Fed Commodities Price Shocks, Global Inflation, Hiring Collapse, Budget Quagmire and Global Imbalances
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011
Executive Summary
I Fed Commodities Price Shocks
IA Instruments and Transmission of Monetary Policy
IB Fed Policy and Commodity Price Shocks
IC Analysis of Valuations of Risk Financial Assets
ID Trends and Cycles of Valuations of Risk Financial Assets
II Global Inflation
III Hiring Collapse
IV Budget Quagmire
V Global Imbalances
VI Economic Indicators
VII Interest Rates
VIII Conclusion
References
Executive Summary
Inflation is everywhere in the world economy rising through the production and distribution chains and surfacing into headline inflation. A key issue in current difficult times is whether commodity price inflation is originating in growth of demand for commodities in emerging markets that are growing more rapidly than advanced economies and supply shocks caused by climatic factors and geopolitical events in the Middle East. An alternative interpretation is that Fed monetary policy over a decade of concern with nonexisting deflation and minimization of deviations of the output gap of actual relative to potential output is causing a carry trade from zero interest rates to long positions in risk financial assets. Fed officials argue that zero interest rates operate through normal channels of lowering interest rates through the term structure of interest rates and that quantitative easing reduces the yields of long-term securities in maturity classes close to those of asset-backed securities, lowering long-term costs of borrowing for investment and consumption. More recently, Fed officials have argued that quantitative easing and zero interest rates create a wealth effect of raising consumption by increasing US stock market valuations and that quantitative easing causes “moderate” devaluation that increases net exports with resulting higher growth of GDP and hiring. The theory of valuation of risk financial assets in uncertainty analyzes zero interest rates and quantitative easing as causing changes in relative valuations of risk financial assets that lead to portfolio rebalancing in the movement toward the efficient frontier. There is no reason why Fed monetary impulses influence only valuation of asset-backed securities that provide financing for consumption and investment, the US stock market and the exchange rate of the dollar relative to other currencies instead of those three classes of securities as well as all the other ones that comprise the unobservable market portfolio. The market portfolio includes risk financial assets such as commodities, emerging market stocks, currencies and the like. Arbitrageurs do not operate only in the market segments targeted by the Fed but in multiple classes of financial assets. Theory suggests that in the presence of zero interest rates and ample liquidity the arbitrageur would borrow at the short-term riskless rate of practically zero and invest with leverage in high risk financial assets such as commodities, emerging market stocks, currencies and the like, which respond more rapidly to the stimulus. The parallel of current experience with that of the Great Inflation and Unemployment of the 1970s is in regards to the similarity in monetary policy and not because of exogenous supply shocks, which is how the technical literature analyzes the 1960s and 1970s (http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). The G20 announced on Apr 15 continuing efforts in addressing global imbalances in current account and domestic deficits and debts. The search for “spillover effects” should focus on the adverse effects for the economy of the US of continuing monetary policy in impulses of zero interest rates and purchases of $2.4 trillion of securities and how it spills over the sound management of policy and determination of exchange rates globally. The pursuit of devaluation of the dollar relative to gold similar to that of 40 percent in 1933-34 may end up with a fed funds rate hike more similar to 22.36 percent as on Jul 22, 1981.
I Fed Commodities Price Shocks. The effects of Fed policy on commodity prices, and in fact most valuations of risk financial assets, are discussed in four subsections: IA Instruments and Transmission of Monetary Policy; IB Fed Policy and Commodity Price Shocks; IC Analysis of Valuations of Risk Financial Assets; and ID Trends and Cycles of Valuations of Risk Financial Assets. Section II considers global inflation.
IA Instruments and Transmission of Monetary Policy. There have been four types of monetary policy by the Fed over the past decade according to the effects desired by the Federal Open Market Committee (FOMC).
First, targets of fed funds rates. The primary instrument of Fed monetary policy is the fed funds rate defined as follows by the Board of Governors of the Federal Reserve System (FRBOPF, 2005, 16):
“The initial link in the chain between monetary policy and the economy is the market for balances held at the Federal Reserve Banks. Depository institutions have accounts at their Reserve Banks, and they actively trade balances held in these accounts in the federal funds market at an interest rate known as the federal funds rate. The Federal Reserve exercises considerable control over the federal funds rate through its influence over the supply of and demand for balances at the Reserve Banks.”
The objective and channel of transmission of changing fed funds rates is described by the Board of Governors of the Federal Reserve System (FRBOPF 2005, 16):
“The FOMC sets the federal funds rate at a level it believes will foster financial and monetary conditions consistent with achieving its monetary policy objectives, and it adjusts that target in line with evolving economic developments. A change in the federal funds rate, or even a change in expectations about the future level of the federal funds rate, can set off a chain of events that will affect other short-term interest rates, longer-term interest rates, the foreign exchange value of the dollar, and stock prices. In turn, changes in these variables will affect households’ and businesses’ spending decisions, thereby affecting growth in aggregate demand and the economy.”
In conventional monetary policy the effects on long-term yields are processed through the lowering of short-term interest rates, such as lower fed funds rates in the US. Lutz (1940, 37) argues that in an economy with (1) perfect foresight or accurate forecasting, (2) zero investment costs for borrowers and lenders and (3) borrowers and lenders shift throughout all maturities, the long-term rate can be conceived “as a sort of average of the future short-term rates.” Let f(t, T) be the forward rate that is derived from the rates at time t, one year for example, and time T, two-year security for example, that is the rate that applies from extending maturity by one year from t (one year) to T (two years). Let rT be the one-year rate at time T, then in the certain economy f(t, T) = rT for all t ≤ T. This equality is assured by the lack of arbitrage opportunities because otherwise arbitrageurs could obtain a profit trading in bonds of periods T and T+1. The unbiased expectations hypothesis states that E[r] = f(t, T) for all t ≤ T (Ingersoll 1987, 387-92; see Cox, Ingersoll and Ross1981, 1985).
Second, rediscount window. The Fed also provides credit collateralized by various types of assets (FRBO 2010DW) in three categories: primary credit to qualifying institutions at a rate higher than the fed funds rate; secondary credit for institutions not qualifying for primary credit at a rate higher than primary credit; and seasonal credit for qualifying institutions. During the credit/dollar crisis the Fed provided credit through 11 facilities such as the Term Auction Facility (TAF) accessible to all institutions qualifying for primary credit (http://www.federalreserve.gov/monetarypolicy/taf.htm http://www.federalreserve.gov/monetarypolicy/bst.htm see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 159-62).
Third, quantitative easing. There have been four rounds of quantitative easing.
(1) Auctions of 30-year Treasury bonds were suspended between 2001 and 2005. This was Treasury policy not Fed policy. The effects were similar to those of quantitative easing: withdrawal of supply from the segment of 30-year bonds would result in higher prices or lower yields for close-substitute mortgage-backed securities with resulting lower mortgage rates. The objective was to encourage refinancing of house loans that would increase family income and consumption by freeing income from reducing monthly mortgage payments.
(2) Between Nov 2008 and Mar 2009 the Fed announced the intention of purchasing $1750 billion of long-term securities: $600 billion of agency mortgage-backed securities and agency debt announced on Nov 25 and $850 billion of agency mortgaged-backed securities and agency debt plus $300 billion of Treasury securities announced on Mar 18, 2009 (Yellen 2011AS, 5-6). The objective of buying mortgage-backed securities was to lower mortgage rates that would “support the housing sector” (Bernanke 2009SL). The FOMC statement on Dec 16, 2008 informs that: “over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and its stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant” (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). The Mar 18 statement of the FOMC explained that: “to provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities up to $1.25 trillion this year, and to increase its purchase of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months” (http://www.federalreserve.gov/newsevents/press/monetary/20090318a.htm). Policy changed to increase prices or reduce yields of mortgage-backed securities and Treasury securities with the objective of supporting housing markets and private credit markets by lowering costs of housing and long-term private credit.
(3) On Aug 10, 2010, the FOMC statement explains the reinvestment policy: “to help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in long-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature” (http://www.federalreserve.gov/newsevents/press/monetary/20100810a.htm). The objective of policy appears to be supporting conditions in housing and mortgage markets with slow transfer of the portfolio to Treasury securities that would support private-sector markets.
(4) As widely anticipated, the FOMC decided on Dec 3, 2010: “to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month” (http://www.federalreserve.gov/newsevents/press/monetary/20101103a.htm). The emphasis appears to shift from housing markets and private-sector credit markets to the general economy, employment and preventing deflation.
There have been three major analyses of the channels of transmission of quantitative easing with relevance to Fed policy.
(1) Bernanke and Reinhart (2004, 88) argue that “the possibility monetary policy works through portfolio substitution effects, even in normal times, has a long intellectual history, having been espoused by both Keynesians (James Tobin 1969) and monetarists (Karl Brunner and Allan Meltzer 1973).” Andrés et al. (2004) explain the Tobin (1969) contribution by optimizing agents in a general-equilibrium model. Both Tobin (1969) and Brunner and Meltzer (1973) consider capital assets to be gross instead of perfect substitutes with positive partial derivatives of own rates of return and negative partial derivatives of cross rates in the vector of asset returns (interest plus principal gain or loss) as argument in portfolio balancing equations (see Pelaez and Suzigan 1978, 113-23). A simplified analysis could consider the portfolio balance equations Aij = f(r, x) where Aij is the demand for i = 1,2,∙∙∙n assets from j = 1,2, ∙∙∙m sectors, r the 1xn vector of rates of return, ri, of n assets and x a vector of other relevant variables. Tobin (1969) and Brunner and Meltzer (1973) assume imperfect substitution among capital assets such that the own first derivatives of Aij are positive, demand for an asset increases if its rate of return (interest plus capital gains) is higher, and cross first derivatives are negative, demand for an asset decreases if the rate of return of alternative assets increases. Theoretical purity would require the estimation of the complete model with all rates of return. In practice, it may be impossible to observe all rates of return such as in the critique of Roll (1977). Policy proposals by the Fed have been focused on the likely impact of withdrawals of stocks of securities in specific segments, that is, of effects of one or several specific rates of return among the n possible rates.
