The “New Economics” of the Rose Garden Turned Stagflation Thorns, US Multinationals Employment, Standard & Poor’s, the Budget Quagmire and Global Inflation
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011
Executive Summary
I The New Economics of the Great Inflation
IA Employment Law of 1946
IB The New Economics
IC The Rose Garden Turned Stagflation Thorns
IV Policy Critique
II US Multinationals and Employment
III Global Inflation
IV Budget Quagmire and Standard & Poor’s
V Trends and Cycles of Valuations of Risk Financial Assets
VI Economic Indicators
VII Interest Rates
VIII Conclusion
References
Executive Summary
A “macroeconomic consensus” developed during the 1950 and 1960s, culminating in a “neoclassical synthesis.” The policy proposal of this consensus was to use new tools of economic analysis, measurement and policy design to manage aggregate demand in maintaining constantly full employment of productive resources such as capital, natural resources and labor without accelerating inflation. The two major building blocks of this consensus were: (1) the relation of the difference between the actual and natural rate of unemployment to the difference between actual inflation and expected inflation; and (2) “Okun’s law” or that increases of the rate of unemployment by one percentage point over 4 percent are associated with decline of GNP by 3 percent or 1 to 3 tradeoff. The critical importance of Okun’s law is the calculation of potential output. Arthur F. Burns (1969PI, 293) interpreted that the policy was based on the belief that fiscal and monetary measures could be used to close the gap between potential and actual output and that incomes policy, or wage and price guidelines, would be successful in restraining inflation. The outcome during the late 1960s and 1970s was the highest inflation in US peacetime history together with high rates of unemployment, or the Great Inflation and Unemployment. The architect of the new economics, Walter W. Heller, delivered the presidential address to the American Economic Association with the following apology:
“Addressing myself for a moment to our reproachful public, let me simply say to them: ‘We never promised you a rose garden without thorns.’ Over most of the past thirty years, macroeconomists have warned again and again, first, that aggressive fiscal and monetary policy to manage aggregate demand was bound to generate inflationary pressures once the economy entered the full employment zone, and second, that while full employment spells inflation, recessions run into price and wage rigidities that thwart deflation, an asymmetry bound to produce a ratchet effect on the price level” (Heller 1975, 16).
The stagflation thorns of the policy errors of the 1960s and 1970s have been explained in terms of monetary policy that in the concern of closing the gap of potential relative to actual output neglected inflation control. The current “macroeconomic consensus” is not very different with the highest accommodation of monetary policy in US history by the Fed in the belief that it can control inflation in an infinitesimal neighborhood around 2 percent, in fear of the same ratchet effect as Heller (1975, 6) while maintaining the rate of unemployment also in a tight neighborhood of, say, 5.5 percent. There are more complex tools and measurement currently but the concepts of inflation gap and output gap dominate the concerns of monetary policy. Similar monetary accommodation with fed funds of 1 percent in 2003 and 2004 and adjustment in 17 increments of 25 basis points from 2004 to 2006 with suspension of auctions of 30-year Treasury bonds acting as quantitative easing was a major cause of the financial crisis and global recession. Inflation thorns are being felt everywhere in the world while monetary policy continues in pursuit of raising inflation by devaluation and increases in commodity prices that like the inflation surprises of the 1970s could close the output gap. The consensus in the Great Inflation and Unemployment and during the past decade is similar, arguing that a substantial gap of actual relative to potential output prevents an increase in inflation, especially if labor markets are depressed and wages are unlikely to be adjusted. In the price level-aggregate income diagram, pY, supply is perfectly horizontal, such that increases in aggregate demand, or MV, money stock (M) times velocity (V), pumped by monetary policy increase income, Y, without increasing the price level, p. The fact is that high inflation and high unemployment have coexisted in numerous historical episodes. It is yet to be verified if the tools of unwinding the zero interest rate and Fed balance sheet of $2.6 trillion are more effective than the incomes policy of the 1970s. Contemporary economists of the 1960s and 1970s questioned if the central bank should be used in promoting the trend of growth of the economy instead of adjusting the economy during cyclical fluctuations (Burns 1969QFE, 279), a view that is relevant currently. If central banks could cause growth, there would never be the current stress of 30 million people jobless or underemployed.
US multinationals have driven productivity increases in the effort to maintain competitiveness in global markets. The most recent report on US multinationals shows reduction in employment in the US while increasing employment in overseas operations. The reduction in domestic employment may be partly the result of the global recession. The US budget quagmire continues in the search for a budget deal with downgrade by Standard & Poor’s of the outlook of US sovereign debt from stable to negative. The comment is completed with analysis of valuations of risk financial assets, economic indicators and interest rates. The final section concludes.
I The New Economics of the Great Inflation. The new economics of the Great Inflation and Unemployment of the 1960s and 1970s consisted of a “consensus” that accumulation of capital, labor and productivity created a smooth long-run trend of actual output. Short-run deviations of actual from potential output, or output gap, were caused by fluctuations in aggregate monetary or nominal demand. Okun’s law provided an estimate of potential output by which every percentage point increase in the rate of unemployment above 4 percent would result in decline of aggregate economic activity, or GNP, by 3.3 percent. Keynesian monetary and fiscal policies could be used to manage aggregate demand in such a way as to maintain the economy constantly close to potential output, or full employment of capital, labor and natural resources with available technology, without inflation. Four subsections analyze the new economics of the Great Inflation and Unemployment of the 1960s and 1970s and the similarity with current fiscal and monetary policy: IA Employment Law of 1946, IB The New Economics, IC The Rose Garden Turned Stagflation Thorns and ID Policy Critique.
IA Employment Law of 1946. Title 15, Chapter 21 § 1021(a) states (http://www.law.cornell.edu/uscode/15/1021.html http://uscode.house.gov/download/pls/15C21.txt http://www.eric.ed.gov/PDFS/ED164974.pdf):
“The Congress declares that it is the continuing policy and responsibility of the Federal Government to use all practicable means in a manner calculated to foster and promote free competitive enterprise and the general welfare, conditions which promote useful employment opportunities and promote full employment and production, increased real income, balanced growth, a balanced Federal budget, adequate productivity growth, proper attention to national priorities, achievement of an improved trade balance through increased exports and improvement in the international competitiveness of agriculture, business and industry, and reasonable price stability as provided in section 1022b (b) of this title. The Congress further declares that it is the purpose of the Full Employment and Balanced Growth Act of 1978 [15 U.S.C. 3101 et seq.] to maximize and place primary emphasis upon the expansion of private employment, and all programs and policies under such Act shall be in accord with such purpose. Toward this end, the effort to expand jobs to the full employment level shall be in this order of priority to the extent consistent with balanced growth. The Congress further declares that it is the purpose of the Full Employment and Balanced Growth Act of 1978 [15 U.S.C. 3101 et seq.] to achieve a balanced Federal budget consistent with the achievement of the medium-term goals specified in section 1022a of this title. The Congress further declares that it is the purpose of the Full Employment and Balanced Growth Act of 1978 [15 U.S.C. 3101 et seq.] to rely principally on the private sector for expansion of economic activity and creation of new jobs for a growing labor force. Toward this end, it is the purpose of this chapter to encourage the adoption of fiscal policies that would establish the share of the gross national product accounted for by Federal outlays at the lowest level consistent with national needs and priorities.”
Section 1022 established the Economic Report of the President, section 1023 created the Council of Economic Advisers (CEA) and section 1024 the Joint Economic Committee of Congress.
The Full Employment and Balanced Growth Act of 1978, Public Law 95-523 of Oct 27, 1978, intends (http://www.eric.ed.gov/PDFS/ED164974.pdf):
“To translate into practical reality the right of all Americans who are able, willing, and seeking to work to full opportunity for useful paid employment at fair rates of compensation; to assert the responsibility of the Federal Government to use all practicable programs and policies to promote full employment, production, and real income, balanced growth, adequate productivity growth, proper attention to national priorities, and reasonable price stability; to require the President each year to set forth explicit short-term and medium-term economic goals; to achieve a better integration of general and structural economic policies; and to improve the coordination of economic policymaking within the Federal Government.”
The Full Employment and Balanced Growth Act of 1978 amended the Employment Act of 1946 15 USC § 1022a to include (http://www.eric.ed.gov/PDFS/ED164974.pdf) by 1983:
“(b) The medium-term goals in the first three Economic Reports [of the President] shall include interim numerical goals for—“(1) reducing the rate of unemployment to not more than 3 per centum among individuals age twenty and over and 4 per centum among individuals aged sixteen and over within a period not extending beyond the fifth calendar year after the first such Economic Report; and (2) reducing the rate of inflation to not more than 3 per centum within the fifth calendar year after the first such Economic Report.”
