Mediocre Growth with High Unemployment and Underemployment, United States Housing, Global Financial and Economic Risk and World Economic Slowdown
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011, 2012
Executive Summary
I Mediocre Economic Growth
II United States Housing
IIA United States New House Sales
IIB United States House Prices
IIIC Factors of US Housing Collapse
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
ESI Mediocre Economic Growth. In the four quarters of 2011 and the first quarter of 2012, US real GDP grew at the seasonally-adjusted annual equivalent rates of 0.4 percent in the first quarter of 2011 (IQ2011), 1.3 percent in IIQ2011, 1.8 percent in IIIQ2011, 3.0 percent in IVQ2011 and 2.2 percent in IQ2012. The annual equivalent rate of growth of GDP for the three final quarters of 2011 and the first quarter of 2012 is 2.1 percent, obtained as follows. Discounting 1.3 percent to one quarter is 0.32 percent {[(1.013)1/4 – 1]100}; discounting 1.8 percent to one quarter is 0.45 percent {[(1.018)1/4 – 1]100}; discounting 3.0 percent to one quarter is 0.742 {[(1.03)1/4 -1]100; and discounting 2.2 percent to one quarter is 0.55 percent {(1.022)1/4 -1]100). Real GDP growth in the four quarters of 2011 and the first quarter of 2012 accumulated to 2.1 percent {[(1.0032 x 1.0045 x 1.00742 x 1.00546)-1]100 = 2.1%}. This is equivalent to growth from IQ2011 to IQ2012 obtained by dividing the seasonally-adjusted annual rate (SAAR) of IQ2012 of $13,502.4 billion by the SAAR of IQ2011 of $13,227.9 (http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1 and Table ESIII-1 below) and expressing as percentage {[($13,502.4/$13,227.9)-1]100 = 2.1%}. The growth rate in annual equivalent for the four quarters of 2011 and the first quarter of 2012 is 1.7 percent {[(1.001 x 1.0032 x 1.0045 x 1.00742 x 1.00546)4/5 -1]100 =1.7%], or {[($13,502.4/$13,216.1)4/5 -1]100 = 1.7%} dividing the SAAR of IQ2012 by the SAAR of IVQ2010 in Table ESIII-1 below, obtaining the average for five quarters and the annual average for one year of four quarters. The US economy is still close to a standstill especially considering the GDP report in detail. The Bureau of Economic Analysis (BEA) of the US Department of Commerce released on Fri Apr 27, 2012, the first estimate of GDP for IQ2012 at 2.2 percent seasonally-adjusted annual rate (SAAR) (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp1q12_adv.pdf).
Characteristics of the four cyclical contractions are provided in Table ESI-1 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.8 percent, which is almost equal to the decline of 5.1 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). The comparison of the global recession after 2007 with the Great Depression is entirely misleading.
Table ESI-1, US, Number of Quarters, Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions
| Number of Quarters | Cumulative Percentage Contraction | Average Percentage Rate | |
| IIQ1953 to IIQ1954 | 4 | -2.5 | -0.63 |
| IIIQ1957 to IIQ1958 | 3 | -3.1 | -9.0 |
| IQ1980 to IIIQ1980 | 2 | -2.2 | -1.1 |
| IIIQ1981 to IVQ1982 | 4 | -2.7 | -0.67 |
| IVQ2007 to IIQ2009 | 6 | -5.1 | -0.87 |
Source: Business Cycle Reference Dates: http://www.nber.org/cycles/cyclesmain.html
Data: http://www.bea.gov/iTable/index_nipa.cfm
Table ESI-2 shows the extraordinary contrast between the mediocre average annual equivalent growth rate of 2.4 percent of the US economy in the eleven quarters of the current cyclical expansion from IIIQ2009 to IQ2012 and the average of 6.2 percent in the four earlier cyclical expansions. The BEA data for the four quarters of 2011 show the economy in standstill with annual growth of 1.6 percent with growth increasing to 2.1 percent from IQ2011 to IQ2012. The expansion of IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent.
Table ESI-2, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions
| Number | Cumulative Growth ∆% | Average Annual Equivalent Growth Rate | |
| IIIQ 1954 to IQ1957 | 11 | 12.6 | 4.4 |
| IIQ1958 to IIQ1959 | 5 | 10.2 | 8.1 |
| IIQ1975 to IVQ1976 | 8 | 9.5 | 4.6 |
| IQ1983 to IV1985 | 13 | 19.6 | 5.7 |
| Average Four Above Expansions | 6.2 | ||
| IIIQ2009 to IQ2012 | 11 | 6.8 | 2.4 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart ESI-1 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.
Chart ESI-1, US, Real GDP, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart ESI-2 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2012. The economy has underperformed during the first eleven quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.
Chart ESI-2, US, Real GDP, 2007-2012
Source: http://www.bea.gov/iTable/index_nipa.cfm
ESII GDP Growth Path. As shown in tables ESI-1 and ESI-2 above the loss of real GDP in the US during the contraction was 5.1 percent but the gain in the cyclical expansion has been only 6.8 percent (last row in Table ESI-2). As a result, the level of real GDP in IQ2012 with the first estimate is only higher by 1.3 percent than the level of real GDP in IVQ2007. Table ESII-1 provides in the second column real GDP in billions of chained 2005 dollars. The third column provides the percentage change of the quarter relative to IVQ2007; the fourth column provides the percentage change relative to the prior quarter; and the final fifth column provides the percentage change relative to the same quarter a year earlier. The contraction actually concentrated in two quarters: decline of 2.3 percent in IVQ2008 relative to the prior quarter and decline of 1.7 percent in IQ2009 relative to IVQ2008. The combined fall of GDP in IVQ2008 and IQ2009 was 4.0 percent (1.023 x 1.017). Those two quarters coincided with the worst effects of the financial crisis. GDP fell 0.2 percent in IIQ2009 but grew 0.4 percent in IIIQ2009, which is the beginning of recovery in the cyclical dates of the NBER. Most of the recovery occurred in three successive quarters from IVQ2009 to IIQ2010 of equal growth at 0.9 percent for cumulative growth in those three quarters of 2.7 percent. The economy lost momentum already in IIIQ2010 and IVQ2010 growing at 0.6 percent in each quarter, or annual equivalent 2.4 per cent combining the two quarters in annual equivalent rate {(1.006 x 1.006)2}. The economy then stalled during the first half of 2011 with growth of 0.1 percent in IQ2011 and 0.33 percent in IIQ2011 for combined annual equivalent rate of 0.86 percent {(1.001 x 1.0033)2}. The economy grew 0.045 percent in IIIQ2011 for annual equivalent growth of 1.12 percent in the first three quarters {(1.001 x 1.0033 x 1.0045)4/3}. Growth picked up in IVQ2011 with 0.69 percent relative to IIIQ2011. Growth in a quarter relative to a year earlier in Table ESIII-1 slows from over 3 percent during three consecutive quarters from IIQ2010 to IVQ2010 to 2.2 percent in IQ2011, 1.6 percent in IIQ2011, 1.5 percent in IIIQ2011 and 1.6 percent in IVQ2011. The revision of the seasonally-adjusted annual rate in IIQ2011 from 1.0 percent to 1.3 percent merely increases growth in IIQ2011 relative to IQ2011 from 0.25 percent to 0.33 percent. There is stronger quarterly growth in IIIQ2011 of 0.45 percent even with the downward revision of the third estimate. Growth in IIQ2011 relative to IIQ2010 and in IIIQ2011 relative to IIIQ2010 remains at the mediocre rates of 1.6 percent and 1.5 percent, respectively, with 1.6 percent in IVQ2011. As shown below, growth of 0.7 percent in IVQ2011 was partly driven by inventory accumulation. In IQ2012, GDP grew 0.5 percent relative to IVQ2011 and 2.1 percent relative to IQ2011. The critical question for which there is not yet definitive solution is whether what lies ahead is continuing growth recession with the economy crawling and unemployment/underemployment at extremely high levels or another contraction or conventional recession. Forecasts of various sources continued to maintain high growth in 2011 without taking into consideration the continuous slowing of the economy in late 2010 and the first half of 2011. The sovereign debt crisis in the euro area is one of the common sources of doubts on the rate and direction of economic growth in the US but there is weak internal demand in the US with almost no investment and spikes of consumption driven by burning saving because of financial repression forever in the form of zero interest rates.
Table ESII-1, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%
| Real GDP, Billions Chained 2005 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| IVQ2007 | 13,326.0 | NA | NA | 2.2 |
| IQ2008 | 13,266.8 | -0.4 | -0.4 | 1.6 |
| IIQ2008 | 13,310.5 | -0.1 | 0.3 | 1.0 |
| IIIQ2008 | 13,186.9 | -1.0 | -0.9 | -0.6 |
| IVQ2008 | 12,883.5 | -3.3 | -2.3 | -3.3 |
| IQ2009 | 12,663.2 | -4.9 | -1.7 | -4.5 |
| IIQ2009 | 12,641.3 | -5.1 | -0.2 | -5.0 |
| IIIQ2009 | 12,694.5 | -4.7 | 0.4 | -3.7 |
| IV2009 | 12,813.5 | -3.8 | 0.9 | -0.5 |
| IQ2010 | 12,937.7 | -2.9 | 0.9 | 2.2 |
| IIQ2010 | 13,058.5 | -2.0 | 0.9 | 3.3 |
| IIIQ2010 | 13,139.6 | -1.4 | 0.6 | 3.5 |
| IVQ2010 | 13,216.1 | -0.8 | 0.6 | 3.1 |
| IQ2011 | 13,227.9 | -0.7 | 0.1 | 2.2 |
| IIQ2011 | 13,271.8 | -0.4 | 0.3 | 1.6 |
| IIIQ2011 | 13,331.6 | 0.04 | 0.5 | 1.5 |
| IV2011 | 13,429.0 | 0.8 | 0.7 | 1.6 |
| IQ2012 | 13,502.4 | 1.3 | 0.5 | 2.1 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
ESIII Factors of GDP Growth and Deceleration. The Bureau of Economic Analysis (BEA) (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp1q12_adv.pdf 1) explains growth of GDP in IQ2012 in terms of positive growth contributions shown in Table ESIII-1:
· Personal consumption expenditures (PCE) growing at 2.9 percent with consumption of durable goods growing at 15.3 percent
· Private inventory investment of 0.59 percentage points
· Exports growing at 5.4 percent
· Residential fixed investment (RFI) growing at 19.1 percent
There were negative contributions:
· Federal government spending (Federal GOV) declining at 5.6 percent
· Nonresidential fixed investment declining at 2.1 percent
· State and local government spending (State/Local GOV) falling at 1.2 percent
· Imports, which are deduction from growth, growing at 4.3 percent
The BEA explains deceleration in real GDP in IQ2012 by:
· Deceleration in private inventory investment from 1.81 percentage points in IVQ2011 to 0.59 percentage points in IQ2012
· Contraction of nonresidential fixed investment (RFI) from growth of 5.2 percent in IVQ2011 to minus 2.1 percent in IQ2012
· Acceleration in the growth rate of imports from 3.7 percent in IVQ2011 to 4.3 percent in IQ2012
Table ESIII-1, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%
| Real GDP, Billions Chained 2005 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| IVQ2007 | 13,326.0 | NA | NA | 2.2 |
| IQ2008 | 13,266.8 | -0.4 | -0.4 | 1.6 |
| IIQ2008 | 13,310.5 | -0.1 | 0.3 | 1.0 |
| IIIQ2008 | 13,186.9 | -1.0 | -0.9 | -0.6 |
| IVQ2008 | 12,883.5 | -3.3 | -2.3 | -3.3 |
| IQ2009 | 12,663.2 | -4.9 | -1.7 | -4.5 |
| IIQ2009 | 12,641.3 | -5.1 | -0.2 | -5.0 |
| IIIQ2009 | 12,694.5 | -4.7 | 0.4 | -3.7 |
| IV2009 | 12,813.5 | -3.8 | 0.9 | -0.5 |
| IQ2010 | 12,937.7 | -2.9 | 0.9 | 2.2 |
| IIQ2010 | 13,058.5 | -2.0 | 0.9 | 3.3 |
| IIIQ2010 | 13,139.6 | -1.4 | 0.6 | 3.5 |
| IVQ2010 | 13,216.1 | -0.8 | 0.6 | 3.1 |
| IQ2011 | 13,227.9 | -0.7 | 0.1 | 2.2 |
| IIQ2011 | 13,271.8 | -0.4 | 0.3 | 1.6 |
| IIIQ2011 | 13,331.6 | 0.04 | 0.5 | 1.5 |
| IV2011 | 13,429.0 | 0.8 | 0.7 | 1.6 |
| IQ2012 | 13,502.4 | 1.3 | 0.5 | 2.1 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
ESIV Shares in National Income by Industry. Table ESIV-1 provides national income by industry without capital consumption adjustment (WCCA). Private industries have share of 85.9 percent in US national income. Most of US national income is in the form of services. In Mar 2012, there were 132.0 million nonfarm jobs in the US, according to estimates of the establishment survey of the Bureau of Labor Statistics (BLS) (http://www.bls.gov/news.release/pdf/empsit.pdf Table B-1, 28). Total private jobs of 108.9 million accounted for 82.9 percent of total nonfarm jobs, of which 11.8 million, or 10.8 percent of total private jobs and 8.9 million of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 91.7 million, or 69.5 percent of total nonfarm jobs and 84.2 percent of total private-sector jobs. Manufacturing has share of 10.0 in US national income, as shown in Table ESIV-1. Most income in the US originates in services. Subsidies and similar measures designed to increase manufacturing jobs will not increase economic growth and employment and may actually reduce growth by diverting resources away from currently employment-creating activities in services because of the drain of taxation.
Table ESIV-1, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total
| SAAR IVQ2011 | % Total | |
| National Income WCCA | 13,332.0 | 100.0 |
| Domestic Industries | 13,105.7 | 98.3 |
| Private Industries | 11,458.8 | 85.9 |
| Agriculture | 133.1 | 1.0 |
| Mining | 170.9 | 1.3 |
| Utilities | 169.3 | 1.3 |
| Construction | 544.5 | 4.1 |
| Manufacturing | 1330.9 | 10.0 |
| Durable Goods | 770.8 | 5.8 |
| Nondurable Goods | 560.1 | 4.2 |
| Wholesale Trade | 764.2 | 5.7 |
| Retail Trade | 906.1 | 6.8 |
| Transportation & WH | 372.0 | 2.8 |
| Information | 441.2 | 3.3 |
| Finance, insurance, RE | 2452.9 | 18.4 |
| Professional, BS | 1893.8 | 14.2 |
| Education, Health Care | 1370.8 | 10.3 |
| Arts, Entertainment | 519.1 | 3.9 |
| Other Services | 390.2 | 2.9 |
| Government | 1646.9 | 12.4 |
| Rest of the World | 226.3 | 1.7 |
Notes: SSAR: Seasonally-Adjusted Annual Rate; WCCA: Without Capital Consumption Adjustment by Industry; WH: Warehousing; RE, includes rental and leasing: Real Estate; Art, Entertainment includes recreation, accommodation and food services; BS: business services
Sources: http://www.bea.gov/iTable/index_nipa.cfm
ESV US New House Sales. The depressed level of residential construction and new house sales in the US is evident in Table ESV-1 providing new house sales not seasonally adjusted in Jan-Mar of various years. Sales of new houses in Jan-Mar 2012 are substantially lower than in any year between 1995 and 2012. There is only an increase of 16.9 percent between Jan-Mar 2011 and Jan-Mar 2012 that will likely disappear as the year proceeds. Sales of new houses in 2012 are lower by 4.6 percent in relation to 2010 and 1.2 percent below the level in 2009. The housing boom peaked in 2005 and 2006 when increases in fed funds rates affected subprime mortgages that were programmed for refinancing in two or three years on the expectation that price increases forever would raise home equity. Higher home equity would permit refinancing under feasible mortgages incorporating full payment of principal and interest (Gorton 2009EFM; see other references in http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Sales of new houses in Jan-Mar 2012 relative to the same period in 2005 fell 74.7 percent and 70.9 percent relative to the same period in 2006. Similar percentage declines are also observed for 2012 relative to years from 2000 to 2004. Sales of new houses in Jan-Mar 2012 fell 46.1 per cent relative to the same period in 1995. The population of the US was 179.3 million in 1960 and 281.4 million in 2000 (Hoobs and Snoops 2012, 16). Detailed historical census reports are available from the US Census Bureau at (http://www.census.gov/population/www/censusdata/hiscendata.html). The US population reached 308.7 million in 2010 (http://2010.census.gov/2010census/data/). The US population increased by 129.4 million from 1960 to 2010 or 72.2 percent. The final row of Table ESV-1 reveals catastrophic data: sales of new houses in Jan-Mar 2012 of 83 thousand units are lower by 31.4 percent relative to 121 thousand units houses sold in Jan-Mar 1963, the first year when data become available, while population increased 72.2 percent.
Table ESV-1, US, Sales of New Houses Not Seasonally Adjusted, Thousands and %
| Not Seasonally Adjusted Thousands | |
| Jan-Mar 2012 | 83 |
| Jan-Mar 2011 | 71 |
| ∆% | 16.9 |
| Jan-Mar 2010 | 87 |
| ∆% Jan-Mar 2012/ | -4.6 |
| Jan-Mar 2009 | 84 |
| ∆% Jan-Mar 2012/ | -1.2 |
| Jan-Mar 2008 | 141 |
| ∆% Jan-Mar 2012/ | -41.1 |
| Jan-Mar 2007 | 214 |
| ∆% Jan-Mar 2012/ | -61.2 |
| Jan-Mar 2006 | 285 |
| ∆% Jan-Mar 2012/Jan-Mar 2006 | -70.9 |
| Jan-Mar 2005 | 328 |
| ∆% Jan-Mar 2012/Jan-Mar 2005 | -74.7 |
| Jan-Mar 2004 | 314 |
| ∆% Jan-Mar 2012/Jan-Mar 2004 | -73.6 |
| Jan-Mar 2003 | 256 |
| ∆% Jan-Mar 2012/ | -67.6 |
| Jan-Mar 2002 | 240 |
| ∆% Jan-Mar 2012/ | -65.4 |
| Jan-Mar 2001 | 251 |
| ∆% Jan-Mar 2012/ | -66.9 |
| Jan-Mar 2000 | 233 |
| ∆% Jan-Mar 2012/ | -64.4 |
| Jan-Mar 1995 | 154 |
| ∆% Jan-Mar 2012/ | -46.1 |
| Jan-Mar 1963 | 121 |
| ∆% Jan-Mar 2012/ | -31.4 |
Source: http://www.census.gov/construction/nrs/
Table ESV-2 provides the entire available annual series of new house sales from 1963 to 2011. The revised level of 306 thousand new houses sold in 2011 is the lowest since 560,000 in 1963 in the 48 years of available data. In that period, the population of the US increased 129.4 million from 179.3 million in 1960 to 308.7 million in 2010, or 72.2 percent. In fact, there is no year from 1963 to 2010 in Table ESV-2 with sales of new houses below 400 thousand with the exception of the immediately preceding years of 2009 and 2010.
Table ESV-2, US, New Houses Sold, NSA Thousands
| 1963 | 560 |
| 1964 | 565 |
| 1965 | 575 |
| 1966 | 461 |
| 1967 | 487 |
| 1968 | 490 |
| 1969 | 448 |
| 1970 | 485 |
| 1971 | 656 |
| 1972 | 718 |
| 1973 | 634 |
| 1974 | 519 |
| 1975 | 549 |
| 1976 | 646 |
| 1977 | 819 |
| 1978 | 817 |
| 1979 | 709 |
| 1980 | 545 |
| 1981 | 436 |
| 1982 | 412 |
| 1983 | 623 |
| 1984 | 639 |
| 1985 | 688 |
| 1986 | 750 |
| 1987 | 671 |
| 1988 | 676 |
| 1989 | 650 |
| 1990 | 534 |
| 1991 | 509 |
| 1992 | 610 |
| 1993 | 666 |
| 1994 | 670 |
| 1995 | 667 |
| 1996 | 757 |
| 1997 | 804 |
| 1998 | 886 |
| 1999 | 880 |
| 2000 | 877 |
| 2001 | 908 |
| 2002 | 973 |
| 2003 | 1,086 |
| 2004 | 1,203 |
| 2005 | 1,283 |
| 2006 | 1,051 |
| 2007 | 776 |
| 2008 | 485 |
| 2009 | 375 |
| 2010 | 323 |
| 2011 | 306 |
Source: http://www.census.gov/construction/nrs/
Percentage changes and average rates of growth of new house sales for selected periods are shown in Table ESV-3. The percentage change of new house sales from 1963 to 2011 is minus 45.4 percent. Between 1991 and 2001, sales of new houses rose 78.4 percent at the average yearly rate of 5.9 percent. Between 1995 and 2005 sales of new houses increased 92.4 percent at the yearly rate of 6.8 percent. There are similar rates in all years from 2000 to 2004. The boom in housing construction and sales began in the 1980s and 1990s. The collapse of real estate culminated several decades of housing subsidies and policies to lower mortgage rates and borrowing terms (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009b), 42-8). Sales of new houses sold in 2011 fell 54.1 percent relative to the same period in 1995.