(2) Chairman Bernanke (2010WP) explained on Nov 4 the objectives of purchasing an additional $600 billion of long-term Treasury securities and reinvesting maturing principal and interest in the Fed portfolio. Long-term interest rates fell and stock prices rose when investors anticipated the new round of quantitative easing. Growth would be promoted by easier lending such as for refinancing of home mortgages and more investment by lower corporate bond yields. Consumers would experience higher confidence as their wealth in stocks rose, increasing outlays. Income and profits would rise and, in a “virtuous circle,” support higher economic growth. Bernanke (2000) analyzes the role of stock markets in central bank policy (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-100). Fed policy in 1929 increased interest rates to avert a gold outflow and failed to prevent the deepening of the banking crisis without which the Great Depression may not have occurred. In the crisis of Oct 19, 1987, Fed policy supported stock and futures markets by persuading banks to extend credit to brokerages. In this view, collapse of stock markets would slow consumer spending.
(3) Yellen (2011AS, 6) broadens the effects of quantitative easing by adding dollar devaluation: “there are several distinct channels through which these purchases tend to influence aggregate demand, including a reduced cost of credit to consumers and businesses, a rise in asset prices that boosts household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.” Devaluation of the dollar to increase aggregate demand by net exports is now part of the transmission of quantitative easing.
II Fed Policy and Commodity Price Shocks. Fed Vice Chair Yellen (2011CP, 2) finds that:
“Since early last summer, the prices of oil, agricultural products, and other raw materials have risen significantly. For example, the price of Brent crude oil has risen more than 70 percent and the price of corn has more than doubled; more broadly, the Commodity Research Bureau's index of non-fuel commodity prices has risen roughly 40 percent. The imprint of these increases has become increasingly visible in overall measures of inflation. For example, inflation as measured by the price index for personal consumption expenditures (PCE) moved up to an annual rate of about 4 percent over the three months ending in February after having averaged less than 1-1/2 percent over the preceding two years. Moreover, survey data suggest that surging prices for gasoline and food have pushed up households' near-term inflation expectations and are making consumers less confident about their economic circumstances.”
The Fed uses the price index of personal consumption expenditures, excluding food and energy. The concern in recent FOMC minutes is that increases in commodity prices could be penetrating into the general PCE price index, without excluding food and energy. The Bureau of Economic Analysis (BEA) general PCE price index for the last available quarter shows inflation of 0.0978, dividing the index of 112.601 for Feb by the index of 111.510 for Nov (http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=81&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Month&FirstYear=2010&LastYear=2011&3Place=N&Update=Update&JavaBox=no). Discrete compounding of 0.0978 for four quarters results in annual equivalent inflation of 3.971 percent, which is the 4 percent mentioned by Vice Chair Yellen (2011CP, 1). The issue here is whether commodity prices can raise overall inflation and if the increase in commodity prices has been influenced by Fed monetary policy. Yellen (2011CP, 2) is also concerned with the relation of the Great Inflation of the 1970s to current monetary policy:
“Indeed, some have even raised the specter of a return to the high inflation of the 1970s in arguing for the urgency of monetary policy tightening.”
There are similar concerns by Blanchard (2011FWEOApr, XV):
“Fears have turned to commodity prices. Commodity prices have increased more than expected, reflecting a combination of strong demand growth and supply shocks. Although these increases conjure up the specter of 1970s-style stagflation, they appear unlikely to derail the recovery. In advanced economies, the decreasing share of oil, the disappearance of wage indexation, and the anchoring of inflation expectations all combine to suggest there will be only small eff ects on growth and core inflation. The challenge will be stronger however in emerging and developing economies, where the consumption share of food and fuel is larger and the credibility of monetary policy is often weaker. Inflation may well be higher for some time but, as our forecasts suggest, we do not expect a major adverse effect on growth. However, risks to the recovery from additional disruptions to oil supply are a concern.”
This blog has raised this concern with the Great Inflation and Unemployment of the 1970s on the basis of the conduct of monetary policy instead of commodity price shocks (http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html)
Yellen (2011CP, 3) reiterates the commitment of the Fed to control inflation:
“The FOMC is determined to ensure that we never again repeat the experience of the late 1960s and 1970s, when the Federal Reserve did not respond forcefully enough to rising inflation and allowed longer-term inflation expectations to drift upward. Consequently, we are paying close attention to the evolution of inflation and inflation expectations.”
Yellen (2011CP, 10-11) states the awareness of the Fed of the experience of the Great Inflation of the 1960s and 1970s and its consequences in the Volcker rate hike that reached the rate on fed funds of 22.36 percent on Jul 22, 1981(http://www.federalreserve.gov/releases/H15/data.htm):
“Indeed, a key lesson from the experience of the late 1960s and 1970s is that the stability of longer-run inflation expectations cannot be taken for granted. At that time, the Federal Reserve’s monetary policy framework was opaque, its measures of resource utilization were flawed, and its policy actions generally followed a stop-start pattern that undermined public confidence in the Federal Reserve’s commitment to keep inflation under control. Consequently, longer-term inflation expectations became unmoored, and nominal wages and prices spiraled upward as workers sought compensation for past price increases and as firms responded to accelerating labor costs with further increases in prices. That wage-price spiral was eventually arrested by the Federal Reserve under Chairman Paul Volcker, but only at the cost of a severe recession in the early 1980s.”
There are three arguments by Yellen (2011CP): (1) explanation of commodity price increases; (2) critique of alternative interpretations; and (3) impact of commodity price increases on overall inflation. (1) Yellen (2011CP) argues that commodity price increases are explained by fundamental demand and supply factors. Commodity prices increase because of the pull of demand by emerging countries, especially China that accounted for 50 percent of demand for oil in the past decade. Advanced economies have not increased oil consumption as shown by the US with GDP growth of 20 percent between 1999 and 2010 but with oil consumption being lower in 2010 than in 1999. Climatic factors such as draughts in China and Russia and similar events have caused the jump in food prices globally. (2) Yellen (2011CP) dismisses arguments that dollar devaluation by 10 percent since Nov 4 after quantitative easing cannot explain the increase in oil prices by 70 percent and of non-energy commodities by 40 percent. Similar arguments are also found wanting in explanatory power. (3) Yellen (2011CP) finds that commodity prices could increase general inflation in the short term but the effects would be transitory because of abundant idle resources. Transitory increases in prices of energy and food would not cause inflation if inflationary expectations are anchored, which according to observations by the Fed would be the case.
IC Analysis of Valuation of Risk Financial Assets. The commitment of the Fed to purchasing long-term securities is designed to impress on investors that prices will increase and yields decline for asset classes that are related to long-term borrowing costs of firms, such as corporate debt and asset-backed securities collateralized with loans. The critical issue with quantitative easing is that the Fed cannot restrict the effects of its policies of zero interest rates and large-scale purchases of securities only to the targeted classes of securities such as long-term Treasury securities and asset-backed securities of the same maturity that are the source of financing loans for investment and consumption. The effects of zero interest rates and quantitative easing are spread throughout the portfolio of financial risk assets that includes commodities, foreign exchange, emerging market stocks and the like. Monetary policy of zero interest rates and more strongly with quantitative easing encourages borrowing or short position at the riskless interest rate near zero and long positions in financial risk assets, which is the carry trade from zero interest rates in the US to global financial risk assets.
Portfolio rebalancing originates in the theory of financial markets in conditions of risk. An important advance in this theory was the application of general equilibrium methods and the elimination of the assumption of perfect substitution between money and other capital assets (Tobin, 1961). Portfolio choice theory developed by Markowitz (1952), Tobin (1958), Hicks (1935, 1962), Treynor (1962), Sharpe (1964), Lintner (1965) and Mossin (1966) provided the separation theorem of Tobin, which states that the share of wealth allocated to individual risky assets is independent of the optimum share of risk assets in the total portfolio, and the theory of choice of an optimum risk-asset portfolio with borrowing or lending at the riskless or “pure” rate of interest. Equilibrium is attained by changes in the share of individual risk assets in the risk-asset portfolio that change their prices or rates of return. Tobin (1969) provided the general equilibrium model in which the Tobin q, or market value of capital relative to the reproduction cost of capital, responds positively to an injection of base money, ∂q/∂B>0, where B is base money. Andrés et al (2004) formalized further the Tobin (1969) model and its applicability to quantitative easing. Vayanos and Vila (2009) formalize for present purposes the preferred habitat model of Culbertson (1957, 1963) and Modigliani and Sutch (1966) with a rich analysis of how arbitrageurs engage in carry trade along the term structure when quantitative easing changes bond prices. Various recent contributions, such as Hamilton and Wu (2010), measure the effects of quantitative easing on Treasury yields.
The Fed does not control the effects of monetary policy on the rebalancing of the portfolio of assets. What the Fed does is create shocks altering relative rates of return of asset holdings that trigger portfolio rebalancing in a movement toward the efficient frontier in which the near zero interest rate creates the opportunity of borrowing to invest in long positions in all types of risk financial assets, including commodities, emerging market stocks and foreign exchange. Fed policy has been providing analysis originally with lowering yields of securities around the term of financing of asset-backed securities with which almost every loan is financed such as car loans, credit card receivables and mortgages; subsequently with wealth effects of increasing stock market prices (Bernanke 2010WP); and more recently by explicitly recognizing the effects on dollar devaluation (Yellen 2011AS). The entire spectrum of valuation of risk financial assets is affected by Fed policy and not just the arbitrary choice of yields of asset-backed securities, the US stock market and dollar devaluation. The critical issue on the Great Inflation is whether the concentration of the Fed solely on the output gap as in the 1960s and 1970s creates the risk of stagflation. In the first round of near zero interest rates and quantitative easing by suspending the auctions of 30 year Treasury bonds CPI inflation rose from 1.9 percent in 2003 to 4.1 percent in 2007, as shown in the last line of Table 1 while the yield of the 10-year Treasury note rose from 3.112 percent on Jun 10, 2003 to 5.297 percent on Jun 12, 2007, as shown in Table 11.