In 1983, CPI inflation was 3.8 percent, after hitting 13.3 percent in 1979, 12.5 percent in 1980 and 8.9 percent in 1981 and the rate of unemployment was 10.8 percent in 1982 and 8.3 percent in 1983. J. Bradford DeLong (1996, 42) argues that the “Humphrey-Hawkins Act has had no effect on anything, save that the Federal Reserve chairman does give his periodic ‘Humphrey-Hawking testimony;’ as a result the workload of the Federal Reserve staff is slightly higher (and perhaps the ‘transparency’ and accountability of Federal Reserve actions has improved).” Congress considered the Employment Act of 1946 because of the loss of jobs during the Great Depression but stopped short of approving the provision for compensatory finance that would have required the government to run budget deficits to compensate for downswings of the business cycle (Santoni 1986). The Full Employment Bill of 1945, amended for approval of the Employment Act of 1946, was a model for the Humphrey Hawkins Act of 1978 (Santoni, 1986, 12). The Employment Act of 1946 created an institution, the Council of Economic Advisers (CEA), which “only because of the institution-building of Arthur Burns and Walter Heller did the CEA acquire the recruitment and staffing patterns that is has today” (DeLong 1996, 43). There are arguments, such as by Friedman (1953), that insufficient knowledge and institutional structure by the government prevent active economic management, which created consensus on the functioning of fiscal automatic stabilizers. DeLong (1996, 43-4) argues that after World War II there has been acceptance that the fiscal deficit is cyclical with resulting deficits during recession and efforts of balancing budgets in economic expansions.
IB The New Economics. The “new economics,” or in the words of James Tobin (1980, 27), the “neoclassical synthesis,” dominated policy thought in the 1960s and 1970s, as vigorously exposed by Heller (1966), Okun (1970) and Tobin (1972), all of whom served in the CEA. According to Heller (1975, 16), the major event breaking with the past was the 1964 tax cut. The target of policy shifted to attaining the economy’s “full employment potential,” following canonical Keynesian economics, while rejecting analysis of structural unemployment. The early 1964 tax cut is credited in this view with promoting faster expansion and budget balance without inflation. Heller (1975, 17) reflected on the policy approach of Heller (1966):
“In a very real sense, economists have been victims of their own success. Macroeconomic policy, capped by the tax cut, was the major force holding the postwar economy on a vastly higher plane than the prewar economy. On one hand, the high employment, limited-recession economy forged with our macroeconomic policy tools is indeed an inflation-prone economy—the formula for successful management of high-pressure prosperity is far more elusive than the formula for getting there. Yet on the other hand, success bred great expectations on the part of the public that economics could deliver prosperity without inflation and with ever-growing material gains in the bargain. The message got through that we had ‘harnessed the existing economics…to the purposes of prosperity, stability and growth,’ and that as to the role of the tax cut in breaking old molds of thinking, ‘nothing succeeds like success’(Heller [1966])”.
The review of Heller (1966), who chaired the CEA of Presidents Kennedy and Johnson in 1961-64, by Arthur Burns (1969HND), who chaired the CEA of President Eisenhower in 1953-56 and subsequently the Board of Governors of the Federal Reserve System 1970-78, follows analysis that would become highly relevant in the 1970s (Burns 1969HND, 311):
“I do not think that economic forecasting is as yet sufficiently accurate to justify fine fiscal tuning. I also fear that if it ever becomes governmental policy to move income taxes up or down at brief intervals, this rule of fiscal behavior will become a normal part of expectations and the effectiveness of fiscal policy in inducing needed changes in investment and consumer spending will therefore be drastically reduced. Thus, if a tax reduction is deemed to be temporary, it will affect economic activity only through its effect on current disposable income and the spending response may be quite small. On the other hand, if the tax reduction is expected to be permanent, both individuals and corporations will not only be more willing to commit their large disposable income, but they are also apt to use their brains, their energy, their liquid resources, and even their credit to take advantage of the new environment in which business is to be done. These considerations argue against frequent changes, but not necessarily against speedy changes, of tax rates.”
Arguments similar to these were refined into the rules versus discretion analysis by Kydland and Prescott (1977). The inadequacy of information for active stabilization policy was addressed by Friedman (1953).
An irony of the Great Inflation and Unemployment is that Burns (1969PI) was aware of the policy errors that were used in subsequent literature to explain the persistence of inflation with high unemployment (Burns 1969PI, 292):
“The new administration proceeded to shape its economic policy on the basis of an ingenious theory, namely, that by adjusting taxes or its own rate of spending, the government would be able to keep the aggregate demand for goods and services closely adjusted to what our economy can produce at full employment. According to this theory, as long as a gap existed between actual output and potential output, it was the responsibility of the government to stimulate demand by increasing its expenditures or by cutting taxes, but maintaining in either case an easy monetary policy.”
This policy, in Burns (1969, 293) view, was based on two beliefs: (1) that the administration could use fiscal and monetary stimuli to increase employment by closing the gap between potential and actual output; and (2) that incomes policy or wage and price guidelines could maintain price stability. DeLong (1997) and Orphanides (2003, 2004) have analyzed the conflict between the analysis of Burns and the policies of the Fed when he chaired the Board of Governors in the 1970s. There is an even more detailed account of the gap management by fiscal/monetary policies away from cyclical adjustment to growth promotion (Burns 1969QFE, 279):
“The central doctrine of this school is that the stage of the business cycle has little relevance to sound economic policy; that policy should be growth-oriented instead of cycle-oriented; that the vital matter is whether a gap exists between actual and potential output; that fiscal deficits and monetary tools need to be used to promote expansion when a gap exists; and that the stimuli should be sufficient to close the gap—provided significant inflationary pressures are not whipped up in the process.”
It is difficult not to find similar ingredients in the prelude to the Great Inflation and Unemployment in the current design of fiscal and monetary policies (Bernanke 2011Feb3):
“Although economic growth will probably increase this year, we expect the unemployment rate to remain stubbornly above, and inflation to remain persistently below, the levels that Federal Reserve policymakers have judged to be consistent over the longer term with our mandate from the Congress to foster maximum employment and price stability. Under such conditions, the Federal Reserve would typically ease monetary policy by reducing the target for its short-term policy interest rate, the federal funds rate. However, the target range for the funds rate has been near zero since December 2008, and the Federal Reserve has indicated that economic conditions are likely to warrant an exceptionally low target rate for an extended period. From December 2008 through March 2010, we purchased about $1.7 trillion in longer-term Treasury, agency, and agency mortgage-backed securities. In August 2010, we began reinvesting the proceeds from all securities that matured or were redeemed in longer-term Treasury securities, so as to keep the size of our securities holdings roughly constant. And in early November, we announced a plan to purchase an additional $600 billion in longer-term Treasury securities by the middle of this year. Fiscal policymakers also face significant challenges. The federal budget deficit has expanded to an average of more than 9 percent of gross domestic product (GDP) over the past two years, up from an average of about 2 percent of GDP during the three years prior to the recession.”
There are no wage/price guidelines currently but the Fed is determined to main price stability and employment (Yellen 2011Apr11):
“Indeed, a key lesson from the experience of the late 1960s and 1970s is that the stability of longer-run inflation expectations cannot be taken for granted. At that time, the Federal Reserve's monetary policy framework was opaque, its measures of resource utilization were flawed, and its policy actions generally followed a stop-start pattern that undermined public confidence in the Federal Reserve's commitment to keep inflation under control. Since then, the Federal Reserve has remained determined to avoid those mistakes and to keep inflation low and stable. It will be important to closely monitor the state of longer-term inflation expectations to ensure that the Federal Reserve's credibility, which has been built up over the past three decades, remains fully intact. I believe this accommodative policy stance is still appropriate because unemployment remains elevated, longer-run inflation expectations remain well anchored, and measures of underlying inflation are somewhat low relative to the rate of 2 percent or a bit less that Committee participants judge to be consistent over the longer term with our statutory mandate. However, there can be no question that sometime down the road, as the recovery gathers steam, it will become necessary for the FOMC to withdraw the monetary policy accommodation we have put in place. That process will involve both raising the target federal funds rate over time and gradually normalizing the size and composition of our security holdings. Importantly, we are confident that we have the tools in place to withdraw monetary stimulus, and we are prepared to use those tools when the right time comes.”
The “consensus macroeconomic framework, vintage 1970” used by “managers of aggregate demand” in stabilization policies is interpreted by Tobin (1980, 23-5) in terms of five broad components. First, determination of the rate of inflation. The key role in determining the rate of inflation is played by the nonagricultural business sector in which prices consist of marked-up labor costs. The standard model is the “augmented Phillips curve.” The analysis by Kydland and Prescott (1977, 447-80, equation 5) uses the “expectation augmented” Phillips curve with the natural rate of unemployment of Friedman (1968) and Phelps (1968), which in the notation of Barro and Gordon (1983, 592, equation 1) is:
Ut = Unt – α(πt – πe) α > 0 (1)
Where Ut is the rate of unemployment at current time t, Unt is the natural rate of unemployment, πt is the current rate of inflation and πe is the expected rate of inflation by economic agents based on current information. Equation (1) expresses unemployment net of the natural rate of unemployment as a decreasing function of the gap between actual and expected rates of inflation. The system is completed by a social objective function, W, depending on inflation, π, and unemployment, U:
W = W(πt, Ut) (2)
The policymaker maximizes the preferences of the public, (2), subject to the constraint of the tradeoff of inflation and unemployment, (1). The total differential of W set equal to zero provides an indifference map in the Cartesian plane with ordered pairs (πt, Ut - Un) such that the consistent equilibrium is found at the tangency of an indifference curve and the Phillips curve in (1). The indifference curves are concave to the origin. The consistent policy is not optimal. Policymakers without discretionary powers following a rule of price stability would attain equilibrium with unemployment not higher than with the consistent policy. The optimal outcome is obtained by the rule of price stability, or zero inflation, and no more unemployment than under the consistent policy with nonzero inflation and the same unemployment. Tobin (1980, 24) postulates that in the augmented Phillips curve wages and prices are influenced by recent trends, expectations of future paths and tightness of demand relative to supply in product and labor markets at current wages and prices.
