulated. Another definition: "To have the greatest market share in a particular industry without having a monopoly...
the worldwide silver market but failed, temporarily driving the price far above its historic levels and intensifying the extraction of silver coins from circulation. The same process occurs today with the copper content of coins such as the pre-1997 Canadian penny
Penny (Canadian coin)
In Canada, a penny is a coin worth one cent or of a dollar. According to the Royal Canadian Mint, the official national term of the coin is the "one-cent piece", but in practice the term penny or cent is universal. Originally, "penny" referred to a two-cent coin. When the two-cent coin was...
, the U.S. one-cent coin
Cent (United States coin)
The United States one-cent coin, commonly known as a penny, is a unit of currency equaling one one-hundredth of a United States dollar. The cent's symbol is ¢. Its obverse has featured the profile of President Abraham Lincoln since 1909, the centennial of his birth. From 1959 to 2008, the reverse...
and the pre-1992 UK copper pennies and halfpence.
This also occurred even with coins made of less expensive metals such as steel
Steel
Steel is an alloy that consists mostly of iron and has a carbon content between 0.2% and 2.1% by weight, depending on the grade. Carbon is the most common alloying material for iron, but various other alloying elements are used, such as manganese, chromium, vanadium, and tungsten...
in India.
Theory
Gresham's law states that any circulating currency consisting of both "good" and "bad" money (both forms required to be accepted at equal value under legal tender law) quickly becomes dominated by the "bad" money. This is because people spending money will hand over the "bad" coins rather than the "good" ones, keeping the "good" ones for themselves.Legal tender laws act as a form of price control. In such a case, the artificially overvalued money is preferred in exchange, because people prefer to save rather than exchange the artificially demoted one (which they actually value higher).
Consider a customer purchasing an item which costs five pence, who possesses several silver sixpence coins. Some of these coins are more debased, while others are less so—but legally, they are all mandated to be of equal value. The customer would prefer to retain the better coins, and so offers the shopkeeper the most debased one. In turn, the shopkeeper must give one penny in change, and has every reason to give the most debased penny. Thus, the coins that circulate in the transaction will tend to be of the most debased sort available to the parties.
If "good" coins have a face value below that of their metallic content, individuals may be motivated to melt them down and sell the metal for its higher intrinsic value, even if such destruction is illegal. As an example, consider the 1965 United States half dollar coins, which contained 40% silver
Silver
Silver is a metallic chemical element with the chemical symbol Ag and atomic number 47. A soft, white, lustrous transition metal, it has the highest electrical conductivity of any element and the highest thermal conductivity of any metal...
. In previous years, these coins were 90% silver. With the release of the 1965 half dollar, which was legally required to be accepted at the same value as the earlier 90% halves, the older 90% silver coinage quickly disappeared from circulation, while the newer debased coins remained in use. As the price of bullion silver continued to rise above the face value of the coins, many of the older half dollars were melted down. Beginning in 1971, the U.S. government gave up on including any silver in the half dollars, as even the metal value of the 40% silver coins began to exceed their face value.
A similar situation occurred in 2007 in the United States with the rising price of copper
Copper
Copper is a chemical element with the symbol Cu and atomic number 29. It is a ductile metal with very high thermal and electrical conductivity. Pure copper is soft and malleable; an exposed surface has a reddish-orange tarnish...
and zinc
Zinc
Zinc , or spelter , is a metallic chemical element; it has the symbol Zn and atomic number 30. It is the first element in group 12 of the periodic table. Zinc is, in some respects, chemically similar to magnesium, because its ion is of similar size and its only common oxidation state is +2...
, which led the U.S. government to ban the melting or mass exportation of one-cent
Cent (United States coin)
The United States one-cent coin, commonly known as a penny, is a unit of currency equaling one one-hundredth of a United States dollar. The cent's symbol is ¢. Its obverse has featured the profile of President Abraham Lincoln since 1909, the centennial of his birth. From 1959 to 2008, the reverse...
and five-cent
Nickel (United States coin)
The nickel is a five-cent coin, representing a unit of currency equaling five hundredths of one United States dollar. A later-produced Canadian nickel five-cent coin was also called by the same name....
coins, respectively.
