Gresham’s Law Redux – Here we go again

Greshams Law simply states ‘the bad currency drives out the good’.  The law was named this in 1860, after the financier Sir Thomas Gresham (1519-1579) who had consulted with Elizabeth I after it was noticed that due to Henry VIII debasement of coinage, changing the composition of the shilling from silver to base metals, people had started hoarding coins to melt down, but also the intrinsic value of these new coins for trading were not internationally recognized, creating huge inflation in England and therefore an issue Elizabeth I needed to solve. 

Gresham’s law had been observed and recognized throughout history. In China during the Yuan Dynasty of the 5th Century BC, a paragraph in a play ‘Frogs’ talks about the debasement of money and Ibn Taimiyyah described the phenomenon as follows:

“If the ruler cancels the use of a certain coin and mints another kind of money for the people, he will spoil the riches (amwal) which they possess, by decreasing their value as the old coins will now become merely a commodity. He will do injustice to them by depriving them of the higher values originally owned by them. Moreover, if the intrinsic values of coins are different it will become a source of profit for the wicked to collect the small (bad) coins and exchange them (for good money) and then they will take them to another country and shift the small (bad) money of that country (to this country). So (the value of) people's goods will be damaged.”

These are just a couple of the times in history the debasement of money following Gresham’s law was recognized.

In modern times you only need to look as far back as 1982, when the US government changed the composition of a penny to zinc from previously copper, making the pre 1982 copper coins eventually worth more than their face value in copper – so people melted them down as they were worth 5 times their face value!

The Great Debasement – Henry VIIII

The Great Debasement of 1544-1551 was a currency debasement policy introduced in 1544 England under the order of Henry VIII which saw the amount of precious metal in gold and silver coins reduced and replaced with cheaper base metals such as copper. 

Henry VIII had needed to fund wars with Scotland and France as well as his lavish lifestyle, so in order to do so decided to debase the currency. Sound familiar?

This saw the value of gold and silver decrease in English coinage, which led to inflation, as abroad, international traders and financiers began to not accept English coinage at face value, and insisted on payment in gold, this led to gold shortages and high inflation in England.    

Elizabeth I to the rescue – Gresham’s Law in reverse

So what saved England from high inflation, trade issues and the resurgence of the currency?

In 1558 Elizabeth I came to power and recognised that the confidence in the monarchy both locally and internationally was an issue that needed solving.  In consultation with Thomas Gresham they determined the solution was to increase once again the finesses in coins to restore confidence in the currency.  Debased currency (bad money) was removed from circulation and replaced with the good currency.  In order to ensure the debased currency was removed, the government enacted a law which forbid ‘good’ coinage from entering foreign markets and ended the legal tender status of all debased currency.

In 1560, under the instructions from the queen, Thomas Gresham withdrew all debased coinage from circulation and had the withdrawn coins melted down and replaced with newly minted coins with high fineness.

Limitations of Gresham’s Law BUT…..

Gresham's law of money has a very limited scope of application in present times, when paper is the universal medium of money. The ‘good money’ in coins can be melted, bagged to foreign lands, and sold by volume under a metallic standard. This is impossible to achieve with paper money or secondary coins. But isn’t this exactly what has happened with the Bretton Woods system being replaced by the Petrodollar…?

Gresham’s law and the Petrodollar

Now it is broadly understood that Gresham’s law does not apply to modern currency as the metals contained within are not relevant to our paper fiat currency.  However, let’s turn that on its head and look at the USD being taken off the Bretton Woods System in 1971.  Due to the US deficits being run to fund the Vietnam War, Nixon knew there was an unsustainable decline in the US gold reserves.  As the USD was the current reserve currency, the gold standard collapse led to a loss of confidence in the USD, causing its value to drop further and causing the US to have high inflation. 

The situation continued throughout the 1970s until Henry Kissinger introduced the Petrodollar in response to solve 3 problems:

  • The Arab-Israel problem
  • The oil problem
  • The currency problem

Under Bretton Woods the USD was seen as a ‘good currency’ for decades.  In application to Greshams law the ‘Petrodollar could be seen as the ‘bad currency’ driving out the good gold backed USD.  Unlike in history where individuals were able to ‘melt down’ the coinage to obtain more value, it could be argued that in fact the US government was able to do this themselves to fund the massive deficits we have seen in the past decades.

Central Banks Hoarding

Now just like in all other periods in history – the USD reserve currency worked well until someone (usually those in charge) decided to debase the currency.  This has been done worldwide with high deficits – but no more than in the US – which has caused catastrophic inflation worldwide. So are we now seeing what Elizabeth I and Thomas Gresham saw and are we about to see Gresham’s law in reverse?

We have written recently about the record levels of gold being bought by Central Banks around the world – could they know that Gresham’s law has run its course and it is about to be run in reverse – the end of the USD reserve currency? Q1 to Q3 of 2022 saw a record 673 tonne of gold bought by central banks around the world.  October and November saw another 84 tonne added and at the end of this month we will learn the December number and hence whole of 2022 and a likely multi decade high accumulation of what is widely now being rediscovered as good money.