It's a fascinating piece, for a number of reasons. The first, and perhaps most interesting, is that the story behind the De Beers cartel is well known. Perhaps not in this depth, but still, it's no secret. Pretty much everyone knows they exercise a monopoly on diamond production and distribution, artificially keeping prices high. And yet, nobody takes the red pill and opts out of the illusion. Call it the power of the diamond industry's marketing. Call it adherence to tradition (created by the diamond industry's marketing). Call it what you will. But it's a powerful force. Consumers know it's a lie, and they choose to live the lie.
Second: a major prediction made in this article did come to pass, but it didn't have the predicted effect on diamond pricing. A serious contender to De Beers emerged in the early 2000s in the form of a multinational, "breakaway" cartel. Yet, both cartels -- and all other minor, independent players in the market -- seem to be acting in concert to keep supplies artificially low, and prices artificially high. In fact, the rate of price increase is at its highest in modern history. Economics tells us that this shouldn't be the case, especially given the emergence of new market entrants. And yet, the rate of price increase took off at precisely the same moment as the entrance of the new competitors. (Source: http://www.ajediam.com/investing_diamonds_investment.html)
What could be causing a major, year-over-year price increase in the face of new competition? Well, one guess would be that the two cartels are colluding in some way. Perhaps they've made an arrangement to fix prices or production. Or perhaps they've carved up the map, and reached some sort of non-competition agreement in each other's territories. Perhaps both. Ordinarily I'd call these ideas paranoid. But the history of the diamond business tells me that we can't put it past these guys.
Sadly, it is almost unheard of here in Japan and I am 99.999% sure it is the same in most of Asia (the real market for diamonds and luxury brands nowadays).
Just a couple weeks ago I was at lunch with my Japanese coworkers and the conversation topic went to one of them thinking on whether to buy a diamond ring to his wife as an anniversary gift.
I told him to better stay away from diamonds, and mentioned the diamond situation (pretty much the contents of the article) and not only not any of them had ever heard about it (despite most of them having graduated from top public and private Japanese universities), but also I ended up getting from all of them the most incredulous and distrustful looks I had ever been given in all my years in Japan.
A fundamentalist vegan urging them to immediately abandon sushi and seek redemption in the purity of soy beans would had been more warmly welcomed to discussion than my comment.
well... it does take awhile for foreign countries to adopt white man's guilt or more broadly music in general. I hear most Europeans/South Americans have not heard of Gangnam Style, I bet there will be a second wave in a month from our Euro/Latin friends.
I agree with you in that the story of De Beers is pretty well known. But - for reasons outlined in the article - the intrinsic linking of diamonds to the act of romance and marriage is well embedded in society. So even if people know it is essentially meaningless (in the true sense of rarity) as far as society goes, they have a social status.
Any society is full of irrational practices and purchases. Throwing rice at a wedding? What's that about? $5 cards to wish someone well? What on earth? Yet these are all accepted by society as societal norms, and even when the companies have conspired to create them (or at least magnify their importance) it is what it is. In a form of social proof, nobody wants to be the first to break with the tradition, which is how most tradition stays. Same goes for Christmas - which is nominally a Christian religious festival, but, at least in the USA, widely adopted by people of all religious and aetheist beliefs. Because nobody wants to be the grouch who doesn't hand out presents.
Interestingly the article mentions the introduction of Argyle diamonds - a friend of mine, while travelling in remote WA bought a large diamond at a fraction of the retail cost, direct from either the mine itself or a local retailer. He kept this for 15 years, which was the time period between purchase and eventually finding someone to marry (and getting it put into a ring).
But as to why the introduction of new sources hasn't drastically affected prices, I think that any new cartel or operator entering the market is just as likely to free-ride the hard work of De Beers. If De Beers spends significant money and influence maintaining a monopoly, and therefore creating monopoly pricing, any new entrant rationally would be well served to restrict supply so that they can free-ride on the monopoly prices without any of the costs of maintaining the monopoly.
"But as to why the introduction of new sources hasn't drastically affected prices, I think that any new cartel or operator entering the market is just as likely to free-ride the hard work of De Beers. If De Beers spends significant money and influence maintaining a monopoly, and therefore creating monopoly pricing, any new entrant rationally would be well served to restrict supply so that they can free-ride on the monopoly prices without any of the costs of maintaining the monopoly."
Perhaps, but it's extremely hard (and not very lucrative) to follow the leader when the leader exercises such dramatic buyer and seller power in a marketplace -- unless you plan to compete on price, or to compete by tapping an entirely different market segment. Perhaps prices are much lower in certain markets, but if that were the case, we probably would have heard about the arbitrage opportunities by now, and commodities traders would have closed that gap in a heartbeat.