In addition to being melted down for its bullion value, money that is considered to be "good" tends to leave an economy through international trade. International traders are not bound by legal tender laws as citizens of the issuing country are, so they will offer higher value for good coins than bad ones. The good coins may leave their country of origin to become part of international trade, escaping that country's legal tender laws and leaving the "bad" money behind. This occurred in Britain during the period of the gold standard
Gold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
.
History of the concept
The law was named after Sir Thomas Gresham, a sixteenth century financial agent of the English Crown in the city of Antwerp, to explain to Queen Elizabeth IElizabeth I of England
Elizabeth I was queen regnant of England and Ireland from 17 November 1558 until her death. Sometimes called The Virgin Queen, Gloriana, or Good Queen Bess, Elizabeth was the fifth and last monarch of the Tudor dynasty...
what was happening to the English shilling. Her father, Henry VIII
Henry VIII of England
Henry VIII was King of England from 21 April 1509 until his death. He was Lord, and later King, of Ireland, as well as continuing the nominal claim by the English monarchs to the Kingdom of France...
, had replaced 40 percent of the silver in the coin with base metals, to increase the government’s income without raising taxes. Astute English merchants and even ordinary subjects would save the good shillings from pure silver and circulate the bad ones; hence, the bad money would be used whenever possible, and the good coinage would be saved and disappear from circulation.
Gresham was not the first to state the law which took his name. The phenomenon had been noted much earlier, in the 14th century, by Nicole Oresme. In the year that Gresham was born, 1519, it was described by Nicolaus Copernicus
Nicolaus Copernicus
Nicolaus Copernicus was a Renaissance astronomer and the first person to formulate a comprehensive heliocentric cosmology which displaced the Earth from the center of the universe....
in a treatise
Treatise
A treatise is a formal and systematic written discourse on some subject, generally longer and treating it in greater depth than an essay, and more concerned with investigating or exposing the principles of the subject.-Noteworthy treatises:...
called Monetae cudendae ratio
Monetae cudendae ratio
Monetae cudendae ratio is a paper on coinage by Nicolaus Copernicus...
: "bad (debased) coinage drives good (un-debased) coinage out of circulation." Copernicus was aware of the practice of exchanging bad coins for good ones and melting down the latter or sending them abroad, and he seems to have drawn up some notes on this subject while he was at Olsztyn
Olsztyn
Olsztyn is a city in northeastern Poland, on the Łyna River. Olsztyn has been the capital of the Warmian-Masurian Voivodeship since 1999. It was previously in the Olsztyn Voivodeship...
in 1519. He made them the basis of a report in German
German language
German is a West Germanic language, related to and classified alongside English and Dutch. With an estimated 90 – 98 million native speakers, German is one of the world's major languages and is the most widely-spoken first language in the European Union....
which he presented to the Prussian Diet held in 1522 at Grudziądz
Grudziadz
Grudziądz is a city in northern Poland on the Vistula River, with 96 042 inhabitants . Situated in the Kuyavian-Pomeranian Voivodeship , the city was previously in the Toruń Voivodeship .- History :-Early history:...
, attending the session with his friend Tiedemann Giese
Tiedemann Giese
Tiedemann Giese Tiedemann Giese Tiedemann Giese (1 June 1480 – 23 October 1550, Heilsberg (Lidzbark), was a member of the patrician Giese family of Danzig (Gdańsk). The brother of the Hanseatic League merchant Georg Giese and relative of Albrecht Giese he became Bishop of Culm (Chełmno) first...
to represent his chapter. Copernicus's Monetae cudendae ratio was an enlarged, Latin
Latin
Latin is an Italic language originally spoken in Latium and Ancient Rome. It, along with most European languages, is a descendant of the ancient Proto-Indo-European language. Although it is considered a dead language, a number of scholars and members of the Christian clergy speak it fluently, and...
version of that report, setting forth a general theory of money for the 1528 diet. He also formulated a version of the quantity theory of money.
