American Depositary Receipt. A negotiable certificate issued by a U.S.

bank representing a specific number of shares of a foreign stock traded on a U.S. stock exchange. ADRs make it easier for Americans to invest in foreign companies, due to the widespread availability of dollar-denominated price information, lower transaction costs, and timely dividend distributions. Read more: http://www.investorwords.com/120/ADR.html#ixzz1lT7Z1Vmy

Repa ria ion

Filed Under Forex

Definition of 'Repatriation'
The process of converting a foreign currency into the currency of one's own country. The amount that the investor will receive depends on the exchange rate between the two currencies being traded at the settlement time.

Investopedia e plains 'Repatriation'

For example, if you are American, converting British pounds back to U.S. dollars is an example of repatriation. If the pound were held by a British financial institution, the dollars would be called eurodollars, therefore, when converting those eurodollars back to dollars, the investor would be exposed to foreign exchange risk

repatriable
Definition
The ability to move an asset from a foreign country to an investor's home country. Assets such as cash are repatriable; assets such as real estate are not. Some countries have laws that prohibit repatriation of certain assets.
Read more: http://www.investorwords.com/18494/repatriable.html#ixzz1lT9SXKuP

What Is Repatriation of Profits?

By Victoria Duff, eHow Contributor

y y y y Print this article Repatriation of profits is the movement of profits made in a business or investment in a foreign country, back to the country of origin. For example: if a U.S. corporation does business in France and makes a profit, it may wish to repatriate that money from France back to the U.S.

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Tax Saver Deposits Vat Tax

1. Function
o

Profits are normally repatriated to protect against expropriation, or to take advantage of currency fluctuation.

Significance
o

Repatriation of profits often has tax consequences. It is possible that the country where the profits are earned will tax them and so will the country of origin when the money is brought onshore.

Benefits
o

A company may find that it can increase its U.S. dollar-denominated profits by repatriating offshore profits. It works if the profits are denominated in expensive foreign currency and the company buys inexpensive dollars with that currency.

Considerations
o

Taxes on repatriated profits are occasionally reduced or omitted during economic crisis in order to stimulate recovery by adding money to the economy. The Information Technology Industry Council, in a January 2009 white paper, estimated that $565 billion in offshore profits that would ordinarily remain offshore, would be repatriated to the U.S. if taxes were temporarily reduced.

Misconceptions
o

Repatriation of profits does not always mean the money goes directly into the economy. Often it is simply the bookkeeping transfer of cash assets from one account to another within the same bank with the only difference being that one account has a foreign address and the other account has a domestic address.

Read more: What Is Repatriation of Profits? | eHow.com http://www.ehow.com/facts_5900045_repatriationprofits_.html#ixzz1lTCFUD8h

LIBOR
Definition
London Inter-Bank Offer Rate. The interest rate that the banks charge each other for loans (usually in Eurodollars). This rate is applicable to the shortterm international interbank market, and applies to very large loans borrowed for anywhere from one day to five years. This market allows banks with liquidityrequirements to borrow quickly from other banks with surpluses, enabling banks to avoid holding excessively large amounts of their asset base as liquid assets.

The LIBOR is officially fixed once a day by a small group of large London banks, but the rate changes throughout the day.
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What is capital account convertibility?

There is no formal definition of capital account convertibility (CAC). The Tarapore committee set up by the Reserve Bank of India (RBI) in 1997 to go into the issue of CAC defined it as the freedom to convert local financial assets into foreign financial assets and vice versa at market determined rates of exchange. In simple language what this means is that CAC allows anyone to freely move from local currency into foreign currency and back. How is CAC different from current account convertibility? Current account convertibility allows free inflows and outflows for all purposes other than for capital purposes such as investments and loans. In other words, it allows residents to make and receive trade-related payments receive dollars (or any other foreign currency) for export of goods and services and pay dollars for import of goods and services, make sundry remittances, access foreign currency for travel, studies abroad, medical treatment and gifts etc. In India, current account convertibility was established with the acceptance of the obligations under Article VIII of the IMFs Articles of Agreement in August 1994. Can CAC coexist with restrictions? Contrary to general belief, CAC can coexist with restrictions other than on external payments. It does not preclude the imposition of any monetary/fiscal measures relating to forex transactions that may be warranted from a prudential point of view. Why is CAC such an emotive issue? CAC is widely regarded as one of the hallmarks of a developed economy. It is also seen as a major comfort factor for overseas investors since they know that anytime they change their mind they will be able to re-convert local currency back into foreign currency and take out their money. In a bid to attract foreign investment, many developing countries went in for CAC in

