Definition
Gresham’s Law is a monetary principle stating that “bad money drives out good.” If two forms of money are in circulation and are accepted by law as having the same face value, but have different intrinsic values, the one with the higher intrinsic value (good money) will be hoarded and disappear from circulation, while the one with lower intrinsic value (bad money) will be spent.
Why It Matters
It explains how legal tender laws can pervert market incentives, causing stable assets to disappear from the economy in favor of debased currency. Recognizing this pattern is crucial for understanding currency crises and the hidden costs of monetary intervention.
Core Concepts
- Intrinsic vs. Face Value: “Good money” is money that has a commodity value (like gold or silver) higher than its market exchange value. “Bad money” is money that has a commodity value lower than its face value (like debased coins or fiat).
- Hoarding and Melting: People will hoard the “good” money because it is a better store of value, or they will melt it down to sell the metal at its higher intrinsic price.
- Legal Tender Laws: The law usually requires that both types of money be accepted at the same face value, which prevents the market from naturally discounting the “bad” money.
- Information Asymmetry: In modern contexts, this can apply to any market where low-quality goods or people (bad) drive out high-quality ones (good) because the market cannot distinguish between them.