Table ESV-3, US, Percentage Change and Average Yearly Rate of Growth of Sales of New One-Family Houses
| ∆% | Average Yearly % Rate | |
| 1963-2011 | -45.4 | NA |
| 1991-2001 | 78.4 | 5.9 |
| 1995-2005 | 92.4 | 6.8 |
| 2000-2005 | 46.3 | 7.9 |
| 1995-2011 | -54.1 | NA |
| 2000-2011 | -65.1 | NA |
| 2005-2011 | -76.1 | NA |
NA: Not Applicable
Source: http://www.census.gov/construction/nrs/
ESVI Global Financial and Economic Risk. The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task both for theory and measurement. The IMF provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2012/update/01/index.htm), of the world financial system with its Global Financial Stability Report (GFSR) (http://www.imf.org/external/pubs/ft/fmu/eng/2012/01/index.htm) and of fiscal affairs with the Fiscal Monitor (http://www.imf.org/external/pubs/ft/fm/2012/update/01/fmindex.htm). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider a summary of global economic and financial risks, which are analyzed in detail in the comments of this blog in Section VI Valuation of Risk Financial Assets, Table VI-4.
Economic risks include the following:
1. China’s Economic Growth. China is lowering its growth target to 7.5 percent per year. The growth rate of GDP of China in the first quarter of 2012 of 1.8 percent is equivalent to 7.4 percent per year
2. United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 30.5 million in job stress, fewer 10 million full-time jobs, high youth unemployment, historically-low hiring and declining real wages.
3. Economic Growth and Labor Markets in Advanced Economies. Advanced economies are growing slowly. There is still high unemployment in advanced economies.
4. World Inflation Waves. Inflation continues in repetitive waves globally (see Section I Inflation Waves at http://cmpassocregulationblog.blogspot.com/2012/03/global-financial-and-economic-risk.html).
A list of financial uncertainties includes:
1. Euro Area Survival Risk. The resilience of the euro to fiscal and financial doubts on larger member countries is still an unknown risk.
2. Foreign Exchange Wars. Exchange rate struggles continue as zero interest rates in advanced economies induce devaluation of their currencies.
3. Valuation of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with lower volumes.
4. Duration Trap of the Zero Bound. The yield of the US 10-year Treasury rose from 2.031 percent on Mar 9, 2012, to 2.294 percent on Mar 16, 2012. Considering a 10-year Treasury with coupon of 2.625 percent and maturity in exactly 10 years, the price would fall from 105.3512 corresponding to yield of 2.031 percent to 102.9428 corresponding to yield of 2.294 percent, for loss in a week of 2.3 percent but far more in a position with leverage of 10:1. Min Zeng, writing on “Treasurys fall, ending brutal quarter,” published on Mar 30, 2012, in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303816504577313400029412564.html?mod=WSJ_hps_sections_markets), informs that Treasury bonds maturing in more than 20 years lost 5.52 percent in the first quarter of 2012.
5. Credibility and Commitment of Central Bank Policy. There is a credibility issue of the commitment of monetary policy (Sargent and Silber 2012Mar20).
6. Carry Trades. Commodity prices driven by zero interest rates have resumed their increasing path
It is in this context of economic and financial uncertainties that decisions on portfolio choices of risk financial assets must be made. There is a new carry trade that learned from the losses after the crisis of 2007 or learned from the crisis how to avoid losses. The sharp rise in valuations of risk financial assets shown in Table VI-1 in the text after the first policy round of near zero fed funds and quantitative easing by the equivalent of withdrawing supply with the suspension of the 30-year Treasury auction was on a smooth trend with relatively subdued fluctuations. The credit crisis and global recession have been followed by significant fluctuations originating in sovereign risk issues in Europe, doubts of continuing high growth and accelerating inflation in China now complicated by political developments, events such as in the Middle East and Japan and legislative restructuring, regulation, insufficient growth, falling real wages, depressed hiring and high job stress of unemployment and underemployment in the US now with realization of growth standstill. The “trend is your friend” motto of traders has been replaced with a “hit and realize profit” approach of managing positions to realize profits without sitting on positions. There is a trend of valuation of risk financial assets driven by the carry trade from zero interest rates with fluctuations provoked by events of risk aversion or the “sharp shifts in risk appetite” of Blanchard (2012WEOApr, XIII). Table ESVI-1, which is updated for every comment of this blog, shows the deep contraction of valuations of risk financial assets after the Apr 2010 sovereign risk issues in the fourth column “∆% to Trough.” There was sharp recovery after around Jul 2010 in the last column “∆% Trough to 4/20/12,” which has been recently stalling or reversing amidst profound risk aversion. “Let’s twist again” monetary policy during the week of Sep 23 caused deep worldwide risk aversion and selloff of risk financial assets (http://cmpassocregulationblog.blogspot.com/2011/09/imf-view-of-world-economy-and-finance.html http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html). Monetary policy was designed to increase risk appetite but instead suffocated risk exposures. There has been rollercoaster fluctuation in risk aversion and financial risk asset valuations: surge in the week of Dec 2, mixed performance of markets in the week of Dec 9, renewed risk aversion in the week of Dec 16, end-of-the-year relaxed risk aversion in thin markets in the weeks of Dec 23 and Dec 30, mixed sentiment in the weeks of Jan 6 and Jan 13 2012 and strength in the weeks of Jan 20, Jan 27 and Feb 3 followed by weakness in the week of Feb 10 but strength in the weeks of Feb 17 and 24 followed by uncertainty on financial counterparty risk in the weeks of Mar 2 and Mar 9. All financial values have fluctuated with events such as the surge in the week of Mar 16 on favorable news of Greece’s bailout even with new risk issues arising in the week of Mar 23 but renewed risk appetite in the week of Mar 30 because of the end of the quarter and the increase in the firewall of support of sovereign debts in the euro area. New risks developed in the week of Apr 6 with increase of yields of sovereign bonds of Spain and Italy, doubts on Fed policy and weak employment report. Asia and financial entities are experiencing their own risk environments. Financial markets were under stress in the week of Apr 13 because of the large exposure of Spanish banks to lending by the European Central Bank and the annual equivalent growth rate of China’s GDP of 7.4 percent in IQ2012. There was strength again in the week of Apr 20 because of the enhanced IMF firewall and Spain placement of debt, continuing into the week of Apr 27. The highest valuations in column “∆% Trough to 4/27/12” are by US equities indexes: DJIA 36.6 percent and S&P 500 37.2 percent, driven by stronger earnings and economy in the US than in other advanced economies. The DJIA reached in intraday trading 13,331.77 on Mar 16, which is the highest level in 52 weeks (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). The carry trade from zero interest rates to leveraged positions in risk financial assets had proved strongest for commodity exposures but US equities have regained leadership. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 4/27/12” had double digit gains relative to the trough around Jul 2, 2010 but now only three valuation show increase of less than 10 percent: China’s Shanghai Composite is 0.6 percent above the trough; STOXX 50 of Europe is 5.5 percent above the trough; and Japan’s Nikkei Average is 7.9 percent above the trough. DJ UBS Commodities is 13.4 percent above the trough; Dow Global is 14.3 percent above the trough; and DAX is 19.9 percent above the trough. Japan’s Nikkei Average is 7.9 percent above the trough on Aug 31, 2010 and 16.4 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 9520.89 on Fri Apr 27, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 7.2 percent lower than 10,254.43 on Mar 11, 2011, on the date of the Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 11.2 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 4/27/12” in Table ESVI-1 shows increases of several valuations of risk financial assets in the week of Apr 27, 2012 such as 1.5 percent for DJIA, 1.8 percent for S&P 500, 1.8 percent for NYSE Financial, 1.0 percent for Dow Global, 0.8 percent for Dax and 1.8 percent for DJ UBS Commodities. There are still high uncertainties on European sovereign risks, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table ESVI-1 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 4/27/12” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Apr 6, 2012. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 4/27/12” but also relative to the peak in column “∆% Peak to 4/20/12.” There are now only three equity indexes above the peak in Table ESVI-1: DJIA 18.1 percent, S&P 500 15.3 percent and Dax 7.4 percent. There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 11.6 percent, Nikkei Average by 16.4 percent, Shanghai Composite by 24.3 percent, STOXX 50 by 10.6 percent and Dow Global by 6.7 percent. DJ UBS Commodities Index is now 3.0 percent below the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. An intriguing issue is the difference in performance of valuations of risk financial assets and economic growth and employment. Paul A. Samuelson (http://www.nobelprize.org/nobel_prizes/economics/laureates/1970/samuelson-bio.html) popularized the view of the troubled relation between stock markets and economic activity in an often-quoted phrase “the stock market has predicted nine of the last five recessions.” In the presence of zero interest rates forever, valuations of risk financial assets are likely to differ from the performance of the overall economy. The interrelations of financial and economic variables prove difficult to analyze and measure.
Table ESVI-1, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 4/27 /12 | ∆% Week 4/27/ 12 | ∆% Trough to 4/27 12 | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 18.1 | 1.5 | 36.6 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 15.3 | 1.8 | 37.2 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | -11.6 | 1.8 | 10.9 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | -6.7 | 1.0 | 14.3 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | -2.9 | -0.1 | 10.9 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | -16.4 | -0.4 | 7.9 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -24.3 | -0.4 | 0.6 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -10.6 | -0.1 | 5.5 |
| DAX | 4/26/ | 5/25/ | -10.5 | 7.4 | 0.8 | 19.9 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 12.4 | -0.3 | -11.2 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | -3.0 | 1.8 | 13.4 |
| 10-Year T Note | 4/5/ | 4/6/10 | 3.986 | 1.931 |
T: trough; Dollar: positive sign appreciation relative to euro (less dollars paid per euro), negative sign depreciation relative to euro (more dollars paid per euro)
Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
I Mediocre Economic Growth. In the four quarters of 2011 and the first quarter of 2012, US real GDP grew at the seasonally-adjusted annual equivalent rates of 0.4 percent in the first quarter of 2011 (IQ2011), 1.3 percent in IIQ2011, 1.8 percent in IIIQ2011, 3.0 percent in IVQ2011 and 2.2 percent in IQ2012. The annual equivalent rate of growth of GDP for the three final quarters of 2011 and the first quarter of 2012 is 2.1 percent, obtained as follows. Discounting 1.3 percent to one quarter is 0.32 percent {[(1.013)1/4 – 1]100}; discounting 1.8 percent to one quarter is 0.45 percent {[(1.018)1/4 – 1]100}; discounting 3.0 percent to one quarter is 0.742 {[(1.03)1/4 -1]100; and discounting 2.2 percent to one quarter is 0.55 percent {(1.022)1/4 -1]100). Real GDP growth in the four quarters of 2011 and the first quarter of 2012 accumulated to 2.1 percent {[(1.0032 x 1.0045 x 1.00742 x 1.00546)-1]100 = 2.1%}. This is equivalent to growth from IQ2011 to IQ2012 obtained by dividing the seasonally-adjusted annual rate (SAAR) of IQ2012 of $13,502.4 billion by the SAAR of IQ2011 of $13,227.9 (http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1 and Table I-6 below) and expressing as percentage {[($13,502.4/$13,227.9)-1]100 = 2.1%}. The growth rate in annual equivalent for the four quarters of 2011 and the first quarter of 2012 is 1.7 percent {[(1.001 x 1.0032 x 1.0045 x 1.00742 x 1.00546)4/5 -1]100 =1.7%], or {[($13,502.4/$13,216.1)4/5 -1]100 = 1.7%} dividing the SAAR of IQ2012 by the SAAR of IVQ2010 in Table I-6 below, obtaining the average for five quarters and the annual average for one year of four quarters. The US economy is still close to a standstill especially considering the GDP report in detail. The Bureau of Economic Analysis (BEA) of the US Department of Commerce released on Fri Apr 27, 2012, the first estimate of GDP for IQ2012 at 2.2 percent seasonally-adjusted annual rate (SAAR) (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp1q12_adv.pdf). The objective of this section is analyzing US economic growth. There is initial brief discussion of the concept of “slow-growth recession” followed by comparison of the current growth experience of the US with earlier expansions after past deep contractions and consideration of performance in 2011.
The concept of growth recession was popular during the stagflation from the late 1960s to the early 1980s. The economy of the US underperformed with several recession episodes in “stop and go” fashion of economic activity while the rate of inflation rose to the highest in a peacetime period (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/05/global-inflation-seigniorage-monetary.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html Appendix I; see Taylor 2012Mar27, 2012Mar28, 2012FP, 2012JMCB). A growth recession could be defined as a period in which economic growth is insufficient to move the economy toward full employment of humans, equipment and other productive resources. The US is experiencing a dramatic slow growth recession with 29.411 million people in job stress, consisting of an effective number of unemployed of 19.192 million, 7.867 million employed part-time because they cannot find full employment and 2.352 million marginally attached to the labor force (see Table I-4 in http://cmpassocregulationblog.blogspot.com/2012/04/thirty-million-unemployed-or.html). The discussion of the growth recession issue in the 1970s by two recognized economists of the twentieth century, James Tobin and Paul A. Samuelson, is worth recalling.
In analysis of the design of monetary policy in 1974, Tobin (1974, 219) finds that the forecast of the President’s Council of Economic Advisers (CEA) was also the target such that monetary policy would have to be designed and implemented to attain that target. The concern was with maintaining full employment as provided in the Employment Law of 1946 (http://www.law.cornell.edu/uscode/15/1021.html http://uscode.house.gov/download/pls/15C21.txt http://www.eric.ed.gov/PDFS/ED164974.pdf) see http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html), which also created the CEA. Tobin (1974, 219) describes the forecast/target of the CEA for 1974:
“The expected and approved path appears to be quarter-to-quarter rates of growth of real gross national product in 1974 of roughly -0.5, 0.1, and 1 percent, with unemployment rising to about 5.6 percent in the second quarter and remaining there the rest of the year. The rate of price inflation would fall shortly in the second quarter, but rise slightly toward the end of the year.”
Referring to monetary policy design, Tobin (1974, 221) states: “if interest rates remain stable or rise during the current (growth) recession and recovery, this will be a unique episode in business cycle annals.” Subpar economic growth is often called a “growth recession.” The critically important concept is that economic growth is not sufficient to move the economy toward full employment, creating the social and economic adverse outcome of idle capacity and unemployed and underemployed workers, much the same as currently.
The unexpected incidence of inflation surprises during growth recessions is considered by Samuelson (1974, 76):
“Indeed, if there were in Las Vegas or New York a continuous casino on the money GNP of 1974’s fourth quarter, it would be absurd to think that the best economic forecasters could improve upon the guess posted there. Whatever knowledge and analytical skill they possess would already have been fed into the bidding. It is a manifest contradiction to think that most economists can be expected to do better than their own best performance. I am saying that the best forecasters have been poor in predicting the general price level’s movements and level even a year ahead. By Valentine’s Day 1973 the best forecasters were beginning to talk of the growth recession that we now know did set in at the end of the first quarter. Aside from their end-of-1972 forecasts, the fashionable crowd has little to blame itself for when it comes to their 1973 real GNP projections. But, of course, they did not foresee the upward surge of food and decontrolled industrial prices. This has been a recurring pattern: surprise during the event at the virulence of inflation, wisdom after the event in demonstrating that it did, after all, fit with past patterns of experience.”
Economists are known for their forecasts being second only to those of astrologers. Accurate forecasts are typically realized for the wrong reasons. In contrast with meteorologists, economists do not even agree on what happened. There is not even agreement on what caused the global recession and why the economy has reached a perilous standstill.
Historical parallels are instructive but have all the limitations of empirical research in economics. The more instructive comparisons are not with the Great Depression of the 1930s but rather with the recessions in the 1950s, 1970s and 1980s. The growth rates and job creation in the expansion of the economy away from recession are subpar in the current expansion compared to others in the past. Four recessions are initially considered, following the reference dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles/cyclesmain.html ): IIQ1953-IIQ1954, IIIQ1957-IIQ1958, IIIQ1973-IQ1975 and IQ1980-IIIQ1980. The data for the earlier contractions illustrate that the growth rate and job creation in the current expansion are inferior. The sharp contractions of the 1950s and 1970s are considered in Table I-1, showing the Bureau of Economic Analysis (BEA) quarter-to-quarter, seasonally adjusted (SA), yearly-equivalent growth rates of GDP. The recovery from the recession of 1953 consisted of four consecutive quarters of high percentage growth rates from IIIQ1954 to IIIQ1955: 4.6, 8.3, 12.0, 6.8 and 5.4. The recession of 1957 was followed by four consecutive high percentage growth rates from IIIQ1958 to IIQ1959: 9.7, 9.7, 8.3 and 10.5. The recession of 1973-1975 was followed by high percentage growth rates from IIQ1975 to IIQ1976: 6.9, 5.3, 9.4 and 3.0. The disaster of the Great Inflation and Unemployment of the 1970, which made stagflation notorious, is even better in growth rates during the expansion phase in comparison with the current slow-growth recession.
Table I-1, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| IQ | IIQ | IIIQ | IVQ | |
| 1953 | 7.7 | 3.1 | -2.4 | -6.2 |
| 1954 | -1.9 | 0.5 | 4.6 | 8.3 |
| 1955 | 12.0 | 6.8 | 5.4 | 2.3 |
| 1957 | 2.5 | -1.0 | 3.9 | -4.1 |
| 1958 | -10.4 | 2.5 | 9.7 | 9.7 |
| 1959 | 8.3 | 10.5 | -0.5 | 1.4 |
| 1973 | 10.6 | 4.7 | -2.1/ | 3.9 |
| 1974 | 3.5 | 1.0 | -3.9 | 6.9 |
| 1975 | -4.8 | 3.1 | 6.9 | 5.3 |
| 1976 | 9.4 | 3.0 | 2.0 | 2.9 |
| 1979 | 0.7 | 0.4 | 2.9 | 1.1 |
| 1980 | 1.3 | -7.9 | -0.7 | 7.6 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ1982 are combined, the impact of lost GDP of 4.8 percent is more comparable to the latest revised 5.1 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.5 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). Table I-2 provides the Bureau of Economic Analysis (BEA) quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981 to 1982 and 2007 to 2009, using the latest major revision published on Jul 29, 2011 (http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf) and the first estimate of IQ2012 released on Apr 27, 2012 (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp1q12_adv.pdf). There were four quarters of contraction in 1981-1982 ranging in rate from -1.5 percent to -6.4 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.7 percent to -8.9 percent. The striking difference is that in the first eleven quarters of expansion from IQ1983 to IIIQ1985, shown in Table 2 in relief, GDP grew at the high quarterly percentage growth rates of 5.1, 9.3, 8.1, 8.5, 8.0, 7.1, 3.9, 3.3, 3.8, 3.4 and 6.4 while the percentage growth rates in the first eleven quarters of expansion from IIIQ2009 to IQ2012, shown in relief in Table I-2, were mediocre: 1.7, 3.8, 3.9, 3.8, 2.5, 2.3, 0.4, 1.3, 1.8, 3.0 and 2.2. Asterisks denote the estimates that have been revised by the BEA. During the four quarters of 2011 GDP grew at annual equivalent rates of 0.4 percent in IQ2011, 1.3 percent in IIQ2011, 1.8 percent in IIIQ2011 and 3.0 percent in IVQ2011 in what can be considered as a slow growth recession because of the 29.4 million in job stress (http://cmpassocregulationblog.blogspot.com/2012/04/thirty-million-unemployed-or.html). The rate of growth of the US economy decelerated from seasonally-adjusted annual equivalent of 3.0 percent in IVQ2011 to 2.2 percent in IQ2012. Inventory change contributed to initial growth but was rapidly replaced by growth in investment and demand in 1983.
Table I-2, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| Q | 1981 | 1982 | 1983 | 1984 | 2008 | 2009 | 2010 |
| I | 8.6 | -6.4 | 5.1 | 8.0 | -1.8* | -6.7* | 3.9* |
| II | -3.2 | 2.2 | 9.3 | 7.1 | 1.3* | -0.7 | 3.8* |
| III | 4.9 | -1.5 | 8.1 | 3.9 | -3.7* | 1.7 | 2.5* |
| IV | -4.9 | 0.3 | 8.5 | 3.3 | -8.9* | 3.8* | 2.3* |
| 1985 | 2011 | ||||||
| I | 3.8 | 0.4 | |||||
| II | 3.4 | 1.3 | |||||
| III | 6.4 | 1.8 | |||||
| IV | 3.1 | 3.0 | |||||
| 1986 | 2012 | ||||||
| I | 3.9 | 2.2 | |||||
| II | 1.6 | ||||||
| III | 3.9 | ||||||
| IV | 1.9 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart I-1 provides strong growth of real quarterly GDP in the US between 1947 and 1999. There is an evident acceleration of the rate of GDP growth in the 1990s as shown by a much sharper slope of the growth curve. Cobet and Wilson (2002) define labor productivity as the value of manufacturing output produced per unit of labor input used (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). Between 1950 and 2000, labor productivity in the US grew less rapidly than in Germany and Japan. The major part of the increase in productivity in Germany and Japan occurred between 1950 and 1973 while the rate of productivity growth in the US was relatively subdued in several periods. While Germany and Japan reached their highest growth rates of productivity before 1973, the US accelerated its rate of productivity growth in the second half of the 1990s. Between 1950 and 2000, the rate of productivity growth in the US of 2.9 percent per year was much lower than 6.3 percent in Japan and 4.7 percent in Germany. Between 1995 and 2000, the rate of productivity growth of the US of 4.6 percent exceeded that of Japan of 3.9 percent and the rate of Germany of 2.6 percent.
