If the supply of total gold increases by 3000 tons, total demand to hold gold must also increase by 3000 tons. That could be a combination to possess gold as a hedge against fiat money, jewelry, or for any other purpose.

Gold Is A Trustworthy Medium Of Exchange.

Since all the gold that was ever mined still exists and is potentially in circulation as a medium of exchange if its highest value is as a medium of exchange, then relatively speaking, the increase in the gold supply – the stock of money – will never be very large.

Apart from the fact that a gold standard prevents governments from inflating, gold should not scare the Friedmanites.

In addition, whatever the stock of money is, that is ideal since prices in a free market are relative. Which means that even if there are many uses for gold in addition to its use as a medium of exchange the relative prices in the economy simply reflect that.

Since trustworthiness is the ‘supreme instrument for the prosperity of the world’ gold is the best means.

I’m not sure how much gold is “tradable” though I count jewelry as part of the gold supply. In many countries jewelry is an alternative form of holding gold; it can and does come back to the market as scrap.

But when you talk about “massive demand growth to keep the price stable” you are still thinking in terms of the consumption framework.

If the supply of gold is 160,000 tons, then the demand for gold is 160,000 tons. If the supply increases the next year from 163,000 tons then the demand the next year is 163,000 tons. If the supply increases due to increased supply by mines to 170,000 tons then the demand is 170,000 tons. This is not “massive” demand growth. Demand grows in step with supply such that they are always equal. If supply is growing by 1% then demand grows by 1%. I have another article on this here: http://www.lewrockwell.com/blumen/blumen14.html.

Also implied in your comment is that if 3000 tons are mined each year then, 3000 tons of “demand” is required to keep the price stable. But this is not so – the price is mainly determined by the demand to hold gold as against the demand to hold dollars and other fiat currencies when taking into account the entire supply of gold and the entire supply of fiat currency.

According to the World Gold Council, there has been about 160,000 tons of gold produced in world history and about 2500 tons are produced every year. How much of that 158,000 is actually in existence? Also, I remember seeing a while back that about 1/3rd of gold is used for “fashion jewelry”, industrial, and dental purposes.

What do you think the real supply of tradeable gold is? Very old gold jewelry, coins, and other artifacts trade far above their weight in gold — those will never be traded on the market. Also consider gold in the third world that is not on the market, family heirlooms, wedding rings, industrial supply, dental, etc.

How big is the supply of gold, really? 20 – 30 thousand tons? IF that’s the case, you’re looking at a 10% annual increase in demand to keep prices stable (with a 2500 ton a year production). I think we’ve been getting massive demand growth for gold over the past 10 years, but that will subside.

Most of the discussion of the gold price in the financial press characterizes the two sides of the gold market as miners and coin + jewelry buyers. My reason for writing this article (and a related piece) is to show that mining has very little impact on the gold price, and that the gold price is primarily determined by the reservation prices of the people who own gold and the reservation prices of the people who own money.

I wasn’t really trying to make any point about gold as currency, since gold is not presently a form of money (see my article on that subject).

“One problem I have with the article is why gold would hit such high prices that people would want to offload their stash? ” The article assumes static preferences for the purpose of making the point that the influence of gold mining on the price is small.

I don’t address the influence on the gold price of an increase in the supply of fiat money, but
I agree with your point here, that if the supply of fiat money increases, then people who own gold would adjust their reservation price upward and owners of fiat money would adjust their buy prices upward.

“market transactions take place at market-clearing prices? Is that news?” No this is not news. Most of the discussion of the gold price in the financial press looks at the gold market as a market with mines on one side and coin + jewelry buyers on the other side. These analysts attribute movements in the gold price primarily to changes in gold supply. The reason that I chose to write this article is to show that this model leads to an incorrect understanding of price.

For the purposes of this discussion I assume that demand is constant. That is not true in the real world. Both supply and demand change all the time. I used this model to isolate the influence on the price of the holders of existing stocks from that of the miners.

“an increase in gold production would cause prices to go down if demand stays constant.” Yes this is true. The point of my article is that the quantitative significance of mine production on the gold price is small.

“It seems to me like this article was little more than a gold bug article extolling gold as a “can’t miss” investment.” No where in the article does it say what the gold price will be, or that it will go up from current levels, go down, or anything else that could be construed as investment advice.

If demand is constant, new marginal sellers (miners) would meet the demands of some marginal buyers. As a result, there would be less marginal buyers (satisfied buyers) than there were before miners entered that market — assuming that DEMAND IS CONSTANT.

Essentially, the author is making the argument that satisfied buyers would be replaced by new buyers — that assumes an increase in demand.

Unless you believe that the market has already “priced in” the level of gold mine stocks, an increase in gold production would cause prices to go down if demand stays constant. If this were the case, only the discovery of new mines would cause the price to go down.

It seems to me like this article was little more than a gold bug article extolling gold as a “can’t miss” investment.

On the other hand, can gold miners just keep getting more gold, period? Gold is being recovered from ever finer quantities of dirt. Far from gold growth being exponential it would in fact taper off as gold miners experience ‘Peak Gold’ – any remaning gold is too expensive to extract thus making the world’s gold supply effectively static.

However, as 2A insinuated and other like to say, that the quantity of money should ideally be fixed. If gold mining has virtually hit its peak then it would make the perfect money as it can longer be inflated. Hence paper money is imperial measurement and gold is a metric form of money.

One problem I have with the article is why gold would hit such high prices that people would want to offload their stash? If gold was heading upwards at such high prices and quickly then this would indicate paper money hyperinflation and no one would be selling gold. If anything they would be hiding it from desperate thieves.

Consider the following excerpt:

“Suppose that, from this new starting point, one gold owner lowered his asking price for one of his ounces below the best offer of the most marginal seller. A trade would then take place between the gold owner and the marginal seller.”

I believe that in these sentences the term “marginal seller” should be replaced by “marginal buyer,” as we cannot know the individual demand curve of the marginal gold seller at any price.

To highlight the point that the gold producers play a minimal role in pricing, I would think that the demand curve shown in Figure 4 would be shifted upwards (or rightwards) so as to intersect the supply curve in the region where the price would be determined by the reservation demand. As it is, it looks like the relatively small amount of gold production (and gold demand) will set the price.

This high transaction cost keeps a lid on the velocity of trading which will keep a lid on price movements. Plus the fear that some central banks that are holding reserves will dump them on the market when the price goes up.

The answer is that dollars are running out of value.