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What is ‘Gresham’s Law’?

“Good and bad coin cannot circulate together,” Sir Thomas Gresham wrote this in a letter to the English Queen Elizabeth I on her ascension in 1558. He was referring to the debasement of English coinage carried out by her father Henry VIII. Henry had reissued coins made with base metals, this meant that even though a coin was declared by the government (or by ‘fiat’) to be worth 1 shilling, the metal in that coin was actually worth much less.

Portrait of Sir Thomas Gresham

Portrait of Sir Thomas Gresham

This meant the ‘good money’, made prior to debasement which contained gold and silver to the value of 1 shilling, was driven out by ‘bad money’: coins made of metals below the value of 1 shilling. This was because when people had a choice they would always use the bad coins in a transaction and retain the good coins because they knew they had more inherent value – even though the state had decreed they were both worth 1 shilling.

The ‘law’ was named retrospectively after Sir Thomas Gresham in the 19th century but it had been observed before: by famous astronomer Nicolaus Copernicus and by the Ancient Greek playwright Aristophanes.

Previously the Islamic scholar Ibn Taimiyyah (1263–1328) had written:

“If the ruler cancels the use of a certain coin and mints another kind of money for the people, he will spoil the riches which they possess, by decreasing their value as the old coins will now become merely a commodity. He will do injustice to them by depriving them of the higher values originally owned by them. Moreover, if the intrinsic values of coins are different it will become a source of profit for the wicked to collect the small (bad) coins and exchange them (for good money) and then they will take them to another country and shift the small (bad) money of that country (to this country). So (the value of) people’s goods will be damaged.”

Modern examples of the law in action were seen in the US when older, pre-1965, US half-dollar coins were allegedly hoarded by citizens as they contained 90% silver, while the newer issued coins only had 40% silver. This coin retention was further compounded by the fall in the value of the dollar which meant that eventually the coin containing silver was worth more than the half-dollar designation it had been given.

The ‘law’ is by no means definitive and academics have previously pointed to it working in reverse, usually following the tipping-point of hyperinflation. In Weimar Germany hyper-inflation saw the mark become worthless and people stopped using it as an exchange of value, using other currencies with ‘value’ or commodities instead. In such situations ‘good’ money, backed by gold or commodity value, can be said to have superseded ‘bad’ money – denominations literally not worth the paper they were printed on.

Gresham’s Law is generally seen as a clumsy when applied to the history of currency. Typically, stronger ‘good’ money has driven out weaker ‘bad’ currency. This goes right back to the widespread use of the Persian daric or Roman denarius in the ancient world, through to the Venetian ducat in the Middle Ages. This was due to trade hegemonies but also the quality of the money itself – the coins being made of gold or silver worth the value of the monetary denomination. They could be trusted abroad and at home. More recently the pound and dollar were seen as ‘good’ money when backed by the gold standard.

However, Gresham’s Law is helpful in defining the phenomenon of ‘good’ and ‘bad’ money and demonstrates the deficit in value between money that is secure and backed by value such as economic strength, acceptability, known value (gold). Compared to money that is only a representation of state fiat.