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 http://www.coinbooks.org/esylum_v18n30a13.html)

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.

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

Objectivism and the Gold Standard

Ayn Rand and Alan Greenspan both assumed that the government would be the only source of money.  Even in Atlas Shrugged when John Galt hands Dagny Taggart his own five dollar gold coin it bears the semata of the United States of America.  “On whose authority?” she asks.  “It says right there,” Galt replies.  The absence of private money in Ayn Rand’s capitalist utopia is curious. 

US 1/10 Gold Eagle,
modern US $5,
older US $5

Nothing requires that money be issued by a government, though there is utility in that for that institution.  While gold proved most useful in the industrial age, and may well continue through the information age, historically, gold only served a special function relative to silver.  Historically, silver was the universal metallic money.  Gold, like copper, was a convenience. 

Moreover, a truly agoric coinage would announce only its weight and fineness and not be denominated in money of account.  If by law the “dollar” is 412 ½ grains of silver, then the definition of the dollar can change by law.  Historically, this is well-known.  Debasements are the rule as government expenditures outrun their incomes.  The coinage suffers as their denominations increase. 

On the other hand, it is important to note certain seeming contradictions to Gresham’s Law in the 19^th century United States.  Silver half dimes circulated alongside nickel 5-cent coins.  Silver and nickel 3-cent coins also passed equivalently.  When the government changed the weight and fineness of the coins in 1834, it declared that all issues of whatever standard were alike legal tender and it made little difference.

In fact, the first gold coins of the United States did not state their money of account value in dollars until 1807 ($5 half eagle), 1808 ($2½ quarter eagle) and then 1838 ($10 eagle).  They were gold coins, nothing more or less.  Likewise, the British sovereign did not and still does not have a mark of value. 

Size of a half dollar and
potentially more useful.

As a large economic entity – even when limited by a constitution – the federal government of the United States easily should benefit from issuing its own currency, as would General Motors, Microsoft, or you.  There is nothing wrong with government money, but it is not necessarily the only money.  While a gold-backed federal currency would be inherently strong the government has the opportunity to consider and issue a variety of moneys – and historically, it has done so.  Gold and silver, of course, both came from the Mint as did minor and token coins in base metal.  However, through the 19^th century and up to the Great Depression, paper promises were backed in gold, and in silver, and in only the credit of the United States.  Some of those unbacked promises paid interest; others did not.  No objective test can show that one kind is “moral” but another not, as long as people have a right to choose. 

But the government does not need to issue its own money.  In 1800 and 1802 republicans in the Senate attempted to shut down the Mint as a drain on the Treasury.  Trade and commerce were carried by foreign coins, largely Spanish dollars and their factions.  Meanwhile, even into the 1830s, merchants along the East Coast kept their books in pounds-shillings-pence, not dollars and cents.  Gold and silver coins from Britain, France, Spain, and Portugal were legal tender until 1857. 

Problems in money and banking generate much discussion among libertarians and objectivists.  Working the Libertarian Party tent at the Ann Arbor Street Fair in 2009, I heard one of my comrades denounce the Federal Reserve and declare that only the government has the right to create money.  Rather than engage in all of that, I offer these links. 

• Should Objectivists Support the Gold Standard?
• Gold Standard (Ayn Rand Lexicon)
• Money (Ayn Rand Lexicon)

Also here on Necessary Facts:

• Money as a Crusoe Concept
• Mere Gold is Not Enough: Hayek's "Denationalisation"
• Money as Speech and Peacemaking
• Numismatics Informs Economics
• Numismatics: the standard of proof in economics
• Murray Rothbard: Fraud or Faker?
• Debt: the Seed of Civilization

Numismatics informs Economics

If economists actually collected and studied the media of commerce, they would avoid errors common even to advocates of capitalism.  Milton Friedman and the monetists were not much smarter than Keynesians.  In fact, even von Mises and Marx made the same claims about the evolution of gold as the highest form of commodity money.  A numismatist knows better, and knows more.

"Bad money drives good money off the market" is a cliche.  More clarity comes from adding that both moneys must be declared equal by law.  In that case, the markets will operate. People will break (avoid, evade, ignore) the law. The undervalued money will go into other channels (savings, export) and the cheaper overvalued money will circulate.  

Social sciences attempt to mimic physical sciences with concise and precise laws about complicated phenomena.  But, even astronomy is theoretically limited to a two-body universe.  Add more bodies and the nice algebra of theory must give way to laborious numerical approximations.  So, too, with economics.  Gresham's Law applies to two currencies - say the silver dollar and the gold dollar; or to silver dollars of one standard versus minor coinage of another fineness.  Reality is more complicated than that.  As Hayek pointed out, a plethora of moneys circulate.  Economists just focus on one or two issues of the government.


Unfortunately, lacking knowledge of numismatics, Hayek could not state his case empirically.  The Austrian school is rationalist, deriving universal laws from a priori assumptions.  

