It may be stated without hesitation that the effect of the increasing
supply of gold upon prices of all bonds, shares, or commodities which
may be classed as speculative, is more decided and certain in its
operation than any other single factor. The process of readjustment due
to this cause would be slow and regular if the principles at issue were
universally and clearly understood. Not being generally recognized,
however, the changes wrought by what is naturally an insidious factor
are, at times, spasmodic and feverish. It is a remarkable fact that
whenever a revolution occurs in any economic or financial process
which is, by its nature, concealed or recondite, its existence and
influence are discovered by a number of students simultaneously but
independently. Important reversions or modifications may be submerged
for a long period, and suddenly light is offered from all parts of
the thinking world. It is probable that this intellectual phenomenon
extends to, or is communicated to the financial world, and that marked
and drastic changes in the affected quarters represent a belated
recognition of forces hitherto unknown, and the readjustment of
affairs by those who see first and furthest. That the operations of
this minority will be important goes without saying. The faculty to
grasp fully and quickly anything salient bearing on financial affairs
is the ground-work of riches and consequently the trained minds of
great holders of shares or commodities will respond most readily to
sound basic arguments, and the greatest holders can often make of
their knowledge a two-edged sword. For example, certain large holders
of bonds, recognizing the fact that increasing gold production means
higher interest rates, and consequently lower prices for bonds, would
be able to dispose of bonds to advantage because of the apparent
general prosperity growing out of this same production of gold. It may
be assumed that in pointing out in interviews, etc., this reign of
prosperity, the gentlemen in question would modestly omit to mention
that the same influences which were causing high prices and much
business in some quarters, were working damage in others.
Something of this kind has been going on in our bond and stock
markets of late. The inevitable influence of gold on prices has made
itself slowly felt for a long period, but it is only in the last year
that a considerable number of individuals whose operations are of
importance in the financial world have come to recognize how powerful
this influence is. Price changes in divers securities and commodities
hitherto unaccounted for, or attributed to wrong influences, have
suddenly been explained to a number of important financiers, and a
correct understanding of the problem has undoubtedly resulted in
radical readjustments in some quarters. With that pertinacity in error
which seems to distinguish the ordinary speculator, he has, however,
gone on attributing these processes of equilibration to causes which
have only a limited bearing on the case. The recent heavy decline in
bonds and stocks, for example, was popularly ascribed to political
and legislative action against railroads. Scarcity of money was given
second place in these deductions, and gold production third place, or
no place at all. If we reverse this order of importance and give gold
production first place, monetary affairs second place, and political
affairs third place, we are nearer the truth. It looks a little
ridiculous that the scope of intelligent perspective should be blocked
by three thousand miles of water, and that the unthinking majority
who ascribe our decline in bonds to local politics should have failed
to recognize so potent a fact as that the decline was world-wide;
but such is the case. The readjustment in bonds was due to excessive
over-production of gold, and it may be safely assumed that so long as
this over-production continues to increase rapidly, bonds will continue
low in price or, what amounts to the same thing, interest rates will
remain high.
As to the importance of a correct understanding on this subject of gold
supply and its influence on prices, I quote from Mr. Byron W. Holt’s
book “The Gold Supply and Prosperity,” which, I may add, is used as the
text book for this chapter. Mr. Holt says:
“This is the great problem that now confronts the
financial world and demands solution of every
investor. Not to solve it may mean great loss and
possible failure. To solve it means success and
greatly enhanced wealth for all who now have either a
fair share of this world’s goods or who have credit
and can intelligently go in debt for a large amount.”
As speculation or investment-speculation, as defined in the
introduction to this book, are the subjects under discussion it is the
intention to take up, in turn, such points as bear particularly upon
price changes of speculative shares and commodities influenced by our
increasing supply of gold. The main points to be considered are as
follows:
1--The effect upon bonds and preferred stocks having a fixed
rate of income.
2--The effect upon common stocks of railroad corporations.
3--The effect upon stocks of industrial corporations.
4--The effect upon speculative commodities--wheat, corn,
oats, cotton, etc.
For the purpose of argument it will be assumed in this discussion that
our supply of gold is rapidly increasing. We know that such has been
the case in recent years, and it is the opinion of most students that
this increase may be confidently expected to continue. To quote again
from the work already mentioned:
“Both the output and supply of gold are likely to increase for many
years.
“While the future output of gold is, of necessity, unknown and
uncertain, there is great unanimity of opinion, among mining experts,
on this point. It appears to be generally recognized that, during the
last twenty years, the industry of gold mining, or rather of gold
production, has been established on a very different and much more
certain basis than any previously existing. No longer is the output
of gold dependent mainly, or even largely, upon placer mining and the
chance finds of ‘free’ gold. The supply of gold, in rock, sand, clay,
and water, being inexhaustible, it is now possible, by machinery and
metallurgical processes, to extract gold, in paying quantities, from
many forms of these vast store-houses. To such an extent is this true
that the future supply of gold is even more secure than is that of
coal, iron, lumber, wheat or cotton.
