‘The major monetary metal in history is silver, not gold.’ – Nobel Laureate Milton Friedman
Although now in correction mode, gold hit another all-time high this week. As we have said on a number of occasions, gold is rising due to the instability of the global financial system. Gold is money and as the ultimate global currency and store of value, the yellow metal is regaining its place in history as a trusted reserve currency.
But throughout history, gold has not been the only monetary metal. Silver has always played a role alongside gold. In fact, up until the beginning of the 20th Century, more people used silver as money than they did gold. You wouldn’t know it though, would you?
Beginning in the last quarter of the 19th century, the major economic powers, the US and Great Britain, systematically de-monetised silver. That is, they worked to remove silver from the global monetary system. This conclusion is debatable but as you will see the decision to stop using silver as money was not one taken voluntarily by the people.
As a consequence, gold/silver ratio has fallen from around 15.5:1 in the early 1700s to 66:1 today. The accompanying chart shows the gold/silver ratio from the early 1970s to today, along with the silver price. If silver is in the process of becoming ‘re-monetised’, at these levels it is exceedingly cheap.
Over the next few weeks we’ll explore the question of whether, after a long absence, silver is in the process of again being viewed as money. In order to answer that question, we first must go back and see how silver was purged from the financial system in the first place.
(A common theme of the following story is the constant impact of Gresham’s Law. Its basic premise is that bad money pushes out good money. In other words, inferior coins or money will always push out quality money. For example, when the metal content of coins exceeds their purchasing power, those coins will not be used as money but instead be melted down and sold for their actual market value. That’s why the metal content of modern day coins is neglible.)
The Beginning of the End
The story of silver as money is as old and long as that of gold. But the story of silver’s demise begins with Great Britain in the 16th Century. Silver was the basis of Britain’s monetary system for hundreds of years. This is evident in the name of its currency, the Pound Sterling.
The country was on a ‘silver standard’ when in 1663 a new gold coin, the ‘Guinea’, was introduced. The value of gold and silver coins fluctuated against each other (as they should) until 1717 when Sir Isaac Newton, who was Master of the Royal Mint, introduced a fixed ratio between silver and gold. The ratio he applied was 15.5:1. That is, gold was considered to be15.5 times the value of silver.
The problem with price fixing is that the ratio is only likely to be exactly right for a short amount of time. Various supply and demand factors mean the ratio fluctuates and price fixing simply creates distortions.
Soon after Newton fixed the gold/silver ratio at 15.5:1, the market considered silver to be undervalued. Gresham’s law went into action.
As a consequence, the circulation of silver began to slowly decline. Britain’s trading partners in Europe valued silver more highly so silver flowed out while gold flowed in. Over the decades, this increasing amount of gold in the monetary system set Britain on course to move to a gold standard in 1816. Given Britain’s economic power, its move to a gold standard slowly influenced its European trading partners to do the same.
Silver as Money in the US
After the revolutionary war in 1776 the fledging US economy was also on a silver standard, with the Spanish silver dollar the anchor currency. But in 1792 Congress passed the Coinage Act, establishing a bimetallic dollar standard. Both silver and gold were considered legal tender and the gold/silver ratio was set at 15:1. (This valued silver slightly higher than Newton had done).
This time, the opposite happened. Subsequent to the passing of the Coinage Act, increased silver production from Mexico saw a rise in the supply of silver and after 1805 the market ratio had fallen to around 15.75:1. The forces of Gresham’s pushed undervalued gold out of circulation and silver became the circulating currency. To quote Murray Rothbard in his excellent “A History of Money and Banking in the United States – the Colonial Era to World War II”:
‘…after 1810 only silver coin, largely overvalued Spanish-American fractional silver coin, circulated within the United States. The rest of the currency was inflated bank paper in various stages of depreciation’
The War of 1812 and various experiments with central banking caused monetary mayhem (which history refers to as booms and busts) in the young US. In 1832 Andrew Jackson campaigned for President on a ‘hard money’ platform. He railed against the banking interests who were intent on creating a monetary system controlled by a privately owned central bank.
He won the election and for the first time the newly created Democratic Party was in power. The Coinage Act of 1834 sought to address the issue of silver overvaluation in relation to gold and it changed the gold/silver ratio to 16:1. The ratio accurately reflected market values and gold and silver coins circulated side-by-side for about 20 years.
But the 1850s were characterised by new gold discoveries all around the world, which increased the production and supply of gold relative to silver. Consequently silver became undervalued at the mandated ratio and rapidly disappeared from circulation. Coins were either hoarded or melted down and sold at the more attractive market price.
The upshot was that the US suffered from a shortage of small denomination silver coins. The problems of having a government decreed ‘bi-metallic standard’ were becoming apparent.
In 1853 Congress decided to change the value of fractional silver coins (up to a maximum of $5). They deliberately overvalued these coins relative to gold to ensure they would remain in circulation. This was the first, albeit small step in silver’s de-monetisation.
In the next few decades, it became apparent that this process would continue. The major European nations were following Great Britain’s lead and moving to a gold standard. At the same time, large silver discoveries in Nevada and other western states in the US pushed down silver’s value relative to gold.
The death knell for silver arrived soon after when in February 1873 Congress passed a law that in effect discontinued the minting of any more silver dollars. In other words, the US mint was no longer turning silver into money in the form of coins.
