Posts Tagged ‘Gresham’s Law’

Third turning point for silver

Sunday, May 31st, 2009

Today, we will continue on the topic of silver investment. This article will form part of a series on silver. In this series, we will explain why we believe silver is going to be a great investment in the coming years, probably even better than gold. As we travel along this series, we will collate the articles in a guide, Why silver will be a better investment than gold in the coming years?.

Previously, in What determines the gold-silver ratio?, we talked about the current and average historic ratio between gold and silver. Today, we will talk about what’s happening in the silver investment market..

By the early 1960s, silver price had risen to US$1.29, due to monetary inflation. At that time, coins in the US had silver in them. At that price, the value of silver content was approximately equalled to the face value of coins. But as monetary inflation continued, Gresham’s Law kicked in- it became more and more profitable to melt the coins and sell the silver for a profit in the spot market, which means silver coins were disappearing from circulation. Hence, the US government began selling silver from its then 3.5 billion ounces stockpile to keep its price down. Eventually, the government removed the silver from coins. As we wrote in Artificially undervalued coins: government interference cripple the free market,

This is exactly a repeat of what happened in the 1960s when the US government made it illegal to melt silver coins. The fact that the underlying value of a coin far exceeds its face value proves that there is a serious underlying problem in the monetary system.

As a result, the public became net buyers of silver in the 1960s.

In 1979, as silver price rose rapidly, the public became net buyers of silver for the second time in history, causing silver to explode to above US$50.

In 2006, the public became net buyers of silver again. As the CPM Group Silver Yearbook reported in 2007,

Last year and this year represent major turning points in the silver market years in which a tectonic shift in the silver investment demand occurs the likes of which are very rare. Specifically, investors shifted from being net sellers of silver into the market from 1990 through 2005, to being net buyers of silver in 2006.

This is the third turning point in the history of silver.

Melting pennies for profit? Gresham’s Law arriving in Australia

Monday, March 10th, 2008

Back in Artificially undervalued coins: government interference cripple the free market, we said that,

Today, we look at the situation described in our previous article, One funny effect of monetary inflation: ?New rules outlaw melting pennies, nickels for profit?. This is exactly a repeat of what happened in the 1960s when the US government made it illegal to melt silver coins. The fact that the underlying value of a coin far exceeds its face value proves that there is a serious underlying problem in the monetary system.

The result was that silver coins ‘disappeared’ due to hoarding. This is Gresham’s Law, which says that an artificially overvalued money tends to drive an artificially undervalued money out of circulation. Today, we announce the arrival of Gresham’s Law in Australia as reported by this newspaper article: High metal costs may shrink local coins. When word of this gets round, we can soon see the Aussie 5c, 10c and 20c coins disappearing.

Thanks monetary inflation!

A brief history of silver and bimetallism

Wednesday, February 27th, 2008

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…

Artificially undervalued coins: government interference cripple the free market

Saturday, December 23rd, 2006

We wonder at the wisdom of government intervening into the free market to maintain the status quo. Granted, sometimes the government have no choice but to impose controls in order to prevent a full-blown crisis from developing. But our question is: how did such condition (that require government interference) occur in the first place? The fact that control imposition is required points to the fact that something has gone wrong in the first place. Worse still, sometimes government prove their ineptness through their policy. The recent Thai government decision (and subsequent retraction) to impose capital restrictions to control its currency is a case in point.

Today, we look at the situation described in our previous article, One funny effect of monetary inflation: ?New rules outlaw melting pennies, nickels for profit?. This is exactly a repeat of what happened in the 1960s when the US government made it illegal to melt silver coins. The fact that the underlying value of a coin far exceeds its face value proves that there is a serious underlying problem in the monetary system. As Murray Rothbard said in What Has Government Done to Our Money?:

Government imposes price controls largely in order to divert public attention from governmental inflation to the alleged evils of the free market. As we have seen, “Gresham’s Law”?that an artificially overvalued money tends to drive an artificially undervalued money out of circulation?is an example of the general consequences of price control. Government places, in effect, a maximum price on one type of money in terms of the other. Maximum price causes a shortage?disappearance into hoards or exports?of the currency suffering the maximum price (artificially undervalued), and leads it to be replaced in circulation by the overpriced money.

In other words, the US dollar notes (artificially overvalued money) will eventually drive out nickels and pennies (artificially undervalued money) out of circulation. Even if the people faithfully obey the law by refraining from melting their nickels and pennies, we can be sure many of them are thinking of hoarding them right now. If ever the nation should be plunged into a financial crisis of hyperinflation, we are sure those coins will be traded as money at their worth far above their face values. In that case, even if the government is still inept enough to impose another law to prevent it from happening, such usage of the coins will be driven underground as a result.

We heard rumours that this state of affairs is also happening elsewhere in the world?South Korea and Philippines (where people are exporting Filipino coins to China to be melted). This is indeed another sign of the times. Be warned. Buy gold. Hoard the coins.