Why Gold (and Silver) Standards Don't Work: Part III - Human Meddling

A few posts back I noted that, originally, "standards" were just official exchange rates. Here I want to quickly elaborate upon why the real world market gets skewed when humans try to fix these rates.

Let's create a simple example. It's the ancient world and copper is one hundred times more abundant than silver. Making the real world market value of an ounce of copper equal to 1/100th of an ounce of silver.

(I'm just using simple numbers here to make things easier. Also, of course, prices aren't just a reflection of relative scarcity. Usefulness and desirability play a part. If a new invention comes along that requires lots of copper, the market value of copper might go up in relation to silver regardless of abundance.)

Anyway, in this simple example, one ounce of silver is worth about one hundred ounces of copper. Naturally, however, this real world value fluctuates.

So, to simplify the complex world (just as I'm doing here with this simple example), a state - let's say an ancient empire - might set an official rate for the purpose of tax collection or issuing coinage.

They then decree: "One ounce of silver is equal to one hundred ounces of copper."

Now, as long as the real world values don't stray too much from this official statement, things work okay. But once the real world market moves too far things start to break down.

Let's say more copper mines are discovered and more copper floods the market. Lowering the value of copper. Perhaps shifting the real world value from an ounce of silver being equal to approximately one hundred ounces of copper to one ounce of silver equalling approximately one hundred and twenty ounces.

This would then mean that the official decree - the official exchange rate - would need changing to reflect this changing reality. However, doing this is often difficult and unappealing, as it might mean having to change the entire system of coinage.

For example, let's say when the ratio was 1/100, copper coins were minted with this value stated on the actual face of the coins. A one ounce copper coin being labelled as being worth 1/100th an ounce of silver. (Similar to how one hundred pennies are stated to equal a pound, or one hundred cents equal to a dollar).

Originally, when the real world ratio of copper to silver was approximately 1/100, this reflected reality. However, as the value of copper goes down this stops being the case. Now the real world value is 1/120, but the coins are still pegged or labelled as 1/100.

When this happens the copper coins cease to be traded as pieces of actual copper and effectively just become tokens (or IOUs) that happen to be made out of copper. Each coin promising the holder 1/100th an ounce of silver, regardless of the physical value.

So, the state - our ancient empire - is officially stating that one hundred one ounce copper coins can be exchanged for one ounce of silver. Even though, in reality - on the open market - one ounce of silver is actually worth one hundred and twenty ounces of copper. So the state is trying to force a false reality onto the world.

And, as the state has the power to issue currency and force people to pay tax in that currency, people are forced to accept it.

(For the record, this isn't necessarily out of malice, or even greed. It's largely just a consequence of humans trying to impose order on a complicated world. Take the current UK government capping bus fares at £2, for example. Then having to increase this cap to £3. Sooner or later reality catches up, and someone has to pay the real world cost.) 

It's once rates become fixed in this way (i.e. become decoupled from actual reality) that the "standard" becomes a standard as we would think of one today. Where everything is pegged to that one commodity (be it gold or silver), and all coins (or paper notes) made of anything else, just become tokens promising payment in that one commodity.

Meaning you end up with situations where the actual value of the metals in the coins bears little resemblance to the face value. Where everything gets skewed by the "standard." Including the commodity used as the standard itself.

So, money started to break down long before the modern era of fiat currencies and digital/paper dollars. It's been a slow eclipse over centuries. Perhaps millennia.

Update: Not So Golden

In my last post I said I'd sold my gold for circa £300 profit. That was somewhat premature, and my hoped for approximate £300 dwindled to an approximate £100. Yet another lesson in trying to play with the bigger boys.

I ditched my gold via Cash4Gold, which straight up looks like a mistake as I type it. I naively assumed they'd offer me something in the ballpark of the spot price; thinking they make their profit selling back at retail. I suspected I would get more selling on eBay (though I've never tried it - perhaps that would be a nice little experiment), but wanted to forgo the effort, so just went with the top of the search engine easiest option. I'm too lazy. A grand don't come for free as they say.

Anyway, the guy originally offered me around £650 - this is for an amount of gold worth closer to £1100 at the current spot price. I refused it. He then offered £824, with the old, "C'mon, what were you expecting, I have to make a profit!" Reluctantly, I accepted. You have to wonder what these guys are giving the little old ladies and single mothers selling their unwanted jewellery.

Again, if I wasn't so lazy, I could've just went to a local pawn broker to see what the standard offer would be. So I only have myself to blame for my country-bumpkin, farm-boy-in-the-city style naivety lol. The journey from buying to selling has been a good education though. When you start buying you quickly realise you're paying a big retail premium over the spot price. That's excluding postage (and VAT if you're buying silver in the UK). Then when you sell you realise you're selling back at a big discount.

I'm sure you can actually sell for a fair price if you put more effort in than me, but again there are practical costs and issues. Sending expensive items through the post. Having the certainty that the person receiving the item has actually received it - it could get stolen, or they could receive it and say they haven't, then refuse to pay. Meaning you'd have to pay to post it in a way that requires a signature, and pay to insure it. Added to this you have the time and effort it takes to list something for sale and deal with the enquiries. In the end I've made about £100 profit - largely, if not wholly, through luck. I could've made that by doing an extra shift at work.

So, all in all, I'd have to say my experiment in buying precious metals hasn't really worked out. Even with such a mega increase in the gold price.