Chart I-1, US, Real GDP 1947-1999
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-2 provides the growth of real quarterly GDP in the US between 1947 an 2011, using the new estimate for IQ2012 GDP. The drop of output in the recession from IVQ2007 to IIQ2009 has been followed by anemic recovery and a standstill that can lead to growth recession, or low rates of economic growth, but perhaps even another contraction or conventional recession.
Chart I-2, US, Real GDP 1947-2011
Source:
US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-3 provides real GDP percentage change on the quarter a year earlier for 1983-1984. The objective is simply to compare expansion in two recoveries from sharp contractions as shown in Table I-2. Growth rates in the early phase of the recovery in 1983 and 1984 were very high, which is the opportunity to reduce unemployment that has characterized cyclical expansion in the postwar US economy.
Chart I-3, Real GDP Percentage Change on Quarter a Year Earlier 1983-1985
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In contrast, growth rates in the comparable first eleven quarters of expansion from 2009 to 2012 in Chart I-4 have been mediocre. As a result, growth has not provided the exit from unemployment and underemployment as in other cyclical expansions in the postwar period. Growth rates did not rise in V shape as in earlier expansions and then declined close to the standstill of growth recessions.
Chart I-4, US, Real GDP Percentage Change on Quarter a Year Earlier 2009-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Table I-3 provides the change in real GDP in the United States in the 1930s, 1980s and 2000s. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). Data are available for the 1930s only on a yearly basis. US GDP fell 4.8 percent in the two recessions (1) from IQ1980 to IIIQ1980 and (2) from III1981 to IVQ1981 to IVQ1982 and 5.1 percent cumulatively in the recession from IVQ2007 to IIQ2009. It is instructive to compare the first two years of the expansions in the 1980s and the current expansion. GDP grew at 4.5 percent in 1983 and 7.2 percent in 1984 while GDP grew at 3.0 percent in 2010, 1.7 percent in 2011 and 2.1 percent in IQ2012 relative to IQ2011. GDP grew at 4.1 percent in 1985 and 3.5 percent in 1986 while the forecasts of participants of the Federal Open Market Committee (FOMC) are 2.4 to 2.9 percent in 2012 and 2.7 to 3.1 percent in 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120425.pdf).
Table I-3, US, Percentage Change of GDP in the 1930s, 1980s and 2000s, ∆%
| Year | GDP ∆% | Year | GDP ∆% | Year | GDP ∆% |
| 1930 | -8.6 | 1980 | -0.3 | 2000 | 4.1 |
| 1931 | -6.5 | 1981 | 2.5 | 2001 | 1.1 |
| 1932 | -13.1 | 1982 | -1.9 | 2002 | 1.8 |
| 1933 | -1.3 | 1983 | 4.5 | 2003 | 2.5 |
| 1934 | 10.9 | 1984 | 7.2 | 2004 | 3.5 |
| 1935 | 8.9 | 1985 | 4.1 | 2005 | 3.1 |
| 1936 | 13.1 | 1986 | 3.5 | 2006 | 2.7 |
| 1937 | 5.1 | 1987 | 3.2 | 2007 | 1.9 |
| 1938 | -3.4 | 1988 | 4.1 | 2008 | -0.3 |
| 1930 | 8.1 | 1989 | 3.6 | 2009 | -3.5 |
| 1940 | 8.8 | 1990 | 1.9 | 2010 | 3.0 |
| 1941 | 17.1 | 1991 | -0.2 | 2011 | 1.7 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart I-5 provides percentage change of GDP in the US during the 1930s. There is vast literature analyzing the Great Depression (Pelaez and Pelaez, Regulation of Banks and Finance (2009) 198-217). Cole and Ohanian (1999) find that US real per capita output was 11 percent lower in 1939 than in 1929 while the typical expansion of real per capita output in the US is 31 percent. Private hours worked in the US were 25 percent lower in 1939 than in 1929.
Chart I-5, US, Percentage Change of GDP in the 1930s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In contrast, Chart I-6 shows rapid recovery from the recessions in the 1980s. High growth rates in the initial quarters of expansion eliminated the unemployment and underemployment created during the contraction. The economy then returned to grow at the trend of expansion, interrupted by another contraction in 1991.
Chart I-6, US, Percentage Change of GDP in the 1980s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-7 provides the rates of growth during the 2000s. Growth rates in the initial eleven quarters of expansion have been relatively lower than during recessions after World War II. As a result, unemployment and underemployment continue at the rate of 18.2 percent of the US labor force (Table I-4 in http://cmpassocregulationblog.blogspot.com/2012/04/thirty-million-unemployed-or.html).
Chart I-7, US, Percentage Change of GDP in the 2000s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Characteristics of the four cyclical contractions are provided in Table I-4 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.8 percent, which is almost equal to the decline of 5.1 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). The comparison of the global recession after 2007 with the Great Depression is entirely misleading.
Table I-4, US, Number of Quarters, Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions
| Number of Quarters | Cumulative Percentage Contraction | Average Percentage Rate | |
| IIQ1953 to IIQ1954 | 4 | -2.5 | -0.63 |
| IIIQ1957 to IIQ1958 | 3 | -3.1 | -9.0 |
| IQ1980 to IIIQ1980 | 2 | -2.2 | -1.1 |
| IIIQ1981 to IVQ1982 | 4 | -2.7 | -0.67 |
| IVQ2007 to IIQ2009 | 6 | -5.1 | -0.87 |
Source: Business Cycle Reference Dates: http://www.nber.org/cycles/cyclesmain.html
Data: http://www.bea.gov/iTable/index_nipa.cfm
Table I-5 shows the extraordinary contrast between the mediocre average annual equivalent growth rate of 2.4 percent of the US economy in the eleven quarters of the current cyclical expansion from IIIQ2009 to IQ2012 and the average of 6.2 percent in the four earlier cyclical expansions. The BEA data for the four quarters of 2011 show the economy in standstill with annual growth of 1.6 percent with growth increasing to 2.1 percent from IQ2011 to IQ2012. The expansion of IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent.
Table I-5, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions
| Number | Cumulative Growth ∆% | Average Annual Equivalent Growth Rate | |
| IIIQ 1954 to IQ1957 | 11 | 12.6 | 4.4 |
| IIQ1958 to IIQ1959 | 5 | 10.2 | 8.1 |
| IIQ1975 to IVQ1976 | 8 | 9.5 | 4.6 |
| IQ1983 to IV1985 | 13 | 19.6 | 5.7 |
| Average Four Above Expansions | 6.2 | ||
| IIIQ2009 to IQ2012 | 11 | 6.8 | 2.4 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart I-8 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.
Chart I-8, US, Real GDP, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-9 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2012. The economy has underperformed during the first eleven quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.
Chart I-9, US, Real GDP, 2007-2012
Source: http://www.bea.gov/iTable/index_nipa.cfm
As shown in Tables I-4 and I-5 above the loss of real GDP in the US during the contraction was 5.1 percent but the gain in the cyclical expansion has been only 6.8 percent (last row in Table I-5). As a result, the level of real GDP in IQ2012 with the first estimate is only higher by 1.3 percent than the level of real GDP in IVQ2007. Table I-6 provides in the second column real GDP in billions of chained 2005 dollars. The third column provides the percentage change of the quarter relative to IVQ2007; the fourth column provides the percentage change relative to the prior quarter; and the final fifth column provides the percentage change relative to the same quarter a year earlier. The contraction actually concentrated in two quarters: decline of 2.3 percent in IVQ2008 relative to the prior quarter and decline of 1.7 percent in IQ2009 relative to IVQ2008. The combined fall of GDP in IVQ2008 and IQ2009 was 4.0 percent (1.023 x 1.017). Those two quarters coincided with the worst effects of the financial crisis. GDP fell 0.2 percent in IIQ2009 but grew 0.4 percent in IIIQ2009, which is the beginning of recovery in the cyclical dates of the NBER. Most of the recovery occurred in three successive quarters from IVQ2009 to IIQ2010 of equal growth at 0.9 percent for cumulative growth in those three quarters of 2.7 percent. The economy lost momentum already in IIIQ2010 and IVQ2010 growing at 0.6 percent in each quarter, or annual equivalent 2.4 per cent combining the two quarters in annual equivalent rate {(1.006 x 1.006)2}. The economy then stalled during the first half of 2011 with growth of 0.1 percent in IQ2011 and 0.33 percent in IIQ2011 for combined annual equivalent rate of 0.86 percent {(1.001 x 1.0033)2}. The economy grew 0.045 percent in IIIQ2011 for annual equivalent growth of 1.12 percent in the first three quarters {(1.001 x 1.0033 x 1.0045)4/3}. Growth picked up in IVQ2011 with 0.69 percent relative to IIIQ2011. Growth in a quarter relative to a year earlier in Table I-6 slows from over 3 percent during three consecutive quarters from IIQ2010 to IVQ2010 to 2.2 percent in IQ2011, 1.6 percent in IIQ2011, 1.5 percent in IIIQ2011 and 1.6 percent in IVQ2011. The revision of the seasonally-adjusted annual rate in IIQ2011 from 1.0 percent to 1.3 percent merely increases growth in IIQ2011 relative to IQ2011 from 0.25 percent to 0.33 percent. There is stronger quarterly growth in IIIQ2011 of 0.45 percent even with the downward revision of the third estimate. Growth in IIQ2011 relative to IIQ2010 and in IIIQ2011 relative to IIIQ2010 remains at the mediocre rates of 1.6 percent and 1.5 percent, respectively, with 1.6 percent in IVQ2011. As shown below, growth of 0.7 percent in IVQ2011 was partly driven by inventory accumulation. In IQ2012, GDP grew 0.5 percent relative to IVQ2011 and 2.1 percent relative to IQ2011. The critical question for which there is not yet definitive solution is whether what lies ahead is continuing growth recession with the economy crawling and unemployment/underemployment at extremely high levels or another contraction or conventional recession. Forecasts of various sources continued to maintain high growth in 2011 without taking into consideration the continuous slowing of the economy in late 2010 and the first half of 2011. The sovereign debt crisis in the euro area is one of the common sources of doubts on the rate and direction of economic growth in the US but there is weak internal demand in the US with almost no investment and spikes of consumption driven by burning saving because of financial repression forever in the form of zero interest rates.
Table I-6, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%
| Real GDP, Billions Chained 2005 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| IVQ2007 | 13,326.0 | NA | NA | 2.2 |
| IQ2008 | 13,266.8 | -0.4 | -0.4 | 1.6 |
| IIQ2008 | 13,310.5 | -0.1 | 0.3 | 1.0 |
| IIIQ2008 | 13,186.9 | -1.0 | -0.9 | -0.6 |
| IVQ2008 | 12,883.5 | -3.3 | -2.3 | -3.3 |
| IQ2009 | 12,663.2 | -4.9 | -1.7 | -4.5 |
| IIQ2009 | 12,641.3 | -5.1 | -0.2 | -5.0 |
| IIIQ2009 | 12,694.5 | -4.7 | 0.4 | -3.7 |
| IV2009 | 12,813.5 | -3.8 | 0.9 | -0.5 |
| IQ2010 | 12,937.7 | -2.9 | 0.9 | 2.2 |
| IIQ2010 | 13,058.5 | -2.0 | 0.9 | 3.3 |
| IIIQ2010 | 13,139.6 | -1.4 | 0.6 | 3.5 |
| IVQ2010 | 13,216.1 | -0.8 | 0.6 | 3.1 |
| IQ2011 | 13,227.9 | -0.7 | 0.1 | 2.2 |
| IIQ2011 | 13,271.8 | -0.4 | 0.3 | 1.6 |
| IIIQ2011 | 13,331.6 | 0.04 | 0.5 | 1.5 |
| IV2011 | 13,429.0 | 0.8 | 0.7 | 1.6 |
| IQ2012 | 13,502.4 | 1.3 | 0.5 | 2.1 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart I-10 provides the percentage change of real GDP from the same quarter a year earlier from 1980 to 1989. There were two contractions almost in succession in 1980 and from 1981 to 1983. The expansion was marked by initial high rates of growth as in other recession in the postwar US period during which employment lost in the contraction was recovered. Growth rates continued to be high after the initial phase of expansion.
Chart I-10, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
The experience of recovery after 2009 is not as complete as during the 1980s. Chart I-11 shows the much lower rates of growth in the early phase of the current expansion and how they have sharply declined from an early peak. The US missed the initial high growth rates in cyclical expansions during which unemployment and underemployment are eliminated.
Chart I-11, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-12 provides growth rates from a quarter relative to the prior quarter during the 1980s. There is the same strong initial growth followed by a long period of sustained growth.
Chart I-12, Percentage Change of Real Gross Domestic Product from Prior Quarter 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-13 provides growth rates in a quarter relative to the prior quarter from 2007 to 2012. Growth in the current expansion after IIIQ2009 has not been as strong as in other postwar cyclical expansions.
Chart I-13, Percentage Change of Real Gross Domestic Product from Prior Quarter 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
The revised estimates and earlier estimates from IQ2008 to IQ2011 in seasonally adjusted annual equivalent rates are shown in Table I-7. The strongest revision is for IVQ2008 for which the contraction of GDP is revised from minus 6.8 percent to minus 8.9 percent. IQ2009 is also revised from contraction of minus 4.9 percent to minus 6.7 percent. There is only minor revision in IIIQ2008 of the contraction of minus 4.0 percent to minus 3.7 percent. Growth of 5.0 percent in IV2009 is revised to 3.8 percent but growth in IIQ2010 is upwardly revised to 3.8 percent. The revisions do not alter the conclusion that the current expansion is much weaker than historical sharp contractions since the 1950s and is now changing into slow growth recession with higher risks of contraction.
Table I-7, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA, Revised and Earlier Estimates
| Quarters | Revised Estimate | Earlier Estimate |
| 2008 | ||
| I | -1.8 | -0.7 |
| II | 1.3 | 0.6 |
| III | -3.7 | -4.0 |
| IV | -8.9 | -6.8 |
| 2009 | ||
| I | -6.7 | -4.9 |
| II | -0.7 | -0.7 |
| III | 1.7 | 1.6 |
| IV | 3.8 | 5.0 |
| 2010 | ||
| I | 3.9 | 3.7 |
| II | 3.8 | 1.7 |
| III | 2.5 | 2.6 |
| IV | 2.3 | 3.1 |
| 2011 | ||
| I | 0.4 | 1.9 |
Source: http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf
http://www.bea.gov/iTable/index_nipa.cfm
Contributions to the rate of growth of GDP in percentage points (PP) are provided in Table I-8. Aggregate demand, personal consumption expenditures (PCE) and gross private domestic investment (GDI) were much stronger during the expansion phase in IQ1983 to IIQ1984 than in IIIQ2009 to IQ2012. GDI provided the impulse of growth in 1983 and 1984, which has not been the case from 2009 to 2012. The investment decision in the US economy has been frustrated in the current cyclical expansion. Growth of GDP in IQ2012 at 2.2 percent at seasonally-adjusted annual rate (SAAR) consisted of positive contributions of 2.04 percentage points of personal consumption expenditures (PCE) + 0.77 percentage points of gross domestic investment (GDI) but with the bulk originating in inventory change of 0.59 percentage points (∆ PI) minus 0.01 percentage points of net exports (net trade or exports less imports) minus 0.60 percentage points of government consumption expenditures and gross investment (GOV). Growth in IVQ2010 was driven mainly by increase in private inventories of 1.81 percentage points.
Table I-8, US, Contributions to the Rate of Growth of GDP in Percentage Points
| GDP | PCE | GDI | ∆ PI | Trade | GOV | |
| 2012 | ||||||
| I | 2.2 | 2.04 | 0.77 | 0.59 | -0.01 | -0.60 |
| 2011 | ||||||
| I | 0.4 | 1.47 | 0.47 | 0.32 | -0.34 | -1.23 |
| II | 1.3 | 0.49 | 0.79 | -0.28 | 0.24 | -0.18 |
| III | 1.8 | 1.24 | 0.17 | -1.35 | 0.43 | -0.02 |
| IV | 3.0 | 1.47 | 2.59 | 1.81 | -0.26 | -0.84 |
| 2010 | ||||||
| I | 3.9 | 1.92 | 3.25 | 3.10 | -0.97 | -0.26 |
| II | 3.8 | 2.05 | 2.92 | 0.79 | -1.94 | 0.77 |
| III | 2.5 | 1.85 | 1.14 | 0.86 | -0.68 | 0.20 |
| IV | 2.3 | 2.48 | -0.91 | -1.79 | 1.37 | -0.58 |
| 2009 | ||||||
| I | -6.7 | -1.02 | -7.76 | -2.66 | 2.44 | -0.33 |
| II | -0.7 | -1.28 | -2.84 | -0.58 | 2.21 | 1.21 |
| III | 1.7 | 1.66 | 0.35 | 0.21 | -0.59 | 0.28 |
| IV | 3.8 | 0.33 | 3.51 | 3.93 | 0.15 | -0.18 |
| 1982 | ||||||
| I | -6.4 | 1.62 | -7.50 | -5.47 | -0.49 | -0.03 |
| II | 2.2 | 0.90 | -0.05 | 2.35 | 0.84 | 0.50 |
| III | -1.5 | 1.92 | -0.72 | 1.15 | -3.31 | 0.57 |
| IV | 0.3 | 4.64 | -5.66 | -5.48 | -0.10 | 1.44 |
| 1983 | ||||||
| I | 5.1 | 2.54 | 2.20 | 0.94 | -0.30 | 0.63 |
| II | 9.3 | 5.22 | 5.87 | 3.51 | -2.54 | 0.75 |
| III | 8.1 | 4.66 | 4.30 | 0.60 | -2.32 | 1.48 |
| IV | 8.5 | 4.20 | 6.84 | 3.09 | -1.17 | -1.35 |
| 1984 | ||||||
| I | 8.0 | 2.35 | 7.15 | 5.07 | -2.37 | 0.86 |
| II | 7.1 | 3.75 | 2.44 | -0.30 | -0.89 | 1.79 |
| III | 3.9 | 2.02 | 1.67 | 0.21 | -0.36 | 0.62 |
| IV | 3.3 | 3.38 | -1.26 | -2.50 | -0.58 | 1.75 |
| 1985 | ||||||
| I | 3.8 | 4.34 | -2.38 | -2.94 | 0.91 | 0.95 |
| II | 3.4 | 2.35 | 1.24 | 0.35 | -2.01 | 1.85 |
| III | 6.4 | 4.91 | -0.68 | -0.16 | -0.01 | 2.18 |
| IV | 3.1 | 0.54 | 2.72 | 1.45 | -0.68 | 0.50 |
Note: PCE: personal consumption expenditures; GDI: gross private domestic investment; ∆ PI: change in private inventories; Trade: net exports of goods and services; GOV: government consumption expenditures and gross investment; – is negative and no sign positive
GDP: percent change at annual rate; percentage points at annual rates
Source: http://www.bea.gov/iTable/index_nipa.cfm
The Bureau of Economic Analysis (BEA) (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp1q12_adv.pdf 1) explains growth of GDP in IQ2012 in terms of positive growth contributions shown in Table I-9:
· Personal consumption expenditures (PCE) growing at 2.9 percent with consumption of durable goods growing at 15.3 percent
· Private inventory investment of 0.59 percentage points
· Exports growing at 5.4 percent
· Residential fixed investment (RFI) growing at 19.1 percent
There were negative contributions:
· Federal government spending (Federal GOV) declining at 5.6 percent
· Nonresidential fixed investment declining at 2.1 percent
· State and local government spending (State/Local GOV) falling at 1.2 percent
· Imports, which are deduction from growth, growing at 4.3 percent
The BEA explains deceleration in real GDP in IQ2012 by:
· Deceleration in private inventory investment from 1.81 percentage points in IVQ2011 to 0.59 percentage points in IQ2012
· Contraction of nonresidential fixed investment (RFI) from growth of 5.2 percent in IVQ2011 to minus 2.1 percent in IQ2012
· Acceleration in the growth rate of imports from 3.7 percent in IVQ2011 to 4.3 percent in IQ2012
Table I-9, US, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase, %
| IQ 2011 | II Q 2011 | IIIQ 2011 | IVQ 2011 | IQ 2012 | |
| GDP | 0.4 | 1.3 | 1.8 | 3.0 | 2.2 |
| PCE | 2.1 | 0.7 | 1.7 | 2.1 | 2.9 |
| Durable Goods | 11.7 | -5.3 | 5.7 | 16.1 | 15.3 |
| NRFI | 2.1 | 10.3 | 15.7 | 5.2 | -2.1 |
| RFI | -2.4 | 4.2 | 1.3 | 11.6 | 19.1 |
| Exports | 7.9 | 3.6 | 4.7 | 2.7 | 5.4 |
| Imports | 8.3 | 1.4 | 1.2 | 3.7 | 4.3 |
| GOV | -5.9 | -0.9 | -0.1 | -4.2 | -3.0 |
| Federal GOV | -9.4 | 1.9 | 2.1 | -6.9 | -5.6 |
| State/Local GOV | -3.4 | -2.8 | -1.6 | -2.2 | -1.2 |
| ∆ PI (PP) | 0.32 | -0.28 | -1.35 | 1.81 | 0.59 |
| Final Sales of Domestic Product | 0.0 | 1.6 | 3.2 | 1.1 | 1.6 |
| Gross Domestic Purchases | 0.7 | 1.0 | 1.3 | 3.1 | 2.1 |
| Prices Gross | 4.0 | 3.3 | 2.0 | 1.1 | 2.4 |
| Prices of GDP | 2.5 | 2.5 | 2.6 | 0.9 | 1.5 |
| Prices of GDP Excluding Food and Energy | 2.5 | 2.7 | 1.8 | 1.1 | 2.3 |
| Prices of PCE | 3.9 | 3.3 | 2.3 | 1.2 | 2.4 |
| Prices of PCE Excluding Food and Energy | 1.6 | 2.3 | 2.1 | 1.3 | 2.1 |
| Prices of Market Based PCE | 4.0 | 3.5 | 2.6 | 1.2 | 2.3 |
| Prices of Market Based PCE Excluding Food and Energy | 1.3 | 2.4 | 2.3 | 1.4 | 2.0 |
| Real Disposable Personal Income* | 2.6 | 1.1 | 0.7 | 0.8 | 0.6 |
| Personal Savings As % Disposable Income | 5.0 | 4.8 | 4.6 | 4.5 | 3.9 |
Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in
private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income
*Percent change from quarter one year ago
Source: http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp1q12_adv.pdf
http://www.bea.gov/iTable/index_nipa.cfm
Percentage shares of GDP are shown in Table I-10. PCE is equivalent to 71.2 percent of GDP and is under pressure with decline of real disposable income, high levels of unemployment and underemployment and higher savings rates than before the global recession, temporarily interrupted by financial repression in the form of zero interest rates. Gross private domestic investment is also growing slowly even with about two trillions of dollars in cash holdings by companies. In a slowing world economy, it may prove more difficult to grow exports faster than imports to generate higher growth. Bouts of risk aversion revalue the dollar relative to most currencies in the world as investors increase their holdings of dollar-denominated assets.
