Hiring Collapse, Ten Million Fewer Full-time Jobs, Youth Unemployment, World Financial Turbulence and World Economic Slowdown: Part I

 

Hiring Collapse, Ten Million Fewer Full-time Jobs, Youth Unemployment, World Financial Turbulence and World Economic Slowdown

Carlos M. Pelaez

© Carlos M. Pelaez, 2010, 2011, 2012

Executive Summary

I Hiring Collapse

IA Hiring Collapse

IB Labor Underutilization

IC Ten Million Fewer Full-time Jobs

ID Youth Unemployment

II United States Foreign Trade

III World Financial Turbulence

IIIA Financial Risks

IIIB Appendix on Safe Haven Currencies

IIIC Appendix on Fiscal Compact

IIID Appendix on European Central Bank Large Scale Lender of Last Resort

IIIE Appendix Euro Zone Survival Risk

IIIF Appendix on Sovereign Bond Valuation

IV Global Inflation

V World Economic Slowdown

VA United States

VB Japan

VC China

VD Euro Area

VE Germany

VF France

VG Italy

VH United Kingdom

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

Appendix I The Great Inflation

Executive Summary

ES I Hiring Collapse. Professor Edward Lazear (2012Jan19) at Stanford University finds that recovery of hiring in the US to peaks in 2007 requires an increase of hiring by 30 percent while hiring levels have increased by only 4 percent since Jan 2009. The high level of unemployment with low level of hiring reduces the statistical probability that the unemployed will find a job. According to Lazear (2012Jan19), the probability of finding a new job currently is about one third of the probability of finding a job in 2007. Improvements in labor markets have not increased the probability of finding a new job. Lazear (2012Jan19) quotes an essay coauthored with James Spletzer forthcoming in the American Economic Review on the concept of churn. A dynamic labor market occurs when a similar amount of workers is hired as those who are separated. This replacement of separated workers is called churn, which explains about two-thirds of total hiring. Typically, wage increases received in a new job are higher by 8 percent. Lazear (2012Jan19) argues that churn has declined 35 percent from the level before the recession in IVQ2007. Because of the collapse of churn there are no opportunities in escaping falling real wages (http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html) by moving to another job. As this blog argues, there are meager chances of escaping unemployment because of the collapse of hiring and those employed cannot escape falling real wages by moving to another job. There are two additional facts discussed below: (1) there are about ten million fewer full-time jobs currently than before the recession of 2008 and 2009; and (2) the extremely high and rigid rate of youth unemployment is denying an early start to young people ages 16 to 24 years.

The Bureau of Labor Statistics (BLS) collects data from about 16,000 US business establishments in nonagricultural industries through the 50 states and DC. The data are released monthly and constitute an important complement to other data provided by the BLS.

Hiring in the nonfarm sector (HNF) has declined from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million while hiring in the private sector (HP) has declined from 60.4 million in 2006 to 43.3 million in 2010 or by 17.1 million, as shown in Table ES-1. The ratio of nonfarm hiring to unemployment (RNF) has fallen from 47.7 in 2006 to 36.4 in 2010 and in the private sector (RHP) from 52.9 in 2006 to 40.3 in 2010 (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html). 

Table ES-1, US, Annual Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US and Percentage of Total Employment

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

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

Chart ES-1 provides the yearly levels of total nonfarm hiring (NFH) in Table I-1. The fall of hiring during the contraction of 2007 to 2009 was much stronger than in the shallow contraction of 2001 with GDP contraction of only 0.4 percent from Mar 2001 (IQ2001) to Dec 2011 (IVQ 2001) compared with 5.1 percent contraction in the much longer recession from Dec 2007 (IVQ2007) to Jun 2009 (IIQ2009) (http://www.nber.org/cycles/cyclesmain.html).

Chart ES-1, US, Total Nonfarm Hiring (HNF), Yearly, 2001-2010

Source: US Bureau of Labor Statistics

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

Total nonfarm hiring (HNF), total private hiring (HP) and their respective rates are provided for the month of Dec in the years from 2001 to 2011 in Table ES-2. Hiring numbers are in thousands. There is some recovery in HNF from 2705 thousand (or 2.7 million) in Dec 2009 to 2841 thousand in Dec 2010 and 2919 thousand in Dec 2011 for cumulative gain of 7.9 percent. HP rose from 2551 thousand in Dec 2009 to 2747 thousand in Dec 2011 for cumulative gain of 7.7 percent. HNF has fallen from 3947 in Dec 2005 to 2919 in Dec 2011 or by 26.0 percent. HP has fallen from 3702 in Dec 2006 to 2747 in Dec 2011 or by 25.8 percent. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.

Table ES-2, US, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment Not Seasonally Adjusted

	HNF	Rate RNF	HP	Rate HP
2001 Dec	3600	2.7	3375	3.1
2002 Dec	3711	2.8	3507	3.2
2003 Dec	3764	2.9	3554	3.3
2004 Dec	3939	3.0	3726	3.4
2005 Dec	3947	2.8	3631	3.2
2006 Dec	3903	2.8	3702	3.2
2007 Dec	3616	2.6	3397	2.9
2008 Dec	2977	2.2	2811	2.5
2009 Dec	2705	2.1	2551	2.4
2010 Dec	2841	2.2	2680	2.5
2011 Dec	2919	2.2	2747	2.5

Source:  US Bureau of Labor Statistics

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

Chart ES-2 provides total nonfarm hiring on a monthly basis from 2001 to 2011. Hiring rebounded in early 2010 but then fell and stabilized at a lower level than the early peak in 2010 of 4347 in Jun. Nonfarm hiring fell again in Oct as shown in Chart ES-2 with SA monthly data. The number of seasonally-adjusted hires in Sep was 4150 thousand, falling to 4042 thousand in Oct or by 2.6 percent but increasing to 4132 in Nov or by 2.2 percent. The number of hires SA fell to 4046 in Dec or by 2.1 percent. The number of hires not seasonally adjusted was 4396 in Sep, falling to 4057 in Oct or by 7.7 percent and falling to 3687 in Nov or by 9.1 percent. In Dec, the number of hires fell to 2919 or by an additional 20.8 percent. The number of nonfarm hiring not seasonally adjusted fell by 33.6 percent from Sep to Dec.

Chart ES-2, US, Total Nonfarm Hiring (HNF), 2001-2011 Month SA

Source: US Bureau of Labor Statistics

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

ES II Labor Underutilization. The Bureau of Labor Statistics also provides alternative measures of labor underutilization shown in Table ES-3. The most comprehensive measure is U6 that consists of total unemployed plus total employed part time for economic reasons plus all marginally attached workers as percent of the labor force. U6 not seasonally annualized has risen from 8.2 percent in 2006 to 16.2 in Jan 2011.

Table ES-3, US, Alternative Measures of Labor Underutilization %

	U1	U2	U3	U4	U5	U6
Jan 2012 NSA	4.9	5.4	8.8	9.4	10.5	16.2
Dec 2011 NSA	4.8	5.0	8.3	8.8	9.8	15.2
Nov     2011 NSA	4.9	4.7	8.2	8.9	9.7	15.0
Oct      2011 NSA	5.0	4.8	8.5	9.1	10.0	15.3
Sep      2011 NSA	5.2	5.0	8.8	9.4	10.2	15.7
Jan 2011 NSA	5.6	6.2	9.8	10.4	11.4	17.3
Dec     2010 NSA	5.4	5.9	9.1	9.9	10.7	16.6
2011	5.3	5.3	8.9	9.5	10.4	15.9
2010	5.7	6.0	9.6	10.3	11.1	16.7
2009	4.7	5.9	9.3	9.7	10.5	16.2
2008	2.1	3.1	5.8	6.1	6.8	10.5
2007	1.5	2.3	4.6	4.9	5.5	8.3
2006	1.5	2.2	4.6	4.9	5.5	8.2
2005	1.8	2.5	5.1	5.4	6.1	8.9
2004	2.1	2.8	5.5	5.8	6.5	9.6
2003	2.3	3.3	6.0	6.3	7.0	10.1
2002	2.0	3.2	5.8	6.0	6.7	9.6

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

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

Monthly seasonally adjusted measures of labor underutilization are provided in Table ES-4. U6 climbed from 16.2 percent in Jun 2011 to 16.4 percent in Oct 2011 and then fell to 15.2 in Dec 2011 and 15.1 percent in Jan 2012. Unemployment is an inaccurate measure of the stress in US job markets. A different calculation in this blog is provided by using the participation rate in the labor force before the global recession. This calculation shows 31.3 million in job stress of unemployment/underemployment in Jan 2012, not seasonally adjusted, corresponding to 19.5 percent of the labor force (http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html Table I-4).

Table ES-4, US, Alternative Measures of Labor Underutilization SA %

	Jan    2012	Dec    2011	Nov 2011	Oct 2011	Sep 2011	Aug  2011	Jul 2011	Jun 2011
U1	4.9	5.0	5.0	5.1	5.3	5.3	5.3	5.3
U2	4.7	4.9	4.9	5.1	5.2	5.3	5.3	5.4
U3	8.3	8.5	8.7	8.9	9.0	9.1	9.1	9.1
U4	8.9	9.1	9.3	9.5	9.6	9.6	9.7	9.7
U5	9.9	10.0	10.2	10.4	10.5	10.6	10.7	10.7
U6	15.1	15.2	15.6	16.0	16.4	16.2	16.1	16.2

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

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

Chart ES-3 provides U6 on a monthly basis from 2001 to 2011. There was a steep climb from 2007 into 2009 and then this measure of unemployment and underemployment stabilized at that high level but declined slightly into Jan 2012.

Chart ES-3, US, U6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons % LF plus all marginally attached workers as % of Labor Force, Month, SA, 2001-2011

Source: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

ES III Ten Million Fewer Full-time Jobs. There is strong seasonality in US labor markets around the end of the year. The number employed part-time for economic reasons because they could not find full-time employment fell from 9.270 million in Sep 2011 to 8.098 million in Dec 2011, seasonally adjusted, or decline of 1.172 million in just three months, as shown in Table ES-5. The number employed full-time increased from 112.479 million in Sep 2011 to 113.765 million in Dec 2011 or 1.286 million. The number employed part-time for economic reasons actually increased without seasonal adjustment from 8.271 million in Nov 2011 to 8.428 million in Dec 2011 or by 157,000 and then to 8.918 million in Jan 2012 or by an additional 490,000 for cumulative increase from Nov 2011 to Jan 2012 of 647,000. The number employed full time without seasonal adjustment fell from 113.138 million in Nov 2011 to 113.050 million in Dec 2011 or by 88,000 and fell further to 111.879 in Jan 2012 for cumulative decrease of 1.259 million. Comparisons over long periods require use of NSA data. The number with full-time jobs fell from a high of 123.219 million in Jul 2007 to 108.770 million in Jan 2010 or by 14.449 million. The number with full-time jobs in Jan 2012 is 111.879, which is lower by 11.3 million relative to the peak of 123.219 million in Jul 2007. There appear to be around 10 million less full-time jobs in the US than before the global recession. Growth at 2.4 percent on average in the ten quarters of expansion since IIIQ2009 compared with 6.2 percent on average in expansions from postwar cyclical contractions is the main culprit of the fractured US labor market (Table I-5 in http://cmpassocregulationblog.blogspot.com/2012/01/mediocre-economic-growth-financial.html).

Table ES-5, US, Employed Part-time for Economic Reasons, Thousands, and Full-time, Millions

	Part-time Thousands	Full-time Millions
Seasonally Adjusted
Jan 2012	8,230	113.845
Dec 2011	8,098	113.765
Nov 2011	8,469	113.212
Oct 2011	8,790	112.841
Sep 2011	9,270	112.479
Aug 2011	8,787	112.406
Not Seasonally Adjusted
Jan 2012	8,918	111.879
Dec 2011	8,428	113.050
Nov 2011	8,271	113.138
Oct 2011	8,258	113.456
Jan 2011	9,187	110.373
Dec 2010	9,205	111.207
Nov 2010	8,670	113.138
Oct 2010	8,408	113.456
Jan 2010	9,290	108.770 (low)
Jun 2009	9,301 (high)	114.014
Jan 2009	8,829	113.815
Jan 2008	5,340	119.322
Jul 2007	4,516	123.219 (high)
Jan 2007	4,726	119.094
Sep 2006	3,735 (low)	120.780
Jan 2006	4,597	116.395

Source: US Bureau of Labor Statistics

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

Chart ES-4 reveals the fracture in the US labor market. The number of workers with full-time jobs not-seasonally-adjusted rose with fluctuations from 2002 to a peak in 2007, collapsing during the global recession. The terrible state of the job market is shown in the segment from 2009 to 2012 with fluctuations around the typical behavior of a stationary series: there is no improvement in the United States in creating full-time jobs.

Chart ES-4, US, Full-time Employed, Thousands, NSA, 2002-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

ES IV Youth Unemployment. The United States is experiencing high youth unemployment as in European economies. Table ES-6 provides the employment level for ages 16 to 24 years of age estimated by the Bureau of Labor Statistics. On an annual basis, youth employment fell from 20.041 million in 2006 to 17.362 million in 2011 or 2.679 million fewer youth jobs. During the seasonal peak months of youth employment in the summer from Jun to Aug, youth employment has fallen by more than two million jobs. There are two hardships behind these data. First, young people cannot find employment after finishing high-school and college, reducing prospects for achievement in older age. Second, students with more modest means cannot find employment to keep them in college.

Table ES-6, US, Employment Level 16-24 Years, Thousands, NSA

Year	Jun	Jul	Aug	Annual
2002	20828	21501	20653	19683
2003	20432	20950	20181	19351
2004	20587	21447	20660	19630
2005	20949	21749	20814	19770
2006	21268	21914	21167	20041
2007	21098	21717	20413	19875
2008	20466	21021	20096	19202
2009	18726	19304	18270	17601
2010	17920	18564	18061	17077
2011	18180	18632	18067	17362

Source: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart ES-5 provides US employment level ages 16 to 24 years from 2002 to 2012. Employment level is sharply lower in Jan 2012 relative to the peak in 2007.

Chart ES-5, US, Employment Level 16-24 Years, Thousands SA, 2002-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Table ES-7 provides US unemployment level ages 16 to 24 years. The number unemployed ages 16 to 24 years increased from 2342 thousand in 2007 to 3634 thousand in 2011 or by 1.292 million. This situation may persist for many years.

Table ES-7, US, Unemployment Level 16-24 Years, Thousands NSA

Year	Jan	Jun	Jul	Aug	Dec	Annual
2002	2754	3167	3034	2688	2374	2683
2003	2748	3542	3200	2724	2248	2746
2004	2767	3191	3018	2585	2294	2638
2005	2661	3010	2688	2519	2055	2521
2006	2366	2860	2750	2467	2007	2353
2007	2363	2883	2622	2388	2323	2342
2008	2633	3450	3408	2990	2928	2830
2009	3278	4653	4387	4004	3532	3760
2010	3983	4481	4374	3903	3352	3857
2011	3851	4248	4110	3820	3161	3634
2012	3416

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart ES-6 provides the unemployment level ages 16 to 24 from 2002 to 2012. The level rose sharply from 2007 to 2010 with tepid improvement into 2012.

Chart ES-6, US, Unemployment Level 16-24 Years, Thousands SA, 2002-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Table ES-8 provides the rate of unemployment of young peoples in ages 16 to 24 years. The annual rate jumped from 10.5 percent in 2007 to 18.4 percent in 2010 and 17.3 percent in 2011. During the seasonal peak in Jun 2011 the rate of youth unemployed was 18.1 percent compared with 10.8 percent in Jun 2007.

Table ES-8, US, Unemployment Rate 16-24 Years, Thousands, NSA 

Year	Jan	Jun	Jul	Aug	Sep	Oct	Nov	Dec	Annual
2002	12.9	13.2	12.4	11.5	11.4	11.2	11.7	10.9	12.0
2003	12.7	14.8	13.3	11.9	12.5	11.6	11.6	10.5	12.4
2004	12.8	13.4	12.3	11.1	11.5	11.6	11.1	10.5	11.8
2005	12.4	12.6	11.0	10.8	10.7	10.3	10.7	9.4	11.3
2006	11.1	11.9	11.2	10.4	10.5	10.2	10.1	9.1	10.5
2007	10.9	12.0	10.8	10.5	11.0	10.3	10.3	10.7	10.5
2008	12.3	14.4	14.0	13.0	13.4	13.2	13.3	13.7	12.8
2009	15.8	19.9	18.5	18.0	18.2	18.5	18.1	17.5	17.6
2010	19.8	20.0	19.1	17.8	17.6	18.1	17.4	16.7	18.4
2011	18.9	18.9	18.1	17.5	17.0	16.2	15.9	15.5	17.3
2012	16.8

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart ES-7 provides the BLS estimate of the not-seasonally-adjusted rate of youth unemployment for ages 16 to 23 years from 2002 to 2012. The rate of youth unemployment increased sharply during the global recession of 2008 and 2009 but has failed to drop to earlier lower levels during the ten quarters of expansion of the economy since IIIQ2009.

Chart ES-7, US, Unemployment Rate 16-24 Years, Thousands, NSA, 2002-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart ES-8 provides longer perspective with the rate of youth unemployment in ages 16 to 24 years from 1948 to 2012. The rate of youth unemployment rose to 20 percent during the contractions of the early 1980s and also during the contraction of the global recession in 2008 and 2009. The data illustrate again the claim in this blog that the contractions of the early 1980s are the valid framework for comparison with the global recession of 2008 and 2009 instead of misleading comparisons with the 1930s. During the initial phase of recovery, the rate of youth unemployment 16 to 24 years fell from 18.9 percent in Jun 1983 to 14.5 percent in Jun 1984 while the rate of youth unemployment 16 to 24 years was nearly the same during the expansion after IIIQ2009: 19.9 percent in Jun 2009, 20.0 percent in Jun 2010 and 18.9 percent in Jun 2011. The difference originates in the vigorous seasonally-adjusted annual equivalent average rate of GDP growth of 5.7 percent during the recovery from IQ1983 to IVQ1985 compared with 2.4 percent on average during the first ten quarters of expansion from IIIQ2009 to IVQ2011 (see Table I-5 at http://cmpassocregulationblog.blogspot.com/2012/01/mediocre-economic-growth-financial.html). The fractured US labor market denies an early start for young people.

Chart ES-8, US, Unemployment Rate 16-24 Years, Percent NSA, 1979-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

I Recovery without Hiring. Professor Edward Lazear (2012Jan19) at Stanford University finds that recovery of hiring in the US to peaks in 2007 requires an increase of hiring by 30 percent while hiring levels have increased by only 4 percent since Jan 2009. The high level of unemployment with low level of hiring reduces the statistical probability that the unemployed will find a job. According to Lazear (2012Jan19), the probability of finding a new job currently is about one third of the probability of finding a job in 2007. Improvements in labor markets have not increased the probability of finding a new job. Lazear (2012Jan19) quotes an essay coauthored with James Spletzer forthcoming in the American Economic Review on the concept of churn. A dynamic labor market occurs when a similar amount of workers is hired as those who are separated. This replacement of separated workers is called churn, which explains about two-thirds of total hiring. Typically, wage increases received in a new job are higher by 8 percent. Lazear (2012Jan19) argues that churn has declined 35 percent from the level before the recession in IVQ2007. Because of the collapse of churn there are no opportunities in escaping falling real wages (http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html) by moving to another job. As this blog argues, there are meager chances of escaping unemployment because of the collapse of hiring and those employed cannot escape falling real wages by moving to another job. There are two additional facts discussed below: (1) there are about ten million fewer full-time jobs currently than before the recession of 2008 and 2009; and (2) the extremely high and rigid rate of youth unemployment is denying an early start to young people ages 16 to 24 years. There are four subsections. IA Hiring Collapse provides the data and analysis on the weakness of hiring in the United States economy. IB Labor Underutilization provides the measures of labor underutilization of the Bureau of Labor Statistics. Statistics on the decline of full-time employment are in IC Ten Million Fewer Full-time Jobs. ID Youth Unemployment provides the data on high unemployment of ages 16 to 24 years.

IA Hiring Collapse. An important characteristic of the current fractured labor market of the US is the closing of the avenue for exiting unemployment and underemployment normally available through dynamic hiring. Another avenue that is closed is the opportunity for advancement in moving to new jobs that pay better salaries and benefits again because of the collapse of hiring in the United States. Those who are unemployed or underemployed cannot find a new job even accepting lower wages and no benefits. The employed cannot escape declining inflation-adjusted earnings because there is no hiring. The objective of this section is to analyze hiring and labor underutilization in the United States.

