No one ‘returns’ silver coins: two laws at work

Monday, 4 April 2005

Hugo Salinas Price

Introduction

I translate a recent article of mine (March 7, 2005) published in Spanish at www.plata.com.mx, because some readers at the Kitco Gold Forum commented on it, and suggested an electronic translator to translate it into English. That translation is largely incomprehensible and, since there has been interest, I present my translation of that article, into English.

Since the article was published, the Committee on Ways and Means of the Lower House of Congress of Mexico held a surprise meeting and killed the projected legislation which would have given Mexico a silver coin to use as money. This, at the instigation of the Mexican Central Bank, very concerned that a silver coin might break its monopoly of fiat money issue.

However, as I said in “Silver’s Three Flags”, it is hard to kill an idea, and excellent legislators who now quite understand the vital importance of re-introducing silver into circulation in Mexico are by no means giving up. A new bill will be presented shortly, and the battle will continue.

One of the pro-silver legislators was asked to visit the personal secretary of the President of Mexico, Vicente Fox. The reason for the meeting was to inquire, “What happened to the silver bill?”

The answer was that the only legislation in recent years to obtain the support of all parties, was killed by members of the President’s own party.

Legislation in Mexico has suffered from a deadlock in recent years, due to party division, and the only legislation obtaining support from all three of the main parties, was: the silver bill!

I predicted this unifying power of silver, ten years ago, in my first little book, “La Plata, el Camino para México” (“Silver, the Road for Mexico”) and it has been gratifying to see my prediction amply confirmed.

I should like to point out that, to my knowledge, in this whole wide world the only concrete and viable project dealing with a step forward in monetary matters, since the first breakdown of the gold standard in 1914, is this project to re-introduce a silver coin into circulation in a permanent fashion, alongside fiat money. (See the text of this project, at www.goldensextant.com, Reginald Howe’s excellent site.)

The silver coin, thus introduced into circulation in parallel with fiat money, would certainly not solve the world’s ills. It is my opinion that these have no solution and will end in chaos.

The only thing that can be done – in my view – is for some country to re-introduce silver into circulation so that humans do not forget that silver (and gold, too) can circulate alongside paper money, by means of this “technological breakthrough”.

What would be accomplished by this measure, would be the building of a bridge of sorts, linking paper money with real money. There is at present no such bridge, nor even a thought of a bridge, but only growing concern and clamor regarding the impending disaster awaiting a world economy based on paper money. Once that bridge is built, however, the path to the totally indispensable return to sound money will have been opened.

Here is the translation, with slight editing, of the March 7, 2005 article:

Silver coins with a fiduciary value

In November of 2004, the Bank of Mexico, Mexico’s Central Bank, sent a document to the Committee on Ways and Means of the Lower House of the Mexican Congress, in which it stated that in the event of a fall in the price of silver, the public would unload upon the Central Bank, large amounts of monetized “Libertads”.

This prediction is without any foundation whatsoever. In the first place, because “Gresham’s Law” applies invariably, and the public will always prefer to retain money of higher quality under any circumstances; in second place, because the fiduciary value of the monetized coin is independent of the value of the material of which it is made: a $100 peso paper bill will always be worth $100 pesos even if the price of paper falls, and a $10 peso coin will always be worth that, even if the price of copper-nickel falls. In third place, because the monetized silver ounce may be spent by the holder in daily commerce, for which reason it will never be necessary to “return it to the Bank” for exchange.

The 0.720 Peso

Let’s take a look at what happened in the past. 458 million silver $1 peso coins were minted in the period 1920-1945. Those silver pesos contained 12 grams of pure silver with a gross weight of 16.66 grams. The fineness was therefore 0.720, by which number they are fondly remembered.

During those twenty five years, the price of silver fluctuated considerably.

When the Bank of Mexico was created in 1925, the price of silver was 69.1 US cents per troy ounce, and the price fell as low as 25.4 cents per ounce in 1932.

Not one single silver peso was ever returned to the Bank of Mexico, during those twenty five years, as a result of a fall in the price of silver.

Why? The public was satisfied that the value of the $1 peso coin, determined by the Congressional decree that gave it that value, was independent of the value of the metal contained in the coin.

This $1 peso silver coin was not minted after 1945, because the rise in the peso value of the silver it contained rose above the value of $1 peso engraved upon the coin.

The coin “States of the Mexican Republic”

Another live example is the case of the coin called “States of the Mexican Republic”, which was put into circulation by the Bank of Mexico itself, in 2003.

