Tuesday, February 1, 2011

Gresham's Law

My comments to an article at The Daily Bell evolved into a discussion about Gresham's Law. See the original editorial here:


Posted by Bionic Mosquito on 2/1/2011 11:19:06 AM

"Before going any further I would like to establish my credentials."

Please, just let your statements and arguments establish your credentials. The world is full of people bragging about their credentials.

"The only thing that needs to be done is to declare the legal tender protection of irredeemable dollar unconstitutional."

Yes, this will suffice. It will never happen, but it will suffice. Don't look to the Constitution as salvation.

"It was clear that the Treasury staff was sabotaging the wishes of President Bush."

This is politically naive. Is it fathomable that Bush, the most insider of insider Presidents, really desired for gold to back the dollar again? Why would anyone believe this? Impossible.

@David Robertson,

You are misinterpreting Gresham's Law, as most do. I quote from Wikipedia: Gresham's law is commonly stated: "Bad money drives out good", but is more accurately stated: "Bad money drives out good if their exchange rate is set by law."

Posted by Bionic Mosquito on 2/1/2011 2:18:48 PM

@David Robertson

It is impossible to read the article you cite and not come to the conclusion I point out in my first post. I do not understand how you are interpreting it.

Selgin is quite clear: where legal tender does not force a preference of one coin over the other, good coins are preferred. Where legal tender requires fixed exchange rates or other favored treatment, the bad coin wins. You have offered evidence to further demonstrate my point. I thank you.

I will suggest in a fully free market, both good and bad coins could circulate, each at a value the market deems appropriate. There will always be a market clearing price for every freely traded asset.

Your "simple observation" is not applicable in this world of legal tender laws. Selgin's paper fully supports the proper interpretation of Gresham's law, as I stated above.

Posted by Bionic Mosquito on 2/1/2011 5:39:31 PM

@David Robertson

"We simply disagree on the results of the application and that is good."

No, we disagree on the definition and interpretation of Gresham's law.

"You and the Daily Bell staff may use your gold and silver coins and keep your FRNs and I will use my FRNs and keep my gold and silver coins."

This comment further demonstrates that you do not understand Gresham's law, or my point.

"We both agree I assume that we view FRNs as inferior. This is the bad money that Gresham avers would drive out the good (gold and silver)."

Try a thought experiment. Pretend you are the seller of goods and not the buyer (yes, it takes two to make a trade). Why would you, the seller of wheat or steel, accept FRNs or other "paper" in exchange for good assets? A market is not just whatever the buyer dictates. The seller must also agree.

Now, in small steps, let's move ahead. Back to you being a buyer. Go find a seller of wheat who will trade it for paper, when there is a market trading wheat for gold. What if there isn't such a seller? You may "want" to pay with paper, but no seller of wheat is willing to accept it. Good money thus drives out bad.

Posted by Bionic Mosquito on 2/1/2011 5:59:10 PM

@David Robertson

I will add: good money may not fully drive out bad money.

Imagine 100% gold backed money, 100% silver backed money, 20% gold backed money, and money backed by the full faith and credit of a taxing authority.

Each will find its level as derived by the market, and would always regularly adjust to each other as market participants dictate. Each type of "money" will find a relative value to each other. The market will determine the worth of each "money" in the market, and each "money" will find a value to settle where it will function for trade.

Every commodity and currency market is a good example of this today. Even the market in gold demonstrates that there are those willing to sell gold at a given price in FRNs. Else, how could you buy gold for FRNs?

That you demonstrate a preference has nothing to do with the correct interpretation of Gresham's law.

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