Gresham’s Law: wrongly formulated or misinterpreted?

Gresham’s Law is often stated as “bad money drives out good money”. There are more precise definitions and the historical context itself provided at Wikipedia’s website. What is frustrating to me and certainly to some historians is the misinterpretation of the underlying general principles related to the ideas behind this law, especially by some Keynesian economists.

Many use Gresham’s Law to argue against monetary reform, especially the idea of returning to a gold standard (i.e. a money based on intrinsic worth (e.g. paper redeemable in precious metals) rather than fiat money, or money backed only by government). There are historical examples of where bad money did prevent the usage of better money that might seem to give credence to these pessimistic views towards the true and valuable monetary reform aforementioned. However in his seminal work “A History Of Money From Ancient Times To the Present Day”, Glyn Davies provides a very insightful perspective on why monetary reform sometimes works and sometimes doesn’t. He contrasts two late Roman emperors: Diocletian and his successor Constantin. He mentions how Diocletian tried monetary reform by reissuing a much purer coinage than his predecessors. However the good coinage was too little to tip the scales towards restoring the economy. Constantin was successful in his subsequent monetary reform because he issued even more good coinage to the point where the scales tipped towards true change for the better. The key was in quantity: if the amount of good money in circulation was too little, it was deemed too precious to part with, whereas if the amount of good money in circulation reached a certain threshold it became the preferred medium of exchange. Why? It is for the simple truth that once money with intrinsic worth returns to the scene in quantities that the general public can amass and trade freely, the money that was always worth less becomes truly worthless as it should be. Good money with intrinsic worth only flows freely once people lose their fear of not being able to retain or regain a store of such good money when the majority of the population have only bad money to trade in exchange.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: