Silver, liquid and illiquid, the ‘modified open mint’ and gold & silver as parallel monetary systems
by Hugo Salinas Price, Plata I. Brief history of silver coinage in the US, 1792 to the present The silver dollar, created by the “Coinage Act” passed by the US Congress on April 2, 1792, was modeled on the Spanish “Piece of Eight” which was a world currency in the late 18th century. The model approved for the U.S. silver dollar was to contain 371.25 grains of pure silver. There are 480 grains to the Troy ounce, and so 371.25/480 gives us .773 of a Troy ounce. Thus, if one silver dollar contained .773 of a Troy ounce, then the full ounce would have to be worth 1/.773, which is $1.293. In the same “Coinage Act” the Founders of the US defined the gold dollar as 24.75 grains of pure gold. The ratio of 371.25: 24.75 gives the gold to silver ratio of 15:1, which was prevalent in Europe at that time. In establishing that ratio, the Founders considered that the purchasing power of the dollar could be indefinitely expressed equally either in silver dollars or in gold dollars. “One currency in two different metals” was the idea, known to us as “bi-metallism”. However, the idea was flawed, as subsequent history was to prove, because – as Austrian economics recognizes – the values of both gold and silver do fluctuate in response to changing economic conditions (gold fluctuating much less than silver) and thus the monetary system devised by the Founders caused disruptions which had to be remedied by varying the established ratio of 15:1. The idea of having both a silver monetary system and a gold monetary system embodied in a single expression of a dollar finally had to be discarded, and gold became the sole basis of the US monetary system. According to Murray N. Rothbard, in his “A History of Money and Banking in the US”, those who perceived a historic downward trend in the value of silver with regard to gold secretly decided to put an end to “bi-metallism” and caused the US Congress to put an end to the “Open Mint” policy regarding silver, under which all silver tendered to the Treasury by the miners had to be minted into silver dollars and returned to the miners. There is an apparent contradiction between Rothbard’s affirmation that the monetary experts of the day perceived a trend toward a falling value for silver, and what kitco.com states as the average prices for the years 1862 – 1876, because the prices kitco.com shows for silver for those years are all well above $1.293 per ounce. The facts support Professor Antal E. Fekete’s contention that the price of silver was not falling when the policy of the “Open Mint” was terminated, and that the price of silver only fell after the “Open Mint” policy ended and as a consequence of the termination of that policy; and that the mining industry did not immediately feel the pain of the change, because the prices of silver remained above $1.293 through 1876, three years after the suspension of the “Open Mint”. The real motive behind the suspension of the “Open Mint” appears to have been a decision to abandon the problematic policy of “bi-metallism” with its fixed ratio between the values of gold and silver money, and to align the US with Great Britain, the predominant financial power of the time, whose monetary system was based exclusively on gold. After 1873, not all silver was potentially money. Only such silver as the Congress authorized the Treasury to purchase from the miners was turned into money. The miners were thus left with stocks of silver which were no longer potentially money: those stocks had become a commodity, silver bullion, which was relatively illiquid. The miners were forced to unload these stocks upon the world market for that commodity and consequently, the price of silver entered a long-lasting slide, which began in 1877. The silver mining industry in the Western U.S. entered a crisis and much silver mining closed down. The ruins of the mining industry left ghost towns such as Aspen, Colorado. From 1877 onward, the price of silver remained below $1.293 dollars per Troy ounce every year up until 1963, with the exception of 1919. However, all the silver dollars and subsidiary silver coinage which existed in the US continued to be used as money, which means that all that coinage was perfectly liquid; in other words the silver coins continued to be unquestionably accepted in payment of purchases or payment of debts, even when the silver they contained had fallen in value. It is important to note this circumstance, as I shall show below. (The silver dollar vanished from circulation because it was displaced by the one-dollar banknote, but there were no banknotes for the subsidiary silver coinage.) This situation continued for almost one hundred years, for it was not until the years 1963 through 1966 that the price of silver began to fluctuate around $1.293 dollars per ounce; in 1963 people began to hoard the silver coins and they began to disappear from circulation. By 1967 the average yearly price of silver had risen to over $2.00 dollars per ounce. (All data, www.kitco.com) In 1967, when the price of the silver in the silver dollar rose to an average yearly price of $2.06, this finally demonetized