Sweat Equity: Gold and Dollar Production

Ever wonder it’s like inside the deepest gold mine on the planet? Or, who buys the gold bars produced by said mine? Speaking of which, where are gold bars actually stored? And, for that matter, have you ever wondered how gold is turned into bars? Or jewelry?

CNBC’s Bob Pisani did. He answered these questions and others in an half-hour television show simply titled, “Gold.” In a sweeping narrative, Pisani took viewers two miles below the earth’s surface in a South African gold mine, the Mponeng. Its name means “look at me” which seems appropriate considering that this it is one of the richest, most productive gold fields ever discovered.

mponeng

Source: http://www.mining-technology.com/projects/mponeng/images/1-mponeng.jpg

 

When asked about the limitations of the gold supply, one of the mine executives replied that “the sky wasn’t the limit but the earth was.” According to employees in the mine, they are drilling deeper than ever before—12,600 feet deep. At this depth, miners face 100 degree heat coupled with 100% humidity. Plus, miners face seismic activity on a regular basis. To generate an ounce of gold, on average, 3.5 metric tons of earth are removed.

Sounds like hard work to find a measly ounce of gold, no? It is. Nevertheless, the 3,500 employees of the Mponeng mine produced 532,000 ounces of gold in 2010.

The costs—both labor and capital—required to produce an ounce of gold are real. The market for gold is constrained by the natural elements found in the earth’s crust. And, gold’s price is determined in the marketplace by its supply and demand.

Gold supplies are sufficient but not unending. The United States Geological Survey estimates that there are roughly 51,000 tons of gold left on land with another twenty million tons are undersea. And, deep sea mining is just beginning to hit its stride.

So, who is buying all this gold? That is, what does demand for gold look like? After being unearthed, gold is purified at refineries to meet general, agreed to standards of purity and weight. The resulting gold bars are then shipped to buyers all over the world. The two largest uses for gold are jewelry and investments: fifty percent of the world’s gold is made into jewelry while thirty percent is used for investments.

According to one of the largest jewelry makers in the world, Stuller of Lafayette, Louisiana, “gold demand is indestructible.” The Stuller vaults hold 100,000 items that are shipped to more than 40,000 clients, making the world’s largest jewelry maker one of the largest express customers of both FedEx and UPS.

Finally, in a rare insider’s look, Pisani gained access to the world’s largest private gold vault—containing 1,200 metric tons of gold—where viewers caught a fleeting glimpse of stacks of gold bars. Vault employees described the process by which gold bars are identified—each with a unique serial number—and catalogued with respect to its physical location. Auditors regularly visit the vault to insure the accuracy of both sets of information about each gold bar.

Fascinating, right? Just for fun let’s briefly contrast labor- and capital-intensive gold production with the creation of fictional dollars.

Let’s start with the obvious. There is no so-called “sweat” equity backing newly created Federal Reserve credit or notes—just the full faith and credit of the United States government (which, just in case anyone forgot, our credit rating was downgraded last year). Production of new credit and notes is inkless and paperless—it occurs electronically via computer.

Dollars—unlike gold—cannot be permanently recycled. In fact, the Chicago Fed has a massive operation to destroy dollars and coins that are unfit for circulation. Want to make $364? Anyone can visit the Chicago Fed and pick up a (free) bag of shredded bills—some assembly required. Interestingly, the Fed does not give out (free) tokens of recycled coins—apparently, some value is retained in the metal.

There are no new private sector jobs created when new dollars are produced. This contrasts sharply with the creation of jobs in a variety of industries related to gold mining—for example, the miners, jewelers, traders, vault keepers, delivery men, and auditors who made an appearance in the first half of this post.

The irony, of course, is that Fed Chairman Bernanke and Treasury Secretary Geithner—the two policymakers largely responsible for making and carrying out our country’s monetary affairs—are employed by those in the private sector.

As inflation rises—which is bound to occur when dollars are produced without corresponding demand—the very miners, jewelers, traders, vault keepers, delivery men, and auditors who are most harmed by (and who can least afford) today’s easy money foot the bill.

The virtues of gold are profound as are the vices of paper money. Gold retains its value over time since its quantity is limited and its price is determined by the market. Paper money loses its value over time since its quantity is limitless and its price is determined outside the market.

Over the long run, a monetary standard based on gold will maintain stable prices while a paper standard will lead inevitably to inflation. The choice for a sound monetary standard is clear.