During the rule of Queen Elizabeth, her finance adviser Sir Tomas gave a theory regarding money which is termed Gresham’s law.
According to him when in the market bad money and good money are circulated side by side at that time bad money drives away good money out of circulation.
“Bad money drives good money out of circulationā – Sir Tomas Gresham.
The bad money means relatively old money which has lost its weight to some extent.
The good money means money that is relatively new and possesses full weight. Bad money drives good money out of circulation in three ways.
Hoarding
The people who are interested in hoarding money, select relatively good money or a new one to hoard it. People’s habit is to deposit the good money into their own hands, and in exchange, they use the bad money.
Melting
When people desire to melt metallic money to prepare for other purposes, then good money is melted rather than bad money. Because the metal in old coins or bad money decreases or causes weight loss. Therefore, new ones are preferred.
Consequently, the bad money or old coins are left in the market. However, the theory is more applicable. If in a country two metallic money is used.
Suppose the exchange ratio of gold and silver is 1:15. That means for 1 gold coin, 15 silver coins are exchanged. But the market price of silver decreases, and the market rate of exchange of the two is 1:16. That means 16 silver coins are obtained for only 1 gold coin.
In this situation, people will take 1 gold coin for 15 silver coins; then they will melt the gold coin to get 16 silver coins in exchange for it.
Thus, people will be collecting gold coins for silver coins in exchange for it, and at last, the gold coins will be driven out of circulation in the market.
By foreign payment
For foreign payments, the good money becomes invisible in the market. Where the foreigners receive payment, then they receive not as a coin but as metal. As metal is greater in the new coin, Therefore, they receive the new ones that are good money in their payments. In this way, good money goes abroad.
Qualities or Characteristics of Good Money
The money by which transactions and exchanges in society can properly be done is then termed as good money. This type of good money has some characteristics which are discussed below:
General acceptability
These things which are to be used as money must be acceptable to all. If the accepted money of a man is not accepted by others, then it cannot be used as a medium of exchange.
Therefore, money should be such a thing that can be accepted by anybody without any hesitation. The money of gold and silver is cordially accepted by all. Therefore, gold money and silver money are good money.
Durability
One of the important qualities of good money is durability. The goods that are used as money must be durable. The goods that are easily destroyed must not be money.
For example, fish, milk, vegetables, etc. are perishable and traditionally these can’t be used as money.
Portability
The goods by which money would be made must be easy to transport. Money must not be made of iron, brick, or coal, etc., because these types of goods are not easily portable from one place to another.
The value of the goods that are much more in comparison with the weight of those goods is termed as easily portable. The money made from these valuable goods is termed good money.
Therefore, the quality of good money is easy portability.
Divisibility
The goods that will be used as money must be divisible. That means the goods by which money would be made should be divisible into small parts, and no small part is destroyed.
For example, gold and silver can be divided into small parts, and no small part of both is useless and valueless. As gold and silver are divisible, therefore, money of gold and silver is good money.
Homogeneity
The goods of homogeneity by which the money will be the best money. The goods of heterogeneity can’t be used as a general medium of exchange.
For example, the rice of Bangladesh and the rice of India may be of different quality.
Therefore, rice can’t be used as money, but the gold of Bangladesh and the gold of the USA are basically of the same quality. Therefore, gold is the perfect good for money.
Stability in value
The value of the goods that are more or less stable is the money of those goods termed as good money. The value of gold and silver is more or less stable. Therefore, money of gold or silver is good money. Therefore, stability in value is one of the most important qualities of good money.
Recognizability
The goods of which money would be made must be easy to recognize. That means the goods would be easily known to any ordinary man. In this connection, the money of gold and silver is recognizable to all.
Malleability
The goods by which the money should be made must be malleable so that a desirable size of money can be formed and suitable print on money can be provided.
For this, the metal of money should be melted to any form and different sizable forms of coins can be prepared.
The goods which will possess the above-mentioned qualities, the money prepared from those goods, are termed as good money. For this, gold and silver money is good money.
Exceptions of the law
Bad money drives good money out of circulation; this statement is not always true. The Gresham’s law does not operate in the following cases.
- Scarcity in the supply of money: If both good money and bad money are inadequate in supply to satisfy the demand of the market, then the law does not operate there. In that case, both good money and bad money would be in circulation in the market.
- In the case of invalid money: If the circulated money is very old and invalid to be usable, then people will not accept that. In that case, only the good money will be valid and circulated in the market. Consequently, the bad money will be driven out of circulation.
- Development of the banking system: For developing the banking system, the operation of the law has been limited. In the bank, both good money and bad money are deposited. Therefore, Gresham’s law is not operated there. Therefore, we may conclude that Gresham’s law has some exceptions. Yet the law has great importance.