The Natural Law of Money
By William Brough
William Brough was born in 1826 in Kelso, Scotland. In his early childhood, the family moved first to Canada and then to Vermont. He began to study medicine but gave it up for business. He moved to New York in 1849 and then to Pennsylvania, where he was a pioneer in the development of the oil industry. He became the first president of the Oil Producer’s Association, and was involved in some important U.S.-Russian oil ventures. He retired in 1885, devoting his time to the study of social and economic subjects and to the writing of two books on money. A chaired professorship at Williams College is named in his honor.In
The Natural Law of Money, William Brough argues forcefully that privately-supplied money offers benefits not offered by government-supplied money.Brough’s analysis includes a discussion of Gresham’s Law. Gresham’s Law is commonly summarized by the catchy phrase “bad money drives out good.” It is just as commonly misunderstood. To understand Gresham’s Law, just remember this one simple requirement for it to hold: Fixed exchange rates.Historically, coins minted of valuable metals like gold or silver frequently became “bad” when they were clipped or shaved, making them weigh less. Coin-defacers could profit by shaving bits off of good coins and then reselling the metal clippings. Shop-owners, too busy to weigh coins for every transaction, were generally content to accept clipped coins at face value, so long as they could later spend those coins at that same face value. In daily transactions, the clipped coins were identical to the unclipped coins–they traded 1 : 1. Once this cycle got started for a currency, the bad coins quickly replaced the good ones, as coin-defacers snapped up and clipped any good coins in circulation. Thus, a gold coin stamped by the government with the value of one dollar might typically contain increasingly less than a dollar’s worth of gold over its lifetime. Eventually a critical point would occur, as the holders of bad coins became worried that other sellers would no longer accept their degraded coin at face value. Those left holding the bag stood to lose a great deal.In the modern world of fiat paper currency, the exact same effect occurs if a money’s quantity is relatively increased by its issuing Central Bank. Its value declines in principle, but it may temporarily be accepted at its stamped face value by those using it for daily transactions or to purchase other currencies, in the expectation that it will retain or return to that stamped value so it can be spent without loss. If the government further requires that the bad currency be exchangeable with another (good) currency at face value (i.e., at a fixed exchange rate), the bad currency will most certainly replace the good one in circulation. Why not accept a piece of paper worth less than a dollar if you can instantly buy with it another currency worth a full dollar? Why not keep any good pieces of paper under your mattress, and simply spend–recirculate–the bad ones? “Good” currencies are hoarded by the knowledgeable or used in illicit trade (because black market transactions typically involve large quantities of cash, which has to be accumulated and held by someone, risking an interim decline in confidence in its value), leaving the “bad” currencies in daily circulation.Gresham’s Law, so obvious and disturbingly critical to daily life that it was discussed in the streets for centuries, does not seem very relevant today. Why not? Gold coins of verified weight are good currency–why do they not drive paper monies out of existence? Because Gresham’s Law requires fixed exchange rates–exchange rates between the “bad” and “good” money that are fixed either by law, custom, or expectations. When coins are clipped but their stamped values trade 1 : 1 with unclipped coins–a fixed exchange rate–the bad coins soon drive out the good ones. When fiat money values are eroded by the increased supply of one relative to the other, but their relative legal values for transactions are mandated by government restrictions, the inflated currency drives out any available uninflated one. If gold or silver coins are required by law–fiat–to exchange with paper money at a fixed rate, and afterwards the quantity of paper money increases relative to that of the precious metal, the paper money will supplant the coin in daily transactions. Many other historical examples abound. The key factor in every case is fixed exchange rates between the bad and good currencies.But if the currencies’ values are instead determined by the market–that is, if they “float” relative to each other–then the clipped or overly-supplied money simply loses value (“depreciates”). Instead of the bad currency supplanting the good one, both currencies can exist side-by-side in circulation, trading at the market rate of exchange. The market participants have an incentive to keep tabs on the relative supplies or market exchange rates because no one wants to accept at face value money that will be worth much less when it comes time to spend it.Consequently, today, flexible exchange rates, supplied by nations implicitly competing in world money markets and simultaneously allowing their citizens access to those international money markets, enable people to substitute quickly their holdings of their domestic currencies for other currencies if they lose faith. The euro competes daily with the British pound, the U.S. dollar, and the currencies of Asia, Eastern Europe, and any other currency that gains a reputation for retaining its value–all of which helps keep values and monetary policies in line. Having suffered through enough fixed-exchange-rate tribulations and inflationary crises, many nations float their exchange rates and allow citizens to hold and use other currencies, at least to limited extents. Emigration allows further competition in money choices; and improved communication via computers allows instant access to information about international conditions affecting money supplies and demands. Thus, Gresham’s Law does not often rear its head in discussions. But Gresham’s Law still holds when rates of exchange are fixed; and it remains an Achilles’ Heel in discussions of returns to gold standards, unified currencies, or fixed (including managed) exchange rates. In money, as in all goods, market competition helps keep supply and demand in line.Does international competition in currencies effectively substitute for private competition? What conditions optimally determine the areas over which a single currency–the most extreme example of fixed exchange rates–can effectively operate? These questions excite international economists today.William Brough is one of only a few writers from the late 1800s who correctly explained Gresham’s Law, as well as many other matters concerning money supplies and these exciting matters of competitively supplied money. For more works on money supply from the late 1800s-early 1900s, see:Primary resources (historical order):
Lombard Street (first published 1873)
The ABC of Finance (first published 1877)
Laughlin, J. Laurence,
The History of Bimetallism in the United States (first published 1885). Empirical evidence on Gresham’s Law.
The Natural Law of Money (first published 1896)
Mises, Ludwig von,
The Theory of Money and Credit (first published 1912)
“The Application of the Theoretical Apparatus of Supply and Demand to Units of Currency” (first published 1921)
Suggested Secondary Resources (alphabetical by author):
Timberlake, Richard H.,
“The Government’s License to Create Money” (
Cato Journal, The Cato Institute, Fall 1989). Online pdf file with helpful discussions of Brough, plus useful bibliography.
White, Lawrence H.,
“Competing Money Supplies,”The Concise Encyclopedia of Economics. Online at the Library of Economics and Liberty.
White, Lawrence H. and George Selgin,
“Why Private Banks and Not Central Banks Should Issue Currency, Especially in Less Developed Countries” Online at the Library of Economics and Liberty, April 19, 2000.
Editor, Library of Economics and Liberty
August, 2003Special thanks to George Selgin, Associate Professor of Economics at the Terry College of Business, University of Georgia, for biographical information on William Brough.
First Pub. Date
New York: G. P. Putnam's Sons
The text of this edition is in the public domain.
FROM THE DAYS OF BARTER TO THE INTRODUCTION OF
THE MODERN CLEARING-HOUSE, AND MONETARY
PRINCIPLES EXAMINED IN THEIR RELATION
TO PAST AND PRESENT LEGISLATION
The Natural Law of Money
State is all in all.—Burke.