An old statement “Bad money drives out good,’’ has become increasingly popular in recent years. The original statement is attributed to Nicolaus Copernicus, the great Polish thinker educated in Italy. A mathematician, an astronomer, a physician, a classics scholar, a translator, a governor, a diplomat and an economist, Copernicus is indeed one of the most brilliant minds that ever lived on earth.
During his old age, a young economist by the name of Thomas Gresham, further expanded the concept initiated by Copernicus and he made an economic law out of it. The idea behind the sentence “Bad money drives out good,” is perfectly explained in a passage from “The Frogs by Aristophanes”, dated 405 BC. It explains in simple words the Gresham’s law:
“The course our city runs is the same towards men and money. She has true and worthy sons. She has fine new gold and ancient silver, coins untouched with alloys, gold or silver, each well minted, tested each and ringing clear. Yet we never use them! Others pass from hand to hand, Sorry brass just struck last week and branded with a wretched brand. So with men we know for upright, blameless lives and noble names. These we spurn for men of brass.”
In a straightforward example, if one is given 1 gold coin plus the same equivalent amount in brass coins, the person would first spend the brass coins (the bad money) before spending the gold coin (good money). The logic can be expanded to currency as well. For example, a citizen of Zimbabwe, a country that has experienced incredible inflation of 89,700,000,000,000,000,000,000 per cent would certainly treasure more 1 euro than the home currency.
As the Copernicus Gresham’s Law became more widespread among experts, it became clearer that it was not just a story or a tale, but rather a practical finance problem that the world’s greatest economist have been trying to solve for centuries.
To make the matter worse, in 1971 the gold standard, the parity of USD to gold, was removed by president Nixon, and ever since, all currency has become fiat currency. A fiat currency has no link or peg to any physical assets. Hence the treasury of a country is free to produce as much currency as per desire. The main challenge comes in when another country decides to invest in the former by purchasing fiat currency.
China for example has purchased $1.1 Trillion, making the Asian giant practically over exposed in investment on a fiat currency. If China was to ask the USA to return the dollar owned into gold, the USA would probably have a really tough time.
At the same time, if China ever decided to embrace gold standard to the local currency, the initial emission of gold reserve would be gigantic. Hence the “bad money” have won. No countries in the world has been bold enough to establish gold standard ever again, making all currency in this world, which is approximately $83 trillion, bad money. In fact, the global quantity of gold market capital is only 8 trillion dollars, which equals to approximately the 10 per cent of all the money on earth.
The physical USD bill available on the market are approximately $1.5 Trillion, while all the combined debt of the USA within the country itself and with all the other countries in the world, is in excess of $18 Trillion. In other words, the USA not only has enough gold to back the currency, but also not enough physical currency to be able to back the virtual/theoretical currency.
With the advent of cryptocurrencies, not only money are no longer backed by precious metals, but also not by real currency, as the majority of the worldwide available currency is also virtual currency. So, despite the aggregate value of nearly $100 billion, all the cryptocurrencies in the world could not be worth a penny overnight.
Our behaviour to “save the best for last” applies to finance as much as it applies to any other social aspect of our life. So before we can actually spend those shiny golden coins, we would prefer to get rid of any other piece of paper with any value written on it.
Stefano Virgilli
vs.voxlab.net@gmail.com
Oman Observer is now on the WhatsApp channel. Click here