Silver interests labelled this law the ‘Crime of 1873’. It was followed a year later by another law ending the legal tender status of all silver dollars above the sum of $5. By 1894 the gold/silver ratio had blown out to 32:1.
While silver ceased to circulate as money, broad-based anger at the earlier Act’s of Congress resulted in more government meddling. Showing that they had learned nothing from decades of Gresham’s law in action, Congress passed the Bland-Allison Act of 1878 and the Sherman Silver Purchase Act of 1890. Both of these acts mandated that the US Treasury buy a certain amount of silver per month at the old value equivalent to 16:1 in terms of gold.
This was obviously inflationary (silver was being re-monetised at an absurdly overvalued rate) and foreigners lost faith in the value of the US dollar. Gold began draining from the Treasury’s coffers as dollars were exchanged for gold.
A new government overturned these Acts and finally, in 1900, Congress passed the Gold Standard Act. This provided for no retention of silver money except as token currency.
The de-monetisation of silver in the US and industrialised world was complete. Would this process have occurred naturally without government action, or was it a deliberate step to force silver out of the monetary system and thus provide more room for government paper money to circulate unimpeded?
Silver’s Final Demise
The reasons behind the demise of silver in the west are debateable. But what is not is the systematic way the west (mainly the US and Britain) went about trying to dismantle the structure of the silver standard as it continued to operate in many of the less developed countries in the world.
This is comprehensively documented, from the US’ perspective at least, in Rothbard’s A History of Money and Banking in the United States. Rothbard says that the early 1900s saw the rise of US economic expansion and influence overseas. As a natural consequence of this, the US also wanted to exert control over the monetary systems of the countries it ‘colonised’.
Rothbard argues that US banking interests sought to pressure third world countries to move from an inflationary silver standard (inflationary due to the falling value of silver relative to gold) to a ‘gold-exchange’ or dollar standard.
This meant that a country’s currency, which would still consist of token silver coins, would be tied to the dollar (or the pound sterling), which in turn was linked to gold. In effect, these countries operated with the dollar or pound as their reserve currency, not gold and certainly not silver.
In this way countries were tied into the US or British economic and monetary system. A gold exchange or dollar/pound standard (rather than a true gold standard) removed the threat of US/British banks being subjected to a run on their gold if they inflated excessively.
[This system was the genesis of the current system of international monetary exchange. Granted, the monetary system has been through a few incarnations (with gold being jettisoned completely in 1971) but the essence of it is to allow banks to create credit at will without suffering the threat of a run.
The collapse of Bear Stearns and Lehman Brothers in 2008 marked the beginning of the end of the system. Not surprisingly, we are still seeing the big banks hold on desperately to the power they have long built up].
On the US side, Puerto Rico was the first country to fit into the system after the US took control from Spain in 1898.
While a more difficult proposition, by 1905 the Philippines followed suit. The Philippines was tougher because it was using the Mexican silver dollar as money. It was known as sound money and widely used amongst third world countries as a currency.
The US plan called for replacing the Mexican silver dollar with a debased American silver coin tied to gold. When implemented, it would have resulted in a one off fall in purchasing power (and the US banks would have pocketed this ‘seigniorage’) but the Philipino’s were not falling for it. In the end some coercion, in the form of threatened taxes, were required to bring the Philippines into the currency system.
Next in line was Mexico and China, both on silver standards and major users of the Mexican silver dollar. Rothbard states that a Commission on International Exchange (CIE) was formed to ‘bring about a fixed relationship between the money’s of the gold-standard countries and the present silver using countries in order to foster export trade and investment opportunities in the gold countries and economic development in the silver countries.’
Mexico converted to gold with relative ease, but China refused. According to Rothbard:
‘China understood the CIE currency scheme all too well. They saw and denounced the seigniorage of the gold exchange standard as an irresponsible and immoral debasement of Chinese currency, an act that would impoverish China while adding to the profits of US banks where the seigniorage reserve funds would be deposited.’
It’s an interesting look back into monetary history considering the current currency tension between the two countries!
China soon replaced the Mexican silver dollar with their own currency called the tael. In a sign of how ingrained silver was in Chinese society, according to Wikipedia the symbol for ‘bank’ in China literally means ‘silver house’ or ‘silver office’.
In 1898 India, under British influence and previously a massive importer of silver, also abandoned the silver standard in favour of a pound exchange standard. The value of the rupee was linked to the pound, which in turn was linked to gold.
So by the early 1900s, silver ceased to be anything other than a token currency. China stayed on the silver standard until 1935, but then switched to national banknotes as their main form of currency.
So the long process of global de-monetisation of silver occurred from around 1870 to 1935, although the job was largely complete by around 1900. The evidence seems to suggest that silver was deliberately de-monetised.
After all, silver fulfilled the role of money very well for thousands of years. Perhaps it was the advent of central banking (the Bank of England was founded in 1694) and the competition from paper money that was the first nail in silver’s coffin?
Government fixing the gold/silver ratio also created major problems. This led to periodic under/over valuation of both metals, which in turn led to excessive inflows/outflows and monetary disorder.
Whatever the reasons, silver has become a monetary relic while gold remains the longest standing currency of all. This has seen the gold/silver ratio fall from 15.5:1 when Isaac Newton was running the Royal Mint to around 66:1 today.
Does this mean silver can never return to its role as money? What is silver used for then, and is it cheap, or just another industrial metal? What are the investment opportunities? These are the questions we’ll seek to answer in the coming weeks.
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