Gresham's Law

This evening, the Wikipedia article Gresham's Law opens with this statement:

Gresham's law is commonly stated: "Bad money drives out good", but more accurately stated: "Bad money drives out good under legal tender laws".

Well, I never heard it put that way before. The "more accurate" version is probably a twist of history inserted by the Austrians. You have to be careful with the economics in Wikipedia. The Wik is full of Austrianisms made to look like part of mainstream thought.

I've heard the five words: Bad money drives out good. I came looking for more, because I wanted to know what Gresham meant. Not what somebody wanted to make it sound like.


First, from the same article, a bit of context:

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 alloying it with a base metal. The public could also debase coins, usually by clipping or scraping off small portions of the precious metal.


In a world where everybody uses gold coins... If you've got two $5 gold coins in your pocket... and one is shiny and new... and the other is thin and worn, and it looks like somebody scraped a bit of gold off the edge of it... You are likely to spend the worn coin and keep the good one. That is the essence of Gresham's Law.

If you are old enough to remember when U.S. quarter was made of silver -- I was in high school -- you will remember how quickly silver quarters disappeared from circulation when the 'sandwich' quarters came out. Almost immediately, there were no more silver quarters when you bought something and looked at the change you got back. That was Gresham's Law in action.


The Wik article Thomas Gresham includes this note:

Gresham's law takes its name from him (although others, including the astronomer Nicolaus Copernicus, had recognized the concept for years) because he urged Queen Elizabeth to restore the debased currency of England. However, Sir Thomas never formulated anything like Gresham's Law, which was the 1857 invention of Henry Dunning MacLeod, an economist with a knack for reading into a text what was not written.


So Gresham wanted the Queen to restore value to the money (by restoring the full measure of precious metal to the coin).

Notable also: The name Gresham's Law didn't surface 'til some three centuries after Gresham. So it's not really a question of determining what Gresham meant by it.

The reference to Henry Dunning MacLeod is footnoted to Gresham on Foreign Exchange by Raymond de Roover. But my search of Google Books turned up nothing useful here. A widened search turned up this, from Economics--The Science of Business by Joseph French Johnson:

17. Gresham's Law.—One of the interesting phenomena which may be noted when two metals or two types of coins, or for that matter two different forms of any kind of money of the same kind of metal, are placed in circulation, is the withdrawal of the heavier coins or the more valuable money from circulation and the continuance of the lighter or less valuable money in the marts of trade. Sir Thomas Gresham reformulated this idea in the sixteenth century during Queen Elizabeth's reign, when he gave utterance to what has since been known as Gresham's Law.


Okay. Well we know it wasn't known as "Gresham's Law" until the nineteenth century. Important to get the details right. But that's just a detail. The balance of the excerpt is useful to the understanding:

The law has been tersely put in this way: "Bad money drives out good money." Thus stated it applies to paper money as well as to metallic money. When competition works freely there is an effort to do the economic work at the least expense and with the largest results. On that basis a fiat paper money ought to circulate and do the money work, but the difficulty with such a suggestion is that the holders of the paper money want in the ultimate analysis something that can be converted into value. Hence there must be a value basis for money of any kind.


Joseph French Johnson's book is from 1921. The Federal Reserve was created only 8 years before. The Dollar went fiat with the Nixon Shock of 1971. Johnson's concern that "there must be a value basis for money" has since been resolved. The value of money to most people is that we can use it to buy things. But the value of money to people with most of the money is that it earns interest. Basically, money is valuable because if you hang on to it today, you'll have more tomorrow. (At least, that's how it looks to me.)

It is to be understood that Gresham's Law begins to work when there is more than enough of the two types of money to do the work. The circulation consists of the cheaper money while that condition exists. When business conditions are such as to demand both kinds of coins and require all the circulating media at hand, the more valuable money circulates side by side with the less valuable money. Just as soon, however, as the demand slackens, the more valuable money is withdrawn from circulation for use in the arts or for export for the settlement of trade balances.


Okay... If economic activity requires use of all of the money, all of it is used. But if there is any excess, people will hang on to the heavier of two gold coins, or whatever they see as the "good" money. And they'll spend the other.

Not bored yet?

The Gresham's Law article from Wikipedia oddly includes this bit:

Gresham's law is named after Sir Thomas Gresham (1519 – 1579), an English financier during the Tudor dynasty. However, it had been stated forty years before by Nicolaus Copernicus, so in parts of central and eastern Europe is known as the Copernicus Law. The phenomenon had been noted even earlier, in the fourteenth century, by Nicole Oresme. The fact of bad money being used in preference to good money is also noted by Aristophenes in his play The Frogs, which dates from around the end of the 5th century BC.


As though it were necessary to scold someone for calling it "Gresham's" Law.

Anyhow, Copernicus:

In 1526 Copernicus wrote a study on the value of money, Monetae cudendae ratio. In it he formulated an early iteration of the theory, now called Gresham's Law, that "bad" (debased) coinage drives "good" (un-debased) coinage out of circulation—70 years before Thomas Gresham. He also formulated a version of quantity theory of money. Copernicus' recommendations on monetary reform were widely read by leaders of both Prussia and Poland in their attempts to stabilize currency.


Forty years before. Seventy years before. Who cares? The attempt to stabilize currency is nothing new. Rather, it is central to the economic story. It is the straight and steady theme about which the braid, the DNA of the economy is wrapped.

See also: the Triffin Dilemma