The Gresham’s Law: Bad money vs. Good money
“The course our city runs is the same towards men and money.
She has true and worthy sons.
She has fine new gold and ancient silver,
Coins untouched with alloys, gold or silver,
Each well minted, tested each and ringing clear.
Yet we never use them!
Others pass from hand to hand,
… These we spurn for men of brass …”
The Frogs, Aristophane
“The illustrious Gresham, who has the merit of being, as far as we can discover, the first who discerned the great fundamental law of the currency, that good and bad money cannot circulate together…Now, as he was the first to perceive that a bad and debased currency is the cause of the disappearance of the good money, we are only doing what is just in calling this great fundamental law of the currency by his name. We may call it Gresham’s law of the currency.”
The elements of political economy, MacLeod
Gresham’s Law states that good and bad money cannot circulate together, and in the long term, bad money drives good money out of circulation. In this context, bad money refers to money which has a lower commodity value than its face value, while on the other hand, good money is money that does not differ much in its intrinsic and nominal value.
According to the Gresham’s Law, if both the good and bad money are used in an economy, and since the people are aware of the real value of good money, they will try to keep as much good money as they can to themselves, and spend the bad money instead. Eventually, the good money will be less and less exchanged to the extent that it may be even driven out from the market.
The term was coined by Henry Dunning MacLeod in 1858 after Sir Thomas Gresham, the first one to formulate this law. Gresham, a 16th century banker, wrote a letter to Queen Elizabeth I in 1558, to warn her of the reasons behind lack of gold in circulation in England. He wrote,
“Ytt may pleasse your majesty to understande, thatt the firste occasion of the fall of exchainge did growe by the Kinges majesty, your latte ffather, in abasinge his quoyne ffrome xxvis. viiid. To xiiis, ivd. Which was the occasion thatt all your ffine goold was convayd ought of this your realme”
Boy oh boy, English was not simple back then.
France experienced such problem in the 13th century. Back then, the king of France decided to mint new coins which contained less metal than the coins which were already being used, at two different parts of the country. Eventually, both cities substituted their domestic currency with the new, lighter coins.
However, some economists argue that Gresham’s Law is only feasible if there is an excess supply of money. In other words, since the main function of money is to serve as a medium of exchange, therefore as long as the total demand for money is higher or at least equal to the total supply of money, there would be no difference between bad money and the good money.
“bad money is not ‘bad’ per se, rather it is cheap.”