Originally published by Chamber of Merchants
Gresham’s Law
Most people would have heard the name “Gresham’s Law” but very few actually know what it is or what it means. It can be a bit complex when you try to explain it, but it is very easy to understand with a little imagination. Gresham’s law is a monetary principle stating that “bad money drives out good”. There are many different examples of this law dating back thousands of years. In can also be used in many other applications, not just monetary based.
For example: Bad news drives out good news. – recently applicable with all the fake news headlines. Bad loans drive out good loans – housing bubble of 2008. As for money:
For example, the Roman government gradually altered both the size and silver content of the Roman coin called the denarius without changing its denomination. Originally the silver coin was almost pure silver weighing about 4.5 grams. Over time it was reduced to only 2% silver. It was eventually replaced by the Argenteus.
In recent US history, the dimes, quarters and half dollars from 1964 and before are coined from 90% silver (making them commodity money). From 1965 and forward, these coins changed to clad coinage. This makes the coins a Fiat Money(currency) and are only worth something because the government has decreed it.
Note: Clad coinage has an inner core of copper, with outer layers of a silver-colored nickel-copper alloy. The clad layers are easy to see on the edges heavily worn U.S. coins.
Bring in the Comex…
What is the Comex?
COMEX is the primary market for trading metals such as gold, silver, copper and aluminum. Formerly known as the Commodity Exchange Inc, the COMEX merged with the New York Mercantile exchange in 1994 and became the division responsible for metals trading.
Buying gold these days is mostly done through buying paper gold. When you buy the paper gold, you are essentially buying a claim on gold. But with the mass creation of paper gold, it might be possible for 500+ other people to have the same claim on that gold coin you think you own. Thus begins a game of musical chairs – but with this game there is one chair and 500+ people! Similar to fractional reserve banking where only a fraction of bank deposits are backed by actual cash.
In the graph below – from early 2016 – it shows that each paper ounce of gold on the Comex has an open interest of 542! As you can see that is a record by far. I could not find any updated info so it may be more or less, but the trend is worrying.
What does this mean?
All those investors out there who purchased gold through GLD (NYSE:GLD) or silver through SLV thinking that they own gold or silver actually don’t own anything except an entry on a ledger somewhere. Up until 2013 the paper/gold ratio was reasonable, but when Gresham’s Law came in to effect, many more people began buying gold, however the inventories of gold never increased to meet demand. History always repeats itself, its just a shame we never learn.
One day this will all end very badly, it may be next week, next year or in 10 years, but one thing for sure is the time is ticking down on that invisible clock when the music stops – and you are scrambling for that last chair.
| The Speculator