ID Trends and Cycles of Valuations of Risk Financial Assets. Near zero interest rates encourage the carry trade of borrowing at extremely low short-term rates and taking long positions in risk financial assets such as commodities, currencies, stocks and so on. Families, investors and most everybody worldwide were encouraged to benefit from the low interest rates originating in Fed policy of 1 percent fed funds rate in 2003-2004 and housing subsidies by borrowing significantly or high leverage, ignoring potential future adverse events or taking high risks, investing fully or having little or no cash assets or low liquidity and induced easy lending or taking unsound credit decisions. The carry trade of borrowing at extremely low short-term rates and taking long positions in risk financial assets is shown in Table 1 in the form of high valuations in most risk financial assets and then eventual collapse in the form of the credit/dollar crisis and global recession after 2007. The financial crisis and global recession were caused by interest rate and housing policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4).
Table 1, Volatility of Assets
| DJIA | 10/08/02-10/01/07 | 10/01/07-3/4/09 | 3/4/09- 4/6/10 | |
| ∆% | 87.8 | -51.2 | 60.3 | |
| NYSE Financial | 1/15/04- 6/13/07 | 6/13/07- 3/4/09 | 3/4/09- 4/16/07 | |
| ∆% | 42.3 | -75.9 | 121.1 | |
| Shanghai Composite | 6/10/05- 10/15/07 | 10/15/07- 10/30/08 | 10/30/08- 7/30/09 | |
| ∆% | 444.2 | -70.8 | 85.3 | |
| STOXX EUROPE 50 | 3/10/03- 7/25/07 | 7/25/07- 3/9/09 | 3/9/09- 4/21/10 | |
| ∆% | 93.5 | -57.9 | 64.3 | |
| UBS Com. | 1/23/02- 7/1/08 | 7/1/08- 2/23/09 | 2/23/09- 1/6/10 | |
| ∆% | 165.5 | -56.4 | 41.4 | |
| 10-Year Treasury | 6/10/03 | 6/12/07 | 12/31/08 | 4/5/10 |
| % | 3.112 | 5.297 | 2.247 | 3.986 |
| USD/EUR | 6/26/03 | 7/14/08 | 6/07/10 | 04/15 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.443 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 04/15 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.5326 |
| New House | 1963 | 1977 | 2005 | 2009 |
| Sales 1000s | 560 | 819 | 1283 | 375 |
| New House | 2000 | 2007 | 2009 | 2010 |
| Median Price $1000 | 169 | 247 | 217 | 203 |
| 2003 | 2005 | 2007 | 2010 | |
| CPI | 1.9 | 3.4 | 4.1 | 1.5 |
Sources: http://online.wsj.com/mdc/page/marketsdata.html
http://www.census.gov/const/www/newressalesindex_excel.html
http://federalreserve.gov/releases/h10/Hist/dat00_eu.htm
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm
http://markets.ft.com/ft/markets/currencies.asp
There is a new carry trade that learned from the losses after the crisis of 2007 or learned from the crisis how to avoid losses. The sharp rise in valuations of risk financial assets shown in Table 1 after the first policy round of near zero fed funds and quantitative easing by withdrawing supply with the suspension of the 30-year Treasury auction was on a smooth trend with relatively subdued fluctuations. The credit crisis and global recession have been followed by significant fluctuations originating in sovereign risk issues in Europe, doubts of continuing high growth and accelerating inflation in China, events such as in the Middle East and Japan and legislative restructuring, regulation, insufficient growth, low wages, depressed hiring and high job stress of unemployment and underemployment in the US. The “trend is my friend” motto of traders has been replaced with a “hit and realize profit” approach of managing positions to realize profits without sitting on positions. There is a trend of valuation of risk financial assets with fluctuations provoked by events of risk aversion. Table 2, which is updated for every comment, shows the deep contraction of risk financial assets after the Apr sovereign risk issues in the fourth column “∆% to Trough” and the sharp recovery after around Jul in the last column “∆% Trough to 4/15/11” with all risk financial assets in the range from 13.7 percent for European stocks to 37.7 percent for commodities, excluding Japan that has currently weaker performance because of the earthquake/tsunami, while the dollar devalued by 21.1 percent and even higher before the new bout of sovereign risk issues in Europe. Aggressive tightening by the Fed to maintain the credibility of inflation not rising above 2 percent—in contrast with timid “measured” policy during the adjustment in Jun 2004 to Jun 2006 after the earlier round of near zero interest rates—may cause another credit/dollar crisis and stress on the overall world economy. The choices may prove tough and will magnify effects on financial variables because of the corner in which policy has been driven by aggressive impulses that have resulted in the fed funds rate of 0 to ¼ percent and holdings by the Fed that move toward 30 percent of Treasury securities in circulation.
Table 2, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 4/ | ∆% Week 4/ | ∆% Trough to 4/ | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 10.1 | -0.3 | 27.4 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 8.4 | -0.6 | 20.1 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | -3.9 | -1.6 | 20.6 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | 4.3 | -1.5 | 27.9 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | 6.3 | -0.3 | 21.4 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | -15.8 | -1.8 | 8.7 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -3.6 | 0.6 | 28.0 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -3.7 | -1.4 | 13.7 |
| DAX | 4/26/ | 5/25/ | -10.5 | 13.4 | -0.5 | 26.6 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 4.6 | 0.3 | -21.1 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | 17.7 | -1.8 | 37.7 |
| 10-Year Tre. | 4/5/ | 4/6/10 | 3.986 | 3.411 |
T: trough; Dollar: positive sign appreciation relative to euro (less dollars paid per euro), negative sign depreciation relative to euro (more dollars paid per euro)
Source: http://online.wsj.com/mdc/page/marketsdata.html.
Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis by the Fed on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. Table 3 shows a gain in the DJIA of 10.1 percent and of the S&P 500 of 8.9 percent since Apr 26 around the time when sovereign risk issues in Europe began to be acknowledged in financial risk asset valuations. There were still fluctuations. Reversals of valuations are possible during aggressive changes in interest rate policy.
Table 3, Percentage Changes of DJIA and S&P 500 in Selected Dates
| 2010 | ∆% DJIA from earlier date | ∆% DJIA from | ∆% S&P 500 from earlier date | ∆% S&P 500 from |
| Apr 26 | ||||
| May 6 | -6.1 | -6.1 | -6.9 | -6.9 |
| May 26 | -5.2 | -10.9 | -5.4 | -11.9 |
| Jun 8 | -1.2 | -11.3 | 2.1 | -12.4 |
| Jul 2 | -2.6 | -13.6 | -3.8 | -15.7 |
| Aug 9 | 10.5 | -4.3 | 10.3 | -7.0 |
| Aug 31 | -6.4 | -10.6 | -6.9 | -13.4 |
| Nov 5 | 14.2 | 2.1 | 16.8 | 1.0 |
| Nov 30 | -3.8 | -3.8 | -3.7 | -2.6 |
| Dec 17 | 4.4 | 2.5 | 5.3 | 2.6 |
| Dec 23 | 0.7 | 3.3 | 1.0 | 3.7 |
| Dec 31 | 0.03 | 3.3 | 0.07 | 3.8 |
| Jan 7 | 0.8 | 4.2 | 1.1 | 4.9 |
| Jan 14 | 0.9 | 5.2 | 1.7 | 6.7 |
| Jan 21 | 0.7 | 5.9 | -0.8 | 5.9 |
| Jan 28 | -0.4 | 5.5 | -0.5 | 5.3 |
| Feb 4 | 2.3 | 7.9 | 2.7 | 8.1 |
| Feb 11 | 1.5 | 9.5 | 1.4 | 9.7 |
| Feb 18 | 0.9 | 10.6 | 1.0 | 10.8 |
| Feb 25 | -2.1 | 8.3 | -1.7 | 8.9 |
| Mar 4 | 0.3 | 8.6 | 0.1 | 9.0 |
| Mar 11 | -1.0 | 7.5 | -1.3 | 7.6 |
| Mar 18 | -1.5 | 5.8 | -1.9 | 5.5 |
| Mar 25 | 3.1 | 9.1 | 2.7 | 8.4 |
| Apr 1 | 1.3 | 10.5 | 1.4 | 9.9 |
| Apr 8 | 0.03 | 10.5 | -0.3 | 9.6 |
| Apr 15 | -0.3 | 10.1 | -0.6 | 8.9 |
Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3004
Table 4, updated with every post, shows that exchange rate valuations affect a large variety of countries, in fact, almost the entire world, in magnitudes that cause major problems for domestic monetary policy and trade flows.
