Bad money drives out good (often called Gresham’s law) is the idea that when two monies must be accepted at a fixed rate even though their true values differ, people will tend to spend the overvalued money and hoard the undervalued money. The “good” money disappears from day-to-day circulation.
Core Mechanics
The logic requires a wedge between:
- the legal tender value (what the law or convention says the money is worth for payments), and
- the market value (what the money is worth for other uses, such as its metal content or its value in another currency).
If two coins are both accepted as “$1” for paying debts, but one coin contains more valuable metal, then paying with the high-metal (“good”) coin is costly. People therefore pay with the low-metal (“bad”) coin and keep, melt, or export the high-metal coin.
A Simple Example
Suppose two coins are legal tender at the same face value, but:
- Coin A contains $1 of silver.
- Coin B contains $1.20 of silver.
If both must be accepted as “$1” in payment, Coin B is undervalued as money (it is worth more as bullion), so people remove Coin B from circulation and spend Coin A.
Modern Analogues
Modern versions can arise when a domestic currency is overvalued by a peg or restrictions and a stronger foreign currency is available. People try to spend the weaker/overvalued payment instrument and store value in the stronger one, pushing the “good” money out of everyday use.