Gresham's Law and Modern Exchange Rates
Gresham's Law is often stated colloquially as "Bad money drives good money out of circulation." More generally, it means that if there are two different currencies circulating at the same face value but with different intrinsic values, the one with the higher intrinsic value will be kept by people, and they will spend the one with the lower intrinsic value.
The latest example of Gresham's Law has become apparent with the circulation of coins in Canada. Back when the US price of a Canadian Loonie was only 67 cents or even 80 or 90 cents US, we rarely if ever received US coins mixed in with our change in Canada. But during the past couple of months as the Canuck buck has appreciated in value to be worth $1.03, $1.07, or more in US currency, I have begun to receive US coins in my change now and then. On average, I would guess I have received about 1% of my change as US coins during the past two months.
In bulk, US coins have a lower intrinsic value than Canadian coins right now. Nevertheless, for minor purchases Canadian and US coins are used interchangeably in Canada — the transaction costs of converting just a couple of US coins into Canadian coins are too high to make the conversion worthwhile.
The result is that rather than get stuck with US coins now, Canadians spend them. Given a choice, they would rather not hold onto the US coins, which (according to the exchange rate, at least) have a lower purchasing power than the Canadian coins. They spend the US coins and hold onto the Canadian coins. In direct confirmation of Gresham's Law, bad money (US coins) is driving good money (Canadian coins) out of circulation.
The latest example of Gresham's Law has become apparent with the circulation of coins in Canada. Back when the US price of a Canadian Loonie was only 67 cents or even 80 or 90 cents US, we rarely if ever received US coins mixed in with our change in Canada. But during the past couple of months as the Canuck buck has appreciated in value to be worth $1.03, $1.07, or more in US currency, I have begun to receive US coins in my change now and then. On average, I would guess I have received about 1% of my change as US coins during the past two months.
In bulk, US coins have a lower intrinsic value than Canadian coins right now. Nevertheless, for minor purchases Canadian and US coins are used interchangeably in Canada — the transaction costs of converting just a couple of US coins into Canadian coins are too high to make the conversion worthwhile.
The result is that rather than get stuck with US coins now, Canadians spend them. Given a choice, they would rather not hold onto the US coins, which (according to the exchange rate, at least) have a lower purchasing power than the Canadian coins. They spend the US coins and hold onto the Canadian coins. In direct confirmation of Gresham's Law, bad money (US coins) is driving good money (Canadian coins) out of circulation.
Category: Economics, International Trade and Finance Posted on
Tuesday, November 13, 2007 at 12:22am
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It's just a shame that the U.S. mint has banned smelting or exporting them. Rather than having to store them in jars, we could be putting them to more economically beneficial application.
I'm still in the habit of scrutinizing my change, for the reason given by Fred. In my case, it's the machines at laundromats.