Growth Recession, Debt Financial Risk Aversion, United States Risk and the Political “Chicken Run to the Edge of the Abyss”
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011
Executive Summary
I Growth Recession
II Debt Financial Risk Aversion
IIA Risk Financial Assets
IIB European Sovereign Risk
III US Risk and the Chicken Run
IIIA Timing and Structure of Government Debt
IIIB Employment Hardship
IV Global Inflation
V Valuation of Risk Financial Assets
VI Economic Indicators
VII Interest Rates
VIII Conclusion
References
Executive Summary
The concept of growth recession was popular during the stagflation from the late 1960s to the early 1980s. The economy of the US underperformed with several recession episodes in “stop and go” fashion of economic activity while the rate of inflation rose to the highest in a peacetime period. Two of the most influential economists of the past century both of whom received the equivalent of the Nobel Prize in economics quoted the concept of growth recession.
Referring to monetary policy design, James Tobin (1974, 221) states: “if interest rates remain stable or rise during the current (growth) recession and recovery, this will be a unique episode in business cycle annals” (italics and emphasis added). Subpar economic growth is often called a “growth recession.” The critically important concept is that economic growth is not sufficient to move the economy toward full employment, creating the social and economic adverse outcome of idle capacity and unemployed and underemployed workers, much the same as currently. The economy is wasting its productive resources that could be used to provide prosperity to the population.
The unexpected incidence of inflation “surprises” during growth recessions is considered by Paul A. Samuelson (1974, 76):
“Indeed, if there were in Las Vegas or New York a continuous casino on the money GNP of 1974’s fourth quarter, it would be absurd to think that the best economic forecasters could improve upon the guess posted there. Whatever knowledge and analytical skill they possess would already have been fed into the bidding. It is a manifest contradiction to think that most economists can be expected to do better than their own best performance. I am saying that the best forecasters have been poor in predicting the general price level’s movements and level even a year ahead. By Valentine’s Day 1973 the best forecasters were beginning to talk of the growth recession that we now know did set in at the end of the first quarter. Aside from their end-of-1972 forecasts, the fashionable crowd has little to blame itself for when it comes to their 1973 real GNP projections. But, of course, they did not foresee the upward surge of food and decontrolled industrial prices. This has been a recurring pattern: surprise during the event at the virulence of inflation, wisdom after the event in demonstrating that it did, after all, fit with past patterns of experience” (italics and emphasis added).
The argument by Feldstein (2011Jun8) is that IQ2011 growth of final sales after deducting inventory change was only 0.6 percent, which is equivalent to growth of only 0.15 percent in the quarter ((1.006)1/4 or 0.6 percent discounted four quarterly periods). This argument was still valid with the third estimate of GDP growth of 1.9 percent in IQ2011 and of contribution of 1.31 percentage points by inventory change. The arguments by Feldstein in Jun that the economy was worst than perceived turned to be prophetic in that the estimate of GDP annual equivalent growth in IQ2011 is revised to 0.4 percent with the economy stalled in an evident slow-growth recession with only 1.3 percent growth in IIQ2011. Real final sales of domestic product, which is equivalent to GDP growth less change in private inventories, is only growing at the annual equivalent rate of 1.1 percent in IIQ2011 that is still in slow-growth recession range even if better than real final sales of domestic product of only 0.1 percent annual equivalent in IQ2011. Growth of the economy is approximating the dimensions of the zero interest rates of monetary policy.
US politics on the budget and the debt in the past few months have become a playground of the “game of chicken.” The text provides references to formal scholarly applications of the chicken game in philosophy, economics and social sciences. There is need only to appeal to the most famous case in Hollywood, which was the “chicken run” in Rebel without a Cause (http://www.youtube.com/watch?v=u7hZ9jKrwvo). In rivalry for Natalie Wood, James Dean engages in a race with stolen cars in competition with a cool gang member driving toward a cliff by the sea: the first jumping out is the “chicken,” or coward. Natalie Wood comforts both contestants in this irrational game and flags the start by raising her hands and jumping. James Dean jumps but his rival is trapped to the door handle by his jacket and falls over the cliff inside his car toward death. The beltway version of the chicken run is a dare of who concedes first on increasing the debt limit instead of perishing in elections. The prize is not the love of Natalie Wood but the votes of the electorate in winning (or losing) the 2012 presidential election. There are many chicken or cowardice yellow stains of which two are paramount: (1) “read my lips” but then agree to tax increases that allegedly caused a defeat in the 1992 election; or (2) cut spending with reductions of benefits in entitlements that can turn record numbers of seniors to vote against you.
The headline of the Wall Street Journal as these last words are written is that there is an agreement (http://professional.wsj.com/article/SB10001424053111903520204576480123949521268.html?mod=WSJ_Home_largeHeadline), that is, the contestants in the chicken run jumped predictably at the same time before the self-imposed date of disaster. The beltway chicken run is simpler for markets that have anticipated (1) that the debt limit will be increased without harms even in delay of a self-imposed deadline of Aug 2 when supposedly there would be unpleasant events such as failure to make social security payments, armed forces paychecks and the like. Markets have also anticipated that inevitably the credit rating of the United States will be downgraded below the current AAA. Table 11 in the text of this comment provides the peaks and troughs of yields of Treasury securities in the 52 weeks ending on Jul 29. All yields on Jul 29 are below their peaks in the past year. The only real rise of yields has been for one-month Treasury bills that have risen to 0.165 percent but still below the peak of 0.17 percent on Dec 1, 2010. The two-year Treasury note traded at 0.392 percent on Jul 22 (Table 1 in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), declining to 0.36 percent on Jul 29. The ten-year Treasury note traded at 2.964 on Jul 22 (Table 1 in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), declining to 2.795 percent on Jul 29. Stock market declines and mild depreciation of the dollar on Jul 29 were caused by the realization that the US economy stalled in the first quarter, growing at only 0.4 percent, and continues weak, growing at 1.3 percent in the second quarter but with indicators showing continuing weakness. The beltway chicken run has been largely ignored by markets. The debt abyss is not on Aug 2 but sometime ahead in the next few years or perhaps earlier when markets begin anticipating a point of debt explosion.
I Growth Recession. The concept of growth recession was popular during the stagflation from the late 1960s to the early 1980s. The economy of the US underperformed with several recession episodes in “stop and go” fashion of economic activity while the rate of inflation rose to the highest in a peacetime period (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/05/global-inflation-seigniorage-monetary.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html). The rate of economic growth of the US collapsed in the first half of 2011, according to new and revised estimates of GDP discussed below. In analysis of the design of monetary policy in 1974, Tobin (1974, 219) finds that the forecast of the President’s Council of Economic Advisers (CEA) was also the target such that monetary policy would have to be designed and implemented to attain that target. The concern was with maintaining full employment as provided in the Employment Law of 1946 (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) see http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html), which also created the CEA. Tobin (1974, 219) describes the forecast/target of the CEA for 1974:
“The expected and approved path appears to be quarter-to-quarter rates of growth of real gross national product in 1974 of roughly -0.5, 0.1, and 1 percent, with unemployment rising to about 5.6 percent in the second quarter and remaining there the rest of the year. The rate of price inflation would fall shortly in the second quarter, but rise slightly toward the end of the year.”
Referring to monetary policy design, Tobin (1974, 221) states: “if interest rates remain stable or rise during the current (growth) recession and recovery, this will be a unique episode in business cycle annals.” Subpar economic growth is often called a “growth recession.” The critically important concept is that economic growth is not sufficient to move the economy toward full employment, creating the social and economic adverse outcome of idle capacity and unemployed and underemployed workers, much the same as currently.
The unexpected incidence of inflation surprises during growth recessions is considered by Samuelson (1974, 76):
“Indeed, if there were in Las Vegas or New York a continuous casino on the money GNP of 1974’s fourth quarter, it would be absurd to think that the best economic forecasters could improve upon the guess posted there. Whatever knowledge and analytical skill they possess would already have been fed into the bidding. It is a manifest contradiction to think that most economists can be expected to do better than their own best performance. I am saying that the best forecasters have been poor in predicting the general price level’s movements and level even a year ahead. By Valentine’s Day 1973 the best forecasters were beginning to talk of the growth recession that we now know did set in at the end of the first quarter. Aside from their end-of-1972 forecasts, the fashionable crowd has little to blame itself for when it comes to their 1973 real GNP projections. But, of course, they did not foresee the upward surge of food and decontrolled industrial prices. This has been a recurring pattern: surprise during the event at the virulence of inflation, wisdom after the event in demonstrating that it did, after all, fit with past patterns of experience.”
Economists are known for their forecasts being second only to those of astrologers. Accurate forecasts are typically for the wrong reasons. In contrast with meteorologists, economists do not even agree on what happened.
Romer and Romer (1989, 149) identify an episode during the Great Inflation and Unemployment of the 1970s in which monetary policy induced a growth recession to lower inflation (see also Schwartz 1989):
“In August, the FOMC [Federal Open Market Committee] recognized the ‘possibility that an appreciable slowing of inflation would prove more difficult to achieve than previously had been anticipated.’ Steps to tighten policy began in August, and in November the government announced a major program to strengthen the weak dollar and combat inflation. The discount rate was raised from 7.25 to 9.5% in four steps from August to November 1978, and reserve requirements were also increased in November. By November the [Federal Reserve] System was fairly explicit that its objective was to cause a growth recession. The tightening of policy was continued despite forecasts of sluggish growth, and despite the fact that ‘skepticism was expressed [by some members of the FOM] that growth in output could be tapered down to a relatively slow rate without bringing on a recession.’”
Many countries in the world are attempting to reduce the rate of growth of the economy to control inflation with policies such as increases in interest rates and quantitative controls on credit in China.
Chile in 1990 is considered by Dornbusch and Fischer (1993, 17) as a successful case of inducing a growth recession to restrain high inflation:
“Against a background of an acceleration of inflation, the incoming government took a firm stand: in the campaign they assertively endorsed highly conservative economic management. Once in office, they actually practiced it. The year 1990 was one of slower growth, necessary to cool off the economy and set the stage for sustained and stable growth in the years to come. Inflation did rise in the calendar year to 27 percent. But by December the growth-recession had done its work, and inflation rates had been pushed down sharply. The point had been made that inflation at 20 to 25 percent was acceptable, but open-ended inflation was not.”
There are likely errors of theory, model, forecasting and lags in implementing this strategy, especially during high inflation.
An interpretation of the Great Inflation and Unemployment by Orphanides (2003, 2004) is based on the argument that errors of measurement of potential output based on an incorrect extrapolation of productivity misled the FOMC into pursuing easy monetary policy that resulted in higher inflation because tightening was actually required. Orphanides and Williams 2008, 2009 and 2010) analyze the stronger argument that monetary policy would have erred even with perfect knowledge of the actual outcome of potential output used with contemporary optimal-control methods. McCarthy (1977) provides measurements of the annual rate of growth of GNP per hour of 4.20 percent in 1947-53, declining to 2.61 percent in 1953-68 and collapsing to 1.41 percent in 1968-73. The explanation by McCarthy (1977) is low growth of the capital/labor ratio in 1970-75 and structural change in the labor force because of entry of young and inexperienced workers.
The fed funds rate is found by Bernanke and Blinder (1992) as providing information on the future path of macroeconomic variables because it reflects changes in bank reserves in response to monetary policy. Bernanke and Blinder (1992) consider the fed funds rate (FUNDS in their abbreviation) and define FFBOND as the spread between the yield of the 10-year note and FUNDS, which is a measurement of the slope of the yield curve because the rate of FUNDS is closely related to the yield short-term Treasury bills. Bernanke and Blinder (1992, 911-12) find:
“Figure 1 displays the behavior of both FUNDS and FFBOND from 1959 through 1989. Readers will immediately notice that the two series behave very similarly; not surprisingly, it is the funds rate, not the bond rate, that dominates movements in FFBOND. Official NBER [National Bureau of Economic Research] business-cycle peaks are indicated by vertical lines in the figure. Notice that every cyclical peak since 1959 was preceded by a sustained run-up in FFBOND. Furthermore, only one sustained increase in FFBOND was not followed by a recession. That episode, which was long and gradual, ended with the 1966 credit crunch, which was followed by a ‘growth recession.’ The figure shows, in a very simple way, why the Federal funds rate has so much predictive power.”
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). The accurate term should be the “Great Inflation and Unemployment.” What turns growth recessions especially bitter is when they coincide with inflation.
The US is experiencing a dramatic slow growth recession with 29.7 million people in job stress, consisting of an effective number of unemployed of 18.4 million, 8.6 million employed part-time because they cannot find full employment and 2.7 million marginally attached to the labor force (http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html). Taylor (2011Jul21), in an article for the Wall Street Journal, compares average annual equivalent growth after the recession of 2007-2009 of only 2.8 percent with 7.1 percent after the comparably strong recent recession of 1981-1982. Growth has not been mediocre but actually stalled since the beginning of the current expansion phase. There were 144 million people with jobs in the US in 2006 compared with only 140 million in Jun 2011 (see Table 2 in http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html). Some common explanations for the current slump are not valid. Negative effects of weak housing currently are inferior compared with negative exports in the 1980s that gave the pejorative name of “rust belt” to the US industrial corridor. Growth originates in aggregate demand consisting of investment and consumption. Taylor (2011Jul21) finds that real GDP growth currently is 60 to 70 percent lower than in the recovery of the 1980s, which is also the case of consumption and investment. Another common misperception is that there has been a systemic financial crisis with many ignoring the debt crisis of 1982 when US money-center banks had more than 40 percent of their capital in loans to emerging countries in default or near default. Several countries that had borrowed for financing balance of payments deficits declared moratoriums on their foreign debts, impairing balance sheets of money-center banks (see, for example, in vast literature, Krugman 1994). The increase in interest rates to deal with stagflation caught the banking industry with short-dated funding and long-term fixed-rate assets. In a parallel of what could happen when monetary policy abandons its near zero interest rates, 1150 US commercial banks, close to 8 percent of the industry, failed, almost twice the number of banks that failed since establishment of the FDIC in 1934 until 1983 (Benston and Kaufman 1997, 139; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7). More than 900 savings and loans associations, equivalent to around 25 percent of the industry, had to be closed, merged or placed in conservatorship (Ibid). Taxpayer funds in the value of $150 billion were used in the resolution of failed savings and loans institutions. In terms of relative dimensions, $150 billion was equivalent to 2.6 percent of GDP of $5800 billion in 1990 and 3.6 percent of GDP of $4217 billion in 1985 (http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=5&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=1980&LastYear=1990&3Place=N&Update=Update&JavaBox=no). The equivalent in terms of 2.6 to 3.6 percent of US GDP in 2010 of $14,657 billion would be $381 billion to $528 billion (data from Ibid). Wide swings in interest rates resulting from aggressive monetary policy can wreck the balance sheets of families, financial institutions and companies while posing another recession risk. While it is true that monetary policy can increase interest rates instantaneously, the increase from zero percent toward much higher levels to contain inflation can have devastating effects on the world economy.