Table 4, Exchange Rates
| Peak | Trough | ∆% P/T | Apr 15 2011 | ∆T | ∆% P | |
| EUR USD | 7/15 | 6/7 2010 | 4/15 | |||
| Rate | 1.59 | 1.192 | 1.443 | |||
| ∆% | -33.4 | 17.4 | -10.2 | |||
| JPY USD | 8/18 | 9/15 | 4/15 2011 | |||
| Rate | 110.19 | 83.07 | 83.11 | |||
| ∆% | 24.6 | 0.04 | 24.6 | |||
| CHF USD | 11/21 2008 | 12/8 2009 | 4/15 2011 | |||
| Rate | 1.225 | 1.025 | 0.896 | |||
| ∆% | 16.3 | 12.6 | 26.9 | |||
| USD GBP | 7/15 | 1/2/ 2009 | 4/15 2011 | |||
| Rate | 2.006 | 1.388 | 1.633 | |||
| ∆% | -44.5 | 14.9 | -22.9 | |||
| USD AUD | 7/15 2008 | 10/27 2008 | 4/15 | |||
| Rate | 1.0215 | 1.6639 | 1.057 | |||
| ∆% | -62.9 | 43.1 | 7.4 | |||
| ZAR USD | 10/22 2008 | 8/15 | 4/8 2011 | |||
| Rate | 11.578 | 7.238 | 6.691 | |||
| ∆% | 37.5 | 6.2 | 41.3 | |||
| SGD USD | 3/3 | 8/9 | 4/15 | |||
| Rate | 1.553 | 1.348 | 1.243 | |||
| ∆% | 13.2 | 7.8 | 19.9 | |||
| HKD USD | 8/15 2008 | 12/14 2009 | 4/8 | |||
| Rate | 7.813 | 7.752 | 7.775 | |||
| ∆% | 0.8 | -0.3 | 0.5 | |||
| BRL USD | 12/5 2008 | 4/30 2010 | 4/15 2011 | |||
| Rate | 2.43 | 1.737 | 1.577 | |||
| ∆% | 28.5 | 9.2 | 35.1 | |||
| CZK USD | 2/13 2009 | 8/6 2010 | 4/8 | |||
| Rate | 22.19 | 18.693 | 16.779 | |||
| ∆% | 15.7 | 10.2 | 24.1 | |||
| SEK USD | 3/4 2009 | 8/9 2010 | 4/15 2011 | |||
| Rate | 9.313 | 7.108 | 6.18 | |||
| ∆% | 23.7 | 13.1 | 33.6 | |||
| CNY USD | 7/20 2005 | 7/15 | 4/15 | |||
| Rate | 8.2765 | 6.8211 | 6.5326 | |||
| ∆% | 17.6 | 4.2 | 21.1 |
Symbols: USD: US dollar; EUR: euro; JPY: Japanese yen; CHF: Swiss franc; GBP: UK pound; AUD: Australian dollar; ZAR: South African rand; SGD: Singapore dollar; HKD: Hong Kong dollar; BRL: Brazil real; CZK: Czech koruna; SEK: Swedish krona; CNY: Chinese yuan; P: peak; T: trough
Note: percentages calculated with currencies expressed in units of domestic currency per dollar; negative sign means devaluation and no sign appreciation
Source: http://online.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000
http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm
http://markets.ft.com/ft/markets/currencies.asp
II Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table 5, updated with every post, provides the latest yearly data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly-indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of the sovereign risk issues (http://www.ft.com/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1G67TzFqs). CPI inflation accelerated to 5.4 percent in China and to 2.7 percent in the euro zone that has already increased interest rates. Food prices in China soared by 11.7 percent in Mar after 11.0 percent in Feb, 10.3 percent in Jan and 9.6 percent in Dec (
http://www.ft.com/cms/s/0/69aa5fcc-670d-11e0-8d88-00144feab49a.html#axzz1J7CmnPhC). PPI inflation accelerated in Japan to 2.0 percent. Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration. The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. There are six key interrelated vulnerabilities in the world economy that have been causing global financial turbulence: (1) sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings; (2) the tradeoff of growth and inflation in China; (3) slow growth (see http://cmpassocregulationblog.blogspot.com/2011_03_01_archive.html http://cmpassocregulationblog.blogspot.com/2011/02/mediocre-growth-raw-materials-shock-and.html), weak hiring (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html and section III Hiring Collapse below) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (http://cmpassocregulationblog.blogspot.com/2011/04/twenty-four-to-thirty-million-in-job_03.html http://cmpassocregulationblog.blogspot.com/2011/03/unemployment-and-undermployment.html); (4) the timing, dose, impact and instruments of normalizing monetary and fiscal policies (see http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies; (5) the earthquake and tsunami affecting Japan that is having repercussions throughout the world economy because of Japan’s share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) the geopolitical events in the Middle East.
Table 5, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 2.9 | 2.7 | 5.8 | 8.8 |
| Japan | 2.5 | 0.0 | 2.0 | 4.6 |
| China | 9.7 | 5.4 | 7.3 | |
| UK | 1.5 | 4.0* | 5.4* output | 8.0 |
| Euro Zone | 2.0 | 2.7 | 6.6 | 9.9 |
| Germany | 4.0 | 2.3 | 6.3 | 6.3 |
| France | 1.5 | 2.2 | 6.3 | 9.6 |
| Nether-lands | 2.4 | 2.0 | 10.3 | 4.3 |
| Finland | 5.0 | 3.5 | 7.7 | 8.0 |
| Belgium | 1.8 | 3.5 | 10.2 | 7.6 |
| Portugal | 1.2 | 3.9 | 6.4 | 11.1 |
| Ireland | -1.0 | 1.2 | 3.9 | 14.9 |
| Italy | 1.5 | 2.8 | 5.7 | 8.4 |
| Greece | -6.6 | 4.3 | 8.0 | 12.4 |
| Spain | 0.6 | 3.3 | 7.6 | 20.5 |
Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier
*Mar Office for National Statistics
PPI http://www.statistics.gov.uk/pdfdir/ppi0411.pdf
CPI http://www.statistics.gov.uk/pdfdir/cpi0411.pdf
** Feb EUROSTAT http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-04042011-AP/EN/4-04042011-AP-EN.PDF
Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html
The twelve months rates of the CPI, PPI, export prices and import prices have been at high levels in the past year, as shown in Table 6. The headline CPI has been rising with 2.7 percent in Mar 2011 and the PPI at 5.8 percent. Export prices rose at 9.5 percent in the 12 months ending in Mar 2011 and import prices at 9.7 percent. An important issue is that shelter costs have a weight of 32 percent in the headline CPI and about 40 percent in the core CPI, excluding food and energy, as analyzed by Evans (2011Apr4). The major component of shelter cost is what homeowners would pay for renting their property, which is called “owner’s equivalent rent.” There are no allowances for house prices or mortgage payments. The Fed will find a dilemma when CPI inflation begins to increase with rents.
Table 6, Twelve-month Percentage Change of CPI, PPI, Export Prices and Import Prices
| CPI | PPI | Export Prices | Import Prices | |
| 2010 | ||||
| Mar | 2.3 | 5.9 | 4.9 | 11.2 |
| Apr | 2.2 | 5.4 | 5.5 | 11.2 |
| May | 2.0 | 5.1 | 5.6 | 8.5 |
| Jun | 1.1 | 2.7 | 3.7 | 4.3 |
| Jul | 1.2 | 4.1 | 3.9 | 4.9 |
| Aug | 1.1 | 3.3 | 4.1 | 3.8 |
| Sep | 1.1 | 3.9 | 4.9 | 3.6 |
| Oct | 1.2 | 4.3 | 5.8 | 3.9 |
| Nov | 1.1 | 3.4 | 6.5 | 4.1 |
| Dec | 1.5 | 4.0 | 6.5 | 5.3 |
| 2011 | ||||
| Jan | 1.6 | 3.6 | 6.9 | 5.6 |
| Feb | 2.1 | 5.6 | 8.7 | 7.2 |
| Mar | 2.7 | 5.8 | 9.5 | 9.7 |
Sources:
CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
PPI http://www.bls.gov/news.release/ppi.nr0.htm
Export prices http://www.bls.gov/web/ximpim/q.htm
Import prices http://www.bls.gov/web/ximpim/r.htm
Data in nominal values throughout the production and distribution chain are showing inflation. Table 7 shows growth of exports of the US in Jan-Feb 2011 relative to Jan-Feb 2010 at 18.1 percent and imports at 19.8 percent. A significant part of this growth is inflation as shown by export and import prices in Table 6.
Table 7, US Trade Balance, Exports and Imports of Goods Jan-Feb Not Seasonally Adjusted Millions of Dollars
| 2010 | 2011 | ∆% | |
| Trade | -85,524 | -105,493 | - |
| Exports | 188,365 | 222,527 | 18.1 |
| Imports | 273,789 | 328,020 | 19.8 |
Source:
http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf
The same behavior is shown by euro area trade. Table 8 shows growth of nominal exports of the euro area of 25.0 percent in Jan-Feb 2011 relative to Jan-Feb 2010 and of imports by 27.8 percent. Part of this nominal growth is caused by inflation.
Table 8, Euro Area Trade Balance, Exports and Imports Jan-Feb Not Seasonally Adjusted Billions of Euros
| Jan-Feb 2010 € Bn | Jan-Feb 2011 € Bn | ∆% | |
| Exports | 208.2 | 260.3 | 25.0 |
| Imports | 217.2 | 277.4 | 27.8 |
| Trade | -9.0 | -17.1 |
Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/6-15042011-AP/EN/6-15042011-AP-EN.PDF
The responses to questionnaires and the indexes of prices paid and prices received of the Empire States Manufacturing Survey, estimated by the Federal Reserve Bank of New York, are shown in Table 9. The percentage of respondents of the survey expecting higher prices paid in the next six months is 62.8 percent and the percentage of respondents expecting higher prices received increased from 38.9 percent in Mar to 44.9 percent in Apr. Hardly anybody is expecting lower prices.
