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Thursday, December 23, 2010 1:57 AM

Gold is Money, What About Silver? Can Gold be Debt?

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FOFOA expressed a number of controversial viewpoints regarding money in his recent article Focal Point: Gold. Specifically, he makes the case gold is money but not silver. He makes some other claims that are highly debatable to say the least. Here are a few snips (emphasis mine) ....

Gold and only gold will fill the monetary store of value role. Not gold and silver. Not precious metals. Just gold.

Money's most vital function in our modern world is lubricating commerce, or more specifically, keeping the essential supply lines flowing – supply lines that bring goods and services to where they are needed. Without it we would be reduced to a barter economy, eternally facing the intractable "double coincidence of wants." This is the problem whereby you must coincidentally find someone that not only wants what you have to trade, but also, coincidentally, has what you want in return. And in the modern world of near-infinite division of labor, this would be a disaster.

So we need money, and lots of it. In fact, we need money in unrestricted amounts! (I'll bet you are surprised to see me write this!) Yes, I said it, we need unrestricted money in order to fulfill this most vital function in our modern society – lubrication! But here's the catch: we need the right money in order to perform this seemingly impossible task.

Money is debt, by its very nature, whether it is gold, paper, sea shells, tally sticks or lines drawn in the sand.(Another shocking statement?) Yes, even gold used as money represents debt.

For this reason, the money used as a store of value must be something completely separate and different from the medium of exchange. It must be so, so that the store of value unit can expand in value while the medium of exchange unit expands in quantity and/or velocity. You may be starting to encounter my thrust. Expand… and expand. Unrestricted by artificial constraints.

A fixed price of gold in your currency ensures the failure of your currency. And it won't take 30 or 40 years this time. It'll happen fast. It wouldn't matter if Ben decided to defend a price of $5,000 per ounce, $50,000 per ounce or $5 million per ounce. It is the act of defending your currency against gold that kills your currency.

To be honest, I really don't know if silver is overvalued or undervalued today at $30/ounce. But if you are counting on the industrial fundamentals of silver for your moonshot like the Zero Hedge article is, or on a busted paper market like the "vigilantes," you may be in for an unpleasant surprise. The same fundamental arguments that are used today were also used back in 1982. In gold, at least, we know that jewelry demand rises and falls opposite the price of gold. But then again, gold is money, right? So, is silver still money?

One of the argument for silver that we hear often is that it is "the poor man's gold." So I guess gold is "the rich man's gold." Well, what is the main difference between rich men and poor men? Is it that the rich have an excess of wealth beyond their daily expenses? In fact, the really rich have "inter-generational wealth," that is, wealth that lies very still through generations. The poor do not have this.
FOFOA Fallacy #1:

"So we need money, and lots of it. In fact, we need money in unrestricted amounts!"

No we don't. Please consider a few re-ordered sentences from Murray Rothbard's classic text What Has Government Done to Our Money?
Money is a commodity used as a medium of exchange.

Like all commodities, it has an existing stock, it faces demands by people to buy and hold it. Like all commodities, its “price” in terms of other goods is determined by the interaction of its total supply, or stock, and the total demand by people to buy and hold it. People “buy” money by selling their goods and services for it, just as they “sell” money when they buy goods and services.

Money is not an abstract unit of account. It is not a useless token only good for exchanging. It is not a “claim on society”. It is not a guarantee of a fixed price level. It is simply a commodity.
What Is The Proper Supply Of Money?

Continuing from the book ...
Now we may ask: what is the supply of money in society and how is that supply used? In particular, we may raise the perennial question, how much money “do we need”?

Must the money supply be regulated by some sort of “criterion,” or can it be left alone to the free market?

All sorts of criteria have been put forward: that money should move in accordance with population, with the “volume of trade,” with the “amounts of goods produced,” so as to keep the “price level” constant, etc.

But money differs from other commodities in one essential fact. And grasping this difference furnishes a key to understanding monetary matters.

When the supply of any other good increases, this increase confers a social benefit; it is a matter for general rejoicing. More consumer goods mean a higher standard of living for the public; more capital goods mean sustained and increased living standards in the future.

[Yet] an increase in money supply, unlike other goods, [does not] confer a social benefit. The public at large is not made richer. Whereas new consumer or capital goods add to standards of living, new money only raises prices—i.e., dilutes its own purchasing power. The reason for this puzzle is that money is only useful for its exchange value.

[Thus] we come to the startling truth that it doesn’t matter what the supply of money is. Any supply will do as well as any other supply. The free market will simply adjust by changing the purchasing power, or effectiveness of the gold-unit [monetary-unit].
The online book is a great read and I highly recommend reading it in entirety.

The key point above is that an increase in money supply confers no overall economic benefit. Over time, money simply buys less and less

FOFOA Fallacy #2:

"Gold used as money represents debt."

The statement is preposterous unless one allows the lending out of more gold than exists. That practice is clearly fraudulent.

