The Scots and Gresham’s Law

The recent Scottish independence elections had raised certain hopes among libertarians and anarchists. Their desire to see a free and independent Scotland (and a smaller Great Britain) enraptured images of Mel Gibson playing “Braveheart” William Wallace and a proud people, once again donning their kilts and marching to the pipes, taking up the cause for liberty. Alba gough brath!


Scottish Independence

That wasn’t going to be the case as the election results revealed. Apparently, Scots act on incentives as do other people. Some of the concerns among the Scottish were the future of socialized pension payments and what kind of money the Scots should have.  Should the Scots stay with the British Pound Sterling or come up with a new national money? Would it be better to adopt the Euro? The latter was the biggest concern for the Independent Party in England who lobbied heavily against Scottish independence.

Nowhere in the discussion did the concept of a free market in money ever come up. Oddly, it is the Scottish Enlightenment which is credited for the advances in modern free market economics. People such as Adam Smith, David Hume, Henry Dunning Macleod, William Brough and even John Law and his “Mississippi Bubble” established a free thinking tradition that elevated the western world into the economic giant it is now. A tradition that seems to be lost in today’s Scotland. It would be unfair to single out the Scots, it has been lost throughout the western world.

So what happened? How did we regress from a free market in money into a global fiat paper standard? It wasn’t always this way. There was a time when banks issued their own money. These were receipts of deposit on gold that customers had deposited in their banks. They were good as gold as they were a claim on a certain weight in gold. At any time the bearer could redeem his receipt (known as a bill for it was a statement of a bank’s debt obligation to pay*) for the physical gold coins. Most people didn’t redeem as the gold was too heavy to circulate in everyday transactions. It was easier and more convenient to circulate silver coinage and paper gold receipts.

This all worked wonderfully. There were a few dishonest banks that attempted to inflate their gold reserves by counterfeiting the paper receipts, a system known today as fractional reserve banking. But these were quickly discovered and went bankrupt**. They died quietly into the night of history, never once causing a systemic risk to the entire financial and banking sectors. That is, it worked well until government got involved in money and banking.

Arbitrage and Money

In the United States, paper money was an instrument of the banking sector. After the disaster of the Continental dollar and other States’ attempts at paper money, the framers at the Constitutional Convention decided that the new national government would only be involved in coining money. It was their belief that governments should never attempt to print their way out of debt again. Article 1, Section 8 of the Constitution allows Congress, “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures“. It does not allow Congress or the Treasury to print paper money. It does allow Congress to “To borrow money on the credit of the United States”. That is, to issue bonds or securities. We know that because Article 1, Section 8 describes the powers granted to Congress to “To provide for the Punishment of counterfeiting the Securities and current Coin of the United States”.

It is important to take into consideration the use of the English language in the middle of the 18th century is quite a bit different today. Where it states, “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures” can be better understood in modern English as, ” To coin money and by regulating the content of the coins, Congress may adjust their value against foreign coins understood under terms in internationally accepted weights and measures, that is in ounces and pounds.” In no way does it mean Congress can increase or decrease the value of silver or gold. But by the 19th century, that’s exactly what they tried to do.

There is a term in economics known as “arbitrage” which according to Wikipedia means, the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. In the 19th century the US government continually attempted to set the parity between gold and silver. In so doing they interfered with a market price causing arbitrage in the money exchange markets. This is something that plagues a bimetallic monetary standard only when governments interfere with the price parity of the the two metals involved.

Originally, the United States was on a silver standard. One US dollar was a coin that contained 371.25 grains of fine Troy silver. Before the Constitution was ever written, the Spanish milled dollar was the adopted monetary unit by the Continental Congress. It was understood that the US dollar would be minted in accordance to that standard. It was by the advice of Treasurer Alexander Hamilton that the government should also mint a gold coin, giving birth to the bimetallic system. The Coinage Act of 1792 then established that the dollar would be a coin weighing 371.25 grains of silver as was the Spanish milled dollar and the gold coin, the Eagle, was “each to be of the value of fifteen dollars or units.” In other words, the gold coins where to have the market value of fifteen silver coins in gold. The government artificially set the ratio of silver to gold at 15 : 1.

This would have been fine but the international market ratio of silver and gold was 15.5 : 1. So, due to arbitrage, gold left the Treasury and silver flowed in, putting the country on a defacto silver standard. In 1834, Congress decided that it didn’t have enough gold in the treasury so it changed the parity of silver and gold again. This time to 16 : 1 and again causing an environment where arbitrage flourished. The Treasury was drained of silver and the country went on a defacto gold standard. This interference continued again and again during the 19th century. Of course these shocks to the monetary supply caused numerous bank panics. None of which was due to a gold standard or free banking or any other such nonsense that mainstream economists and pundits will tell you. All of our country’s bank panics and depressions were and are caused by government intervention. Plain and simple.

