If you have been with us for a long time, you would know that we cover gold extensively. If you have not already, we suggest that you read our guide, Why should you invest in gold?, before reading the rest of this article. The material for today’s article comes from Professor Murray Rothbard’s book, What Has Government Done to Our Money?.

Today, we will talk about gold’s troublesome sister, silver. As we quoted the late Professor Murray Rothbard in our earlier article, What about silver?,

It is very possible that the market, given free rein, might eventually establish one single metal as money. But in recent centuries, silver stubbornly remained to challenge gold.

Why did silver stubbornly remain in circulation as money? As Professor Murray Rothbard continued,

Silver remained in circulation precisely because it was convenient (for small change, for example).

As we said before in Properties of good money, a commodity has to be sufficiently rare to qualify as money. But it cannot be too rare. Silver, the less rare sister of gold, was useful for smaller transactions because gold was too rare for further smaller sub-divisions.

Hence, in the free market of the past, both gold and silver circulated side-by-side,

The relative supplies of and demands for the two metals will determine the exchange rate between the two, and this rate, like any other price, will continually fluctuate in response to these changing forces. At one time, for example, silver and gold ounces might exchange at 16:1, another time at 15:1, etc.

In that sense, we can see gold and silver as two different ‘currencies’ whose values fluctuated freely against one another according to the free market. But then, the government came in to ‘help’ the market to ‘simplify’ matters by fixing the exchange rate between gold and silver. The fixed gold-silver ratio was known as bimetallism. The next step after bimetallism was to give specific weight of gold (and silver) a national name (e.g. dollar, pound, etc). Once these national names (instead of a specific weight of gold and silver) take root, it eventually became an abstract unit of value of its own, thereby losing its original meaning in terms of a specific weight of gold and silver. Eventually, these abstract units became the national currencies of today.

Bimetallism helped the government to manipulate money. But it introduced its own set of problems. The free market’s exchange rate between gold and silver would always be freely fluctuating, depending on the supply and demand relative to each other at each instance of time. But by fixing the exchange ratio between them, it introduced the situation whereby one will always be artificially undervalued or overvalued relative to each other. When that happens, Gresham’s law will kick in (see Artificially undervalued coins: government interference cripple the free market for an explanation of Gresham’s law), which resulted in the state of affairs that Rothbard described,

Gold then disappears into cash balance, black market, or exports, when silver flows in from abroad and comes out of cash balances to become the only circulating currency in Ruritania [hypothetical country used as an example]. For centuries, all countries struggled with calamitous effects of suddenly alternating metallic currencies. First silver would flow in and gold disappear; then, as the relative market ratios changed, gold would pour in and silver disappear.

Eventually, what happened? As Rothbard continued,

Finally, after weary centuries of bimetallic disruption, governments picked one metal as the standard, generally gold. Silver was relegated to “token coin” status, for small denominations, but not at full weight.

The next question for investors is this: assuming that one day the world will return to the gold standard, will silver regain its free-market status as secondary money? We will explore more on this idea next…