Gresham’s Law is a monetary principle named after Sir Thomas Gresham in 1860, but the principle goes back as far as the end of the fifth century BC. According to the principle, any currency in circulation that consists of “good” and “bad” money (both are required to be accepted at equal face value by legal tender laws) will quickly be dominated by the “bad” money.
The reason is that people will keep the “good” money to themselves instead of exchanging it and spend their “bad” money instead. The tender laws act as a sort of price control mechanism.
Let’s say a customer purchases an item that costs 99 cents. The customer has multiple dollars, some of which are paper dollars while others are silver dollars. Now, the law mandates that they all be of the same value. Although they are all of the same value, the customer prefers to keep the “good” money, thus she offers the shopkeeper the “worst” dollar, the most debased one with no silver in it – the paper dollar. The shopkeeper in turn must give one cent in change and will give the customer the “worst” penny he has. Nothing with any collectible value. So, this leads to the coins circulating in the transaction are always the most debased ones available to either party.
Melting down “good” coins
When “Good” coins have a face value lower than their metallic content, people may be tempted to melt them down and sell them for their higher value—even if melting down the coins is illegal. For example, the 1965 United States half dollar coins contained 40% silver, whereas, in previous years, these coins were 90% silver. The 1965 half dollar was legally required to be accepted at the same value as their earlier versions, and when it was released, the older 90% silver coins quickly disappeared from circulation, while the newer debased coins remained in use. The value of the dollar continued to decline, and as a result, the value of the silver content exceeded the face value of the coins, and many of the older half dollars were melted down. From 1971 onwards, the US government didn’t include any silver in the half dollars. At that time ,even the metal value of the 40% silver coins began to exceed their face value.
Holding on to “good” coins
“Good” money also tends to leave an economy through international trade—since international traders aren’t bound by legal tender laws like the citizen of the issuing country are, they will pay more for “good” coins than for “bad” ones. This happened in Britain during the period of the gold standard.
When the Coinage Act passed in 1965, Canada and the US abandoned silver and switched to cheaper metals, thereby inflating the new debased coins relative to the supply of the former silver coins. Citizens held on to their silver coins to capture the value of their metal content over the inflated and debased value of the new coins. They used the new coins in transactions, and the silver coins disappeared from circulation.
In the late 1970s, the Hunt brothers failed to corner the worldwide silver market, but because of their attempt, the price of silver temporarily far exceeded its historic levels, thus intensifying the extraction of silver coins from circulation. We are witnessing the same process today with the copper content of various coins—we’re even seeing the process happen in India with steel coins.