Legal Tender Laws and The Circulation of Money

Photo by Karolina Grabowska on Pexels.com

It may be fair to suggest that Thier’s Law and Gresham’s Law are not necessarily opposing ideas. Rather they are both rule-based phenomena. Essentially, the nature of legal tender laws dictates which variety of money (higher-valued money or lower-valued money) is hoarded. How can we be so sure? Let’s take Thier’s Law for example. Let’s take the below definition of the monetary concept from an outstandingly well-written undergraduate thesis on cryptocurrency.

“Thiers’ Law, named after French historian Adolphe Thiers, asserts that in the absence of legal tender laws forcing them to accept both currencies, sellers will choose to transact with the currency of higher perceived long-term value. (P.9)”

In the context of this very description of the concept, the mention of the “absence” of legal tender laws comes into play. Meaning that given there are no rules coercively forcing us to accept the two currencies of varying degrees of intrinsic value at the same nominal value. Giving the observant reader the impression that the occurrence of Thier’s Law is the byproduct of the rules governing monetary exchange. In contrast, Gresham’s Law has always implied the existence of legal tender laws. The overvalued money with the distorted nominal value would never be assigned such a value by the market. Such a proclamation could only come in the form of government fiat. Gold and silver (bi-metallism) are of equal nominal value because the king says so. Regardless of the edicts of royal decree individual market participants are going to respond accordingly to the irrational rules set forth by the king. That would be to use the less valuable silver in day-to-day transactions and save the gold.

Thier’s Law Applied to Human Capital

Photo by cottonbro on Pexels.com

This blog entry was inspired by feedback from Enrique at the Prior Probability blog.

If Gresham’s Law applies to retain human capital in the job market, is it possible that Thier’s law (p.9) could also be applicable in certain contexts? On money, when legal tender laws forcing vendors to accept both forms of money at nominal value, economic agents will choose to transact with the higher valued currency. Presenting an axiom that is the opposite of Gresham’s Law, “ Good money drives out bad money”. Typically in the arena of monetary economics, the divide between advocates of Gresham’s Law and Thier’s Law is a sharply delineated dichotomy. Most proponents of one will not defend the possibility that the principle could apply to the circulation of money.

However, in terms of the circulation of human capital these concepts are not necessarily opposed. Employee retention is the byproduct of several highly qualitative attributes that are generally specific to a certain firm. In corporate vernacular, the term “culture” is thrown around so frequently that it has become a buzzword deeply embedded in the American psyche. Companies such as Google, go to great lengths to demonstrate that they have a flexible, open, and innovative corporate culture. The veracity of the claims is ultimately judged by the perceptions of the individual employees. One employee may adore working at Google, while their colleague completely despises the company’s ethos. Making the ebbs-and-flows of human capital even more complex. Employee retention at the individual level is based upon a multitude of various factors. The aggregated collection of the opinions of all the individual employees regarding their work-life satisfaction tends to paint a fuller picture. If while perusing Glassdoor, you happen to see a company with eighty-five two-star ratings, chances are this is not the petty slander of a few disgruntled employees. This is why oftentimes companies will periodically send out surveys to their employees in an attempt to measure overall morale throughout their organization.

Putting aside the highly individualized variable of career satisfaction metrics for an entire firm, if there is a pattern of talented employees leaving, there is a retention problem. Sometimes this may be isolated to a specific department even if the firm as a whole has no issues keeping competent and productive workers. Certain companies and even job roles select for specific attributes that may not be conducive to attracting skilled and reliable labor. Some industries are notorious for high turnover rates, one salient example being the hospitality industry. I remember a few years back, being in between jobs, so I briefly worked at a call-center. For me, this was an income stream until I found something else, for many of the people in my training class it was a lifelong career path. This path was a volatile one. Staying only a few months at one company and then abruptly quitting, generally with no notice. Upon receiving a new job offer, I gave my supervisor my two-week notice and he was astonished by the fact I even bothered to take this step. After only six months, only five people (including myself) out of the twenty-five in my training class remained. Industries and job roles with high turnover may be more willing to retain employees with fewer skills or with a poor performance history, due to the outflow of higher-skilled employees. Perfectly mirror the effect described in Thier’s lawinstead of money, the commodity that is flowing out of the firms is quality human capital.

