It was noticed and stated many years ago by Sir Thomas Gresham that full-weight coins would not continue to circulate with clipped, worn, or light-weight ones, and that the latter would drive the former out of the country. This statement has been extended and enlarged into what is known as Gresham's Law, which, as generally formulated, is that a poorer money will drive a better one out of circulation. In this form it is commonly accepted as true, but is often misunderstood and misapplied.
It is, in fact, but a particular case of the more general law that any commodity will seek the market where it is worth the most, where it will exchange for the most of other commodities.
The full-weight coins would exchange for no more in the country of issue than would the light-weight ones (within certain limits), but when it was desired to ship coins to other countries where they were valued by weight and not by tale, the full-weight ones were more valuable, and were, therefore, selected for such shipment, leaving the poorer ones to circulate at home.
The larger application of Gresham's law to money as a whole is as follows:—
The resultants of all the various forces acting on money value through supply and demand evidently must be different in different countries, and thereby may cause the money of one country to rise in value while that of another falls. When this occurs between two countries using the same metal as a part of their money,—that is, either between two gold-standard or two silver-standard countries, Gresham's law immediately operates to bring the two moneys again to a uniform value.
Since the gold varies in value with the money as a whole, it will, under such circumstances, be worth more in the country having the higher money value than in the other, and a flow of gold will set in from the country where it is worth the least to the one where it has the greater value. This flow of gold decreases the amount of money in the country from which it goes, and increases the amount in the other, thus raising the value of money in the one, and lowering it in the other, until they are again on an equality within the limits of the cost of shipping gold from one to the other.
The operation of this law, therefore, tends to make the value of money uniform, and average prices the same in all countries using the same standard.
The gold which thus flows from one country to another does not go, of course, without a return of other commodities in exchange. The operation will be clearer if stated in its converse form.
Since prices and money values are complementary terms, one rising as the other falls, and vice versa, a rise in the value of money means lower prices, on the average, in that country. People will buy in the cheapest market, and if prices are lower in one country than in others, they will buy in that country in preference to others; the balance of trade, as it is called, will be in their favour; gold will be sent in payment for the commodities bought: it will increase the money supply and raise prices there, and at the same time it will lower those of the country from which it goes until prices in the two are again on a level.
It must not be supposed, however, as it evidently has been by some, that the operation of this law in regulating prices and making them uniform as between different countries at the same time, has any effect whatever on prices and money values as between two different periods.