I am delighted to host another student guest post, this time by Anand Jetha. This is the 10th student guest post of this semester. You can see all the student guest posts from my “Monetary and Financial Theory” class at this link. This is the second student guest post by Anand. His first was “Slow Progress in Battery Technology Will Hold Back Electric Cars.”

Many may know of the company De Beers as one of the cornerstones of fine jewelry. They are the leader when it comes to mining and selling diamonds to the world. What you may not have known is that they are the reason people will pay thousands of dollars for a nice diamond wedding ring instead of the hundreds or even tens of dollars you should be paying. How can the price be so inflated? It starts with the fact that De Beers in the early 1900s controlled an almost perfect monopoly of diamond mine production in the world. They single-handedly created a multi-billion dollar industry by finding a way to control both the demand and supply of the then nonexistent diamond market.

Let’s talk about the demand side first. De Beers started a massive advertising campaign with the advertising agency N. W. Ayer in the early 1900s. They wanted to convince the world that diamonds were the only things that could be put on a wedding ring. They ousted every other gem that was being used at the time, including rubies and emeralds, and convinced the world that the “diamond is forever.” They staged diamonds in movies, by giving them to celebrities, and even through songs. The ad agency and De Beers masterfully created diamond demand out of nothing. The advertising is why today it would ludicrous to think about a wedding ring without a diamond since they are the symbol of love and marriage.

The supply side is what’s keeping the price currently from falling. A common misconception is that diamonds are rare and the reason that the price remains high. Actually, of all the gems on Earth, diamonds are the most common and they can even be created in laboratories. However, De Beers’s early and sustained control of over 80% of diamond production allowed them to effectively depress supply.  The company constantly mines and searches for rough diamonds across the world as they are currently doing in Kalahari Desert of Botswana. But they do not release the diamonds. All those diamonds, mined or purchased from others, are kept in vaults. They try to collect as many as possible so the company can control the supply at any given moment. They release just enough diamonds to match the growth in demand (marriages) across the world so they can maintain their artificially high price.

It’s very hard to tell if the bubble will ever pop. Some evidence says that since De Beers is losing market share in new yearly production, the market will start to fill with diamonds and pop the bubble. Because of its vast hoard of diamonds, the sky is the limit if De Beers wanted to increase diamond supply. But its ability to limit diamond supply is compromised if there are other suppliers who want to sell as many as possible while the prices are high. So there is hope that change might be coming to the diamond market. 

Update: On Miles’s Facebook page, Robert Flood makes this point: 

Diamonds are more an example of a very well run monopoly than a bubble. If you like this stuff, gold, which is not a monopoly, is much more puzzling: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2166636 (Btw, wedding rings are usually just gold, no stones. Engagement rings are the ones with the diamond(s).)