The question becomes how can these opposed ideas transpire concurrently in the same labor market or even the same company. The answer to this question is predicated upon a “rules of the game” type logic. Each company and each interior department within a firm operate as governing bodies directing the task of workers. Meaning both varying capacity function as “ruler-makers” within the company. Think of corporate policy as being analogous to the federal government, while the department formulated rules are similar to state law. Clearly, in most cases, corporate policy supersedes department policies. If these rules are too onerous or unjust there is little a qualified and skilled employee could other than leave. Either accept and abide by the rules set forth or resign. Resignation being a clear withdrawal of consent on the part of the employee. One relevant example of this is companies still drug testing for marijuana in states where it is legal. Granted, it is an organization’s prerogative to make employees refraining from drug use a contingency of employment. However, if enough high-caliber job candidates take to smoking cannabis they may be in a bit of a quandary. A few years back the FBI ran into this problem due to their “drug-free” employment policy.

If the rules governing the management of a firm are too oppressive, people with options are going to find another job opportunity. What the company is left with are those who lack the skills, ambition, and conscientiousness required for productivity. The employer is left with the staff that clings to their jobs for dear-life as odds are they do not carry too much value on the job market. Much how department policies such as catering to senior and skilled workers can impose an effect similar to Gresham’s Law the opposite is also true. If you create rules that disincentives tenure and self-development, odds are you will lose a lot of great workers. The kind of workers that can be a game-changer in managing strategic customers. As we have observed with the call-center example, frequently due to the oppressive rules, low pay, and dismal work environment people with potential tend to leave these positions. Leaving you with the unskilled and the desperate who are locked-in to the role due to their circumstances. Keeping this dynamic in mind, it is a wonder why people expect quality service whenever they call tech support.

Gresham’s Law Applied to Human Capital- Career Stagnation

Photo by August de Richelieu on Pexels.com

The premise behind Gresham’s Law is that money of a higher intrinsic value will be hoarded while the money of a lower substantive value but legally recognized as having the same nominal value will be circulated throughout the economy. Succinctly put, “..bad money drives out good money…” pithily sums up this economic phenomenon. However, is this occurrence solely confined to the commodity of money? Doesn’t the observations convey in Gresham’s Law applicable to other goods? For example, unless a baseball card collect is presented with an astronomically large monetary offer, odds are they will be unwilling to part with a limited-run rookie card of a legendary major league player. This scenario reflects many of the assumptions regarding commodity value implicit in Gresham’s Law. Generally, rare collectibles are held on to, while mass-produced memorabilia is readily available at the local garage sale or swap meet. Most collectors will hang on to the items that are considered valuable unless another interested party can provide a commodity in exchange that exceeds the perceived value of the collectible held by the hobbyist in possession of the coveted item.

However, how does Gresham’s Law interact with the intangible commodity of human capital? A firm or a business unit within a firm would want to retain top-level talent and let go of the mediocre/poor performers. Before we can delve into this analysis we must distinguish what human capital is. Human capital is the economic value that the employee brings to the firm. Typically through their experience, education, certifications, knowledge of company procedures and policies, position-specific “tribal knowledge”, critical thinking skills, and other pertinent soft skills. For readers who have never worked in a corporate environment before tribal knowledge is the informal and unwritten knowledge of best practices of how to perform within a specific job role. It stands to reason that a potential employee possessing all of these attributes would be a hot commodity on the job market. If currently employed by a company would be an employee of a high value.

If human capital is valued in a similar sense to other commodities such as money, how do businesses act in a manner to retain this high-quality talent? The answer most human resources representatives would give is that their organization creates an environment that fosters career advancement. Stressing the perks such as tuition reimbursement, possession of company stock options, and opportunities for placement in vertical job positions. While these factors may play a role in some employees choosing to work long-term for the same company, there is another variable that HR will not be forthright about. That is oftentimes exceptional employees with a high degree of human capital end up getting pigeonholed to the same role. Oftentimes these individuals are blocked from transferring to other business units or positions within the company by the request of middle and executive management. The reason behind limiting this MVP’s potential is quite pragmatic, the business unit cannot afford to lose this individual. Their skills and knowledge are essential to the day-to-day operations of the business. It would be nearly impossible to fill the void if they were to get promoted or transition to a lateral position within the firm. In the corporate world, this individual may be referred to as a subject matter expert or colloquially known as a SME.

It should be noted that the desperate attempts of management to relegate this individual to the same job role has the propensity to backfire. Why? Because this individual gets fed up with their limited job prospects and ends seeking career advancement at another firm. In a free market for employment, a high-quality employee has many prospective options when it comes to their career. If a firm stubbornly, confines them to a shallow career path they will simply look for employment at another company.

Gresham’s Law- A Fallacy?

silver round coins on banknote
Photo by Dmitry Demidov on Pexels.com

 

 

Gresham’s Law is seen as one of the many enduring laws of the discipline of economics. Much like the laws of Comparative Advantage, Supply and Demand, and Diminishing Returns. However, is it possible that Gresham’s Law is based upon a misconception? After all, there are several examples of undervalued and overvalued currency simultaneously circulating at the same nominal value. Do these exceptions invalidate Gresham’s Law? Depending on who you ask, yes. However, proponents claim that these outlying examples apply to conditions under which Gresham’s Law is not applicable. Both sides generating formidable arguments.

