Expanding Bank Cash and Deposits with Stagnating Loans, Budget/Debt Quagmire, United States Housing Collapse, Global Financial Turbulence and World Economic and Trade Slowdown with Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011, 2012
Executive Summary
I United States Monetary and Fiscal Policy
IA United States Commercial Banks Assets and Liabilities
IA1 Transmission of Monetary Policy
IA2 Functions of banks
IA3 United States Commercial Banks Assets and Liabilities
IB United States Budget/Debt Quagmire
II United States Housing Collapse
IIA United States New House Sales
IIB United States House Prices
IIC Factors of United States 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
IIIG Appendix on Deficit Financing of Growth and the Debt Crisis
IIIGA Monetary Policy with Deficit Financing of Economic Growth
IIIGB Adjustment during the Debt Crisis of the 1980s
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 Expanding Bank Cash and Deposits with Stagnating Loans. Selected assets and liabilities of US commercial banks, not seasonally adjusted, in billions of dollars, from Report H.8 of the Board of Governors of the Federal Reserve System are provided in Table ESI-1. Data are not seasonally adjusted to permit comparison between Jul 2011 and Jul 2012. Total assets of US commercial banks grew 4.1 percent from $12,307 billion in Jul 2011 to $12,806 billion in Jul 2012. US GDP in 2011 is estimated at $15,076 billion (http://www.bea.gov/iTable/index_nipa.cfm). Thus, total assets of US commercial banks are equivalent to around 80 percent of US GDP. Bank credit grew 5.9 percent from $9147 billion in Jul 2011 to $9692 billion in Jul 2012. Securities in bank credit increased 8.6 percent from $2415 billion in Jul 2011 to $2622 billion in Jul 2012. A large part of securities in banking credit consists of US Treasury and agency securities, growing 10.7 percent from $1640 billion in Jul 2011 to $1816 billion in Jul 2012. Credit to the government that issues or backs Treasury and agency securities of $1816 in Jul 2012 is about 18.7 percent of total bank credit of US commercial banks of $9692 billion. Mortgage-backed securities, providing financing of home loans, grew 14.1 percent, from $1160 billion in Jul 2011 to $1324 billion in Jul 2012. Loans and leases were less dynamic, growing 5.0 percent from $6732 billion in Jul 2011 to $7070 billion in Jul 2012. The only dynamic class is commercial and industrial loans, growing 14.3 percent from Jul 2011 to Jul 2012 and providing $1442 billion or 20.4 percent of total loans and leases of $7070 billion in Jul 2012. Real estate loans increased only 0.9 percent, providing $3515 billion in Jul 2012 or 49.7 percent of total loans and leases. Consumer loans increased only 1.9 percent, providing $1104 billion in Jul 2012 or 15.6 percent of total loans. Cash assets “include vault cash, cash items in process of collection, balances due from depository institutions and balances due from Federal Reserve Banks” (http://www.federalreserve.gov/releases/h8/current/default.htm). Cash assets in US commercial banks fell 4.4 percent from $1761 billion in Jul 2011 to $1683 billion in Jul 2012 but a single year of the series masks exploding cash in banks as a result of unconventional monetary policy, which is discussed below. Bank deposits increased 6.4 percent from $8227 billion to $8757 billion. The difference between bank deposits and total loans and leases in banks increased from $1495 billion in Jul 2011 to $1687 billion in Jul 2012 or by $192 billion, which is roughly equal to the increase in securities in bank credit by $207 billion from $2415 billion in Jul 2011 to $2622 billion in Jul 2012 and to the increase in Treasury and agency securities by $176 billion from $1640 billion in Jul 2011 to $1816 billion in Jul 2012. Loans and leases increased $338 billion from $6732 billion in Jul 2011 to $7070 billion in Jul 2012. Banks expanded both lending and investment in lower risk securities partly because of the weak economy and credit disappointments during the global recession that has resulted in an environment of fewer sound lending opportunities. Lower interest rates resulting from monetary policy may not necessarily encourage higher borrowing in the current loss of dynamism of the US economy with real disposable income per capita in IIQ2012 lower than in IVQ2007 (See ESVI below) in contrast with long-term growth of per capita income in the United States at 2 percent per year from 1870 to 2010 (Lucas 2011May).
Table ESI-1-1, US, Assets and Liabilities of Commercial Banks, NSA, Billions of Dollars
| Jul 2011 | Jul 2012 | ∆% | |
| Total Assets | 12,307 | 12,806 | 4.1 |
| Bank Credit | 9147 | 9692 | 5.9 |
| Securities in Bank Credit | 2415 | 2622 | 8.6 |
| Treasury & Agency Securities | 1640 | 1816 | 10.7 |
| Mortgage-Backed Securities | 1160 | 1324 | 14.1 |
| Loans & Leases | 6732 | 7070 | 5.0 |
| Real Estate Loans | 3484 | 3515 | 0.9 |
| Consumer Loans | 1083 | 1104 | 1.9 |
| Commercial & Industrial Loans | 1262 | 1442 | 14.3 |
| Other Loans & Leases | 903 | 1009 | 11.7 |
| Cash Assets* | 1761 | 1683 | -4.4 |
| Total Liabilities | 10,913 | 11,332 | 3.8 |
| Deposits | 8227 | 8757 | 6.4 |
Note: balancing item of residual assets less liabilities not included
*”Includes vault cash, cash items in process of collection, balances due from depository institutions and balances due from Federal Reserve Banks.”
Source: Board of Governors of the Federal Reserve System http://www.federalreserve.gov/releases/h8/current/default.htm
Chart ESI-1 of the Board of Governors of the Federal Reserve System provides cash assets in commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Acquisitions of securities for the portfolio of the central bank were processed by increases in bank cash reserves. There is no comparable experience in US economic history and such flood of money was never required to return US economic growth to trend of 3 percent per year and 2 percent per year in per capita income after events such as recessions and wars (Lucas 2011May). It is difficult to argue that higher magnitudes of monetary and fiscal policy impulses would have been more successful. Selective incentives to the private sector of a long-term nature could have been more effective.
Chart ESI-1, US, Cash Assets in Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart ESI-2 of the Board of Governors of the Federal Reserve System provides total assets of Federal Reserve Banks in millions of dollars on Wednesdays from 2002 to 2012. This is what is called the central bank balance sheet (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-62, Regulation of Banks and Finance (2009b) 224-27). Consecutive rounds of unconventional monetary policy increased total assets by purchase of mortgage-backed securities, agency securities and Treasury securities. Bank reserves in cash and deposited at the central bank swelled as shown in Chart ESI-1. The central bank created assets in the form of securities financed with creation of liabilities in the form of reserves of depository institutions.
Chart ESI-2, US, Total Assets of Federal Reserve Banks, Wednesday Level, Millions of Dollars, 2002 to 2012
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1
Chart ESI-3 of the Board of Governors of the Federal Reserve System provides deposits in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Deposit growth clearly accelerated after 2001 and continued during the current cyclical expansion after bumps during the global recession.
Chart ESI-3, US, Deposits in Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart ESI-4 of the Board of Governors of the Federal Reserve System provides Treasury and agency securities in US commercial banks, not seasonally adjusted, in billions of dollars from 1973 to 2012. Holdings stabilized between the recessions of 2001 and after IQ2007. There was rapid growth during the global contraction especially after unconventional monetary policy in 2008 and nearly vertical increase without prior similar historical experience during the various bouts of unconventional monetary policy. Banks hoard cash and less risky Treasury and agency securities instead of risky lending because of the weakness of the economy and the lack of demand for financing sound business projects.
Chart ESI-4, US, Treasury and Agency Securities in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart ESI-5 of the Board of Governors of the Federal Reserve System provides total loans and leases in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Total loans and leases of US commercial banks contracted sharply and have stalled during the cyclical expansion.
Chart ESI-5, US, Loans and Leases in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart ESI-6 of the Board of Governors of the Federal Reserve System provides real estate loans in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Housing subsidies and low interest rates caused a point of inflexion to higher, nearly vertical growth until 2007. Real estate loans have contracted in downward trend partly because of adverse effects of uncertainty on the impact on balance sheets of the various mechanisms of resolution imposed by policy.
Chart ESI-6, US, Real Estate Loans in Bank Credit, Not Seasonally Adjusted, B1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart ESI-7 of the Board of Governors of the Federal Reserve System provides consumer loans in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Consumer loans even increased during the contraction then declined and increased vertically to decline again. There was high demand for reposition of durable goods that exhausted and limited consumption again with increase in savings rates in recent periods.
Chart ESI-7, US, Consumer Loans in Bank Credit, Not Seasonally Adjusted, US Commercial Banks, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
ESII United States Budget/Debt Quagmire. The major hurdle in adjusting the fiscal situation of the US is shown in Table ESII-1 in terms of the rigid structure of revenues that can be increased and outlays that can be reduced. There is no painless adjustment of a debt exceeding 70 percent of GDP. On the side of revenues, taxes provide 90.9 percent of revenue in 2011 and are projected to provide 92.2 percent in the total revenues from 2013 to 2022 in the CBO projections. Thus, revenue measures are a misleading term for what are actually tax increases. The choices are especially difficult because of the risks of balancing inequity and disincentives to economic activity. Individual income taxes are projected to increase from 47.4 percent of federal government revenues in 2011 to 51.4 percent in total revenues projected by the CBO from 2013 to 2022. There are equally difficult conflicts in what the government gives away in a rigid structure of expenditures. Mandatory expenditures account for 56.3 percent of federal government outlays in 2011 and are projected to increase to 62.4 percent of the total projected by the CBO for the years 2013 to 2022. The total of Social Security plus Medicare and Medicaid accounts for 43.4 percent of federal government outlays in 2011 and is projected to increase to 51.5 percent in the total for 2013 to 2022. The inflexibility of what to cut is more evident in the first to the last row of Table ESII-1 with the aggregate of defense plus Social Security plus Medicare plus Medicaid accounting for 62.7 percent of expenditures in 2011, rising to 66.6 percent of the total outlays projected by the CBO from 2013 to 2022. The cuts are in discretionary spending that declines from 37.4 percent of the total in 2011 to 28.9 percent of total outlays in the CBO projection for 2013 to 2022.
Table ESII-1, Structure of Federal Government Revenues and Outlays, $ Billions and Percent
| 2011 | % Total | Total 2013-2022 | % Total | |
| Revenues | 2,303 | 100.00 | 41,565 | 100.00 |
| Individual Income Taxes | 1,091 | 47.4 | 21,379 | 51.4 |
| Social Insurance Taxes | 819 | 35.6 | 12,476 | 30.0 |
| Corporate Income Taxes | 181 | 7.9 | 4,477 | 10.8 |
| Other | 212 | 9.2 | 3,232 | 7.8 |
| Outlays | 3,603 | 100.00 | 43,823 | 100.0 |
| Mandatory | 2,027 | 56.3 | 27,324 | 62.4 |
| Social Security | 725 | 20.1 | 10,545 | 24.1 |
| Medicare | 560 | 15.5 | 7,722 | 17.6 |
| Medicaid | 275 | 7.6 | 4,291 | 9.8 |
| SS + Medicare + Medicaid | 1,560 | 43.3 | 22,558 | 51.5 |
| Discre- | 1,346 | 37.4 | 12,664 | 28.9 |
| Defense | 700 | 19.4 | 6,726 | 15.4 |
| Non- | 646 | 17.9 | 5,370 | 12.3 |
| Net Interest | 230 | 6.4 | 3,835 | 8.8 |
| Defense + SS + Medicare + Medicaid | 2,260 | 62.7 | 29,284 | 66.8 |
| MEMO: GDP | 15,076 | 217,200 |
Source: CBO (2012JanBEO), CBO (2012AugBeo).
ESIII United States Housing Collapse. The depressed level of residential construction and new house sales in the US is evident in Table ESIII-1 providing new house sales not seasonally adjusted in Jan-Jul of various years. Sales of new houses in Jan-Jul 2012 are substantially lower than in any year between 1963 and 2012 with the exception of 2010 and 2011. There are only two increases of 21.1 percent between Jan-Jul 2011 and Jan-Jul 2012 and 7.7 percent between Jan-Jul 2010 and Jan-Jul 2012. Sales of new houses in 2012 are lower by 31.5 percent relative to 2008, 56.6 percent relative to 2007, 66.5 percent relative to 2006 and 71.9 percent relative to 2005. The housing boom peaked in 2005 and 2006 when increases in fed funds rates to 5.25 percent in Jun 2006 from 1.0 percent in Jun 2004 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-Jul 2012 relative to the same period in 2004 fell 69.7 percent and 65.7 percent relative to the same period in 2003. Similar percentage declines are also observed for 2012 relative to years from 2000 to 2004. Sales of new houses in Jan-Jul 2012 fell 44.6 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 ESIII-1 reveals catastrophic data: sales of new houses in Jan-Jul 2012 of 224 thousand units are lower by 34.3 percent relative to 341 thousand units houses sold in Jan-Jul 1963, the first year when data become available, while population increased 72.2 percent.
Table ESIII-1, US, Sales of New Houses Not Seasonally Adjusted, Thousands and %
| Not Seasonally Adjusted Thousands | |
| Jan-Jul 2012 | 224 |
| Jan-Jul 2011 | 185 |
| ∆% | 21.1 |
| Jan-Jul 2010 | 208 |
| ∆% Jan-Jul 2012/ | 7.7 |
| Jan-Jul 2009 | 225 |
| ∆% Jan-Jul 2012/ | -0.4 |
| Jan-Jul 2008 | 327 |
| ∆% Jan-Jul 2012/ | -31.5 |
| Jan-Jul 2007 | 516 |
| ∆% Jan-Jul 2012/ | -56.6 |
| Jan-Jul 2006 | 668 |
| ∆% Jan-Jul 2012/Jan-Jul 2006 | -66.5 |
| Jan-Jul 2005 | 796 |
| ∆% Jan-Jul 2012/Jan-Jul 2005 | -71.9 |
| Jan-Jul 2004 | 739 |
| ∆% Jan-Jul 2012/Jan-Jul 2004 | -69.7 |
| Jan-Jul 2003 | 653 |
| ∆% Jan-Jul 2012/ | -65.7 |
| Jan-Jul 2002 | 581 |
| ∆% Jan-Jul 2012/ | -61.4 |
| Jan-Jul 2001 | 569 |
| ∆% Jan-Jul 2012/ | -60.6 |
| Jan-Jul 2000 | 536 |
| ∆% Jan-Jul 2012/ | -58.2 |
| Jan-Jul 1995 | 404 |
| ∆% Jan-Jul 2012/ | -44.6 |
| Jan-Jul 1963 | 341 |
| ∆% Jan-Jul 2012/ | -34.3 |
Source: US Census Bureau http://www.census.gov/construction/nrs/
Table ESIII-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 2011 in Table ESIII-2 with sales of new houses below 400 thousand with the exception of the immediately preceding years of 2009 and 2010.
Table ESIII-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: US Census Bureau http://www.census.gov/construction/nrs/
Chart ESIII-1 of the US Bureau of the Census provides the entire monthly sample of new houses sold in the US between Jan 1963 and Jul 2012 without seasonal adjustment. The series is almost stationary until the 1990s. There is sharp upward trend from the early 1990s to 2005-2006 after which new single-family houses sold collapse to levels below those in the beginning of the series in the 1960s.
Chart ESIII-1, US, New Single-family Houses Sold, NSA, 1963-2012
Source: US Census Bureau
http://www.census.gov/construction/nrs/
Percentage changes and average rates of growth of new house sales for selected periods are shown in Table ESIII-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 ESIII-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/
Percentage changes of median and average prices of new houses sold in selected years are shown in Table ESIII-4. 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 ESIII-4, 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/
Chart ESIII-2 of the US Census Bureau provides the entire series of new single-family sales median prices from Jan 1963 to Jul 2012. There is long-term sharp upward trend with few declines until the current collapse. Median prices increased sharply during the Great Inflation of the 1960s and 1970s and paused during the savings and loans crisis of the late 1980s and the recession of 1991. Housing subsidies throughout the 1990s caused sharp upward trend of median new house prices that accelerated after the fed funds rate of 1 percent from 2003 to 2004. There was sharp reduction of prices after 2006 without full recovery of earlier prices.
Chart ESIII-2, US, Median Sales Price of New Single-family Houses Sold, US Dollars, NSA, 1963-2012
Source: US Census Bureau
http://www.census.gov/construction/nrs/
ESIV World Economic and Trade Slowdown. Table ESIV-1 provides the latest available estimates of GDP for the regions and countries followed in this blog for IQ2012 and IIQ2012. Growth is weak throughout most of the world. Japan’s GDP increased 1.3 percent in IQ2012 and 2.9 percent relative to a year earlier but part of the jump could be the low level a year earlier because of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Japan is experiencing difficulties with the overvalued yen because of worldwide capital flight originating in zero interest rates with risk aversion in an environment of softer growth of world trade. Japan’s GDP grew 0.3 percent in IIQ2012 at the seasonally adjusted annual rate (SAAR) of 1.4 percent, which is much lower than 5.5 percent in IQ2012. Growth of 3.5 percent in IIQ2012 in Japan relative to IIQ2011 has effects of the low level of output because of Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. China grew at 1.8 percent in IIQ2012, which annualizes to 7.4 percent. Xinhuanet informs that Premier Wen Jiabao considers the need for macroeconomic stimulus, arguing that “we should continue to implement proactive fiscal policy and a prudent monetary policy, while giving more priority to maintaining growth” (http://news.xinhuanet.com/english/china/2012-05/20/c_131599662.htm). Premier Wen elaborates that “the country should properly handle the relationship between maintaining growth, adjusting economic structures and managing inflationary expectations” (http://news.xinhuanet.com/english/china/2012-05/20/c_131599662.htm). China’s GDP grew 7.6 percent in IIQ2012 relative to IIQ2011. Growth rates of GDP of China in a quarter relative to the same quarter a year earlier have been declining from 2011 to 2012. China’s GDP grew 8.1 percent in IQ2012 relative to a year earlier but only 7.6 percent in IIQ2012 relative to a year earlier. GDP was flat in the euro area in IQ2012 and also in IQ2012 relative to a year earlier. Euro area GDP contracted 0.2 percent IIQ2012 and fell 0.4 percent relative to a year earlier. Germany’s GDP increased 0.5 percent in IQ2012 and 1.7 percent relative to a year earlier. In IIQ2012, Germany’s GDP increased 0.3 percent and 0.5 percent relative to a year earlier but 1.0 percent relative to a year earlier when adjusted for calendar (CA) effects. Growth of US GDP in IQ2012 was 0.5 percent, at SAAR of 2.0 percent and higher by 2.4 percent relative to IQ2011. US GDP increased 0.4 percent in IIQ2012, 1.5 percent at SAAR and 2.2 percent relative to a year earlier (Section I Mediocre and Decelerating United States Economic Growth http://cmpassocregulationblog.blogspot.com/2012/07/decelerating-united-states-recovery.html) but with substantial underemployment and underemployment (Section I http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html) and weak hiring (Section I http://cmpassocregulationblog.blogspot.com/2012/08/recovery-without-hiring-ten-million.html and earlier http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-hiring-ten-million.html). UK GDP fell 0.5 percent in IIQ2012, declining 0.5 percent relative to IIQ2011. In IQ2011, UK GDP fell 0.3 percent, declining 0.2 percent relative to a year earlier. Italy has experienced decline of GDP in four consecutive quarters from IIIQ2011 to IIQ2012. Italy’s GDP fell 0.7 percent in IIQ2012 and declined 2.5 percent relative to IIQ2011. France’s GDP stagnated in both IQ2012 and IIQ2012 and fell 0.3 percent relative to a year earlier.
Table ESIV-1, Percentage Changes of GDP Quarter on Prior Quarter and on Same Quarter Year Earlier, ∆%
| IQ2012/IVQ2011 | IQ2012/IQ2011 | |
| United States | QOQ: 0.5 SAAR: 2.0 | 2.4 |
| Japan | QOQ: 1.3 SAAR: 5.5 | 2.9 |
| China | 1.8 | 8.1 |
| Euro Area | 0.0 | 0.0 |
| Germany | 0.5 | 1.7 |
| France | 0.0 | 0.3 |
| Italy | -0.8 | -1.4 |
| United Kingdom | -0.3 | -0.2 |
| IIQ2012/IQ2012 | IIQ2012/IIQ2011 | |
| United States | QOQ: 0.4 SAAR: 1.5 | 2.2 |
| Japan | QOQ: 0.3 | 3.5 |
| China | 1.8 | 7.6 |
| Euro Area | -0.2 | -0.4 |
| Germany | 0.3 | 0.5 1.0 CA |
| France | 0.0 | 0.3 |
| Italy | -0.7 | -2.5 |
| United Kingdom | -0.5 | -0.5 |
QOQ: Quarter relative to prior quarter; SAAR: seasonally adjusted annual rate
Source: Country Statistical Agencies
http://www.bea.gov/national/index.htm#gdp http://www.esri.cao.go.jp/en/sna/sokuhou/sokuhou_top.html http://www.stats.gov.cn/enGliSH/
There is evidence of deceleration of growth of world trade and even contraction in more recent data. Table ESIV-2 provides two types of data: growth of exports and imports in the latest available months and in the past 12 months; and contributions of net trade (exports less imports) to growth of real GDP. Japan provides the most worrisome data (see also Section VB below). In Jul 2012, Japan’s exports fell 5.8 percent in the month and 8.1 percent in 12 months while imports increased 4.4 percent in the month and 2.1 percent in 12 months. The second part of Table ESIV-2 shows that net trade deducted 0.3 percentage points from Japan’s growth of GDP in IIQ2012. In Jul 2012, China’s exports fell 1.8 percent in the month and increased 1.0 percent in 12 months. Germany’s exports fell 1.5 percent in the month of Jun and increased 7.4 percent in the 12 months ending in Jun while imports fell 3.0 percent in the month of Jun and decreased 1.5 percent in the 12 months ending in Jun. Net trade contributed 1.1 percentage points to growth of Germany’s GDP in IIQ2012. The Flash Germany Composite Output Index of the Markit Flash Germany PMI®, combining manufacturing and services, fell from 47.5 in Jul to 47.0 in Aug, which is the lowest since Jun 2009 and the fourth consecutive month of decline with declines of both services and manufacturing and sharp decline of new export orders for manufacturers (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9949). Tim Moore, Senior Economist at Markit, finds deterioration in business conditions in Germany relative to the first semester of 2012 with new export orders in manufacturing falling at the sharpest rate since Apr 2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9949).