Table I-10, US, Percentage Shares of GDP, %
| IVQ2011 | |
| GDP | 100.0 |
| PCE | 71.2 |
| Goods | 24.5 |
| Durable | 8.0 |
| Nondurable | 16.5 |
| Services | 46.7 |
| Gross Private Domestic Investment | 13.2 |
| Fixed Investment | 12.6 |
| NRFI | 10.3 |
| RFI | 2.3 |
| Change in Private | 0.6 |
| Net Exports of Goods and Services | -4.0 |
| Exports | 13.9 |
| Goods | 9.8 |
| Services | 4.1 |
| Imports | 17.9 |
| Goods | 15.1 |
| Services | 2.9 |
| Government | 19.6 |
| Federal | 7.9 |
| State and Local | 11.7 |
PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment
Source: http://www.bea.gov/iTable/index_nipa.cfm
Table I-11 shows percentage point (PP) contributions to the annual levels of GDP growth in the earlier recessions 1958-1959, 1975-1976, 1982-1983 and 2009, 2010 and 2011. The data incorporate the new revisions released by the BEA on Jul 29, 2011 and the third estimate of 2011 GDP released on Mar 29, 2012. The most striking contrast is in the rates of growth of annual GDP in the expansion phases of 7.2 percent in 1959, 4.5 percent in 1983 followed by 7.2 percent in 1984 and 4.1 percent in 1985 but only 3.0 percent in 2010 after six consecutive quarters of growth and 1.7 percent in 2011 after ten consecutive quarters of expansion. Annual levels also show much stronger growth of PCEs in the expansions after the earlier contractions than in the expansion after the global recession of 2007. Gross domestic investment was much stronger in the earlier expansions than in 2010 and 2011.
Table I-11, US, Percentage Point Contributions to the Annual Growth Rate of GDP
| GDP | PCE | GDI | ∆ PI | Trade | GOV | |
| 1958 | -0.9 | 0.54 | -1.25 | -0.18 | -0.89 | 0.70 |
| 1959 | 7.2 | 3.61 | 2.80 | 0.86 | 0.00 | 0.76 |
| 1975 | -0.2 | 1.40 | -2.98 | -1.27 | 0.89 | 0.48 |
| 1976 | 5.4 | 3.51 | 2.84 | 1.41 | -1.08 | 0.10 |
| 1982 | -1.9 | 0.86 | -2.55 | -1.34 | -0.60 | 0.35 |
| 1983 | 4.5 | 3.65 | -1.45 | 0.29 | -1.35 | 0.76 |
| 1984 | 7.2 | 3.43 | 4.63 | 1.95 | -1.58 | 0.70 |
| 1985 | 4.1 | 3.32 | -0.17 | -1.06 | -0.42 | 1.41 |
| 2009 | -3.5 | -1.32 | -3.61 | -0.84 | 1.11 | 0.34 |
| 2010 | 3.0 | 1.44 | 1.96 | 1.64 | -0.51 | 0.14 |
| 2011 | 1.7 | 1.53 | 0.60 | -0.21 | 0.05 | -0.44 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Table I-12 provides more detail of the contributions to growth of GDP from 2009 to 2011 using annual-level data. PCEs contributed 1.44 PPs to GDP growth in 2010 of which 0.99 percentage points (PP) in goods and 0.46 PP in services. Gross private domestic investment (GPDI) deducted 3.61 PPs of GDP growth in 2009 of which -2.77 PPs by fixed investment and -0.84 PPs of inventory change (∆PI) and added 1.96 PPs to GPDI in 2010 of which 0.32 PPs of fixed investment and 1.64 PPs of inventory accumulation (∆PI). Trade, or exports of goods and services net of imports, contributed 1.11 PPs in 2009 of which exports deducted 1.18 PPs and imports added 2.29 PPs. In 2010, trade deducted 0.51 PPs with exports contributing 1.31 PPs and imports deducting 1.82 PPs. In 2009, government added 0.34 PP of which 0.45 PPs by the federal government and -0.11 PPs by state and local government; in 2010, government added 0.14 PPs of which 0.37 PPs by the federal government with state and local government deducting 0.23 PPs. The final column of Table I-12 provides the estimate for 2011. There is not much difference in PCE with 1.53 PPs of contribution in 2011 after 1.44 PPs in 2010. The breakdown into goods and services is similar. Gross private domestic investment contributed 1.96 PPs in 2010 with 1.64 PPs originating in accumulation of private inventories but the contribution of gross private domestic investment was only 0.60 PPs in 2011. Net exports of goods and services contributed marginally in 2011 with 0.05 PPs. Government deducted 0.44 PPs in 2011. The expansion since IIIQ2009 has been characterized by weak contributions of aggregate demand, which is the sum of personal consumption expenditures plus gross private domestic investment. The US did not recover strongly from the global recessions as typical in past cyclical expansions. Recovery tends to be more sluggish as the expansion matures. At the margin in IVQ2011 the acceleration of expansion was driven by inventory accumulation instead of aggregate demand of consumption and investment. Growth of PCE was partly the result of burning savings because of financial repression, which may not be sustainable in the future.
Table I-12, US, Contributions to Growth of Gross Domestic Product in Percentage Points
| 2009 | 2010 | 2011 | |
| GDP Growth ∆% | -3.5 | 3.0 | 1.7 |
| Personal Consumption Expenditures (PCE) | -1.32 | 1.44 | 1.53 |
| Goods | -0.69 | 0.99 | 0.87 |
| Durable | -0.41 | 0.53 | 0.60 |
| Nondurable | -0.28 | 0.46 | 0.27 |
| Services | -0.63 | 0.46 | 0.66 |
| Gross Private Domestic Investment (GPDI) | -3.61 | 1.96 | 0.60 |
| Fixed Investment | -2.77 | 0.32 | 0.81 |
| Nonresidential | -2.05 | 0.42 | 0.84 |
| Structures | -0.85 | -0.51 | 0.12 |
| Equipment, software | -1.20 | 0.93 | 0.72 |
| Residential | -0.72 | -0.11 | -0.03 |
| Change Private Inventories | -0.84 | 1.64 | -0.21 |
| Net Exports of Goods and Services | 1.11 | -0.51 | 0.05 |
| Exports | -1.18 | 1.31 | 0.86 |
| Goods | -1.04 | 1.12 | 0.67 |
| Services | -0.13 | 0.19 | 0.19 |
| Imports | 2.29 | -1.82 | -0.81 |
| Goods | 2.19 | -1.74 | -0.78 |
| Services | 0.10 | -0.08 | -0.03 |
| Government Consumption Expenditures and Gross Investment | 0.34 | 0.14 | -0.44 |
| Federal | 0.45 | 0.37 | -0.17 |
| National Defense | 0.30 | 0.18 | -0.13 |
| Nondefense | 0.16 | 0.19 | -0.03 |
| State and Local | -0.11 | -0.23 | -0.28 |
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
Table I-13 provides national income by industry without capital consumption adjustment (WCCA). Private industries have share of 85.9 percent in US national income. Most of US national income is in the form of services. In Mar 2012, there were 132.0 million nonfarm jobs in the US, according to estimates of the establishment survey of the Bureau of Labor Statistics (BLS) (http://www.bls.gov/news.release/pdf/empsit.pdf Table B-1, 28). Total private jobs of 108.9 million accounted for 82.9 percent of total nonfarm jobs, of which 11.8 million, or 10.8 percent of total private jobs and 8.9 million of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 91.7 million, or 69.5 percent of total nonfarm jobs and 84.2 percent of total private-sector jobs. Manufacturing has share of 10.0 in US national income, as shown in Table I-13. Most income in the US originates in services. Subsidies and similar measures designed to increase manufacturing jobs will not increase economic growth and employment and may actually reduce growth by diverting resources away from currently employment-creating activities because of the drain of taxation.
Table I-13, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total
| SAAR IVQ2011 | % Total | |
| National Income WCCA | 13,332.0 | 100.0 |
| Domestic Industries | 13,105.7 | 98.3 |
| Private Industries | 11,458.8 | 85.9 |
| Agriculture | 133.1 | 1.0 |
| Mining | 170.9 | 1.3 |
| Utilities | 169.3 | 1.3 |
| Construction | 544.5 | 4.1 |
| Manufacturing | 1330.9 | 10.0 |
| Durable Goods | 770.8 | 5.8 |
| Nondurable Goods | 560.1 | 4.2 |
| Wholesale Trade | 764.2 | 5.7 |
| Retail Trade | 906.1 | 6.8 |
| Transportation & WH | 372.0 | 2.8 |
| Information | 441.2 | 3.3 |
| Finance, insurance, RE | 2452.9 | 18.4 |
| Professional, BS | 1893.8 | 14.2 |
| Education, Health Care | 1370.8 | 10.3 |
| Arts, Entertainment | 519.1 | 3.9 |
| Other Services | 390.2 | 2.9 |
| Government | 1646.9 | 12.4 |
| Rest of the World | 226.3 | 1.7 |
Notes: SSAR: Seasonally-Adjusted Annual Rate; WCCA: Without Capital Consumption Adjustment by Industry; WH: Warehousing; RE, includes rental and leasing: Real Estate; Art, Entertainment includes recreation, accommodation and food services; BS: business services
Sources: http://www.bea.gov/iTable/index_nipa.cfm
II United States Housing. The objective of this section is to provide the latest data and analysis of US housing. Subsection IIA United States New House Sales reviews the latest data on new house sales in the US. Subsection IIB United States House Prices considers the latest available data on US house prices. Subsection IIC Factors of US Housing Collapse analyzes the causes of the US housing crisis.
IIA United States New House Sales. Data and other information continue to provide depressed conditions in the US housing market. Table II-1 shows sales of new houses in the US at seasonally-adjusted annual equivalent rate (SAAR). House prices fell in eight of fifteen months from Jan 2011 to Mar 2012. Revisions show decline of house sales of 3.5 percent in Jan and increase of house sales by 7.3 percent in Feb, which is partly the cause of decline of 7.1 percent in Mar. The annual equivalent rate in the first three months of 2012 is minus 14.4 percent. There was significant strength in Sep-Dec with annual equivalent rate of 62.3 percent. The annual equivalent rate in May-Aug was minus 22.5 percent and minus 13.1 percent in Jan-Apr.
Table II-1, US, Sales of New Houses at Seasonally-Adjusted (SA) Annual Equivalent Rate, Thousands and %
| SA Annual Rate | ∆% | |
| Mar 2012 | 328 | -7.1 |
| Feb | 353 | 7.3 |
| Jan | 329 | -3.5 |
| AE ∆% Jan-Mar | -14.4 | |
| Dec 2011 | 341 | 5.9 |
| Nov | 322 | 3.5 |
| Oct | 311 | 3.0 |
| Sep | 302 | 4.1 |
| AE ∆% Sep-Dec | 62.3 | |
| Aug | 290 | -1.7 |
| Jul | 295 | -2.6 |
| Jun | 303 | -1.6 |
| May | 308 | -2.5 |
| AE ∆% May-Aug | -22.5 | |
| Apr | 316 | 3.6 |
| Mar | 305 | 8.5 |
| Feb | 281 | -9.4 |
| Jan | 310 | -6.3 |
| AE ∆% Jan-Apr | -13.1 | |
| Dec 2010 | 331 | 4.3 |
AE: Annual Equivalent
Source: http://www.census.gov/construction/nrs/
There is additional information of the report of new house sales in Table II-2. The stock of unsold houses stabilized in Apr-Aug at average 6.6 monthly equivalent sales at current sales rates and then dropped to 6.4 in Sep, 6.1 in Oct, 5.8 in Nov and revised 5.3 in Dec, increasing slightly to revised 5.4 in Jan but declined to revised 5.0 in Feb and now 5.3 in Mar. Median and average house prices oscillate. In Mar 2012, median prices of new houses sold not seasonally adjusted (NSA) fell 1.0 but after increasing revised 8.7 percent in Feb and average prices rose 2.2 percent in Feb and 8.0 percent in Mar. There are only five months with price increases in both median and average house prices: Apr with 1.9 percent in median prices and 3.1 percent in average prices, Jun with 8.2 percent in median prices and 3.9 percent in average prices, Oct with 3.6 percent in median prices and 1.1 percent in average prices, Dec with 2.0 percent in median prices and 5.2 percent in average prices and Feb 2012 with 8.7 percent in median prices and 2.2 percent in average prices. Median prices of new houses sold in the US fell in nine of the 15 months from Jan 2011 to Mar 2012 and average prices fell in eight months.
Table II-2, US, New House Stocks and Median and Average New Homes Sales Price
| Unsold* | Median | Month | Average New House Sales Price USD | Month | |
| Mar 2012 | 5.3 | 234,500 | -1.0 | 291,200 | 8.0 |
| Feb | 5.0 | 236,900 | 8.7 | 269,700 | 2.2 |
| Jan | 5.4 | 218,000 | –0.3 | 263,600 | 0.3 |
| Dec 2011 | 5.3 | 218,600 | 2.0 | 262,900 | 5.2 |
| Nov | 5.8 | 214,300 | -4.7 | 250,000 | -3.2 |
| Oct | 6.1 | 224,800 | 3.6 | 258,300 | 1.1 |
| Sep | 6.4 | 217,000 | -1.2 | 255,400 | -1.5 |
| Aug | 6.7 | 219,600 | -4.5 | 259,300 | -4.1 |
| Jul | 6.8 | 229,900 | -4.3 | 270,300 | -1.0 |
| Jun | 6.6 | 240,200 | 8.2 | 273,100 | 3.9 |
| May | 6.5 | 222,000 | -1.2 | 262,700 | -2.3 |
| Apr | 6.6 | 224,700 | 1.9 | 268,900 | 3.1 |
| Mar | 7.0 | 220,500 | 0.2 | 260,800 | -0.8 |
| Feb | 7.8 | 220,100 | -8.3 | 262,800 | -4.7 |
| Jan | 7.2 | 240,100 | -0.5 | 275,700 | -5.5 |
| Dec 2010 | 6.9 | 241,200 | 9.8 | 291,700 | 3.5 |
*Percent of new houses for sale relative to houses sold
Source: http://www.census.gov/construction/nrs/
The depressed level of residential construction and new house sales in the US is evident in Table II-3 providing new house sales not seasonally adjusted in Jan-Mar of various years. Sales of new houses in Jan-Mar 2012 are substantially lower than in any year between 1995 and 2012. There is only an increase of 16.9 percent between Jan-Mar 2011 and Jan-Mar 2012 that will likely disappear as the year proceeds. Sales of new houses in 2012 are lower by 4.6 percent in relation to 2010 and 1.2 percent below the level in 2009. The housing boom peaked in 2005 and 2006 when increases in fed funds rates affected subprime mortgages that were programmed for refinancing in two or three years on the expectation that price increases forever would raise home equity. Higher home equity would permit refinancing under feasible mortgages incorporating full payment of principal and interest (Gorton 2009EFM; see other references in http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Sales of new houses in Jan-Mar 2012 relative to the same period in 2005 fell 74.7 percent and 70.9 percent relative to the same period in 2006. Similar percentage declines are also observed for 2012 relative to years from 2000 to 2004. Sales of new houses in Jan-Mar 2012 fell 46.1 per cent relative to the same period in 1995. The population of the US was 179.3 million in 1960 and 281.4 million in 2000 (Hoobs and Snoops 2012, 16). Detailed historical census reports are available from the US Census Bureau at (http://www.census.gov/population/www/censusdata/hiscendata.html). The US population reached 308.7 million in 2010 (http://2010.census.gov/2010census/data/). The US population increased by 129.4 million from 1960 to 2010 or 72.2 percent. The final row of Table I-3 reveals catastrophic data: sales of new houses in Jan-Mar 2012 of 83 thousand units are lower by 31.4 percent relative to 121 thousand units houses sold in Jan-Mar 1963, the first year when data become available, while population increased 72.2 percent.
Table II-3, US, Sales of New Houses Not Seasonally Adjusted, Thousands and %
| Not Seasonally Adjusted Thousands | |
| Jan-Mar 2012 | 83 |
| Jan-Mar 2011 | 71 |
| ∆% | 16.9 |
| Jan-Mar 2010 | 87 |
| ∆% Jan-Mar 2012/ | -4.6 |
| Jan-Mar 2009 | 84 |
| ∆% Jan-Mar 2012/ | -1.2 |
| Jan-Mar 2008 | 141 |
| ∆% Jan-Mar 2012/ | -41.1 |
| Jan-Mar 2007 | 214 |
| ∆% Jan-Mar 2012/ | -61.2 |
| Jan-Mar 2006 | 285 |
| ∆% Jan-Mar 2012/Jan-Mar 2006 | -70.9 |
| Jan-Mar 2005 | 328 |
| ∆% Jan-Mar 2012/Jan-Mar 2005 | -74.7 |
| Jan-Mar 2004 | 314 |
| ∆% Jan-Mar 2012/Jan-Mar 2004 | -73.6 |
| Jan-Mar 2003 | 256 |
| ∆% Jan-Mar 2012/ | -67.6 |
| Jan-Mar 2002 | 240 |
| ∆% Jan-Mar 2012/ | -65.4 |
| Jan-Mar 2001 | 251 |
| ∆% Jan-Mar 2012/ | -66.9 |
| Jan-Mar 2000 | 233 |
| ∆% Jan-Mar 2012/ | -64.4 |
| Jan-Mar 1995 | 154 |
| ∆% Jan-Mar 2012/ | -46.1 |
| Jan-Mar 1963 | 121 |
| ∆% Jan-Mar 2012/ | -31.4 |
Source: http://www.census.gov/construction/nrs/
Table II-4 provides the entire available annual series of new house sales from 1963 to 2011. The revised level of 306 thousand new houses sold in 2011 is the lowest since 560,000 in 1963 in the 48 years of available data. In that period, the population of the US increased 129.4 million from 179.3 million in 1960 to 308.7 million in 2010, or 72.2 percent. In fact, there is no year from 1963 to 2010 in Table II-4 with sales of new houses below 400 thousand with the exception of the immediately preceding years of 2009 and 2010.
Table II-4, US, New Houses Sold, NSA Thousands
| 1963 | 560 |
| 1964 | 565 |
| 1965 | 575 |
| 1966 | 461 |
| 1967 | 487 |
| 1968 | 490 |
| 1969 | 448 |
| 1970 | 485 |
| 1971 | 656 |
| 1972 | 718 |
| 1973 | 634 |
| 1974 | 519 |
| 1975 | 549 |
| 1976 | 646 |
| 1977 | 819 |
| 1978 | 817 |
| 1979 | 709 |
| 1980 | 545 |
| 1981 | 436 |
| 1982 | 412 |
| 1983 | 623 |
| 1984 | 639 |
| 1985 | 688 |
| 1986 | 750 |
| 1987 | 671 |
| 1988 | 676 |
| 1989 | 650 |
| 1990 | 534 |
| 1991 | 509 |
| 1992 | 610 |
| 1993 | 666 |
| 1994 | 670 |
| 1995 | 667 |
| 1996 | 757 |
| 1997 | 804 |
| 1998 | 886 |
| 1999 | 880 |
| 2000 | 877 |
| 2001 | 908 |
| 2002 | 973 |
| 2003 | 1,086 |
| 2004 | 1,203 |
| 2005 | 1,283 |
| 2006 | 1,051 |
| 2007 | 776 |
| 2008 | 485 |
| 2009 | 375 |
| 2010 | 323 |
| 2011 | 306 |
Source: http://www.census.gov/construction/nrs/
Chart I-1 of the US Bureau of the Census shows the sharp decline of sales of new houses in the US. Sales rose temporarily until about mid 2010 but then declined to a lower plateau.
Chart II-1, US, New One-Family Houses Sold in the US, SAAR (Seasonally-Adjusted Annual Rate)
Source: US Census Bureau
http://www.census.gov/briefrm/esbr/www/esbr051.html
Percentage changes and average rates of growth of new house sales for selected periods are shown in Table II-5. The percentage change of new house sales from 1963 to 2011 is minus 45.4 percent. Between 1991 and 2001, sales of new houses rose 78.4 percent at the average yearly rate of 5.9 percent. Between 1995 and 2005 sales of new houses increased 92.4 percent at the yearly rate of 6.8 percent. There are similar rates in all years from 2000 to 2004. The boom in housing construction and sales began in the 1980s and 1990s. The collapse of real estate culminated several decades of housing subsidies and policies to lower mortgage rates and borrowing terms (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009b), 42-8). Sales of new houses sold in 2011 fell 54.1 percent relative to the same period in 1995.
Table II-5, US, Percentage Change and Average Yearly Rate of Growth of Sales of New One-Family Houses
| ∆% | Average Yearly % Rate | |
| 1963-2011 | -45.4 | NA |
| 1991-2001 | 78.4 | 5.9 |
| 1995-2005 | 92.4 | 6.8 |
| 2000-2005 | 46.3 | 7.9 |
| 1995-2011 | -54.1 | NA |
| 2000-2011 | -65.1 | NA |
| 2005-2011 | -76.1 | NA |
NA: Not Applicable
Source: http://www.census.gov/construction/nrs/
The available historical data of median and average prices of new houses sold in the US between 1963 and 2010 is provided in Table II-6. On a yearly basis, median and average prices reached a peak in 2007 and then fell substantially.
Table I-6, US, Median and Average Prices of New Houses Sold, Annual Data
| Period | Median | Average |
| 1963 | $18,000 | $19,300 |
| 1964 | $18,900 | $20,500 |
| 1965 | $20,000 | $21,500 |
| 1966 | $21,400 | $23,300 |
| 1967 | $22,700 | $24,600 |
| 1968 | $24,700 | $26,600 |
| 1969 | $25,600 | $27,900 |
| 1970 | $23,400 | $26,600 |
| 1971 | $25,200 | $28,300 |
| 1972 | $27,600 | $30,500 |
| 1973 | $32,500 | $35,500 |
| 1974 | $35,900 | $38,900 |
| 1975 | $39,300 | $42,600 |
| 1976 | $44,200 | $48,000 |
| 1977 | $48,800 | $54,200 |
| 1978 | $55,700 | $62,500 |
| 1979 | $62,900 | $71,800 |
| 1980 | $64,600 | $76,400 |
| 1981 | $68,900 | $83,000 |
| 1982 | $69,300 | $83,900 |
| 1983 | $75,300 | $89,800 |
| 1984 | $79,900 | $97,600 |
| 1985 | $84,300 | $100,800 |
| 1986 | $92,000 | $111,900 |
| 1987 | $104,500 | $127,200 |
| 1988 | $112,500 | $138,300 |
| 1989 | $120,000 | $148,800 |
| 1990 | $122,900 | $149,800 |
| 1991 | $120,000 | $147,200 |
| 1992 | $121,500 | $144,100 |
| 1993 | $126,500 | $147,700 |
| 1994 | $130,000 | $154,500 |
| 1995 | $133,900 | $158,700 |
| 1996 | $140,000 | $166,400 |
| 1997 | $146,000 | $176,200 |
| 1998 | $152,500 | $181,900 |
| 1999 | $161,000 | $195,600 |
| 2000 | $169,000 | $207,000 |
| 2001 | $175,200 | $213,200 |
| 2002 | $187,600 | $228,700 |
| 2003 | $195,000 | $246,300 |
| 2004 | $221,000 | $274,500 |
| 2005 | $240,900 | $297,000 |
| 2006 | $246,500 | $305,900 |
| 2007 | $247,900 | $313,600 |
| 2008 | $232,100 | $292,600 |
| 2009 | $216,700 | $270,900 |
| 2010 | $221,800 | $272,900 |
| 2011 | $227,200 | $267,900 |
Source: http://www.census.gov/construction/nrs/
Percentage changes of median and average prices of new houses sold in selected years are shown in Table II-7. Prices rose sharply between 2000 and 2005. In fact, prices in 2011 are higher than in 2000. Between 2006 and 2011, median prices of new houses sold fell 7.8 percent and average prices fell 12.4 percent. Between 2010 and 2011, median prices increased 2.4 percent and average prices fell 1.8 percent.
Table II-7, US, Percentage Change of New Houses Median and Average Prices, NSA, ∆%
| Median New | Average New Home Sales Prices ∆% | |
| ∆% 2000 to 2003 | 15.4 | 18.9 |
| ∆% 2000 to 2005 | 42.5 | 43.5 |
| ∆% 2000 to 2011 | 34.4 | 29.4 |
| ∆% 2005 to 2011 | -5.7 | -9.8 |
| ∆% 2000 to 2006 | 45.9 | 47.8 |
| ∆% 2006 to 2011 | -7.8 | -12.4 |
| ∆% 2009 to 2011 | 4.8 | -1.1 |
| ∆% 2010 to 2011 | 2.4 | -1.8 |
Source: http://www.census.gov/construction/nrs/
IIB United States House Prices. Table II-8 shows the euphoria of prices during the boom and the subsequent decline. House prices rose 94.3 percent in the 10-city composite of the Case-Shiller home price index and 77.2 percent in the 20-city composite between Feb 2000 and Feb 2005. Prices rose over 100 percent from Feb 2000 to Feb 2006, increasing 121.6 percent for the 10-city composite and 101.7 percent for the 20-city composite. House prices rose 36.4 percent between Feb 2003 and Feb 2005 for the 10-city composite and 31.1 percent for the 20-city composite propelled by low fed funds rates of 1.0 percent between Jun 2003 and Jun 2004 and then only increasing by 0.25 basis points at every meeting of the Federal Open Market Committee (FOMC). Simultaneously, the suspension of auctions of the 30-year Treasury bond caused decline of yields of mortgage-backed securities with resulting decrease in mortgage rates. Similarly, between Feb 2003 and Feb 2006 the 10-city index gained 55.6 percent and the 20-city index increased 49.2 percent. House prices have fallen from Feb 2006 to Feb 2012 by 34.2 percent for the 10-city composite and 33.9 percent for the 20-city composite. Measuring house prices is quite difficult because of the lack of homogeneity that is typical of standardized commodities. In the 12 months ending in Feb 2012, house prices fell 3.6 percent in the 10-city composite and fell 3.5 percent in the 20-city composite in what has become a second round of decreases in prices of houses in the US. The final row in Table II-8 shows that house prices increased 45.7 percent between Feb 2000 and Feb 2012 for the 10-city composite and increased 33.2 percent for the 20-city composite. Standard & Poor’s Case-Shiller estimates that both composite indices are lower by 35.0 percent relative to their peaks in 2006 (http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff--p-us----).
Table II-8, US, Percentage Changes of Standard & Poor’s Case-Shiller Home Price Indices, Not Seasonally Adjusted, ∆%
| Feb | 10-City Composite | 20-City Composite |
| ∆% Feb 2000 to Feb 2003 | 42.4 | 35.2 |
| ∆% Feb 2000 to Feb 2005 | 94.3 | 77.2 |
| ∆% Feb 2003 to Feb 2005 | 36.4 | 31.1 |
| ∆% Feb 2000 to Feb 2006 | 121.6 | 101.7 |
| ∆% Feb 2003 to Feb 2006 | 55.6 | 49.2 |
| ∆% Feb 2005 to Feb 2012 | -25.0 | -24.8 |
| ∆% Feb 2006 to Feb 2012 | -34.2 | -33.9 |
| ∆% Feb 2009 to Feb 2012 | -5.0 | -6.3 |
| ∆% Feb 2010 to Feb 2012 | -6.3 | -6.8 |
| ∆% Feb 2011 to Feb 2012 | -3.6 | -3.5 |
| ∆% Feb 2000 to Feb 2012 | 45.7 | 33.2 |
With the exception of Apr 2011 and Feb 2012, house prices seasonally-adjusted have declined in every month for both the 10-city and 20-city Case-Shiller composites from Dec 2010 to Feb 2012, as shown in Table II-9. Without seasonal adjustment, house prices fell from Dec 2010 throughout Mar 2011 and then increased in every month from Apr to Aug but fell in every month from Sep to Feb. The not seasonally adjusted index registers declines in Feb of 0.8 percent for both the 10- and 20-city composites. Declining house prices cause multiple adverse effects of which two are quite evident. (1) There is a disincentive to buy houses in continuing price declines. (2) More mortgages could be losing fair market value relative to mortgage debt. Another possibility is a wealth effect that consumers restrain purchases because of the decline of their net worth in houses.
Table II-9, US, Monthly Percentage Change of S&P Case-Shiller Home Price Indices, Seasonally Adjusted, ∆%
| 10-City Composite SA | 10-City Composite NSA | 20-City Composite SA | 20-City Composite NSA | |
| Feb 2012 | 0.1 | -0.8 | 0.2 | -0.8 |
| Jan | -0.2 | -1.0 | -0.1 | -1.0 |
| Dec 2011 | -0.6 | -1.2 | -0.5 | -1.2 |
| Nov | -0.8 | -1.4 | -0.7 | -1.3 |
| Oct | -0.7 | -1.3 | -0.7 | -1.3 |
| Sep | -0.6 | -0.6 | -0.7 | -0.7 |
| Aug | -0.4 | 0.1 | -0.5 | 0.0 |
| Jul | -0.1 | 0.9 | -0.01 | 1.0 |
| Jun | -0.2 | 1.0 | -0.2 | 1.2 |
| May | -0.1 | 1.0 | -0.1 | 1.0 |
| Apr | 0.5 | 0.6 | 0.6 | 0.6 |
| Mar | -0.6 | -1.0 | -0.8 | -1.0 |
| Feb | -0.4 | -1.3 | -0.3 | -1.2 |
| Jan | -0.3 | -1.1 | -0.3 | -1.1 |
| Dec 2010 | -0.3 | -0.9 | -0.3 | -0.9 |
The Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac, provides the FHFA House Price Index (HPI) that “is calculated using home sales price information from Fannie Mae- and Freddie Mac-acquired mortgages” (http://www.fhfa.gov/webfiles/22558/2q2011HPI.pdf). Table II-10 provides the FHFA HPI for purchases only, which shows behavior similar to that of the Case-Shiller index but with lower magnitudes. House prices catapulted from 2000 to 2003, 2005 and 2006. From IVQ2000 to IVQ2006, the index for the US as a whole rose 55.0 percent and by close or higher than 70 percent for New England, Middle Atlantic and South Atlantic but only by 33.2 percent for East South Central. Prices fell relative to 2011 from all years since 2005. From IVQ2000 to IVQ2011, prices rose for the US and the four regions in Table II-10.
Table II-10, US, FHFA House Price Index Purchases Only NSA ∆%
| United States | New England | Middle Atlantic | South Atlantic | East South Central | |
| 4Q2000 | 24.6 | 40.7 | 35.9 | 25.8 | 11.1 |
| 4Q2000 | 50.3 | 65.2 | 67.9 | 62.4 | 25.5 |
| 4Q2000 to | 55.0 | 62.3 | 72.6 | 70.6 | 33.2 |
| 4Q2005 t0 | -16.3 | -13.6 | -7.3 | -22.0 | -1.6 |
| 4Q2006 | -18.9 | -12.1 | -9.8 | -25.8 | -7.3 |
| 4Q2007 to | -16.9 | -10.4 | -10.2 | -23.3 | -9.1 |
| 4Q2009 to | -6.4 | -3.6 | -4.9 | -8.3 | -5.2 |
| 4Q2010 to | -2.4 | -2.0 | -3.4 | -2.7 | -0.7 |
| 4Q2000 to | 25.8 | 42.7 | 55.6 | 26.6 | 23.5 |
Source: http://www.fhfa.gov/webfiles/23396/4Q2011hpi.pdf
Data of the FHFA HPI for the remaining US regions are provided in Table II-11. Behavior is not very different than in Table II-10 with the exception of East North Central. House prices in the Pacific region doubled between 2000 and 2006. Although prices of houses declined sharply from 2005 to 2011, there was still appreciation relative to 2000.
Table II-11, US, FHFA House Price Index Purchases Only NSA ∆%
| West South Central | West North Central | East North Central | Mountain | Pacific | |
| 4Q2000 | 11.2 | 18.4 | 14.8 | 18.9 | 44.2 |
| 4Q2000 | 23.8 | 31.2 | 24.0 | 57.6 | 106.9 |
| 4Q2000 to 4Q2006 | 31.7 | 34.1 | 23.9 | 68.8 | 107.8 |
| 4Q2005 t0 | 8.2 | -6.9 | -16.4 | -26.2 | -37.8 |
| 4Q2006 | 1.7 | -8.9 | -16.4 | -31.1 | -38.1 |
| 4Q2007 to | -1.7 | -8.5 | -13.5 | -28.8 | -31.5 |
| 4Q2009 to | -1.2 | -4.7 | -5.5 | -10.9 | -10.3 |
| 4Q2010 to | 1.2 | -1.2 | -2.7 | -3.5 | -4.8 |
| 4Q2000 to 4Q2011 | 33.9 | 22.1 | 3.6 | 16.3 | 28.6 |
Source: http://www.fhfa.gov/webfiles/23396/4Q2011hpi.pdf
Chart II-2 of the Federal Housing Finance Agency shows the Housing Price Index four-quarter price change from IVQ2001 to IVQ2011. House prices appreciated sharply from 1998 to 2005 and then fell rapidly. Recovery began already after IVQ2008 but there was another decline after IIIQ2010. The rate of decline improved in the second half of 2011.
Chart II-2, US, Federal Housing Finance Agency House Price Index Four Quarter Price Change
Source: Federal Housing Finance Agency
http://www.fhfa.gov/Default.aspx?Page=14
Monthly and 12-month percentage changes of the FHFA House Price Index are provided in Table II-12. Percentage monthly increases of the FHFA index were positive from Apr to Jul while 12 months percentage changes improved steadily from more or equal to minus 6 percent in Mar to May to minus 4.3 percent in Jun. The FHFA house price index fell 0.9 percent in Oct and fell 3.4 percent in the 12 months ending in Oct. There was significant recovery in Nov with increase in the house price index of 0.7 percent and reduction of the 12-month rate of decline to 2.2 percent. The house price index rose 0.1 percent in Dec and the 12-month percentage change fell to minus 1.6 percent. There was further improvement with revised decline 0.5 percent in Jan 2012 and decline of the 12-month percentage change to minus 1.2 percent. The index changed to positive change of 0.3 percent in Feb 2012 and increase of 0.4 percent in the 12 months ending in Feb 2012.
Table II-12, US, FHFA House Price Index Purchases Only SA. Month and NSA 12-Month ∆%
| Month ∆% SA | 12 Month ∆% NSA | |
| Feb 2012 | 0.3 | 0.4 |
| Jan | -0.5 | -1.2 |
| Dec 2011 | 0.1 | -1.5 |
| Nov | 0.7 | -2.2 |
| Oct | -0.9 | -3.4 |
| Sep | 0.3 | -2.6 |
| Aug | -0.3 | -4.0 |
| Jul | 0.1 | -3.7 |
| Jun | 0.6 | -4.3 |
| May | 0.2 | -6.0 |
| Apr | 0.3 | -6.1 |
| Mar | -0.5 | -6.0 |
| Feb | -1.4 | -5.4 |
| Jan | -0.7 | -4.6 |
| Dec 2010 | -3.9 | |
| Dec 2009 | -1.9 | |
| Dec 2008 | -9.7 | |
| Dec 2007 | -3.0 | |
| Dec 2006 | 2.5 | |
| Dec 2005 | 9.9 | |
| Dec 2004 | 10.1 | |
| Dec 2003 | 7.9 | |
| Dec 2002 | 7.8 | |
| Dec 2001 | 6.8 | |
| Dec 2000 | 7.1 | |
| Dec 1999 | 6.1 | |
| Dec 1998 | 5.9 | |
| Dec 1997 | 3.4 | |
| Dec 1996 | 2.8 | |
| Dec 1995 | 2.8 | |
| Dec 1994 | 2.6 | |
| Dec 1993 | 3.1 | |
| Dec 1992 | 2.4 |
Source: http://www.fhfa.gov/Default.aspx?Page=87
Table II-12 provides 12-month percentage changes of the FHFA house price index since 1992 when data become available for 1991. Table II-13 provides percentage changes and average rates of percent change per year for various periods. Between 1992 and 2011, the FHFA house price index increased 74.4 percent at the yearly average rate of 3.0 percent. In the period 1992-2000, the FHFA house price index increased 39.0 percent at the average yearly rate of 4.2 percent. The rate of price increase accelerated to 7.5 percent in the period 2000-2003 and to 8.5 percent in 2000-2005 and 7.5 percent in 2000-2006. At the margin the average rate jumped to 10.0 percent in 2003-2005 and 7.5 percent in 2003-2006. House prices measured by the FHFA house price index declined 18.6 percent between 2006 and 2011 and 16.6 percent between 2005 and 2011.
Table II-13, US, FHFA House Price Index, Percentage Change and Average Rate of Percentage Change per Year, Selected Dates 1992-2011
| Dec | ∆% | Average ∆% per Year |
| 1992-2011 | 74.4 | 3.0 |
| 1992-2000 | 39.0 | 4.2 |
| 2000-2003 | 24.2 | 7.5 |
| 2000-2005 | 50.3 | 8.5 |
| 2003-2005 | 21.0 | 10.0 |
| 2005-2011 | -16.6 | NA |
| 2000-2006 | 54.1 | 7.5 |
| 2003-2006 | 24.1 | 7.5 |
| 2006-2011 | -18.6 | NA |
Source: http://www.fhfa.gov/Default.aspx?Page=87
IIC Factors of US Housing Collapse. Weakness in the housing sector is being considered as an important factor of the financial crisis, global recession and slow growth recession. Chairman Bernanke (2011Oct4JEC, 2-3) states:
“Other sectors of the economy are also contributing to the slower-than-expected rate of expansion. The housing sector has been a significant driver of recovery from most recessions in the United States since World War II. This time, however, a number of factors--including the overhang of distressed and foreclosed properties, tight credit conditions for builders and potential homebuyers, and the large number of “underwater” mortgages (on which homeowners owe more than their homes are worth)--have left the rate of new home construction at only about one-third of its average level in recent decades.”
The answer to these arguments can probably be found in the origins of the financial crisis and global recession. Let V(T) represent the value of the firm’s equity at time T and B stand for the promised debt of the firm to bondholders and assume that corporate management, elected by equity owners, is acting on the interests of equity owners. Robert C. Merton (1974, 453) states:
“On the maturity date T, the firm must either pay the promised payment of B to the debtholders or else the current equity will be valueless. Clearly, if at time T, V(T) > B, the firm should pay the bondholders because the value of equity will be V(T) – B > 0 whereas if they do not, the value of equity would be zero. If V(T) ≤ B, then the firm will not make the payment and default the firm to the bondholders because otherwise the equity holders would have to pay in additional money and the (formal) value of equity prior to such payments would be (V(T)- B) < 0.”
Pelaez and Pelaez (The Global Recession Risk (2007), 208-9) apply this analysis to the US housing market in 2005-2006 concluding:
“The house market [in 2006] is probably operating with low historical levels of individual equity. There is an application of structural models [Duffie and Singleton 2003] to the individual decisions on whether or not to continue paying a mortgage. The costs of sale would include realtor and legal fees. There could be a point where the expected net sale value of the real estate may be just lower than the value of the mortgage. At that point, there would be an incentive to default. The default vulnerability of securitization is unknown.”