the silver coinage. Since that time, the silver coinage cannot be used as money, because no one will tender in payment of a debt a coin that is worth more than its face value, but only accepted for its face value in payment. What happened in 1967 when the price of silver rose above $1.293 per ounce was that the silver coinage lost liquidity because it was demonetized; in other words, the silver coinage was no longer money.These silver coins are still bought and sold, but these operations require access to a market where a seller or a buyer of silver dollars, half-dollars, quarters and dimes can be found. And the prices of the coins are subject to a spread, which is the mark of illiquidity: a higher price for the buyer or a lower price for the seller. II. Theoretical monetization of a $50 dollar silver coin A new silver dollar coin, or one looking like it, could once again be used as money, without the requirement of legislation making it imperative for the Treasury to mint all silver presented to it by the public, i.e. without the “Open Mint” policy. This could be done by re-creating the situation which existed after 1877 and before 1963, when the silver in the silver dollar was worth less than $1.293. Here’s how it could be done: The price of silver today, March 15, 2012, is about $32.50 per ounce. Let us assume that a new silver coin, similar to the old silver dollar, would have the same .773 of a Troy ounce of silver. .773 x 32.50 = $25.12 dollars, which at today’s price of silver, would be the value of the silver in the new silver coin. So a coin could be struck which would have $25.12 dollars of silver in it, but, as was the case in the period 1877-1963, the monetary value of the coin would have to be more – not less – than the value of the silver in the coin. So we might have a new coin, looking like the old silver dollar, but it might be stamped with a value of $50 dollars on it. This coin would be immediately accepted as money with a completely liquid value of $50 dollars. No spread between purchase and sale prices. The Mint would not be subsidizing the mining industry: it would purchase silver to be minted at $32.50 per ounce, and pay the miners the full price. Purchasing the silver at $32.50 and turning it into a coin with a face value of $50 would produce seigniorage, a profit for the Treasury which runs the Mint. This certainly could be done, but it would be a measure that would be short-lived; sooner or later, the price of silver, which is in a rising trend, will rise above $64.68 dollars per ounce and the coin we are considering would then no longer be money; it would be demonetized and, once again, people would be holding coins which had lost liquidity. Because at over $64.68 per ounce, and .773 of an ounce of pure silver in the coin, the value of the silver in the coin, if melted down, would be worth more than $50 dollars, the face value of the hypothetical new coin. Will the price of silver double from where it is now? The Chairman of the Federal Reserve, Ben Bernanke, has stated that he is looking for a moderate inflation of 2%. It is quite possible that once inflation takes hold in the US it will escape control and again reach 14% inflation per year (there was such a rate of inflation back in the 70’s) which makes prices double in 5 years. Only six years ago, in March 2006, the price of silver was $10.00 per ounce and it has tripled since then. So a new $50 dollar silver coin, replicating the old silver dollar, would have a short life span, and once again, people would not have silver money, liquidity, for their savings. The hypothetical $50 dollar coin would become an illiquid commodity held in people’s savings. For this reason, we have proposed that any new silver coin to be used as money, anywhere, must have a quoted and not a stamped value; a quote which will set the coin’s monetary value above the “melt value”; and in order to keep the monetary value above the “melt value”, the quote would have to be increased with increases in the price of silver, but once raised, the quote would not be diminished with falls in the price of silver. (Remember that the price of the silver in the silver dollar fell considerably during the period 1877-1963 and yet no one questioned the monetary value of the silver coinage, as we noted above.) In this way, the silver coin – whatever its weight and purity – would be kept in a state of permanent liquidity useable as money in any transaction with no problem at all. It would continue to be money indefinitely. What we have been discussing, here and in many other articles, is a procedure to impart full liquidity to what is at present a relatively illiquid commodity, silver coins. In the 20th century, silver went out of use as money because its rising price – responding to fractional-reserve banking and the inflation it produced – caused all the silver coinage with stamped values to reach their “melting point”: the world’s silver coinage was largely melted down. Many other uses were found for silver, spurred by the rise of technology. Huge quantities of the world’s stock of silver were consumed by industry, leaving only a much diminished remnant in stock in the world today. At the present