Whatever Your Definition of Gresham's Law, It's Still a Myth
AP Photo/Dmitri Lovetsky
Whatever Your Definition of Gresham's Law, It's Still a Myth
AP Photo/Dmitri Lovetsky
Story Stream
recent articles

Fox Business Channel anchor David Asman was a columnist for the Wall Street Journal’s legendary editorial page back in the early 1990s. This was when the old Soviet Union thankfully dissolved.

At the time of dissolution, Asman was reporting and commentating from St. Petersburg. In one of his dispatches, he noted the existence of all manner of street performers in the city’s squares. Asman observed that they politely nodded if rubles were dropped in their hats, but a dollar contribution was cause for stopping whatever they were doing in order to personally thank the individual who parted with dollars.

Asman’s report has always been a reminder of how ludicrous is the notion that central banks “monetize” their country’s debt. Please. Such a view is strangely popular among normally serious people, but if there were any truth to it, the Soviet Union would still exist today care of Gosbank.

What’s a creation of government can’t prop up government. The Fed can purchase lots of Treasury debt not because it’s the Fed, but because it’s backed by the most productive people on earth. The Fed’s swagger isn’t its own just as Gosbank’s rather limited “balance sheet” decades ago wasn’t a consequence of its own parsimony.

But that’s not the purpose of this piece. Its purpose is to address Gresham’s Law. Some wise people questioned a recent column dismissing the Law, but the stance here hasn’t changed despite some impressive responses.

In its most basic form Gresham’s Law says that “bad money drives out good.” In other words, if there’s a quality currency circulating in a city, state or country in concert with a lightly-regarded one, the lightly viewed one will push the good out of circulation as wise people place the credible under the proverbial mattress. It makes sense at first glance, but only at first glance. When thought about, such a supposition is more than a bit nonsensical.

Implicit in what makes no sense is that producers of goods and services readily accept what’s exchangeable for relatively fewer, or exponentially fewer goods and services. Except that they don’t. Trade is not money for products; rather it’s products for products. Producers aren’t in the business of producing in return for a little or a lot less. This statement of the obvious explains Asman’s experience in St. Petersburg, and it explains why U.S. dollars circulate prominently around the world. Despite its often inept oversight by the U.S. Treasury over the decades, the dollar is a relatively trusted medium of exchange. Producers willing to receive dollars in return for the goods and services on offer do so because they can reasonably assume the dollar will command roughly commensurate market goods when brought to market.

It’s all simple, market-based evidence that Gresham’s Law in its most basic “bad money drives out good” form, isn’t very meaningful. Real world evidence and common sense dictate that the Law is a myth.

But wait, some will wisely say. Gresham’s Law is more than good money driving out bad. While the Law in its most simple form doesn’t stand up to market realities, Murray Rothbard defined it differently. Per Rothbard, Gresham’s amounted to “money overvalued by the state drives out money undervalued by the state.” On its face it’s a bit more compelling, but only a bit.

Implicit in Rothbard’s definition is that the state can decree prices that will have some sway in actual markets. Except that markets always speak no matter what governments say. Governments can decree rent cheap, or borrowing at zero cost, but the mildly sapient know better. Along currency lines, it was long said that the Soviets maintained an implicit peg of the ruble to the dollar, particularly during the gold-exchange standard era, but those rubles “earned” by the people long remained unused thanks to black markets in the old U.S.S.R. not sharing the government’s view about the ruble’s exchangeability.

Considering the mark in post-WWI Germany, it’s not as though German monetary authorities redefined the mark as something less than 1 four billionth of a dollar as much as the markets priced the latter as such. Needless to say, the well overvalued mark rapidly disappeared from circulation in Germany while credible currencies like the dollar were eminently exchangeable for goods and services on offer there.

To believe, as Gresham’s Law believers do, that the bad or overvalued by the state drives out the good is to presume that markets are more than dense; that products for products that defines all trade suddenly loses its way once government acts. But that’s not true. Producers don’t produce so that they can get less in return. Since they don’t, it’s always the good pushing out the bad mainly because people don’t provide goods and services in the hope of being ripped off

Another definition of Gresham’s is along the lines of a bi-metallic system of money. Government might keep the ratio between gold and silver defined money as constant, but if one commodity rises relative to the other in the marketplace, the overvalued (by government) will be the currency of choice over the undervalued.

It’s compelling, but is hoarding ultimately the result? If the hoarding takes place within a bank, the hoarded funds are going to continue to circulate, by definition. If not, as in if the money is literally going under a mattress or into a coffee can, there remains the reality of the marketplace. Translated, the currency holder doesn’t really decide that bad money will replace good. In truth, the seller of goods and services will make that decision. Just because a buyer wants to offer the bad money in return for market goods doesn’t mean the seller will accept it. If this is doubted, readers should travel to Caracas, Teheran, and Pyongyang with plans to use bolivars, tomans and won while in each. Good luck eating.

What’s true in the cities mentioned applies to any bi-metallic system. Assuming the bad is driving out the good, it’s presumably only if sellers deem the bad money worthy of exchange, or if they’ve come up with a sufficient “haircut” for those offering the bad.

The main thing is that what’s viewed as a “Law” is anything but once common sense enters the picture. It’s easy to see why this is true once it’s remembered that no one buys, sells, lends or borrows with “money.” Underlying all monetary transactions is the movement of real market goods, which is why Gresham’s Law is a myth no matter the system.


John Tamny is editor of RealClearMarkets, Vice President at FreedomWorks, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com). His next book, set for release in March of 2021, is titled When Politicians Panicked: The New Coronavirus, Expert Opinion, and a Tragic Lapse of Reason. Other books by Tamny include They're Both Wrong: A Policy Guide for America's Frustrated Independent Thinkers, The End of Work, about the exciting growth of jobs more and more of us love, Who Needs the Fed? and Popular Economics. He can be reached at jtamny@realclearmarkets.com.  

Show comments Hide Comments