Second, aggregate monetary demand. The only way in which aggregate monetary demand, or nominal income, affects prices, output, wages and employment is through tightness in labor and product markets. Combinations of fiscal and monetary policies that result in the same change in aggregate demand have the same impact on inflation and real economic activity.
Third, Okun’s law. The concern of Okun (1962) is with the design of fiscal and monetary policy for “maximum employment” as provided in the Employment Act of 1946. That task requires the measurement of the output that the economy can produce under full employment. Okun (1962) admits that quantifying the gap or difference between actual and potential output is imprecise but there are no better competing measures of the performance of the economy. Arthur M. Okun developed the concepts while at the CEA of President Kennedy and chaired the CEA in 1968-1969. The measurement of potential output assumes prevailing technological knowledge, capital stock, natural resources, and training and education of the labor force. The difference between actual and potential output depends on the assumption that aggregate demand is precisely at that level which employs four percent of the civilian labor force. If aggregate demand were at a lower level, the economy does not produce potential output, resulting in an excess of potential over actual output or gap. The empirical model also does not take into account changes in hours worked per person and in participation in the labor force and labor productivity under full employment. All effects on output by idle resources are assumed to be incorporated in the rate of unemployment. Potential output estimates the loss of output caused by unemployment of more than 4 percent. Okun’s law or empirical finding is that (Okun 1962):
“In the postwar period, on the average, each extra percentage point in the unemployment rate above four percent has been associated with about a three percent decrement in real GNP”
The statement is careful in expressing the empirical result on the basis of the structure estimated with data with 55 quarters from IIQ1947 to IVQ1960, resulting in the estimated relation (Okun 1962):
Y = 0.30 – 0.30X (3)
Where Y is the quarterly change in the unemployment rate expressed in percentage points and X is the quarterly percentage change of real GNP. If GNP is unchanged from one quarter to the next, X =0, trend increases in productivity and growth of the labor force result in an increase of the rate of unemployment by 0.3 percentage points. Unemployment is 0.3 point lower for each increment of one percent of GNP (0.30 x X = 0.3 x 1). An increase of one percentage point in unemployment is equivalent to decrease of GNP by 3.3 percent (1/0.3).
Fourth, accelerations of inflation. Tighter markets of products and labor at high employment rates result in acceleration of inflation above those incorporated in inflation expectations and historical trends. Slack in product and labor market causes deceleration of inflation but at a slower rate. The utilization of resources and market tightness at the natural rate of unemployment of Friedman (1968) and Phelps (1968) does not cause upward or downward pressure of wages and prices relative to expected paths. The consensus accepted a nonaccelerating inflation rate of unemployment (NAIRU) but with divergence on whether it coincided with equilibrium or optimum employment.
Fifth, instruments. There was no widespread consensus on the instruments of demand management.
A critical assumption of the “neoclassical synthesis” of macroeconomics analysis and policy is separating trends in long-run supply from fluctuations in short-run demand (Tobin 1980, 27). The trend of actual output is determined by supply factors depending on the steady growth of labor, capital and technology. Neoclassical analysis of equilibrium of choices of savers and investors over time explains the trend of output. Disequilibrium in the consensus is generated by short-run demand fluctuations around the trend that are “analyzable and understandable by Keynesian tools upgraded and modernized” (Tobin 1980, 27). Growth of labor force and productivity would provide the inputs for estimating potential output along a smooth trend. Okun’s law would explain the reaction of employment and output to deviations from potential caused by demand shocks. The neoclassical consensus framework provided the tools that with measurements of deviations of actual from potential output, or output gap, permits the management of aggregate demand with monetary/fiscal policies in about any mix. The economy could be maintained almost permanently at full employment of productive resources.
IC The Rose Garden Turned Stagflation Thorns. The 1960s and 1970s were characterized by stagflation or combination of the highest inflation in a peacetime period in US history and high rates of unemployment that was labeled “stagflation.” Heller (1975, 16) explained as follows:
“Addressing myself for a moment to our reproachful public, let me simply say to them: "We never promised you a rose garden without thorns." Over most of the past thirty years, macroeconomists have warned again and again, first, that aggressive fiscal and monetary policy to manage aggregate demand was bound to generate inflationary pressures once the economy entered the full employment zone, and second, that while full employment spells inflation, recessions run into price and wage rigidities that thwart deflation, an asymmetry bound to produce a ratchet effect on the price level”
Tobin (1980, 19) explained more accurately (see also Tobin 1980AA and Lucas 1981):
“Higher inflation, higher unemployment-the relentless combination frustrated policymakers, forecasters, and theorists throughout the decade. The disarray in diagnosing stagflation and prescribing a cure makes any appraisal of the theory and practice of macroeconomic stabilization as of 1980 a foolhardy venture.”
DeLong (1997, 247-8) shows that the 1970s were the only peacetime period of inflation in the US without parallel in the prior century. The price level in the US drifted upward since 1896 with jumps resulting from the two world wars: “on this scale, the inflation of the 1970s was as large an increase in the price level relative to drift as either of this century’s major wars” (DeLong, 1997, 248). Monetary policy focused on accommodating higher inflation, with emphasis solely on the mandate of promoting employment, has been blamed as deliberate or because of model error or imperfect measurement for creating the Great Inflation (http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). As DeLong (1997) shows, the Great Inflation began in the mid 1960s, well before the oil shocks of the 1970s (see also the comment to DeLong 1997 by Taylor 1997, 276-7). A counterfactual of the 1970s immediately rises out of Table 1, which consists of simulating current monetary and fiscal policies in doses much more aggressive than in the 1960s and 1970s proposed as a true rose garden without thorns. What would have been the Great Inflation and Unemployment if the Federal Reserve would have lowered interest rates to zero in 1961, in fear of deflation because of 0.7 percent CPI inflation, and purchased the equivalent of 30 percent of the Treasury debt in long-term securities, subsequently engaging in quantitative easing II in 1964 after CPI inflation of 1.0 percent? The counterfactual would not be complete without including the unknown path of the US debt, tax and interest rate increases to exit from unsustainable debt and the largest monetary accommodation in US history.
Table 1, US Annual Rate of Growth of GDP and CPI and Unemployment Rate 1960-1982
| ∆% GDP | ∆% CPI | UNE | |
| 1960 | 2.5 | 1.4 | 6.6 |
| 1961 | 2.3 | 0.7 | 6.0 |
| 1962 | 6.1 | 1.3 | 5.5 |
| 1963 | 4.4 | 1.6 | 5.5 |
| 1964 | 5.8 | 1.0 | 5.0 |
| 1965 | 6.4 | 1.9 | 4.0 |
| 1966 | 6.5 | 3.5 | 3.8 |
| 1967 | 2.5 | 3.0 | 3.8 |
| 1968 | 4.8 | 4.7 | 3.4 |
| 1969 | 3.1 | 6.2 | 3.5 |
| 1970 | 0.2 | 5.6 | 6.1 |
| 1971 | 3.4 | 3.3 | 6.0 |
| 1972 | 5.3 | 3.4 | 5.2 |
| 1973 | 5.8 | 8.7 | 4.9 |
| 1974 | -0.6 | 12.3 | 7.2 |
| 1975 | -0.2 | 6.9 | 8.2 |
| 1976 | 5.4 | 4.9 | 7.8 |
| 1977 | 4.6 | 6.7 | 6.4 |
| 1978 | 5.6 | 9.0 | 6.0 |
| 1979 | 3.1 | 13.3 | 6.0 |
| 1980 | -0.3 | 12.5 | 7.2 |
| 1981 | 2.5 | 8.9 | 8.5 |
| 1982 | -1.9 | 3.8 | 10.8 |
| 1983 | 4.5 | 3.8 | 8.3 |
| 1984 | 7.2 | 3.9 | 7.3 |
| 1985 | 4.1 | 3.8 | 7.0 |
| 1986 | 3.5 | 1.1 | 6.6 |
| 1987 | 3.2 | 4.4 | 5.7 |
| 1988 | 4.1 | 4.4 | 5,3 |
| 1989 | 3.6 | 4.6 | 5.4 |
| 1990 | 1.9 | 6.1 | 6.3 |
Note: GDP: Gross Domestic Product; CPI: consumer price index; UNE: rate of unemployment; CPI and UNE are at year end instead of average to obtain a complete series
Source: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
http://www.bls.gov/web/empsit/cpseea01.htm
http://data.bls.gov/pdq/SurveyOutputServlet
ID Policy Critique. Okun (1962) carefully warns that the estimates of what came to be known as Okun’s law are valid for the structure of data used in 1948-1960. Lucas (1976) shows that parameters estimated from a structure in a past period may change significantly in a new structure prevailing in the intended policy period (see Lucas 1995, 255). An example that is current is stimulating the economy with temporary investment tax credits (Chari 1998, 183). Firms may anticipate the tax credit as it moves through the approval process of legislative debates, Congressional approval and final enactment, postponing investment decisions that worsen the recession which the tax credit intended to soften (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 112-16). Plosser and Schwert (1979) find deficiencies in the econometric measurement of potential output and Okun’s law and also conceptual problems. Potential output does not have operational substance because it is unrelated to aggregate demand. Thus, potential output is not that level of output that would occur without “unexpected random shocks to aggregate supply or demand” (Plosser and Schwert 1979, 184). Even if potential output were to be estimated without econometric deficiencies, it would pass the Lucas (1976) critique for policy simulation only if the behavior of economic agents were to remain the same during the implementation of policy as during the estimation period (Plosser and Schwert 1979, 184-5). Policy simulations with econometric estimates of potential output may provide biased estimates of the effects that may actually occur. Lucas (1978) challenges the assumption, crucial in Okun’s law, that there is a full-employment rate of unemployment, 4 percent in Okun (1962), which can be used as target of economic policy. Unemployment above 4 percent could be considered a waste in excess of “frictional unemployment,” which normally exists in the lag of matching skills of workers to job openings. This unemployment policy target is not operational in unemployment policy because “economists have no coherent idea as to what full employment means or how it can be measured” (Lucas 1978, 353).
