Friday, July 8, 2011

Paper and Gold: Bad Money Drives Out Good Money

Gresham's Law is a dictum widely used in the gold and silver community.

Gresham's law states that any circulating currency consisting of both "good" and "bad" money (both forms required to be accepted at equal value under legal tender law) quickly becomes dominated by the "bad" money.

So when you have currencies used as legal tender in a system, these will consist of 'bad' and 'good' mediums of exchange. So that in daily transactions, people will naturally hand over the bad money first, rather then the good money, because they want to keep the good money for themselves. Hoard it in other words.

How does this relate to gold and silver?

Pretend you had a one ounce gold coin worth $1500 and a bunch of paper notes with the nominal value of $1500 (say 15 x $100 notes). If you were given the choice to exchange the coin or notes for an asset, right now, in this economic climate, what would you do? If you understood the monetary value of gold and the basis behind faith-based fiat money systems, then you would probably use the notes. If you didn't understand the laws of fiat money, you may be ambivalent and just think, "Now is my chance to get rid of this pesky gold coin", and use it.

You see 'bad' money drives out 'good' money. The gold is hoarded because it is 'good' or 'best'.

We are seeing massive amounts of hoarding worldwide. With the latest European crisis, the euro is now at an all time high against gold. The British pound the same. The USD will not be far behind. The New Zealand dollar, well, that is an interesting case. For now it is seen as a 'safe haven' currency, however a case can be made that it is about eight cents to the USD too high at present.

People in Europe, and elsewhere, are hoarding gold because, historically, it is the soundest money available. The owner of gold does not have to have 'faith' in the government that mints it. The 'heads' depicted on the notes, whether Washington or Hillary are associated with a system whereby 'confidence ' is foundational to its ability to survive.

A loss of confidence in the system will not be pretty. Historically, this causes an increase in the velocity of money flows, as people hold onto bad money for less time. Hyperinflation occurs and the hoarding of gold increases. When gold is used as payment, you do not need any 'faith' in its value (except to know it's purity, which can easily be verified).

Consider how Central Banks are using gold now as the reserve currency of choice. They are now net buyers of gold. They are more than happy to hoard gold and swap their paper notes for it. If we are seeing this sort of activity from top bankers, then what does this suggest about their 'faith' in governments and their paper promises? Individuals too, who see the writing on the wall for their currencies, like the Central Bankers, are hoarding gold outside the jurisdiction of their countries.

Bad money is driving out good money.

With Gresham’s Law, gold is hoarded, or leaves the country. It ceases to be used as money in circulation.

People lose faith in paper and the governments who print more and devalue it. More people lock in their wealth with gold, and wait.

Gold in New Zealand dollars: $1839.62 per oz
Previous all time high: $1955.10 per oz

Silver in New Zealand dollars: $43.77 per oz
Previous all time high: $48.58
per oz

The Anglo-Far East Company
The Original Private Bullion Custodian
Your reference: an-001

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