Fiat money and silver coin quotas

In all the fuss about soaring commodity prices lately, it's easy to lose sight of the fact that "price" has two variables - money (e.g., dollars) and goods (e.g., a barrel of oil). Far too little attention has been paid to the numerator in this equation (dollars) when seeking to explain why prices (dollars divided by goods) have moved upward so sharply.

Further, the value of the U.S. dollar relative to other paper money has made the discussion unnecessarily complicated. Asking, "How could the price of oil triple while the value of the dollar has fallen by just 40 percent against the euro?" just confuses the issue.

No major currency is backed with anything other than a promise by the issuing government to act responsibly and therein lies the problem.

Nowhere is this problem more evident than in the announcement that the U.S. Mint has now imposed quotas for silver eagles.

In one of the most hubristic moves ever by a government - as a sort of bold proclamation that fiat money will endure forever, no matter how much of it the government creates - for many years now, the mint has manufactured silver and gold coins with market values far in excess of their fixed face value.

One dollar silver coins sell for $19 or $20 in coin shops or online at eBay. Similarly, a $50 gold coin (still accepted as legal tender at its face value) now fetches more than $900 on the open market.

People are beginning to figure out that there is something seriously wrong with this math.

This report($) in the Wall Street Journal provides the details on the new quotas:

The government rationed food during World War II and gasoline in the 1970s. Now, it's imposing quotas on another precious commodity: 2008 dollar coins known as silver eagles.

The coins, each containing about an ounce of silver, have become so popular among investors seeking alternatives to stocks and real estate that the U.S. Mint can't make them fast enough. In March, the mint stopped taking orders for the bullion coins. Late last month, it began limiting how many coins its 13 authorized buyers world-wide are allowed to purchase.

"This came out of nowhere," says Mark Oliari, owner of Coins 'N Things Inc. in Bridgewater, Mass., one of the biggest buyers of silver eagles. With customers demanding twice as many as they did last year, Mr. Oliari would like to buy 500,000 a week. But the mint will sell him only around 100,000.

The coins have a face value of $1. But the mint sells them for the going price of silver, plus a small premium, to a handful of wholesalers, brokerage companies, precious-metals firms, coin dealers and banks. The dealers mark the coins up a bit more and sell them to the public. Currently, the coins are fetching about $19 apiece, with some sellers seeking more than $20.

This is an interesting twist on Gresham's Law that posits "bad money will drive good money out of circulation" - individuals are increasing taking their "bad money" (U.S. dollars) and exchanging it for "good money" (precious metals) in a shocking example of how people aren't as dumb as the government might hope.

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