The Demonetization of Silver

The Demonetization of Silver

September 4, 2006

There is some debate as to whether silver is an industrial commodity or a monetary metal. The answer, for now, is that it is whatever people think it is. If they decide to hold it as a monetary metal, then that’s what it is, and if they do not have any interest in it as a monetary metal, then its value falls to the point at which it becomes an industrial metal.

Silver had always been a monetary metal in the past, dating back into prehistory. Gold was too, but gold was too valuable for day-to-day transactions, so most commerce took place with silver. The ratio between gold and silver was typically around 16:1, although it sometimes was as high as 7:1 in some places (China). This ended in the 1870s, with a worldwide “demonetization of silver” (Andrew Carnegie, from two weeks ago, had a lot to say about this). This “demonetization” reflected the fact that, during the 1870s, the use of paper banknotes, linked to gold, had become widespread, so people did fewer and fewer transactions with silver. The problems of a bimetallic (gold/silver) standard were a persistent incentive to drop silver as well. Thus, beginning in the 1870s, the vast quantities of silver previously used for money became a huge industrial surplus, and silver’s value in relation to gold plummeted, dropping to around 100:1 in the 1930s.

Oddly enough, silver did not always stay at such low valuations. After the 1930s low, it recovered back to near 16:1 in 1968. Why 1968? That was the year that the IMF introduced the Special Drawing Rights, which was the first time that the US dollar was not freely convertible into gold. Forward thinking investors began to get very nervous, and for good reason too since the dollar was officially delinked from gold a few years later in 1971, setting off the most disastrous worldwide inflation.

If you were a very nervous investor of 1968, what would you do? Buy gold, of course, in correct anticipation of the upcoming inflation. However, for US investors, investment holdings of gold had been illegal since the War Powers Act of 1933. How about silver instead? Anyway, that’s one hypothesis. Silver’s value against gold dropped in the early 1970s (gold investment became legal again in, I believe, 1974), but it made a return to its 1968 ratio in 1980, with a rise to $50/oz. or 16:1 with gold also momentarily at $800/oz. At this time people were lining up around the block to dump their soon-to-be-worthless dollars (they thought) for gold and silver. Actually, things began to turn around then, with Paul Volcker at the Fed clumsily but effectively putting a stop to dollar devaluation.

Silver’s value has been rising again, from a low of about 80:1 in 2003. Today it is around 48:1. Will it rise back to 16:1? I think it will, because there really is very little silver remaining out there, at least in tradeable coin/bullion form. A relatively modest further decline in the USD vs gold will likely trigger new investment demand for silver, which will quickly exhaust existing bullion supply. Although those who argue that silver is now an industrial commodity have been correct, for the last couple decades, the fact remains that you can buy bars of silver at any coin store, while I have yet to see any bars of Molybdenum or Vanadium for sale. Within the next 12 months I can easily see a situation where we have $1000/oz. gold and silver is around 20:1, or $50/oz. Within two years we could see $1600/oz. gold and silver at 16:1 or $100/oz. Around that time, I plan to trade my silver for a condo bought out of bank liquidation. There is no particular reason to stick around once silver has returned to its 16:1 level, although it is not inconceivable that it could go as far as 10:1.