According to the economist George Selgin
George Selgin
George A. Selgin is a professor of economics in the Terry College of Business at the University of Georgia, a senior fellow at the Cato Institute in Washington DC, and an associate editor of Econ Journal Watch...
in his paper "Gresham's Law":
Gresham made his observations of good and bad money while in the service of Queen Elizabeth, with respect only to the observed poor quality of British coinage. The earlier monarchs, Henry VIII and Edward VI, had forced the people to accept debased coinage by means of their legal tender laws. Gresham also made his comparison of good and bad money where the precious metal in the money was the same metal, but of different weight. He did not compare silver to gold, or gold to paper.
Origin of the name
In his "Gresham's Law" article, Selgin also offers the following comments regarding the origin of the name:The referenced passage from The Frogs
The Frogs
The Frogs is a comedy written by the Ancient Greek playwright Aristophanes. It was performed at the Lenaia, one of the Festivals of Dionysus, in 405 BC, and received first place.-Plot:...
is as follows (usually dated at 405 BCE):
Precursors
Ancient Sources Describing the Currency Devaluation PhenomenonThe currency devaluation phenomenon was already stated in ancient sources. Following are a few examples:
The Bible
1. Machpela Cave transaction:
Genesis 23:16:
Abraham weighed to Ephron the silver… four hundred shekels of silver, according to the current merchants' standard.
According to Gresham’s law, one can understand that Abraham, who promised Ephron (in Genesis 23:9) full payment, gave him good money - in market and wallet altogether. Not only did Abraham agree to pay the price Ephron had set, he even paid it with good money, for the market and the wallet altogether.
2. The building of the Temple
Kings I 10:21
All King Solomon's drinking vessels were of gold, and all the vessels of the house of the forest of Lebanon were of pure gold; none were of silver; it was nothing accounted of in the days of Solomon.
The fact that silver metal was used as a method of payment in ancient Israel, one can learn from this verse and from the double meaning of the word kesef (in Hebrew: money, silver). In the days of Solomon there was high inflation as far as this metal (silver) was concerned. The balance between the metals - silver and gold, which were used among other things as means of payment, was broken so bad against the silver metal until It was nothing accounted of.
Silver was nothing accounted of indicates a situation of hyper-inflation (in terms of silver metal) in the days of King Solomon, and can shed light on the background to the division of the kingdom after him. Since under these conditions, the distribution of the nation’s resources and wealth changes radically, the people become impoverished, and the kingdom crumbles down, just like a disease or a fire which damages are felt only after they have occurred.
One should note that throughout generations and transcripts of the bible, the words according to the current commercial standard and Nothing were never dropped, although seemingly, they do not contain any additional information.
The Mishna
3. The Mishna Bava Metzia
Bava Metzia 4:1
Bad coins acquire good coins, but good coins do not acquire bad coins;
This source describes the same phenomenon described by the Gresham law, though no explanation is given to this phenomenon. The writers of Mishnva have probably not fully grasped the dynamics behind the phenomenon, but merely stated it.
Ibn Taymiyyah
Ibn Taimiyyah (1263–1328) described the phenomenon as follows:Notably this passage mentions only the flight of good money abroad and says nothing of its disappearance due to hoarding or melting.
Reverse of Gresham's Law (Thiers' Law)
In an influential theoretical article, Rolnick and Weber (1986) argued that bad money would drive good money to a premium rather than driving it out of circulation. However their research did not take into account the context in which Gresham made his observation. Rolnick and Weber ignored the influence of legal tender legislation which requires people to accept both good and bad money as if they were of equal value. They also focused mainly on the interaction between different metallic monies, comparing the relative "goodness" of silver to that of gold, which is not what Gresham was speaking of.The experiences of dollarization
Dollarization
Dollarization occurs when the inhabitants of a country use foreign currency in parallel to or instead of the domestic currency. The term is not only applied to usage of the United States dollar, but generally to the use of any foreign currency as the national currency.The biggest economies to have...
