Gresham's Law
Gresham's Law is the tendency for overvalued money to stay in circulation while undervalued money is hoarded, melted or exported, when the law forces both to be accepted at the same face value. It is usually summarised as 'bad money drives out good'.
Also called: bad money drives out good · Gresham law · Copernicus-Gresham law
The mechanism needs two kinds of money that the law treats as equal but the market does not. If two coins both settle a £1 debt and one contains more silver than the other, anyone paying a bill hands over the lighter coin and keeps the heavier one, which is worth more as metal, abroad or in a drawer. The legal tender rule makes the bad coin acceptable; the gap between face value and metal value makes the good coin too valuable to spend.
The name is a nineteenth-century label. Henry Dunning Macleod attached it to Sir Thomas Gresham in 1857, but the idea had been set out by Nicole Oresme in the 1360s and by Nicolaus Copernicus in the sixteenth century. Gresham's own concern was practical: after the debasement of the English coinage under Henry VIII and Edward VI, he pressed Elizabeth I to call in the bad money, and the recoinage that began in 1560 restored the sterling standard. Research on that period suggests the effect was weaker than the slogan implies, partly because people could not always tell good coins from bad.
The same logic appears wherever a fixed official price meets a different market price: bimetallic mint ratios, an official exchange rate set well below the parallel-market rate, or two stablecoins accepted at par although their reserves differ. When people are free to refuse or discount the weaker money, the reverse, Thiers' Law, takes over.
In practice
Gresham's Law depends on enforced equal acceptance. Where sellers can quote different prices for different moneys, or refuse one outright, the better money tends to win instead.
Example
Two coins each have a face value of £1. One contains £1.20 of silver at market prices, the other 80p. A shopkeeper paid in either gives change in the light coin and sells the heavy one to a bullion dealer for £1.20. Before long only light coins circulate.
Learn more on Money Wiki
This page gives the short answer. Money Wiki has a longer guide to Gresham's Law, with more detail and background.
Commonly confused with
| Term | How it differs |
|---|---|
| Thiers' Law | Gresham's Law applies when the law fixes the exchange rate between two moneys, so bad money circulates. Thiers' Law applies when that fixed rate breaks down, so good money is preferred and the bad money falls out of use. |
See also
- DebasementDebasement is reducing the precious-metal content of coins while keeping their face value, so that the issuer can strike more coins from the same metal. It works as a hidden tax on holders of money and was the classic historical route to inflation.
- Thiers' LawThiers' Law is the reverse of Gresham's Law: when people are free to refuse or discount a weak money, the stronger money drives it out of use. It describes what happens in high inflation, when residents switch to a foreign currency.
- BimetallismBimetallism is a monetary standard in which the currency unit is defined by fixed amounts of both gold and silver, and the mint coins both metals at a legal ratio. It works only while that legal ratio stays close to the market price of the two metals.
- Legal TenderLegal tender is money that a creditor must accept in settlement of a debt, so that a debtor who offers it in full cannot be sued for non-payment. It does not oblige a shop or anyone else to accept that money for a purchase.
- Parallel Market RateA parallel market rate is the rate at which a currency actually trades outside official channels, in a country where the official rate is not obtainable. In a tightly controlled market it is often the only rate at which real business clears.