Gresham's law

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Gresham's law is commonly stated: "Bad money drives out good", but is more accurately stated: "Bad money drives out good if their exchange rate is set by law."

This law applies specifically when there are two forms of commodity money in circulation which are required by legal-tender laws to be accepted as having similar face values for economic transactions. The artificially overvalued money tends to drive an artificially undervalued money out of circulation [1] and is a consequence of price control.

Gresham's law is named after Sir Thomas Gresham (1519–1579), an English financier during the Tudor dynasty. However, the law had been stated forty years before by Nicolaus Copernicus, so in parts of central and eastern Europe it is known as the Copernicus Law. The phenomenon had been noted even earlier, in the 14th century, by Nicole Oresme. The fact of bad money being used in preference to good money is also noted by Aristophanes in his play The Frogs, which dates from around the end of the 5th century BC.

Contents

'Good' money and 'bad' money

"Good" money is money that shows little difference between its nominal value (the face value of the coin) and its commodity value (the value of the metal of which it is made, often precious metals, nickel, or copper.)

In the absence of legal-tender laws, metal coin money will freely exchange at somewhat above bullion market value. This is not a purely theoretical result but may instead be observed today in bullion coins such as the South African Krugerrand, the American Gold Eagle, or even the silver Maria Theresa thaler (Austria). Coins of this type are of a known purity and are in a convenient form to handle. People prefer trading in coins rather than in anonymous hunks of precious metal, so they attribute more value to the coins. As there is also demand from coin collectors, coining is frequently profitable.

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