Revisiting Gresham’s Law: An Historical Overview

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Portretten van Sir Thomas Gresham en Anne Fernely Rijksmuseum SK-A-3118.jpeg – licensed under Wikimedia Commons

In 1562, Sir Thomas Gresham, acting as financial advisor to the English Crown, wrote a letter to Queen Elizabeth I where he made the following observation:

“Ytt may please your majesty to understand, thatt the firste occasion of the fall of exchainge did growe by the Kinges majesty, your latte father, in abasinge his quoyne ffrome vi ounces fine too iii ounces fine. Wheruppon the exchainge fell ffrome xxvis. viiid. to xiiis. ivd. which was the occasion thatt all your fine goold was convayd ought of this your realme.”

In modern day English, this means that gold had been leaving England after Henry VIII had started minting coins with lower gold content, alloying them with more base metals. Though, as economic historian Frank Whitson Fetter points out, while Henry VIII had indeed debased the coins of England, it was actually Edward VI who had enacted the particular policy of debasement that Gresham refers to. After this policy of debasing the currency was enacted, a trend arose in which the new coins with lower gold content would continue to circulate in England while the older coins with higher gold content would be spent elsewhere.

Owing to Gresham’s observation in the sixteenth century, Scottish economist, Henry Dunning Macleod coined the term “Gresham’s Law” in his 1858 treatise, Elements of Political Economy, where he credited Gresham with being “the first who discerned the great fundamental law of the currency, that good and bad money cannot circulate together.” Today, Gresham’s Law is often formulated as follows: Bad money drives out good. But, Macleod was wrong to credit Gresham with being the first to discover the law. Knowledge of this phenomenon is ancient, in fact. The first instance we have of this phenomenon being described in the West comes from the Greek playwright Aristophanes’ comedy, The Frogs, in which the leader of the Chorus describes how Athenian citizens are much like coins, with the good ones being driven out and the bad ones being kept in the city.

This phenomenon did not go unnoticed in the medieval era either. The fourteenth century French philosopher Nicole Oresme noted that when princes debased their coins, the pure coins tended to go into foreign countries. He writes, “such alterations and debasements diminish the amount of gold and silver in the realm, since these metals, despite any embargo, are carried abroad, where they command a higher value. For men try to take their money to the places where they believe it to be worth most. And this reduces the material for money in the realm.” Renaissance thinker Nicholas Copernicus also formulated a version of Gresham’s Law in 1526 in his treatise, On the Minting of Coin where he lamented that the Prussian government’s debasing coins with copper would make it that “Prussia, stripped of gold and silver, will have merely copper coinage” and that “When the best of the old coins have completely disappeared, they then pick out the least bad of the coins still in circulation, leaving only the worst coins to circulate as money.”

After Gresham but before Macleod, David Hume and Adam Smith, two Scottish philosophers, had also pointed to the tendency for one form of money to drive out another when discussing the circulation of paper money. For Hume, Britain had very little gold while France had much because in Britain there was access to paper money whereas in France, there was not. Smith celebrated this phenomenon pointing out that the use of paper money “replaces a very expensive instrument of commerce with one much less costly, and sometimes equally convenient,” with the result being that “Circulation comes to be carried on by a new wheel, which it costs less both to erect and to maintain than the old one” So well-known through history was such a phenomenon that it is astounding that we only now refer to Macleod’s nineteenth century name for the Law.

Though this phenomenon has been known throughout human history, interpretation of the law has become victim to a number of what Canadian Nobel Laureate in economics, Robert Mundell, calls “abuses”. The law, ‘bad money drives out good’ is not true without qualification. Indeed, in many cases, a more stable currency would drive out a less stable one. Varying contexts in which some writers interpret the law may lead to different conclusions. For example, in his Money and the Mechanisms of Exchange, economist and logician, William Stanley Jevons, argued that because people want to spend money instead of keep it, they cannot be trusted to select the less base coins. Instead, they want the least valuable coins to “get in their neighbors’ pockets.” And thus, he used Gresham’s law to suggest that a more and more debased currency “can only be prevented by the constant supervision of the state,”

One puzzle which may arise is why it is that people would choose to accept more base coins in the first place. If both buyers and sellers want to get rid of more base coins and keep better coins, then why would they accept the base ones for payment? In some contexts, there is an answer. In Gresham’s England, there was a law in place which “forbade any person to receive or to utter any coin at a price above the current value or proclamation rate.” Imagine a situation in which someone had two coins; one of 100% gold and the other of a debased alloy of 80% gold and 20% copper. When choosing which coin to pay with, the consumer would do exactly as Jevons had predicted and try to get the debased coin “in their neighbors’ pockets.” Because such a law was in place, the seller would be legally required to accept the debased coin at the same value as the pure coin. Seeing as it was always preferable to buy goods with debased money in domestic markets, the good money would tend to be spent in foreign markets where it commanded a higher price, as it was not artificially undervalued by law. Mundell suggests that a better statement of Gresham’s Law would be “Bad money drives out good if they exchange for the same price.”

Known for over two millennia, Gresham’s law has been a topic of interest for economists, philosophers, and even playwrights well before Macleod. After him it was still not obvious that the colloquial ‘Bad money drives out good’ requires careful attention to context. We might do well to listen to American economist, Murray Rothbard who suggests that “[Gresham’s] law really says that ‘money overvalued artificially by government will drive out of circulation artificially undervalued money’.”


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