An appropriate measure of job stress is considered by Blanchard and Katz (1997, 53):

“The right measure of the state of the labor market is the exit rate from unemployment, defined as the number of hires divided by the number unemployed, rather than the unemployment rate itself. What matters to the unemployed is not how many of them there are, but how many of them there are in relation to the number of hires by firms.”

The natural rate of unemployment and the similar NAIRU are quite difficult to estimate in practice (Ibid; see Ball and Mankiw 2002).

The Bureau of Labor Statistics (BLS) created the Job Openings and Labor Turnover Survey (JOLTS) with the purpose that (http://www.bls.gov/jlt/jltover.htm#purpose):

“These data serve as demand-side indicators of labor shortages at the national level. Prior to JOLTS, there was no economic indicator of the unmet demand for labor with which to assess the presence or extent of labor shortages in the United States. The availability of unfilled jobs—the jobs opening rate—is an important measure of tightness of job markets, parallel to existing measures of unemployment.”

The BLS collects data from about 16,000 US business establishments in nonagricultural industries through the 50 states and DC. The data are released monthly and constitute an important complement to other data provided by the BLS.

Hiring in the nonfarm sector (HNF) has declined from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million while hiring in the private sector (HP) has declined from 60.4 million in 2006 to 43.3 million in 2010 or by 17.1 million, as shown in Table I-1. The ratio of nonfarm hiring to unemployment (RNF) has fallen from 47.7 in 2006 to 36.4 in 2010 and in the private sector (RHP) from 52.9 in 2006 to 40.3 in 2010 (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html). 

Table I-1, US, Annual Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US and Percentage of Total Employment

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

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

Chart I-1 provides the yearly levels of total nonfarm hiring (NFH) in Table I-1. The fall of hiring during the contraction of 2007 to 2009 was much stronger than in the shallow contraction of 2001 with GDP contraction of only 0.4 percent from Mar 2001 (IQ2001) to Dec 2011 (IVQ 2001) compared with 5.1 percent contraction in the much longer recession from Dec 2007 (IVQ2007) to Jun 2009 (IIQ2009) (http://www.nber.org/cycles/cyclesmain.html).

Chart I-1, US, Total Nonfarm Hiring (HNF), Yearly, 2001-2010

Source: US Bureau of Labor Statistics

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

Chart I-2 shows the ratio or rate of nonfarm hiring to unemployment (RNF) that also fell much more in the recession of 2007 to 2009 than in the shallow recession of 2001.

Chart I-2, US, Rate Total Nonfarm Hiring (HNF), Yearly, 2001-2010

Source: US Bureau of Labor Statistics

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

Yearly percentage changes of total nonfarm hiring (HNF) are provided in Table I-2. There were much milder declines in 2002 of 6.2 percent and 3.4 percent in 2003 followed by strong rebounds of 6.6 percent in 2004 and 4.7 percent in 2005. In contrast, the contractions of nonfarm hiring in the recession after 2007 were much sharper in percentage points: 2.4 in 2007, 14.7 in 2008 and 16 percent in 2009. On a yearly basis, nonfarm hiring grew 4.1 percent in 2010 relative to 2009.

Table I-2, US, Annual Total Nonfarm Hiring (HNF), Yearly Percentage Change, 2001-2010

Year	Annual
2002	-6.2
2003	-3.4
2004	6.6
2005	4.7
2006	0.6
2007	-2.4
2008	-14.7
2009	-16.0
2010	4.1

Source: US Bureau of Labor Statistics

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

Chart I-3 plots yearly percentage changes of nonfarm hiring. Percentage declines after 2007 were quite sharp.

Chart I-3, US, Annual Total Nonfarm Hiring (HNF), Yearly Percentage Change, 2001-2010

Source: US Bureau of Labor Statistics

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

Total private hiring (HP) yearly data are provided in Chart I-4. There has been sharp contraction of total private hiring in the US and only mild recovery in 2010.

Chart I-4, US, Total Private Hiring, Yearly, 2001-2010

Source:

US Bureau of Labor Statistics

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

Chart I-5 plots the rate of total private hiring relative to unemployment (RHP). The rate collapsed during the global recession after 2007.

Chart I-5, US, Rate Total Private Hiring, Yearly, 2001-2010

Source:

US Bureau of Labor Statistics

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

Total nonfarm hiring (HNF), total private hiring (HP) and their respective rates are provided for the month of Dec in the years from 2001 to 2011 in Table I-3. Hiring numbers are in thousands. There is some recovery in HNF from 2705 thousand (or 2.7 million) in Dec 2009 to 2841 thousand in Dec 2010 and 2919 thousand in Dec 2011 for cumulative gain of 7.9 percent. HP rose from 2551 thousand in Dec 2009 to 2747 thousand in Dec 2011 for cumulative gain of 7.7 percent. HNF has fallen from 3947 in Dec 2005 to 2919 in Dec 2011 or by 26.0 percent. HP has fallen from 3702 in Dec 2006 to 2747 in Dec 2011 or by 25.8 percent. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.

Table I-3, US, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment Not Seasonally Adjusted

	HNF	Rate RNF	HP	Rate HP
2001 Dec	3600	2.7	3375	3.1
2002 Dec	3711	2.8	3507	3.2
2003 Dec	3764	2.9	3554	3.3
2004 Dec	3939	3.0	3726	3.4
2005 Dec	3947	2.8	3631	3.2
2006 Dec	3903	2.8	3702	3.2
2007 Dec	3616	2.6	3397	2.9
2008 Dec	2977	2.2	2811	2.5
2009 Dec	2705	2.1	2551	2.4
2010 Dec	2841	2.2	2680	2.5
2011 Dec	2919	2.2	2747	2.5

Source:  US Bureau of Labor Statistics

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

Chart I-6 provides total nonfarm hiring on a monthly basis from 2001 to 2011. Hiring rebounded in early 2010 but then fell and stabilized at a lower level than the early peak in 2010 of 4347 in Jun. Nonfarm hiring fell again in Oct as shown in Chart I-6 with SA monthly data. The number of seasonally-adjusted hires in Sep was 4150 thousand, falling to 4042 thousand in Oct or by 2.6 percent but increasing to 4132 in Nov or by 2.2 percent. The number of hires SA fell to 4046 in Dec or by 2.1 percent. The number of hires not seasonally adjusted was 4396 in Sep, falling to 4057 in Oct or by 7.7 percent and falling to 3687 in Nov or by 9.1 percent. In Dec, the number of hires fell to 2919 or by an additional 20.8 percent. The number of nonfarm hiring not seasonally adjusted fell by 33.6 percent from Sep to Dec.

Chart I-6, US, Total Nonfarm Hiring (HNF), 2001-2011 Month SA

Source: US Bureau of Labor Statistics

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

Similar behavior occurs in the rate of nonfarm hiring plot in Chart I-7. Recovery in early 2010 was followed by decline and stabilization at a lower level but with decrease in monthly SA estimates from 3.2 in Sep 2011 to 3.1 in 2011 and stability at 3.1 in Oct, Nov and Dec. The rate not seasonally adjusted fell from 3.7 in Jun 2011 to 2.2 in Dec. Rates of nonfarm hiring NSA were in the range of 2.8 to 4.6 in 2006.

Chart I-7, US, Rate Total Nonfarm Hiring, Month SA 2001-2011

Source: US Bureau of Labor Statistics

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

There is only milder improvement in total private hiring shown in Chart I-8. Hiring private (HP) rose in 2010 followed by stability and renewed increase in 2011. The number of private hiring seasonally adjusted fell from 3885 thousand in Sep to 3785 in Oct or by 2.6 percent and increased to 3853 in Nov or by 1.8 percent. The number of private hiring not seasonally adjusted fell from 4027 in Sep to 3816 in Oct or by 5.2 percent, falling to 3488 in Nov or by 8.6 percent. In Dec, NSA private hiring fell to 2747 or by 21.2 percent for cumulative decline of 31.8 percent from Sep to Dec. Companies do not hire in the latter part of the year that explains the high seasonality in year-end employment data. For example, NSA private hiring fell from 5015 in Sep 2006 to 3702 in Dec 2006 or by 26.2 percent. Private hiring NSA data are useful in showing the huge declines from the period before the global recession. In Jul 2006 private hiring was 5695, declining to 4010 in Jul 2011 or by 29.6 percent. Private hiring NSA fell from 5695 in Jul 2006 to 3682 in Jul or by 35.3 percent. The conclusion is that private hiring in the US is about a third below of the hiring before the global recession. The main problem in recovery of the US labor market has been the low rate of growth of 2.4 percent in the ten quarters of expansion of the economy since IIIQ2009 compared with average 6.2 percent in prior expansions from contractions (Table I-5 in http://cmpassocregulationblog.blogspot.com/2012/01/mediocre-economic-growth-financial.html). The US missed the opportunity to recover employment as in past cyclical expansions from contractions.

Chart I-8, US, Total Private Hiring Month SA 2011-2011

Source: US Bureau of Labor Statistics

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

Chart I-9 shows similar behavior in the rate of private hiring. The rate in 2011 in monthly SA data has not risen significantly above the peak in 2010. The rate seasonally adjusted fell from 3.6 in Sep to 3.5 in Oct and Nov and then 3.4 in Dec. The rate not seasonally adjusted fell from 3.7 in Sep to 3.2 in Nov and then to 2.5 in Dec. The NSA rate of private hiring fell from 5.0 in Jun 2006 to 3.6 in Jun 2009 but recovery was insufficient to only 4.1 in Jun 2011.

Chart I-9, US, Rate Total Private Hiring Month SA 2011-2011

Source: US Bureau of Labor Statistics

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

The JOLTS report of the Bureau of Labor Statistics also provides total nonfarm job openings (TNF JOB), TNF JOB rate and TNF LD (layoffs and discharges) shown in Table I-4 for the month of Dec from 2001 to 2011. The final column provides TNF LD for the years from 2001 to 2010. Nonfarm job openings fell from a peak of 4094 in Dec 2006 to 2987 in Dec 2011 or by 27.0 percent while the rate dropped from 2.9 to 2.2. Nonfarm layoffs and discharges (TNF LD) rose from 1984 in Dec 2005 to 2703 in Dec 2008 or by 36.2 percent. The yearly data show layoffs and discharges rising from 21.5 million in 2006 to 26.3 million in 2009 or by 22.3 percent.

Table I-4, US, Job Openings and Total Separations, Thousands NSA

	TNF JOB	TNF JOB Rate	TNF LD SA	TNF LD Year
Dec 2001	3080	2.3	2076	24351
Dec 2002	2692	2.0	2214	23325
Dec 2003	2830	2.1	2263	23959
Dec 2004	3407	2.5	2260	23389
Dec 2005	3913	2.8	1984	22774
Dec 2006	4094	2.9	2015	21468
Dec 2007	3863	2.7	2033	22577
Dec 2008	2613	1.9	2703	23737
Dec 2009	2105	1.6	2203	26318
Dec 2010	2583	1.9	1935	21243
Dec 2011	2987	2.2	1872	NA

Notes: TNF JOB: Total Nonfarm Job Openings; LD: Layoffs and Discharges

Source: US Bureau of Labor Statistics

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

Chart I-10 shows monthly job openings rising from the trough in 2009 to a high in the beginning of 2010. Job openings then stabilized into 2011 but have surpassed the peak of 2010 with 3376 seasonally adjusted in Dec 2011 relative to 2921 in Dec 2010 but fell from 3377 in Sep 2011 to 3118 in Nov or 7.7 percent. Job opening recovered in Dec at 3376. The high of job openings not seasonally adjusted in 2010 was 3295 in Apr 2010 that was surpassed by 3454 in Sep 2011. The level of job openings not seasonally adjusted fell to 2761 in Nov 2011 or by 20.1 percent relative to Sep 2011. There is here again the strong seasonality of year-end labor data. Job openings NSA fell from 4845 in Oct 2006 to 2357 in Oct 2009 or by 51.4 percent, recovering to 3315 in Oct 2011 or by 40.6 percent, which is still 31.6 percent in Oct 2011 relative to Oct 2006. Again, the main problem in recovery of the US labor market has been the low rate of growth of 2.4 percent in the ten quarters of expansion of the economy since IIIQ2009 compared with average 6.2 percent in prior expansions from contractions (Table I-5 in http://cmpassocregulationblog.blogspot.com/2012/01/mediocre-economic-growth-financial.html). The US missed the opportunity to recover employment as in past cyclical expansions from contractions.

Chart I-10, US Job Openings, Thousands NSA, 2001-2011

Source: US Bureau of Labor Statistics

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

The rate of job openings in Chart I-11 shows similar behavior. The rate not seasonally adjusted rose from the high of 2.3 in Apr 2010 to 2.5 in Sep 2011 but fell back to 2.3 in Nov 2011. The rate not seasonally adjusted rose from 2.3 in Jul 2010 to 2.6 in Sep 2011 and fell further to 2.0 in Nov 2011 and 2.2 in Dec 2011. The rate of job openings NSA fell from 3.7 in Apr 2006 to 1.8 in Apr 2009, recovering insufficiently to 2.4 in Apr 2011.

Chart I-11, US, Rate of Job Openings, Thousands NSA, 2001-2011

Source: US Bureau of Labor Statistics

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

Total separations are shown in Chart I-12. Separations are much lower in 2010 than before the global recession.

Chart I-12, US, Total Separations, Month SA, 2001-2011

Source: US Bureau of Labor Statistics

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

Yearly total separations are shown in Chart I-13. Separations are much lower in 2010 than before the global recession.

Chart I-13, US, Total Separations, Yearly, 2001-2010

Source: US Bureau of Labor Statistics

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

Table I-5 provides total nonfarm total separations from 2001 to 2010. Separations fell from 62.7 million in 2006 to 46.3 million in 2010 or by 16.4 million.

Table I-5, US, Total Nonfarm Total Separations, Thousands, 2001-2010

Year	Annual
2001	65610
2002	60412
2003	57847
2004	59666
2005	62107
2006	62699
2007	62173
2008	57525
2009	50544
2010	46347

Source: US Bureau of Labor Statistics

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

Monthly data of layoffs and discharges reach a peak in early 2009, as shown in Chart I-14. Layoffs and discharges dropped sharply with the recovery of the economy in 2010 and 2011 once employers reduced their job count to what was required for cost reductions and loss of business.

Chart I-14, US, Total Nonfarm Layoffs and Discharges, Monthly SA, 2011-2011

Source: US Bureau of Labor Statistics

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

Layoffs and discharges in Chart I-15 rose sharply to a peak in 2009. There was pronounced drop into 2010.

Chart I-15, US, Total Nonfarm Layoffs and Discharges, Yearly, 2001-2010

Source: US Bureau of Labor Statistics

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

Table I-6 provides annual nonfarm layoffs and discharges from 2001 to 2010. Layoffs and discharges peaked at 26.3 million in 2009 and then fell to 21.2 million in 2010, by 5.1 million, or 19.4 percent.

Table I-6, US, Total Nonfarm Layoffs and Discharges, 2001-2010

Year	Annual
2001	24351
2002	23325
2003	23959
2004	23389
2005	22774
2006	21468
2007	22577
2008	23737
2009	26318
2010	21243

Source: US Bureau of Labor Statistics

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

IB Labor Underutilization. The Bureau of Labor Statistics also provides alternative measures of labor underutilization shown in Table I-7. The most comprehensive measure is U6 that consists of total unemployed plus total employed part time for economic reasons plus all marginally attached workers as percent of the labor force. U6 not seasonally annualized has risen from 8.2 percent in 2006 to 16.2 in Jan 2011.

Table I-7, US, Alternative Measures of Labor Underutilization %

	U1	U2	U3	U4	U5	U6
Jan 2012 NSA	4.9	5.4	8.8	9.4	10.5	16.2
Dec 2011 NSA	4.8	5.0	8.3	8.8	9.8	15.2
Nov     2011 NSA	4.9	4.7	8.2	8.9	9.7	15.0
Oct      2011 NSA	5.0	4.8	8.5	9.1	10.0	15.3
Sep      2011 NSA	5.2	5.0	8.8	9.4	10.2	15.7
Jan 2011 NSA	5.6	6.2	9.8	10.4	11.4	17.3
Dec     2010 NSA	5.4	5.9	9.1	9.9	10.7	16.6
2011	5.3	5.3	8.9	9.5	10.4	15.9
2010	5.7	6.0	9.6	10.3	11.1	16.7
2009	4.7	5.9	9.3	9.7	10.5	16.2
2008	2.1	3.1	5.8	6.1	6.8	10.5
2007	1.5	2.3	4.6	4.9	5.5	8.3
2006	1.5	2.2	4.6	4.9	5.5	8.2
2005	1.8	2.5	5.1	5.4	6.1	8.9
2004	2.1	2.8	5.5	5.8	6.5	9.6
2003	2.3	3.3	6.0	6.3	7.0	10.1
2002	2.0	3.2	5.8	6.0	6.7	9.6

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

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

Monthly seasonally adjusted measures of labor underutilization are provided in Table I-8. U6 climbed from 16.2 percent in Jun 2011 to 16.4 percent in Oct 2011 and then fell to 15.2 in Dec 2011 and 15.1 percent in Jan 2012. Unemployment is an inaccurate measure of the stress in US job markets. A different calculation in this blog is provided by using the participation rate in the labor force before the global recession. This calculation shows 31.3 million in job stress of unemployment/underemployment in Jan 2012, not seasonally adjusted, corresponding to 19.5 percent of the labor force (http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html Table I-4).

Table I-8, US, Alternative Measures of Labor Underutilization SA %

	Jan    2012	Dec    2011	Nov 2011	Oct 2011	Sep 2011	Aug  2011	Jul 2011	Jun 2011
U1	4.9	5.0	5.0	5.1	5.3	5.3	5.3	5.3
U2	4.7	4.9	4.9	5.1	5.2	5.3	5.3	5.4
U3	8.3	8.5	8.7	8.9	9.0	9.1	9.1	9.1
U4	8.9	9.1	9.3	9.5	9.6	9.6	9.7	9.7
U5	9.9	10.0	10.2	10.4	10.5	10.6	10.7	10.7
U6	15.1	15.2	15.6	16.0	16.4	16.2	16.1	16.2

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

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

Chart I-16 provides U6 on a monthly basis from 2001 to 2011. There was a steep climb from 2007 into 2009 and then this measure of unemployment and underemployment stabilized at that high level but declined into Jan 2012.

Chart I-16, US, U6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons % LF plus all marginally attached workers as % of Labor Force, Month, SA, 2001-2011

Source: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart I-17 provides the number employed part-time for economic reasons or who cannot find full-time employment. There are sharp declines at the end of 2009, 2010 and 2011.

Chart I-17, US, Working Part-time for Economic Reasons

Thousands, Month SA 2001-2011

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm http://www.bls.gov/cps/cpsatabs.htm

There is strong seasonality in US labor markets around the end of the year. The number employed part-time for economic reasons because they could not find full-time employment fell from 9.270 million in Sep 2011 to 8.098 million in Dec 2011, seasonally adjusted, or decline of 1.172 million in just three months, as shown in Table I-9. The number employed full-time increased from 112.479 million in Sep 2011 to 113.765 million in Dec 2011 or 1.286 million. The number of employed part-time for economic reasons actually increased without seasonal adjustment from 8.271 million in Nov 2011 to 8.428 million in Dec 2011 or by 157,000 and then to 8.918 million in Jan 2012 or by an additional 490,000 for cumulative increase from Nov 2011 to Jan 2012 of 647,000. The number employed full time without seasonal adjustment fell from 113.138 million in Nov 2011 to 113.050 million in Dec 2011 or by 88,000 and fell further to 111.879 in Jan 2012 for cumulative decrease of 1.259 million. Comparisons over long periods require use of NSA data. The number with full-time jobs fell from a high of 123.219 million in Jul 2007 to 108.770 million in Jan 2010 or by 14.449 million. The number with full-time jobs in Jan 2012 is 111.879, which is lower by 11.3 million relative to the peak of 123.219 million in Jul 2007. There appear to be around 10 million less full-time jobs in the US than before the global recession. Growth at 2.4 percent on average in the ten quarters of expansion since IIIQ2009 compared with 6.2 percent on average in expansions from postwar cyclical contractions is the main culprit of the fractured US labor market (Table I-5 in http://cmpassocregulationblog.blogspot.com/2012/01/mediocre-economic-growth-financial.html).

