In economics, Gresham's law is a monetary principle stating that "bad money drives out good". For example, if there are two coins in circulation containing metal of different value, which are accepted by law as having similar face value, the more valuable coin based on the inherent value of its component metals will gradually disappear from circulation. The law was named in 1857 by economist Henry Dunning Macleod after Sir Thomas Gresham, an English financier during the Tudor dynasty. Gresham had urged Queen Elizabeth to restore confidence in the debased English currency. The concept was thoroughly defined in Renaissance Europe by Nicolaus Copernicus and known centuries earlier in classical Antiquity, the Near East and China.
"Good money" and "bad money" Under Gresham's law, "good money" is money that shows little difference between its nominal value (the face value of the coin) and its melt value (the intrinsic value of the metal item based solely on the market value of the metal of which it is made, often precious metals, such as gold or silver). The price spread between face value and commodity value when it is minted is called seigniorage. As some coins do not circulate, remaining in the possession of coin collectors, this can increase demand for coins. 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 alloying it with a base metal. The public could also debase coins, usually by clipping or scraping off small portions of the precious metal, also known as "stemming" (reeded edges on coins were intended to make clipping evident). Other examples of bad money include counterfeit coins made from base metal. Today, virtually all circulating coins are made from base metals, often the cheapest available, durable base metal; collectively these monies are known as fiat money. While virtually all contemporary coinage is composed solely of base metals, there have been periods during the twenty-first century in which the market values of some base metals, such as copper, have been high enough that at least one common coin (the U.S. nickel) still maintained "good money" status. In the case of clipped, scraped, or counterfeit coins, the commodity value was reduced by fraud. 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. The old saying, "a bad penny always turns up" is a colloquial recognition of Gresham's law.
Theory The 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. Legal tender laws act as a form of price control. In such a case, the intrinsically less valuable money is preferred in exchange, because people prefer to save the intrinsically more valuable money. Imagine that a customer with several silver sixpence coins purchases an item that costs five pence. Some of the customer's 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. The 1965 United States half-dollar coins contained 40% silver; in previous years these coins were 90% silver (.900 or, one nine fine). 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 value of the dollar (Federal Reserve notes) continued to decline, resulting in the value of the silver content exceeding the face value of the coins, many of the older half dollars were melted down or removed from circulation and into private collections and hoards. Beginning in 1971, the U.S. government abandoned including any silver in half dollars. The metal value of the 40% silver coins began to exceed their face value, which resulted in a repeat of the previous event. The 40% silver coins also began to vanish from circulation and into coin hoards. A similar situation occurred in 2007 in the United States with the rising price of copper, zinc, and nickel, which led the U.S. government to ban the melting or mass exportation of one-cent and five-cent coins. 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 adoption of the gold standard: In 1717, then-Master of the Mint Isaac Newton declared the gold guinea to be worth 21 silver shillings. This overvalued the gold guinea in Britain, making it "bad", and encouraged people to send "good" silver shillings abroad, where it could buy more gold than at home. This gold was then minted as currency, which bought silver shillings, which were sent abroad for gold, and so on. For a century, hardly any silver coins were minted in Britain, and Britain had moved onto a de facto gold standard.
… excerpt ends here. Continue reading the full article.