Historical parallels are instructive but have all the limitations of empirical research in economics. The more instructive comparisons are not with the Great Depression of the 1930s but rather with the recessions in the 1950s, 1970s and 1980s. The growth rate and job creation in the expansion of the economy away from recession are subpar in the current expansion compared to others in the past. Four recessions are initially considered, following the reference dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles/cyclesmain.html ): IIQ1953-IIQ1954, IIIQ1957-IIQ1958, IIIQ1973-IQ1975 and IQ1980-IIIQ1980. The data for the earlier contractions illustrate that the growth rate and job creation in the current expansion are inferior. The sharp contractions of the 1950s and 1970s are considered in Table 1, showing the Bureau of Economic Analysis (BEA) quarter-to-quarter, seasonally adjusted (SA), yearly-equivalent growth rates of GDP. The recovery from the recession of 1953 consisted of four consecutive quarters of high percentage growth rates from IIIQ1954 to IIIQ1955: 4.6, 8.3, 12.0, 6.8 and 5.4. The recession of 1957 was followed by four consecutive high percentage growth rates from IIIQ1958 to IIQ1959: 9.7, 9.7, 8.3 and 10.5. The recession of 1973-1975 was followed by high percentage growth rates from IIQ1975 to IIQ1976: 6.9, 5.3, 9.4 and 3.0. The disaster of the Great Inflation and Unemployment of the 1970, which made stagflation notorious, is even better in growth rates during the expansion phase from contractions in comparison than the current slow-growth recession.
Table 1, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| IQ | IIQ | IIIQ | IVQ | |
| 1953 | 7.7 | 3.1 | -2.4 | -6.2 |
| 1954 | -1.9 | 0.5 | 4.6 | 8.3 |
| 1955 | 12.0 | 6.8 | 5.4 | 2.3 |
| 1957 | 2.5 | -1.0 | 3.9 | -4.1 |
| 1958 | -10.4 | 2.5 | 9.7 | 9.7 |
| 1959 | 8.3 | 10.5 | -0.5 | 1.4 |
| 1973 | 10.6 | 4.7 | -2.1 | 3.9 |
| 1974 | 3.5 | 1.0 | -3.9 | 6.9 |
| 1975 | -4.8 | 3.1 | 6.9 | 5.3 |
| 1976 | 9.4 | 3.0 | 2.0 | 2.9 |
| 1979 | 0.7 | 0.4 | 2.9 | 1.1 |
| 1980 | 1.3 | -7.9 | -0.7 | 7.6 |
The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ1982 are combined, the impact of lost GDP of 2.3 percent is more comparable to the latest revised 5.1 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.5 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). Table 2 provides the Bureau of Economic Analysis (BEA) quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981-1982 and 2007 to 2009, using the latest major revision published on Jul 29, 2011 (http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf). There were four quarters of contraction in 1981-1982 ranging in rate from -1.5 percent to -6.4 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.7 percent to -8.9 percent. The striking difference is that in the first eight quarters of expansion from IQ1983 to IIIQ1984, shown in Table 2 in relief, GDP grew at the high quarterly percentage growth rate of 5.1, 9.3, 8.1, 8.5, 7.1, 3.9, 3.3 and 5.4 while the percentage growth rate in the first eight quarters from IIIQ2009 to IQ2011, shown in relief in Table 2, was mediocre: 1.7, 3.8, 3.9, 3.8, 2.5, 2.3, 0.4 and 1.3. Asterisks denote the estimates that have been revised by the BEA. During half a year GDP has been growing at 0.4 percent in IQ2011 and 1.3 percent in IIQ2011 in what can be considered as a slow growth recession because of the 29.7 million in job stress. Inventory change contributed to initial growth but was rapidly replaced by growth in investment and demand in 1983. The key difference may be found in the negative incentive to business and household investment and business hiring from the structural shock to business models resulting from legislative restructurings and regulation with alleged benefits in the long-term but adverse short-term growth and jobs effects
Table 2, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| Q | 1981 | 1982 | 1983 | 1984 | 2008 | 2009 | 2010 |
| I | 8.6 | -6.4 | 5.1 | 7.1 | -1.8* | -6.7* | 3.9* |
| II | -3.2 | 2.2 | 9.3 | 3.9 | 1.3* | -0.7 | 3.8* |
| III | 4.9 | -1.5 | 8.1 | 3.3 | -3.7* | 1.7 | 2.5* |
| IV | -4.9 | 0.3 | 8.5 | 5.4 | -8.9* | 3.8* | 2.3* |
| 1985 | 2011 | ||||||
| I | 3.8 | 0.4* | |||||
| II | 3.4 | 1.3 | |||||
| III | 6.4 | ||||||
| IV | 3.1 |
*Revised Jul 2011.
Source:
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp1q11_2nd.pdf
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_3rd.pdf
The revised estimates and earlier estimates from IQ2008 to IQ2011 are shown in Table 3. The strongest revision is for IVQ2008 for which the contraction of GDP is revised from minus 6.8 percent to minus 8.9 percent. IQ2009 is also revised from contraction of minus 4.9 percent to minus 6.7 percent. There is only minor revision in IIIQ2008 of the contraction of minus 4.0 percent to minus 3.7 percent. Growth of 5.0 percent in IV2009 is revised to 3.8 percent but growth in IIQ2010 is upwardly revised to 3.8 percent. The revisions do not alter the conclusion that the current expansion is much weaker than historical sharp contractions since the 1950s and is now changing into slow growth recession
Table 3, Quarterly Growth Rates of GDP, % Annual Equivalent SA, Revised and Earlier Estimates
| Quarters | Revised Estimate | Earlier Estimate |
| 2008 | ||
| I | -1.8 | -0.7 |
| II | 1.3 | 0.6 |
| III | -3.7 | -4.0 |
| IV | -8.9 | -6.8 |
| 2009 | ||
| I | -6.7 | -4.9 |
| II | -0.7 | -0.7 |
| III | 1.7 | 1.6 |
| IV | 3.8 | 5.0 |
| 2010 | ||
| I | 3.9 | 3.7 |
| II | 3.8 | 1.7 |
| III | 2.5 | 2.6 |
| IV | 2.3 | 3.1 |
| 2011 | ||
| I | 0.4 | 1.9 |
Source: http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf
The contributions to the rate of growth of GDP in percentage points (PP) are provided in Table 4. Aggregate demand, personal consumption expenditures (PCE) and gross private domestic investment (GDI) were much stronger during the expansion phase in IQ1983 to IIQ1984 than in IIIQ2009 to IQ2011. In an article for the WSJ, Feldstein (2011Jun8) argues that US economic growth will be subpar in the best conditions with continuing high levels of unemployment and underemployment. Feldstein (2011Jun8) analyzes the decline in the rate of growth of GDP from 3.2 percent in IVQ2010 (fourth quarter of 2010) to 1.8 percent in IQ2011. Table 4 shows that the decomposition of the rate of growth of GDP of 1.9 percent in IQ2011, which now attributes 1.31 percentage points to change in inventories (see http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html). GDP data are seasonally-adjusted quarterly growth rates expressed in annual equivalent. The argument by Feldstein (2011Jun8) is that growth of final sales after deducting inventory change was only 0.6 percent, which is equivalent to growth of only 0.15 percent in the quarter ((1.006)1/4 or 0.6 percent discounted four quarterly periods). This argument was still valid with the third estimate of GDP growth of 1.9 percent in IQ2011 and of contribution of 1.31 PP by inventory change. The economy stalled. Inventory accumulation cannot sustain economic growth that requires increasing demand in investment and consumption. Business only invests when sales increase. Consumers need to see their income growing and the evidence is that real disposable income stagnated in the first four months of 2011 (http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html). Real wages are falling, 44 million people struggle with food stamps, hiring has collapsed and between 24 and 30 million people are unemployed or underemployed (http://cmpassocregulationblog.blogspot.com/2011/06/unemployment-and-underemployment-of-24.html). Feldstein (2011Jun8) also finds significant weakness in short-term economic indicators, which are analyzed in this blog weekly. The arguments by Feldstein in Jun turned to be prophetic in that the estimate of GDP growth in IQ2011 is revised to 0.4 percent with the economy stalled in an evident slow-growth recession with only 1.3 percent growth in IIQ2011.
Table 4, Contributions to the Rate of Growth of GDP in Percentage Points
| GDP | PCE | GDI | ∆ PI | Trade | GOV | |
| 2011 | ||||||
| I | 0.4 | 1.47 | 0.47 | 0.32 | -0.34 | -1.23 |
| II | 1.3 | 0.07 | 0.87 | 0.18 | 0.58 | -0.23 |
| 2010 | ||||||
| I | 3.9 | 1.92 | 3.25 | 2.64 | -0.97 | -0.26 |
| II | 3.8 | 2.05 | 2.92 | 0.82 | -1.94 | 0.77 |
| III | 2.5 | 1.85 | 1.14 | 1.61 | -0.68 | 0.20 |
| IV | 2.3 | 2.48 | -0.91 | -3.42 | 1.37 | -0.58 |
| 2009 | ||||||
| I | -6.7 | -1.02 | -7.76 | -2.66 | 2.44 | -0.33 |
| II | -0.7 | -1.28 | -2.84 | -0.58 | 2.21 | 1.21 |
| III | 1.7 | 1.66 | 0.35 | 0.21 | -0.59 | 0.28 |
| IV | 3.8 | 0.33 | 3.51 | 3.93 | 0.15 | -0.18 |
| 1982 | ||||||
| I | -6.4 | 1.62 | -7.50 | -5.47 | -0.49 | -0.03 |
| II | -2.2 | 0.90 | -0.05 | 2.35 | 0.84 | 0.50 |
| III | -1.5 | 1.92 | -0.72 | 1.15 | -3.31 | 0.57 |
| IV | 0.3 | 4.64 | -5.66 | -5.48 | -0.10 | 1.44 |
| 1983 |
|
|
|
|
|
|
| I | 5.1 | 2.54 | 2.20 | 0.94 | -0.30 | 0.63 |
| II | 9.3 | 5.22 | 5.87 | 3.51 | -2.54 | 0.75 |
| III | 8.1 | 4.66 | 4.30 | 0.60 | -2.32 | 1.48 |
| IV | 8.5 | 4.20 | 6.84 | 3.09 | -1.17 | -1.35 |
| 1984 | ||||||
| I | 8.0 | 2.35 | 7.15 | 5.07 | -2.37 | 0.86 |
| II | 7.1 | 3.75 | 2.44 | -0.30 | -0.89 | 1.79 |
| III | 3.9 | 2.02 | -0.89 | 0.21 | -0.36 | 0.62 |
| IV | 3.3 | 3.38 | 1.79 | -2.50 | -0.58 | 1.75 |
| 1985 | ||||||
| I | 3.8 | 4.34 | -2.38 | -2.94 | 0.91 | 0.95 |
Note: PCE: personal consumption expenditures; GDI: gross private domestic investment; ∆ PI: change in private inventories; Trade: net exports of goods and services; GOV: government consumption expenditures and gross investment; – is negative and no sign positive
GDP: percent change at annual rate; percentage points at annual rates
Source:
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp1q11_2nd.pdf
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_3rd.pdf
Table 5 provides more detailed information on the causes of the deceleration of GDP growth from 2.3 percent in IVQ2010 to 0.4 percent in IQ2011. The estimates incorporate the revisions of Jul 29, 2011. The BEA finds three source of contribution to GDP growth in IQ2011: (1) growth of PCE by 2.1 percent; (2) growth of exports by 7.9 percent; (3) positive contribution of private inventory investment of 0.32 PP; and (4) growth of nonresidential fixed investment (NRFI) by 2.1 percent. The factors that contributed to reduction of growth in IQ2011 were: (1) decline in residential fixed investment by 2.4 percent; (2) increase of imports by 8.3 percent, which are a deduction to GDP growth; and (3) contraction of federal and state/local government or combined government (GOV) by 5.9 percent. There are three sources causing deceleration of growth: (1) deceleration of nonresidential fixed investment (NRFI) from 8.7 percent to 2.1 percent; (2) deceleration of PCE growth from 3.6 percent in IVQ2010 to 2.1 percent in IQ2011 (with durable goods growth declining from 17.2 percent in IVQ2010 to 11.7 percent in IQ2011; (3) change of growth of 2.5 percent of RFI in IVQ2010 to minus 2.4 percent in IQ2011; (4) acceleration of decline of government consumption and expenditures (GOV) from minus 2.8 percent to minus 5.9 percent with federal government consumption and expenditures decelerating from minus 3.0 percent to minus 9.4 percent, caused by decline in defense expenditures by -11.7 percent, and state/local from minus 2.7 percent to minus 3.4 percent.
Table 5, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase, %
| IVQ2010 | IQ2011 | |
| GDP | 2.3 | 0.4 |
| PCE | 3.6 | 2.1 |
| Durable Goods | 17.2 | 11.7 |
| NRFI | 8.7 | 2.1 |
| RFI | 2.5 | -2.4 |
| Exports | 7.8 | 7.9 |
| Imports | -2.3 | 8.3 |
| GOV | -2.8 | -5.9 |
| Federal GOV | -3.0 | -9.4 |
| State/Local GOV | -2.7 | -3.4 |
| ∆ PI (PP) | -1.79 | 0.32 |
| Gross Domestic Purchases | 0.9 | 0.7 |
| Prices Gross Domestic Purchases | 2.1 | 4.0 |
| Prices of GDP | 1.9 | 2.5 |
| Prices of GDP Excluding Food and Energy | 1.3 | 2.5 |
| Prices of PCE | 1.9 | 3.9 |
| Prices of PCE Excluding Food and Energy | 0.7 | 1.6 |
| Prices of Market Based PCE | 1.8 | 4.0 |
| Prices of Market Based PCE Excluding Food and Energy | 0.3 | 1.3 |
| Real Disposable Personal Income | 0.3 | 0.2 |
| Personal Savings As % Disposable Income | 5.2 | 4.9 |
Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in
private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income
*Percent change from quarter one year ago
Source:
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf
According to the BEA, the positive contributions to GDP growth in IIQ2011, shown in Table 6, are: (1) growth of exports of 6.0 percent; (2) growth of NRFI of 6.3 percent; (3) change in private inventory investment contributing 0.18 percentage points to GDP growth; and (4) growth of 2.2 percent of federal government spending. Offsetting factors of GDP growth are (1) negative growth of 3.4 percent of state and local government spending; and (2) growth of imports of 1.3 percent, which is a deduction from GDP growth. PCE, which is equivalent to about 70 percent of GDP, which has a share of GDP of 71.0 percent (http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1), stalled with growth of only 0.1 percent in seasonally-adjusted annual equivalent rate. Real final sales of domestic product, which is equivalent to GDP growth less change in private inventories, is only 1.1 percent in IIQ2011 that is still in slow-growth recession range even if better than only 0.1 percent in IQ2011. Current-dollar GDP, which the BEA defines as the market value of US output of goods and services, rose to a seasonally-adjusted annual level of $15,003.8 billion in IIQ2011.
Table 6, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase, %
| IQ2011 | IIQ2011 | |
| GDP | 0.4 | 1.3 |
| PCE | 2.1 | 0.1 |
| Durable Goods | 11.7 | -4.4 |
| NRFI | 2.1 | 6.3 |
| RFI | -2.4 | 3.8 |
| Exports | 7.9 | 6.0 |
| Imports | 8.3 | 1.3 |
| GOV | -5.9 | -1.1 |
| Federal GOV | -9.4 | 2.2 |
| State/Local GOV | -3.4 | -3.4 |
| ∆ PI (PP) | 0.32 | 0.18 |
| Real Final Sales of Domestic Product | 0.1 | 1.1 |
| Gross Domestic Purchases | 0.7 | 0.7 |
| Prices Gross Domestic Purchases | 4.0 | |
| Prices of GDP | 2.5 | 2.3 |
| Prices of GDP Excluding Food and Energy | 2.5 | 2.5 |
| Prices of PCE | 3.9 | 3.1 |
| Prices of PCE Excluding Food and Energy | 1.6 | 2.1 |
| Prices of Market Based PCE | 4.0 | 3.5 |
| Prices of Market Based PCE Excluding Food and Energy | 1.3 | 2.4 |
| Real Disposable Personal Income* | 2.5 | 1.3 |
| Personal Savings As % Disposable Income | 4.9 | 5.1 |
Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in
private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income
*Percent change from same quarter one year ago
Source:
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf
Percentage shares of GDP are shown in Table 7. PCE is equivalent to 70.6 percent of GDP and is growing at very low levels with stagnation of real disposable income, high levels of unemployment and underemployment and higher savings rates. Gross private domestic investment is also growing slowly even with about two trillions of dollars in cash holdings by companies. In a slowing world economy, it may prove more difficult to grow exports faster than imports to generate higher growth.
