Gresham’s Law Briefly Revisited in a Constitutional Context

by Michael S. Rozeff

Are you aware that a Federal Reserve dollar bill is not a constitutional dollar? Perhaps you are,
but if so, do you know what a constitutional dollar literally is? Is it gold? Is it silver? Is it both?
What actually is meant by a metal standard? Can the U.S. or any country be on two standards at
the same time? Can two metals circulate as coin if there is but one standard, or does one metal
have to drive the other out of circulation? How and why does Gresham’s law work when a
country uses metal coin for money? In what ways are certain statements of Gresham’s law
misleading?

Sooner or later, if and when the power of the Federal Reserve over money is revoked in a
constitutional manner, and if and when constitutional coin comes back into use, these and similar
questions will need to be asked, answered, and understood. That is what this article does in
compact fashion.

In his meticulously-researched two-volume work, Pieces of Eight, constitutional lawyer Edwin

Vieira, Jr. shows beyond any doubt that the constitutional dollar in the United States is an
“historically determinate, fixed weight of fine silver.” The Coinage Act of 1792 is but one source
among many that makes this evident, reading “the money of account of the United States shall be
expressed in dollars or units...of the value [mass or weight] of a Spanish milled dollar as the
same is now current, and to contain three hundred and seventy-one grains and four sixteenth
parts of a grain of pure...silver.” The U.S. legally and constitutionally is on a silver standard,
although we would not know it today since the government has illegally and unconstitutionally
removed silver as currency and replaced it with the Federal Reserve notes that we know as dollar
bills. The latter language avoids, obfuscates, and obscures the actual and tangible meaning of
dollar as a specific weight of silver.

The U.S. has historically minted gold coins as well as silver coins, as the Constitution instructed.
It regulated their “Value”, by which is meant the weight of gold they contained, in order to bring
the meaning of a gold dollar into conformity with the silver standard coin that contains 371.25
grains of pure silver. This too was constitutionally mandated. It did the same for foreign coins,
up until 1857. The U.S. never was or could be constitutionally on a dual standard or a gold
standard. It circulated silver and gold coins as media of exchange by adjusting the content of the
gold dollar to a silver standard dollar. For example, the Coinage Act of 1792 authorizes
“EAGLES – each to be of the value of ten dollars or units [i.e., of ten silver dollars], and to
contain two hundred and forty-seven grains, and four eighths of a grain of pure...gold.” Since the
dollar contained 371.25 grains of silver, this brought into legal equivalence 3712.5 grains of
silver and 247.5 grains of gold. The ratio was 15.

In the Coinage Act of 1834, Congress adjusted the gold eagle: “...each eagle shall contain two-
hundred and thirty-two grains of pure gold...” This brought into legal equivalence 3712.5 grains
of silver and 232 grains of gold. The ratio was 16.002155. The reason for the change was that
gold had appreciated in market value relative to the silver standard.
Old coins could be brought in and re-minted for free (after waiting 40 days.) If old coins were
not re-minted, they were to be accepted as payments “at the rate of ninety-four and eight-tenths
of a cent per pennyweight.” The weights of the earlier and later eagles were influenced by a
change in the standard gold alloy. The rate of 94.8 cents per pennyweight takes that change as
well as the alteration in the pure gold content into account so that payments made in either the
old or the new coins become very nearly equivalent in terms of the amounts of pure gold being
paid.

With this as introduction, let us go on to an explanation of Gresham’s law and the reason why
Congress made such adjustments in the weight of gold in the gold dollar as it was
constitutionally mandated to do.

Suppose that the dollar is constitutionally defined as a unit that contains 371.25 grains of silver,
and suppose that the unit is physically identified with a specific silver coin that contains that
mass of silver. Since grains are unfamiliar units, let us note that there are 480 grains per troy oz.
Hence, 371.25 grains weigh 0.7734375 troy oz. That is to say, if a silver dollar standard is
officially and constitutionally instituted with each dollar having the mass of 371.25 grains of
silver, this means that the dollar is defined as containing 0.7734375 troy oz of silver. In all non-
fraudulent exchanges involving dollars, someone who pays or receives a dollar is supposed to
pay or receive that mass (or loosely weight) of silver in coin or its equivalent in bullion (bars or
ingots). The dollar sign, $, in such a regime means 1 silver dollar of the official weight of
0.7734375 troy oz of pure silver. The word “dollar” means the silver coin of that specific mass.

A standard is something that is unchanging. A yard always has 36 inches. A pound always has
16 ounces. A standard constitutional dollar always has the same amount of a given metal that is
chosen as its definition, until the constitution is amended to alter the standard, or unless the
constitution allows the legislature to alter the standard.

