Buy Silver or Gold?

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This problem
faces every contrarian investor who has decided that the U.S. dollar
will not reverse from the course it has been on since 1913: a 95%
reduction in purchasing power.

There are a
few contrarians who think that deflation is coming: both monetary
deflation and price deflation. As far as I know, there are only
about a dozen of them who write newsletters or run websites. For
some reason, most of the deflationists seem to think that gold’s
price will rise in a mass deflation. They do not warn their subscribers,
"Don’t buy gold or silver!" If they did, they would have
fewer subscribers.

Robert Prechter
has never joined this camp. He started predicting $125 gold at least
15 years ago. He is consistent. The other deflationists are either
inconsistent or silent on the gold question.

In contrast,
I think gold’s price will rise because the money supply will rise.
I recommend that your first $10,000 in gold be purchased as one-ounce
coins. American eagles are more expensive than Krugerrands. Eagles
by law are designated as numismatic coins. In 1933, when the U.S.
government confiscated gold coins and bullion, it exempted numismatic
coins. If you are worried about gold confiscation — I am not — then
the eagles make some sense. But you get more gold for your buck
with Krugerrands. On these and other precious money issues, click

Why gold’s
price should rise in the face of falling prices, including all other
commodity prices, remains a mystery to the rest of us gold bugs.

The original
deflationist, J.
Irving Weiss
, announced a looming price deflation in 1967, at
Harry Schultz’s original gold conference. I was there. He told us
to buy T-bills. I bought gold coins instead. Since then, American
prices have risen by about six to one. He remains the model deflationist:
he never retracted his prediction over the next three decades. His
son Martin continues to announce it. But the father had an excuse
for his blindness. He had borrowed $500 from his mother in 1929
and turned it into $100,000 by 1931.

He had made
his fortune in the classic bear market of all time, and he never
figured out that this was a once-in-a-career opportunity. The Great
Depression dipped his investment strategy in cement.

Here, I am
talking about hard-core inflationists. Most of them favor gold over
silver. A few prefer silver over gold for their core holdings. I
am not one of them. Let me tell you why.


In June, 1963,
the government passed legislation severing the legal connection
between silver certificates and silver. No longer could you take
in a silver certificate to the U.S. Treasury and get a fixed number
of ounces of silver.

I could see
exactly what was coming. Gresham’s Law was about to be re-confirmed:
"Bad money drives good money out of circulation." That
is, the government-overvalued money drives out of circulation the
government-undervalued money. I began buying silver coins the next
month with my first full-time paycheck. I made $500 a month, and
by September, I had bought over $1,000 in silver coins. I believed
in thrift!

I bought them
because the local bank had silver coins. I kept buying more every
paycheck. I remember a teller — a young woman — who told me: "You
can always get coins. Why do you want to buy so many of them?"
I don’t recall what I told her. I doubt that I explained Federal
Reserve policy and Gresham’s Law to her. Technically, the bank had
to provide coins for me on request. They had only silver coins,
other than pennies and nickels. I knew what would come soon: clad
coins. They did.

By October,
silver coins were going out of circulation. There was a shortage
on the turnpikes for making change. There were no clad coins yet.
They came in 1964. So, dimes, quarters, and fifty-cent pieces were
in short supply.

That was the
de-monetization of silver. Collectors removed them from circulation.
Occasionally, we would find a silver coin among the legally authorized
slugs, but not often after 1966.

The public
did not know the difference. There was no outcry against the government
for having legislated this gigantic counterfeiting operation. Copper
coins with shiny laminate on them were just fine with the average

Beginning around
1968, gold began to be demanded in ever-greater quantities by foreign
governments, especially France. This had been going steadily for
a decade. The Johnson Administration attempted several counter-measures,
such as a two-tier gold price: one for the European free market
in gold and the other for central banks to buy American gold. Nothing
worked. Finally, Nixon unilaterally ended gold convertibility in
1971, which destroyed the 1944 Bretton Woods agreement: central
banks’ use of the dollar as their reserve currency, with the dollar
redeemable in gold at $35/oz, but only by national governments and
central banks.

