January 15, 2005

Gresham's Law

My father taught me Gresham's law when I was very small. It's become a refrain in the family. During the Second War, the government coined steel pennies with a low copper content. My father's formulation was "bad money drives good money out of circulation." If you had a steel penny and a copper penny, so he said, you'd spend the steel one first (unless you wanted the steel one for a collection). Thus the steel penny tended to drive the copper one out of circulation.

Although a powerful concept, it's really not that simple, as Robert Mundell explains in a very interesting historical treatment of the debasement of coinage, bimetallism, and other obscure but interesting matters. It's amazing what you can find by googling.

To summarize:
Gresham's Law, properly understood, can be a powerful tool in the hands of historians for the study of monetary history. The catchy phrase, "bad money drives out good," is not a correct statement of Gresham's Law nor is it a correct empirical assertion. Throughout history, the opposite has been the case. The laws of competition and efficiency ensure that "good money drives out bad." The great international currencies--shekels, darics, drachmas, staters, solidi, dinars, ducats, deniers, livres, pounds, dollars--have always been "good" not "bad" money.

Gresham's Law comes into play only if the "good" and "bad" exchange for the same price. "Good money drives out bad if they exchange for the same price" is an acceptable expression of Gresham's Law. But a better statement of it is that "Cheap money drives out dear, if they exchange for the same price." Put in this way, Gresham's Law becomes a theorem of the general law of economy, a consequence of the theory of rational economic behavior.

Now if I could only figure out why you can't find a Susan B. Anthony dollar coin anywhere.

No comments: