CMP Associates Regulation Blog: World Financial Turbulence, Global Growth Recession, Inflation and Monetary Policy and Economic Uncertainty

World Financial Turbulence, Global Growth Recession, Inflation and Monetary Policy and Economic Uncertainty

Carlos M. Pelaez

Executive Summary

I World Financial Turbulence

II Inflation and Monetary Policy

IIA Conventional and Unconventional Monetary Policy

IIB Deflation

IIC Appendix: Theory of Monetary Policy

III Global Inflation

IV United States Economic Uncertainty

V World Trade and Growth

VA Japan

VB Euro Area

VC Germany

VD United Kingdom

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

Executive Summary

Unconventional monetary policy of zero interest rates and quantitative easing has been inspired by fear of deflation (see Pelaez and Pelaez, International Financial Architecture (2005), 18-28 The Global Recession Risk (2007), 83-95). Key percentage average yearly rates of the US economy on growth and inflation are provided in Table 4 extracted here from the text. The choice of dates prevents the measurement of long-term potential economic growth because of two recessions in 2001 and the drop in GDP of 5.1 percent followed with unusually low economic growth for an expansion phase after recession (http://cmpassocregulationblog.blogspot.com/2011_07_01_archive.html). Between 2000 and 2010, real GDP grew at the average rate of 1.6 percent per year, nominal GDP at 3.9 percent and the implicit deflator at 2.5 percent. The average rate of CPI inflation was 2.4 percent per year and 2.5 percent excluding food and energy. PPI inflation increased at 2.6 percent per year on average and at 1.6 percent excluding food and energy. There is also inflation in international trade. Import prices grew at 2.2 percent per year between 2000 and 2010 and 3.3 percent between 2000 and 2011. The commodity price shock is revealed by inflation of import prices of petroleum at10.4 percent per year between 2000 and 2010 and at 13.4 percent between 2000 and 2011. The average growth rates of imports excluding fuels are much lower at 1.7 percent for 2000 to 2010 and 2.1 percent for 2000 to 2011. Export prices rose at the average rate of 2.2 percent between 2000 and 2010 and at 2.9 percent in 2000 to 2011. What spared the US of a decade long deterioration of the terms of trade, (export prices)/(import prices), was its diversification and competitiveness in agriculture. Agricultural export prices grew at the average yearly rate of 5.1 percent in 2000 to 2010 and at 6.8 percent in 2000 to 2011. US nonagricultural export prices rose at 1.7 percent per year in 2000 to 2010 and at 2.3 percent in 2000 to 2011. These dynamic growth rates are not similar to those for the economy of Japan where inflation was negative in seven of the 10 years in the 2000s.

Table 4, US, Average Growth Rates of Real and Nominal GDP, Consumer Price Index, Producer Price Index and Import and Export Prices, Percent per Year

Real GDP	2000-2010: 1.6%
Nominal GDP	2000-2010: 3.9%
Implicit Price Deflator	2000-2010: 2.5%
CPI	2000-2010: 2.4% 2000-2011: 2.5%
CPI ex Food and Energy	2000-2010: 2.0% 2000-2011: 1.9%
PPI	2000-2010: 2.6% 2000-2011: 3.0%
PPI ex Food and Energy	2000-2010: 1.6% 2000-2011: 1.7%
Import Prices	2000-2010: 2.2% 2000-2011: 3.3%
Import Prices of Petroleum and Petroleum Products	2000-2010: 10.4% 2000-2011: 13.4%
Import Prices Excluding Fuels	2000-2010: 1.7% 2000-2011: 2.1%
Export Prices	2000-2010: 2.2% 2000-2011: 2.9%
Agricultural Export Prices	2000-2010: 5.1% 2000-2011: 6.8%
Nonagricultural Export Prices	2000-2010: 1.7% 2000-2011: 2.3%

Note:rates for price indexes in the row beginning with “CPI” and ending in the row “Nonagricultural Export Prices” are for Jul 2000 to Jul 2010 and and for Jul 2010 to Jul 2011. Import prices excluding fuels are not available before 2002.

Sources:

http://www.bea.gov/iTable/index_nipa.cfm http://www.bls.gov/ppi/data.htm

http://www.bls.gov/mxp/data.htm http://www.bls.gov/cpi/data.htm

Unconventional monetary policy of zero interest rates and large-scale purchases of long-term securities for the balance sheet of the central bank is proposed to prevent deflation. CPI inflation of all goods and CPI inflation excluding food and energy are shown in Table 5 in the text below for the past 60 years. The data are percentage changes of annual levels of the CPI index. There is only one negative change by 0.4 percent in the CPI all goods annual index in 2009 but not one year of negative annual yearly change in the CPI excluding food and energy annual inflation. Zero interest rates and quantitative easing are designed to lower costs of borrowing for investment and consumption, increase stock market valuations and devalue the dollar. In practice, the carry trade is from zero interest rates to a large variety of risk financial assets including commodities. Resulting commodity price inflation squeezes family budgets and deteriorates the terms of trade with negative effects on aggregate demand and employment. Excessive valuations of risk financial assets eventually result in crashes of financial markets with possible adverse effects on economic activity and employment.

Producer price inflation history in the past five decades does not provide evidence of deflation, as shown in Table 6 in the text. The finished core PPI does not register even one single year of decline. The headline PPI experienced only six isolated cases of decline:

-0.3 percent in 1963,

-1.4 percent in 1986,

-0.8 percent in 1986, -0.8 percent in 1998,

-1.3 percent in 2001

-2.6 percent in 2009.

Deflation should show persistent cases of decline of prices and not isolated events. Fear of deflation in the US has caused a distraction of monetary policy. Symmetric inflation targets around 2 percent in the presence of multiple lags in effect of monetary policy and imperfect knowledge and forecasting are mostly unfeasible and likely to cause instability instead of desired price stability.

I World Financial Turbulence. The past three months have been characterized by financial turbulence, attaining unusual magnitude in the past three weeks. Table 1, updated with every comment in this blog, provides beginning values on Aug 15 and daily values throughout the week ending on Aug 19 of a few financial variables. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Aug 12 and the percentage change in that week below the label of the financial risk asset. The first five rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy, the growth recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing inflation. The current week was dominated by the meeting of the Chancellor of Germany, Angela Merkel, and the President of France, Nicolas Sarkozt. The dollar/euro rate is quoted as number of dollars USD per one euro EUR, USD 1.424/EUR in the first row, column 1 in the block for currencies in Table 1 for Fri Aug 12, depreciating to USD 1.4441 on Mon Aug 15. Table 1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention is required to maintain consistency in characterizing movements of the exchange rate in Table 1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.4441/EUR on Aug 15; the second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Aug 12, to the last business day of the current week, in this case Fri Aug 19, such as depreciation of 1.0 percent for the dollar to USD 1.439/EUR by Aug 19; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (negative sign) by 1.0 percent from the rate of USD 1.424/EUR on Fri Aug 12 to the rate of USD 1.439 on Fri Aug 19 and depreciated by 0.3 percent from the rate of USD 1.4341 on Thu Aug 19 to USD 1.439 on Fri Aug 19. The political “game of chicken” in the US ended with predictable outcome of an increase in the Treasury debt ceiling (http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html ), with mild if any impact on risk aversion except by investors exercising abundance of caution in the unlikely case a of deciding player in the “chicken game” jumping in the abyss of selective default of US debt. The agreement to end the chicken game has provided for a second round of confrontation in deciding the budget in a committee with equal number of members of each party and automatic expenditure cuts in case of failure of an agreement. Even the downgrade of the credit rating of US debt by Standard & Poor’s for the first time in over seven decades had been warned and was widely anticipated but is having only an unexpected shock of deception.

Table 1, Weekly Financial Risk Assets Aug 15 to Aug 19, 2011

M 15

Tu 16

W 17

Th 18

Fr 19

USD/
EUR

1.424 0.3%

1.4441

-1.4%

1.4406

-1.2%

0.2%

1.4439

-1.4%

-0.2%

1.4341

-0.7%

0.7%

1.439

-1.0%

-0.3%

JPY/
USD

76.67 2.2%

76.8605

-0.2

76.7718

-0.1%

0.1%

76.5010

0.2%

0.3%

76.5585

0.1%

-0.1%

76.79

-0.3

CHF/
USD

0.773 -1.3%

0.7847

-1.5%

0.7933

-2.6%

-1.1%

0.7896

-2.1%

0.5%

0.7937

-2.6%

-0.5%

0.786

-1.7%

0.9%

CHF/EUR
1.1091 -1.3%

1.1331

-2.2%

1.1428

-3.0%

-0.8%

1.1401

-2.8%

0.2%

1.1382

-2.6%

0.2%

1.1310

-2.9%

0.6%

USD/
AUD

1.035

0.9662

-1.1%

1.0501

0.9523

1.4%

1.0473

0.9548

1.2

-0.2%

1.0549

0.9480

1.9%

0.7%

1.0407

.9609

0.5%

-1.3%

1.041

0.9606

0.5%

0.0%

10 Year
T Note

2.249

2.31

2.22

2.16

2.07

2.066

2 Year T Note
0.192

0.19

0.18

0.19

0.192

DJIA

11269.02

-1.5%

1.9%

1.2%

-0.7%

1.2%

0.04%

-2.5%

-3.7%

-4.0%

-1.6%

DJ Global

1861.30

-2.4%

2.0%

1.6%

-0.4 %

1.9%

0.3%

-2.4%

-4.2%

-3.9%

-1.6%

DJ Asia Pacific

1260.23

-3.0%

1.9%

2.2%

0.3%

2.5%

0.3%

0.8%

-1.7%

-2.0%

-2.8%

Nikkei
8963.72

-3.6%

1.4%

1.6%

0.2%

1.0%

-0.6%

-0.2%

-1.3%

-2.7%

-2.5%

Shanghai

2593.17

-1.3%

1.3%

0.6%

-0.7%

0.3%

-0.3

-1.3%

-1.6%

-2.3%

-0.9%

DAX
5997.74

-3.8%

0.4%

-0.04%

-0.5%

-0.8%

-0.8

-6.6%

-5.8%

-8.6%

-2.2

DJ UBS Comm.

157.03

0.6%

0.9%

0.0%

1.7%

0.8%

0.04%

-1.6%

1.3%

1.2%

WTI $ B
85.390

-1.9%

87.660

2.7%

86.930

1.8%

-0.8

87.490

2.4%

0.6%

81.700

-4.3%

-6.6%

82.600

-3.2%

1.1%

Brent $/B

107.88

-1.3%

109.660

-1.6%

109.380

1.4%

-0.2%

110.690

2.6%

1.2%

106.680

-1.1%

-3.6%

109.00

1.0%

2.2%

Gold $/oz

1747.80

5.1%

1764.50

0.9%

1788.00

2.3%

1.3%

1792.20

2.5%

0.2%

1826.600

4.4%

1.9%

1854.20

6.1%

1.5%

Note: USD: US dollar; EUR: euro; JPY: Japanese Yen; CHF: Swiss

Franc; AUD: Australian dollar; Comm.: commodities; B: barrels; oz: ounce

Sources:

http://www.bloomberg.com/markets/

http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

The relative stability of the USD/EUR rate is likely influenced by a variety of factors that reflect relative weaknesses in taking positions in financial assets denominated in dollar or euro:

1. Sudden realization of the low “growth recession” (http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html) of the US revealed by release on Fri Jul 29 of GDP growth of 0.4 percent in the US in IQ2011 and the preliminary estimate of 1.3 percent in IIQ2011

2. Frustrating fracture of the US job market in the employment situation report released on Aug 5 with 25 to 30 million people unemployed or underemployed and falling wages for those still employed (http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html) and the fall of hiring in the US by more than 17 million, as shown below in Section IV United States Economic Uncertainty, which frustrates opportunities for exiting unemployment/underemployment and aspiration of higher remuneration in a new job

3. Evidence of growth recession worldwide in the purchasing managers’ indexes and multiple economic indicators covered systematically in this blog in regions and countries that generate three quarter of world economic activity and dominate international financial markets

4. Flattening growth of US personal income with resulting collapse of personal consumption expenditures as revealed by the monthly personal income report (http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html)

5. Turbulence in financial markets as the crisis spreads toward much larger countries in Europe with increasing doubts of the capacity of governments to stop the process. Proposals for increasing political and fiscal integration could have long-term favorable effects but may not contain financial turmoil immediately. A euro bond could also have stabilizing effects but could also weaken the external financial position of Germany and France. The drivers of financial turbulence are combinations of renewed fears of default, downgrades of Ireland, Cyprus, Greece and Spain, rise in sovereign bond spreads, fluctuating bank stocks in Italy, France, United States and other countries, weak employment report, growth recession of the US and worldwide and expected downgrading of US debt now materialized even after increase of the federal debt limit. Markets recovered temporarily with the expectation and then statement by the Council of the European Union (2011Jul21) announcing formally the Greek program (see http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html). Financial turbulence then returned with wider oscillations of valuations of risk financial assets in evidently deteriorating trends

Another manifestation of financial turbulence is in the appreciation of “safe haven” currencies such as the Japanese yen, JPY, and Swiss franc. Investors concerned with risks in exposures in assets denominated in dollar and euro move their funds to JPY and CHF denominated assets. In the week, as shown in Table 1, the Japanese yen traded in a tight range between JPY 76.5010/USD and JPY 76.79/USD on Aug 19 for almost nil depreciation of 0.3 percent. The Swiss franc depreciated 1.7 percent relative to the dollar and 2.9 percent relative to the euro. Both the yen and the Swiss franc touched historical levels of relative strength. Domestic economic activity in Japan and Switzerland suffer from the trend of appreciation of their national currencies relative to the dollar and euro by diminishing the competitiveness in internal and foreign markets of Japanese and Swiss goods and services. FX trading during the week was dominated by expectations of new measures by the Swiss National Bank (SNB), including the possibility of exchange controls and a peg of the Swiss franc to the euro. On Aug 17, the SNB announced new measures short of exchange controls and a peg to the euro (http://www.snb.ch/en/mmr/reference/pre_20110817/source/pre_20110817.en.pdf):

“The measures taken thus far by the Swiss National Bank (SNB) against the strength of the Swiss franc are having an impact. Nevertheless, the Swiss franc remains massively overvalued. The SNB has therefore decided to expand again significantly the supply of liquidity to the Swiss franc money market. In so doing, it is increasing the downward pressure on money market interest rates with a view to further weakening the Swiss franc exchange rate. With immediate effect, it aims to expand banks’ sight deposits at the SNB further, from CHF 120 billion to CHF 200 billion. In order to achieve this new target level as quickly as possible, it will continue to repurchase outstanding SNB Bills and to employ foreign exchange swaps. Furthermore, the SNB reiterates that it will, if necessary, take further measures against the strength of the Swiss franc.”

The measures are designed to force an outflow of foreign capital from Swiss capital markets by reducing the rate of interest toward zero. There was some success of these measures shown in Table 1 by the depreciation of the Swiss franc by 1.7 percent relative to the dollar and by 2.9 percent relative to the euro. It is possible that the Swiss franc may appreciate again in another bout of risk aversion, triggering new measures by Swiss authorities.

Another manifestation of uncertainty on financial risks is the collapse of the yields of 10 year securities of the governments of the US and Germany shown in Table 1. The two-year note of the US has stabilized at 0.192 percent while the yield on the German two-year note traded as low as 0.59 percent on Thu August 18, finishing at 0.65 percent on Fri Aug 19. The 10-year Treasury note of the US had more room to fall and traded at 2.066 percent by Fri Aug 19 with the 10-year note of Germany trading at 2.11 percent. Cynthia Lin, writing on Aug 18 on “Treasury yield dips below 2%,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424053111903639404576516090399287736.html?mod=WSJPRO_hpp_LEFTTopStories), finds that the yield of the 10-year Treasury note traded below 2 percent on Thu Aug 18, after release of the unfavorable reading of the Philadelphia Fed Business Outlook Survey showing 2009 recession levels, which is analyzed in Section IV United States Economic Uncertainty. Lin finds that the 10-year yield trading below 2 percent at 1.974 percent in intraday trading, is a historical low record. The yield on the 30-year bond traded at 3.399 percent in intraday trading, which is the lowest since Jan 2009. Richard Milne, writing on Aug 19 on “West shows worrying signs of ‘Japanisation,’” published in the Financial Times (http://www.ft.com/intl/cms/s/0/c86470b2-ca7b-11e0-94d0-00144feabdc0.html#axzz1VYuTjnkl), analyzes views by market participants on the possible similarity between low yields in the US, UK and Europe and the collapse of yields in Japan during the “lost decade” of deflation and stagnation in the 1990s. This issue is analyzed in the following section II Inflation and Monetary Policy. Key differences are that the fall of yields is in caused by international financial risk aversion instead of internal economic conditions and that there is inflation instead of deflation.

The final rows of Table 1 show sharp losses of all major stock indexes and mixed changes in valuations of commodity prices. Stocks collapsed during the week with the realization that further measures for bailouts of European sovereign risks and banks may be politically and economically unfeasible. New economic information for the US and the world, which is analyzed in various sections below, shows slowing world economic activity and continuing inflation. The environment is highly unfavorable for corporate profits determining stock valuations because revenue from sales may stall as a result of weakening world economic activity. Concerns in financial markets centered around banks, as analyzed by Deborah Ball, writing on Aug 20 on “Bank woes take center stage,” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424053111903596904576518462334049434.html?mod=WSJ_hp_LEFTWhatsNewsCollection), with two important facts: (1) the Swiss National Bank revealed that it had used the swap facility with the Federal Reserve System on Aug 10 for borrowing of $200 million on Aug 10, at a rate of 1.08 percent, which was repaid on Aug 18; (2) a European bank borrowed $500 million for one week from the European Central Bank for the first time of such borrowing since Feb 23; and (3) the 3-month LIBOR charged by banks for unsecured interbank lending rose to 0.303 percent, which is the highest level since Apr. Investors and traders also ponder how banks will fare during the growth slowdown, or growth recession, with already damaging events such as mortgage paybacks and tightening regulation. In this environment of risk aversion, the only dynamic commodity was gold, rising 6.1 percent by Fri Aug 19 to $1854/oz.

Three euro zone countries have engaged in bailouts within the mechanism created by the European Union, IMF and European Central Bank: Portugal, Ireland and Greece. The combined GDPs of Portugal, Ireland and Greece add to $739 billion, which represents only 6.1 percent of the euro zone GDP of $12,192.8 billion, shown in Table 2. The problem is in the exposure of European banks to the bailed out countries and of banks worldwide to the bailed out countries and to the European banks. These exposures are much more important in relative terms of speed in propagating financial stress than the combined GDP of the bailed out countries.

Table 2, World and Selected Regional and Country GDP and Fiscal Situation

	GDP USD 2010 USD Billions	Primary Net Lending Borrowing % GDP 2010	General Government Net Debt % GDP 2010
World	57,920.3
Euro Zone	12,192.8	-3.6	64.3
Portugal	229.3	-4.6	79.1
Ireland	204.3	-29.7	69.4
Greece	305.4	-3.2	142.0
Spain	1,409.9	-7.8	48.8
Major Advanced Economies G7	31,891.5	-6.9	74.4
United States	14,657.8	-10.6	64.8
UK	2,247.5	-8.6	69.4
Germany	3,315.6	-3.3	53.8
France	2,582.5	-7.7	74.6
Japan	5,458.9	-9.5	117.5
Canada	1,574.1	-5.5	32.2
Italy	2,055.1	-4.6	99.6
China	5,878.3	-2.6	17.7
Cyprus	23.2	-5.4	61.6

Source: http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx

II Inflation and Monetary Policy. The objective of this section is to analyze past and possible new impulses of monetary policy. Subsection IIA Conventional and Unconventional Monetary Policy provides synthetic analysis of the tools and objectives of monetary policy. Subsection IIB Deflation provides the background of inflation of the US. IIC Appendix Theory of Monetary Policy serves as reference to those interested in more formal communication of the theory supporting past and possible new impulses of monetary policy.

IIA Conventional and Unconventional Monetary Policy. Real interest rates in the US, or interest rates less the expectation of inflation in the term of the instrument, have been negative during substantial periods in the past decade while monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”

There are two types of monetary policy, conventional and unconventional. First, conventional monetary policy consists of lowering fed funds rate to stimulate the economy. For example, the overnight fed funds rate has been fixed at zero percent since Dec 16, 2008 when the Federal Open Market Committee (FOMC) decided: “The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent” (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). The rationale for the zero interest rate is provided by the FOMC as (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm):

“Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

The structure of the FOMC is as follows (http://www.federalreserve.gov/monetarypolicy/fomc.htm):

“The Federal Open Market Committee (FOMC) consists of twelve members--the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee's assessment of the economy and policy options.”

Banks and other financial institutions maintain reserves in cash and other highly liquid instruments to face eventual withdrawals by depositors. Banks deposit excess reserves at the Federal Reserve Banks in their districts. The fed funds rate is the unsecured rate applicable to loans by banks with excess reserves deposited at the Federal Reserve Banks to those needing immediate cash. Conventional monetary policy is designed to affect the fed funds rate by means of “open market operations” (http://www.federalreserve.gov/pubs/frseries/frseri2.htm):

“Depository institutions are required to maintain reserves in certain proportions against various types of their checkable deposits. Open market operations directly affect the level of reserves in the banking system. Federal Reserve purchases of securities add to reserves; sales withdraw reserves from the System. If reserves increase, depository institutions will generally acquire new loans and investments, which will tend to exert downward pressure on interest rates.

Open market operations as directed by the FOMC are the major tool used to influence the total amount of money and credit available in the economy. The Federal Reserve attempts to provide enough reserves to encourage expansion of money and credit in keeping with the goals of price stability and sustainable growth in economic activity.”

A decrease in the fed funds rate is believed to reduce long-term interest rates to encourage higher investment and consumption, or aggregate demand for goods and services. Consider the two-year Treasury note. Bloomberg provides a quote on the two-year note on Aug 19 with the following information (http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/):

Coupon 0.375% per year

Maturity 0/7/31/2013

Price 100-11/32/Yield 0.19%

The two-year note pays four semi-annual coupons of 0.375 percent and is priced at 100.3438 that is equivalent to yield of 0.19 percent. The cash flow of the securities consists of four coupons paid every six months with the last one together with redemption of principal. If the price is 100, the yield is 0.375 percent, consisting of the rate of discount of the cash flow to the present which results in price of 100. The key concept is the forward rate. Consider an example by Kessel (1965, 6) that the one-year rate is 2 percent and the two-year rate 3 percent. The forward rate is the rate implied between the one-year and two-year rates. The current price of the one-year security is exp (-0.2) = exp (-0.02) = 0.98020 and the price of the two-year security is exp (-0.2x3) = exp (-0.06) = 0.94176. The forward rate between the two-year security and the one-year security is: ln (exp(-.rn)/exp(-.r(n-1)) = ln (exp -0.02/exp(-0.06) = 0.04 or 4 percent, where ln is the natural logarithm, r the yield of the security and n the number of periods. The unbiased expectations hypothesis states that “the forward rates are unbiased estimates of future short-term rates. Four percent is not only the forward rate—it is the expected one-year rate one year hence, i.e., it is what the market thinks the one-year rate will be one year hence” (Kessel 1965, 6). The channel of transmission of the fed funds rate is by altering the expectations of forward rates. By lowering the fed funds rate, the FOMC attempts to lower forward rates such that longer term bonds used to fund loans for investment and consumption of durable goods have lower yields, which means that borrowing costs for investment and consumption are lower. Banks raise funds for loans by bundling loans of similar term and credit quality into a bond that is sold to investors. If the yield of these bonds decline, banks pay less for funds that can be lent at lower rates for investment and consumption. Higher investment and consumption, or aggregate demand, would increase, raising economic activity and employment.

Second, unconventional monetary consists of large-scale purchase of long-term securities by the central bank, or quantitative easing. The Dec 16, 2008 statement of the FOMC describes this policy (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm):

“The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, 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 it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.”

The balance sheet of the Fed has $2.7 trillion of long-term securities. Coupons and redemptions of these securities are being reinvested in the purchase of long-term Treasury securities. The objective of unconventional policy is the same as in conventional policy: lowering long-term yields of bonds to reduce borrowing costs of investment and consumption. The policy is more targeted to specific segments of maturities that could directly lower yields and thus borrowing costs for investment and consumption. This policy is an available alternative when interest rates are at zero or very near to zero, which is called the zero bound. Nominal interest rates cannot be negative. Thus, the central bank acts directly by buying bonds in, say, the seven-year maturity, that increases their prices, which is equivalent to lowering their yields. Costs of funding loans are lowered such that the costs of loans for investment and consumption are also lowered.

The mix of conventional and unconventional monetary policy has two other intended channels. (1) Quantitative easing with zero interest rates is designed to create a wealth effect. Plentiful liquidity at lower interest rates would channel financial investment into stock markets. 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.

(2) Quantitative easing is also designed to devalue the dollar. Vice Chair 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.” Net exports contribute directly to higher GDP growth or higher economic activity.

An immediate area of interest is that monetary and devaluation policy has united. An essay by Chairman Bernanke in 1999 on Japanese monetary policy received attention in the press, stating that (Bernanke 2000, 165):

“Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and experiment—in short, to do whatever it took to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done”

Quantitative easing has never been proposed by Chairman Bernanke or other economists as certain science without adverse effects. There is another suggestion to the Bank of Japan (BOJ) by Chairman Bernanke in the same essay that is very relevant to current events and the contentious issue of ongoing devaluation wars (Ibid, 161):

“Because the BOJ has a legal mandate to pursue price stability, it certainly could make a good argument that, with interest rates at zero, depreciation of the yen is the best available tool for achieving its mandated objective. The economic validity of the beggar-thy-neighbor thesis is doubtful, as depreciation creates trade—by raising home country income—as well as diverting it. Perhaps not all those who cite the beggar-thy-neighbor thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery. A yen trading at 100 to the dollar is in no one’s interest”

Chairman Bernanke is referring to the argument by Joan Robinson based on the experience of the Great Depression that: “in times of general unemployment a game of beggar-my-neighbour is played between the nations, each one endeavouring to throw a larger share of the burden upon the others (Robinson 1947, 156). Devaluation is one of the tools used in these policies (Ibid, 157). Banking crises dominated the experience of the United States, but countries that recovered were those devaluing early such that competitive devaluations rescued many countries from a recession as strong as that in the US (see references to Ehsan Choudhri, Levis Kochin and Barry Eichengreen in Pelaez and Pelaez, Regulation of Banks and Finance, 205-9; for the case of Brazil that devalued early in the Great Depression recovering with an increasing trade balance see Pelaez, 1968, 1972; Brazil devalued and abandoned the gold standard during crises in the historical period as shown by Pelaez 1976, Pelaez and Suzigan 1981). Beggar-my-neighbor policies did work for individual countries but the criticism of Joan Robinson was that it was not optimal for the world as a whole. Because of this experience most countries of the world tried to create cooperation through international financial institutions, the International Monetary Fund (IMF) and the World Bank. The global devaluation war is also forcing many countries into painful macroeconomic adjustment and central bank intervention with repeated calls by the IMF for coordination and cooperation in sharing the adjustment to world imbalances.

IIB Deflation. There was fear of deflation in 2002-2003 (Pelaez and Pelaez, International Financial Architecture, 18-27, The Global Recession Risk, 83-94). The rationale for lowering the fed funds rate to 1 percent was fear of deflation (Bernanke 2002FD). When year-end consumer price inflation rose from 1.9 percent in 2003 to 3.3 percent in 2004, 3.4 percent in 2005, 2.5 percent in 2006 and 4.1 percent in 2007 (ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt), the FOMC increased the target on the fed funds rate by 17 consecutive rounds of 25 basis points in meetings from Jun 2004 to Jun 2006, raising the rate from 1 percent to 5.25 percent. Monetary policy in the first round of fear of deflation with fed funds of 1 percent between Jun 2003 and Jun 2004 was implemented jointly with a yearly housing subsidy of $221 billion, policy of affordable housing and the purchase or guarantee of $1.6 trillion of nonprime securities by Fannie and Freddie. Short-term interest rates near zero combined with the housing stimulus distorted risk/return calculations. The carry trade consisted of borrowing at close to zero short-term interest rates and taking long positions in housing and risk financial assets such as commodities, equities, emerging equities, corporate debt, junk bonds and so on. These positions relied on rollover of short-term funding to benefit from the short-term rates in everything from adjustable rate mortgages to sale and repurchase agreements of securitized credit obligations. Liquidity was minimized because of the high alternative-return penalty of near zero interest rates. High risks were assumed in the belief that the Fed would maintain the near zero interest rates forever. Creditworthiness was ignored in the belief that increasing prices, such as in real estate, would cushion losses, such as by selling the house to cover the mortgage. Leverage was magnified because of the perceived certainty of returns in an environment of low interest rates indefinitely. The near zero interest rates of the Fed in 2003-2004 induced the causes of the credit/dollar crisis and global recession: excessive risks, high leverage, low liquidity, reliance on short-term funding and unsound credit decisions (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).

Monetary policy is trying simultaneously to attain a rate of inflation, measured by the price index of personal consumption expenditures (PCE) excluding food and energy, in the neighborhood of 2 percent, say, in an open interval (1.9, 2.0), and at the same time a NAIRU or rate of unemployment that does not accelerate inflation somewhere between 5 and 6 percent or (5,6). There have been numerous, stimulating and profound contributions to central banking (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), Financial Regulation after the Global Recession (2009a) but there are no foolproof theory, empirical verification, statistically meaningful forecasting and operational tools to implement a set of PCE core inflation and NAIRU such as [Inflation in (1.9, 2.0), NAIRU in (5,6)]. In practice, there will be problems of temporal consistency (Kydland and Prescott 1977; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 112-6). Inflation and unemployment could turn out to be higher than without the policy impulses. In particular, the issue considered during testimony by Chairman Bernanke (2011Feb9) is that if inflation is moving toward (3.00 to 4.00), the Fed may be forced to abandon improving NAIRU in (8.0, 9.0). If the Fed continues monetary stimulus to lower NAIRU to (7.0, 8.0), inflation may jump from (5.0 to 6.0) eventually having adverse effects on growth and employment. There is no precision in the timing, doses and effects of monetary policy.

Unconventional policy has been inspired by fear of deflation. The loss in the value of collateral by debtors because of deflation in the 1930s was an important restriction of the volume of credit, together with the dismantling of intermediation services by the banking panics, contributing to the propagation and unusual depth of the Great Depression (Bernanke, 1983); see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 198-217). However, a study of 17 countries over 100 years finds that in 90 percent of the cases of deflation there was no depression (Andrew Atkeson and Patrick Kehoe 2004).

Table 3 provides another illustration of the empirical analysis of Lucas (2011May19) that catch-up rates of growth of regions and countries relative to long-term US economic growth declined after the 1970s. Japan still had an excellent growth decade in the 1980s with very high rates of GDP growth. A major mystery is the collapse of economic growth in Japan and deceleration of prices in the 1990s that has been labeled “the lost decade” (see Pelaez and Pelaez, The Global Recession Risk (2007), 81-115). Fear of deflation and stagnation similar to that of Japan motivated unconventional monetary policy in the form of extremely low and even zero interest rates and quantitative easing or large-scale purchase of government securities for the balance sheet of central banks (see Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-95). Japan’s rate of GDP growth recovered in the 2000s but the economy has not regained the dynamism of the 1980s and earlier decades. Declines of CPI inflation have occurred in seven years from 2000 to 2010 and Japan continues unconventional policy in the form of zero interest rates and quantitative easing.

Table 3, Japan, Real GDP Growth and Consumer Prices ∆% from the Previous Calendar Year 1981-2010

	GDP ∆%	CPI ∆%
2010	4.0	-0.7
2009	-6.3	-1.4
2008	-1.2	1.4
2007	2.4	0.0
2006	2.0	0.3
2005	1.9	-0.3
2004	2.7	0.0
2003	1.4	-0.3
2002	0.3	-0.9
2001	0.2	-0.7
2000	2.9	-0.7
1990s
1999	-0.1	-0.3
1998	-2.0	0.6
1997	1.6	1.8
1996	2.6	0.1
1995	1.9	-0.1
1994	0.9	0.7
1993	0.2	1.3
1992	0.8	1.6
1991	3.3	3.3
1990	5.6	3.1
1980s
1989	5.4	2.3
1988	7.1	0.7
1987	4.1	0.1
1986	2.8	0.6
1985	6.3	2.0
1984	4.5	2.3
1983	3.1	1.9
1982	3.4	2.8
1981	4.2	4.9

Source: http://www.esri.cao.go.jp/en/sna/sokuhou/qe/gdemenu_ea.html

http://www.stat.go.jp/english/data/cpi/1588.htm#his

Key percentage average yearly rates of the US economy on growth and inflation are provided in Table 4. The choice of dates prevents the measurement of long-term potential economic growth because of two recessions in 2001 and the drop in GDP of 5.1 percent followed with unusually low economic growth for an expansion phase after recession (http://cmpassocregulationblog.blogspot.com/2011_07_01_archive.html). Between 2000 and 2010, real GDP grew at the average rate of 1.6 percent per year, nominal GDP at 3.9 percent and the implicit deflator at 2.5 percent. The average rate of CPI inflation was 2.4 percent per year and 2.5 percent excluding food and energy. PPI inflation increased at 2.6 percent per year on average and at 1.6 percent excluding food and energy. There is also inflation in international trade. Import prices grew at 2.2 percent per year between 2000 and 2010 and 3.3 percent between 2000 and 2011. The commodity price shock is revealed by inflation of import prices of petroleum at 10.4 percent per year between 2000 and 2010 and at 13.4 percent between 2000 and 2011. The average growth rates of imports excluding fuels are much lower at 1.7 percent for 2000 to 2010 and 2.1 percent for 2000 to 2011. Export prices rose at the average rate of 2.2 percent between 2000 and 2010 and at 2.9 percent in 2000 to 2011. What spared the US of a decade long deterioration of the terms of trade, (export prices)/(import prices), was its diversification and competitiveness in agriculture. Agricultural export prices grew at the average yearly rate of 5.1 percent in 2000 to 2010 and at 6.8 percent in 2000 to 2011. US nonagricultural export prices rose at 1.7 percent per year in 2000 to 2010 and at 2.3 percent in 2000 to 2011. These dynamic growth rates are not similar to those for the economy of Japan where inflation was negative in seven of the 10 years in the 2000s.

Table 4, US, Average Growth Rates of Real and Nominal GDP, Consumer Price Index, Producer Price Index and Import and Export Prices, Percent per Year

Real GDP	2000-2010: 1.6%
Nominal GDP	2000-2010: 3.9%
Implicit Price Deflator	2000-2010: 2.5%
CPI	2000-2010: 2.4% 2000-2011: 2.5%
CPI ex Food and Energy	2000-2010: 2.0% 2000-2011: 1.9%
PPI	2000-2010: 2.6% 2000-2011: 3.0%
PPI ex Food and Energy	2000-2010: 1.6% 2000-2011: 1.7%
Import Prices	2000-2010: 2.2% 2000-2011: 3.3%
Import Prices of Petroleum and Petroleum Products	2000-2010: 10.4% 2000-2011: 13.4%
Import Prices Excluding Fuels	2000-2010: 1.7% 2000-2011: 2.1%
Export Prices	2000-2010: 2.2% 2000-2011: 2.9%
Agricultural Export Prices	2000-2010: 5.1% 2000-2011: 6.8%
Nonagricultural Export Prices	2000-2010: 1.7% 2000-2011: 2.3%

Sources:

http://www.bea.gov/iTable/index_nipa.cfm http://www.bls.gov/ppi/data.htm

http://www.bls.gov/mxp/data.htm http://www.bls.gov/cpi/data.htm

Unconventional monetary policy of zero interest rates and large-scale purchases of long-term securities for the balance sheet of the central bank is proposed to prevent deflation. CPI inflation of all goods and CPI inflation excluding food and energy are shown in Table 5 for the past 60 years. The data are percentage changes of annual levels of the CPI index. There is only one negative change by 0.4 percent in the CPI all goods annual index in 2009 but not one year of negative annual yearly change in the CPI excluding food and energy annual inflation. Zero interest rates and quantitative easing are designed to lower costs of borrowing for investment and consumption, increase stock market valuations and devalue the dollar. In practice, the carry trade is from zero interest rates to a large variety of risk financial assets including commodities. Resulting commodity price inflation squeezes family budgets and deteriorates the terms of trade with negative effects on aggregate demand and employment. Excessive valuations of risk financial assets eventually result in crashes of financial markets with possible adverse effects on economic activity and employment.

Table 5, US, Consumer Price Index All Goods and Excluding Food and Energy Annual Percentage Changes

	CPI All Goods Annual ∆%	CPI Excluding Food and Energy Annual ∆%
2010	1.6	1.0
2009	-0.4	1.7
2008	3.8	2.3
2007	2.8	2.3
2006	3.2	2.5
2005	3.4	2.2
2004	2.7	1.8
2003	2.3	1.4
2002	1.6	2.4
2001	2.8	2.6
2000	3.4	2.4
1999	2.2	2.1
1998	1.6	2.3
1997	2.3	2.4
1996	3.0	2.7
1995	2.8	3.0
1994	2.6	2.8
1993	3.0	3.3
1992	3.0	3.7
1991	4.2	4.9
1990	5.4	5.0
1989	4.8	4.5
1988	4.1	4.4
1987	3.6	4.1
1986	1.9	4.0
1985	3.6	4.3
1984	4.3	5.0
1983	3.2	4.0
1982	6.2	7.4
1981	10.3	10.4
1980	13.5	12.4
1979	11.3	9.8
1978	7.6	7.4
1977	6.5	6.3
1976	5.8	6.5
1975	9.1	9.1
1974	11.0	8.3
1973	6.2	3.6
1972	3.2	3.0
1971	4.4	4.7
1970	5.7	6.3
1969	5.5	5.8
1968	4.2	4.6
1967	3.1	3.6
1966	2.9	2.4
1965	1.6	1.2
1964	1.3	1.6
1963	1.3	1.3
1962	1.0	1.3
1961	1.0	1.3
1960	1.7	1.3

Core: excluding foods and energy

Source: http://data.bls.gov/cgi-bin/dsrv?cu

Producer price inflation history in the past five decades does not provide evidence of deflation, as shown in Table 6. The finished core PPI does not register even one single year of decline. The headline PPI experienced only six isolated cases of decline: -0.3 percent in 1963, -1.4 percent in 1986, -0.8 percent in 1986, -0.8 percent in 1998, -1.3 percent in 2001 and -2.6 percent in 2009. Deflation should show persistent cases of decline of prices and not isolated events. Fear of deflation in the US has caused a distraction of monetary policy. Symmetric inflation targets around 2 percent with multiple lags in effect of monetary policy and imperfect knowledge and forecasting are mostly unfeasible and likely to cause instability instead of desired price stability.

Table 6, Producer Price Index Finished Goods and Finished core Annual Percentage Changes

	Finished Goods Annual ∆%	Finished core Annual ∆%
2010	4.2	1.2
2009	-2.6	2.6
2008	6.3	3.4
2007	3.9	1.9
2006	3.0	1.5
2005	4.8	2.4
2004	3.6	1.5
2003	3.2	0.2
2002	-1.3	0.1
2001	2.0	1.4
2000	3.8	1.3
1999	1.8	1.7
1998	-0.8	0.9
1997	0.4	0.3
1996	2.7	1.4
1995	1.9	2.1
1994	0.6	1.0
1993	1.2	1.2
1992	1.2	2.4
1991	2.1	3.6
1990	4.9	3.7
1989	5.2	4.4
1988	2.5	3.3
1987	2.1	2.4
1986	-1.4	2.3
1985	1.0	2.5
1984	2.1	2.4
1983	1.6	3.0
1982	4.1	5.7
1981	9.2	8.6
1980	13.4	11.2
1979	11.2	8.9
1978	7.9	7.5
1977	6.4	6.0
1976	4.5	5.7
1975	10.6	11.4
1974	15.4	11.4
1973	9.1
1972	3.2
1971	3.1
1970	3.4
1969	3.8
1968	2.8
1967	1.1
1966	3.2
1965	1.8
1964	0.3
1963	-0.3
1962	0.3
1961	0.0
1960	0.9

Core: excluding foods and energy

Source: http://www.bls.gov/ppi/#tables

IIC Appendix: Theory of Monetary Policy. This subsection can be skipped by those not interested in technical details of economic theory. The critical issues of quantitative easing are the theoretical framework explaining how massive injections of base money in large-scale asset purchases (LASP) prevent deflation, increase aggregate demand and motivate private-sector hiring and what empirical evidence supports these intended effects. This section considers a specific explanation of how quantitative easing by LSAP of Treasury securities can lower yields by appeal to the preferred-habitat theory of the term structure of interest rates (Culbertson 1957, 1963; Modigliani and Sutch 1966) as reformulated by Vayanos and Vila (2009) and analyzed empirically by D’Amico and King (2010).

The central issue is deriving theoretically how changes in the quantity of securities held by the public by monetary policy affect yields of securities, that is, how massive withdrawals of long-term Treasury securities reduce yields in the target maturity that in turn could reduce borrowing costs to the private sector, motivating investment and hiring. Quantitative easing is often referred as “unconventional” monetary policy such as in the statement by Bernanke (2010KC) on Aug 27 (http://www.federalreserve.gov/newsevents/speech/bernanke20100827a.htm): “the [Federal Open Market] Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary.” Conventional monetary policy consists of reducing fed funds rates that jointly with subdued inflation expectations by the private sector result in lower short-term real interest rates, or nominal interest rates less inflation expectations (Svensson 2003, 146) lower real rates of longer maturities that stimulate aggregate demand and output, moving the economy out of recession. Conventional policy is not feasible when fed fund rates are as currently at 0 to ¼ percent.

The expectations hypothesis of the term structure of interest rates states “that the relationship between interest rates on different maturities is determined in the main by expectations as to the future course of interest rates” (Lutz 1940, 62). Consider an example by Kessel (1965, 6) that the one-year rate is 2 percent and the two-year rate 3 percent. The forward rate is the rate implied between the one-year and two-year rates. The current price of the one-year security is exp (-0.2) = exp (-0.02) = 0.98020 and the price of the two-year security is exp (-0.2x3) = exp (-0.06) = 0.94176. The forward rate between the two-year security and the one-year security is: ln (exp(-.rn)/exp(-.r(n-1)) = ln (exp -0.02/exp(-0.06) = 0.04 or 4 percent, where ln is the natural logarithm, r the yield of the security and n the number of periods. The unbiased expectations hypothesis states that “the forward rates are unbiased estimates of future short-term rates. Four percent is not only the forward rate—it is the expected one-year rate one year hence, i.e., it is what the market thinks the one-year rate will be one year hence” (Kessel 1965, 6).

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, as 4 percent in the example, from the rates at time t, one-year security in the example, and time T, two-year security in the example, that is the rate that applies from extending maturity by one year from t (one year) to T (two years). Let r_T be the one-year rate at time T, then in the certain economy f(t, T) = r_T 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). It is not possible to find a specification for effects on yields of altering quantities of securities by monetary policy withdrawals in the expectations hypothesis (D’Amico and King, 7-9).

An important channel of transmission of quantitative easing is that “if money is an imperfect substitute for other financial assets, then large increases in the money supply will lead investors to seek to rebalance their portfolios, raising prices and reducing yields on alternative, non-money assets. In turn, lower yields on long-term assets will stimulate economic activity” (Bernanke and Reinhart 2004, 88). 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 channel of transmission of large increases in base money, or currency held by the public and reserves deposited by banks at the Fed, depends on the assumption that money and other financial assets are not perfect substitutes. The framework of Tobin (1969) analyzes the determination of market-clearing rates of returns and volumes in the capital accounts of economic units, sectors and the economy as a whole. The model specifies the determinants of the demand and supply of these assets and how prices of assets and rates of return clear markets. Money is one of the assets and the commercial banking system one of many sectors. National wealth is the sum of private total wealth plus net government debt, obtained by summing the columns of assets in a balance sheet of the economy. Tobin’s q variable is the ratio of the market value of capital to the reproduction cost of capital. The concept of capital extends to houses, plants, equipment, durable goods and others (Tobin 1969, 29). Money, M, in Tobin’s complete model of money, physical capital, securities and banks is “high-powered money,” consisting of currency held by the public and reserves of commercial banks at the Fed. Tobin derives the sensitivity of q to M as ∂q/∂M > 0, that is, an increase in base money, M, causes an increase in q, which is the price of the market value of capital relative to its reproduction cost. Current production and asset accumulation increase (see also Pelaez and Suzigan 1978, 120-3). According to Tobin (1969, 25-6): “the essential characteristic is that the interest on money is exogenously fixed by law or convention, while the rate of return on securities is endogenous, market determined. If the roles of the two assets in this respect were reversed, so also would be the economic impacts of changing their supplies. The way for the central bank to achieve an expansionary monetary impact would be to buy money with securities!” The effect of an increase in the supply of an asset with non-fixed rate is a change in its own rate of return. When the rate of return is determined exogenously, as in the case of outside money, the adjustment is by changes in the rates of return of other assets or equivalently their prices. Large scale purchases of securities, or quantitative easing, inject high-powered money or bank reserves in exchange for withdrawal of the supply of duration-rich bonds, reducing their rates of return or increasing their prices. The intended effect is to lower the reproduction cost of capital, or long-term borrowing costs, such that Tobin’s q or its expectation increases, augmenting the demand for physical assets such as plant, equipment, houses, durables goods and the like.

Brunner and Meltzer (1973, 51) point to a deficiency of earlier research: “when inflation occurs, asset owners shift from money to bonds and real capital; these assets are perfect substitutes, so bond prices adjust costlessly and instantaneously to changes in the rate of inflation.” The key change in assumptions is that “the movements of interest rates and asset prices can diverge, and asset owners can choose to hold money or bonds or real capital” (Ibid, 52). In this model “the market value of wealth consists of money, bonds and capital at current prices” (Ibid, 53).

An optimizing model from microeconomic foundations is developed by Andrés et al. (2004) with the assumption of imperfect substitution between different classes of securities. The estimates of this model using quarterly data for the US from 1980 to 1999 “confirm that some of the observed deviations of long-term rates from the expectations theory of the term structure can be traced to movements in the relative stocks of financial assets, just as claimed by Tobin (1969)” (Andrés et al, 688). The traditional channel of transmission of monetary policy is by influencing long-term interest rates with changes in the expected path of short-term rates. The “unconventional” or “quantitative easing” channel of monetary policy is processed by increases in base money that alter relative prices of financial securities, thus reducing long-term yields and increasing aggregate demand.

Further theoretical efforts permitted the analysis of the choice of holding money and financial assets. An important development is the theory of portfolio selection with “the rule that the investor does (or should) consider expected return a desirable thing and variance of return an undesirable thing” and that “this rule has many sound points, both as a maxim for, and hypothesis about, investment behavior” (Markowitz 1952, 77). The use of expected return and the variance or volatility of return is directly useful: “in theoretical analysis we might inquire, for example, about the various effects of a change in the beliefs generally held about a firm, or a general change in the preference as to expected return versus variance of return, or a change in the supply of a security” (Markowitz 1952, 91). In disaggregated portfolio analysis, weights are assigned to individual securities but they may also “represent aggregates such as, say, bonds, stocks and real estate” (Markowitz 1952, 91). Consider the case where there are i = 1, 2, ∙∙∙ n securities X_i with probability distribution that has mean or expected value μ_i and standard deviation σ_i. The investor can choose portfolio weights w_i for the proportion of each security held, with the sum of the weights adding to unity.