Table 9, FRBNY Empire State Manufacturing Survey Percentage Replies and Index of Prices Paid and Received
| Higher | Same | Lower | Index | |
| Prices Paid Past Month | ||||
| Mar | 53.25 | 46.75 | 0.00 | 53.25 |
| Apr | 60.26 | 37.18 | 2.56 | 57.69 |
| Prices Received Past Month | ||||
| Mar | 25.97 | 68.83 | 5.19 | 20.78 |
| Apr | 29.49 | 67.95 | 2.56 | 26.92 |
| Prices Paid Next 6 Months | ||||
| Mar | 72.73 | 25.97 | 1.30 | 71.43 |
| Apr | 62.82 | 30.77 | 6.41 | 56.41 |
| Prices Received Next 6 Months | ||||
| Mar | 38.96 | 58.44 | 2.60 | 36.36 |
| Apr | 44.87 | 48.72 | 6.41 | 38.46 |
Source: http://www.newyorkfed.org/survey/empire/april2011.pdf
DeLong (1997, 247-8) shows that the 1970s were the only peacetime period of inflation in the US without parallel in the prior century. The price level in the US drifted upward since 1896 with jumps resulting from the two world wars: “on this scale, the inflation of the 1970s was as large an increase in the price level relative to drift as either of this century’s major wars” (DeLong, 1997, 248). Monetary policy focused on accommodating higher inflation, with emphasis solely on the mandate of promoting employment, has been blamed as deliberate or because of model error or imperfect measurement for creating the Great Inflation (http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). As DeLong (1997) shows, the Great Inflation began in the mid 1960s, well before the oil shocks of the 1970s (see also the comment to DeLong 1997 by Taylor 1997, 276-7). A counterfactual of the 1970s immediately rises out of Table 10. What would have been the Great Inflation if the Federal Reserve would have lowered interest rates to zero in 1961, in fear of deflation because of 0.7 percent CPI inflation, and purchased the equivalent of 30 percent of the Treasury debt in long-term securities, subsequently engaging in quantitative easing II in 1964 after CPI inflation of 1.0 percent? The counterfactual would not be complete without including the unknown path of the US debt, tax and interest rate increases to exit from unsustainable debt and the largest monetary accommodation in US history.
Table 10, US Annual Rate of Growth of GDP and CPI and Unemployment Rate 1960-1982
| ∆% GDP | ∆% CPI | UNE | |
| 1960 | 2.5 | 1.4 | 6.6 |
| 1961 | 2.3 | 0.7 | 6.0 |
| 1962 | 6.1 | 1.3 | 5.5 |
| 1963 | 4.4 | 1.6 | 5.5 |
| 1964 | 5.8 | 1.0 | 5.0 |
| 1965 | 6.4 | 1.9 | 4.0 |
| 1966 | 6.5 | 3.5 | 3.8 |
| 1967 | 2.5 | 3.0 | 3.8 |
| 1968 | 4.8 | 4.7 | 3.4 |
| 1969 | 3.1 | 6.2 | 3.5 |
| 1970 | 0.2 | 5.6 | 6.1 |
| 1971 | 3.4 | 3.3 | 6.0 |
| 1972 | 5.3 | 3.4 | 5.2 |
| 1973 | 5.8 | 8.7 | 4.9 |
| 1974 | -0.6 | 12.3 | 7.2 |
| 1975 | -0.2 | 6.9 | 8.2 |
| 1976 | 5.4 | 4.9 | 7.8 |
| 1977 | 4.6 | 6.7 | 6.4 |
| 1978 | 5.6 | 9.0 | 6.0 |
| 1979 | 3.1 | 13.3 | 6.0 |
| 1980 | -0.3 | 12.5 | 7.2 |
| 1981 | 2.5 | 8.9 | 8.5 |
| 1982 | -1.9 | 3.8 | 10.8 |
| 1983 | 4,5 | 3.8 | 8.3 |
| 1984 | 7.2 | 3.9 | 7.3 |
| 1985 | 4.1 | 3.8 | 7.0 |
| 1986 | 3.5 | 1.1 | 6.6 |
| 1987 | 3.2 | 4.4 | 5.7 |
| 1988 | 4.1 | 4.4 | 5,3 |
| 1989 | 3.6 | 4.6 | 5.4 |
| 1990 | 1.9 | 6.1 | 6.3 |
Note: GDP: Gross Domestic Product; CPI: consumer price index; UNE: rate of unemployment; CPI and UNE are at year end instead of average to obtain a complete series
Source: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
http://www.bls.gov/web/empsit/cpseea01.htm
http://data.bls.gov/pdq/SurveyOutputServlet
The impact of stagflation on financial markets could cause high risks of another financial crisis because of the zero short-term fed funds rate and low yields of long-term Treasury securities. The pressure on interest rates rising from zero is heightened by the large-scale purchases of long-term securities by the Fed that may have to unwind the position in rising inflation and/or pay higher interest on excess reserves of banks held at the Fed, thus raising borrowing costs throughout the economy. On Apr 13, the line “Reserve Bank credit” in the Fed balance sheet was $2649 billion, or $2.6 trillion, with portfolio of long-term securities of $2416 billion, or $2.4 trillion, consisting of $1289 billion of nominal Treasury notes and bonds, $59 billion of inflation-indexed notes and bonds, $131 billion of federal agency securities and $937 billion of mortgage-backed securities; “reserve balances with Federal Reserve Banks” stood at $1531 billion, or $1.5 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1).
Table 11, updated with every blog comment, provides in the second column the yield at the close of market of the 10-year Treasury note on the date in the first column. The price in the third column is calculated with the coupon of 2.625 percent of the 10-year note current at the time of the second round of quantitative easing after Nov 3, 2010 and the final column “∆% 11/04/10” calculates the percentage change of the price on the date relative to that of 101.2573 at the close of market on Nov 4, 2010, one day after the decision on quantitative easing by the Fed on Nov 3, 2010. Prices with the new coupon of 3.63 percent in recent auctions (http://www.treasurydirect.gov/instit/annceresult/press/preanre/2011/2011.htm) are not comparable to prices in Table 11. The highest yield in the decade was 5.510 percent on May 1, 2001 that would result in a loss of principal of 22.9 percent relative to the price on Nov 4. The Fed has created a “duration trap” of bond prices. Duration is the percentage change in bond price resulting from a percentage change in yield or what economists call the yield elasticity of bond price. Duration is higher the lower the bond coupon and yield, all other things constant. This means that the price loss in a yield rise from low coupons and yields is much higher than with high coupons and yields. Intuitively, the higher coupon payments offset part of the price loss. Prices/yields of Treasury securities were affected by the combination of Fed purchases for its program of quantitative easing and also by the flight to dollar-denominated assets because of geopolitical risks in the Middle East and subsequently by the tragic earthquake and tsunami in Japan. The yield of 3.411 percent at the close of market on Apr 15, 2011, would be equivalent to price of 93.3874 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price loss of 7.8 percent relative to the price on Nov 4, 2010, one day after the decision on the second program of quantitative easing. If inflation accelerates, yields of Treasury securities may rise sharply. Yields are not observed without special yield-lowering effects such as the flight into dollars caused by the events in the Middle East, continuing purchases of Treasury securities by the Fed, the tragic earthquake and tsunami affecting Japan and recurring fears on European sovereign issues. Important causes of the rise in yields shown in Table 11 are expectations of rising inflation and US government debt estimated to exceed 70 percent of GDP in 2012 (http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html), rising from 40.8 percent of GDP in 2008 and 53.2 percent in 2009 (Table 2 in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html). There is no simple exit of this trap created by the highest monetary policy accommodation in US history together with the highest deficits and debt in percent of GDP since World War II.
Table 11, Yield, Price and Percentage Change to November 4, 2010 of Ten-Year Treasury Note
| Date | Yield | Price | ∆% 11/04/10 |
| 05/01/01 | 5.510 | 78.0582 | -22.9 |
| 06/10/03 | 3.112 | 95.8452 | -5.3 |
| 06/12/07 | 5.297 | 79.4747 | -21.5 |
| 12/19/08 | 2.213 | 104.4981 | 3.2 |
| 12/31/08 | 2.240 | 103.4295 | 2.1 |
| 03/19/09 | 2.605 | 100.1748 | -1.1 |
| 06/09/09 | 3.862 | 89.8257 | -11.3 |
| 10/07/09 | 3.182 | 95.2643 | -5.9 |
| 11/27/09 | 3.197 | 95.1403 | -6.0 |
| 12/31/09 | 3.835 | 90.0347 | -11.1 |
| 02/09/10 | 3.646 | 91.5239 | -9.6 |
| 03/04/10 | 3.605 | 91.8384 | -9.3 |
| 04/05/10 | 3.986 | 88.8726 | -12.2 |
| 08/31/10 | 2.473 | 101.3338 | 0.08 |
| 10/07/10 | 2.385 | 102.1224 | 0.8 |
| 10/28/10 | 2.658 | 99.7119 | -1.5 |
| 11/04/10 | 2.481 | 101.2573 | - |
| 11/15/10 | 2.964 | 97.0867 | -4.1 |
| 11/26/10 | 2.869 | 97.8932 | -3.3 |
| 12/03/10 | 3.007 | 96.7241 | -4.5 |
| 12/10/10 | 3.324 | 94.0982 | -7.1 |
| 12/15/10 | 3.517 | 92.5427 | -8.6 |
| 12/17/10 | 3.338 | 93.9842 | -7.2 |
| 12/23/10 | 3.397 | 93.5051 | -7.7 |
| 12/31/10 | 3.228 | 94.3923 | -6.7 |
| 01/07/11 | 3.322 | 94.1146 | -7.1 |
| 01/14/11 | 3.323 | 94.1064 | -7.1 |
| 01/21/11 | 3.414 | 93.4687 | -7.7 |
| 01/28/11 | 3.323 | 94.1064 | -7.1 |
| 02/04/11 | 3.640 | 91.750 | -9.4 |
| 02/11/11 | 3.643 | 91.5319 | -9.6 |
| 02/18/11 | 3.582 | 92.0157 | -9.1 |
| 02/25/11 | 3.414 | 93.3676 | -7.8 |
| 03/04/11 | 3.494 | 92.7235 | -8.4 |
| 03/11/11 | 3.401 | 93.4727 | -7.7 |
| 03/18/11 | 3.273 | 94.5115 | -6.7 |
| 03/25/11 | 3.435 | 93.1935 | -7.9 |
| 04/01/11 | 3.445 | 93.1129 | -8.0 |
| 04/08/11 | 3.576 | 92.0635 | -9.1 |
| 04/15/11 | 3.411 | 93.3874 | -7.8 |
Note: price is calculated for an artificial 10-year note paying semi-annual coupon and maturing in ten years using the actual yields traded on the dates and the coupon of 2.625% on 11/04/10
Source:
http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3020
There is a false impression that the Fed has the “science,” measurements and forecasting to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table 12 when the Fed pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table 12 shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without Fed tightening because of the long lag in effect of monetary policy on inflation. The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery and creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether exotic policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability. A glance at Table 12 shows CPI inflation of 0.7 percent in 1961, creating a counterfactual of what would have been the Great Inflation if the Fed had set the policy rate at zero and purchased a third of the outstanding Treasury debt. The symmetric inflation target of “a little less than 2 percent,” or an infinitesimal neighborhood of 2, is an extremely dangerous misplaced analogy with the Great Depression that may bring the economy closer to the relevant historical event of the Great Inflation of the 1970s that ended with the rate hike that reached 22.36 percent for fed funds on Jul 22, 1981 and the Great Bond Crash of 1994.
