Gresham’s law is an economic principle that states, “bad money drives out good.” This means that when two forms of currency are in circulation, the less valuable currency will tend to circulate more widely than the more valuable currency. This phenomenon was first described by Sir Thomas Gresham, an English financier during the Tudor dynasty.
Key Facts
- Definition: Gresham’s law refers to the phenomenon where lower-quality or less valuable currency tends to circulate more widely than higher-quality or more valuable currency.
- Origin: The law is named after Sir Thomas Gresham, an English financier during the Tudor dynasty, who urged Queen Elizabeth to restore confidence in the debased English currency.
- Observation: Gresham observed that when two forms of commodity money with similar face values are in circulation, the more valuable commodity tends to disappear from circulation over time.
- Good money vs. bad money: Under Gresham’s law, “good money” refers to money that has little difference between its face value and commodity value, while “bad money” has a commodity value considerably lower than its face value.
- Historical context: Gresham’s law was particularly relevant when coins were made from precious metals like gold and silver. Governments would debase coins by reducing the precious metal content, leading to the coexistence of debased (bad) and undebased (good) coins.
- Legal tender laws: Legal tender laws, which require both forms of money to be accepted at equal value, contribute to the dominance of bad money. People tend to spend bad money and hoard good money, leading to the disappearance of the latter from circulation.
Origins of Gresham’s Law
Gresham’s law is named after Sir Thomas Gresham, who urged Queen Elizabeth to restore confidence in the debased English currency. Gresham observed that when two forms of commodity money with similar face values are in circulation, the more valuable commodity tends to disappear from circulation over time. This is because people are more likely to spend the less valuable currency and hoard the more valuable currency.
Good Money vs. Bad Money
Under Gresham’s law, “good money” refers to money that has little difference between its face value and commodity value, while “bad money” has a commodity value considerably lower than its face value. In the historical context, good money was often made from precious metals like gold and silver, while bad money was made from debased metals.
Historical Context of Gresham’s Law
Gresham’s law was particularly relevant when coins were made from precious metals like gold and silver. Governments would debase coins by reducing the precious metal content, leading to the coexistence of debased (bad) and undebased (good) coins. Legal tender laws, which require both forms of money to be accepted at equal value, contribute to the dominance of bad money. People tend to spend bad money and hoard good money, leading to the disappearance of the latter from circulation.
Conclusion
Gresham’s law is a fundamental principle in economics that has been observed throughout history. It highlights the importance of maintaining the integrity of a currency and the potential consequences of debasing or manipulating the money supply.
Sources:
- https://www.investopedia.com/terms/g/greshams-law.asp
- https://en.wikipedia.org/wiki/Gresham%27s_law
- https://river.com/learn/terms/g/greshams-law/
FAQs
What is Gresham’s law?
Gresham’s law is an economic principle that states that “bad money drives out good.” In other words, when two forms of currency are in circulation, the less valuable currency will tend to circulate more widely than the more valuable currency.
Who is Gresham’s law named after?
Gresham’s law is named after Sir Thomas Gresham, an English financier during the Tudor dynasty. Gresham observed that when two forms of commodity money with similar face values are in circulation, the more valuable commodity tends to disappear from circulation over time.
What is good money and bad money?
Under Gresham’s law, “good money” refers to money that has little difference between its face value and commodity value, while “bad money” has a commodity value considerably lower than its face value. Historically, good money was often made from precious metals like gold and silver, while bad money was made from debased metals.
What is the historical context of Gresham’s law?
Gresham’s law was particularly relevant when coins were made from precious metals like gold and silver. Governments would debase coins by reducing the precious metal content, leading to the coexistence of debased (bad) and undebased (good) coins. Legal tender laws, which require both forms of money to be accepted at equal value, contribute to the dominance of bad money. People tend to spend bad money and hoard good money, leading to the disappearance of the latter from circulation.
What are some examples of Gresham’s law?
Examples of Gresham’s law can be seen throughout history. One example is the debasement of the English currency during the reign of Henry VIII. Another example is the circulation of counterfeit coins alongside genuine coins. In modern times, Gresham’s law can be seen in the hoarding of precious metals during periods of economic uncertainty.
What are the implications of Gresham’s law?
Gresham’s law has several implications for economic policy. It suggests that governments should avoid debasing their currency, as this can lead to inflation and a loss of confidence in the currency. It also suggests that governments should take steps to prevent the circulation of counterfeit money.
How can Gresham’s law be prevented?
There are several ways to prevent Gresham’s law from occurring. One way is to maintain the integrity of the currency by avoiding debasement and ensuring that the face value of the currency is close to its commodity value. Another way is to enforce laws against counterfeiting and to educate the public about the dangers of counterfeit money.
Is Gresham’s law still relevant today?
Gresham’s law is still relevant today, even though most currencies are no longer backed by precious metals. It can still occur when there is a difference in the value of different forms of currency, such as when there is a black market exchange rate.