The rule of Markowitz (1952, 82) states that “investors would (or should) want” to choose a portfolio of combinations of (μ_p, that are efficient, which are those with minimum variance or risk for given expected return μ_p or more and maximum expected μ_p for given variance or risk or less.

An important issue in deriving the liquidity preference function as in (2) is the explanation of “why should anyone hold the non-interest bearing obligations of the government instead of its interest bearing obligations?” (Tobin 1958, 65). A theoretical solution is to consider the demand for monetary assets such as money and bonds. Individuals are assumed to make decisions on a subjective probability distribution of returns with two parameters, mean or expected return, μ_p, and standard deviation or dispersion around the mean, σ_p. The more complete model of Tobin (1958) consists of portfolio choice of monetary assets by maximizing a utility function subject to a budget constraint. The separation theorem of Tobin (1958) postulates that the decision of the optimum composition or proportionate weights of the risk-asset portfolio is independent of the share of total wealth allocated to risky assets and the optimum holding of cash, assuming risk aversion and perfectly competitive markets (Hicks 1962; Treynor 1962; Sharpe 1964, 426-7; Lintner 1965, 13, 15-18; Mossin 1966): “the proportionate composition of the non-cash assets is independent of their aggregate share of the investment balance” (Tobin 1958). Total utility depends on expected return and standard deviation of returns of the portfolio:

U = U(μ_p, σ_p) (7)

An indifference map in the (μ_p, σ_p) plane can be derived from (7) and the points of tangency from the origin of the opportunity loci, μ_p = β σ_p, satisfy utility maximization. The displacement of the equilibrium results in a liquidity preference schedule depending inversely on the rate of interest with two extremes: at relatively high interest rates demand for cash is very low and most of the portfolio is allocated to bonds; at low interest rates the portfolio collapses mostly into holding cash with minor holdings of bonds. The liquidity trap would occur at very low interest rates or in more contemporary work at the zero lower bound (ZLB).

The analysis of money demand in terms of general equilibrium value theory was proposed by Hicks (1935, 12-3) from the departing analysis of the balance sheets of individuals and institutions with assets in the capital segment consisting of money, debts, stocks and productive equipment. Net worth or wealth would be the constraint comparable to income in value theory. Expected yield and risk would be the determinants of optimal portfolio choice with the “representative individual distributing his assets among relatively safe and relatively risky investments” on the basis of “his estimates of risk and his subjective preference for much or little risk-bearing” (Hicks 1935, 10). The analysis is formalized by Hicks (1962, 799-802). A general equilibrium theory of the capital account would provide the choices of capital assets in balance sheets of economic units with the determination of yields in markets for capital assets with the constraint of net worth (Tobin 1961, 28). This theory would explain the proportions of holding assets and debts in portfolios and balance sheets. A deficiency of earlier models is the assumption of capital, bonds and private debts as perfect substitutes with a single rate of interest. The increase in supply of a long-term government bond would raise its yield relative to those of other assets but not by as much for close substitutes, such as short-term securities and money, and for less perfect substitute assets, such as capital (Tobin 1961, 34). The proper bond rate to compare with the rate of return on capital is the yield less the expected capital gain or loss.

The general equilibrium model of capital asset market prices considers m individuals choosing portfolio shares of n capital assets on the basis of the n yields of different assets (Mossin 1966, 679-73). Each individual has a portfolio consisting of proportionate shares of the n capital assets. The yields and the portfolios are random variables. Each individual is assumed to behave as if maximizing a utility function depending on expected yields and variances of yields. The resulting allocation is Pareto optimal as it is the case of Walrasian general equilibrium systems (Arrow 1951, Debreu 1951; see Duffie and Sonnenschein 1988). Thus, the model assumes perfect competition with all the individual assumptions or lack of frictions. Portfolio weights are chosen to reach a point on the efficient frontier. The optimal allocation is found at the tangency of the highest indifference curve with the market line relating expected yield to the riskless interest rate, r_f, as intercept, and the standard deviation of the portfolio σ_p with the riskless interest rate intercept being the difference with the displacement of equilibrium in the Tobin (1958) model that relies on loci originating at the origin in the (μ_p, σ_p) plane. Sharpe (1964, 435) provides the description of the movement toward equilibrium as investors reshuffle their portfolios in search of the point in the efficient frontier, using ϕ as the point in (μ_p, σ_p) plane to be reached in the efficient frontier:

The attempts by investors to purchase the assets in combination ϕ would, of course, lead to a revision of prices. The prices of assets in ϕ will rise and, since an asset’s expected return relates future income to present price, their expected returns will fall. This will reduce the attractiveness of combinations which include such assets; thus point ϕ (among others) will move to the left of its initial position. On the other hand, the prices of assets not in ϕ will fall, causing an increase in their expected returns and a rightward movement of points representing combinations which include them

The withdrawal of long-term Treasury securities in the desired duration segment would increase the prices of those goods or equivalently reduce their yields. The expected returns include the capital gain resulting from the price increase. Private-sector debt securities in that segment would also increase in price, lowering their yields. Lower yields mean lower costs of capital in debt securities and of asset-backed securities with loans for consuming durable goods. The optimal point at the tangency ϕ of the efficient frontier with the market opportunity line can be separated from the optimal point of tangency with an indifference curve, allowing investing or borrowing at the short-term riskless rate. There is thus an opportunity to engage in the carry trade of borrowing at the short-term riskless and investing in a portfolio of risk financial assets at the point ϕ on the efficient frontier.

Another approach is by the preferred-habitat models proposed by Culbertson (1957, 1963) and Modigliani Sutch (1966). This approach is formalized by Vayanos and Vila (2009). The model considers investors or “clientele” who do not abandon their segment of operations unless there are extremely high potential returns and arbitrageurs who take positions to profit from discrepancies. Pension funds matching benefit liabilities would operate in segments above 15 years; life insurance companies operate around 15 years; and asset managers and bank treasury managers are active in segments around 15 years (Ibid, 1). Hedge funds, proprietary trading desks and bank maturity transformation activities are examples of potential arbitrageurs. The role of arbitrageurs is to incorporate “information about current and future short rates into bond prices” (Ibid, 12). Suppose monetary policy raises the short-term rate above a certain level. Clientele would not trade on this information, but arbitrageurs would engage in carry trade, shorting bonds and investing at the short-term rate, in a carry “roll-up” trade, resulting in decline of bond prices or equivalently increases in yields. This is a situation of an upward-sloping yield curve. If the short-term rate were lowered, arbitrageurs would engage in carry trade borrowing at the short-term rate and going long bonds, resulting in an increase in bond prices or equivalently decline in yields, or carry “roll-down” trade. The risk premiums of bonds are positively associated with the slope of the term structure (Ibid, 13). Fama and Bliss (1987, 689) find with data for 1964-85 that “1-year expected returns for US Treasury maturities to 5 years, measured net of the interest rate on a 1-year bond, vary through time. Expected term premiums are mostly positive during good times but mostly negative during recessions.” Vayanos and Vila (2009) develop a model with two-factors, the short-term rate and demand or quantity. The term structure moves because of shocks of short-term rates and demand. An important finding is that demand or quantity shocks are largest for intermediate and long maturities while short-rate shocks are largest for short-term maturities.

Dwelling into the simplest possible equation, the demand for a financial asset, A_i, with the subscript i denoting 1 to m financial assets, can be expressed in terms of its own rate of return, r_i, a vector r of m-1 rates of alternative financial assets, and a vector x of other relevant variables, or A_i = f(r_i, r, x). Large increases in base money alter relative rates of return of multiple assets, triggering rebalancing of asset portfolios. These large increases in base money are accompanied by fed funds rates of 0 to ¼ percent, which is effectively a near zero short-term interest rate. The problem with quantitative easing is that the zero interest rate creates arbitrage opportunity to fund portfolios at low interest rates in the US and take long positions in high risk financial assets such as commodities, emerging market stocks, currencies and anything that is traded in relatively liquid markets. Consider the short-term rate of 4.75 percent in Australia. The traditional carry trade (Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 203-4, Government Intervention in Globalization (2009c), 70-4) consisted of borrowing in the low-yielding currency, the US dollar, selling the US dollar against the Australian dollar, and investing the proceeds at 4.75 percent. An investor with risk aversion would buy the US dollar forward to hedge depreciation of the Australian dollar. The high risk of this strategy is found in the critical assumption in the overshooting model of Dornbusch (1976) that foreign exchange rates move more rapidly than prices of goods and services. If the carry trade were fixed for 30 days, the investor would only obtain (30/360)4.75 or 0.396 percent, which is a huge gain relative to the cost of 0.5 percent per year of borrowing in the US for a month of 0.66 percent (using the annualized money market yield as proxy) or (30/360)0.66 equal to 0.055 percent in 30 days. Assuming no change in the US dollar/Australian exchange rate, the gain would be: (360/30)(0.396-0.055) equal to earning 0.34 percent in a month or 4.092 percent per year. Table 6 below shows that exchange rates have changed sharply such that the risk of principal loss is quite high. Investors discovered far more rewarding arbitrage by the carry trade to commodities, emerging market stocks and debt securities, junk bonds and currencies. Investment in physical capital for production has been inhibited by legislative restructurings and regulation together with uncertainty about future taxes and interest rates.

Economic agents interpreted the monetary stimulus and housing subsidies to be permanent, creating the expectation that the Fed had issued an illusory put option or floor on wealth. The result of the first round of near-zero interest rates and housing subsidies was to distort the calculation of risks and returns by households, business and government. The belief in a floor on wealth induced high leverage, excessive risk, minimum liquidity because of its high opportunity cost or foregone yield and unsound credit decisions that caused the credit/dollar crisis and global recession (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).

III Global Inflation. III Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. New readings of world economic activity will be released at the turn of Aug but it is worthwhile to continue considering the information released on Aug 1 for Jul. The available information is that the world economy continued to expand in Jul. There is high association in the past 13 years between global GDP and the JP Morgan Global Manufacturing and Services PMI^TM (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8416). Expansion is a reading above 50.0 and contraction a reading below 50.0. The JP Morgan Global Manufacturing and Services PMI^TM rose from 52.3 in Jun to 52.6 in Jul, which means that world overall output, manufacturing and services, expanded at a faster rate (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8416). Output activity in the JP Morgan Global Services PMI^TM (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8417) rose from 52.2 in Jun to 53.1 in Jul, meaning that global services grew at a faster rate in Jul, compensating for decline in the JP Morgan Global Manufacturing PMI^TM from 52.3 in Jun to 50.6 in Jul, signaling that manufacturing was expanding at a slower rate in Jul (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8379). The index of new orders of the JP Morgan Global Manufacturing and Services PMI^TM fell from 52.0 in Jun to 51.1 in Jul, signaling expansion at a slower rate. Input prices continue to rise but at a slower rate, with the index of input prices falling from 58.6 in Jun to 56.3 in Jul. The employment index continues to increase at a slower rate, falling from 52.5 in Jun to 51.2 in Jul (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8416).

Table 7 updated with every post, provides the latest annual 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). Newly available data on inflation is considered below in this section. The data in Table 7 for the euro zone and its members is updated from information provided by Eurostat but individual country information is this section in this section as soon as available.

Table 7, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates

	GDP	CPI	PPI	UNE
US	2.9	3.6	7.0	9.1
Japan	-0.7***	0.2	2.5	4.6
China	9.6	6.5	7.5
UK	1.8	4.5* RPI 5.2	5.9* output 18.5* input 13.1**	7.7
Euro Zone	1.7	2.5	5.9	9.9
Germany	2.8	2.6	5.6	6.0
France	1.6	2.1	6.1	9.5
Nether-lands	1.5	2.9	9.1	4.2
Finland	3.7	3.7	7.2	7.8
Belgium	2.5	4.0	9.0	7.3
Portugal	-0.9	3.0	5.9	12.4
Ireland	-1.0	1.0	5.2	14.0
Italy	0.8	2.1	4.7	8.1
Greece	-4.8	2.1	6.3	15.1
Spain	0.7	3.0	6.7	20.9

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

*Office for National Statistics

PPI http://www.statistics.gov.uk/pdfdir/ppi0811.pdf

CPI http://www.statistics.gov.uk/pdfdir/cpi0611.pdf

** Excluding food, beverage, tobacco and petroleum

http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-04042011-AP/EN/4-04042011-AP-EN.PDF

***Change from IQ2011 relative to IQ2010 http://www.esri.cao.go.jp/jp/sna/sokuhou/kekka/gaiyou/main_1.pdf

Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html

Table 8 provides the forecasts of the Federal Reserve Board Members and Federal Reserve Bank Presidents for the FOMC meeting in Jun. Inflation by the price index of personal consumption expenditures (PCE) was forecast for 2011 in the Apr meeting of the FOMC between 2.1 to 2.8 percent. Table 8 shows that the interval has narrowed to PCE (personal consumption expenditures) headline inflation of between 2.3 and 2.5 percent. The FOMC focuses on core PCE inflation, which excludes food and energy. The Apr forecast of core PCE inflation was an interval between 1.3 and 1.6 percent. Table 8 shows the revision of this forecast in Jun to a higher interval between 1.5 and 1.8 percent. The Statement of the FOMC meeting on Jun 22 analyzes inflation as follows (http://www.federalreserve.gov/newsevents/press/monetary/20110622a.htm):

“Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

The FOMC statement on Aug 9 changed the “extended period” to specific 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20110809a.htm):

“To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate”

Table 8, Forecasts of PCE Inflation and Core PCE Inflation by the FOMC, %

	PCE Inflation	Core PCE Inflation
2011	2.3 to 2.5	1.5 to 1.8
2012	1.5 to 2.0	1.4 to 2.0
2013	1.5 to 2.0	1.4 to 2.0
Longer Run	1.7 to 2.0

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20110622.pdf

Inflation is extremely important in analyzing the desirable and actual direction of monetary policy. Consumer price inflation in the 12 months ending in Jul and the annual equivalent in Jan-Jul are shown in Table 9. Headline CPI inflation or the all items CPI rose 3.6 percent in the 12 months ending in Jul and 4.1 percent in annual equivalent, which is inflation for a full year corresponding to the cumulative in Jan-Jul. Inflation is high for all items with the exception of shelter because of the depressed state of real estate and services less energy because of the fractured labor market as services are labor intensive but is close to 2 percent even for the lowest segments of the CPI index. The drivers of 12 month inflation were primarily the energy goods of energy, gasoline and fuel oil as well as food, food at home and food away from home. The stagnation of real disposable income in the first six months of 2011 could reflect effects of inflation of goods and energy squeezing family budgets.

Table 9, US, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent Jan-Jul 2011 ∆%

	∆% 12 Months Jul 2011/Jul 2010 NSA	∆% Annual Equivalent Jan-Jul 2011 SA
CPI All Items	3.6	4.1
CPI ex Food and Energy	1.8	2.6
Food	4.2	5.9
Food at Home	5.4	7.9
Food Away from Home	2.6	3.0
Energy	19.0	15.5
Gasoline	33.6	23.8
Fuel Oil	37.2	33.6
New Vehicles	4.0	8.3
Used Cars and Trucks	5.3	9.4
Medical Care Commodities	2.9	9.4
Services Less Energy Services	1.7	1.9
Apparel	3.1	6.4
Shelter	1.4	1.9
Transportation Services	2.9	2.6
Medical Care Services	3.2	2.8

Source: http://www.bls.gov/news.release/pdf/cpi.pdf

The moderation of commodity price increases is shown in Table 10 in the most recent quarter of May to Jul. All three components of energy, gasoline and fuel oil fell at high annual equivalent rates. Pressure for food continued during the quarter with relatively high annual equivalent rates of 3.3 percent for food, 5.3 percent for food at home and 2.8 percent for food away from home. The CPI excluding food and energy was quite dynamic in the quarter, increasing at an annual equivalent rate of 3.3 percent, exceeding 2.0 percent for headline CPI inflation. Apparel inflation accelerated to annual equivalent of 16.3 percent and inflation of used cars and trucks accelerated to annual equivalent of 14.5 percent.

Table 10, US, Monthly Percentage Change of Consumer Price Index SA and Annual Equivalent May-Jul 2011

2011	Jul	Jun	May	May-Jul AE ∆%
CPI All Items	0.5	-0.2	0.2	2.0
CPI ex Food and Energy	0.2	0.3	0.3	3.3
Food	0.4	0.2	0.4	4.1
Food at Home	0.6	0.2	0.5	5.3
Food Away from Home	0.2	0.3	0.2	2.8
Energy	2.8	-4.4	-1.0	-10.4
Gasoline	4.7	-6.8	-2.0	-16.4
Fuel Oil	-1.7	-2.2	-0.8	-17.3
New Vehicles	0.0	0.6	1.1	7.0
Used Cars and Trucks	0.7	1.6	1.1	14.5
Medical Care Commodities	0.0	-0.1	0.0	0.4
Services Less Energy Services	0.2	0.1	0.2	2.0
Apparel	1.2	1.4	1.2	16.3
Shelter	0.3	0.2	0.2	2.8
Transport-ation Services	-0.1	-0.3	0.1	1.2
Medical Care Services	0.3	0.3	0.3	3.7

Source: http://www.bls.gov/news.release/pdf/cpi.pdf

The relative importance or weights of items in the CPI are shown in Table 11. Food and transportation account for 32.1 percent of consumer expenditures and housing for 41.460 percent such that food, transportation and housing account for 73.56 percent of consumer expenditures. Housing is still in recession conditions and a significant part, 24.9 percent, consists of “owners’ equivalent rent,” which is a calculation of what owners would pay if they would rent their own house. The major categories are shown in relief. Motor fuel has risen sharply with gasoline increasing 35.6 percent in the 12 months ending in Jun but accounts for only 5.079 percent of CPI expenditures. Lower income families experience more stress from increases in food and fuel, which represent a higher proportion of their expenses.

Table 11, US, Relative Importance, 2007-2008 Weights, of Components in the Consumer Price Index, US City Average, Dec 2010

All Items	100.000
Food and Beverages	14.792
Food	13.742
Food at home	7.816
Food away from home	5.926
Housing	41.460
Shelter	31.955
Rent of primary residence	5.925
Owners’ equivalent rent	24.905
Apparel	3.601
Transportation	17.308
Private Transportation	16.082
New vehicles	3.513
Used cars and trucks	2.055
Motor fuel	5.079
Gasoline	4.865
Medical Care	6.627
Medical care commodities	1.633
Medical care services	4.994
Recreation	6.293
Education and Communication	6.421
Other Goods and Services	3.497

Source: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiri2010.txt

Monthly rates of CPI all items and CPI excluding food and energy are shown in Table 12 together with the annual equivalent rate in the first seven months of 2011 and the 12 months rates. What is surprising about these data is the acceleration of CPI inflation excluding food and energy in the quarter May to Jul to 3.3 percent annual equivalent shown in Table 10, which is much higher than the 12 month rate of 1.8 percent and the annual equivalent for the first seven months of 2.6 percent shown in Table 12.

Table 12, US, Consumer Price Index ∆%

	CPI All Goods SA ∆%	CPI Excluding Food and Energy SA ∆%
SA
Jul	0.5	0.2
Jun	-0.2	0.3
May	0.2	0.3
Apr	0.4	0.2
Mar	0.5	0.1
Feb	0.5	0.2
Jan	0.4	0.2
Dec 2010	0.4	0.1
Annual Equivalent Jan-Jul 2011	4.1	2.6
NSA 12 Months Jul 2011	3.6	1.8
NSA 12 Months Jun	3.6	1.6
NSA 12 Months May	3.6	1.5
NSA 12 Months Apr	3.2	1.3
NSA 12 Months Mar	2.7	1.2
NSA 12 Months Feb	2.1	1.1
NSA 12 Months Jan	1.6	1.0
NSA 12 Months Dec 2010	1.5	0.8

Source: http://data.bls.gov/cgi-bin/dsrv?cu

There is an unwelcome surprise in producer price inflation (PPI) in the US as shown in Table 13. PPI inflation accelerated. While headline PPI inflation fell 0.4 percent in Jun and rose 0.3 percent excluding food and energy, headline inflation accelerated to 0.2 percent in Jul and to 0.4 percent excluding food and energy. The annual equivalent rate for Jan-Jun is high at 8.3 percent for headline inflation and 3.8 percent for PPI excluding food and energy. PPI inflation has risen from 6.8 percent in the 12 months ending in Apr for headline inflation and 2.1 excluding food and energy to 7.2 percent in the 12 months ending in Jul for headline inflation and 2.5 percent excluding food and energy.

Table 13, US, Producer Price Index ∆%

	Total SA ∆%	Excluding Food and Energy SA ∆%
SA
Jul	0.2	0.4
Jun	-0.4	0.3
May	0.2	0.2
Apr	0.9	0.3
Mar	0.7	0.3
Feb	1.5	0.2
Jan	1.0	0.5
Dec 2010	0.9	0.2
Annual Equivalent Jan-Jul	8.3	3.8
NSA 12 Months Jul	7.2	2.5
NSA 12 Months Jun	7.0	2.4
NSA 12 Months May	7.3	2.1
NSA 12 Months Apr	6.8	2.1

Source: http://www.bls.gov/news.release/pdf/ppi.pdf

Smaghi (2011Mar4) argues that monetary policy models assume that the rate of growth of the economy is determined by internal factors of individual countries while the rate of interest is determined by “long-term equilibrium conditions in the US.” An important characteristic of world economic growth is two-speed growth rates with emerging countries growing at faster rates than advanced economies during the past decade and as forecast in the foreseeable future. Rapid growth of emerging-market economies (EME) “is pushing up demand for commodities, in particular food and energy, and increasing these prices permanently, in terms of overall levels and rates of change” (Smaghi 2011Mar4). The consumption basket of the euro area gives weight of 30 percent to imported food and energy. If commodity prices increase at 4 percent per year, accompanying the rate of growth of the world economy, euro area consumer prices increase yearly by 1.2 percent merely because of the impact of imported food and energy. If the other 70 percent of the basket of consumption used in CPI calculations grow at 2 percent, the CPI will grow at 2.6 percent, 1.4 percent from the 70 percent growing at 2 percent per year and 1.2 percent of the 30 percent that are imported and grow at 4 percent per year. Inflation is higher than the 2 percent ceiling tolerated by most central banks in the world.

There are four propositions in the supply shock explanation of the Great Inflation (Blinder and Rudd 2010, 1; Blinder 1982, 262-3; see Blinder 1979). (1) Aggregate demand and aggregate supply determine the economy’s underlying or “core” inflation; headline inflation tends to converge to core inflation. (2) There are multiple factors affecting aggregate demand but not exclusively monetary and fiscal policy; the growth rate of productivity in the long term is the main driving factor of supply but supply shocks restricting aggregate supply can prevail in the short run. (3) The core inflation rate excluding energy and food is a proxy for the rate of inflation of all inflation components other than food and energy. (4) Changes in food and energy prices can temporarily cause headline inflation to deviate from core inflation but there could be other factors such as relaxing wage-price controls in 1974. An influential approach to empirical practice captures the essence of core inflation’s definition (Quah and Vahey 1995, 1130):

“Core inflation is defined as that component of measured inflation that has no medium- to long-rum impact on real output. This definition captures the commonly held view that (moderate) movements in inflation can be benign for the real economy once financial and wage contracts have been written taking into account (rewriting those contracts—or adjusting implicit agreements—might be time consuming).”

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.

A major conflict of these explanations and current events is that China’s GDP continues to grow as rates close to 10 percent per year but commodity prices fell in May. Interruption of the carry trade from zero interest rates to leveraged positions in commodities because of risk aversion is providing better explanation of commodity prices than China’s growth. Another problem with the conventional explanation is that the US PPI has been accelerating both in the headline index and in the index excluding food and energy, as shown in Table 14. The 12-month rate of increase of headline PPI jumped from 2.7 percent in Jun 2010 to 7.2 percent in Jul 2011 while in the same period the core rate of PPI inflation rose from 1.1 percent to 2.5 percent.

Table 14, US, Headline and Core PPI Inflation Monthly SA and 12 Months NSA ∆%

	Finished Goods SA Month	Finished Goods NSA 12 month	Finished Core SA Month	Finished Core NSA 12 months
Jul 2011	0.2	7.2	0.4	2.5
Jun	-0.4	7.0	0.3	2.4
May	0.2	7.3	0.2	2.1
Apr	0.9	6.8	0.3	2.1
Mar	0.7	5.6	0.3	2.0
Feb	1.5	5.4	0.2	1.8
Jan	1.0	3.6	0.5	1.6
Dec 2010	0.9	3.8	0.2	1.4
Nov	0.5	3.4	0.0	1.2
Oct	0.6	4.3	-0.3	1.6
Sep	0.3	3.9	0.2	1.6
Aug	0.6	3.3	0.1	1.3
Jul	0.1	4.1	0.2	1.5
Jun	-0.3	2.7	0.1	1.1
May	-0.2	5.1	0.2	1.3
Apr	-0.1	5.4	0.1	0.9
Mar	0.7	5.9	0.2	0.9
Feb	-0.4	4.2	0.0	1.0
Jan	1.1	4.5	0.3	1.0

Core: excluding food and energy

Source: http://www.bls.gov/ppi/#tables

Inflation is a global phenomenon as revealed in US exports, imports and their major components. The rate of inflation of US imports in the 12 months ending in Jul 2011 was 14.0 percent but moderating at the margin with decline by 0.4 percent in the annual equivalent for May-Jul, as shown in Table 15. Fuel imports rose at the absurdly high rate of 45.5 percent in the 12 months ending in July but then fell at the annual equivalent rate of 8.9 percent in the quarter May-Jul. Fuels account for 27.2 percent of US imports. The fall in imported fuel prices in the May-Jul quarter was the result of offsetting carry trades from zero interest rates to leveraged positions in commodities because China continues to grow at rates close to 10 percent per year, which does not explain falling commodity prices. Prices of imports of capital goods rose by only 1.4 percent in the 12 months ending in Jul and 0.4 percent annual equivalent in the May-Jul quarter, which helps to moderate import prices because capital goods account for 20.7 percent of US imports. Prices of durable manufactured imports rose only 0.3 percent in the 12 months ending in Jul 2011 and fell 0.4 percent in the quarter May-Jul. There is redistribution of income and wealth from production of industrial goods toward activities in production and sale of commodities as revealed by sharply deteriorating trends of industrial prices relative to commodities prices. The combined share in imports of consumer goods and automotive vehicles, parts and engines is 33.2 percent. Behavior of export prices is similar. Export prices rose 9.8 percent in the twelve months ending in Jul but grew at only 0.4 percent annual equivalent in the quarter May-Jul. The US export structure has a hedge in agriculture. Agricultural export prices rose 25.9 percent in the 12 months ending in Jul but fell 17.5 percent in annual equivalent rate in the quarter May-Jul. The hedge is only partial because agricultural exports account for only 11.9 percent of total exports. Export prices of industrial goods by the US increased faster than prices of imports of industrial goods, which results in gains from trade because of the high share of 88.1 of nonagricultural exports in total US exports.

Table 15, US, Prices of Exports and Imports 12 Months and Annual Equivalent %

	12 Month ∆% Jul 2011	Annual ∆%Equivalent May-Jul 2011	% Total
Imports	14.0	-0.4	100.0
Fuel	45.5	-8.9	27.2
Nonfuel	5.5	2.0	72.8
Capital Goods	1.4	0.4	20.7
Automotive vehicles, parts & engines	3.9	4.5	9.2
Consumer Goods Ex Automotive	1.9	3.7	24.0
Durables Manufactured	0.3	-0.4	11.2
Non-Manufactured Consumer Goods	12.3	19.0	1.0
Exports	9.8	0.4	100.0
Agricultural	25.9	-17.5	11.9
Non-Agricultural	8.3	3.7	88.1
Industrial Supplies and Materials	20.2	-2.0	35.2
Capital Goods	1.3	2.0	34.3
Automotive vehicles, parts & engines	2.2	3.7	6.6
Consumer Goods Excluding Autos	5.7	10.0	13.3
Nondurable Manufactured	2.7	3.3	6.7
Durables Manufactured	3.7	2.8	5.3

Source:

http://www.bls.gov/news.release/pdf/ximpim.pdf

http://www.bls.gov/news.release/archives/ximpim_06102011.pdf

http://www.bls.gov/mxp/data.htm#

While the 12 months rates of change of import prices in the 12 months ending in the month of Jul from 2001 to 2011 have fluctuated, they have typically exceeded the equally oscillating rates of change of export prices, as shown in Table 16. The US has experienced faster price increases of nonagricultural exports, which account for 88.1 percent of total exports, relative to more moderate increases of imports excluding fuels. This differential rate of price increase of nonagricultural exports versus increases in imports excluding fuels has moderated the deterioration of the US trade balance resulting from fast increases of fuel prices accounting for 27.2 percent of US total imports.

Table, 16, US, Twelve Months Percentage Rates of Change of Prices of Exports and Imports

	Imports	Imports Ex Fuels	Exports	Exports Non-Ag
Jul 2011	14.0	5.5	9.8	8.3
Jul 2010	4.9	3.1	3.9	4.1
Jul 2009	-19.1	-7.3	-8.3	-6.6
Jul 2008	21.4	7.8	10.2	7.6
Jul 2007	2.8	2.9	4.0	2.9
Jul 2006	7.0	2.4	4.5	4.7
Jul 2005	8.2	2.1	2.8	3.2
Jul 2004	5.6	2.5	4.5	3.7
Jul 2003	2.3	1.1	1.1	0.7
Jul 2002	-1.7	-1.6	-0.7	-0.9
Jul 2001	-4.1	-2.4	-1.0	-1.4

Source: http://www.bls.gov/mxp/data.htm#

A major vulnerability of the US trade balance originates in much faster 12 months rates of price increase for petroleum imports than for agricultural exports, as shown in Table 17. Fuels and lubricants account for 27.2 percent of US imports of which 25.8 percent by petroleum and petroleum products, with crude providing 19.2 percent (http://www.bls.gov/news.release/pdf/ximpim.pdf 5). Agricultural exports account for only 11.1 percent of US exports and thus provide only limited hedge.

Table 17, US, Twelve Months Percentage Rates of Price Increases of Petroleum Imports and Agricultural Exports

	Petroleum Imports	Agricultural Exports
Jul 2011	48.9	25.9
Jul 2010	14.3	2.3
Jul 2009	-49.3	-22.5
Jul 2008	78.6	39.7
Jul 2007	3.6	17.8
Jul 2006	28.5	2.1
Jul 2005	47.3	-1.7
Jul 2004	30.9	14.7
Jul 2003	14.6	6.3
Jul 2002	4.6	1.6
Jul 2001	-15.7	3.6

Source: http://www.bls.gov/mxp/data.htm#

The Federal Reserve Bank of Philadelphia Business Outlook Survey finds moderating prices (http://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0811.pdf 1):

“Diffusion indexes for prices paid and prices received were lower this month and suggest a continued trend of moderating price pressures. The prices paid index declined 12 points and has now declined 36 points over the last three months. More firms reported declines in prices received for their products this month (19 percent) than reported increases (10 percent). The prices received index decreased 10 points, resulting in the first negative reading since last November.”

The indicators of current prices paid and received in Table 18 show the continuing moderation of prices from May to Aug 2011. Prices paid or prices of inputs are still expanding but more slowly as shown by the index of 12.8 but prices received are now contraction with a reading of minus 9.0. Expectations about the future six months in the second block of data in Table X still register price pressures. The index of prices received rose from 8.3 in Jul and 2.5 in Jun to 16.5 in Aug with the percentage of respondents expecting increasing prices rising from 19.3 in Jun and 22.5 in Jul to 30.1 in Aug. The index of expectations of prices paid continues to be at a high level of 34.6.

Table 18, US, FRB of Philadelphia Business Outlook Survey, Prices Paid and Prices Received, SA

	Increase	No Change	Decrease	Index
Current
Prices Paid
Aug	26.1	59.4	13.3	12.8
Jul	32.6	59.9	7.5	25.1
Jun	36.6	49.6	9.8	26.8
May	56.3	35.6	8.0	48.3
Prices Received
Aug	10.1	69.9	19.1	-9.0
Jul	17.7	65.1	16.6	1.1
Jun	16.8	66.5	12.4	4.4
May	19.7	76.2	2.9	16.8
Six Months
Prices Paid
Aug	42.6	48.7	8.0	34.6
Jul	44.6	43.4	5.9	38.7
Jun	40.4	40.0	12.9	27.5
May	59.1	33.1	6.7	52.4
Prices Received
Aug	30.1	54.6	13.6	16.5
Jul	22.5	61.4	14.2	8.3
Jun	19.3	56.0	16.7	2.5
May	34.9	53.2	7.6	27.3

Source: http://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0811.pdf

The Empire State Manufacturing Survey of the New York Federal Reserve Bank finds continuing moderating price pressures in Aug (http://www.newyorkfed.org/survey/empire/aug2011.pdf 2):

“The prices paid index continued its marked decline in August, dropping fifteen points to 28.3—an indication that the pace of input price increases slowed over the month. This index has now fallen a cumulative forty-two points since May. The prices received index retreated three points to 2.2, suggesting that selling prices were little changed.”

Table 19 provides the price segments of the Empire State Manufacturing Survey of the New York Fed. The rate of price increase of prices paid or cost of inputs has significantly fallen from an index of 69.89 in May to 28.26 in Aug with prices increasing at much slower pace; the index of prices received or sales price fell from 27.96 in May to 2.17 in Aug, indicating almost no price change. As it is the case of the Philadelphia Business Outlook Survey, the Empire State Manufacturing Survey shows expectations of still rising prices in the next six months. The index of prices paid or cost of inputs is much lower at 42.39 in Aug than 68.82 in May but still registers expectations of price increases; the index of prices received has collapsed from 35.48 in May to 15.22 in Aug, which still registers moderate price increase expectations

Table 19, US, FRBNY Empire State Manufacturing Survey, Prices Paid and Prices Received, SA

	Higher	Same	Lower	Index
Current
Prices Paid
May	69.89	30.11	0.00	69.89
Jun	58.16	39.80	2.04	56.12
Jul	47.78	47.78	4.44	43.33
Aug	34.78	58.70	6.52	28.26
Prices Received
May	33.33	61.29	5.38	27.96
Jun	17.35	76.53	6.12	11.22
Jul	14.44	76.67	8.89	5.56
Aug	15.22	71.74	13.04	2.17
Six Months
Prices Paid
May	70.97	26.88	2.15	68.82
Jun	58.16	38.78	3.06	55.10
Jul	56.67	37.78	5.56	51.11
Aug	46.74	48.91	4.35	42.39
Prices Received
May	40.86	53.76	5.38	35.48
Jun	30.61	58.16	11.22	19.39
Jul	38.89	52.22	8.89	30.00
Aug	23.91	67.39	8.70	15.22

Source: http://www.newyorkfed.org/survey/empire/july2011.pdf

http://www.newyorkfed.org/survey/empire/aug2011.pdf

Table 20 provides the 12 months rates of HICP inflation in the quarter May to Jul 2011 and their key components. HICP inflation fell to 2.5 percent in Jul 2011 relative to Jul 2010. Excluding food and energy, HICP 12-month inflation in Jul fell to 1.2 percent from 1.6 percent in Jun and 1.5 percent in May. Energy inflation rose to 11.8 percent in Jul from 10.9 percent in Jun and 11.1 percent in May even after the fall of commodity prices beginning in May. Food is increasing at 2.6 percent in Jul, similar to headline HIPC inflation, and not very different from 2.7 percent in Jun and May.

Table 20, Euro Area Harmonized Index of Consumer Prices 12 Months ∆%

	Jul 11 /Jul 10	Jun 11 /Jun 10	May 11/ May 10
All	2.5	2.7	2.7
Ex Energy, Food, Alcohol and Tobacco	1.2	1.6	1.5
Energy	11.8	10.9	11.1
Food	2.6	2.7	2.7
Housing	5.0	4.8	4.7
Transport	5.5	5.3	5.3

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-17082011-AP/EN/2-17082011-AP-EN.PDF

Additional insight in the process of inflation in the euro area is provided by Eurostat’s Table 21 with the sub-indices of the HICP with highest impact on the 12-month rate of inflation in Jul of 2.5 percent. The highest impact of a sub-index is that of fuels for transport with weight of 46.9 percent, or percentage representation in the construction of the index, rising 13.3 percent in the 12 months ending in Jul and contributing 0.51 percentage points (PP) to HICP inflation. Commodity price increases affect advanced economies that depend on imported energy such as those of the euro area and the US. The combined percentage contributions of fuels for transport (0.51PP), heating oil (0.19PP), electricity (0.14PP) and gas (0.10PP) add to 0.94 PP. The highest negative contributions to the 12-month rate of 2.5 percent in Jul are telecommunications (0.14PP) and garments (0.27PP).

Table 21, Euro Area Harmonized Index of Consumer Prices Sub-Indices with Most Important Impact %

Jul/11/ Jul/10	Weight %	Rate ∆%	Impact Percentage Points PP
Fuels for Transport	46.9	13.3	0.51
Heating Oil	9.5	23.7	0.19
Electricity	24.5	8.1	0.14
Gas	16.7	8.2	0.10
Air Transport	5.8	8.5	0.04
Jewelry and Watches	5.3	9.7	0.04
Rents	59.8	1.5	-0.07
IT Equipment	5.0	-11.5	-0.07
Vegetables	15.8	-2.2	-0.07
Cars	39.3	0.7	-0.08
Telecom	30.1	-1.8	-0.14
Garments	49.5	-3.2	-0.27

PP: percentage points

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-17082011-AP/EN/2-17082011-AP-EN.PDF

Headline HICP inflation from Jun to Jul was minus 0.6 percent. Table 22 provides the weights, rate of inflation from Jun to Jul 2011 and impact in percentage points. Risk aversion caused decline of commodity prices after May appearing in Table 22 as a minor contribution of 0.06 PP to inflation by fuels for transport from Jun into July. The highest positive contributions are different for monthly inflation: package holidays with price increases of 9.3 percent contributing 0.14 PP in Jul and accommodation services with price increases of 6.1 percent contributing 0.11 PP. Footwear fell 13.3 percent in Jul, reducing inflation by 0.18 PP, and garments falling 15.2 percent, reducing inflation by 0.75 PP.

Table 22, Euro Area Harmonized Index of Consumer Prices Sub-Indices with Most Important Impact %

Jul 11/ Jun 11	Weight %	Rate ∆%	Impact Percentage Points
Package Holidays	15.1	9.3	0.14
Accomm. Services	15.7	6.1	0.11
Rents	59.8	0.4	0.06
Air Transport	5.8	9.4	0.06
Fuels for Transport	46.9	0.5	0.06
Restaurants and Cafes	70.1	0.1	0.06
Clothing Accessories	2.1	-8.4	-0.02
Other Personal Effects	4.3	-4.5	-0.02
Vegetables	15.8	-2.4	-0.03
Fruit	11.7	-4.3	-0.05
Footwear	13.8	-13.3	-0.18
Garments	49.5	-15.2	-0.75

Acomm: accommodation

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-17082011-AP/EN/2-17082011-AP-EN.PDF

Monthly and 12-months rates of HIPC inflation in 2011 and Dec 2010 are shown in Table 23. Most of 2011 HIPC inflation occurred in the quarter Feb-Apr when commodity prices soared. The 12-months rate of HIPC inflation rose from 2.2 percent in Dec 2010 to 2.5 percent in Jul 2011 with a peak in Apr of 2.8 percent. The annual equivalent inflation rate, or inflation that would occur in a full year repeating the experience of cumulative inflation in Jan-Jul, is 1.9 percent. Unconventional monetary policy of zero interest rates and quantitative easing stimulate the carry trade from zero interest rates to commodity prices that deteriorate the terms of trade of the euro area and the US without stimulating economic activity caught in uncertainty similar to that analyzed by Frank H. Knight (http://cmpassocregulationblog.blogspot.com/ http://cmpassocregulationblog.blogspot.com/2010/07/rise-of-era-of-uncertainty_29.html). Markets and companies are flooded with cheap money and increments are not going to result in investment and consumption or aggregate demand. Diagnosis and impulses of monetary policy are erroneous.

Table 23, Euro Area Harmonized Index of Consumer Prices Month and 12 Months ∆%

	Month ∆%	12 Months ∆%
Jul 2011	-0.6	2.5
Jun	0.0	2.7
May	0.0	2.7
Apr	0.6	2.8
Mar	1.4	2.7
Feb	0.4	2.4
Jan	-0.7	2.3
AE ∆%	1.9
Dec 2010	0.6	2.2

AE: annual equivalent

Source: http://epp.eurostat.ec.europa.eu/tgm/refreshTableAction.do;jsessionid=9ea7d07e30ddb98901a269ed40d6ae0fe31f2f9f8f3c.e34OaN8Pc3mMc40Lc3aMaNyTa3qKe0?tab=table&plugin=1&pcode=teicp000&language=en

Producer price inflation in Germany rose 0.7 percent in Jul relative to Jun, as shown in Table 24, and 5.8 percent in the 12 months ending in Jul. Most of the jump of the PPI in Jul was the result of an increase in the energy component by 1.9 percent in Jul relative to Jun and of 10 percent in the 12 months ending in Jul 2011 (http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/DE/Content/Statistiken/Preise/ErzeugerpreiseGewerblicherProdukte/Aktuell,templateId=renderPrint.psml). Table 24 shows vigorous PPI year-over-year increases during the commodity price boom until 2008, drop by 4.2 percent in 2009 during the global recession, moderate increase by 1.6 percent in 2010 and the increase toward around 6 percent 12 months rates in 2011. The annual equivalent rate of the PPI in Jan-Jul is 7.0 percent.

Table 24, Germany, Producer Price Index ∆%

	Month SA ∆%	12 Months NSA ∆%
Jul	0.7	5.8
Jun	0.1	5.6
May	± 0.0	6.1
Apr	1.0	6.4
Mar	0.4	6.2
Feb	0.7	6.4
Jan	1.2	5.7
AE ∆% Jan-Jul	7.0
Dec 2010	0.7	5.3
Nov	0.2	4.4
Oct	0.4	4.3
Sep	0.3	3.9
Aug	0.0	3.2
Jul	0.5	3.7
		Year over Year ∆%
2010/2009		1.6
2009/2008		-4.2
2008/2007		5.5
2007/2006		1.3
2006/2005		5.4
2005/2004		4.4

AE: annual equivalent

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/KeyIndicators/ProducerPrices/liste__erzpr,templateId=renderPrint.psml

Germany is more exposed to increases in prices of commodities because of the lack of domestic sources. Table 25 shows the monthly and 12 months rates of increase of import and export prices of Germany from Jun 2010 to Jun 2011. Import prices have increased much faster than export prices.

Table 25, Germany, Export and Import Prices Month and 12 Months ∆%

	Export Prices 12 Months NSA ∆%	Export Prices Month CSA ∆%	Import Prices 12 Months NSA ∆%	Import Prices Month CSA ∆%
Jun 2011	3.4	0.1	6.5	-0.3
May	3.8	0.1	8.1	-0.1
Apr	4.2	0.0	9.4	-0.2
Mar	4.9	0.1	11.3	0.4
Feb	5.4	0.1	11.9	0.7
Jan	5.4	0.6	11.8	0.6
Dec 2010	5.2	0.8	12.0	2.1
Nov	4.5	0.4	10.0	1.2
Oct	4.3	0.2	9.2	0.4
Sep	4.6	0.5	9.9	1.2
Aug	4.2	0.3	8.6	0.1
Jul	4.1	0.2	9.9	0.5
Jun	3.9	0.4	9.1	0.8

CSA: calendar and seasonally adjusted

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/KeyIndicators/ProducerPrices/liste__erzpr,templateId=renderPrint.psml

Consumer price inflation in the UK has been moderating in the quarter May to Jul, as shown in Table 26. Inflation was flat in Jul, fell 0.1 percent in Jun and rose only 0.2 percent in May. The highest price increases were between Feb and Apr. The decline in commodity prices after May has contributed to a reduction of CPI inflation. The annual equivalent rate of CPI inflation in the first seven months of 2011 is 3.8 percent, which is lower than the 12-month rate in Jul of 4.4 percent. Twelve months rates of price increase rose from 3.7 percent in Dec to 4.4 percent in Jul.

Table 26, UK Consumer Price Index ∆%

	Month	12 Months
Jul	0.0	4.4
Jun	-0.1	4.2
May	0.2	4.5
Apr	1.0	4.5
Mar	0.3	4.0
Feb	0.7	4.4
Jan	0.1	4.0
Jan-May AE ∆%	3.8
Dec	1.0	3.7

AE: annual equivalent

Surce: http://www.statistics.gov.uk/pdfdir/cpi0711.pdf

Percentage changes in Jul and contributions in percentage points of components of the CPI of the UK are shown in Table 27. The Office for National Statistics of the UK identifies four major drivers of CPI inflation from Jun into Jul (http://www.statistics.gov.uk/pdfdir/cpi0811.pdf). (1) Transport prices rose 0.6 percent, with the largest increase in air transport fares by 9.8 percent, which is typical at the start of the summer holidays in Jul. (2) Prices of housing and household services rose 0.4 percent, with the largest increases in housing rent and in costs of maintaining and repairing residences. (3) Clothing and footwear prices fell 3.5 percent as typical in the summer sales season because of discounts with the major sales in women’s outwear. (4) Prices of furniture, household equipment and maintenance fell 1.1 percent primarily as a result of a 4.3 percent decline in prices for furniture and furnishings also because of seasonal sales.

Table 27, UK, Monthly of Components of Consumer Price Index and Percentage Points Contributions, % and Percentage Points

Jul 2011	Jul Month ∆%	Contributions in Percentage Points
All Items	0.0
Food & non-alcoholic beverages	0.3	0.03
Alcohol & tobacco	0.6	0.03
Clothing & footwear	-3.5	-0.22
Housing & household services	0.4	0.05
Furniture & household goods	-1.1	-0.07
Health	0.6	0.01
Transport	0.6	0.09
Communication	0.8	0.02
Recreation & culture	0.0	0.00
Education	0.0	0.00
Restaurants & hotel	0.1	0.02
Miscellaneous goods & services	0.3	0.03

Source: http://www.statistics.gov.uk/pdfdir/cpi0811.pdf

Commodity prices drive inflation rates in advanced economies. Table 28 provides the 12-months rate of CPI change in Jul and contributions in percentage points of components of the CPI change. The Office for National Statistics of the UK identifies four major contributors to the 12-month rate of increase of the CPI (http://www.statistics.gov.uk/pdfdir/cpi0811.pdf). (1) The contribution of transport to the 4.4 percent increase in the CPI was 1.3 percentage points. In the 12-months ending in Jul 2011, prices of fuels and lubricants rose 15.1 percent and air transport fares rose 12.5 percent. (2) The contribution of food and non-alcoholic prices was 0.7 percentage points with a rate of price increase of 6.2 percent. Major prices increases were: 9.7 percent in bread and cereals, 6.6 percent in meat prices, 7.5 percent in sugar and similar items and 7.9 percent in non-alcoholic drinks. (3) Prices of housing and household services contributed 0.6 percentage points with the largest increases in domestic heating costs and housing rents. (4) Restaurants and hotels contributed 0.5 percentage points with increases in restaurant and cafe prices of 4.8 percent.