There are multiple important determinants of the interest rate: “aggregate wealth, the distribution of wealth among investors, expected rate of return on physical investment, taxes, government policy and inflation” (Ingersoll 1987, 405). Aggregate wealth is a major driver of interest rates (Ibid, 406). Unconventional monetary policy, with zero fed funds rates and flattening of long-term yields by quantitative easing, causes uncontrollable effects on risk taking that can have profound undesirable effects on financial stability. Excessively aggressive and exotic monetary policy is the main culprit and not the inadequacy of financial management and risk controls.
The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent restatement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption decisions is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:
W = Y/r (1)
Equation (1) shows that as r goes to zero, r →0, W grows without bound, W→∞.
Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at close to zero interest rates, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).
The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper to purchase default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4).
There are significant elements of the theory of bank financial fragility of Diamond and Dybvig (1983) and Diamond and Rajan (2000, 2001a, 2001b) that help to explain the financial fragility of banks during the credit/dollar crisis (see also Diamond 2007). The theory of Diamond and Dybvig (1983) as exposed by Diamond (2007) is that banks funding with demand deposits have a mismatch of liquidity (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 58-66). A run occurs when too many depositors attempt to withdraw cash at the same time. All that is needed is an expectation of failure of the bank. Three important functions of banks are providing evaluation, monitoring and liquidity transformation. Banks invest in human capital to evaluate projects of borrowers in deciding if they merit credit. The evaluation function reduces adverse selection or financing projects with low present value. Banks also provide important monitoring services of following the implementation of projects, avoiding moral hazard that funds be used for, say, real estate speculation instead of the original project of factory construction. The transformation function of banks involves both assets and liabilities of bank balance sheets. Banks convert an illiquid asset or loan for a project with cash flows in the distant future into a liquid liability in the form of demand deposits that can be withdrawn immediately.
In the theory of banking of Diamond and Rajan (2000, 2001a, 2001b), the bank creates liquidity by tying human assets to capital. The collection skills of the relationship banker convert an illiquid project of an entrepreneur into liquid demand deposits that are immediately available for withdrawal. The deposit/capital structure is fragile because of the threat of bank runs. In these days of online banking, the run on Washington Mutual was through withdrawals online. A bank run can be triggered by the decline of the value of bank assets below the value of demand deposits.
Pelaez and Pelaez (Regulation of Banks and Finance 2009b, 60, 64-5) find immediate application of the theories of banking of Diamond, Dybvig and Rajan to the credit/dollar crisis after 2007. It is a credit crisis because the main issue was the deterioration of the credit portfolios of securitized banks as a result of default of subprime mortgages. It is a dollar crisis because of the weakening dollar resulting from relatively low interest rate policies of the US. It caused systemic effects that converted into a global recession not only because of the huge weight of the US economy in the world economy but also because the credit crisis transferred to the UK and Europe. Management skills or human capital of banks are illustrated by the financial engineering of complex products. The increasing importance of human relative to inanimate capital (Rajan and Zingales 2000) is revolutionizing the theory of the firm (Zingales 2000) and corporate governance (Rajan and Zingales 2001). Finance is one of the most important examples of this transformation. Profits were derived from the charter in the original banking institution. Pricing and structuring financial instruments was revolutionized with option pricing formulas developed by Black and Scholes (1973) and Merton (1973, 1974, 1998) that permitted the development of complex products with fair pricing. The successful financial company must attract and retain finance professionals who have invested in human capital, which is a sunk cost to them and not of the institution where they work.
The complex financial products created for securitized banking with high investments in human capital are based on houses, which are as illiquid as the projects of entrepreneurs in the theory of banking. The liquidity fragility of the securitized bank is equivalent to that of the commercial bank in the theory of banking (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 65). Banks created off-balance sheet structured investment vehicles (SIV) that issued commercial paper receiving AAA rating because of letters of liquidity guarantee by the banks. The commercial paper was converted into liquidity by its use as collateral in SRPs at the lowest rates and minimal haircuts because of the AAA rating of the guarantor bank. In the theory of banking, default can be triggered when the value of assets is perceived as lower than the value of the deposits. Commercial paper issued by SIVs, securitized mortgages and derivatives all obtained SRP liquidity on the basis of illiquid home mortgage loans at the bottom of the pyramid. The run on the securitized bank had a clear origin (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 65):
“The increasing default of mortgages resulted in an increase in counterparty risk. Banks were hit by the liquidity demands of their counterparties. The liquidity shock extended to many segments of the financial markets—interbank loans, asset-backed commercial paper (ABCP), high-yield bonds and many others—when counterparties preferred lower returns of highly liquid safe havens, such as Treasury securities, than the risk of having to sell the collateral in SRPs at deep discounts or holding an illiquid asset. The price of an illiquid asset is near zero.”
III World Financial Turbulence. Financial markets are being shocked by multiple factors including (1) world economic slowdown; (2) growth in China with political development, Japan and world trade; (3) slow growth propelled by savings reduction in the US with high unemployment/underemployment, falling wages and hiring collapse; 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. Some of this material is updated in Subsection IIIA when new data are available and then maintained in the appendixes for future reference until updated again in Subsection IIIA. 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 IIIE 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 Apr 20 and daily values throughout the week ending on Fri Apr 27 of various 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 Apr 20 and the percentage change in that prior week below the label of the financial risk asset. For example, the US dollar (USD) appreciated 0.1 percent to USD 1.3078/EUR in the week ending on Apr 13. 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 1.3220/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Apr 20, appreciating to USD 1.3156/EUR on Mon Apr 23, or by 0.5 percent. The dollar appreciated because fewer dollars, $1.3156, were required on Mon Apr 23 to buy one euro than $1.3220 on Apr 20. 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 1.3156/EUR on Apr 23; 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 Apr 20, to the last business day of the current week, in this case Fri Apr 27, such as depreciation by 0.2 percent to USD 1.3253/EUR by Apr 27; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (denoted by negative sign) by 0.2 percent from the rate of USD 1.3220/EUR on Fri Apr 20 to the rate of USD 1.3253/EUR on Fri Apr 27 {[(1.3253/1.3220) – 1]100 = 0.2%} and depreciated (denoted by negative sign) by 0.1 percent from the rate of USD 1.3238 on Thu Apr 26 to USD 1.3253/EUR on Fri Apr 27 {[(1.3253/1.3238) -1]100 = 0.1%}. 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, depreciating the dollar.
III-I, Weekly Financial Risk Assets Apr 23 to Apr 27, 2012
| Fri Apr 20, 2012 | M 23 | Tue 24 | W 25 | Thu 26 | Fr 27 |
| USD/EUR 1.3220 -1.1% | 1.3156 0.5% 0.5% | 1.3187 0.2% -0.2% | 1.3220 0.0% -0.2% | 1.3238 -0.1% -0.1% | 1.3253 -0.2% -0.1% |
| JPY/ USD 81.51 -0.7% | 81.16 0.4% 0.4% | 81.31 0.2% -0.2% | 81.34 0.2% 0.0% | 80.97 0.7% 0.5% | 80.27 1.5% 0.9% |
| CHF/ USD 0.9088 1.2% | 0.9137 -0.5% -0.5% | 0.9113 -0.3% 0.3% | 0.9090 0.0% 0.3% | 0.9079 0.1% 0.1% | 0.9065 0.3% 0.2% |
| CHF/ EUR 1.2014 0.1% | 1.2021 -0.1% -0.1% | 1.2017 0.0% 0.0% | 1.2016 0.0% 0.0% | 1.2018 0.0% 0.0% | 1.2014 0.0% 0.0% |
| USD/ AUD 1.0378 0.9636 0.1% | 1.0317 0.9693 -0.6% -0.6% | 1.0297 0.9712 -0.8% -0.2% | 1.0361 0.9652 -0.2% 0.6% | 1.0393 0.9622 0.1% 0.3% | 1.0471 0.9550 0.9% 0.7% |
| 10 Year T Note 1.959 | 1.94 | 1.97 | 1.99 | 1.94 | 1.931 |
| 2 Year T Note 0.268 | 0.26 | 0.27 | 0.27 | 0.26 | 0.26 |
| German Bond 2Y 0.14 10Y 1.71 | 2Y 0.12 10Y 1.65 | 2Y 0.13 10Y 1.70 | 2Y 0.12 10Y 1.74 | 2Y 0.09 10Y 1.68 | 2Y 0.10 10Y 1.70 |
| DJIA 13029.26 1.4% | 12927.17 -0.8% -0.8% | 13001.56 -0.2% 0.6% | 13090.72 0.5% 0.7% | 13204.62 1.3% 0.9% | 13228.31 1.5% 0.2% |
| DJ Global 1926.87 0.9% | 1897.99 -1.5% -1.5% | 1913.37 -0.7% 0.8% | 1928.62 0.1% 0.8% | 1936.10 0.5% 0.4% | 1946.39 1.0% 0.5% |
| DJ Asia Pacific 1270.07 -0.6% | 1263.05 -0.6% -0.6% | 1259.50 -0.8% -0.3% | 1262.46 -0.6% 0.2% | 1270.05 0.0% 0.6% | 1269.26 -0.1% -0.1% |
| Nikkei 9561.36 -0.8% | 9542.17 -0.2% -0.2% | 9468.04 -1.0% -0.8% | 9561.01 0.0% 1.0% | 9561.83 0.0% 0.0% | 9520.89 -0.4% -0.4% |
| Shanghai 2406.86 2.0% | 2388.59 -0.8% -0.8% | 2388.83 -0.7% 0.0% | 2406.81 0.0% 0.8% | 2404.70 -0.1% -0.1% | 2396.32 -0.4% -0.3% |
| DAX 6750.12 2.5% | 6523.00 -3.4% -3.4% | 6590.41 -2.4% 1.0% | 6704.50 -0.7% 1.7% | 6739.90 -0.2% 0.5% | 6801.32 0.8% 0.9% |
| DJ UBS Comm. 138.20 -4.7% | 137.91 -0.2% -0.2% | 138.14 0.0% 0.2% | 138.80 0.4% 0.5% | 139.56 1.0% 0.5% | 140.63 1.8% 0.8% |
| WTI $ B 104.03 1.2% | 103.07 -0.9% -0.9% | 103.54 -0.5% 0.5% | 104.11 0.1% 0.6% | 104.39 0.3% 0.3% | 104.82 0.8% 0.4% |
| Brent $/B 118.85 -1.9% | 118.84 0.0% 0.0% | 118.18 -0.6% -0.6% | 119.04 0.1% 0.7% | 119.74 0.7% 0.6% | 119.55 0.6% -0.1% |
| Gold $/OZ 1643.0 -0.9% | 1639.5 -0.2% -0.2% | 1642.2 0.0% 0.2% | 1645.4 0.1% 0.2% | 1658.3 0.9% 0.8% | 1663.0 1.2% 0.3% |
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
Spain continues to drive euro area credit risk with hurdles in adjusting its high fiscal deficit, domestic economic recession, high unemployment and unresolved bank balance sheets. Spain’s National Statistics Institute, Instituto Nacional de Estadística (INE), released on Apr 27 its “Economically Active Population Survey” for IQ2012 (http://www.ine.es/en/daco/daco42/daco4211/epa0112_en.pdf). INE’s summary of the survey is as follows (http://www.ine.es/en/daco/daco42/daco4211/epa0112_en.pdf):
“ Employment in the first quarter of 2012 registers a decrease of 374,300 persons, reaching a total of 17,433,200 employed persons. The interannual employment variation rate stands at –3.96%.
The economically active population drops by 8,400 persons this quarter. The number of unemployed persons increases by 365,900 persons, the total number thus standing at 5,639,500.
The unemployment rate grows 1.59 points, standing at 24.44%. In turn, the
activity rate remains at 59.94%.
The loss of employment is almost three times higher among men (278,300 less) than among women (96,000 less). Conversely, the loss of employment increases almost the same between men and women.
All sectors record a reduction in the number of employed persons this quarter.
Wage-earners with a permanent contract decrease by 138,400, and wage earners with a temporary contract do so by 279,600.
The number of households with all of their active members unemployed increases
by 153,400 this quarter, standing at 1,728,400.
By Autonomous Community, the unemployment rate fluctuates between 13.55% in País Vasco and 33.17% in Andalucía. The activity rate fluctuates between 51.33%, recorded in Principado de Asturias, and 64.77%, registered in Illes Balears.
Employment registers its greatest decreases in Andalucia, Cataluña and Comunitat Valenciana, and the greatest decrease in unemployment. Comunidad de Madrid was the only Autonomous Community that registers an increase in employment. The unemployment increases in all Autonomous Communities.”
The Bank of Spain released on Apr 18 new worrisome data on delinquent credit in Spain’s credit institutions (http://www.bde.es/webbde/es/secciones/prensa/Agenda/Datos_de_credit_c62379ebaa85631.html). The aggregate balance sheet of institutions supervised by the Bank of Spain registered total credit of €1,508,626 million in 2006 with delinquent credit of €10,859 million or 0.7 percent. The latest available data for Feb 2012 registers total credit of €1,763,312 million with delinquent credit of €143,815 million or 8.2 percent. Total credit has contracted from a peak of €1,869,882 million in 2008 to €1,763,313 on Feb 2012 or by 5.7 percent. Delinquent credit has risen from €10,859 million in 2006 to €143,815 million in Feb 2012 or by 1224 percent. The credit standing of Spain may be further imperiled if the country is forced into bank nationalizations or absorptions of bad loans by the government. There is troubled history of government ownership and control of banks (Pelaez and Pelaez, Regulation of Banks and Finance: Theory and Policy after the Credit Crisis (2009b), 227-9; Pelaez 1975, Pelaez and Suzigan 1981, following Cameron 1961, 1967, 1972). Christopher Bjork and Jonathan House, writing on “Spanish banks’ ECB borrowing hits high,” on Apr 13, published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304356604577341133498311916.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyze the impact on valuations of risk financial assets from new data on Spanish bank borrowing. The Bank of Spain, as quoted by Bjork and House, provided information on average Spanish bank borrowing from the European Central Bank increasing from €169.85 billion in Feb to €316.3 billion in Mar, or USD 417.10 billion, which are substantially higher than €106.3 billion before long-term refinancing operations (LTRO). Spain borrowed 28 percent of lending of €1.1 trillion by the ECB to banks in the euro zone. A crucial fact provided by Bjork and House is that Spanish banks devoted €40.6 billion of their assigned LTROs to buying Spanish government debt, which is equivalent to one half of the needs of Spain in 2012. LTROs are effectively a bailout of Spain in which the European Central Bank (ECB) is taking credit risks in contrast with mostly rate risks in quantitative easing by the Fed.
A critical development in the resolution of the European debt crisis is the increase in available resources of the IMF announced in a joint statement of the IMFC and the Group of 20 Finance Ministers and Central Bank Governors (IMFC 2012Apr20):
“There are firm commitments to increase resources made available to the IMF by over $430 billion in addition to the quota increase under the 2010 reform. These resources will be available for the whole membership of the IMF, and not earmarked for any particular region.”
Resources are not earmarked for the European debt crisis but it is the most threatening current vulnerability in the world economy.
The JPY reversed recent depreciation, appreciating 1.5 percent during the week of Apr 2. Japan’s has not been very successful in the past in foreign exchange interventions (Pelaez and Pelaez, The Global Recession Risk (2007), 107-9). Japan is currently combining unconventional monetary policy and exchange intervention. The Policy Board of the Bank of Japan decided at its meeting on Apr 27, 2012 to enhance monetary easing as follows ():
“1. At the Monetary Policy Meeting held today, the Policy Board of the Bank of Japan made the following decisions, by a unanimous vote, regarding the Asset Purchase Program (hereafter referred to as "the Program").
(1) The Bank decided to increase the total size of the Program by about 5 trillion yen, from about 65 trillion yen to about 70 trillion yen, with the following changes in its composition.
(a) An increase in the purchase of Japanese government bonds (JGBs) by about 10 trillion yen
(b) An increase in the purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) by about 200 billion yen and 10 billion yen, respectively
(c) A reduction in the maximum outstanding amount of the Bank's fixed-rate funds-supplying operation against pooled collateral with a six-month term, by about 5 trillion yen, taking into account the recent episodes of undersubscription
(2) With the aim of smoothly conducting the large-scale purchases after today's increase and encouraging a decline in longer-term interest rates effectively, the Bank decided to extend the remaining maturity of JGBs to be purchased under the Program from "one to two years" to "one to three years." It also decided to extend the remaining maturity of corporate bonds to be purchased under the Program just as is the case of JGBs.
(3) The Bank decided to increase the outstanding amount of the Program to about 70 trillion yen by around end-June 2013, while maintaining the existing schedule of increasing the outstanding amount of the Program to about 65 trillion yen by around end-2012.”
The Policy Board of the Bank of Japan decided at its meeting on April 10, 2010 to continue “powerful easing” (http://www.boj.or.jp/en/announcements/release_2012/k120410a.pdf 2):
“The Bank recognizes that Japan's economy faces the critical challenge of overcoming deflation and returning to a sustainable growth path with price stability. The goal of overcoming deflation will be achieved both through efforts to strengthen the economy's growth potential and support from the financial side. With this in mind, the Bank will pursue powerful monetary easing, and will support private financial institutions in their efforts to strengthen the foundations for Japan's economic growth via the fund-provisioning measure to support strengthening the foundations for economic growth. At today's meeting, as shown in the Attachment, the Bank established detailed rules for a new U.S. dollar lending arrangement equivalent to 1 trillion yen, of which a preliminary outline was released at the previous meeting in March.”
The Policy Board of the Bank of Japan decided three important measures of enhancing monetary easing at the meeting held on Feb 14, 2012 (Bank of Japan 2012EME, 2012PSG and 2012APP). First, the Bank of Japan (2012Feb14EME, 2012Feb14PSG) adopted a “price stability goal” for the “medium term” of 2 percent of the “year-on-year rate of change of the CPI” with the immediate goal of inflation of 1 percent. Japan’s CPI inflation in the 12 months ending in Dec was minus 0.2 percent. Second, the Bank of Japan (2012Feb14EME, 1-2) will conduct “virtually zero interest rate policy” by maintaining “the uncollateralized overnight call rate at around 0 to 0.1 percent.” Third, the Bank of Japan (20012Feb13EME, 2014Feb14APP) is increasing the size of its quantitative easing:
“The Bank increases the total size of the Asset Purchase Program by about 10 trillion yen, from about 55 trillion yen to about 65 trillion yen. The increase in the Program is earmarked for the purchase of Japanese government bonds. By fully implementing the Program including the additional expansion decided today, by the end of 2012, the amount outstanding of the Program will be increased by about 22 trillion yen from the current level of around 43 trillion yen.”
IIIB Appendix on Safe Haven Currencies analyzes the burden on the Japanese economy of yen appreciation. Policy rates close to zero by major central banks in the world together with quantitative easing tend to depreciate currencies. Monetary policy is an indirect form of currency intervention.
The Swiss franc appreciated 0.3 percent in the week of Apr 27 to CHF 0.9065/USD relative to the dollar and remained unchanged relative to the euro to CHF 1.2014, as shown in Table III-1. The important event was appreciation of 0.3 percent by Apr 6 relative to the euro to the very bottom of the exchange rate floor at CHF 1.2009/EUR. William L. Watts, writing on “Euro weakness triggers Swissie showdown,” on Apr 5, published by MarketWatch (http://www.marketwatch.com/story/euro-weakness-triggers-swissie-showdown-2012-04-05), quotes exchange strategists claiming that at point on Apr 5 the Swiss franc traded at CHF 1.1990/EUR. Some participants believe that there was intervention by the Swiss National Bank to defend the floor of CHF `1.2000/EUR. The Australian dollar appreciated 0.1 percent to USD 1.0378/AUD by Apr 20 because of unfavorable environment for carry trades. The AUD is considered a carry trade commodity currency.
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. As shown in past updates of Table III-1, the ten-year Treasury yield fell from 2.234 percent on Mar 23 to 2.214 percent on Mar 30, collapsing to 2.058 percent on Apr 6 after the employment report and declining further to 1.987 percent on Apr 13, 1.959 percent on Apr 20 and 1.931 percent on Apr 27 because of increasing risk aversion. The ten-year Treasury yield is still at a level well below consumer price inflation of 2.7 percent in the 12 months ending in Mar (see subsection IB United States Inflation at http://cmpassocregulationblog.blogspot.com/2012/04/fractured-labor-market-with-hiring.html). Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. As shown in past updates of Table III-1, the two-year Treasury yield fell marginally from 0.35 percent on Mar 23 to 0.335 percent on Mar 30 and then to 0.31 percent on Apr 6 and 0.27 percent on Apr 13, remaining almost unchanged at 0.268 percent on Apr 20 and 0.26 percent on Apr 27. 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. The latest statement of the Federal Open Market Committee (FOMC) on Apr 25, 2012 does not have sufficient changes suggesting that it contributed to the rise in Treasury yields (http://www.federalreserve.gov/newsevents/press/monetary/20120425a.htm). The statement continues to consider inflation low, unemployment high and growth at a moderate pace. Because of the “slack” in the economy, the FOMC anticipates maintaining the zero interest rate policy until 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20120425a.htm):
“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.”
