What Is Gresham’s Law?
Gresham’s law is a long-standing monetary principle usually summarized as “bad money drives out good.” It describes what happens when two forms of money with the same legal face value but different intrinsic or market values circulate together. When law or custom forces both to be accepted at the same nominal value, people tend to spend the “bad” (lower intrinsic/market value) money and hoard or remove the “good” (higher intrinsic/market value) money from circulation.
Key takeaways
– Gresham’s law: when two monies circulate at a legally fixed face value but different market values, the cheaper/less-desirable money tends to circulate while the more valuable money is hoarded or withdrawn. [Investopedia]
– The law historically applied to coins made of precious metals; it still helps explain currency behavior under legal-tender regimes and in cases of hyperinflation or dollarization. [Investopedia; Britannica]
– The opposite can occur — “good money drives out bad” — if legal-tender enforcement is weak or absent (people voluntarily refuse the weak money). [Investopedia]
Understanding Gresham’s law (mechanics and logic)
– Two monies, one face value: If two types of currency are accepted as equal by law (e.g., old silver coin and new base-metal coin both accepted as “1 unit”), but one has higher intrinsic or market value, rational actors will spend the less valuable money and keep the more valuable one.
– Incentive: The holder seeks to preserve value. If a coin’s metal content is worth more than its face, it becomes an asset to hold or melt; if a coin is debased, you prefer to spend it rather than hold it.
– Legal tender role: The effect typically depends on legal tender laws that require acceptance at face value. Where those laws are weak or unenforced, people can refuse the low-value currency and the dynamic may reverse.
Good money vs. bad money — definitions and examples
– Good money: currency whose market/intrinsic value is equal to or greater than its face value — e.g., coins with substantial precious-metal content, or a stable fiat currency widely trusted.
– Bad money: currency whose intrinsic or market value is below face value — e.g., debased coins, hyperinflated paper currency, or currencies with very limited acceptance.
– Historical example: When Henry VIII reduced silver content in English coinage, older high-silver coins were hoarded while newer debased coins circulated. Sir Thomas Gresham observed and articulated this dynamic. [Investopedia]
Historical and modern examples
– Coin debasement (Renaissance England): Debasement led holders to hoard older, higher-value coins. [Investopedia]
– U.S. pennies: In 1982 the composition of the U.S. one-cent coin changed to mostly zinc; older pre‑1982 copper pennies then had higher intrinsic metal value than the post‑1982 coins. The U.S. subsequently made it illegal to melt coins for their metal content. [Investopedia; CFR Part 82]
– Revolutionary War (U.S.): Continentals and other paper issues depreciated, while gold and silver coins disappeared from circulation. [Investopedia]
– Hyperinflation and dollarization (Zimbabwe, 2008): When a currency collapses, people abandon it in favor of foreign currencies; the market forces overwhelmed legal-tender rules and the foreign “good” money displaced the local “bad” money. [Investopedia; BBC/IMF accounts]
– Modern fiat system: Since most countries moved to fiat currency, classic precious-metal examples are rarer, but the principle helps explain currency substitution and hoarding behavior during instability. [Investopedia; Britannica]
Gresham’s law and legal tender laws
– Legal tender laws make a currency acceptable to settle debts at face value. When two currencies are declared equivalent by law but have different real values, Gresham’s law tends to operate.
– If legal-tender rules are poorly enforced, however, people can refuse the weak currency and use the stronger one instead — producing the reverse effect.
How the gold standard and fiat money affect the law
– Under a gold or bimetallic standard, coin metal content mattered directly; debasement produced immediate hoarding or melting of “good” coins.
– Under fiat systems, debasement happens via excessive issuance and inflation. Rather than melting coins, people avoid the devalued currency by switching to more stable foreign currencies, barter, or assets — a modern parallel to Gresham’s observations.
Practical steps — what to do when Gresham’s law is a risk
Below are concrete recommendations for four audiences: policymakers, central banks, businesses, and individuals.
