GRESHAM'S LAW

INTRODUCTION
 In economics, Gresham's law is a monetary
principle stating that "bad money drives out
good".
 For example, if there are two forms of
commodity money in circulation, which are
accepted by law as having similar face
value, the more valuable commodity will
disappear from circulation.

GOOD MONEY &
BAD MONEY
 Good money is money that shows little difference between its
nominal value (the face value of the coin) and its commodity
value (the value of the metal of which it is made, often precious
metals, nickel, or copper).
 On the other hand, bad money is money that has a commodity
value considerably lower than its face value and is in circulation
along with good money, where both forms are required to be
accepted at equal value as legal tender.
 In Gresham's day, bad money included any coin that had been
debased. Debasement was often done by the issuing body, where
less than the officially specified amount of precious metal was
contained in an issue of coinage, usually by alloying it with a
base metal. The public could also debase coins, usually by
clipping or scraping off small portions of the precious metal, also
known as "stemming" (reeded edges on coins were intended to
make clipping evident). Other examples of bad money include
counterfeit coins made from base metal. Today all circulating
coins are made from base metals, known as fiat money.

EXAMPLES
 Silver coins were widely circulated in Canada (until 1968)
and in the United States (until 1964 for dimes and quarters
and 1970 for half-dollars) when the Coinage Act of 1965 was
passed. These countries debased their coins by switching to
cheaper metals thereby inflating the new debased currency in
relation to the supply of the former silver coins. The silver
coins disappeared from circulation as citizens retained them
to capture the steady current and future intrinsic value of the
metal content over the newly inflated and therefore devalued
coins, using the newer coins in daily transactions.In the late
1970s, the Hunt brothers attempted to corner the worldwide
silver market but failed, temporarily driving the price far
above its historic levels and intensifying the extraction of
silver coins from circulation.The same process occurs today
with the copper content of coins such as the pre-1997
Canadian penny, the pre-1982 United States penny and the
pre-1992 UK copper pennies and two pence.This also
occurred even with coins made of less expensive metals such
as steel in India.

THEORY
 Gresham's law states 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. (For a
formal model see Bernholz and Gersbach 1992).
This is because people spending money will
hand over the "bad" coins rather than the "good"
ones, keeping the "good" ones for themselves.
Legal tender laws act as a form of price control.
In such a case, the artificially overvalued money
is preferred in exchange, because people prefer
to save rather than exchange the artificially
demoted one (which they actually value
higher).

 Consider a customer purchasing an item which costs five
pence, who possesses 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.

 If "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 intrinsic value, even if such
destruction is illegal. As an example, consider the 1965 United
States half dollar coins, which contained 40% silver. In
previous years, these coins were 90% silver. With the release
of the 1965 half dollar, which was legally required to be
accepted at the same value as the earlier 90% halves, the older
90% silver coinage quickly disappeared from circulation,
while the newer debased coins remained in use. As the value
of the dollar (Federal Reserve notes) continued to decline,
resulting in the value of the silver content exceeding the face
value of the coins, many of the older half dollars were melted
down.Beginning in 1971, the U.S. government gave up on
including any silver in the half dollars, as even the metal value
of the 40% silver coins began to exceed their face value.

 A similar situation occurred in 2007 in the United
States with the rising price of copper, zinc, and
nickel, which led the U.S. government to ban
the melting or mass exportation of one-cent
and five-cent coins.
 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 as citizens of the
issuing country are, so they will offer higher value
for good coins than bad ones. The good coins
may leave their country of origin to become
part of international trade, escaping that
country's legal tender laws and leaving the
"bad" money behind. This occurred in Britain
during the period of the gold standard.

THEIR'S LAW
(REVERSE OF GRESHAM'S LAW)
 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 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 monies, comparing the relative "goodness" of
silver to that of gold, which is not what Gresham was
speaking of.
 The experiences of dollarization in countries with weak
economies and currencies (for example Israel in the
1980s, Eastern Europe and countries in the period
immediately after the collapse of the Soviet bloc, or
South American countries throughout the late 20th and
early 21st century) may be seen as Gresham's Law
operating in its reverse form (Guidotti & Rodriguez, 1992),
because in general the dollar has not been legal tender
in such situations, and in some cases its use has been
illegal.

 Adam Fergusson pointed out that in 1923 during the great
Inflation in the Weimar Republic Gresham's Law began to
work in reverse, as the official money became so worthless
that virtually nobody would take it. This was particularly serious
because farmers began to hoard food. Accordingly, any
currencies backed by any sorts of value became the
circulating mediums of exchange. In 2009 hyperinflation in
Zimbabwe began to show similar characteristics.
 These examples show that, in the absence of effective 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. In short, in the absence of legal
tender laws, the seller will not accept anything but money of
certain value (good money), while the existence of legal
tender laws will cause the buyer to offer only money with the
lowest commodity value (bad money) as the creditor must
accept such money at face value.

 The Nobel prize-winner Robert Mundell
believes that Gresham's Law could be more
accurately rendered, taking care of the
reverse, if it were expressed as, "Bad money
drives out good if they exchange for the
same price."
 The reverse of Gresham's Law, that good
money drives out bad money whenever the
bad money becomes nearly worthless, has
been named "Thiers' Law" by economist Peter
Bernholz, in honor of French politician and
historian Adolphe Thiers."Thiers' Law will only
operate later [in the inflation] when the
increase of the new flexible exchange rate
and of the rate of inflation lower the real
demand for the inflating money."

APPLICATION
 The principles of Gresham's law can sometimes be
applied to different fields of study. Gresham's law may
be generally applied to any circumstance in which the
"true" value of something is markedly different from the
value people are required to accept, due to factors
such as lack of information or governmental decree.
 In the market for used 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 financial incentive to pass all used
cars off as "good" cars, especially lemons. This makes it
difficult to buy a good car at a fair price, 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
reduce the risk of overpaying. High-quality cars tend to
be pushed out of the market, because there is no good
way to establish that they really are worth more.
Certified pre-owned programs are an attempt to
mitigate this problem by providing a warranty and other
guarantees of quality.

 "The Market for Lemons" is a work that examines this problem
in more detail. Some also use an explanation of Gresham's
Law as "The more efficient you become, the less effective you
get"; i.e. "when you try to go on the cheap, you will stop
selling" or "the less you invest in your non-tangible services, the
fewer sales you will get."
 Vice President Spiro Agnew used Gresham's law in describing
American news media, stating that "Bad news drives out good
news," although his argument was closer to that of a race to
the bottom for higher ratings rather than over and
undervaluing certain kinds of news.
 Gregory Bateson postulated an analogue to Gresham's Law
operating in cultural evolution, in which "the oversimplified
ideas will always displace the sophisticated and the vulgar
and hateful will always displace the beautiful. And yet the
beautiful persists."
 Gresham's law has been cited as "Silver currency will
inevitably force gold currency out of circulation" (L. Pyenson,
Servants of Nature (W.W. Norton, 1999) p. 21); this suggests a
fundamental misinterpretation, cf. Mundell.