Table 7, US Percentage Shares of GDP, %
| IVQ2010 | |
| GDP | 100.0 |
| PCE | 70.6 |
| Goods | 23.6 |
| Services | 47.0 |
| Gross Private Domestic Investment | 12.3 |
| Fixed Investment | 12.1 |
| NRFI | 9.8 |
| RFI | 2.2 |
| Change in Private Inventories | 0.3 |
| Net Exports of Goods and Services | -3.4 |
| Exports | 13.1 |
| Imports | 16.5 |
| Government | 20.5 |
| Federal | 8.4 |
| State and Local | 12.1 |
PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment
Source: http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1
Table 8 shows the percentage point (PP) contributions to the annual levels of GDP growth in the earlier recessions 1958-1959, 1975-1976, 1982-1983 and 2009 and 2010. The data incorporate the new revisions released by the BEA on Jul 29, 2011. The most striking contrast is in the rates of growth of annual GDP in the expansion phases of 7.2 percent in 1959, 4.5 percent in 1983 followed by 7.2 percent in 1984 and 4.1 percent in 1985 but only 3.0 percent in 2010 after six consecutive quarters of growth. The annual levels also show much stronger growth of PCEs in the expansions after the earlier contractions. PCEs contributed 1.44 PPs to GDP growth in 2010 of which 0.99 PP in goods and 0.46 PP in services. GDI deducted 3.61 PPs of GDP growth in 2009 of which -2.77 PPs by fixed investment and -0.84 PP of ∆PI and added 1.96 PPs to GDI in 2010 of which 0.48 PPs of fixed investment and 1.64 PPs of ∆PI. Trade, or exports of goods and services net of imports, contributed 1.11 PPs in 2009 of which exports deducted 1.18 PPs and imports added 2.29 PPs. In 2010, trade deducted 0.51 PP with exports contributing 1.31 PPs and imports deducting 1.82 PPs. In 2009, Government added 0.34 PP of which 0.45 PP by the federal government and -0.11 PP by state and local government; in 2010, government added 0.14 PP of which 0.37 PP by the federal government with state and local government deducting 0.23 PP.
Table 8, Percentage Point Contributions to the Annual Growth Rate of GDP
| GDP | PCE | GDI | ∆ PI | Trade | GOV | |
| 1958 | -0.9 | 0.54 | -1.25 | -0.18 | -0.89 | 0.70 |
| 1959 | 7.2 | 3.61 | 2.80 | 0.86 | 0.00 | 0.76 |
| 1975 | -0.2 | 1.40 | -2.98 | -1.27 | 0.89 | 0.48 |
| 1976 | 5.4 | 3.51 | 2.84 | 1.41 | -1.08 | 0.10 |
| 1982 | -1.9 | 0.86 | -2.55 | -1.34 | -0.60 | 0.35 |
| 1983 | 4.5 | 3.65 | -1.45 | 0.29 | -1.35 | 0.76 |
| 1984 | 7.2 | 3.43 | 4.63 | 1.95 | -1.58 | 0.70 |
| 1985 | 4.1 | 3.32 | -0.17 | -1.06 | -0.42 | 1.41 |
| 2009 | -3.5 | -1.32 | -3.61 | -0.84 | 1.11 | -0.09 |
| 2010 | 3.0 | 1.44 | 1.96 | 1.64 | -0.51 | 0.14 |
Source:
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_3rd.pdf
II Debt Financial Risk Aversion. This section considers continuing risk aversion in the world economy in subsection IIA Risk Financial Assets. Subsection IIB European Sovereign Risk analyzes new events in the euro zone.
The past three months have been characterized by unusual financial turbulence. Table 9, updated with every comment in this blog, provides beginning values on Jul 25 and daily values throughout the week ending on Jul 29. All data are for New York time at 5 PM. The first three rows provide three 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. The week was 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, the growth recession in the US, worldwide deceleration of economic growth and continuing inflation. The dollar/euro rate is quoted as number of dollars USD per one euro EUR, USD 1.440/EUR in Table 9 on Jul 29. Table 9 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 9 as appreciation and depreciation. Until the political “game of chicken” ends in the US with predictable outcome of an increase in the Treasury debt ceiling, there is the possibility of some risk aversion by investors exercising abundance of caution in the unlikely case a of deciding player in the “chicken game” jumps in the abyss of selective default of US debt. The depreciation of the dollar by 0.6 percent on Jul 29 is more likely influenced by the sudden realization of the low growth recession 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. These issues are discussed in greater detail in section III US Risk and the Chicken Run. A combination of renewed fears of default, downgrades of Ireland, Cyprus, Greece and Spain, rise in sovereign bond spreads and declining bank stocks in Italy, weak employment report and growth recession of the US and alerts on downgrading of US debt even in case of increase of the federal debt limit are important factors of risk aversion. Markets recovered 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). The Japanese yen appreciated by 2.2 percent during the week reaching JPY 76.77/USD by Fr Jul 29, which is quite strong; the JPY is used as safe haven from world risks after a downgrade of its sovereign credit rating because of the country’s internal generation of savings to pay for its high debt while fears of another Japanese and G7 intervention have subsided. The Swiss franc traded at CHF 0.788/USD on Fri Jul 29, which reflects risk aversion by funds flowing away from risk positions to temporarily benefitting from safe haven in a strong deposit and investment market. Table 9 now includes also the rate of exchange between the Swiss franc and the euro, which appreciated by 3.8 percent to CHF 1.1314/USD by Fri Jul 29. The Australian dollar, AUD, is considered a “commodity currency,” fluctuating in carry trades from lower interest rates in countries such as Japan to high interest rates in Australia and New Zealand but also in large volumes from zero interest rates in the US to commodities and other risk financial assets (see Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 202-4, Government Intervention in Globalization (2009c), 70-4). The Australian dollar is quote in dollars per unit of Australian dollar, USD/AUD. Table 9 provides the standard quote in the market in terms of USD/AUD but calculates the movement in terms of units of Australian dollar per dollar, or AUD/USD. The AUD continued its appreciation with 1.2 percent gained to USD 1.0990/AUD by Fri Jul 29.
Table 9, Daily Valuation of Risk Financial Assets
| Jul 25 | Jul 26 | Jul 27 | Jul 28 | Jul 29 | |
| USD/ 1.4363 | 1.4376 -0.1% -0.1% | 1.4509 -1.0% -0.9% | 1.4366 -0.02% 0.9% | 1.4317 0.3% 0.3% | 1.440 -0.3% -0.6% |
| JPY/ 78.52 | 78.3325 0.2% 0.2% | 77.9303 0.8% 0.5% | 77.9365 0.7% 0.01% | 77.7640 0.9% 0.2% | 76.77 2.2% 1.3% |
| CHF/ 0.816 | 0.8057 1.3% 1.3% | 0.8013 1.8% 0.5% | 0.8013 1.8% 0.0% | 0.8013 1.8% 0.0% | 0.788 3.4% 1.6% |
| CHF/ EUR 1.1766 | 1.1583 1.6% 1.6% | 1.1626 1.2% -0.4% | 1.1507 2.2% 1.0% | 1.1472 2.5% 0.3% | 1.1314 3.8% 1.3% |
| USD/ AUD 1.0861 | 1.0846 0.1% 0.1% | 1.0950 0.8% 0.9% | 1.1022 1.5% 0.6% | 1.0992 1.2% 0.3% | 1.0990 1.2% 0.0% |
| 10 Year Yield | 3.01 | 2.95 | 2.98 | 2.95 | 2.795 |
| 2 Year Yield | 0.41 | 0.39 | 0.44 | 0.42 | 0.36 |
| 10 Year | 2.76 | 2.74 | 2.65 | 2.63 | 2.54 |
| DJIA 12681.16 | -0.7% -0.7% | -1.4% -0.7%% | -2.9% -1.6% | -3.5% 0.5% | -4.2% -0.8% |
| DJ Global 2154.76 | -0.7% -0.7% | -0.5% 0.1% | -2.0% -1.5% | -2.5% -0.5% | -3.1% -0.6% |
| DAX 7326.39 | 0.2% 0.2% | 0.3% 0.1% | -1.0% -1.3% | -1.9% -0.9% | -2.3% -0.4% |
| DJ Asia Pacific 1428.84 | -0.8% -0.8% | 0.1% 0.9% | 0.0% -0.1% | -0.9% -0.9% | -1.5% -0.6% |
| Shanghai 2770.79 | -2.9% -2.9% | -2.4% 0.5% | -1.7% 0.8% | -2.2% -0.9% | -2.5% -0.3% |
| Nikkei 10132.11 | -0.8% -0.8% | -0.3% 0.5% | -0.8% -0.5% | -2.3% -1.5% | -2.9% -0.7% |
| WTI $/b 99.730 | 99.14 -0.6% -0.6% | 99.480 -0.3% 0.3% | 97.150 -2.6% -2.3% | 97.170 -2.6% 0.02% | 95.920 -3.8% -1.3% |
| Brent $/b 118.470 | 117.71 -0.6% -0.6% | 118.34 -0.1% 0.5% | 117.430 -0.9% -0.8% | 117.300 -0.9% -0.1% | 116.610 -1.6% -0.6% |
| Gold $/ounce1602.90 | 1616.90 0.9% 0.9% | 1622.00 1.2% 0.3% | 1617.00 0.9% -0.3% | 1618.50 0.9% 0.1% | 1628.60 1.6% 0.6% |
Note: For the exchange rates the percentage is the cumulative change since Fri the prior week; for the exchange rates appreciation is a positive percentage and depreciation a negative percentage; USD: US dollar; JPY: Japanese Yen; CHF: Swiss Franc; AUD: Australian dollar; B: barrel; for the four stock indexes and prices of oil and gold the upper line is the percentage change since the past week and the lower line the percentage change from the prior day;
Source: http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
The three sovereign bond yields in Table 9 capture renewed risk aversion in the flight away from risk financial assets toward the safety of US Treasury securities and German securities. The 2-year US Treasury note is highly attractive because of minimal duration or sensitivity to price change and its yield continued fluctuating in a tight low range between 0.39 and 0.41 percent, trading at 0.36 percent on Fri Jul 29. The entire yield curve is analyzed in Section III US Risk and the Chicken Run. There is generalized expectation in financial markets, shown by only somewhat weaker bid/coverage ratios in the auctions of two, five and seven year US Treasury notes and the yields in Table 1, that there will not be default of US debt because of political failure to raise the debt limit. The expectation of a downgrade is also quite generalized without much discernible turbulence in the market for Treasury securities. Much the same is true of the 10-year Treasury note and the 10-year bond of the government of Germany, trading at 2.795 percent for the 10-year Treasury note and to 2.54 percent for the 10-year government bond of Germany by Fri Jul 29. The strong yield of the 10-year government bond of Germany could be reflecting fears of spread of the sovereign risk doubts to larger countries. Market can still become volatile under perceptions of challenges in the sovereign rescue program of Europe and/or downgrade of the credit rating of the US. Section V Valuation of Risk Financial Assets provides more details and comparisons of performance in peaks and troughs.
The upper row in the stock indexes in Table 9 measures the percentage cumulative change to Jul 29 since the closing level in the prior week on Jul 22 and the lower row measures the daily percentage change. Performance of equities markets deteriorated significantly. The DJ Global index dropped 4.2 percent in the week as a result of the weakening economy with an adverse durable goods report on Jul 27 and the GDP revisions and advanced estimate on Jul 29. All six indexes in Table 9 registered sharp losses throughout the week. The advanced economies are jointly moving toward a slow growth recession plagued with vulnerabilities of sovereign risks in Europe, slow growth with 29.7 million in job stress in the US that is embarking in an unsustainable debt path and troubling inflation/growth tradeoff in China.
The final block of Table 9 shows upward performance of oil and gold futures. Brent lost 1.6 percent in the week to $116.61/barrel but WTI dropped 3.9 percent to $95.92/barrel. Gold gained 1.6 percent by Fri Jul 29 with some investors believing gold can hedge vulnerabilities in world financial markets.
IIB European Sovereign Risk. There are euro zone countries that are relatively sound in terms of fiscal situations and financial variables, especially spreads of sovereign bonds and government debts and deficits, such as France and Germany. Three euro zone countries have engaged in bailouts within the mechanism created by the European Union, IMF and European Central Banks: 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 10. 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. The turmoil during the past two weeks manifested in the form of increases in the sovereign bond spreads and declines in the stock markets and bank stocks of Spain and Italy. The addition of the GDP of Spain and Italy to the bailed-out countries totals $4204 billion, which is equivalent to 34.5 percent of euro zone GDP. David Cottle writing on Jul 12 on “Italy fears rattle Europe’s markets” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303812104576441302547119220.html?mod=WSJPRO_hpp_LEFTTopStories) informs that Italy’s “total capital market debt” is €1598 billion, approximately $2.2 trillion, which is the largest in the euro zone and the third largest in the world after the US and Japan. There is a cushion in that only €88 billion mature in 2011 and €190 billion mature in 2012. Perhaps the major source of concern for propagation of turbulence in Italy is that French banks had $392.6 billion in Italian government and private debt at the end of 2010, according to Bank for International Settlements (BIS) data, as informed by Fabio Benedetti-Valentini, writing on Jul 12, 2011, on “French banks face greatest Italian risk” published by Bloomberg (http://www.bloomberg.com/news/2011-07-12/france-s-bnp-credit-agricole-on-frontline-with-italian-risk.html).
Table 10, 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
On Jul 25, Moody’s Investors Service (2011Jul25) downgraded to Ca from Caa1 the local and foreign currency bond ratings of Greece. According to Moody’s, private creditors of Greek debt are likely to suffer significant financial losses in holdings of government debt of Greece because of the joint program of the Council of the European Union (2011Jul21) and the debt exchange proposed by the IIF (2011Jul21) (see http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html). The probability of default on Greek government debt is almost 100 percent, in the view of Moody’s because the IIF (2011Jul21) warns of losses exceeding 20 percent of holdings. Moody’s (2011Jul25) finds that the program of the Council of the European Union (2011Jul21) will improve the probability that Greece will stabilize financial markets and the economy, reducing the weight of debt. Other European sovereigns benefit such as by lower rates and longer terms in the case of Ireland and Portugal in comparison with substantial haircuts or even worst in a “disorderly payment default.” Greek risk will continue over several years in the form of debt exceeding 100 percent of GDP with major challenges in successfully implementing required fiscal and economic reforms.