UK’s exports fell 4.6 percent in Jun and decreased 1.4 percent in Apr-Jun 2012 relative to Apr-Jun 2011 while imports fell 0.7 percent in Jun and increased 2.2 percent in Apr-Jun 2012 relative to Apr-Jun 2011. Net trade deducted 1.0 percentage points from UK GDP growth in IIQ2012. France’s exports fell 1.9 percent in Jun and net trade deducted 0.5 percentage points to GDP growth in IIQ2012. US exports increased 0.9 percent in Jun 2012 and 7.1 percent in Jan-Jun relative to a year earlier but net trade deducted 0.31 percentage points from GDP growth in IIQ2012. The Markit Flash US Manufacturing Purchasing Managers’ Index™ (PMI™) seasonally adjusted increased marginally from 51.4 in Jul to 51.9 in Aug, indicating the third weakest reading since Oct 2009 in the beginning of the current recovery with the lowest in Dec 2010 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9958). New export orders registered 48.7 in Aug still in contraction territory with 48.6 in Jul. Rob Dodson, Economist at Markit, finds that IIIQ2012 is at the lowest in the current recovery (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9958). Trade values incorporate both price and quantity effects that are difficult to separate. Data do suggest that world trade slowdown is accompanying world economic slowdown.
Table ESIV-2, Growth of Trade and Contributions of Net Trade to GDP Growth, ∆% and % Points
| Exports | Exports 12 M ∆% | Imports | Imports 12 M ∆% | |
| USA | 0.9 Jun | 7.1 Jan-Jun | -1.5 Jun | 6.0 Jan-Jun |
| Japan Jul | -5.8 | -8.1 | 4.4 | 2.1 |
| China | -1.8 Jul | 1.0 Jul 7.8 Jan-Jul | 2.2 Jul | 4.7 Jul 6.5 Jan-Jul |
| Euro Area | 2.2 Jun | 8.3 Jan-Jun | -2.9 Jun | 2.4 Jan-Jun |
| Germany | -1.5 Jun CSA | 7.4 Jun | -3.0 Jun CSA | -1.5 Jun |
| France Jun | -1.9 | 4.3 | -0.4 | 5.8 |
| Italy Jun | -1.4 | 5.5 | -5.3 | -7.1 |
| UK | -4.6 Jun | -1.4 Apr-Jun | -0.7 Jun | 2.2 Apr-Jun |
| Net Trade % Points GDP Growth | % Points | |||
| USA IIQ2012 | -0.31 | |||
| Japan IIQ2012 | -0.3 | |||
| Germany IIQ2012 | 1.1 | |||
| France IIQ2012 | -0.5 | |||
| UK IIQ2012 | -1.0 |
Sources: http://www.census.gov/foreign-trade/ http://www.bea.gov/iTable/index_nipa.cfm
http://www.customs.go.jp/toukei/latest/index_e.htm http://www.esri.cao.go.jp/en/sna/sokuhou/sokuhou_top.html
http://english.customs.gov.cn/publish/portal191/ http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home
https://www.destatis.de/EN/PressServices/Press/pr/2012/08/PE12_287_811.html;jsessionid=A761BC574543A771416A9CF81034F7BA.cae1 http://lekiosque.finances.gouv.fr/AppChiffre/Portail_default.asp
http://www.statistics.gov.uk/hub/index.html
The geographical breakdown of exports by imports of Japan with selected regions and countries is provided in Table ESIV-3 for Jul 2012. The share of Asia in Japan’s trade is more than one half, 55.6 percent of exports and 45.1 percent of imports. Within Asia, exports to China are 19.0 percent of total exports and imports from China 21.6 percent of total imports. The second largest export market for Japan in Jul 2012 is the US with share of 17.6 percent of total exports and share of imports from the US of 8.8 percent in total imports. Western Europe has share of 9.6 percent in Japan’s exports and of 11.0 percent in imports. Rates of growth of exports of Japan in Jul are sharply negative for most countries and regions with the exception of 4.7 percent for exports to the US, 15.3 percent to Canada and 9.0 percent for exports to the Middle East. Comparisons relative to 2011 may have some bias because of the effects of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Deceleration of growth in China and the US and threat of recession in Europe can reduce world trade and economic activity, which could be part of the explanation for the decline of Japan’s exports by 8.1 percent in Jul 2012 while imports increased by 2.1 percent but higher levels after the earthquake and declining prices may be another factor. Growth rates of imports in the 12 months ending in Jul are sharply higher with exception of declines in imports mostly of raw materials: minus 5.4 percent for Middle East, minus 6.6 percent for Australia and minus 27.7 percent for Brazil. Imports from Asia increased 2.8 percent in the 12 months ending in Jul while imports from China increased 3.3 percent.
Table ESIV-3, Japan, Value and 12-Month Percentage Changes of Exports and Imports by Regions and Countries, ∆% and Millions of Yens
| Jun 2012 | Exports | 12 months ∆% | Imports Millions Yens | 12 months ∆% |
| Total | 5,313,281 | -8.1 | 5,830,663 | 2.1 |
| Asia | 2,956,186 | -9.0 | 2,629,261 | 2.8 |
| China | 1,009,095 | -11.9 | 1,259,160 | 3.3 |
| USA | 934,186 | 4.7 | 512,324 | 7.6 |
| Canada | 63,745 | 15.3 | 93,209 | 15.8 |
| Brazil | 38,537 | -8.7 | 72,324 | -27.7 |
| Mexico | 69,165 | -5.6 | 29,749 | 15.9 |
| Western Europe | 510,315 | -28.4 | 639,386 | 8.4 |
| Germany | 137,005 | -19.8 | 169,862 | 14.9 |
| France | 38,336 | -33.3 | 94,594 | 18.8 |
| UK | 70,222 | -32.0 | 47,673 | 25.2 |
| Middle East | 184,758 | 9.0 | 989,543 | -5.4 |
| Australia | 110,817 | -25.0 | 399,395 | -6.6 |
Source: http://www.customs.go.jp/toukei/latest/index_e.htm
ESV Flight to Government Securities of the United States and Germany. Yields on sovereign debt backed up again with the yield of the ten-year government bond of Spain rising sharply to 7.224 percent on Fri Jul 20 while the yield of the ten-year government bond of Italy increased to 6.158 percent but eased again on Fri Jul 27 on the expectations of massive government support with the yield of the ten-year government bond of Spain falling to 6.731 percent and the yield of the ten-year government bond of Italy dropping to 5.956 percent. The ten-year government bond of Spain was quoted at yield of 6.827 percent on Fri Aug 3 and the ten-year government bond of Italy was quoted at 6.064 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). The ten-year government bond of Spain was quoted at 6.868 percent on Aug 10, declining to 6.447 percent on Aug 17 and 6.403 percent on Aug 24, and the ten-year government bond of Italy fell from 5.894 percent on Aug 10 to 5.709 percent on Aug 17 and 5.618 percent on Aug 24. Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Diminishing aversion is captured by increase of the yield of the two- and ten-year Treasury notes and the two- and ten-year government bonds of Germany. Table ESV-1 provides yields of US and German governments bonds and the rate of USD/EUR. Yields of US and German government bonds decline during shocks of risk aversion and the dollar strengthens in the form of fewer dollars required to buy one euro. The yield of the US ten-year Treasury note fell from 2.202 percent on Aug 26, 2011 to 1.459 percent on Jul 20, 2012, reminiscent of experience during the Treasury-Fed accord of the 1940s that placed a ceiling on long-term Treasury debt (Hetzel and Leach 2001), while the yield of the ten-year government bond of Germany fell from 2.16 percent to 1.17 percent. Under increasing risk appetite, the yield of the ten-year Treasury rose to 1.544 on Jul 27, 2012 and 1.569 percent on Aug 3, 2012, while the yield of the ten-year Government bond of Germany rose to 1.40 percent on Jul 27 and 1.42 percent on Aug 3. Yields have been on an increasing trend with the US ten-year note at 1.814 percent on Aug 17 and the German ten-year bond at 1.50 percent with sharp decline on Aug 24 to 1.684 percent for the yield of the US ten-year note and 1.35 for the yield of the German ten-year bond. The US dollar strengthened significantly from USD 1.450/EUR on Aug 26, 2011, to USD 1.2158 on Jul 20, 2012, or by 16.2 percent, but depreciated to USD 1.2320/EUR on Jul 27, 2012 and 1.2387 on Aug 3, 2012 in expectation of massive support of highly indebted euro zone members. Doubts returned at the end of the week of Aug 10, 2012 with appreciation to USD 1.2290/EUR and decline of the yields of the two-year government bond of Germany to -0.07 percent and of the ten-year to 1.38 percent. On Aug 17, the US dollar depreciated by 0.4 percent to USD 1.2335/EUR and the ten-year bond of Germany yielded -0.04 percent. Risk appetite returned in the week of Aug 24 with depreciation by 1.4 percent to USD 1.2512/EUR and lower yield of the German two-year bond to -0.01 percent and of the US two-year note to 0.266 percent. Under zero interest rates for the monetary policy rate of the US, or fed funds rate, carry trades ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield is still around consumer price inflation of 1.4 percent in the 12 months ending in Jul (see subsection II United States Inflation at http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/07/world-inflation-waves-financial.html) and the expectation of higher inflation if risk aversion diminishes. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table ESV-1 provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.
Table ESV-1, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate
| US 2Y | US 10Y | DE 2Y | DE 10Y | USD/ EUR | |
| 8/24/12 | 0.266 | 1.684 | -0.01 | 1.35 | 1.2512 |
| 8/17/12 | 0.288 | 1.814 | -0.04 | 1.50 | 1.2335 |
| 8/10/12 | 0.267 | 1.658 | -0.07 | 1.38 | 1.2290 |
| 8/3/12 | 0.242 | 1.569 | -0.02 | 1.42 | 1.2387 |
| 7/27/12 | 0.244 | 1.544 | -0.03 | 1.40 | 1.2320 |
| 7/20/12 | 0.207 | 1.459 | -0.07 | 1.17 | 1.2158 |
| 7/13/12 | 0.24 | 1.49 | -0.04 | 1.26 | 1.2248 |
| 7/6/12 | 0.272 | 1.548 | -0.01 | 1.33 | 1.2288 |
| 6/29/12 | 0.305 | 1.648 | 0.12 | 1.58 | 1.2661 |
| 6/22/12 | 0.309 | 1.676 | 0.14 | 1.58 | 1.2570 |
| 6/15/12 | 0.272 | 1.584 | 0.07 | 1.44 | 1.2640 |
| 6/8/12 | 0.268 | 1.635 | 0.04 | 1.33 | 1.2517 |
| 6/1/12 | 0.248 | 1.454 | 0.01 | 1.17 | 1.2435 |
| 5/25/12 | 0.291 | 1.738 | 0.05 | 1.37 | 1.2518 |
| 5/18/12 | 0.292 | 1.714 | 0.05 | 1.43 | 1.2780 |
| 5/11/12 | 0.248 | 1.845 | 0.09 | 1.52 | 1.2917 |
| 5/4/12 | 0.256 | 1.876 | 0.08 | 1.58 | 1.3084 |
| 4/6/12 | 0.31 | 2.058 | 0.14 | 1.74 | 1.3096 |
| 3/30/12 | 0.335 | 2.214 | 0.21 | 1.79 | 1.3340 |
| 3/2/12 | 0.29 | 1.977 | 0.16 | 1.80 | 1.3190 |
| 2/24/12 | 0.307 | 1.977 | 0.24 | 1.88 | 1.3449 |
| 1/6/12 | 0.256 | 1.957 | 0.17 | 1.85 | 1.2720 |
| 12/30/11 | 0.239 | 1.871 | 0.14 | 1.83 | 1.2944 |
| 8/26/11 | 0.20 | 2.202 | 0.65 | 2.16 | 1.450 |
| 8/19/11 | 0.192 | 2.066 | 0.65 | 2.11 | 1.4390 |
| 6/7/10 | 0.74 | 3.17 | 0.49 | 2.56 | 1.192 |
| 3/5/09 | 0.89 | 2.83 | 1.19 | 3.01 | 1.254 |
| 12/17/08 | 0.73 | 2.20 | 1.94 | 3.00 | 1.442 |
| 10/27/08 | 1.57 | 3.79 | 2.61 | 3.76 | 1.246 |
| 7/14/08 | 2.47 | 3.88 | 4.38 | 4.40 | 1.5914 |
| 6/26/03 | 1.41 | 3.55 | NA | 3.62 | 1.1423 |
Note: DE: Germany
Source:
http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
http://www.federalreserve.gov/releases/h15/data.htm
http://www.ecb.int/stats/money/long/html/index.en.html
Chart ESV-1 of the Board of Governors of the Federal Reserve System provides the ten-year and two-year Treasury constant maturity yields. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe.
Chart ESV-1, US, Ten-Year and Two-Year Treasury Constant Maturity Yields Jul 3, 2001-Aug 20, 2012
Note: US Recessions in shaded areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
ESVI Loss of Dynamism of the United States Economy. Lucas (2011May) estimates US economic growth in the long-term at 3 percent per year and about 2 percent per year in per capita terms. There are displacements from this trend caused by events such as wars and recessions but the economy then returns to trend. Historical US GDP data exhibit remarkable growth: Lucas (2011May) estimates an increase of US real income per person by a factor of 12 in the period from 1870 to 2010. The explanation by Lucas (2011May) of this remarkable growth experience is that government provided stability and education while elements of “free-market capitalism” were an important driver of long-term growth and prosperity. The analysis is sharpened by comparison with the long-term growth experience of G7 countries (US, UK, France, Germany, Canada, Italy and Japan) and Spain from 1870 to 2010. Countries benefitted from “common civilization” and “technology” to “catch up” with the early growth leaders of the US and UK, eventually growing at a faster rate. Significant part of this catch up occurred after World War II. Lucas (2011May) finds that the catch up stalled in the 1970s. The analysis of Lucas (2011May) is that the 20-40 percent gap that developed originated in differences in relative taxation and regulation that discouraged savings and work incentives in comparison with the US. A larger welfare and regulatory state, according to Lucas (2011May), could be the cause of the 20-40 percent gap. Cobet and Wilson (2002) provide estimates of output per hour and unit labor costs in national currency and US dollars for the US, Japan and Germany from 1950 to 2000 (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). The average yearly rate of productivity change from 1950 to 2000 was 2.9 percent in the US, 6.3 percent for Japan and 4.7 percent for Germany while unit labor costs in USD increased at 2.6 percent in the US, 4.7 percent in Japan and 4.3 percent in Germany. From 1995 to 2000, output per hour increased at the average yearly rate of 4.6 percent in the US, 3.9 percent in Japan and 2.6 percent in Germany while unit labor costs in USD fell at minus 0.7 percent in the US, 4.3 percent in Japan and 7.5 percent in Germany. There was increase in productivity growth in the G7 in Japan and France in the second half of the 1990s but significantly lower than the acceleration of 1.3 percentage points per year in the US. Long-term economic growth and prosperity are measured by the key indicators of growth of real income per capita, or what is earned per person after inflation. A refined concept would include real disposable income per capita, or what is earned per person after inflation and taxes.
Table ESVI-1 provides the data required for broader comparison of the cyclical expansions of IQ1983 to IVQ1985 and the current one from 2009 to 2012. First, in the 13 quarters from IQ1983 to IVQ1985, GDP increased 19.6 percent at the annual equivalent rate of 5.7 percent; real disposable personal income (RDPI) increased 14.5 percent at the annual equivalent rate of 4.3 percent; RDPI per capita increased 11.5 percent at the annual equivalent rate of 3.4 percent; and population increased 2.7 percent at the annual equivalent rate of 0.8 percent. Second, in the 12 quarters of the current cyclical expansion from IIIQ2009 to IIQ2012, GDP increased 6.75 percent at the annual equivalent rate of 2.2 percent; real disposable personal income (RDPI) increased 3.8 percent at the annual equivalent rate of 1.2 percent; RDPI per capita increased 1.4 percent at the annual equivalent rate of 0.5 percent; and population increased 2.3 percent at the annual equivalent rate of 0.8 percent. Third, since the beginning of the recession in IVQ2007 to IIQ2012, GDP increased 1.7 percent, or barely above the level before the recession; real disposable personal income increased 3.5 percent; population increased 3.7 percent; and real disposable personal income per capita is 0.2 percent lower than the level before the recession. Real disposable personal income is the actual take home pay after inflation and taxes and real disposable income per capita is what is left per inhabitant. The current cyclical expansion is the worst in the period after World War II in terms of growth of economic activity and income. The United States grew during its history at high rates of per capita income that made its economy the largest in the world. That dynamism is disappearing.
Table ESVI-1, US, GDP, Real Disposable Personal Income, Real Disposable Income per Capita and Population in 1983-85 and 2007-2011, %
| # Quarters | ∆% | ∆% Annual Equivalent | |
| IQ1983 to IVQ1985 | 13 | ||
| GDP | 19.6 | 5.7 | |
| RDPI | 14.5 | 4.3 | |
| RDPI Per Capita | 11.5 | 3.4 | |
| Population | 2.7 | 0.8 | |
| IIIQ2009 to IIQ2012 | 12 | ||
| GDP | 6.75 | 2.2 | |
| RDPI | 3.8 | 1.2 | |
| RDPI per Capita | 1.4 | 0.5 | |
| Population | 2.3 | 0.8 | |
| IVQ2007 to IIQ2012 | 19 | ||
| GDP | 1.7 | ||
| RDPI | 3.5 | ||
| RDPI per Capita | -0.2 | ||
| Population | 3.7 |
RDPI: Real Disposable Personal Income
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
ESVII 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 second 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 28.6 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 http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars.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 with fluctuations caused by intermittent risk aversion.
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 8/24/12,” 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, 2011, 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 [(1.018)4], which was repeated in IIQ2012. 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. Risk aversion returned in the week of May 4 because of the expectation of elections in Europe and the new trend of deterioration of job creation in the US. Europe’s sovereign debt crisis and the fractured US job market continued to influence risk aversion in the week of May 11. Politics in Greece and banking issues in Spain were important factors of sharper risk aversion in the week of May 18. Risk aversion continued during the week of May 25 and exploded in the week of Jun 1. Expectations of stimulus by central banks caused valuation of risk financial assets in the week of Jun 8 and in the week of Jun 15. Expectations of major stimulus were frustrated by minor continuance of maturity extension policy in the week of Jun 22 together with doubts on the silent bank run in highly indebted euro area member countries. There was a major rally of valuations of risk financial assets in the week of Jun 29 with the announcement of new measures on bank resolutions by the European Council. New doubts surfaced in the week of Jul 6, 2012 on the implementation of the bank resolution mechanism and on the outlook for the world economy because of interest rate reductions by the European Central, Bank of England and People’s Bank of China. Risk appetite returned in the week of July 13 in relief that economic data suggests continuing high growth in China but fiscal and banking uncertainties in Spain spread to Italy in the selloff of July 20, 2012. Mario Draghi (2012Jul26), president of the European Central Bank, stated: “But there is another message I want to tell you.
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” This statement caused return of risk appetite, driving upward valuations of risk financial assets worldwide. Buiter (2011Oct31) analyzes that the European Financial Stability Fund (EFSF) would need a “bigger bazooka” to bail out euro members in difficulties that could possibly be provided by the ECB. The dimensions of the problem may require more firepower than a bazooka perhaps that of the largest conventional bomb of all times of 44,000 pounds experimentally detonated only once by the US in 1948 (http://www.airpower.au.af.mil/airchronicles/aureview/1967/mar-apr/coker.html). Risk appetite continued in the week of Aug 3, 2012, in expectation of purchases of sovereign bonds by the ECB. Growth of China’s exports by 1.0 percent in the 12 months ending in Jul 2012 released in the week of Aug 10, 2012, together with doubts on the purchases of bonds by the ECB injected a mild dose of risk aversion. There was optimism on the resolution of the European debt crisis on Aug 17, 2012. The week of Aug 24, 2012 had alternating shocks of risk aversion and risk appetite from the uncertainties of success of the Greek adjustment program, the coming decision of the Federal Constitutional Court of Germany on the European Stability Mechanism, disagreements between the Deutsche Bundesbank and the European Central Bank on purchase of sovereign bonds of highly indebted euro area member countries and the exchange of letters between Darrell E. Issa (2012Aug1), Chairman of the House Committee on Oversight and Government Reform, and Chairman Bernanke (2012Aug22) on monetary policy. The highest valuations in column “∆% Trough to 8/24/12” are by US equities indexes: DJIA 35.8 percent and S&P 500 38.0 percent, driven by stronger earnings and economy in the US than in other advanced economies but with doubts on the relation of business revenue to the weakening economy and fractured job market. The DJIA reached 13,359.62 in intraday trading on May 1, 2012, 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 8/24/12” had double digit gains relative to the trough around Jul 2, 2010 but now many valuations of equity indexes show increase of less than 10 percent: China’s Shanghai Composite is 12.2 percent below the trough; Japan’s Nikkei Average is 2.8 percent above the trough; DJ Asia Pacific TSM is 7.2 percent above the trough; Dow Global is 10.7 percent above the trough; STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 10.3 percent above the trough; and NYSE Financial is 7.8 percent above the trough. DJ UBS Commodities is 17.2 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 22.9 percent above the trough. Japan’s Nikkei Average is 2.8 percent above the trough on Aug 31, 2010 and 20.4 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 9070.76 on Fri Aug 24, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 11.5 percent lower than 10,254.43 on Mar 11, 2011, on the date of the Tōhoku or Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 4.9 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 8/24/12” in Table ESVI-1 shows that there were decreases of valuations of risk financial assets in the week of Aug 24, 2012 such as 1.0 percent for DAX, 1.7 percent for STOXX 50, 0.3 percent for NYSE Financial, 0.2 percent DJ Asia Pacific TSM, 1.0 percent Japan’s Nikkei Average and 0.4 percent for Dow Global. DJ UBS Commodities increased 1.6 percent. China’s Shanghai Composite fell 1.1 percent. The DJIA decreased 0.9 percent and S&P 500 decreased 0.5 percent. The USD depreciated 1.4 percent. There are still high uncertainties on European sovereign risks and banking soundness, 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 8/24/12” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Aug 24, 2012. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 8/24/12” but also relative to the peak in column “∆% Peak to 8/24/12.” There are now only three equity indexes above the peak in Table ESVI-1: DJIA 17.4 percent, S&P 500 15.9 percent and DAX 10.1 percent. There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 14.1 percent, Nikkei Average by 20.4 percent, Shanghai Composite by 33.9 percent, DJ Asia Pacific by 6.2 percent, STOXX 50 by 6.6 percent and Dow Global by 9.6 percent. DJ UBS Commodities Index is now 0.2 percent above the peak. The US dollar strengthened 17.3 percent relative to 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 2010 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 elusive 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 8/24/ /12 | ∆% Week 8/24/12 | ∆% Trough to 8/24/ 12 | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 17.4 | -0.9 | 35.8 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 15.9 | -0.5 | 38.0 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | -14.1 | -0.3 | 7.8 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | -9.6 | -0.4 | 10.7 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | -6.2 | -0.2 | 7.2 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | -20.4 | -1.0 | 2.8 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -33.9 | -1.1 | -12.2 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -6.6 | -1.7 | 10.3 |
| DAX | 4/26/ | 5/25/ | -10.5 | 10.1 | -1.0 | 22.9 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 17.3 | -1.4 | -4.9 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | 0.2 | 1.6 | 17.2 |
| 10-Year T Note | 4/5/ | 4/6/10 | 3.986 | 1.684 |
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 United States Monetary and Fiscal Policy. Monetary and fiscal policies have been proposed and implemented vigorously most everywhere in the world. This section considers the impact of monetary policy transmission on banks in Subsection IA United States Commercial Bank Assets and Liabilities. Fiscal policy is considered in Subsection IB United States Budget/Debt Quagmire in the light of the new budget and economic outlook of the Congressional Budget Office (CBO 2012AugBEO).
