Mental Model: Gresham’s Law

thomas_gresham

Gresham’s law is commonly stated as “Bad money drives out good.”

More broadly stated, “the bad drives out the good,” the concept can apply to many things.

Whenever coins containing precious metals have been used along with base metal coins of the same denomination, the bad coins have driven the good coins out of circulation.  (Kiplingers, January, 1974)

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In Plato’s Revenge, William Ophuls writes:

As with Gresham’s law in economics, bad values drive out good, so moral currency is continuously debased.

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From Charlie Munger’s 1984 Letter to Wesco Shareholders

Although interest rates have subsided from the 1981-82 peak, the low and slowly changing interest rates of former years are plainly gone with the wind, as are the former government0decreed limits on interest rate competition for savings accounts and the favouritism for savings and loan associations over banks. But an agency of the U.S. Government (…) continues to insure savings accounts in the savings and loan industry, just as it did before. The result may well be bolder and bolder conduct by many savings and loan associations. A sort of Gresham’s Law (“bad loan practice drives out good”) may take effect for fully competitive but deposit-insured institutions, through increased copying by cautions institutions of whatever apparent-high-yield loan and investment strategies seem to allow competitors to bid away their savings accounts and yet report substantial earnings. If so, if “bold conduct drives our conservative conduct,” there eventually could be widespread insolvencies caused by bold credit extensions come to grief.

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Former Canadian Prime Minister Mackenzie King writes:

In the reign of Queen Elizabeth, an official named Gresham observed that where different metals were in circulation as coinage and some were better than others of the same nominal value, the coins made of the inferior metal tended to drive the better out of circulation. The better coins were either hoarded or melted down and sold as bullion, were used in the fine arts, or were absorbed in the foreign exchanges. In other words, what Gresham discovered was that cheaper money tends to drive out dearer; that when people begin to discriminate between two coinages, they will invariably pay out the inferior and hoard the better, thus removing the better from circulation. This phenomenon once generally observed came to be described as a “Law,” and was identified with Gresham’ s name, since it was Gresham who was first successful in drawing public attention to it. Amongst money-changers, Gresham’ s Law of the precious metals is better known than the Ten Commandments.

Something analogous to Gresham’s Law will be found to obtain in the case of competing standards in Industry. Assuming there is indifference in the matter of choice between competing commodities or services, but that in the case of such commodities or services the labor standards involved vary, the inferior standard, if brought in this manner into competition with a higher standard, will drive it out, or drag the higher down to its level. This is effected by the opportunity of under-selling which comes, where in such cases human well-being is sacrificed to material ends. The superior standard, not being recognized or demanded, is unable to hold its own, and in time disappears. This Law is just as real and relentless in its operation in Industry as Gresham’s Law of the precious metals is with respect to money and the mechanism of exchange. Indeed, a more accurate exposition would describe both as manifestations of one and the same law, which I propose to call the Law of Competing Standards. I see no reason why economists should not recognize the existence of such a law, and incorporate it immediately in economic science as being quite as significant as the Law of Supply and Demand, the Law of Diminishing Returns, or any other Law accorded a place in its nomenclature.

The Law of Competing Standards is doubtless a part of the general Law of Competition, under which the cheaper of two commodities gains in competition a preference over the dearer. What Gresham discovered was an important sequence of the Law of Competition as applied to coinage; namely, the disappearance, in the course of time, of the superior metals. Observance of a like sequence in the case of standards in Industry is highly desirable. As respects labor standards, I believe that recognition of the operation of the Law of Competing Standards over ever-widening areas would do more than aught else to clear up the most baffling problems with which Industry is confronted, and to point the way to a solution of many situations which hitherto have seemed incapable of solution.

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Politics:
In politics bad behavior tends to drive out higher moral values and principles. This could be rephrased more broadly if you assume there might be a Gresham’s law to truth — lies drive out truth.

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Origins
Gresham’s law is named after Sir Thomas Gresham, an English Financier who died in 1579. However, the original principle had widely stated forty years before by Nicolaus Copernicus. In some parts of the world (mostly central and Eastern Europe) the law is still known as the Copernicus Law.

Gresham’s Law is part of the Farnam Street Mental Model Network