Gresham's Law - Reverse of Gresham's Law (Thiers' Law)

Reverse of Gresham's Law (Thiers' Law)

In an influential theoretical article, Rolnick and Weber (1986) argued that bad money would drive good money to a premium rather than driving it out of circulation. However, their research did not take into account the context in which Gresham made his observation. Rolnick and Weber ignored the influence of legal tender legislation which requires people to accept both good and bad money as if they were of equal value. They also focused mainly on the interaction between different metallic monies, comparing the relative "goodness" of silver to that of gold, which is not what Gresham was speaking of.

The experiences of dollarization in countries with weak economies and currencies (for example Israel in the 1980s, Eastern Europe and countries in the period immediately after the collapse of the Soviet bloc, or South American countries throughout the late 20th and early 21st century) may be seen as Gresham's Law operating in its reverse form (Guidotti & Rodriguez, 1992), since in general the dollar has not been legal tender in such situations, and in some cases its use has been illegal.

Adam Fergusson pointed out that in 1923 during the great Inflation in the Weimar Republic Gresham's Law began to work in reverse, since the official money became so worthless that virtually nobody would take it. This was particularly serious since farmers began to hoard food. Accordingly, any currencies backed by any sorts of value became the circulating mediums of exchange. In 2009 Hyperinflation in Zimbabwe began to show similar characteristics.

These examples show that in the absence of effective legal tender laws, Gresham's Law works in reverse. If given the choice of what money to accept, people will transact with money they believe to be of highest long-term value. However, if not given the choice, and required to accept all money, good and bad, they will tend to keep the money of greater perceived value in their possession, and pass on the bad money to someone else. In short, in the absence of legal tender laws, the seller will not accept anything but money of certain value (good money), while the existence of legal tender laws will cause the buyer to offer only money with the lowest commodity value (bad money) as the creditor must accept such money at face value.

The Nobel prize-winner Robert Mundell believes that Gresham's Law could be more accurately rendered, taking care of the reverse, if it were expressed as, "Bad money drives out good if they exchange for the same price."

The reverse of Gresham's Law, that good money drives out bad money whenever the bad money becomes nearly worthless, has been named "Thiers' Law" by economist Peter Bernholz, in honor of French politician and historian Adolphe Thiers. "Thiers' Law will only operate later when the increase of the new flexible exchange rate and of the rate of inflation lower the real demand for the inflating money."