Modern Example of Gresham`s Law

An example of Gresham`s Law can be found today in the United States. Coinflation means that the metal content of a nickel is worth just over 20% more than the nominal area. Gresham`s Law may affect government intervention in the circulation of money. While agents in high-inflation countries are free to choose their medium of exchange, low-inflation money tends to crowd out low-inflation money. It can also influence the decisions of bankers and regulators. Monetary policy refers to the measures taken by a country`s central bank to control the money supply in order to stabilize the economy. For example, policymakers manipulate the monetary cycle to boost employment, GDP and price stability using instruments such as interest rates, reserves, bonds, etc. Gresham`s law states that bad money drives out good. But how can this happen and what does it mean for the modern economy and for investors in digital assets? Cory Doctorow wrote that an effect similar to Gresham`s Law occurred in emissions trading. The alleged information asymmetry is that people have trouble distinguishing the effectiveness of purchased loans, but can easily identify the price. As a result, cheap credits that are inefficient can replace expensive but rewarding carbon credits. [27] As an example, The Nature Conservancy has been cited, which offers cheap but «meaningless» carbon credits by buying cheap land that is unlikely to be deforested anyway, rather than expensive and valuable land threatened by logging. [28] Gresham`s law is of lesser importance in a paper money system.

Under a metal standard, «good money» can be melted, exported abroad and sold by weight. This cannot be done with paper money or minor coins. Therefore, Gresham`s law is of very limited applicability nowadays, where the paper standard is used almost universally. Money operates in a different way than a domestic medium of exchange; It can also be used for foreign exchange, as a commodity or as a store of value. When a particular type of money is worth more in one of these other functions, it is used or hoarded in foreign currency instead of being used for domestic transactions. For example, from 1792 to 1834, the United States maintained a silver-gold exchange rate of 15:1, while in Europe, ratios ranged from 15.5:1 to 16.06:1. This made it profitable for gold owners to sell their gold on the European market and bring their money to the United States Mint. The effect was that gold was removed from the U.S. domestic cycle; The «inferior» money had driven him away. When hyperinflation occurs, foreign currencies usually replace local currencies, which would be an example of Gresham`s law working the other way around.

If a currency rapidly loses value, people will quickly stop using it in favor of more stable foreign currencies, even if there are legal regulations. In the event of hyperinflation, foreign currencies often replace hyperinflated local currencies; This is an example of Gresham`s Law working the other way around. Once a currency depreciates quickly enough, people tend to stop using it in favor of more stable foreign currencies, sometimes even in the face of repressive legal sanctions. For example, during Zimbabwe`s hyperinflation in July 2008, inflation reached an estimated annual rate of 250 million percent. Although still legally required to recognize the Zimbabwean dollar as legal tender, many people in the country began to abandon its use in transactions, eventually forcing the government to recognize the de facto and de jure dollarization of the economy. In the chaos of an economic crisis with a nearly worthless currency, the government was unable to effectively enforce its legal tender laws. Good (more stable) money pushed bad money (hyperinflationary) out of circulation, first on the black market, then in general use, and finally with official government support. In Gresham`s time, bad money included any coin that had been devalued. Cancellation was often effected by the issuing authority when less than the officially determined quantity of precious metal was contained in an issue of coins, usually by alloying with a base metal.

The public could also devalue coins, usually by cutting or scraping small portions of the precious metal, also known as «stemming» (the edges of reeds on coins should make the cut clear). Other examples of bad money are fake base metal coins. Today, virtually all circulation coins are made of base metals, known as fiat money. While virtually all contemporary coins are made entirely of base metals, in some contemporary years of the 21st century when copper values were relatively high, at least one ordinary coin (American nickel) still retained the status of «good money» (largely dependent on market rates). In modern times, the legal ties between currencies and precious metals have weakened and have finally been completely broken. With the introduction of fiat money as legal tender (and accounting entry fees by reserve banks), this means that money issuers are able to receive seigniorage by printing or lending money at will, rather than minting new coins. This ongoing devaluation has led to a sustained trend in inflation, which is the norm most of the time in most economies. In extreme cases, this process can even lead to hyperinflation, where the money is then literally not worth the paper it is printed on.

The problem of coins is mostly obsolete in modern times, but the practical problems are more important than ever. According to Ben Tamari, the phenomenon of currency devaluation was already recognized in ancient sources. [6] He gives some examples, including the transaction of the cave of Machpela[7] and the construction of the temple[8] from the Bible and the Mishnah in the treatise Bava Metzia (Bava Metzia 4:1) of the Talmud. [6] These examples show that Gresham`s Law works the other way around in the absence of effective legal tender laws. When given the choice of which money to accept, people will exchange money that they believe to be of the highest value in the long run.

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noviembre 2022


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