An example of Gresham's law in action following the First World War, the amount of paper money has flooded Europe as people began collecting coins for their metal intrinsic value and as an insurance against the decline of paper money value. Accordingly, coins as the “good money” virtually disappeared. Another example:
In 1896, Americans have begun to collect gold coins when it became clear that the government would start making silver coins and make it legally equal to the value of gold coins.
This observation about human nature and the nature of money is taken from the name of a financier Sir Thomas Gresham (1519-1579). He created the Royal Exchange in London, he pointed out that people would keep the heavy weight coins and pass along the light weight coins. The reason is that dealers are often shave the sides of coins and the public to hold the unshaved coins as long as possible, which are heavy and seems to have more intrinsic value, while spending the lighter coins for transaction. He was not the first to see this behavior, but he was the first to define this law.
Here is the definition of Gresham's law:
Where by legal enactment a government assigns the same nominal value to two or more forms of circulatory medium whose intrinsic values differ, payments will always, as far as possible, be made in that medium of which the cost of production is least, the more valuable medium tending to disappear from circulation.
In other words, watch what you spend.