IA United States Commercial Banks Assets and Liabilities. Subsection IA1 Transmission of Monetary Policy recapitulates the mechanism of transmission of monetary policy. Subsection IA2 Functions of Banking analyzes the functions of banks in modern banking theory. Subsection IA3 United States Commercial Bank Assets and Liabilities provides data and analysis of US commercial bank balance sheets in report H.8 of the Board of Governors of the Federal Reserve System on Assets and Liabilities of Commercial Banks in the United States (http://www.federalreserve.gov/releases/h8/current/default.htm).
IA Transmission of Monetary Policy. The critical fact of current world financial markets is the combination of “unconventional” monetary policy with intermittent shocks of financial risk aversion. There are two interrelated unconventional monetary policies. First, unconventional monetary policy consists of (1) reducing short-term policy interest rates toward the “zero bound” such as fixing the fed funds rate at 0 to ¼ percent by decision of the Federal Open Market Committee (FOMC) since Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). Second, unconventional monetary policy also includes a battery of measures to also reduce long-term interest rates of government securities and asset-backed securities such as mortgage-backed securities.
When inflation is low, the central bank lowers interest rates to stimulate aggregate demand in the economy, which consists of consumption and investment. When inflation is subdued and unemployment high, monetary policy would lower interest rates to stimulate aggregate demand, reducing unemployment. When interest rates decline to zero, unconventional monetary policy would consist of policies such as large-scale purchases of long-term securities to lower their yields. A major portion of credit in the economy is financed with long-term asset-backed securities. Loans for purchasing houses, automobiles and other consumer products are bundled in securities that in turn are sold to investors. Corporations borrow funds for investment by issuing corporate bonds. Loans to small businesses are also financed by bundling them in long-term bonds. Securities markets bridge the needs of higher returns by savers obtaining funds from investors that are channeled to consumers and business for consumption and investment. Lowering the yields of these long-term bonds could lower costs of financing purchases of consumer durables and investment by business. The essential mechanism of transmission from lower interest rates to increases in aggregate demand is portfolio rebalancing. Withdrawal of bonds in a specific maturity segment or directly in a bond category such as currently mortgage-backed securities causes reductions in yield that are equivalent to increases in the prices of the bonds. There can be secondary increases in purchases of those bonds in private portfolios in pursuit of their increasing prices. Lower yields translate into lower costs of buying homes and consumer durables such as automobiles and also lower costs of investment for business. There are two additional intended routes of transmission.
1. Unconventional monetary policy or its expectation can increase stock market valuations (Bernanke 2010WP). Increases in equities traded in stock markets can augment perceptions of the wealth of consumers inducing increases in consumption.
2. Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can cause increases in net exports of the US that increase aggregate economic activity (Yellen 2011AS).
Monetary policy can lower short-term interest rates quite effectively. Lowering long-term yields is somewhat more difficult. The critical issue is that monetary policy cannot ensure that increasing credit at low interest cost increases consumption and investment. There is a large variety of possible allocation of funds at low interest rates from consumption and investment to multiple risk financial assets. Monetary policy does not control how investors will allocate asset categories. A critical financial practice is to borrow at low short-term interest rates to invest in high-risk, leveraged financial assets. Investors may increase in their portfolios asset categories such as equities, emerging market equities, high-yield bonds, currencies, commodity futures and options and multiple other risk financial assets including structured products. If there is risk appetite, the carry trade from zero interest rates to risk financial assets will consist of short positions at short-term interest rates (or borrowing) and short dollar assets with simultaneous long positions in high-risk, leveraged financial assets such as equities, commodities and high-yield bonds. Low interest rates may induce increases in valuations of risk financial assets that may fluctuate in accordance with perceptions of risk aversion by investors and the public. During periods of muted risk aversion, carry trades from zero interest rates to exposures in risk financial assets cause temporary waves of inflation that may foster instead of preventing financial instability (http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html). During periods of risk aversion such as fears of disruption of world financial markets and the global economy resulting from collapse of the European Monetary Union, carry trades are unwound with sharp deterioration of valuations of risk financial assets. More technical discussion is in IA Appendix: Transmission of Unconventional Monetary Policy at http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html.
IA2 Functions of Banks. Modern banking theory analyzes three important functions provided by banks: monitoring of borrowers, provision of liquidity services and transformation of illiquid assets into immediately liquid assets (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 51-60).
1. Monitoring. Banks monitor projects to ensure that funds are allocated to their intended projects (Diamond 1984, 1996). Banks issue deposits, which are secondary assets, to acquire loans, which are primary assets. Monitoring reduces costs of participating in business projects. Acting as delegated monitor, banks obtain information on the borrower, allowing less costly participation through the issue of unmonitored deposits. Monitoring of borrowers provides enhanced less costly participation by investors through the issue of deposits. There is significant reduction of monitoring costs by delegating to a bank. If there are many potential investors, monitoring by the bank of a credit name is less costly than the sum of individual monitoring of the same credit name by all potential investors. Banks permit borrowers to reach many investors for their projects while affording investors less costly participation in the returns of projects of bank borrowers.
2. Transformation of Illiquid Loans into Liquid Deposits. Diamond and Dybvig (1986) analyze bank services through their balance sheets.
i. Assets. Banks provide loans to borrowers. The evaluation of borrowers prevents “adverse selection,” which consists of banks choosing unsound projects and failing to finance sound projects. Monitoring of loans prevents “moral hazard,” which consists of borrowers using the funds of the loan for purposes other than the project for which they were lent, as for example, using borrowed bank funds for speculative real estate instead of for the intended industrial project. Relationship banking improves the information on borrowers and the monitoring function.
ii. Liabilities. Banks provide numerous services to their clients such as holding deposits, clearing transactions, currency inventory and payments for goods, services and obligations.
iii. Assets and Liabilities: Transformation Function. The transformation function operates through both sides of the balance sheet: banks convert illiquid loans in the asset side into liquid deposits in the liability side. There is rich theory of banking (Diamond and Rajan 2000, 2001a,b). Securitized banking provides the same transformation function by bundling mortgage and other consumer loans into securities that are then sold to investors who finance them in short-dated sale and repurchase agreements (Pelaez and Pelaez, Regulation of Banks and Finance (2008b), 61-6).
Banking was important in facilitating economic growth in historical periods (Cameron 1961, 1967, 1972; Cameron et al. 1992). Banking is also important currently because small- and medium-size business may have no other form of financing than banks in contrast with many options for larger and more mature companies that have access to capital markets. Personal consumptions expenditures have share of 71.0 percent of GDP in IIQ2012 (Table I-10 http://cmpassocregulationblog.blogspot.com/2012/07/decelerating-united-states-recovery.html). Most consumers rely on their banks for real estate loans, credit cards and personal consumer loans. Thus, it should be expected that success of monetary policy in stimulating the economy would be processed through bank balance sheets.
IA3 United States Commercial Banks Assets and Liabilities. Data and analysis on US commercial bank assets and liabilities are introduced below in two forms: two tables provide not seasonally adjusted (NSA) assets and liabilities from Jul 2011 to Jul 2011 and seasonally adjusted annual rates of percentage change (SAAR); and a group of charts permits different perspectives of longer historical series.
Selected assets and liabilities of US commercial banks, not seasonally adjusted, in billions of dollars, from Report H.8 of the Board of Governors of the Federal Reserve System are provided in Table IA-1. Data are not seasonally adjusted to permit comparison between Jul 2011 and Jul 2012. Total assets of US commercial banks grew 4.1 percent from $12,307 billion in Jul 2011 to $12,806 billion in Jul 2012. US GDP in 2011 is estimated at $15,076 billion (http://www.bea.gov/iTable/index_nipa.cfm). Thus, total assets of US commercial banks are equivalent to around 80 percent of US GDP. Bank credit grew 5.9 percent from $9147 billion in Jul 2011 to $9692 billion in Jul 2012. Securities in bank credit increased 8.6 percent from $2415 billion in Jul 2011 to $2622 billion in Jul 2012. A large part of securities in banking credit consists of US Treasury and agency securities, growing 10.7 percent from $1640 billion in Jul 2011 to $1816 billion in Jul 2012. Credit to the government that issues or backs Treasury and agency securities of $1816 in Jul 2012 is about 18.7 percent of total bank credit of US commercial banks of $9692 billion. Mortgage-backed securities, providing financing of home loans, grew 14.1 percent, from $1160 billion in Jul 2011 to $1324 billion in Jul 2012. Loans and leases were less dynamic, growing 5.0 percent from $6732 billion in Jul 2011 to $7070 billion in Jul 2012. The only dynamic class is commercial and industrial loans, growing 14.3 percent from Jul 2011 to Jul 2012 and providing $1442 billion or 20.4 percent of total loans and leases of $7070 billion in Jul 2012. Real estate loans increased only 0.9 percent, providing $3515 billion in Jul 2012 or 49.7 percent of total loans and leases. Consumer loans increased only 1.9 percent, providing $1104 billion in Jul 2012 or 15.6 percent of total loans. Cash assets “include vault cash, cash items in process of collection, balances due from depository institutions and balances due from Federal Reserve Banks” (http://www.federalreserve.gov/releases/h8/current/default.htm). Cash assets in US commercial banks fell 4.4 percent from $1761 billion in Jul 2011 to $1683 billion in Jul 2012 but a single year of the series masks exploding cash in banks as a result of unconventional monetary policy, which is discussed below. Bank deposits increased 6.4 percent from $8227 billion to $8757 billion. The difference between bank deposits and total loans and leases in banks increased from $1495 billion in Jul 2011 to $1687 billion in Jul 2012 or by $192 billion, which is roughly equal to the increase in securities in bank credit by $207 billion from $2415 billion in Jul 2011 to $2622 billion in Jul 2012 and to the increase in Treasury and agency securities by $176 billion from $1640 billion in Jul 2011 to $1816 billion in Jul 2012. Loans and leases increased $338 billion from $6732 billion in Jul 2011 to $7070 billion in Jul 2012. Banks expanded both lending and investment in lower risk securities partly because of the weak economy and credit disappointments during the global recession that has resulted in an environment of fewer sound lending opportunities. Lower interest rates resulting from monetary policy may not necessarily encourage higher borrowing in the current loss of dynamism of the US economy with real disposable income per capita in IIQ2012 lower than in IVQ2007 (ESIV at http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html) in contrast with long-term growth of per capita income in the United States at 2 percent per year from 1870 to 2010 (Lucas 2011May).
Table IA-1, US, Assets and Liabilities of Commercial Banks, NSA, Billions of Dollars
| Jul 2011 | Jul 2012 | ∆% | |
| Total Assets | 12,307 | 12,806 | 4.1 |
| Bank Credit | 9147 | 9692 | 5.9 |
| Securities in Bank Credit | 2415 | 2622 | 8.6 |
| Treasury & Agency Securities | 1640 | 1816 | 10.7 |
| Mortgage-Backed Securities | 1160 | 1324 | 14.1 |
| Loans & Leases | 6732 | 7070 | 5.0 |
| Real Estate Loans | 3484 | 3515 | 0.9 |
| Consumer Loans | 1083 | 1104 | 1.9 |
| Commercial & Industrial Loans | 1262 | 1442 | 14.3 |
| Other Loans & Leases | 903 | 1009 | 11.7 |
| Cash Assets* | 1761 | 1683 | -4.4 |
| Total Liabilities | 10,913 | 11,332 | 3.8 |
| Deposits | 8227 | 8757 | 6.4 |
Note: balancing item of residual assets less liabilities not included
*”Includes vault cash, cash items in process of collection, balances due from depository institutions and balances due from Federal Reserve Banks.”
Source: Board of Governors of the Federal Reserve System http://www.federalreserve.gov/releases/h8/current/default.htm
Seasonally adjusted annual equivalent rates (SAAR) of change of selected assets and liabilities of US commercial banks from the report H.8 of the Board of Governors of the Federal Reserve System are provided in Table IA-2 annually from 2007 to 2011 and for Jul 2012. The global recession had strong impact on bank assets as shown by declines of total assets of 6.1 percent in 2008 and 2.8 percent in 2010. Loans and leases fell 10.2 percent in 2009 and 5.8 percent in 2010. Commercial and industrial loans fell 18.6 percent in 2009 and 9.0 percent in 2011. Unconventional monetary policy caused an increase of cash assets of banks of 155.6 percent in 2008, 47.4 percent in 2009 and 49.1 percent in 2011 and at the SAAR of 31.6 percent in Jul 2012. Acquisitions of securities for the portfolio of the central bank injected reserves in depository institutions that were held as cash and reserves at the central banks because of the lack of sound lending opportunities and the adverse expectations in the private sector on doing business. The truly dynamic investment of banks has been in securities in bank credit, growing at the SAAR of 17.7 percent in Jul 2012. Throughout the crisis banks allocated increasing part of their assets to the safety of Treasury and agency securities, or credit to the US government and government-backed credit, with growth of 15.5 percent in 2009 and 15.1 percent in 2010 and at the rate of 16.1 percent in Jul 2012. Deposits grew at the rate of 15.4 percent in Jul 2012. The credit intermediation function of banks is broken because of adverse expectations on future business and is not easily mended simply by monetary and fiscal policy. Incentives to business and consumers are more likely to be effective in this environment in recovering willingness to assume risk on the part of the private sector, which is the driver of growth and job creation.
Table IA-2, US, Selected Assets and Liabilities of Commercial Banks, Seasonally Adjusted Annual Rate, ∆%
| 2007 | 2008 | 2009 | 2010 | 2011 | Jul 2012 | |
| Total Assets | 10.3 | 7.8 | -6.1 | -2.8 | 5.3 | 10.9 |
| Bank Credit | 9.3 | 2.2 | -6.6 | -2.8 | 1.7 | 7.0 |
| Securities in Bank Credit | 6.1 | -2.1 | 6.8 | 6.7 | 1.8 | 17.7 |
| Treasury & Agency Securities | -6.4 | 3.0 | 15.5 | 15.1 | 2.8 | 16.1 |
| Other Securities | 26.7 | -8.3 | -5.1 | -7.1 | -0.5 | 21.0 |
| Loans & Leases | 10.2 | 3.4 | -10.2 | -5.8 | 1.7 | 3.1 |
| Real Estate Loans | 7.0 | -0.1 | -5.6 | -5.6 | -4.0 | 0.5 |
| Consumer Loans | 5.4 | 5.1 | -3.2 | -7.0 | -0.5 | 1.8 |
| Commercial & Industrial Loans | 18.1 | 12.9 | -18.6 | -9.0 | 9.6 | 13.6 |
| Other Loans & Leases | 19.3 | 1.8 | -23.3 | 0.1 | 18.8 | 2.5 |
| Cash Assets | -0.7 | 155.6 | 47.4 | -8.5 | 49.1 | 31.6 |
| Total Liabilities | 11.1 | 10.6 | -7.3 | -3.5 | 5.5 | 11.8 |
| Deposits | 9.1 | 5.4 | 5.2 | 2.4 | 6.6 | 15.4 |
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-1 of the Board of Governors of the Federal Reserve System provides quarterly seasonally adjusted annual rates (SAAR) of cash assets in US commercial banks from 1973 to 2012. Unconventional monetary policy caused an increase in cash assets in late 2008 of close to 500 percent at SAAR and also in following policy impulses. Such aggressive policies were not required for growth of GDP at the average rate of 5.7 percent in 13 quarters of cyclical expansion from IQ1983 to IV1985 while the average rate in 12 quarters of cyclical expansion from IIIQ2009 to IIQ2012 has been at the rate of 2.2 percent (Table I-5 at http://cmpassocregulationblog.blogspot.com/2012/07/decelerating-united-states-recovery.html). The difference in magnitude of the recessions is not sufficient to explain weakness of the current cyclical expansion. There were two consecutive contractions in the 1980s with decline of 2.2 percent in two quarters from IQ1980 to IIIQ1980 and 2.7 percent from IIIQ1981 to IVQ1982 that are almost identical to the contraction of 4.7 percent from IVQ2007 to IIQ2009 (Table I-4 at http://cmpassocregulationblog.blogspot.com/2012/07/decelerating-united-states-recovery.html). There was also a decade-long financial and banking crisis during the 1980s. The debt crisis of 1982 (Pelaez 1986) wiped out a large part of the capital of large US money-center banks. Benston and Kaufman (1997, 139) find that there was failure of 1150 US commercial and savings banks between 1983 and 1990, or about 8 percent of the industry in 1980, which is nearly twice more than between the establishment of the Federal Deposit Insurance Corporation in 1934 through 1983. More than 900 savings and loans associations, representing 25 percent of the industry, were closed, merged or placed in conservatorships (see Pelaez and Pelaez, Regulation of Banks and Finance (2008b), 74-7). The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) created the Resolution Trust Corporation (RTC) and the Savings Association Insurance Fund (SAIF) that received $150 billion of taxpayer funds to resolve insolvent savings and loans. The GDP of the US in 1989 was $5482.1 billion (http://www.bea.gov/iTable/index_nipa.cfm), such that the partial cost to taxpayers of that bailout was around 2.7 percent of GDP in a year. US GDP in 2011 is estimated at $15,075.7 billion, such that the bailout would be equivalent to cost to taxpayers of about $412.5 billion in current GDP terms. A major difference with the Troubled Asset Relief Program (TARP) for private-sector banks is that most of the costs were recovered with interest gains whereas in the case of savings and loans there was no recovery.
Chart IA-1, US, Cash Assets, Commercial Banks, Seasonally Adjusted Annual Rate, 1973-2012, ∆%
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-2 of the Board of Governors of the Federal Reserve System provides quarterly SAARs of bank credit at US commercial banks from 1973 to 2012. Rates collapsed sharply during the global recession as during the recessions of the 1980s and then rebounded. In both episodes rates of growth of bank credit did not return to earlier magnitudes.
Chart IA-2, US, Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, 1973-2012, ∆%
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-3 of the Board of Governors of the Federal Reserve System provides deposits at US commercial banks from 1973 to 2012. Deposits fell sharp during and after the global recession but then rebounded in the cyclical expansion.
Chart IA-3, US, Deposits, Commercial Banks, Seasonally Adjusted Annual Rate, 1973-2012, ∆%
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
There is similar behavior in the 1980s and in the current cyclical expansion of SAARs holdings of Treasury and agency securities in US commercial banks provided in Chart IA-4 of the Board of Governors of the Federal Reserve System for the period 1973 to 2012. Sharp reductions of holdings during the contraction were followed by sharp increases.
Chart IA-4, US, Treasury and Agency Securities in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, 1973-2012, ∆%
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-5 of the Board of Governors of the Federal Reserve System provides SAARs of change of total loans and leases in US commercial banks from 1973 to 2012. The decline in the current cycle of SAARs was much sharper and the rebound did not recover earlier growth rates. Part of the explanation originates in demand for loans that was high during rapid economic growth at 5.7 percent per year on average in the cyclical expansion of the 1980s in contrast with lower demand during tepid economic growth at 2.2 percent per year on average in the current weak expansion.
Chart IA-5, US, Loans and Leases in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, 1973-2012, ∆%
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
There is significant difference in the two cycles of the 1980s and the current one in quarterly SAARs of real estate loans in US commercial banks provided in Chart IA-6 of the Board of Governors of the Federal Reserve System. The difference is explained by the debacle in real estate after 2006 compared to expansion during the 1980s even in the midst of the crisis of savings and loans and real estate credit. In both cases, government policy tried to influence recovery and avoid market clearing.