The different-segment theory is interesting, but it seems very hard to fathom without some sort of non-compete arrangement in place -- be it in X or Y geography, or for Z consumer segment, etc.
My best guess is that this is a two-sided story. There's a major demand factor involved (perhaps in Asia), coupled with the likelihood that the two cartels aren't directly competing. B has to go along with A if there's a price increase, because we know that the supply isn't actually low. There are enough diamonds to keep up with surging demand.
Well, we don't know what the cost-structure of the other market entrants are. Perhaps they have a much higher cost structure than De Beers, and thus there is no point in starting a price war as it not only destroys the long-term market for the gems, but the newer entrants might get wiped out.
I think Game Theory is the right way to look at this - who really gains from a drop in prices? Sure, the new consumer wins - but at the cost of destroying a societal norm. The new entrant might gain short-term profits but at the expense of their long term market and possibly their very existence.
The opportunities for diamond arbitrage are very small, both because there aren't large organised exchanges (no diamond futures contract I'm aware of) and because the retail market is controlled by the suppliers, removing the possibility of 'black market' arbitrage.
Many, many companies would love to exert control over their market in the same way. I just think that new entrants want a piece of the monopoly pie rather than disrupting the entire industry.
Another possibility is that I'm reversing cause and effect here. Perhaps demand started soaring first, which inspired the entrance of the new player, who quickly shored up the gap in demand -- thereby restoring supply/demand equilibrium to the market, and keeping prices stable. Not out of the realm of possibility.
In such a scenario, De Beers wouldn't necessarily or aggressively chase the second player into the new market. It's doing just fine in its existing markets, and it doesn't want to risk setting off a price war over the new market.
Free markets always tend towards monopoly/oligopoly/cartel structures in the long term - because the firms that do so retain their pricing advantage (profits) and the firms that don't - die.
I have to think that the idea of free/natural markets has to be one of the greatest tricks ever pulled by anyone at any time (next to communism). Markets are artificial and restrictive for a reason - they're created by governments for the benefit of the populace - they are probably the most unnatural constructions ever created in human history (next to the corporation/government).
It is in the interests of market participants to maximise profits (to survive/grow). Efficient markets are the enemy of profits. Hence, market participants will make markets less efficient as a function of their incentives - if they can. It may seem more efficient in the short term - i.e. price wars - but in the long term - after the field is cleared - prices always rise in some form or another.
Free/natural markets are probably one of the greatest lies ever sold.
> Free markets always tend towards monopoly/oligopoly/cartel structures in the long term - because the firms that do so retain their pricing advantage (profits) and the firms that don't - die.
This might be true, but short term profits are still attractive to people who want to disrupt the industry. If I discovered a significant diamond mine in my backyard, I'd undercut the inflated prices of the current cartel before attracting attention from the big boys. [1] The only way to disrupt the diamond market is to invent a replacement product that is accepted by all females/males that want diamonds.
[1]every single startup on HN that is "disruptive" and pining to be acquired
> Free markets always tend towards monopoly/oligopoly/cartel structures in the long term - because the firms that do so retain their pricing advantage (profits) and the firms that don't - die.
Can you give any example?
> Free/natural markets are probably one of the greatest lies ever sold.
What do you mean? Free markets are not a lie. There are tons of free markets. If I buy bread at the supermarket, I can choose among multiple brands.
Any industry that makes money will tend towards this in one form or another. This does not mean that there are no competitors or independents not making money - it merely means the vast majority of the market is consumed by a few companies/brands who set the prices and keep price floors.
Bread is an example of a cartel structure reinforced with marketing, economies of scale (monopoly) and previous consumer buy in. You can choose from multiple brands - but you'll notice the price of bread isn't falling very quickly - it's an implicit pricing pact - you can undercut your competitors - but not for long, and definitely not forever.
Oh, I see you're using a definition of Cartel that's rather different than the standard one[1]. If you just mean that commodity producers more or less converging around a price without an explicit agreement between them to inflate that price than of course every commodity ends up being a "cartel" and you'd have a hard time finding an economist who would disagree with you.
I think you've got this wrong. Any firm that defects from the cartel will tend to gain market share at the expense of all the firms that remain in the cartel. Thus, its really the firms in that remain in the cartel that die. So the whole thing looks a lot like a Prisoner's Dilemma game played between the firms looking to cartelize.
Now, they might do things like sign contracts between each other to prevent defection, or buy each other's stock to make defection less profitable than profitable than playing along, but then you have to worry about disruption from outside the cartel. Or you could forcibly cartelize industries like FDR tried to do with the National Recovery Administration if the government really wants an industry to be profitable when it wouldn't otherwise be.
