Note that the law applies not just to a particular type of coins, but to the exchange rates between different money commodities as well. Suppose in a bimetallic standard, metal A is pegged to metal B at a ratio of 1:10, but the market value of a unit of metal A is 12x that of metal B. In this case, we have a price ceiling whereby metal A is artificially undervalued, and per Gresham’s Law, will be driven out of circulation.

Let’s revisit the concept of price. Rothbard notes that price, in essence, refers to purchasing power. Consider the statement “The price of a cup is $5.” This means that the purchasing power of $5 is a cup, but also, reflexively, the purchasing power of a cup is $5. In the latter formulation, the cup-seller can think of buying five dollars with a cup.

Now what happens if the government inflates the dollar supply? There are more dollars in circulation, but the stock of goods and services in the economy remains the same. The prices bid up, so now the cup costs, say, $7. The purchasing power of the dollar has fallen, and the purchasing power of the cup has increased. (One of the desired properties of money is that of “store of value.” But in this dollar inflation scenario, we note that the cup is serving as a better store of value than the canonical money.)

Now suppose the government enforces a price ceiling on cups using the pretext of protecting consumers. The government would really be asking people to pretend that something worth $7 (the cup) is worth $6 (the six dollar bills). In this case, by Gresham’s Law, we would expect cups to be hoarded, or taken out of circulation (perhaps exported to another country or sold in black markets.)

Thus, Gresham’s Law dooms price ceilings. Anything artificially undervalued by such mechanisms will suffer removal from circulation.

  1. Thinking Correctly About Inflation
  2. When Money is Abundant, Everything Else is Scarce
  3. Gresham’s Law Clarified
  4. Gresham’s Law and Fiat Currencies

References

  1. Rothbard, Murray. What Has Government Done To Our Money? Chapter 1.