Chart IA-6, US, Real Estate Loans in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, 1973-2012, ∆%
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
There is significant difference in quarterly SAARs of change of consumer loans in US commercial banks in the 1980s and during the current cycle as shown in Chart IA-7 of the Board of Governors of the Federal Reserve System. Quarterly SAARs of consumer loans in US commercial banks fell sharply during the contraction of 1980 and oscillated with upward trend during the contraction of 1983-1984 but increased sharply in the cyclical expansion. In contrast, SAARs of consumer loans in US commercial banks collapsed to high negative magnitudes during the contraction and have increased at very low magnitudes during the current cyclical expansion.
Chart IA-7, US, Consumer Loans in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, 1973-2012, ∆%
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
The explanation of this diverging behavior of consumer loans is in Table IA-3. In the cyclical expansion from IQ1983 to IVQ1985, real disposable personal income per capita, or what is left per inhabitant after inflation and taxes, increased 11.5 percent, at annual equivalent rate of 3.4 percent. Consumers were richer in income and demanded more consumer loans. In contrast, real disposable income per capita increased 2.3 percent in the current cyclical expansion from IIIQ2009 to IIQ2012 at the annual equivalent rate of 0.8 percent. In fact, the consumer is still worst off than before the global recession: real disposable per capita income in IIQ2012 is 0.2 percent below the level in IVQ2007. Consumers demand fewer loans currently and low interest rates may be insufficient to recover confidence and growth.
Table IA-3, US, GDP, Real Disposable Personal Income, Real Disposable Income per Capita and Population in 1983-85 and 2007-2011, %
| # Quarters | ∆% | ∆% Annual Equivalent | |
| IQ1983 to IVQ1985 | 13 | ||
| GDP | 19.6 | 5.7 | |
| RDPI | 14.5 | 4.3 | |
| RDPI Per Capita | 11.5 | 3.4 | |
| Population | 2.7 | 0.8 | |
| IIIQ2009 to IQ2012 | 12 | ||
| GDP | 6.75 | 2.2 | |
| RDPI | 3.8 | 1.2 | |
| RDPI per Capita | 1.4 | 0.5 | |
| Population | 2.3 | 0.8 | |
| IVQ2007 to IIQ2012 | 19 | ||
| GDP | 1.7 | ||
| RDPI | 3.5 | ||
| RDPI per Capita | -0.2 | ||
| Population | 3.7 |
RDPI: Real Disposable Personal Income
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IA-8 of the Board of Governors of the Federal Reserve System provides cash assets in commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Acquisitions of securities for the portfolio of the central bank were processed by increases in bank cash reserves. There is no comparable experience in US economic history and such flood of money was never required to return US economic growth to trend of 3 percent per year and 2 percent per year in per capita income after events such as recessions and wars (Lucas 2011May). It is difficult to argue that higher magnitudes of monetary and fiscal policy impulses would have been more successful. Selective incentives to the private sector of a long-term nature could have been more effective.
![clip_image002[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfiles207D7F1\CashAssetsBn7312DDPChart3.png "clip_image002[1]")
Chart IA-8, US, Cash Assets in Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-9 of the Board of Governors of the Federal Reserve System provides total assets of Federal Reserve Banks in millions of dollars on Wednesdays from 2002 to 2012. This is what is called the central bank balance sheet (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-62, Regulation of Banks and Finance (2009b) 224-27). Consecutive rounds of unconventional monetary policy increased total assets by purchase of mortgage-backed securities, agency securities and Treasury securities. Bank reserves in cash and deposited at the central bank swelled as shown in Chart IA-8. The central bank created assets in the form of securities financed with creation of liabilities in the form of reserves of depository institutions.
![clip_image004[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfiles207D7F1\AFEDBS0212DDPChart3.png "clip_image004[1]")
Chart IA-9, US, Total Assets of Federal Reserve Banks, Wednesday Level, Millions of Dollars, 2002 to 2012
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1
Chart IA-10 of the Board of Governors of the Federal Reserve System provides deposits in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Deposit growth clearly accelerated after 2001 and continued during the current cyclical expansion after bumps during the global recession.
![clip_image006[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfiles207D7F1\DepositsDDPChart3.png "clip_image006[1]")
Chart IA-10, US, Deposits in Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-11 of the Board of Governors of the Federal Reserve System provides Treasury and agency securities in US commercial banks, not seasonally adjusted, in billions of dollars from 1973 to 2012. Holdings stabilized between the recessions of 2001 and after IQ2007. There was rapid growth during the global contraction especially after unconventional monetary policy in 2008 and nearly vertical increase without prior similar historical experience during the various bouts of unconventional monetary policy. Banks hoard cash and less risky Treasury and agency securities instead of risky lending because of the weakness of the economy and the lack of demand for financing sound business projects.
Chart IA-11, US, Treasury and Agency Securities in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-12 of the Board of Governors of the Federal Reserve System provides total loans and leases in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Total loans and leases of US commercial banks contracted sharply and have stalled during the cyclical expansion.
Chart IA-12, US, Loans and Leases in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-13 of the Board of Governors of the Federal Reserve System provides real estate loans in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Housing subsidies and low interest rates caused a point of inflexion to higher, nearly vertical growth until 2007. Real estate loans have contracted in downward trend partly because of adverse effects of uncertainty on the impact on balance sheets of the various mechanisms of resolution imposed by policy.
Chart IA-13, US, Real Estate Loans in Bank Credit, Not Seasonally Adjusted, B1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Chart IA-14 of the Board of Governors of the Federal Reserve System provides consumer loans in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2012. Consumer loans even increased during the contraction then declined and increased vertically to decline again. There was high demand for reposition of durable goods that exhausted and limited consumption again with increase in savings rates in recent periods.
Chart IA-14, US, Consumer Loans in Bank Credit, Not Seasonally Adjusted, US Commercial Banks, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
Finally, Chart IA-15 of the Board of Governors of the Federal Reserve System provides commercial and industrial loans not seasonally adjusted in billions of dollars from 1973 to 2012. Commercial and industrial loans fell sharply during both contractions in 2001 and after IVQ2007 and then rebounded with accelerated growth. Commercial and industrial loans have not reached again the peak during the global recession.
Chart IA-15, US, Commercial and Industrial Loans in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, 1973-2012, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h8/current/default.htm
IB United States Budget/Debt Quagmire. The US is facing a major fiscal challenge. Table IB-1 provides federal revenues, expenditures, deficit and debt as percent of GDP and the yearly change in GDP in the eight decades from 1930 to 2011. The most recent period of debt exceeding 90 percent of GDP based on yearly observations in Table IB-1 is between 1944 and 1948. The debt/GDP ratio actually rose to 106.2 percent of GDP in 1945 and to 108.7 percent of GDP in 1946. GDP fell 10.9 percent in 1946, which is only matched in Table IB-1 by the decline of 13.1 percent in 1932. Part of the decline is explained by the bloated US economy during World War II, growing at 17.1 percent in 1941, 18.5 percent in 1942 and 16.4 percent in 1943. Expenditures as a share of GDP rose to their highest in the series: 43.6 percent in 1943, 43.6 percent in 1944 and 41.9 percent in 1945. The repetition of 43.6 percent in 1943 and 1944 is in the original source of Table IB-1. During the Truman administration from Apr 1945 to Jan 1953, the federal debt held by the public fell systematically from the peak of 108.7 percent of GDP in 1946 to 61.6 percent of GDP in 1952. During the Eisenhower administration from Jan 1953 to Jan 1961, the federal debt held by the public fell from 58.6 percent of GDP in 1953 to 45.6 percent of GDP in 1960. The Truman and Eisenhower debt reductions were facilitated by diverse factors such as low interest rates, lower expenditure/GDP ratios that could be attained again after lowering war outlays and less rigid structure of mandatory expenditures than currently. There is no subsequent jump of debt as the one from 40.5 percent of GDP in 2008 to 67.7 percent of GDP in 2011 and projected by the Congressional Budget Office (CBO 2012AugBEO) at 72.8 percent in 2012.
Table IB-1, United States Central Government Revenue, Expenditure, Deficit, Debt and GDP Growth 1930-2011
| Rev | Exp | Deficit | Debt | GDP | |
| 1930 | 4.2 | 3.4 | 0.8 | -8.6 | |
| 1931 | 3.7 | 4.3 | -0.6 | -6.5 | |
| 1932 | 2.8 | 6.9 | -4.0 | -13.1 | |
| 1933 | 3.5 | 8.0 | -4.5 | -1.3 | |
| 1934 | 4.8 | 10.7 | -5.9 | 10.9 | |
| 1935 | 5.2 | 9.2 | -4.0 | 8.9 | |
| 1936 | 5.0 | 10.5 | -5.5 | 13.1 | |
| 1937 | 6.1 | 8.6 | -2.5 | 5.1 | |
| 1938 | 7.6 | 7.7 | -0.1 | -3.4 | |
| 1939 | 7.1 | 10.3 | -3.2 | 8.1 | |
| 1940s | |||||
| 1940 | 6.8 | 9.8 | -3.0 | 44.2 | 8.8 |
| 1941 | 7.6 | 12.0 | -4.3 | 42.3 | 17.1 |
| 1942 | 10.1 | 24.3 | -14.2 | 47.0 | 18.5 |
| 1943 | 13.3 | 43.6 | -30.3 | 70.9 | 16.4 |
| 1944 | 20.9 | 43.6 | -22.7 | 88.3 | 8.1 |
| 1945 | 20.4 | 41.9 | -21.5 | 106.2 | -1.1 |
| 1946 | 17.7 | 24.8 | -7.2 | 108.7 | -10.9 |
| 1947 | 16.5 | 14.8 | 1.7 | 96.2 | -0.9 |
| 1948 | 16.2 | 11.6 | 4.6 | 84.3 | 4.4 |
| 1949 | 14.5 | 14.3 | 0.2 | 79.0 | -0.5 |
| 1950s | |||||
| 1950 | 14.4 | 15.6 | -1.1 | 80.2 | 8.7 |
| 1951 | 16.1 | 14.2 | 1.9 | 66.9 | 7.7 |
| 1952 | 19.0 | 19.4 | -0.4 | 61.6 | 3.8 |
| 1953 | 18.7 | 20.4 | -1.7 | 58.6 | 4.6 |
| 1954 | 18.5 | 18.8 | -0.3 | 59.5 | -0.6 |
| 1955 | 16.5 | 17.3 | -0.8 | 57.2 | 7.2 |
| 1956 | 17.5 | 16.5 | 0.9 | 52.0 | 2.0 |
| 1957 | 17.7 | 17.0 | 0.8 | 48.6 | 2.0 |
| 1958 | 17.3 | 17.9 | -0.6 | 49.2 | -0.9 |
| 1959 | 16.2 | 18.8 | -2.6 | 47.9 | 7.2 |
| 1960s | |||||
| 1960 | 17.8 | 17.8 | 0.1 | 45.6 | 2.5 |
| 1961 | 17.8 | 18.4 | -0.6 | 45.0 | 2.3 |
| 1962 | 17.6 | 18.8 | -1.3 | 43.7 | 6.1 |
| 1963 | 17.8 | 18.6 | -0.8 | 42.4 | 4.4 |
| 1964 | 17.6 | 18.5 | -0.9 | 40.0 | 5.8 |
| 1965 | 17.0 | 17.2 | -0.2 | 37.9 | 6.4 |
| 1966 | 17.3 | 17.8 | -0.5 | 34.9 | 6.5 |
| 1967 | 18.4 | 19.4 | -1.1 | 32.9 | 2.5 |
| 1968 | 17.6 | 20.5 | -2.9 | 33.9 | 4.8 |
| 1969 | 19.7 | 19.4 | 0.3 | 29.3 | 3.1 |
| 1970s | |||||
| 1970 | 19.0 | 19.3 | -0.3 | 28.0 | 0.2 |
| 1971 | 17.3 | 19.5 | -2.1 | 28.1 | 3.4 |
| 1972 | 17.6 | 19.6 | -2.0 | 27.4 | 5.3 |
| 1973 | 17.6 | 18.7 | -1.1 | 26.0 | 5.8 |
| 1974 | 18.3 | 18.7 | -0.4 | 23.9 | -0.6 |
| 1975 | 17.9 | 21.3 | -3.4 | 25.3 | 0.2 |
| 1976 | 17.1 | 21.4 | -4.2 | 27.5 | 5.4 |
| 1977 | 18.0 | 20.7 | -2.7 | 27.8 | 4.6 |
| 1978 | 18.0 | 20.7 | -2.7 | 27.4 | 5.6 |
| 1979 | 18.5 | 20.1 | -1.6 | 25.6 | 3.1 |
| 1980s | |||||
| 1980 | 19.0 | 21.7 | -2.7 | 26.1 | -0.3 |
| 1981 | 19.6 | 22.2 | -2.6 | 25.8 | 2.5 |
| 1982 | 19.2 | 23.1 | -4.0 | 28.7 | -1.9 |
| 1983 | 17.5 | 23.5 | -6.0 | 33.1 | 4.5 |
| 1984 | 17.3 | 22.2 | -4.8 | 34.0 | 7.2 |
| 1985 | 17.7 | 22.8 | -5.1 | 36.4 | 4.1 |
| 1986 | 17.5 | 22.5 | -5.0 | 39.5 | 3.5 |
| 1987 | 18.4 | 21.6 | -3.2 | 40.6 | 3.2 |
| 1988 | 18.2 | 21.3 | -3.1 | 41.0 | 4.1 |
| 1989 | 18.4 | 21.2 | -2.8 | 40.6 | 3.6 |
| 1990s | |||||
| 1990 | 18.0 | 21.9 | -3.9 | 42.1 | 1.9 |
| 1991 | 17.8 | 22.3 | -4.5 | 45.3 | -0.2 |
| 1992 | 17.5 | 22.1 | -4.7 | 48.1 | 3.4 |
| 1993 | 17.5 | 21.4 | -3.9 | 49.3 | 2.9 |
| 1994 | 18.0 | 21.0 | -2.9 | 49.2 | 4.1 |
| 1995 | 18.4 | 20.6 | -2.2 | 49.1 | 2.5 |
| 1996 | 18.8 | 20.2 | -1.4 | 48.4 | 3.7 |
| 1997 | 19.2 | 19.5 | -0.3 | 45.9 | 4.5 |
| 1998 | 19.9 | 19.1 | 0.8 | 43.0 | 4.4 |
| 1999 | 19.8 | 18.5 | 1.4 | 39.4 | 4.8 |
| 2000s | |||||
| 2000 | 20.6 | 18.2 | 2.4 | 34.7 | 4.1 |
| 2001 | 19.5 | 18.2 | 1.3 | 32.5 | 1.1 |
| 2002 | 17.6 | 19.1 | -1.5 | 33.6 | 1.8 |
| 2003 | 16.2 | 19.7 | -3.4 | 35.6 | 2.5 |
| 2004 | 16.1 | 19.6 | -3.5 | 36.8 | 3.5 |
| 2005 | 17.3 | 19.9 | -2.6 | 36.9 | 3.1 |
| 2006 | 18.2 | 20.1 | -1.9 | 36.6 | 2.7 |
| 2007 | 18.5 | 19.7 | -1.2 | 36.3 | 1.9 |
| 2008 | 17.6 | 20.8 | -3.2 | 40.5 | -0.3 |
| 2009 | 15.1 | 25.2 | -10.1 | 54.1 | -3.1 |
| 2010s | |||||
| 2010 | 15.1 | 24.1 | -9.0 | 62.8 | 2.4 |
| 2011 | 15.4 | 24.1 | -8.7 | 67.7 | 1.8 |
Sources:
Office of Management and Budget. 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB. CBO (2012JanBEO). CBO (2012Jan31). CBO (2012AugBEO).
Bureau of Economic Analysis, Department of Commerce, http://www.bea.gov/iTable/index_nipa.cfm Congressional Budget Office http://www.cbo.gov/
Chart IB-1 shows the sharp impact of the 1946 contraction of 10.9 percent of GDP. Growth rebounded strongly, as in all postwar expansion, with growth of 8.7 percent in 1950, 7.7 percent in 1951, 3.8 percent in 1952 and 3.8 percent in 4.6 percent in 1953. The data in Charts IV-1 and IV-2 are changes in the level of real GDP in a year, which is different from the seasonally-adjusted quarterly annual equivalent rates (SAAR) (http://cmpassocregulationblog.blogspot.com/2012/07/decelerating-united-states-recovery.html).
Chart IB-1, Percentage Change of Real GDP 1945-2011
Source: Bureau of Economic Analysis, Department of Commerce
http://www.bea.gov/iTable/index_nipa.cfm
Yearly changes in Chart IV-2 show vigorous recovery from the contractions of 1982, 1991 and 2001. Rapid growth recovered levels of employment prior to the contraction. The anemic recovery after IIQ2009 and the current standstill have not occurred in the US postwar economy.
Chart IB-2, Percentage Change of Real GDP 1980-2011
Source: Bureau of Economic Analysis, Department of Commerce
http://www.bea.gov/iTable/index_nipa.cfm
The capital budgeting decision of business requires the calculation of present value of projects. This calculation consists of a projection toward the horizon of planning of revenues net of costs, which are discounted to present value by the weighted average cost of capital. Business invests in the projects with highest net present value. The nonpartisan Congressional Budget Office (CBO) provides a similar service. Congress and the administration send budget proposals and legislation for evaluation by the CBO of their effects on federal government revenues, expenditures, deficit or surpluses and debt. The CBO does not provide its own policy proposals but analyzes alternative policies. The CBO uses state of the art knowledge but significant uncertainty remains because of the hurdle of projecting financial and economic variables to the future.
Table IB-2 provides the latest exercise by the CBO (2012AugBEO) of projecting the fiscal accounts of the US. Table IB-2 extends data back to 1995 with the projections of the CBO from 2012 to 2022. Budget analysis in the US uses a ten-year horizon. The significant event in the data before 2011 is the budget surpluses from 1998 to 2001, from 0.8 percent of GDP in 1998 to 2.4 percent of GDP in 2000. Debt held by the public fell from 49.1 percent of GDP in 1995 to 32.5 percent of GDP in 2001.
Table IB-2, US, CBO Baseline Budget Outlook 2012-2022
| Out | Out | Deficit | Deficit | Debt | Debt | |
| 1995 | 1,516 | 20.6 | -164 | -2.2 | 3,604 | 49.1 |
| 1996 | 1,560 | 20.2 | -107 | -1.4 | 3,734 | 48.4 |
| 1997 | 1,601 | 19.5 | -22 | -0.3 | 3,772 | 45.9 |
| 1998 | 1,652 | 19.1 | +69 | +0.8 | 3,721 | 43.0 |
| 1999 | 1,702 | 18.5 | +126 | +1.4 | 3,632 | 39.4 |
| 2000 | 1,789 | 18.2 | +236 | +2.4 | 3,410 | 34.7 |
| 2001 | 1,863 | 18.2 | +128 | +1.3 | 3,320 | 32.5 |
| 2002 | 2,011 | 19.1 | -158 | -1.5 | 3,540 | 33.6 |
| 2003 | 2,159 | 19.7 | -378 | -3.4 | 3,913 | 35.6 |
| 2004 | 2,293 | 19.6 | -413 | -3.5 | 4,295 | 36.8 |
| 2005 | 2,472 | 19.9 | -318 | -2.6 | 4,592 | 36.9 |
| 2006 | 2,655 | 20.1 | -248 | -1.9 | 4,829 | 36.6 |
| 2007 | 2,729 | 19.7 | -161 | -1.2 | 5,035 | 36.3 |
| 2008 | 2,983 | 20.8 | -459 | -3.2 | 5,803 | 40.5 |
| 2009 | 3,518 | 25.2 | -1,413 | -10.1 | 7,545 | 54.1 |
| 2010 | 3,456 | 24.1 | -1,294 | -9.0 | 9,019 | 62.8 |
| 2011 | 3,603 | 24.1 | -1,300 | -8.7 | 10,128 | 67.7 |
| 2012 | 3,563 | 22.9 | -1,128 | -7.3 | 11,318 | 72.8 |
| 2013 | 3,554 | 22.4 | -641 | -4.0 | 12,064 | 76.1 |
| 2014 | 3,595 | 21.9 | -387 | -2.4 | 12,545 | 76.6 |
| 2015 | 3,754 | 21.5 | -213 | -1.2 | 12,861 | 73.8 |
| 2016 | 4,003 | 21.6 | -186 | -1.0 | 13,144 | 70.8 |
| 2017 | 4,206 | 21.4 | -123 | -0.6 | 13,371 | 67.9 |
| 2018 | 4,407 | 21.2 | -79 | -0.4 | 13,536 | 65.2 |
| 2019 | 4,681 | 21.5 | -130 | -0.6 | 13,746 | 63.2 |
| 2020 | 4,932 | 21.7 | -142 | -0.6 | 13,964 | 61.4 |
| 2021 | 5,183 | 21.8 | -144 | -0.6 | 14,181 | 59.8 |
| 2022 | 5,509 | 22.3 | -213 | -0.9 | 14,464 | 58.5 |
| 2013 to 2017 | 19,111 | -1,549 | NA | NA | ||
| 2013 | 43,823 | 21.9 | -2,258 | -1.9 | NA | NA |
Note: Out = outlays
Source: CBO (2011AugBEO); Office of Management and Budget. 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB; CBO. 2011JanBEO. Budget and Economic Outlook. Washington, DC, Jan. CBO. 2012AugBEO. Budget and Economic Outlook. Washington, DC, Aug 22. CBO. 2012Jan31. Historical budget data. Washington, DC, Jan 31.
Consecutive deficits of more than one trillion dollars in the four years from 2009 to 2012, adding to $5135 billion, resulted in an increase in debt held by the public from 40.5 percent of GDP in 2008 to projected 72.8 percent of GDP in 2012 in a debt explosion without parallel in data after World War II in Table IB-1. An important part of the fiscal situation is the jump in federal government expenditures from $2,983 billion in 2008 to $3,518 billion in 2009, or 17.9 percent, equivalent to an increase of federal government expenditures from 20.8 percent of GDP in 2008 to 25.2 percent of GDP in 2009.
The exercise by the CBO in Table IIB-2 is not able to reduce expenditures back to 20 percent, which is a historical ceiling for the outlays/GDP ratio.
