| print this
the free encyclopedia
is commonly stated as: "When there is a legal tender
currency, bad money drives good money out of circulation".
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
Definitions of "good money"
and "bad money"
1.1 Good money
1.2 Bad money
3 History of the concept
3.1 Origin of the title
4 Gresham's law in reverse
5 Gresham's law in other fields
6 Popular Culture References
of "good money" and "bad money"
terms "good" and "bad" money are used
in a technical sense, and with regard to exchange values
imposed by legal tender legislation, as follows:
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
coined bullion of which the coins are made.
example is the US dollar, which, prior to the 1900s was
equal to 1/20.67 ounce (1.5048 g) of gold, and carried an
exchange value roughly equal to its coined gold market value.
is worth noting that in the absence of legal tender laws,
metal coin money will freely exchange at somewhat above
bullion market value. (This is not a purely theoretical
result, but rather can be observed today in bullion coins
such as the Krugerrand (South Africa) and the American Gold
Eagle (United States)). Honestly coined money is of a known
purity, and in a convenient form to handle. People prefer
trading in coins to anonymous hunks of bullion, so they
attribute more value to the coins. Thus, coining is frequently
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 day, bad money included any coin that had been
"debased". Debasement was often done by members
of the public, cutting or scraping off some of the metal.
Coinage could also be debased by the issuing body, whereby
less than the officially mandated amount of precious metal
is contained in an issue of coinage, usually by alloying
it with base metal. Other examples of "bad" money
include counterfeit coins made from base metal. In all of
these examples, the market value was the supposed value
of the coin in the market.
the case of clipped, scraped or counterfeit coins, the market
value has been reduced by fraud, while the exchange value
remains at the higher value. On the other hand, with coinage
debased by a government issuer the market value of the coinage
was often reduced quite openly, but the exchange value of
the debased coins was held at the higher level by legal
modern money is "bad money" in this sense, since
fiat money has entirely replaced the commodity money to
which Gresham's law applies. The ubiquity of fiat money
could indeed be taken as evidence for the truth of Gresham's
law says that any circulating currency consisting of both
"good" and "bad" money (both forms required
to be accepted at equal value under legal tender law) quickly
becomes dominated by the "bad" money. This is
because people spending money will hand over the "bad"
coins rather than the "good" ones, keeping the
"good" ones for themselves.
a customer purchasing an item which costs five pence, who
has in their possession several silver sixpence coins. Some
of these coins are more debased, while others are less so
— but legally, they are all mandated to be of equal
value. The customer would prefer to retain the better coins,
and so offers the shopkeeper the most debased one. In turn,
the shopkeeper must give one penny in change — and
has every reason to give the most debased penny. Thus, the
coins that circulate in the transaction will tend to be
of the most debased sort available to the parties.
"good" coins have a face value below that of their
metallic content, individuals may be motivated to melt them
down and sell the metal for its higher bullion value, even
if such defacement is illegal. For an example of this, consider
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 half, 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.
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.
of the concept
to George Selgin in his paper "Gresham's Law":
for Gresham himself, he observed "that good and bad
coin cannot circulate together" in a letter written
to Queen Elizabeth on the occasion of her accession in
1558. The statement was part of Gresham's explanation
for the "unexampled state of badness" England's
coinage had been left in following the "Great Debasements"
of Henry VIII and Edward VI, which reduced the metallic
value of English silver coins to a small fraction of what
that value had been at the time of Henry VII. It was owing
to these debasements, Gresham observed to the Queen, that
"all your ffine goold was convayd ought of this your
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.
Law" was also earlier described by Nicolaus Copernicus,
in the year that Gresham was born in a treatise named Monetae
of the title
Selgin in his paper "Gresham's Law" offers the
expression "Gresham's Law" dates back only to
1858, when British economist Henry Dunning Macleod (1858,
p. 476–8) decided to name the tendency for bad money
to drive good money out of circulation after Sir Thomas
Gresham (1519–1579). However, references to such
a tendency, sometimes accompanied by discussion of conditions
promoting it, occur in various medieval writings, most
notably Nicholas Oresme's (c. 1357) Treatise on money.
The concept can be traced to ancient works, including
Aristophanes' The Frogs, where the prevalence of bad politicians
is attributed to forces similar to those favoring bad
money over good.
passage from The Frogs referred to is as follows; it is
usually dated at 405 B.C.:
course our city runs is the same towards men and money.
