Silver As Currency: Why Not?

February 28, 2014

  "Those who cannot remember the past are condemned to repeat."

  - George Santayana, The Life of Reason (1905)

THIS PHRASE, so often misquoted, is full of meaning.

Santayana's comment shows a depth of understanding of the world which many people lack today. Essentially it tells us that our lives must be built on what we know of the past. It cannot be built only on concepts but on tested and tried results.

This truth carries into all parts of life, including what we call the economy. Coming from the Greek word oikonimia, it means "management of the household". How can you manage anything without knowing the past experience and wisdom handed down generation to generation? Simple things like taking care of your home come from your family this way. Protecting and husbanding your money also requires knowledge of what's come before.

Silver is a commodity growing in appeal as an investment vehicle recently. Whether coins, or more cost-efficient silver investment bars, bullion has averaged 17.8% annual returns over the last 10 years, beating every major asset class and outpacing even gold bullion's 12.6% annual average.

But with huge swings from 80% gains to 35% losses, silver demands to be understood historically, along with the current market environment, to properly assess its function in our world and in your portfolio.

In the 19th century silver was used as a means of exchange alongside gold in many countries. United States of America, Mexico, China and India to name a few were using silver. But during that time period there were a couple of significant changes. Major silver discoveries in the USA and Mexico were to wreak havoc upon the markets. Because silver lost its value as supply grew in abundance. This meant the ratios between gold and silver prices then understood as permanent were no longer acceptable.

It would seem obvious that a commodity used as money will demand a new course of action if its value becomes questionable. This after all is how inflation of the money supply affects the economy. A surplus of commodity-money would also cause complications not just in the US economy but around the globe. This would in turn affect trade globally and the negotiation of values.

Still, in the early years of silver's demise as currency, as a means of exchange, the view prevailed that "one commodity employed as money does not go out of use until it is superseded by another of superior qualifications for the service.

"This is the natural law that governs the change from one kind of money to another."

In 1867 silver was trading at 6 to 1 parity with gold, as there had been many gold finds in that decade. But as the century wore on, no large gold finds were made and silver production continued to grow. The "silver lobby" was large, and though the US was moving to the gold standard it supported the price of silver much as it does milk now.

Of course the market always dictates true value and by 1893 the parity was rising above 16 to 1. Yet the silver lobby remained large and though there were no longer discussions of bimetallic standard usage in the USA, price support continued to be a hot topic.

Many politicians in the USA were protesting about the demonetization of silver. They had derided the government's attempts at ending silver as currency for many years since the mid-19th century, and did manage to get Washington to continue to purchase silver from the market, artificially supporting the price and value of coin within its borders.

The USA was a growing country and needed to trade with the rest of the world. It needed as well to move to the Gold Standard and did so officially by 1896. No matter the effort put forth by the silver lobby in the late part of that century. The end for silver as freely mint-able currency was coming to a head. A peg was simply not sustainable, due to excess supply and a shrinking global demand, as other nations moved onto the Gold Standard.

Between 1893 and 1933 there were many machinations in the US to support the silver market. In 1918 the Pittman Act had the government buying US Silver and keeping it from hitting the global economy until the middle of 1923. Market forces then took over, and at the demise of the Pittman Act the silver price traded lower.

Come 1931 the British Pound, losing its status as the world's reserve currency, was devalued due to the Great Depression. The US stuck with the Gold Standard, but banned private ownership and devalued its Dollar from $20.67 to $35 per ounce in 1933. This devaluation hurt China, because its silver money rose in value, which in turn hurt China's international competitiveness. This brought about a financial crisis which then added downward pressure on the value of silver.  This crisis was a principal factor in silver's demise as a currency in Asia. By 1935 China, the last of the holdouts, gave up on the Silver Standard.

As in any market, when a government or any other entity tries to falsely direct the price of a commodity, they may be successful for a short time but the market will eventually correct itself. Commodity versus currency, prices eventually become quite transparent.

In 1913 when the US Federal Reserve was created to uphold but adapt the Gold Standard, a new era had begun. Elasticity of money, meaning the growth of paper money versus actual gold stocks, got under way. This would lead us to the current form of unfunded paper money, initiated in 1971 when the United States' gold reserves were cut from backing the Dollar. But history clearly shows the path by which silver eventually failed in its function as a currency, beginning in the 1800s.

Yes, there are some people who argue that silver has value over paper money in a religious sense. As if somewhere in the Bible it was chosen to be money by the almighty Himself...! I am not in that camp. There is obviously a natural intrinsic value the metal has that paper money does not hold. Yet it is government which currently dictates our forms of currency by law. Render unto Caesar, remember.

Does any of silver's history as money negate the value it has held and continues to hold as an investment vehicle? Absolutely not. Silver though out of use as currency since China demonetized it in 1935 is still actively bought for just this purpose. In India (and indeed most of the world) when gold is not available silver steps in to take its place. And perhaps it is best for the average man that silver, unlike gold, is free from governmental encumbrances of the past. It enables a person looking for a hard asset that is liquid to own it and know it will always be in demand without the dictates or meddling of politicians.

As the world searches for value, the individual investor seeks a place to protect some of his or her hard-earned income from political and economic uncertainty. Silver remains a precious metal without a declaration of the state. But its properties hold powerful appeal to the industrial, scientific and investment communities, as well as to jewelry and silverware consumers the world over.

Silver is a beautiful metal that will always have value for mankind both in function and form. You cannot say this about the Euro or the US Dollar. Let alone Bitcoin.

Miguel Perez-Santalla

(c) BullionVault 2014

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

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Miguel Perez-Santalla is vice president of business development for BullionVault, the physical gold and silver exchange founded a decade ago and now the world's #1 provider of physical bullion ownership online. A fierce advocate for retail investors, and a regular speaker at industry and media events, Miguel has over 30 years' experience in the precious metals business, previously working at the United States' top coin dealerships, as well as international refining group Heraeus.

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