Table 28, UK, Twelve-Month Rates of Components of Consumer Price Index and Percentage Points Contributions. % and Percentage Points

Jul 2011	Jul 12 months ∆%	Contributions in Percentage Points
All Items	4.4	0.0
Food & non-alcoholic beverages	6.2	0.69
Alcohol & tobacco	10.3	0.43
Clothing & footwear	3.1	0.15
Housing & household services	4.6	0.59
Furniture & household goods	4.8	0.31
Health	3.5	0.08
Transport	7.8	1.25
Communication	2.5	0.07
Recreation & culture	-0.2	-0.04
Education	5.3	0.10
Restaurants & hotel	4.4	0.54
Miscellaneous goods & services	2.7	0.26

Source: http://www.statistics.gov.uk/pdfdir/cpi0811.pdf

IV United States Economic Uncertainty. There is economic and financial uncertainty in the US and the world. Table USA provides available information on the economy that is covered in this blog. The recovery of the US economy began to decelerate toward the end of 2010 into 2011. It is uncertain if the deceleration would continue in the form of low rates of economic growth or if the economy will turn around and grow more rapidly again.

Table USA, US Economic Indicators

Consumer Price Index	Jun 12 months NSA ∆%: 3.6; ex food and energy ∆%: 1.6 Jun month ∆%: –0.2; ex food and energy ∆%: 0.3 Blog 08/21/11
Producer Price Index	Jun 12 months NSA ∆%: 7.0; ex food and energy ∆% 2.4 Jun month SA ∆% –0.4; ex food and energy∆%: 0.3 Blog 08/21/11
PCE Inflation	Jun 12 months NSA ∆%: headline 1.6; ex food and energy ∆% 1.3 Blog 08/07/11
Employment Situation	Household Survey: Jul Unemployment Rate SA 9.1% Blog calculation People in Job Stress Jul: 29.6 million NSA Establishment Survey: Jul Nonfarm Jobs +117,000; Private +154,000 Jun 12 months Average Hourly Earnings Inflation Adjusted ∆%: minus 1.6% Blog 08/07/11
Nonfarm Hiring	Nonfarm Hiring fell from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million Private-Sector Hiring May 2011 4.250 million lower by 1.256 million than 5.506 million in May 2001 Blog 08/21/11
GDP Growth	BEA Revised National Income Accounts back to 2003 IQ2011 SAAR ∆%: 0.4 IIQ2011 SAAR ∆%: 1.3 Blog 07/31/11
Personal Income and Consumption	Jun month ∆% SA Real Disposable Personal Income (RDPI) 0.3 Jun month SA ∆% Real Personal Consumption Expenditures (RPCE) : 0.0 12 months NSA ∆%: RDPI: 0.3; RPCE ∆%: 1.0 Blog 08/07/11
Employment Cost Index	IIQ2011 SA ∆%: 0.7 Jun 12 months ∆%: 3.4 Blog 08/07/11
Industrial Production	Jul month SA ∆%: 0.9 Jun 12 months NSA ∆%: 3.7 Capacity Utilization: 77.5 Blog 08/21/11
New York Fed Manufacturing Index	General Business Conditions Aug: –7.72 New Orders: –7.82 Blog 08/21/11
Philadelphia Fed Business Outlook Index	General Index from 3.2 Jul to -30.7 Aug New Orders from Jul 0.1 to -30.7 Aug Blog 08/21/11
Manufacturing Shipments and Orders	Jun/May New Orders SA ∆%: –0.8; ex transport ∆%: 0.1 12 months Jun NSA ∆%: 12.5; ex transport ∆% 12.8 Blog 08/07/11
Durable Goods	Jun New Orders SA ∆%: minus 2.1; ex transport ∆%: 0.1 Jun 12 months NSA New Orders ∆%: 9.4; ex transport∆% : 9.2 Blog 07/31/11
Sales of Merchant Wholesalers	Jan-Jun 2011/2010 ∆%: Total 15.2; Durable Goods: 11.9; Nondurable Goods 17.8 Blog 08/14/11
Sales and Inventories of Manufacturers, Retailers and Merchant Wholesalers	Jun 11/Jun 10 NSA ∆%: Total Business 12.1; Manufacturers 12.3 Retailers 9.1; Merchant Wholesalers 14.6 Blog 08/14/11
Sales for Retail and Food Services	Jul 12 months ∆%: Retail and Food Services: 8.5; Retail ∆% 8.9 Blog 08/14/11
Value of Construction Put in Place	Jun SAAR month SA ∆%: 0.2 Jun 12 months NSA: –4.7 Blog 08/07/11
Case-Shiller Home Prices	May 2011/May 2010 ∆% NSA: 10 Cities –3.6; 20 Cities: –4.5 ∆% May SA: 10 Cities 0.1; 20 Cities: –0.1 Blog 07/31/11
New House Sales	Jun month SAAR ∆%: -0.9 Jan/Jun 2011/2010 NSA ∆%: –11.9 Blog 07/31/11
Housing Starts and Permits	Jul Starts month SA ∆%: -1.5; Permits ∆%: -3.2 Jan/Jul 2011/2010 NSA ∆% Starts -3.6; Permits ∆% –5.1 Blog 08/21/11
Trade Balance	Balance Jun SA -$53,067 million versus May -$50,831 million Exports Jun SA ∆%: -2.3 Imports Jun SA ∆%: -0.8 Exports Jan-Jun 2011/2010 NSA ∆%: 18.3 Imports Jan-Jun 2011/2010 NSA ∆%: 17.9 Blog 08/14/11
Export and Import Prices	Jun 12 months NSA ∆%: Imports 13.6; Exports 9.9 Blog 08/21/11
Consumer Credit	Jun ∆% annual rate: 7.7% Blog 08/07/11
Net Foreign Purchases of Long-term Treasury Securities	May Net Foreign Purchases of Long-term Treasury Securities: $3.7 billion Jun versus May $24.2 billion Major Holders of Treasury Securities: China $1165 billion; Japan $911 billion Blog 08/21/11
Treasury Budget	Fiscal Year to Jul 2011/2010 ∆%: Receipts 8.0; Outlays 2.4; Deficit -5.9; Individual Income Taxes 23.8 Deficit Fiscal Year to Jul 2011: $1,099,901 million Blog 08/14/11

Links to blog comments in Table USA:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

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, as shown in Table 29. The ratio of nonfarm hiring to unemployment (RNF) has fallen from 47.7 in 2006 to 36.4 in 2010 and in the private sector (RHP) from 52.9 in 2006 to 40.3 in 2010 (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html).

Table 29, Annual Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US and Percentage of Total Employment

	HNF	Rate RNF	HP	Rate HP
2001	63,766	48.4	59,374	53.6
2002	59,797	45.9	55,665	51.1
2003	57,787	44.5	54,082	49.9
2004	61,624	46.9	57,534	52.4
2005	64,498	48.2	60,444	54.0
2006	64,870	47.7	60,419	52.9
2007	63,326	46.0	58,760	50.9
2008	53,986	39.5	50,286	44.0
2009	45,372	34.7	41,966	38.8
2010	47,234	36.4	43,299	40.3

Source: http://www.bls.gov/jlt/data.htm

Table 30 provides total HNF and HP in the month of Jun from 2001 to 2011. An important characteristic of the labor market in the US is that HNF has declined from 6.243 million in Jun 2006 to 4.812 million in Jun 2011, or by 1.431 million, and HP has fallen from 5.742 million in Jun 2006 to 4.466 million in Jun 2011, or by 1.276 million. HNF of 4.812 million in Jun 2011 is almost unchanged relative to 4.658 million in Jun 2010. HP in Jun 2011 of 4.466 million is lower by 0.963 million than 5.429 million in Jun 2001 during the full strength of the prior recession in 2001 with major losses in employment while in Jun 2011 the economy is in the eight consecutive quarter of recovery. The US labor market is fractured, creating fewer opportunities to exit job stress of unemployment and underemployment of 25 to 30 million people and declining inflation-adjusted wages in the midst of fast increases in prices of everything (http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/06/unemployment-and-underemployment-of-24.html http://cmpassocregulationblog.blogspot.com/2011/05/job-stress-of-24-to-30-million-falling.html http://cmpassocregulationblog.blogspot.com/2011/04/twenty-four-to-thirty-million-in-job_03.html).

Table 30, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment in Jun Not Seasonally Adjusted

	HNF	Rate RNF	HP	Rate HP
2001 Jun	5912	4.4	5429	4.8
2002 Jun	5602	4.3	5175	4.7
2003 Jun	5456	4.2	5044	4.6
2004 Jun	5789	4.4	5381	4.9
2005 Jun	6233	4.6	5821	5.2
2006 Jun	6243	4.6	5742	5.0
2007 Jun	6140	4.4	5629	4.8
2008 Jun	5468	4.0	5027	4.3
2009 Jun	4286	3.3	3930	3.6
2010 Jun	4658	3.6	4282	4.0
2011 Jun	4812	3.6	4466	4.1

Source: http://www.bls.gov/jlt/data.htm

The Bureau of Labor Statistics (BLS) also calculates alternative measures of labor underutilization for the US and all states. Table 31 shows six measure of underutilization described in the note. There is dramatic rise in the broad measure of labor underutilization, U6, or total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons as percent of the labor force plus all marginally attached workers. This blog provides the numerator of U6 after the release of every employment situation report by the BLS. The number for Jun is 25.319 million in job stress (see Table 6 in http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html Table 1 in http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/06/unemployment-and-underemployment-of-24.html) but using a different rate of participation of the population in the labor force the number could be 29.693 million (see Table 7 and discussion in http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html Table 2 and discussion in http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/06/unemployment-and-underemployment-of-24.html).

Table 31, Alternative Measures of Labor Underutilization %

	U1	U2	U3	U4	U5	U6
Jul 2011 NSA	5.2	5.2	9.3	10.0	10.9	16.3
Jul 2010 NSA	5.5	5.8	9.7	10.4	11.2	16.8
2010	5.7	6.0	9.6	10.3	11.1	16.7
2009	4.7	5.9	9.3	9.7	10.5	16.2
2008	2.1	3.1	5.8	6.1	6.8	10.5
2007	1.5	2.3	4.6	4.9	5.5	8.3
2006	1.5	2.2	4.6	4.9	5.5	5.6

Note: LF: labor force; U1, persons unemployed 15 weeks % LF; U2, job losers and persons who completed temporary jobs %LF; U3, total unemployed % LF; U4, total unemployed plus discouraged workers, plus all other marginally attached workers; % LF plus discouraged workers; U5, total unemployed, plus discouraged workers, plus all other marginally attached workers % LF plus all marginally attached workers; U6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons % LF plus all marginally attached workers

Source: http://www.bls.gov/news.release/pdf/empsit.pdf

Seasonally-adjusted measures of labor underutilization for Jul 2010 and Mar to Jul 2011 are provided in Table 32. The more comprehensive measure is U6 consisting of total unemployed plus all marginally attached workers plus total employed part-time for economic reasons as percent of the labor force plus all marginally attached workers. U6 has increased SA from 15.7 percent in Mar 2011 to 16.1 percent in Jul 2011. Unemployed and underemployed for long periods lose hope and skills of ever again being productive and enjoy working.

Table 32, US, Alternative Measures of Labor Underutilization SA %

	Jul 2010	Mar 2011	Apr 2011	May 2011	Jun 2011	Jul 2011
U1	5.7	5.3	5.1	5.3	5.3	5.3
U2	5.9	5.4	5.3	5.4	5.4	5.4
U3	9.5	8.8	9.0	9.1	9.2	9.1
U4	10.2	9.4	9.5	9.5	9.8	9.8
U5	11.0	10.3	10.4	10.3	10.7	10.7
U6	16.5	15.7	15.9	15.8	16.1	16.1

Source: http://www.bls.gov/news.release/pdf/empsit.pdf

An article in Real Time Economics of the Wall Street Journal on Jul 16 on “Number of the week: 5% unemployment could be a decade away” (http://blogs.wsj.com/economics/2011/07/16/number-of-the-week-5-unemployment-could-be-over-a-decade-away/) provides an approximation of the number of months that would be required for the economy to return to the 5 percent unemployment rate of 2007. The unemployment rate used is that for Jun of 9.2 percent, with 14.1 million unemployed, on the basis of the household survey. There is not much difference relative to the unemployment rate of 9.1 percent in Jul. Job creation in the first half of 2011 was 757,000 jobs, on the basis of the establishment survey. Assuming that job creation is approximately the same in the household survey as in the establishment survey, there would be a gain of 1.6 million new jobs in the year forward from Jun 2011 to Jun 2012. Real Time Economics adds to the calculation the growth of the labor force projected by the Census as 1.4 million people aged 16 and over. Employment would grow by 1.6 million while the labor force would grow by 1.4 million, reducing unemployment by only 200,000 that would still leave the rate of unemployment at 8.9 percent. Under those assumptions about employment growth and labor force growth, the rate of unemployment of 5 percent would only be attained in Dec 2024. Another recession would create a setback in the calculations. A related issue is that there appears to be an additional 4 million unemployed who are not counted because they abandoned the hope of finding another job, such that the total unemployment in Jun is more likely to be closer to 18.4 million. To that would have to be added 8.6 million barely making a living in part-time jobs because they cannot find anything better and 2.7 million marginally attached to the labor force. The total number of people in job stress in the US is 29.693 million in Jun 2011 (http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html) and 29.577 million in Jul 2011 (http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html). The US is suffering a suffocating unemployment and underemployment stress that would require much faster growth than that experienced in the current weakest recovery from a recession since World War II.

Industrial production in the Fed survey rose 0.9 percent in Jul, as shown in Table 33. The Fed report states (http://www.federalreserve.gov/releases/g17/current/):

“Industrial production advanced 0.9 percent in July. Although the index was revised down in April, primarily as a result of a downward revision to the output of utilities, stronger manufacturing output led to upward revisions to production in both May and June. Manufacturing output rose 0.6 percent in July, as the index for motor vehicles and parts jumped 5.2 percent and production elsewhere moved up 0.3 percent. The output of mines advanced 1.1 percent, and the output of utilities increased 2.8 percent, as the extreme heat during the month boosted air conditioning usage. At 94.2 percent of its 2007 average, total industrial production for July was 3.7 percentage points above its year-earlier level. The capacity utilization rate for total industry climbed to 77.5 percent, a rate 2.2 percentage points above the rate from a year earlier but 2.9 percentage points below its long-run (1972--2010) average.”

Industry did have an impact from the supply-chain disruption caused by the earthquake/tsunami in Japan that appears as a fall of total industry by 0.3 percent in Apr, as shown in Table 33. Manufacturing rose 0.6 percent after a decline of 0.4 percent in Apr. Growth in the intermediate months of Jun and May for manufacturing was 0.2 percent.

Table 33, Industrial Production and Capacity Utilization, SA %

	Jul	Jun	May	Apr	Jul 2011/ Jul 2010
Total	0.9	0.4	0.2	-0.3	3.7
Market Groups
Final Products	1.0	0.1	0.4	-0.2	3.2
Consu-mer Goods	1.1	0.1	0.0	-0.4	1.3
Business Equip-ment	0.6	0.2	1.4	-0.1	8.5
Non Industry Supplies	0.7	0.2	0.3	-0.3	2.2
Cons- truction	0.3	0.2	1.3	0.0	4.4
Mat- erials	0.9	0.7	0.0	-0.4	4.7
Groups
Manu- facturing	0.6	0.2	0.2	-0.4	3.8
Mining	1.1	1.2	0.6	0.5	6.6
Utilities	2.8	0.8	-0.4	-0.9	-0.2
Capacity	77.5	76.9	76.7	76.6	0.7

Sources: http://www.federalreserve.gov/releases/g17/current/

Table 34 provides the monthly and 12-months rates of growth of manufacturing from 2007 to 2011 and the 12-months rate of growth in Dec from 2003 to 2006. Growth of manufacturing picked up in 2006 and 2007 and then fell during the global recession. There were three months of decline of manufacturing in 2007. The 12-months rates of growth begin to increase in 2010 but decelerate significantly after Feb 2011. There are various effects in addition to the supply chain interruption. US real disposable income stagnated in the first half of 2011 and GDP growth was 0.4 percent in IQ2011 in seasonally adjusted annual equivalent rate that is equivalent to only 0.1 percent in IQ2011 relative to IVQ2010.

Table 34, Monthly and 12 Months Rates of Growth of Manufacturing ∆%

	Month SA ∆%	12 Months NSA ∆%
Jul 2011	0.6	3.9
Jun	0.2	3.9
May	0.2	3.7
Apr	-0.4	4.6
Mar	0.6	5.9
Feb	0.1	6.2
Jan	-6.7	6.2
Dec 2010	0.2	6.2
Nov	0.8	5.3
Oct	-0.04	6.2
Sep	0.8	5.9
Aug	0.9	6.6
Jul	1.3	6.9
Jun	-0.3	8.2
May	-1.2	7.8
Apr	-0.8	6.1
Mar	-1.9	5.9
Feb	0.1	0.6
Jan	-1.6	6.2
Dec 2009	0.2	-3.2
Nov	0.8	-5.9
Oct	-0.04	-8.9
Sep	0.8	-10.3
Aug	0.9	-13.3
Jul	1.3	-14.9
Jun	-0.3	-17.4
May	-1.2	-17.4
Apr	-0.8	-18.1
Mar	-1.9	-17.1
Feb	0.1	-16.0
Jan	2.8	-16.5
Dec 2008	-3.1	-14.1
Nov	-2.4	-11.5
Oct	-0.6	-9.2
Sep	-3.4	-9.0
Aug	-1.4	-5.5
Jul	-1.1	-4.1
Jun	-0.6	-3.5
May	-0.6	-2.8
Apr	-1.2	-1.5
Mar	-0.4	-0.9
Feb	-0.5	0.6
Jan	0.3	1.9
Dec 2007	0.3	1.8
Nov	0.3	3.2
Oct	-0.5	2.8
Sep	0.5	3.2
Aug	-0.5	2.9
Jul	0.3	3.8
Jun	0.3	3.3
May	-0.2	3.5
Apr	0.7	4.0
Mar	0.7	2.8
Feb	0.5	2.0
Jan	0.3	1.8
Dec 2006		3.2
Dec 2005		1.4
Dec 2004		2.8
Dec 2003		1.7

Source: http://www.federalreserve.gov/releases/g17/table1_2.htm

Chart 1 from the Federal Reserve survey of industrial production and capacity utilization shows sharp acceleration of growth and capacity in the 1990s but flattening slope of the growth curve in the 2000s. Part of the problem of recovery of industry in the current cyclical upswing is the underlying less dynamic environment of growth in the past decade.

The Empire State Manufacturing Survey of the Federal Reserve Bank of New York finds significant worsening of economic conditions in the district (http://www.newyorkfed.org/survey/empire/aug2011.pdf):

“The August Empire State Manufacturing Survey indicates that conditions for New York manufacturers continued to worsen. The general business conditions index fell four points to -7.7, its third consecutive negative reading. The new orders index also remained below zero, at -7.8, while the shipments index was positive at 3.0. The unfilled orders and inventories indexes dropped further into negative territory. The index for number of employees was slightly positive, while the average workweek index was slightly negative. Future indexes weakened significantly. The future general business conditions index plummeted twenty-four points to 8.7, its lowest level since February 2009, and the future new orders and shipments indexes, while positive, fell to near-record lows exceeded only by their September 2001 readings. The capital expenditures index was also down sharply.”

Many indicators of real economic activity are returning to their levels in 2009 and even some close to prior record lows. These are diffusion indexes such that negative values indicate contraction. The two critical indexes in Table 35 are General Business Condition now deeper in negative territory at -7.82 and new orders, an indicator of future production, deeper in negative territory at -7.82. Indexes of expectations for the next six months have significantly declined with General Business conditions down from 25.56 in Jul to very slow 6.52 in Aug and new orders from 25.56 in Jul to only 7.61 in Aug.

Table 35, New York Federal Reserve Bank Empire State Manufacturing Survey Index

	Jun	Jul	Aug
Current Conditions
General Business Conditions	-7.79	-3.76	-7.72
New Orders	-3.61	-5.45	-7.82
Shipments	-8.02	2.22	3.01
Unfilled Orders	0.00	-12.22	-15.22
Inventories	1.02	-5.56	-7.61
# Employees	10.20	1.11	3.26
Average Employee Workweek	-2.04	-15.56	-2.17
Expectations Six Months
General Business Conditions	22.45	32.22	8.70
New Orders	15.31	25.56	6.52
Shipments	17.35	30.00	7.61
Unfilled Orders	-9.18	5.56	-6.52
Inventories	-9.18	1.1	7.61
# Employees	6.12	17.78	6.52
Average Employee Workweek	-2.04	2.22	-4.35

Source: http://www.newyorkfed.org/survey/empire/aug2011.pdf

http://www.newyorkfed.org/survey/empire/july2011.pdf

The Business Outlook Survey of the Federal Reserve Bank of Philadelphia is another indicator returning to lows in 2009 (http://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0811.pdf):

“The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, decreased from a slightly positive reading of 3.2 in July to ‐30.7 in August. The index is now at its lowest level since March 2009 (see Chart). The demand for manufactured goods, as measured by the current new orders index, paralleled the decline in the general activity index, falling 27 points. The current shipments index fell 18 points and recorded its first negative reading since September of last year. Suggesting weakening activity, indexes for inventories, unfilled orders, and delivery times were all in negative territory this month.”

An analysis of the Business Outlook Survey in relation to other indexes is provided by Shiller and Trebin (2003). As with the segment of prices, there is difference between current activity and expectations for the next six months in Table 36. The decline of the general index is brutal, from 3.2 in Jul to 30.7 in Aug, which places the level similar at contraction similar to that in Mar 2009. Perhaps the more important change is the reading of new orders at minus 26.8. All segments of the current survey are strongly negative with the exception of number of employees at minus 5.2. The expectations for the next six months are lower than in Jul but all in positive territory except for unfilled orders and average employee workweek.

Table 36, FRB of Philadelphia Business Outlook Survey Diffusion Index SA

	Jun	Jul	Aug
Current Jun/May
General Index	-7.7	3.2	-30.7
New Orders	-7.6	0.1	-26.8
Shipments	4.0	4.3	-13.9
Unfilled Orders	-16.3	-16.3	-20.9
Number Employees	4.1	8.9	-5.2
Average Employee Workweek	1.9	-5.4	-14.4
Expectation Six Months
General Index	2.5	23.7	1.4
New Orders	7.9	27.8	16.3
Shipments	6.6	23.0	12.6
Unfilled Orders	-9.6	2.9	-3.5
Number Employees	5.5	10.1	7.8
Average Employee Workweek	-1.6	4.1	-5.3

Sources: http://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0711.pdf

http://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0611.pdf

The residential construction report of the US Bureau of the Census in Table 37 shows monthly decline by 1.5 percent from Jun into July, measured in seasonally adjusted annual equivalent rates, after increasing by 10.8 percent from May into Jun. Housing permits fell 3.2 percent in Jul 2011 relative to Jun after increasing 1.3 percent from May into Jun.

Table 37, Housing Starts and Permits Seasonally Adjusted Annual Equivalent Rates, Thousands of Units, %

	Housing Starts	Housing Permits
Jul 2011	604	597
Jun 2011	613	617
∆% Jul/Jun 2011	-1.5	-3.2
May 2011	553	609
∆% Jun/May 2011	10.8	1.3

Source: http://www.census.gov/const/newresconst.pdf

Housing starts, not seasonally adjusted, fell 3.6 percent in Jan-Jul 2011 relative to Jan-Jul

2010 and new permits fell 5.1 percent, as shown in Table 38. Housing starts fell 69.9 percent in Jan-Jul 2011 relative to the same period in 2006 and 71.5 percent relative to the same period in 2005. New permits in Jan-Jul 2011 fell 70.8 percent relative to Jan-Jul 2006 and 72.6 percent relative to Jan-Jul 2005. The National Association of Realtors informs that existing home sales, consisting of completed sales of single family homes, condominiums and co-ops, fell 3.5 percent seasonally adjusted in Jul relative to Jun and are 21.0 percent above the level in Jul 2010, which was a trough immediately after the expiration of the home buyer tax credit (http://www.realtor.org/press_room/news_releases/2011/07/existing_slip).

