Gresham's law Guide, Meaning , Facts, Information and Description
Gresham's law is stated as: "bad money drives good money out of circulation".Gresham's law applies specifically when there are two forms of commodity money in circulation which are forced, by the application of legal tender laws, to be respected as having the same face value in the marketplace. It is named after Sir Thomas Gresham, an English financier in Tudor times.
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2 The definitions of good money and bad money 3 Gresham's context 4 Gresham's law in reverse 5 Analogical extensions of Gresham's law 6 References |
Good money is money that has little difference between its exchange value and its commodity value. In the original discussions of Gresham's law, money was conceived of entirely as metallic coins, so the commodity value is the market value of the bullion of which the coins are made.
If "good" coins have a face value below that of their metallic content, individuals may melt them down and sell the metal for its higher bullion value. For an example of this, we will look at the 1965 US Half-dollars which were made from only 40% silver. The previous year the half-dollar was 90% silver. With the release of the 1965 dollar, which was legally required to be accepted at the same value as the previous year's 90% halves, the older 90% silver coinage of the US quickly disappeared from circulation, and the debased money was allowed to circulate in its stead. As the price of bullion silver rose above the face value of the coins many of those old half-dollars were melted down.
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 the way citizens of the country are, so they will offer higher value for good coins than bad ones, and thus higher value than can be obtained within the country. The good coins may leave their country of origin to become part of international trade. Thus, the good money is driven out of the country of issue, escaping that country's legal tender laws and leaving the "bad" money behind. This occurred in Britain during the period of the Gold Exchange Standard.
The experiences of dollarization in economies with weak economies and currencies (for example Israel in the 1980s, the Eastern European countries in the period immediately after the collapse of the Soviet block, or South American countries throughout the late twentieth and early twenty-first century) may be seen as Gresham's Law operating in its reverse form (Guidotti & Rodriguez, 1992), since in general the dollar has not been legal tender in such situations, and in some cases its use has been illegal.
These examples show that in the absence of legal tender laws, Gresham's law works in reverse. If given the choice of what money to accept, people will transact with money they believe to be of highest long-term value. However, if not given the choice, and required to accept all money, good and bad, they will tend to keep the money of greater perceived value in their possession, and pass on the bad money to someone else.
This is an Article on Gresham's law. Page Contains Information, Facts Details or Explanation Guide About Gresham's law Origin of the title
George Selgin in his paper "Gresham's Law" offers the following comments:
The passage from The Frogs referred to is as follows; it is usually dated at 405 B.C.:The definitions of good money and bad money
The terms "good" and "bad" money are used in a technical sense, and with regard to exchange values imposed by legal tender legislation, as follows:
Bad money is money that has a substantial difference between its commodity value and its market value, where market value is lower than exchange value.
Gresham's law says that any circulating currency consisting of both "good" and "bad" money, where both forms are required to be accepted at equal value under legal tender law, quickly becomes dominated by the "bad" money. This is because those spending money will hand over the "bad" coins rather than the "good" ones, keeping the "good" ones for themselves. Gresham's context
According to George Selgin in his paper "Gresham's Law":
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 the British coinage. The previous monarchs, Henry VIII and Edward VI, forced the people to accept debased coinage by means of their legal tender laws. Gresham also made his comparison of good and bad money where the precious metal in the money was the same. He did not compare silver to gold, or gold to paper.Gresham's law in reverse
In an influential theoretical article, Rolnick and Weber (1986) argued that bad money would drive good money to a premium rather than driving it out of circulation. However their research did not take into account the context in which Gresham made his observation. Rolnick and Weber ignored the influence of legal tender legislation which forces people to accept both good and bad money as if they were of equal value. They also focussed mainly on the interaction between different metallic moneys, comparing the relative "goodness" of silver to that of gold, which is not what Gresham was speaking of.Analogical extensions of Gresham's law
The Gresham's Law principle has been applied, by analogy, to many different fields. For example, in higher education, "Diploma mills" have come into existence producing low-cost qualifications which are often of little or no market value. According to Gresham's law as it applies to money, these "bad" diplomas ought to drive out the "good diplomas". However, unlike laws for money, there is no law requiring employers to accept all diplomas as being of equal value. Consequently, each employer is free to assess the value of qualifications as they see fit.References