FORM Act And Gold

The US House of Representatives approved the Fed Oversight Reform and Modernization (FORM) Act of 2015. What does it imply for the Fed’s independence and the gold market?

 

The bill was passed in November, but it came practically unnoticed by the media and financial analysts. However, together with the highway bill, it potentially matters far more than many more dramatic stories. Why?

 

First, it requires the Fed to operate under a rule-based framework. The rule-based monetary policy, strongly supported by Milton Friedman, would limit the Fed’s discretionary authority, since the rule would be made public and any deviation from it would lead to a congressional audit. Such a change would be a positive solution for the U.S. economy and negative for the gold market, as it would greatly reduce the uncertainty of the Fed’s future policy actions.

 

Second, the FORM Act would restrict the Fed’s emergency lending authority. Making it more difficult to lend to insolvent firms at artificially low rates of interest would be a reasonable move from the long-term economic point of view, but it would limit the Fed’s power to act as a lender of last resort to much of the financial system. Therefore, the financial panics could be more severe, which could be positive for the gold market.

 

Third, the FORM Act would allow for the Government Accountability Office audits of the Fed’s monetary policy. Fourth, the FORM Act would establish a Centennial Monetary Commission, which would be a bipartisan congressional commission to examine the United States monetary policy. These parts are not easy to assess, but it seems that they would, at least indirectly, impinge on the independence of the central bank. The smaller the independence of the central bank, the higher the inflation rate and the lower the bank’s credibility. The lower the Fed’s credibility, the higher the price of gold.

 

The take-home message is that the U.S. House of Representatives approved the Fed Oversight Reform and Modernization Act of 2015, which would greatly change the way the Fed operates. The FORM Act’s potential impact on the gold market, if the U.S. Senate and the White House approve it, is not easy to determine. On the one hand, a rule-based monetary policy and higher transparency would greatly reduce uncertainty concerning the Fed’s future policy actions, which would be negative for gold – a safe-haven and a non-confidence vote against the Fed’s policy. On the other hand, the FORM Act is another bill which would probably reduce the Fed’s independence. In the long-run, it would be positive for the yellow metal. It is probably no coincidence that both bills (the FORM Act and the Highway Bill) were voted when the Fed is going to raise interest rates. The U.S. Congress is not indifferent to the level of interest rates. It would not be the first time when the U.S. Congress threats the Fed’s independence in the face of a possible rate hike. This is another reason why the U.S. central bank will be reluctant to hike interest rates aggressively next year. A path of future hikes slower and more gradual than expected would be positive for the price of gold.

 

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