There are three interpretations of the role of monetary policy in causing the Great Inflation and Unemployment: inflation surprise, inadvertent policy mistake and imperfect information (for ample discussion see http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html).
First, inflation surprise. According to Kydland and Prescott (1977), Policymakers without discretionary powers following a rule of price stability would attain equilibrium with unemployment not higher than with the consistent policy. The optimal outcome is obtained by the rule of price stability, or zero inflation, and not more unemployment than under the consistent policy with nonzero inflation and the same unemployment. Equation (1) is used by Barro and Gordon (1983) in showing the temptation of the policymaker to create “inflation surprises” by pursuing an inflation rate that is higher than that expected by economic agents that lowers the difference between the actual and natural unemployment rate by the term – α(πt – πe).
Second, inadvertent policy mistake. The Great Inflation from the 1960s and early 1980s and the subsequent disinflation and protracted period or Long Boom (coined by Taylor 1998LB) are analyzed by Clarida, Galí en Gertler (2000) by means of a forward monetary policy rule. The baseline monetary policy rule considered by Clarida, Galí and Gertler (CGG) is a simple linear equation:
r*t = r* + β(inflation gap) + γ(output gap) (4)
Where r*t is the Fed’s target rate for the fed funds rate in period t, r* is the desired nominal rate corresponding to both inflation and output being at their target levels (CGG 2000, 150), (inflation gap) is the deviation of actual inflation from target inflation and (output gap) is the percentage difference between actual GDP and its target. The rule is forward looking because the two gaps are relative to future desired levels. A second monetary rule is on the implied relation for the real rate of interest target:
rr*t = rr* + (β -1)(inflation gap) + γ(output gap) (5)
Where rr*t is the ex ante real rate target and rr* = r* - π* is the long-run equilibrium real rate. Equation (5) shows that the response of policy to the inflation gap depends on whether β is greater or less than one and the response to the output gap on whether γ is positive or negative.
CGG (2000) use quarterly time series for the period IQ1960 to IVQ1996, with the pre-Volcker period before 1979 and the Volcker-Greenspan period after 1979. The baseline estimates show π* at 4.24 percent in the pre-Volcker period and 3.58 percent in the Volcker-Greenspan period; β at 0.83 in pre-Volcker and 2.15 in Volcker-Greenspan; and γ at 0.27 in pre-Volcker and 0.93 in Volcker-Greenspan. The estimates are significant and checked for robustness over several dimensions. The data reveal that the Fed reacted weakly to expectations of inflation by allowing declines in real rates of interest or raising nominal interest but not by enough to increase real interest rates.
Third, imperfect information. Orphanides (2003, 2004) emphasizes the erroneous measurement of potential output, and a consequence of the output gap in equation (4), which misled the regulators in pursuing an “activist” policy of trying to prevent the output gap from increasing when it was decreasing. The policy to prevent the erroneously measured output gap from increasing was lowering interest rates but the actual gap was actually tightening and inflation control required higher interest rates.
II US Multinationals and Employment. The impact of international trade on employment and wages and the issue of offshore provision of services to the US economy are among the most controversial issues in the analysis of globalization (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 178-98, Government Intervention in Globalization (2008c), 97-101). The Lucas paradox (1988, 1990) analyzes the lack of capital flows from developed to developing nations to equalize capital/labor ratios and wages (see Alfaro, Kalemli-Ozcan and Volosovych 2008). Consider a production function relating output to homogeneous capital and labor and two countries using the same technology. The difference in output per worker in the two countries can only be caused by differences in the amount of capital used per worker, or capita/labor ratio. Under diminishing returns, or output increasing at a decreasing rate, the marginal product in the less productive developing economy is higher than in the developed countries. Capital would flow from the developed economy into activities in the developing economy where it can earn higher returns until capital/labor ratios were equalized and thus wages and returns on capital. Using the data of the Center for International Comparisons at the University of Pennsylvania (http://pwt.econ.upenn.edu/) and a Cobb-Douglas function, Lucas (1990 92-3) estimates that the marginal production of capital in India is about 58 times larger in India than in the United States in 1988. Adjusting for human capital, the marginal product would still be five times larger in India than in the US, motivating huge inflows of capital from developed to developing economies.
The United Nations Conference on Trade and Development (UNCTAD) prepares yearly the world investment report (UNCTAD 2010WIR). The inward stock of foreign direct investment (FDI) rose from $2082 billion at current prices in 1990 to $17,743 billion in 2009 and in the same period the outward FDI stock rose from $2087 billion to $18,982 billion (UNCTAD 2010, 16). Cross-border Mergers and Acquisitions (M&A) rose from $99 billion in 1990 to $707 billion in 2008 but declined to $250 billion in 2009. Sales of foreign affiliates of transnational companies (TNC) rose from $6026 billion in 1990 to $31,069 billion in 2008 but declined to $29,298 billion in 2009. Total assets of foreign affiliates of TNCs rose from $5938 billion in 1990 to $77,057 billion in 2009. Employment by TNC foreign affiliates rose from 24.5 million in 1990 to 78.8 million in 2009. Employment in foreign affiliates in China reached 16 million workers in 2008. US foreign affiliates employment fell by half a million in 2001-2008. There were 82,000 TNCs in 2008 of which 72 percent were based in developed countries and 28 percent in developing and transition economies. In 2008, 92.0 percent of foreign assets of the top 5000 TNCs were in companies headquartered in developed countries of which 40.4 percent in the European Union, 29.5 percent in the United States and 13.3 percent in Japan UNCTAD 2010WIR, 18). In the past 20 years, TNCs have been expanding faster abroad than in the home country, which UNTACD (2010WIR, 18) explains by “new countries and industries opening to FDI, greater economic cooperation, privatizations, improvement in transport and telecommunications, infrastructure, and the growing availability of financial resources for FDI, especially for cross-border M&As.” UNCTAD (2010WIR, 19) estimates slow recovery of FDI flow, declining from $1.8 trillion in 2008 to around $1.2 trillion in 2010 and around $1.4 trillion in 2011. The level of 2008 will only be attained in 2012 with flows projected in the interval of $1.6 trillion to $2 trillion with baseline of $1.8 trillion.
The McKinsey & Co Global Institute (MGI) has provided research on US multinational companies (MNC) that are equivalent to the UNCTAD TNCs (Cummings et al. 2010UMNC). MGI research finds that increases in value added per worker, or productivity, accounted for 32 percent of real nonfarm business sector GDP in the 1970s, 36 percent in the 1980s, 47 percent in the 1990s and 72 percent in 2000-2007. The past four decades have been characterized by globalization in various ways, requiring international competitiveness for prosperity and to maintain high standards of living. UNCTAD’s data shows the growing importance of other regions in attracting MNCs. US policy, according to MGI, should capitalize on its strengths such as market allocation, education and training of the labor force, innovation and others. Institutional factors are also important such as developed capital markets and a corporate law framework that protects minority shareholders while allowing required consolidation via the capital markets (Pelaez and Pelaez, Globalization and the State Vol. I (2008a), 46-77, Globalization and the State Vol. II (2009b), 148-179. Government Intervention in Globalization (2008c), 40-56, Financial Regulation after the Global Recession (2009a), 121-49, Regulation of Banks and Finance (2009b), 117-56)). US MNCs of around 2270 companies in 2007 concentrated most of their activities in the US: 60 percent of sales, two-thirds of employment, three-quarters of wages and 60 percent of assets (Cummings et al. 2010UMNC, 3). The average compound rate of growth of labor productivity of US MNCs in 1990 to 2007 was 3.6 percent per year while that of other companies was 1.5 percent per year, value added grew at 4.5 percent for MNCs compared with 2.9 percent for other companies but employment grew at 0.7 percent per year while growing at 1.5 percent per year in other companies. There is an amplifying effect of US MNCs throughout the economy because they purchase 90 percent of their inputs from US sources. Average wages of managerial, professional and technical employees of US MNCs exceeded by 37 percent those in other companies and by 13 percent in other occupations.