in countries with weak economies and currencies (for example Israel
Israel
The State of Israel is a parliamentary republic located in the Middle East, along the eastern shore of the Mediterranean Sea...
in the 1980s, Eastern Europe
Eastern Europe
Eastern Europe is the eastern part of Europe. The term has widely disparate geopolitical, geographical, cultural and socioeconomic readings, which makes it highly context-dependent and even volatile, and there are "almost as many definitions of Eastern Europe as there are scholars of the region"...
and countries in the period immediately after the collapse of the Soviet bloc
Eastern bloc
The term Eastern Bloc or Communist Bloc refers to the former communist states of Eastern and Central Europe, generally the Soviet Union and the countries of the Warsaw Pact...
, or South America
South America
South America is a continent situated in the Western Hemisphere, mostly in the Southern Hemisphere, with a relatively small portion in the Northern Hemisphere. The continent is also considered a subcontinent of the Americas. It is bordered on the west by the Pacific Ocean and on the north and east...
n countries throughout the late 20th and early 21st century) may be seen as Gresham's Law operating in its reverse form (Guidotti & Rodriguez, 1992), since in general the dollar has not been legal tender in such situations, and in some cases its use has been illegal.
Adam Fergusson
Adam Fergusson (MEP)
Adam Dugdale Fergusson is a British journalist, author and Conservative Party politician who served one term in the European Parliament. He has remained involved in the field of European Union affairs since, as a Special Adviser to Conservative governments and as a business consultant...
pointed out that in 1923 during the great Inflation in the Weimar Republic
Inflation in the Weimar Republic
The hyperinflation in the Weimar Republic was a three year period of hyperinflation in Germany between June 1921 and July 1924.- Analysis :...
Gresham's Law began to work in reverse, since the official money became so worthless that virtually nobody would take it. This was particularly serious since farmers began to hoard food. Accordingly, any currencies backed by any sorts of value became the circulating mediums of exchange. In 2009 Hyperinflation in Zimbabwe
Hyperinflation in Zimbabwe
Hyperinflation in Zimbabwe began shortly after destruction of productive capacity in Zimbabwe's civil war and confiscation of white-owned farmland. Food output capacity fell 45%, manufacturing output 29% in 2005, 26% in 2006 and 28% in 2007, and unemployment rose to 80%...
began to show similar characteristics.
These examples show that in the absence of effective legal tender laws, Gresham's Law works in reverse. If given the choice of what money to accept, people will transact with money they believe to be of highest long-term value. However, if not given the choice, and required to accept all money, good and bad, they will tend to keep the money of greater perceived value in their possession, and pass on the bad money to someone else. In short, in the absence of legal tender laws, the seller will not accept anything but money of certain value (good money), while the existence of legal tender laws will cause the buyer to offer only money with the lowest commodity value (bad money) as the creditor must accept such money at face value.
The Nobel prize-winner Robert Mundell
Robert Mundell
Robert Mundell, CC is a Nobel Prize-winning Canadian economist. Currently, Mundell is a professor of economics at Columbia University and the Chinese University of Hong Kong....
believes that Gresham's Law could be more accurately rendered, taking care of the reverse, if it were expressed as, "Bad money drives out good if they exchange for the same price."
The reverse of Gresham's Law, that good money drives out bad money whenever the bad money becomes nearly worthless, has been named "Thiers' Law" by economist Peter Bernholz, in honor of French politician and historian Adolphe Thiers
Adolphe Thiers
Marie Joseph Louis Adolphe Thiers was a French politician and historian. was a prime minister under King Louis-Philippe of France. Following the overthrow of the Second Empire he again came to prominence as the French leader who suppressed the revolutionary Paris Commune of 1871...
. "Thiers' Law will only operate later [in the inflation] when the increase of the new flexible exchange rate and of the rate of inflation lower the real demand for the inflating money."
