Saturday, December 8, 2012

Gresham's Law Applied to Gold & Silver

A better explanation is that when money is not valued correctly or its price is distorted it may be pulled out of circulation when its perceived value is greater than its distorted "market" value.

Let's say the price of some metal (say gold or silver) is manipulated by market participants...lets just say by some company like JP Morgan, who artificially keeps the price low by say...using paper derivatives, unbacked by any metal. Let's also say some currency, say the US Dollar is over valued by its users who are unaware the Federal Reserve is debasing the dollar by printing trillions. The result would be an overvaluation of the US Dollar and an undervalued distorted price of metal.

Some market participants, who were aware of the distortions would use their Dollars to buy the metals, attempting an arbitrage between the two forms of money. This could be done by individuals who want to preserve their wealth by changing currencies (from dollars to gold) or by countries like China who want to get rid of foreign reserves in the depreciating currency to buy sound money.

Now you know how Gresham's Law effects gold, and silver and why shortages will result. Gold and silver will be hoarded by those who understand its true value (as well as that of the dollar) until the prices reflect their true price.

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