The report on employment, sales and capital expenditures of US MNCs by the Bureau of Economic Analysis (http://www.bea.gov/newsreleases/international/mnc/2011/pdf/mnc2009.pdf) is showing declines of employment in the US, shown in Table 2, that are growing concerns (http://professional.wsj.com/article/SB10001424052748704821704576270783611823972.html?mod=WSJPRO_hps_MIDDLEForthNews). Total employment by US MNCs declined by 600,000 from 31.9 million in 1999 to 31.3 million in 2009. While total employment increased at US MNCs majority owned affiliates, USMNCFA in Table 2, from 7.9 million in 1999 to 10.3 million in 2009, or by 2.4 million, employment by the parent company in the US, US MNCP in Table 2, fell from 24.0 million in 1999 to 21.1 million in 2009, or by 2.9 million. A significant part of employment reduction is explained by the fall of 1.7 million in US MNCP from 2007 to 2009. Many US MNCs operate in industrial sectors that were strongly affected by the recession and had even started shrinking before the overall contraction of the economy. The overall evaluation of MNCs must take into account their role in driving productivity and competitiveness in the economy that is required for faster growth in all sectors.
Table 2, Total Employment by US Multinational Companies (US MNC), Employment in Parent Company in the US (US MNCP) and Employment in Majority-owned Foreign Affiliates (US MNCFA) in Millions of Employees
| US MNC | US MNCP | US MNCFA | |
| 1989 | 24.8 | 19.6 | 5.2 |
| 1994 | 25.1 | 19.3 | 5.8 |
| 1999 | 31.9 | 24.0 | 7.9 |
| 2004 | 31.5 | 22.4 | 9.0 |
| 2007 | 33.2 | 22.8 | 10.4 |
| 2008 | 32.7 | 22.3 | 10.4 |
| 2009 | 31.3 | 21.1 | 10.3 |
Note: US MNC: US multinational companies; US MNCP: US multinational companies parent; US MNCFA: US multinational companies majority-owned foreign affiliates
Source:
http://www.bea.gov/newsreleases/international/mnc/2011/pdf/mnc2009.pdf
III Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table 3, updated with every post, provides the latest yearly data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly-indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of the sovereign risk issues (http://www.ft.com/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1G67TzFqs). CPI inflation accelerated to 5.4 percent in China and to 2.7 percent in the euro zone that has already increased interest rates. Food prices in China soared by 11.7 percent in Mar after 11.0 percent in Feb, 10.3 percent in Jan and 9.6 percent in Dec (http://www.ft.com/cms/s/0/69aa5fcc-670d-11e0-8d88-00144feab49a.html#axzz1J7CmnPhC). PPI inflation accelerated in Japan to 2.0 percent. Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration. The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. There are six key interrelated vulnerabilities in the world economy that have been causing global financial turbulence: (1) sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings (see section IV in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html); (2) the tradeoff of growth and inflation in China; (3) slow growth (see http://cmpassocregulationblog.blogspot.com/2011_03_01_archive.html http://cmpassocregulationblog.blogspot.com/2011/02/mediocre-growth-raw-materials-shock-and.html), weak hiring (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html and section III Hiring Collapse in http://cmpassocregulationblog.blogspot.com/2011/04/fed-commodities-price-shocks-global.html ) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (http://cmpassocregulationblog.blogspot.com/2011/04/twenty-four-to-thirty-million-in-job_03.html http://cmpassocregulationblog.blogspot.com/2011/03/unemployment-and-undermployment.html); (4) the timing, dose, impact and instruments of normalizing monetary and fiscal policies (see http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies; (5) the earthquake and tsunami affecting Japan that is having repercussions throughout the world economy because of Japan’s share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) the geopolitical events in the Middle East.
Table 3, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 2.9 | 2.7 | 5.8 | 8.8 |
| Japan | 2.5 | 0.0 | 2.0 | 4.6 |
| China | 9.7 | 5.4 | 7.3 | |
| UK | 1.5 | 4.0* | 5.4* output | 8.0 |
| Euro Zone | 2.0 | 2.7 | 6.6 | 9.9 |
| Germany | 4.0 | 2.3 | 6.3 | 6.3 |
| France | 1.5 | 2.2 | 6.3 | 9.6 |
| Nether-lands | 2.4 | 2.0 | 10.3 | 4.3 |
| Finland | 5.0 | 3.5 | 7.7 | 8.0 |
| Belgium | 1.8 | 3.5 | 10.2 | 7.6 |
| Portugal | 1.2 | 3.9 | 6.4 | 11.1 |
| Ireland | -1.0 | 1.2 | 3.9 | 14.9 |
| Italy | 1.5 | 2.8 | 5.7 | 8.4 |
| Greece | -6.6 | 4.3 | 8.0 | 12.4 |
| Spain | 0.6 | 3.3 | 7.6 | 20.5 |
Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier
*Mar Office for National Statistics
PPI http://www.statistics.gov.uk/pdfdir/ppi0411.pdf
CPI http://www.statistics.gov.uk/pdfdir/cpi0411.pdf
** Feb EUROSTAT http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-04042011-AP/EN/4-04042011-AP-EN.PDF
Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html
The responses to the questionnaires of the Business Outlook Survey of the Federal Reserve Bank of Philadelphia in Table 4 show that 58.5 percent of the firms surveyed experienced increases in prices paid in Apr relative to Mar and 60.4 percent expect price increases in the next six months. Prices paid increased for 30.2 percent of the firms in Apr relative to Mar and 42.6 percent expect increases in prices received in the next six months. The report states (http://www.phil.frb.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0411.pdf):
“Firms continue to report price increases for inputs as well as their own manufactured goods. The prices paid index declined 7 points this month but remains about 45 points higher than readings just seven months ago. Fifty-nine percent of the firms reported higher prices for inputs this month, compared to 64 percent last month. On balance, firms also reported an increase in prices for their own manufactured goods: The prices received index increased 5 points and has steadily increased over the last eight months. Thirty percent of firms reported higher prices for their own goods this month; just 3 percent reported price reductions.”
Table 4, Reponses to Prices Paid and Prices Received by the Business Outlook Survey Apr 2011 %
| Increase | No Change | Decrease | |
| Apr/Mar | |||
| Prices Paid | 58.5 | 40.0 | 1.4 |
| Prices Received | 30.2 | 67.0 | 2.7 |
| Six Months/Apr | |||
| Prices Paid | 60.4 | 31.3 | 3.3 |
| Prices Received | 42.6 | 45.3 | 5.1 |
Source:
http://www.phil.frb.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0411.pdf
The impact of stagflation on financial markets could cause high risks of another financial crisis because of the zero short-term fed funds rate and low yields of long-term Treasury securities. The pressure on interest rates rising from zero is heightened by the large-scale purchases of long-term securities by the Fed that may have to unwind the position in rising inflation and/or pay higher interest on excess reserves of banks held at the Fed, thus raising borrowing costs throughout the economy. On Apr 20, the line “Reserve Bank credit” in the Fed balance sheet was $2670 billion, or $2.7 trillion, with portfolio of long-term securities of $2439 billion, or $2.4 trillion, consisting of $1321 billion of nominal Treasury notes and bonds, $57 billion of inflation-indexed notes and bonds, $128 billion of federal agency securities and $933 billion of mortgage-backed securities; “reserve balances with Federal Reserve Banks” stood at $1463 billion, or $1.5 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1).
Table 5, updated with every blog comment, provides in the second column the yield at the close of market of the 10-year Treasury note on the date in the first column. The price in the third column is calculated with the coupon of 2.625 percent of the 10-year note current at the time of the second round of quantitative easing after Nov 3, 2010 and the final column “∆% 11/04/10” calculates the percentage change of the price on the date relative to that of 101.2573 at the close of market on Nov 4, 2010, one day after the decision on quantitative easing by the Fed on Nov 3, 2010. Prices with the new coupon of 3.63 percent in recent auctions (http://www.treasurydirect.gov/instit/annceresult/press/preanre/2011/2011.htm) are not comparable to prices in Table 5. The highest yield in the decade was 5.510 percent on May 1, 2001 that would result in a loss of principal of 22.9 percent relative to the price on Nov 4. The Fed has created a “duration trap” of bond prices. Duration is the percentage change in bond price resulting from a percentage change in yield or what economists call the yield elasticity of bond price. Duration is higher the lower the bond coupon and yield, all other things constant. This means that the price loss in a yield rise from low coupons and yields is much higher than with high coupons and yields. Intuitively, the higher coupon payments offset part of the price loss. Prices/yields of Treasury securities were affected by the combination of Fed purchases for its program of quantitative easing and also by the flight to dollar-denominated assets because of geopolitical risks in the Middle East and subsequently by the tragic earthquake and tsunami in Japan. The yield of 3.402 percent at the close of market on Apr 21, 2011, would be equivalent to price of 93.4646 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price loss of 7.7 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 issues. Important causes of the rise in yields shown in Table 5 are expectations of rising inflation and US government debt estimated to exceed 70 percent of GDP in 2012 (http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html), rising from 40.8 percent of GDP in 2008 and 53.2 percent in 2009 (Table 2 in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html). There is no simple exit of this trap created by the highest monetary policy accommodation in US history together with the highest deficits and debt in percent of GDP since World War II.
