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One thing you
often hear about gold, as a monetary asset, is that the supply of gold
– the amount of gold in the world – increases by about 2% each
year due to mining. We don’t really consume gold. Most of the gold that
has ever been mined (the U.S. Geological Survey estimates 85%) still exists
today as bars, coins and jewelry. Even the small bit that is used in industry
is often recycled.
The next thing you typically hear is that a gold standard system works
because the “money supply” increases at a stable rate, in line
with mining production. In other words, the rate of growth of quantity is
stable.
This is totally incorrect. If you look at any historical gold standard
system, such as the Bank of England in the 1880s, you find that the “money
supply” (base money) is in fact quite variable, and doesn’t
follow this “2% per year” rule at all.
For example, in 1900, the U.S. monetary base increased to an estimated $1,344
million, from $1,126 million in 1899. That’s an increase of 19.4%.
In 1896, however, the U.S. monetary base fell to $944m from $1,022m in 1895,
a decrease of 7.6%.
There’s nothing stable at all about the “money supply” with
a gold standard system. It adjusts, automatically via the value parity, to
the economic conditions of the time.
The “stable” part is stable value. The British pound maintained a
defined value compared to gold. Gold, likewise, maintained a stable value in
part because the supply was very large and stable.
Here is one of our favorite 19th century references, John Stuart Mill, on the
subject:
“[O]n the whole, no commodities are so little exposed [as gold and
silver] to causes of variation. They fluctuate less than almost any other
things in their cost of production. And from their durability, the total
quantity in existence is at all times so great in proportion to the annual
supply, that the effect on value even of a change in the cost of production
is not sudden; a very long time being required to diminish materially the
quantity in existence, and even to increase it greatly not being a rapid
process. Gold and silver, therefore, are more fit than any other commodity to
be the subject of engagements for receiving or paying a given quantity at
some distant period.”
Let’s look at some of the recent specifics. How is gold different than
copper?
Almost all the gold ever mined is stored in the form of bullion and jewelry.
Copper is completely different. Almost all the copper mined today is used
immediately, for some practical purpose. Very little is stored for the long
term.
In 2010, world production of copper was estimated at 16.2 million tons.
However, known world inventories of copper, on major exchanges, were about
645,000 tons. So, the physical inventory was only 4% of world production.
Likewise, industrial demand for copper was also around 16.2 million tons per
year.
What if, for some reason, copper mining ceased completely? Obviously, there
would only be that small inventory of 645,000 tons available. This would be a
big problem.
Now let’s look at gold. In 2010, world production of gold was estimated
at 72 million troy oz. The amount of gold in the world was about 5.0 billion
ounces. So, the production was only about 1.4% of the inventory.
What if world gold production stopped completely? It would mean that we would
have 5.0 billion ounces of gold, instead of 5.072 billion ounces. Big deal.
That’s one reason why gold’s value is stable, making it usable as
a monetary benchmark.
The World Gold Council produces some statistics on uses of gold. In 2010, the
WGC says that there was 2,586 tons of gold produced. The amount used for
industrial purposes was 466 tons. The remainder went into coins and jewelry.
Let’s look at that: 466 tons into industry, 2,586 tons produced, and
roughly 155,000 tons in existence. Industrial demand is only 0.3% of
available supply.
Even that industrial demand is largely satisfied from recycling. The WGC says
that 1,645 tons were available from recycling in 2010. This includes both
industrial recycling and scrap jewelry, but it shows that recycled gold is
also a major source of bullion.
We are accustomed, in the U.S., to seeing gold jewelry that costs much more
than the value of the bullion contained. Maybe that’s why we own hardly
any gold jewelry. It’s different in the rest of the world. Most of the
gold jewelry in the world is in Asia, notably India. In Asia, the cost of the
jewelry is just a bit higher than the value of the bullion contained –
about 2% higher on average. In other words, there’s about a 2%
“fabrication premium” to turn the bullion into something
wearable.
Actually, that’s about the same “fabrication premium” as we
have today for bullion coins like Krugerrands and
American Eagles. Most of this jewelry serves the same function as Krugerrands and Eagles serve for us. It is, in essence, a
store of monetary value. Plus, you can wear it. Maybe those Asians are on to
something.
Gold has been money for thousands of years because its value is stable. The
sorts of “supply and demand” issues that affect other commodities
are not relevant for gold.
Nathan Lewis
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