Table 12, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994
| 1994 | FF | 30Y | 30P | 10Y | 10P | MOR | CPI |
| Jan | 3.00 | 6.29 | 100 | 5.75 | 100 | 7.06 | 2.52 |
| Feb | 3.25 | 6.49 | 97.37 | 5.97 | 98.36 | 7.15 | 2.51 |
| Mar | 3.50 | 6.91 | 92.19 | 6.48 | 94.69 | 7.68 | 2.51 |
| Apr | 3.75 | 7.27 | 88.10 | 6.97 | 91.32 | 8.32 | 2.36 |
| May | 4.25 | 7.41 | 86.59 | 7.18 | 88.93 | 8.60 | 2.29 |
| Jun | 4.25 | 7.40 | 86.69 | 7.10 | 90.45 | 8.40 | 2.49 |
| Jul | 4.25 | 7.58 | 84.81 | 7.30 | 89.14 | 8.61 | 2.77 |
| Aug | 4.75 | 7.49 | 85.74 | 7.24 | 89.53 | 8.51 | 2.69 |
| Sep | 4.75 | 7.71 | 83.49 | 7.46 | 88.10 | 8.64 | 2.96 |
| Oct | 4.75 | 7.94 | 81.23 | 7.74 | 86.33 | 8.93 | 2.61 |
| Nov | 5.50 | 8.08 | 79.90 | 7.96 | 84.96 | 9.17 | 2.67 |
| Dec | 6.00 | 7.87 | 81.91 | 7.81 | 85.89 | 9.20 | 2.67 |
Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months
Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
III Hiring Collapse. An appropriate measure of job stress is considered by Blanchard and Katz (1997, 53):
“The right measure of the state of the labor market is the exit rate from unemployment, defined as the number of hires divided by the number unemployed, rather than the unemployment rate itself. What matters to the unemployed is not how many of them there are, but how many of them there are in relation to the number of hires by firms.”
The natural rate of unemployment and the similar NAIRU are quite difficult to estimate in practice (Ibid; see Ball and Mankiw 2002).
The Bureau of Labor Statistics (BLS) created the Job Openings and Labor Turnover Survey (JOLTS) with the purpose that (http://www.bls.gov/jlt/jltover.htm#purpose):
“These data serve as demand-side indicators of labor shortages at the national level. Prior to JOLTS, there was no economic indicator of the unmet demand for labor with which to assess the presence or extent of labor shortages in the United States. The availability of unfilled jobs—the jobs opening rate—is an important measure of tightness of job markets, parallel to existing measures of unemployment.”
The BLS collects data from about 16,000 US business establishments in nonagricultural industries through the 50 states and DC. The data are released monthly and constitute an important complement to other data provided by the BLS.
Hiring in the nonfarm sector (HNF) has declined from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million while hiring in the private sector (HP) has declined from 60.4 million in 2006 to 43.3 million in 2010 or by 17.1 million. The ratio of nonfarm hiring to unemployment (RHNF) has fallen from 9.3 in 2006 to 3.2 in 2010 and in the private sector (RHP) from 8.6 in 2006 to 2.9 in 2010 (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html). Table 13 provides total HNF and HP in the month of Feb from 2001 to 2011. An important characteristic of the labor market in the US is that HNF has declined from 4.521 million in Feb 2006 to 3.291 million in Feb 2011, or by 1.23 million, and HP has fallen from 4.269 million in Feb 2006 to 3.111 million in Feb 2011, or by 1.158 million. HNF of 3.291 in Feb 2011 is lower by 1.251 million than in Feb 2010 and HP in Feb 2011 of 3.111 million in Feb 2011 is lower by 1.148 million than 4.259 million in Feb 2001. The US labor market is fractured, creating fewer opportunities to exit job stress of unemployment and underemployment of 24 to 30 million people and nearly frozen wages in the midst of fast increases in prices of everything except inadequately measured rents and shelter costs of homeowners (http://cmpassocregulationblog.blogspot.com/2011/04/twenty-four-to-thirty-million-in-job_03.html).
Table 13, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment in February Not Seasonally Adjusted
| HNF | Rate RNF | HP | Rate HP | |
| 2001 | 4,542 | 3.5 | 4,259 | 3.9 |
| 2002 | 4,072 | 3.2 | 3,827 | 3.6 |
| 2003 | 3,930 | 3.1 | 3,712 | 3.5 |
| 2004 | 3,933 | 3.0 | 3,704 | 3.5 |
| 2005 | 4,383 | 3.3 | 4,153 | 3.8 |
| 2006 | 4,521 | 3.4 | 4,269 | 3.8 |
| 2007 | 4,324 | 3.2 | 4,056 | 3.6 |
| 2008 | 4,063 | 3.0 | 3,830 | 3.4 |
| 2009 | 3,325 | 2.5 | 3,141 | 2.9 |
| 2010 | 3,133 | 2.5 | 2,920 | 2.8 |
| 2011 | 3,291 | 2.6 | 3,111 | 2.9 |
Source: http://www.bls.gov/jlt/data.htm
IV Budget Quagmire. The Treasury Monthly Statement (http://www.fms.treas.gov/mts/mts0311.pdf) provides receipts, outlays and balance for the first six months of the 2011 fiscal year from Oct 2010 to Mar 2011, shown in Table 14. Receipts rose by 6.9 percent in Oct-Mar, outlays increased by 10.7 percent and the deficit increased from $716.990 billion in 2010 to $829.410 billion or by 15.7 percent.
Table 14, Treasury Budget Statement Receipts, Outlays and Balance Dollar Millions
| Receipts | Outlays | Balance | |
| FY 2010 | 2,161,746 | 3,455,949 | 1,294,204 |
| Oct-Mar 2010 | 953,892 | 1,670,882 | 716,990 |
| Oct-Mar 2011 | 1,019,896 | 1,849,306 | 829,410 |
| ∆% | 6.9 | 10.7 | 15.7 |
Source: http://www.fms.treas.gov/mts/mts0311.pdf
The President outlined on Apr 13 a new budget plan (http://blogs.wsj.com/washwire/2011/04/13/text-of-obama-speech-on-the-deficit/):
“This is my approach to reduce the deficit by $4 trillion over the next twelve years. It’s an approach that achieves about $2 trillion in spending cuts across the budget. It will lower our interest payments on the debt by $1 trillion. It calls for tax reform to cut about $1 trillion in spending from the tax code. And it achieves these goals while protecting the middle class, our commitment to seniors, and our investments in the future.”
On Apr 14 the heads of the National Commission on Fiscal Reform and Responsibility (NCFRR) met with the President and announced their support of his new budget plan (http://professional.wsj.com/article/SB10001424052748703983104576262932534033722.html?mod=WSJPRO_hpp_LEFTTopStories). On Apr 15, the House passed H. Con. Res. 34, the Fiscal Year 2012 Budget Resolution by a vote of 235-193 (http://budget.house.gov/News/DocumentSingle.aspx?DocumentID=237237). Meanwhile a group of six senators, three from each major party, is working on the conciliation of the NCFRR plan.
The path of adjustment of US fiscal affairs is still uncertain. Table 15 shows the available data from the NCFRR plan and the House Budget Committee (HBC) budget as released before passing in the House of Representatives. More careful comparison requires scoring by the Congressional Budget Office (CBO) with uniform estimating techniques and assumptions. A key principle of any long-term solution is reducing the ratio of expenditures to GDP back to 20 percent or less, which is what the US has been able to finance with taxes over the long term (http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html).
Table 15, National Commission (NCFRR) Plan and House Budget Committee (HBC) Budget
| NCFRR | NCFRR | HBC | HBC | |
| 2011 | 3,703 | 23.8 | 3,618 | 24.1 |
| 2012 | 3,671 | 23.3 | 3,529 | 22.5 |
| 2013 | 3,691 | 22.1 | 3,559 | 21.7 |
| 2014 | 3,842 | 21.6 | 3,586 | 20.8 |
| 2015 | 4,024 | 21.6 | 3,671 | 20.2 |
| 2016 | 4,276 | 21.9 | 3,858 | 20.2 |
| 2017 | 4,450 | 21.8 | 3,998 | 20.0 |
| 2018 | 4,597 | 21.6 | 4,123 | 19.7 |
| 2019 | 4,839 | 21.8 | 4,352 | 19.9 |
| 2020 | 5,052 | 21.8 | 4,544 | 19.9 |
| Total 2011-2020 | 42,145 | Average | 38,838 | Average 20.8 |
| Average Percent | 3.5 | 3.0 |
Sources:
http://budget.house.gov/UploadedFiles/PathToProsperityFY2012.pdf
Table 16 shows the ratios of deficit and debt to GDP for both the NCFRR and HBC plans. In both plans, the deficits would shrink to less than 2 percent of GDP and the debt would decline below 70 percent of GDP. There are differences in taxation, outlays and programs in the approaches of the White House and members of Congress. These differences are beginning to sharpen with the deadline for increasing the debt limit of the US in May.