A similar risk aversion phenomenon occurred in Germany. Eurostat confirmed euro zone CPI inflation is at 2.7 percent for the 12 months ending in Mar 2012 but jumping 1.3 percent in the month of Mar (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-17042012-AP/EN/2-17042012-AP-EN.PDF See Tables IV-4 through IV-7 at http://cmpassocregulationblog.blogspot.com/2012/04/imf-view-of-world-economy-and-finance.html) but the yield of the two-year German government bond fell from 0.23 percent on Mar 23 to 0.21 percent on Mar 30, 0.14 percent on Apr 6 and 0.13 percent on Apr 13 with 0.14 percent on Apr 20 and 0.10 percent on Apr 27 while the yield of the ten-year German government bond fell from 1.87 on Mar 23 to 1.79 percent on Mar 30 and then to 1.74 on Apr 6 and also on Apr 13 with 1.71 percent on Apr 20 and 1.70 percent on Apr 27, as shown in Table III-1 and past updates. Safety overrides inflation-adjusted yield but there could be duration aversion. Turbulence has also affected the market for German sovereign bonds.
Equity indexes in Table III-1 were mostly strong during the week of Apr 27 but with declines in Asian equities. Germany’s Dax increased 0.8 percent while DJIA gained 1.5 percent in the week of Apr 27 and Dow Global increased 1.0 percent. Japan’s Nikkei Average interrupted recent increases with decline of 3.9 percent in the week of Apr 6, decline of 0.5 percent in the week of Apr 13 and declines of 0.8 percent in the week of Apr 20 and 0.4 percent in the week of Apr 27. Dow Asia Pacific dropped 0.1 percent in the week of Apr 27 while Shanghai’s composite decreased 0.4 percent.
Commodities were mostly strong during the week of Apr 27. The DJ UBS Commodities Index increased 1.8 percent. WTI gained 0.8 percent and Brent decreased 0.1 percent. Gold increased 1.2 percent.
Risk aversion during the week of Mar 2, 2012, was dominated by the long-term refinancing operations (LTRO) of the European Central Bank. LTROs and related principles are analyzed in subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort. First, as analyzed by David Enrich, writing on “ECB allots €529.5 billion in long-term refinancing operations,” published on Feb 29, 2012 by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203986604577252803223310964.html?mod=WSJ_hp_LEFTWhatsNewsCollection), the ECB provided a second round of three-year loans at 1.0 percent to about 800 banks. The earlier round provided €489 billion to more than 500 banks. Second, the ECB sets the fixed-rate for main refinancing operations at 1.00 percent and the overnight deposit facility at 0.25 percent (http://www.ecb.int/home/html/index.en.html) for negative spread of 75 basis points. That is, if a bank borrows at 1.0 percent for three years through the LTRO and deposits overnight at the ECB, it incurs negative spread of 75 basis points. An alternative allocation could be to lend for a positive spread to other banks. Richard Milne, writing on “Banks deposit record cash with ECB,” on Mar 2, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/9798fd36-644a-11e1-b30e-00144feabdc0.html#axzz1nxeicB6H), provides important information and analysis that banks deposited a record €776.9 billion at the ECB on Fri Mar 2 at interest receipt of 0.25 percent, just two days after receiving €529.5 billion of LTRO loans at interest cost of 1.0 percent. The main issue here is whether there is ongoing perceptions of high risks in counterparties in financial transactions that froze credit markets in 2008 (see Pelaez and Pelaez, Regulation of Banks and Finance (2009a), 57-60, 217-27, Financial Regulation after the Global Recession (2009b), 155-67). Richard Milne and Mary Watkins, writing on “European finance: the leaning tower of perils,” on Mar 27, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/82205f6e-7735-11e1-baf3-00144feab49a.html#axzz1qOqWaqF2), raise concerns that the large volume of LTROs can create future problems for banks and the euro area. An important issue is if the cheap loans at 1 percent for three-year terms finance the carry trade into securities of the governments of banks. Balance sheets of banks may be stressed during future sovereign-credit events. Sam Jones, writing on “ECB liquidity fuels high stakes hedging,” on Apr 4, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/cb74d63a-7e75-11e1-b009-00144feab49a.html#axzz1qyDYxLjS), analyzes unusually high spreads in government bond markets in Europe that could have been caused by LTROs. There has been active relative value arbitrage of these spreads similar to the strategies of Long-Term Capital Management (LTCM) of capturing high spreads in mortgage-backed securities jointly with hedges in Treasury securities (on LTCM see Pelaez and Pelaez, International Financial Architecture (2005), 108-12, 87-9, The Global Recession Risk (2007) 12-3, 102, 176, Globalization and the State, Vol. I (2008a), 59-64).
Table III-1A provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the LTROs. Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increasing from €546,747 million on Dec 31, 2010, to €870,130 million on Dec 28, 2011 and €1,142,714 million on Apr 20, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,752,388 million in the statement of Apr 20.
Table III-1A, Consolidated Financial Statement of the Eurosystem, Million EUR
| Dec 31, 2010 | Dec 28, 2011 | Apr 20, 2012 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 423,706 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 240,381 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 54,618 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 19,271 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 1,142,714 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 183,692 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 609,674 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 31,131 |
| 9 Other Assets | 278,719 | 336,574 | 252,923 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 2,967,923 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,752,388 |
| Capital and Reserves | 78,143 | 81,481 | 85,532 |
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
http://www.ecb.int/press/pr/wfs/2012/html/fs120424.en.html
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.
The members of the European Monetary Union (EMU), or euro area, established the European Financial Stability Facility (EFSF), on May 9, 2010, to (http://www.efsf.europa.eu/about/index.htm):
- “Provide loans to countries in financial difficulties
- Intervene in the debt primary and secondary markets. Intervention in the secondary market will be only on the basis of an ECB analysis recognising the existence of exceptional financial market circumstances and risks to financial stability
- Act on the basis of a precautionary programme
- Finance recapitalisations of financial institutions through loans to governments”
The EFSF will be replaced by the permanent European Stability Mechanism (ESM) in 2013. On Mar 30, 2012, members of the euro area reached an agreement providing for sufficient funding required in rescue programs of members countries facing funding and fiscal difficulties and the transition from the EFSF to the ESM. The agreement of Mar 30, 2012 of the euro area members provides for the following (http://www.consilium.europa.eu/media/1513204/eurogroup_statement_30_march_12.pdf):
· Acceleration of ESM paid-in capital. The acceleration of paid-in capital for the ESM provides for two tranches paid in 2012, in July and Oct; another two tranches in 2013; and a final tranche in the first half of 2014. There could be acceleration of paid-in capital is required to maintain a 15 percent relation of paid-in capital and the outstanding issue of the ESM
· ESM Operation and EFSF transition. ESM will assume all new rescue programs beginning in Jul 2012. EFSF will administer programs begun before initiation of ESM activities. There will be a transition period for the EFSF until mid 2013 in which it can engage in new programs if required to maintain the full lending limit of €500 billion.
· Increase of ESM/EFSF lending limit. The combined ceiling of the ESM and EFSF will be increased to €700 billion to facilitate operation of the transition of the EFSF to the ESM. The ESM lending ceiling will be €500 billion by mid 2013. The combined lending ceiling of the ESM and EFSF will continue to €700 billion
· Prior lending. The bilateral Greek loan facility of €53 billion and €49 billion of the EFSF have been paid-out in supporting programs of countries: “all together the euro area is mobilizing an overall firewall of approximately EUR 800 billion, more than USD 1 trillion” (http://www.consilium.europa.eu/media/1513204/eurogroup_statement_30_march_12.pdf)
· Bilateral IMF contributions. Members of the euro area have made commitments of bilateral contributions to the IMF of €150 billion
A key development in the bailout of Greece is the approval by the Executive Board of the International Monetary Fund (IMF) on Mar 15, 2012, of a new four-year financing in the value of €28 billion to be disbursed in equal quarterly disbursements (http://www.imf.org/external/np/tr/2012/tr031512.htm). The sovereign debt crisis of Europe has moderated significantly with the elimination of immediate default of Greece. New economic and financial risk factors have developed, which are covered in VI Valuation of Risk Financial Assets and V World Economic Slowdown.
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 an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the LTROs. Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increasing from €546,747 million on Dec 31, 2010, to €870,130 million on Dec 28, 2011 and €1,142,714 million on Apr 20, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,752,388 million in the statement of Apr 20.
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 | Apr 20, 2012 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 423,706 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 240,381 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 54,618 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 19,271 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 1,142,714 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 183,692 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 609,674 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 31,131 |
| 9 Other Assets | 278,719 | 336,574 | 252,923 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 2,967,923 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,752,388 |
| Capital and Reserves | 78,143 | 81,481 | 85,532 |
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
http://www.ecb.int/press/pr/wfs/2012/html/fs120424.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 euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate 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. Newly available 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 42.7 percent of the total. Exports to the non-European Union area are growing at 11.8 percent in Feb 2012 relative to Feb 2011 while those to EMU are growing at 3.5 percent.
Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%
| Feb 2012 | Exports | ∆% Feb 2012/ Feb 2011 | Imports | Imports |
| EU | 56.0 | 4.1 | 53.3 | -2.4 |
| EMU 17 | 42.7 | 3.5 | 43.2 | -1.5 |
| France | 11.6 | 5.4 | 8.3 | -1.5 |
| Germany | 13.1 | 7.4 | 15.6 | -4.4 |
| Spain | 5.3 | -7.4 | 4.5 | -6.0 |
| UK | 4.7 | 9.5 | 2.7 | -9.1 |
| Non EU | 44.0 | 11.8 | 46.7 | 4.6 |
| Europe non EU | 13.3 | 16.7 | 11.1 | 8.6 |
| USA | 6.1 | 21.5 | 3.3 | 7.2 |
| China | 2.7 | -4.8 | 7.3 | -11.5 |
| OPEC | 4.7 | 2.9 | 8.6 | 15.9 |
| Total | 100.0 | 7.3 | 100.0 | 0.8 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: http://www.istat.it/it/archivio/59291
Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €493 million with the 17 countries of the euro zone (EMU 17) in Feb and €535 million in Jan-Feb. Depreciation to parity could permit greater competitiveness in improving the trade surpluses of €699 million in Jan-Feb with Europe non European Union and of €1093 million with the US. There is significant rigidity in the trade deficits in Jan-Feb of €3209 million with China and €4472 million with members of the Organization of Petroleum Exporting Countries (OPEC).
Table III-4, Italy, Trade Balance by Regions and Countries, Millions of Euro
| Regions and Countries | Trade Balance Feb 2012 Millions of Euro | Trade Balance Cumulative Jan-Feb 2012 Millions of Euro |
| EU | 439 | 1,199 |
| EMU 17 | -493 | -535 |
| France | 964 | 1,796 |
| Germany | -470 | -870 |
| Spain | 158 | 484 |
| UK | 664 | 1,301 |
| Non EU | -1,552 | -6,658 |
| Europe non EU | 601 | 699 |
| USA | 837 | 1,093 |
| China | -1,477 | -3,209 |
| OPEC | -1,892 | -4,472 |
| Total | -1,113 | -5,549 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: http://www.istat.it/it/archivio/59291
Growth rates of Italy’s trade and major products are provided in Table III-5 for the period Feb 2012 relative to Feb 2011. Growth rates are high for the total and all segments of exports. Imports of nondurable goods increased 3.8 percent and imports of energy increased 29.7 percent driven by carry trades into commodities futures. The higher rate of growth of exports of 7.3 percent relative to imports of 0.8 percent may reflect weak demand in Italy.
Table III-5, Italy, Exports and Imports % Share of Products in Total and ∆%
| Exports | Exports | Imports | Imports | |
| Consumer | 28.9 | 8.0 | 25.0 | 2.5 |
| Durable | 5.9 | 2.8 | 3.0 | -6.6 |
| Non | 23.0 | 9.4 | 22.0 | 3.8 |
| Capital Goods | 32.2 | 5.8 | 20.8 | -5.2 |
| Inter- | 34.3 | 6.3 | 34.5 | -10.8 |
| Energy | 4.7 | 20.7 | 19.7 | 29.7 |
| Total ex Energy | 95.3 | 6.7 | 80.3 | -5.4 |
| Total | 100.0 | 7.3 | 100.0 | 0.8 |
Source: http://www.istat.it/it/archivio/59291
Table III-6 provides Italy’s trade balance by product categories in Feb 2012 and cumulative Jan-Feb 2012. Italy’s trade balance excluding energy generated surplus of €6475 million in Feb 2012 but the energy trade balance created deficit of €11,934 million. The overall deficit was €5459 million. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.
Table III-6, Italy, Trade Balance by Product Categories, € Millions
| Feb 2012 | Cumulative Jan-Feb 2012 | |
| Consumer Goods | 1,264 | 1,425 |
| Durable | 953 | 1,428 |
| Nondurable | 311 | -3 |
| Capital Goods | 3,161 | 5,160 |
| Intermediate Goods | 264 | -111 |
| Energy | -5,802 | -11,934 |
| Total ex Energy | 4,689 | 6,475 |
| Total | -1,113 | -5,459 |
Source: http://www.istat.it/it/archivio/59291
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. 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-7 is constructed with IMF World Economic Outlook database (http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/index.aspx) 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-7, World and Selected Regional and Country GDP and Fiscal Situation
| GDP 2012 | Primary Net Lending Borrowing | General Government Net Debt | |
| World | 69,660 | ||
| Euro Zone | 12,586 | -0.5 | 70.3 |
| Portugal | 221 | 0.1 | 110.9 |
| Ireland | 210 | -4.4 | 102.9 |
| Greece | 271 | -1.0 | 153.2 |
| Spain | 1,398 | -3.6 | 67.0 |
| Major Advanced Economies G7 | 34,106 | -4.8 | 88.3 |
| United States | 15,610 | -6.1 | 83.7 |
| UK | 2,453 | -5.3 | 84.2 |
| Germany | 3,479 | 1.0 | 54.1 |
| France | 2,712.0 | -2.2 | 83.2 |
| Japan | 5,981 | -8.9 | 135.2 |
| Canada | 1,805 | -3.1 | 35.4 |
| Italy | 2,067 | 2.9 | 102.3 |
| China | 7992 | -1.3* | 22.0** |
*Net Lending/borrowing**Gross Debt
Source: http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/weoselgr.aspx
The data in Table III-7 are used for some very simple calculations in Table III-8. The column “Net Debt USD Billions” in Table III-8 is generated by applying the percentage in Table III-7 column “General Government Net Debt % GDP 2010” to the column “GDP USD Billions.” The total debt of France and Germany in 2012 is $4138.5 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 $3927.8 billion, adding rows D+E+F+G+H in column “Net Debt USD billions.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table III-8. 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 $8066.3 billion, which would be equivalent to 130.3 percent of their combined GDP in 2012. 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 231.9 percent if including debt of France and 167.0 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-8, 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 | 8,847.9 | ||
| B Germany | 1,882.1 | $8066.3 as % of $3479 =231.9% $5809.9 as % of $3479 =167.0% | |
| C France | 2,256.4 | ||
| B+C | 4,138.5 | GDP $6,191.0 Total Debt $8066.3 Debt/GDP: 130.3% | |
| D Italy | 2,114.5 | ||
| E Spain | 936.7 | ||
| F Portugal | 245.3 | ||
| G Greece | 415.2 | ||
| H Ireland | 216.1 | ||
| Subtotal D+E+F+G+H | 3,927.8 |
Source: calculation with IMF data http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/index.aspx
There is extremely important information in Table III-9 for the current sovereign risk crisis in the euro zone. Table III-9 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Feb. German exports to other European Union (EU) members are 58.5 percent of total exports in Feb 2012 and 58.9 percent in Jan-Feb 2012. Exports to the euro area are 38.8 percent in Feb and 39.3 percent in Jan-Feb. Exports to third countries are 37.9 percent of the total in Feb and 41.1 percent in Jan-Feb. 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-9, Germany, Structure of Exports and Imports by Region, € Billions and ∆%
| Feb 2012 | Feb 12-Month | Jan–Feb 2012 € Billions | Jan-Feb 2012/ | |
| Total | 91.3 | 8.6 | 177.3 | 8.9 |
| A. EU | 53.4 % 58.5 | 5.4 | 104.4 % 58.9 | 5.4 |
| Euro Area | 35.4 % 38.8 | 3.3 | 69.7 % 39.3 | 4.0 |
| Non-euro Area | 18.0 % 19.7 | 9.7 | 34.7 % 19.6 | 8.5 |
| B. Third Countries | 37.9 % 41.5 | 13.4 | 72.9 % 41.1 | 14.4 |
| Total Imports | 76.5 | 6.1 | 149.3 | 6.2 |
| C. EU Members | 48.7 % 63.7 | 6.6 | 93.6 % 62.7 | 6.9 |
| Euro Area | 34.1 % 44.6 | 5.5 | 65.5 % 43.9 | 6.3 |
| Non-euro Area | 14.6 % 19.1 | 9.3 | 28.1 % 18.8 | 8.6 |
| D. Third Countries | 27.8 % 36.3 | 5.2 | 55.8 % 37.4 | 4.9 |
Notes: Total Exports = A+B; Total Imports = C+D
Source:
Statistiche Bundesamt Deutschland
https://www.destatis.de/EN/PressServices/Press/pr/2012/04/PE12_129_51.html
IIIF 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:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (4)
Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+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 Rt, t+τ. The second equation of Cochrane (2011Jan, 5) is:
MtV(it, ·) = PtYt (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 blog comment, 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 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 | 2.1 | 2.7 | 2.8 | 8.2 |
| Japan | -0.6 | 0.5 | 0.6 | 4.5 |
| China | 8.9 | 3.6 | -0.3 | |
| UK | 0.0 | 3.5* | 3.6* output | 8.3 |
| Euro Zone | 0.7 | 2.7 | 3.6 | 10.8 |
| Germany | 2.0 | 2.3 | 3.2 | 5.7 |
| France | 0.2 | 2.6 | 4.3 | 10.0 |
| Nether-lands | -0.7 | 2.9 | 4.2 | 4.9 |
| Finland | 1.2 | 2.9 | 3.9 | 7.4 |
| Belgium | 0.9 | 3.1 | 3.6 | 7.2 |
| Portugal | -2.7 | 3.1 | 4.2 | 15.0 |
| Ireland | NA | 2.2 | 3.8 | 14.7 |
| Italy | -0.5 | 3.8 | 3.2 | 9.3 |
| Greece | -7.0 | 1.4 | 6.9 | NA |
| Spain | 0.3 | 1.8 | 3.4 | 23.6 |
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 http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/march-2012/index.html **Core
PPI http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/march-2012/index.html
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 2.1 percent in IQ2012 relative to IQ2011 (Table 8, p 11 in http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp1q12_adv.pdf See Section I Mediocre Economic Growth). Japan’s GDP fell 0.6 percent in IVQ2011 relative to IVQ2010 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 7.1 percent in IIIQ2011 to decline at the SAAR of 0.7 percent in IVQ 2011 (see Section VB at http://cmpassocregulationblog.blogspot.com/2012/03/thirty-million-unemployed-or_11.html); the UK grew at 0.0 percent in IQ2012 relative to IQ2011 and GDP fell 0.2 percent in IQ2012 relative to IVQ2011 (see Section VB and http://www.ons.gov.uk/ons/rel/gva/gross-domestic-product--preliminary-estimate/q1-2012/stb-q1-2012.html); and the Euro Zone grew at 0.7 percent in IVQ2011 relative to IVQ2010 but declined 0.3 percent in IVQ2011 relative to IIIQ2011 (see Section VD at http://cmpassocregulationblog.blogspot.com/2012/03/thirty-million-unemployed-or_11.html and http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-06032012-AP/EN/2-06032012-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: 8.2 percent in the US but 18.3 percent for unemployment/underemployment or job stress of 29.4 million (see Table I-4 http://cmpassocregulationblog.blogspot.com/2012/04/thirty-million-unemployed-or.html), 4.5 percent for Japan (see Section VB), 8.3 percent for the UK with high rates of unemployment for young people (see the labor statistics of the UK in Subsection VH in http://cmpassocregulationblog.blogspot.com/2012/04/imf-view-of-world-economy-and-finance_22.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/03/global-financial-and-economic-risk_18.html) and 10.8 percent in the Euro Zone (section VD in http://cmpassocregulationblog.blogspot.com/2012/04/thirty-million-unemployed-or_08.html). Twelve-month rates of inflation have been quite high, even when some are moderating at the margin: 2.7 percent in the US, 0.5 percent for Japan, 3.6 percent for China, 2.7 percent for the Euro Zone and 3.5 percent for the UK (http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/march-2012/index.html). Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. There are six key interrelated vulnerabilities in the world economy that have been causing global financial turbulence: (1) sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings (see Section III in this post and the earlier post http://cmpassocregulationblog.blogspot.com/2012/04/imf-view-of-world-economy-and-finance.html); (2) the tradeoff of growth and inflation in China now with change in growth strategy to domestic consumption instead of investment and political developments in a decennial transition; (3) slow growth by repression of savings with de facto interest rate controls (see section I and earlier http://cmpassocregulationblog.blogspot.com/2012/04/mediocre-economic-growth-falling-real.html), weak hiring with the loss of 10 million full-time jobs (see section II in http://cmpassocregulationblog.blogspot.com/2012/04/fractured-labor-market-with-hiring.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/03/global-financial-and-economic-risk.html and http://cmpassocregulationblog.blogspot.com/2012/02/hiring-collapse-ten-million-fewer-full.html) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (see Section I Thirty Million Unemployed or Underemployed in http://cmpassocregulationblog.blogspot.com/2012/04/thirty-million-unemployed-or.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/03/thirty-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) 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 Apr 25, 2012, revealed the following policy intentions (http://www.federalreserve.gov/newsevents/press/monetary/20120425a.htm):
“Release Date: April 25, 2012
For immediate release
Information received since the Federal Open Market Committee met in March suggests that the economy has been expanding moderately. Labor market conditions have improved in recent months; the unemployment rate has declined but remains elevated. Household spending and business fixed investment have continued to advance. Despite some signs of improvement, the housing sector remains depressed. Inflation has picked up somewhat, mainly reflecting higher prices of crude oil and gasoline. However, 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 to remain moderate over coming quarters and then to pick up gradually. Consequently, the Committee anticipates that the unemployment rate will decline gradually toward levels that it judges to be consistent with its dual mandate. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The increase in oil and gasoline prices earlier this year is expected to affect inflation only temporarily, and the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its 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 Apr 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. Policy now focuses on improving conditions in real estate by attempting to reduce mortgage rates: “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.”
