Bi-metallism

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[1] Historically, Bi-Metallism was a currency standard that pegged currencies to either silver or gold. The standard became largely unpopular and died out over the course of the 19th century once governments and empires became aware of its inherent flaws. Its most apparent problem is articulated in Gresham's Law, famously known as the proverbial phrase, "Bad money drives out good." "Bad money" is money whose intrinsic value is lower than its nominal value. Conversely, "good money" has an intrinsic value that is higher than its nominal value. The intrinsic value is determined by the market according to the law of supply and demand, whereas the nominal value, or official value, is set by the government issuer. The law is premised on the fact that both monies circulate simultaneously in the domestic market as legal tenders. Once the discrepancies between the intrinsic value and nominal value of the monies become known to the public, people will try to make gains from the arbitrage. This can be done in two ways: (1) hoard the "good money" until its official value rises to its intrinsic value; (2) trade in "bad money" for "good money" at the official value and do the reverse operation in the international market. Regardless of which method is practiced, the result is that the "good money" is withdrawn from domestic circulation.

In a country with the system of bi-metallism, the "good money" and the "bad money" are simply the two different mints. For the sake of illustration, suppose the domestic country's official bank or mint value for gold is higher than the international market price for gold. Hence, gold is considered to be the "bad money" and silver the "good money." Anyone looking to make a profit could trade in their gold for silver at the mint rate and then go to international market and trade in the silver for gold. They would now have more gold than they originally had. As a result, gold flows readily into the mint, while silver is sucked out of domestic market and flows into foreign markets where it is valued higher. This discrepancy was unavoidable because official values of gold and silver were fixed while the prices of gold and silver fluctuated due to their resource-status. Fluctuation in price level, however, is a natural inevitability of the laws of supply and demand.


It grew increasingly difficult to change the official exchange rate to agree with the market value because the credibility of the system would be shaken, and people would lose faith in the ability of outside actors to manually regulate the market. Furthermore, the justification for someone who has the power over changing the exchange rate would be viciously contested and seem extremely corrupt.


People understood that there was a problem with Bi-Metallism fairly quickly, however, at the time, the standard seemed enticing. Numerous countries had either mass amounts of silver, or mass amounts of gold, and it was vital to ascertain exchange rates with which to trade. Britain advocated for a bi-metallic currency standard because France had silver and Mexico had gold and Britain wanted to trade with both countries without extreme transaction costs. When Sir Isaac Newton overvalued gold, silver to be abandoned and dispersed in foreign markets where it was cheaper relative to gold. The gold standard took over after the collapse of the bi-metallic standard system as the central exchange rate mechanism.

  1. Cohen, Benjamin J. The Future of Money. Princeton, N.J.: Princeton University Press, 2004. Ch 1