It should be mentioned that Natural Laws, Laws of Science, etc. tend to be perceived as being fixed. Immutable. Is this an accurate interpretation of such a variety of Laws (economic laws included)? By definition, a scientific law is an enduring observation that has been universally replicated. Contrary to the popular opinion it is not definitive. Meaning that is still subject to some variation and possible exceptions. Whenever a Profession Skateboard performs a particularly daring stunt, we refer to it as “gravity-defying”.  Such a statement does not so much invalidate the Law of Gravity but demonstrates a mild momentary exception. Within seconds of completing the mauver, the skateboarder is pulled back down by the gravitation force of the Earth.

 

It is possible that I am mischaracterizing the exceptions of the Laws of Gravity.  I am far from well versed in physics. I have never taken much interest in it as a field of study.  Even the moon to some extent has gravitational force it is just to a lesser extent than Earth. Making the law exist in a continuum of applicability versus an outright exception. I would surmise the same is applicable to the laws of the social sciences as well.

 

There was a 1986 study published by the Minnesota  Federal Reserve that put into question the veracity of Gresham’s Law. The controversial study was authored by  Christopher A. Sims and Arthur J. Rolnick. Two particularly salient exceptions cited in the article were pertaining to Silver Dollars and Greenbacks in the United States.  In the years between 1792 and 1853, the U.S. Silver Dollar and the Spanish milled Dollar simultaneously circulated at the same face value. The Spanish milled Dollar contained 373.5 grains of pure silver in contrast to the U.S. Silver Dollar only contained 371.25. Making the foreign silver coin heavier and possessing a higher intrinsic value. Despite the fact that Gresham’s law is considered axiomatically true the Spanish Silver Dollar was not driven out of circulation (P.4) [1].

 

The second notable exception to Gresham’s Law referenced in the study was the exchange of Greenbacks. Greenbacks were one of the earliest examples of purely fiat currency in the United States. Which the paper money that was not backed by specie was produced to help fund the Civil War [2]. Per the contingencies of Gresham’s Law, we would assume that the Greenbacks drove currencies backed by gold and silver out of circulation. Some sources did claim that this was the case.  Not so.

 

Did greenbacks drive out specie? Some textbooks claim they did (Prager 1982, p. 32, for example), but Moses, writing in 1892, makes it clear that in the West, despite the presence of greenbacks, gold remained the unit of account and a medium of exchange. He says that a contributor to the San Francisco Daily Herald wrote that greenbacks were also current there, but at a discount (Moses 1892, p. 18): “A writer in this journal, February 16,1863, found very little difficulty arising from the use of legal tender notes; for they had a market value, and most people were ready to receive them at that value.” In the East, it appeared that the money system was reversed. There, according to Moses (1892, p. 15), greenbacks were accepted as the unit of account and specie circulated at a premium. (Sims &Rolnick, 1986, p.5) [3].

 

Both researchers provided expanded upon how such exceptions could occur. They repudiate the claim that they did not cover any true exceptions. As in both instances, the rate of exchange in both examples was not fixed. They rebut this claim by stating that holding a fixed exchange rate is inoperable.  Historically they aren’t any records of mints operating in such a manner. Also, if a mint has a large stock of commodity money offered at a “bargain” for the establishment will either run out of money and either go out of business or change course in coinage policy (page6-7) [4]. Sims and Rolnick also disputed the claim that mints did not fix exchange rates but legal tender laws did. Such laws do not prevent prices from being calculated in “bad” money. Meaning vendors would make a larger profit at the expense of public ignorance of the difference in intrinsic value (Page 7) [5]. Based upon these observations they concluded that the assumed conditions of Gresham’s Law were incorrect. Bad money drives out good money when the transaction costs are significantly high to use good money (Page 9) [6].

 

Naturally, these arguments were not meet without resistance.  Economist George Selgin provides some strong counter-arguments to the 1986 study. Selgin dispels the potential of the exchange rate claim causing naive customers to be duped by vendors. Acceptance of both monies at face value is based upon legal penalties for discriminating between them rather than a personal appraisal. Per Selgin Gresham’s Law only applies if customers and vendors are “legally compelled” to accept overvalued and undervalued money of the same face value. Pertaining to the exception of the Greenback-era in California local authorities refused to enforce federal legal tender laws [7].

 

 

 

Gresham’s Law Explained

 

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].