Table 16, National Commission (NCFRR) and House Budget Committee (HBC) Deficit and Debt as Percent of GDP
| NCFRR | NCFRR | HBC | HBC | |
| 2011 | 7.9 | 66.9 | 9.2 | 68.8 |
| 2012 | 6.0 | 71.0 | 6.3 | 72.8 |
| 2013 | 3.9 | 71.5 | 4.3 | 74.5 |
| 2014 | 2.6 | 70.4 | 2.9 | 74.2 |
| 2015 | 2.3 | 69.8 | 2.4 | 73.2 |
| 2016 | 2.2 | 69.3 | 2.5 | 72.5 |
| 2017 | 1.8 | 68.6 | 2.0 | 71.7 |
| 2018 | 1.4 | 67.5 | 1.8 | 70.7 |
| 2019 | 1.3 | 66.6 | 1.9 | 69.8 |
| 2020 | 1.2 | 65.5 | 1.8 | 68.7 |
Sources:
http://budget.house.gov/UploadedFiles/PathToProsperityFY2012.pdf
V Global Imbalances. The G20 (2011Apr15) meeting of Finance Ministers and Central Bank Governors considered various actions on important issues of global financial coordination: (1) vigilance of downside risks to ongoing global economic recovery; (2) strengthening the international monetary system with various initiatives centered around the International Monetary Fund (IMF); (3) welcoming the new arrangements to borrow (NAB) and completion of work required to implement the reform of IMF quota and governance by the annual meetings of 2012; (4) recommendations from international organizations to prevent “excessive price volatility in food and agricultural markets and its impact on food security” and recommendations on regulation and supervision of commodities derivatives and markets by IOSCO (International Organization of Securities Commissions http://www.iosco.org/ on the international financial institutions see Pelaez and Pelaez, International Financial Architecture (2005), Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 114-48, Government Intervention in Globalization (2008c), 145-54); and (5) strengthening the Financial Stability Board (FSB http://www.financialstabilityboard.org/) and recommendations.
The G20 (2011Apr15) focused at its Washington meeting on the issue of world global imbalances (see Pelaez and Pelaez, The Global Recession Risk (2007), Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 180-210, Government Intervention in Globalization (2009c), 167-81). The G20 (2011Apr15) agreed in February on indicators for a two-step process: “These indicators are (i) public debt and fiscal deficits; and private savings rate and private debt (ii) and the external imbalance composed of the trade balance and net investment income flows and transfers, whilst taking due consideration of exchange rate, fiscal, monetary and other policies.” The G20 completed the first steep at the Apr 15 meeting by agreeing on “indicative guidelines against which each of these indicators will be assessed” (Ibid). The guidelines are not targets but rather “reference values for each available indicators allowing for identification of countries for the second step in-depth assessment.” There are four approaches in the G20 (2011Apr15) agreement:
“1 -- A structural approach, which is based on economic models and grounded in economic theory, which benchmarks G20 members against each indicator in a way that takes into account specific circumstances including large commodity producers (e.g. its demographic profile, oil balance or trend growth).
· 2 -- A statistical approach which benchmarks G20 countries on the basis of their national historical trends.
· 3 -- A statistical approach which benchmarks G20 country's historical indicators against groups of countries at similar stages in their development.
· 4 -- A statistical approach which draws on data, benchmarking G20 country's indicators against the full G20. ”
The period preceding the major increase in external imbalances of 1990 to 2004 is used in the statistical approaches with reference values in 1990 to 2010 as a complement. The in depth assessment is determined by comparing forecast values in 2013-15 to “values suggested by the guidelines.” Countries that have “persistently large imbalances” under at least two of the four approaches will be selected to analyze the actual causes of the imbalances and barriers of adjustment. There will also be evaluation of exchange rate and monetary policies, allowing for country specific factors. The second step will use IMF forecasts but also allowing individual country assessments. The determination of spillover effects in the second stage will be for countries that account for more than 5 percent of total G20 GDP.
World Economic Outlook (WEO) data of the IMF is used in Table 17 for a group of countries. There are large countries with significant forecast current account (CAD) surpluses relative to GDP in 2012: 6.3 percent for China with more than $3 trillion of reserves; 4.6 percent for Germany; and 2.3 percent for Japan. There are large countries with significant CAD deficits: 3.2 percent for US and 1.9 percent for UK. The other countries in Table 17 are passive recipients of the spillover effects mostly originating in China and the US. A major source of future potential “spillover effects” on world financial markets and the world economy is the unsustainable path of the US debt, reaching 72.4 percent of GDP in 2021 with fiscal deficit of 10.8 percent in the IMF forecast in Table 17. The exchange rate policies of China and the US are shown in the two rows of Table 1 labeled “USD/EUR,” or dollars per euro, and “CNY/USD,” of Chinese yuan per dollar. The exotic monetary policy of the US of permanently defending against deflation and from any deviation of the output gap from what the FOMC desires at the moment, similar to the Great Inflation and Unemployment of the 1970s (http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html), was influential in depreciating the dollar from USD 1.1424/EUR on Jun 25, 2003 to USD 1.5914/EUR on July 14, 2008, or by 39.3 percent, and then again from USD 1.192/EUR on Jun 7, 2010 to USD 1.443/EUR on Apr 15, 2011, or by 21.1 percent (see also Table 2). The Fed, deliberately or not but effectively, may have simply imitated devaluations in the 1930s (Bernanke 2002FD):
“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”
Table 17, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2011 Dollar GDP
| GDP $B | FD %GDP 2011 | CAD %GDP 2011 | Debt %GDP 2011 | FD%GDP 2012 | CAD%GDP 2012 | Debt %GDP 2012 | |
| US | 15227 | -10.6 | -3.2 | 64.8 | -10.8 | -3.2 | 72.4 |
| Japan | 5821 | -9.9 | 2.3 | 127.8 | -8.4 | 2.3 | 135.1 |
| UK | 2471 | -8.6 | -2.4 | 75.1 | -6.9 | -1.9 | 78.6 |
| Euro | 12939 | -4.4 | 0.03 | 66.9 | -3.6 | 0.05 | 68.2 |
| Ger | 3519 | -2.3 | 5.1 | 54.7 | -1.5 | 4.6 | 54.7 |
| France | 2751 | -6.0 | -2.8 | 77.9 | -5.0 | -2.7 | 79.9 |
| Italy | 2181 | -4.3 | -3.4 | 100.6 | -3.5 | -2.9 | 100.4 |
| Can | 1737 | -4.6 | -2.8 | 35.1 | -2.8 | -2.6 | 36.3 |
| China | 6516 | -1.6 | 5.7 | 17.1 | -0.9 | 6.3 | 16.3 |
| Brazil | 2090 | -2.4 | -2.6 | 39.9 | -2.6 | -2.9 | 39.4 |
Note: GER = Germany; Can = Canada; FD = fiscal deficit; CAD = current account deficit
Source: http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx
The combination of zero interest rates, quantitative easing and the continuous pursuit of correcting deviations in the output gap from what is desired by the FOMC over the past ten years has been a key determinant of a major financial crisis, global recession, jobless recovery, frustration of hiring, low wages and risks of a second act of the Great Inflation and Unemployment of the 1970s. Fed monetary policy in the past ten years not only has heightened financial instability in the US and the world financial system but it has created spillovers, or external diseconomies, to the rest of the world, frustrating sound monetary policy in economies such as that of Brazil that is caught between the competitive devaluation of the US and the undervalued yuan much the same as many countries in emerging Asia and Latin America. A significant part of the trend of commodity prices is caused by the zero interest rate of the US not by growth and higher demand in emerging countries that cannot implement sound policies because of resulting overvaluation of their currencies that frustrates their share in growth of world trade. More normal monetary policy instead of exotic policies by zero interest rates and purchases of $2.4 trillion of long-term securities would eliminate the spillover effects on other countries and promote financial stability and growth in the US.
VI Economic Indicators. Trade continues to grow at high rates with significant price effects as shown by Tables 6, 7 and 8. Manufacturing is growing at fast rates, leading the economic recovery but already showing price pressures. There are some doubts on initial jobless claims that have risen significantly. The FRBO survey shows growth of industrial production of 0.8 percent in Mar with annual growth in the first quarter of 6.0 percent. Manufacturing output grew by 0.7 percent in Mar for the fourth consecutive month of strong growth at an annual rate of 9.1 percent in the first quarter. Total industrial capacity stood at 93.6 percent of the 2007 average but 5.9 percent above the level a year earlier. The rate of capacity utilization for total industry increased by 0.5 percentage point, reaching 77.4 percent, which is 3.0 percentage points below the average in 1972 to 2010 (http://www.federalreserve.gov/releases/g17/current/). The Empire State Manufacturing Survey of the FRBNY finds improvement at “an accelerated pace in April” (http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html). The general index increased to 21.7, for the fifth consecutive month of growth and its highest level in a year. New orders grew 17 points, reaching 22.3. As documented in Table 9, the indexes for prices paid and received increased to the highest level over a year, suggesting continuing acceleration of prices. The Beige Book of the Fed finds continuing improvement (http://www.federalreserve.gov/fomc/beigebook/2011/20110413/default.htm):
“Reports from the twelve Federal Reserve Districts indicated that economic activity generally continued to improve since the last report. While many Districts described the improvements as only moderate, most Districts stated that gains were widespread across sectors, and Kansas City described its economic gains as solid. Manufacturing continued to lead, with virtually every District citing examples of steady improvement, often with reports of increased hiring.”