the 80s not realising that free mobility of capital leaves countries open to both sudden and huge inflows as well as outflows, both of which can be potentially destabilising. More important, that unless you have the institutions, particularly financial institutions, capable of dealing with such huge flows countries may just not be able to cope as was demonstrated by the East Asian crisis of the late nineties. Following the East Asian crisis, even the most ardent votaries of CAC in the World Bank and the IMF realised that the dangers of going in for CAC without adequate preparation could be catastrophic. Since then the received wisdom has been to move slowly but cautiously towards CAC with priority being accorded to fiscal consolidation and financial sector reform above all else. In India, the Tarapore committee had laid down a three-year road-map ending 19992000 for CAC. It also cautioned that this time-frame could be speeded up or delayed depending on the success achieved in establishing certain pre-conditions primarily fiscal consolidation, strengthening of the financial system and a low rate of inflation. With the exception of the last, the other two pre-conditions have not yet been achieved. What is the position in India today? Convertibility of capital for non-residents has been a basic tenet of Indias foreign investment policy all along, subject of course to fairly cumbersome administrative procedures. It is only residents both individuals as well as corporates who continue to be subject to capital controls. However, as part of the liberalisation process the government has over the years been relaxing these controls. Thus, a few years ago, residents were allowed to invest through the mutual fund route and corporates to invest in companies abroad but within fairly conservative limits. Buoyed by the very comfortable build-up of forex reserves, the strong GDP growth figures for the last two quarters and the fact that progressive relaxations on current account transactions have not lead to any flight of capital, on Friday the government announced further relaxations on the kind and quantum of investments that can be made by residents abroad. These relaxations are to be reviewed after six months and if the experience is not adverse, we may see further liberalisation and in the not-toodistant future full CAC.

Current account convertibility refers to freedom in respect of Payments and transfers for current international transactions. In other words, if Indians are allowed to buy only foreign goods and services but restrictions remain on the purchase of assets abroad, it is only current account convertibility. As of now, convertibility of the rupee into foreign currencies is almost wholly free for current account i.e. in case of transactions such as trade, travel and tourism, education abroad etc. The government introduced a system of Partial Rupee Convertibility (PCR) (Current Account Convertibility) on February 29,1992 as part of the Fiscal Budget for 1992-93. PCR is designed to provide a powerful boost to export as well as to achieve as efficient import substitution. It is designed to reduce the scope for bureaucratic controls, which contribute to delays and inefficiency. Government liberalized the flow of foreign exchange to include items like amount of foreign currency that can be procured for purpose like travel abroad, studying abroad, engaging the service of foreign consultants etc. What it means that people are allowed to have access to foreign currency for buying a whole range of consumables products and services. These relaxations coincided with the liberalization on the industry and commerce front which is why we have Honda City cars, Mars chocolate and Bacardi in India. Components of Current Account Covered in the current account are all transactions (other than those in financial items) that involve economic values and occur between resident non-resident entities. Also covered are offsets to current economic values provided or acquired without a quid pro quo. Specifically, the major classifications aregoods and services, income, and current transfers. 1. Goods and services Goods y General merchandise covers most movable goods that residents export to, or import from, non residentsand that, with a few specified exceptions, undergo changes in ownership (actual or imputed). y Goods for processing covers exports (or, in the compiling economy, imports) of goods crossing the frontier for processing abroad and subsequent re-import (or, in the compiling economy, export) of the goods, which are valued on a gross basis before and after processing. The treatment of this item in thegoods account is an exception to the change of ownership principle. y Repairs on goods covers repair activity on goods provided to or received from non residents on ships, aircraft, etc. repairs are valued at the prices (fees paid or received) of the repairs and not at the gross values of the goods before and after repairs are made. y Goods procured in ports by carriers covers all goods (such as fuels, provisions, stores, and supplies) that resident/nonresident carriers (air, shipping, etc.) procure abroad or in the compiling economy. The classification does not cover auxiliary services (towing, maintenance, etc.), which are covered under transportation. y Nonmonetary gold covers exports and imports of all gold not held as reserve assets (monetary gold) by the authorities. Nonmonetary gold is treated the same as any other commodity and, when feasible, is subdivided into gold held as a store of value and other (industrial) gold. Services

Transportation covers most of the services that are performed by residents for nonresidents (and vice versa) and that were included in shipment and other transportation in the fourth edition of the Manual. However, freight insurance is now included with insurance services rather than with transportation. Transportation includes freight and passenger transportation by all modes of transportation and other distributive and auxiliary services, including rentals of transportation equipment with crew.

Travel covers goods and servicesincluding those related to health and educationacquired from an economy by non resident travelers (including excursionists) for business and personal purposes during their visits (of less than one year) in that economy. Travel excludes international passenger services, which are included in transportation. Students and medical patients are treated as travelers, regardless of the length of stay. Certain othersmilitary and embassy personnel and non resident workersare not regarded as travelers. However, expenditures by non resident workers are included in travel, while those of military and embassy personnel are included in government services

Communications services covers communications transactions between residents and nonresidents. Such services comprise postal, courier, and telecommunications services (transmission of sound, images, and other information by various modes and associated maintenance provided by/for residents for/by non residents).

