What Is Gresham’s Law?
Gresham’s Law is essentially this: BAD MONEY DRIVES OUT GOOD MONEY. What is good money and what is bad money and how does bad money drive out good money? I will explain.
Good money is essentially legal tender that has some intrinsic value, or it can be described as money where there is not much difference in its nominal value and its commodity value. For example, if a coin is worth $1 and the metal is melted down, that metal should be worth about $1 as well. This is good money.
Bad money is the opposite. It is where the commodity value of the money is worth far less than the nominal value. Paper currency is a good example of bad money.
Typically, when we talk about Gresham’s Law, we’re referring to coinage. Let’s look at some examples of Gresham’s Law in action…
Prior to 1965, US quarters and dimes were made of 90% silver. This was good money. Due to inflationary pressures, the price of silver increased and soon it began to cost the government more money to produce the silver coins than the coins were deemed to be worth (nominal value). As a result, the government decided to stop using silver. They started using copper and nickel. The result was people started saving all pre-’65 dimes and quarters because they were worth more for their metal content than as legal tender. The good money was driven out of circulation. There was actually a coin shortage for a few years and the US Mint pumped out their new coins as fast as possible to make up for the shortage. Again, bad money drove out the good money.
Why do we care?
So, does this even apply today? Do we have any “good money” left? Actually, we do. Interestingly, the nickels still being produced by the US Mint are worth more than the nominal value. According to Coinflation, the current value of a nickel’s metal content is just over 6 cents, or 20+% more than the nominal value. As such, many people believe it is a near certainty that the Mint will change the metal content of the nickels to make them cheaper to produce. After all, the Mint is losing money with each Nickel produced. The current composition is 75% copper, 25% nickel. Many believe it will change to a cheaper metal like steel.
In fact, Obama has already signed into law a provision that would allow the Mint to make this change (you can read about it here). You can expect that when this change occurs, Gresham’s Law will go into effect immediately. You will see the copper/nickel nickels vanish from circulation. The bad money will drive out the good.
You actually have the opportunity to profit from such a change by hoarding nickels. It’s a risk-free speculation. If the change doesn’t happen, then your nickels are still worth the legal tender of five cents. If history repeats itself, you could easily see the older nickels worth 2x to 3x the nominal value.
A Couple Notes
First, it’s currently illegal to melt down the nickels; however, this has typically changed once an investor market opens up for a batch of coins. While melting nickels would remain illegal for some time, it would likely change down the road.
Second, pennies also fall into the category of being worth more as a commodity versus its nominal value, but to make any decent amount of money from saving pennies, you’d have to store way too many. The space and time required to do so is not worth it in my opinion. Nickels are the much better option.