Table 5, 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 |
Note: price is calculated for an artificial 10-year note paying semi-annual coupon and maturing in ten years using the actual yields traded on the dates and the coupon of 2.625% on 11/04/10
Source:
http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3020
There is a false impression that the Fed has the “science,” measurements and forecasting to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table 6 when the Fed pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table 6 shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without Fed tightening because of the long lag in effect of monetary policy on inflation. The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery and creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether exotic policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability. A glance at Table 1 shows CPI inflation of 0.7 percent in 1961, creating a counterfactual of what would have been the Great Inflation if the Fed had set the policy rate at zero and purchased a third of the outstanding Treasury debt. The symmetric inflation target of “a little less than 2 percent,” or an infinitesimal neighborhood of 2, is an extremely dangerous misplaced analogy with the Great Depression that may bring the economy closer to the relevant historical event of the Great Inflation of the 1970s that ended with the rate hike that reached 22.36 percent for fed funds on Jul 22, 1981 and the Great Bond Crash of 1994.
Table 6, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994
| 1994 | FF | 30Y | 30P | 10Y | 10P | MOR | CPI |
| Jan | 3.00 | 6.29 | 100 | 5.75 | 100 | 7.06 | 2.52 |
| Feb | 3.25 | 6.49 | 97.37 | 5.97 | 98.36 | 7.15 | 2.51 |
| Mar | 3.50 | 6.91 | 92.19 | 6.48 | 94.69 | 7.68 | 2.51 |
| Apr | 3.75 | 7.27 | 88.10 | 6.97 | 91.32 | 8.32 | 2.36 |
| May | 4.25 | 7.41 | 86.59 | 7.18 | 88.93 | 8.60 | 2.29 |
| Jun | 4.25 | 7.40 | 86.69 | 7.10 | 90.45 | 8.40 | 2.49 |
| Jul | 4.25 | 7.58 | 84.81 | 7.30 | 89.14 | 8.61 | 2.77 |
| Aug | 4.75 | 7.49 | 85.74 | 7.24 | 89.53 | 8.51 | 2.69 |
| Sep | 4.75 | 7.71 | 83.49 | 7.46 | 88.10 | 8.64 | 2.96 |
| Oct | 4.75 | 7.94 | 81.23 | 7.74 | 86.33 | 8.93 | 2.61 |
| Nov | 5.50 | 8.08 | 79.90 | 7.96 | 84.96 | 9.17 | 2.67 |
| Dec | 6.00 | 7.87 | 81.91 | 7.81 | 85.89 | 9.20 | 2.67 |
Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months
Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
IV Budget Quagmire. The path of adjustment of US fiscal affairs is still uncertain. Table 7 shows the available data from the National Commission on Fiscal Reform and Responsibility (NCFRR) plan and the House Budget Committee (HBC) budget as released before passing in the House of Representatives. More careful comparison requires scoring by the Congressional Budget Office (CBO) with uniform estimating techniques and assumptions. A key principle of any long-term solution is reducing the ratio of expenditures to GDP back to 20 percent or less, which is what the US has been able to finance with taxes over the long term (http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html
Table 7, National Commission (NCFRR) Plan and House Budget Committee (HBC) Budget
| NCFRR | NCFRR | HBC | HBC | |
| 2011 | 3,703 | 23.8 | 3,618 | 24.1 |
| 2012 | 3,671 | 23.3 | 3,529 | 22.5 |
| 2013 | 3,691 | 22.1 | 3,559 | 21.7 |
| 2014 | 3,842 | 21.6 | 3,586 | 20.8 |
| 2015 | 4,024 | 21.6 | 3,671 | 20.2 |
| 2016 | 4,276 | 21.9 | 3,858 | 20.2 |
| 2017 | 4,450 | 21.8 | 3,998 | 20.0 |
| 2018 | 4,597 | 21.6 | 4,123 | 19.7 |
| 2019 | 4,839 | 21.8 | 4,352 | 19.9 |
| 2020 | 5,052 | 21.8 | 4,544 | 19.9 |
| Total 2011-2020 | 42,145 | Average | 38,838 | Average 20.8 |
| Average Percent | 3.5 | 3.0 |
Sources:
http://budget.house.gov/UploadedFiles/PathToProsperityFY2012.pdf
Table 8 shows that outlays in the CBO baseline estimate and in the first White House Budget (WHB) proposal of Feb 14 under the assumptions and methods of the CBO are quite similar in dollar values and as percent of GDP. For the entire period 2011-2021 the outlays of the CBO of $45,770 billion, or 23.3 percent of GDP, differ by only $402 billion from those of the WHB of $46,172 billion, or 23.5 percent of GDP. According to the CBO (2011PBM, 2), average outlays in the US have been 20.8 percent in over 40 years.
Table 8, CBO Outlays and White House Budget (WHB) Outlays
| CBO | CBO | WHB | WHB | |
| 2011 | 3,629 | 24.1 | 3,655 | 24.3 |
| 2012 | 3,639 | 23.2 | 3,708 | 23.6 |
| 2013 | 3,779 | 23.0 | 3,800 | 23.2 |
| 2014 | 3,954 | 22.9 | 3,976 | 23.0 |
| 2015 | 4,180 | 23.0 | 4,191 | 23.0 |
| 2016 | 4,460 | 23.3 | 4,476 | 23.4 |
| 2017 | 4,661 | 23.3 | 4,687 | 23.4 |
| 2018 | 4,856 | 23.2 | 4,896 | 23.4 |
| 2019 | 5,148 | 23.6 | 5,200 | 23.8 |
| 2020 | 5,412 | 22.7 | 5,483 | 24.0 |
| 2021 | 5,680 | 23.9 | 5,756 | 24.2 |
| 2011-2021 | 45,770 | 23.3 | 46,172 | 23.5 |
Note: http://www.cbo.gov/ftpdocs/121xx/doc12103/2011-03-18-APB-PreliminaryReport.pdf
Government spending in 2000 was 18.2 percent of GDP and 19.6 percent of GDP in 2007 but the average in the past three years has been 24.4 percent of GDP, as shown by Taylor (2011Apr22). It has not been feasible to tax more than 20 percent of GDP in the US (see Becker, Schultz and Taylor 2011Apr4). Thus, slowing growth of the national debt requires reducing spending to what can be paid with current taxes or around 20 percent of GDP. Otherwise, the yearly deficit would continue to add to the national debt with rising share of interest payments in spending. Taylor (2011Apr22) calculates the second WHB proposal of Apr 13 for the next decade, finding that spending is lower in proportion of GDP, over 22 percent by 2021, than in the original WHB of Feb 14 of 24.2 percent in 2021. There is the issue of whether the debt would become unsustainable, meaning that there could be risk premium on yields of Treasury securities. An additional issue raised by Taylor (2011Apr22) is that if investment increases because of lower government expenditures and slower growth of government debt, government spending of 19 to 20 percent of higher economic activity or GDP would provide more dollar resources for provision of public goods by the government.
Blinder (2011Apr19) argues that spending cuts in the HBC plan have adverse redistributive consequences. The reduction of expenditures would weaken significantly Medicare, which is the health insurance of elderly poor and middle-class people. There would be additional restrictions of Medicaid, which is the health insurance of the poor. Simultaneously, Blinder (2011Apr19) argues that taxes would be lowered for upper income brackets.
The definition of AAA credit rating by Standard & Poor’s is that the obligor “has extremely strong capacity to meet its financial commitments” and that AAA “is the highest issuer credit rating assigned by Standard & Poor’s” (http://www.standardandpoors.com/spf/delivery/assets/files/Understanding_Rating_Definitions.pdf). The S&P’s ‘A-+’rating for short-term credit is also the highest rating, which is given because of strong commitment by the obligor to meet its obligation. On Apr 18, 2011, Standard & Poor’s (2011Apr18) affirmed the ‘AAA/A-1+’ of US sovereign long-term/short-term credit rating of the United States of America. The announcement by S&P’s raised concern over the US’s “very large budget deficit and rising government indebtedness” and that “the path to addressing these is not clear to us,” leading to the decision to revise the “outlook on the long-term rating to negative from stable.” The risks are defined by Standard & Poor’s (2011Apr18) as:
“We believe there is a material risk that the U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.”
DeLong (2011Apr19) provides an interesting political economy analysis of the outlook downgrade of US long-term debt. If the downgrade were surprising news, equities would have fallen, capital flight would have caused devaluation of the dollar and yields of Treasury securities would have risen. But none of these typical reactions occurred. There could be excessive reading of short-term market reactions. DeLong (2011Apr19) find the possibility that there could be a political actor trying to influence the budget deal that could end the budget quagmire. Bond market reactions have triggered efforts to correct deficits and debt. The threat of an effective US sovereign debt downgrade in 2013 could also motivate the required budget deal.