On Jul 27, Moody’s Investors Service (2011Jul27) announced the downgrade of Cyprus government bond rating to Baa1 from A2 with negative outlook. The short-term debt of Cyprus is downgraded to P-2 from P-1. Cyprus is now included in the last row of Table 10. The economy is minute with GDP of only $23.2 billion but the government deficit is 5.4 percent of GDP and gross general government debt is 61.6 percent of GDP. Moody’s mentions three “drivers” for the downgrade of Cyprus. (1) The main difficulty is the fiscal position of Cyprus that was worsened by the destruction of the Vasilikos power plant on Jul 11 that was accidentally caused by an explosion at a nearby naval base. The destruction of the plant compromises the intended measures of the government of Cyprus to enhance its fiscal sustainability. Moody’s (2011Jul27) now finds that Cypriot GDP growth will be 0 percent in 2011 and only 1 percent in 2012 because of the impact on energy supply of the Vasilikos plant destruction. Government revenue will be stressed by the lower rate of economic growth. (2) As true in most countries, there is political conflict in Cyprus on the implementation of fiscal austerity. (3) Cypriot sovereign credit is dependent on the size of its banking sector with bank assets of around 600 percent of GDP after excluding subsidiaries and branches of foreign banks and 860 percent of GDP when including subsidiaries and branches of foreign banks. Moody’s (2011Jul27) finds that capitalization of Cypriot banks and liquidity buffers in the past year have improved the capacity to absorb shocks resulting from the losses of exposures to losses in their exposures to Greece. Nevertheless, Moody’s (2011Jul27) finds that Cyprus may have to provide assistance to at least some of its banks in the next few years. The governor of the Central Bank of Cyprus is Dr. Athanasios Orphanides whose multiple scholarly contributions are frequently quoted in professional literature and in this blog (http://www.centralbank.gov.cy/nqcontent.cfm?a_id=6656), particularly in the analysis of monetary policy during the Great Inflation. Peter Spiegel and Joshua Chaffin, writing on Jul 27 from Brussels and Nicosia on “Cyprus downgrade increases rescue fears” published in the Financial Times (http://www.ft.com/intl/cms/s/0/856fb806-b86b-11e0-b62b-00144feabdc0.html#axzz1T16tl4ul) analyze the possible impact of the downgrade of Cyprus on the European Union sovereign risk rescue. Spiegel and Chaffin quote data from the European Banking Authority that two banks in Cyprus have combined holdings of €5.8 billion or around $8.4 billion. Spiegel and Chaffin also inform that about 40 percent of loans granted by the three largest Cypriot banks, accounting for 55 percent of total bank assets, are to debtors in Greece. The stress tests revealed by the European Banking Authority in Jul also reveal that two Cypriot entities are the third and seventh largest creditors of Greek bonds in Europe. The complicating factor is in the form of unpredictable political developments.
On Jul 29, Moody’s Investors Service (2011Jul29) informed it was placing Spain’s government rating of Aa2 on review for possible downgrade but without affecting the Prime-1 short-term ratings. There are two drivers of this decision. (1) The increasing funding pressure to Spain and other sovereign resulting from the rescue program of the Council of the European Union (2011Jul21) and the IIF (2011Jul21) debt exchange proposal. In the view of Moody’s Investors Service (2011Jul29) funding pressures likely will exacerbate. (2) Spain’s low rate of economic growth and fiscal imbalances in regional governments are also challenges to continuing government fiscal consolidation. The two-year government security of Spain rose from 3.86 percent on Jul 22 to 4.30 percent on Jul 29, or by 44 basis points. Miles Johnson, writing from Madrid on Jul 29 on “Zapatero calls early Spanish elections,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/142b00d0-b9d1-11e0-8171-00144feabdc0.html#axzz1T16tl4ul), informs that the prime minister of Spain announced elections on Nov 20, instead of scheduled in Mar, in an effort to enhance his party’s position and implement economic reforms. Spain’s large budget deficit of 9.2 percent of GDP is the toughest problems instead of debt/GDP ratio of 48.8 percent but increasingly difficult to fund in international markets as the borrowing costs of Spain returned to the times of the peseta instead of the euro as currency. Spain also has one of the highest unemployment rates in the world even when considering its decline from 21.3 percent in the first quarter of 2011 to 20.9 percent in the second quarter.
Matthew Dalton, writing on Jul 30 on “Italy, Spain worries complicate Greece aid,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424053111903635604576476503660642290.html?mod=WSJ_hps_sections_world), analyzes how concerns on Italy and Spain are complicating aid to Greece. Italy and Spain are committed with the other euro zone countries to provide bilateral loans to Greece but have experienced rising borrowing costs. The yield on the two-year government bond of Italy rose from 3.90 percent on Jul 22 to 4.61 percent on Jul 29 while that of the Spanish two-year government bond rose from 3.86 percent on Jul 22 to 4.30 percent on Jul 29. The yield on the 10-year government bond of Italy rose from 5.40 percent on Jul 22 to 5.89 percent on Jul 29 while that of the 10-year government bond of Spain rose from 5.79 percent on Jul 22 to 6.08 percent on Jul 29. These yields are higher than the rates paid on the first Greek bailout as informed by Dalton. In fact, Italy and Spain are experiencing a negative spread in funding at their high yields and lending to Greece at lower yields. There will be delays in the issue of bonds by the European Financial Stability Facility (EFSF) as summer vacations in Europe stall financial markets to fund the €5.8 billion disbursement to Greece in Sep. A possible solution may be to exempt Italy and Spain to extend bilateral finance because of other time-consuming restructuring of rules of the EFSF in the rescue package to Greece.
Research by professors Paola Sapienza, Northwestern University’s Kellog Graduate School of Management, and Luigi Zingales, University of Chicago’s Booth School of Business, analyzes the causes of the rise in yields of Italy’s government bonds, as published in the Financial Times (Sapienza and Zingales 2011Jul14). The argument by Sapienza and Zingales (2011Jul14) is that yields rose not because of an “irrational panic” of speculators with ill feelings about Italy but rather as a result of a credibility crisis. The word credit in the Merriam-Webster’s 11th Collegiate Dictionary originates from “Old Italian credito,” meaning “something entrusted to another, loan, from neuter of creditus, past participle of credere to believe, entrust.” Its primary meaning is “reliance on the truth or reality of something.” Sapienza and Zingales (2011Jul14) emphasize credere, meaning trust. Using sophisticated sampling techniques, Sapienza and Zingales (2011Jul14) find that eroding perceptions of trust in the leadership of Italy is the fundamental perception of mistrust affecting yields of Italian bonds, or country risk, instead of conspiracy by foreign speculators. In an interview for Bloomberg’s Tom Keene, professor Zingales explained that public opinion in Italy blames international events for rising country risk. Guy Dinmore, writing on Jul 26 on “Italy: a throne under threat,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/7fa6305c-b7b8-11e0-8523-00144feabdc0.html#axzz1T16tl4ul), provides similar analysis of leadership conflicts in Italy. This is occurring as Italian politicians discourse fluently about yields on 10-year government securities and their spreads relative to comparable German government bonds. Politics are increasingly measured by market performances of Italian financial risks. Dinmore finds that the debt of Italy of €1900 billion, or about $2.7 trillion and about 120 percent of GDP, is three times larger than the combined debts of Greece, Portugal and Ireland, and trading at spreads higher than in first Greek rescue package. Governments in countries in crisis, with right-of-center or left-of-center ruling parties, have experienced credibility crises that make adjustments even more difficult. Marcus Walker, writing on Jul 26 on “Frenemies: two Greek rivals hold nation’s fate in balance,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303406104576443851497096450.html?mod=WSJPRO_hpp_MIDDLETopStories) analyzes similar political tensions in Greece. Another article by Guy Dinmore, writing on Jul 28 on “Yields rise in Italian bond auction,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/439241fe-b908-11e0-bd87-00144feabdc0.html#axzz1T16tl4ul), informs of sharp increase to a peak in 11 years of the yields on Italy’s auction of €2.7 billion, or $3,93 billion, of its 10-year government security at 5.77 percent, which is 83 basis points higher than 4.94 percent in the auction of the 10-year Italian government bond on Jun 28. Dinmore quotes Ignazio Visco, deputy director of the Bank of Italy, which is Italy’s central bank (http://www.bancaditalia.it/bancaditalia), informing that an increase of the borrowing costs of Italy by 100 basis points is equivalent to 0.2 percent of GDP in the first year, increasing to 0.4 percent of GDP in the second year and to 0.5 percent of GDP in the third year. Italy would experience problems with spreads of over 300 basis points relative to 10-year government bonds. Table 9 shows the 10-year bond of Germany trading at 2.54 percent on Jul 29 for a spread of the Italian 10-year bond of 335 basis points relative to the yield of 5.89 percent on Jul 29.
The answer of what to do in the European sovereign risk event is highly complex. Analysis and proposals for solution are provided by professors Luigi Zingales, University of Chicago Booth School of Business, and Roberto Perotti, Bocconi University. The current rescue package of the Council of the European Union (2011Jul21) is criticized by Zingales and Perotti (2011Jul27) because it encourages moral hazard. An important contribution in modern banking theory is the monitoring function of banks (Diamond 2007, Diamond and Dybvig 1983, Diamond and Rajan 2000, 2001A, 2001B; see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 39-42, Regulation of Banks and Finance (2009b), 51-8 and http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Monitoring consists of the specialized relationship banker following that the project for which the funds were lent is adequately implemented and that funds are not used for a different project. A type of moral hazard, for example, would occur if the borrower for an industrial project with sound budgeting capital of discounted future net cash flows uses instead the funds to engage in speculative commercial real estate without sound capital budgeting. In the analogy of Zingales and Perotti, the efforts of collective action by government are directed toward extinguishing the fire and then catching the arsonist but the problem would return if extinguishing the fire destroys the evidence on the arsonist. The current system imposes income redistribution from German taxpayers to sovereigns located mostly in Southern Europe and from taxpayers to bank creditors and shareholders. Zingales and Perotti (2011Jul27) propose three taxes to avoid future moral hazard and income redistribution of bailouts in what they claim to be a more effective and fair resolution of the sovereign debt crisis. (1) A euro tax on bank debt, not profits as was rejected by the European Union leaders at their meeting on Jul 21, would raise required revenue and prevent moral hazard in careless lending by assessing the tax on the prior month’s spreads of credit default swaps (CDS). The tax would penalize careless banks while rewarding prudent banks. (2) A second euro tax would be imposed on sovereign debt in proportion to the prior month’s CDS spreads. This would result in an automatic haircut without causing default. Future borrowing costs would not be affected because the tax incidence on the stock of debt but not future issue of debt. The same effect would be attained in penalizing careless creditors and raising revenue. Zingales and Perotti (2011Jul27) find a disadvantage that reduction of the stock of debt would reduce bank capital, which could be replenished with the proceeds of the tax. (3) The third proposal is to allocate the first 60 percent of a country’s debt to a “blue bond” with guarantees by the European Union and the remainder to a “red bond” subject to market discipline or price reductions in case of careless borrowing. Tom Lauricella, Kathy Burne and David Enrich, writing on Jul 28 on “When Greek CDS don’t do the job,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424053111903635604576472372838529088.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyze disappointment by holders of Greek bonds may fail to obtain protection bought by CDS that would not trigger default payments in case of Greece’s default. Prices of CDS did reflect the probability of default in the months prior to the European Union agreement. The issue is whether repetition of such “voluntary” private sector participation prevents future fair pricing of CDS.
III US Risk and the Chicken Run. US politics on the budget and the debt in the past few months have become a playground of the “game of chicken.” The most famous case in Hollywood was the “chicken run” in Rebel without a Cause (http://www.youtube.com/watch?v=u7hZ9jKrwvo). In rivalry for Natalie Wood, James Dean engages in a race with stolen cars in competition with a cool gang member driving toward a cliff by the sea: the first jumping out is the “chicken,” or coward. Natalie Woods comforts both contestants in this irrational game and flags the start by raising her hands and jumping. James Dean jumps but his rival is trapped to the door handle by his jacket and falls over the cliff inside his car toward death. The beltway version of the chicken run is a dare of who concedes first on increasing the debt limit instead of perishing in elections. The prize is not the love of Natalie Wood but the votes of the electorate in winning (or losing) the 2012 presidential election. There are many chicken or cowardice yellow stains of which two are paramount: (1) “read my lips” but then agree to tax increases that allegedly caused a defeat in the 1992 election; or (2) cut spending with reductions of benefits in entitlements that can turn record numbers of seniors to vote against you.
The chicken game is used in a variety of fields and applications, as for example, in economic theory (Kalai and Lehrer 1993, Hart 2005, Jensen, Sloth and Whitta-Jacobsen), management science (Bryant 1984), political science (Slomp and La Manna 1996, Coram 1997), economics of voter turnout (Dhillon and Peralta 2002), economic regulation (Leibeinstein 1983, McChesney 1987, Sandler and Hartley 2001, Sandler and Arce 2003) and public choice (Lipman 1986, Morris and Munger 1998). The beltway chicken run is simpler for markets that have anticipated (1) that the debt limit will be increased without harms even in delay of a self-imposed deadline of Aug 2 when supposedly there would be unpleasant events such as failure to make social security payments, armed forces paychecks and the like. Markets have also anticipated that inevitably the credit rating of the United States will be downgraded below the current AAA. Table 11 provides the peaks and troughs of yields of Treasury securities in the 52 weeks ending on Jul 29. All yields in Table 11 are below their peaks in the past year. The only real rise of yields has been for one-month Treasury bills that have risen to 0.165 percent but still below the peak of 0.17 percent on Dec 1, 2010. The two-year Treasury note traded at 0.392 percent on Jul 22 (Table 1 in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), declining to 0.36 percent on Jul 29 as shown in Table 9 above. The ten-year Treasury note traded at 2.964 on Jul 22 (Table 1 in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), declining to 2.795 percent on Jul 29 as shown in Table 9 above. Stock market declines and mild depreciation of the dollar on Jul 29 were caused by the realization that the US economy stalled in the first quarter, growing at only 0.4 percent, and continues weak, growing at 1.3 percent in the second quarter but with indicators showing continuing weakness. The beltway chicken run has been largely ignored by markets. The debt abyss is not on Aug 2 but sometime ahead in the next few years as analyzed in Subsection IIA Timing and Structure of Government Debt. An equally important issue is considered in Subsection IIB Employment Hardship.
Table 11, Peaks and Troughs of Yields of Treasury Securities 52 Weeks Ending Jul 29, 2011, %
| 1 Month T-Bill | |
| Peak 12/01/10 | 0.17 |
| Trough 6/28/11 | 0.07 |
| Jul 29, 2011 | 0.165 |
| 3 Month T-Bill | |
| Peak 11/30/10 | 0.167 |
| Trough 7/19/11 | 0.02 |
| Jul 29, 2011 | 0.094 |
| 6 Month T-Bill | |
| Peak 12/28/10 | 0.206 |
| Trough 7/14/11 | 0.038 |
| Jul 29, 2011 | 0.165 |
| 1 Year T-Note | |
| Peak 2/09/11 | 0.305 |
| Trough 6/24/11 | 0.137 |
| Jul 29, 2011 | 0.201 |
| 2 Year T-Note | |
| Peak 2/08/11 | 0.854 |
| Trough 11/03/10 | 0.332 |
| Jul 29 | 0.356 |
| 5 Year T-Note | |
| Peak 2/08/11 | 2.401 |
| Trough 11/04/10 | 1.027 |
| Jul 29, 2011 | 1.351 |
| 7 Year T-Note | |
| Peak 2/08/11 | 3.128 |
| Trough 11/04/10 | 1.719 |
| Jul 29, 2011 | 2.095 |
| 10 Year T Note | |
| Peak 2/08/11 | 3.739 |
| Trough 10/07/10 | 2.385 |
| Jul 29, 2011 | 2.795 |
| 30 Year T-Bond | |
| Peak 2/8/11 | 4.766 |
| Trough 8/26/10 | 3.510 |
| Jul 29, 2011 | 4.128 |
Source: http://professional.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3014
IIA Timing and Structure of Government Debt. There are two issues on the central government or federal debt: (1) debt projections suggest an unsustainable path and it has not been possible to raise government revenue by more than 20 percent of GDP; and (2) the structure of expenditures has a high proportion of mandatory items. These two characteristics are discussed in turn.