Table 38, Housing Starts and New Permits, Thousands of Units, NSA, and %

	Housing Starts	New Permits
Jan-Jul 2011	344.9	346.6
Jan-Jul 2010	357.7	365.3
∆%/ Jan-Jun 2011	-3.6	-5.1
Jan-Jul 2006	1145.8	1185.1
∆%/Jan-Jul 2011	-69.9	-70.8
Jan-Jul 2005	1211.2	1264.1
∆%/ Jan-Jul 2011	-71.5	-72.6

Source: http://www.census.gov/const/newresconst.pdf

http://www.census.gov/const/newresconst_200707.pdf

http://www.census.gov/const/newresconst_200607.pdf

The headline number in the Treasury international capital report in Table 39 is the last line C, which consist of the net purchases by foreigners of long-term securities less net purchases by US residents of long-term securities issued in other jurisdictions. The distribution is important in understanding capital flows and simple letter symbols have been added to facilitate understanding. The first line A consists of “Foreign Purchases less Sales of US Long-Term Securities.” A is divided in two parts: A1 or net purchases by the private sector from foreign jurisdictions; and A2 or net purchases by the official sector of other jurisdictions (such as central banks). There is a simple identity:

A = A1 + A2 = Net purchases by the foreign private sector + Net purchases by the foreign official sector

A (Jun) = -$23.0 billion + $11.5 billion = -$11.5 billion.

The foreign private sector A1 can buy Treasury securities (A11) or agency securities (A12), corporate securities (A13) and equities (A14). Thus,

A1 = A11 + A12 + A13 + A14

A1 (Jun) = -$18.3 billion + $2.1 billion - $10.0 billion + $3.1 billion = -$23.0 billion.

There is a minor rounding error. In May, the private sector of other jurisdictions engaged in net purchases of $16.4 billion of Treasury securities but sold net $18.3 billion of Treasury securities in Jun.

In the same way,

A2 = A21 + A22 + A23 + A24

A2 (Jun) = $13.8 billion -$2.4billion – $0.7billion + $0.8billion = $11.5 billion

A (Jun) = A1 + A2 = -$23.0 + $11.5 = -$11.5 bilhões

This means that net sales by foreigners of long-term US securities were negative $11.5 billion.

B measures net purchases by US residents of securities issued in foreign jurisdictions that are divided in fixed-income securities (B1), or foreign bonds, and equities (B2). B in Jun was $15.2 billion.

“Net Foreign Purchases of US Long-term Securities,” C, are equal to the sum of A (Foreign Purchases less Sales of US Long-term Securities) plus B (Net US Purchases of Long-term Foreign Securities). That is,

C = A + B = C (Jun) = -$11.5 billion + $15.2 billion = $3.7 billion

It is difficult to separate various factors affecting decisions. Managers of large volumes of fixed-income securities do not appear to have taken seriously the game of chicken with the increase in the limit of US debt. The US was not facing default because of insolvency.

Table 39, Net Cross-Borders Flows of US Long-Term Securities, Billion Dollars, NSA

	Apr 2011	May 2011	Jun 2011
A Foreign Purchases less Sales of US LT Securities	44.8	44.6	-11.5
A1 Private	14.7	21.4	-23.0
A11 Treasury	-4.8	16.4	-18.3
A12 Agency	5.7	-8.9	2.1
A13 Corporate Bonds	-2.8	6.0	-10.0
A14 Equities	16.6	7.9	3.1
A2 Official	30.1	23.2	11.5
A21 Treasury	28.1	21.5	13.8
A22 Agency	1.8	0.7	-2.4
A23 Corporate Bonds	-1.0	-0.4	-0.7
A24 Equities	1.2	1.4	0.8
B Net US Purchases of LT Foreign Securities	-14.2	-20.4	15.2
B1 Foreign Bonds	-1.3	-14.1	-13.4
B2 Foreign Equities	-12.9	-6.4	1.8
C Net Foreign Purchases of US LT Securities	30.6	24.2	3.7

C = A + B;

A = A1 + A2

A1 = A11 + A12 + A13 + A14

A2 = A21 + A22 + A23 + A24

B = B1 + B2

Sources: http://www.treasury.gov/press-center/press-releases/Pages/tg1277.aspx

The combination of current account deficits and government deficits will require much stronger foreign financing. The main doubt is whether expectations of continuing devaluation of the dollar and increases in government debt will reach a point of satiation of US securities at which a discount premium on US government debt may force abrupt fiscal and external adjustment. The fiscal theory of the price level also argues that inflation would rise. High economic growth over more than a century and relatively sound fiscal management has allowed the US to avoid distrust of its debt obligations. There is no past experience of debt disruption but current circumstances are worrisome. Table 40 provides the major holders of US Treasury securities in Jun 2011, Mar 2011 and Dec 2010. China, the UK, Japan, oil exporting countries and Brazil increased their holdings of US Treasury securities. There may be a limit as to how much US Treasury debt foreign holders may desire but that point of satiation is not in the immediate future.

Table 40, Major Foreign Holders of Treasury Securities $ Billions at End of Period

	Jun 2011	Mar 2011	Dec 2010
China	1165.5	1144.9	1160.1
Japan	911.0	907.9	882.3
United Kingdom	349.5	325.2	271.6
Oil Exporters	229.6	222.3	211.9
Brazil	207.1	193.5	186.1
Taiwan	153.4	156.1	155.1
Caribbean Banking Centers	140.5	154.9	168.1
Hong Kong	118.4	122.1	134.2
Russia	109.8	127.8	151.0
Switzerland	108.2	109.9	107.0

Source: http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt

V World Trade and Growth. The relationship of trade, capital flows and economic growth has been the subject of intensive research. The gains from international trade and the role of trade in employment and conservation of resources are also widely researched (see Pelaez and Pelaez, Globalization and the State Vol. I (2009a), Globalization and the State Vol. II (2009b) and Government Intervention in Globalization (2009c)). Trade has been an important driver of growth in the past decade; trade contracted during the global recession; and trade has been driving growth in the expansion. The JP Morgan Global PMI compiled by Markit shows that world manufacturing exports have nearly stagnated with the worst performance since Jul 2009 (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/global_economy_11_07_07.pdf).

The forecasts of world output and trade growth in the revised Jun World Economic Outlook of the IMF are shown in Table 41. World output contracted by 0.5 percent in 2009 and then rebounded with growth of 5.1 percent in 2010 with the IMF projecting growth of 4.3 percent in 2011 and 4.5 percent in 2012. The contraction of 0.5 percent in 2009 is actually a much higher loss when adding GDP growth of 4 percent or more that would have occurred in the absence of the global recession. Table 41 shows strong impact of the global recession in the form of contraction of world trade by 10.8 percent. The advanced economies suffered much more with declines of 12.0 percent in exports and 12.5 percent in imports but the impact on emerging and developing economies was also strong with contraction of both exports and imports by 7.9 percent. Output growth of 5.1 percent was accompanied by double-digit increases in trade, 12.4 percent, and exports and imports of advanced economies and emerging and developing economies. Projections for 2011 and 2012 are for more moderate growth after the initial jump in 2010. New data on growth and trade are discussed below in the remainder of this section divided into three subsections, according to regions, using regional data tables: IVA Japan, IVB Euro Area, VC Germany and IVD United Kingdom.

Table 41, IMF Forecasts of Growth of World Output and World Trade ∆%

	2009	2010	2011	2012
Output	-0.5	5.1	4.3	4.5
Trade	-10.8	12.4	8.2	6.7
Exports
Advanced Economies	-12.0	12.3	6.8	6.1
Emerging Developing	-7.9	12.8	11.2	8.3
Imports
Advanced Economies	-12.5	11.6	6.0	5.1
Emerging Developing	-7.9	13.7	12.1	9.0

Source: http://www.imf.org/external/pubs/ft/weo/2011/update/02/index.htm

VA Japan. The regional data table for Japan, Table JPY, provides a summary of major economic indicators and the date and links of the blog comment in which greater detail can be obtained. Japan’s continues robust recovery from the natural disaster in the form of the earthquake/tsunami on Mar 11. Several recent important indicators are discussed below.

Table JPY, Japan, Economic Indicators

Historical GDP and CPI	1981-2010 Real GDP Growth and CPI Inflation 1981-2010 Blog 07/31/11
Corporate Goods Prices	Jul ∆% 0.2 12 months ∆% 2.9 Blog 08/14/11
Consumer Price Index	Jun SA ∆% –0.1 Jun 12 months NSA ∆% 0.2 Blog 07/31/11
Real GDP Growth	IIQ2011 ∆%: –0.3 on IQ2011; Seasonally adjusted annual equivalent rate ∆%: –1.3 ∆% from quarter a year earlier: –0.9% Blog 08/14/11
Employment Report	Jun Unemployed 2.93 million Unemployment rate: 4.6% Blog 07/31/11
All Industry Index	Jun month SA ∆% 2.3 12 months NSA ∆% 0.2 Blog 08/21/11
Industrial Production	Jun SA month ∆%: 3.9 12 months NSA ∆% –1.6 Blog 07/31/11
Machine Orders	Apr-Jun 2011 ∆% –9.6 Forecast Jul –Sep 2011 ∆% –0.9 Jun ∆% Excluding Volatile Orders 7.7 Blog 08/14/2011
Tertiary Index	Jun month SA ∆% 1.19 Jun 12 months NSA ∆% 0.8 Blog 08/14/2011
Wholesale and Retail Sales	Jun 12 months: Total ∆% 2.9 Wholesale ∆%: 3.5 Retail ∆%: 1.1 Blog 07/31/11
Trade Balance	Exports Jul 12 months ∆%: -3.3 Imports Jul 12 months ∆% 9.9 Blog 08/21/11

Links to blog comments in Table JPY:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

The all industry index of Japan and real GDP are shown in Table 42. The index is a broad measure of economic activity with contributions by agriculture (not shown in Table 42 with low weight of 1.4 percent), industrial production, tertiary activities and government. The all industry index is constructed for monthly and quarterly frequency and quarter data supplement real GDP. The earthquake/tsunami of Mar 11, 2011, had a strong impact on the economy of Japan. Real GDP fell 0.3 percent in IIQ2011 while the all industry index fell 0.4 percent and industrial production declined 7.1 percent. The all industry index had a strong negative drop of 1.9 percent IQ2011, originating in decline of industry by 2.0 percent and tertiary activity by 1.4 percent. Real GDP still grew 0.9 percent. Recovery was uneven in Japan in 2010 with weak performance in IVQ2010 in which both the all industry declined, by 0.2 percent, as well as real GDP that fell 0.6 percent.

Table 42, Japan, Indices of All Industry Activity Percentage Change from Prior Quarter SA ∆%

	CON	IND	TERT	GOVT	ALL IND	REAL GDP
Weight %	5.7	18.3	63.2	11.4	100.0
2011
IIQ	-7.1	-4.0	-0.1	0.4	-0.4	-0.3
IQ	2.7	-2.0	-1.4	0.2	-1.9	0.9
2010
IV Q	-1.8	-0.1	0.3	-0.3	-0.2	-0.6
III Q	1.9	-1.0	0.6	0.0	0.7	1.0
IIQ	-0.9	0.7	0.4	-0.2	0.8	-0.1
IQ	0.7	7.4	0.7	-0.4	1.3	2.3

AG: indices of agriculture, forestry and fisheries has weight of 1.4% and is not included in official report or in this table; CON: indices of construction industry activity; IND: indices of industrial production; TERT: indices of tertiary industry activity; GOVT: indices of government services, etc.; ALL IND: indices of all industry activity

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201106j.pdf

Monthly percentage changes of the all industry index SA are shown in Table 43. Measure by the general perspective of the all industry index, economic activity in Japan in 2010 was erratic and weak in various months. There were two months of 0 percent change, in May and Oct, two months of negative change, Aug -0.5 percent and Sep -0.4 percent and growth was only 0.1 percent in Dec 2010. After two good months in Jan, 0.5 percent, and Feb, 0.9 percent, the all industry index fell 6.4 percent in Mar with the earthquake/tsunami occurring on Mar 11. Industrial production fell 15.5 percent in the month of Mar, construction dropped 8.6 percent and tertiary activity declined 5.9 percent. Japan recovered in V shape, with growth of 1.7 percent in Apr, 1.8 percent in May and 2.3 percent in Jun.

Table 43, Japan, Indices of All Industry Activity Percentage Change from Prior Month SA ∆%

	CON	IND	TERT	GOVT	ALL IND
Jun 2011	0.3	3.8	1.9	0.8	2.3
May	3.7	6.2	0.8	0.4	1.8
Apr	5.7	1.6	2.7	-0.1	1.7
Mar	-8.6	-15.5	-5.9	-0.1	-6.4
Feb	6.3	1.8	0.8	0.2	0.9
Jan	2.3	0.0	-0.1	0.0	0.5
Dec 2010	-0.5	2.4	-0.2	0.3	0.1
Nov	-1.4	1.6	0.6	-0.4	0.3
Oct	0.1	-1.4	0.2	-0.1	0.0
Sep	-1.9	-0.8	-0.4	-0.1	-0.4
Aug	1.6	-0.1	0.1	0.1	-0.5
Jul	0.8	0.3	0.7	0.1	1.1
Jun	-2.1	-1.5	0.1	-0.1	0.2
May	6.3	-0.1	-0.3	0.0	0.0
Apr	-3.1	0.6	1.6	-0.2	0.9

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201106j.pdf

Table 44 provides the percentage change of the all industry activity and real GDP from the earlier calendar year from 2008 to 2010 and of the quarter relative to the same quarter a year earlier for 2010 and 2011. The global recession resulted in deep contraction of the economy of Japan with decline of GDP by 6.3 percent in 2009 after dropping 1.2 percent in 2008. The deceleration of the economy in IVQ2010 is evident in the decline of the year-on-year quarterly rate of GDP growth to 2.1 percent compared with higher growth in the first three quarter.

Table 44, Japan, Indices of All Industry Activity Percentage Change from Earlier Calendar Year and Same Quarter Year Earlier NSA ∆%

	CON	IND	TERT	GOVT	ALL IND	REAL GDP
Weight %	5.7	18.3	63.2	11.4	100.0
Calendar Year
20010	-7.0	16.4	1.3	-0.7	3.1	4.0
2009	-5.6	-21.9	-5.2	0.1	-7.7	-6.3
2008	-7.6	-3.4	-1.0	-1.4	-1.9	-1.2
2011
IIQ	-4.6	-6.8	-0.6	0.3	-1.7	-1.0
IQ	1.6	-2.5	-0.1	-0.4	-0.5	-1.0
2010
IV Q	-0.6	5.9	1.6	-0.8	2.1	2.1
III Q	-3.2	14.0	1.8	-0.6	3.2	5.0
IIQ	-11.3	21.3	1.4	-0.7	3.5	3.1
IQ	-12.4	28.0	0.8	-0.5	3.9	5.6

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201106j.pdf

Finally, Table 45 provides the percentage change of the all industry index relative to the same month a year earlier. Japan was not able to grow relative to the same month a year earlier n the month of Jun 2011 with 0.2 per cent higher than in Jun 2010. Industrial production was growing at extremely high 12 months rates ranging from 12.1 percent in Sep 2010 to 27.0 percent in Apr but the rate fell sharply to 5.0 percent in Oct 2010. Tertiary activity also weakened in Oct 2010.

Table 45, Japan, Indices of All Industry Activity Percentage Change from Same Month Year Earlier NSA ∆%

	CON	IND	TERT	GOVT	ALL IND
Jun 2011	-4.0	-1.7	0.8	1.0	0.2
May	-6.0	-5.5	-0.3	-0.5	-1.4
Apr	-3.8	-13.6	-2.3	0.4	-4.0
Mar	-1.1	-13.1	-3.1	-0.3	-4.5
Feb	4.4	2.9	2.0	-0.3	2.0
Jan	1.3	4.6	1.1	-0.5	1.4
Dec 2010	-0.5	5.9	1.8	-0.7	2.1
Nov	-0.5	7.0	2.5	-1.9	2.7
Oct	-1.1	5.0	0.5	0.3	1.3
Sep	-2.8	12.1	1.3	-0.6	2.7
Aug	-1.7	15.5	2.3	-1.1	3.8
Jul	-5.3	14.6	1.6	-0.1	3.3
Jun	-8.3	16.6	1.0	-0.7	3.0
May	-8.1	20.7	1.2	-0.9	3.4
Apr	-17.0	27.0	1.9	-0.4	-

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201106j.pdf

The economy of Japan has been affected by at least four effects beyond its control. (1) Financial risk aversion diverts capital from investment in risk financial assets to the safe haven of Japan, which even after downgrading of its sovereign risk rating is attractive because of the country’s ability to finance its debt with domestic savings. Capital inflows appreciate the JPY with adverse effects on the competitiveness of Japanese products in markets at home and abroad. (2) The earthquake/tsunami required major efforts to recover the economy already in a weak growth phase at the turn of 2010. (3) Deceleration of world economic growth and regional problems such as European soft economy and China’s efforts to slow growth to control inflation have adverse effects on demand for exports from countries such as Japan. (4) Zero interest rates and quantitative easing encourage carry trades that result in higher commodity prices. Japan is shocked by deterioration of its terms of trade, or export prices relative to import prices, and profit margins of exporters are compressed. Table 46 provides exports, imports and the trade balance of Japan since Jul 2010. Exports had a major shock from the earthquake/tsunami, falling by 12.4 percent in Apr 2011 relative to Apr 2010 and falling 8 percent from the cumulative Apr-Jun 2011 to Apr-Jun 2010. Exports in Jul fell 3.3 percent relative to a year earlier while imports gained 9.9 percent for a trade balance surplus of JPY 72.5 billion. Imports continued to increase by 10.4 percent in Apr-Jun and 9.9 percent in Jul. Japan’s trade surplus reversed in Apr-Jun to a deficit of JPY 1,256 billion.

Table 46, Japan, Exports, Imports and Trade Balance, NSA JPY Billions and ∆%

	Exports JPY Billions	12 months ∆%	Imports JPY Billions	12 months ∆%	Balance YPY Billions
Jul 2011	5,781.9	-3.3	5,709.4	9.9	72.5
Jun	5,775.6	-1.6	5,706.9	9.8	68.6
May	4,760.0	-10.3	5,617.3	12.4	-857.3
Apr	5,156.6	-12.4	5.624.3	9.0	-467.7
Mar	5,861.2	-2.3	5,674.9	12.0	186.3
Feb	5.589.0	9.0	4,938.7	10.0	650.3
Jan	4,970.3	1.4	5,449.7	12.2	-479.4
Dec 2010	6,112.0	12.9	5,392.4	10.7	32.6
Nov	5,439.8	9.1	5,282.2	14.3	157.6
Oct	5,722.5	7.8	4,909.9	8.9	812.6
Sep	5,839.6	14.3	5,065.3	10.3	774.3
Aug	5,209.8	15.5	5,146.0	18.4	63.8
Jul	5,981.9	23.5	5,197.3	16.1	784.6
Jan-Mar 2011	16,420.5	2.4	16,063.3	11.4	357.3
Apr-Jun 2011	15,692.2	-8.0	16,948.5	10.4	-1,256.3

Source: http://www.customs.go.jp/toukei/info/index_e.htm

An important fact of the economy of Japan is its concentration in exporting industrial products. Table 47 shows that the combined share of industrial products in Japan is 84 percent: chemicals 9.7 percent, manufactured goods 13.1 percent, machinery 21.4 percent, electrical machinery 18.3 percent and transport equipment 21.5 percent. With exception of an increase by 1.3 percent in machinery, all categories of industrial products have fallen in the 12 months ending in Jul 2011. While total exports of Japan fell 3.3 percent in the 12 months ending in Jul, total imports rose by 9.9 percent. Imports of raw materials, accounting for 8.4 percent of total imports, rose 15.1 percent, and mineral fuels, accounting for 31.7 percent of total imports, rose 24.5 percent. The joint share of raw materials and mineral fuels is 39.6 percent of total imports. Thus, about 40 percent of Japan’s imports are concentrated in products driven by high increases in their prices resulting from carry trades from zero interest rates of monetary policy to commodity risk positions.

Table 47, Japan, Structure and Growth of Exports and Imports % and ∆%

Jul 2011	Value JPY Billions	% of Total	∆%
Exports	5,781.9	100.0	-3.3
Foodstuffs	27.4	0.5	-12.4
Raw Materials	81.9	1.4	19.1
Mineral Fuels	138.9	2.4	36.7
Chemicals	560.2	9.7	-6.4
Manufactures	757.6	13.1	-1.2
Machinery	1,234.9	21.4	1.3
Electrical Machinery	1,058.9	18.3	-8.3
Transport Equipment	1,245.5	21.5	-7.9
Other	676.3	11.7	-1.7
Imports	5,709.4	100.0	9.9
Foodstuffs	485.5	8.5	4.4
Raw Materials	479.3	8.4	15.1
Mineral Fuels	1810.4	31.7	24.5
Chemicals	540.5	9.5	19.7
Manufactures	502.6	8.8	8.7
Machinery	431.2	7.6	4.5
Electrical Machinery	684.1	12.0	-3.3
Transport Equipment	118.3	2.1	-25.5
Other	657.6	11.5	-1.7

Source: http://www.customs.go.jp/toukei/shinbun/trade-st_e/2011/2011074e.pdf

IVB Euro Area. The regional data table for the euro zone, Table EUR, summarizes important economic indicators for the members of the European Monetary Union. Euro zone GDP is growing at 2.5 percent with significant diversity of growth experiences among the 17 members.

Table EUR, Euro Area Economic Indicators

GDP	IIQ2011 ∆% 0.2; IIQ2011/IIQ2010 ∆% 1.7 Blog 08/21/11
HICP	Flash Jul 12 months ∆%: 2.5 http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-29072011-CP/EN/2-29072011-CP-EN.PDF 12 months Jun ∆%: 2.7 Blog 07/17/11
Producer Prices	Jun month ∆%: 0.0 Jun 12 months ∆%: 5.9 Blog 08/07/11
Industrial Production	Jun month ∆%: -0.7 Jun 12 months ∆%: 2.9 Blog 08/14/11
Industrial New Orders	May month ∆%: 3.6 May 12 months ∆%: 15.5 Blog 07/24/11
Construction Output	May month ∆%: –1.1 May 12 months ∆%: –1.9 Blog 07/24/11
Retail Sales	Jun month ∆%: 0.9 Jun 12 months ∆%: –0.4 Blog 08/07/11
Trade	Jan-Jun 2011/2010 Exports ∆%: 16.8 Imports ∆%: 17.8 Blog 08/21/11

Links to blog comments in Table EUR:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

Markets were disappointed with the release of GDP IIQ2011 growth of 0.2 percent SA relative to IQ2011, shown in Table 48. In IQ2011, GDP grew by 0.8 percent relative to IVQ2010.

Table 48, Euro Area, Quarter GDP ∆% on Prior Quarter SA

	IQ	IIQ	IIIQ	IV
2011	0.8	0.2
2010	0.3	0.9	0.4	0.3
2009	-2.6	-0.2	0.4	0.3

Source: http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&language=en&pcode=teina011&plugin=1

Growth rates of GDP in the euro area in a quarter relative to the same quarter a year earlier NSA are shown in Table 49. The recession was quite deep in 2009 with declines of GDP by 5.4 percent in IQ2009 and 5.5 percent in IIQ2009. The euro area has grown in the past six quarters.

Table49, Euro Area, Quarter GDP ∆% on Same Quarter a Year Earlier NSA

	IQ	IIQ	IIIQ	IV
2011	2.5	1.7
2010	1.0	2.2	2.0	2.0
2009	-5.4	-5.5	-3.9	-1.8

Source: http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&language=en&pcode=teina011&plugin=1

A decade’s perspective on euro area GDP growth is provided in Table 50. Growth rates were slow in 2002 and 2003 but picked up to 3.1 percent in 2006 and 2.8 percent in 2008. GDP fell 4.2 percent in 2009. Growth in 2010 was 1.8 percent even with the shocks of the sovereign risk problems in Apr-Jul 2010, recurring in Nov 2010 and again after Mar 2011.

