In the December issue of Forbes magazine, 2016 Investment Guide, Steve Forbes' monthly Fact and Comment section was detailed with his opinions and intuitions on the future of the American currency as a gold standard. Like many journalists, Forbes uses incorrect economic data and analyses to justify the common Republican proposition to introduce a gold standard to back the American dollar. He details three supporting reasons for a gold standard: that gold promotes economic growth, gold does not mitigate the central bank's function to lend during times of panic and that gold does not constrain the money supply. All of his commentaries on the state of the gold standard are wrong.
Forbes' first comment that gold does not have the potential to restrain economic growth remains as egregious as Donald Trump's plans for foreign policy. Forbes bases this comment on the assumption that gold, as a currency, is stable and that the dollar backed by gold is stable. While gold is indeed more stable than most other commodities, gold is still subject to the forces of supply and demand. Therefore, the price has the potential to fluctuate as rampantly as any other commodity on any number of bases: consumer preference, change of tastes, naturally occurring phenomenon, etc. Gold remains as unpredictable as any other commodity in the market. Forbes makes the mistake of only attributing the currency aspect of gold instead of the commodity aspect that is governed by supply and demand in a way that is much different from currency. This is the biggest problem China is facing in regards to trying to amass enough gold to back their own currency, which is quickly failing before the smoking dragon's very own eyes.
The second point Forbes raises is that gold does not constrict the flexibility to the central bank to respond. In actuality, gold does. This may get a bit complicated, but please bear with me. Forbes basis this assumption on the fact that a central bank only needs to bring collateral in to mitigate a crisis and that gold plays no role in this. This assumes that banks will hold their recommended rates of reserves and keeps enough leverage on their books to insure against a financial crisis. However, as seen in the Savings and Loan Crisis of the '90s and the Financial Crisis of 2008, banks rarely adhere to these basic stipulations in times of crises. Added to this, gold places a limit on how much the Central Bank (Federal Reserve) can influence the money market and the supply of money. During a financial crisis, the government initiates a policy known as quantitative easing. At its most basic level, quantitative easing (simply labeled as QE) is the systematic creation and implementation of several billions of dollars of money that is injected into a specific sector of the economy. In the Financial Crisis of 2008, billions of dollars were pumped into the financial sector, known as the big bank bailout every taxpayer contributed toward. Quantitative easing only works if the currency is flexible enough to be changed by the governing agency responsible for this change. The introduction of gold will create a rigid currency that will not be flexible enough to accommodate change or support massive amounts of money being pushed into the system. Forbes' commentary comes from a common Republican ideal to halt quantitative easing altogether as the government means of responding to crisis to shorten the debt and to basically allow control of the market by large scale corporations.
Forbes' final comment is that gold does not constrain the money supply. His comment is based on the assumption that gold is not affected by supply shocks. This may be true in the modern day century as gold mined and melted down is never lost. However, gold can be destroyed and made worthless. So there are supply indicators that indicate a shortening of the gold supply. It is by no means governed by only demand.
It should be noted that a gold standard could work during peaceful economic times where a country does not have outstanding debt on their balance books. However, the only way to support the gold standard would be to accumulate as much gold as we can possibly manage and control a significant portion of the gold market to back up the American currency as a stronger currency. The switch to gold now would cause severe economic shocks and force the dollar to depreciate dramatically. These are the issues China is facing in their pursuits of achieving a gold standard. It should also be noted that the pursuit of such a large mass of gold to back a currency will significantly increase the price of gold as demand skyrockets. So we must be careful in our accumulation of gold so as not to bankrupt the country in the process.
