What is Gresham’s Law?

Gresham’s Law applies to currency markets, stating that “bad money drives out good.”

The rule was based on the value of coins made from precious metals. Since removing metallic currency norms, the idea describes global currency stability and mobility.

Gresham’s Law e.xplained

In 1519–1579, Sir Thomas Gresham, a financier, wrote on currency value and minting. He eventually formed the Royal Exchange of the City of London. After Henry VIII replaced a significant amount of the silver in the English shilling with base metals, residents hoarded coins with more silver, worth more than their face value.

The two currencies were liquid and exchangeable concurrently. Gresham noticed bad money eroding good money. Bad money is a currency worth less than its face value. Money can be worth more than its face value. People will spend bad money first and save good money. In the 19th century, Scottish economist Henry Dunning Macleod credited this law to Gresham.

Good vs. Bad Money

In the past, mints were made from precious metals like gold, silver, and others, enhancing their worth. Coin issuers may decrease the level of precious metals utilized and pass them off as full-value coins. New coins with less metal sell for less. Old coins were worth more.

However, legal tender regulations require that new coins with less metal have the same face value as old ones. Laws overvalued new currencies and devalued old coins. Governments, monarchs, and other currency issuers used this technique to generate revenue and settle old coin obligations with new coins at par.

Consumers immediately exchanged their less valuable coins when obliged to accept both coins as the same monetary unit. They kept their old ones, devaluing the currency and reducing its buying power. Governments blamed speculators, controlled money, banned coin removal, and confiscated private precious metal sources to resist Gresham’s Law.

The Gresham Law and Legal Tender

Modern economies with legal tender laws demonstrate Gresham’s Law. Traditional Gresham’s Law applies when all currency units must have the same face without adequate legal tender rules; Gresham’s Law reverses, as good money pushes lousy money out of circulation so people won’t take it.

Since paper money is legal currency, issuers can create money, contributing to inflation in most nations. People cease using a currency that loses value quickly in favor of more stable foreign currencies, often despite harsh legal penalties.

Zimbabwe’s 2008 hyperinflation led to widespread abandonment of the official currency, the Zimbabwe dollar, reducing the country’s ding to de facto and de jure dolla. With a near-worthless currency, the The government could not enforce legal tender requirements during an economic crisis. Good, steady money eliminates unstable, hyperinflated money.

As international currencies, stable currencies like the U.S. dollar or euro are good money. More minor currencies of less developed nations circulate little beyond their issuing countries and are called poor money.

Example of Gresham’s Law

The U.S. government modified the coin content to 97.5% zinc in 1982. While maintaining face value, pre-1982 pennies were worth more than post-1982 ones. Copper prices surged from $0.6662/lb. In 1982, it was $3.0597/lb. In 2006, due to currency debasement and inflation, the purchasing power of a penny was reduced by approximately 80%.

As people started melting old pennies for copper, the U.S. enforced draconian sanctions, including a $10,000 fine or five years in jail.

Legal tender laws?

Countries define legal tender as the money used to pay taxes, contracts, penalties, and damages. All countries recognize the national currency as legal. How does Gresham’s Law apply?

When do paper and precious metal coins apply?

People accept paper notes and circulate gold and silver coins, proving Gresham’s Law. Bad paper money, used as payment during the U.S. Revolutionary War, banished gold and silver coins, good money.

How Does a Gold Standard Affect Gresham’s Law?

Gold supported the U.S. dollar when it became the world’s reserve currency in 1944 under the Bretton Woods Agreement. Gresham’s law applications are rare since the global financial system switched to fiat currencies. Under the Bretton Woods system, countries had to ensure currency convertibility into U.S. dollars, which were convertible to gold for foreign governments.

Bottom Line

Currency markets can use Gresham’s Law, which asserts that “bad money drives out good.” Coins made from precious metals changed in value and composition according to Gresham’s Law. Gresham’s Law is unusual since the global financial system uses fiat currencies.

Conclusion

• Sir Thomas Gresham, a banker from 1519 until 1579, wrote on coin value and minting.
• Gresham’s Law claims “bad money drives out good.”
• The law says overpriced money will force undervalued currency out of circulation.
• The law tracks currency debasement consequences.