Gold and Gresham’s Law

Gresham’s Law of economics (also known as Copernicus’ Law, as Nicolaus Copernicus first formulated the theory in 1519) states simply that:

“When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.”

Regular readers will straight away see the application of this law to what’s going on right now in the world.  Gresham’s Law often gets quoted in terms of ‘good’ money and ‘bad’ money.  From Wikipedia:

“This is because people spending money will hand over the "bad" coins rather than the "good" ones, keeping the "good" ones for themselves. Legal tender laws act as a form of price control. In such a case, the artificially overvalued money is preferred in exchange, because people prefer to save rather than exchange the artificially demoted one (which they actually value higher).”

Since we left the gold standard and in particular since the GFC, the US, Euro, China, Japan, etc, etc have ‘printed’ literally trillions in ‘bad’ fiat currency in a desperate attempt to reflate the economy.  At the same time we have seen the massive and unprecedented shift of gold (‘good money’) from West to East that we often update you on.  See the correlation?

There is another application of Gresham’s Law playing out right now and that is of ‘paper’ or ‘synthetic’ gold and silver in the form of COMEX futures contracts (bad money) and real or physical gold and silver (good money).  As we wrote last week, that is seeing a record disconnect as the physical gold is being ‘saved’ to the tune of 294 ‘bad money’ claims to each ‘good money’ ounce of gold.  When that comes undone, you would most certainly want to be in the ‘good money’ camp….

Topically, last night gold and silver prices got dragged down again within a global commodities rout.  But as we wrote on Friday, gold is money not a commodity.  Silver in effect ‘wears two hats’ in that it is both (hence in part the sky high gold silver ratio right now… note to contrarians…).  The ‘good money’ dynamic must overcome this misconception at some stage soon.

So whilst the hapless hoards spend their freshly printed dollars the smart ones are snapping up the ‘good’ money in the form of gold and silver at low prices.  If you’ve missed it before, the following cartoon sums it up.