This rule of thumb is also known as ‘Gresham’s Law’

“At the core of Gresham’s law is the concept of good money versus bad money. The law holds that bad money drives out good money in circulation. Bad money is then the currency that is considered to have equal or less value compared to its face value. Meanwhile, good money is currency that is believed to have greater value or more potential for greater value than its face value. One basic assumption for the concept is that both currencies are equally liquid and available for use simultaneously. Logically, consumers will choose to use bad money over good money because good money has the potential to be worth more than its face value.”

‘Concept’, ‘the law holds’, ‘is considered’, ‘value’, ‘compared’, ‘is believed’, ‘assumption’, ‘logically’…
So. The way I see it, ‘Gresham’s Law’ is about people interacting according to their own ‘impressions’, ‘drives’ and ‘internal logic’.

But wait. Things are far more interesting than ‘commoners’ hoarding the potentially more valuable coins, when having the ‘opportunity’ to choose between good and bad money.

“The minting of coins provides the most basic example of Gresham’s law applied. In fact, Gresham’s law itself was built around the minting of coins and Gresham’s service to Queen Elizabeth I of England. Sir Thomas Gresham lived from 1519 to 1579, working as a financier serving the Queen and later founding the Royal Exchange of the City of London. Henry VIII had changed the composition of the English shilling, replacing a substantial portion of the silver with base metals. Gresham’s consultations with the Queen explained that consumers were aware of the change and began separating the English shilling coins based on their production dates to hoard the coins with more silver which, when melted down, were worth more than their face value.”

In fact, Gresham’s Law is about ‘commoners’ reacting in a logical manner whenever the powerful had tried to ‘trick’ the less powerful into accepting less valuable coinage.

Let’s examine the situation from another angle.

Gold and silver had been used to make coins for a number of reasons.
Both were rare enough to maintain their perceived value no matter how much of them might have been ‘suddenly’ discovered. For example, the Spaniards had brought shiploads of precious metals into Europe from South America without creating much ‘inflation’.
They, individually and or alloyed, were soft enough to be minted using primitive technology. The oldest coins made of precious metals go back almost 3000 years…
Both gold and silver are impervious to the passage of time. That being the motive for those coins having survived for so long.

For these three reasons gold and silver had been the obvious choices when people had realized they needed a ‘technology’ for making payments and for preserving and transporting value.

In reality, this is the intrinsic logic for which gold and silver had been valuable for us. They had represented the most convenient manner of making payments and for transporting/preserving value. As metals, gold was basically useless until the advent of microelectronics while silver had become really useful only after Daguerre started using it to make primitive photographs.

So. Ancient people had discovered that by using gold and silver coins they could vastly accelerate their economies. The most interested being, of course, the powerful of the day.
The rulers. Those who had the means and the authority to mint.
Some of whom also had the gumption to mess with the whole process. For their own profit, of course. Why do you think Hieron, the King of Syracuse, had hired Archimedes to determine whether a piece of metal – a crown, but the shape had no real meaning, was made of pure gold – as the goldsmiths pretended, or not?

Instead of a conclusion.
Since the start of time, some people have tried to swindle the others. No matter how high their position on the social ladder. And the rest have tried to protect themselves. Or, sometimes, even to emulate the ‘bad’ behavior.

This being the beauty of the free market.
Whenever a market is truly free, the reasonable people naturally weed out the swindlers.
Whenever the swindlers happen to have the upper hand, the rest have no other option but to follow suit. To hoard the ‘good’ money.
The consequence being the slowing down of the economic cycle. To the ultimate ‘bad’ of everybody. The swindlers included. And their children/suitors!

 

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