Silver As Money

October 15, 2015

silver eagleGold is money, admittedly not often circulating as such today. Fiat currencies issued by governments have driven gold out of circulation. But where does this leave silver?

Money-substitutes, bank notes and bank deposits, were originally backed by physical silver, and were switched in favour of gold-backed money-substitutes over the last two centuries. It was a process that happened first in England, starting with Isaac Newton's declaration in 1717 that silver would be exchanged at the Royal Mint in the ratio of fifteen and a half ounces to one of gold. While Newton was a towering genius in physical science, he didn't understand markets, and that an inflexible bimetallic standard not adjusting for the subjectivity of prices would be problematic.

Market preferences in subsequent years deemed gold preferable to silver at Newton's exchange ratio, because British merchants tended to pay for imports from the Continent with silver while hoarding gold. This might have been due to the convenience of gold for merchants' dealings, or it could equally have been due to price arbitrage. For whatever reason, Britain moved towards gold and finally adopted it as the government's preferred money when the first sovereigns were issued in 1821.

In was not a market vote against silver: it was the result of an attempt at bimetallism that failed, and a government that decided to switch from its centuries-old sterling silver standard. Other countries followed later falling into line with Britain, with Germany and the United States eventually accepting gold as the leading metallic money in the 1870s. And as Von Mises records in his Theory of Money and Credit, "The sharp decline in the price of silver since 1873 is recognised as largely due to the demonetisation of this metal in most countries."1

This is an important point, obvious perhaps on reflection. The move from Newton's gold-to-silver ratio of 15.5:1 to today's 70:1 can be put down largely to silver's demonetisation. Today, the price of silver measured in the world's reserve currency, by which it trades, is heavily influenced by a cartel of industrial users and their banks through the financial markets.

History tells us that silver, and not gold, was coinage for the masses, continuing in this role until relatively recently, before silver coins were completely debased. The question now to be considered is whether or not silver will ever be remonetised. If so, we can expect the ratio to fall towards Newton's formula, implying the silver price will rise significantly relative to that of gold.

The base case for gold returning into circulation for transactions is that it becomes superior again to fiat currencies as money. Clearly, this is most likely to happen in the event of a serious dislocation of the current monetary system, and the failure by governments to come up with a convincing alternative. We can all have our views on this matter, but assuming for a moment that this is a possibility, it is worth understanding the differences between gold and silver as monetary metals today.

As a rule of thumb the silver price is twice as volatile as that of gold and the underlying price dynamics are different. Nearly all the gold mined throughout history has accumulated as above-ground stock, and current mine production is adding to it at a rate of less than two per cent annually, approximately matching global population growth. However with silver, according to The Silver Institute, roughly sixty per cent of consumption is industrial, the balance of forty per cent going into silverware, coins and bars, and jewellery.

This means about 400 million ounces (12,400 tonnes) is accumulating annually in public hands. During the last twenty years the US Geological Survey estimates over 400,000 tonnes of silver have been mined worldwide, so it is likely that approximately 160,000 tonnes of this total is publicly owned, based on a 60/40 split, in addition to stocks previously accumulated. We have no credible estimates for gold accumulation over the same period, beyond mine output of about 50,000 tonnes, much of which has disappeared into secret, wealthy and relatively concentrated ownership. By way of contrast, most households around the world possess some silver in one form or another.

The advantage silver offers the masses as money is partly psychological: you can acquire a lot more of it for less government currency. This obvious fact has led commentators to deride it as poor man's gold. Both metals of course are infinitely divisible; but what matters more for ordinary people is that gold today costs $1170 per ounce, while silver costs only $16. Even if the silver price rises, the disparity will never close for the common man.

If gold does return to its historic status as transaction money, it is therefore certain that silver will as well. Given both metals have a long-run history of acceptability as money, it is hard to imagine otherwise. But silver has a further advantage: the US Government set a precedent by confiscating and banning ownership of gold in 1933, while silver, the people's money circulating in coins, was left alone.

The thought that the US Government might at a future date implement such a policy is, frankly, daft. It would be ironic that having denied gold has any role as money, banning its use in this role and confiscating it would amount to an acceptance that it is, after all, money. But governments do daft things when their backs are against the wall. You only have to recall the price and wage controls that were introduced in a number of jurisdictions during the 1970s, including America, in a forlorn attempt to cap price inflation. Under pressure, a future US Government, in conjunction with other like-minded states, would almost certainly consider restricting their citizens' rights to gold ownership, with or without confiscation. It may be politically expedient to clobber the rich who own gold, but it would be difficult to extend these restrictions to silver, because of its industrial applications and the widespread public outcry that would surely follow.

However, the likelihood of a catastrophic failure of fiat currencies, with or without attempts to outlaw possession of gold or silver, is currently beyond the consideration of all but a small fringe of economists and financial commentators. This is now changing, due to the failure of monetary and economic policies in the advanced economies. As concerns over increasing economic and financial instability mount, and with them the risk to confidence in government currencies being maintained, attention should move towards the potential for gold to mitigate these risks. What is not generally appreciated, even among many sound money advocates, is that silver historically fulfilled the role as the people's money ever since coins were invented, with gold being preferred only for larger transactions.

No doubt the principal focus will always be on gold as the ultimate metallic money, but the temptation to overlook silver's monetary credentials is a mistake. Arguably, it could even have a greater claim than gold to be the people's money, because for all of commercial history it has been more widely circulating for that mundane purpose.

1. Part 2: The Value of Money, page.106, translation by H E Batson, Yale University Press 1953.

Alasdair Macleod | Head of Research

Alasdair became a stockbroker in 1970 and a Member of the London Stock Exchange in 1974. His experience encompasses equity and bond markets, fund management, corporate finance and investment strategy. After 27 years in the City, Alasdair moved to Guernsey. He worked as a consultant at many offshore institutions and was an Executive Director at an offshore bank in Guernsey and Jersey.

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