She has true and worthy sons.
She has fine new gold and ancient silver,
coins untouched with alloys, gold or silver,
each well minted, tested each and ringing clear.
Yet we never use them!
Others pass from hand to hand,
sorry brass just struck last week and branded with a wretched
So with men we know for upright, blameless lives and noble
These we spurn for men of brass....
law in reverse
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 requires
people to accept both good and bad money as if they were
of equal value. They also focused 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.
experiences of dollarization in countries 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 bloc, 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.
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. Said in another way, in the absence of legal tender
laws, the seller will not accept anything but money of real
worth (good money), while the existence of legal tender
laws will force the seller to accept money with no commodity
value (bad money). Thus, the buyer will always try to spend
his bad money first, but in the absence of legal tender
laws, the seller will not accept money with no real worth.
law in other fields
section does not cite its references or sources. Please
help improve this article by introducing
appropriate citations. (help, get involved!)
principles of Gresham's Law can sometimes be applied to
different fields of study. Gresham's Law generally speaks
to any circumstance in which the "true" value
of something is markedly different from the value people
must accept, due to factors such as lack of information
or governmental decree.
the market for second hand cars, lemon automobiles (analogous
to bad currency) will drive out the good cars. The problem
is one of asymmetry of information. Sellers have a strong
incentive to pass all cars off as "good" cars,
even lemons. This makes buying a car at a fair rate for
a "good" car chancy, as the buyer risks overpaying
for a lemon. The result is that buyers will only pay the
fair price of a lemon, so at least they won't be ripped
off. The quality cars are thus pushed out of the market,
because there is no good way to establish that they really
are worth more. The Market for Lemons is a work that examines
this problem in more detail.
Law poses a similar trap in education. Suppose a policy
is laid down judging schools entirely based on the percentage
of its students that pass a standardized test. This creates
an incentive for schools to focus their resources exclusively
on students near the pass/fail border, and ignore both more
talented students as well as students seen as unlikely to
pass even with help. The imposed standard treats all passes
as equal, and ignores the value of, say, raising a B student
to an A student. The school gets no added benefit from helping
a student who would already pass. (If a school actually
responds this way, and this occurs in a location which allows
easy switching of schools, most likely all the better students
will in fact leave, as Gresham's Law predicts.)
case in education where Gresham's Law generally does not
apply is with "diploma mills," schools that offer
diplomas even to those with very low qualifications for
a price. It may seem that according to Gresham's law these
"bad" diplomas ought to drive out the "good
diplomas." However, unlike money, there is no law in
most countries requiring employers to accept all diplomas
as being of equal value and each employer is free to assess
the value of qualifications as they see fit. In the countries
or governmental organizations where the law does require
blindness, this effect does occur.
The first question worth a million dollars in the Hong Kong
version of "Who wants to be a millionaire?" asked
the name of the person who first said the famous quote "Bad
money drives good money out of circulation".
The political version of the law is mentioned on pages 120-121
of Poul Anderson's "Iron," a novella in Larry
Niven's collection Man-Kzin Wars.
Gresham's Law is referenced in Philip K. Dick's 1962 novel
The Man in the High Castle where, due to the U.S. being
conquered by Japan, there is a large market for American
antiques. As a result, an industry emerges for counterfeit
"historic American art objects" which, if ever
discovered to be fake, would make the market collapse.
Armitage, Angus, The World of Copernicus, New York, Mentor
Books, 1951, pp. 89-91 (chapter 24: The Diseases of Money).
Copernicus made notes on "Gresham's [Copernicus'?]
Law" in 1519, presented a report on it to a 1522 diet,
and drew up an enlarged, Latin-language version of his treatise,
setting forth a general theory of money, for the 1528 diet.
Guidotti, P. E., & Rodriguez, C. A. (1992). Dollarization
in Latin America - Gresham law in reverse. International
Monetary Fund Staff Papers, 39, 518-544.
Rolnick, A. J., & Weber, W. E. (1986). Gresham's law
or Gresham's fallacy. Journal of Political Economy, 94,
Selgin, G., University of Georgia (2003). Gresham's Law.
Spiegel, Henry William (1991). The growth of economic thought,
3rd. ISBN 0-8223-0965-3.