Chart IB-3 of the Congressional Budget Office (CBO) shows total deficits or surpluses of the US from 2000 to 2022. There is a difficult climb from the record deficit of 10.1 percent of GDP in 2009 and cumulative deficit of $5135 billion in four consecutive years of deficits exceeding one trillion dollars from 2009 to 2012. The CBO projects a baseline scenario with faster and stronger adjustment and an alternative scenario with more delayed and less successful adjustment.
Chart IB-3, US, Total Deficits or Surplus as Percent of GDP
Source: Congressional Budget Office
CBO (2012AugBEO).
Table IB-3 provides federal revenues, outlays, deficit and debt as percent of GDP. The adjustment depends on increasing the revenues from 15.4 percent of GDP in 2011 to 21.4 percent of GDP in 2022, which is above the 40-year average of 18 percent of GDP while outlays fall only from 24.1 percent of GDP in 2011 to 22.3 percent of GDP in 2022. The last row of Table 15 provides the CBO estimates of averages for 1971 to 2010 of 18.0 percent for revenues/GDP, 21.9 percent for outlays/GDP and 37.0 percent for debt/GDP.
Table IB-3, US, CBO Projections of Federal Government Revenues, Outlays, Deficit and Debt as Percent of GDP
| Revenues | Outlays | Deficit | Debt | |
| 2011 | 15.4 | 24.1 | -8.7 | 67.7 |
| 2012 | 15.7 | 22.9 | -7.3 | 72.8 |
| 2013 | 18.4 | 22.4 | -4.0 | 76.1 |
| 2014 | 19.6 | 21.9 | -2.4 | 76.6 |
| 2015 | 20.3 | 21.5 | -1.2 | 73.8 |
| 2016 | 20.6 | 21.6 | -1.0 | 70.8 |
| 2017 | 20.7 | 21.4 | -0.6 | 67.9 |
| 2018 | 20.8 | 21.2 | -0.4 | 65.2 |
| 2019 | 20.9 | 21.5 | -0.6 | 63.2 |
| 2020 | 21.1 | 21.7 | -0.6 | 61.4 |
| 2021 | 21.2 | 21.8 | -0.6 | 59.8 |
| 2022 | 21.4 | 22.3 | -0.9 | 58.5 |
| Total 2013-2017 | 20.0 | 21.7 | -1.8 | NA |
| Total 2013-2022 | 20.6 | 21.7 | -1.1 | NA |
| Average | 18.0 | 21.9 | NA | 37.0 |
Source: CBO (2012AugBEO).
The CBO (2012AugBEO) projects economic variables shown in Table IB-4 required for the fiscal projections. Real GDP growth is projected at 2.1 percent in 2012 and minus 0.5 percent in 2013, jumping to 4.3 percent on average from 2014 to 2017 and 2.4 percent from 2018 to 2022. The recession of 2012 with negative growth of 0.5 percent would occur from failure to extend tax reductions at the turn of 2013. It is not possible to forecast another downturn from 2013 to 2022 that could worsen further the US fiscal situation. The CBO projects subdued inflation but the rate of unemployment remains at high levels, declining to 5.4 percent by 2017, which is around the current measurement of the natural rate of unemployment. Interest rates are assumed to remain at relatively low levels but increase in the latter years of the projections. Different paths of economic variables would alter the projections of fiscal variables.
Table IB-4, US, CBO Economic Projections for Calendar Years 2012 to 2022, ∆%
| 2012 ∆% | 2013 ∆% | 2014-2017 Average ∆% | 2018-2022 Average ∆% | |
| Real GDP | 2.1 | -0.5 | 4.3 | 2.4 |
| PCE Inflation | 1.4 | 1.4 | 1.8 | 2.0 |
| Core PCE Inflation | 1.9 | 1.5 | 1.8 | 2.0 |
| CPI Inflation | 1.3 | 1.6 | 2.1 | 2.3 |
| Core CPI | 2.1 | 1.7 | 2.0 | 2.2 |
| Unem- | 8.2 | 8.8 | 7.3 | 5.4 |
| 3-Month Treasury | 0.1 | 0.1 | 1.3 | 3.7 |
| 10-Year treasury Note | 1.8 | 1.8 | 3.4 | 5.0 |
Source: CBO (2012AugBEO).
The major hurdle in adjusting the fiscal situation of the US is shown in Table IB-5 in terms of the rigid structure of revenues that can be increased and outlays that can be reduced. There is no painless adjustment of a debt exceeding 70 percent of GDP. On the side of revenues, taxes provide 90.9 percent of revenue in 2011 and are projected to provide 92.2 percent in the total revenues from 2013 to 2022 in the CBO projections. Thus, revenue measures are a misleading term for what are actually tax increases. The choices are especially difficult because of the risks of balancing inequity and disincentives to economic activity. Individual income taxes are projected to increase from 47.4 percent of federal government revenues in 2011 to 51.4 percent in total revenues projected by the CBO from 2013 to 2022. There are equally difficult conflicts in what the government gives away in a rigid structure of expenditures. Mandatory expenditures account for 56.3 percent of federal government outlays in 2011 and are projected to increase to 62.4 percent of the total projected by the CBO for the years 2013 to 2022. The total of Social Security plus Medicare and Medicaid accounts for 43.4 percent of federal government outlays in 2011 and is projected to increase to 51.5 percent in the total for 2013 to 2022. The inflexibility of what to cut is more evident in the first to the last row of Table IB-5 with the aggregate of defense plus Social Security plus Medicare plus Medicaid accounting for 62.7 percent of expenditures in 2011, rising to 66.6 percent of the total outlays projected by the CBO from 2013 to 2022. The cuts are in discretionary spending that declines from 37.4 percent of the total in 2011 to 28.9 percent of total outlays in the CBO projection for 2013 to 2022.
Table IB-5, Structure of Federal Government Revenues and Outlays, $ Billions and Percent
| 2011 | % Total | Total 2013-2022 | % Total | |
| Revenues | 2,303 | 100.00 | 41,565 | 100.00 |
| Individual Income Taxes | 1,091 | 47.4 | 21,379 | 51.4 |
| Social Insurance Taxes | 819 | 35.6 | 12,476 | 30.0 |
| Corporate Income Taxes | 181 | 7.9 | 4,477 | 10.8 |
| Other | 212 | 9.2 | 3,232 | 7.8 |
| Outlays | 3,603 | 100.00 | 43,823 | 100.0 |
| Mandatory | 2,027 | 56.3 | 27,324 | 62.4 |
| Social Security | 725 | 20.1 | 10,545 | 24.1 |
| Medicare | 560 | 15.5 | 7,722 | 17.6 |
| Medicaid | 275 | 7.6 | 4,291 | 9.8 |
| SS + Medicare + Medicaid | 1,560 | 43.3 | 22,558 | 51.5 |
| Discre- | 1,346 | 37.4 | 12,664 | 28.9 |
| Defense | 700 | 19.4 | 6,726 | 15.4 |
| Non- | 646 | 17.9 | 5,370 | 12.3 |
| Net Interest | 230 | 6.4 | 3,835 | 8.8 |
| Defense + SS + Medicare + Medicaid | 2,260 | 62.7 | 29,284 | 66.8 |
| MEMO: GDP | 15,076 | 217,200 |
Source: CBO (2012JanBEO), CBO (2012AugBeo).
The CBO (2012JanBEO) must use current law without any changes in the baseline scenario but also calculates another alternative scenario with different assumptions. In the alternative scenario shown in Table IB-6 the debt/GDP ratio rises to 94.2 percent by 2022. The US is facing an unsustainable debt/GDP path.
Table IB-6, US, CBO Base and Alternative Scenarios, Billions of Dollars and Percent
| Base 2012 | Alternative 2012 | Base 2013-2022 | Alternative 2013-2022 | |
| Revenue | 2,435 | 2,435 | 41,565 | 36,483 |
| % GDP | 15.7 | 15.7 | 20.6 | 18.1 |
| Outlays | 3,563 | 3,563 | 43,823 | 46,457 |
| % GDP | 22.9 | 22.9 | 21.7 | 23.0 |
| Deficit | -1,128 | -1,128 | -2,258 | -9,975 |
| % GDP | -7.3 | -7.3 | -1.1 | -4.9 |
| Debt | 11,318 | 11,318 | 14,464* | 22,181* |
| % GDP | 72.8 | 72.8 | 58.5* | 89.7* |
*Debt held by the public in 2022
Source: CBO (2012AugBEO).
I United States Housing Collapse. The objective of this section is to provide the latest data and analysis of US housing. Subsection IA United New House Sales analyzes the collapse of US new house sales. Subsection IB United States House Prices considers the latest available data on house prices. Subsection IC Factors of US Housing Collapse provides the analysis of the causes of the housing crisis of the US.
IA United States New House Sales. Data and other information continue to provide depressed conditions in the US housing market with improvement at the margin. Table II-1 shows sales of new houses in the US at seasonally-adjusted annual equivalent rate (SAAR). House sales fell in eight of nineteen months from Jan 2011 to Jul 2012 but mostly concentrated in Jan-Feb 2011 and May-Aug 2011. In Jan-Jul 2012, house prices increased at the annual equivalent rate of 17.1 percent. There was significant strength in Sep-Dec 2011 with annual equivalent rate of 56.4 percent. The annual equivalent rate in May-Aug 2011 was minus 18.1 percent and minus 12.2 percent in Jan-Apr 2011 but after increase of 13.6 percent in Dec 2010.
Table II-1, US, Sales of New Houses at Seasonally-Adjusted (SA) Annual Equivalent Rate, Thousands and %
| SA Annual Rate | ∆% | |
| Jul 2012 | 372 | 3.6 |
| Jun | 359 | -3.5 |
| May | 372 | 3.9 |
| Apr | 358 | 1.7 |
| Mar | 352 | -3.8 |
| Feb | 366 | 7.9 |
| Jan | 339 | 0.0 |
| AE ∆% Jan-Jul | 17.1 | |
| Dec 2011 | 339 | 3.7 |
| Nov | 327 | 4.1 |
| Oct | 314 | 2.6 |
| Sep | 306 | 4.8 |
| AE ∆% Sep-Dec | 56.4 | |
| Aug | 292 | -1.7 |
| Jul | 297 | -2.3 |
| Jun | 304 | -1.3 |
| May | 308 | -1.3 |
| AE ∆% May-Aug | -18.1 | |
| Apr | 312 | 3.7 |
| Mar | 301 | 10.3 |
| Feb | 273 | -11.4 |
| Jan | 308 | -5.5 |
| AE ∆% Jan-Apr | -12.2 | |
| Dec 2010 | 326 | 13.6 |
AE: Annual Equivalent
Source: US Census Bureau 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 2011 at average 6.6 monthly equivalent sales at current sales rates and then dropped to 4.5 in May 2012, increasing to 4.9 in Jun 2012. Median and average house prices oscillate. In Jun 2012, median prices of new houses sold not seasonally adjusted (NSA) fell 1.9 percent but after decreasing revised 1.5 percent in Apr and increasing 8.2 percent in Feb. Average prices fell 1.5 percent in Jun after sharp drop of 2.9 percent in May 2012 following consecutive increases in five months of 0.9 percent in Apr, 3.5 percent in Mar, 3.1 percent in Feb, 1.1 percent in Jan and 5.2 percent in Dec 2011. There are only six months with price increases in both median and average house prices: Apr 2011 with 1.9 percent in median prices and 3.1 percent in average prices, Jun 2011 with 8.2 percent in median prices and 3.9 percent in average prices, Oct 2011 with 3.6 percent in median prices and 1.1 percent in average prices, Dec 2011 with 2.0 percent in median prices and 5.2 percent in average prices, Jan 2012 with 1.4 percent in median prices and 1.1 percent in average prices and Feb 2012 with 8.2 percent in median prices and 3.1 percent in average prices. Median prices of new houses sold in the US fell in nine of the 18 months from Jan 2011 to Jun 2012 and average prices fell in ten 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 | |
| Jul 2012 | 4.6 | 224,200 | -2.1 | 263,200 | -1.4 |
| Jun | 4.8 | 229,100 | -3.4 | 266,900 | -3.8 |
| May | 4.6 | 237,200 | 0.3 | 277,500 | -3.6 |
| Apr | 4.9 | 236,400 | -1.4 | 287,900 | 1.5 |
| Mar | 4.9 | 239,800 | 0.0 | 283,600 | 3.5 |
| Feb | 4.8 | 239,900 | 8.2 | 274,000 | 3.1 |
| Jan | 5.3 | 221,700 | 1.4 | 265,700 | 1.1 |
| Dec 2011 | 5.4 | 218,600 | 2.0 | 262,900 | 5.2 |
| Nov | 5.7 | 214,300 | -4.7 | 250,000 | -3.2 |
| Oct | 6.1 | 224,800 | 3.6 | 258,300 | 1.1 |
| Sep | 6.3 | 217,000 | -1.2 | 255,400 | -1.5 |
| Aug | 6.6 | 219,600 | -4.5 | 259,300 | -4.1 |
| Jul | 6.7 | 229,900 | -4.3 | 270,300 | -1.0 |
| Jun | 6.6 | 240,200 | 8.2 | 273,100 | 3.9 |
| May | 6.6 | 222,000 | -1.2 | 262,700 | -2.3 |
| Apr | 6.7 | 224,700 | 1.9 | 268,900 | 3.1 |
| Mar | 7.1 | 220,500 | 0.2 | 260,800 | -0.8 |
| Feb | 8.0 | 220,100 | -8.3 | 262,800 | -4.7 |
| Jan | 7.3 | 240,100 | -0.5 | 275,700 | -5.5 |
| Dec 2010 | 7.0 | 241,200 | 9.8 | 291,700 | 3.5 |
*Percent of new houses for sale relative to houses sold
Source: US Census Bureau 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-Jul of various years. Sales of new houses in Jan-Jul 2012 are substantially lower than in any year between 1963 and 2012 with the exception of 2010 and 2011. There are only two increases of 21.1 percent between Jan-Jul 2011 and Jan-Jul 2012 and 7.7 percent between Jan-Jul 2010 and Jan-Jul 2012. Sales of new houses in 2012 are lower by 31.5 percent relative to 2008, 56.6 percent relative to 2007, 66.5 percent relative to 2006 and 71.9 percent relative to 2005. The housing boom peaked in 2005 and 2006 when increases in fed funds rates to 5.25 percent in Jun 2006 from 1.0 percent in Jun 2004 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-Jul 2012 relative to the same period in 2004 fell 69.7 percent and 65.7 percent relative to the same period in 2003. Similar percentage declines are also observed for 2012 relative to years from 2000 to 2004. Sales of new houses in Jan-Jul 2012 fell 44.6 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 II-3 reveals catastrophic data: sales of new houses in Jan-Jul 2012 of 224 thousand units are lower by 34.3 percent relative to 341 thousand units houses sold in Jan-Jul 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-Jul 2012 | 224 |
| Jan-Jul 2011 | 185 |
| ∆% | 21.1 |
| Jan-Jul 2010 | 208 |
| ∆% Jan-Jul 2012/ | 7.7 |
| Jan-Jul 2009 | 225 |
| ∆% Jan-Jul 2012/ | -0.4 |
| Jan-Jul 2008 | 327 |
| ∆% Jan-Jul 2012/ | -31.5 |
| Jan-Jul 2007 | 516 |
| ∆% Jan-Jul 2012/ | -56.6 |
| Jan-Jul 2006 | 668 |
| ∆% Jan-Jul 2012/Jan-Jul 2006 | -66.5 |
| Jan-Jul 2005 | 796 |
| ∆% Jan-Jul 2012/Jan-Jul 2005 | -71.9 |
| Jan-Jul 2004 | 739 |
| ∆% Jan-Jul 2012/Jan-Jul 2004 | -69.7 |
| Jan-Jul 2003 | 653 |
| ∆% Jan-Jul 2012/ | -65.7 |
| Jan-Jul 2002 | 581 |
| ∆% Jan-Jul 2012/ | -61.4 |
| Jan-Jul 2001 | 569 |
| ∆% Jan-Jul 2012/ | -60.6 |
| Jan-Jul 2000 | 536 |
| ∆% Jan-Jul 2012/ | -58.2 |
| Jan-Jul 1995 | 404 |
| ∆% Jan-Jul 2012/ | -44.6 |
| Jan-Jul 1963 | 341 |
| ∆% Jan-Jul 2012/ | -34.3 |
Source: US Census Bureau 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 2011 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: US Census Bureau http://www.census.gov/construction/nrs/
Chart II-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
Chart II-2 of the US Bureau of the Census provides the entire monthly sample of new houses sold in the US between Jan 1963 and Jul 2012 without seasonal adjustment. The series is almost stationary until the 1990s. There is sharp upward trend from the early 1990s to 2005-2006 after which new single-family houses sold collapse to levels below those in the beginning of the series in the 1960s.
![clip_image015[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfiles177DE6\NHSNSA6312ChartImage-201208232038%5b3%5d.jpg "clip_image015[1]")
Chart II-2, US, New Single-family Houses Sold, NSA, 1963-2012
Source: US Census Bureau
http://www.census.gov/construction/nrs/
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 annual 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 II-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/
Chart II-3 of the US Census Bureau provides the entire series of new single-family sales median prices from Jan 1963 to Jul 2012. There is long-term sharp upward trend with few declines until the current collapse. Median prices increased sharply during the Great Inflation of the 1960s and 1970s and paused during the savings and loans crisis of the late 1980s and the recession of 1991. Housing subsidies throughout the 1990s caused sharp upward trend of median new house prices that accelerated after the fed funds rate of 1 percent from 2003 to 2004. There was sharp reduction of prices after 2006 without full recovery of earlier prices.
Chart II-3, US, Median Sales Price of New Single-family Houses Sold, US Dollars, NSA, 1963-2012
Source: US Census Bureau
http://www.census.gov/construction/nrs/
Chart II-4 of the US Census Bureau provides average prices of new houses sold from the mid 1970s to Jul 2012. There is similar behavior as with median prices of new houses sold in Chart II-3. The only stress occurred in price pauses during the savings and loans crisis of the late 1980s and the collapse after 2006.
Chart II-4, US, Average Sales Price of New Single-family Houses Sold, US Dollars, NSA, 1975-2012
Source: US Census Bureau
http://www.census.gov/construction/nrs/
IIA United States House Prices. 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://fhfa.gov/webfiles/24216/q22012hpi.pdf 1). Table IIB-1 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 IIQ2000 to IIQ2006, the index for the US as a whole rose 59.5 percent, with 75.3 percent for New England, 79.4 percent for Middle Atlantic, 73.5 for South Atlantic but only by 31.6 percent for East South Central. Prices fell relative to 2012 from all years since 2005 with some exceptions for 2011. From IIQ2000 to IIQ2011, prices rose for the US and the four regions in Table IIB-1.
Table IIB-1, US, FHFA House Price Index Purchases Only NSA ∆%
| United States | New England | Middle Atlantic | South Atlantic | East South Central | |
| 2Q2000 | 22.9 | 40.8 | 34.1 | 24.2 | 9.9 |
| 2Q2000 | 48.6 | 71.9 | 66.6 | 57.2 | 21.9 |
| 2Q2000 to | 59.5 | 75.3 | 79.4 | 73.5 | 31.6 |
| 2Q2005 t0 | -9.9 | -13.3 | -1.7 | -14.1 | 4.6 |
| 2Q2006 | -16.1 | -14.9 | -8.7 | -22.1 | -3.1 |
| 2Q2007 to | -17.2 | -13.7 | -10.2 | -23.7 | -7.5 |
| 2Q2010 to | -2.6 | -3.4 | -3.5 | -3.5 | -1.3 |
| 2Q2011 to | 3.1 | -1.2 | -0.6 | 4.1 | 3.2 |
| 2Q2000 to | 33.8 | 49.1 | 63.8 | 35.1 | 27.6 |
Source: Federal Housing Finance Agency http://fhfa.gov/Default.aspx?Page=14
Data of the FHFA HPI for the remaining US regions are provided in Table IIB-2. Behavior is not very different than in Table IIB-2 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 2012, there was still appreciation relative to 2000.
Table IIB-2, US, FHFA House Price Index Purchases Only NSA ∆%
| West South Central | West North Central | East North Central | Mountain | Pacific | |
| 2Q2000 | 12.0 | 18.1 | 14.6 | 17.4 | 40.7 |
| 2Q2000 | 22.4 | 31.8 | 25.2 | 50.7 | 104.2 |
| 2Q2000 to 2Q2006 | 31.2 | 37.2 | 28.0 | 69.8 | 124.6 |
| 2Q2005 to | 16.1 | -2.8 | -13.2 | -15.3 | -30.6 |
| 2Q2006 | 8.2 | -6.6 | -15.1 | -24.8 | -36.9 |
| 2Q2007 to | 2.7 | -8.1 | -14.4 | -27.1 | -35.1 |
| 2Q2010 to | 1.5 | -2.4 | -2.3 | -2.6 | -5.7 |
| 2Q2011 to | 3.5 | 3.3 | 2.8 | 7.0 | 3.6 |
| 2Q2000 to 2Q2012 | 39.8 | 27.4 | 5.5 | 22.0 | 38.2 |
Source: Federal Housing Finance Agency http://fhfa.gov/Default.aspx?Page=14
Chart IIB-1 of the Federal Housing Finance Agency shows the Housing Price Index four-quarter price change from IQ2001 to IQ2012. House prices appreciated sharply from 1998 to 2005 and then fell rapidly. Recovery began already after IIQ2008 but there was another decline after IIQ2010. The rate of decline improved in the second half of 2011 and into 2012 with movement into positive territory in IIQ2012.
