Lipton’s Speech And Gold

Yesterday, David Lipton, the first deputy managing director of the International Monetary Fund (IMF), delivered a speech at the National Association for Business Economics in Washington, D.C. What can we learn from his lecture?

Lipton Warns Against Economic Derailment

Something is up with the global economy. You know this for sure when the very economic elites are warning of a recession or “risk of economic derailment”. Just a few days ago, the BIS published its quarterly report warning against the unintended effects of negative interest rates and consequences of fading confidence in central banks and policymakers. Yesterday, David Lipton, the IMF’s influential second-in-command, called for action to boost global growth as “we are clearly at a delicate juncture, where risk of economic derailment has grown”. Let’s take a closer look at his speech.

Lipton started with noticing that the IMF’s latest reading of the global economy once again showed a weakening baseline. He pointed out that risks have increased further and concerns about the health of the global economy are intensified by a growing perception that policymakers are running out of ammunition. True. Importantly, Lipton noted that the weak recovery is partially caused by unresolved legacies, i.e. a high share of non-performing loans in many banks’ balance sheets, especially in Europe. What he failed to notice is that the sluggishness of the repair of bank balance sheets is caused by the very loose monetary policy, since low-interest rates and free bank reserves hinder the incentives to deleverage. This is why his calls for further stimulating aggregate demand by monetary policy and mostly by fiscal policy (since the scope for monetary policy to boost domestic demand further is limited) are nonsensical.

Global Economy Needs Structural Reforms

We are curious when economists will realize that Keynesian recipes to stimulate the economy have failed. We have finally reached the long term when we can no longer cut corners and boost growth through borrowing. Lipton intuitively senses it, because he says that without structural reform the long-run growth prospects will be inadequate. He calls for lowering barriers to entry in product and services markets, reducing the labor tax wedge, removing barriers to competition, cutting red tape, enhancing labor mobility, and investing more in education and research. True. Unfortunately, structural reforms should not be expected in the near future. Instead, we could get further monetary accommodation, for instance, from the ECB this week. The possible further ECB monetary easing may not be fully factored into the price of gold, so Draghi may negatively surprise the gold market (through a stronger U.S. dollar). On the other hand, given the current market sentiment, further actions may revive concerns about the NIRP and the limits of monetary policy. In the very long term, the lack of structural reforms will be positive for the gold market since global growth will remain stubbornly low without pro-growth, supply-side policies.

Challenges for Emerging Markets

Lipton also addressed the problems of emerging markets. He noted that excess capacity has been unwinding there through sharp declines in capital spending while rising private debt, often denominated in foreign currency, is increasing risks to banks and sovereign balance sheets. He also pointed out that the rise in global risk aversion (sovereign credit spreads widened – in Latin America and Africa by over 300 basis points over the past year), led to a sharp retrenchment in global capital and trade flows from emerging markets, which saw about $200 billion in net capital outflows last year. Indeed, many emerging markets are doomed.  China is slowing down, Russia is still shrinking, while Brazil is facing the worst recession in decades, just to name a few. The problems of emerging markets should strengthen the U.S. dollar and exert some downward pressure on the price of gold, however, gold has recently been able to rise despite the appreciation of the greenback.

Conclusions

The take-home message is that Lipton described the global economy as a scary place. His speech perfectly fits into the dominant narrative of weakening global growth, higher risks of an economic derailment and impotent monetary policy. Therefore, it should be grist for the gold bulls’ mill.

Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium-term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.