Table 50, Euro Area Yearly GDP ∆%

	GDP ∆%
2010	1.8
2009	-4.2
2008	0.4
2007	2.8
2006	3.1
2005	1.7
2004	2.2
2003	0.8
2002	0.9
2001	1.9

Source: http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&plugin=1&language=en&pcode=tsieb020

Exports, imports and the trade balance of the euro area in Jan-Jun 2011 and Jan-Jun 2010 are shown in Table 51. There is divergence between the cumulative and monthly data. Exports in Jan-Jun 2011 grew 16.8 percent relative to the same period in 2010 and imports by 17.8 percent. Exports in Jun 2011 grew only 3.4 percent relative to a year earlier and imports 3.3 percent. There should be a price effect from the fall of commodity prices that also reduced the rate of growth of final products. The current release only provides the breakdown of exports and imports until May but the next release will provide the breakdown for Jan-Jun, permitting more definitive analysis. The trade deficit deteriorated from $11.9 billion in Jan-Jun 2010 to $21.3 billion in Jan-Jun 2011.

Table 51, Exports, Imports and Trade Balance of the Euro Area, Billions of Euros and Percent, NSA

	Exports	Imports
Jan-Jun 2011	847.3	868.6
Jan-Jun 2010	725.5	737.4
∆%	16.8	17.8
Jun 2011	143.0	142.1
Jun 2010	138.3	137.6
∆%	3.4	3.3
Trade Balance	Jan-Jun 2011	Jan-Jun 2010
	-21.3	-11.9

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/6-15072011-AP/EN/6-15072011-AP-EN.PDF

VC Germany. The country data table for Germany is provided in Table DE. The German economy has been growing reasonably but stalled to GDP growth of only 0.1 percent in IIQ2011 relative to IQ2011. Germany successfully restructured its economy toward strong participation in world trade.

Table DE, Germany, Economic Indicators

GDP	IIQ2011 0.1 ∆%; II/Q2011/IIQ2010 ∆% 2.7 Blog 08/21/11
Consumer Price Index	Jul month SA ∆%: 0.4 Jul 12 months ∆%: 2.4 Blog 08/14/11
Producer Price Index	Jun month ∆%: 0.1 12 months NSA ∆%: 5.6 Blog 08/07/11
Industrial Production	Jun month SA ∆%: –0.9 12 months NSA: 0.9 Blog 08/07/11
Machine Orders	Jun month ∆%: 1.8 Jun 12 months ∆%: 3.0 Blog 08/07/11
Employment Report	Employment Accounts: Jun Employed 12 months NSA ∆%: 1.2 Labor Force Survey: Jun Unemployment Rate: 6.1% Blog 07/31/11
Trade Balance	Trade Balance NSA Jun €6.0 billion versus May €15.6 billion Exports Jun 12 month NSA ∆%: 3.1 (versus ∆% 19.9 May) Imports Jun 12 months NSA ∆%: 6.0 (versus ∆% 15.6 May) Exports Jun month SA ∆%: -1.2; Imports Jun month SA ∆%: 0.3 Blog 08/14/11

Links to blog comments in Table DE:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

The Statistisches Bundesamt Deutschland (SBD) released revised estimates of the national accounts of Germany since 1991. According to the SBD, the Germany economy decelerated in IIQ2011 (http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2011/08/PE11__297__811,templateId=renderPrint.psml):

“The momentum with which the German economy started into 2011 has slowed down considerably. In the second quarter of 2011, the gross domestic product (GDP) rose just 0.1% – upon price, seasonal and calendar adjustment – on the first quarter, as reported by the Federal Statistical Office (Destatis). The result for the first quarter of 2011 was slightly corrected downwards to +1.3%”

Table 52 shows the growth rate of GDP on a quarter relative to the earlier quarter. Capital formation and exports contributed positively to GDP growth in IIQ2011. A high increase in imports that deteriorated the trade balance contributed negatively to GDP growth, resulting also in an increase in inventories. Another factor of GDP growth deceleration originated in consumption expenditures of households and construction capital formation

Table 52, Germany Quarter GDP ∆% Relative to Prior Quarter

	IQ	IIQ	IIIQ	IV
2011	1.3	0.1
2010	0.5	1.9	0.8	0.5
2009	-4.0	0.3	0.8	0.7
2008	1.1	-0.4	-0.4	-2.2
2007	0.7	0.6	0.9	0.3

Seasonal and calendar adjusted

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2011/08/PE11__297__811,templateId=renderPrint.psml

The rates of growth of GDP of Germany in a quarter relative to the same quarter a year earlier are shown in Table 53. The global recession reflected in sharp drops of quarterly GDP relative to a year earlier in five consecutive quarters from IVQ2008 to IVQ2009. Germany’s economy rebounded strongly with rates ranging from 3.7 percent to 4.7 percent between IIQ2010 to IQ2011. The reduction of the rate of growth to 0.1 percent in IIQ2011 resulted in a reduction of the year on year rate to 2.7 percent.

Table 53, Germany, Quarter GDP ∆% Relative to Same Quarter a Year Earlier

	IQ	IIQ	IIIQ	IV
2011	4.7	2.7
2010	2.5	4.0	4.0	3.7
2009	-6.7	-6.2	-5.1	-2.3
2008	2.9	1.8	0.5	-1.9
2007	4.5	3.4	3.4	2.3

Calendar adjusted

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2011/08/PE11__297__811,templateId=renderPrint.psml

Revised annual growth rates of GDP for Germany are shown in Table 54. The recession was strong in Germany with reduction of the rate of growth in 2008 to 0.8 percent and decline of 5.1 percent in 2009. The economy returned to 3.6 percent growth in 2010.

Table 54, Germany, GDP Year ∆%

	Unadjusted	Calendar Adjusted
2010	3.7	3.6
2009	-5.1	-5.1
2008	1.1	0.8
2007	3.3	3.4

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2011/08/PE11__297__811,templateId=renderPrint.psml

VD United Kingdom. The UK economy continues to grow at moderate rates, as shown in the country data Table UK. IIQ2011 GDP grew 0.2 percent and 0.7 percent relative to a year earlier.

Table UK, UK Economic Indicators


CPI	Jun month ∆%: –0.1 Jun 12 months ∆%: 4.2 Blog 07/17/11
Output/Input Prices	Output Prices: Jul 12 months NSA ∆%: 5.9; excluding food, petroleum ∆%: 3.3 Input Prices: Jul 12 months NSA ∆%: 18.5 Excluding ∆%: 13.1 Blog 08/07/11
GDP Growth	IIQ2011 prior quarter ∆% 02; year earlier same quarter ∆%: 0.7 Blog 07/17/11
Industrial Production	Jun 2011/Jun 2010 NSA ∆%: Industrial Production -0.3; Manufacturing 2.1 Jun 2011/May 2011 SA ∆%: Industrial Production 0.0; Manufacturing -0.4Blog 08/14/11
Retail Sales	Jul month SA ∆%: 0.2 Jul 12 months ∆%: 0.0 Blog 08/21/11
Labor Market	Mar-May Unemployment Rate: 7.7% Blog 07/17/11
Trade Balance	Balance Jun -₤4,496 billion Exports Jun ∆%: -2.8 IIQ2011/IIQ2010 ∆%: 8.6 Imports Jun ∆%: -1.5 IIQ2011/IQ2010 ∆%: 7.3 Blog 08/14/11

Links to blog comments in Table UK:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

There are mixed results in the UK labor market report for quarter Apr-Jun in Table 55. The unemployment rate rose from 7.7 percent in the prior quarter to 7.9 percent; the number employed increased by 25,000 and by 251,000 in the year; and the number unemployed rose by 38,000 to 2.49 million. The earnings growth rate of 2.3 percent is below inflation and does not set pressure on the monetary policy committee of the Bank of England. The adverse part of the report is the rise by 83,000 to 1.26 million of persons who work part-time because they cannot find another job, which is the highest level since 1992. The global recession has resulted in high rates of unemployment and underemployment in advanced economies. Another adverse aspect is the rise in the claimant count by 37,100 with higher rate of 4.9 percent.

Table 55, UK Labor Market Statistics

	Quarter Apr-Jun 2011
Unemployment Rate	7.9%
Number Unemployed	+38,000 (2.49 million)
Number Unemployed Up to Six months	+66,000 to reach 1.23 million (largest increase in the series since Jun 2009)
Inactivity Rate 16-64 Years of Age	23.2%
Employment Rate	70.7%
Number Employed	+25,000 in Apr-Jun, +251,000 in year to reach 29.27 million, lower than peak of 29.57 million in Mar-May 2008
Earnings Growth Rates Year on Year	2.3%
Part-Time Because No Other Job Available	+83,000 (1.26 million, highest since 1992)
	Jul 2011
Claimant Count	Latest estimate: 1,564 thousand; +37,100 since Jun (rate: 4.9% +0.1 from 4.8% in Jun)

Source: http://www.statistics.gov.uk/pdfdir/lmsuk0811.pdf

The UK Office for National Statistics estimates that the volume of retails sales stagnated in Jul 2011 and rose only 0.2 percent relative to Jul 2010 (http://www.statistics.gov.uk/pdfdir/rs0811.pdf), as shown in Table 56. As in most advanced economies, demand has been weak with significant fluctuations in monthly sales. Chart 2 shows trendless oscillation of retail sales in the UK in the past 14 months. The annual equivalent rate in the first seven months of 2011 is 1.7 percent.

Table 56, UK, Volume of Retail Sales ∆%

	Month SA ∆%	12 Months ∆%
Jul 2011	0.2	0.0
Jun	0.8	0.4
May	-1.3	-0.1
Apr	1.1	2.3
Mar	0.0	0.7
Feb	-1.2	0.9
Jan	1.4	5.0
AE ∆%	1.7
Dec 2010	-0.9	-0.8

Source: http://www.statistics.gov.uk/pdfdir/rs0811.pdf

Chart 2, UK Retail Sales

Source: http://www.statistics.gov.uk/pdfdir/rs0811.pdf

Total retail sales of the UK excluding automotive fuel have been growing at 12 months rates that parallel total retail sales, as shown in Table 57. The driver of poor retails sales performance has been the segment of predominantly food stores with negative 12-months rates of growth and record decline in Jun. Nonfood store sales have been more dynamic and auto fuel sales recovered in 2011 from sharp drops in 2010.

Table 57, UK, 12 Months Rates of Growth of Retail Sales by Component Groups ∆%

	All Retail	Ex Auto Fuel	Food Stores	Non- Food	Auto Fuel
Jul 2011	0.0	-0.2	-1.6	-1.1	2.6
Jun	0.4	0.2	-4.1	0.8	3.5
May	-0.1	-0.3	-3.7	0.2	2.0
Apr	2.3	2.2	1.1	1.3	3.7
Mar	0.7	0.3	-1.1	0.2	4.2
Feb	0.9	0.6	-1.9	0.8	4.6
Jan	5.0	4.8	-2.0	8.7	7.1
Dec 2010	-0.8	0.1	-3.7	1.6	-9.7

Source: http://www.statistics.gov.uk/pdfdir/rs0811.pdf

The breakdown of the 12-month rate of growth of 0.0 percent in Jul into percentage point contributions is shown in Table 58. Predominantly food stores have a share of 42 percent of the retail sales index. The decline in 12 months of predominantly food stores sales volume by 1.6 results in a deduction of 0.7 percentage points contributions to the 0.0 percent growth rate of total retail sales [(0.42 x 0.016)100 = 0.7 % points]. The fall by 1.1 percent of predominantly nonfood stores volume contributes minus 0.5 percentage points. Non-store retailing grew by 16.9 percent that even with its minute share of 4.5 percent in the retail sales index results in contribution of 1.0 percentage point. Automotive fuel volume grew by 2.6 percent with positive contribution of 0.2 percentage points.

Table 58, UK Volume of Retail Sales 12-month ∆% and Percentage Points Contributions by Sectors

Jul 2011	Weight % of All Retailing	Volume SA 12 Months ∆%	PP Contribution % points
All Retailing	100.00	0.0
Mostly Food Stores	42.0	-1.6	-0.7
Mostly Nonfood Stores
Total	43.3	-1.1	-0.5
Non- specialized	7.6	4.0	0.3
Textile, Clothing & Footwear	12.1	-1.0	-0.1
Household Goods Stores	10.2	-4.1	-0.4
Other	13.4	-2.0	-0.3
Non-store Retailing	4.5	16.9	1.0
Automotive Fuel	10.2	2.6	0.2

Source: http://www.statistics.gov.uk/pdfdir/rs0811.pdf

The UK Office for National Statistics estimates that retails sales in Jul 2011 in the UK, unadjusted for inflation, reached ₤26.0 billion for a 2.3 percent increase relative to €24.9 billion in Jul 2010 (http://www.statistics.gov.uk/pdfdir/rs0811.pdf 1). Table 59 provides the growth rates and percentage contributions by segments to the increase in the value of retail sales. Sales of predominantly food stores rose 4.0, contributing 1.7 percentage points to the rate of 4.3 percent. Sales of automotive fuel rose 17.7 percent, contributing 1.8 percentage points to total retail sales value growth. The joint contribution of predominantly food stores and automotive fuel to growth of value of retail sales was 3.5 percent with the remainder consisting of 0.7 percentage points contributed by non-store retailing, rising 16.1 percent, and 0.1 percentage points by predominantly nonfood stores. The increase in value of consumer sales was all inflation with flat growth of volume in 12 months. The commodity price shock has resulted in stagnation of sales volumes by squeezing purchasing power of consumers.

Table 59, UK Value of Retail Sales 12-month ∆% and Percentage Points Contributions by Sectors

Jul 2011	Weight % of All Retailing	Value SA 12 Months ∆%	PP Contribution % points
All Retailing	100.0	4.3
Mostly Food Stores	42.0	4.0	1.7
Mostly Nonfood Stores
Total	43.3	0.2	0.1
Non- specialized	7.6	3.6	0.3
Textile, Clothing & Footwear	12.1	2.7	0.3
Household Goods Stores	10.2	-3.4	-0.3
Other	13.4	-1.5	-0.2
Non-store Retailing	4.5	16.1	0.7
Automotive Fuel	10.2	17.7	1.8

Source: http://www.statistics.gov.uk/pdfdir/rs0811.pdf

VI Valuation of Risk Financial Assets. V Valuation of Risk Financial Assets. The financial crisis and global recession were caused by interest rate and housing subsidies and affordability 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). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

Table 60 shows the phenomenal impulse to valuations of risk financial assets originating in the initial shock of near zero interest rates in 2003-2004 with the fed funds rate at 1 percent, in fear of deflation that never materialized, and quantitative easing in the form of suspension of the auction of 30-year Treasury bonds to lower mortgage rates. World financial markets were dominated by monetary and housing policies in the US. Between 2002 and 2008, the DJ UBS Commodity Index rose 165.5 percent largely because of the unconventional monetary policy encouraging carry trade from low US interest rates to long leveraged positions in commodities, exchange rates and other risk financial assets. The charts of risk financial assets show sharp increase in valuations leading to the financial crisis and then profound drops that are captured in Table 60 by percentage changes of peaks and troughs. The first round of quantitative easing and near zero interest rates depreciated the dollar relative to the euro by 39.3 percent between 2003 and 2008, with revaluation of the dollar by 25.1 percent from 2008 to 2010 in the flight to dollar-denominated assets in fear of world financial risks and then devaluation of the dollar by 20.7 percent by Fri Aug 19, 2011. Dollar devaluation is a major vehicle of monetary policy in reducing the output gap that is implemented in the probably erroneous belief that devaluation will not accelerate inflation. The last row of Table 60 shows CPI inflation in the US rising from 1.9 percent in 2003 to 4.1 percent in 2007 even as monetary policy increased the fed funds rate from 1 percent in Jun 2004 to 5.25 percent in Jun 2006.

Table 60, 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	08/19 /2011
Rate	1.1423	1.5914	1.192	1.439
CNY/USD	01/03 2000	07/21 2005	7/15 2008	08/19 2011
Rate	8.2798	8.2765	6.8211	6.3825
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

Table 61 extracts four rows of Table 60 with the Dollar/Euro (USD/EUR) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 25.1 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul, 2010, shown in Table 63 below, the dollar has devalued again to USD 1.439/EUR or by 20.7 percent. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD until it revalued to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent and after fixing it again to the dollar, revalued to CNY 6.3925/USD on Fri Aug 19, 2011, or by an additional 6.3 percent, for cumulative revaluation of 22.8 percent.

Table 61, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate

USD/EUR	6/26/03	7/14/08	6/07/10	08/19 /2011
Rate	1.1423	1.5914	1.192	1.439
CNY/USD	01/03 2000	07/21 2005	7/15 2008	08/19 2011
Rate	8.2798	8.2765	6.8211	6.3925

Source: Table 60.

Dollar devaluation did not eliminate the US current account deficit, which is projected by the International Monetary Fund (IMF) at 3.2 percent of GDP in 2011 and also in 2012, as shown in Table 62. Revaluation of the CNY has not reduced the current account surplus of China, which is projected by the IMF to increase from 5.7 percent of GDP in 2011 to 6.3 percent of GDP in 2012.

Table 62, 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

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 60 above after the first policy round of near zero fed funds and quantitative easing by the equivalent of 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, falling real wages, depressed hiring and high job stress of unemployment and underemployment in the US now with realization of slow growth recession. The “trend is your 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 driven by the carry trade from zero interest rates with fluctuations provoked by events of risk aversion. Table 63, which is updated for every comment of this blog, shows the deep contraction of valuations of risk financial assets after the Apr 2010 sovereign risk issues in the fourth column “∆% to Trough.” There was sharp recovery after around Jul 2010 in the last column “∆% Trough to 08/19/11,” which is now stalling or reversing amidst profound risk aversion. Recovering risk financial assets are in the range from 4.9 percent for the Dow Global and 28.2 percent for the DJ UBS Commodity Index. Before the current round of risk aversion, all assets in the column “∆% Trough to 08/19/11” had double digit gains relative to the trough around Jul 2, 2010. There are now several valuations lower than those at the trough around Jul 2: European stocks index STOXX 50 is now 7.6 percent below the trough on Jul 2, 2010; the NYSE Financial Index is 6.8 percent below the trough on Jul 2, 2010; Germany DAX index is 3.4 percent below; and Japan’s Nikkei is 1.2 percent below the trough on Aug 31, 2010 and 23.5 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 8719.24 on Fri Aug 19, which is 14.9 percent below 10,254.43 on Mar 11 on the date of the earthquake. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 20.7 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 08/19/2011” shows negative performance of all financial assets, except for gain of 1.3 percent for the DJ UBS Commodity index, with DAX losing 8.6 percent, the Nikkei Average losing 2.7 percent and the NYSE Financial Index dropping 5.4 percent. The Dow Global lost 3.9 percent with losses in all stock indexes in Table 63 for a second consecutive week. DJIA dropped 4.0 percent and S&P 500 fell 4.7 percent. There are still high uncertainties on European sovereign risks, US debt/growth recession and China’s growth and inflation tradeoff. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with caution instead of more aggressive risk exposures. There is a fundamental change in Table 63 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 8/19/11” that provides the percentage from the peak in Apr 2010 before the sovereign risk event to Jul 29. Most financial risk assets had gained not only relative to the trough as shown in column “∆% Trough to 8/19/11” but also relative to the peak in column “∆% Peak to 8/19/11.” Only one index is now above the peak, DJ UBS Commodity Index by 9.6 percent. There are several indexes well below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 25.8 percent, Nikkei Average by 23.5 percent, Shanghai Composite by 19.9 percent and STOXX 50 by 21.8 percent. The factors of risk aversion have adversely affected the performance of financial risk assets. The performance relative to the peak in Apr is more important than the performance relative to the trough around early Jul because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010.

Table 63, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 8/ 19/11	∆% Week 8/ 19/11	∆% Trough to 8/ 19/11
DJIA	4/26/ 10	7/2/10	-13.6	-3.5	-4.0	11.7
S&P 500	4/23/ 10	7/20/ 10	-16.0	-7.7	-4.7	9.9
NYSE Finance	4/15/ 10	7/2/10	-20.3	-25.8	-5.4	-6.8
Dow Global	4/15/ 10	7/2/10	-18.4	-14.4	-3.9	4.9
Asia Pacific	4/15/ 10	7/2/10	-12.5	-5.6	-2.0	7.9
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-23.5	-2.7	-1.2
China Shang.	4/15/ 10	7/02 /10	-24.7	-19.9	-2.3	6.4
STOXX 50	4/15/10	7/2/10	-15.3	-21.8	-5.6	-7.6
DAX	4/26/ 10	5/25/ 10	-10.5	-13.5	-8.6	-3.4
Dollar Euro	11/25 2009	6/7 2010	21.2	4.9	-1.1	-20.7
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	9.6	1.3	28.2
10-Year Tre.	4/5/ 10	4/6/10	3.986	2.066

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 of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. Table 64 shows a gain by Apr 29, 2011 in the DJIA of 14.3 percent and of the S&P 500 of 12.5 percent since Apr 26, 2010, around the time when sovereign risk issues in Europe began to be acknowledged in financial risk asset valuations. The last row of Table 64 for Aug 19 shows that the S&P 500 is now 7.3 percent below the Apr 26, 2010 level and the DJIA is only 3.5 percent below the level on Apr 26, 2010. Multiple rounds of risk aversion eroded the earlier gains, showing that risk aversion can destroy market value even with zero interest rates.

Table 64, Percentage Changes of DJIA and S&P 500 in Selected Dates

2010	∆% DJIA from earlier date	∆% DJIA from Apr 26	∆% S&P 500 from earlier date	∆% S&P 500 from Apr 26
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
Apr 22	1.3	11.6	1.3	10.3
Apr 29	2.4	14.3	1.9	12.5
May 6	-1.3	12.8	-1.7	10.6
May 13	-0.3	12.4	-0.2	10.4
May 20	-0.7	11.7	-0.3	10.0
May 27	-0.6	11.0	-0.2	9.8
Jun 3	-2.3	8.4	-2.3	7.3
Jun 10	-1.6	6.7	-2.2	4.9
Jun 17	0.4	7.1	0.04	4.9
Jun 24	-0.6	6.5	-0.2	4.6
Jul 1	5.4	12.3	5.6	10.5
Jul 8	0.6	12.9	0.3	10.9
Jul 15	-1.4	11.4	-2.1	8.6
Jul 22	1.6	13.2	2.2	10.9
Jul 29	-4.2	8.4	-3.9	6.6
Aug 05	-5.8	2.1	-7.2	-1.0
Aug 12	-1.5	0.6	-1.7	-2.7
Aug 19	-4.0	-3.5	-4.7	-7.3

Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3004

Table 65, 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. Dollar devaluation is expected to continue because of zero fed funds rate, expectations of rising inflation and the large budget deficit of the federal government (http://professional.wsj.com/article/SB10001424052748703907004576279321350926848.html?mod=WSJ_hp_LEFTWhatsNewsCollection) but with interruptions caused by risk aversion events.

