16 January 2009

Why are there not enough coins?

I was recently asked the following question: There was always enough coin production capacity under the gold standard when a gold coins were struck on private account free of seigniorage charges and in unlimited quantity. With all the technological improvements of the past 100 years, why is there any question about "enough capacity"?

While I work at a mint, I am not a manufacturing person so have only picked up a cursory knowledge of coin production. I sought out additional information from the Perth Mint’s CEO, Ed Harbuz, who ran the South African Mint before coming to Perth and is an engineer by trade and a manufacturing guy, so he knows not only the general issues but also the state of the operations of most of the other mints. This has helped inform my comments below.

Firstly, under the gold standard mints were geared up to do nothing but gold and silver coins. Now they are geared up to do base metal coins with gold and silver a niche or side part of the operations, from a volume point of view. The Perth Mint is different in this respect because it is focused on precious metals, whereas other mints are primarily circulating coin operations.

Secondly, lets distinguish between blank manufacturing and minting, they two key steps in making a coin. Blank manufacturing is process manufacturing where inventory is measured in weights and losses and scrap are involved. Minting is unit manufacturing where inventory is measured in units (i.e. number of coins) and is much simpler.

Most mints have many presses, and probably too many for their circulating coin needs. However, the technological improvements made for these have been focused on circulating coin production. They are high speed presses (12 coins a second) for small sizes with low relief designs – all optimised for high volume/low quality production. Certainly most of these presses can be converted to strike precious metal coins, but it is not just a case of putting a new die in and feeding in gold blanks – physical changes and reprogramming is required. In addition, some of the presses are specialised for small coins and would not be able to take the usual 1oz gold coin size. So while it is possible to utilise circulating coin presses to do gold coins, there would still be some work and capital investment required.

However, minting is not really where the problem is. It is blank manufacturing where the bottleneck is. Blank manufacturing, in the trade parlance, involves melting, casting, rolling, cutting out of the blanks (blanking), annealing and various surface treatment processes. It is a far more involved and “messy” process than minting. It is Ed’s view that while there may be enough presses (once converted) in the world to stamp out gold coins there is simply not enough gold blank manufacturing capacity in the world to meet the current demand levels. So can we not convert existing base metal blank manufacturing to gold?

Here is where the technological improvements made are of no use. Mass base metal blank manufacturing deals in metals that are significantly less value that the face value of the coin. As a result, the process is optimised for speed, not quality or security: if a blank is no good, throw it away; weight control tolerances are lax (do you care if your copper coin has slightly more or less copper in it?); metal evaporating when it is melted is not recovered and so on. You cannot allow any of these things with gold, due to its high cost. To convert base metal blank manufacturing you would have to install weight control machines, scrubbers to collect evaporated gold, lock down the building and install physical security, etc. These are major changes and without them the cost of production of a gold coin would be very high.

The result is that circulating coin mints are not optimised/designed for precious metal coining and can only be done so with difficultly. Certainly, if we moved to a gold standard then conversion of base metal circulating coin equipment or addition of dedicated precious metal coin production lines would be made and we would have enough coins.

In the interim, mints will only invest capital in precious metal production facilities if they believe that the current demand for gold coins will continue for a number of years, otherwise they will not recover their investment. The hesitancy of mints to gear up is because the cost of a modern full precious metal coin production line is high.

What sort of investment is required? One Grabener coin press (the most commonly used one) is circa $1 million. That is just for the press, for blank manufacture you need melting furnaces, breakdown mills, pickling plants, weighing machines, scrubbers, vacuum furnances etc etc. If you look at the last Perth Mint annual report (which is almost exclusively a precious metals mint), you will see that on page 24 the cost of plant and equipment (pre depreciation) is AUD 22 million. That equipment supported only 8.1 million blanks and an 8% share of the world gold bullion coin market. And we haven’t even begun to consider working capital requirements cover cash costs and work-in-progress inventory.

One can see that to meet mass market demand for real (gold) money many times the Perth Mint’s capacity would be required across the minting industry (public and/or private). Thus a substantial amount of dollar investment is required.

This discussion of investment then leads us to ponder Professor Fekete’s comments in The Mechanism of Capital Destruction: “A falling interest-rate structure is lethal. It is an insidious destroyer of capital.”

Now most government mints are not affected by interest rates or commercial factors. But even so I think, as a general statement, that we cannot expect Government mints to make the sort of decisive and entrepreneurial decision required to invest to meet future demand; to take the gamble that retail coin demand will continue. This sort of high risk/high return is not in their bureaucratic nature. For those of a conspiracy bent, this is an academic question anyway as the mints have been told by their masters, those that set the interest rates, to make as few gold coins as (plausibly) possible.

This then leaves us relying on private mints to meet the demand. But then is the capital destruction nature of a falling/rising/oscillating interest rate causing private mints to be unwilling to invest in the equipment to meet the demand for coins? And in these markets where will they get the funding from anyway?

The conclusion is that we will continue to have coin shortages (and high premiums) while retail demand for gold continues. In some sense this is necessary, as it is an economic signal to minters to encourage them to invest to make these extraordinary profits. But will this signal work in the current environment? We have a catch-22 type situation (or insidious conspiracy, if you prefer): the interest rate policy of Government destroys the capital of private mints, making them unable/unwilling to spend on equipment to make enough coins to meet demand, but neither are Government mints commercial enough to invest (or told not to). Either way, shall we ever have enough coin production capacity?

There is an alternative view. For all other manufacturers, a zero or near zero interest rate does not cause them to say “money is free, lets borrow heaps and build additional car manufacturing lines”. This is because the sort of dire economic environment that drives the interest rate to zero is the same one that drives consumer demand down. People are not concerned about making money, they are concerned about conserving money (or more accurately, wealth).

However, is it not this demand to conserve wealth that also results in driving demand for gold up? If so, unlike other manufacturers who see falling prices and sales, minters would see that they have increasing demand and increasing prices (premiums). Would this not make taking on zero cost debt a low risk decision? As mentioned earlier, the key is belief by minters in sustainable demand (see this blog for a discussion on the types of issues involved).

While you may consider the unprecedented demand that has occurred as a clear signal, the minters obviously do not as they are rationing supply instead of increasing it. How long before they act? Hard even for me to say, and I work inside one.

6 comments:

Jacq said...

Hi Bron,

Thanks for the article. You have mentioned these points before in Canberra, and it is good to have them now on a blog for others to see.

I agree with the points you have raised, however, I must say that as time goes on, is it plausible to suggest that if retail demand remains high for the next 3 years into 2011, or maybe possibly even for much longer, that the Perth Mint would actually take the plunge and invest in the required equipment to meet the high demand?

Or would it first take a phase transition, with its concomitant symptoms of: loss of confidence in governments, loss of confidence in currency, loss of confidence in the current makeup of the financial system, and the ensuing private markets that would arrive to meet demand, before governments would jump on the bandwagon, fearing that they would miss out and that their existential threat would end badly, and actually invest in required equipment to meet the demand?

One must remember that when dealing with issues pertaining to the populace, governments don't preempt - they never have - but rather, they react after the fact, and then dress this up as preemption, which actually results in the opposite of its intentions.

It seems to me that you are saying that it would take such a prolonged & sustained high retail demand, and a total loss of confidence in the current system, and an ensuing private market to form to meet demand, before government backed minters would even consider increasing their abilities to manufacture more precious metal coins. Would this be a reasonable summary of your points?

kind regards.
jl.

Bron said...

It depends on the Mint. In the case of the Perth Mint (and probably the Royal Canadian Mint), being for profit Government entities, they will invest in equipment, and I doubt it would take 3 years of continued demand to make it happen.

Other, more bureaucratic mints which are more Government department in nature are likely not to respond as quickly.

So your phase transition scenario depends on the country and how closely that country's mint is tied to government and how commercial it is. You would have to rank mints on a continum from bureaucratic to entrepreneurial.

In respect of the Perth Mint, consider these facts:

1. State Government owned, not Federal.
2. Purely precious metal mint, not distracted by circulating currency requirements - if it doesn't sell gold and silver, its existence is threatened.
3. Runs a $2 billion Depository
4. Issued an ASX listed ETF-type product

No other mint in the world demonstrates this sort of innovation and committment to precious metals. Add in 200+ tonnes of gold production and it is my view that Australians are sitting pretty compared to many other countries. There will still be some sort of transition, but it won't be as bad.

Greg Atkinson said...

Bron,

I was wondering if you have any idea of what it costs to get most gold out of the ground? For example around 80% of the world's oil apparently can be produced at less than $20 USD a barrel and this this puts a floor under the oil price. I wonder if these is a similar price support for gold?

Cheers,

Greg
Shareswatch Blog

Bron said...

The cost of gold production does put a floor, it was one of the factors that came into play when gold got down to $250.

Various mines have difference cash costs of production. I don't know what the average is or the cost curve. Possibly http://goldnerds.com.au/ would know or try World Gold Council http://www.gold.org/ or GMFS http://www.gfms.co.uk/

Anonymous said...

Hello Bron,
Great post. Very interesting to get a further insight into the production process, and the manufacturing investment scenario. One area your post does not touch on is the simple fact of the monopoly that the larger mints enjoy. Being part of government is a huge benefit that I don't think you really appreciate in your discussion.
Of course governmental monopolies are well known for their inefficiency and waste. Just look at the justice system. Other monopolies would include public transportation (even when 'privatised' they still enjoy government protection to preserve the monopoly).

If I were to start minting, I would expect the normal competitive pressures that a new entrant is subject to. However, if I were to produce a coin or bar and that were denominated in dollars, I am pretty sure I would be classified as a criminal. You may protest that I could seek government approval to do so, but we both know such approval would never be given.


Cheers,
Keith

Bron said...

Keith,

Yes, Government's keep a monopoly on the issuance of currency but there would not be anything wrong with you creating your own currency (but you would have to call them medallions or tokens) and marketing it as a medium of exchange. This is effectively what Barter Card does and that has not been shut down as illegal, so I see no reason why you could not creat your own gold backed/based payment system.

Looking for a consultant to advise you? :)