First, unsustainable path and ceiling of feasible revenue/GDP. The debt of the US could face two types of paths: (1) the possibility of a point of explosion that would force sudden adjustment that could occur in the form of sharp increases in taxes, draconian cuts in expenditures, increases in taxes, dollar devaluation and low rates of economic growth with resulting unemployment; or (2) less disorderly adjustment that would still result in low rates of economic growth and permanent high levels of unemployment. Disorderly adjustments are void of political connotations and have sound grounding in experience. A monumental effort of data gathering, calculation and analysis by Carmen M. Reinhart and Kenneth Rogoff is highly relevant to banking crises, financial crash, debt crises and economic growth (Reinhart 2010CB; Reinhart and Rogoff 2011AF, 2011Jul14, 2011EJ, 2011CEPR, 2010FCDC, 2010GTD, 2009TD, 2009AFC, 2008TDPV; see also Reinhart and Reinhart 2011Feb, 2010AF and Reinhart and Sbrancia 2011). An alternative scenario of the CBO (2011LTBO) provides measurements of the impact of adjustment of high debt levels. Reinhart and Rogoff (2010GTD, 2011CEPR) classify the dataset of 2317 observations into 20 advanced economies and 24 emerging market economies. In each of the advanced and emerging categories, the data for countries is divided into buckets according to the ratio of gross central government debt to GDP: below 30, 30 to 60, 60 to 90 and higher than 90 (Reinhart and Rogoff 2010GTD, Table 1, 4). Median and average yearly percentage growth rates of GDP are calculated for each of the buckets for advanced economies. There does not appear to be any relation for debt/GDP ratios below 90. The highest growth rates are for debt/GDP ratios below 30: 3.7 percent for the average and 3.9 for the median. Growth is significantly lower for debt/GDP ratios above 90: 1.7 for the average and 1.9 percent for the median. GDP growth rates for the intermediate buckets are in a range around 3 percent: the highest 3.4 percent average for the bucket 60 to 90 and 3.1 percent median for 30 to 60. There is even sharper contrast for the United States: 4.0 percent growth for debt/GDP ratio below 30; 3.4 percent growth for debt/GDP ratio of 30 to 60; 3.3 percent growth for debt/GDP ratio of 60 to 90; and minus 1.8 percent, contraction, of GDP for debt/GDP ratio above 90.
Table 12 provides fiscal projections under an alternative fiscal scenario, which is based on the following assumptions (CBO 2011LTBO, 2):
“The alternative fiscal scenario embodies several changes to current law that would continue certain tax and spending policies that people have grown accustomed to (because the policies are in place now or have been in place recently). Versions of some of the changes assumed in the scenario—such as those related to the tax cuts originally enacted in 2001, the AMT, certain other tax provisions, and Medicare’s payments to physicians—have regularly been enacted in the past and are widely expected to be made in some form over the next few years. After 2021, the alternative fiscal scenario also incorporates modifications to several provisions of current law that might be difficult to sustain for a long period. Thus, the scenario includes changes to certain restraints on the growth of spending for Medicare and to indexing provisions that would slow the growth of federal subsidies for health insurance coverage. In addition, the scenario includes unspecified changes in tax law that would keep revenues constant as a share of GDP after 2021.”
Table 12, CBO Long-term Budget Outlook Alternative Fiscal Scenario, % of GDP
| 2011 | 2021 | 2035 | |
| Spending | 24.1 | 25.9 | 33.9 |
| Primary | 22.7 | 21.5 | 25.0 |
| SS | 4.8 | 5.3 | 6.1 |
| Medicare | 3.7 | 4.3 | 6.7 |
| Medicaid | 1.9 | 2.8 | 3.7 |
| Other | 12.3 | 9.1 | 8.5 |
| Interest | 1.4 | 4.4 | 8.9 |
| Revenues | 14.8 | 18.4 | 18.4 |
| Deficit | -9.3 | -7.5 | -15.5 |
| Primary | -7.9 | -3.1 | -6.6 |
| Debt | 69 | 101 | 187 |
Primary spending is spending other than interest payments. Primary deficit or surplus is revenue less primary spending.
Source: http://www.cbo.gov/ftpdocs/122xx/doc12212/06-21-Long-Term_Budget_Outlook.pdf
An important distinguishing characteristic of the alternative fiscal scenario in Table 12 is the much sharper increase in debt held by the public from 69 percent of GDP in 2011 to 101 percent of GDP in 2021 and 187 percent of GDP in 2035. Accordingly, interest payments on the debt jump from 1.4 percent of GDP in 2011 to 8.9 percent of GDP in 2035. In contrast with the extended-baseline scenario, the alternative fiscal scenario fixes revenue as percent of GDP at 18.4 percent after 2035.
Fiscal projections by the CBO incorporate a host of assumptions on demographic variables, such as the rate of growth and consumption of the US population, economic variables, interest rates, labor market factors, real GDP and earnings per worker. The CBO (2011LTBO) analyzes how the performance of the economy would be affected by an increase in debt held by the public over 76 percent of GDP, which is used as benchmark economic conditions. The CBO uses a Solow-type model in measuring effects on the economy of fiscal policies under the two scenarios (after Solow 1956, 1989; see Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 11-16)). The method is discussed in CBO (2011PBB, Appendix A, 31-7). The calculations by the CBO (2011LTBO, 28-31) are shown in Table 13. The impact is much softer on GDP than on GNP because “the change in GDP does not reflect the increased future outflow of profits and interest generated by the additional capital inflow” (CBO 2011LTBO, 28). The striking result in Table 13 is the sharp reduction of GNP by 2035 of 6.7 percentage points to 17.6 percentage points over what it would be under the benchmark debt level of 76 percent and of GDP from 2.4 percentage points to 9.9 percentage points.
Table 13, Effects on GNP and GDP of Fiscal Policies in CBO’s Scenarios in Percentage Difference from Benchmark Level
| 2025 | 2035 | |
| Extended Baseline | ||
| GNP | -0.2 to –0.4 | -0.5 to –1.6 |
| GDP | (-0.05 to 0.05 to –0,2 | -0.2 to –1.3 |
| Alternative Fiscal | ||
| GNP | -2.2 to –5.7 | -6.8 to –17.6 |
| GDP | -0.4 to –3.1 | -2.4 to –9.9 |
Source: http://www.cbo.gov/ftpdocs/122xx/doc12212/06-21-Long-Term_Budget_Outlook.pdf
Second, rigid structure of federal spending. The fiscal situation of the US is even more complex because of the structure of outlays for 2011 shown in Table 14. Mandatory expenditures are 57.5 percent of total outlays and 14.5 percent of GDP. Discretionary expenditures are 37.1 percent of total outlays but $908 billion are national security expenditures out of total discretionary of $1416 billion. An even more important constraint is that the expenditures for Social Security, Medicare and Medicaid are $1506 billion equivalent to 9.9 percent of GDP and 39.4 percent of total outlays. The Sep 2010 projections of the Centers for Medicare and Medicaid (CMS) estimate 2011 Federal expenditures on health, including CHIP (Children’s Health Insurance Program) of $989.6 billion (http://www.cms.gov/NationalHealthExpendData/downloads/NHEProjections2009to2019.pdf).
Table 14, Outlays of 2011 in the White House Budget Proposal in $ Billions and Percents of GDP and Total Outlays
| 2011 | |
| Discretionary | 1416 |
| Percent of GDP | 9.4 |
| Percent of Total Outlays | 37.1 |
| Security | 908 |
| Non-security | 507 |
| Mandatory | 2194 |
| Percent of GDP | 14.5 |
| Percent of Total Outlays | 57.5 |
| Social Security | 742 |
| Medicare | 488 |
| Medicaid | 276 |
| Subtotal | 1506 |
| Percent of GDP | 9.9 |
| Percent of Total | 39.4 |
| Net Interest and Disaster | 209 |
| Total Outlays | 3819 |
| Percent of GDP | 25.3 |
| GDP | 15,080 |
Source: http://www.whitehouse.gov/sites/default/files/omb/budget/fy2012/assets/tables.pdf Page 173, Table S-3.
Note: there are discrepancies between outlays and receipts and the deficit between Table S-1 used for Table 1 in this writing and Table S-4 used for Table 2 in this writing.
IIB Employment Hardship. In an article in the Financial Times, Martin Feldstein (2011Jul25) finds that the true issue in the US is jobs. The problem is the fractured labor market. Feldstein (2011Jul25) calculates 29 million Americans who are unable to find the job they desire. Additional information provides deeper insight. Table 15 consists of data and additional calculations using the Bureau of Labor Statistics (BLS) household survey, illustrating the possibility that the actual rate of unemployment could be 11.6 percent and the number of people in job stress could be closer to 30 million. The first column provides for 2006 the yearly average population (POP), labor force (LF), participation rate or labor force as percent of population (PART %), employment (EMP), employment population ratio (EMP/POP %), unemployment (UEM), the unemployment rate as percent of labor force (UEM/LF Rate %) and the number of people not in the labor force (NLF). The numbers in column 2006 are averages in millions while the monthly numbers for Jun 2010 and May and Jun 2011 are in thousands, not seasonally adjusted. The average yearly participation rate of the population in the labor force was in the range of 62.0 percent minimum to 67.1 percent maximum between 2000 and 2006 with the average of 66.4 percent (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). The objective of Table 15 is to assess how many people could have left the labor force because they do not think they can find another job. Row “LF PART 66.2 %” applies the participation rate of 2006, almost equal to the rates for 2000 to 2006, to the population in Jun 2010 and May and Jun 2011 to obtain what would be the labor force of the US if the participation rate had not changed. In fact, the participation rate fell to 65.1 percent by Jun 2010 and was 64.1 percent in May 2011 and 64.5 percent in Jun 2011, suggesting that many people simply gave up on finding another job. Row “∆ NLF UEM” calculates the number of people not counted in the labor force because they could have given up on finding another job by subtracting from the labor force with participation rate of 66.2 percent (row “LF PART 66.2%”) the labor force estimated in the household survey (row “LF”). Total unemployed (row “Total UEM”) is obtained by adding unemployed in row “∆NLF UEM” to the unemployed of the household survey in row “UEM.” The row “Total UEM%” is the effective total unemployed “Total UEM” as percent of the effective labor force in row “LF PART 66.2%.” The results are that: (1) there are an estimated 4.004 million unemployed who are not counted because they left the labor force on their belief they could not find another job (∆NLF UEM); (2) the total number of unemployed is effectively 18.413 million (Total UEM) and not 14.409 million (UEM) of whom many have been unemployed long term; (3) the rate of unemployment is 11.6 percent (Total UEM%) and not 9.3 percent, not seasonally adjusted, or 9.2 percent seasonally adjusted; and (4) the number of people in job stress is close to 30 million by adding the 4.004 million leaving the labor force because they believe they could not find another job. The last row of Table 15 provides the number of people in job stress (“In Job Stress) not seasonally adjusted at 29.693 million in Jun 2011, adding the total number of unemployed (“Total UEM”), plus those involuntarily in part-time jobs because they cannot find anything else (“Part Time Economic Reasons”) and the marginally attached to the labor force (“Marginally attached to LF”). The employment population ratio “EMP/POP %” dropped from 62.9 percent on average in 2006 to 58.9 percent in Jun 2010, 58.5 percent in May 2011 and 58.5 percent in Jun 2011 and the number of employed (EMP) dropped from 144 million to 140 million. What really matters for labor input in production and wellbeing is the number of people with jobs or the employment/population ratio, which has declined and does not show signs of increasing. There are almost four million fewer people working in 2011 than in 2006 and the number employed is not increasing. The number of hiring relative to the number unemployed measures the chances of becoming employed. The number of hiring in the US economy has declined by 17 million and does not show signs of increasing (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html see sections on Hiring Collapse in http://cmpassocregulationblog.blogspot.com/2011/07/financial-risk-aversion-hiring-collapse.html http://cmpassocregulationblog.blogspot.com/2011/06/increasing-risk-aversion-analysis-of.html).
Table 15, Population, Labor Force and Unemployment, NSA
| 2006 | Jun 2010 | May 11 | Jun 11 | |
| POP | 229 | 237,690 | 239,313 | 239,489 |
| LF | 151 | 154,767 | 153,449 | 154,538 |
| PART% | 66.2 | 65.1 | 64.1 | 64.5 |
| EMP | 144 | 139,882 | 140,028 | 140,129 |
| EMP/POP% | 62.9 | 58.9 | 58.5 | 58.5 |
| UEM | 7 | 14,885 | 13,421 | 14,409 |
| UEM/LF Rate% | 4.6 | 9.6 | 8.7 | 9.3 |
| NLF | 77 | 82,923 | 85,864 | 84,951 |
| LF PART 66.2% | 157,351 | 158,425 | 158,542 | |
| ∆NLF UEM | 2,584 | 4,976 | 4,004 | |
| Total UEM | 17,469 | 18,397 | 18,413 | |
| Total UEM% | 11.1 | 11.6 | 11.6 | |
| Part Time Economic Reasons | 8,734 | 8,144 | 8,600 | |
| Marginally Attached to LF | 2,591 | 2,206 | 2,680 | |
| In Job Stress | 28,794 | 28,747 | 29,693 |
Pop: population; LF: labor force; PART: participation; EMP: employed; UEM: unemployed; NLF: not in labor force; ∆NLF UEM: additional unemployed; Total UEM is UEM + ∆NLF UEM; Total UEM% is Total UEM as percent of LF PART 66.2%; In Job Stress = Total UEM + Part Time Economic Reasons + Marginally Attached to LF
Note: the first column for 2006 is in average millions; the remaining columns are in thousands; NSA: not seasonally adjusted
The labor force participation rate of 66.2% in 2006 is applied to current population to obtain LF PART 66.2%; ∆NLF UEM is obtained by subtracting the labor force with participation of 66.2 percent from the household survey labor force LF; Total UEM is household data unemployment plus ∆NLF UEM; and total UEM% is total UEM divided by LF PART 66.2%
Sources:
ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf
http://www.bls.gov/news.release/archives/empsit_12032010.pdf
http://www.bls.gov/news.release/pdf/empsit.pdf
Feldstein (2011Jul25) argues that the drop in house prices depressed residential construction, causing a major drop in household wealth. Continuing declines of house prices are depressing further construction and spending by families. Companies have cut production because of weak demand.
Table 16 shows the euphoria of prices during the boom and the subsequent decline. House prices rose by 94.1 percent in the 10-city composite of the Case-Shiller home price index and 77.9 percent in the 20-city composite between May 2000 and May 2005. Prices have fallen 31.9 percent since 2006 for the 10-city composite and by 32.2 percent for the 20-city composite.
Table 16, Percentage Changes of Standard & Poor’s Case-Shiller Home Price Indices, Not Seasonally Adjusted, ∆%
| 10-City Composite | 20-City Composite | |
| ∆% May 2000 to May 2003 | 39.8 | 33.1 |
| ∆% May 2000 to May 2005 | 94.1 | 77.9 |
| ∆% May 2000 to May 2011 | 44.9 | 32.9 |
| ∆% May 2005 to May 2011 | -25.3 | -25.3 |
| ∆% Aug 2006 to May 2011 | -31.9 | -32.2 |
| ∆% May 2009 to May 2011 | 1.6 | -0.1 |
| ∆% May 2010 to May 2011 | -3.6 | -4.5 |
The seasonally adjusted S&P Case-Shiller indices are shown in Table 17. With the exception of Apr, prices have fallen in all months since Dec 2010.
