What is Gresham's law ? explain this statement Bad money drives good money out of circulation and Point out the different forms of its application and the conditions essential to its operations and also criticise on it
GRESHAM'S LAW :-
Definition of Gresham's Law : " When bad money and good money both are circulating side by side as a media of exchange bad money drives good money out of circulation other things remaining the same."
Bad money we mean underweight or clipped due to circulation. Good money is that money which contains full value which is stated on the face of the coin. This law applies to the coinage system. But this law have been reformed and now its application is extended to both metallic and nonmetallic currency.
This law is associated with the name of Mr. Thomsan Gresham who was the famous merchant and financial advisor of Queen Elizbeth. During her father reign a large number of underweight coins were in circulation. People were loosing faith in the currency. Queen tried to declare the debased coins from circulation by issuing the new coins. But people hold the new coins and passed on the old coins. In this way former disappeared from circulation. So Mr. Gresham formulated the law that bad money drives good money from circulation when both are in circulation side by side.
OPERATION OF THE GRESHAM LAW :
1. Good Money Is Hoarded :-
When the new (good money) coins and old coins (bad money) or underweight or clipped coins are circulating together, people will prefer the new coins for the purpose of hoarding. In this way new coins will disappear and old coins (bad money) will remain in circulation.
2. Good Money Is Melted :-
If any person wants to melt the coins for ornaments he will prefer to melt the full weight coins (good money). So bad money will remain in circulation.
3. Good Money Is Exported :-
Gold generally acceptable by all the world. If any importer of goods wants to make the payment in gold the exporter, he will melt new coins having full weight. It will create shortage of money in the country.
APPLICATION OF THE GRESHAM'S LAW :
This law is applicable in the following monetary standards.
1. Mono-Metallism :-
When the worn out coins (bad money) and new full weight coins (good money) are made by the same material and they have the same face value, circulate together. In case of hoarding, melting or exporting good money will be used and bad money will remain in circulation.
2. Bi-metallism :-
When two mettles say gold and silver are used as a materials for the standard money and a ratio of exchange is fixed by law between their values, this system is called Bi-Metallism. When the mint ratio of exchange of mettles differ from the market ratio, one mettle would be over valued and the other would be under valued. So over valued (good money) metal coin will disappear from circulation. It may be hoarded, exported or melted.
3. Paper Money :-
When coins and paper money circulate side by side as a standard money, then metallic money will be considered good money. If at any time money is to be hoarded, exported or melted coins will be preferred over paper money.
4. Credit Money :-
If secured and unsecured credit money is circulating as a media of exchange, the unsecured credit (bad money) will drive the good money (secured credit) out of circulation.
LIMITATIONS OF THE GRESHAM'S LAW :
This law is not applicable under the following circumstances :
1. Bad Money Disliked :-
If the bad money is disliked by the people and they hesitate to accept it then bad money can not serve and remain in circulation.
2. Govt. Prohibition :-
If Govt. takes severe action against those persons who hoard, melt or export the under valued (good money) money, then bad money can not serve.
3. Small Quantity :-
If the quantity of bad money is very small and it can not meet the requirements of the people in that case good and bad money both will remain in circulation.