Table I-9, US, Employed Part-time for Economic Reasons, Thousands, and Full-time, Millions

	Part-time Thousands	Full-time Millions
Seasonally Adjusted
Jan 2012	8,230	113.845
Dec 2011	8,098	113.765
Nov 2011	8,469	113.212
Oct 2011	8,790	112.841
Sep 2011	9,270	112.479
Aug 2011	8,787	112.406
Not Seasonally Adjusted
Jan 2012	8,918	111.879
Dec 2011	8,428	113.050
Nov 2011	8,271	113.138
Oct 2011	8,258	113.456
Jan 2011	9,187	110.373
Dec 2010	9,205	111.207
Nov 2010	8,670	113.138
Oct 2010	8,408	113.456
Jan 2010	9,290	108.770 (low)
Jun 2009	9,301 (high)	114.014
Jan 2009	8,829	113.815
Jan 2008	5,340	119.322
Jul 2007	4,516	123.219 (high)
Jan 2007	4,726	119.094
Sep 2006	3,735 (low)	120.780
Jan 2006	4,597	116.395

Source: US Bureau of Labor Statistics

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

People lose their marketable job skills after prolonged unemployment and find increasing difficulty in finding another job. Chart I-18 shows the sharp rise in unemployed over 27 weeks and stabilization at an extremely high level.

Chart I-18, US, Number Unemployed for 27 Weeks or Over, Thousands SA Month 2001-2011

Sources: http://www.bls.gov/cps/data.htm

Another segment of U6 consists of people marginally attached to the labor force who continue to seek employment but less frequently on the frustration there may not be a job for them. Chart I-19 shows the sharp rise in people marginally attached to the labor force after 2007 and subsequent stabilization.

Chart I-19, US, Marginally Attached to the Labor Force, SA Month 2001-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

IC Ten Million Fewer Full-time Jobs. Chart I-20 reveals the fracture in the US labor market. The number of workers with full-time jobs not-seasonally-adjusted rose with fluctuations from 2002 to a peak in 2007, collapsing during the global recession. The terrible state of the job market is shown in the segment from 2009 to 2012 with fluctuations around the typical behavior of a stationary series: there is no improvement in the United States in creating full-time jobs.

Chart I-20, US, Full-time Employed, Thousands, NSA, 2002-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

ID Youth Unemployment.

ID Youth Unemployment. The United States is experiencing high youth unemployment as in European economies. Table I-10 provides the employment level for ages 16 to 24 years of age estimated by the Bureau of Labor Statistics. On an annual basis, youth employment fell from 20.041 million in 2006 to 17.362 million in 2011 or 2.679 million fewer youth jobs. During the seasonal peak months of youth employment in the summer from Jun to Aug, youth employment has fallen by more than two million jobs. There are two hardships behind these data. First, young people cannot find employment after finishing high-school and college, reducing prospects for achievement in older age. Second, students with more modest means cannot find employment to keep them in college.

Table I-10, US, Employment Level 16-24 Years, Thousands, NSA

Year	Jun	Jul	Aug	Annual
2002	20828	21501	20653	19683
2003	20432	20950	20181	19351
2004	20587	21447	20660	19630
2005	20949	21749	20814	19770
2006	21268	21914	21167	20041
2007	21098	21717	20413	19875
2008	20466	21021	20096	19202
2009	18726	19304	18270	17601
2010	17920	18564	18061	17077
2011	18180	18632	18067	17362

Source: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart I-21 provides US employment level ages 16 to 24 years from 2002 to 2012. Employment level is sharply lower in Jan 2012 relative to the peak in 2007.

Chart I-21, US, Employment Level 16-24 Years, Thousands SA, 2002-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Table I-11 provides US unemployment level ages 16 to 24 years. The number unemployed ages 16 to 24 years increased from 2342 thousand in 2007 to 3634 thousand in 2011 or by 1.292 million. This situation may persist for many years.

Table I-11, US, Unemployment Level 16-24 Years, Thousands NSA

Year	Jan	Jun	Jul	Aug	Dec	Annual
2002	2754	3167	3034	2688	2374	2683
2003	2748	3542	3200	2724	2248	2746
2004	2767	3191	3018	2585	2294	2638
2005	2661	3010	2688	2519	2055	2521
2006	2366	2860	2750	2467	2007	2353
2007	2363	2883	2622	2388	2323	2342
2008	2633	3450	3408	2990	2928	2830
2009	3278	4653	4387	4004	3532	3760
2010	3983	4481	4374	3903	3352	3857
2011	3851	4248	4110	3820	3161	3634
2012	3416

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart I-22 provides the unemployment level ages 16 to 24 from 2002 to 2012. The level rose sharply from 2007 to 2010 with tepid improvement into 2012.

Chart I-22, US, Unemployment Level 16-24 Years, Thousands SA, 2002-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Table I-12 provides the rate of unemployment of young peoples in ages 16 to 24 years. The annual rate jumped from 10.5 percent in 2007 to 18.4 percent in 2010 and 17.3 percent in 2011. During the seasonal peak in Jun 2011 the rate of youth unemployed was 18.1 percent compared with 10.8 percent in Jun 2007.

Table I-12, US, Unemployment Rate 16-24 Years, Thousands, NSA 

Year	Jan	Jun	Jul	Aug	Sep	Oct	Nov	Dec	Annual
2002	12.9	13.2	12.4	11.5	11.4	11.2	11.7	10.9	12.0
2003	12.7	14.8	13.3	11.9	12.5	11.6	11.6	10.5	12.4
2004	12.8	13.4	12.3	11.1	11.5	11.6	11.1	10.5	11.8
2005	12.4	12.6	11.0	10.8	10.7	10.3	10.7	9.4	11.3
2006	11.1	11.9	11.2	10.4	10.5	10.2	10.1	9.1	10.5
2007	10.9	12.0	10.8	10.5	11.0	10.3	10.3	10.7	10.5
2008	12.3	14.4	14.0	13.0	13.4	13.2	13.3	13.7	12.8
2009	15.8	19.9	18.5	18.0	18.2	18.5	18.1	17.5	17.6
2010	19.8	20.0	19.1	17.8	17.6	18.1	17.4	16.7	18.4
2011	18.9	18.9	18.1	17.5	17.0	16.2	15.9	15.5	17.3
2012	16.8

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart I-23 provides the BLS estimate of the not-seasonally-adjusted rate of youth unemployment for ages 16 to 23 years from 2002 to 2012. The rate of youth unemployment increased sharply during the global recession of 2008 and 2009 but has failed to drop to earlier lower levels during the ten quarters of expansion of the economy since IIIQ2009.

Chart I-23, US, Unemployment Rate 16-24 Years, Thousands, NSA, 2002-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

Chart I-24 provides longer perspective with the rate of youth unemployment in ages 16 to 24 years from 1948 to 2012. The rate of youth unemployment rose to 20 percent during the contractions of the early 1980s and also during the contraction of the global recession in 2008 and 2009. The data illustrate again the claim in this blog that the contractions of the early 1980s are the valid framework for comparison with the global recession of 2008 and 2009 instead of misleading comparisons with the 1930s. During the initial phase of recovery, the rate of youth unemployment 16 to 24 years fell from 18.9 percent in Jun 1983 to 14.5 percent in Jun 1984 while the rate of youth unemployment 16 to 24 years was nearly the same during the expansion after IIIQ2009: 19.9 percent in Jun 2009, 20.0 percent in Jun 2010 and 18.9 percent in Jun 2011. The difference originates in the vigorous seasonally-adjusted annual equivalent average rate of GDP growth of 5.7 percent during the recovery from IQ1983 to IVQ1985 compared with 2.4 percent on average during the first ten quarters of expansion from IIIQ2009 to IVQ2011 (see Table I-5 at http://cmpassocregulationblog.blogspot.com/2012/01/mediocre-economic-growth-financial.html). The fractured US labor market denies an early start for young people.

Chart I-24, US, Unemployment Rate 16-24 Years, Percent NSA, 1979-2012

Sources: US Bureau of Labor Statistics

http://www.bls.gov/cps/data.htm

II United States Trade. Table II-1 provides the trade balance of the US and monthly growth of exports and imports seasonally adjusted. The US trade balance deteriorated sharply in Dec and Nov with growth of imports by cumulative 2.4 percent and cumulative decline of exports by 0.3 percent, resulting in a deficit of $47,058 million in Nov and $48,800 million in Dec, which are the highest since $51,817 million in Jun. There was mild improvement in the balance of international trade in goods and services of the US from Jul to Oct, declining from deficit of $50,254 million in May and $51,817 million in Jun to deficit of $42,984 million in Oct, as shown in Table II-1. In the months of Jun to Oct, exports increased 4.4 percent, at the annual equivalent rate of 13.8 percent, while imports increased 0.6 percent, at the annual equivalent rate of 1.7 percent. The trade balance deteriorated from cumulative deficit of $500,027 million in Jan-Dec 2010 to deficit of $558,020 million in Jan-Dec 2011.

Table II-1, US, Trade Balance of Goods and Services Seasonally Adjusted Millions of Dollars and ∆%  

	Trade Balance	Exports	Month ∆%	Imports	Month ∆%
Dec 2011	-48,800	178,757	0.7	227,557	1.3
Nov	-47,058	177,525	-1.0	224,583	1.0
Oct	-42,984	179,333	-0.7	222,317	-0.9
Sep	-43,884	180,579	1.5	224,463	0.6
Aug	-45,054	178,003	0.1	223,057	-0.2
Jul	-45,782	177,772	3.5	223,554	0.0
Jun	-51,817	171,755	-2.2	223,572	-1.1
May	-50,254	175,694	-0.3	225,948	2.9
Apr	-43,275	176,266	1.3	219,541	-0.2
Mar	-46,110	173,942	4.9	220,052	4.2
Feb	-45,431	165,687	-1.3	211,118	-1.9
Jan	-47,571	167,810	2.3	215,380	5.3
Dec 2010	-40,454	164,006	1.7	204,459	2.2
Jan-Dec 2011	-558,020	2,103,123		2,661,143
Jan-Nov 2010	-500,027	1,837,577		2,337,604

Note: Trade Balance of Goods and Services = Exports of Goods and Services less Imports of Goods and Services. Trade balance may not add exactly because of errors of rounding.

Source: http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf

Table II-1A provides the US international trade balance, exports and imports on an annual basis from 1992 to 2011. The most recent estimate of the US current account deficit by the Bureau of Economic Analysis of the US Department of Commerce is for IIIQ2011 (http://www.bea.gov/scb/pdf/2012/01%20January/0112_itaq.pdf 1):

“The US current account deficit—a net measure of transactions between the United States and the rest of the world in goods, services, income, and unilateral current transfers—decreased to $110.3 billion (preliminary) in the third quarter of 2011 from $124.7 billion (revised) in the second quarter. The deficit decreased to 2.9 percent of current-dollar gross domestic product (GDP)—down from 3.3 percent in the second quarter—after six straight quarters at 3.0 percent or higher. Most of the decrease reflected a drop in the deficit on goods; smaller contributions came from a decrease in net unilateral current transfers and increases in the surpluses on services and income” (for the balance of payments in IIIQ2011 see http://cmpassocregulationblog.blogspot.com/2011/12/recovery-without-hiring-world-inflation_1721.html).

In IVQ2010, “the deficit decreased to 3.0 percent of current-dollar GDP from 3.4 percent, the first decrease after five straight quarterly increases” (http://www.bea.gov/scb/pdf/2011/04%20April/0411_itaq-text.pdf 1). The ratio of the current account deficit to GDP has stabilized around 3 percent of GDP compared with much higher percentages before the recession (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71). The current account deficit reached 6.1 percent of GDP in 2006. The external imbalance of the US measured by the current account deficit must be financed with foreign borrowings. The US borrows heavily from other countries. China is the largest holder of US Treasury securities with $1132.6 billion in Nov 2011, slightly lower than $1160.1 billion in Dec 2010. Japan increased its holdings from $882.3 billion in Dec 2010 to $1038.9 billion in Nov 2011. The United Kingdom increased its holdings to $429.4 billion in Nov 2011 relative to $270.4 billion in billion in Dec 2010 (Table VA-9 at http://cmpassocregulationblog.blogspot.com/2012/01/world-inflation-waves-united-states_22.html).

Table II-1A, US, International Trade Balance, Exports and Imports SA, Millions of Dollars

Period	Balance	Exports	Imports
Total
Annual
1992	-39,212	616,882	656,094
1993	-70,311	642,863	713,174
1994	-98,493	703,254	801,747
1995	-96,384	794,387	890,771
1996	-104,065	851,602	955,667
1997	-108,273	934,453	1,042,726
1998	-166,140	933,174	1,099,314
1999	-263,160	967,008	1,230,168
2000	-376,749	1,072,783	1,449,532
2001	-361,771	1,007,726	1,369,496
2002	-417,432	980,879	1,398,311
2003	-490,984	1,023,519	1,514,503
2004	-605,357	1,163,146	1,768,502
2005	-708,624	1,287,441	1,996,065
2006	-753,288	1,459,823	2,213,111
2007	-696,728	1,654,561	2,351,289
2008	-698,338	1,842,682	2,541,020
2009	-381,272	1,575,037	1,956,310
2010	-500,027	1,837,577	2,337,604
2011	-558,020	2,103,123	2,661,143

Source: http://www.bea.gov/international/index.htm#trade

Chart II-1 of the US Census Bureau of the Department of Commerce shows that the trade deficit (gap between exports and imports) fell during the economic contraction after 2007 but has grown again during the expansion. There was slight improvement at the margin from Jul to Oct 2011 but new increase in the gap in Nov and Dec as both exports and imports stagnate in value. Weaker world and internal demand and moderating commodity price increases explain the declining or less dynamic changes in exports and imports in Chart II-1.

Chart II-1, US Balance, Exports and Imports of Goods and Services $ Billions

Source: US Census Bureau

http://www.census.gov/briefrm/esbr/www/esbr042.html

The balance of international trade in goods of the US seasonally-adjusted is shown in Table II-2. The US has a dynamic surplus in services that reduces the large deficit in goods for a still very sizeable deficit in international trade of goods and services. The balance in international trade of goods deteriorated sharply from $645.9 billion in Jan-Dec 2010 to $737.1 billion in Jan-Dec 2011. Deterioration occurred both in the petroleum balance, exports less imports of petroleum, as well as in the non-petroleum balance, exports less imports of non-petroleum goods. Exports rose 16.3 percent with non-petroleum exports growing 13.3 percent. Total imports rose 15.5 percent with petroleum imports increasing 30.7 percent and non-petroleum imports increasing 12.1 percent.

Table II-2, US, International Trade in Goods Balance, Exports and Imports $ Millions and ∆% SA

	Jan-Dec 2011	Jan-Dec 2010	∆%
Total Balance	-737,057	-645,857
Petroleum	-326,543	-265,235
Non Petroleum	-399,749	-369,662
Total Exports	1,498,226	1,288,699	16.3
Petroleum	112,757	70,868	59.1
Non Petroleum	1,367,908	1,207,395	13.3
Total Imports	2,235,283	1,934,555	15.5
Petroleum	439,300	336,103	30.7
Non Petroleum	1,767,656	1,577,057	12.1

Details may not add because of rounding and seasonal adjustment

Source: http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf

US exports and imports of goods not seasonally adjusted in Jan-Dec 2010 and Jan-Dec 2011 are shown in Table II-3. The rate of growth of exports was 16.3 percent, which is slightly higher than 15.5 percent for imports. The US has partial hedge of commodity price increases in exports of agricultural commodities that rose 17.7 percent and of mineral fuels that increased 58.9 percent both because of higher prices of raw materials and commodities. The US exports an insignificant amount of crude oil. US exports and imports consist mostly of manufactured products, with less rapidly increasing prices. US manufactured exports rose only 11.3 percent while imports rose 11.8 percent. Significant part of the US trade imbalance originates in imports of mineral fuels growing by 28.3 percent and crude oil increasing 29.5 percent. The limited hedge in exports of agricultural commodities and mineral fuels compared with substantial imports of mineral fuels and crude oil results in deterioration of the terms of trade of the US, export prices relative to import prices, originating in commodity price increases caused by carry trades from zero interest rates.

Table II-3, US, Exports and Imports of Goods, Not Seasonally Adjusted Millions of Dollars and %

	Jan-Dec 2011 $ Millions	Jan-Dec 2010 $ Millions	∆%
Exports	1,498,226	1,288,699	16.3
Manufactured	972,276	873,246	11.3
Agricultural Commodities	136,318	115,786	17.7
Mineral Fuels	127,919	80.460	58.9
Crude Oil	1,460	1,368	6.7
Imports	2,235,283	1,934,555	15.5
Manufactured	1,609,058	1,438,617	11.8
Agricultural Commodities	99,121	82,015	20.8
Mineral Fuels	455,373	354,968	28.3
Crude Oil	336,795	260,105	29.5

Source: http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf

III World Financial Turbulence. Financial markets are being shocked by multiple factors including (1) world economic slowdown; (2) growth in China, Japan and world trade; (3) slow growth propelled by savings reduction in the US with high unemployment/underemployment; and (3) the outcome of the sovereign debt crisis in Europe. This section provides current data and analysis. Subsection IIIA Financial Risks provides analysis of the evolution of valuations of risk assets during the week. There are various appendixes at the end of this section for convenience of reference of material related to the euro area debt crisis. Subsection IIIB Appendix on Safe Haven Currencies discusses arguments and measures of currency intervention. Subsection IIIC Appendix on Fiscal Compact provides analysis of the restructuring of the fiscal affairs of the European Union in the agreement of European leaders reached on Dec 9, 2011. Subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort considers the policies of the European Central Bank. Appendix IIID Euro Zone Survival Risk analyzes the threats to survival of the European Monetary Union. Subsection IIIF Appendix on Sovereign Bond Valuation provides more technical analysis.

IIIA Financial Risks. The past half year has been characterized by financial turbulence, attaining unusual magnitude in recent months. Table III-1, updated with every comment in this blog, provides beginning values on Fr Feb 3 and daily values throughout the week ending on Fri Feb 10 of several financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Feb 3 and the percentage change in that prior week below the label of the financial risk asset. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing waves of inflation. The most important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9 (European Council 2911Dec9), which is analyzed in IIIC Appendix on Fiscal Compact. European leaders reached a new agreement on Jan 30 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/127631.pdf).

The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.319/EUR in the first row, first column in the block for currencies in Table V-1 for Fri Feb 3, appreciating to USD 1.3130/EUR on Mon Feb 6, or by 0.2 percent. The dollar appreciated because fewer dollars, $1.3130, were required on Feb 6 to buy one euro than $1.316 on Feb 3. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.3130/EUR on Feb 6; the second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Feb 3, to the last business day of the current week, in this case Fri Feb 10, such as depreciation by 0.2 percent to USD 1.319/EUR by Feb 10; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (negative sign) by 0.2percent from the rate of USD 1.316/EUR on Fri Feb 3 to the rate of USD 1.319/EUR on Fri Feb 10 {[(1.319/1.316) – 1]100 = 0.2% and appreciated by 0.7 percent from the rate of USD 1.3285 on Thu Feb 9 to USD 1.319/EUR on Fri Feb 10 {[(1.319/1.3285) -1]100 = -0.7%}. Other factors constant, appreciation of the dollar relative to the euro is caused by increasing risk aversion, with rising uncertainty on European sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from higher yielding risk financial assets to the safety of dollar investments. When risk aversion declines, funds have been moving away from safe assets in dollars to risk financial assets.

III-I, Weekly Financial Risk Assets Feb 6 to Feb 10, 2012

Fri Feb 3, 2011	Mon 6	Tue 7	Wed 8	Thu 9	Fri 10
USD/EUR 1.316 0.5%	1.3130 0.2% 0.2%	1.3263 -0.8% -1.0%	1.3258 -0.7% 0.0%	1.3285 -0.9% -0.2%	1.319 -0.2% 0.7%
JPY/  USD 76.58 0.1%	76.5765 0.0% 0.0%	76.7765 -0.3% -0.3%	77.0490 -0.6% -0.4%	77.6888 -1.4% -0.8%	77.595 -1.3% 0.1%
CHF/  USD 0.919 0.0%	0.9189 0.0% 0.0%	0.9116 0.8% 0.8%	0.9128 0.7% -0.1%	0.9118 0.8% 0.1%	0.9174 0.2% -0.6%
CHF/ EUR 1.2080 -0.1%	1.2066 0.1% 0.1%	1.2091 -0.1% -0.2%	1.2101 -0.2% -0.1%	1.2113 -0.3% -0.1%	1.2089 -0.1% 0.2%
USD/  AUD 1.0772 0.9283 1.0%	1.0728 0.9321 -0.4% -0.4%	1.0804 0.9256 0.3% 0.7%	1.0793 0.9265 0.2% -0.1%	1.0786 0.9271 0.1% -0.1%	1.067 0.9372 -1.0% -1.1%
10 Year  T Note 1.923	1.90	1.98	1.98	2.03	1.974
2 Year     T Note 0.234	0.23	0.25	0.25	0.26	0.274
German Bond 2Y 0.20 10Y 1.93	2Y 0.18 10Y 1.89	2Y 0.22 10Y 1.96	2Y 0.25 10Y 1.98	2Y 0.27 10Y 2.02	2Y 0.24 10Y 1.91
DJIA 12862.23 1.6%	12845.13 -0.1% -0.1%	12878.20 0.1% 0.3%	12883.95 0.2% 0.0%	12890.46 0.2% 0.1%	12801.23 -0.5% -0.7%
DJ Global 1976.98 2.5%	1974.79 -0.1% -0.1%	1981.30 0.2% 0.3%	1990.00 0.7% 0.4%	1993.49 0.8% 0.2%	1964.70 -0.6% -1.4%
DJ Asia Pacific 1272.70 1.3%	1278.40 0.5% 0.5%	1278.72 0.5% 0.0%	1294.96 1.7% 1.3%	1295.69 1.8% 0.1%	1279.54 0.5% -1.3%
Nikkei 8831.93 -0.1%	8929.20 1.1% 1.1%	8917.52 1.0% -0.1%	9015.59 2.1% 1.1%	9002.24 1.9% -0.2%	8947.17 1.3% -0.6%
Shanghai 2330.40 0.5%	2331.14 0.0% 0.0%	2291.90 -1.7% -1.7%	2347.53 0.7% 2.4%	2349.59 0.8% 0.1%	2351.98 0.9% 0.1%
DAX 6766.67 3.9%	6764.83 0.0% 0.0%	6754.20 -0.2% -0.2%	6748.76 -0.3% -0.1%	6788.80 0.3% 0.6%	6692.96 -1.1% -1.4%
DJ UBS Comm. 145.54 -0.7%	145.84 0.2% 0.2%	146.04 0.3% 0.1%	145.89 0.2% -0.1%	146.55 0.7% 0.5%	144.89 -0.4% -1.1%
WTI $ B 97.78 -1.8%	97.22 -0.6% -0.6%	98.60 0.8% 1.4%	99.11 1.4% 0.5%	99.70 2.0% 0.6%	98.94 1.2% -0.8%
Brent    $/B 114.50 2.7%	116.37 1.6% 1.6%	116.16 1.4% -0.2%	117.72 2.8% 1.3%	118.70 3.7% 0.8%	117.57 2.7% -1.0%
Gold  $/OZ 1728.5 -0.7%	1722.6 -0.3% -0.3%	1748.8 1.2% 1.5%	1736.1 0.4% -0.7%	1731.7 0.2% -0.3%	1722.6 -0.3% -0.5%

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

Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce

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

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

Table III-1 shows results in valuations of risk financial assets in the week of Feb 6 to Feb 10 that were affected by the impasse on the negotiation of the bailout for Greece. Risk aversion returned in earlier weeks because of the uncertainties on rapidly moving political development in Greece, Italy, Spain and perhaps even in France and Germany. Most currency movements in Table III-1 reflect alternating bouts of risk aversion because of continuing doubts on the success of the new agreement on Europe reached in the week of Dec 9, 2011 and the new agreement reached on Jan 30, 2012. Risk aversion is observed in foreign exchange markets with daily trading of around $4 trillion. The dollar had fluctuated in a tight range with hardly any changes but depreciated after advanced guidance by the Federal Open Market Committee (FOMC) that fed funds rates may remain at 0 to ¼ percent until the latter part of 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20120125a.htm http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120125.pdf). The JPY depreciated initially during the week but ended only 0.2 percent weaker because of appreciation of 0.7 percent on Fri Feb 10 as a result of the impasse of approving austerity measures in Greece. IIIB Appendix on Safe Haven Currencies analyzes the burden on the Japanese economy of yen appreciation. The Swiss franc appreciated 0.2 percent relative to the dollar and depreciated 0.1 percent relative to the euro. The Australian dollar appreciated to USD 1.0793/AUD on Feb 8 for cumulative appreciation of 0.2 percent relative to USD 1.0772/AUD on Feb 3 but depreciated 1.1 percent on Fri Feb 10 for cumulative depreciation in the week of 1.0 percent to USD 1.067/AUD.

Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Increasing aversion is captured by decrease of the yield of the ten-year Treasury note from 2.326 percent on Oct 28 to 1.964 percent on Fri Nov 25, 2.065 on Dec 9 and collapse to 1.847 percent by Fr Dec 16. The yield of the ten-year Treasury rose from 1.81 percent on Mon Dec 19 to 2.027 percent on Fri Dec 23, falling to 1.871 percent on Fri Dec 30 and increasing to 1.957 percent on Jan 6 but falling again to 1.869 on Jan 13. More relaxed risk aversion is shown in the increase of the yield of the ten-year Treasury to 2.026 percent on Fri Jan 20 but renewed aversion with decline to 1.893 percent on Jan 27 and 1.923 on Feb 3. As shown in Table V-1, the ten-year Treasury yield rose to 1.974 on Fri Feb 10. The ten-year Treasury yield is still at a level well below consumer price inflation of 3.0 percent in the 12 months ending in Dec (http://cmpassocregulationblog.blogspot.com/2012/01/world-inflation-waves-united-states.html). Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury with stable low yield of 0.226 percent on Dec 16 but rising to 0.28 percent on Dec 23 and then falling to 0.239 percent on Fri Dec 30, increasing to 0.256 on Fri Jan 6 but falling to 0.225 on Jan 13. The yield of the two-year Treasury rose to 0.242 percent on Fri Jan 20 in an environment of more relaxed risk aversion but fell to 0.215 on Fri Jan 27 in another shock of aversion, standing at 0.234 on Feb 3. As shown in Table V-1, the two-year Treasury yield rose to 0.274 percent on Fri Feb 10. Investors are willing to sacrifice yield relative to inflation in defensive actions to avoid turbulence in valuations of risk financial assets but may be managing duration more carefully. During the financial panic of Sep 2008, funds moved away from risk exposures to government securities.

A similar risk aversion phenomenon occurred in Germany. The flash estimate of euro zone CPI inflation is at 2.7 percent for the 12 months ending in Jan 2012 (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-01022012-AP/EN/2-01022012-AP-EN.PDF) but the yield of the two-year German government bond fell from 0.32 percent on Dec 9 to 0.22 percent on Dec 16, virtually equal to the yield of the two-year Treasury note of the US and settled at 0.23 percent on Fri Dec 23, collapsing to 0.14 percent on Fri Dec 30 and rising to 0.17 percent on Jan 6 and 0.15 percent on Jan 13. The yield of the two-year government bond of Germany increased to 0.21 percent in an environment of marginally more relaxed risk aversion on Jan 20 but fell to 0.19 percent on Jan 27 and 0.20 percent on Feb 3. As shown in Table V-1, the yield of the two-year German government bond increased to 0.274 percent on Fri Feb 10. The yield of the ten-year German government bond has also collapsed from 2.15 percent on Dec 9 to 1.85 percent on Dec 16, rising to 1.96 percent on Dec 23, falling to 1.83 percent on Dec 30, which was virtually equal to the yield of 1.871 percent of the US ten-year Treasury note. The ten-year government bond of Germany traded at 1.85 percent on Jan 6 and at 1.77 percent on Jan 13, increasing to 1.93 percent on Jan 20 but falling to 1.86 percent on Jan 27 and rising to 1.93 percent on Feb 10. As shown in Table V-1, the yield of the ten-year government bond of Germany settled at 1.91 percent on Fri Feb 10. Safety overrides inflation-adjusted yield but there could be duration aversion. Turbulence has also affected the market for German sovereign bonds.

There was strong performance of equity indexes in Table III-1 during the week of Feb 6. Germany’s Dax rose 1.1 percent with decline of 1.4 percent on Feb 10 as a result of the uncertainty on Greece’s austerity measures and bailout package. DJIA lost 0.5 percent in the week of Feb 10 with decline of 0.7 percent on Fri Feb 10 as a result of the impasse on Greece. Dow Global fell 0.6 percent in the week of Feb 10. Japan’s Nikkei Average gained 1.3 percent. Dow Asia Pacific rose 0.5 percent.

Financial risk assets increase during moderation of risk aversion in carry trades from zero interest rates and fall during increasing risk aversion. Commodities were mixed in the week of Feb 10 but fell in daily trading on Fri Feb 10 because of the impasse on Greece. During the week of Feb 10, DJ UBS Commodities Index fell 0.4 percent; WTI gained 1.2 percent but Brent increased 2.7 percent; and gold lost 0.3 percent.

There is extremely important information in Table III-1A for the current sovereign risk crisis in the euro zone. Table III-1A provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Dec. German exports to other European Union members are 47.4 percent of total exports in Dec and 59.2 percent in Jan-Dec. Exports to the euro area are 31.8 percent in Dec and 39.7 percent in Jan-Dec. Exports to third countries are 44.3 percent of the total in Dec and 40.8 percent in Jan-Dec. There is similar distribution for imports. Economic performance in Germany is closely related to its high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of its high share in exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.

Table III-1A, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	Dec 2011 € Billions	12 Months ∆%	Jan-Dec 2011 € Billions	Jan-Dec 2011/ Jan-Dec 2010 ∆%
Total Exports	85.1	5.0	1,060.1	11.4
A. EU Members	47.4 % 55.7	-1.6	627.3 % 59.2	9.9
Euro Area	31.8 % 37.4	-3.3	420.9 % 39.7	8.6
Non-euro Area	15.5 % 18.2	2.2	206.4 % 19.5	12.6
B. Third Countries	37.7 % 44.3	14.7	432.8 % 40.8	13.6
Total Imports	72.1	5.4	902.0	13.2
C. EU Members	45.9 % 63.7	5.1	572.6 % 63.5	13.8
Euro Area	31.9 % 44.2	3.5	401.5 % 44.5	12.9
Non-euro Area	14.0 % 19.4	8.8	171.1 % 18.9	16.1
D. Third Countries	26.2 % 36.3	6.1	329.4 % 36.5	12.0

Notes: Total Exports = A+B; Total Imports = C+D

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2012/02/PE12__044__51,templateId=renderPrint.psml

IIIB Appendix on Safe Haven Currencies. Safe-haven currencies, such as the Swiss franc (CHF) and the Japanese yen (JPY) have been under threat of appreciation but also remained relatively unchanged. A characteristic of the global recession would be struggle for maintaining competitiveness by policies of regulation, trade and devaluation (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation War (2008c)). Appreciation of the exchange rate causes two major effects on Japan.

1. Trade. Consider an example with actual data (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 70-72). The yen traded at JPY 117.69/USD on Apr 2, 2007 and at JPY 102.77/USD on Apr 2, 2008, or appreciation of 12.7 percent. This meant that an export of JPY 10,000 to the US sold at USD 84.97 on Apr 2, 2007 [(JPY 10,000)/(USD 117.69/USD)], rising to USD 97.30 on Apr 2, 2008 [(JPY 10,000)/(JPY 102.77)]. If the goods sold by Japan were invoiced worldwide in dollars, Japanese’s companies would suffer a reduction in profit margins of 12.7 percent required to maintain the same dollar price. An export at cost of JPY 10,000 would only bring JPY 8,732 when converted at JPY 102.77 to maintain the price of USD 84.97 (USD 84.97 x JPY 102.77/USD). If profit margins were already tight, Japan would be uncompetitive and lose revenue and market share. The pain of Japan from dollar devaluation is illustrated by Table 58 in the Nov 6 comment of this blog (http://cmpassocregulationblog.blogspot.com/2011/10/slow-growth-driven-by-reducing-savings.html): The yen traded at JPY 110.19/USD on Aug 18, 2008 and at JPY 75.812/USD on Oct 28, 2011, for cumulative appreciation of 31.2 percent. Cumulative appreciation from Sep 15, 2010 (JPY 83.07/USD) to Oct 28, 2011 (JPY 75.812) was 8.7 percent. The pain of Japan from dollar devaluation continues as illustrated by Table VI-6 in Section VII Valuation of Risk Financial Assets: The yen traded at JPY 110.19/USD on Aug 18, 2008 and at JPY 78.08/USD on Dec 23, 2011, for cumulative appreciation of 29.1 percent. Cumulative appreciation from Sep 15, 2010 (JPY 83.07/USD) to Dec 23, 2011 (JPY 78.08) was 6.0 percent.

2. Foreign Earnings and Investment. Consider the case of a Japanese company receiving earnings from investment overseas. Accounting the earnings and investment in the books in Japan would also result in a loss of 12.7 percent. Accounting would show fewer yen for investment and earnings overseas.

There is a point of explosion of patience with dollar devaluation and domestic currency appreciation. Andrew Monahan, writing on “Japan intervenes on yen to cap sharp rise,” on Oct 31, 2011, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204528204577009152325076454.html?mod=WSJPRO_hpp_MIDDLETopStories), analyzes the intervention of the Bank of Japan, at request of the Ministry of Finance, on Oct 31, 2011. Traders consulted by Monahan estimate that the Bank of Japan sold JPY 7 trillion, about $92.31 billion, against the dollar, exceeding the JPY 4.5 trillion on Aug 4, 2011. The intervention caused an increase of the yen rate to JPY 79.55/USD relative to earlier trading at a low of JPY 75.31/USD. The JPY appreciated to JPY76.88/USD by Fri Nov 18 for cumulative appreciation of 3.4 percent from JPY 79.55 just after the intervention. The JPY appreciated another 0.3 percent in the week of Nov 18 but depreciated 1.1 percent in the week of Nov 25. There was mild depreciation of 0.3 percent in the week of Dec 2 that was followed by appreciation of 0.4 percent in the week of Dec 9. The JPY was virtually unchanged in the week of Dec 16 with depreciation of 0.1 percent but depreciated by 0.5 percent in the week of Dec 23, appreciating by 1.5 percent in the week of Dec 30. Historically, interventions in yen currency markets have been unsuccessful (Pelaez and Pelaez, The Global Recession Risk (2007), 107-109). Interventions are even more difficult currently with daily trading of some $4 trillion in world currency markets. Risk aversion with zero interest rates in the US diverts hot capital movements toward safe-haven currencies such as Japan, causing appreciation of the yen. Mitsuru Obe, writing on Nov 25, on “Japanese government bonds tumble,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204452104577060231493070676.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the increase in yields of the Japanese government bond with 10 year maturity to a high for one month of 1.025 percent at the close of market on Nov 25. Thin markets in after-hours trading may have played an important role in this increase in yield but there may have been an effect of a dreaded reduction in positions of bonds by banks under pressure of reducing assets. The report on Japan sustainability by the IMF (2011JSRNov23, 2), analyzes how rising yields could threaten Japan:

· “As evident from recent developments, market sentiment toward sovereigns with unsustainably large fiscal imbalances can shift abruptly, with adverse effects on debt dynamics. Should JGB yields increase, they could initiate an adverse feedback loop from rising yields to deteriorating confidence, diminishing policy space, and a contracting real economy.

· Higher yields could result in a withdrawal of liquidity from global capital markets, disrupt external positions and, through contagion, put upward pressure on sovereign bond yields elsewhere.”

Exchange rate controls by the Swiss National Bank (SNB) fixing the rate at a minimum of CHF 1.20/EUR (http://www.snb.ch/en/mmr/reference/pre_20110906/source/pre_20110906.en.pdf) has prevented flight of capital into the Swiss franc. The Swiss franc remained unchanged relative to the USD in the week of Dec 23 and appreciated 0.2 percent in the week of Dec 30 relative to the USD and 0.5 percent relative to the euro, as shown in Table II-1. Risk aversion is evident in the depreciation of the Australian dollar by cumulative 2.5 percent in the week of Fr Dec 16 after no change in the week of Dec 9. In the week of Dec 23, the Australian dollar appreciated 1.9 percent, appreciating another 0.5 percent in the week of Dec 30 as shown in Table II-1. Risk appetite would be revealed by carry trades from zero interest rates in the US and Japan into high yielding currencies such as in Australia with appreciation of the Australian dollar (see Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 202-4, Pelaez and Pelaez, Government Intervention in Globalization (2008c), 70-4).

IIIC Appendix on Fiscal Compact. There are three types of actions in Europe to steer the euro zone away from the threats of fiscal and banking crises: (1) fiscal compact; (2) enhancement of stabilization tools and resources; and (3) bank capital requirements. The first two consist of agreements by the Euro Area Heads of State and government while the third one consists of measurements and recommendations by the European Banking Authority.

1. Fiscal Compact. The “fiscal compact” consists of (1) conciliation of fiscal policies and budgets within a “fiscal rule”; and (2) establishment of mechanisms of governance, monitoring and enforcement of the fiscal rule.

i. Fiscal Rule. The essence of the fiscal rule is that “general government budgets shall be balanced or in surplus” by compliance of members countries that “the annual structural deficit does not exceed 0.5% of nominal GDP” (European Council 2011Dec9, 3). Individual member states will create “an automatic correction mechanism that shall be triggered in the event of deviation” (European Council 2011Dec9, 3). Member states will define their automatic correction mechanisms following principles proposed by the European Commission. Those member states falling into an “excessive deficit procedure” will provide a detailed plan of structural reforms to correct excessive deficits. The European Council and European Commission will monitor yearly budget plans for consistency with adjustment of excessive deficits. Member states will report in anticipation their debt issuance plans. Deficits in excess of 3 percent of GDP and/or debt in excess of 60 percent of GDP will trigger automatic consequences.

ii. Policy Coordination and Governance. The euro area is committed to following common economic policy. In accordance, “a procedure will be established to ensure that all major economic policy reforms planned by euro area member states will be discussed and coordinated at the level of the euro area, with a view to benchmarking best practices” (European Council 2011Dec9, 5). Governance of the euro area will be strengthened with regular euro summits at least twice yearly.

2. Stabilization Tools and Resources. There are several enhancements to the bailouts of member states.

i. Facilities. The European Financial Stability Facility (EFSF) will use leverage and the European Central Bank as agent of its market operations. The European Stability Mechanism (ESM) or permanent bailout facility will be operational as soon as 90 percent of the capital commitments are ratified by member states. The ESM is planned to begin in Jul 2012.

ii. Financial Resources. The overall ceiling of the EFSF/ESM of €500 billion (USD 670 billion) will be reassessed in Mar 2012. Measures will be taken to maintain “the combined effective lending capacity of EUR 500 billion” (European Council 2011Dec9, 6). Member states will “consider, and confirm within 10 days, the provision of additional resources for the IMF of up to EUR 200 billion (USD 270 billion), in the form of bilateral loans, to ensure that the IMF has adequate resources to deal with the crisis. We are looking forward to parallel contributions from the international community” (European Council 2011Dec9, 6). Matthew Dalton and Matina Stevis, writing on Dec 20, 2011, on “Euro Zone Agrees to New IMF Loans,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204791104577107974167166272.html?mod=WSJPRO_hps_MIDDLESecondNews), inform that at a meeting on Dec 20, finance ministers of the euro-zone developed plans to contribute €150 billion in bilateral loans to the IMF as provided in the agreement of Dec 9. Bailouts “will strictly adhere to the well established IMF principles and practices.” There is a specific statement on private sector involvement and its relation to recent experience: “We clearly reaffirm that the decisions taken on 21 July and 26/27 October concerning Greek debt are unique and exceptional; standardized and identical Collective Action clauses will be included, in such a way as to preserve market liquidity, in the terms and conditions of all new euro government bonds” (European Council 2011Dec9, 6). Will there be again “unique and exceptional” conditions? The ESM is authorized to take emergency decisions with “a qualified majority of 85% in case the Commission and the ECB conclude that an urgent decision related to financial assistance is needed when the financial and economic sustainability of the euro area is threatened” (European Council 2011Dec9, 6).

