This famous principle explains how, when both "good money" (money with intrinsic value) and "bad money" (money with less or no intrinsic value) circulate together, people tend to hoard the good money and spend the bad money. The result? Bad money dominates the market.
Relevance in a modern economic context
The evolution of Gresham's Law in modern times
Gresham's Law originated in the era of bimetallism, when gold and silver coins circulated. If one currency had higher intrinsic value (e.g., gold coins) than the other, people would hoard the valuable currency (good money) and spend the less valuable one (bad money).
Today, "bad money" refers to fiat currency with no intrinsic value, while "good money" could be tied to commodities like gold or emerging assets like Bitcoin.
Fiat currency as "bad money"
Since the abandonment of the gold standard, fiat currencies have become the norm. However, their value is backed solely by government trust and central bank policies rather than tangible assets.
Example:
In countries like Venezuela and Zimbabwe, hyperinflation rendered their fiat currencies essentially worthless (bad money). Citizens turned to the US dollar, gold, and even Bitcoin (good money) as stores of value.
Hoarding good money
People tend to hold onto assets with intrinsic or stable value (like gold or Bitcoin) while using depreciating fiat currency for transactions.
Gresham's Law and cryptocurrency
Bitcoin as "good money"
With its capped supply (21 million coins) and decentralized nature, Bitcoin is increasingly viewed as a form of "good money." People hold Bitcoin as a store of value while spending fiat currencies, which are subject to inflation and manipulation.
Example: In El Salvador, which adopted Bitcoin as legal tender, citizens are more likely to save Bitcoin and use the US dollar for everyday expenses.
Cryptocurrencies with weak fundamentals or poorly designed tokenomics (e.g., unlimited supply) often act as "bad money," pushing well-established cryptocurrencies like Bitcoin and Ethereum out of transactional use. Read a free bitcoin book.
Gold vs. fiat in history
Gresham's Law played a significant role during the gold standard. For instance:
In the 19th century, when silver coins were debased or when fiat paper money was introduced, people hoarded gold coins and used the less valuable alternatives for transactions.
Example: The 1933 Gold Confiscation Act in the United States forced citizens to turn in gold coins and use fiat dollars instead, essentially removing "good money" from circulation.
Practical examples of Gresham's Law in action
Coin clipping: In ancient times, governments would debase coinage by mixing precious metals like gold and silver with cheaper metals. People would hoard the full-weight coins and spend the debased ones.
Modern collectibles
Rare coins or high-quality currency notes (like pre-1971 US dollars redeemable for gold) are often kept out of circulation by collectors, leaving lower-quality notes in use.
Physical pennies in the US made of copper (pre-1982) are often hoarded, as their copper value exceeds their face value. Newer, cheaper pennies are used instead.
Central bank policies and the decline of "good money"
Gresham's Law also applies to monetary policy. When central banks print large amounts of money (quantitative easing), the "bad money" dilutes the overall value of the currency. This incentivizes people to seek alternative assets as stores of value.
Real estate and stocks as "good money"
In recent years, people have used real estate, stocks, and even art as hedges against inflation, avoiding long-term savings in fiat money.
The dominance of fiat money as "bad money" drives savers to hoard assets that protect against inflation (e.g., Bitcoin, gold).
Key lessons for the modern economy
The rise of alternative currencies
The emergence of Bitcoin and other cryptocurrencies shows that people are actively seeking "good money" in an era of inflationary fiat currencies.
Economic incentives
Gresham's Law demonstrates how rational behavior (hoarding good money) can have unintended consequences, such as driving valuable assets out of circulation and leaving inferior money as the primary medium of exchange.
Policy implications
To counteract the effects of Gresham's Law, governments must ensure currency stability and limit inflationary practices.
Key Takeaways
Good money vs. bad oney
People instinctively save money they perceive as more valuable ("good money") and use less valuable money ("bad money") for transactions.
Fiat vs. Bitcoin
In modern economies, fiat currencies are often seen as "bad money" due to inflation, while Bitcoin and gold represent "good money" due to their scarcity and intrinsic value.
Economic rationality
Gresham's Law reflects how human nature and economic incentives influence the flow of money in a financial system.
💡 Final Thought: Gresham's Law continues to resonate in today's economy, especially in the context of fiat currencies, inflation, and the rise of cryptocurrencies. As people seek "good money", the debate between centralized and decentralized monetary systems intensifies, shaping the future of global finance. 🌍💰📉
