Nineteenth-century economists liked to illustrate the importance of scarcity to value by using the water and diamond paradox. Why is water cheap, even though it is necessary for human life, and diamonds are expensive and therefore of high value, even though humans can quite easily get by without them? Marx’s labour theory of value — naïvely applied — would argue that diamonds simply take a lot more time and effort to produce. But the new utility theory of value, as the marginalists defined it, explained the difference in price through the scarcity of diamonds. Where there is an abundance of water, it is cheap. Where there is a scarcity (as in a desert), its value can become very high. For the marginalists, this scarcity theory of value became the rationale for the price of everything, from diamonds, to water, to workers’ wages.

The idea of scarcity became so important to economists that in the early 1930s it prompted one influential British economist, Lionel Robbins (1898–1984), Professor of Economics at the London School of Economics, to define the study of economics itself in terms of scarcity; his description of it as ‘the study of the allocation of resources, under conditions of scarcity’ is still widely used.8 The emergence of marginalism was a pivotal moment in the history of economic thought, one that laid the foundations for today’s dominant economic theory.

— Mariana Mazzucato (2018, 64-65) The Value of Everything

The Manufacturing of Scarcity qua Market Manipulation

American males enter adulthood through a peculiar rite of passage: they spend most of their savings on a shiny piece of rock. They could invest the money in assets that will compound over time and someday provide a nest egg. Instead, they trade that money for a diamond ring, which isn’t much of an asset at all. As soon as a diamond leaves a jeweler, it loses over 50% of its value. (Priceonomics 2014, 3)

We exchange diamond rings as part of the engagement process because the diamond company De Beers decided in 1938 that it would like us to. Prior to a stunningly successful marketing campaign, Americans occasionally exchanged engagement rings, but it wasn’t pervasive. Not only is the demand for diamonds a marketing invention, but diamonds aren’t actually that rare. Only by carefully restricting the supply has De Beers kept the price of a diamond high. (Priceonomics 2014, 3)

Countless American dudes will attest that the societal obligation to furnish a diamond engagement ring is both stressful and expensive. But this obligation only exists because the company that stands to profit from it willed it into existence. (Priceonomics 2014, 3)

So here is a modest proposal: Let’s agree that diamonds are bullshit and reject their role in the marriage process. Let’s admit that we as a society were tricked for about a century into coveting sparkling pieces of carbon, but it’s time to end the nonsense. (Priceonomics 2014, 3-4)

The Concept of Intrinsic Value

In finance, there is concept called intrinsic value. An asset’s value is essentially driven by the (discounted) value of the future cash that asset will generate. For example, when Hertz buys a car, its value is the profit Hertz will earn from renting it out and selling the car at the end of its life (the “terminal value”). For Hertz, a car is an investment. When you buy a car, unless you make money from it somehow, its value corresponds to its resale value. Since a car is a depreciating asset, the amount of value that the car loses over its lifetime is a very real expense you pay. (Priceonomics 2014, 4)

A diamond is a depreciating asset masquerading as an investment. There is a common misconception that jewelry and precious metals are assets that can store value, appreciate, and hedge against inflation. That’s not wholly untrue. (Priceonomics 2014, 4)

Gold and silver are commodities that can be purchased on financial markets. They can appreciate and hold value in times of inflation. You can even hoard gold under your bed and buy gold coins and bullion (albeit at approximately a 10% premium to market rates). If you want to hoard gold jewelry, however, there is typically a 100-400% retail markup. So jewelry is not a wise investment. (Priceonomics 2014, 4)

But with that caveat in mind, the market for gold is fairly liquid and gold is fungible — you can trade one large piece of gold for ten smalls ones like you can trade a ten-dollar bill for ten one-dollar bills. These characteristics make it a feasible investment. (Priceonomics 2014, 4)

Diamonds, however, are not an investment. The market for them is not liquid, and diamonds are not fungible. (Priceonomics 2014, 4-5)

The first test of a liquid market is whether you can resell a diamond. In a famous piece published by The Atlantic in 1982, Edward Epstein explains why you can’t sell used diamonds for anything but a pittance:

“Retail jewelers, especially the prestigious Fifth Avenue stores, prefer not to buy back diamonds from customers, because the offer they would make would most likely be considered ridiculously low. The ‘keystone,’ or markup, on a diamond and its setting may range from 100 to 200 percent, depending on the policy of the store; if it bought diamonds back from customers, it would have to buy them back at wholesale prices. Most jewelers would prefer not to make a customer an offer that might be deemed insulting and also might undercut the widely held notion that diamonds go up in value. Moreover, since retailers generally receive their diamonds from wholesalers on consignment and need not pay for them until they are sold, they would not readily risk their own cash to buy diamonds from customers.” (Priceonomics 2014, 5)