3. Bank Capital. The European Banking Authority (EBA) finds that European banks have a capital shortfall of €114.7 billion (http://stress-test.eba.europa.eu/capitalexercise/Press%20release%20FINAL.pdf). To avoid credit difficulties, the EBA recommends “that the credit institutions build a temporary capital buffer to reach a 9% Core Tier 1 ratio by 30 June 2012” (http://stress-test.eba.europa.eu/capitalexercise/EBA%20BS%202011%20173%20Recommendation%20FINAL.pdf 6). Patrick Jenkins, Martin Stabe and Stanley Pignal, writing on Dec 9, 2011, on “EU banks slash sovereign holdings,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/a6d2fd4e-228f-11e1-acdc-00144feabdc0.html#axzz1gAlaswcW), analyze the balance sheets of European banks released by the European Banking Authority. They conclude that European banks have reduced their holdings of riskier sovereign debt of countries in Europe by €65 billion from the end of 2010 to Sep 2011. Bankers informed that the European Central Bank and hedge funds acquired those exposures that represent 13 percent of their holdings of debt to Greece, Ireland, Italy, Portugal and Spain, which are down to €513 billion by the end of IIIQ2011.

IIID Appendix on European Central Bank Large Scale Lender of Last Resort. European Central Bank. The European Central Bank (ECB) has been pressured to assist in the bailouts by acquiring sovereign debts. The ECB has been providing liquidity lines to banks under pressure and has acquired sovereign debts but not in the scale desired by authorities. In an important statement to the European Parliament, the President of the ECB Mario Draghi (2011Dec1) opened the possibility of further ECB actions but after a decisive “fiscal compact:”

“What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.

Just as we effectively have a compact that describes the essence of monetary policy – an independent central bank with a single objective of maintaining price stability – so a fiscal compact would enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively.

We might be asked whether a new fiscal compact would be enough to stabilise markets and how a credible longer-term vision can be helpful in the short term. Our answer is that it is definitely the most important element to start restoring credibility.

Other elements might follow, but the sequencing matters. And it is first and foremost important to get a commonly shared fiscal compact right. Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term. After all, investors are themselves often taking decisions with a long time horizon, especially with regard to government bonds.

A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations.”

An important statement of Draghi (2011Dec15) focuses on the role of central banking: “You all know that the statutes of the ECB inherited this important principle and that central bank independence and the credible pursuit of price stability go hand in hand.”

Draghi (2011Dec19) explains measures to ensure “access to funding markets” by euro zone banks:

§ “We have decided on three-year refinancing operations to support the supply of credit to the euro area economy. These measures address the risk that persistent financial markets tensions could affect the capacity of euro area banks to obtain refinancing over longer horizons.

§ Earlier, in October, the Governing Council had already decided to have two more refinancing operations with a maturity of around one year.

§ Also, it was announced then that in all refinancing operations until at least the first half of 2012 all liquidity demand by banks would be fully allotted at fixed rate.

§ Funding via the covered bonds market was also facilitated by the ECB deciding in October to introduce a new Covered Bond Purchase Programme of €40 billion.

§ Funding in US dollar is facilitated by lowering the pricing on the temporary US dollar liquidity swap arrangements.”

Lionel Barber and Ralph Atkins interviewed Mario Draghi on Dec 14 with the transcript published in the Financial Times on Dec 18 (http://www.ft.com/intl/cms/s/0/25d553ec-2972-11e1-a066-00144feabdc0.html#axzz1gzoHXOj6) as “FT interview transcript: Mario Draghi.” A critical question in the interview is if the new measures are a European version of quantitative easing. Draghi analyzes the difference between the measures of the European Central Bank (ECB) and quantitative easing such as in Japan, US and UK:

1. The measures are termed “non-standard” instead of “unconventional.” While quantitative easing attempts to lower the yield of targeted maturities, the three-year facility operates through the “bank channel.” Quantitative easing would not be feasible because the ECB is statutorily prohibited of funding central governments. The ECB would comply with its mandate of medium-term price stability.

2. There is a critical difference in the two programs. Quantitative easing has been used as a form of financial repression known as “directed lending.” For example, the purchase of mortgage-backed securities more recently or the suspension of the auctions of 30-year bonds in response to the contraction early in the 2000s has the clear objective of directing spending to housing. The ECB gives the banks entire discretion on how to use the funding within their risk/return decisions, which could include purchase of government bonds.

The question on the similarity of the ECB three-year lending facility and quantitative easing is quite valid. Tracy Alloway, writing on Oct 10, 2011, on “Investors worry over cheap ECB money side effects,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/d2f87d16-f339-11e0-8383-00144feab49a.html#axzz1hAqMH1vn), analyzes the use of earlier long-term refinancing operations (LTRO) of the ECB. LTROs by the ECB in Jun, Sep and Dec 2009 lent €614 billion at 1 percent. Alloway quotes estimates of Deutsche Bank that banks used €442billion to acquire assets with higher yields. Carry trades developed from LTRO funds at 1 percent into liquid investments at a higher yield to earn highly profitable spreads. Alloway quotes estimates of Morgan Stanley that European debt of GIIPS (Greece, Ireland, Italy, Portugal and Spain) in European bank balance sheets is €700 billion. Tracy Alloway, writing on Dec 21, 2011, on “Demand for ECB loans rises to €489bn,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/d6ddd0ae-2bbd-11e1-98bc-00144feabdc0.html#axzz1hAqMH1vn), informs that European banks borrowed the largest value of €489 billion in all LTROs of the ECB. Tom Fairless and David Cottle, writing on Dec 21, 2011, on “ECB sees record refinancing demand,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204464404577111983838592746.html?mod=WSJPRO_hpp_LEFTTopStories), inform that the first of three operations of the ECB lent €489.19 billion, or $639.96 billion, to 523 banks. Three such LTROs could add to $1.9 trillion, which is not far from the value of quantitative easing in the US of $2.5 trillion. Fairless and Cottle find that there could be renewed hopes that banks could use the LTROs to support euro zone bond markets. It is possible that there could be official moral suasion by governments on banks to increase their holdings of government bonds or at least not to sell existing holdings. Banks are not free to choose assets in evaluation of risk and returns. Floods of cheap money at 1 percent per year induce carry trades to high-risk assets and not necessarily financing of growth with borrowing and lending decisions constrained by shocks of confidence.

The LTROs of the ECB are not very different from the liquidity facilities of the Fed during the financial crisis. Kohn (2009Sep10) finds that the trillions of dollars in facilities provided by the Fed (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-64, Regulation of Banks and Finance (2009b), 224-7) could fall under normal principles of “lender of last resort” of central banks:

“The liquidity measures we took during the financial crisis, although unprecedented in their details, were generally consistent with Bagehot's principles and aimed at short-circuiting these feedback loops. The Federal Reserve lends only against collateral that meets specific quality requirements, and it applies haircuts where appropriate. Beyond the collateral, in many cases we also have recourse to the borrowing institution for repayment. In the case of the TALF, we are backstopped by the Treasury. In addition, the terms and conditions of most of our facilities are designed to be unattractive under normal market conditions, thus preserving borrowers' incentives to obtain funds in the market when markets are operating normally. Apart from a very small number of exceptions involving systemically important institutions, such features have limited the extent to which the Federal Reserve has taken on credit risk, and the overall credit risk involved in our lending during the crisis has been small.

In Ricardo's view, if the collateral had really been good, private institutions would have lent against it. However, as has been recognized since Bagehot, private lenders, acting to protect themselves, typically severely curtail lending during a financial crisis, irrespective of the quality of the available collateral. The central bank--because it is not liquidity constrained and has the infrastructure in place to make loans against a variety of collateral--is well positioned to make those loans in the interest of financial stability, and can make them without taking on significant credit risk, as long as its lending is secured by sound collateral. A key function of the central bank is to lend in such circumstances to contain the crisis and mitigate its effects on the economy.”

The Bagehot (1873) principle is that central banks should provide a safety net, lending to temporarily illiquid but solvent banks and not to insolvent banks (see Cline 2001, 2002; Pelaez and Pelaez, International Financial Architecture (2005), 175-8). Kohn (2009Apr18) characterizes “quantitative easing” as “large scale purchases of assets:”

“Another aspect of our efforts to affect financial conditions has been the extension of our open market operations to large-scale purchases of agency mortgage-backed securities (MBS), agency debt, and longer-term Treasury debt. We initially announced our intention to undertake large-scale asset purchases last November, when the federal funds rate began to approach its zero lower bound and we needed to begin applying stimulus through other channels as the economic contraction deepened. These purchases are intended to reduce intermediate- and longer-term interest rates on mortgages and other credit to households and businesses; those rates influence decisions about investments in long-lived assets like houses, consumer durable goods, and business capital. In ordinary circumstances, the typically quite modest volume of central bank purchases and sales of such assets has only small and temporary effects on their yields. However, the extremely large volume of purchases now underway does appear to have substantially lowered yields. The decline in yields reflects "preferred habitat" behavior, meaning that there is not perfect arbitrage between the yields on longer-term assets and current and expected short-term interest rates. These preferences are likely to be especially strong in current circumstances, so that long-term asset prices rise and yields fall as the Federal Reserve acquires a significant portion of the outstanding stock of securities held by the public.”

Non-standard ECB policy and unconventional Fed policy have a common link in the scale of implementation or policy doses. Direct lending by the central bank to banks is the function “large scale lender of last resort.” If there is moral suasion by governments to coerce banks into increasing their holdings of government bonds, the correct term would be financial repression.

An important additional measure discussed by Draghi (2011Nov19) is relaxation on the collateral pledged by banks in LTROs:

“Some banks’ access to refinancing operations may be restricted by lack of eligible collateral. To overcome this, a temporary expansion of the list of collateral has been decided. Furthermore, the ECB intends to enhance the use of bank loans as collateral in Eurosystem operations. These measures should support bank lending, by increasing the amount of assets on euro area banks’ balance sheets that can be used to obtain central bank refinancing.”

There are collateral concerns about European banks. David Enrich and Sara Schaefer Muñoz, writing on Dec 28, on “European bank worry: collateral,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203899504577126430202451796.html?mod=WSJPRO_hpp_LEFTTopStories), analyze the strain on bank funding from a squeeze in the availability of high-quality collateral as guarantee in funding. High-quality collateral includes government bonds and investment-grade non-government debt. There could be difficulties in funding for a bank without sufficient available high-quality collateral to offer in guarantee of loans. It is difficult to assess from bank balance sheets the availability of sufficient collateral to support bank funding requirements. There has been erosion in the quality of collateral as a result of the debt crisis and further erosion could occur. Perceptions of counterparty risk among financial institutions worsened the credit/dollar crisis of 2007 to 2009. The banking theory of Diamond and Rajan (2000, 2001a, 2001b) and the model of Diamond Dybvig (1983, 1986) provide the analysis of bank functions that explains the credit crisis of 2007 to 2008 (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 155-7, 48-52, Regulation of Banks and Finance (2009b), 52-66, 217-24). In fact, Rajan (2005, 339-41) anticipated the role of low interest rates in causing a hunt for yields in multiple financial markets from hedge funds to emerging markets and that low interest rates foster illiquidity. Rajan (2005, 341) argued:

“The point, therefore, is that common factors such as low interest rates—potentially caused by accommodative monetary policy—can engender excessive tolerance for risk on both sides of financial transactions.”

A critical function of banks consists of providing transformation services that convert illiquid risky loans and investment that the bank monitors into immediate liquidity such as unmonitored demand deposits. Credit in financial markets consists of the transformation of asset-backed securities (SRP) constructed with monitoring by financial institutions into unmonitored immediate liquidity by sale and repurchase agreements (SRP). In the financial crisis financial institutions distrusted the quality of their own balance sheets and those of their counterparties in SRPs. The financing counterparty distrusted that the financed counterparty would not repurchase the assets pledged in the SRP that could collapse in value below the financing provided. A critical problem was the unwillingness of banks to lend to each other in unsecured short-term loans. Emse Bartha, writing on Dec 28, on “Deposits at ECB hit high,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204720204577125913779446088.html?mod=WSJ_hp_LEFTWhatsNewsCollection), informs that banks deposited €453.034 billion, or $589.72 billion, at the ECB on Dec 28, which is a record high in two consecutive days. The deposit facility is typically used by banks when they do prefer not to extend unsecured loans to other banks. In addition, banks borrowed €6.225 billion from the overnight facility on Dec 28, when in normal times only a few hundred million euro are borrowed. The collateral issues and the possible increase in counterparty risk occurred a week after large-scale lender of last resort by the ECB in the value of €489 billion in the prior week. The ECB may need to extend its lender of last resort operations.

The financial reform of the United States around the proposal of a national bank by Alexander Hamilton (1780) to develop the money economy with specialization away from the barter economy is credited with creating the financial system that brought prosperity over a long period (see Pelaez 2008). Continuing growth and prosperity together with sound financial management earned the US dollar the role as reserve currency and the AAA rating of its Treasury securities. McKinnon (2011Dec18) analyzes the resolution of the European debt crisis by comparison with the reform of Alexander Hamilton. Northern states of the US had financed the revolutionary war with the issue of paper notes that were at risk of default by 1890. Alexander Hamilton proposed the purchase of the states’ paper notes by the Federal government without haircuts. McKinnon (2011Dec18) describes the conflicts before passing the assumption bill in 1790 for federal absorption of the debts of states. Other elements in the Hamilton reform consisted of creation of a market for US Treasury bonds by their use as paid-in capital in the First Bank of the United States. McKinnon (2011Dec18) finds growth of intermediation in the US by the branching of the First Bank of the United States throughout several states, accepting deposits to provide commercial short-term credit. The reform consolidated the union of states, fiscal credibility for the union and financial intermediation required for growth. The reform also introduced low tariffs and an excise tax on whisky to service the interest on the federal debt. Trade relations among members of the euro zone are highly important to economic activity. There are two lessons drawn by McKinnon (2011Dec18) from the experience of Hamilton for the euro zone currently. (1) The reform of Hamilton included new taxes for the assumption of debts of states with concrete provisions for their credibility. (2) Commercial lending was consolidated with a trusted bank both for accepting private deposits and for commercial lending, creating the structure of financial intermediation required for growth.

IIIE Appendix Euro Zone Survival Risk. Markets have been dominated by rating actions of Standard & Poor’s Ratings Services (S&PRS) (2012Jan13) on 16 members of the European Monetary Union (EMU) or eurozone. The actions by S&PRS (2012Jan13) are of several types:

1. Downgrades by two notches of long-term credit ratings of Cyprus (from BBB/Watch/NegA-3+ to BB+/Neg/B), Italy (from A/Watch Neg/A-1 to BBB+/Neg/A-2), Portugal (from BBB-/Watch Neg/A-3 to BB/Neg/B) and Spain (from AA-/Watch Neg/A-1+ to A/Neg/A-1).

2. Downgrades by one notch of long-term credit ratings of Austria (from AAA/Watch Neg/A-1+ to AA+/Neg/A-1+), France (from AAA/Watch Neg/A-1+ to AA+/Neg A-1+), Malta (from A/Watch, Neg/A-1 to A-/Neg/A-2), Slovakia (from A+/Watch Neg/A-1 to A/Stable/A-1) and Slovenia (AA-/Watch Neg/A-1+ to A+/Neg/A-1).

3. Affirmation of long-term ratings of Belgium (AA/Neg/A-1+), Estonia (AA-/Neg/A-1+), Finland (AAA/Neg/A-1+), Germany (AAA/Stable/A-1+), Ireland (BBB+/Neg/A-2), Luxembourg (AAA/Neg/A-1+) and the Netherlands (AAA/Neg/A-1+) with removal from CreditWatch.

4. Negative outlook on the long-term credit ratings of Austria, Belgium, Cyprus, Estonia, Finland, France, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia and Spain, meaning that S&PRS (2012Jan13) finds that the ratings of these sovereigns have a chance of at least 1-to-3 of downgrades in 2012 or 2013.

S&PRS (2012Jan13) finds that measures by European policymakers may not be sufficient to contain sovereign risks in the eurozone. The sources of stress according to S&PRS (2012Jan13) are:

1. Worsening credit environment

2. Increases in risk premiums for many eurozone borrowers

3. Simultaneous attempts at reducing debts by both eurozone governments and households

4. More limited perspectives of economic growth

5. Deepening and protracted division among Europe’s policymakers in agreeing to approaches to resolve the European debt crisis

There is now only one major country in the eurozone with AAA rating of its long-term debt by S&PRS (2012Jan13): Germany. IIIE Appendix Euro Zone Survival Risk analyzes the hurdle of financial bailouts of euro area members by the strength of the credit of Germany alone. The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is abouy $3531.6 billion. There is some simple “unpleasant bond arithmetic.” Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is about $7385.1 billion, which would be equivalent to 126.3 percent of their combined GDP in 2010. Under this arrangement the entire debt of the euro zone including debt of France and Germany would not have nil probability of default. Debt as percent of Germany’s GDP would exceed 224 percent if including debt of France and 165 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Charles Forelle, writing on Jan 14, 2012, on “Downgrade hurts euro rescue fund,” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204409004577159210191567778.html), analyzes the impact of the downgrades on the European Financial Stability Facility (EFSF). The EFSF is a special purpose vehicle that has not capital but can raise funds to be used in bailouts by issuing AAA-rated debt. S&P may cut the rating of the EFSF to the new lowest rating of the six countries with AAA rating, which are now down to four with the downgrades of France and Austria. The other rating agencies Moody’s and Fitch have not taken similar action. On Jan, S&PRS (2012Jan16) did cut the long-term credit rating of the EFSF to AA+ and affirmed the short-term credit rating at A-+. The decision is derived from the reduction in credit rating of the countries guaranteeing the EFSF. In the view of S&PRS (2012Jan16), there are not sufficient credit enhancements after the reduction in the creditworthiness of the countries guaranteeing the EFSF. The decision could be reversed if credit enhancements were provided.

The flow of cash from safe havens to risk financial assets is processed by carry trades from zero interest rates that are frustrated by episodes of risk aversion or encouraged with return of risk appetite. European sovereign risk crises are closely linked to the exposures of regional banks to government debt. An important form of financial repression consists of changing the proportions of debt held by financial institutions toward higher shares in government debt. The financial history of Latin America, for example, is rich in such policies. Bailouts in the euro zone have sanctioned “bailing in” the private sector, which means that creditors such as banks will participate by “voluntary” reduction of the principal in government debt (see Pelaez and Pelaez, International Financial Architecture (2005), 163-202). David Enrich, Sara Schaeffer Muñoz and Patricia Knowsmann, writing on “European nations pressure own banks for loans,” on Nov 29, 2011, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204753404577066431341281676.html?mod=WSJPRO_hpp_MIDDLETopStories), provide important data and analysis on the role of banks in the European sovereign risk crisis. They assemble data from various sources showing that domestic banks hold 16.2 percent of Italy’s total government securities outstanding of €1,617.4 billion, 22.9 percent of Portugal’s total government securities of €103.9 billion and 12.3 percent of Spain’s total government securities of €535.3 billion. Capital requirements force banks to hold government securities to reduce overall risk exposure in balance sheets. Enrich, Schaeffer Muñoz and Knowsmann find information that governments are setting pressures on banks to acquire more government debt or at least to stop selling their holdings of government debt.

Bond auctions are also critical in episodes of risk aversion. David Oakley, writing on Jan 3, 2012, on “Sovereign issues draw euro to crunch point,” published by the Financial Times (http://www.ft.com/intl/cms/s/0/63b9d7ca-2bfa-11e1-98bc-00144feabdc0.html#axzz1iLNRyEbs), estimates total euro area sovereign issues in 2012 at €794 billion, much higher than the long-term average of €670 billion. Oakley finds that the sovereign issues are: Italy €220 billion, France €197 billion, Germany €178 billion and Spain €81 billion. Bond auctions will test the resilience of the euro. Victor Mallet and Robin Wigglesworth, writing on Jan 12, 2012, on “Spain and Italy raise €22bn in debt sales,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/e22c4e28-3d05-11e1-ae07-00144feabdc0.html#axzz1j4euflAi), analyze debt auctions during the week. Spain placed €10 billion of new bonds with maturities in 2015 and 2016, which was twice the maximum planned for the auction. Italy placed €8.5 billion of one-year bills at average yield of 2.735 percent, which was less than one-half of the yield of 5.95 percent a month before. Italy also placed €3.5 billion of 136-day bills at 1.64 percent. There may be some hope in the sovereign debt market. The yield of Italy’s 10-year bond dropped from around 7.20 percent on Jan 9 to about 6.70 percent on Jan 13 and then to around 6.30 percent on Jan 20. The yield of Spain’s 10-year bond fell from about 6.60 percent on Jan 9 to around 5.20 percent on Jan 13 and then to 5.50 percent on Jan 20.

