Gresham's Law
Gresham's Law
The principle that when two forms of money are legally valued at the same rate, the overvalued money tends to circulate while the undervalued money is hoarded or exported.
Gresham's Law is the principle that when two forms of money are legally valued equally, inferior money tends to drive superior money out of circulation.
The Legal Exchange Rate Matters
Gresham's Law does not simply mean that bad money always defeats good money. The effect is most relevant when two monetary forms are forced to trade at an official rate that differs from their market value.
When people can freely choose exchange rates, the higher-quality money may trade at a premium instead of disappearing from use.
What Is Gresham's Law?
Suppose two coins are legally treated as equal even though one contains more valuable metal. Rational holders have an incentive to spend the lower-value coin and keep, melt, export, or sell the higher-value coin.
The lower-quality monetary unit therefore remains in day-to-day circulation while the higher-quality unit becomes scarce.
The Basic Mechanism
The mechanism can be summarized in four steps:
Good Money and Bad Money
The phrases good money and bad money are shorthand for a difference between official value and market value.
Its legal value is high relative to its underlying or market value, so people prefer to spend it.
Its market value is high relative to its legal value, so people prefer to hold or remove it from circulation.
Why the Principle Has Limits
Gresham's Law depends on institutional conditions. If exchange rates are allowed to float, users can demand more units of one currency for another rather than treating them as legally identical.
This is why the principle should be understood as a rule about monetary incentives under fixed or enforced exchange relationships.
Why It Matters for Monetary Literacy
Gresham's Law illustrates how legal rules can interact with market valuations. It also helps explain historical coin shortages, bimetallic tensions, and why monetary quality can affect how people choose to spend or save different forms of money.
When law says two monies are equal but the market says otherwise, people change which one they spend and which one they keep.
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