Spanish 8-reales "dollar" a world trade coin
of the 18th and 19th centuries, this one
chopnarked by Chinese merchants

Many conservatives across the spectrum know that the US Silver Dollar was modeled on the Spanish 8 Reales of the 1780s.   Fewer know that until 1857, Spanish money was one of about a dozen foreign currencies in silver and gold that were legal tender in America, alongside issues of the Federal government.  Many banks of the time issued paper money that promised U.S. federal silver coin in redemption but showed pictures of Spanish and Mexican coins.  (See Spanish Coins on American Notes here.) 


From the beginning of the Federal Mint, there was always a push for alternate currencies to make daily commerce easier.  The US ten-cent dime and 25-cent quarter dollar were not commonly convenient.  Many people relied on worn Spanish pistareens or "fips."  These were approximately half-reales (about 12-1/2 cents when full and new) but circulated at different values depending on circumstances.   That is a basic lesson for economists: to see what people actually do, not to prescribe how they should conduct business. 

In apparent violation of Gresham's Law, presenting a test case for hard money conservatives, the US Mint 3-cent silver and 3-cent nickel circulated side-by-side. The base metal coin did not drive the precious metal competitor from the market.  The same was true of the US Mint 5-cent nickel versus the silver half-dime.  The US Treasury also issued Fractional Paper, an emergency scrip from the Civil War that circulated alongside coinage, even after the apparent necessity was gone.  People could have demanded hard money (as small silver coins), but they did not.  The paper was good enough.  Moreover, fractional coinage - and of course the paper - was a limited legal tender, typically good only for a dollar or two, maybe five, depending on the coins and the laws of the moment. 

Like Europe of the Middle Ages, America also knew apparent "bullion famines" during which times coins were scarce.  They left the country to buy goods from abroad.  That is what money is for.  At other times, with Americans goods being exported and business at home being brisk, merchants sold off their small change at a discount to get rid of the excess.  

Eric P. Newman was president of the American Numismatic Society.  With Kenneth Bressett, former president of the American Numismatic Association, Newman wrote The Fantastic 1804 Dollar.  He is less famous generally but perhaps more highly honored among serious numismatists for his many explorations of Colonial and Early US paper money and his many monographs on other topics.  According to one presentation, delivered at a Coinage of the Americas Conference, December 2, 1984, counterfeit copper coins of the colonial era circulated for over fifty years, into at least the late 1830s in the Appalachian villages of western Virginia.  In Canada, these small copper conveniences are known as "blacksmith tokens."  

Earlier this year, Bernard von Nothaus was convicted on federal charges for issuing his own Liberty Dollars.  Any active American coin collector with a Red Book knows that private issues in gold and copper claim a long and proud history independent of the faltering efforts of the U.S. Mint.  Private silver was unnecessary because of the masses of Spanish (and English, etc.) coins circulating at the time.  We know from old records that into the 1830s many merchants in Boston, New York, etc., kept their books in Pounds-Shillings-Pence.  Business with English partners was brisk; and traditions have strength. 

The Pounds-Shillings-Pence system itself was a radical innovation, a conceptual leap, an epistemological creation that remains unappreciated by those who are ignorant of the history of trade and commerce.  In the broad centuries we call the Middle Ages, any local authority with bullion could strike his (sometimes her) own coins. Much of it came from "plate" household goods of silver; much came from new mines. Easily a hundred different kinds of coins, struck to different standards, often of lower debased finenesses circulated.  Broadly, the old Roman pound continued, while the new German mark ascended.  To rationalize the chaos, bankers invented pounds-shillings-pence.  It did not matter how you built up the quantities, when the books were balanced, you needed 240 pence or 20 shillings (12 pence each) to make a pound (or 12 "Troyez" ounces) of fine silver.  Bankers in the Middle Ages invented abstract money of account to meet the demands of competing currencies. 

Silver penny of Hughes of Champagne,
about 1 gram: dameter of a dime.

This was spontaneous order.  No Dumbarton Oaks Agreement was needed.  No theoretical papers were published.  And no general law was enforced on all.  The Big Problem of Small Change by Thomas J. Sargent and Francoise Velde is a chronicle of monetary media in the Middle Ages.  As a time when Europe had perhaps a thousand independent polities, the stories carry meaning for anyone who wants to understand international monetary systems today.  The work has been criticized by economics professors of the Austrian school for its larger (and largely questionable) theoretical framework, but as a compendium, it is unexcelled.  

As I said in the previous post, there is no standard textbook in numismatics.  No one-volume Samuelson makes life easy for freshmen.  Nothing from any Foundation for Numismatic Education delivers "Numismatics in One Lesson" or the "The Cliches of Monetism."  You can start with the Red Book, the Breen Encyclopedia, the Garrett Collection.  But you will soon discover the new works from Whitman and Krause and Stanton.  Numismatics is active and aware, curious about new facts, fascinated by new discoveries, open to new explanations of accepted evidence... and always being tested in the largest unregulated money market on Earth.

Quinarius of Cato the Younger struck at Utica.
"Pro Per: for himself."  His own silver
financed republican resistance to
Julius Caesar.

ALSO ON NECESSARY FACTS

Gresham's Conjecture

Supplies and Demands
Numismatics: the Standard of Proof in Economics

Scripophily: the Study of Stocks and Bonds