Making Economic Sense

Chapter 91
Are Diamonds Really Forever?
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The international diamond cartel, the most successful cartel in history, far more successful than the demonized OPEC, is at last falling on hard times. For more than a century, the powerful DeBeers Consolidated Mines, a South African corporation controlled by the Rothschild Bank in London, has managed to organize the cartel, restricting the supply of diamonds on the market and raising the price far above what would have been market levels. [p. 320]

It is not simply that DeBeers mines much of the world's diamonds; DeBeers has persuaded the world's diamond miners to market virtually all their diamonds through DeBeer's Central Selling Organization (CSO), which then grades, distributes, and sells all the rough diamonds to cutters and dealers further down on the road toward the consumer.

Even an unchallenged cartel, of course, does not totally control its price or its market; even it is at the mercy of consumer demand. One of the reasons that diamond prices and profits are slumping is the current world recession. World demand, and particularly consumer demand in the U.S. for diamonds, has fallen sharply, with consumers buying fewer diamonds and downgrading their purchases to cheaper gems, which of course particularly hits the market in the expensive stones.

But how could even this degree of cartel success occur in a free market? Economic theory and history both tell us that maintaining a cartel, for any length of time, is almost impossible on the free market, as the firms who restrict their supply are challenged by cartel members who secretly cut their prices in order to expand their share of the market as well as by new producers who enter the fray enticed by their higher profits attained by the cartelists. So, how could DeBeers maintain such a flourishing, century-long cartel on the free market?

The answer is simple: the market has not been really free. In particular, in South Africa, the major center of world diamond production, there has been no free enterprise in diamond mining. The government long ago nationalized all diamond mines, and anyone who finds a diamond mine on his property discovers that the mine immediately becomes government property. The South African government then licenses mine operators who lease the mines from the government and, it so happened, that lo and behold!, the only licensees turned out to be either DeBeers itself or other firms who were willing to play ball with the DeBeers cartel. In short: the international diamond cartel was only main tained and has only prospered because it was enforced by the South African government.

And enforced to the hilt: for there were severe sanctions against any independent miners and merchants who tried to produce [p. 321] "illegal" diamonds, even though they were mined on what used to be private property. The South African government has invested considerable resources in vessels that constantly patrol the coast, firing on and apprehending the supposedly pernicious diamond "smugglers."

Back in the pre-Gorbachev era, it was announced that Russia had discovered considerable diamond resources. For a while, there was fear among DeBeers and the cartelists that the Russians would break the international diamond cartel by selling in the open market abroad. Never fear, however. The Soviet government, as a professional monopolist itself, was happy to cut a deal with DeBeers and receive an allocation of their own quota of diamonds to sell to the CSO.

But now the CSO and DeBeers are in trouble. The problem is not only the recession; the very structure of the cartel is at stake, with the problem centering on the African country of Angola. Not that the communist government (or formerly communist, but now quasi-communist, government) refuses to cooperate with the cartel. It always has. The problem is three-fold. First, even though the Angolan civil war is over, the results have left the government powerless to control most of the country. Secondly, the end of the war has given independent wildcatters access to the Cuango River in northern Angola, a territory rich in diamonds. And thirdly, the African drought has dried up the Cuango along with other rivers, leaving the rich alluvial diamond deposits in the beds and on the banks of the Cuango accessible to the eager prospectors.

With the diamond deposits available and free of war, and the central government unable to enforce the cartel, 50,000 prospectors have happily poured into the Cuango Valley of Angola. Furthermore, the prospectors are being protected by a private army of demobilized but armed Angolan soldiers. As one Johannesburg broker pointed out, "If you fly a patrol over the province you can get shot down by a missile. And it's a 100-mile river. You can't put a fence around it."

So far, DeBeers has been holding the line by buying up the "over-supply" caused by the influx of Angolan diamonds; this year, the cartel may be forced to buy no less than $500 million in "illegal" Angolan diamonds, twice as much as that country's [p. 322] official output. Consequently, DeBeers is taking heavy losses; as a result, Julian Ogilvie Thompson, the arrogant and aristocratic chairman of DeBeers, was forced to announce that the company was slashing its dividend, for only the second time since World War II. Immediately, DeBeers' shares plummeted by one-third, taking with it much of the Johannesburg Stock Exchange.

Overall, DeBeers's CSO had to purchase $4.8 billion of rough diamonds in 1992, while being able to sell only $3.5 billion. This huge pileup of inventory could break the cartel price; to stave off such a perceived disaster, DeBeers ordered cartel members to cut back 25 % on the diamonds they had already contracted to market through the cartel. Such a large cutback sets the stage for individual firms to sneak supplies into the market and evade the cartel restrictions. No wonder that Sir Harry Oppenheimer, the octogenarian head of DeBeers, decided to "vacation" in Russia at the end of August, presumably to persuade the Russians to resist any temptation to engage in free-market competition in the diamond market. With luck, however, the forces of free competition--as well as the world's consumers of diamonds--may triumph.

Source: Ludwig Von Mises Institute, Alabama