Economically, there can only be a single such standard dollar at a time. One cannot
simultaneously have the dollar mean a certain amount of silver and another amount of gold. An
economy cannot have two concurrent and different standards of the dollar, such as a silver dollar
and a gold dollar. The reason for this, as will be now be discussed, is that the relative prices of
any two metals fluctuate over time.

The exchange rates of gold for silver vary over time due to the changing supplies and demands
for these metals in markets. At one time, 1 oz of gold may exchange for 16 oz of silver, while at
another time it may exchange for 25 oz of silver. These fluctuations go on unceasingly. If an
attempt is made to make a dollar simultaneously be two standards, it will fail. If a dollar is made
to be 1 oz of gold and also 16 oz of silver, what is a dollar when they no longer exchange at that
ratio? What is a dollar when they exchange at 1 oz of gold to 25 oz of silver? There is no answer.
There is no answer because the dollar cannot simultaneously be two different weights of two
different metals whose rates of exchange vary over time. One or the other of the two metals has
to be chosen as a standard.

The fluctuations occur in the market even if the government sets an official rate of exchange
between the two metals, which is what was done in the various coinage acts. The government
can attempt to force a given exchange rate, but this will not alter the fact that the market
exchange rate departs from the forced exchange rate. The result of a discrepancy between legal
and market rates of exchange will be that one of the metals will disappear from circulation. That
result comes under the heading of Gresham’s law in operation.

There are two ways that the government can, without the use of force, keep both silver and gold
circulating as money, even if only one of them, here taken to be silver, is the standard. One way
is to regulate the value of the official gold dollar as time passes, which means to change the
official rate of exchange between gold and silver in order to bring it into accord with the market
rate of exchange. That is what the coinage acts did. The other way is to avoid using a gold dollar
altogether, and produce gold coins that have a known weight but no designation as a dollar. The
gold coin can “float” or have a changing price against the silver standard dollar. This method
was not used but it could and should be used in the future if and when the constitutional silver
dollar is restored as the unit of account.

Let us examine in more detail how a money standard works, such as the silver standard, and let
us understand Gresham’s law.

Suppose that there is a single silver standard that is given by a dollar that contains 0.7734375 oz
of silver. Suppose also that at some specific time, the price of a troy ounce of gold in terms of
silver is $16 in the market. This means that 1 oz of gold exchanges in the market for 16 silver
dollars, each dollar containing 0.7734375 oz of silver. That is, 1 oz of gold exchanges for 12.375
oz of silver.

Now suppose that the government issues a gold coin. If an official gold coin is made that says it
is a $16 gold coin, , stamped literally 16 dollars, it will contain 1 troy oz of gold worth exactly
$16, that is, worth 16 silver dollars. Suppose that the government goes one step further. It makes
this exchange rate the official rate, such that in debt contracts, one is permitted to pay either 16
silver dollars or 1 of these gold coins. The official exchange rate is 1/16 oz of gold per silver
dollar, or 0.0625 oz of gold per silver dollar. The silver standard and accompanying law make
silver a legal payment or legal tender in debt contracts, unless perhaps the private parties to the
contract are allowed to specify otherwise. With gold’s price officially fixed at 1 oz per 16 silver
dollars, then gold at that price is also a legal tender in payment of debts. The government in this
example is attempting to keep both gold and silver in circulation by making the official rate the
same as the market rate.

The law may also enable one legally to write contracts to protect against future changes in the
market rate of exchange, but that is another matter. We want to see what occurs if the official
rate of exchange of silver and gold deviates from the market rate as time passes.

In the unlikely case that the market price of gold remains at $16 indefinitely, this gold coin
provides a substitute or equivalent to the silver standard, even though there is but a single
standard. If this market ratio prevails through time, staying at the official rate, there is no real
difference between gold and silver for payment purposes. In this situation, one can think in terms
of either a silver or gold standard, even though there really is a single standard. There is no
significant difference.
However, this situation never occurs. Market prices do change. A single standard then becomes
essential in an economic sense if the dollar is to retain a clear definition as a standard. When the
market rate of exchange occurs, the fact that the standard is a silver standard means that the
dollar is fixed at 371.25 grains of silver, no matter what happens to the price of gold in terms of
silver. If the relative prices of silver and gold change, that shows up in a change solely in the
price of gold. This will make the “16 dollar” designation on the gold coin obsolete from a market
point of view, but not from an official point of view. This is going to set in motion certain events
that we now look into. These events are certain to occur because of a profit incentive that is
created by the discrepancy between the market and official rates.