Would I buy gold again?

I think if I ever buy gold with a view to making profit (or just outstripping inflation) I'll probably buy paper gold, dare I say it.* That's speaking as a pleb who's trying to make/save enough money to pay for a deposit on a house at some point, not as a wealthy person trying to protect that wealth.

If I do buy more physical metal I think it'll be silver, and I wouldn't be buying it with a view to making profit or even breaking even. I'll more be buying it as a nice little gift to myself - a gift that has the added luxury of retaining value and acting as a safety net if you ever do need money.

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*This also adds an interesting addendum to the last post about gold standards. The difference between the paper (or digital) representation of gold and the gold itself. The physical gold needs to be stored/transported/secured/audited/insured. Which add extra real world costs. Meaning the two things can't ever truly be the same. Though one may stand in lieu of the other.

(Incidentally, I'm using Dezgo to generate these images. The one above was generated from a prompt asking for a 'richly coloured Dante Gabriel Rossetti painting showing lots of gold coins.' I quite like it, odd though it is.

https://dezgo.com/text2image/sdxl )

I'm Off The Gold Standard

I've just sold my gold.

Back in 2021 I bought some gold to ward off inflation. Like a crucifix to ward off vampires. Though I felt somewhat vampiric myself being so materialistic and self-interested. I didn't buy an amazing amount. About half an ounce in total, and it cost me about £750 altogether, premium and postage included. I'm now selling it for the spot price, so I should make about £300 profit approx.

I don't know if it's wise to sell now, but it feels like a good time to take the money and run. Reinvest it elsewhere.

The Gold Standard

It's got me thinking about gold standards again though. I've been watching all the various goldbugs on YouTube. The opinions are always interesting - they certainly make good criticisms of the fiat system. However, I think they don't quite get it when it comes to gold standards.

I've stated before that gold standards don't work.

Gold Standards Don't Work

Gold Standards Don't Work: Part II - Goldilocks Knows

Warm Silver Porridge: Not too hot, not too cold - just right!

To get a better sense of this, it's useful to look at why historically silver was used as a "standard."

Silver is a natural intermediary between copper and gold. So it's natural to use it as a measure.

Let's imagine you live in earlier times - in the age of metals - and you have five ounces of silver saved in a bank, and an IOU from the bank saying they owe you that five ounces of silver. In theory, you could redeem that money in copper or gold instead. However, it wouldn't be as practical.

Say, at the time, one ounce of silver was worth fifty ounces of copper, and one ounce of gold was worth fifteen ounces of silver.

To redeem the equivalent of that five ounces of silver in copper would mean having to carry a big, heavy bag of two hundred and fifty ounces of copper out of the bank. Likewise, redeeming it in gold would mean having to take out a tiny 1/3 fraction of a one ounce gold coin. Which would be harder to break down if you wanted to split it further. So, five silver coins is much easier. Like Goldilocks (or rather, Silverlocks) - not too big, not too small.

It's like paying a bus fare. Using a £50 note to pay a £3 bus fare isn't practical. The bus driver would be quite annoyed. Similarly, paying it with three hundred 1p coins would be annoying and impractical too. So things in the middle - £1 coins, 50p pieces, £5 notes - are more appropriate to the task.

If banks or states used copper as a standard it wouldn't be very practical for wealthy people saving/borrowing/trading/paying tax in large amounts. On the flip side, a gold standard wouldn't be very practical for poorer and more regular people with their much smaller amounts. Some that may never have even seen a gold coin in real life before. So silver is the happy medium.

It's Only Natural

Historically there were silver "standards" not because people chose to have silver standards, but because that was just the most natural way to do things.

On top of this, it also wasn't a "standard" as we would think of a "gold standard" now. They weren't issuing paper currency backed specifically by silver (though banks might issue written IOUs). The "standard" was just the official measure. Gold, silver and copper coins were all equally valid and used for trade. The standard just stated what the official conversion rates were.

So, to give a simple example, let's say all citizens have to pay one silver coin in tax. However, there are poorer people that don't have access to silver, so have to pay in copper. The state then says how many copper coins equals one silver coin so people know what to pay. Of course, in the real world, the value of copper in relation to silver is changing all the time. So the official rate is there just to make tax collection simpler. It could be they set the rate as one ounce of silver being equivalent to forty ounces of copper. That being a close approximation to the real market value at the time. However, this wouldn't be a good approximation forever, as values fluctuate. Therefore, sometime later, the official rate might be changed to better reflect the changing real world market values. Maybe changing to 41 to 1 instead, and so on.

So, again, these official rates were approximations of a real world market where people used metal coins - of all different metals - that had actual physical value relating to their scarcity. That floated around relative to each other, and kept each other in check. If gold became too scarce people would use silver, and vice versa. Like in the simple example above, where you could pay your taxes in copper if you didn't have silver.

As I've mentioned elsewhere, in the real world market place anything can be a currency. It's only the demand that tax be paid in a specific currency that moves things away from this more natural state of affairs. You could make that argument that the poorer people with copper coins in that simple example earlier could have just converted them to silver to pay their tax (i.e. buy one silver coin with their forty copper coins). However, if people had to get the actual silver, that demand would push the value of silver up further. So the real world silver price would get skewed by the demand this special status creates.

Likewise, if you have a gold standard where everything must be paid in gold, you end up with an unnatural economy.

Anything Can Be Currency In A World Without Tax