Table 17, Monthly Percentage Change of S&P Case-Shiller Home Price Indices, Seasonally Adjusted, ∆%
| 10-City Composite | 20-City Composite | |
| May | 0.1 | -0.1 |
| Apr | 0.4 | 0.4 |
| Mar | -0.3 | -0.6 |
| Feb | -0.4 | -0.3 |
| Jan | -0.4 | -0.3 |
| Dec 2010 | -0.4 | -0.4 |
Let V(T) represent the value of the firm’s equity at time T and B stand for the promised debt of the firm to bondholders and assume that corporate management, elected by equity owners, is acting on the interests of equity owners. Robert C. Merton (1974, 453) states:
“On the maturity date T, the firm must either pay the promised payment of B to the debtholders or else the current equity will be valueless. Clearly, if at time T, V(T) > B, the firm should pay the bondholders because the value of equity will be V(T) – B > 0 whereas if they do not, the value of equity would be zero. If V(T) ≤ B, then the firm will not make the payment and default the firm to the bondholders because otherwise the equity holders would have to pay in additional money and the (formal) value of equity prior to such payments would be (V(T)- B) < 0.”
Pelaez and Pelaez (The Global Recession Risk (2007), 208-9) apply this analysis to the US housing market in 2005-2006 concluding:
“The house market [in 2006] is probably operating with low historical levels of individual equity. There is an application of structural models [Duffie and Singleton 2003] to the individual decisions on whether or not to continue paying a mortgage. The costs of sale would include realtor and legal fees. There could be a point where the expected net sale value of the real estate may be just lower than the value of the mortgage. At that point, there would be an incentive to default. The default vulnerability of securitization is unknown.”
There are multiple important determinants of the interest rate: “aggregate wealth, the distribution of wealth among investors, expected rate of return on physical investment, taxes, government policy and inflation” (Ingersoll 1987, 405). Aggregate wealth is a major driver of interest rates (Ibid, 406). Unconventional monetary policy, with zero fed funds rates and flattening of long-term yields by quantitative easing, causes uncontrollable effects on risk taking that can have profound undesirable effects on financial stability. Excessively aggressive and exotic monetary policy is the main culprit and not the inadequacy of financial management and risk controls.
The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent restatement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption decisions is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:
W = Y/r (1)
Equation (1) shows that as r goes to zero, r →0, W grows without bound, W→∞.
Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at close to zero interest rates, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).
The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper to purchase default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4).
Table 18 summarizes the brutal drops in assets and net worth of US households and nonprofit organizations from 2007 to IQ2011. Real estate fell in value by $5.2 trillion and financial assets by $1.7 trillion, explaining most of the drop in net worth of $6.1 trillion.
Table 18 Difference in Millions of Dollars from 2007 to IQ2011
| Assets | -6,606.5 |
| Nonfinancial | -4,887.1 |
| Real Estate | -5,180.4 |
| Financial | -1,719.4 |
| Liabilities | 494.9 |
| Net Worth | -6,111.6 |
Source: http://www.federalreserve.gov/releases/z1/Current/z1.pdf
IV Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. The JP Morgan Global PMI, compiled by Markit, provides an important reading of the world economy, analyzed by Markit’s Chief Economist Chris Williamson (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/global_economy_11_07_07.pdf). The JP Morgan Global PMI, compiled by Markit, registered the weakest quarter of private sector output growth in manufacturing and services since IIIQ2009, when the world economy began recovering, falling from 52.7 in May to 52.2 in Jun. Japan recovered sharply from the Mar earthquake/tsunami but the JP Morgan Global PMI compiled by Markit shows that the index is significantly lower in Jun than in May, being consistent with world GDP growth at the low annual rate of 2 percent. Japan’s sharp recovery has been compensated in the index by weak IIQ2011 growth in the US, with Jun being at the lowest in 22 months, and similar weakness in the euro zone and the UK. Growth has also weakened in the BRIC countries of Brazil, Russia, India and China. The JP Morgan Global PMI compiled by Markit shows that world manufacturing exports have nearly stagnated with the worst performance since Jul 2009. The softness of the economy is worldwide and persistent.
Table 19 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). The flash HSBC Manufacturing PMI™ for China declined from 50.1 in Jun to 48.9 in Jul, with the sharpest deterioration of manufacturing since Mar 2009 (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/CN_NOTE_21_07_11.pdf http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/CN_Manufacturing_ENG_1108_PR_FLASH.pdf). China’s rate of growth of industrial production rose from 13.3 percent in May to 15.1 percent in Jun. The rate could decline to about 10 percent as suggested by the flash PMI. Both official data and the PMI have tracked slowing export growth in China that peaked in early 2010 (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/CN_NOTE_21_07_11.pdf). Economic conditions have worsened for smaller companies relative to larger ones. Aaron Back and Jason Dean writing on Jul 9, 2011 on “China price watchers predict another peak” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304793504576433443699064616.html?mod=WSJ_hp_LEFTWhatsNewsCollection) inform that China’s CPI inflation jumped to 6.4 per cent in Jun relative to a year earlier, much higher than 5.5 percent in May but many economists believe that inflation could decline in the second half of the year. Comparisons with high rates of CPI inflation late in 2010 will likely result in lower 12 months rates of inflation later in 2011. Jamil Anderlini writing on Jul 9, 2011, on “China inflation hits three-year high” published by the Financial Times (http://www.ft.com/intl/cms/s/0/693daad2-aa1d-11e0-958c-00144feabdc0.html#axzz1Repz5K5o) informs that food prices increased 14.4 percent in the 12 months ending in Jun. Core non-food prices increased 3 percent in the 12 months ending in Jun, which is the highest rate in five years, suggesting inflation is spreading in the economy. Headline CPI inflation rose 0.3 percent in Jun relative to May but prices excluding food were stable, which could signal decelerating inflation. Aaron Back writing on Jul 6, 2011 on “China raises interest rates” published by the Wall Street Journal Asia Business (http://professional.wsj.com/article/SB10001424052702303544604576429393824293666.html?mod=WSJ_hp_LEFTWhatsNewsCollection) informs that the People’s Bank of China raised the one-year lending rate from 6.31 percent to 6.56 percent and the one-year deposit rate to 3.5 percent from 3.25 percent. This was the fifth increase in interest rates in 2010 and 2011. The People’s Bank of China has raised the reserve requirements of banks six times in 2011. The concern with inflation in China is that it could be a factor in a “hard landing” of the economy with growth lower than 7 percent. The lending rate may not be negative in real terms if during the next 12 months inflation falls below the yearly rate of 6.5 percent. An issue is China is the use of generous credit growth to prevent the impact of the global recession on China. Deposit rates of 3.5 percent are likely to be lower than forward inflation, stimulating the purchase of speculative assets such as housing and also goods that may rise more than expected inflation. Martin Vaughan writing on July 5, 2011 on “Moody’s warns on China debt” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304803104576427062691548064.html?mod=WSJ_hp_LEFTWhatsNewsCollection) informs of the warning by Moody’s Investors Service that China’s National Audit Office (NAO) understated CNY 3.5 trillion or $541 billion of bank loans to local governments. That portion of loans has poor documentation and highest exposure to delinquencies. NAO has concluded that banks have lent CNY 8.5 trillion to local government. A critical issue in China is the percentage of those loans that could become nonperforming and the impact that could occur on bank capital and solvency. The report by Moody’s Investors Service “estimates that the Chinese banking system’s economic nonperforming loans could reach between 8% and 12% of total loans, compared to 5% to 8% in the agency’s base case, and 10% to 18% in its stress case” (http://www.moodys.com/research/Moodys-Scale-of-problem-loans-to-Chinese-local-governments-greater?lang=en&cy=global&docid=PR_222068). A hard landing in China could have adverse repercussions in the regional economy of Asia and throughout the world’s financial markets and economy. The combination of a hard landing in China with sovereign risk difficulties in Europe and further slowing of the US economy could have strong, unpredictable effects. Jamil Anderlini writing from Shanghai on Jul 10, 2011 on “Trade data show China economy slowing” published by the Financial Times (http://www.ft.com/intl/cms/s/0/eeedc000-aabc-11e0-b4d8-00144feabdc0.html#axzz1Repz5K5o) informs that Chinese imports grew at 19.3 percent in June 2011 relative to Jun 2010, which is significantly below the 12-month rate of 28.4 percent in May. China’s industrial activity appears to be decelerating as suggested by lower imports of commodities such as crude oil, aluminum and iron ore, all falling in the 12 months ending in Jun 2011. China’s imports of crude oil fell 11.5 percent in Jun 2011 relative to Jun 2010 and copper imports grew in Jun but were lower than a year earlier. China’s exports grew 17.9 percent in Jun from a year earlier to a monthly record of $162 billion. The trade surplus of China in Jun of $22.3 billion was higher than $13 billion in May and may reignite the complaints about China’s exchange rate policy. Simon Rabinovitch writing on Jul 12 on “China’s foreign reserves climb by $153 billion” published by the Financial Times (http://www.ft.com/intl/cms/s/0/13c382e6-ac59-11e0-bac9-00144feabdc0.html#axzz1Repz5K5o) informs that China’s foreign reserves rose by $153 billion in IIQ2011 after increasing $197 billion in IQ2011, reaching $3197 billion, which is around 50 percent of GDP and three times higher than reserves by any other country. The trade surplus contributed $47 billion of the increase of reserves of $153 billion in IIQ2011 with the remainder originating mostly in investment inflows and interest earnings. Aaron Back writing on Jul 13 on “China growth suggests tightening ahead” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304223804576443493415667206.html?mod=WSJ_hp_LEFTWhatsNewsCollection) analyzes new data on China showing fast expansion of the economy that could signal further tightening measures. China’s GDP grew at 9.5 percent in IIQ2011, which is lower than 9.7 percent in IQ2011. Most countries report GDP growth as seasonally adjusted quarterly rates converted in annual equivalent. The adjustment of Chinese data for seasonality in annual equivalent results in GDP growth of 9.1 in IIQ2011 compared with 8.7 percent growth in IQ2011. The growth rate of GDP of China in IIQ2011 increased slightly to 2.2 percent in that quarter. Industrial production rose to the 12-month rate in Jun of 15.1 percent, which is higher than 13.3 percent in May. Real estate investment in Jan-Jun 2011 rose to CNY 2.625 trillion, equivalent to about $405 billion, which is higher by 32.9 percent relative to Jan-Jun 2010. Sales of commercial and residential property sales in Jan-Jun 2011 rose 24.1 percent relative to 2010, which is higher than 18.1 percent in Jan-May.
Table 19, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 2.9 | 3.6 | 7.0 | 9.2 |
| Japan | -0.7*** | 0.2 | 2.5 | 4.6 |
| China | 9.5 | 6.4 | 6.8 | |
| UK | 1.8 | 4.5* | 5.7* output | 7.7 |
| Euro Zone | 2.5 | 2.5 | 6.2 | 9.9 |
| Germany | 4.8 | 2.4 | 6.1 | 6.0 |
| France | 2.2 | 2.3 | 6.0 | 9.5 |
| Nether-lands | 3.2 | 2.5 | 10.7 | 4.2 |
| Finland | 5.8 | 3.4 | 8.0 | 7.8 |
| Belgium | 3.0 | 3.4 | 9.7 | 7.3 |
| Portugal | -0.7 | 3.3 | 5.9 | 12.4 |
| Ireland | -1.0 | 1.2 | 5.3 | 14.0 |
| Italy | 1.0 | 3.0 | 4.8 | 8.1 |
| Greece | -4.8 | 3.1 | 7.2 | 15.1 |
| Spain | 0.8 | 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/ppi0711.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
Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). 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 I Financial Risk Aversion in this post, section IV in http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html and Section I Increasing Risk Aversion in http://cmpassocregulationblog.blogspot.com/2011/06/increasing-risk-aversion-analysis-of.html and 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/2011/06/financial-risk-aversion-slow-growth.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/05/mediocre-growth-world-inflation.html 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/2011/07/twenty-five-to-thirty-million.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 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 20 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 20 shows that the interval has narrowed to PCE 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 20 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.”
Table 20, 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
Japan’s economy continues to recover in V-shape. Table 21 shows wholesale and retail sales 12-months rates of increase. The economy of Japan hit a soft spot at the end of 2010, as shown by decline in retail sales of 2.1 percent. The earthquake/tsunami on Mar 11 had devastating effects with retail sales dropping 8.3 percent, wholesale sales increasing only 1.2 percent and total sales falling 1.3 percent. The impact carried into Apr with retail sales losing 4.8 percent in 12 months. Retail sales finally rose by 1.1 percent in the 12 months ending in Jun.
Table 21 Japan, Wholesale and Retail Sales 12 Month ∆%
| Total | Wholesale | Retail | |
| Jun | 2.9 | 3.5 | 1.1 |
| May | 1.3 | 2.3 | -1.3 |
| Apr | -2.6 | -1.7 | -4.8 |
| Mar | -1.3 | 1.2 | -8.3 |
| Feb | 5.3 | 7.2 | 0.1 |
| Jan | 3.3 | 4.6 | 0.1 |
| Dec 2010 | 3.5 | 5.7 | -2.1 |
Source: http://www.meti.go.jp/english/statistics/tyo/syoudou/index.html
Japan’s economy continues to function with an almost nil rate of consumer price inflation. Table 22 shows decline of consumer prices by 0.1 percent in Jun relative to May and increase by 0.2 percent in the 12 months ending in Jun. Inflation picked up in Apr and Mar at 0.3 percent per month, coinciding with the increase in commodity prices. Inflation decelerated in May to 0.1 percent and declined by 0.1 percent in Jun together with collapse of commodity prices.
Table 22, Japan, Consumer Price Index ∆%
| ∆% Month SA | ∆% 12 Months NSA | |
| Jun 2011 | -0.1 | 0.2 |
| May | 0.1 | 0.3 |
| Apr | 0.3 | 0.3 |
| Mar | 0.3 | 0.0 |
| Feb | -0.1 | 0.0 |
| Jan | -0.2 | 0.0 |
| Dec 2010 | -0.3 | 0.0 |
Source: http://www.stat.go.jp/english/data/cpi/index.htm
The drivers of CPI inflation in Japan are the segments of (1) fuel, light and water charges, increasing by 0.4 percent in Jun and 3.3 percent in 12 months; and transport and communications, falling by 0.6 percent in Jun but increasing by 1.1 in 12 months, as shown in Table 23. Inflation in the Ku area of Tokyo was 0 percent in the preliminary estimate for Jul and 0.5 percent in 12 months, with fuel, light and water charges increasing 1.0 percent and 2.6 percent in 12 months.
Table 23, Japan CPI Jun 2011 ∆%
| Jun/May ∆% | Year ∆% | |
| CPI | -0.1 | 0.2 |
| CPI Excluding Fresh Food | -0.2 | 0.4 |
| CPI Excluding Food and Energy | -0.1 | 0.1 |
| CPI Goods | 0.0 | 0.3 |
| CPI Services | ||
| CPI Excluding Imputed Rent | 0.0 | 0.3 |
| CPI Fuel, Light, Water Charges | 0.4 | 3.3 |
| CPI Transport Communications | -0.6 | 1.1 |
| CPI Ku-are Tokyo | 0.0 | 0.5 |
| Fuel, Light, Water Charges Ku Area Tokyo | 1.0 | 2.6 |
Note: Ku-area Tokyo CPI data preliminary for Jul
Source: http://www.stat.go.jp/english/data/cpi/1581.htm
Euro zone countries calculate domestic price increases and a harmonized price index. Table 19 is updated using the harmonized price index provided by Eurostat. Table 24 shows the consumer price index for Germany with the advance estimate for Jul at 2.4 percent in 12 months and 0.4 percent from Jun to July. The annual equivalent inflation in Germany is lower at 2.2 because of the fall of CPI inflation by 0.4 percent in Jan.