And when I think of successful cartels in history I think of DeBeers and OPEC and... well, those are the only two I could name that lasted longer than a few years.
Any defecting firm will also lose a great deal even with the market share gain - hence why there were so few long term winners after the dot com boom. You'll notice that a lot of the firms that did this have survived and raised prices above inflation utilizing monopoly power - just like I stated above.
> And when I think of successful cartels in history I think of DeBeers and OPEC and... well, those are the only two I could name that lasted longer than a few years.
Another would be drug cartels. They keep prices artificially high so that everyone gets a share of the profits. But cartels in general always have players that "cheat" by independently lowering/raising the price. If a player is caught cheating, the cartel usually punishes the rogue player by excluding them from future pricing meetings and use their market share to kill the player both figuratively and literally when drugs are involved.
Nah, the problem with drug cartels is that they aren't cartels, as can be seen by the body count they're racking up against each other south of the border. They aren't cartels at all in the economic sense of the term, but rather firms competing against each other.
The term "cartel" arguably did apply up until around the death of Pablo Escobar, and the subsequent usurpation of power from the Colombian producers by the Mexican distributors. For the most part, the drug trade really was a single, multinational, price-fixing monopoly (or at least a cooperative oligopoly) under Pablo's reign.
[I'm not trying to give the guy any credit or praise for his actions, though.]
the story behind the De Beers cartel is well known.
Is it really? Or are you assuming that because you and your friends know about it that you think that everyone knows about it? (not an attack, just a easy trap to fall into).
players in the market -- seem to be acting in concert
I think that whenever a new participant enters the market they find that the most profitable path is to collude with the existing cartels. After all, if diamonds are really worth nothing, why would you enter the market unless you planned to keep the status quo?
What could be causing a major, year-over-year price increase in the face of new competition
I seem to remember reading somewhere that the growing affluence of Asian markets was increasing demand. But that might be the marketing spin.
edit: added everything under "or are you assuming" sentence.
It's really well known. There are articles written up about it every few years. It gets the occasional pop culture shout out.
We could split hairs for awhile and debate about how well known it is, or whether "Joe Sixpack" in Des Moines knows about it. But it's far from obscure.
I'll grant you that a lot of the major demand drivers (young couples, new money, etc.) probably don't know, or at least don't care. And that might make all the difference.
EDIT: Seems we both edited our posts at the same time. I think the Asian theory is interesting, and it might be the most savory / least fishy driver of price increases. Perhaps the "Joe Sixpack" of Shanghai, newly monied and with very few reasonable investment options in his home country, is buying diamonds left and right. Wouldn't surprise me. Either way, it seems odd that the cartels wouldn't go head to head in Asia for the big prize here, unless they reached a gentleman's agreement on territories.
EDIT: Seems we both edited our posts at the same time
An edit-off at 10 paces. Draw!
I think the whole thing is fascinating. From a marketing perspective it's amazing how De Beers manufactured demand for diamonds out of near nothingness.
it seems odd that the cartels wouldn't go head to head
This is an example of mutually assured destruction at play. The big players can't go head-to-head selling what is essentially a commodity good, without price cutting which would eventually lead to diamonds being sold for their true value. None of the players are interested in that.
> I think that whenever a new participant enters the market they find that the most profitable path is to collude with the existing cartels. After all, if diamonds are really worth nothing, why would you enter the market unless you planned to keep the status quo?
Also, DeBeers has diamonds and cash enough to sell below your cost of pulling things out of the ground for a lot longer than you can stay solvent.
Second: a major prediction made in this article did come to pass, but it didn't have the predicted effect on diamond pricing. A serious contender to De Beers emerged in the early 2000s in the form of a multinational, "breakaway" cartel. Yet, both cartels -- and all other minor, independent players in the market -- seem to be acting in concert to keep supplies artificially low, and prices artificially high. In fact, the rate of price increase is at its highest in modern history. Economics tells us that this shouldn't be the case, especially given the emergence of new market entrants. And yet, the rate of price increase took off at precisely the same moment as the entrance of the new competitors. (Source: http://www.ajediam.com/investing_diamonds_investment.html)
What could be causing a major, year-over-year price increase in the face of new competition? Well, one guess would be that the two cartels are colluding in some way. Perhaps they've made an arrangement to fix prices or production. Or perhaps they've carved up the map, and reached some sort of non-competition agreement in each other's territories. Perhaps both. Ordinarily I'd call these ideas paranoid. But the history of the diamond business tells me that we can't put it past these guys.