A combination of strong economic data in China analyzed in subsection VC and the realization of the widely expected downgrade could explain the strength of the European sovereign debt market. Emese Bartha, Art Patnaude and Nick Cawley, writing on January 17, 2012, on “European T-bills see solid demand,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204555904577166363369792848.html?mod=WSJPRO_hpp_LEFTTopStories), analyze successful auctions treasury bills by Spain and Greece. A day after the downgrade, the EFSF found strong demand on Jan 17 for its six-month debt auction at the yield of 0.2664 percent, which is about the same as sovereign bills of France with the same maturity.

There may be some hope in the sovereign debt market. The yield of Italy’s 10-year bond dropped from around 7.20 percent on Jan 9 to about 6.70 percent on Jan 13 and then to around 6.30 percent on Jan 20. The yield of Spain’s 10-year bond fell from about 6.60 percent on Jan 9 to around 5.20 percent on Jan 13 and then to 5.50 percent on Jan 20. Paul Dobson, Emma Charlton and Lucy Meakin, writing on Jan 20, 2012, on “Bonds show return of crisis once ECB loans expire,” published in Bloomberg (http://www.bloomberg.com/news/2012-01-20/bonds-show-return-of-crisis-once-ecb-loans-expire-euro-credit.html), analyze sovereign debt and analysis of market participants. Large-scale lending of last resort by the European Central Bank, considered in VD Appendix on European Central Bank Large Scale Lender of Last Resort, provided ample liquidity in the euro zone for banks to borrow at 1 percent and lend at higher rates, including to government. Dobson, Charlton and Meakin trace the faster decline of yields of short-term sovereign debt relative to decline of yields of long-term sovereign debt. The significant fall of the spread of short relative to long yields could signal concern about the resolution of the sovereign debt while expanding lender of last resort operations have moderated relative short-term sovereign yields. Normal conditions would be attained if there is definitive resolution of long-term sovereign debt that would require fiscal consolidation in an environment of economic growth.

Charles Forelle and Stephen Fidler, writing on Dec 10, 2011, on “Questions place EU pact,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203413304577087562993283958.html?mod=WSJPRO_hpp_LEFTTopStories#project%3DEUSUMMIT121011%26articleTabs%3Darticle), provide data, information and analysis of the agreement of Dec 9. There are multiple issues centering on whether investors will be reassured that the measures have reduced the risks of European sovereign obligations. While the European Central Bank has welcomed the measures, it is not yet clear of its future role in preventing erosion of sovereign debt values.

Another complicating factor is whether there will be further actions on sovereign debt ratings. On Dec 5, 2011, four days before the conclusion of the meeting of European leaders, Standard & Poor’s (2011Dec5) placed the sovereign ratings of 15 members of the euro zone on “CreditWatch with negative implications.” S&P finds five conditions that trigger the action: (1) worsening credit conditions in the euro area; (2) differences among member states on how to manage the debt crisis in the short run and on measures to move toward enhanced fiscal convergence; (3) household and government debt at high levels throughout large parts of the euro area; (4) increasing risk spreads on euro area sovereigns, including those with AAA ratings; and (5) increasing risks of recession in the euro zone. S&P also placed the European Financial Stability Facility (EFSF) in CreditWatch with negative implications (http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245325307963). On Dec 9, 2011, Moody’s Investors Service downgraded the ratings of the three largest French banks (http://www.moodys.com/research/Moodys-downgrades-BNP-Paribass-long-term-ratings-to-Aa3-concluding--PR_232989 http://www.moodys.com/research/Moodys-downgrades-Credit-Agricole-SAs-long-term-ratings-to-Aa3--PR_233004 http://www.moodys.com/research/Moodys-downgrades-Socit-Gnrales-long-term-ratings-to-A1--PR_232986 ).

Improving equity markets and strength of the euro appear related to developments in sovereign debt negotiations and markets. Alkman Granitsas and Costas Paris, writing on Jan 29, 2012, on “Greek debt deal, new loan agreement to finish next week,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204573704577189021923288392.html?mod=WSJPRO_hpp_LEFTTopStories), inform that Greece and its private creditors were near finishing a deal of writing off €100 billion, about $132 billion, of Greece’s debt depending on the conversations between Greece, the euro area and the IMF on the new bailout. An agreement had been reached in Oct 2011 for a new package of fresh money in the amount of €130 billion to fill needs through 2015 but was contingent on haircuts reducing Greece’s debt from 160 percent of GDP to 120 percent of GDP. The new bailout would be required to prevent default by Greece of €14.4 billion maturing on Mar 20, 2012. There has been increasing improvement of sovereign bond yields. Italy’s ten-year bond yield fell from over 6.30 percent on Jan 20, 2012 to slightly above 5.90 percent on Jan 27. Spain’s ten-year bond yield fell from slightly above 5.50 percent on Jan 20 to just below 5 percent on Jan 27.

An important difference, according to Beim (2011Oct9), between large-scale buying of bonds by the central bank between the Federal Reserve of the US and the European Central Bank (ECB) is that the Fed and most banks do not buy local and state government obligations with lower creditworthiness. The European Monetary Union (EMU) that created the euro and the ECB did not include common fiscal policy and affairs. Thus, EMU cannot issue its own treasury obligations. The line “Reserve bank credit” in the Fed balance sheet for Jan 25, 2012, is $2902 billion of which $2570 billion consisting of $1565 billion US Treasury notes and bonds, $68 billion inflation-indexed bonds and notes, $101 billion Federal agency debt securities and $836 billion mortgage-backed securities (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The Fed has been careful in avoiding credit risk in its portfolio of securities. The 11 exceptional liquidity facilities of several trillion dollars created during the financial crisis (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-62) have not resulted in any losses. The Fed has used unconventional monetary policy without credit risk as in classical central banking.

Beim (2011Oct9, 6) argues:

“In short, the ECB system holds more than €1 trillion of debt of the banks and governments of the 17 member states. The state-by-state composition of this debt is not disclosed, but the events of the past year suggest that a disproportionate fraction of these assets are likely obligations of stressed countries. If a significant fraction of the €1 trillion were to be restructured at 40-60% discounts, the ECB would have a massive problem: who would bail out the ECB?

This is surely why the ECB has been so shrill in its antagonism to the slightest mention of default and restructuring. They need to maintain the illusion of risk-free sovereign debt because confidence in the euro itself is built upon it.”

Table III-2 provides the consolidated financial statement of the Eurosystem on Dec 31, 2010 and Dec 28, 2011. Memo items provide the sum of lines 5, “lending to euro area credit institutions related to monetary policy operations denominated in euro,” and 7, “securities of euro area residents denominated in euro,” which has increased from €1,004,174 million on Dec 31, 2010 to €1,489,759 million on Dec 28, 2011. This sum is roughly what concerns Beim (2012Oct9) because of the probable exposure relative to capital to institutions and sovereigns with higher default risk. To be sure, there is no precise knowledge of the composition of the ECB portfolio of loans and securities with weights and analysis of the risks of components. Javier E. David, writing on Jan 16, 2012, on “The risks in ECB’s crisis moves,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204542404577158753459542024.html?mod=WSJ_hp_LEFTWhatsNewsCollection), informs that the estimated debt of weakest euro zone sovereigns held by the ECB is €211 billion, with Greek debt in highest immediate default risk being only 17 percent of the total. Another unknown is whether there is high risk collateral in the €489 billion three-year loans to credit institutions at 1 percent interest rates. The potential risk is the need for recapitalization of the ECB that could find similar political hurdles as the bailout fund EFSF. There is a recurring issue of whether the ECB should accept a haircut on its portfolio of Greek bonds of €40 billion acquired at discounts from face value. An article on “Haircut for the ECB? Not so fast,” published by the Wall Street Journal on Jan 28, 2012 (http://blogs.wsj.com/davos/2012/01/28/haircut-for-the-ecb-not-so-fast/), informs of the remarks by Mark Carney, Governor of the Bank of Canada and President of the Financial Stability Board (FSB) (http://www.financialstabilityboard.org/about/overview.htm), expressing what appears to be correct doctrine that there could conceivably be haircuts for official debt but that such a decision should be taken by governments and not by central banks.

Table III-2, Consolidated Financial Statement of the Eurosystem, Million EUR

	Dec 31, 2010	Dec 28, 2011
1 Gold and other Receivables	367,402	419,822
2 Claims on Non Euro Area Residents Denominated in Foreign Currency	223,995	236,826
3 Claims on Euro Area Residents Denominated in Foreign Currency	26,941	95,355
4 Claims on Non-Euro Area Residents Denominated in Euro	22,592	25,982
5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro	546,747	879,130
6 Other Claims on Euro Area Credit Institutions Denominated in Euro	45,654	94,989
7 Securities of Euro Area Residents Denominated in Euro	457,427	610,629
8 General Government Debt Denominated in Euro	34,954	33,928
9 Other Assets	278,719	336,574
TOTAL ASSETS	2,004, 432	2,733,235
Memo Items
Sum of 5 and  7	1,004,174	1,489,759
Capital and Reserves	78,143	81,481

Source: European Central Bank

http://www.ecb.int/press/pr/wfs/2011/html/fs110105.en.html

http://www.ecb.int/press/pr/wfs/2011/html/fs111228.en.html

Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. That success would be assured with growth of the Italian economy. A critical problem is that the common currency prevents Italy from devaluation to parity or the exchange rate that would permit export growth to promote internal economic activity that generates fiscal revenues for primary fiscal surplus that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Data in Table III-3 providing Italy’s trade with regions and countries supports the argument of Caballero and Giavazzi (2012Jan15). Italy’s exports to the European Monetary Union (EMU) are only 43.6 percent of the total. Exports to non-European Union area are growing at 15.2 percent in the 12 months ending in Nov while those to EMU are growing at 9.6 percent.

Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12 Months ∆%

	Exports % Share	∆% Jan-Nov 2011/ Jan-Nov 2010	Imports % Share	Imports ∆% Jan-Nov 2011/ Jan-Nov 2010
EU	57.3	9.5	54.8	6.9
EMU 17	43.6	9.6	44.6	6.4
France	11.6	11.9	8.8	4.2
Germany	13.0	13.2	16.1	6.4
Spain	5.8	2.3	4.6	8.1
UK	5.2	-1.0	2.7	9.4
Non EU	42.7	15.2	45.2	15.1
Europe non EU	12.0	24.4	10.3	20.2
USA	6.0	11.9	3.0	18.5
China	2.6	16.5	7.8	5.3
OPEC	5.3	-1.3	9.5	-0.4
Total	100.0	11.9	100.0	10.6

Notes: EU: European Union; EMU: European Monetary Union (euro zone)

Source: http://www.istat.it/it/archivio/50960

Growth rates of Italy’s trade and major products are provided in Table III-4 for the period Jan-Nov 2011 relative to Jan-Nov 2010. Growth rates are high for the total and all segments with the exception of decline of durable goods imports of 6.4 percent. Capital goods exports increased 11.1 percent relative to a year earlier and intermediate products by 14.4 percent.

Table III-4, Italy, Exports and Imports % Share of Products in Total and ∆%

	Exports Share %	Exports ∆% Jan-Nov 2011/ Jan-Nov 2010	Imports Share %	Imports ∆% Jan-Nov 2011/ Jan-Nov 2010
Consumer Goods	29.5	9.4	25.3	8.0
Durable	6.3	4.7	3.5	-6.4
Non Durable	23.2	10.6	21.8	10.3
Capital Goods	32.4	11.1	22.4	1.3
Inter- mediate Goods	33.5	14.4	33.9	13.9
Energy	4.6	16.1	18.4	19.6
Total ex Energy	95.4	11.7	81.6	8.6
Total	100.0	11.9	100.0	10.6

Source: http://www.istat.it/it/archivio/50960

Table III-5 provides Italy’s trade balance by product categories in Nov and Jan-Nov 2011. Italy’s trade balance excluding energy is a surplus of €30,523 in Jan-Nov 2011 but the energy trade balance is a deficit of €56,301 million. Italy has significant competitiveness in contrast with some other countries with debt difficulties.

Table III-5, Italy, Trade Balance by Product Categories, € Millions

	Nov 2011	Jan-Nov 2011
Consumer Goods	877	7,361
Durable	876	9,256
Nondurable	1	-1,896
Capital Goods	3,075	33,579
Intermediate Goods	78	-10,417
Energy	-5,610	-56,301
Total ex Energy	4,030	30,523
Total	-1,581	-25,778

Source: http://www.istat.it/it/archivio/50960

Brazil faced in the debt crisis of 1982 a more complex policy mix. Between 1977 and 1983, Brazil’s terms of trade, export prices relative to import prices, deteriorated 47 percent and 36 percent excluding oil (Pelaez 1987, 176-79; Pelaez 1986, 37-66; see Pelaez and Pelaez, The Global Recession Risk (2007), 178-87). Brazil had accumulated unsustainable foreign debt by borrowing to finance balance of payments deficits during the 1970s. Foreign lending virtually stopped. The German mark devalued strongly relative to the dollar such that Brazil’s products lost competitiveness in Germany and in multiple markets in competition with Germany. The resolution of the crisis was devaluation of the Brazilian currency by 30 percent relative to the dollar and subsequent maintenance of parity by monthly devaluation equal to inflation and indexing that resulted in financial stability by parity in external and internal interest rates avoiding capital flight. With a combination of declining imports, domestic import substitution and export growth, Brazil followed rapid growth in the US and grew out of the crisis with surprising GDP growth of 4.5 percent in 1984.

The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the following Subsection IIID Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 30 the yield of the 2-year bond of the government of Greece was quoted around 100 percent. In contrast, the 2-year US Treasury note traded at 0.239 percent and the 10-year at 2.871 percent while the comparable 2-year government bond of Germany traded at 0.14 percent and the 10-year government bond of Germany traded at 1.83 percent (see Table III-1). There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt of 120 percent of GDP, which is the third largest in the world after the US and Japan. Appendix IIIE links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).

Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.

Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:

“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”

If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.

The prospects of survival of the euro zone are dire. Table III-6 is constructed with IMF World Economic Outlook database for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2010.

Table III-6, World and Selected Regional and Country GDP and Fiscal Situation

	GDP 2010 USD Billions	Primary Net Lending Borrowing % GDP 2010	General Government Net Debt % GDP 2010
World	62,911.2
Euro Zone	12,167.8	-3.6	65.9
Portugal	229.2	-6.3	88.7
Ireland	206.9	-28.9	78.0
Greece	305.4	-4.9	142.8
Spain	1,409.9	-7.8	48.8
Major Advanced Economies G7	31,716.9	-6.5	76.5
United States	14,526.6	-8.4	68.3
UK	2,250.2	-7.7	67.7
Germany	3,286.5	-1.2	57.6
France	2,562.7	-4.9	76.5
Japan	5,458.8	-8.1	117.2
Canada	1,577.0	-4.9	32.2
Italy	2,055.1	-0.3	99.4
China	5,878.3	-2.3	33.8*
Cyprus	23.2	-5.3	61.6

*Gross Debt

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

The data in Table III-6 are used for some very simple calculations in Table III-7. The column “Net Debt USD Billions” in Table III-7 is generated by applying the percentage in Table III-6 column “General Government Net Debt % GDP 2010” to the column “GDP USD Billions.” The total debt of France and Germany in 2010 is $3853.5 billion, as shown in row “B+C” in column “Net Debt USD Billions” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $3531.6 billion. There is some simple “unpleasant bond arithmetic” in the two final columns of Table III-7. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $7385.1 billion, which would be equivalent to 126.3 percent of their combined GDP in 2010. Under this arrangement the entire debt of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 224 percent if including debt of France and 165 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks.

Table III-7, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %

	Net Debt USD Billions	Debt as % of Germany Plus France GDP	Debt as % of Germany GDP
A Euro Area	8,018.6
B Germany	1,893.0		$7385.1 as % of $3286.5 =224.7% $5424.6 as % of $3286.5 =165.1%
C France	1,960.5
B+C	3,853.5	GDP $5849.2 Total Debt $7385.1 Debt/GDP: 126.3%
D Italy	2,042.8
E Spain	688.0
F Portugal	203.3
G Greece	436.1
H Ireland	161.4
Subtotal D+E+F+G+H	3,531.6

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

There is extremely important information in Table III-8 for the current sovereign risk crisis in the euro zone. Table III-8 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Dec. German exports to other European Union members are 47.4 percent of total exports in Dec and 59.2 percent in Jan-Dec. Exports to the euro area are 31.8 percent in Dec and 39.7 percent in Jan-Dec. Exports to third countries are 44.3 percent of the total in Dec and 40.8 percent in Jan-Dec. There is similar distribution for imports. Economic performance in Germany is closely related to its high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of its high share in exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.

Table III-8, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	Dec 2011 € Billions	12 Months ∆%	Jan-Dec 2011 € Billions	Jan-Dec 2011/ Jan-Dec 2010 ∆%
Total Exports	85.1	5.0	1,060.1	11.4
A. EU Members	47.4 % 55.7	-1.6	627.3 % 59.2	9.9
Euro Area	31.8 % 37.4	-3.3	420.9 % 39.7	8.6
Non-euro Area	15.5 % 18.2	2.2	206.4 % 19.5	12.6
B. Third Countries	37.7 % 44.3	14.7	432.8 % 40.8	13.6
Total Imports	72.1	5.4	902.0	13.2
C. EU Members	45.9 % 63.7	5.1	572.6 % 63.5	13.8
Euro Area	31.9 % 44.2	3.5	401.5 % 44.5	12.9
Non-euro Area	14.0 % 19.4	8.8	171.1 % 18.9	16.1
D. Third Countries	26.2 % 36.3	6.1	329.4 % 36.5	12.0

Notes: Total Exports = A+B; Total Imports = C+D

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2012/02/PE12__044__51,templateId=renderPrint.psml

VF Appendix on Sovereign Bond Valuation. There are two approaches to government finance and their implications: (1) simple unpleasant monetarist arithmetic; and (2) simple unpleasant fiscal arithmetic. Both approaches illustrate how sovereign debt can be perceived riskier under profligacy.

First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:

D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)

Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,

{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:

N(t+1) = (1+n)N(t), n>-1 (2)

The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:

B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)

On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.

Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:

(M_t + B_t)/P_t = E_t∫(1/R_{t, t+τ})s_t+τdτ (4)

Equation (4) expresses the monetary, M_t, and debt, B_t, liabilities of the government, divided by the price level, P_t, in terms of the expected value discounted by the ex-post rate on government debt, R_{t, t+τ}, of the future primary surpluses s_t+τ, which are equal to T_t+τ – G_t+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post R_{t, t+τ}. The second equation of Cochrane (2011Jan, 5) is:

M_tV(i_t, ·) = P_tY_t (5)

Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):

“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”

An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.

There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:

(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress

(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality

(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.

IV Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table IV-1 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 (Peter Spiegel and Quentin Peel, “Europe: Northern Exposures,” Financial Times, Mar 9, 2011 http://www.ft.com/intl/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1gAlaswcW). Newly available data on inflation is considered below in this section. Data in Table IV-1 for the euro zone and its members are updated from information provided by Eurostat but individual country information is provided in this section  as soon as available, following Table IV-1. Data for other countries in Table IV-1 are also updated with reports from their statistical agencies. Economic data for major regions and countries is considered in Section V World Economic Slowdown following with individual country and regional data tables.