V Trends and Cycles of Valuations of Risk Financial Assets. Near zero interest rates encourage the carry trade of borrowing at extremely low short-term rates and taking long positions in risk financial assets such as commodities, currencies, stocks and so on. Families, investors and most everybody worldwide were encouraged to benefit from the low interest rates originating in Fed policy of 1 percent fed funds rate in 2003-2004 and housing subsidies by borrowing significantly or high leverage, ignoring potential future adverse events or taking high risks, investing fully or having little or no cash assets or low liquidity and induced easy lending or taking unsound credit decisions. The carry trade of borrowing at extremely low short-term rates and taking long positions in risk financial assets is shown in Table 9 in the form of high valuations in most risk financial assets and then eventual collapse in the form of the credit/dollar crisis and global recession after 2007. The financial crisis and global recession were caused by interest rate and housing policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4)).
Table 9, Volatility of Assets
| DJIA | 10/08/02-10/01/07 | 10/01/07-3/4/09 | 3/4/09- 4/6/10 | |
| ∆% | 87.8 | -51.2 | 60.3 | |
| NYSE Financial | 1/15/04- 6/13/07 | 6/13/07- 3/4/09 | 3/4/09- 4/16/07 | |
| ∆% | 42.3 | -75.9 | 121.1 | |
| Shanghai Composite | 6/10/05- 10/15/07 | 10/15/07- 10/30/08 | 10/30/08- 7/30/09 | |
| ∆% | 444.2 | -70.8 | 85.3 | |
| STOXX EUROPE 50 | 3/10/03- 7/25/07 | 7/25/07- 3/9/09 | 3/9/09- 4/21/10 | |
| ∆% | 93.5 | -57.9 | 64.3 | |
| UBS Com. | 1/23/02- 7/1/08 | 7/1/08- 2/23/09 | 2/23/09- 1/6/10 | |
| ∆% | 165.5 | -56.4 | 41.4 | |
| 10-Year Treasury | 6/10/03 | 6/12/07 | 12/31/08 | 4/5/10 |
| % | 3.112 | 5.297 | 2.247 | 3.986 |
| USD/EUR | 6/26/03 | 7/14/08 | 6/07/10 | 04/22 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.455 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 04/22 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.5080 |
| New House | 1963 | 1977 | 2005 | 2009 |
| Sales 1000s | 560 | 819 | 1283 | 375 |
| New House | 2000 | 2007 | 2009 | 2010 |
| Median Price $1000 | 169 | 247 | 217 | 203 |
| 2003 | 2005 | 2007 | 2010 | |
| CPI | 1.9 | 3.4 | 4.1 | 1.5 |
Sources: http://online.wsj.com/mdc/page/marketsdata.html
http://www.census.gov/const/www/newressalesindex_excel.html
http://federalreserve.gov/releases/h10/Hist/dat00_eu.htm
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm
http://markets.ft.com/ft/markets/currencies.asp
Table 9A extracts four rows of Table 9 with the Dollar/Euro (USD/EUR) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies disguised as 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 11, the dollar has devalued again to USD 1.455/EUR or by 22.1 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 6.5080/USD on Apr 22, 2011, or by an additional 4.6 percent, for cumulative revaluation of 21.4 percent.
Table 9A, 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 | 04/22 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.455 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 04/22 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.5080 |
Source: Table 9.
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 10. 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, as shown in Table 10.
Table 10, 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 9 after the first policy round of near zero fed funds and quantitative easing by withdrawing supply with the suspension of the 30-year Treasury auction was on a smooth trend with relatively subdued fluctuations. The credit crisis and global recession have been followed by significant fluctuations originating in sovereign risk issues in Europe, doubts of continuing high growth and accelerating inflation in China, events such as in the Middle East and Japan and legislative restructuring, regulation, insufficient growth, low wages, depressed hiring and high job stress of unemployment and underemployment in the US. The “trend is 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 with fluctuations provoked by events of risk aversion. Table 11, which is updated for every comment, shows the deep contraction of risk financial assets after the Apr 2010 sovereign risk issues in the fourth column “∆% to Trough” and the sharp recovery after around Jul 2010 in the last column “∆% Trough to 4/22/11” with all risk financial assets in the range from 14.4 percent for European stocks to 40.5 percent for commodities, excluding Japan that has currently weaker performance because of the earthquake/tsunami, while the dollar devalued by 22.1 percent and even higher before the new bout of sovereign risk issues in Europe. Aggressive tightening by the Fed to maintain the credibility of inflation not rising above 2 percent—in contrast with timid “measured” policy during the adjustment in Jun 2004 to Jun 2006 after the earlier round of near zero interest rates—may cause another credit/dollar crisis and stress on the overall world economy. The choices may prove tough and will magnify effects on financial variables because of the corner in which policy has been driven by aggressive impulses that have resulted in the fed funds rate of 0 to ¼ percent and holdings by the Fed that move toward 30 percent of Treasury securities in circulation.
Table 11, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 4/ | ∆% Week 4/ | ∆% Trough to 4/ | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 11.6 | 1.3 | 29.1 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 9.9 | 1.3 | 30.8 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | -3.5 | 0.5 | 21.2 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | 5.8 | 1.4 | 29.6 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | 8.5 | 2.1 | 23.9 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | -15.0 | 0.9 | 9.7 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -4.9 | -1.3 | 26.3 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -3.1 | 0.6 | 14.4 |
| DAX | 4/26/ | 5/25/ | -10.5 | 15.2 | 1.6 | 28.7 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 3.8 | -0.8 | -22.1 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | 20.1 | 2.1 | 40.5 |
| 10-Year Tre. | 4/5/ | 4/6/10 | 3.986 | 3.402 |
T: trough; Dollar: positive sign appreciation relative to euro (less dollars paid per euro), negative sign depreciation relative to euro (more dollars paid per euro)
Source: http://online.wsj.com/mdc/page/marketsdata.html.
Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis by the Fed on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. Table 12 shows a gain in the DJIA of 11.6 percent and of the S&P 500 of 10.3 percent since Apr 26 around the time when sovereign risk issues in Europe began to be acknowledged in financial risk asset valuations. There were still fluctuations. Reversals of valuations are possible during aggressive changes in interest rate policy.
Table 12, Percentage Changes of DJIA and S&P 500 in Selected Dates
| 2010 | ∆% DJIA from earlier date | ∆% DJIA from | ∆% S&P 500 from earlier date | ∆% S&P 500 from |
| Apr 26 | ||||
| May 6 | -6.1 | -6.1 | -6.9 | -6.9 |
| May 26 | -5.2 | -10.9 | -5.4 | -11.9 |
| Jun 8 | -1.2 | -11.3 | 2.1 | -12.4 |
| Jul 2 | -2.6 | -13.6 | -3.8 | -15.7 |
| Aug 9 | 10.5 | -4.3 | 10.3 | -7.0 |
| Aug 31 | -6.4 | -10.6 | -6.9 | -13.4 |
| Nov 5 | 14.2 | 2.1 | 16.8 | 1.0 |
| Nov 30 | -3.8 | -3.8 | -3.7 | -2.6 |
| Dec 17 | 4.4 | 2.5 | 5.3 | 2.6 |
| Dec 23 | 0.7 | 3.3 | 1.0 | 3.7 |
| Dec 31 | 0.03 | 3.3 | 0.07 | 3.8 |
| Jan 7 | 0.8 | 4.2 | 1.1 | 4.9 |
| Jan 14 | 0.9 | 5.2 | 1.7 | 6.7 |
| Jan 21 | 0.7 | 5.9 | -0.8 | 5.9 |
| Jan 28 | -0.4 | 5.5 | -0.5 | 5.3 |
| Feb 4 | 2.3 | 7.9 | 2.7 | 8.1 |
| Feb 11 | 1.5 | 9.5 | 1.4 | 9.7 |
| Feb 18 | 0.9 | 10.6 | 1.0 | 10.8 |
| Feb 25 | -2.1 | 8.3 | -1.7 | 8.9 |
| Mar 4 | 0.3 | 8.6 | 0.1 | 9.0 |
| Mar 11 | -1.0 | 7.5 | -1.3 | 7.6 |
| Mar 18 | -1.5 | 5.8 | -1.9 | 5.5 |
| Mar 25 | 3.1 | 9.1 | 2.7 | 8.4 |
| Apr 1 | 1.3 | 10.5 | 1.4 | 9.9 |
| Apr 8 | 0.03 | 10.5 | -0.3 | 9.6 |
| Apr 15 | -0.3 | 10.1 | -0.6 | 8.9 |
| Apr 22 | 1.3 | 11.6 | 1.3 | 10.3 |
Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3004
Table 13, 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).
