Bad Money! Gresham’s Law Explained

In a previous post we discussed the pros and cons of the two monetary standards: commodity and paper. Evidently developed economies have moved beyond the commodity (or metallic) standard for a good reason.

Bad Money Drives Good Money Out of Circulation

There is in an inherent problem for a bimetallic standard that can be described as ‘Gresham’s Law’. Here is an example why a bimetallic standard pushes a country to a monometallic standard.


Let’s assume a fictional country is on a bimatallic standard of gold and silver. There are two different ratios of the values: mint (government) and market. The table below provides some real numbers to examine.

Gold:Silver Official Prices

Mint Ratio 60:1

Market Ratio 50:1

Gold

$300/ounce

$250/ounce

Silver

$5/ounce

$5/ounce

Here’s the problem. The decline in the price of gold (for whatever fictional reason) makes it profitable to sell 1 ounce of gold for $300 to the mint, buy 60 ounces of silver and the exchange 50 ounces of silver for one ounce of gold in the market.

Results? Government has lots of gold and no silver. The overvalued money (gold in this case) has driven poor silver out of the official monetary system. The fictitious country is now on a monometallic standard.

4 thoughts on “Bad Money! Gresham’s Law Explained

  1. anon

    I would like to thank the author / web admin for this example.

  2. Richy Lichez

    Money, like all things in a capitalistic self-serving world, should be beset by natural forces of supply and demand, to avoid the corrupt manipulations of governments and anti-competitive forces. The threat of competition is the strongest device in protecting consumers’ interests. And since we’re all consumers (even those who think they’re entitled to favoratism wrought by labor-union exploits). So, it’s not only logical but provable that price-fixing of one currency to another is never a wise decision in the long-run. Metals were a currency during the bimetallic era of the US.

  3. I dont think its possible. Not according to even weak form of markets. But I dont have the data to confront that.

    What do you think?

    Olga Lednichenko
    http://olgalednichenko.wordpress.com/

  4. Elijah Eberechukwu

    Sir thank u for this topic. But i want a clear explanation if possible with example. The gresham’s law ‘bad money drives good money in circulation’

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