Table IV-1, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates

	GDP	CPI	PPI	UNE
US	1.6	3.0	5.7	8.3
Japan	-0.7	-0.2	1.3	4.6
China	8.9	4.5	0.7
UK	0.8	4.2* RPI 4.8	4.1* output 2.4** input 7.0*	8.4
Euro Zone	1.4	2.7	4.3	10.4
Germany	3.0	2.8	4.0	5.5
France	1.6	2.7	4.6	9.9
Nether-lands	1.1	2.7	5.0	4.9
Finland	2.7	3.2	2.8	7.6
Belgium	1.8	3.7	4.5	7.2
Portugal	-1.7	3.8	4.4	13.6
Ireland	NA	1.7	4.4	14.5
Italy	NA	3.7	4.0	8.9
Greece	-5.2	2.8	5.7	19.2
Spain	0.8	2.9	5.2	22.9

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.ons.gov.uk/ons/rel/ppi2/producer-price-index/january-2012/stb-producer-price-index---january-2012.html

CPI http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/december-2011/index.html

**Excluding food, beverage, tobacco and petroleum

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

Table IV-1 shows the simultaneous occurrence of low growth, inflation and unemployment in advanced economies. The US grew at 1.6 percent in IVQ2011 relative to IVQ2010 (Table 8, p 11 in http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp4q11_adv.pdf). Japan’s GDP fell 0.7 percent in IIIQ2011 relative to IIIQ2010 and contracted 1.7 percent in IIQ2011 relative to IIQ2010 because of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 but grew at the seasonally-adjusted annual rate (SAAR) of 5.6 percent in IIIQ2011 (http://www.esri.cao.go.jp/jp/sna/sokuhou/kekka/gaiyou/main_1.pdf); the UK grew at 0.8 percent in IVQ2011 relative to IVQ2010 and GDP fell 0.2 percent in IVQ2011 relative to IIIQ2011 (http://www.ons.gov.uk/ons/rel/gva/gross-domestic-product--preliminary-estimate/q4-2011/stb-q4-2011.html); and the Euro Zone grew at 1.4 percent in IIIQ2011 relative to IIIQ2010 (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-06122011-AP/EN/2-06122011-AP-EN.PDF). These are stagnating or “growth recession” rates, which are positive growth rates instead of contractions but insufficient to recover employment. The rates of unemployment are quite high: 8.3 percent in the US but 19.5 percent for unemployment/underemployment (see Table I-4 in I Thirty-One Million Unemployed or Underemployed and http://cmpassocregulationblog.blogspot.com/2012/01/thirty-million-unemployed-or.html), 4.6 percent for Japan, 8.4 percent for the UK with high rates of unemployment for young people (see the labor statistics of the UK in subsection VH http://cmpassocregulationblog.blogspot.com/2012/01/world-inflation-waves-united-states_22.html) and 10.4 percent in the Euro Zone. Twelve-month rates of inflation have been quite high, even when some are moderating at the margin: 3.0 percent in the US, minus 0.2 percent for Japan, 2.7 percent for the Euro Zone and 4.2 percent for the UK. 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 III in this post and the earlier post http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html) (2) the tradeoff of growth and inflation in China; (3) slow growth by repression of savings with de facto interest rate controls (http://cmpassocregulationblog.blogspot.com/2012/01/mediocre-economic-growth-financial.html), weak hiring (http://cmpassocregulationblog.blogspot.com/2012/01/recovery-without-hiring-united-states.html) and continuing job stress of 24 to 31 million people in the US and stagnant wages in a fractured job market (see Section I Thirty-One Million Unemployed or Underemployed at http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html); (4) the timing, dose, impact and instruments of normalizing monetary and fiscal policies (see IV Budget/Debt Quagmire in http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html 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 Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 that had 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.

In the effort to increase transparency, the Federal Open Market Committee (FOMC) provides both economic projections of its participants and views on future paths of the policy rate that in the US is the federal funds rate or interest on interbank lending of reserves deposited at Federal Reserve Banks. These projections and views are discussed initially followed with appropriate analysis.

The statement of the FOMC at the conclusion of its meeting on Jan 25, 2012, revealed the following policy intentions (http://www.federalreserve.gov/newsevents/press/monetary/20120125a.htm):

“Information received since the Federal Open Market Committee met in December suggests that the economy has been expanding moderately, notwithstanding some slowing in global growth. While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed. Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects economic growth over coming quarters to be modest and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that over coming quarters, inflation will run at levels at or below those consistent with the Committee's dual mandate.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy.  In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability. ”

There are several important issues in this statement.

1. Mandate. The FOMC 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”

2. Extending Average Maturity of Holdings of Securities. The statement of Jan 25, 2012, invokes the mandate that inflation is subdued but employment below maximum such that further accommodation is required. Accommodation consists of low interest rates. The new “Operation Twist” (http://cmpassocregulationblog.blogspot.com/2011_09_01_archive.html http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html) or restructuring the portfolio of securities of the Fed by selling short-dated securities and buying long-term securities has the objective of reducing long-term interest rates. Lower interest rates would stimulate consumption and investment, or aggregate demand, increasing the rate of economic growth and thus reducing stress in job markets.

3. Target of Fed Funds Rate. The FOMC continues to maintain the target of fed funds rate at 0 to ¼ percent.

4. Advance Guidance. The FOMC increases transparency by advising on the expectation of the future path of fed funds rate. This guidance is the view that conditions such as “low rates of resource utilization and a subdued outlook for inflation over the medium run are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

5. Monitoring and Policy Focus. The FOMC reconsiders its policy continuously in accordance with available information: “The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.”

These policy statements are carefully crafted to express the intentions of the FOMC. The main objective of the statements is to communicate as clearly and firmly as possible the intentions of the FOMC to fulfill its dual mandate. During periods of low inflation and high unemployment and underemployment such as currently the FOMC may be more biased toward measures that stimulate the economy to reduce underutilization of workers and other productive resources. The FOMC also is vigilant about inflation and ready to change policy in the effort to attain its dual mandate.

The FOMC also released the economic projections of governors of the Board of Governors of the Federal Reserve and Federal Reserve Banks presidents shown in Table IV-2. The Fed releases the data with careful explanations (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120125.pdf). Columns “∆% GDP,” “∆% PCE Inflation” and “∆% Core PCE Inflation” are changes “from the fourth quarter of the previous year to the fourth quarter of the year indicated.” The GDP report for IVQ2011 is analyzed in the current post of this blog in section I. The Bureau of Economic Analysis (BEA) provides the GDP report with the second estimate for IVQ2011 to be released on Feb 29 and the third estimate on Mar 29 (http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm). PCE inflation is the index of personal consumption expenditures (PCE) of the report of the Bureau of Economic Analysis (BEA) on “Personal Income and Outlays” (http://www.bea.gov/national/index.htm#personal), which is analyzed in this blog as soon as available. The next report will be released at 8:30 AM on Jan 30, 2012. PCE core inflation consists of PCE inflation excluding food and energy. Column “UNEMP %” is the rate of unemployment measured as the average civilian unemployment rate in the fourth quarter of the year. The Bureau of Labor Statistics (BLS) provides the Employment Situation Report with the civilian unemployment rate in the first Friday of every month, which is analyzed in this blog. The report for February will be released on Feb 3, 2012 (http://www.bls.gov/cps/). “Longer term projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy” (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120125.pdf).

It is instructive to focus on 2012, as 2013, 2014 and longer term are too far away, and there is not much information on what will happen in 2013 and beyond. The central tendency should provide reasonable approximation of the view of the majority of members of the FOMC but the second block of numbers provides the range of projections by FOMC participants. The first row for each year shows the projection introduced after the meeting of Jan 25 and the second row “Nov PR” the projection of the Nov meeting. There are three major changes in the view.

1. Growth “GDP ∆.” The FOMC has reduced the forecast of GDP growth in 2012 from 3.3 to 3.7 percent in Jun to 2.5 to 2.9 percent in Nov and now to 2.2 to 2.7 percent at the Jan 25 meeting.

2. Rate of Unemployment “UNEM%.” The FOMC increased the rate of unemployment from 7.8 to 8.2 percent in Jun to 8.5 to 8.7 percent in Nov but has reduced it to 8.2 to 8.5 percent at the Jan 25 meeting.

3. Inflation “∆% PCE Inflation.” The FOMC changed the forecast of personal consumption expenditures (PCE) inflation from 1.5 to 2.0 percent in Jun to virtually the same of 1.4 to 2.0 percent in Nov but has reduced it to 1.4 to 1.8 percent at the Jan 25 meeting.

4. Core Inflation “∆% Core PCE Inflation.” Core inflation is PCE inflation excluding food and energy. There is again not much of a difference of the projection for 2012 in Jun of 1.4 to 2.0 percent and the Nov projection of 1.5 to 2.0 percent, which has been reduced slightly to 1.5 to 1.8 percent at the Jan 25 meeting.

Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal

Reserve Bank Presidents in FOMC, January 2012 and November 2011

	∆% GDP	UNEM %	∆% PCE Inflation	∆% Core PCE Inflation
Central Tendency
2012  Nov PR	2.2 to 2.7 2.5 to 2.9	8.2 to 8.5 8.5 to 8.7	1.4 to 1.8 1.4 to 2.0	1.5 to 1.8 1.5 to 2.0
2013  Nov PR	2.8 to 3.2 3.0 to 3.5	7.4 to 8.1 7.8 to 8.2	1.4 to 2.0 1.5 to 2.0	1.5 to 2.0 1.4 to 1.9
2014  Nov PR	3.3 to 4.0 3.0 to 3.9	6.7 to 7.6 6.8 to 7.7	1.6 to 2.0 1.5 to 2.0	1.6 to 2.0 1.5 to 2.0
Longer Run	2.3 to 2.6 2.4 to 2.7	5.2 to 6.0 5.2 to 6.0	2.0 1.7 to 2.0
Range
2012 Nov PR	2.1 to 3.0 2.3 to 3.5	7.8 to 8.6 8.1 to 8.9	1.3 to 2.5 1.4 to 2.8	1.3 to 2.0 1.3 to 2.1
2013 Nov PR	2.4 to 3.8 2.7 to 4.0	7.0 to 8.2 7.5 to 8.4	1.4 to 2.3 1.4 to 2.5	1.4 to 2.0 1.4 to 2.1
2014 Nov PR	2.8 to 4.3 2.7 to 4.5	6.3 to 7.7 6.5 to 8.0	1.5 to 2.1 1.5 to 2.4	1.4 to 2.0 1.4 to 2.2
Longer Run	2.2 to 3.0 2.2 to 3.0	5.0 to 6.0 5.0 to 6.0	2.0 1.5 to 2.0

Notes: UEM: unemployment; PR: Projection

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120125.pdf

Another important decision at the FOMC meeting on Jan 25, 2012, is formal specification of the goal of inflation of 2 percent per year but without specific goal for unemployment (http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm):

“Following careful deliberations at its recent meetings, the Federal Open Market Committee (FOMC) has reached broad agreement on the following principles regarding its longer-run goals and monetary policy strategy. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.

The FOMC is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.

Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances.

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants' estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC's Summary of Economic Projections. For example, in the most recent projections, FOMC participants' estimates of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent, roughly unchanged from last January but substantially higher than the corresponding interval several years earlier.

In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary.  However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate. ”

The probable intention of this specific inflation goal is to “anchor” inflationary expectations. Massive doses of monetary policy of promoting growth to reduce unemployment could conflict with inflation control. Economic agents could incorporate inflationary expectations in their decisions. As a result, the rate of unemployment could remain the same but with much higher rate of inflation (see Kydland and Prescott 1977 and Barro and Gordon 1983; 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). Strong commitment to maintaining inflation at 2 percent could control expectations of inflation.

The FOMC continues its efforts of increasing transparency that can improve the credibility of its firmness in implementing its dual mandate. Table IV-3 provides the views by participants of the FOMC of the levels at which they expect the fed funds rate in 2012, 2013, 2014 and the in the longer term. The table is inferred from a chart provided by the FOMC with the number of participants expecting the target of fed funds rate (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120125.pdf). There are 14 participants expecting the rate to remain at 0 to ¼ percent in 2012 and only three to be higher. Not much change is expected in 2013 either with 11 participants anticipating the rate at the current target of 0 to ¼ percent and only six expecting higher rates. The rate would still remain at 0 to ¼ percent in 2014 for six participants with five expecting the rate to be in the range of 0.5 to 1 percent and two participants expecting rates from 1 to 1.5 percent but only 4 with rates exceeding 2.5 percent. This table is consistent with the guidance statement of the FOMC that rates will remain at low levels until late in 2014.

Table IV-3, US, Views of Target Federal Funds Rate at Year-End of Federal Reserve Board Members and Federal Reserve Bank Presidents Participating in FOMC, January 25, 2012

	0 to 0.25	0.5 to 1.0	1.0 to 1.5	1.75 to 2.0	2.5 to 2.75	3.75 to 4.5
2012	14	1	2
2013	11	4		2
2014	6	5	2		4
Longer Run						17

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120125.pdf

Additional information is provided in Table IV-4 with the number of participants expecting increasing interest rates in the years from 2012 to 2016. It is evident from Table IV-4 that the prevailing view in the FOMC is for interest rates to continue at low levels in future years. This view is consistent with the economic projections of low economic growth, relatively high unemployment and subdued inflation provided in Table IV-2.

Table IV-4, US, Views of Appropriate Year of Increasing Target Federal Funds Rate of Federal Reserve Board Members and Federal Reserve Bank Presidents Participating in FOMC, January 25, 2012

Appropriate Year of Increasing Target Fed Funds Rate	Number of Participants
2012	3
2013	3
2014	5
2015	4
2016	2

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120125.pdf

Inflation in advanced economies has been moderating at the producer price level with moderation of the commodity price shock. Table IV-5 provides the month and 12-month percentage rates of inflation of Japan’s corporate goods price index (CGPI). Inflation measured by the CGPI fell 0.1 percent in Jan and increased 0.5 percent in 12 months. Measured by 12-month rates, CGPI inflation has increased from minus 0.2 percent in Jul 2010 to a high of 2.8 percent in Jul 2011 and now to much lower 0.5 percent in Dec 2012. Fiscal-year inflation for 2011 is 2.0 percent, which is the highest after declines in 2009 and 2010 but lower than 4.5 percent in the commodity shock driven by zero interest rates during the global recession in 2008. At the margin, annual equivalent inflation in the quarter Jul to Dec 2011 is minus 1.6 percent compared with annual equivalent inflation in Jan-Apr 2011 of 7.1 percent. Annual equivalent inflation in May-Jun 2011 was minus 1.2 percent. Annual equivalent inflation in Dec 2011 to Jan 2012 is minus 0.6 percent. Moderation of commodity price increases after May 2011 has caused collapse of monthly inflation toward zero or less with minus 0.1 percent in Jan. The CGPI of Japan follows the same pattern of inflation waves. Inflation was relatively high in the first four months of 2011 driven by the carry trade from zero interest rates to commodity futures and other risk financial assets. Risk aversion influenced by the European sovereign debt crisis after May caused reversal of long positions in commodity futures and other risk financial assets, causing declines in prices of commodities and raw materials.

Table IV-5, Japan Corporate Goods Price Index (CGPI) ∆%

	Month	Year
Jan 2012	-0.1	0.5
Dec 2011	0.0	1.2
AE ∆% Dec-Jan	-0.6
Nov	0.0	1.6
Oct	-0.8	1.6
Sep	-0.1	2.5
Aug	-0.2	2.6
Jul	0.2	2.8
AE ∆% Jul-Dec	-1.6
Jun	0.0	2.5
May	-0.2	2.2
AE ∆% May-Jun	-1.2
Apr	1.0	2.6
Mar	0.6	2.0
Feb	0.1	1.7
Jan	0.6	1.6
AE ∆% Jan-Apr	7.1
Dec 2010	0.4	1.2
Nov	0.0	0.9
Oct	0.2	0.9
Sep	0.0	-0.1
Aug	0.0	0.0
Jul	-0.1	-0.2
Fiscal Year
2011		2.0
2010		-0.1
2009		-5.2
2008		4.5

AE: annual equivalent

Source: http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1201.pdf

Further insight into inflation of the corporate goods price index (CGPI) of Japan is provided in Table IV-6. Manufactured products accounting for 91.9 percent of the products in the index fell 0.1 percent in Jan and increased 0.2 percent in 12 months. Petroleum and coal with weight of 5.4 percent rose 1.2 percent in Jan and increased 5.6 percent in 12 months. Japan exports manufactured products and imports raw materials and commodities such that the country’s terms of trade, or export prices relative to import prices, deteriorate during commodity price increases. In contrast, prices of machinery and equipment, with weight of 10.8 percent, were flat in Jan and fell 0.4 percent in 12 months. In general, most manufactured products experienced negative increases in prices while inflation rates were high in 12 months for products originating in raw materials and commodities. Ironically, unconventional monetary policy of zero interest rates and quantitative easing that intended to increase aggregate demand and GDP growth deteriorated the terms of trade of advanced economies

Table IV-6, Japan, Corporate Goods Prices and Selected Components, % Weights, Month and 12 Months ∆%

Jan 2012	Weight	Month ∆%	12 Month ∆%
Total	1000.0	-0.1	0.5
Mfg Industry Products	918.8	0.0	0.2
Processed Food	114.5	0.0	0.3
Petroleum & Coal	53.8	1.2	5.6
Machinery & Equipment	108.4	0.0	-0.4
Electric & Electronic	129.0	-0.3	-3.6
Electric Power, Gas & Water	46.5	-0.3	10.3
Iron & Steel	52.6	-0.6	1.1
Chemicals	85.2	0.2	1.9
Transport Equipment	10.6	0.1	-0.2

Source: http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1201.pdf

Percentage point contributions to change of the corporate goods price index (CGPI) in Dec 2011 are provided in Table IV-7 divided into domestic, export and import segments. Petroleum and coal contributed 0.08 percentage points and pulp, paper & related products 0.02 to domestic CGPI inflation that fell 0.1 percent because of deductions of 0.06 percentage points by agriculture, forestry & fishery, 0,04 by other manufacturing, 0.04 by iron & steel and 0.02 by information & communications equipment. The exports CGPI rose 0.3 percent on the basis of the contract currency and fell 0.6 percent on the basis of the yen with positive contributions of 0.32 percentage points by chemicals & related products, 0.19 by metals & related products and 0.12 by general machinery & equipment. Transportation equipment deducted 0.26 percentage points and electric & electronic products 0.17. The imports CGPI fell 1.0 percent on the contract currency basis and 1.9 percent on the yen basis. The most important contributions were deductions of 0.62 percentage points by petroleum, coal & natural gas and 0.34 by metals & related products.

Table IV-7, Japan, Percentage Point Contributions to Change of Corporate Goods Price Index

Groups Jan 2012	Contribution to Change Percentage Points
A. Domestic Corporate Goods Price Index	Monthly Change:  -0.1%
Agriculture, Forestry & Fishery	-0.06
Other Manufacturing	-0.04
Iron & Steel	-0.04
Information & Communications Equipment	-0.02
Petroleum & Coal Products	0.08
Pulp, Paper & Related Products	0.02
B. Export Price Index	Monthly Change:  0.3% contract currency basis -0.6% Yen basis
Chemicals & Related Products	0.32
Metals & Related Products	0.19
General Machinery & Equipment	0.12
Transportation Equipment	-0.26
Electric & Electronic Products	-0.17
C. Import Price Index	Monthly Change: -1.0 % contract currency basis -1.9% Yen basis
Petroleum, Coal & Natural Gas	-0.62
Metals & Related Products	-0.34
Foodstuffs & Feedstuffs	-0.07
General Machinery & Equipment	0.04

Source: http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1201.pdf

China is experiencing similar inflation behavior as the advanced economies, as shown in Table IV-8. Jan 2012 inflation of the price indexes for industry is minus 0.1 percent and 12 months inflation is only 0.7 percent. There were few drivers of inflation in Jan with most components in Table IV-8 falling on a monthly basis in row “Month Dec ∆%.” There were decreases of prices of mining & quarrying which fell 0.8 percent in Jan after increasing 6.1 percent in 12 months. Consumer goods increased 0.1 percent in Jan and 2.1 percent in 12 months. Prices of the various categories of inputs in the purchaser price index also fell in Jan after also falling in Nov and Oct. Only fuel and power increased 0.2 percent in Jan and 6.6 percent in 12 months.

Table IV-8, China, Price Indexes for Industry ∆%

	Month    Jan ∆%	12-Month Dec ∆%	Year 2012 ∆%
I Producer Price Indexes	-0.1	0.7	0.7
Means of Production	-0.1	0.3	0.3
Mining & Quarrying	-0.8	6.1	6.1
Raw Materials	0.2	1.7	1.7
Processing	-0.2	0.9	-0.9
Consumer Goods	0.1	2.1	2.1
Food	0.2	3.5	3.5
Clothing	0.1	3.1	3.1
Daily Use Articles	0.0	1.6	1.6
Durable Consumer Goods	0.2	-0.2	-0.2
II Purchaser Price Indexes	-0.3	2.0	2.0
Fuel and Power	0.2	6.6	6.6
Ferrous Metals	-1.1	-1.1	-1.1
Nonferrous Metals	-0.8	-2.5	-2.5
Raw Chemical Materials	-0.5	0.3	0.3
Wood & Pulp	-0.2	1.8	1.8
Building Materials	-0.4	2.5	2.5
Other Industrial Raw Materials	-0.1	1.0	1.0
Agricultural	0.0	3.9	3.9
Textile Raw Materials	-0.3	2.6	2.6

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20120209_402782975.htm

Producer price inflation in China was -0.7 percent in Jan and 0.7 percent in 12 months, as shown in Table IV-9. In the six months Jul-Dec 2011 annual equivalent inflation is minus 3.9 percent, slowing to -2.4 percent in annual equivalent in Dec to Jan. In contrast, in the first half of the year annual equivalent inflation was 20.4 percent. Inflation has fallen at the margin in China. Inflation worldwide is driven by inflation waves that abate during heightened risk aversion but is driven upward by the carry trade from zero interest rates to positions in commodity futures as analyzed in a past comment of this blog (http://cmpassocregulationblog.blogspot.com/2012/01/world-inflation-waves-united-states.html), which will be updated in the comment of next week.