For policymakers (objective: preserve trust and minimize distortion)
1. Maintain credible fiscal and monetary policy. Avoid chronic large deficits financed by money creation; credibility reduces incentives to flee to alternative monies.
2. Avoid abrupt, arbitrary coin or currency redesigns that change intrinsic or perceived value without clear public communication and rationale.
3. If metal-content coins present arbitrage opportunities, consider changing legal rules (e.g., banning melting/export of coins) and enforcing penalties only as a last resort while addressing root causes. (The U.S. imposes penalties on melting coins — CFR Part 82.) [CFR Part 82]
4. Use transparent redenomination or exchange programs when a currency is failing (with legal, logistical, and social protections), rather than secretly debasing or forcing parity.
5. Consider options for controlled currency substitution or dual-currency systems if hyperinflation makes local currency unusable; manage transition to avoid disruption.
For central banks (objective: preserve monetary function and circulation)
1. Communicate monetary policy clearly and anchor inflation expectations (inflation targeting, independent central banking where feasible).
2. Manage currency reform with clear timelines and public education to avoid hoarding of “good” units.
3. Monitor market signals (premiums on foreign currency, withdrawal of certain denominations) as early warning signs.
4. Actively supply small denominations or alternatives in crises so everyday transactions can continue without creating incentives to hoard specific coins or notes.
For businesses (objective: maintain operations and manage currency risk)
1. Price contracts and invoices in stable currencies when possible; include clauses to allow currency adjustments in prolonged instability.
2. Accept multiple forms of payment (electronic transfers, major foreign currencies) where legal and practical.
3. Use hedging and currency-convertible accounts to limit exposure to local currency collapses.
4. Keep some liquidity in widely accepted currencies or assets during periods of high currency risk.
For individuals (objective: protect real value of savings and transactional ability)
1. Diversify store-of-value holdings (stable foreign currencies, bank deposits, short-term bonds, or real assets) depending on legal constraints and costs.
2. In high-inflation environments, move from nominal cash into real assets (goods, durable commodities) or foreign currency as appropriate.
3. Use digital banking and electronic payments when available; they can reduce friction and reliance on low-quality physical currency.
4. Be aware of legal restrictions on currency exchange or coin melting and follow official channels to reduce legal risk.
When Gresham’s law reverses: “good money drives out bad”
– If legal tender is not enforced — or enforcement collapses — people can and often do reject weak money. This was evident in episodes of hyperinflation where foreign currencies or barter supplanted the failing domestic money (Zimbabwe is a modern example). Policymakers should be aware that heavy-handed enforcement without addressing underlying monetary collapse will fail.
The bottom line
Gresham’s law — “bad money drives out good” — is a compact way to describe how incentives and legal rules shape what currency people actually use. Historically rooted in coin debasement, the principle still matters today for monetary policy, crisis management, and personal finance. Effective policy mixes credible monetary management, clear communication, and practical measures (e.g., redenomination, dual-currency transition) to reduce the incentives that cause “good” money to vanish from circulation. Individuals and companies can mitigate risk through diversification, use of stable currencies, and appropriate hedging.
Selected sources and further reading
– Michela Buttignol, “Gresham’s Law,” Investopedia. https://www.investopedia.com/terms/g/greshams-law.asp
– Britannica, “Gresham’s law.” https://www.britannica.com/topic/Greshams-law
– U.S. Code of Federal Regulations, Part 82 — 5 Cent and One Cent Coin Regulations (penalties on melting coins). https://www.ecfr.gov/current/title-31/subtitle-B/chapter-I/part-82
– Macrotrends, “Copper Prices 45 Year Historical Chart” (for copper price trends and coin-metal value context). https://www.macrotrends.net/1470/copper-prices-historical-chart
– BBC and IMF coverage on Zimbabwe’s hyperinflation and dollarization (overview and case study): search “Zimbabwe hyperinflation 2008 BBC IMF”
If you want, I can:
– Expand one of the practical-step lists into a detailed policy memo or business contingency plan.
– Prepare a short checklist for individuals to protect savings in a high-inflation environment.