Table 24, Germany, Consumer Price Index ∆%
| Month | 12 Months | |
| Jul 2011 | 0.4 | 2.4 |
| Jun | 0.1 | 2.3 |
| May | 0.0 | 2.3 |
| Apr | 0.2 | 2.4 |
| Mar | 0.5 | 2.1 |
| Feb | 0.5 | 2.1 |
| Jan | -0.4 | 2.0 |
| AE ∆% | 2.2 | |
| Dec 2010 | 1.0 | 1.7 |
Inflation of industrial prices of France is 6.1 percent in the 12 months ending in Jun, as shown in Table 25. Monthly inflation in Jun was negative or zero with the exception of 0.4 percent in food, alcohol and tobacco. Refining fell 2.2 percent and rose 21.6 percent in 12 months, being with mining, energy and water, 7.3 percent, and food, alcohol and tobacco, 7.3 percent, the drivers of industrial price inflation.
Table 25, France, Industrial Prices ∆%
| Month ∆% Jun 2011 | 12 Months ∆% | |
| Total Industrial Prices | -0.1 | 6.1 |
| Mining, Energy and Water | -0.2 | 7.3 |
| Manufacturing | -0.1 | 5.9 |
| Food, Alcohol, Tobacco | 0.4 | 7.3 |
| Refining | -2.2 | 21.6 |
| Electronics, Informatics, Machines | ||
| Transport Equipment | 0.4 | 1.8 |
| Other Industrial Products | 0.0 | 4.2 |
Source: http://www.insee.fr/fr/indicateurs/ind25/20110729/IPPI_0611.pdf
The rate of inflation of industrial prices in France accelerated from 5.4 percent in the 12 months ending in Dec to the peak of 6.7 percent in Mar and April, falling to 6.1 percent in Jun (see Table 26). The annual equivalent rate in the first six months that would prevail if repeated in a full year is 6.1 percent. Commodity price shocks drove the rate of industrial price increase upward until Apr and then drove it downward in Jun and May with the fall in commodity prices worldwide.
Table 26, France, Industrial Prices ∆%
| Month ∆% | 12-Month ∆% | |
| Jun 2011 | -0.1 | 6.1 |
| May | -0.5 | 6.2 |
| Apr | 1.0 | 6.7 |
| Mar | 0.9 | 6.7 |
| Feb | 0.8 | 6.3 |
| Jan | 0.9 | 5.6 |
| AE ∆% | 6.1 | |
| 2010 | 0.8 | 5.4 |
Source: http://www.bdm.insee.fr/bdm2/affichageSeries.action?bouton=OK&001569919=on&codeGroupe=966
Industrial prices in Italy follow the same behavior as in other European countries. The 12 month rate of increase of industrial prices rose from 4.7 percent in Dec 2010 to the peak of 6.2 percent in Mar, declining to 4.7 percent in Jun (see Table 27). Commodity price increases caused high increases in monthly industrial prices until Apr and then minus 0.2 percent in May and only 0.1 percent in Jun. The annual equivalent rate for the first six months is 6.8 percent.
Table 27, Italy, Industrial Prices
| Month ∆% | 12 Months ∆% | |
| Jun 2011 | 0.1 | 4.7 |
| May | -0.2 | 4.8 |
| Apr | 0.7 | 5.6 |
| Mar | 0.8 | 6.2 |
| Feb | 0.7 | 5.8 |
| Jan | 1.2 | 5.3 |
| AE ∆% | 6.8 | |
| Dec 2010 | 0.7 | 4.7 |
Source: http://www.istat.it/salastampa/comunicati/in_calendario/preprod/20110729_00/
Consumer price inflation in Italy also follows producer price inflation, as shown in Table 28. The 12-month rate of inflation in Dec of 1.9 percent was followed with increases, reaching a peak of 2.7 percent in Jun. The monthly rate of inflation dropped to only 0.1 percent in both Jun and May. The annual equivalent rate is 3.7 percent, which is higher than the 12 month rates.
Table 28, Italy, Consumer Price Index ∆%
| Month ∆% | 12 Months ∆% | |
| Jun 2011 | 0.1 | 2.7 |
| May | 0.1 | 2.6 |
| Apr | 0.5 | 2.6 |
| Mar | 0.4 | 2.5 |
| Feb | 0.3 | 2.4 |
| Jan | 0.4 | 2.1 |
| AE ∆% | 3.7 | |
| Dec 2010 | 0.4 | 1.9 |
Source: http://www.istat.it/salastampa/comunicati/in_calendario/precon/20110714_00/
The rate of unemployment of Japan rose slightly to 4.6 percent in Jun from 4.5 percent in May, as shown in Table 29. The number of unemployed of 2.93 million fell by 360,000 relative to a year earlier and the number of employed rose by 30,000 in the year to June, reaching 60.02million.
Table 29, Japan, Employment Report Jun 2011
| Unemployed | 2.93 million |
| Change since last year | -360 thousand |
| Unemployment rate | 4.6% SA +0.1 |
| Employed | 60.02 million |
| Change since last year | +30 thousand |
Source: http://www.stat.go.jp/english/data/roudou/154.htm
As in the United States, Germany calculates employment using employment accounts, shown in Table 30. Employment not seasonally annualized has increased by 2.5 percent since Jan 2009 or by 982,000. Additions to the employed have been steady but quite modest. Part of the explanation is that Germany avoided significant decline in employment by means of agreements among the government, employers and unions.
Table 30, Germany, People Employed, Employment Accounts
| # Employed NSA Millions | ∆% 12 months | # Employed SA Millions | ∆% Month/ Prior Month | |
| Jun 2011 | 40.882 | 1.2 | 40.892 | 0.1 |
| May | 40.816 | 1.2 | 40.838 | 0.1 |
| Apr | 40.683 | 1.3 | 40.800 | 0.1 |
| Mar | 40.482 | 1.4 | 40.756 | 0.1 |
| Feb | 40.329 | 1.4 | 40.712 | 0.1 |
| Jan | 40.284 | 1.3 | 40.664 | 0.2 |
| Dec 2010 | 40.821 | 1.1 | 40.593 | 0.1 |
| Dec 2009 | 40.367 | -0.3 | 40.145 | 0.1 |
| Jan 2009 | 39.900 | -1.5 | 40.274 | 0.0 |
The labor force survey for Germany is shown in Table 31. The rate of unemployment has declined from 6.8 percent in Jun 2010 to 6.1 percent in Jun 2011. The number of unemployed fell from 2.82 million to 2.57 million.
Table 31, Germany, Unemployment Labor Force Survey
| Jun 2011 | May 2011 | Jun 2010 | |
| NSA | |||
| Number Unemployed Millions | 2.57 | 2.48 | 2.82 |
| % Rate Unemployed | 6.1 | 5.9 | 6.8 |
| SA | |||
| Number Unemployed Millions | 2.58 | 2.59 | 2.96 |
| % Rate Unemployed | 6.1 | 6.1 | 7.1 |
NSA: not seasonally adjusted; SA: seasonally adjusted
Further evidence on the V-shaped recovery in Japan is provided by industrial production in Table 32. The impact of the tsunami/earthquake was brutal with decline of industrial production in Mar of 15.5 percent and 13.1 percent in 12 months. Industrial production already grew 1.6 percent in Apr and rose 6.2 percent in May and 3.9 percent in Jun. Industrial production in Jun 2011 is now only 1.6 percent below Jun 2010.
Table 32, Japan, Industrial Production ∆%
| ∆% Month SA | ∆% 12 Months NSA | |
| Jun 2011 | 3.9 | -1.6 |
| May | 6.2 | -5.5 |
| Apr | 1.6 | -13.6 |
| Mar | -15.5 | -13.1 |
| Feb | 1.8 | 2.9 |
| Jan | 0.0 | 4.6 |
| Dec 2010 | 2.4 | 5.9 |
Source: http://www.meti.go.jp/statistics/tyo/iip/result/pdf/press/h2a2005j.pdf
http://www.meti.go.jp/english/statistics/tyo/iip/index.html
The rate of GDP growth of the UK fell from 0.5 percent in IQ2011 and 1.6 percent relative to a year earlier to 0.2 percent in IIQ2011 and 0.7 percent relative to a year earlier. This is still good recovery from the drop of 0.5 percent in IVQ2010. Table 33 shows strong impact of the global recession on the economy of the UK with high quarter on quarter drops in GDP.
Table 33, UK GDP Growth ∆%
| Quarter/Prior Quarter | Quarter/Quarter Prior Year | |
| IIQ2011 | 0.2 | 0.7 |
| IQ2011 | 0.5 | 1.6 |
| IVQ2010 | -0.5 | 1.5 |
| IIIQ2010 | 0.6 | 2.4 |
| IIQ2010 | 1.1 | 1.6 |
| IQ2010 | 0.4 | -0.2 |
| IVQ2009 | 0.5 | -2.9 |
| IIIQ2009 | -0.3 | -5.3 |
| IIQ2009 | -0.8 | -5.9 |
| IQ2009 | -2.2 | -5.4 |
Source:http://www.statistics.gov.uk/pdfdir/gdp0711.pdf
GDP growth by gross value added by sectors for the UK is provided in Table 34. Services provided the dynamism that prevented collapse of the economy in IIQ2011 but grew only 1.1 percent in 2010. Manufacturing and total industrial production performed weakly.
Table 34, UK GDP Growth by Gross Value Added
| IIQ2011/IQ2010 ∆% | 2010/2009 ∆% | |
| GDP | 0.2 | 1.4 |
| Agriculture | -1.3 | -3.5 |
| Industrial Production | -1.4 | 2.1 |
| Manufacturing | -0.3 | 3.6 |
| Services | 0.5 | 1.1 |
Sources: http://www.statistics.gov.uk/pdfdir/gdp0711.pdf
The report on French consumer spending shows strong recovery in Jun from declines in Apr and May, as shown in Table 35. Manufactured goods consumption rose 1.1 percent in Jun and 2.2 percent in 12 months. Total consumer spending rose 1.2 percent, durables gained 2.3 percent and food increased 2.3 percent. Performance in IIQ2011 relative to IQ2011 was negative in all segments of consumer spending. Advanced economies are plagued by weak demand.
Table 35, France, Consumer Spending ∆%
| Apr | May | Jun | Jun 11/ Jun 10 | IIQ11/ IQ11 | |
| Manu- factured Goods | -1.1 | -1.2 | 1.1 | 2.2 | -2.0 |
| Total Cons. Spending | -1.5 | -0.3 | 1.2 | 1.8 | -1.8 |
| Durables | -2.8 | -1.4 | 2.3 | 4.0 | -3.3 |
| Autos | -10.1 | -1.7 | 2.2 | 0.9 | -11.2 |
| Food | 1.4 | -1.4 | 2.3 | 4.0 | -3.3 |
Cons: consumer
Source: http://www.insee.fr/fr/indicateurs/ind19/20110729/biens_juin.pdf
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 1 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 1 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 1, 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). Table 36 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 36, 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
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 37 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 37 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 37, 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
Table 38, 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 38. 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 2.795 percent at the close of market on Fr Jul 29, 2011, would be equivalent to price of 98.5258 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price loss of 2.7 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 38 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 Jul 27, 2011, the line “Reserve Bank credit” in the Fed balance sheet stood at $2847 billion, or $2.8 trillion, with portfolio of long-term securities of $2620 billion, or $2.6 trillion, consisting of $1545 billion Treasury nominal notes and bonds, $66 billion of notes and bonds inflation-indexed, $112 billion Federal agency debt securities and $897 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $1656 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 38, 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 |
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
V Valuation of Risk Financial Assets. 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 39 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 39 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 20.8 percent by Fri Jul 29, 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 39 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 39, 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 | 07/29 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.440 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 07/29 2011 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.4370 |
| 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 39A extracts four rows of Table 39 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 41 below, the dollar has devalued again to USD 1.440/EUR or by 20.8 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 6.4470/USD on Fri Jul 29, 2011, or by an additional 5.6 percent, for cumulative revaluation of 22.2 percent.
Table 39A, 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 | 07/29 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.440 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 07/29 2011 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.4370 |
Source: Table 21.
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 40. 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 40, 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 39 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 41, 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” and the sharp recovery after around Jul 2010 in the last column “∆% Trough to 07/29/11” with all risk financial assets in the range from 9.3 percent for the European stocks index STOXX 50 to 31.3 percent for the DJ UBS Commodity Index. Japan has significantly improved performance rising 11.4 percent above the trough. The Nikkei Average closed at 9833.03 on Fri Jul 29, only 4.1 percent below 10,254.43 on Mar 11 on the date of the earthquake and 6.8 percent above the lowest Fri closing on Mar 18 of 9206.75. The dollar depreciated by 20.8 percent and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 07/29/2011” shows positive performance of all financial assets. The Dow Global lost 3.1 percent with losses in all stock indexes in Table 41. The Nikkei Average dropped 2.9 percent. The DJIA fell 4.2 percent and both S&P and NYSE Financial fell 3.9 percent. The STOXX 50 of Europe lost 2.0 percent and DAX of Germany fell 2.3 percent. There are still high uncertainties on European sovereign risks, US debt/growth recession and China’s growth and inflation tradeoff. The DJ UBS Commodity Index fell 1.5 percent in the week. 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 41 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 7/29/11” 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 7/29/11” but also relative to the peak in column “∆% Peak to 7/29/11.” There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 11/3 percent, Nikkei Average by 13.7 percent, Shanghai Composite by 14.6 percent and STOXX 50 by 7.4 percent. The gainers relative to the peak in Apr 2010 are: DAX by 13.1 percent, Asia Pacific by 7.6 percent, S&P 500 by 6.2 percent, DJIA by 8.4 percent, Dow Global by only 0.1 percent and the DJ UBS Commodities Index by 12.3 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. Aggressive tightening of monetary policy 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 of long-term securities close to 30 percent of Treasury securities in circulation.
Table 41, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 7/ 29/11 | ∆% Week 7/ | ∆% Trough to 7/ | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 8.4 | -4.2 | 25.4 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 6.2 | -3.9 | 26.4 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | -11.3 | -3.9 | 15.9 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | 0.1 | -3.1 | 22.7 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | 7.6 | -1.5 | 22.9 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | -13.7 | -2.9 | 11.4 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -14.6 | -2.5 | 13.4 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -7.4 | -2.0 | 9.3 |
| DAX | 4/26/ | 5/25/ | -10.5 | 13.1 | -2.3 | 26.2 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 4.8 | -0.3 | -20.8 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | 12.3 | -1.5 | 31.3 |
| 10-Year Tre. | 4/5/ | 4/6/10 | 3.986 | 2.795 |
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 42 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. There were still fluctuations. Reversals of valuations are possible during aggressive changes in interest rate policy and other market events. The stock market of the US then entered a period of six consecutive weekly declines interrupted by a week of advance and then another decline in the week of Jun 24. In the week of May 6, return of risk aversion, resulted in moderation of the valuation of the DJIA to 12.8 percent and that of the S&P 500 to 10.6 percent. There was further loss of dynamism in the week of May 13 with the DJIA reducing its gain to 12.4 percent and the S&P 500 to 10.4 percent. Further declines lowered the gain to 11.7 percent in the DJIA and to 10.0 in the S&P 500 by Fri May 20. By Fri May 27 the gains were further reduced to 11.0 percent for the DJIA and 9.8 percent for the S&P 500. In the fifth consecutive week of declines in the week of Fri June 3, the DJIA fell 2.3 percent, reducing the cumulative gain to 8.4 percent, and the S&P 500 also lost 2.3 percent, resulting in cumulative gain of 7.3 percent. The DJIA lost another 1.6 percent and the S&P 500 also 2.2 percent in the week of Jun 10, reducing the cumulative gain to 6.7 percent for the DJIA and of 4.9 percent for the S&P 500. The DJIA gained 0.4 percent in the week of Jun 17, to break the round of six consecutive weekly declines, rising 7.1 percent relative to Apr 26, 2010, while the S&P moved sideways by 0.04 percent, with gain of 4.9 percent relative to Apr 26, 2010. In the week of Jun 24, the DJIA lost 0.6 percent and the S&P lost 0.2 percent. The DJIA had lost 6.8 percent between Apr 29 and Jun 10, 2011, and the S&P 500 lost 6.9 percent. The losses were almost gained back in the week of Jul 1 with the DJIA gaining 12.3 percent and the S&P 500 10.5 percent. There were gains of 0.6 percent for the DJIA and 0.3 percent in the week of Jul 8 even with turmoil around sovereign risk issues in Europe and an abnormally weak employment situation report released on Fri Jul 8. The DJIA closed on Fri Jul 8 only 1.2 percent lower than the closing on Fri Apr 29 and the S&P 500 closed only 1.5 percent below the level of Apr 29. Continuing risk aversion as a result of sovereign risk uncertainty in Europe influenced the loss of 1.4 percent by the DJIA in the week of Jul 15, reducing the cumulative gain to 11.4 percent and much sharper loss by the S&P 500 of 2.1 percent with reduction of the cumulative gain by 8.6 percent. Improved risk moods as a result of the program for Greece raised the valuation of the DJIA to 13.2 percent on Jul 22 and that of the S&P 500 to 10.9 percent. The realization of the growth recession in the week of Jul 29 together with some effects of the “game of chicken” with the debt ceiling caused another drop of the DJIA and the S&P 500 by 4.2 percent and 3.9 percent, respectively. The cumulative gain fell to 8.4 percent for the DJIA and to 6.6 percent for the S&P 500. There may be a brief relief rally on the end, for the time being, of the game of chicken on the budget and the debt that will return for a second episode at the end of the year.