time, the ownership of silver has become attractive because the policies of massive credit expansion by governments and banking systems around the world are creating fear about the future purchasing power of fiat money. In 2011, the demand for silver coins both in the US and in Canada reached such a height, that all the mined silver production in both countries was insufficient to supply the demand for silver coinage on the part of Americans and Canadians. This demand exists in spite of the fact that the silver coins which the public is purchasing so eagerly are relatively illiquid, because they are not money. III. The “Open Mint” as it functioned before 1873 Let us now discuss the possibility and consequences of re-adopting the policy of the “Open Mint” for silver as it functioned before 1873. We are not in favor of that old “Open Mint” policy for silver because, under the present fiat money system, such a policy would necessarily imply an enormous subsidy for the mining industry, as we shall show. Under the policy of the old, pre-1873 “Open Mint” for silver all producers and holders of silver (except banks and the US Government, to follow the rules which governed the old “Open Mint”) would be able to tender their silver to the Treasury and have the same amount of silver returned to them in the form of silver coins, free of charge. There are fundamental questions to be asked, about this policy. What would be the monetary value of the silver coins minted by the Treasury out of the silver bullion presented to it? The owners of the silver coins minted by the Treasury would certainly want to know the fiat money value of their coins. Could they be expected to wish to receive these coins, with the simple assurance of a law that declared them “legal tender for all debts public and private”, but without a known monetary value? It should be obvious that in order for these coins to be acceptable, they would have to fill one of two conditions: a) the coins would have a monetary value stamped upon them, which would doom them to eventual illiquidity as illustrated in the example we have given above, or else b) the coins would have to receive a quoted, and not stamped, legally valid adjustable monetary value, as also described above. In other words, in both cases the “Open Mint”, if implemented today, would have to insert its coins into the presently existing fiat money world, in parallel with that fiat money and with a monetary value for its coinage expressed in terms of fiat money. There is no third way. The consideration of an “Open Mint” policy has to take into account the present monetary and financial organization of today’s world. The money in use, the “US Dollar”, is fiat money which is – regrettable as it may be – the actual money of the US and of the world, and the “Open Mint” would be forced to accommodate itself to this fact. If applied today, the old “Open Mint” policy would require the Mint to accept all the silver tendered to it and to return it in full to the owners of the silver in the form of coins with a monetary value expressed in terms of fiat money; a monetary value which could not be reduced in the case of falls in the world market price for silver – the only form in which the coins would be welcomed by the owners of the tendered silver bullion. Suppose that the Treasury were to quote a monetary value in fiat dollars for the minted coins, equal to the prevalent world price of silver at the time the silver was delivered to the Mint. There would be no subsidy to the silver miners, at that moment. But what if one week later, the price of silver on the world markets has declined? Either the stamped value, if that were the chosen method of monetization, or the quoted value, either one would be above the world price of silver. (The previous quote, as explained above, would remain in place – otherwise the coins would not be considered money, but as a commodity.) Under this situation, all miners in the world would rush to tender their silver bullion to the “Open Mint” because the Mint would be taking the miners’ bullion at the world price and handing it back to them in the form of coins worth more than the value of the bullion, in effect subsidizing the silver miners, and a Mint which subsidizes the mining industry is not politically acceptable. Thus we come to the conclusion that an “Open Mint” policy as it functioned pre-1873 is only viable when silver is once again per se money, and the fundamental unit of money is a silver coin with a defined design, weight and purity and there is no fiat money system in existence, nor a fixed ratio of value with regard to gold. IV. A “Modified Open Mint” for silver, today However, a small change can make the “Open Mint” viable within a fiat money system! Under the old “Open Mint”, all silver tendered to the Mint was returned, in coined form, to the owners of the silver. A “Modified Open Mint” for our times would require that those who take silver to the Mint will accept coins with a quoted fiat value in full payment for the fiat money value of the silver tendered, at the prevailing world price at the time of the transaction. Thus the miners receive full payment in fiat money terms in the form of silver