Construction services covers construction and installation project work that is, on a temporary basis, performed abroad/in the compiling economy or in Extra territorial enclaves by resident/non resident enterprises and associated personnel. Such work does not include that undertaken by a foreign affiliate of a resident enterprise or by an unincorporated site office that, if it meets certain criteria, is equivalent to a foreign affiliate.

Insurance services covers the provision of insurance to non residents by resident insurance enterprises and vice versa. This item comprises services provided for freight insurance (on goods exported and imported), services provided for other types of direct insurance (including life and non-life), and services provided for reinsurance.

Financial services (other than those related to insurance enterprises and pension funds) covers financial intermediation services and auxiliary services conducted between residents and nonresidents. Included are commissions and fees for letters of credit, lines of credit, financial leasing services, foreign exchange transactions, consumer and business credit services, brokerage services, underwriting services, arrangements for various forms of hedging instruments, etc. Auxiliary services include financial market operational and regulatory services, security custody services, etc.

Computer and information services covers resident/non resident transactions related to hardware consultancy, software implementation, information services (data processing, data base, news agency), and maintenance and repair of computers and related equipment.

Royalties and license fees covers receipts (exports) and payments (imports) of residents and nonresidents for (i) the authorized use of intangible non produced, nonfinancial assets and proprietary rightssuch as trademarks, copyrights, patents, processes, techniques, designs, manufacturing rights, franchises, etc. and (ii) the use, through licensing agreements, of produced originals or prototypes such as manuscripts, films, etc.

Other business services provided by residents to nonresidents and vice versa covers merchanting and other trade-related services; operational leasing services; and miscellaneous business, professional, and technical services.

Personal, cultural, and recreational services covers (i) audiovisual and related services and (ii) other cultural services provided by residents to non-residents and vice versa. Included under (i) are services associated with the production of motion pictures on films or video tape, radio and television programs, and musical recordings. (Examples of these services are rentals and fees received by actors, producers, etc. for productions and for distribution rights sold to the media.) Included under (ii) are other personal, cultural, and recreational servicessuch as those associated with libraries, museumsand other cultural and sporting activities.

Government services i.e. covers all services (such as expenditures of embassies and consulates) associated with government sectors or international and regional organizations and not classified under other items. 2. Income

Compensation of employees covers wages, salaries, and other benefits, in cash or in kind, and includes those of border, seasonal, and other non-resident workers (e.g., local staff of embassies).

Investment income covers receipts and payments of income associated, respectively, with residents holdings of external financial assets and with residents liabilities to nonresidents. Investment income consists of direct investment income, portfolio investment income, and other investment income. The direct investment component is divided into income on equity (dividends, branch profits, and reinvested earnings) and income on debt (interest); portfolio investment income is divided into income on equity (dividends) and income on debt (interest); other investment income covers interest earned on other capital (loans, etc.) and, in principle, imputed income to households from net equity in life insurance reserves and in pension funds. 3. Current transfers Current transfers are distinguished from capital transfers, which are included in the capital andfinancial account in concordance with the SNA treatment of transfers. Transfers are the offsets to changes, which take place between residents and nonresidents, in ownership of real resources or financial items and, whether the changes are voluntary or compulsory, do not involve a quid pro quo in economic value. Current transfers consist of all transfers that do not involve (i) transfers of ownership of fixed assets; (ii) transfers of funds linked to, or conditional upon, acquisition or disposal of fixed assets; (iii)

forgiveness,without any counterparts being received in return, of liabilities by creditors. All of these are capital transfers. Current transfers include those of general government (e.g., current international cooperation between different governments, payments of current taxes on income and wealth, etc.), and other transfers (e.g., workers remittances, premiumsless service charges, and claims on non-life insurance). A full discussion of the distinction between current transfers and capital transfers.

Capital account convertibility

From Wikipedia, the free encyclopedia

Capital account convertibility is a feature of a nation's financial regime that centers on the ability to conduct transactions of local financial assets into foreign financial assets freely and at market determined exchange rates.[1] It is sometimes referred to as capital asset liberation or CAC. In layman's terms, full capital account convertibility allows local currency to be exchange for foreign currency without any restriction on the amount.[citation needed] This is so local merchants can easily conduct transnational business without needing foreign currency exchanges to handle small transactions.[citation needed] CAC is mostly a guideline to changes of ownership in foreign or domestic financial assets and liabilities. Tangentially, it covers and extends the framework of the creation and liquidation of claims on, or by the rest of the world, on local asset and currency markets.[2]
Contents
[hide]

1 History 2 Tenets 3 Application 4 Controversy 5 References

[edit]History
CAC was first coined as a theory by the Reserve Bank of India in 1997 by the Tarapore Committee, in an effort to find fiscal and economic policies that would enable developing Third World countries transition to globalized market economies.[3] However, it had been practiced, although without formal thought or organization of policy or restriction, since the very early 90's. Article VIII of the IMFs Articles of Agreement is agreed by most economists to have been the basis for CAC, although it notably failed to anticipate problems with the concept in regard to outflows of currency.