Table 42, 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 |
| 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 |
Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3004
Table 43, 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. Joe Leahy writing on Jul 1 from São Paulo on “Brazil fears economic fallout as real soars” published in the Financial Times (http://www.ft.com/intl/cms/s/0/8430cd36-a40c-11e0-8b4f-00144feabdc0.html#axzz1Qt9Zxqcy) informs that the Brazilian real traded at the strongest level relative to the dollar since floating in 1999 with the strong currency eroding the country’s competitiveness in industrial products. 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 43, Exchange Rates
| Peak | Trough | ∆% P/T | Jul 29, 2011 | ∆% T Jul 29 2011 | ∆% P Jul 29 2011 | |
| EUR USD | 7/15 | 6/7 2010 | 7/29 2011 | |||
| Rate | 1.59 | 1.192 | 1.440 | |||
| ∆% | -33.4 | 17.2 | -10.4 | |||
| JPY USD | 8/18 | 9/15 | 7/29 2011 | |||
| Rate | 110.19 | 83.07 | 76.77 | |||
| ∆% | 24.6 | 7.6 | 30.3 | |||
| CHF USD | 11/21 2008 | 12/8 2009 | 7/29 2011 | |||
| Rate | 1.225 | 1.025 | 0.788 | |||
| ∆% | 16.3 | 23.1 | 35.7 | |||
| USD GBP | 7/15 | 1/2/ 2009 | 7/29 2011 | |||
| Rate | 2.006 | 1.388 | 1.642 | |||
| ∆% | -44.5 | 15.4 | -22.2 | |||
| USD AUD | 7/15 2008 | 10/27 2008 | 7/29 | |||
| Rate | 1.0215 | 1.6639 | 1.099 | |||
| ∆% | -62.9 | 45.3 | 10.9 | |||
| ZAR USD | 10/22 2008 | 8/15 | 7/29 2011 | |||
| Rate | 11.578 | 7.238 | 6.682 | |||
| ∆% | 37.5 | 7.7 | 42.3 | |||
| SGD USD | 3/3 | 8/9 | 7/29 | |||
| Rate | 1.553 | 1.348 | 1.203 | |||
| ∆% | 13.2 | 10.8 | 22.5 | |||
| HKD USD | 8/15 2008 | 12/14 2009 | 7/29 | |||
| Rate | 7.813 | 7.752 | 7.794 | |||
| ∆% | 0.8 | -0.5 | 0.2 | |||
| BRL USD | 12/5 2008 | 4/30 2010 | 7/29 2011 | |||
| Rate | 2.43 | 1.737 | 1.551 | |||
| ∆% | 28.5 | 10.7 | 36.2 | |||
| CZK USD | 2/13 2009 | 8/6 2010 | 7/29 | |||
| Rate | 22.19 | 18.693 | 16.779 | |||
| ∆% | 15.7 | 10.2 | 24.4 | |||
| SEK USD | 3/4 2009 | 8/9 2010 | 7/29 2011 | |||
| Rate | 9.313 | 7.108 | 6.273 | |||
| ∆% | 23.7 | 11.7 | 32.6 | |||
| CNY USD | 7/20 2005 | 7/15 | 7/29 | |||
| Rate | 8.2765 | 6.8211 | 6.4370 | |||
| ∆% | 17.6 | 5.6 | 22.2 |
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
VI Economic Indicators. The advance report on durable goods manufacturers’ shipments and new orders in Table 44 shows decline of new orders of durable goods by 2.1 percent from May into Jun. Durable goods data are among the most volatile and difficult to interpret short-term economic indicators. An important source of volatility is large value items such as aircraft. Investors and traders were concerned with the drop in new orders of durable goods released on Wed Jul 27. Excluding transportation new orders rose 0.1 percent but fell 1.8 percent excluding defense. Transport equipment fell 8.5 percent and motor vehicles declined 1.4 percent. The major source of decline was the fall by 28.9 percent of nondefense aircraft but capital goods also fell 4.1 percent.
Table 44, Durable Goods Manufacturers’ Shipments and New Orders, SA, %
| Jun/May ∆% | May/Apr ∆% | Apr/Mar ∆% | |
| Total | |||
| S | 0.5 | 0.5 | -1.4 |
| NO | -2.1 | 1.9 | -2.5 |
| Excluding Transport | |||
| S | 0.7 | 0.8 | -0.7 |
| NO | 0.1 | 0.7 | -0.1 |
| Excluding Defense | |||
| S | 0.5 | 0.6 | -1.2 |
| NO | -1.8 | 1.5 | -2.7 |
| Transport Equipment | |||
| S | -0.3 | -0.6 | -3.7 |
| NO | -8.5 | 5.8 | -9.3 |
| Motor Vehicles | |||
| S | -1.5 | 0.2 | -5.3 |
| NO | -1.4 | 0.3 | -5.3 |
| Nondefense Aircraft | |||
| S | 3.6 | -1.5 | -2.0 |
| NO | -28.9 | 31.4 | -29.0 |
| Capital Goods | |||
| S | 0.8 | 1.0 | -1.9 |
| NO | -4.1 | 5.5 | -5.1 |
Note: S: shipments; NO: new orders; Transport: transportation. Data adjusted for seasonality but not adjusted for inflation.
Source: http://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf
Durable goods manufacturers’ shipments and new orders, not seasonally adjusted, grew rapidly when comparing the first six months of 2011 relative to the first six months of 2010, shown in Table 45. The data are not adjusted for changes in prices such that there might be inflation behind double-digit growth.
Table 45, Durable Goods Manufacturers’ Shipments and New Orders, NSA, %
| Jan-Jun 2011/Jan-Jun 2010 ∆% | |
| Total | |
| S | 7.6 |
| NO | 9.4 |
| Excluding Transport | |
| S | 8.7 |
| NO | 9.2 |
| Excluding Defense | |
| S | 9.5 |
| NO | 10.7 |
| Transport Equipment | |
| S | 4.3 |
| NO | 10.2 |
| Motor Vehicles | |
| S | 10.7 |
| NO | 11.1 |
| Nondefense Aircraft | |
| S | 8.0 |
| NO | 28.2 |
| Capital Goods | |
| S | 4.7 |
| NO | 9.7 |
Note: S: shipments; NO: new orders; Transport: transportation. Data not adjusted for seasonality and not adjusted for inflation.
Source: http://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf
Sales of new homes SA at annual equivalent rate fell 0.9 percent in Jun and 0.6 percent in May after rising strongly by 3.9 percent in Apr and by 8.5 percent in Mar, as shown in Table 46. The first two months of the year were disappointing for real estate even adjusted for seasonality with declines of new home sales by 9.4 percent in Feb and decline by 6.3 percent in Jan. The pending home sales index of the National Association of Realtors based on contract signings but not closings rose 2.4 percent from May into Jun, reaching a level that is 19.8 percent higher than in Jun 2010, which is a low point of the index following the expiration of the tax credit for home buying (http://www.realtor.org/press_room/news_releases/2011/07/rise_june).
Table 46, Sales of New Homes at Seasonally-Adjusted (SA) Annual Equivalent Rate, Thousands and %
| SA Annual Rate Thousands | ∆% | |
| Jun 2011 | 312 | -0.9 |
| May | 315 | -0.6 |
| Apr | 317 | 3.9 |
| Mar | 305 | 8.5 |
| Feb | 281 | -9.4 |
| Jan | 310 | -6.3 |
| Dec 2010 | 331 | 15.3 |
Source: http://www.census.gov/const/newressales.pdf
The housing sector continues to be depressed relative to the prior year and the peak in 2005 to 2006. Table 47 shows that new home sales not seasonally adjusted fell 11.9 percent in Jan-Jun 2011 relative to the same period in 2010, 68.9 percent relative to the same period in 2006 and 73.2 percent relative to the same period in 2005.
Table 47, Sales of New Homes Not Seasonally Adjusted, Thousands and %
| Not Seasonally Adjusted Thousands | |
| Jan-Jun 2011 | 182 |
| Jan-Jun 2010 | 160 |
| ∆% | -11.9* |
| Jan-Jun 2006 | 585 |
| ∆% Jan-Jun 2011/Jan-Jun 2006 | -68.9 |
| Jan-Jun 2005 | 679 |
| ∆% Jan-Jun 2011/Jan-Jun 2005 | -73.2 |
*Computed using unrounded data
Source: http://www.census.gov/const/newressales.pdf
http://www.census.gov/const/newressales_200706.pdf
http://www.census.gov/const/newressales_200606.pdf
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 48 provides the major holders of US Treasury securities in May 2011 and Dec 2010. 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.
Table 48, Major Foreign Holders of Treasury Securities $ Billions at End of Period
| May 2011 | Dec 2010 | |
| China | 1159.8 | 1160.1 |
| Japan | 912.4 | 882.3 |
| United Kingdom | 346.5 | 271.6 |
| Oil Exporters | 229.8 | 211.9 |
| Brazil | 211.4 | 186.1 |
| Taiwan | 153.4 | 155.1 |
| Caribbean Banking Centers | 148.3 | 168.1 |
| Hong Kong | 121.9 | 134.2 |
| Russia | 115.2 | 151.0 |
| Switzerland | 108.2 | 107.0 |
Source: http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt
Crude oil input in refineries remained nearly stable at 15,379 thousand barrels per day on average in the four weeks ending on Jul 22 from 15,350 thousand barrels per day in the four weeks ending on Jul 15, as shown in Table 49. The rate of capacity utilization in refineries continues at a high level close to 90 percent. The decisive factor was the increase of imports of crude oil to 9,474 barrels per day on average from 9,234 barrels per day. Stable utilization with rising imports resulted in an increase of commercial crude oil stocks by 2.3 million barrels from 354.0 million on Jul 22 to 351.7 million on Jul 15. Gasoline stocks rose by 1 million barrels and stocks of fuel oil by 3.3 million barrels. The most worrisome fact is that supply of gasoline fell from 9,399 barrels per day on Jul 23, 2010, to 9,088 barrel per day on Jul 22, 2011, or by 3.3 percent, while fuel oil supply fell by 3.5 percent. Part of the fall in consumption is due to higher prices and part to the growth recession. Table 49 also shows increase in the world oil price by 54.3 percent from Jul 23, 2010 to Jul 22, 2011. Gasoline prices rose by 34.6 percent from Jul 26, 2010 to July 25, 2011.
Table 49, Energy Information Administration Weekly Petroleum Status Report
| Four Weeks Ending Thousand Barrels/Day | 07/22/11 | 07/15/11 | 07/23/10 |
| Crude Oil Refineries Input | 15,379 | 15,350 | 15,419 |
| Refinery Capacity Utilization % | 88.7 | 88.7 | 90.6 |
| Motor Gasoline Production | 9,215 | 9,192 | 9,460 |
| Distillate Fuel Oil Production | 4,519 | 4,470 | 4,418 |
| Crude Oil Imports | 9,474 | 9,234 | 9,923 |
| Motor Gasoline Supplied | 9,088 | 9,154 | 9,399 |
| Distillate Fuel Oil Supplied | 3,482 | 3,505 | 3,608 |
| 07/22/11 | 07/15/11 | 07/23/10 | |
| Crude Oil Stocks Million B | 354.0 | 351.7 | 360.8 |
| Motor Gasoline Million B | 213.5 | 212.5 | 222.2 |
| Distillate Fuel Oil Million B | 151.8 | 148.5 | 167.5 |
| World Crude Oil Price $/B | 113.87 | 113.49 | 73.80 |
| 07/25/11 | 07/18/11 | 07/26/10 | |
| Regular Motor Gasoline $/G | 3.699 | 3.682 | 2.749 |
B: barrels; G: gallon
Initial claims for unemployment insurance seasonally adjusted fell 24,000 to reach 398,000 in the week of Jul 23 from 422,000 in the week of Jul 16, as shown in Table 50. Claims not seasonally adjusted, or the actual estimate, fell 103,503 to reach 366,578 in the week of Jul 23 from 470,081 in the week of Jul 16. The labor market is not showing improvement with claims around 400,000, seasonally adjusted, but claims without seasonal adjustment fell sharply from Jul 16 to Jul 23. The next employment situation report will be released on Fri Aug 5.
Table 50, Initial Claims for Unemployment Insurance
| SA | NSA | 4-week MA SA | |
| Jul 23 | 398,000 | 366,578 | 413,750 |
| Jul 16 | 422,000 | 470,081 | 422,250 |
| Change | -24,000 | -103,503 | -8,500 |
| Jul 9 | 408,000 | 473,963 | 424,000 |
| Prior Year | 457,000 | 413,679 | 455,750 |
Note: SA: seasonally adjusted; NSA: not seasonally adjusted; MA: moving average
Source: http://www.dol.gov/opa/media/press/eta/ui/current.htm
VII. 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 51 provides inflation of the CPI. In Jan-Jun 2011, CPI inflation for all items seasonally adjusted was 3.7 percent in annual equivalent, that is, compounding inflation in the first six months and assuming it would be repeated during the second half of 2011. In the 12 months ending in Jun, 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-May and 1.6 percent in 12 months. Bloomberg provides the yield curve of US Treasury securities (http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/). The lowest yield is 0.09 percent for three months or virtually zero, 0.16 percent for six months, 0.20 percent for 12 months, 0.38 percent for two years, 0.57 percent for three years, 1.39 percent for five years, 2.13 percent for seven years, 2.83 percent for ten years and 4.13 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 51. 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 51, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent Jan-May 2011 ∆%
| ∆% 12 Months Jun 2011/Jun | ∆% Annual Equivalent Jan-Jun 2011 SA | |
| CPI All Items | 3.6 | 3.7 |
| CPI ex Food and Energy | 1.6 | 2.6 |
Source: http://www.bls.gov/news.release/pdf/cpi.pdf
VIII Conclusion. With the game of chicken over there may be real efforts to address the substantive issues of growth recession, job hardship and fiscal consolidation
(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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