“Even if prospecting were to stop and attention were to be devoted
only to the gold mines and bodies already discovered, and geologically
in sight, it is probable that the output of gold would continue to
increase for many years. As Mr. Selwyn-Brown, a gold mining expert,
tells us in his very interesting article, ‘as the rich surface deposits
are being worked out, improvements in mining and metallurgical
processes are enabling poorer and poorer deposits to be worked.’ That
is, improvements in ‘stamp mills,’ cyanide mills, dredging machines and
other gold extracting apparatus and processes are being made so rapidly
that it is, every year, becoming profitable to work lower and lower
grades of ore, sand and earth. As the grade declines the quantity in
sight increases rapidly. In fact there are almost literally mountains
of low grade gold ore that can even now be worked profitably. Some of
the largest, most productive and most profitable mines of today contain
ore averaging less than $3 and, in some instances, only $2 of gold per
ton.
“The supply of such ore being inexhaustible the output depends upon
the number and size of the mills employed to extract the gold. It is
reasonably certain that, for years to come, the improvements in methods
and processes of mining will more than keep pace with both the decline
in the quality of the ore and the increase in the cost of mining due to
rising prices and wages, occasioned by the depreciation of gold.
“In view of all the facts, Mr. Selwyn-Brown’s conclusion that ‘a
progressive increase each year may confidently be expected’ is
conservative. This conclusion, is almost a certainty. The uncertainty
lies in the possibility, if not probability, either of discovering
many important new mines in the practically unexplored parts of every
continent, or of making improvements that will radically reduce the
cost of extracting gold. In either case the increase in the output of
gold might be not simply arithmetically but geometrically progressive.”
Admitting that the question of gold production is debatable, it remains
for the future to develop any radical change, and it will be necessary
for the student to decide this point for himself either by the light
of facts as yet not established, or by accepting theories as yet
not convincingly erected. If a change occurs, or may reasonably be
expected, an understanding of the subject from the positive side of
the question loses none of its value. The principles involved could be
as successfully applied in reading the probable future by modifying or
reversing effects, and reconciling them to a modification or reversal
in the cause. If, for example, we accept the theory that increased gold
production means advancing commodity prices, and find reason later
to believe that gold production will cease to maintain its ratio of
increase, we may alter our views accordingly so far as this single
influence is concerned.
_1--The effect of the increasing gold production on bonds and preferred
stocks having a fixed rate of income._
In this division of the question the crux of the whole matter is
interest on money. The question might, in fact, be stated thus: “What
is the effect of increasing gold supply on money interest rates?” and
having solved that problem, the original inquiry is answered.
To reach a reasonable solution we must first examine the effect of an
unduly increasing supply of gold on commodity prices. Over-production
in any quarter inevitably leads to lower prices. Gold being a fixed
standard cannot decline in figures, but it does so in fact. That is to
say, the flexible prices of things which gold will buy rise to fill
the gap. Thus, since 1896, prices of commodities have risen 50%. The
man who loaned money ten years ago finds its purchasing power impaired
33⅓%, when it is returned to him today, for the reason that commodity
prices having advanced 50% in the interim, his dollar will now buy only
66⅔% of what it would buy in 1897. This impairment of principal will
be covered, in part at least, by interest rates. This effect, if not
recognized and arbitrary would adjust itself automatically, regardless
of whether or not investors recognize the influence of changing values
of gold, for money, finding higher returns in other quarters, would
speedily desert the long-term, fixed-interest investment field, and
prices of such securities would decline through lack of demand.
On the subject of interest rates Mr. Holt says:
“But there is another reason why interest rates
should be high when prices are rising. When money
is shrinking in value interest rates should be high
to make up, or partly make up, the losses on the
principals of loans. To illustrate: Suppose that
prices are rising 10% a year. This means that the
purchasing power of money is declining about 10% a
year. Suppose, then, that $100 were loaned for one
year at 5%. At the end of the year the lender would
have $105; but with this $105 he could buy only about
as much as he could have bought with $95, at the
beginning of the year. In reality, he has received
no interest at all but has, instead, paid $5 to the
man for holding his $100. The man with money to
loan cannot afford to do business in this way. He
is usually as wise as are his neighbors, and fully
as able to protect his own interests and to get all
his money is worth, either by buying real property,
investing in bonds and stock or by loaning on notes
or on call.”
In submitting the above contentions it must be fairly stated that
there is some diversity of opinion as to the effects of gold on
interest rates. A few writers demur to the theory; others hold that
the effect is nil, and one or two openly adopt the negative side
of the discussion, and state that more money means lower rates of
interest. The majority of recent investigators, however, appear to be
accepting the theory as given herein, and it may be added that prices
of the class of securities considered have borne out the hypothesis
faithfully, and that the minority have failed to offer convincing
explanations of this readjustment. It will not do to point to the
fact that money has been fully employed in constructive rather than
investment fields of late; for while this is true enough, it does not
explain why gilt-edged bonds such as British Consols have declined
in value, while stocks and shares which did not bear the onus of
circumscribed returns have advanced. There are, of course, contributory
causes: the Labor-Socialistic Government in England no doubt affects
the prices of consols, but this influence is specific, and loses
most of its force when we consider that not only these particular
securities, but practically all others of their class the world over
have suffered a radical decline. In other words, interest rates have
grown comprehensively higher. The theory appears sound, is borne out
by events, and mere denial does not weaken it. It may well be accepted
until its opponents succeed in giving us something more convincing in
its place.
In support of the theory, Mr. Holt reproduces the following table of
British bonds from Moody’s Magazine for October, 1906.