Initial jobless claims, seasonally adjusted, rose by 27,000 to 412,000 in the week of Apr 9 from 385,000 in the week of Apr 2. Initial jobless claims, not seasonally adjusted, rose 89,686 to 443,503 in the week of Apr 9 from 353,817 in the week of Apr 2. The four-week moving average of initial jobless claims, seasonally adjusted, rose 5500 to 395,750 in the week of Apr 9 from 390,250 in the week of Apr 2 (http://www.dol.gov/opa/media/press/eta/ui/current.htm). There could be an end of quarter effect but the revisions become important.
VII Interest Rates. The 10-year Treasury note traded at 3.41 percent on Apr 15, which is lower than 3.58 percent a week earlier but higher than 3.26 percent a month earlier (http://markets.ft.com/markets/bonds.asp). Yields of Treasury securities have been fluctuating with shocks of risk aversion originating in sovereign risk issues in Europe, events in the Middle East, tough tradeoff of inflation and growth in China, effects of the earthquake/tsunami in Japan and anemic growth, hiring, wages, budget quagmire and inflation risks in the US. For the first time in a long period the 10-year government bond of Germany traded at negative spread of only four basis points relative to the US Treasury, with yield of 3.71 percent. The 10-year government bond of Greece traded at 14.16 percent for negative spread of 10.78 percentage points relative to the 10-year government bond of Germany (http://markets.ft.com/markets/bonds.asp). The US Treasury note maturing in 02/21 with coupon of 3.63 percent traded at yield of 3.41 percent or equivalent price of 101.78 percent, which is different than the price in Table 11 for a hypothetical Treasury note with coupon of 2.625 percent and maturity in exactly ten years.
VIII Conclusion. Inflation is accelerating throughout the world. The issue of global imbalances considered by the G20 must address the return to normalcy of monetary policy in the US. That return is complicated by the increase of interest rates from zero with holdings of long-term securities of $2.4 trillion. Delaying an interest rate closer to inflation may require sharp increases in interest rates in the future that may flatten the growth path of the economy, creating additional stress on job markets. (Go to http://cmpassocregulationblog.blogspot.com/ http://sites.google.com/site/economicregulation/carlos-m-pelaez)
http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10 )
References
Andrés, Javier, J. David López-Salido and Edward Nelson. 2004. Tobin’s imperfect asset substitution in optimizing equilibrium. Journal of Money, Credit and Banking 36 (4, Aug): 665-90.
Ball, Laurence and N. Gregory Mankiw. 2002. The NAIRU in theory and practice. Journal of Economic Perspectives 16 (4, Autumn): 115-36.
Bernanke, Ben S. 2002FD. Deflation: making sure “it” doesn’t happen here. Washington DC, National Economists Club, Nov 21 http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm
Bernanke, Ben S. 2000. A crash course for central bankers. Foreign Policy 120 (Sep/Oct): 49.
Bernanke, Ben S. 2009SL. The crisis and the policy response. London: Stamp Lecture LSE, Jan 13 http://www.federalreserve.gov/newsevents/speech/bernanke20090113a.htm
Bernanke, Ben S. 2010WP. What the Fed did and why: supporting the recovery and sustaining price stability. Washington Post, Nov 4. http://www.washingtonpost.com/wp-dyn/content/article/2010/11/03/AR2010110307372_pf.html
Bernanke, Ben S. and Vincent R. Reinhart. 2004. Conducting monetary policy at very low short-term interest rates. American Economic Review 94 (2): 85-90.
Blanchard, Olivier. 2011FWEOApr. Foreword. World Economic Outlook April 2011. Washington, DC: IMF http://www.imf.org/external/pubs/ft/weo/2011/01/pdf/text.pdf
Blanchard, Olivier and Lawrence F. Katz. 1997. What we know and do not know about the natural rate of unemployment. Journal of Economic Perspectives 11 (1, Winter): 51-72.
Brunner, Karl and Allan H. Meltzer. 1973. Mr. Hicks and the “monetarists.” Economica NS 40 (157, Feb): 44-59.
Cox, John C., Jonathan E. Ingersoll, Jr. and Stephen A. Ross. 1981. A re-examination of traditional hypotheses about the term structure of interest rates. Journal of Finance 36 (4, Sep): 769-99.
Cox, John C., Jonathan E. Ingersoll, Jr. and Stephen A. Ross. 1985. A theory of the term structure of interest rates. Econometrica 53 (2, Mar): 385-407.
Culbertson, John M. 1957. The term structure of interest rates. Quarterly Journal of Economics 71 (4, Nov): 485-517.
Culbertson, John M. 1963. The term structure of interest rates: reply. Quarterly Journal of Economics 77 (4, Nov): 691-6.
DeLong, J. Bradford. 1997. America’s peacetime inflation: the 1970s. In Chrstina Romer and David Romer, eds. Reducing inflation: motivation and strategy. Chicago: University of Chicago Press.
Evans, Kelly. 2011Apr4. Housing bubble continues to haunt Fed. Wall Street Journal, Apr 4.
FRBO. 2005PF. The Federal Reserve System: purposes & functions. Ninth Edition. Washington, DC, FRD, Jun http://www.federalreserve.gov/pf/pdf/pf_complete.pdf
FRBO. 2010DW. The Federal Reserve discount window. Washington, DC, FRBO, Jul 21.
G20. 2011Apr15. Final communiqué. Washington, DC, Meeting of the G20 Finance Ministers and Central Bank Governors, Apr 15 http://www.g20.utoronto.ca/2011/2011-finance-110415-en.html http://www.g8-g20.com/g8-g20/g20/english/for-the-press/news-releases/meeting-of-finance-ministers-and-central-bank.1104.html
Hamilton, James D. and Jing Wu. 2010. The effectiveness of alternative monetary policy tools in a zero lower bound environment. San Diego, University of California San Diego, Nov 3 http://dss.ucsd.edu/~jhamilto/zlb.pdf
Hicks, John R. 1935. A suggestion for simplifying the theory of money. Economica NS 2 (5, Feb): 1-19.
Hicks, John R. 1962. Liquidity. Economic Journal 72 (288, Dec): 787-802
Ingersoll, Jr., Jonathan E. 1987. Theory of financial decision making. Totowa, NJ: Rowan.
Lintner, John. 1965. The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economics and Statistics 47 (1, Feb): 12-37.
Lutz, Friedrich A. 1940. The structure of interest rates. Quarterly Journal of Economics 55 (1, Nov): 36-63.
Markowitz, Harry. 1952. Portfolio selection. Journal of Finance 7 (1, Mar): 77-91.
Modigliani, Franco and Richard Sutch. 1966. Innovations in interest rate policy. American Economic Review 56 (1/2, Mar): 178-97.
Mossin, Jan. 1966. 1966. Equilibrium in a capital asset market. Econometrica 34 (4, Oct): 768-83.
Pelaez, Carlos M. and Carlos A. Pelaez. 2005. International Financial Architecture. Basingstoke: Palgrave Macmillan. http://us.macmillan.com/QuickSearchResults.aspx?search=pelaez%2C+carlos&ctl00%24ctl00%24cphContent%24ucAdvSearch%24imgGo.x=26&ctl00%24ctl00%24cphContent%24ucAdvSearch%24imgGo.y=14 http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10
Pelaez, Carlos M. and Carlos A. Pelaez. 2007. The Global Recession Risk. Basingstoke: Palgrave Macmillan. http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10
Pelaez, Carlos M. and Carlos A. Pelaez. 2008a. Globalization and the State: Vol. I. Basingstoke: Palgrave Macmillan. http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10
Pelaez, Carlos M. and Carlos A. Pelaez. 2008b. Globalization and the State: Vol. II. Basingstoke: Palgrave Macmillan.
Pelaez, Carlos M. and Carlos A. Pelaez. 2008c. Government Intervention in Globalization. Basingstoke: Palgrave Macmillan. http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10
Pelaez, Carlos M. and Carlos A. Pelaez. 2009a. Financial Regulation after the Global Recession. Basingstoke: Palgrave Macmillan. http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10
Pelaez, Carlos M. and Carlos A. Pelaez. 2009b. Regulation of Banks and Finance. Basingstoke: Palgrave Macmillan.http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10
Pelaez, Carlos Manuel and Wilson Suzigan. 1978. Economia Monetária. São Paulo, Atlas.
Roll, Richard. 1977. A critique of the asset pricing theory’s tests. Part I: on past and potential testability of the theory. Journal of Financial Economics 4 (2, Mar): 129-76.
Sharpe, William F. 1964. Capital asset prices: a theory of market equilibrium under conditions of risk. Journal of Finance 19 (3, Sep): 425-42.
Taylor, John B. 1997. Comment. In Chrstina Romer and David Romer, eds. Reducing inflation: motivation and strategy. Chicago: University of Chicago Press.
Tobin, James. 1958. Liquidity preference as behavior toward risk. Review of Economic Studies 26 (Feb): 65-86.
Tobin, James. 1961. Money, capital, and other stores of value. American Economic Review 51 (2, May): 26-37.
Tobin, James. 1969. A general equilibrium approach to monetary theory. Journal of Money Credit and Banking 1(1, Feb): 15-29.
Treynor, Jack L. 1962. Toward a theory of market value of risky assets, unpublished manuscript, 1962, provided by Craig W. French, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=628187
Yellen, Janet L. 2011AS. The Federal’s Reserve’s asset purchase program. Denver, Colorado, Allied Social Science Association Annual Meeting, Jan 8 http://federalreserve.gov/newsevents/speech/yellen20110108a.pdf
Yellen, Janet L. 2011CP. Commodity prices, the economic outlook and monetary policy. New York, NY, Economic Club of New York, Feb 11 http://www.federalreserve.gov/newsevents/speech/yellen20110411a.pdf
Vayanos, Dimitri and Jean-Luc Vila. 2009. A preferred-habitat model of the term structure of interest rates. New Orleans, AFA Meetings Paper, Nov 1. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=971439
© Carlos M. Pelaez, 2010, 2011
No comments:
Post a Comment