Gresham's Law


03 Oct 2002

Gresham's Law

Gresham's law - first articulated in the sixteenth century - may have some interesting applications for the twenty-first century.

Sir Thomas Gresham probably did not expect, when he expressed his opinion that "bad money drives out good", that it would become a dictum, and indeed a Law in monetary economics named after him. He probably also did not expect that the dictum would become more well known than its originator, to the extent that someone regrettably managed to get away with prize money of only half a million Hong Kong dollars instead of the grand slam one million in the "Who Wants To Be A Millionaire?" gameshow.

Were he alive today, Sir Thomas Gresham would probably not be too interested in half a million - or even a million - Hong Kong dollars since he was able in the year 1551 to earn the extremely large sum (by the values of the time) of twenty shillings a day. He was so knowledgeable in currency and exchange that he played a prominent part in advising Queen Elizabeth I on the reform of the currency; and he was so well off and well placed that he could afford to entertain her twice as his guest. According to Palgrave's Dictionary of Political Economy, "his business was to negotiate royal loans with Flemish merchants, to buy arms and military stores, and to smuggle into England as much bullion as possible". So he must have had money coming out of his ears.

His personal finances aside, I wonder whether Sir Thomas Gresham might have a view on the applicability of his Law in a situation where money takes the form much more prominently of accounting entries rather than of coins in circulation. It is understandable that in a situation where two mediums of exchange come into circulation together the more valuable will tend to disappear from circulation as the less valuable will tend to be spent first, hence his Law. But this is on the assumption that the community will accept the bad money and not demand the good money as a medium of exchange. Perhaps by law they have to, particularly when, for example, the bad money has the status of legal tender. In terms of the money saved, the good money will be preferred over the bad, if this is not disallowed by exchange control regulations. In terms of bank deposits, therefore, the good money would be favoured and would possibly dominate in the balance sheet of the banking system.

I also wonder whether Sir Thomas Gresham might have a view on the applicability of his Law when there is a market, and therefore an exchange rate, between the two currencies. The intrinsic values of the two currencies could be equalised through a freely determined exchange rate, and possibly through interest rates, if there is a reliable market for it, in which case it would be difficult to choose between the good money and the bad. But if the exchange rate is somehow fixed, then the perception of good and bad may be formed, probably on the basis of the reputation of the mints, the relative liquidity of the currencies and other considerations. And what if convertibility between the two currencies is restricted, at least by law, in one jurisdiction but not in the other? Which currency will be favoured over the other, and is the one favoured necessarily the good one? And then what if free convertibility is introduced between the two currencies?

I do not have answers to these intriguing questions, which came to mind as I pondered, in the early morning hours under the effect of jet lag, the likely scenario, in the fullness of time, under "one country, two (three or even four) currencies".


Joseph Yam

3 October 2002


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