Revising Gresham’s Law
…various interests and groups, notably including “Keynesian” economists, have sold to the public a “quasi-doctrine” which teaches, in effect, that “less is more” or that (in other words) “bad money is better than good money”. Here we can remember the classic ancient economics saying called “Gresham’s law” which was “The bad money drives out the good”.~John Nash, Ideal Money
Gresham’s law is often brought up in regard to the plausibility of bitcoin’s future success and the role it might play in our global financial system and day to day lives. However, the law is often misappropriated especially by those trying to paint a certain narrative for bitcoin. In this writing I mean to disambiguate the misappropriation and give a clearer understanding of the concept and significance of Gresham’s law.
In the video below, renown “bitcoin evangelist” Andreas Antonopoulos makes the exact error Nash warns us about with a story about how Prime Minister of India Narendra Modi made sweeping “overnight” demonetization regulations:
Andreas refers to the worthless notes as “bad” which isn’t much of a misappropriation, however, he subsequently continues on to apply the same definition of “bad money” to the observations made by Gresham (in his statements to Queen Elizabeth).
Andreas goes on to imply that nationally issued central banked money (aka fiat) is intrinsically “bad money”, and that in relation to bitcoin (aka “good money”), will become effectively valueless.
But Andreas has contradicted himself and he is using rhetoric to hide this obvious fact.
In order to perfectly see this we must understand how Gresham’s law was observed in the first place. Our authority on the history of economics George Selgin explains:
As for Gresham himself, he observed “that good and bad coin cannot circulate together” in a letter written to Queen Elizabeth on the occasion of her accession in 1558. The statement was part of Gresham’s explanation for the “unexampled state of badness” England’s coinage had been left in following the “Great Debasements” of Henry VIII and Edward VI, which reduced the metallic value of English silver coins to a small fraction of what it had been at the time of Henry VII. It was owing to these debasements, Gresham observed to the Queen, that “all your fine gold was convayed out of this your realm.”
Gresham was asked to survey the cause for the exit of gold from her purview and the reason given was that her mandated “fiat” dubbed bad money, replaced the circulating gold. The gold, dubbed good money, was taken to the international markets.
In Andreas’ talk he suggests a society hoards the good money and circulates the bad, but he concludes with the idea that this phenomenon will lead to bitcoin overtaking fiat. These two points are not resolvable (without rhetoric and absurdity) so like many bitcoiners do Andreas smashes his non sequitur conclusion into “eventually bitcoin takes over”.
To understand his mistake we must understand what Gresham meant by “good money” and “bad money”. “Good money” refers to what is often called commodity money, that is such that the market value of the coin is an expression of the commodity the coin is made up of. In contrast, “bad money” or “fiat” is a money in which the face value is mandated to hold a certain stated value which is not an expression of the medium used for exchange (ie paper).
That is to say, Gresham observed a phenomenon in which actual gold was replaced by a fiat (mandated by the queen) and by which he referred to the former as good money and the latter as bad money. The cause for the phenomenon is easy to understand. The queen’s money, which is mandated as legal tender, is only valuable as such in her realm. If such a money was taken out of her scope of influence it, like commodity money, it would be only worth the MEDIUM it was noted on.
Gresham’s law is not necessarily a statement of the differing value trends between the compared monies. This is what Andreas implies and it is what causes him to misapply Gresham’s law and therefore force himself into a rhetorical based conclusion.
Put another way “fiat” does NOT imply an inflationary value trend. Fiat is simply a mandated value and for the purposes of the citizenry that accepts and uses that fiat, it is not necessarily true, depending on external and international economic factors, that fiat or “bad money” implies a devaluation trend.
We can think of an example in which a population has gold as their monetary standard, has that standard influenced by an external population’s ability to create supply shocks on gold. In such a scenario a wise advisor would tell the queen the best scenario is to abandon the gold standard lest the shocks destabilize and embargo the stability of the monarchy’s economy (and empire!).
In such a scenario it would seem not unreasonable that there could be the possibility if fiat was introduced as a plan to leave such a gold standard that the result could be FAVORABLE for the queen’s population. In this case “fiat” becomes the decree “ together we will move to a different standard” and then the use of fiat and the fleeing of gold from the realm (in anticipation for example of a great inflation of gold supply) becomes a wealth preserving counter-strategy.
In this sense it becomes absurd to suggest that fiat or “bad money” has the implication of a devaluing trend. Gresham’s law therefore is not the observation necessarily of an inflationary money versus a deflationary money but rather the observation of a commodity based money versus a fiat mandated money and Andreas certain misses this subtle but significant point.