However, before the formalization of CAC, there were problems with the theory. Free flow of assets was required to work in both directions. Although CAC freely enabled investment in the country, it also enabled quick liquidation and removal of capital assets from the country, both domestic and foreign. It also exposed domestic creditors to overseas credit risks, fluctuations in fiscal policy, and manipulation.[4] As a result, there were severe disruptions that helped to contribute to the East Asian crisis of the mid 90's. In Malaysia, for example, there were heavy losses in overseas investments of at least one bank, in the magnitude of hundreds of millions of dollars. These were not realized and identified until a reform system strengthened regulatory and accounting controls.[5] This led to the Tarapore Committee meeting which formalized CAC as utilizing a mixture of free asset allocation and stringent controls.[4]

[edit]Tenets
CAC has 5 basic statements designed as points of action:[6] All types of liquid capital assets must be able to be exchanged freely, between any two nations in the world, with standardized exchange rates.

   

The amounts must be a significant amount (in excess of $500,000). Capital inflows should be invested in semi-liquid assets, to prevent churning and excessive outflow. Institutional investors should not use CAC to manipulate fiscal policy or exchange rates. Excessive inflows and outflows should be buffered by national banks to provide collateral.

[edit]Application
In most traditional theories of international trade, the reasoning for capital account convertibility was so that foreign investors could invest without barriers. Prior to its implementation, foreign investment was hindered by uneven exchange rates due to corrupt officials, local businessmen had no convenient way to handle large cash transactions, and national banks were disassociated from fiscal exchange policy and incurred high costs in supplying hard-currency loans for those few local companies that wished to do business abroad. Due to the low exchange rates and lower costs associated with Third World nations, this was expected to spur domestic capital, which would lead to welfare gains, and in turn lead to higher GDP growth. The tradeoff for such growth was seen as a lack of sustainable internal GNP growth and a decrease in domestic capital investments.[7] When CAC is used with the proper restraints, this is exactly what happens. The entire outsourcing movement with jobs and factories going overseas is a direct result of the foreign investment aspect of CAC. The Tarapore Committee's recommendation of tying liquid assets to static assets (i.e., investing in long term government bonds, etc) was seen by many economists as directly responsible for stabilizing the idea of capital account liberalization.

[edit]Controversy
Despite changes in wording over the years, and additional safeguards, there is still criticism of CAC by some economists. American economists, in particular, find the restriction on inflows to Third World countries being invested in improvements as negative, since they would rather see such transactions put to direct use in growing capital.[4][2]

[edit]References

Big Mac Index

How Far from Fair Value is Your Currency?
The Economist's Big Mac Index (July 28th, 2011 Big Mac prices) valued at today's exchange rates Country Big Mac Price in Local Currency United States Argentina Australia Brazil Britain Canada Chile China Colombia Czech Republic Denmark Egypt $ 4.07 Peso 20.0 A$ 4.56 Real 9.50 2.39 C$ 4.73 Peso 1850 Yuan 14.7 Peso 8400 Koruna 69.3 DK 28.5 Pound 14.1 in US dollars
Implied PPP rate + Today's Exchange Rate 1 USD = Over(+) / Under(-) Valuation against the USD, % ++

4.0700 4.6105 4.8880 5.5143 3.7787 4.7381 3.8606 2.3336 4.6693 3.6351 5.0371 2.3290

--4.92 1.12 2.34 0.59 1.16 455 3.60 2066 17.1 7.01 3.47

1.0000 4.3379 0.9329 1.7228 0.6325 0.9983 479.200 6.2993 1798.98 19.0643 5.6580 6.0541

--13.4189 20.0557 35.8254 -6.7194 16.1975 -5.0501 -42.8508 14.8429 -10.3036 23.8954 -42.6835

Euro area Hong Kong Hungary India Indonesia Israel Japan Malaysia Mexico New Zealand Norway Pakistan Peru Philippines Poland Russia Saudi Arabia Singapore South Africa South Korea Sweden Switzerland Taiwan

3.44 HK$ 15.1 Forint 760 Rupee 84.0

4.5198 1.9470 3.4237 1.7014

0.85 3.71 187 20.7 5543 3.91 78.7 1.77 7.87 1.25 11.1 50.5 2.46 29.0 2.12 18.5 2.46 1.08 4.78 910 11.9 1.60 18.5