From Rothbard:
Curiously, many people have argued that it would be impossible for banks to make money if they were to operate on this “100 percent reserve” basis (gold always represented by its receipt). Yet, there is no real problem, any more than for any warehouse. Almost all warehouses keep all the goods for their owners (100 percent reserve) as a matter of course—in fact, it would be considered fraud or theft to do otherwise. Their profits are earned from service charges to their customers. The banks can charge for their services in the same way. If it is objected that customers will not pay the high service charges, this means that the banks’ services are not in very great demand, and the use of their services will fall to the levels that consumers find worthwhile.
FOFOA Fallacy #3:

Gold and only gold will fill the monetary store of value role. Not gold and silver. Not precious metals. Just gold.

Like FOFOA I believe gold is money. However, unlike FOFOA I think money is whatever the free market says it is. The problem is, we do not have a free market we only have government decree mandating the use of dollars, Pounds, Yen, Renmimbi, Euros, and Francs as money.

From Rothbard:
Coexisting Moneys: 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. It is not necessary, however, for the government to step in and save the market from its own folly in maintaining two moneys.

Silver remained in circulation precisely because it was convenient (for small change, for example). Silver and gold could easily circulate side by side, and have done so in the past. 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. Which metal will serve as a unit of account depends on the concrete circumstances of the market. If gold is the money of account, then most transactions will be reckoned in gold ounces, and silver ounces will exchange at a freely-fluctuating price in terms of the gold.
Would a free market settle on gold only right now, or gold and silver, or as some dreamers think, energy?

Historically speaking, the market has already ruled out energy. The most likely reason is energy lacks desirable properties in regards to divisibility, storage, and transportability. Does anyone really want to go to the supermarket and buy bread based in kilowatts? The idea sounds nonsensical because it is nonsensical. That the free market has never deemed energy as money in any practical application speaks for itself.

In contrast, and when available, the free market has always gravitated to gold.

Why Gold?

Gold has a multitude of properties that make it suitable for money. Gold is scarce, non-corrosive, easily divisible, easy portable, and it does not degrade or rot away under any atmospheric conditions. Gold's scarcity and the fact that its supply is unlikely to suffer sudden increases, makes it the prime candidate to act as a medium of exchange. Historically, gold's use as money is unparalleled in the free market.

Silver as Money?

Silver has many of the same properties as gold. Moreover, silver has had long-term uses as money. In theory, the free market could conceivably decide that silver is money or that both silver and gold are money.

At times, in select places, the free market has settled on copper, furs, or even large stones as money, the latter on Yap Island. However, history shows that such definitions of money are fleeting or extremely localized.

If the free market did decide on silver as money (or silver and gold as money), the opinion of FOFOA (or anyone else) would be meaningless.

Assuming for a moment the free market did select silver and gold as money, could a dual standard work at a fixed rate of exchange between silver and gold?

Here I am 100% in agreement with FOFOA: Absolutely not. No fixed valuation between gold and anything else is possible, not just gold and silver.

Would the Free Market Select Both Silver and Gold as Money?

While theoretically possible, in today's world silver has one huge drawback that gold does not have: Silver is used up. Gold is not.

Silver is widely use in industrial applications. For example, silver is used in photography, mirrors, computer keyboards, musical instruments, numerous medicinal purposes, watches, hearing aids, batteries, and a whole slew of purposes most people are not aware of.

Silver has conductivity properties unlike any other metal.

Wikipedia has a nice list of Industrial Uses of Silver as well as a discussion of its metallic properties. Here are a three uses from that link, that most people would never realize.

  • Silver is used to convert ethylene to ethylene oxide, an important industrial reaction needed to make polyesters.
  • Because silver readily absorbs free neutrons, it is commonly used to make control rods that regulate the fission chain reaction in pressurized water nuclear reactors, generally in the form of an alloy containing 80% silver, 15% indium, and 5% cadmium.
  • Silver is used to make solder and brazing alloys, and as a thin layer on bearing surfaces can provide a significant increase in galling resistance and reduce wear under heavy load, particularly against steel.

In contrast to silver, nearly every ounce of gold ever mined is still in workable existence, not discarded and buried in a dump.

Historically speaking, when silver was used as money, it did not have the wide industrial uses it has today. Would that matter? It might, or it might not.

Just the Math Maam

FOFOA commented on a statement I made in Still More Hype Regarding Silver; Just the Math Maam

"As a deflationist who believes Gold is Money (see Misconceptions about Gold for a discussion), I am long both silver and gold and have been for years."

In that awkwardly phrased sentence, I commingled two distinct ideas.

1. Gold is Money
2. I am not short silver.

As noted above, the free market could theoretically accept silver as money, although there are reasons that it might not. I simply wanted to refute allegations about me being short silver, conspiring with banks, and other such nonsense.