coins which they can deposit in the banking system for the full value of their silver. However, since the coins will be slightly overvalued, in order to insert them into the monetary system, the weight of pure silver in the silver coins returned to the miner will be less than the weight of the pure silver tendered to the Mint. The Treasury, which operates the Mint, will retain the difference in silver as seigniorage, or profit. Economists call this type of coin, which has a content of precious metal lower in value than the monetary value of the coin (the “face value”, if stamped) by the somewhat derogatory term of “token” coinage. Tokens they may well be, but tokens that will preserve some value for centuries, unlike fiat which is a “fair creature of an hour”. The miners would be delighted with this situation. At present, they give up their entire silver in exchange for a fiat money payment. Under the proposed scheme, the miners are paid in silver coins with the same fiat money value in payment, and they have the option of retaining all or part of their payment in the form of silver coins whose value may rise, but not fall. It is clear that tendering their silver to the Treasury would benefit the miners. Nature does not operate through abrupt changes; she works through subtle changes. We do not think the US should wait for the inevitable total breakdown of the false fiat dollar monetary system; preparations should begin at once to open the way for a reform. The introduction of fully liquid silver money, to remain in use permanently, can be accomplished simply and with little or no disruption by allowing it to be considered as money in parallel with fiat money, as long as fiat money lasts. This process can be carried out without noxious subsidies by a policy decision where the “Modified Open Mint” will purchase all silver tendered to it by the public at world prices, to be paid in terms of fiat money. The public – the miners – will receive full payment in fiat money numbers, in the form of silver coins worth that amount according to their present quote. The miners receive full payment in fiat money, but a smaller quantity of silver than that which they tendered (the silver coins are slightly overvalued). If they wish, the miners can deposit these coins in the banking system and receive their full payment – in fiat money – credited to their account. When the folly of fiat money shall have run its course – and it shall most certainly run its course – the alternative for a monetary reform will already be in place: silver money. d V. A visualization of the end of fiat money Let us visualize the end of the present fiat-dollar system. At some point in the coming catastrophe of fiat money – let us say when the new silver coin resembling the old silver dollar is worth $1,000 fiat dollars (or perhaps thousands of fiat dollars!) – the US Government will be forced to decide for a radical reform. (This is what happened in France in 1797.) Under the scenario we envision, the Mint will have been functioning and will have put quantities of these coins into the hands of the public, who will have been putting all the silver coinage into savings; because of the higher quality of this money, it will not be used actively for purchases but following Gresham’s Law, it will be retained in savings – though useable at any moment as money. Since virtually all the silver coinage will come to rest in savings, the effect of monetizing silver will not have inflationary effects – people will not be spending this excellent money. In a great crisis, the Government, beset with Revolution, will decide that enough is enough and declare all fiat money invalid and cancelled (just as Zimbabwe did recently). The Federal Reserve will be abolished along with fractional-reserve banking. The Government will be forced to restrict its spending to what it can collect in taxes. Only the new silver dollars will remain as money, with an astronomical value in the vanished fiat money. To remedy this, the new silver dollar will be recognized as “the coin of the realm” with a reformed value of: $1 dollar. The economy will swiftly – more swiftly than anyone can imagine – recover its vibrancy and a new era of hope will begin for the American people. The new economy of the US, having eliminated the dream-inducing drug of fiat money, will grow upon the solid base of reality. At this time, the policy of the Mint can revert to the old “Open Mint” policy; the silver dollar is once again the basis of a silver monetary system, and all silver is once again potentially money. If the new silver dollar is modeled on the old silver dollar, with .773 of an ounce of silver, then the price for silver will be, once again, $1.293 reformed silver dollars per ounce. VI. The Market will signal how much silver money is to be minted When considering a silver monetary system and the policy of a “Modified Open Mint” and an eventual Classic “Open Mint” after silver becomes the basis of a silver monetary system, it is necessary to think about limits and unintended consequences. Surely there will be unintended consequences, for they are inseparable from all human action (ask anyone who marries.) The worst consequence would be