0.7611 7.7557 221.983 49.3697 8992.81 3.7178 76.3280 3.0184 12.7876 1.2006 5.8252 90.8061 2.7028 42.6704 3.1871 30.2397 3.7506 1.2459 7.6242 1118.69 6.7246 0.9177 29.5795

11.6805 -52.1642 -15.7593 -58.0714 -38.3619 5.1697 3.1076 -41.3597 -38.4560 4.1146 90.5514 -44.3870 -8.9833 -32.0372 -33.4818 -38.8221 -34.4105 -13.3157 -37.3049 -18.6549 76.9622 74.3489 -37.4567

Rupiah 22534 2.5058 Shekel 15.9 320 Ringgit 7.20 Peso 32.0 NZ$ 5.10 Kroner 45.0 Rupee 205 4.2767 4.1924 2.3854 2.5024 4.2479 7.7251 2.2576

New Sol 10.0 3.6999 Peso 118 Zloty 8.63 Rouble 75.0 Riyal 10.0 S\$ 4.41 Rand 19.45 Won 3700 SKr 48.4 SFr 6.5 NT$ 75.0 2.7654 2.7078 2.4802 2.6662 3.5396 2.5511 3.3074 7.1975 7.0829 2.5355

Thailand Turkey

Baht 70.0 Lire 6.5

2.2615 3.6995

17.2 1.60

30.9524 1.7570

-44.4308 -8.9357

+ The Purchasing Power Parity (PPP) rate is the local Big Mac price divided by its price in the United States. Prices and their corresponding implied PPP rates are the latest figures available from The Economist. ++ The Over/Under valuation against the dollar is calculated as follows using OANDA's latest rates: 100 x (PPP - Exchange Rate) / Exchange Rate

What is the Big Mac Index?

The Economist uses the price of the ubiquitous McDonald's meal to calculate the "Big Mac Index", a guide showing how far from fair value different world currencies are. The Big Mac theory (a.k.a. purchasing-power parity, or PPP) says that exchange rates should even out the prices of Big Macs sold across the world. The implied PPP shown in the table is the exchange rate that would make a Big Mac cost the same abroad as it does in the USA. When you compare actual exchange rates with the implied PPP rate, you will see that most currencies are trading way above or below the US dollar, meaning that they are over- or undervalued. Keep in mind that PPP is a long-term indicator, pointing to where currencies ought to go in the future. (It's also best to use it only to measure currencies between countries that are at a similar stage of development.)
How to read this table

If a Big Mac costs 3.38 in countries that use the euro and $3.73 in the US, then the implied PPP rate is 3.38/3.73 = 0.91. If the actual exchange rate for the euro is lower that the implied PPP rate, the Big Mac theory suggests that the value of the euro might go up until it reaches the implied PPP rate. If the actual exchange rate is higher, then you might expect the euro to go down until it hits the implied PPP rate. The percentage of under- and over-valuation from the current exchange rate is shown in the table.
TRY ALSO...

y y y y

Travel Exchange Rates

Historical Exchange Rates Currency Graph Money Transfers

Gresham's law
From Wikipedia, the free encyclopedia

Gresham's law is an economic principle that states: "When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation."[1] It is commonly stated as: "Bad money drives out good", but is more accurately stated: "Bad money drives out good if their exchange rate is set by law." This law applies specifically when there are two forms of commodity money in circulation which are required by legal-tender laws to be accepted as having similar face values for economic transactions. The artificially overvalued money tends to drive an artificially undervalued money out of circulation[2] and is a consequence of price control. Gresham's law is named after Sir Thomas Gresham (15191579), who was an English financier during the Tudor dynasty. However, the law had been stated forty years earlier byNicolaus Copernicus. In Poland it is known as the Copernicus-Gresham Law. The phenomenon had been noted even earlier, in the 14th century, by Nicole Oresme. This notion was developed also during the time of the Mamluk Empire. Specifically, it was developed by the Muslim jurist and historian Al-Maqrizi (1364-1442) who wrote about a particular period in the Mamluk dynasty when the rulers were simultaneously increasing the supply of a lower valued (copper) currency and hoarding the more valued (gold and silver) currencies[3]. This can be found in his work titled "Study of the Monetary System". The fact of bad money being used in preference to good money is also noted by Aristophanes in his play The Frogs, which dates from around the end of the 5th century BC.
Contents
[hide]

1 'Good' money and 'bad' money 2 Examples 3 Theory 4 History of the concept

o o

4.1 Origin of the name 4.2 Precursors

5 Ibn Taymiyyah 6 Reverse of Gresham's Law (Thiers' Law) 7 Application 8 Other versions of Gresham's law 9 See also 10 Notes

