The Elephant In The Gold Room

We will start this off with a pet peeve. Too often, one is reading something about gold. It starts off well enough, discussing problems with the dollar or the bond market or a real estate bubble… and then bam! Buy gold because the dollar is gonna be worthless! That number again is 1-800-BUY-GOLD or we have another 1-800-GOT-GOLD in case the lines on the first number are busy!

Whether the writer is a bullion dealer, or whether just some HODLer (a term from bitcoin—it means Holding On For Dear Life) hoping for a higher price and an opportunity to unload some gold to make profit$, it matters not. The “buy gold” message undermines the economic point. Perhaps the economics (or pseudo-economics) point bolsters the buy-gold message, but it certainly hasn’t over the last 8 years.

Faulty Logic

On to our topic for today, this economics point often takes the form:

  1. Defect X causes currencies to fail
  2. The dollar has defect X
  3. Therefore the dollar will fail…
  4. …And that means people want to pay gold to merchants

Gresham’s Law states that if two forms of money have equal monetary value set by the government, then the one that is undervalued will not circulate. It is often taken to mean that if a precious metal coin and a base metal coin are both legal tender, then the base metal will circulate and people will hoard the precious metal. That is true, but its application is broader than that.

The Coinage Act of 1792 established an official policy of bimetallism. A dollar was defined to mean 24.75 grains of pure gold or 371.25 grains of pure silver. It fixed the ratio of gold to silver at 15 to 1.

The market ratio was closer to 15.5 (of course, it was not a fixed ratio, but moved as all market prices do). 15, being a lower number, overvalues silver slightly. That is, the monetary value of silver was a bit higher than its commodity value. And the opposite for gold.

Predictably, silver circulated and gold did not. Gresham’s Law was in full force and effect.

A more well-known case occurred in 1965 when the US Mint switched from silver to base metal (a copper-nickel alloy) for quarters and dimes. We had read an excerpt of a speech by President Johnson (which now seems to be offline), in which he promised that the old silver coins would circulate alongside the new slugs. But it did not work out that way. It cannot. And Gresham tells us why not.

Why Gold Does Not Circulate Today

Today, despite vast quantities of gold and silver coins, they do not circulate. Gresham is not quite the explanation. Although the US one-ounce silver coin is stamped with a legal tender value of $1, people are not stupid. These coins are freely bought and sold based on the market price of silver (plus a premium for being manufactured into a recognizable coin).

1 2 3 4
View single page >> |
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.