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/fomcprojtabl20120425.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 IQ2012 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 IQ2012 to be released on May 31 (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 Apr 30. 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 Apr will be released on May 4, 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/fomcprojtabl20120425.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 2.2 to 2.7 percent at the Jan 25 meeting but increased it to 2.4 to 2.9 percent at the Apr 25, 2012 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 and further down to 7.2 to 8.0 percent at the Apr 25, 2012 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 but increased it to 1.9 to 2.0 percent at the Apr 25, 2012 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 but increased to 1.5 to 1.8 percent at the Apr 25, 2012 meeting.
Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents in FOMC, January 2012 and April 2012
| ∆% GDP | UNEM % | ∆% PCE Inflation | ∆% Core PCE Inflation | |
| Central | ||||
| 2012 | 2.4 to 2.9 | 7.2 to 8.0 | 1.9 to 2.0 | 1.8 to 2.0 |
| 2013 | 2.7 to 3.1 | 7.3 to 7.7 | 1.6 to 2.0 | 1.7 to 2.0 |
| 2014 | 3.1 to 3.6 | 6.7 to 7.4 | 1.7 to 2.0 | 1.8 to 2.0 |
| Longer Run Jan PR | 2.3 to 2.6 | 5.2 to 6.0 | 2.0 | |
| Range | ||||
| 2012 | 2.1 to 3.0 | 7.2 to 8.2 | 1.8 to 2.3 | 1.7 to 2.0 |
| 2013 | 2.4 to 3.8 | 7.0 to 8.1 | 1.5 to 2.1 | 1.6 to 2.1 |
| 2014 | 2.9 to 4.3 | 6.3 to 7.7 | 1.5 to 2.2 | 1.7 to 2.2 |
| Longer Run Jan PR | 2.2 to 3.0 | 4.9 to 6.0 | 2.0 |
Notes: UEM: unemployment; PR: Projection
Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120425.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/fomcprojtabl20120425.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 four participants with three expecting the rate to be in the range of 0.5 to 1 percent and three participants expecting rates from 1 to 2.0 percent but only 7 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, April 25, 2012
| 0 to 0.25 | 0.5 to 1.0 | 1.0 to 1.5 | 1.0 to 2.0 | 2.0 to 2.75 | 3.5 to 4.5 | |
| 2012 | 14 | 1 | 2 | |||
| 2013 | 11 | 1 | 3 | 2 | ||
| 2014 | 4 | 3 | 3 | 7 | ||
| Longer Run | 17 |
Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120425.pdf
Additional information is provided in Table IV-4 with the number of participants expecting increasing interest rates in the years from 2012 to 2015. 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, Apr 25, 2012
| Appropriate Year of Increasing Target Fed Funds Rate | Number of Participants |
| 2012 | 3 |
| 2013 | 3 |
| 2014 | 7 |
| 2015 | 4 |
Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120425.pdf
Unconventional monetary policy of zero interest rates and quantitative easing has been used in Japan and now also in the US. Table IV-5 provides the consumer price index of Japan, with inflation of 0.5 percent in 12 months ending in Mar and 0.5 percent NSA (not-seasonally-adjusted) and 0.1 percent SA (seasonally-adjusted) in the month of Mar. Inflation of consumer prices in the first two months of 2012 annualizes at 3.7 percent SA and 2.4 percent NSA. There are negative percentage changes in most of the 12-month rates in 2011 with the exception of Jul and Aug both with 0.2 percent and stability in Sep. All monthly and 12-month rates of inflation are positive in the first quarter of 2012. There are eight years of deflation and one of zero inflation in the 12-month rate of inflation in Dec from 1995 to 2010. This experience is entirely different from that of the US that shows long-term inflation. It is difficult to justify unconventional monetary policy because of risks of deflation similar to those experienced in Japan.
Table IV-5, Japan, Consumer Price Index, All Items ∆%
| ∆% Month SA | ∆% Month NSA | ∆% 12-Month NSA | |
| Mar 2012 | 0.1 | 0.5 | 0.5 |
| Feb | 0.3 | 0.2 | 0.3 |
| Jan | 0.3 | 0.2 | 0.1 |
| Dec 2011 | 0.1 | 0.0 | -0.2 |
| Nov | -0.1 | -0.6 | -0.5 |
| Oct | 0.0 | 0.1 | -0.2 |
| Sep | -0.1 | 0.0 | 0.0 |
| Aug | -0.2 | 0.1 | 0.2 |
| Jul | 0.3 | 0.0 | 0.2 |
| Jun | -0.1 | -0.2 | -0.4 |
| May | -0.1 | 0.0 | -0.4 |
| Apr | -0.1 | 0.1 | -0.4 |
| Mar | 0.0 | 0.3 | -0.5 |
| Feb | 0.1 | 0.0 | -0.5 |
| Jan | 0.0 | -0.1 | -0.6 |
| Dec 2010 | -0.2 | –0.3 | 0.0 |
| Dec 2009 | -1.7 | ||
| Dec 2008 | 0.4 | ||
| Dec 2007 | 0.7 | ||
| Dec 2006 | 0.3 | ||
| Dec 2005 | -0.1 | ||
| Dec 2004 | 0.2 | ||
| Dec 2003 | -0.4 | ||
| Dec 2002 | -0.3 | ||
| Dec 2001 | -1.2 | ||
| Dec 2000 | -0.2 | ||
| Dec 1999 | -1.1 | ||
| Dec 1998 | 0.6 | ||
| Dec 1997 | 1.8 | ||
| Dec 1996 | 0.6 | ||
| Dec 1995 | -0.3 | ||
| Dec 1994 | 0.7 | ||
| Dec 1993 | 1.0 | ||
| Dec 1992 | 1.2 | ||
| Dec 1991 | 2.7 | ||
| Dec 1990 | 3.8 |
Source: http://www.stat.go.jp/english/data/cpi/1581.htm
http://www.e-stat.go.jp/SG1/estat/ListE.do?lid=000001088492
Unconventional monetary policy of zero interest rates and large-scale purchases of long-term securities for the balance sheet of the central bank is proposed to prevent deflation. The data of CPI inflation of all goods and CPI inflation excluding food and energy for the past six decades show only one negative change by 0.4 percent in the CPI all goods annual index in 2009 but not one year of negative annual yearly change in the CPI excluding food and energy measuring annual inflation (http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html). Zero interest rates and quantitative easing are designed to lower costs of borrowing for investment and consumption, increase stock market valuations and devalue the dollar. In practice, the carry trade is from zero interest rates to a large variety of risk financial assets including commodities. Resulting commodity price inflation squeezes family budgets and deteriorates the terms of trade with negative effects on aggregate demand and employment. Excessive valuations of risk financial assets eventually result in crashes of financial markets with possible adverse effects on economic activity and employment.
Producer price inflation history in the past five decades does not provide evidence of deflation. The finished core PPI does not register even one single year of decline. The headline PPI experienced only six isolated cases of decline (http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html):
-0.3 percent in 1963,
-1.4 percent in 1986,
-0.8 percent in 1986,
-0.8 percent in 1998,
-1.3 percent in 2001
-2.6 percent in 2009.
Deflation should show persistent cases of decline of prices and not isolated events. Fear of deflation in the US has caused a distraction of monetary policy. Symmetric inflation targets around 2 percent in the presence of multiple lags in effect of monetary policy and imperfect knowledge and forecasting are mostly unfeasible and likely to cause price and financial instability instead of desired price and financial stability.
Chart IV-1 provides the consumer price index NSA from 1960 to 2012. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.
Chart IV-1, US, Consumer Price Index, All Items, NSA, 1960-2012
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart IV-2 provides 12-month percentage changes of the consumer price index from 1960 to 2012. There are actually three waves of inflation in the second half of the 1960s, in the mid 1970s and again in the late 1970s. Inflation rates then stabilized in a range with only two episodes above 5 percent.
Chart IV-2, US, Consumer Price Index, All Items, NSA, 12-Month Percentage Change 1960-2012
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart IV-3 provides the consumer price index excluding food and energy from 1960 to 2012. There is long-term inflation in the US without episodes of deflation.
Chart IV-3, US, Consumer Price Index Excluding Food and Energy, NSA, 1960-2012
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart IV-4 provides 12-month percentage changes of the consumer price index excluding food and energy from 1960 to 2012. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.
Chart IV-4, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 1960-2012
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
More detail on the consumer price index of Japan in Mar is shown in Table IV-6. Inflation in the 12 months ending in Mar has been driven by items rich in commodities such as 4.7 percent in fuel, light and water charges with monthly increase of 0.6 percent in the month of Mar. There is similar behavior in the preliminary estimate for Apr for the Ku Area of Tokyo with increase of 0.2 percent of fuel, light and water charges and increase of 6.4 percent in 12 months. There is inflation in all items in the consumer price index with increases in Mar of 0.7 percent in goods but only 1.1 percent in 12 months, which is still high for Japan. There is mild deflation in the CPI excluding food, alcoholic beverages and energy with minus 0.5 percent in the 12 months ending in Mar but increase of 0.3 percent in the month of Mar. The CPI excluding imputed rent increased 062 percent in Mar but only 0.7 percent in 12 months. The all-items CPI estimate for Apr of the Ku-Area of Tokyo remained stable but declined 0.3 percent in 12 months.
Table IV-6, Japan, Consumer Price Index, ∆%
| 2012 | Mar 2012/Feb 2012 ∆% | Year ∆% |
| CPI All Items | 0.5 | 0.5 |
| CPI Excluding Fresh Food | 0.5 | 0.2 |
| CPI Excluding Food, Alcoholic Beverages and Energy | 0.3 | -0.5 |
| CPI Goods | 0.7 | 1.1 |
| CPI Services | 0.2 | 0.0 |
| CPI Excluding Imputed Rent | 0.6 | 0.7 |
| CPI Fuel, Light, Water Charges | 0.6 | 4.7 |
| CPI Transport Communications | 1.5 | 1.0 |
| CPI Ku-Area Tokyo All Items | 0.0 | -0.3 |
| Fuel, Light, Water Charges Ku Area Tokyo | 0.2 | 6.4 |
Note: Ku-area Tokyo CPI data preliminary for Apr 2012
http://www.stat.go.jp/english/data/cpi/1581.htm
http://www.e-stat.go.jp/SG1/estat/ListE.do?lid=000001085751
The Federal Statistical Office of Germany, Statistiche Bundesamt Deutschland, provides a preliminary estimate of consumer price inflation of 0.1 percent in Apr and 2.0 percent in the 12 months ending in Apr (https://www.destatis.de/DE/PresseService/Presse/Pressemitteilungen/2012/04/PD12_146_611.html). There are five waves of consumer price inflation in Germany similar to those worldwide (http://cmpassocregulationblog.blogspot.com/2012/04/fractured-labor-market-with-hiring.html), as shown in Table IV-7. In the first wave, annual equivalent inflation was 4.9 percent in Feb-Apr 2011 during risk appetite in carry trades from zero interest rates to commodity futures. In the second wave, annual equivalent consumer price inflation collapsed to 0.6 percent in May-Jun because of risk aversion caused by European sovereign debt. In the third wave, annual equivalent consumer price inflation was 2.4 percent in Jul-Dec as a result of relaxed risk aversion. In the fourth wave, annual equivalent inflation was 1.8 percent in Dec 2011 to Jan 2012. In the fifth wave, annual equivalent inflation rose to 6.2 percent in Feb-Mar during another energy-commodity carry trade shock.
Table IV-7, Germany, Consumer Price Index ∆%
| 12-Month ∆% | Month ∆% | |
| Apr 2012 | 2.0 | 0.1 |
| Mar | 2.1 | 0.3 |
| Feb | 2.3 | 0.7 |
| AE ∆% Feb-Mar | 6.2 | |
| Jan | 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 ∆% Feb-Apr | 4.9 | |
| 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
https://www.destatis.de/EN/PressServices/Press/pr/2012/04/PE12_134_611.html
https://www.destatis.de/DE/PresseService/Presse/Pressemitteilungen/2012/04/PD12_146_611.html
Chart IV-5, 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, decline in Jan 2012 and another upward spike in Feb and Mar 2012. If risk aversion declines, new carry trades from zero interest rates to commodity futures could again result in higher inflation.
Chart IV-5, Germany, Consumer Price Index, Unadjusted, 2005=100
Source: Statistiche Bundesamt Deutschland
https://www.destatis.de/DE/ZahlenFakten/Indikatoren/Konjunkturindikatoren/Konjunkturindikatoren.html
Chart IV-6 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. The annual equivalent rate of 6.2 percent in Feb-Mar 2012 is pulling up the trend.
Chart IV-6, Germany, Consumer Price Index, Unadjusted and Trend, 2005=100
Source: Statistiche Bundesamt Deutschland
https://www.destatis.de/DE/ZahlenFakten/Indikatoren/Konjunkturindikatoren/Konjunkturindikatoren.html
Table IV-8 provides the monthly and 12-month rate of inflation for segments of the consumer price index in Mar 2012. Inflation excluding energy increased 0.1 percent in Mar 2012 and rose 1.6 percent in 12 months. Excluding household energy inflation increased 0.4 percent in Mar and rose 0.4 percent in 12 months. There were price increases across categories such as 0.7 percent in nondurable consumer goods and 0.9 percent in food. There were also strong increases in energy-related prices. Heating oil rose 8.6 percent in 12 months but fell 0.2 percent in Mar. Motor fuels increased 4.0 percent in Mar and 7.7 percent in 12 months.
Table IV-8, Germany, Consumer Price Index ∆%
| Mar 2012 | Weight | 12- Month ∆% | Month ∆% |
| Total | 1,000.00 | 2.1 | 0.3 |
| Excluding heating oil and motor fuels | 955.42 | 1.8 | 0.2 |
| Excluding household energy | 940.18 | 1.8 | 0.4 |
| Excluding Energy | 904.81 | 1.6 | 0.1 |
| Total Goods | 493.00 | 3.2 | 0.8 |
| Nondurable Consumer Goods | 305.11 | 4.3 | 0.7 |
| Medium-Term Life Consumer Goods | 95.24 | 2.3 | 1.4 |
| Durable Consumer Goods | 92.65 | 0.0 | 0.0 |
| Services | 507.00 | 1.1 | -0.2 |
| Energy Components | |||
| Motor Fuels | 35.37 | 7.7 | 4.0 |
| Household Energy | 59.82 | 6.0 | 0.3 |
| Heating Oil | 9.21 | 8.6 | -0.2 |
| Food | 89.99 | 2.7 | 0.9 |
Source: Statistiche Bundesamt Deutschland
https://www.destatis.de/EN/PressServices/Press/pr/2012/04/PE12_134_611.html
There are waves of inflation of producer prices in France as everywhere in the world economy (http://cmpassocregulationblog.blogspot.com/2012/04/fractured-labor-market-with-hiring.html), as shown in Table IV-9. There was a first wave of sharply increasing inflation in the first four months of 2011 originating in the surge of commodity prices driven by carry trade from zero interest rates to commodity futures risk positions. Producer price inflation in the first four months of 2011 was at the annual equivalent rate of 11.4 percent. In the second wave, producer prices fell 0.5 percent in May and another 0.1 percent in Jun for annual equivalent inflation in May-Jun of minus 3.5 percent. In the third wave from Jul to Sep, annual equivalent producer price inflation was 2.8 percent. In the fourth wave Oct-Dec 2011, annual equivalent producer price inflation was 2.4 percent. In the fifth wave from Dec 2011 to Feb 2012, average annual inflation rose to 4.9 percent. In the sixth wave in Jan 2012 to Mar 2012, annual equivalent inflation jumped to 7.9 percent. The bottom part of Table IV-15 shows producer price inflation at 3.5 percent in the 12 months ending in Dec 2005 and again at 5.2 percent in the 12 months ending in Dec 2007. Producer prices fell in 2008 and 2009 during the global contraction and decline of commodity prices but returned at 5.4 percent in the 12 months ending in Dec 2010.
Table IV-9, France, Producer Price Index for the French Market, ∆%
| Month | 12 Months | |
| Mar 2012 | 0.5 | 3.7 |
| Feb | 0.7 | 4.1 |
| Jan | 0.7 | 4.2 |
| AE ∆% Jan-Mar | 7.9 | |
| Dec 2011 | -0.2 | 4.6 |
| AE ∆% Dec-Feb | 4.9 | |
| Nov | 0.4 | 5.6 |
| Oct | 0.4 | 5.7 |
| AE ∆% Oct-Dec | 2.4 | |
| Sep | 0.3 | 6.1 |
| Aug | 0.0 | 6.2 |
| Jul | 0.4 | 6.3 |
| AE ∆% Jul-Sep | 2.8 | |
| Jun | -0.1 | 6.1 |
| May | -0.5 | 6.2 |
| AE ∆% May-Jun | -3.5 | |
| Apr | 1.0 | 6.7 |
| Mar | 0.9 | 6.7 |
| Feb | 0.8 | 6.3 |
| Jan | 0.9 | 5.6 |
| AE ∆% Jan-Apr | 11.4 | |
| Dec 2010 | 0.8 | 5.4 |
| Dec 2009 | 0.1 | -2.9 |
| Dec 2008 | -1.5 | -0.2 |
| Dec 2007 | 0.6 | 5.2 |
| Dec 2006 | -0.2 | 2.9 |
| Dec 2005 | 0.2 | 3.5 |
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20120427
Chart IV-18 of the Institut National de la Statistique et des Études Économiques of France provides the behavior of the producer price index of France for the various segments: import prices, foreign markets, domestic market and all markets. All the components exhibit the rise to the peak in 2008 driven by carry trades from zero interest rates of unconventional monetary policy that was of such an impulse as to drive increases in commodity prices during the global recession. Prices collapsed with the flight out of financial risk assets such as commodity positions to government obligations. Commodity price increases returned with zero interest rates and subdued risk aversion. The shock of confidence of the current European sovereign risk moderated exposures to financial risk that influenced the flatter curve of France’s producer prices followed by another mild trend of increase and moderation in Dec 2011 and then renewed inflation in the first quarter of 2012.
Chart IV-7, France, Producer Price Index (PPI)
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20120427
France’s producer price index for the domestic market is shown in Table IV-10 for Mar 2012. The segment of prices of coke and refined petroleum increased 2.8 percent in Mar and increased 13.6 percent in 12 months. Manufacturing prices, with the highest weight in the index, increased 0.6 percent in Mar and rose 3.1 percent in 12 months. Mining prices increased 0.2 percent in the month and increased 7.4 percent in 12 months.
Table IV-10, France, Producer Price Index for the Domestic Market, %
| Mar 2012 | Weight | Month ∆% | 12 Months ∆% |
| Total | 1000 | 0.5 | 3.7 |
| Mining | 130 | 0.2 | 7.4 |
| Mfg | 870 | 0.6 | 3.1 |
| Food Products, Beverages, Tobacco | 188 | 0.4 | 3.0 |
| Coke, Refined Petroleum | 70 | 2.8 | 13.6 |
| Electrical, Electronic | 92 | 0.3 | 0.8 |
| Transport | 79 | 0.0 | 1.7 |
| Other Mfg | 441 | 0.2 | 1.4 |
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20120427
© Carlos M. Pelaez, 2010, 2011, 2012
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