Chart IIB-1, 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 IIB-3. Percentage monthly increases of the FHFA index were positive from Apr to Jul 2011 while 12 months percentage changes improved steadily from more or equal to minus 6 percent in Mar to May 2011 to minus 4.4 percent in Jun. The FHFA house price index fell 0.9 percent in Oct 2011 and fell 3.3 percent in the 12 months ending in Oct. There was significant recovery in Nov 2012 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 0.2 percent in Dec 2011 and the 12-month percentage change fell to minus 1.4 percent. There was further improvement with revised decline of 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 0.2 percent in the 12 months ending in Feb 2012. There was strong improvement in Mar 2012 with gain in prices of 1.6 percent and 2.5 percent in 12 months. The house price index of FHFA increased 0.7 percent in Apr 2012 and 3.0 percent in 12 months and improvement continued with increase of 0.6 percent in May 2012 and 3.6 percent in the 12 months ending in May 2012. Improvement consolidated with increase of 0.7 percent in Jun 2012 and 3.7 percent in 12 months.
Table IIB-3, US, FHFA House Price Index Purchases Only SA. Month and NSA 12-Month ∆%
| Month ∆% SA | 12 Month ∆% NSA | |
| Jun 2012 | 0.7 | 3.7 |
| May | 0.6 | 3.6 |
| Apr | 0.7 | 3.0 |
| Mar | 1.6 | 2.5 |
| Feb | 0.3 | 0.2 |
| Jan | -0.5 | -1.2 |
| Dec 2011 | 0.2 | -1.4 |
| Nov | 0.7 | -2.2 |
| Oct | -0.9 | -3.3 |
| Sep | 0.4 | -2.5 |
| Aug | -0.3 | -3.9 |
| Jul | 0.2 | -3.6 |
| Jun | 0.6 | -4.4 |
| May | 0.1 | -5.9 |
| Apr | 0.3 | -6.0 |
| Mar | -0.7 | -6.1 |
| Feb | -1.1 | -5.3 |
| Jan | -0.7 | -4.7 |
| Dec 2010 | -3.9 | |
| Dec 2009 | -1.8 | |
| Dec 2008 | -9.9 | |
| Dec 2007 | -3.0 | |
| Dec 2006 | 2.5 | |
| Dec 2005 | 9.8 | |
| Dec 2004 | 10.2 | |
| Dec 2003 | 7.9 | |
| Dec 2002 | 7.8 | |
| Dec 2001 | 6.7 | |
| Dec 2000 | 7.2 | |
| Dec 1999 | 6.2 | |
| Dec 1998 | 5.9 | |
| Dec 1997 | 3.4 | |
| Dec 1996 | 2.8 | |
| Dec 1995 | 2.9 | |
| Dec 1994 | 2.6 | |
| Dec 1993 | 3.1 | |
| Dec 1992 | 2.4 |
Source:
Source: Federal Housing Finance Agency http://fhfa.gov/Default.aspx?Page=14
The bottom part of Table IIB-3 provides 12-month percentage changes of the FHFA house price index since 1992 when data become available for 1991. Table IIB-4 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 39.4 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 IIB-4, 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 | 74.9 | 3.0 |
| 1992-2000 | 39.4 | 4.2 |
| 2000-2003 | 24.3 | 7.5 |
| 2000-2005 | 50.4 | 8.5 |
| 2003-2005 | 21.0 | 10.0 |
| 2005-2011 | -16.6 | NA |
| 2000-2006 | 54.2 | 7.5 |
| 2003-2006 | 24.1 | 7.5 |
| 2006-2011 | -18.6 | NA |
Source:
Federal Housing Finance Agency http://fhfa.gov/Default.aspx?Page=14
III World Financial Turbulence. Financial markets are being shocked by multiple factors including (1) world economic slowdown; (2) slowing growth in China with political development and slowing growth in 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. Subsection IIIG Appendix on Deficit Financing of Growth and the Debt Crisis provides analysis of proposals to finance growth with budget deficits together with experience of the economic history of Brazil.
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 Aug 17 and daily values throughout the week ending on Aug 24 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 Aug 17 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Aug 17, 2012”, first row “USD/EUR 1.2335 -0.4%,” provides the information that the US dollar (USD) depreciated 0.4 percent to USD 1.2335/EUR in the week ending on Fri Aug 17 relative to the exchange rate on Fri Aug 10. 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) and another agreement on Jun 29, 2012 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf).
The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.2335/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Aug 17, depreciating to USD 1.2443/EUR on Mon Aug 20, or by 0.9 percent. The dollar depreciated because more dollars, $1.2443, were required on Mon Aug 20 to buy one euro than $1.2335 on Aug 17. 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 such as 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 1.2335/EUR on Aug 17; the second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Aug 17, to the last business day of the current week, in this case Fri Aug 17, such as depreciation by 1.4 percent to USD 1.2512/EUR by Aug 24; 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 1.4 percent from the rate of USD 1.2335/EUR on Fri Aug 17 to the rate of USD 1.2512/EUR on Fri Aug 24 {[(1.2512/1.2335) – 1]100 = 1.4%} and appreciated (denoted by positive sign) by 0.4 percent from the rate of USD 1.2564 on Thu Aug 23 to USD 1.2512/EUR on Fri Aug 24 {[(1.2512/1.2564) -1]100 = -0.4%}. 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.
Table III-I, Weekly Financial Risk Assets Aug 21 to Aug 25, 2012
| Fri Aug 17, 2012 | M 20 | Tue 21 | W 22 | Thu 23 | Fr 24 |
| USD/EUR 1.2335 -0.4% | 1.2443 -0.9% -0.9% | 1.2467 -1.1% -0.2% | 1.2528 -1.6% -0.5% | 1.2564 -1.8% -0.3% | 1.2512 -1.4% 0.4% |
| JPY/ USD 79.57 -1.7% | 79.47 0.1% 0.1% | 79.25 0.4% 0.3% | 78.59 1.2% 0.8% | 78.51 1.3% 0.1% | 78.65 1.1% -0.2% |
| CHF/ USD 0.9738 0.3% | 0.9731 0.1% 0.1% | 0.9634 1.1% 1.0% | 0.9588 1.5% 0.5% | 0.9557 1.8% 0.3% | 0.9597 1.4% -0.4% |
| CHF/ EUR 1.2012 0.0% | 1.2011 0.0% 0.0% | 1.2011 0.0% 0.0% | 1.2012 0.0% 0.0% | 1.2009 0.0% 0.0% | 1.2008 0.0% 0.0% |
| USD/ AUD 1.0419 0.9598 -1.5% | 1.0447 0.9572 0.3% 0.3% | 1.0473 0.9548 0.5% 0.3% | 1.0506 0.9518 0.8% 0.3% | 1.0439 0.9579 0.2% -0.6% | 1.0404 0.9612 -0.1% -0.3% |
| 10 Year T Note 1.814 | 1.81 | 1.80 | 1.69 | 1.68 | 1.684 |
| 2 Year T Note 0.288 | 0.28 | 0.29 | 0.26 | 0.26 | 0.266 |
| German Bond 2Y -0.04 10Y 1.50 | 2Y -0.02 10Y 1.51 | 2Y 0.01 10Y 1.56 | 2Y 0.01 10Y 1.46 | 2Y -0.01 10Y 1.38 | 2Y -0.01 10Y 1.35 |
| DJIA 13275.20 0.5% | 13271.64 0.0% 0.0% | 13203.58 -0.5% -0.5% | 13172.76 -0.8% -0.2% | 13057.46 -1.6% -0.9% | 13157.97 -0.9% 0.8% |
| DJ Global 1893.85 0.7% | 1894.18 0.0% 0.0% | 1902.65 0.5% 0.5% | 1892.39 -0.1% -0.5% | 1888.49 -0.3% -0.2% | 1885.92 -0.4% -0.1% |
| DJ Asia Pacific 1229.43 0.3% | 1229.55 0.0% 0.0% | 1234.27 0.4% 0.4% | 1229.07 0.0% -0.4% | 1241.16 0.9% 1.0% | 1226.75 -0.2% -1.2% |
| Nikkei 9162.50 3.0% | 9171.16 0.1% 0.1% | 9156.92 -0.1% -0.2% | 9131.74 -0.3% -0.3% | 9178.12 0.2% 0.5% | 9070.76 -1.0% -1.2% |
| Shanghai 2114.89 -2.5% | 2106.96 -0.4% -0.4% | 2118.27 0.2% 0.5% | 2107.71 -0.3% -0.5% | 2113.07 -0.1% 0.3% | 2092.10 -1.1% -1.0% |
| DAX 7040.88 1.4% | 7033.68 -0.1% -0.1% | 7089.32 0.7% 0.8% | 7017.75 -0.3% -1.0% | 6949.57 -1.3% -1.0% | 6971.07 -1.0% 0.3% |
| DJ UBS Comm. 143.11 -0.1% | 144.09 0.7% | 145.83 1.9% 1.2% | 146.12 2.0% 0.2% | 145.98 2.0% -0.1% | 145.36 1.6% -0.4% |
| WTI $ B 96.01 3.4% | 95.97 0.0% 0.0% | 96.80 0.8% 0.9% | 97.29 1.3% 0.5% | 96.13 0.1% -1.2% | 96.15 0.1% 0.0% |
| Brent $/B 113.76 0.7% | 113.53 -0.2% -0.2% | 114.60 0.7% 0.9% | 114.91 1.0% 0.3% | 115.01 1.1% 0.1% | 113.59 -0.1% -1.2% |
| Gold $/OZ 1619.4 -0.2% | 1623.0 0.2% 0.2% | 1640.0 1.3% 1.0% | 1655.0 2.2% 0.9% | 1672.3 3.3% 1.0% | 1672.9 3.3% 0.0% |
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
Discussion of current and recent risk-determining events is followed below by analysis of risk-measuring yields of the US and Germany and the USD/EUR rate.
First, Risk-Determining Events. Risk in the week of Aug 24, 2012, was dominated by expectations of the dimensions, nature and timing of purchases by the European Central Bank (ECB) of sovereign bonds of highly indebted euro zone member countries; dimensions of further monetary accommodation by the Federal Open Market Committee (FOMC) and timing before or after the US presidential, Congressional state and local elections of Nov 6, 2012; and the outcome of program for Greece and decision of the Federal Constitutional court of Germany (http://www.bundesverfassungsgericht.de/en/index.html) on the constitutionality of the European Stability Mechanism (ESM) for bailouts of highly-indebted of euro zone members. Brian Blackstone and Tom Fairless, writing on Aug 20, 2012, on “ECB quashes yield-cap speculation,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443855804577600922867544772.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the ECB denied rumors that it planned to impose caps on yields of governments bonds of highly indebted euro area member countries while the central bank of Germany, Deutsche Bundesbank, increased its opposition to bond purchases by the ECB as solution to high yields of sovereign bonds. Jon Hilsenrath, writing on “Bernanke letter defends Fed actions,” on Aug 24, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444358404577609231770784446.html?mod=WSJ_hp_LEFTWhatsNewsCollection#project%3Dissaletter082412%26articleTabs%3Darticle), finds support for FOMC policies and possible further actions in a letter by Chairman Bernanke (2012Aug22) in reply to inquiry by Representative Darrell Issa (2012Aug1), which were obtained and published by the WSJ on Aug 22, 2012 (http://online.wsj.com/public/resources/documents/Bernankeletter0812.pdf http://s3.documentcloud.org/documents/413447/issaletter0812.pdf). Issa (2012Aug1) inquired from Chairman Bernanke about analysis of monetary policy of various types, including by distinguished Professor Allan Meltzer (http://www.amazon.com/Allan-H.-Meltzer/e/B001H6MWPC/ref=ntt_dp_epwbk_0), the author of three scholarly analytical volumes on the history of the Federal Reserve (Meltzer 2004, 2010a, 2010b), who has emphasized the short-term nature of economic policy that could be more effective if focused on the long term. Chairman Bernanke (2012Aug22), who is also an eminent scholar, provided detailed answers to the queries by Issa (2012Aug1). The first sentence of the reply ignited positive risk taking in financial markets operating with low holiday volumes: “There is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery.” Market participants are now focused on the presentations and speeches of Chairman Bernanke, Mario Draghi, President of the ECB and other participants at the meeting of central bankers in Jackson Hole at the Annual Economic Policy Symposium of the Federal Reserve Bank of Kansas City. Gerrit Wiesmann, Dimitris Kontogiannis and Ralph Atking, writing on Aug 24, 2012, on “Greece not written off, says Merkel,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/b97287a0-ee02-11e1-b0e4-00144feab49a.html#axzz24VRMqcph), analyze the meeting of Chancellor Angela Merkel and Greece’s Prime Minister Antonis Samaras after which Merkel declared that Germany would provide as much help to Greece as possible but did not endorse extending time limits for the Greek bailout program. There is the constitutionality decision on the EMS bailout system by the Federal Constitutional Court of Germany (http://www.bundesverfassungsgericht.de/en/index.html) as well as elections in the Netherlands. Market will move widely in the return from holidays in Sep.
There were €1,508,626 million total loans in the balance sheets of supervised institutions in Spain in 2006 of which $10,859 million, or 0.7 percent of total loans, classified as from “doubtful debtors,” according to data from the Bank of Spain (http://www.bde.es/webbde/es/estadis/infoest/a0403e.pdf). Total loans on an annual basis peaked in 2008 at €1,869,882 million of which €63,057 million, or 3.4 percent, from doubtful debtors. Total loans in Dec 2011 reached €1,782,554 million of which €139,760 million, or 7.8 percent, from doubtful debtors. In Jun 2012, total loans reached €1,743,979 million of which €164,361 million, or 9.4 percent, from doubtful debtors. Credit risk in balance sheets of Spanish banks continues to deteriorate. Loans have declined 6.7 percent from the peak in 2008 to Jun 2012 while doubtful loans have increased 160.7 percent.
International financial risk continues to be dominated by whether the European Central Bank (ECB) can rescue sovereign debts of highly-indebted euro zone member countries. The first approach of the ECB was by the program of long-term refinancing operations (LRTO) that swelled its balance sheet risk assets consisting of loans to member banks and purchases of sovereign bonds of member countries from €1.0 trillion in the balance sheet of Dec 31, 2010 to €1.8 trillion in the latest consolidated financial statement on Aug 3, 2012 (http://www.ecb.int/press/pr/wfs/2012/html/fs120807.en.html). The capital of the ECB is €85.7 billion or 4.7 percent of risk assets mostly in banks and sovereigns with high probability of default. It is not possible to measure accurately by how much the ECB would have to increase its holdings of debt of sovereigns with high risk of default that would “resolve” or at least push forward the sovereign debt crisis of the euro zone. There is a sort of chicken game to the edge of the abysm similar in US debt and deficit negotiations (http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html) between financial markets and the ECB that created the impasse during the past few weeks.
There were no changes of interest rate policy at the meeting of the European Central Bank (ECB) on Aug 2, 2012 (http://www.ecb.int/press/pr/date/2012/html/pr120802.en.html):
“2 August 2012 - Monetary policy decisions
At today’s meeting the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.75%, 1.50% and 0.00% respectively.
The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.”
At the press conference following the announcement, Mario Draghi, President of the ECB, answered the question of whether there would be a program of buying sovereign bonds of euro zone members by the EFSF/ESM (European Financial Stability Fund/European Stability Mechanism) jointly with a program by the ECB (http://www.ecb.int/press/pressconf/2012/html/is120802.en.html):
“Draghi: Let me reread the related passage of my Introductory Statement, because that basically answers your question. It says: “The adherence of governments to their commitments”, namely fiscal reforms, structural reforms and so on, “and the fulfilment by the EFSF/ESM of their role are necessary conditions” for some actions on the ECB’s side. So, the first thing is that governments have to go to the EFSF, because, as I said several times, the ECB cannot replace governments, or cannot replace the action that other institutions have to take on the fiscal side. “The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy” – which means that to go to the EFSF is a necessary condition, but not a sufficient one, because the monetary policy is independent – “may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed.” That gives you the answer to the question. I should add that “over the coming weeks, we will design the appropriate modalities for such policy measures”. So, many of the details will be worked out by the relevant committees within the ECB.”
Further doubts were raised on the “reservations” by the Bundesbank (Central Bank of Germany) concerning sovereign bond purchases by the ECB as revealed by Mario Draghi in an answer to a question at the press conference (http://www.ecb.int/press/pressconf/2012/html/is120802.en.html):
“Draghi: And fourth, the endorsement to do whatever it takes – again, to use the same words – whatever it takes to preserve the euro as a stable currency has been unanimous. But, it’s clear and it’s known that Mr Weidmann and the Bundesbank – although we are here in a personal capacity and we should never forget that – have their reservations about programmes that envisage buying bonds, so the idea is now we have given guidance, the Monetary Policy Committee, the Risk Management Committee and the Market Operations Committee will work on this guidance and then we’ll take a final decision where the votes will be counted. But so far that’s the situation; I think that’s a fair representation of our discussion today.”
Participants in financial markets began to believe in further purchases of sovereign bonds of euro zone members by the ECB.
Returning risk appetite on European assets was largely caused by expectations of a different turn in the bailout of highly indebted countries. The enthusiasm of markets was caused by the following remarks of Mario Draghi (2012Jul26), President of the European Central Bank (ECB), at the Global Investment Conference in London (http://www.ecb.int/press/key/date/2012/html/sp120726.en.html):
“But there is another message I want to tell you.
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
These remarks encouraged market participants that the ECB would resume its program of purchasing sovereign bonds of highly indebted members of the euro zone. Valuations of risk financial assets climbed sharply while yields of sovereign bonds of highly indebted members of the euro zone fell substantially. Charles Forelle and Tom Fairless, writing on “Europe’s leaders move to show resolve,” on Jul 27, 2012, published in the WSJ (http://professional.wsj.com/article/SB10000872396390443931404577552920809640442.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyze remarks by various European leaders on the intention to support Spain and Italy with strong measures that also contributed to the jump in valuations of risk financial assets. Brian Blackstone, writing on “ECB to discuss rescue plan with Bundesbank,” on Jul 27, 2012, published in the WSJ (http://professional.wsj.com/article/SB10000872396390444840104577553234196518556.html), inform of a future meeting between the chief executives of the ECB and the Bundesbank to discuss the rescue program. Earlier in the week, Jon Hilsenrath, writing on “Fed moves closer to action,” on Jul 24, 2012, published in the WSJ (http://professional.wsj.com/article/SB10000872396390444025204577547173267325402.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzed economic and financial data and statements by officials that raise the possibility of further easing policies by the Federal Open Market Committee (FOMC). Buiter (2011Oct31) analyzes that the European Financial Stability Fund (EFSF) would need a “bigger bazooka” to bail out euro members in difficulties that could possibly be provided by the ECB. Table III-7 in IIIE Appendix Euro Zone Survival Risk below provides the combined GDP in 2012 of the highly indebted euro zone members estimated in the latest World Economic Outlook of the IMF at $4167 billion or 33.1 percent of total euro zone GDP of $12,586 billion. Using the WEO of the IMF, Table III-8 in IIIE Appendix Euro Zone Survival Risk below provides debt of the highly indebted euro zone members at $3927.8 billion in 2012 that increases to $5809.9 billion when adding Germany’s debt, corresponding to 167.0 percent of Germany’s GDP. There are additional sources of debt in bailing out banks. The dimensions of the problem may require more firepower than a bazooka perhaps that of the largest conventional bomb of all times of 44,000 pounds experimentally detonated only once by the US in 1948 (http://www.airpower.au.af.mil/airchronicles/aureview/1967/mar-apr/coker.html).
The selloff in world financial market on Fri Jul 20 was largely caused by doubts on the success of Spain resolution of its banks. Ilan Brat, David Román and Charles Forelle, writing on “Spanish worries feed global fears,” on Jul 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444464304577538613391486808.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyze the selloff in financial markets by the warning by the Spanish government of prolonged weak economic conditions with decline of GDP of 0.5 percent in 2013 while the government of the province of Valencia will require €18 billion from the central government. Other provincial governments are in need of cash. Spain intends to lower its deficit from 8.9 percent of GDP in 2011 to 2.8 percent by 2014. The yield of the ten-year government bond of Spain rose sharply to 7.224 percent on Fri Jul 20 while the yield of the ten-year government bond of Italy increased to 6.158 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). The FTSE MIB index of Italian equities dropped 4.38 percent on Fri Jul 20 while the IBEX 35 index of Spanish equities fell 5.82 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).
Charles Forelle and David Enrich, writing on “Euro-zone banks cut back lending,” on Jul 13, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303919504577524482252510066.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyze the new mechanics of interbank lending in the euro zone. In the older regime, the deficits of households, corporations and governments of highly-indebted members of the euro zone were financed by banks in their jurisdictions that received interbank loans from banks in the less indebted or financially-stronger countries. The increase of perceptions of default risk in counterparties in transactions among financial institutions constituted an important disruption of the international financial system during the financial crisis (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 217-24, 60, Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 155-7). Counterparty risk perceptions rose significantly in sale and repurchase agreements (SRP) in which the financing counterparty doubted the credit quality of the collateral and of the financed counterparty to repurchase the security. Another form of counterparty risk was the sharp increase in the LIBOR-OIS in which lending banks doubted the balance sheet of borrowing counterparty banks in uncollateralized interbank loans. The sovereign debt crisis in the euro zone caused sharp increases in the perception of counterparty risk evaluation by lending banks in financially-stronger jurisdictions of balance sheets and repayment capacity of borrowing banks in highly-indebted countries. Forelle and Enrich, “Euro zone banks cut back lending,” use central bank information showing that long-term financing by the European Central Bank (ECB) is filling the financing gap of banks in highly indebted countries with significant part of ECB lending simply returning as deposits in countries in stronger jurisdictions and also as deposits at the ECB. As a result, risk spreads of interest rates in highly indebted countries have increased relative to interest rates in stronger countries, which is a movement in opposite direction of what would be desired to resolve the euro zone financial crisis. Crisis resolution has moved to preventing banking instability that could accentuate the financial crisis and fiscal standing of highly-indebted countries.
Current financial risk is dominated by interest rate decisions of major central banks and the new program of rescue of banks and countries in the sovereign risk event in the euro zone. At the meeting of its Governing Council on Jul 5, 2010, the European Central Bank took the following policy measures (http://www.ecb.int/press/pr/date/2012/html/pr120705.en.html):
“5 July 2012 - Monetary policy decisions
At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.75%, starting from the operation to be settled on 11 July 2012.