11 References 12 External links

[edit]'Good'

money and 'bad' money

"Good" money is money that shows little difference between its nominal value (the face value of the coin) and its commodity value (the value of the metal of which it is made, oftenprecious metals, nickel, or copper.) In the absence of legal-tender laws, metal coin money will freely exchange at somewhat above bullion market value. This is not a purely theoretical result but may instead be observed today in bullion coins such as the Canadian Gold Maple Leaf, the South African Krugerrand, the American Gold Eagle, or even the silver Maria Theresa thaler (Austria). Coins of this type are of a known purity and are in a convenient form to handle. People prefer trading in coins rather than in anonymous hunks of precious metal, so they attribute more value to the coins of equal weight. The price spread between face value and commodity value is called seigniorage. Since some coins do not circulate, remaining in the possession of coin collectors, this can increase demand for coinage. On the other hand, "bad" money is money that has a commodity value considerably lower than its face value and is in circulation along with good money, where both forms are required to be accepted at equal value as legal tender. In Gresham's day, bad money included any coin that had been debased. Debasement was often done by the issuing body, where less than the officially specified amount of precious metal was contained in an issue of coinage, usually by alloying it with a base metal. The public could also debase coins, usually by clipping or scraping off small portions of the precious metal. Other examples of "bad" money include counterfeit coins made from base metal. In the case of clipped, scraped, or counterfeit coins, the commodity value was reduced by fraud, as the face value remains at the previous higher level. On the other hand, with a coinage debased by a government issuer, the commodity value of the coinage was often reduced quite openly, while the face value of the debased coins was held at the higher level by legal tender laws.

[edit]Examples
Silver coins were widely circulated in Canada (until 1968) and in the United States (until 1964 for dimes and quarters and 1971 for half-dollars). However, these countries debased their coins by switching to cheaper metals as the market value of silver rose above that of the face value. The silver coins disappeared from circulation as citizens retained them to capture the higher current or perceived future intrinsic value of the metal content over their face value, using the newer coins in daily transactions. In the late 1970s, the Hunt brothers attempted tocorner the worldwide silver market but failed, temporarily driving the price far above its

historic levels and intensifying the extraction of silver coins from circulation.[4] The same process occurs today with the copper content of coins such as the pre-1997 Canadian penny, the U.S. one-cent coin and the pre1992 UK copper pennies and halfpence. This also occurred even with coins made of less expensive metals such as steel in India.[5]

[edit]Theory
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. This is because people spending money will hand over the "bad" coins rather than the "good" ones, keeping the "good" ones for themselves. Legal tender laws act as a form of price control. In such a case, the artificially overvalued money is preferred in exchange, because people prefer to save rather than exchange the artificially demoted one (which they actually value higher). Consider a customer purchasing an item which costs five pence, who possesses several silver sixpence coins. Some of these coins are more debased, while others are less sobut legally, they are all mandated to be of equal value. The customer would prefer to retain the better coins, and so offers the shopkeeper the most debased one. In turn, the shopkeeper must give one penny in change, and has every reason to give the most debased penny. Thus, the coins that circulate in the transaction will tend to be of the most debased sort available to the parties. If "good" coins have a face value below that of their metallic content, individuals may be motivated to melt them down and sell the metal for its higher intrinsic value, even if such destruction is illegal. As an example, consider the 1965 United States half dollar coins, which contained 40% silver. In previous years, these coins were 90% silver. With the release of the 1965 half dollar, which was legally required to be accepted at the same value as the earlier 90% halves, the older 90% silver coinage quickly disappeared from circulation, while the newer debased coins remained in use. As the price of bullion silver continued to rise above the face value of the coins, many of the older half dollars were melted down. Beginning in 1971, the U.S. government gave up on including any silver in the half dollars, as even the metal value of the 40% silver coins began to exceed their face value. A similar situation occurred in 2007 in the United States with the rising price of copper and zinc, which led the U.S. government to ban the melting or mass exportation of one-cent andfive-cent coins, respectively. In addition to being melted down for its bullion value, money that is considered to be "good" tends to leave an economy through international trade. International traders are not bound by legal tender laws as citizens of the issuing country are, so they will offer higher value for good coins than bad ones. The good coins may leave their country of origin to become part of international trade, escaping that country's legal tender laws and leaving the "bad" money behind. This occurred in Britain during the period of the gold standard.