the creation of a “bubble” in the minting of silver, where minting would go on in unlimited fashion until a final crash. What would limit the minting of silver under a “Modified Open Mint”? Under the “Modified Open Mint” the price of silver paid to miners would be the world price of silver, paid to them for its fiat money value, but in the form of silver coins with a monetary value. Once in operation, the policy of the “Modified Open Mint” would undoubtedly raise the world price of silver strongly, in terms of fiat money. The latent demand for silver coinage, which has not been satisfied for many decades, would explode and raise the price of silver, perhaps many times over its previous price, clearly revealing the enormous depreciation of the fiat dollar. The minting of silver coinage would proceed at a furious pace. As the price of silver rose, the value of the silver coinage in terms of fiat money would rise to unsuspected heights. This would be to the advantage of those who purchased their silver coins early. Purchasers for the increasingly expensive coins would gradually become fewer. At some price, the value of the silver coinage would be so high, that purchasers would become less and less able to obtain the silver coins, which would all be going into savings. New savings would continue to seek refuge in the possession of silver coins as long as the fiat money system continued in existence, but the initial rush into silver would have passed. The stage would be set for a drastic step: the abolition of fiat money by a Government utterly unable to continue the farce of fictitious money, faced with a population on the verge of violent Revolution. Once that decisive step is taken, the Classic “Open Mint” can resume operation and all silver becomes, once again, potentially money. Silver has to come out of savings and into active use for everyday purchases and payments, because there is no other medium available. Fiat money is gone. What can then determine the amount of silver to be tendered to the Treasury, for minting? The only remaining limiting factor must be a fall in the relative value of silver with regard to gold, which will be expressed as a rising price of gold in terms of silver. A rise in the value of gold with regard to silver means that people are opting for gold coin rather than for silver coin thus restraining the silver miners from offering silver to the Treasury, for minting into coin. Industry will offer a competitive alternative to monetization by the Treasury. The miners will, following their own interest, wish to invest the proceeds of their mining operations in a currency which is going up with respect to silver: gold. They will sell their production to Industry in exchange for payment in gold. Industry will be willing to purchase the silver for its needs, as the price of silver expressed in gold is going down. We can think of no other way to recover the use of silver as money. In our opinion silver has been, historically, the vitally important complement to gold, because for thousands of years it has been the main monetary instrument for the masses of humanity. Its recovery as money is vital to the continued existence of our civilization. VII. Considerations regarding gold Today we have the price of silver denominated in terms of fiat money, which is the money in use. As we have pointed out, as long as this situation persists, a monetized silver coin will have to be given a monetary value in terms of fiat money. Only when fiat money has been abolished will the new silver dollar become the denominator for all prices, including the price of gold. (The silver dollar will not “set” the price of gold; it will merely express the fluctuating value relationship between silver and gold.) We know that at present, the rising price of gold is principally a reflection of the falling value of fiat money. It is in the nature of things, that gold is a monetary metal superior to silver in quality: the marginal utility of silver is lower than that of gold. When silver once again becomes the basic unit of a monetary system, it will be in terms of silver that gold is valued. A varying price of gold, in terms of silver, would apparently indicate that gold is going up, or gold is going down, when in reality a moving price of gold in terms of silver would mean that it is principally the value of silver that is moving. In the “Coinage Act” of 1792, the Founders of the US determined a fixed ratio between the values of silver and gold at 15:1, which was prevalent in Europe at that time. Today we know that all prices must be flexible. The idea of a fixed price – embodied in the idea of a fixed ratio between the values of gold and silver – contradicts the concept of price. The Founders of the US were wise men, but in attempting to set a fixed ratio between the values of gold and silver as they did in the “Coinage Act” of 1792, according to the economic thinking of their time, they made a mistake. The ratio of monetary value between gold and silver will have to be expressed in terms of a floating silver price for gold, just as today the prices of silver and gold are expressed in terms of floating fiat money prices for silver and gold. It is useless to speculate at what ratios – or prices – gold will trade with regard to silver because this is something that we cannot know before it takes place. The “Coinage Act” of 1792 determined that the gold dollar was to contain 24.75 grains of pure gold, and the silver dollar was to contain 371.25 grains of pure silver. 