Application
The principles of Gresham's law can sometimes be applied to different fields of study. Gresham's law may be generally applied to any circumstance in which the "true" value of something is markedly different from the value people are required to accept, due to factors such as lack of information or governmental decree.In the market for used cars, lemon automobiles
Lemon (automobile)
A lemon is a car, often new, that is found to be defective only after it has been bought. Any vehicle with numerous, severe issues can be termed a "lemon", and, by extension, any product with flaws too great or severe to serve its purpose can be described as a "lemon".-Origin:The use of the word...
(analogous to bad currency) will drive out the good cars. The problem is one of asymmetry of information. Sellers have a strong financial incentive to pass all used cars off as "good" cars, especially lemons. This makes it difficult to buy a good car at a fair price, as the buyer risks overpaying for a lemon. The result is that buyers will only pay the fair price of a lemon, so at least they reduce the risk of overpaying. High-quality cars tend to be pushed out of the market, because there is no good way to establish that they really are worth more. Certified pre-owned
Certified Pre-Owned
A Certified Pre-Owned or CPO, car is a type of used car.Most often late-model, they differ from run of the mill used cars by having been inspected, refurbished, and certified by a manufacturer or other certifying authority. They also typically include an extended warranty, special financing, and...
programs are an attempt to mitigate this problem by providing a warranty
Warranty
In business and legal transactions, a warranty is an assurance by one party to the other party that specific facts or conditions are true or will happen; the other party is permitted to rely on that assurance and seek some type of remedy if it is not true or followed.In real estate transactions, a...
and other guarantees of quality. "The Market for Lemons
The Market for Lemons
"The Market for Lemons: Quality Uncertainty and the Market Mechanism" is a 1970 paper by the economist George Akerlof. It discusses information asymmetry, which occurs when the seller knows more about a product than the buyer. A lemon is an American slang term for a car that is found to be...
" is a work that examines this problem in more detail.
Some also use an explanation of Gresham's Law as "The more efficient you become, the less effective you get"; i.e. "when you try to go on the cheap, you will stop selling" or "the less you invest in your non-tangible services, the fewer sales you will get".
Vice President Spiro Agnew
Spiro Agnew
Spiro Theodore Agnew was the 39th Vice President of the United States , serving under President Richard Nixon, and the 55th Governor of Maryland...
, used Gresham's law in describing American news media
News media
The news media are those elements of the mass media that focus on delivering news to the general public or a target public.These include print media , broadcast news , and more recently the Internet .-Etymology:A medium is a carrier of something...
, stating that "Bad news drives out good news," although his argument was closer to that of a race to the bottom
Race to the bottom
A race to the bottom is a socio-economic concept that is argued to occur between countries as an outcome of regulatory competition, progressive taxation policies and social welfare spending...
for higher ratings rather than over and undervaluing certain kinds of news.
Gresham's law has been cited as "Silver currency will inevitably force gold currency out of circulation" (L. Pyenson, Servants of Nature (W.W. Norton, 1999) p. 21); this suggests a fundamental misinterpretation, cf. Mundell (above).
Other versions of Gresham's law
A work of Taqiuddin Ahmad al-MaqriziAl-Maqrizi
Taqi al-Din Ahmad ibn 'Ali ibn 'Abd al-Qadir ibn Muhammad al-Maqrizi ; Arabic: , was an Egyptian historian more commonly known as al-Maqrizi or Makrizi...
in the 14th century also mentioned that bad money drives away the good money from the market, because people tend to use bad money for transactions and save the good money. Al-Maqrizi found this happening in Egypt and analysed the phenomenon.
See also
- List of multiple discoveries
- Adages named after people
- Lemon socialismLemon socialism"Lemon socialism" is a pejorative term for government support of private-sector companies whose imminent collapse is perceived to threaten broader economic stability. Some assert it is not a subcategory of socialism per se; rather, it points to a corruption of free-market capitalist systems, which...
- Penny debate in the United States
External links
- "Bad Money Drives Out Good" - The Future of Freedom Foundation
- Coinflation.com - illustrates Gresham's Law based upon the current metal value of coins in circulation.