[edit]History

of the concept

The law was named after Sir Thomas Gresham, a sixteenth century financial agent of the English Crown in the city of Antwerp, to explain to Queen Elizabeth I what was happening to the English shilling. Her father, Henry VIII, had replaced 40 percent of the silver in the coin with base metals, to increase the governments income without raising taxes. Astute English merchants and even ordinary subjects would save the good shillings from pure silver and circulate the bad ones; hence, the bad money would be used whenever possible, and the good coinage would be saved and disappear from circulation.[6] Gresham was not the first to state the law which took his name. The phenomenon had been noted much earlier, in the 14th century, by Nicole Oresme. In the year that Gresham was born, 1519, it was described by Nicolaus Copernicus in a treatise called Monetae cudendae ratio: "bad (debased) coinage drives good (undebased) coinage out of circulation." Copernicus was aware of the practice of exchanging bad coins for good ones and melting down the latter or sending them abroad, and he seems to have drawn up some notes on this subject while he was at Olsztyn in 1519. He made them the basis of a report in German which he presented to the Prussian Diet held in 1522 at Grudzi dz, attending the session with his friend Tiedemann Giese to represent his chapter. Copernicus's Monetae cudendae ratio was an enlarged, Latin version of that report, setting forth a general theory of money for the 1528 diet. He also formulated a version of the quantity theory of money.[7] According to the economist George Selgin in his paper "Gresham's Law": As for Gresham himself, he observed "that good and bad coin cannot circulate together" in a letter written to Queen Elizabeth on the occasion of her accession in 1558. The statement was part of Gresham's explanation for the "unexampled state of badness" England's coinage had been left in following the "Great Debasements" of Henry VIII andEdward VI, which reduced the metallic value of English silver coins to a small fraction of what it had been at the time of Henry VII. It was owing to these debasements, Gresham observed to the Queen, that "all your fine gold was convayed out of this your realm."[8] This notion was also developed during the time of the Mamluk Empire, as noted above. Gresham made his observations of good and bad money while in the service of Queen Elizabeth, with respect only to the observed poor quality of British coinage. The earlier monarchs, Henry VIII and Edward VI, had forced the people to accept debased coinage by means of their legal tender laws. Gresham also made his comparison of good and bad money where the precious metal in the money was the same metal, but of different weight. He did not compare silver to gold, or gold to paper.

[edit]Origin

of the name

In his "Gresham's Law" article, Selgin also offers the following comments regarding the origin of the name:

The expression "Gresham's Law" dates back only to 1858, when British economist Henry Dunning Macleod (1858, p. 4768) decided to name the tendency for bad money to drive good money out of circulation after Sir Thomas Gresham (15191579). However, references to such a tendency, sometimes accompanied by discussion of conditions promoting it, occur in various medieval writings, most notably Nicholas Oresme's (c. 1357) Treatise on money. The concept can be traced to ancient works, including Aristophanes' The Frogs, where the prevalence of bad politicians is attributed to forces similar to those favoring bad money over good.[8] The referenced passage from The Frogs is as follows (usually dated at 405 BCE): The course our city runs is the same towards men and money. She has true and worthy sons. She has fine new gold and ancient silver, Coins untouched with alloys, gold or silver, Each well minted, tested each and ringing clear. Yet we never use them! Others pass from hand to hand, Sorry brass just struck last week and branded with a wretched brand. So with men we know for upright, blameless lives and noble names. These we spurn for men of brass...

[edit]Precursors
Ancient Sources Describing the Currency Devaluation Phenomenon The currency devaluation phenomenon was already stated in ancient sources. Following are a few examples:[9] The Bible 1. Machpela Cave transaction: Genesis 23:16: Abraham weighed to Ephron the silver four hundred shekels of silver, according to the current merchants' standard. According to Greshams law, one can understand that Abraham, who promised Ephron (in Genesis 23:9) full payment, gave him good money - in market and wallet altogether. Not only did Abraham agree to pay the price Ephron had set, he even paid it with good money, for the market and the wallet altogether.

2. The building of the Temple

Kings I 10:21 All King Solomon's drinking vessels were of gold, and all the vessels of the house of the forest of Lebanon were of pure gold; none were of silver; it was nothing accounted of in the days of Solomon. The fact that silver metal was used as a method of payment in ancient Israel, one can learn from this verse and from the double meaning of the word kesef (in Hebrew: money, silver). In the days of Solomon there was high inflation as far as this metal (silver) was concerned. The balance between the metals - silver and gold, which were used among other things as means of payment, was broken so bad against the silver metal until It was nothing accounted of. Silver was nothing accounted of indicates a situation of hyper-inflation (in terms of silver metal) in the days of King Solomon, and can shed light on the background to the division of the kingdom after him. Since under these conditions, the distribution of the nations resources and wealth changes radically, the people become impoverished, and the kingdom crumbles down, just like a disease or a fire which damages are felt only after they have occurred. One should note that throughout generations and transcripts of the bible, the words according to the current commercial standard and Nothing were never dropped, although seemingly, they do not contain any additional information.

The Mishna 3. The Mishna Bava Metzia Bava Metzia 4:1 Bad coins acquire good coins, but good coins do not acquire bad coins; This source describes the same phenomenon described by the Gresham law, though no explanation is given to this phenomenon. The writers of Mishnva have probably not fully grasped the dynamics behind the phenomenon, but merely stated it.