Consider two examples in which market prices deviate from the official exchange ratio. The first
one occurs when gold advances in price relative to silver. Suppose that 1 oz of gold becomes
able to buy 20 silver dollars in the market. The market exchange ratio becomes 0.05 oz of gold
per silver dollar, while the official rate is 0.0625 oz of gold per silver dollar. The gold piece
becomes more valuable. An oz of gold now exchanges for 15.46875 oz of silver, which is the
amount of silver in 20 silver dollars. At the official rate, it exchanges for 12.375 oz of silver.

Now we explore the profit opportunity that lies at the heart of Gresham’s law. If someone owes
32 dollars and can pay in either silver or gold coins, which will be chosen? Will it be silver or
gold? Intuitively, one pays with the less expensive metal, which is silver. One holds gold off the
market and instead uses silver for payments. The more expensive metal disappears from
circulation as money or coin, although it will continue to be used for jewelry, teeth, and
industrial applications.

The official contractual rate in debt contracts calls for either 32 silver dollars or 32/16 = 2 gold
coins. But 2 gold coins exchange for 40 silver dollars in the market. If one possesses 2 gold
coins, one can buy 40 silver dollars in the market by ignoring the official rate of exchange. One
can then pay the debt with 32 of these silver dollars and have 8 silver dollars left over. This is
clearly preferable to paying out the entire 2 gold coins to satisfy the debt, since one gets rids of
the debt and has 8 dollars left over. Hence, one will pay at the official rate in silver dollars, not in
gold coins.

The situation being described contains a risk-free arbitrage (or profit) opportunity. Exploiting it
drives gold out of circulation as money. For example, suppose one starts by borrowing 2 gold
coins. One then buys 40 silver dollars and keeps 8 of them. One then repays the loan of the gold
coins with 32 silver dollars, since they are legal tender. Keep repeating this operation again and
again to augment one’s pile of free silver. This is a money machine, which is what a risk-free
arbitrage is, in which one party gains and the other loses. The lender of gold coins is obeying the
law by honoring the official exchange rate, but he is losing on this deal since the 32 silver dollars
that he is repaid cannot buy 2 gold coins in the market. He will stop lending gold coins. He will
put an end to the money machine. This is why finance theories typically assume that assets are
priced so as to preclude risk-free arbitrage opportunities.

Let us think of this in another way, which is in terms of exchange rates. An exchange rate when
silver is the standard is expressed as a number of oz of gold per silver dollar. When gold
appreciates in price relative to silver, the exchange rate falls. That is, less gold is required to
exchange for one silver dollar. In the example, one can satisfy the debt at the official exchange
rate of 0.0625 oz of gold per silver dollar, whereas the silver dollar fetches only 0.05 oz of gold
in the market. Silver that is used to extinguish debt has a greater value than silver that is used to
buy gold in the market as coin. Therefore, silver will be used for payments of debt and all other
exchanges, not gold.

The result of gold having appreciated in price relative to silver and of the market rate of
exchange of gold for silver having fallen below the official rate of exchange (0.05 oz of gold per
silver dollar as opposed to 0.0625 oz of gold per silver dollar) is that gold will disappear from
circulation as payments. This is an example of Gresham’s law. When two metals are legal tender
at an official rate of exchange and when one metal’s market price appreciates in terms of the
metal used as a standard (here silver), that (appreciated) metal (here gold) will disappear from
circulation as money. Gresham’s law is an application of the idea that money machines do not
exist in equilibrium, or that there is no free lunch, or that risk-free arbitrage opportunities do not
exist in equilibrium.

There is another way of describing what happens when gold appreciates in price relative to silver
but the official rate is lower. One can say that the official exchange rate undervalues gold. The
undervalued metal disappears from circulation. This language is misleading and confusing,
however. Is silver overvalued? It seems natural to conclude that silver is overvalued if gold is
undervalued. However, silver is not overvalued. Silver cannot possibly be overvalued because it
is the standard being used to define the dollar. Despite the very great drawback introduced by use
of the terms “undervalued” and “overvalued” in this context, they have been common in debates
on bimetallism. They have contributed to confusion, erroneous analysis, and policy blunders
with costly consequences, the reason being that they obscure the fact that one metal is the
standard; and in the U.S. that constitutional metal has always been and still is silver.

One also hears Gresham’s law stated as “bad money drives out the good.” This too is misleading,
confusing, and erroneous. In the example of gold appreciating and disappearing, silver is by no
means “bad money” nor is gold “good money”. There is no good and bad money at all. Silver is
the metal being used as the standard. It has not driven gold or good money out of circulation. The
fixed exchange rate of gold set at too high a level compared to the going market rate has caused
that to happen.