2. The interest rate on the marginal lending facility will be decreased by 25 basis points to 1.50%, with effect from 11 July 2012.
3. The interest rate on the deposit facility will be decreased by 25 basis points to 0.00%, with effect from 11 July 2012.
The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.”
The President of the ECB Mario Draghi summarized the reasons for the policy measures as follows (http://www.ecb.int/press/pressconf/2012/html/is120705.en.html):
“Based on our regular economic and monetary analyses, we decided to cut the key ECB interest rates by 25 basis points. Inflationary pressure over the policy-relevant horizon has been dampened further as some of the previously identified downside risks to the euro area growth outlook have materialised. Consistent with this picture, the underlying pace of monetary expansion remains subdued. Inflation expectations for the euro area economy continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. At the same time, economic growth in the euro area continues to remain weak, with heightened uncertainty weighing on confidence and sentiment.”
The Bank of England decided on Jul 5, 2012 to increase its policy of quantitative easing (http://www.bankofengland.co.uk/publications/Pages/news/2012/066.aspx ):
“The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to increase the size of its asset purchase programme, financed by the issuance of central bank reserves, by £50 billion to a total of £375 billion.
UK output has barely grown for a year and a half and is estimated to have fallen in both of the past two quarters. The pace of expansion in most of the United Kingdom’s main export markets also appears to have slowed. Business indicators point to a continuation of that weakness in the near term, both at home and abroad. In spite of the progress made at the latest European Council, concerns remain about the indebtedness and competitiveness of several euro-area economies, and that is weighing on confidence here. The correspondingly weaker outlook for UK output growth means that the margin of economic slack is likely to be greater and more persistent.”
The People’s Bank of China (PBC) also cut interest rates simultaneously with the other major central banks (http://www.pbc.gov.cn/publish/english/955/2012/20120608171005950734495/20120608171005950734495_.html):
“The PBC has decided to cut RMB benchmark deposit and loan interest rates for financial institutions as of June 8, 2012. The one-year RMB benchmark deposit and loan interest rates will be lowered both by 0.25 percentage points. Adjustments are made correspondingly to benchmark interest rates on deposits and loans of other maturities and to deposit and loan interest rates on personal housing provident fund.”
Monetary authorities worldwide are assessing higher risks to the economy.
The key decisions of the summit of European Leaders with regards to resolving the sovereign debt issues are (http://www.european-council.europa.eu/home-page/highlights/summit-impact-on-the-eurozone?lang=en):
“Euro area summit statement
Eurozone heads of state or government decided:
- to establish a single banking supervisory mechanism run the by the ECB, and, once this mechanism has been created,
- to provide the European Stability Mechanism (ESM) with the possibility to inject funds into banks directly.
Spain's bank recapitalisation will begin under current rules, i.e. with assistance provided by the European Financial Stability Facility (EFSF) until the ESM becomes available. The funds will then be transferred to the ESM without gaining seniority status.
It was also agreed that EFSF/ESM funds can be used flexibly to buy bonds for member states that comply with common rules, recommendations and timetables.
The Eurogroup has been asked to implement these decisions by 9 July 2012.”
Valuations of risk financial assets increased sharply after the announcement of these decisions. The details will be crafted at a meeting on finance ministries of the European Union on Jul 9, 2012.
The definition of “banking panic” by Calomiris and Gorton (1991, 112) during the Great Depression in the US is:
“A banking panic occurs when bank debt holders at all or many banks in the banking system suddenly demand that banks convert their debt claims into cash (at par) to such an extent that the banks suspend convertibility of their debt into cash, or in the case of the United States, act collectively to avoid suspension of convertibility by issuing clearing house loan certificates.”
The financial panic during the credit crisis and global recession consisted of a run on the sale and repurchase agreements (SRP) of structured investment products (http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Cochrane and Zingales (2009) argue that the initial proposal for the Troubled Asset Relief Program (TARP) instead of the failure of Lehman Bros caused the flight into the dollar and Treasury securities. Washington Mutual experienced a silent run in the form of internet withdrawals. The current silent run in the euro area is from banks with challenged balance sheets in highly indebted member countries to banks and government securities in countries with stronger fiscal affairs. The analysis of the IMF 2012 Article IV Consultation focuses on this key policy priority of reversing the silent run on challenged euro area banks.
Jonathan House, writing on “Spanish banks need as much as €62 billion in new capital,” on Jun 21, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304765304577480062972372858.html?mod=WSJ_hp_LEFTWhatsNewsCollection), informs that two independent studies estimate the needs new capital of Spain’s banks at €62, billion, around $78.8 billion, which will be used by the government of Spain in the request for financial assistance from the European Union during the meeting with finance ministers.
The European Central Bank (ECB) announced changes in acceptable collateral for refinancing (http://www.ecb.int/press/pr/date/2012/html/pr120622.en.html):
“On 20 June 2012 the Governing Council of the European Central Bank (ECB) decided on additional measures to improve the access of the banking sector to Eurosystem operations in order to further support the provision of credit to households and non-financial corporations.
The Governing Council has reduced the rating threshold and amended the eligibility requirements for certain asset-backed securities (ABSs). It has thus broadened the scope of the measures to increase collateral availability which were introduced on 8 December 2011 and which remain applicable.
In addition to the ABSs that are already eligible for use as collateral in Eurosystem operations, the Eurosystem will consider the following ABSs as eligible:
1. Auto loan, leasing and consumer finance ABSs and ABSs backed by commercial mortgages (CMBSs) which have a second-best rating of at least “single A” in the Eurosystem’s harmonised credit scale, at issuance and at all times subsequently. These ABSs will be subject to a valuation haircut of 16%.
2. Residential mortgage-backed securities (RMBSs), securities backed by loans to small and medium-sized enterprises (SMEs), auto loan, leasing and consumer finance ABSs and CMBSs which have a second-best rating of at least “triple B” in the Eurosystem’s harmonised credit scale, at issuance and at all times subsequently. RMBSs, securities backed by loans to SMEs, and auto loan, leasing and consumer finance ABSs would be subject to a valuation haircut of 26%, while CMBSs would be subject to a valuation haircut of 32%.
The risk control framework with higher haircuts applicable to the newly eligible ABS aims at ensuring risk equalisation across asset classes and maintaining the risk profile of the Eurosystem.
The newly eligible ABSs must also satisfy additional requirements which will be specified in the legal act to be adopted Thursday, 28 June 2012. The measures will take effect as soon as the relevant legal act enters into force.”
Second, Risk-Measuring Yields and Exchange Rate. Yields on sovereign debt backed up again with the yield of the ten-year government bond of Spain rising sharply to 7.224 percent on Fri Jul 20 while the yield of the ten-year government bond of Italy increased to 6.158 percent but eased again on Fri Jul 27 on the expectations of massive government support with the yield of the ten-year government bond of Spain falling to 6.731 percent and the yield of the ten-year government bond of Italy dropping to 5.956 percent. The ten-year government bond of Spain was quoted at yield of 6.827 percent on Fri Aug 3 and the ten-year government bond of Italy was quoted at 6.064 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). The ten-year government bond of Spain was quoted at 6.868 percent on Aug 10, declining to 6.447 percent on Aug 17 and 6.403 percent on Aug 24, and the ten-year government bond of Italy fell from 5.894 percent on Aug 10 to 5.709 percent on Aug 17 and 5.618 percent on Aug 24. Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Diminishing aversion is captured by increase of the yield of the two- and ten-year Treasury notes and the two- and ten-year government bonds of Germany. Table III-1A provides yields of US and German governments bonds and the rate of USD/EUR. Yields of US and German government bonds decline during shocks of risk aversion and the dollar strengthens in the form of fewer dollars required to buy one euro. The yield of the US ten-year Treasury note fell from 2.202 percent on Aug 26, 2011 to 1.459 percent on Jul 20, 2012, reminiscent of experience during the Treasury-Fed accord of the 1940s that placed a ceiling on long-term Treasury debt (Hetzel and Leach 2001), while the yield of the ten-year government bond of Germany fell from 2.16 percent to 1.17 percent. Under increasing risk appetite, the yield of the ten-year Treasury rose to 1.544 on Jul 27, 2012 and 1.569 percent on Aug 3, 2012, while the yield of the ten-year Government bond of Germany rose to 1.40 percent on Jul 27 and 1.42 percent on Aug 3. Yields have been on an increasing trend with the US ten-year note at 1.814 percent on Aug 17 and the German ten-year bond at 1.50 percent with sharp decline on Aug 24 to 1.684 percent for the yield of the US ten-year note and 1.35 for the yield of the German ten-year bond. The US dollar strengthened significantly from USD 1.450/EUR on Aug 26, 2011, to USD 1.2158 on Jul 20, 2012, or by 16.2 percent, but depreciated to USD 1.2320/EUR on Jul 27, 2012 and 1.2387 on Aug 3, 2012 in expectation of massive support of highly indebted euro zone members. Doubts returned at the end of the week of Aug 10, 2012 with appreciation to USD 1.2290/EUR and decline of the yields of the two-year government bond of Germany to -0.07 percent and of the ten-year to 1.38 percent. On Aug 17, the US dollar depreciated by 0.4 percent to USD 1.2335/EUR and the ten-year bond of Germany yielded -0.04 percent. Risk appetite returned in the week of Aug 24 with depreciation by 1.4 percent to USD 1.2512/EUR and lower yield of the German two-year bond to -0.01 percent and of the US two-year note to 0.266 percent. Under zero interest rates for the monetary policy rate of the US, or fed funds rate, carry trades ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield is still around consumer price inflation of 1.4 percent in the 12 months ending in Jul (see subsection II United States Inflation at http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/07/world-inflation-waves-financial.html) and the expectation of higher inflation if risk aversion diminishes. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table III-1A provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.
Table III-1A, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate
| US 2Y | US 10Y | DE 2Y | DE 10Y | USD/ EUR | |
| 8/24/12 | 0.266 | 1.684 | -0.01 | 1.35 | 1.2512 |
| 8/17/12 | 0.288 | 1.814 | -0.04 | 1.50 | 1.2335 |
| 8/10/12 | 0.267 | 1.658 | -0.07 | 1.38 | 1.2290 |
| 8/3/12 | 0.242 | 1.569 | -0.02 | 1.42 | 1.2387 |
| 7/27/12 | 0.244 | 1.544 | -0.03 | 1.40 | 1.2320 |
| 7/20/12 | 0.207 | 1.459 | -0.07 | 1.17 | 1.2158 |
| 7/13/12 | 0.24 | 1.49 | -0.04 | 1.26 | 1.2248 |
| 7/6/12 | 0.272 | 1.548 | -0.01 | 1.33 | 1.2288 |
| 6/29/12 | 0.305 | 1.648 | 0.12 | 1.58 | 1.2661 |
| 6/22/12 | 0.309 | 1.676 | 0.14 | 1.58 | 1.2570 |
| 6/15/12 | 0.272 | 1.584 | 0.07 | 1.44 | 1.2640 |
| 6/8/12 | 0.268 | 1.635 | 0.04 | 1.33 | 1.2517 |
| 6/1/12 | 0.248 | 1.454 | 0.01 | 1.17 | 1.2435 |
| 5/25/12 | 0.291 | 1.738 | 0.05 | 1.37 | 1.2518 |
| 5/18/12 | 0.292 | 1.714 | 0.05 | 1.43 | 1.2780 |
| 5/11/12 | 0.248 | 1.845 | 0.09 | 1.52 | 1.2917 |
| 5/4/12 | 0.256 | 1.876 | 0.08 | 1.58 | 1.3084 |
| 4/6/12 | 0.31 | 2.058 | 0.14 | 1.74 | 1.3096 |
| 3/30/12 | 0.335 | 2.214 | 0.21 | 1.79 | 1.3340 |
| 3/2/12 | 0.29 | 1.977 | 0.16 | 1.80 | 1.3190 |
| 2/24/12 | 0.307 | 1.977 | 0.24 | 1.88 | 1.3449 |
| 1/6/12 | 0.256 | 1.957 | 0.17 | 1.85 | 1.2720 |
| 12/30/11 | 0.239 | 1.871 | 0.14 | 1.83 | 1.2944 |
| 8/26/11 | 0.20 | 2.202 | 0.65 | 2.16 | 1.450 |
| 8/19/11 | 0.192 | 2.066 | 0.65 | 2.11 | 1.4390 |
| 6/7/10 | 0.74 | 3.17 | 0.49 | 2.56 | 1.192 |
| 3/5/09 | 0.89 | 2.83 | 1.19 | 3.01 | 1.254 |
| 12/17/08 | 0.73 | 2.20 | 1.94 | 3.00 | 1.442 |
| 10/27/08 | 1.57 | 3.79 | 2.61 | 3.76 | 1.246 |
| 7/14/08 | 2.47 | 3.88 | 4.38 | 4.40 | 1.5914 |
| 6/26/03 | 1.41 | 3.55 | NA | 3.62 | 1.1423 |
Note: DE: Germany
Source:
http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
http://www.federalreserve.gov/releases/h15/data.htm
http://www.ecb.int/stats/money/long/html/index.en.html
Chart III-1A of the Board of Governors of the Federal Reserve System provides the ten-year and two-year Treasury constant maturity yields. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe.
![clip_image018[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfiles207D7F1\TCM2Y10Y0112DDPChart3.png "clip_image018[1]")
Chart III-1A, US, Ten-Year and Two-Year Treasury Constant Maturity Yields Jul 3, 2001-Aug 20, 2012
Note: US Recessions in shaded areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
Equity indexes in Table III-1 were mostly lower in the week ending on Aug 24, 2012 with alternating enthusiasm on purchases of bonds by the European Central Bank (ECB) and the exchange of letters between Bernanke (2012Aug22) and Issa (2012Aug1), in which Bernanke (2012Aug22) states: “There is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery.” DJIA increased 0.8 percent on Aug 24 after the release of the letter of Bernanke (2012Aug22) but still lost 0.9 percent in the week. Germany’s Dax increased 0.3 percent on Fri Aug 24, dropping 1.0 percent in the week. Dow Global declined 0.1 percent on Aug 24 and decreased 0.4 percent in the week. Japan’s Nikkei Average decreased 1.2 percent on Fri Aug 24 with release of decline of exports by 8.1 percent in the 12 months ending in Jul 2012 and decreased 1.0 percent in the week. Dow Asia Pacific TSM decreased 1.2 percent on Aug 24 and declined 0.2 percent in the week while Shanghai Composite fell 1.1 percent in the week, decreasing 1.0 percent on Fri Aug 24. Low holiday volume prevents observation of risk perceptions but there is evident trend of deceleration of the world economy that could affect corporate revenue and equity valuations.
Commodities were mixed in the week of Aug 24, 2012. The DJ UBS Commodities Index decreased 0.4 percent on Fri Aug 24 but increased 1.6 percent in the week, as shown in Table III-1. WTI was unchanged on Fri Aug 24 and increased 0.1 percent in the week while Brent fell 1.2 percent on Fri Aug 24 and decreased 0.1 percent in the week. Gold increased 3.3 percent in the week of Aug 24.
The operations of the European Central Bank (ECB) are important in analyzing risk taking in financial markets. Some events are discussed initially below followed by analysis of the ECB’s balance sheet. 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-1B 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” increased from €546,747 million on Dec 31, 2010, to €870,130 million on Dec 28, 2011 and €1,208,269 million on Aug 17, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,811,046 million in the statement of Aug 17. There is high credit risk in these transactions with capital of only €85,749 million.
Table III-1B, Consolidated Financial Statement of the Eurosystem, Million EUR
| Dec 31, 2010 | Dec 28, 2011 | Aug 17, 2012 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 433,778 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 261,438 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 51,131 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 16,456 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 1,208,269 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 218,214 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 602,777 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 30,041 |
| 9 Other Assets | 278,719 | 336,574 | 263,740 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 3,085,845 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,811,046 |
| Capital and Reserves | 78,143 | 85,748 | 85,749 |
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/fs120821.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” increased from €546,747 million on Dec 31, 2010, to €870,130 million on Dec 28, 2011 and €1,208,269 million on Aug 17, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,811,046 million in the statement of Aug 17. There is high credit risk in these transactions with capital of only €85,749 million.
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 | Aug 17, 2012 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 433,778 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 261,438 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 51,131 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 16,456 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 1,208,269 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 218,214 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 602,777 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 30,041 |
| 9 Other Assets | 278,719 | 336,574 | 263,740 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 3,085,845 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,811,046 |
| Capital and Reserves | 78,143 | 85,748 | 85,749 |
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/fs120821.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 9.9 percent in Jun 2012 relative to Jun 2011 while those to EMU are falling at 1.2 percent.
Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%
| Jun 2012 | Exports | ∆% Jan-Jun 2012/ Jan-Jun 2011 | Imports | Imports |
| EU | 56.0 | 0.0 | 53.3 | -7.5 |
| EMU 17 | 42.7 | -1.2 | 43.2 | -7.1 |
| France | 11.6 | -0.3 | 8.3 | -5.3 |
| Germany | 13.1 | 1.3 | 15.6 | -10.0 |
| Spain | 5.3 | -8.5 | 4.5 | -8.1 |
| UK | 4.7 | 10.6 | 2.7 | -14.8 |
| Non EU | 44.0 | 9.9 | 46.7 | -3.8 |
| Europe non EU | 13.3 | 11.3 | 11.1 | -5.6 |
| USA | 6.1 | 18.2 | 3.3 | 3.4 |
| China | 2.7 | -11.6 | 7.3 | -17.1 |
| OPEC | 4.7 | 24.1 | 8.6 | 25.3 |
| Total | 100.0 | 4.2 | 100.0 | -5.8 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/68816
Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €410 million with the 17 countries of the euro zone (EMU 17) in Jun and deficit of €1619 million in Jan-Jun. Depreciation to parity could permit greater competitiveness in improving the trade surpluses of €4964 million in Jan-Jun with Europe non European Union and of €6610 million with the US. There is significant rigidity in the trade deficits in Jan-Jun of €8304 million with China and €11,076 million with members of the Organization of Petroleum Exporting Countries (OPEC). Higher exports could drive economic growth in the economy of Italy that would permit less onerous adjustment of the country’s fiscal imbalances, raising the country’s credit rating.
Table III-4, Italy, Trade Balance by Regions and Countries, Millions of Euro
| Regions and Countries | Trade Balance Jun 2012 Millions of Euro | Trade Balance Cumulative Jan-Jun 2012 Millions of Euro |
| EU | 997 | 5,130 |
| EMU 17 | -410 | -1,619 |
| France | 1,136 | 5,902 |
| Germany | -536 | -3,168 |
| Spain | 46 | 951 |
| UK | 990 | 4,576 |
| Non EU | 1,520 | -5,215 |
| Europe non EU | 1,402 | 4,964 |
| USA | 1,337 | 6,610 |
| China | -1,515 | -8,304 |
| OPEC | -1,301 | -11,076 |
| Total | 2,517 | -85 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/68816
Growth rates of Italy’s trade and major products are provided in Table III-5 for the period Jan-Jun 2012 relative to Jan-Jun 2011. Growth rates of imports are negative with the exception of energy. The higher rate of growth of exports of 4.2 percent in Jan-Jun 2012/Jan-Jun 2011 relative to imports of minus 5.8 percent may reflect weak demand in Italy with GDP declining during four consecutive quarters from IIIQ2011 through IIQ2012.
Table III-5, Italy, Exports and Imports % Share of Products in Total and ∆%
| Exports | Exports | Imports | Imports | |
| Consumer | 28.9 | 5.5 | 25.0 | -3.0 |
| Durable | 5.9 | 2.0 | 3.0 | -7.9 |
| Non | 23.0 | 6.4 | 22.0 | -2.3 |
| Capital Goods | 32.2 | 2.6 | 20.8 | -12.1 |
| Inter- | 34.3 | 2.7 | 34.5 | -12.4 |
| Energy | 4.7 | 18.8 | 19.7 | 10.5 |
| Total ex Energy | 95.3 | 3.5 | 80.3 | -9.5 |
| Total | 100.0 | 4.2 | 100.0 | -5.8 |
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/68816
Table III-6 provides Italy’s trade balance by product categories in Jun 2012 and cumulative Jan-Jun 2012. Italy’s trade balance excluding energy generated surplus of €7122 million in Jun 2012 and €32,595 million in Jan-Jun 2012 but the energy trade balance created deficit of €4605 million in Jun 2012 and €32,680 million in Jan-Jun 2012. The overall surplus in Jun 2012 was €2517 million but there was an overall deficit of €85 million in Jan-Jun 2012. 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
| Jun 2012 | Cumulative Jan-Jun 2012 | |
| Consumer Goods | 1,674 | 7,016 |
| Durable | 1,092 | 5,600 |
| Nondurable | 583 | 1,416 |
| Capital Goods | 4,747 | 23,497 |
| Intermediate Goods | 700 | 2,081 |
| Energy | -4,605 | -32,680 |
| Total ex Energy | 7,122 | 32,595 |
| Total | 2,517 | -85 |
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/68816
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 VE-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 Jun 2012. German exports to other European Union (EU) members are 56.7 percent of total exports in Jun 2012 and 58.0 percent in Jan-Jun 2012. Exports to the euro area are 41.8 percent in May and 38.7 percent in Jan-May. Exports to third countries are 37.5 percent of the total in Jun and 38.5 percent in Jan-Jun. There is similar distribution for imports. Exports to non-euro countries are growing at 4.8 percent in Jun 2012 and 4.2 percent in Jan-Jun 2012 while exports to the euro area are falling 3.0 percent in Jun and increasing 0.6 percent in Jan-Jun 2012. Price competitiveness through devaluation could improve export performance and growth. 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 ∆%
| Jun 2012 | Jun 12-Month | Jan–Jun 2012 € Billions | Jan-Jun 2012/ | |
| Total | 94.6 | 7.4 | 550.4 | 4.8 |
| A. EU | 53.6 % 56.7 | -0.5 | 319.0 % 58.0 | 0.6 |
| Euro Area | 35.5 % 37.5 | -3.0 | 212.0 % 38.5 | -1.1 |
| Non-euro Area | 18.0 % 19.0 | 4.8 | 107.1 % 19.5 | 4.2 |
| B. Third Countries | 41.1 % 43.5 | 19.8 | 231.4 % 42.0 | 11.1 |
| Total Imports | 76.7 | 1.5 | 457.1 | 2.4 |
| C. EU Members | 49.3 % 64.3 | -1.4 | 290.7 % 63.6 | 2.0 |
| Euro Area | 34.9 % 45.5 | -2.8 | 204.8 % 44.8 | 1.5 |
| Non-euro Area | 14.4 % 18.8 | 2.2 | 85.9 % 18.8 | 3.3 |
| D. Third Countries | 27.5 % 35.9 | 7.2 | 166.4 % 36.4 | 3.0 |
Notes: Total Exports = A+B; Total Imports = C+D
Source:
Statistiche Bundesamt Deutschland https://www.destatis.de/EN/PressServices/Press/pr/2012/08/PE12_269_51.html;jsessionid=5AB45783D1BE8502BB1AF4397C769BCD.cae1
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.
