The Enduring Glow of Gold

The global economy has already entered into stagflation with a growth rate of 2 percent and inflation at 3 percent. With an inflation rate twice as high as the growth rate, the global economy will slip deeper into stagflation. Despite the recent setback, gold remains a big beneficiary of the current macro environment and has the potential to reach new highs in the current year and rise much higher in 2014.

By Andy Xie
05.06.2013 18:47
Caixin Online

The global economy has already entered into stagflation with a growth rate of 2 percent and inflation at 3 percent. The inflation rate is likely to rise above 4 percent in 18 months while the growth rate will remain stuck in the same range. With inflation twice as high as the growth rate, the global economy will slip deeper into stagflation.

The recent decline in commodity prices does not signal a reversal in the inflationary trend. It is a onetime redistribution of mining income to consumer purchasing power. The prevailing negative real interest rate channels monetary growth above economic growth into inflation wherever there is shortage. Manual labor in emerging economies, skilled labor in the developed economies, agricultural commodities, rent, healthcare, education, etc., are leading the inflationary trend.

Inflation expectations are already a self-reinforcing influence on emerging economies such as India. It will take root in developed economies. When this occurs, the global economy will run into an inflationary crisis as a result of wrong-headed policies used to deal with the financial crisis.

Multinational companies remain the biggest beneficiaries of the current global environment. The macro instabilities give them opportunities to arbitrage the frequent fluctuations in demand and production costs across the globe. The negative real interest rate has boosted their profits significantly, too.

Speculative capital also profits from the mismatch between economic challenges and policy responses. The global economy needs flexibility on the supply side to handle the dislocations from globalization and technology development. The primary policy response so far is the use of monetary stimulus, in the hopes that a demand kick will snowball into a virtuous cycle in each national economy. For the past five years, it hasn't worked to achieve its main objective. But it has created big fluctuations in asset markets, giving speculative capital a golden opportunity to engage in the biggest wealth redistribution in modern history.

Despite its recent setback, gold remains a big beneficiary of the current macro environment. It could make a new high in the current year and rise much higher in 2014. The gold bull market will end when an inflation crisis pushes central bankers around the world to tighten aggressively.

Stagflation is Now

The emerging economies exhibit significant symptoms of stagflation. All major emerging economies are facing significant slowdown. But the attempts to stimulate are checked by inflationary problems. The IMF projects a 5.5 percent GDP growth rate in 2013 for emerging economies. The Q1 data suggests a much weaker year. I see 4 percent for the year. The broadest inflation gauge, the GDP deflator, is likely around 6 percent. Emerging economies are easing monetary policy on the whole, just haltingly to demonstrate some credibility on inflationary concerns. But the easing policy remains the main trend. It is likely that inflation will surpass twice the GDP growth rate.

The U.S. economy grew by 1.7 percent in 2012 with GDP deflator, the broadest inflation gauge, at 2.4 percent. In the first quarter of 2013, it reported a 2.5 percent rate, of which 1 percent came from inventory accumulation, and GDP deflator at 0.9 percent. It appears that the U.S. economy is stuck at a 2 percent growth rate and GDP deflator is slightly higher.

The U.S. economy is experiencing a mild form of stagflation. The high unemployment keeps wage under control. But, shouldn't one be concerned about the significant inflation pressure despite such a weak economy? As a mismatch remains a major force in the U.S. unemployment picture, wage inflation is quite possible in many pockets. Energy and agricultural industries already face such pressures.

Both the IMF and the OECD project a 1.4 percent GDP growth rate for developed economies. The Q1 data suggests that this is just too optimistic. I think 1 percent is more likely. While weak growth is disinflationary, momentum and imported inflation are significant forces. The whole OECD block is likely to be similar to the U.S. with GDP deflator above growth.

At current exchange rates, the OECD block accounts for about two-thirds of the global economy and the emerging economies, one-third. This fact suggests that the global economy will grow at 2 percent with inflation at 3 percent.

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