Gresham's law

thumb|Sir [[Thomas Gresham]]

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 coinage.

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 21st century in which the market values of some base metals, like copper, have been high enough that at least one common coin (the U.S. nickel) still maintained "good money" status.

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 Isaac Newton, then Master of the Mint, 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.

Austrian economist Hans-Hermann Hoppe said that "so-called Gresham's law" only applies under certain conditions, largely a result of governmental interventionist policies. In his 2021 book, Economy, Society, and History Hoppe states:<blockquote>You might have heard about the so-called Gresham's law, which states that bad money drives out good money, but this law only holds if there are price controls in effect, only if the exchange ratios of different monies are fixed and no longer reflect market forces. Is it the case that bad money drives out good money under normal circumstances without any interference? No, for money holds to exactly the same law that holds for every other good. Good goods drive out bad goods. Good money drives out bad money, so this bezant was for something like 800 years considered to be the best money available and was preferred by merchants from India to Rome to the Baltic Sea.</blockquote>

History of the concept

Gresham was not the first to state the law which took his name. The phenomenon had been noted by Aristophanes in his play The Frogs, usually dated at 405 BC:

According to Ben Tamari, the currency devaluation phenomenon was already recognized in ancient sources. In China, Yuan dynasty economic authors Yeh Shih and Yuan Hsieh were aware of the same phenomenon.

Ibn Taimiyyah described the phenomenon as follows:

Notably this passage mentions only the flight of good money abroad and says nothing of its disappearance due to hoarding or melting. Palestinian economist Adel Zagha also attributes a similar concept to medieval Islamic thinker Al-Maqrizi, who offered, claims Zagha, a close approximation to what would become known as Gresham's law centuries later.

In the 14th century it was noted by Nicole Oresme , in his treatise On the Origin, Nature, Law, and Alterations of Money, and by jurist and historian Al-Maqrizi in the Mamluk Empire<!--when exactly did he do it?-->.

Johannes de Strigys, an agent of Ludovico III Gonzaga, Marquis of Mantua in Venice, wrote in a 1472 report ("that the bad money will chase out the good").

In the year that Gresham was born, 1519, it was described by Nicolaus Copernicus in a treatise called : "bad (debased) coinage drives good (un-debased) coinage out of circulation". Copernicus was aware of the practice of exchanging bad coins for good ones and melting down the latter or sending them abroad, and he seems to have drawn up some notes on this subject while he was at Olsztyn in 1519. He made them the basis of a report which he presented to the Prussian Diet held in 1522, attending the session with his friend Tiedemann Giese to represent his chapter. Copernicus's was an enlarged, Latin version of that report, setting forth a general theory of money for the 1528 diet. He also formulated a version of the quantity theory of money. For this reason, it is occasionally known as the Gresham–Copernicus law.

Sir Thomas Gresham, a 16th-century financial agent of the English Crown in the city of Antwerp, was one in a long series of proponents of the law, which he did to explain to Queen Elizabeth I what was happening to the English shilling. Her father, Henry VIII, had replaced 40% of the silver in the coin with base metals, to increase the government's income without raising taxes. Astute English merchants and ordinary subjects saved the good shillings from pure silver and circulated the bad ones. Hence, the bad money would be used whenever possible, and the good coinage would be saved and disappear from circulation.

According to the economist George Selgin:

Gresham made his observations of good and bad money while in the service of Queen Elizabeth, with respect only to the observed poor quality of British coinage. Earlier monarchs, Henry VIII and Edward VI, had forced the people to accept debased coinage by means of legal tender laws. Gresham also made his comparison of good and bad money where the precious metal in the money was the same metal, but of different weight. He did not compare silver to gold, or gold to paper.

In his "Gresham's Law" article, Selgin also offers the following comments regarding the origin of the name: