Sunday, December 10, 2006

The Economics of Diamonds

The new movie "Blood Diamond" has brought attention to the economics of diamonds.

Q: How did diamonds, which are a relatively common mineral, become so expensive?
A: The supply of diamonds to the market is tightly controlled and restricted by a powerful diamond cartel: DeBeers Consolidated Mines Ltd. DeBeers is a South African firm with an office in London as its main distribution operation for selling rough stones, at non-negotiable prices to diamond wholesalers, only ten times a year.

Q: Which country has the world's largest supply of unpolished diamonds?

A: It's not Botswana, Russia, Canada or S. Africa which are the four largest diamond producers. The answer is: the UK. The world's largest stockpile of uncut diamonds is in the vault of the DeBeers office in central London, at 17 Charterhouse Street. DeBeers maintains high prices, while it successfully peddles the myth that supply is scarce with effective advertising and marketing. DeBeers alone spends $180 million yearly on advertising, and its clients (wholesalers) spend another $270 million.

There is a recent book about diamonds: "
The Heartless Stone: A Journey Through the World of Diamonds, Deceit and Desire," by Tom Zoellner, here is the website for the book. Here is an excerpt that appeared in Time magazine:

"De Beers has managed the remarkable feat of operating a 17th century economic model in a 21st century world. Fluctuations of supply and demand are not tolerated. Three floors beneath the DeBeers office in London are a series of vaults that contain the world's largest stockpile of unpolished diamonds—the best estimates put it at half a billion dollars. To De Beers, they remain much more valuable right where they are. The continuing stability of the diamond industry depends on an artificial scarcity that De Beers has worked hard to create."

From an
article in The Economist about diamonds:

"The diamond industry sells $60 billion of jewelery alone each year. For generations it has been run by De Beers as a cartel. The South African firm dominated the digging and trading of diamonds for most of the 20th century. The system for distributing diamonds established decades ago by De Beers is curious and anomalous—no other such market exists, nor would anything similar be tolerated in a serious industry. With its near monopoly as a trader of rough stones, De Beers has been able to maintain and increase the prices of diamonds by regulating their supply."

The diamond industry has to be one of the biggest marketing scams in the history of the world:

Step #1: Take a relatively common mineral of compressed carbon, artificially restrict the supply and distribution of that mineral by means of a powerful and ruthless cartel, and charge consumers an artificially high price, way above the true market price.

Step #2: Pursue an aggressive worldwide marketing campaign to deceive people into believing the myth that diamonds are somehow "special and scarce," when that specialness and scarceness are completely man-made and artificial, carefully created and orchestrated by the DeBeers diamond cartel.

Think about the advertising slogan "Diamonds are forever." Well, wouldn't a rock or a penny or a piece of steel be forever too? I have sharks' teeth that are 50 million years old, so I think sharks' teeth are probably forever too. And wouldn't a ruby or an emerald or a bar of gold be forever too? And why pay a lot of money for something that will last for a million years when you'll only be able to use it for maybe 50 years? Seems irrational.

What is the current biggest threat to the diamond cartel, and why is it possible that "cartels aren't forever?" Cultured, laboratory-grown diamonds, produced in diamond growth chambers by companies like Gemesis that have the same physical, chemical and optical characteristics as a mined diamond.

Bottom Line: Don't support the diamond cartel, don't buy into the myth and scam of "false scarcity," and if you must buy diamonds, buy laboratory diamonds!



At 12/10/2006 12:18 PM, Blogger Mark J. Perry said...

From a loyal reader of my blog, I got this question: "I assume you are totally supportive of the diamond situation as it is free market working according to your view. It is capitalism at its finest. Entreprenuership flourishing---GREAT. As for me, I don't care. Diamonds are a luxury in the extreme and this is not an issue that interests me in this form. What say you?"

A: In an unregulated free market, cartels could certainly organize and operate, which is the case of DeBeers operating legally in many countries like the UK for years.

However, economic theory tells us that cartels are inherently unstable, and eventually disintegrate as long as they are exposed to market forces and not protected by government regulation. As the article in The Economist that I referenced in my posting says, "DeBeers's days of market dominance are clearly drawing to a close." Cartels are unstainable in the long run, and the DeBeers cartel is slowly losing its power, as diamond production increases at new mines in Canada, and as cultured diamonds gain popularity.

At 12/10/2006 12:30 PM, Blogger Mark J. Perry said...

From my student: "Economic theory must be solid. DeBeers has only been functioning for hundreds of years. Keep on truckin."

At 12/10/2006 4:21 PM, Anonymous Robert said...

This is very interesting. At best we have a natural monopoly (very uncommon) and, if DeBeers does not qualify in that category, we have a long-lasting cartel (very uncommon).

At 12/10/2006 7:44 PM, Blogger Steve Miles said...

This is interesting, creating scarcity to maintain prices. This has to be the exception to the general rule of cartels, that some member always breaks free. I wonder what oil prices would be if they had the same discipline?

At 3/31/2010 8:29 AM, Anonymous Created Diamonds Blog said...

Oh, there is one more book to prove DeBeers' unfair policy concerning diamond cartels. "The Rise and Fall of Diamonds" by Edward Jay Epstein. He is just a great author and investigator. Like his interview. Epstein reveals the secret of high prices for diamonds, more over he gives facts and prooves. I think, there is always an alternative. Even DeBeers giant has a rival. Cultured diamonds are close on the heals. Moreover, they are much cheaper and not so rare. Hope, there is a great chance for customers to have affordable diamonds.


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