The central
banks still kept their interest-bearing T-bills and other dollar-denominated
assets as part of their legal reserves. They kept gold, too, but
from 1971 on, they still bought mainly dollar-denominated assets,
not gold. This is true today. The dollar has never lost its reserve
currency status, despite the closing of the gold window. The bankers
ignored this semi-final de-monetization of gold in 1971, in much
the same way that Americans ignored the final de-monetization of
silver in 1963.

I say semi-final.
Why not final? Because the U.S. government did not immediately sell
off its gold hoard in 1971. Most central banks have refused to sell
all of their gold. They have generally ceased buying newly mined
gold or gold from the free market, but they do buy gold bullion
from each other. Some of them have sold off part of their gold supplies,
but this has been done mainly since the mid-1980s.

Silver, in
contrast, has been completely de-monetized. It is an industrial
metal or a jewelry metal. Its price peaked in January, 1980, at
$50 an ounce. It then fell for the next 23 years, bottoming at $4.67
in January, 2003. That was a 90% loss of price, but really closer
to 94%, because of the fall in the dollar’s value, 1980—2003. In
short, silver was an investment catastrophe for over 20 years.

Gold is perceived
as a money metal that is used by central banks. It is used by Asians
as an inflation hedge. Silver has lost that perceived value. So,
silver is more volatile. There was nothing to prevent its fall after

There is something
else to consider. For almost the entire 23 years of its price decline,
there were bullish silver brokers who kept talking about the huge
gap between low silver production and high silver consumption. Here
is my question: If that argument led to losses for 23 years, why
should anyone believe the same argument today? There was a negative
correlation for most of those 23 years between that argument and
the price of silver.

The official
figures for demand and supply remain steady, year after year: from
770 million ounces to 900 million ounces. See
the figures for 1995—2004

I have seen
no plausible explanation for the fact that for 23 years, a metal
that was being consumed out of unknown storehouses could keep falling
in price. If the publicly available supply/demand statistics were
that impossible for that long a period — silver supplies by the
hundreds of millions of ounces per year coming from above-ground
sources (where?) — then why should anyone trust price forecasts
based on today’s supply/demand statistics?

Until a silver
bull can explain clearly from verifiable evidence the origin of
the silver held in above-ground sources — at least 200 million ounces
per year every year for 25 years — I will pay no attention to the
argument. How was it that above-ground supplies did not decline
in availability, despite a 94% decline in silver’s real price? When
you hear this argument, be polite, but ignore it. Do not invest
a clad dime based on this argument.


For at least
a decade, central banks have been lending gold to specialized brokerage
firms, called bullion banks. The bullion banks borrow this gold
at absurdly low interest rates — well under 1% per year. Then they
sell this borrowed gold into the world’s private gold markets. This
keeps down the price of gold: added supply.

The bullion
banks then take the money they earn from the sale of this borrowed
gold and purchase higher yielding debt certificates. They may get
6%. So, they are borrowed short — the low lease rate — and lent
long: bonds.

They owe gold,
not money. The central banks still list this leased/sold gold on
their books. But there is no leased gold in central banks’ vaults;
it has been leased out, then sold. The public believes that this
gold is there, but it’s gone. It has gone into jewelry, maybe in
India. Some daughter has her share of the central banks’ gold in
her dowry in the form of a necklace or rings.

The central
banks do not report that it is gone. So, there is always the threat
that the public will figure out that the leased gold is gone. But,
for now, the politicians either are as ignorant as the public or
content with the arrangement. So, the odds are that the public will
not learn about the missing gold. In any case, voters are just about
incapable of mounting a political attack on central banks, which
truly are untouchable politically.

But the fact
remains that the banks have depleted their hoards of gold. So, their
ability to push down the price of the gold is becoming more limited.
Central banks have not announced lately the usual warning: "We
are going to sell gold over the next few months." Of course,
no profit-seeking owner of a commodity ever announces his plan to
sell. That would depress the price. He wants to maximize the sale
price. In contrast, central bankers do make these announcements.
This indicates that their profits come from other sources. One such
profit source is political: the public’s perception that monetary
policy is sound, a fact testified to by the fact that gold’s price
has not risen much. The central bankers are temporarily buying the
illusion of price stability: a lower gold price.