Table 13, Exchange Rates
| Peak | Trough | ∆% P/T | Apr 22 2011 | ∆T | ∆% P | |
| EUR USD | 7/15 | 6/7 2010 | 4/22 | |||
| Rate | 1.59 | 1.192 | 1.455 | |||
| ∆% | -33.4 | 18.1 | -9.3 | |||
| JPY USD | 8/18 | 9/15 | 4/22 2011 | |||
| Rate | 110.19 | 83.07 | 81.85 | |||
| ∆% | 24.6 | 1.5 | 25.7 | |||
| CHF USD | 11/21 2008 | 12/8 2009 | 4/22 2011 | |||
| Rate | 1.225 | 1.025 | 0.883 | |||
| ∆% | 16.3 | 13.9 | 27.9 | |||
| USD GBP | 7/15 | 1/2/ 2009 | 4/22 2011 | |||
| Rate | 2.006 | 1.388 | 1.652 | |||
| ∆% | -44.5 | 15.9 | -21.4 | |||
| USD AUD | 7/15 2008 | 10/27 2008 | 4/15 | |||
| Rate | 1.0215 | 1.6639 | 1.074 | |||
| ∆% | -62.9 | 44.0 | 8.8 | |||
| ZAR USD | 10/22 2008 | 8/15 | 4/22 2011 | |||
| Rate | 11.578 | 7.238 | 6.707 | |||
| ∆% | 37.5 | 7.3 | 42.1 | |||
| SGD USD | 3/3 | 8/9 | 4/22 | |||
| Rate | 1.553 | 1.348 | 1.236 | |||
| ∆% | 13.2 | 8.3 | 20.4 | |||
| HKD USD | 8/15 2008 | 12/14 2009 | 4/8 | |||
| Rate | 7.813 | 7.752 | 7.767 | |||
| ∆% | 0.8 | -0.2 | 0.6 | |||
| BRL USD | 12/5 2008 | 4/30 2010 | 4/15 2011 | |||
| Rate | 2.43 | 1.737 | 1.564 | |||
| ∆% | 28.5 | 9.9 | 35.6 | |||
| CZK USD | 2/13 2009 | 8/6 2010 | 4/22 | |||
| Rate | 22.19 | 18.693 | 16.545 | |||
| ∆% | 15.7 | 11.5 | 25.4 | |||
| SEK USD | 3/4 2009 | 8/9 2010 | 4/15 2011 | |||
| Rate | 9.313 | 7.108 | 6.009 | |||
| ∆% | 23.7 | 15.5 | 35.5 | |||
| CNY USD | 7/20 2005 | 7/15 | 4/22 | |||
| Rate | 8.2765 | 6.8211 | 6.5080 | |||
| ∆% | 17.6 | 4.6 | 21.4 |
Symbols: USD: US dollar; EUR: euro; JPY: Japanese yen; CHF: Swiss franc; GBP: UK pound; AUD: Australian dollar; ZAR: South African rand; SGD: Singapore dollar; HKD: Hong Kong dollar; BRL: Brazil real; CZK: Czech koruna; SEK: Swedish krona; CNY: Chinese yuan; P: peak; T: trough
Note: percentages calculated with currencies expressed in units of domestic currency per dollar; negative sign means devaluation and no sign appreciation
Source: http://online.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000
http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm
http://markets.ft.com/ft/markets/currencies.asp
The International Monetary and Financial Committee of the IMF (IMFC) released the communiqué of its meeting on Apr 16 with a statement on the issue of capital flows (IMFC 2011Apr16):
“The IMF’s recent work on managing capital inflows is a step that should lead toward a comprehensive and balanced approach for the management of capital flows drawing on country experiences. Giving due regard to country-specific circumstances and the benefits of financial integration, such an approach should encompass recommendations for both policies that give rise to outward capital flows and the management of inflows. We urge the IMF to deepen its analysis of global liquidity, the varied experiences of member countries with capital account management, liberalization of cross-border capital flows, and development of domestic financial markets.”
The Wall Street Journal finds that emerging nations oppose the measures to codify capital controls in response to floods of cheap money originating in Fed policy (http://professional.wsj.com/article/SB10001424052748703702004576268980074855142.html?mod=WSJ_hp_LEFTWhatsNewsCollection). The rationale for the dissent within the IMFC is that the new codes of conduct on capital controls constitute policies of advanced economies to prevent policies in emerging nations to compensate for the effects on their internal economies of zero interest rates and quantitative easing in advance economies. Monetary policy by the Fed in the form of zero interest rates and large-scale purchases of long-term securities causes portfolio rebalancing toward commodities and emerging market securities that inflate emerging market economies and appreciate their currencies. The US supports the code of conduct on capital controls at the IMF and also further revaluation of the CNY/USD rate. The WSJ finds intervention on Apr 20 of central banks in South Korea, Thailand and Malaysia to arrest the appreciation of their currencies (http://professional.wsj.com/article/SB10001424052748704658704576274282408104342.html?mod=WSJ_hps_sections_markets).
VI Economic Indicators. Manufacturing continues to expand but at a slower pace in the Philadelphia region of the Federal Reserve. Housing continues to be week and jobless claims fell. The evaluation of the level of general business activity of the Business Outlook Survey of the Philadelphia FRB fell 24.9 points from 43.4 in Mar to 18.5 in Apr and the expectation for the next six months fell 29.4 points from 63.0 in Mar to 33.6 in Apr (http://www.phil.frb.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0411.pdf). The index of new orders fell 21.5 points from 40.3 in Mar to 18.8 in Apr and the expectation for the next six months fell 30.9 points from 60.1 in Mar to 29.2 in Apr. The survey still shows expansion but at a slower pace. Privately-owned housing units authorized by building permits were at the annual equivalent rate of 594,000 in Mar, which is higher by 11.2 percent than 534,000 in Feb; privately-owned housing starts in Mar were at the seasonally-adjusted annual rate of 549,000 in Mar, which is 7.2 percent above the estimate of 512,000 in Feb; housing permits not seasonally adjusted fell by 12.2 percent in the first quarter of 2011 relative to the first quarter of 2010 and housing starts fell 9.9 percent in the first quarter of 2011 relative to the first quarter in 2010 (http://www.census.gov/const/newresconst.pdf). Table 14 shows that housing starts in the first quarter are lower in 2011 by 73.9 percent relative to 2006 and by 73.0 percent relative to 2011; housing permits are lower in the first quarter of 2011 by 74.2 percent relative to 2006 and by 73.1 percent relative to 2011.
Table 14, Housing Starts and Permits in the First Quarter of 2011, 2006 and 2005, Not Seasonally Annualized
| Jan-Mar | 2011 | 2006 | ∆% 2011 | 2005 | ∆% 2011 |
| Starts | 121.0 | 464.1 | -73.9 | 448.2 | -73.0 |
| Permits | 127.9 | 496.0 | -74.2 | 475.2 | -73.1 |
Source: http://www.census.gov/const/newresconst_200603.pdf
http://www.census.gov/const/newresconst_200703.pdf
http://www.census.gov/const/newresconst_201103.pdf
The National Association of Realtors finds that seasonally-adjusted existing home sales rose 3.7 percent in Mar relative to Feb but are below 6.3 percent relative to Mar 2010 (http://www.realtor.org/press_room/news_releases/2011/04/rise_march). The House Price Index of the Federal Housing Finance Agency, seasonally adjusted, fell 1.6 percent in Feb relative to Jan and fell 5.7 percent in the 12 months ending in Mar 2011; the index is lower by 18.6 percent relative to its peak in Apr 2007 (http://www.fhfa.gov/webfiles/21155/HPI42111.pdf). The US Energy Information Administration estimates that in the week of Apr 15 US commercial crude oil inventories, not including the Strategic Petroleum Reserve, fell by 2.3 million barrels from the prior week and stood at 357.0 million barrels (http://www.eia.doe.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/pdf/highlights.pdf). US crude oil imports were on average 8.1 million barrels per day, declining by 518 thousand barrels per day from the prior week and lower than 8.7 million barrels per day on average in the past four weeks, which is lower by 603,000 barrels per day relative to the same four-week period in 2010. On Apr 15, the average world crude oil price stood at $119.39/barrel, higher by $2.23/barrel than in the prior week and $36.36/barrel higher than a year earlier. Retail average regular gasoline price rose for a fourth consecutive week to $3.844/gallon on Apr 18, 2011, $0.053/gallon higher than in the prior week and $0.984/gallon higher than a year earlier. Initial jobless claims seasonally adjusted fell 13,000 in the week of Apr 16, reaching 403,000 compared with 416,000 a week earlier. Initial jobless claims not seasonally adjusted fell 67,357 in the week of Apr 16, reaching 380,668 compared with 448,025 in the prior week. The four-week moving average seasonally adjusted fell 2250 to 399,000 in the week of Apr 16 compared with 396,750 a week earlier (http://www.dol.gov/opa/media/press/eta/ui/current.htm).
VII Interest Rates. The 10-year Treasury note traded at 3.39 percent on Apr 22, which is lower than 3.41 percent a week earlier and also lower than 3.41 percent a month earlier (http://markets.ft.com/research/Markets/Bonds?ftauth=1303657138150). The 10-year government bond of Germany traded at 3.27 percent for negative spread of 12 basis points relative to the comparable US Treasury while the 10-year government bond of Greece traded at 15.09 percent for positive spread of 11.82 percentage points relative to the 10-year government bond of Germany (http://markets.ft.com/RESEARCH/Markets/Government-Bond-Spreads). The US Treasury with coupon of 3.63 percent and maturing in 02/21 traded at yield of 3.39 percent equivalent to price of 101.91, which is not comparable to the price in Table 5 for a bond with coupon of 2.625 percent and maturity in exactly ten years.
VIII Conclusion. There is similarity between the pursuit of permanent growth trends of economic activity and employment by the Fed currently and in the 1960s and 1970s. The argument in both cases was that inflation would not constitute a problem as long as there was a gap between potential and actual output. The major difference is that supply shocks caused the rise in commodity prices in the 1970s while zero interest rates and quantitative easing have stimulated commodity prices and multiple other valuations of financial risk assets. The FOMC should return monetary policy to normalcy. (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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