When you buy a diamond, you buy it at retail, which is a 100% to 200% markup. If you want to resell it, you have to pay less than wholesale to incent a diamond buyer to risk her own capital on the purchase. Given the large markup, this will mean a substantial loss on your part. The same article puts some numbers around the dilemma: (Priceonomics 2014, 5-6)

(….) We like diamonds because Gerold M. Lauck told us to. Until the mid-20th century, diamond engagement rings were a small and dying industry in America, and the concept had not really taken hold in Europe. (Priceonomics 2014, 7)

Not surprisingly, the American market for diamond engagement rings began to shrink during the Great Depression. Sales volume declined and the buyers that remained purchased increasingly smaller stones. But the U.S. market for engagement rings was still 75% of De Beers’ sales. With Europe on the verge of war, it didn’t seem like a promising place to invest. If De Beers was going to grow, it had to reverse the trend. (Priceonomics 2014, 7)

And so, in 1938, De Beers turned to Madison Avenue for help. The company hired Gerold Lauck and the N. W. Ayer advertising agency, which commissioned a study with some astute observations. Namely, men were the key to the market. As Epstein wrote of the findings:

“Since ‘young men buy over 90% of all engagement rings’ it would be crucial to inculcate in them the idea that diamonds were a gift of love: the larger and finer the diamond, the greater the expression of love. Similarly, young women had to be encouraged to view diamonds as an integral part of any romantic courtship” (Priceonomics 2014, 7)

(….) The next time you look at a diamond, consider this: nearly every American marriage begins with a diamond because a bunch of rich white men in the 1940s convinced everyone that its size determines a man’s self-worth. They created this convention — that unless a man purchases (an intrinsically useless) diamond, his life is a failure — while sitting in a room, racking their brains on how to sell diamonds that no one wanted. (Priceonomics 2014, 8)

A History of Market Manipulation

(….) What, you might ask, could top institutionalizing demand for a useless product out of thin air? Monopolizing the supply of diamonds for over a century to make that useless product extremely expensive. You see, diamonds aren’t really even that rare. (Priceonomics 2014, 10)

Before 1870, diamonds were very rare. They typically ended up in a Maharaja’s crown or a royal necklace. In 1870, enormous deposits of diamonds were discovered in Kimberley, South Africa. As diamonds flooded the market, the financiers of the mines realized they were making their own investments worthless. As they mined more and more diamonds, they became less scarce and their price dropped. (Priceonomics 2014, 10)

The diamond market may have bottomed out were it not for an enterprising individual by the name of Cecil Rhodes. He began buying up mines in order to control the output and keep the price of diamonds high. By 1888, Rhodes controlled the entire South African diamond supply, and in turn, essentially the entire world supply. One of the companies he acquired was eponymously named after its founders, the De Beers brothers. (Priceonomics 2014, 10)

Building a diamond monopoly isn’t easy work. It requires a balance of ruthlessly punishing and cooperating with competitors, as well as a very long-term view. For example, in 1902, prospectors discovered a massive mine in South Africa that contained as many diamonds as all of De Beers’ mines combined. The owners initially refused to join the De Beers cartel, and only joined three years later after new owner Ernest Oppenheimer recognized that a competitive market for diamonds would be disastrous for the industry. In Oppenheimer’s words: (Priceonomics 2014, 10-11)

“Common sense tells us that the only way to increase the value of diamonds is to make them scarce, that is to reduce production.” (Priceonomics 2014, 11)

(….) We covet diamonds in America for a simple reason: the company that stands to profit from diamond sales decided that we should. De Beers’ marketing campaign single handedly made diamond rings the measure of one’s success in America. Despite diamonds’ complete lack of inherent value, the company manufactured an image of diamonds as a status symbol. And to keep the price of diamonds high, despite the abundance of new diamond finds, De Beers executed the most effective monopoly of the 20th century. (Priceonomics 2014, 13)

~ ~ ~

The history of De Beers’ ruthless behavior in its drive to maintain its monopoly is well documented. There were so successful at creating a market in monopoly that eventually such a monstrosity as blood diamonds could exist. But that is another story. The moral of the story is that when it comes to capitalism there is really no such thing as intrinsic value or a “free market,” and that slick marketing can make a terd sell for the price of diamond.

Upon this market manipulation economists built a house of cards that overlooked the monopolist’s manipulations and instead claimed diamonds are expensive because they are rare. Diamonds are bullshit and by extension so too is modern economics theory of scarcity largely bullshit too.