This perception
is now changing as gold’s price keeps rising. Yet the kitty is depleted.
The gold has been leased, then sold. There may be some future announcements
of some central bank’s looming gold sales, but the silence so far
has been deafening.

So, the gold
overhang of the central banks is no longer the sword of Damocles.
It is more like the switchblade knife of Damocles.

The central
banks now face a major problem. If gold’s price gets too high, the
private bullion banks will be trapped. They owe gold to central
banks, but they cannot afford to buy gold in the private markets
in order to repay it to the central banks. If they are ever asked
to repay, they will go bankrupt.

The central
banks therefore will face exposure as being in collusion with a
bunch of profit-seeking Enrons: busted and owing the government’s
gold to the central banks. My guess is that central bankers knew
from the beginning that they would never see this gold again. They
just wanted a cover: "leasing" rather than "sales"
of the government’s gold.

The downward
pressure on gold is today no longer so great as it was a decade
ago. The threat is reduced because the vaults are less full.

No central
bank holds silver as a monetary reserve. No central bank is committed
to buying or selling silver for public perception reasons. Silver
has been de-monetized. It is no longer on the political radar. So,
silver is closer to a true free market commodity. It is therefore
more subject to the ups and downs of the business cycle.

You can make
more money in silver when the market rises: no overhang of leased
silver in central ban vaults. You can also lose more money when
silver falls, along with the economy: no central bank buying of

Finally, if
the bullion banks are ever asked to repay the gold, the gold bullion
market faces a day of reckoning: massive buying by shorts (bullion
banks) or else the widespread awareness that central banks do not
have as much gold to sell off to keep down its price. Both events
would drive up the price of gold. There is no comparable upward
pressure for silver.


There was a
close correlation for many decades: 15 to one. That was because
this ratio was set by Federal law. It was a price control. Gresham’s
law always took over. The overvalued metal would drive out of circulation
the undervalued metal. For as long as the government would supply
the undervalued metal, the coins would circulate side by side. But
when the gold/silver ratio diverged too much from 15-to-one, speculators
would buy up the coins of the undervalued metal and ship them abroad
or melt them down for their value as metal (higher) rather than
money (lower).

To find today’s
ratio, divide the price of gold by the price of silver. It is nowhere
close to 15 to one. In 1963, when silver went out of circulation,
silver was about $1.30, while gold was $35. That was 27 to one.
Before 1963, silver’s price was lower, so the ratio was higher.
But the ratio did not matter. Gold’s price was a fake price. Americans
were not legally allowed to own gold bullion. So, silver circulated.
Gold didn’t. Then, in 1963, it became profitable to buy silver coins
and hoard them or melt them down. Silver coins disappeared.

Again, the
gold/silver ratio as a forecasting tool produced only losses, 1980
to 2003. Silver’s market price fell by 90%. Gold’s price fell by
70%. The gold/silver ratio increased.

When you discover
an alleged semi-fixed price ratio that produces forecasting errors
for 23 years, it is best to avoid adopting it as your precious metals
allocation strategy.

In any given
12-month period — and you can’t be sure which 12 months — the price
of gold or silver may rise or fall by a greater percentage than
the other. It does no good to trade back and forth, given the income
tax consequences. You may do it once, but let it go at that.


The best way
to buy silver is to buy 90% silver coins: pre-1964.
Take delivery. The sack of coins weighs over 56 pounds. Get them
divided into two bags. I recommend dimes: more transactions per
bag. But it doesn’t matter that much unless there is a complete
monetary breakdown.

coins are far more versatile. That is because they are worth more
per unit of weight and volume. They are easier to hide. They are
easier to move across a border.

8, 2006

North [send him mail] is the
author of Mises
on Money
. Visit
He is also the author of a free 17-volume series, An
Economic Commentary on the Bible

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