[edit]Ibn

Taymiyyah

Ibn Taimiyyah (12631328) described the phenomenon as follows: If the ruler cancels the use of a certain coin and mints another kind of money for the people, he will spoil the riches (amwal) which they possess, by decreasing their value as the old coins will now become merely a commodity. He will do injustice to them by depriving them of the higher values originally owned by them. Moreover, if the intrinsic value of coins are different it will become a source of profit for the wicked to collect the small (bad) coins and exchange them (for good money) and then they will take them to another country and shift the small (bad) money of that country (to this country). So (the value of) people's goods will be damaged.

Notably this passage mentions only the flight of good money abroad and says nothing of its disappearance due to hoarding or melting.[10]

[edit]Reverse

of Gresham's Law (Thiers' Law)

In an influential theoretical article, Rolnick and Weber (1986) argued that bad money would drive good money to a premium rather than driving it out of circulation. However their research did not take into account the context in which Gresham made his observation. Rolnick and Weber ignored the influence of legal tender legislation which requires people to accept both good and bad money as if they were of equal value. They also focused mainly on the interaction between different metallic monies, comparing the relative "goodness" of silver to that of gold, which is not what Gresham was speaking of. The experiences of dollarization in countries with weak economies and currencies (for example Israel in the 1980s, Eastern Europe and countries in the period immediately after the collapse of the Soviet bloc, or South American countries throughout the late 20th and early 21st century) may be seen as Gresham's Law operating in its reverse form (Guidotti & Rodriguez, 1992), since in general the dollar has not been legal tender in such situations, and in some cases its use has been illegal. Adam Fergusson pointed out that in 1923 during the great Inflation in the Weimar Republic Gresham's Law began to work in reverse, since the official money became so worthless that virtually nobody would take it. This was particularly serious since farmers began to hoard food. Accordingly, any currencies backed by any sorts of value became the circulating mediums of exchange.[11] In 2009 Hyperinflation in Zimbabwe began to show similar characteristics. These examples show that in the absence of effective legal tender laws, Gresham's Law works in reverse. If given the choice of what money to accept, people will transact with money they believe to be of highest longterm value. However, if not given the choice, and required to accept all money, good and bad, they will tend to keep the money of greater perceived value in their possession, and pass on the bad money to someone else. In short, in the absence of legal tender laws, the seller will not accept anything but money of certain value (good money), while the existence of legal tender laws will cause the buyer to offer only money with the lowest commodity value (bad money) as the creditor must accept such money at face value.[12] The Nobel prize-winner Robert Mundell believes that Gresham's Law could be more accurately rendered, taking care of the reverse, if it were expressed as, "Bad money drives out good if they exchange for the same price."[13] The reverse of Gresham's Law, that good money drives out bad money whenever the bad money becomes nearly worthless, has been named "Thiers' Law" by economist Peter Bernholz, in honor of French politician and historian Adolphe Thiers.[14] "Thiers' Law will only operate later [in the inflation] when the increase of the new flexible exchange rate and of the rate of inflation lower the real demand for the inflating money."[15]

[edit]Application
The principles of Gresham's law can sometimes be applied to different fields of study. Gresham's law may be generally applied to any circumstance in which the "true" value of something is markedly different from the value people are required to accept, due to factors such as lack of information or governmental decree. In the market for used cars, lemon automobiles (analogous to bad currency) will drive out the good cars.[16] The problem is one of asymmetry of information. Sellers have a strong financial incentive to pass all used cars off as "good" cars, especially lemons. This makes it difficult to buy a good car at a fair price, as the buyer risks overpaying for a lemon. The result is that buyers will only pay the fair price of a lemon, so at least they reduce the risk of overpaying. High-quality cars tend to be pushed out of the market, because there is no good way to establish that they really are worth more. Certified pre-owned programs are an attempt to mitigate this problem by providing a warranty and other guarantees of quality. "The Market for Lemons" is a work that examines this problem in more detail. Some also use an explanation of Gresham's Law as "The more efficient you become, the less effective you get"; i.e. "when you try to go on the cheap, you will stop selling" or "the less you invest in your non-tangible services, the fewer sales you will get". Vice President Spiro Agnew, used Gresham's law in describing American news media, stating that "Bad news drives out good news," although his argument was closer to that of a race to the bottom for higher ratings rather than over and undervaluing certain kinds of news.[17] Gresham's law has been cited as "Silver currency will inevitably force gold currency out of circulation" (L. Pyenson, Servants of Nature (W.W. Norton, 1999) p. 21); this suggests a fundamental misinterpretation, cf. Mundell (above).

[edit]Other

versions of Gresham's law

A work of Taqiuddin Ahmad al-Maqrizi in the 14th century also mentioned that bad money drives away the good money from the market, because people tend to use bad money for transactions and save the good money. Al-Maqrizi found this happening in Egypt and analysed the phenomenon.[citation needed]