For completeness, we consider the opposite case in which gold depreciates relative to the silver
standard. Suppose that the market exchange rate rises to 0.076923 oz of gold per silver dollar,
which means that silver buys more gold and that gold’s price has fallen. One oz of gold trades
for 1/0.076923 silver dollars, that is, 13 silver dollars. Suppose that a debt of $32 is to be paid.
One can pay in either silver or gold dollars. This again requires 2 gold coins at the official rate.
The cost of that in the market in silver dollars is 13 x 2 = 26 silver dollars. If one had 32 silver
dollars, one could use 26 of them to buy 2 gold dollars in order to pay off the debt. One would
have left over 6 silver dollars which one could keep. Therefore, it’s less expensive to pay the
debt with gold, which is relatively less expensive in the market as compared with the official
exchange rate. Gresham’s law again goes to work. Silver disappears from circulation. When two
metals are legal tender at an official rate of exchange and when one metal’s market price
depreciates in terms of the metal used as a standard (here silver), that (depreciated) metal (here
gold) will circulate and the other metal (here silver) will disappear from circulation as a medium
of exchange while maintaining its role as a medium of account.

In practice, a rather small depreciation of gold (1 to 3 percent) is enough to cause silver coins to
disappear from circulation. Suppose we start with a 20 official and market ratio of silver to gold
at which there is an equivalence of 0.05 oz of gold and the amount of silver in one silver dollar.
This means that 1 silver dollar buys exactly $1 worth of gold at the official and market rate, and
that 20 silver dollar coins buy 1 gold coin that weighs 1 oz and is worth 20 times as much as the
silver in one silver dollar.

Suppose now that the market price for gold declines such that there is now 0.051 oz of gold per
silver dollar. This is a 2 percent increase in the market exchange ratio. At the official exchange
rate of 20 silver dollars per gold coin, the 0.051 oz of gold is worth 0.051 x 20 = $1.02 (i.e., 1.02
silver dollars.) If one had to pay $1, it would be better to pay it in the less expensive metal (here
gold), at the official rate of 0.05 oz of gold per $. People will tend to use gold for exchanges and
hold silver off the market.

If small changes drive one metal or the other out of circulation, the government has to adjust the
official exchange rates frequently if both are to be kept in circulation. This is both costly and
inconvenient. The solution to this is straightforward. Choose one metal as a standard and allow
the price of the other metal to fluctuate freely or float in the market. If silver is the standard, then
gold coins can be minted with no dollar designation at all stamped on them and with no law
saying that the coin is a certain number of dollars. They can be minted with the weight of pure
gold shown. Then when they are used as payments or used as a basis for issuing e-credits or gold
certificates, their weights can be used in conjunction with the changing price of gold to gauge
appropriate payments and receipts.

Q. What is a constitutional dollar literally (in the U.S.)?

A. It is a silver coin containing 371.25 grains of pure silver.

Q. Is a gold standard constitutional?

A. No, not for the U.S. and not as the Constitution is written. It should be noted, however, that
individual states have a constitutional power to make specie (silver, gold, or both) and only
specie legal tender.

Q. What is meant by a metal standard?

A. It means a unit with a name, like the dollar, that contains a specific weight of metal.

Q. Can the U.S. or any country be on two metal standards at the same time?
A. No, this will not be practicable because of the continual changes in relative prices of any two
metals.
Q. Can two metals circulate as coin if there is but one standard?
A. Yes. The metal that is not the standard can circulate as a coin of a given weight of that
precious metal whose value at any given time is determined by reference to market prices. Such
a coin need not carry any specific dollar designation. This obviates Gresham’s law.
Q. Does one metal have to drive the other out of circulation?
A. No. As long as the metal that is not the standard is not legally made to exchange at a fixed
ratio to the standard metal, both metals can circulate just as silver and gold both trade in today’s
markets. Gresham’s law will not come into play.

Q. How and why does Gresham’s law work when a country uses metal coin for money?
A. Gresham’s law takes hold when the government fixes an exchange rate between two metals.
When the market rate of exchange deviates from the fixed rate, arbitrage opportunities arise that
make it profitable to use the less expensive metal as means of payment at the official rate. Then
the more expensive metal disappears from circulation as a medium of exchange.

Q. What is an accurate rendition of Gresham’s law in the case of two metals?

A. When two metals are legal tender at an official rate of exchange and when one metal’s market
price appreciates in terms of the metal used as a standard, the appreciated metal will disappear
from circulation as money and the metal used as a standard will circulate. Conversely, when two
metals are legal tender at an official rate of exchange and when one metal’s market price
depreciates in terms of the metal used as a standard, the depreciated metal will circulate and the
metal used as a standard will disappear from circulation as a medium of exchange although it is
still the medium of account.

Put more simply: When two metals are legal tender at a fixed official rate of exchange, that metal
which is less expensive at the market rate of exchange will tend to circulate for payments while
the more expensive metal will tend to disappear as a medium of exchange.