Sep 28, 2007 – Last week I spoke at the annual Silver Summit in Coeur d’Alene, Idaho. I had two basic messages. I first explained that while I am very bullish about the prospects for gold, I am even more bullish about silver. Even though the gold/silver ratio has been declining for fifteen years, it still takes 54 ounces of silver to buy one ounce of gold, which is well above its historical average of 16-to-1. So I expect this ratio to continue to fall, meaning silver will outperform gold. But more importantly, I also explained why silver – like gold – is money.
Basically, gold is money because it is useful in economic calculation. In other words, we can use gold just like we use any national currency to price any good or service. Crude oil is the good that I most often use to explain this principle, which is clear in the following chart.
This chart presents a base-100 analysis of crude oil prices in terms of dollars and goldgrams (grams of gold, and the unit of account of my company, GoldMoney) – and it now includes silver too, about which more in a moment. In other words, to establish the comparison in this chart, this analysis assumes that one barrel of crude oil equals 100 units of each currency as of December 1945. The month-end price is thereafter calculated based on the actual dollar price of crude oil and the prevailing dollar-to-goldgram rate of exchange. We can see from this chart (the red line is the price of crude oil in goldgrams) that a goldgram today purchases basically the same amount of crude oil as it has at any other time shown on this data line.
Thus, the price of crude oil today is not out of line with past experience, provided it is measured in terms of goldgrams. When viewed by its goldgram price, crude oil today costs not much more than it did throughout the sixty-two years presented in this chart, and has occasionally cost a lot less.
These two prices of crude oil are surprisingly different. Why has the price of the same commodity taken two separate paths so unexpectedly divergent? Clearly, the answer lies in the money used to calculate crude oil’s price.
We can see that crude oil’s price fluctuates in both data lines, rising and falling in dollars and goldgrams. After all, nothing in our world is static, and we clearly see in these prices an example of that reality. Supply and demand changes cause the price of crude oil to fluctuate in both dollars and goldgrams.
This interaction between supply and demand is basic economics, but this fundamental principle becomes distorted and therefore difficult to assess over long periods of time when the dollar – or for that matter, any other national currency – is used to measure prices. National currencies do not provide an accurate, consistent measure of buying power. In other words, because the dollar is being inflated, the trend of crude oil prices in dollars in this chart (the blue line) is rising. But goldgrams are not being inflated, so the price of crude oil in terms of goldgrams continues to trend sideways.
The price of crude oil is rising in dollar terms only because the dollar is losing buying power because of inflation – the dollar is being debased. In contrast to the dollar, gold is not being debased by inflation, which is the reason the prices in this chart are so very different. National currencies come up short when compared to the goldgram. Gold is still a useful tool to determine the price of any good or service, so gold has not been “demonetized”, as governments would have us believe. In other words, gold is money. And silver is money too.
I have added to the above chart the price of crude oil in terms of silver. It does not exactly track the price of crude oil in goldgrams, but it is close. This comparison means that silver is basically as good a money as gold. There is one last point regarding this chart. Why is the price of crude oil in terms of gold so consistent? The answer to this question rests largely upon logic because it is difficult to locate all the hard facts needed to support it. But basically, the answer is that all the factors affecting supply and demand of crude oil and gold are changing at approximately the same rate.
That is to say, world population growth is estimated at 1.14% annually, which is an indication of the growth in demand for crude oil. Then, it is estimated that about 156,000 tons of gold have been mined throughout history. Because gold is accumulated – in contrast to other commodities, all of which are consumed – nearly all of this gold still exists in the current above-ground stock. The weight of gold lost due to shipwrecks, attrition of circulating coinage, etc., is unknowable, but it generally is believed to be fairly small because of the care given to gold in view of its high value. If we assume, therefore, that the aboveground gold stock is 156,000 tons, then 2,500 tons of new production is increasing that stock by 1.6% annually.
The rate of new wealth creation is harder to determine. Estimates are that world gross domestic product (GDP) grew by 4.9% last year, but not all of this economic production increased the world’s net wealth. In my view, therefore, it is not unreasonable to assume that the rate of new wealth creation remains approximately somewhere between 1.14% and 1.6%, which explains why the purchasing power of gold remains consistent over long periods of time. It’s because all the factors of supply and demand are changing by approximately the same rate, which contrasts to the dollar.
M3 – which is the total quantity of dollars in circulation – is now growing by more than 13% per annum as reported by www.shadowstats.com. So the dollar is being inflated because the supply of dollars is growing much faster than the demand for dollar-money, with the result that the dollar purchases less. We usually express this relationship by saying the price of crude oil is rising.
In summary, this relationship between the factors of supply and demand determines prices. Because these factors for gold and basic commodities like crude oil change at about the same rate, gold’s ability to measure prices is unique. It’s what makes gold to be sound money. And as the above chart shows, silver is sound money too.