Gresham’s Law

Gresham’s Law: “Bad Money Drives Out Good”

What is Gresham’s Law?

Gresham’s Law summarizes a pattern in monetary circulation: when two forms of money are accepted at the same face value but differ in intrinsic or perceived value, the cheaper or overvalued form (“bad money”) tends to circulate while the more valuable or under‑valued form (“good money”) is hoarded or removed from circulation.

Historical origin

The principle is named after Sir Thomas Gresham (1519–1579), an English financier who observed the effects of coin debasement during the Tudor period. Rulers who reduced the precious‑metal content of coins but kept their face value created incentives to spend the new, less‑valuable coins and hoard older, purer coins.

How it works

• Two monetary units circulate at the same nominal value but different intrinsic value (e.g., older silver coins vs. newly debased coins, or stable foreign currency vs. hyperinflated local currency).
• Legal or customary acceptance at par makes the less‑valuable currency usable in transactions.
• Rational economic actors spend the overvalued money and retain the more valuable money for its purchasing power or melt/sell its metal content.
• The result: the “bad” money dominates everyday transactions; “good” money disappears from circulation.

Role of legal tender laws

Legal tender laws that require creditors and merchants to accept a currency at its face value reinforce Gresham’s mechanism. When such laws are strictly enforced, bad money will tend to drive out good. Conversely, if legal tender rules are weak or unenforced, people can refuse overvalued money, and “good” money may drive “bad” money out of use (currency substitution).

Modern context and limits

• Transition from metallic to fiat money changed how Gresham’s pattern appears. Issuers can expand paper currency, which can produce inflation rather than classical coin‑melting behavior.
• In extreme cases (hyperinflation, currency collapse), people abandon the national currency in favor of stable foreign currencies or barter. That outcome can represent a reversal of the conventional phrasing: good money (stable foreign currency) drives bad money (collapsed local currency) out of circulation.
• Legal restrictions (e.g., prohibitions on melting or exporting coins) are sometimes used to counteract hoarding of intrinsically valuable coins.

Notable examples

• Tudor England: Debasement of coinage under Henry VIII led people to hoard older silver coins and spend inferior new coins.
• U.S. pennies (1982 change): When the U.S. changed penny composition from copper to copper‑plated zinc, older pennies with higher metal value became more likely to be hoarded or collected.
• Revolutionary War era U.S.: Poorly backed paper money circulated while gold and silver coins were hoarded.
• Zimbabwe (2000s): Hyperinflation made the Zimbabwe dollar effectively worthless in transactions; people shifted to stable foreign currencies, producing widespread dollarization.

Policy implications

• Debasement can act as a hidden tax—reducing real value held by the public—so governments must weigh short‑term fiscal gains against long‑term loss of confidence.
• Strong, credible monetary institutions and anti‑inflation policies help preserve a currency’s role as a medium of exchange.
• When citizens lose trust in a currency, legal tender laws alone may be insufficient to maintain its use.

Key takeaways

• Gresham’s Law: when two monies circulate at fixed nominal parity, the cheaper (bad) tends to circulate; the more valuable (good) is hoarded.
• Legal tender laws often enable the effect; weak enforcement can produce the opposite outcome.
• The law originated with coin debasement but still has relevance in modern contexts such as inflation, currency substitution, and dollarization.
• Policymakers should consider how coin composition, monetary issuance, and credibility affect public incentives to hold or spend different forms of money.

Conclusion: Gresham’s Law remains a useful lens for understanding how relative perceived value, legal rules, and public trust determine which forms of money circulate and which are withdrawn from everyday use.