Why pay dear when you can pay cheap ?

The bimetallic Standard offered the debtors something nice : they could repay their debts in the cheapest metal. The market value of the metal that coins (dollars if you want) were minted from changed every day, but the value of the coins when used to repay debts or to buy something was constant. A dollar is a dollar, be it gold or silver. So nobody would pay with a coin whose metal content was worth more than its legal-tender value, and those undervalued coins were either melted or hoarded. Conversely, overvalued coins, that is coins whose value as a legal tender was greater than the value of their metal content if melted, were the only to circulate. Bad money drives out good money, as Thomas Gresham, a scottish banker, first said it.

On the , you will see what someone smart holding a silver bar will do when silver is more valuable on the bullion market than at the mint.

Silver Bar : 1500 gr

Gold exchanges for silver at 15:1 on the bullion market, but only at 16:1 at the legal price.

Minting Machine

The US Mint

Etching of the American Mint

This picture represent the US Mint, which was the place where people brought their gold and silver in exchange for dollars. You needed 371 grains of silver or 22.5 grains of gold for one dollar. (A grain is an old monetary unit)

Minting Machine

Silver Dollar

You can either coin your silver bar directly at the mint, in which case you will get 4.04 $, or you can first exchange it on the bullion market for gold and then coin the gold at the mint. In that case you will get 4.5$, because silver is undervalued as a legal tender.

Gold Dollar

4.04 $

4.25 $

Silver is undervalued when used as money, so no one will use it.

Gold is overvalued when used as money, so gold coins will be the only one to circulate.

Whenever the market ratio of silver to gold prices rises above the legal ratio, the monetary system will use only gold and it is a de facto monometallic gold standard. That was the situation of the USA for the greater part of the 19th century.

What happens when the market silver price of gold differs too much from the legal price ?

To understand this, a simple example is sufficient Let's assume you have a bar of silver and you need some dollars. You have then two options :

First, you can simply go to the mint and ask for your silver to be coined. You will then receive the legal amount of dollars for your silver, that is 1500/371, because a dollar is defined as 371 grains of silver. (left hand side of the picture)
Second, you can first exchange your silver bar on the open (bullion) market at the prevailing price. Let's assume it's 15:1, which makes silver more valuable here than at the mint, where it is legally set at 371/22.5= 16 grains of silver for one grain of gold. (Right hand side of the picture)

Return to Monetary History
Return to François Micheloud's Homepage