For the record, I am not short silver and I have never been short silver. Perhaps at some point I might but I certainly have no plans to do so.

Email Exchange With James Turk

In regards to Just the Math Maam, I received this email from James Turk.
Hi Mish

I would never defend JPM either. And I see blaming JPM a bit like blaming wet streets for rain. The bigger picture is of course US government intervention, which is done to make the dollar look worthy of being the world's reserve currency when we all know that it is not worthy of that esteemed position so critical to the health of the global economy.

Anyway, I thought your article was good and well-reasoned - to a point. The only part I would take exception with is the last paragraph. I agree that price suppression benefits those of us getting rid of over-valued dollars and buying under-valued gold and silver. But there is a bigger issue here. Government intervention distorts the market process, one important result of which is that the market gives bad signals (one reason, for example, why so many houses were built on spec). These bad signals hurt the market process because entrepreneurs end up putting accumulated capital in the wrong places (malinvestment as the Austrian economists call it), which destroys capital and therefore erodes the backbone of capitalism. I would like to see government intervention in the market ended.

I agree with what James Turk said above.

I should not have said "Assuming that JPMorgan could and did suppress the price of something below its natural value, everyone should be happy, not bitching about the opportunity to buy something of value at a cheap price!"

I was attempting to be cute. Unfortunately, such statements condone unfair treatment of producers, among other distortions. I was wrong and I have a simple policy about such things. When you are wrong, admit it. It's not the first and it won't be the last.

In regards to government intervention in general, I could not possibly agree more with what James Turk said. Both of us want to abolish the Fed and place the world (not just the US), on a sound currency system.

In regards to what JPMorgan is doing specifically, in a separate exchange James said "Unfortunately, neither of us have the hard data to prove our point of view, so we can only agree to disagree until some hard data emerges."

That is a fair position. There is room for error here, lots of room, on both sides.

Currently there is a mountain of hype. I asked James if he thought efforts to squeeze JPMorgan were misguided or counterproductive. James writes ...
It is not counterproductive because the publicity is bringing attention to the silver market, which is good. This attention is leading to more people understanding the fundamentals of silver, which are very positive. Silver is still good value, so more people are buying silver which is also good because the silver they are purchasing will help protect them from the hyperinflation of the dollar that I expect. In fact, I see rising commodity prices and the recent collapse of T-bond prices over the last several weeks as important writing on the wall that hyperinflation is not just possible, but rather, it is rapidly approaching.

However, I agree that focusing on JPM is misguided if people do not recognize who is the real culprit, which is the US government. It is the schemer behind the curtain engineering the price manipulation through the ESF and other means to preserve the unconstitutional fiat money system now prevailing.
To the question "If JPMorgan is in fact under some sort of squeeze, would the exchanges act to protect JPMorgan, whatever it took?"

He replied writing ....
Yes, of course, the exchanges always favor the dealers because the dealers control the exchanges. Just ask the Hunts. More recently, ask those people on the LME who were long nickel when that exchange changed the rules, and there wasn't even any allegations in that case of speculators trying to squeeze the nickel shorts. The nickel longs were industrial users who bought nickel to hedge their production requirements. In short, the exchanges always protect the insiders. As the "insiders", they are also the controllers.
I asked James "Regardless of what JPMorgan is or isn’t doing, isn’t the best approach be to quietly, accumulate metal without attempting to sponsor mass viral actions?"

To that he replied ...
Yes, of course. That is exactly what Warren Buffett did when he quietly accumulated 130 million ounces of silver from July 1997 until the announcement of his purchases in February 1998. Nevertheless, his quiet accumulation drove silver from $4.15 when he began buying to over $7 when he made his announcement, and back then silver was relatively plentiful, not as good value as today and very much out of favor.

So if someone tried to buy 130 million ounces of silver today, it would in my view take at least as long as the 8 months it took Mr. Buffett and would probably drive the price to over $100 per ounce. I therefore have to question the reliability of SLV's supposed silver backing when I see it ostensibly adding tens of millions of ounces in just a few weeks. It just doesn't seem possible to me, particularly given prevailing market conditions where physical metal is so tight and difficult to locate compared to as recently as just two years ago.
Constructive Things You Can Do

I am still sticking with the belief indiscriminate complaining about silver shorts via the internet is not going to accomplish much, even if it is true.

A much better use of time would be to do constructive things like sit down with your legislative representative, give them the following books and briefly explain what is going on.

Those are Amazon links to order books to give to your representative. Here are free online versions.

Admittedly most won't get it, at least at first. Over time they will, if enough people are willing to present the message properly.

Attitudes rule and attitudes are changing. You can help. If you want to do something more productive than whining about silver shorts, buy those books, schedule some time with your legislative representative, forget the hype about hyperinflation at least for the discussion with your representative, then calmly explain how the Fed has created these boom-bust cycles and why we need to end the Fed.

Mike "Mish" Shedlock
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