Table IV-9, China, Month and 12-Month Rate of Change of Producer Price Index, ∆%

	12-Month ∆%	Month ∆%
Jan 2012	0.7	-0.1
Dec 2011	1.7	-0.3
AE ∆% Dec-Jan		-2.4
Nov	2.7	-0.7
Oct	5.0	-0.7
Sep	6.5	0.0
Aug	7.3	0.1
Jul	7.5	0.0
AE ∆% Jul-Dec		-3.9
Jun	7.1	0.0
May	6.8	0.3
Apr	6.8	0.5
Mar	7.3	0.6
Feb	7.2	0.8
Jan	6.6	0.9
AE ∆% Jan-Jun		20.4
Dec 2010	5.9	0.7

AE: Annual Equivalent

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20120209_402782975.htm

Chart IV-1 of the National Bureau of Statistics of China provides monthly and 12-month rates of inflation of the price indexes for the industrial sector. Negative monthly rates in Oct, Nov and Dec pulled down the 12 months rates to 5.0 percent in Oct, 2.7 percent in Nov and 1.7 percent in Dec. At the margin since Jun inflation had been almost zero to Sep and fell 0.7 percent in Oct, another 0.7 percent in Nov and 0.3 percent in Dec. In Jan 2012, further decline of producer prices by 0.1 percent lowered the 12-month rate to 0.7 percent.

Chart IV-1, China, Producer Prices for the Industrial Sector Month and 12 months ∆%

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20120209_402782975.htm

China is highly conscious of food price inflation because of its high weight in the basket of consumption of the population. Consumer price inflation in China in Jan was 1.5 percent and 4.5 percent in 12 months, as shown in Table IV-10. By far the highest increase occurred in food with increase of 4.2 percent in Jan and increase of 10.5 percent in the 12 months ending in Jan. Another area of concern is housing inflation of 0.2 percent in Jan and 1.9 percent in 12 months. Prices of services increased 0.8 percent in Jan and 2.2 percent in 12 months. In contrast with producer prices, there were increases in most components with the exception of decline of 0.1 percent in clothing but increase of 3.3 percent in the 12 months ending in Jan.

Table IV-10, China, Consumer Price Index

2012	Jan   Month   ∆%	Dec 12- Month  ∆%	Year 2011   ∆%
Consumer Prices	1.5	4.5	4.5
Urban	1.5	4.5	4.5
Rural	1.5	4.6	4.6
Food	4.2	10.5	10.5
Non-food	0.2	1.8	1.8
Consumer Goods	1.8	5.5	5.5
Services	0.8	2.2	2.2
Commodity Categories:
Food	4.2	10.5	10.5
Tobacco, Liquor	0.1	3.7	3.7
Clothing	-1.0	3.3	3.3
Household	0.4	2.6	2.6
Healthcare & Personal Articles	0.1	2.6	2.6
Transportation & Communication	0.4	0.2	0.2
Recreation, Education, Culture & Services	1.1	0.7	0.7
Residence	0.2	1.9	1.9

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20120209_402782970.htm

Month and 12-month rates of change of consumer prices are provided in Table IV-11. In contrast with producer prices, the annual equivalent rate of consumer price inflation rose from 2.0 percent in Apr to Jun to 3.0 percent in Jul to Dec and 11.3 percent in Dec to Jan. At the marginal monthly level, consumer prices are increasing at a relatively high rate of 3.0 percent to 11.3 percent compared with 8.3 percent in annual equivalent in Jan-Mar. Inflation waves accelerate in carry trades from zero interest rates to commodity futures positions when risk aversion diminishes. There are some internal price pressures of foods in China

Table IV-11, China, Month and 12-Month Rates of Change of Consumer Price Index ∆%

	Month ∆%	12-Month ∆%
Jan 2012	1.5	4.5
Dec 2011	0.3	4.1
AE ∆% Dec to Jan	11.3
Nov	-0.2	4.2
Oct	0.1	5.5
Sep	0.5	6.1
Aug	0.3	6.2
Jul	0.5	6.5
AE ∆% Jul to Dec	3.0
Jun	0.3	6.4
May	0.1	5.5
Apr	0.1	5.3
AE ∆% Apr to Jun	2.0	2.0
Mar	-0.2	5.4
Feb	1.2	4.9
Jan	1.0	4.9
AE ∆% Jan to Mar	8.3
Dec 2010	0.5	4.6

AE: Annual Equivalent

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20120209_402782970.htm

Chart IV-2 of the National Bureau of Statistics of China provides monthly and 12-month rates of consumer price inflation. In contrast with producer prices, consumer prices had not moderated at the monthly marginal rates. Consumer prices fell 0.2 percent in Nov after increasing only 0.1 percent in Oct but increased 0.3 percent in Dec and a high 1.5 percent in Jan.

Chart IV-2, China, Consumer Prices ∆% Month and 12 Months Aug 2010 to Aug 2011

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20120209_402782970.htm

The Statistiche Bundesamt Deutschland or Federal Statistical Agency of Germany confirmed that the consumer price index of Germany rose 2.3 percent in 2011 in relation to 2010, as shown in Table IV-12. The preliminary estimate of the consumer price index in Dec is now confirmed as an increase of 2.1 percent relative to Dec 2010. CPI inflation in Dec is confirmed at 0.7 percent “mainly due to seasonal factors” (http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2011/12/PE11__487__611,templateId=renderPrint.psml). Consumer prices fell 0.4 percent in Germany in Jan and also increased 2.1 percent in 12 months. Most inflation in Germany in 2011 concentrated in three months: 0.4 percent in Jul, 0.5 percent in Mar and 0.5 percent in Feb. A quarter composed of those three months repeated for an entire year would result in annual equivalent inflation of 5.8 percent. Annual equivalent inflation in Jul-Dec was at the annual equivalent rate of 2.4 percent, which is higher than the 12-month rate of 2.1 percent in Dec and Jan. Annual equivalent inflation in Dec-Jan is lower at 1.8 percent.

Table IV-12, Germany, Consumer Price Index ∆%

	12 Months ∆%	Month ∆%
Jan 2012	2.1	-0.4
Dec 2011	2.1	0.7
AE ∆% Dec-Jan		1.8
Nov	2.4	0.0
Oct	2.5	0.0
Sep	2.6	0.1
Aug	2.4	0.0
Jul	2.4	0.4
AE ∆% Jul-Dec		2.4
Jun	2.3	0.1
May	2.3	0.0
AE ∆% May-Jun		0.6
Apr	2.4	0.2
Mar	2.1	0.5
Feb	2.1	0.5
Jan	2.0	-0.4
AE ∆% Jan-Apr		2.4
Dec 2010	1.7	1.0
Nov	1.5	0.1
Oct	1.3	0.1
Sep	1.3	-0.1
Aug	1.0	0.0
Annual Average ∆%
2011	2.3
2010	1.1
2009	0.4
2008	2.6

AE: Annual Equivalent

Source: Statistiche Bundesamt Deutschland

http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2012/02/PE12__048__611,templateId=renderPrint.psml

Chart IV-3, of the Statistiche Bundesamt Deutschland, or Federal Statistical Agency of Germany, provides the unadjusted consumer price index of Germany from 2003 to 2012. There is an evident acceleration in the form of sharper slope in the first months of 2011 and then a flattening in more recent months with renewed strength in Dec but decline in Jan 2012. If risk aversion declines, new carry trades from zero interest rates to commodity futures could again result in higher inflation.

Chart IV-3, Germany, Consumer Price Index, Unadjusted, 2005=100

Source: Statistiche Bundesamt Deutschland

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

Chart IV-4 of the Statistiche Bundesamt Deutschland, or Federal Statistical Agency of Germany, provides the unadjusted consumer price index of Germany and trend from 2007 to 2012. Inflation moderated during the global recession but regained the sharper slope with the new carry trades from zero interest rates to commodity futures beginning in 2010.

Chart IV-4, Germany, Consumer Price Index, Unadjusted and Trend, 2005=100

Source: Statistiche Bundesamt Deutschland

http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/Prices/Content100/kpre510graf0.psml

Table IV-13 provides the monthly and 12-month rate of inflation for segments of the consumer price index in Jan 2012. Inflation excluding energy fell 0.5 percent in Jan 2012 and rose 1.8 percent in 12 months. Excluding household energy inflation fell 0.5 percent in Jan and rose 1.7 percent in 12 months. High increases in Germany’s consumer prices in Jan were 1.2 percent in nondurable consumer goods and 0.9 percent in food. There were also strong increases in energy-related prices. Heating oil rose 17.2 percent in 12 months and 3.9 percent in Jan. Motor fuels increased 2.7 percent in Jan and 6.4 percent in 12 months.

Table IV-13, Germany, Consumer Price Index ∆%

Jan 2012	Weight	12- Month ∆%	Month   ∆%
Total	1,000.00	2.1	-0.4
Excluding heating oil and motor fuels	955.42	1.8	-0.5
Excluding household energy	940.18	1.7	-0.5
Excluding Energy	904.81	1.5	-0.6
Total Goods	493.00	3.2	0.4
Nondurable Consumer Goods	305.11	4.2	1.2
Medium-Term Life Consumer Goods	95.24	2.0	-1.5
Durable Consumer Goods	92.65	0.3	0.0
Services	507.00	1.2	-1.2
Energy Components
Motor Fuels	35.37	6.4	2.7
Household Energy	59.82	7.7	1.5
Heating Oil	9.21	17.2	3.9
Food	89.99	2.7	0.9

Source: Statistiche Bundesamt Deutschland

http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2012/02/PE12__048__611,templateId=renderPrint.psml

Inflation in the UK is somewhat higher than in many advanced economies, deserving more detailed analysis. Table IV-14 provides 12-month percentage changes of UK output prices for all manufactured products, excluding food, beverage and petroleum and excluding duty. The 12-month rates rose significantly in 2011 in all three categories, reaching 6.3 percent for all manufactured products in Sep 2011 but declining to 5.7 percent in Oct, 5.4 percent in Nov, 4.8 percent in Dec and 4.1 percent in Jan. Output price inflation is highly sensitive to commodity prices as shown by the increase by 6.7 percent in 2008 when oil prices rose over $140/barrel even in the midst of a global recession driven by the carry trade from zero interest rates to oil futures. The mirage episode of false deflation in 2001 and 2002 is also captured by the output prices for the UK, which was originated in decline of commodity prices but was used as an argument for the unconventional monetary policy of zero interest rates and quantitative easing during the past decade.

Table IV-14, UK Output Prices 12 Months ∆% NSA

	All Manufactured Products	Excluding Food, Beverage and Petroleum	All Excluding Duty
Jan 2012	4.1	2.4	4.1
Dec 2011	4.8	3.0	4.8
Nov	5.4	3.1	5.6
Oct	5.7	3.3	5.9
Sep	6.3	3.7	6.4
Aug	6.0	3.5	6.2
Jul	6.1	3.4	6.2
Jun	5.8	3.2	5.9
May	5.4	3.4	5.5
Apr	5.6	3.6	5.8
Mar	5.6	3.1	5.5
Feb	5.3	3.1	5.2
Jan	5.0	3.3	5.0
Dec 2010	4.2	2.7	4.0
Year ∆%		Ex Food
2010	4.2	3.0	3.9
2009	1.6	2.5	0.9
2008	6.7	3.7	6.7
2007	2.3	1.4	2.1
2006	2.0	1.5	2.0
2005	1.9	1.0	1.9
2004	1.0	-0.3	0.6
2003	0.6	0.1	0.5
2002	-0.1	-0.4	-0.3
2001	-0.3	-0.6	-1.1
2000	1.4	-0.5	0.8
1999	0.6	-0.9	-0.3

Source: http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/january-2012/index.html

Monthly and annual equivalent rates of change of output prices are shown in Table IV-15. There has been significant deceleration of output price inflation from an annual equivalent rate of 12.0 percent in Jan-Apr to 1.5 percent annual equivalent in May-Dec. There was monthly inflation in all three measurements of UK’s output prices in Jan 2012. An important characteristic is that output prices excluding food, beverage and petroleum decelerated from an annual equivalent rate of change of 6.5 percent in Jan-Apr to 1.4 percent in May-Nov and only 0.4 percent in Nov-Jan. Another important characteristic is that prices in all three measurements rose in each and every month of 2011 with the exception of the decline by 0.1 percent in Oct, Nov and Dec for the index excluding food, beverage and petroleum and decreases in all three indexes in Dec. Data in the tables include all revisions.

Table IV-15, UK Output Prices Month ∆% NSA

	All Manufactured Products	Excluding Food, Beverage and Petroleum	All Excluding Duty
Jan 2012	0.5	0.3	0.4
Dec 2011	-0.2	-0.1	-0.2
Nov	0.2	-0.1	0.2
Nov-Jan ∆% AE	2.0	0.4	1.6
Oct	0.0	-0.1	0.1
Sep	0.3	0.3	0.2
Aug	0.0	0.1	0.1
Jul	0.3	0.4	0.3
Jun	0.2	0.2	0.2
May	0.2	0.2	0.2
May-Dec ∆% AE	1.5	1.4	1.7
Apr	1.1	0.8	0.9
Mar	1.1	0.5	1.1
Feb	0.5	0.0	0.5
Jan	1.1	0.8	1.1
Jan-Apr ∆% AE	12.0	6.5	7.1
Dec 2010	0.5	0.0	0.6

Source: http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/january-2012/index.html

Input prices in the UK have been more dynamic than output prices, as shown by Table IV-16. The 12-month rates of increase of input prices, even excluding food, tobacco, beverages and petroleum, are very high, reaching 18.0 percent in Sep 2011 for materials and fuels purchased and 13.2 percent excluding food, beverages and petroleum. Inflation in 12 months of materials and fuels purchased moderated to 8.7 percent in Dec 2011 and 7.3 percent excluding food, tobacco, beverages and petroleum. There was further moderation to 7.0 percent in Jan 2012 for materials and fuel purchased and 5.4 percent excluding food, tobacco and petroleum. There is only comparable experience with 22.2 percent inflation of materials and fuels purchased in 2008 and 16.9 percent excluding food, beverages and petroleum. UK input and output inflation is sensitive to commodity price increases driven by carry trades from zero interest rates. The mirage of false deflation is also observed in input prices in 1999 and then again from 2001 to 2003.

Table IV-16, UK Input Prices 12 Months ∆% NSA

	Materials and Fuels Purchased	Excluding Food, Tobacco, Beverages and Petroleum
Jan 2012	7.0	5.4
Dec 2011	8.9	7.3
Nov	13.8	10.2
Oct	14.5	11.0
Sep	18.1	13.3
Aug	16.3	13.0
Jul	18.5	13.3
Jun	16.8	12.6
May	16.3	11.4
Apr	17.9	12.2
Mar	14.8	10.3
Feb	14.9	10.7
Jan	14.2	10.5
Dec 2010	13.1	9.0
Year ∆%
2010	9.9	5.7
2009	-3.8	1.6
2008	22.2	16.9
2007	2.9	2.3
2006	9.8	7.3
2005	10.9	6.9
2004	3.3	1.6
2003	1.2	-0.6
2002	-4.4	-4.8
2001	-1.2	-1.2
2000	7.4	3.7
1999	-1.3	-3.6

Source: http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/january-2012/index.html

Table IV-17 provides monthly percentage changes of UK input prices for materials and fuels purchased and excluding food, tobacco, beverages and petroleum. The carry trade from zero interest rates to commodity futures drove input price inflation to annual equivalent 35.6 percent in Jan-Apr 2011 with input price inflation excluding food, tobacco, beverages and petroleum at annual equivalent of 17.8 percent in Jan-Apr. Risk aversion originating in the sovereign debt crisis in Europe caused unwinding of carry trades with annual equivalent inflation in May-Dec of input price inflation of minus 2.6 percent but a high 2.4 percent excluding foods, tobacco, beverages and petroleum. In Nov to Jan, annual equivalent inflation of materials and fuels purchased turned positive at 1.2 percent while excluding food, tobacco, beverages and petroleum turned negative at 2.4 percent.

Table IV-17, UK Input Prices Month ∆% 

	Materials and Fuels Purchased NSA	Excluding Food, Tobacco, Beverages and Petroleum SA
Jan 2012	0.5	-0.2
Dec 2011	-0.6	-0.6
Nov	0.4	0.2
Nov-Jan ∆% AE	1.2	-2.4
Oct	-0.8	-0.5
Sep	2.1	0.7
Aug	-1.9	0.2
Jul	0.6	0.8
Jun	0.1	0.9
May	-1.6	-0.1
May-Dec ∆% AE	-2.6	2.4
Apr	2.8	1.9
Mar	3.8	0.9
Feb	1.4	1.2
Jan	2.3	1.5
Jan-Apr ∆% AE	35.6	17.8
Dec 2010	3.9	1.9

Source: http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/january-2012/index.html

The UK Office for National Statistics also provides contributions in percentage points to the monthly and 12-month rates of inflation of manufactured products, shown in Table IV-18. Petroleum is the second largest contributor with 0.86 percentage points to the 12-month rate behind 0.81 percentage points contributed by food products. There are diversified sources of contributions to 12 months output price inflation such as 0.56 percentage points by clothing, textile and leather and 0.11 percentage points by chemical and pharmaceutical. In general, contributions by products rich in commodities are the drivers of inflation. Petroleum was also the second most important contributor to monthly output prices with 0.14 percentage points behind 0.18 percentage points by tobacco and alcohol.

Table IV-18, Contributions to Month and 12-Month Change in Prices of All Manufactured Products, Percentage Points

Dec 2011	12 Months % Points	12 Months ∆%	Month  % Points	Month ∆%
Total %	4.1	4.1	0.5	0.5
Food Products	0.87	5.5	0.00	0.1
Tobacco & Alcohol	0.81	7.8	0.18	1.6
Clothing, Textile & Leather	0.56	5.1	0.08	0.7
Paper and Printing	0.12	3.1	0.01	0.3
Petroleum	0.86	7.5	0.14	1.1
Chemical & Pharmaceutical	0.11	1.3	0.02	0.3
Metal, Machinery & Equipment	0.11	3.0	-0.01	-0.3
Computer, Electrical & Optical	0.01	0.1	0.02	0.3
Transport Equipment	0.13	1.3	0.01	0.0
Other Manufactured Products	0.53	3.1	0.04	0.2

Source: http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/january-2012/stb-producer-price-index---january-2012.html

The UK Office for National Statistics also provides contributions in percentage points to the monthly and 12-month rates of inflation of input prices, shown in Table IV-19. Crude oil is the large contributor with 4.04 percentage points to the 12-month rate and 0.60 percentage points to the monthly rate in Jan. Inflation also transfers to the domestic economy through the prices of imported inputs.

Table IV-19, UK, Contributions to Month and 12-Month Change in Prices of Inputs, Percentage Points

Dec 2011	12 Months % Points	12 Months ∆%	Month % Points	Month ∆%
Total	7.0	7.6	0.5	0.5
Fuel	0.78	8.1	-0.21	-2.0
Crude Oil	4.04	15.7	0.60	2.1
Domestic Food Materials	0.28	2.7	0.02	0.2
Imported Food Materials	0.28	5.1	0.04	0.7
Other Domestic Produced Materials	0.11	2.6	0.01	0.2
Imported Metals	-0.19	-2.3	0.04	0.5
Imported Chemicals	0.42	3.7	-0.01	-0.1
Imported Parts and Equipment	0.61	3.9	0.06	0.4
Other Imported Materials	0.68	6.8	-0.06	-0.5

Source: http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/january-2012/stb-producer-price-index---january-2012.html

 

© Carlos M. Pelaez, 2010, 2011, 2012