Table 65, Exchange Rates

	Peak	Trough	∆% P/T	Aug 19, 2011	∆T Aug 19 2011	∆P Aug 19 2011
EUR USD	7/15 2008	6/7 2010		8/19 2011
Rate	1.59	1.192		1.439
∆%			-33.4		17.2	-10.5
JPY USD	8/18 2008	9/15 2010		8/19 2011
Rate	110.19	83.07		76.79
∆%			24.6		7.6	30.3
CHF USD	11/21 2008	12/8 2009		8/19 2011
Rate	1.225	1.025		0.786
∆%			16.3		23.3	35.8
USD GBP	7/15 2008	1/2/ 2009		8/19 2011
Rate	2.006	1.388		1.646
∆%			-44.5		15.7	-21.9
USD AUD	7/15 2008	10/27 2008		8/19 2011
Rate	1.0215	1.6639		1.041
∆%			-62.9		42.3	5.9
ZAR USD	10/22 2008	8/15 2010		8/19 2011
Rate	11.578	7.238		7.189
∆%			37.5		0.7	37.9
SGD USD	3/3 2009	8/9 2010		8/19 2011
Rate	1.553	1.348		1.21
∆%			13.2		10.2	22.1
HKD USD	8/15 2008	12/14 2009		8/19 2011
Rate	7.813	7.752		7.797
∆%			0.8		-0.6	0.2
BRL USD	12/5 2008	4/30 2010		8/19 2011
Rate	2.43	1.737		1.594
∆%			28.5		8.2	34.4
CZK USD	2/13 2009	8/6 2010		8/19 2011
Rate	22.19	18.693		16.998
∆%			15.7		9.1	23.4
SEK USD	3/4 2009	8/9 2010		8/19 2011
Rate	9.313	7.108		6.384
∆%			23.7		10.2	31.5
CNY USD	7/20 2005	7/15 2008		8/19 2011
Rate	8.2765	6.8211		6.3925
∆%			17.6		6.3	22.8

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

Table 66, 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 new coupons such as 3.63 percent in recent auctions (http://www.treasurydirect.gov/instit/annceresult/press/preanre/2011/2011.htm) are not comparable to prices in Table 66. 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, subsequently by the tragic earthquake and tsunami in Japan and now again by the sovereign risk doubts in Europe and the growth recession in the US. The yield of 2.066 percent at the close of market on Fr Aug 19, 2011, would be equivalent to price of 105.0270 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price gain of 3.7 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 credit issues. The realization of a growth recession is also influencing yields. Important causes of the rise in yields shown in Table 66 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 http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html), rising from 40.8 percent of GDP in 2008, 53.5 percent in 2009 (Table 2 in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html) and 69 percent in 2011. On Aug 17, 2011, the line “Reserve Bank credit” in the Fed balance sheet stood at $2818 billion, or $2.8 trillion, with portfolio of long-term securities of $2718 billion, or $2.7 trillion, consisting of $1648 billion Treasury nominal notes and bonds, $66 billion of notes and bonds inflation-indexed, $111 billion Federal agency debt securities and $893 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $1645 billion or $1.6 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). 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. Risk aversion from various sources, discussed in section I, has been affecting financial markets for several weeks. The risk is that in a reversal of risk aversion that has been typical in this cyclical expansion of the economy yields of Treasury securities may back up sharply.

Table 66, 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
04/22/11	3.402	93.4646	-7.7
04/29/11	3.290	94.3759	-6.8
05/06/11	3.147	95.5542	-5.6
05/13/11	3.173	95.3387	-5.8
05/20/11	3.146	95.5625	-5.6
05/27/11	3.068	96.2089	-4.9
06/03/11	2.990	96.8672	-4.3
06/10/11	2.973	97.0106	-4.2
06/17/11	2.937	97.3134	-3.9
06/24/11	2.872	97.8662	-3.3
07/01/11	3.186	95.2281	-5.9
07/08/11	3.022	96.5957	-4.6
07/15/11	2.905	97.5851	-3.6
07/22/11	2.964	97.0847	-4.1
07/29/11	2.795	98.5258	-2.7
08/05/11	2.566	100.5175	-0.7
08/12/11	2.249	103.3504	2.1
08/19/11	2.066	105.270	3.7

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

VII Economic Indicators. Crude oil input in refineries fell to 15,473 thousand barrels per day on average in the four weeks ending on Aug 12 from 15,524 thousand barrels per day in the four weeks ending on Aug 5, as shown in Table 67. The rate of capacity utilization in refineries continues at a high level close to 90 percent. Imports of crude oil rose from 9,278 thousand barrels per day on average to 9,298 thousand barrels per day. Declining utilization with increasing imports resulted in an increase of commercial crude oil stocks by 4.2 million barrels from 349.8 million on Aug 5 to 354.0 million on Aug 12. Gasoline stocks fell 3.5 million barrels and stocks of fuel oil fell 0.8 million barrels. The most worrisome fact is that supply of gasoline fell from 9,451 thousand barrels per day on Aug 13, 2010, to 9,163 thousand barrels per day on Aug 5, 2011, or by 3.0 percent, while fuel oil supply rose 5.8 percent. Part of the fall in consumption of gasoline is due to higher prices and part to the growth recession. Table 67 also shows increase in the world oil price by 32.7 percent from Aug 13, 2010 to Aug 12, 2011. Gasoline prices rose by 32.0 percent from Aug 16, 2010 to Aug 15, 2011.

Table 67, US, Energy Information Administration Weekly Petroleum Status Report

Four Weeks Ending Thousand Barrels/Day	08/12/11	08/05/11	08/13/10
Crude Oil Refineries Input	15,473	15,524	15,335
Refinery Capacity Utilization %	89.1	89.4	90.0
Motor Gasoline Production	9,298	9,278	9,450
Distillate Fuel Oil Production	4,565	4,571	4,321
Crude Oil Imports	9,305	9,319	9,913
Motor Gasoline Supplied	9,163 ∆% 2011/2010= -3.0%	9,122	9,451
Distillate Fuel Oil Supplied	3,739 ∆% 2011/2010 = 5.8%	3,701	3,534
	08/12/11	08/05/11	08/13/10
Crude Oil Stocks Million B	354.0 ∆= 4.2 MB	349.8	354.2
Motor Gasoline Million B	210.1 ∆= –3.5MB	213.6	223.3
Distillate Fuel Oil Million B	151.5 ∆= -0.8 MB	152.3	173.1
World Crude Oil Price $/B	102.56 ∆% 2011/2010 32.7	111.41	77.28
	08/15/11	08/08/11	08/16/10
Regular Motor Gasoline $/G	3.674 ∆% 2011/2010 32.0	3.711	2.783

B: barrels; G: gallon

Source: http://www.eia.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/pdf/highlights.pdf

Initial claims for unemployment insurance seasonally adjusted increased 9,000 to reach 408,000 in the week of Aug 13 from 399,000 in the week of Aug 6, as shown in Table 68. Claims not seasonally adjusted, or the actual estimate, fell 11,739 to reach 342,669 in the week of Aug 13 from 354,408 in the week of Aug 6.

Table 68, US, Initial Claims for Unemployment Insurance

	SA	NSA	4-week MA SA
Aug 13	408,000	342.669	402,500
Aug 6	399,000	354,408	406,000
Change	+9,000	-11,739	-3,500
Jul 30	403,000	341,103	408,250
Prior Year	488,000	405,484	474,250

Note: SA: seasonally adjusted; NSA: not seasonally adjusted; MA: moving average

Source: http://www.dol.gov/opa/media/press/eta/ui/current.htm

VIII Interest Rates. It is quite difficult to measure inflationary expectations because they tend to break abruptly from past inflation. There could still be an influence of past and current inflation in the calculation of future inflation by economic agents. Table 69 provides inflation of the CPI. In Jan-Jul 2011, CPI inflation for all items seasonally adjusted was 4.1 percent in annual equivalent, that is, compounding inflation in the first seven months and assuming it would be repeated during the remainder of 2011. In the 12 months ending in Jul, CPI inflation of all items not seasonally adjusted was 3.6 percent. The second row provides the same measurements for the CPI of all items excluding food and energy: 2.6 percent annual equivalent in Jan-Jun and 1.8 percent in 12 months. Bloomberg provides the yield curve of US Treasury securities at 8:34PM New York time Aug 21 (http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/). The lowest yield is 0.00 percent for three months or zero, 0.02 percent for six months, 0.08 percent for 12 months, 0.20 percent for two years, 0.35 percent for three years, 0.91 percent for five years, 1.43 percent for seven years, 2.06 percent for ten years and 3.36 percent for 30 years. The Irving Fisher definition of real interest rates is approximately the difference between nominal interest rates, which are those estimated by Bloomberg, and the rate of inflation expected in the term of the security, which could behave as in Table 69. Real interest rates in the US have been negative during substantial periods in the past decade while monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”

Negative real rates of interest distort calculations of risk and returns from capital budgeting by firms, through lending by financial intermediaries to decisions on savings, housing and purchases of households. Inflation on near zero interest rates misallocates resources away from their most productive uses and creates uncertainty of the future path of adjustment to higher interest rates that inhibit sound decisions.

Table 69, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%

	∆% 12 Months Jul 2011/Jul 2010 NSA	∆% Annual Equivalent Jan-Jul 2011 SA
CPI All Items	3.6	4.1
CPI ex Food and Energy	1.8	2.6

Source: http://www.bls.gov/news.release/pdf/cpi.pdf

IX Conclusion. Growth recession does not necessarily lead to another contraction. There is more evidence of deceleration in Europe than in the US and Asia. Financial turbulence may continue because of the shocks of risk aversion resulting from the lack of a definitive resolution of European sovereign risks. Monetary policy should move toward conventional impulses

(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 ).

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Table USA, US Economic Indicators

Consumer Price Index	Jun 12 months NSA ∆%: 3.6; ex food and energy ∆%: 1.6 Jun month ∆%: –0.2; ex food and energy ∆%: 0.3 Blog 08/21/11
Producer Price Index	Jun 12 months NSA ∆%: 7.0; ex food and energy ∆% 2.4 Jun month SA ∆% –0.4; ex food and energy∆%: 0.3 Blog 08/21/11
PCE Inflation	Jun 12 months NSA ∆%: headline 1.6; ex food and energy ∆% 1.3 Blog 08/07/11
Employment Situation	Household Survey: Jul Unemployment Rate SA 9.1% Blog calculation People in Job Stress Jul: 29.6 million NSA Establishment Survey: Jul Nonfarm Jobs +117,000; Private +154,000 Jun 12 months Average Hourly Earnings Inflation Adjusted ∆%: minus 1.6% Blog 08/07/11
Nonfarm Hiring	Nonfarm Hiring fell from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million Private-Sector Hiring May 2011 4.250 million lower by 1.256 million than 5.506 million in May 2001 Blog 08/21/11
GDP Growth	BEA Revised National Income Accounts back to 2003 IQ2011 SAAR ∆%: 0.4 IIQ2011 SAAR ∆%: 1.3 Blog 07/31/11
Personal Income and Consumption	Jun month ∆% SA Real Disposable Personal Income (RDPI) 0.3 Jun month SA ∆% Real Personal Consumption Expenditures (RPCE) : 0.0 12 months NSA ∆%: RDPI: 0.3; RPCE ∆%: 1.0 Blog 08/07/11
Employment Cost Index	IIQ2011 SA ∆%: 0.7 Jun 12 months ∆%: 3.4 Blog 08/07/11
Industrial Production	Jul month SA ∆%: 0.9 Jun 12 months NSA ∆%: 3.7 Capacity Utilization: 77.5 Blog 08/21/11
New York Fed Manufacturing Index	General Business Conditions Aug: –7.72 New Orders: –7.82 Blog 08/21/11
Philadelphia Fed Business Outlook Index	General Index from 3.2 Jul to -30.7 Aug New Orders from Jul 0.1 to -30.7 Aug Blog 08/21/11
Manufacturing Shipments and Orders	Jun/May New Orders SA ∆%: –0.8; ex transport ∆%: 0.1 12 months Jun NSA ∆%: 12.5; ex transport ∆% 12.8 Blog 08/07/11
Durable Goods	Jun New Orders SA ∆%: minus 2.1; ex transport ∆%: 0.1 Jun 12 months NSA New Orders ∆%: 9.4; ex transport∆% : 9.2 Blog 07/31/11
Sales of Merchant Wholesalers	Jan-Jun 2011/2010 ∆%: Total 15.2; Durable Goods: 11.9; Nondurable Goods 17.8 Blog 08/14/11
Sales and Inventories of Manufacturers, Retailers and Merchant Wholesalers	Jun 11/Jun 10 NSA ∆%: Total Business 12.1; Manufacturers 12.3 Retailers 9.1; Merchant Wholesalers 14.6 Blog 08/14/11
Sales for Retail and Food Services	Jul 12 months ∆%: Retail and Food Services: 8.5; Retail ∆% 8.9 Blog 08/14/11
Value of Construction Put in Place	Jun SAAR month SA ∆%: 0.2 Jun 12 months NSA: –4.7 Blog 08/07/11
Case-Shiller Home Prices	May 2011/May 2010 ∆% NSA: 10 Cities –3.6; 20 Cities: –4.5 ∆% May SA: 10 Cities 0.1; 20 Cities: –0.1 Blog 07/31/11
New House Sales	Jun month SAAR ∆%: -0.9 Jan/Jun 2011/2010 NSA ∆%: –11.9 Blog 07/31/11
Housing Starts and Permits	Jul Starts month SA ∆%: -1.5; Permits ∆%: -3.2 Jan/Jul 2011/2010 NSA ∆% Starts -3.6; Permits ∆% –5.1 Blog 08/21/11
Trade Balance	Balance Jun SA -$53,067 million versus May -$50,831 million Exports Jun SA ∆%: -2.3 Imports Jun SA ∆%: -0.8 Exports Jan-Jun 2011/2010 NSA ∆%: 18.3 Imports Jan-Jun 2011/2010 NSA ∆%: 17.9 Blog 08/14/11
Export and Import Prices	Jun 12 months NSA ∆%: Imports 13.6; Exports 9.9 Blog 08/21/11
Consumer Credit	Jun ∆% annual rate: 7.7% Blog 08/07/11
Net Foreign Purchases of Long-term Treasury Securities	May Net Foreign Purchases of Long-term Treasury Securities: $3.7 billion Jun versus May $24.2 billion Major Holders of Treasury Securities: China $1165 billion; Japan $911 billion Blog 08/21/11
Treasury Budget	Fiscal Year to Jul 2011/2010 ∆%: Receipts 8.0; Outlays 2.4; Deficit -5.9; Individual Income Taxes 23.8 Deficit Fiscal Year to Jul 2011: $1,099,901 million Blog 08/14/11

Links to blog comments in Table USA:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

Table JPY, Japan, Economic Indicators

Historical GDP and CPI	1981-2010 Real GDP Growth and CPI Inflation 1981-2010 Blog 07/31/11
Corporate Goods Prices	Jul ∆% 0.2 12 months ∆% 2.9 Blog 08/14/11
Consumer Price Index	Jun SA ∆% –0.1 Jun 12 months NSA ∆% 0.2 Blog 07/31/11
Real GDP Growth	IIQ2011 ∆%: –0.3 on IQ2011; Seasonally adjusted annual equivalent rate ∆%: –1.3 ∆% from quarter a year earlier: –0.9% Blog 08/14/11
Employment Report	Jun Unemployed 2.93 million Unemployment rate: 4.6% Blog 07/31/11
All Industry Index	Jun month SA ∆% 2.3 12 months NSA ∆% 0.2 Blog 08/21/11
Industrial Production	Jun SA month ∆%: 3.9 12 months NSA ∆% –1.6 Blog 07/31/11
Machine Orders	Apr-Jun 2011 ∆% –9.6 Forecast Jul –Sep 2011 ∆% –0.9 Jun ∆% Excluding Volatile Orders 7.7 Blog 08/14/2011
Tertiary Index	Jun month SA ∆% 1.19 Jun 12 months NSA ∆% 0.8 Blog 08/14/2011
Wholesale and Retail Sales	Jun 12 months: Total ∆% 2.9 Wholesale ∆%: 3.5 Retail ∆%: 1.1 Blog 07/31/11
Trade Balance	Exports Jul 12 months ∆%: -3.3 Imports Jul 12 months ∆% 9.9 Blog 08/21/11

Links to blog comments in Table JPY:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

Table CNY, China, Economic Indicators

Price Indexes for Industry	Jul 12 months ∆%: 7.5 Jan-Jul ∆%: 7.1 Blog 08/14/11
Consumer Price Index	Jul month ∆%: 0.5 Jul 12 month ∆%: 6.5 Jan-Jul ∆%: 5.5 Blog 08/14/11
Value Added of Industry	Jul 12 month ∆%: 14.0 Blog 08/14/11
GDP Growth Rate	Year IIQ2011 ∆%: 9.6 Quarter IIQ2011 ∆%: 2.2 Blog 08/14/11
Investment in Fixed Assets	Jan-Jul ∆%: 25.4 Blog 08/14/11
Retail Sales	Jul month ∆%: 1.3 Jul 12 month ∆%: 17.2 Blog 08/14/11
Trade Balance	Jul $31.5 billion Exports ∆% 20.4 Imports ∆% 22.9 Jan-Jul $76.2 billion Exports ∆% 23.4 Import ∆% 26.9 Blog 08/14/11

Table EUR, Euro Area Economic Indicators

GDP	IIQ2011 ∆% 0.2; IIQ2011/IIQ2010 ∆% 1.7 Blog 08/21/11
HICP	Flash Jul 12 months ∆%: 2.5 http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-29072011-CP/EN/2-29072011-CP-EN.PDF 12 months Jun ∆%: 2.7 Blog 07/17/11
Producer Prices	Jun month ∆%: 0.0 Jun 12 months ∆%: 5.9 Blog 08/07/11
Industrial Production	Jun month ∆%: -0.7 Jun 12 months ∆%: 2.9 Blog 08/14/11
Industrial New Orders	May month ∆%: 3.6 May 12 months ∆%: 15.5 Blog 07/24/11
Construction Output	May month ∆%: –1.1 May 12 months ∆%: –1.9 Blog 07/24/11
Retail Sales	Jun month ∆%: 0.9 Jun 12 months ∆%: –0.4 Blog 08/07/11
Trade	Jan-Jun 2011/2010 Exports ∆%: 16.8 Imports ∆%: 17.8 Blog 08/21/11

Links to blog comments in Table EUR:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

Table DE, Germany, Economic Indicators

GDP	IIQ2011 0.1 ∆%; II/Q2011/IIQ2010 ∆% 2.7 Blog 08/21/11
Consumer Price Index	Jul month SA ∆%: 0.4 Jul 12 months ∆%: 2.4 Blog 08/14/11
Producer Price Index	Jun month ∆%: 0.1 12 months NSA ∆%: 5.6 Blog 08/07/11
Industrial Production	Jun month SA ∆%: –0.9 12 months NSA: 0.9 Blog 08/07/11
Machine Orders	Jun month ∆%: 1.8 Jun 12 months ∆%: 3.0 Blog 08/07/11
Employment Report	Employment Accounts: Jun Employed 12 months NSA ∆%: 1.2 Labor Force Survey: Jun Unemployment Rate: 6.1% Blog 07/31/11
Trade Balance	Trade Balance NSA Jun €6.0 billion versus May €15.6 billion Exports Jun 12 month NSA ∆%: 3.1 (versus ∆% 19.9 May) Imports Jun 12 months NSA ∆%: 6.0 (versus ∆% 15.6 May) Exports Jun month SA ∆%: -1.2; Imports Jun month SA ∆%: 0.3 Blog 08/14/11

Links to blog comments in Table DE:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

Table FR, France, Economic Indicators

CPI
PPI	Jun month ∆%: –0.1 Jun 12 months ∆%: 6.1
GDP Growth	IIQ2011/IQ2011 ∆%: 0.0 IIQ2011/IIQ2010 ∆%: 1.6 Blog 08/14/11
Industrial Production	Jun/May SA ∆%: Industrial Production -1.6; Manufacturing –1.9 Jun 12 months NSA ∆%: Industrial Production 2.1; Manufacturing 3.8 Blog 08/14/11
Consumer Spending	Jun Manufactured Goods ∆%: 1.1 Jun Manufactured Goods ∆%: 2.2 Blog 08/07/11

Table IT, Italy, Economic Indicators

Consumer Price Index	Jul month ∆%: 0.3 Jun 12 months ∆%: 2.7 Blog 08/14/11
Producer Price Index	Jun month ∆%: 0.1 Jun 12 months ∆%: 2.7
GDP Growth	IQ2011/IVQ2010 SA ∆%: 0.1 IQ2011/IQ2010 NSA ∆%: 1.0 Blog 08/14/11
Industrial Production	Jun month ∆%: –0.6 12 months ∆%: 0.2 Blog 08/07/11
Trade Balance	Balance Jun SA -€ 1,944 million versus May -€ 3,114 Exports Jun month SA ∆%: -0.8 Imports Jun month SA ∆%: 4.1 Exports 12 months NSA ∆%: 8.1 Imports 12 months NSA ∆%: 3.2 Blog 08/14/11

Table UK, UK Economic Indicators


CPI	Jun month ∆%: –0.1 Jun 12 months ∆%: 4.2 Blog 07/17/11
Output/Input Prices	Output Prices: Jul 12 months NSA ∆%: 5.9; excluding food, petroleum ∆%: 3.3 Input Prices: Jul 12 months NSA ∆%: 18.5 Excluding ∆%: 13.1 Blog 08/07/11
GDP Growth	IIQ2011 prior quarter ∆% 02; year earlier same quarter ∆%: 0.7 Blog 07/17/11
Industrial Production	Jun 2011/Jun 2010 NSA ∆%: Industrial Production -0.3; Manufacturing 2.1 Jun 2011/May 2011 SA ∆%: Industrial Production 0.0; Manufacturing -0.4Blog 08/14/11
Retail Sales	Jul month SA ∆%: 0.2 Jul 12 months ∆%: 0.0 Blog 08/21/11
Labor Market	Apr-Jun Unemployment Rate: 7.9% Blog 08/21/11
Trade Balance	Balance Jun -₤4,496 billion Exports Jun ∆%: -2.8 IIQ2011/IIQ2010 ∆%: 8.6 Imports Jun ∆%: -1.5 IIQ2011/IQ2010 ∆%: 7.3 Blog 08/14/11

Links to blog comments in Table UK:

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

Appendix I. The Great Inflation

Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart I1 for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart I1 cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s; the loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy. This interpretation is consistent with the case of the 24 emerging market economies analyzed by Reinhart and Rogoff (2010GTD, 4), concluding that “higher debt levels are associated with significantly higher levels of inflation in emerging markets. Median inflation more than doubles (from less than seven percent to 16 percent) as debt rises from the low (0 to 30 percent) range to above 90 percent. Fiscal dominance is a plausible interpretation of this pattern.”

The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:

“So, inflation is caused by ‘tightness’ and deflation by ‘slack’ in the economy. This is not just a cause and forecasting variable, it is the cause, because given ‘slack’ we apparently do not have to worry about inflation from other sources, notwithstanding the weak correlation of [Phillips circuits]. These statements [by the Fed] do mention ‘stable inflation expectations. How does the Fed know expectations are ‘stable’ and would not come unglued once people look at deficit numbers? As I read Fed statements, almost all confidence in ‘stable’ or ‘anchored’ expectations comes from the fact that we have experienced a long period of low inflation (adaptive expectations). All these analyses ignore the stagflation experience in the 1970s, in which inflation was high even with ‘slack’ markets and little ‘demand, and ‘expectations’ moved quickly. They ignore the experience of hyperinflations and currency collapses, which happen in economies well below potential.”

Chart I1, Brazil, Phillips Circuit 1963-1987

©Carlos Manuel Pelaez, O cruzado e o austral. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.

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/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html 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). TableI1 provides the change in GDP, CPI and the rate of unemployment from 1960 to 1990. There are three waves of inflation (1) in the second half of the 1960s; (2) from 1973 to 1975; and (3) from 1978 to 1981. In one of his multiple important contributions to understanding the Great Inflation, Meltzer (2005) distinguishes between one-time price jumps, such as by oil shocks, and a “maintained” inflation rate. Meltzer (2005) uses a dummy variable to extract the one-time oil price changes, resulting in a maintained inflation rate that was never higher than 8 to 10 percent in the 1970s. There is revealing analysis of the Great Inflation and its reversal by Meltzer (2005, 2010a, 2010b).

Table I1, 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.bea.gov/national/nipaweb/TableView.asp?SelectedTable=2&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=2009&LastYear=2010&3Place=N&Update=Update&JavaBox=no

http://www.bls.gov/web/empsit/cpseea01.htm

http://data.bls.gov/pdq/SurveyOutputServlet

There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table I2 when monetary policy 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 I2 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 monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). 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 while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.

Table I2, 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.t

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Sunday, August 21, 2011

World Financial Turbulence, Global Growth Recession, Inflation and Monetary Policy and Economic Uncertainty

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