Its nominal value (we might say its “quote”) is $100 pesos, according to the legislation approved by Congress the 19th of December of 2002.

The “States of the Mexican Republic” coin contains half an ounce of pure silver. Its legal tender value does not fluctuate with the price of the silver it contains.

The legal tender value of this coin is independent of the value of the silver it contains. If the price of silver goes down, it is still a $100 peso coin. No one returns it to the Bank of Mexico because the price of silver has gone down.

This coin has in its favor, the fact that it contains half an ounce of pure silver, which makes it more desirable than a $100 peso paper bill, independently of the fact that it is beautiful and few coins are being minted. Because it contains silver, it will always have some value and will always be more desirable than a paper bill, which has no intrinsic value.

The problem with this coin is that inevitably, the day will come when it will reach the “point of fusion”, which is the moment when half an ounce of silver is worth more than $100 pesos. The coin will then either be retained by coin collectors or sent to the refinery, but in any case it will cease to be money. It will not be able to circulate even if it survives the refinery.

If by some magical means we could erase the “$100 pesos” stated on the coin and increase the value of the coin in case of a rise in the peso value of silver bullion, and if legislation were to establish explicitly what is today implicit, namely that the new value could not be reduced, then we would have substantially and precisely what the present projected legislation which is in committee aims to achieve.

The creation of a monetary unit of supreme quality, that will circulate permanently in parallel with paper money, without eliminating it, only requires very simple legislation to become a tangible reality for Mexico.

It requires only that to the Economic or Natural Law that applies to silver as a commodity, we apply additionally Positive or Legislated Law that turns the coin into money.

Economic or Natural Law and Positive or Legislated Law

Both laws will operate upon the monetized silver ounce.

The “Libertad” ounce, which has no nominal value, can be endowed with a legal tender value by a quote from the Bank of Mexico.

The reason that coins of base metals bear an engraved value, is to communicate their legal tender value to the public. Communication of the legal tender value of the ounce can be carried out quite as efficiently by modern means of communication: the press, radio and television, and the interbank electronic communications network, thus obviating the lack of an engraved value on the coin itself.

The absence of an engraved nominal value will insure that this “Libertad” ounce will never reach the “point of fusion”, that is, that the moment when the value of its silver content will be greater than the legal tender value will never arrive.

The history of silver coinage in Mexico consists of a series of “silver crises”, as has been documented by the historian of the Bank of Mexico, Eduardo Turrent. In the past, on six different occasions silver coins with engraved nominal value reached the point of fusion, went out of circulation and ended up in the refinery.

This would never happen to the “Libertad” silver ounce, according to the projected legislation, because when Supply and Demand should increase the value of silver, the Bank of Mexico would simply increase the quoted legal tender value of the coin, thus allowing it to remain in circulation.

Thus, the first Law that we mentioned, Economic or Natural Law, would operate freely upon the silver coin, without driving it from circulation.

However, at present only the Economic or Natural Law operates and as the value of silver bullion rises and falls, so does the value of the “Libertad” ounce, because it is at present, a commodity coin: it is not money.

The public is constantly purchasing this coin in relatively modest quantities, because the purchase of a commodity coin is a speculative operation that attracts only a limited sector of the population.

The contribution of Positive or Legislated Law

What this silver project would achieve is to turn this coin into money, so that its possession would not constitute speculation, since it could be used as money at its quoted legal tender value at any moment, with all the attraction that precious metal has for savings.

A money coin differs from a commodity coin in that money, in today’s world, is no longer a product of Economic or Natural Law, as it once was, but rather (in Mexico as well as all over the world) a product of Legislation by Congress when it approves Monetary Law. It is this legislation and nothing else, which bestows the quality of money upon the bills issued and coinage minted by the Bank of Mexico.

One of the implicit conditions upon any legal tender money, sanctioned by a Monetary Law (Legislation or Positive Law) is that its legal tender value cannot be reduced.

Legislation – Positive Law – never before had to express this condition explicitly, because all bills and coinage have always had a printed or engraved value which it has been impossible to reduce.

This implicit condition which applies to all coinage which we use as money, becomes a condition which must be made explicit in the case of the silver “Libertad” ounce, because it bears no engraved value. In other words, the Monetary Law must establish, explicitly, that its legal tender value, once quoted, cannot be reduced.

It is indispensable that legislation must make explicit what has always been implicit: the legal tender value of money cannot be reduced.

