Gresham's Law

As I started collecting Roman coins a few years back, I always thought it was kind of weird how certain denominations would just disappear. The denarius really kind of disappeared not long of the introduction of the Antoninianus by Caracalla. The Antoninianus disappeared around the time of about Diocletian. For a while I wondered why. Then I got a few books on the Roman economy, instead of the coinage, and came across the concept of Gresham's Law, which basically says that good metal (meaning pure silver or gold) will be driven out of circulation when bad metal (or debased coinage) is introduced into the system and is tarriffed at a similar amount via fiat.

The hoards of Roman coins that have been found bear out the truth in Gresham's Law. Going into the distributions of the precious metal coins in hoards is beyond the scope of what I want to do here, but suffice it to say that it is possible to identify debasements in the currency by the distributions - exactly as Gresham said would be possible.

One of the side effects of Gresham's Law was that the token coinage - that coinage whose value was declared by the state - was also driven from circulation - much, much earlier in fact than the precious coinage.

So given that our currency is now a fiat or token currency, what does that mean for our economy? Charles Adams believes that we will eventually have to revert back to a metal backing for our currency.

I think that he is partially right.

One of the problems that we're facing these days is that most nations have gone to a fiat currency. Many of them try to disguise it by claiming to be pegged to the US dollar or the Euro, but in the end, they are still basically tarriffed by fiat.

Too much money today trades hand, backed only by the "full faith and credit" of some government. Unfortunately there is nothing to constrain these governments; there is nothing to make them act in a fiscally responsible manner. As the governments continue to print more and more token currency, backed only by a promise, widespread and significant inflation will ultimately occur over the long term.

The other big risk, besides inflation, is if there is suddenly a crisis in the confidence in either the US or EU government and their "full faith and credit." With so many currencies being tied to one or the other, there are very, very few safe havens in the currency world. Not enough in fact. Any kind of significant crises in confidence could plunge the entire world economy in a massive depression as a huge chunk of the world's store of wealth becomes worthless.

Gold and silver coinage was always valuable, not because of whose picture was on it or which government minted the coin, it was valuable because of what it was made of. Paper currency backed by a failing (or believed to be failing) government is worth, well the value of the paper and nothing more.

Now I'm not suggesting that the US or the EU needs to return to a precious metal backed system, but we need to have more countries do so. If there was a realistic alternative to the fiat currencies there might be enough fiscal responsibility pressure applied to the fiat currency governments to keep them in some sort of line.

The ideal, in my opinion (as well as Mr. Adams), would be to return to a metal backed system in the US. But, if enough other countries were to revert to a gold or silver standard, it would be enough to hold the Treasury in check.

However, I think that the EU would lodge some pretty serious protests at the idea of some foreign, US dollar pegged currencies reverting to a gold standard. Why?

Right now, many of the pegged nations are holding huge stores of US dollars in their reserves. If they reverted to a gold standard and had to replace those greenbacks with bullion, they would flood the market with excess US dollars, which would drive down the value of the US dollar in foreign exchange markets. As the value of the dollar drops, it will put more and more pressure on Europe to get their fiscal house in order - something which is really politically untenable given the necessary structural changes that would have to take place in the European economy.

The Treasury would probably welcome this development right now, as a depreciation of the dollar would help to stimulate US exports. Looking in the medium and long terms it would require the US economy to restructure itself again, as imports would become more expensive.

But the dollar could only depreciate so far before pressure began to build to reign in the skyrocketing cost of imported items.

Ultimately, having a real alternative to the fiat currencies would help as stupid fiscal policy decisions would be punished by an almost immediate flight to quality, as represented by the gold standard currencies. Intelligent fiscal policy would be rewarded by an immediate flight to opportunity, as represented by the fiat currencies. But, in the end, the market would have a real choice and people would have a real opportunity to protect wealth.

Not every nation needs to revert to a gold standard. In fact, it is probably a good thing to have the large economies, like the US and the EU, operating on a fiat system. We just need to have a real alternative, in the event of poor policy.

Diocletian had to reform the Roman coinage because of rampant inflation caused by the fact that virtually the entire world (as the Roman's knew it) was working on a failing fiat system. Had he not reformed the coinage, eventually it would have been replaced by a primitive barter system. The system failed as the citizens lost faith in the government to maintain it.

In the US we're not at that point yet. But it could happen, even within our lifetimes.

There needs to be some significant store of currency, somewhere, tied to a real store of value.

We need to use the IMF, the World Bank, and our own foreign aid to get a bunch of these nations to untie themselves from the dollar and the Euro.

We need to let Gresham's Law run its course. Fiat money and precious metal backed money can successfully co-exist as was proven by the early years of the Imperial Roman economy. The good money can be either type of currency. It all depends on the policies implemented by the fiat currency governments. We need to let the good money displace the bad.

Or we need to find our Diocletian.