371.25/24.75 gives us a ratio of 15:1. Evidently there was a confusion of the concepts of value and weight. Silver coins were minted that were 15 times heavier in pure silver, than the gold coins. Why 15 times? Because it was thought that gold was worth 15 times the value of silver. Thus by making the silver coin 15 times heavier, it was expected that they would have equal value – an unwarranted assumption! In order to understand how coins with a 15:1 ratio of weight can have monetary values which are not 15:1 it helps to consider the gold coinage and the silver coinage as two different currencies, and not as silver and gold expressions of one single currency, the US dollar. Legislation can make a silver coin weigh 15 times what a gold coin weighs, but it cannot stipulate that those coins shall have equal value! Considered as two different currencies circulating in parallel one with the other, it becomes clear that their monetary values could fluctuate around some fairly stable ratio. This fluctuation of the future ratio between gold and silver would be entirely healthy and could easily be accounted for in commerce – today the world has about 170 different fiat currencies, they are all fluctuating with one another at every second of the day, and yet international commerce goes on nonetheless. In “A Monetary and Banking History of the US” Murray N. Rothbard investigated how the legally prescribed relationship of 15:1 and later 16:1 in value between gold and silver affected politics and the economy of the US in the past. A scholar, reading an old 19th century report such as “gold is scarce”, might re-interpret the report this way: “the purchasing power of the silver dollar having fallen slightly, without any change in the legal exchange rate between gold and silver, the holders of gold are reluctant to exchange their gold for silver, which is presently overvalued at the legal exchange rate.” In other words, “the sellers of gold want more silver for their gold, and those who would purchase gold with silver insist upon paying no more than the legal exchange rate of 16:1”. There are proposals for a restoration of gold as the international numeraire by means of a new “Bretton Woods Agreement”, but such proposals represent one of those huge steps which Nature abhors; as soon as such a conference were called with the announced purpose of reforming the international monetary system, complete chaos and paralysis would take hold of all markets. Are we to believe that a world that is foundering upon universal use of fiat money is going to give birth to the restoration of the gold standard? What must come first is the establishment of order and reality at the grass-roots level. When order is established at the popular level, it will be much easier to extend that order to the higher level of gold operations, one of which is the payment of international obligations. Thus, it is our opinion that the path to the restoration of gold as money, would have to take place after the restoration of silver as the basis for a silver monetary system of the US. The US would ideally have two parallel monetary systems, floating in value with regard to each other: a silver monetary system and a gold monetary system. “Bi-metallism” was a product of economic thought of the 18th Century. Today we know that fixed ratios of gold to silver can only lead to economic disruption. The two systems could operate alongside each other, the market determining the relative values between them. Such restoration of silver as popular money can only be effected by a gradual process, and that process can only be the gradual insertion of silver coinage into circulation in parallel with fiat money. At the conclusion of the process, gold and silver will circulate as money, in parallel: silver for everyday popular needs, gold for large transactions both in cash and in credit. We have proposed that the insertion of silver money into the fiat monetary system should be carried out by the Central Bank (or the Treasury, where applicable) in a limited fashion, seeking only to supply sufficient quantity of coins to prevent the market’s addition of premiums, due to scarcity, to the silver coinage. The reason we proposed this limitation of the minting activity of the Central Bank (or Treasury) was to make the required legislation for this important step politically acceptable, A much more ambitious project, the creation of the “Modified Open Mint” for silver would be the indispensable and definitive political step which would lead naturally to the reform of the US’s monetary system. Today, it would appear impossible to gather the necessary political support for this measure; however, it is possible that in a future grand crash, when the whole world is on fire, the political will for a “Modified Open Mint” will overcome all objections and a belated reform of the US monetary system will take place.