Good Money, Bad Money and Gresham's Law

There is a law of economics, known as "Gresham´s Law" and when discussing money or digital currency backed by gold, it is important to know a little about this powerful topic. Good old Wikipedia describes Gresham´s Law like this: "When there is a legal-tender currency, bad money drives good money out of circulation." Or, more accurately: "Money overvalued by the State will drive money undervalued by the State out of circulation." Looking at it another way, if inflation in the US keeps rising then your food and gas will continue to go up in price. When you visit the grocery store if you had the option to pay with pure gold coins (good money) or US backed paper dollars...with the price of gold moving higher and the value of those USDs is falling because of inflation what would you spend?

Knowing that gold is going up in value and that inflation is killing the value of paper dollars, you should want to keep the gold (good money) and get rid of all those paper dollars (bad money) Thus, Gresham´s law, the bad money (paper) will always drive the good money (gold and silver) out of circulation as users keep what contains value and spend what is perceived as having no real intrinsic value, the paper.

The really amazing fact about this economic law is that Sir Thomas Gresham lived from 1519 - 1579 a very long time ago. How was it possible he could predict how the economies of today´s world would function? It seems that during the 16th century, gold and silver were used in the local coinage just as they were minted during the early 20th century Throughout these periods in history, the same rules applied. Please note that unlike today, during Gresham´s time all the money was coinage, and consequently good money showed little difference between its exchange value and its commodity value.

Gresham´s law is only applicable when there are two forms of commodity money in circulation which are forced (legal tender) and respected as having the same face value in the marketplace. For example if you lived in Chicago during the 1920´s you could spend either US gold coins or paper currency backed by gold coins. This is a great demonstration of legal tender, showing us the paper (which we will recognize as bad money) and the gold (the good money). Circulating currency consisting of both "good" and "bad" money quickly becomes dominated by the "bad" money.

Gresham, was a financial advisor to Queen Elizabeth. In his now famous letter to the Queen in 1558, he stated that he noticed in all similar situations "that good and bad coin cannot circulate together". The bad money would be used whenever possible and the good money [coinage] would be saved and disappear from circulation. It seems that even in 16th century England, Sir Gresham was able to recognize this trend and create the rule that still applies in today´s world. Of course the sound money policy was not new. These ideas had surfaced more than 2000 years before in ancient Greek society. There were many times in the history of previous societies when Gresham could apply and test his theories.

Gresham´s law can also be observed in reverse. With no legal tender laws applicable and people are given the chance to accept both good and bad money, they will more often transact with the money they believe will retain the highest long-term value (good money). That rule only applies when there is a choice of which money to accept. If people are not given a choice, and required to accept all money, they will tend to keep the money of greater perceived value in their possession, and spend all their bad money.

The best example of this law in action, could be seen after the 1964-1965 debasement of silver coins in America. In 1965, nobody was spending the 1964 or earlier manufactured US quarters because of their silver content.

In other words, with no legal tender laws where consumers can use their preferred method of payment, sellers will never accept anything but money with real value (good money, commodities like gold and silver). Who would want paper money of no real value, instead of accepting gold coins? Nobody.

Secondly, where there are existing legal tender laws, sellers are forced to accept bad money (paper) with no commodity value so buyers will always spend their bad money first, as it is required to be accepted.

Recognizing Gresham´s Law is important when we discuss the daily use and expansion plans for Digital Gold Currency. Many people knowledgeable on this subject will tell you that no population is going to use digital gold grams in their daily lives as money until all their US dollars are spent!

If we follow Sir Gresham´s impressive law, consumers spending habits won´t change until we are rid of all those dollars and seek more ´sound money´.

If ever required to accept both dollars and gold, consumer may just move completely away from those dollars and into digital gold currency. Most people will say we are more than a few years away from something like that happening.

Perhaps, in the years ahead, choosing to transact business in Digital Gold Currency may not involve such a conscience thought as it happens today. Digital Gold will always be the safer alternative.

DGC Magazine