Is There Such A Thing As Bad Money?

Nicolaus Copernicus is famous for figuring out that the earth is, in  FACT, not the center of the universe.  One of his lesser achievements was to determine that that is such a thing as “bad money”.  Some time after he did this, another man, Thomas Gresham, made this idea popular and it became known as “Gresham’s Law”.

What Is Gresham’s Law? Gresham’s Law basically states that bad money will always drive out good money.  It’s that simple.

Good Money vs. Bad Money

So what IS good money?  Good money, according to Copernicus and Gresham is money that either HAS tangible value (anything that can be traded for something to eat, drink or protect yourself in effect) such as gold, silver and other precious metals or gems.

Bad money is money that is back by FAITH (i.e. belief without proof).  Fiat currencies are now used in place of REAL money because it’s a lot easier to manipulate, erm, I mean, manage.  It can be printed at will, or simply typed into a computer to create higher numbers in an organization’s account, be it a small company, a large company or indeed an entire government.

Rome

Historically, one of the first nations to use fiat currency on a grand scale was Rome.  Originally, their government simply used precious metals (silver, gold and copper mostly) and created coins that were valued at exactly each coin’s “melt value”.  In other words, it was worth as much as a coin with some politician’s face on it as it was WITHOUT the face.

Debasement

As the Roman politicians took Rome to war (many, MANY wars) they had trouble paying for them.  They also increased the size of the government and of course, this took MONEY to pay for a lager government (because governments can ONLY COST MONEY, they NEVER create wealth).

They initially tried openly taxing the people more, but this was met with dissent.  So, rather than face their displeasure, they came up with a cunning plan.  Instead of making the coins ALL gold (or silver etc.) they thought that they could make the “gold” coins out of gold AND copper, because copper was more abundant and so, more easily available.

This was called “debasing” the coins.  In effect, they were TAXING the Roman people without them knowing it, so that they could pay for their ever expanding government and empire.

The Politicians Went Further

Realizing how easy this had been to fool an entire nation, the politicians of the day went further, MUCH further.  Eventually (over a period of many years) they had put so much “filler” metal into the coins that they were mostly made out of bronze; a nice looking an very durable alloy. They could then keep the gold for themselves (REAL money) and hoard it for a rainy day, one that eventually came with the collapse of the Roman Empire.

Once, the most powerful nation in the world, Rome was no more.

Gresham’s Law Revisited

So, Thomas Gresham realized that good money (gold etc.) would always be drive out by bad money (fiat currency, or coins with no intrinsic value) and this happened because it allowed governments to simply mint or print (or digitally create these days) money out of thin air.

The bad money will increase in supply because it’s easy to create and the good money will find it’s way into the hands of the ruling classes.

On a smaller scale, individuals will always exchange something with NO intrinsic value for food, water, shelter etc. rather than something that DOES have intrinsic value, because, like the ruling politicians, they want to keep the good stuff for themselves.

Bulgaria

On a trip to Bulgaria one year, I experienced this myself, when four local hotels grouped together and printed their OWN currency and would rather accept these “vouchers” than the official currency of their government (the Lev), because the Bulgarian government had overprinted their national currency to the point that nobody had any faith in it.

Doing this created an underground economy, where people traded goods directly (cutting out the tax on sales etc.) and also creating a high demand for other countries currencies, which were considered (at the time) more stable than the Lev.

Luke.