Saturday, March 10, 2012

Gresham's Conjecture

We learn it as "Gresham's Law" the claim that "bad money drives good money from the market." But the general rule has many exceptions.

Free market economists quickly amend Gresham's Assertion to insist that both moneys must be legally equivalent. If a gold dollar and a silver dollar both circulate, and if their relative value changes, then the under-valued one will be hoarded.  If you can get $1.10 in silver for a gold dollar, you will save the gold coin and pass off the silver dollar, which is overvalued: worth only 90.9 cents in gold; it is good for 100 cents of a dollar. Therefore, people will hoard the coin with the greater intrinsic value.  This has some truth; history provides examples. 

Even that thumbnail explanation may be too broad; and unwarranted extensions and expansions are issued by shallow thinkers such as the "anarcho-capitalist" Murray N. Rothbard (1926-1995) of the Austrian school. In his book, A History of Money and Banking in the United States: The Colonial Era to World War II, on page 126, Rothbard claims that the nickel-copper small cent was hoarded (true) and exported (not true). Rothbard also asserts: "The penny shortage was finally alleviated when a debased and lighter-weight penny was issued in the spring of 1864, consisting of bronze instead of nickel and copper." This is utter nonsense.

There was no incentive to export a coin in the uncommon nickel alloy 88% copper 12% nickel. Nickel was chosen largely from the influence of Joseph Wharton who owned a mine. The Mint found the nickel alloy too hard: dies wore out.  The Mint turned to the more familiar and softer "French bronze" 95% copper with a 5% tin-zinc mix. The lighter coins did not drive the older issues from the market. The success of the Northern armies in the War Between the States brought confidence to the markets, though perhaps any peace  would have, regardless of who won.  In point of fact - facts often being absent from the works of Rothbard - when the smaller cents (called "nicks" or "nickels") were first issued in 1854, people lined up at the Philadelphia Mint to turn in their heavier (and therefore more intrinsically valuable) Large Cents (1793-1857). The Mint was exchanging old cents for new, one for one, but boys who had been early in the lines sold their Small Cents for premiums.  They were curios.  Eventually, they fell to parity ... and Large Cents (now scarcer) were pursued even more passionately by numismatists.

Proof  Three Cent Silver  1858
Heritage Auctions Sept. 2010 Long Beach Signature Sale Lot 5029
Proof Three Cent Nickel 1870 
Heritage Auctions Sept. 2010 Long Beach Signture Sale Lot 5132 
The history of United States federal coinage provides other counter-examples to Gresham's Conjecture.  The silver half dime circulated alongside the nickel 5-cent coin. The 3-cent silver circulated alongside the 3-cent nickel. While gold and silver did fluctuate in value, causing problems for the Mint, which was a huge consumer and reseller of both, mostly, US silver coins and US gold coins went into separate channels.
Proof Seated Half Dime 1870 
Heritage Auctions 2010 April-May Milwaukee Lot 2515 
Proof Shield Nickel  1870
Heritage Auctions 2010 January Orlando, Lot 3679 
From 1878-1904, the US Mint struck over 24 million ounces of silver dollars per year, far in excess of anyone's demand, to meet the political agenda of Western mining interests. The Comstock Lode and other strikes flooded the markets with cheap silver and the price of it fell relative to gold.  Nonetheless, silver dollars sat in bags; and even today fully one-third are in uncirculated condition.  According to Gresham's Suggestion, silver dollars should have driven gold dollars from the market.  They did not. It seems that gold dollars were not in demand at all. (See
The tendency just described is, however, limited by the fact that coins of different metals are unlikely to be equally useful in different transactions. In particular, gold coins will generally be of larger denominations and as such cannot supply the need for smaller change (cf. Sargent and Velde 2002). Consequently, even though gold may be legally overvalued relative to silver, and silver may cease to be voluntarily rendered to the mint, silver coins are unlikely to disappear from circulation altogether.  "Gresham's Law" by George Selgin at Economic History here.
Gresham's Rule does have some validity.  In the Middle Ages, when coins hundreds of years old still circulated, old, worn coins were spent while new, heavy coins were held.  As Europe experienced perhaps putative "silver famines" the purity of coinages fell. As silver became relatively more valuable, it took less to buy the same goods and services. Coins fell in purity.  Had they not, you would have needed tweezers to hold a penny's worth of silver. Debasement was a convenience.  But it still meant that if two coins are both "pennies" and one has more silver than the other the common choice is to spend the lighter coin.  Even so, history provides many examples of heavy coins such as the stable and reliable English sterling penny being the engines of commerce.

Numismatics Informs Economics
Numismatics: the Standard of Proof in Economics
Supplies and Demands
Murray Rothbard: Fraud or Faker

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