Gresham’s Law

Henry Dunning Macleod

In 1858, Scottish economist Henry Dunning Macleod published a work called, Elements of Political Economy where he described a certain phenomenon with money exchanges he referred to as “Gresham’s Law”.  He credited the law to an English financier named Sir Thomas Gresham who, while writing reports to the Queen, described a phenomenon in money where arbitrage was taking place between “bad” money and “good” money. Evidently, neither Macleod or Gresham ever knew about the many historical figures who came before them and had already described this very same “law” at work. It was commonly known as “Copernicus’ Law” before economist Irving Fisher made Gresham’s Law the popular term in modern economics with his book, “The Purchasing Power of Money“.

Gresham’s Law states, “Bad money drives out good money”.  This is poor economic analysis. People don’t naturally seek after

Sir Thomas Gresham

Sir Thomas Gresham

“bad” goods over “good” goods. After all, they are called “goods” because it is what consumers desire. Something good for their money. Gresham didn’t take an important element into account, namely fiat (decree) exchange rates. What Gresham was describing is that people tended to hold the higher valued money and circulated the undervalued money in a bimetallic monetary system. Unknown to Gresham, this arbitrage only happened because government fiat, and not the market, had set the price parity of the two metals. Since Fisher’s book, modern economists have misapplied Gresham’s Law to the affect that any private commodity backed monetary system cannot be good because people will gravitate to the bad money. This causes panics and shortages. Therefore we cannot have a free market in money. It is the duty of governments to produce money and regulate it’s value.

A Scotsman Returns

William Brough

We began this discussion with the Scottish and we will end it with one, William Brough. Brough (pronounced “Bruff”) was born in Kelso, Scotland in 1826. His family later moved to Canada and then Vermont. He began to study medicine but gave it up to study business in New York. He later moved to Pennsylvania where he became a pioneer in the development of the oil industry. He later became the first President of the Oil Producers Association. He retired in 1855 and pursued his interests in social and economic studies. A chair professorship at Williams College is named after him.

Brough published a book in 1896 titled,”The Natural Law of Money” where he contends that free market money is far superior to government produced money. His is the first serious treatise describing the errors of Gresham’s Law. He explains how fixed exchange rates caused the phenomenon Gresham had described.

Throughout history, rare metal coins would be clipped and the shavings sold to a buyer. Unnoticed, these clipped coins would continue to circulate at face value. This bad money would end up being accepted by retailers who were too busy to weigh each coin during a transaction. They would continue to be exchanged and clipped until the bad money became obviously “really bad money” and an unsuspecting patron would be stuck with it.

In more modern times, fiat paper money has fallen victim to the same principle. When a government over produces the paper money it takes a while for unsuspecting patrons to find out. It continues to be exchanged at it’s face value purchasing goods and being exchanged against other currencies. Once the exchange rate is fixed we see Gresham’s Law begin. People will circulate the bad overproduced money and horde the “good” money, relatively speaking. Through arbitrage people are able to profit from the artificial exchange rate. Eventually, the bad money becomes so bad that it’s no longer accepted unless the government has deemed it as legal tender and the only means for exchanges to take place. At which point confidence in the bad money is lost, causing prices to sharply rise, as was the case in 1920s Germany and more recently in Zimbabwe.


As Brough and so many of his fellow travellers in the Austrian tradition have concluded, the natural state of money is separated from government. The problems occur when government assumes the role of money creator. An independent Scotland would had prospered if the new government divorced itself from money and banking. By allowing the private production of money based on a commodity, Scotland could have propelled itself into a first world economy. The first nation to adopt a sound money policy in this age of currency devaluation would be the winner. Scotland may well have experienced an opportunity forgone.


* On a side note, today a dollar bill is not a bank’s obligation to pay the bearer, as it is no longer backed by commodity money. It is backed by debt. Your debt. More precisely, the government’s debt and it’s ability to tax it’s citizens enough to cover the debt. In other words, today’s paper money is a debt obligation against whomever uses the money and not the bank that charges interest on the money.  Pretty slick.

** Notice that banks rarely go bankrupt today. They are deemed insolvent and are either bailed out, bailed in, or are liquidated. People go bankrupt, although they aren’t a bank or corporation. Or are they? For further information read our article, “Bonds and Bondage, Who Owns Who” .

[Main image credit:]


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