pexels-photo-3943748.jpeg
Photo by cottonbro on Pexels.com

 

Much like the physical sciences, economics has immutable laws. The Law of Supply and Demand is equally as well known as Newton’s Law of Gravity. In this essay, I will expound upon an economic law that is not as well known to the general public. Arguably, it is just as important as the Law of Supply and Demand. That is Gresham’s Law. Have you ever wonder why people invest in gold or tend to hang on to their cryptocurrency? Outside of legal constraints and vendors opting not accepting such mediums of exchange, Gresham’s Law provides some insight.

 

Colloquially Gresham’s Law has been oversimplified to being defined as “bad” money drives out “good” money. Essentially the introduction of “bad” money will replace “good” money in circulation. It is important to clarify what is meant by “good” and “bad” money.  Bad money is a currency that has a higher nominal value than intrinsic value, making it overvalued (Sparavigna, 2014, P.1) [1]. Vice versa is true of “good” money or undervalued currency. Gresham’s law does not come into effect until legal-tender laws designate that both varieties of money have the same exchange value (Sparavigna, 2014, P.1) [2]. The undervalued currency tends to exit circulation in one of two ways. People either start to hoard the undervalued money (Sparavigna, 2014, P.3) [3]. The undervalued currency leaves circulation through exportation. In the case of monetary metals, the coins are melted down and the bullion is sold abroad (Fetter, 1922, P.46)[4].

 

The general premise behind Gresham’s Law predates its namesake. Tudor-era financier Sir Thomas Gresham. One of the earliest recorded observations of what became known as Gresham’s Law dates back to ancient Greece. In Aristophane’s play  The Frogs a parallel is drawn between the substitution of gold coins for copper coins and the declining quality in politicians (Sullivan, 2005, P.5) [5]. In the 1300s King Charles, the Fifth of France enlisted the help Nicole Oresme to resolve the economic instability caused by the fluctuation in the value of the French coinage. Oresme made the observation that when two coins present having the same face value but different intrinsic value, the higher value coin leaves circulation. The coins of a higher metal content were melted down and the bullion was sold abroad. Oresme believed that government-sanctioned monetary laws should prevent currency debasement (Sparavigna, 2014, P.6) [6].

 

Another theorist who posited a nascent form of Gresham’s Law was no other than Copernicus. He perceived money as ultimately as an estimated indicator of value. If the value was artificially manipulated would cause disruptions in the market (Sparavigna, 2014, P.7) [7]. Copernicus suggested from a policy standpoint that any new money introduced into circulation should be of the same nominal and intrinsic value as the old money. If not the old currency will move out of circulation (Sparavigna, 2014, P.7) [8].  Then there was Sir Thomas Gresham whom this economic law is named after. In 1858,  Henry Dunning Macleod officially named this economic phenomenon after Gresham (Sparavigna, 2014, P.1) [9]. Gresham famously wrote a letter to Queen Elizabeth concerning how reducing the weight of minted coinage encouraged the export of the older coins. Despite popular misconception and clumsy interpretation of Gresham’s letter, there was a stipulation. Good doesn’t necessarily drive out bad. Bad money will remain in circulation providing that the “baser” coins are produced in limited quantity and do not exceed “trade needs” (Sparavigna, 2014, P.9) [10].

 

The misapplication of Gresham’s Law due to careless interpretation has lead to many faulty claims. Attempts to invalidate the law or restructure its conditions have been predicated on such flimsy grounds (Selgin, 2003) [11]. American economist Frank Fetter reinforces Gresham’s stipulation in his 1922 book Modern Economic Problems:

 

The law applies only under certain conditions and within certain limitations. The “ good” will be driven out only if the total amount of money in circulation is in excess of what would be needed if all were of full weight and of the best quality. Paradoxically speaking, if there is not too much money altogether, the bad money is just as good as the good money. But, even if good money is driven out, it may not leave the Country. It may behoarded, or be picked out by banks and savings institutions to retain as their reserves or be melted for use in the arts. (Fetter, 1922, P.42-43) [12].

Making it crucial to properly interpret the conditions under which Gresham’s Law holds. Good money drives out bad money is a far too rudimentary presentation of this economic law.

 

One novel interpretation of Gresham’s Law came from the grandfather of Anarcho-capitalism himself, Murray Rothbard. He stated that Gresham’s Law could not happen in a purely free market. That govenment intervention would be necessary to artificially overvalue one currency and then undervalue another other. That retaining full redemption value of even worn coins versus intentionally debased coins only takes place due to government decree. Valuing a new coin and worn coin at the same nominal value operated as a form of “imposed price control” (Rothnard, 1980, P.19) [13]. Due to the fact that the government is setting a firm pricing floor and ceiling for the value of the worn coins. When by the pure monetary weight they have lost value.

 

Gresham’s Law certainly is an underappreciated economic law.  Generally only acknowledged by monetary economists, gold enthusiasts, cryptocurrency enthusiasts, and proponents of the Austrian School of Economics. To really put it into context please consider the following example. An American Silver Dollar or Silver Eagle has a face value of $1.00. A 2020 edition of the U.S. Silver Dollar retails between $20.00-$25.00 [14]. Which is substantially larger than its nominal value. This is why Silver Dollars are held and sold by collectors rather than used to buy a Big Gulp at the local 7-11 convenience store. Current Silver Dollars are approximately 99.9 % pure silver, 1 ounce by weight. The price of silver today (3/31/20) is $14.29 per ounce [15].

 

 

 

 

 

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.