During the reign of Queen Elizabeth I, in England in the middle of sixteenth century, a number of debased, clipped and sweated coins of previous reigns were in circulation. Queen Elizabeth, therefore, thought of reforming the currency system. She tried to replace bad coins by the issue of new, full weighted coins. But as soon as these new coins made appearance, they disappeared. She consulted Sir, Thomas Gresham, her financial adviser, who observed and explained this tendency. His observation has been named as Gresham's Law.
The law states that bad money tends to drive good money out of circulation. By bad money is meant all money which is inferior or cheaper in substance value.
In a country where good and bad coins of the same metal circulate as legal tender, bad money tends to drive good money out of circulation. In this case old, worn-out and light-weighted coins are bad money.
The law operates under bimetallism. if, of two coins of gold and silver current side by side, one becomes overvalued or bad money it will drive the undervalued or good money out of circulation. Suppose, the market ratio as well as mint ratio between silver and gold coins is 16 silver coins equal to 1 gold coin. The market price of silver may fall so that one gold coin exchange now for 17 silver coins. The mint ration being unchanged, one gold coin will exchange for 16 silver coins only. That is gold undervalued at the mint. In this case relatively overvalued silver coins will drive gold coins out of circulation. Everyone will keep the gold coins and give only silver coins. Thus, there will be no gold coins left in the market.
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