Without this essential condition, expressed by a Monetary Law, it will not be possible to turn the silver “Libertad” ounce into money. We must understand that the Mexican banking system will refuse any remittance of such “Libertad” coins to it as money, if the quoted legal tender value of the coins may be reduced the next day.

Without this essential condition, it is impossible to turn the “Libertad” ounce into money.

Effect of the sanction of Legislation or Positive law upon the “Libertad”

Today, Legislation (Positive Law) creates money. Congress legislates and the Bank of Mexico carries out the creation. Today, money is born of legislation. The connection with the materials of which it is made is not material: they can be paper, plastic, copper-nickel, etc. Money in bank deposits is not even that, only magnetic fields in computers.

The legislative project to monetize the “Libertad” ounce contemplates the use of silver because it provides an intrinsic value to the coin, which is absent from paper, plastic or copper-nickel money; this intrinsic value will serve to protect savings in ounces from the devaluation of our monetary unit, the peso, and to give Mexico a coin that will circulate as money as long as there is a Bank of Mexico to quote its value (and probably, I might add, after it is gone.)

Once legislation approves the monetization of the silver “Libertad” ounce with an official quote of its legal tender value by the Bank of Mexico, the ounce will share with the rest of the bills and coins issued or minted by the Bank of Mexico, the legal sanction that turns it into money, independently of the value of the material of which it is made, which is the condition of all the money presently in circulation in the country.

Thanks to this legislation, the ounce will continue to be money at its most recent quote, notwithstanding any reduction in the value of silver bullion: it is Legislation, Positive Law, which authorizes the creation of money, and the material of which it is made is irrelevant to its legal tender value.

In brief:

The “Libertad” silver ounce is currently a commodity coin, whose value is subject to the Economic Law of Supply and Demand.

To turn it into money which will circulate permanently in Mexico, with all the incentives for savings which an undevaluable currency provides, it is necessary to make it the object of Legislation – of Positive Law - with three essential provisions:

1.     That the Bank of Mexico bestow upon it a quote which will determine its legal tender value.

2.     That the Bank of Mexico increase its quoted legal tender value when there is a rise in the price of silver.

3.     That the Bank of Mexico maintain the last quote unchanged, in case there is a fall in the price of silver.

The radical difference between the ounce as commodity and the ounce as money

As we have tried to make clear, these three provisions are logically indispensable in monetizing the silver ounce.

We must make clear that maintaining a fixed price or value of any thing, produces quite different effects when we deal with commodities, than when we deal with money.

When we subject a commodity to a minimum price the result is, invariably, an excess supply of that commodity. If an official entity insures a minimum price for rice, beans or sugar, the official warehouses will be bulging with these products when the market price of rice, or beans, or sugar falls below the minimum official price. That is an unquestionable fact.

However, this consequence of the operation of the Natural Law of Supply and Demand does not follow in the case of a silver ounce turned into money, since, as we have pointed out, Legislation or Positive Law determines its legal tender value independently of the material of which it is made. Both theory, and more importantly, experience validate this statement, as we have shown above.

Therefore, the “Libertad” ounce will continue to be money and will still be saved at any legal tender quote, independently of a fall in the price of silver bullion, by reason of the legislation that has turned it into money.

No one is going to dump his monetized “Libertad” ounces even though there is a fall in the price of silver to one fifth or even less, because in spite of any fall in the price of silver, the ounce will not suffer any reduction in its legal tender value and it will be, in any case, money of higher quality and following Gresham’s Law it will be more desirable than its equivalent in paper or plastic bills or copper-nickel coins.   

(“Gresham’s Law”, named after an English economist of the XVI Century, stipulates that when a payment can be made with either of two coins, the payer will offer the coin he values less, and retain the coin he values more highly.)

As was the case for twenty five years with the 0.720 silver $1 peso coin, or with the “States of the Mexican Republic” coins of today, no one is going to “liquidate” his holdings of “Libertad” ounces turned into money, because there has been a fall in the price of silver, for the simple reason that their legal tender value is not affected by that fall, and because the ounce already has the “liquidity” of money. There is no sense in talking about “liquidation” of what is already “liquid”.

Legislation, Positive Law, will have turned a commodity, the silver ounce, into money, and with that legislation the Mexican Congress will have bestowed upon Mexico a social benefit that costs nothing, but which has enormous economic, psychological and political value for the nation.

This legislation will be a true benefit, because there are already more than 20 million “Libertad” ounces in Mexican hands and because Mexicans will happily hand over and pay for with bills, all the ounces that the Bank of Mexico may wish to mint in the future.