IIIG Appendix on Deficit Financing of Growth and the Debt Crisis. This section is divided into two subsections. Subsection IIIGA Monetary Policy with Deficit Financing of Economic Growth analyzes proposals to promote economic growth with government deficits financed by monetary policy. Subsection IIIGB Adjustment during the Debt Crisis of the 1980s provides the routes of adjustment of Brazil during the debt crisis after 1983.
IIIGA Monetary Policy with Deficit Financing of Economic Growth. The advice of Bernanke (2000, 159-161, 165) to the Bank of Japan (BOJ) to reignite growth and employment in the economy consisted of zero interest rates and commitment to a high inflation target as proposed by Krugman (1999):
“I agree that this approach would be helpful, in that it would give private decision makers more information about the objectives of monetary policy. In particular, a target in the 3-4 percent range for inflation to be maintained for a number of years, would confirm not only that the BOJ is intent on moving safely away from a deflationary regime but also that it intends to make up some of the ‘price-level gap’ created by 8 years of zero or negative inflation. In stating an inflation target of, say, 3-4 percent, the BOJ would be giving the direction in which it will attempt to move the economy. The important question, of course, is whether a determined Bank of Japan would be able to depreciate the yen. I am not aware of any previous historical episode, including the period of very low interest rates in the 1930s, in which a central bank has been unable to devaluate its currency. There is strong presumption that vigorous intervention by the BOJ, together with appropriate announcements to influence market expectations, could drive down the value of the yen significantly. Further, there seems little reason not to try this strategy. The ‘worst’ that could happen would be that the BOJ would greatly increase its holdings of reserve assets. Perhaps not all of those who cite the beggar-thy-neighbor thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery. Franklin D. Roosevelt was elected president of the United States in 1932 with the mandate to get the country out of the Depression. In the end, his most effective actions were the same ones that Japan needs to take—namely, rehabilitation of the banking system and devaluation of the currency.”
Bernanke (2002) also finds devaluation to be a powerful policy instrument to move the economy away from deflation and weak economic and financial conditions:
“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”
Krugman (2012Apr24) finds that this advice of then Professor Bernanke (2000) is relevant to current monetary policy in the US. The relevance would be in a target of inflation in the US of 4 percent, which was the rate prevailing in the late years of the Reagan Administration. The liquidity trap is defined by Krugman (1998, 141) “as a situation in which conventional monetary policies have become impotent, because nominal interest rates are at or near zero: injecting monetary base into the economy has no effect, because base and bonds are viewed by the private sector as perfect substitutes.” The adversity of the liquidity trap in terms of weakness in output and employment can be viewed as an economy experiencing deflation that cannot be contained by increases in the monetary base, or currency held by the public plus reserves held by banks at the central bank. The argument of monetary neutrality is that an increase in money throughout all future periods will increase prices by the same proportion. According to Krugman (1998, 142), the liquidity trap occurs because the public does not expect that the central bank will continue the monetary expansion once inflation returns to a certain level. Expectations are critical in explaining the liquidity trap and have been shaped by the continued fight against inflation by central banks during several decades with the possible exception of Japan beginning with the lost decade when deflation became the relevant policy concern. In this framework, monetary policy is ineffectual if perceived by the public as temporary. Credible monetary policy is perceived by the public as permanent deliberate increase in prices or output: “if the central bank can credibly promise to be irresponsible—that is, convince the market that it will in fact allow prices to rise sufficiently—it can bootstrap the economy out of the trap” (Krugman 1998, 161).
Fed Chairman Bernanke (2012Apr25, 7-8) argues that there is no conflict between his advice to the Bank of Japan as Princeton Professor Bernanke (2000) and current monetary policy by the Federal Open Market Committee (FOMC):
“So there’s this view circulating [Princeton Professor Paul Krugman at http://www.nytimes.com/2012/04/29/magazine/chairman-bernanke-should-listen-to-professor-bernanke.html?pagewanted=all] that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. Our—my views and our policies today are completely consistent with the views that I held at that time. I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation—that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer—are not exhausted, there are still other things that the central bank can do to create additional accommodation. Now, looking at the current situation in United States, we are not in deflation. When deflation became a significant risk in late 2010, or at least a modest risk in late 2010, we used additional balance sheet tools to help return inflation close to the 2 percent target. Likewise, we have been aggressive and creative in using non-federal-funds-rate-centered tools to achieve additional accommodation for the U.S. economy. So the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation, and, clearly, when you’re in deflation and in recession, then both sides of your mandates, so to speak, are demanding additional accommodation. In this case, it’s—we are not in deflation, we have an inflation rate that’s close to our objective. Now, why don’t we do more? Well, first I would again reiterate that we are doing a great deal; policy is extraordinarily accommodative. We—and I won’t go through the list again, but you know all the things that we have done to try to provide support to the economy. I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction—a slightly increased pace of reduction in the unemployment rate? The view of the Committee is that that would be very reckless. We have—we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been be able to take strong accommodative actions in the last four or five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.”
Chairman Bernanke (2012Apr 25, 10-11) explains current FOMC policy:
“So it’s not a ceiling, it’s a symmetric objective, and we attempt to bring inflation close to 2 percent. And in particular, if inflation were to jump for whatever reason—and we don’t have, obviously don’t have perfect control of inflation—we’ll try to return inflation to 2 percent at a pace which takes into account the situation with respect to unemployment. The risk of higher inflation—you say 2½ percent; well, 2½ percent expected change might involve a distribution of outcomes, some of which might be much higher than 2½ percent. And the concern we have is that if inflation were to run well above 2 percent for a protracted period, that the credibility and the well-anchored inflation expectations, which are such a valuable asset of the Federal Reserve, might become eroded, in which case we would in fact have less rather than more flexibility to use accommodative monetary policy to achieve our employment goals. I would cite to you, just as an example, if you look at Vice Chair Yellen’s paper, which she gave—or speech, which she gave a couple of weeks ago, where she described a number of ways of looking at the late 2014 guidance. She showed there some so-called optimal policy rules that come from trying to get the best possible outcomes from our quantitative econometric models, and what you see, if you look at that, is that the best possible outcomes, assuming perfect certainty, assuming perfect foresight—very unrealistic assumptions—still involve inflation staying quite close to 2 percent. So there is no presumption even in our econometric models that you need inflation well above target in order to make progress on unemployment.”
In perceptive analysis of growth and macroeconomics in the past six decades, Rajan (2012FA) argues that “the West can’t borrow and spend its way to recovery.” The Keynesian paradigm is not applicable in current conditions. Advanced economies in the West could be divided into those that reformed regulatory structures to encourage productivity and others that retained older structures. In the period from 1950 to 2000, Cobet and Wilson (2002) find that US productivity, measured as output/hour, grew at the average yearly rate of 2.9 percent while Japan grew at 6.3 percent and Germany at 4.7 percent (see Pelaez and Pelaez, The Global Recession Risk (2007), 135-44). In the period from 1995 to 2000, output/hour grew at the average yearly rate of 4.6 percent in the US but at lower rates of 3.9 percent in Japan and 2.6 percent in the US. Rajan (2012FA) argues that the differential in productivity growth was accomplished by deregulation in the US at the end of the 1970s and during the 1980s. In contrast, Europe did not engage in reform with the exception of Germany in the early 2000s that empowered the German economy with significant productivity advantage. At the same time, technology and globalization increased relative remunerations in highly-skilled, educated workers relative to those without skills for the new economy. It was then politically appealing to improve the fortunes of those left behind by the technological revolution by means of increasing cheap credit. As Rajan (2012FA) argues:
“In 1992, Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, partly to gain more control over Fannie Mae and Freddie Mac, the giant private mortgage agencies, and partly to promote affordable homeownership for low-income groups. Such policies helped money flow to lower-middle-class households and raised their spending—so much so that consumption inequality rose much less than income inequality in the years before the crisis. These policies were also politically popular. Unlike when it came to an expansion in government welfare transfers, few groups opposed expanding credit to the lower-middle class—not the politicians who wanted more growth and happy constituents, not the bankers and brokers who profited from the mortgage fees, not the borrowers who could now buy their dream houses with virtually no money down, and not the laissez-faire bank regulators who thought they could pick up the pieces if the housing market collapsed. The Federal Reserve abetted these shortsighted policies. In 2001, in response to the dot-com bust, the Fed cut short-term interest rates to the bone. Even though the overstretched corporations that were meant to be stimulated were not interested in investing, artificially low interest rates acted as a tremendous subsidy to the parts of the economy that relied on debt, such as housing and finance. This led to an expansion in housing construction (and related services, such as real estate brokerage and mortgage lending), which created jobs, especially for the unskilled. Progressive economists applauded this process, arguing that the housing boom would lift the economy out of the doldrums. But the Fed-supported bubble proved unsustainable. Many construction workers have lost their jobs and are now in deeper trouble than before, having also borrowed to buy unaffordable houses. Bankers obviously deserve a large share of the blame for the crisis. Some of the financial sector’s activities were clearly predatory, if not outright criminal. But the role that the politically induced expansion of credit played cannot be ignored; it is the main reason the usual checks and balances on financial risk taking broke down.”
In fact, Raghuram G. Rajan (2005) anticipated low liquidity in financial markets resulting from low interest rates before the financial crisis that caused distortions of risk/return decisions provoking the credit/dollar crisis and global recession from IVQ2007 to IIQ2009. Near zero interest rates of unconventional monetary policy induced excessive risks and low liquidity in financial decisions that were critical as a cause of the credit/dollar crisis after 2007. Rajan (2012FA) argues that it is not feasible to return to the employment and income levels before the credit/dollar crisis because of the bloated construction sector, financial system and government budgets.
Proposals for higher inflation target of 4 percent for FOMC monetary policy are based on the view that interest rates are too high in real terms because the nominal rate is already at zero and cannot be lowered further. Rajan (2012May8) argues that higher inflation targets by the FOMC need not increase aggregate demand as proposed in those policies because of various factors:
· Pension Crisis. Baby boomers close to retirement calculate that their savings are not enough at current interest rates and may simply save more. Many potential retirees are delaying retirement in order to save what is required to provide for comfortable retirement.
· Regional Income and Debt Disparities. Unemployment, indebtedness and income growth differ by regions in the US. It is not feasible to relocate demand around the country such that decreases in real interest rates may not have aggregate demand effects.
· Inflation Expectations. Rajan (2012May) argues that there is not much knowledge about how people form expectations. Increasing the FOMC target to 4 percent could erode control of monetary policy by the central bank. More technical analysis of this issue, which could be merely repetition of inflation surprise in the US Great Inflation of the 1970s, is presented in Appendix IIA.
· Frictions. Keynesian economics is based on rigidities of wages and benefits in economic activities but there may be even more important current inflexibilities such as moving when it is not possible to sell and buy a house.
Thomas J. Sargent and William L. Silber, writing on “The challenges of the Fed’s bid for transparency,” on Mar 20, published in the Financial Times (http://www.ft.com/intl/cms/s/0/778eb1ce-7288-11e1-9c23-00144feab49a.html#axzz1pexRlsiQ), analyze the costs and benefits of transparency by the Fed. In the analysis of Sargent and Silber (2012Mar20), benefits of transparency by the Fed will exceed costs if the Fed is successful in conveying to the public what policies would be implemented and how forcibly in the presence of unforeseen economic events. History has been unkind to policy commitments. The risk in this case is if the Fed would postpone adjustment because of political pressures as has occurred in the past or because of errors of evaluation and forecasting of economic and financial conditions. Both political pressures and errors abounded in the unhappy stagflation of the 1970s also known as the US Great Inflation (see 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 and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB). The challenge of the Fed, in the view of Sargent and Silber 2012Mar20), is to convey to the public the need to deviate from the commitment to interest rates of zero to ¼ percent because conditions have changed instead of unwarranted inaction or policy changes. Errors have abounded such as a critical cause of the global recession pointed by Sargent and Silber (2012Mar20): “While no president is known to have explicitly pressurized Mr. Bernanke’s predecessor, Alan Greenspan, he found it easy to maintain low interest rates for too long, fuelling the credit boom and housing bubble that led to the financial crisis in 2008.” Sargent and Silber (2012Mar20) also find need of commitment of fiscal authorities to consolidation needed to attain sustainable path of debt. Further analysis is provided in Appendix IIA Inflation Surprise and Appendix IIB Unpleasant Monetarist Arithmetic at http://cmpassocregulationblog.blogspot.com/2012/05/world-inflation-waves-monetary-policy.html.
According to an influential school of thought, the interrelation of growth and inflation in Latin America is complex, preventing analysis of whether inflation promotes or restricts economic growth (Seers 1962, 191). In this view, there are multiple structural factors of inflation. Successful economic policy requires a development program that ameliorates structural weaknesses. Policy measures in developed countries are not transferable to developing economies.
In extensive research and analysis, Kahil (1973) finds no evidence of the role of structural factors in Brazilian inflation from 1947 to 1963. In fact, Kahil (1973, 329) concludes:
“The immediate causes of the persistent and often violent rise in prices, with which Brazil was plagued from the last month of 1948 to the early months of 1964, are pretty obvious: large and generally growing public deficits, together with too rapid an expansion of bank credit in the first years and, later, exaggerated and more and more frequent increases in the legal minimum wages.”
Kahil (1973, 334) analyzes the impact of inflation on the economy and society of Brazil:
“The real incomes of the various social classes alternately suffered increasingly frequent and sharp fluctuations: no sooner had a group succeeded in its struggle to restore its real income to some previous peak than it witnessed its erosion with accelerated speed; and it soon became apparent to all that the success of any important group in raising its real income, through government actions or by other means, was achieved only by reducing theirs. Social harmony, the general climate of euphoria, and also enthusiasm for government policies, which had tended to prevail until the last months of 1958, gave way in the following years of galloping inflation to intense political and social conflict and to profound disillusionment with public policies. By 1963 when inflation reached its runaway stage, the economy had ceased to grow, industry and transport were convulsed by innumerable strikes, and peasants were invading land in the countryside; and the situation further worsened in the first months of 1964.”
Professor Nathiel H. Leff (1975) at Columbia University identified another important contribution of Kahil (1975, Chapter IV“The supply of capital,” 127-185) of key current relevance to current proposals to promote economic growth and employment by raising inflation targets:
“Contrary to the assertions of some earlier writers on this topic, Kahil concludes that inflation did not lead to accelerated capital formation in Brazil.”
In econometric analysis of Brazil’s inflation from 1947 to 1980, Barbosa (1987) concludes:
“The most important result, based on the empirical evidence presented here, is that in the long run inflation is a monetary phenomenon. It follows that the most challenging task for Brazilian society in the near future is to shape a monetary-fiscal constitution that precludes financing much of the budget deficits through the inflation tax.”
Experience with continuing fiscal deficits and money creation tend to show accelerating inflation. Table III-10 provides average yearly rates of growth of two definitions of the money stock, M1, and M2 that adds also interest-paying deposits. The data were part of a research project on the monetary history of Brazil using the NBER framework of Friedman and Schwartz (1963, 1970) and Cagan (1965) as well as the institutional framework of Rondo E. Cameron (1967, 1972) who inspired the research (Pelaez 1974, 1975, 1976a,b, 1977, 1979, Pelaez and Suzigan 1978, 1981). The data were also used to test the correct specification of money and income following Sims (1972; see also Williams et al. 1976) as well as another test of orthogonality of money demand and supply using covariance analysis. The average yearly rates of inflation are high for almost any period in 1861-1970, even when prices were declining at 1 percent in 19th century England, and accelerated to 27.1 percent in 1945-1970. There may be concern in an uncontrolled deficit monetized by sharp increases in base money. The Fed may have desired to control inflation at 2 percent after lowering the fed funds rate to 1 percent in 2003 but inflation rose to 4.1 percent in 2007. There is not “one hundred percent” confidence in controlling inflation because of the lags in effects of monetary policy impulses and the equally important lags in realization of the need for action and taking of action and also the inability to forecast any economic variable. Romer and Romer (2004) find that a one percentage point tightening of monetary policy is associated with a 4.3 percent decline in industrial production. There is no change in inflation in the first 22 months after monetary policy tightening when it begins to decline steadily, with decrease by 6 percent after 48 months (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 102). Even if there were one hundred percent confidence in reducing inflation by monetary policy, it could take a prolonged period with adverse effects on economic activity. Certainty does not occur in economic policy, which is characterized by costs that cannot be anticipated.
Table III-10, Brazil, Yearly Growth Rates of M1, M2, Nominal Income (Y), Real Income (y), Real Income per Capita (y/n) and Prices (P)
| M1 | M2 | Y | y | y/N | P | |
| 1861-1970 | 9.3 | 6.2 | 10.2 | 4.6 | 2.4 | 5.8 |
| 1861-1900 | 5.4 | 5.9 | 5.9 | 4.4 | 2.6 | 1.6 |
| 1861-1913 | 4.7 | 4.7 | 5.3 | 4.4 | 2.4 | 0.1 |
| 1861-1929 | 5.5 | 5.6 | 6.4 | 4.3 | 2.3 | 2.1 |
| 1900-1970 | 13.9 | 13.9 | 15.2 | 4.9 | 2.6 | 10.3 |
| 1900-1929 | 8.9 | 8.9 | 10.8 | 4.2 | 2.1 | 6.6 |
| 1900-1945 | 8.6 | 9.1 | 9.2 | 4.3 | 2.2 | 4.9 |
| 1920-1970 | 17.8 | 17.3 | 19.4 | 5.3 | 2.8 | 14.1 |
| 1920-1945 | 8.3 | 8.7 | 7.5 | 4.3 | 2.2 | 3.2 |
| 1920-1929 | 5.4 | 6.9 | 11.1 | 5.3 | 3.3 | 5.8 |
| 1929-1939 | 8.9 | 8.1 | 11.7 | 6.3 | 4.1 | 5.4 |
| 1945-1970 | 30.3 | 29.2 | 33.2 | 6.1 | 3.1 | 27.1 |
Note: growth rates are obtained by regressions of the natural logarithms on time. M1 and M2 definitions of the money stock; Y nominal GDP; y real GDP; y/N real GDP per capita; P prices.
Source: See Pelaez and Suzigan (1978), 143; M1 and M2 from Pelaez and Suzigan (1981); money income and real income from Contador and Haddad (1975) and Haddad (1974); prices by the exchange rate adjusted by British wholesale prices until 1906 and then from Villela and Suzigan (1973); national accounts after 1947 from Fundação Getúlio Vargas.
Chart III-1 shows in semi-logarithmic scale from 1861 to 1970 in descending order two definitions of income velocity, money income, M1, M2, an indicator of prices and real income.
Chart III-1, Brazil, Money, Income and Prices 1861-1970.
Source: © Carlos Manuel Pelaez and Wilson Suzigan. 1981. História Monetária do Brasil Segunda Edição. Coleção Temas Brasileiros. Brasília: Universidade de Brasília, 21.
Table III-11 provides yearly percentage changes of GDP, GDP per capita, base money, prices and the current account in millions of dollars during the acceleration of inflation after 1947. There was an explosion of base money or the issue of money and three waves of inflation identified by Kahil (1973). Inflation accelerated together with issue of money and political instability from 1960 to 1964. There must be a role for expectations in inflation but there is not much sound knowledge and measurement as Rajan (2012May8) argues. There have been inflation waves documented in periodic comments in this blog (http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs.html) . The risk is ignition of adverse expectations at the crest of one of worldwide inflation waves. Lack of credibility of the commitment by the FOMC to contain inflation could ignite such perverse expectations. Deficit financing of economic growth can lead to inflation and financial instability.
Table III-11, Brazil, GDP, GDP per Capita, Base Money, Prices and Current Account of the Balance of Payments, ∆% and USD Millions, 1947-1971
| GDP ∆% | GDP per Capita ∆% | Base Money ∆% | Prices ∆% | Current USD Millions | |
| 1947 | 2.4 | 0.1 | -1.4 | 14.0 | 162 |
| 1948 | 7.4 | 4.9 | 4.6 | 7.6 | -24 |
| 1949 | 6.6 | 4.2 | 14.5 | 4.0 | -74 |
| 1950 | 6.5 | 4.0 | 23.0 | 10.0 | 52 |
| 1951 | 5.9 | 2.9 | 15.3 | 21.9 | -291 |
| 1952 | 8.7 | 5.6 | 17.7 | 10.2 | -615 |
| 1953 | 2.5 | -0.5 | 15.5 | 12.1 | 16 |
| 1954 | 10.1 | 6.9 | 23.4 | 31.0 | -203 |
| 1955 | 6.9 | 3.8 | 18.0 | 14.0 | 17 |
| 1956 | 3.2 | 0.2 | 16.9 | 21.6 | 194 |
| 1957 | 8.1 | 4.9 | 30.5 | 13.9 | -180 |
| 1958 | 7.7 | 4.6 | 26.1 | 10.4 | -253 |
| 1959 | 5.6 | 2.5 | 32.3 | 37.7 | -154 |
| 1960 | 9.7 | 6.5 | 42.4 | 27.6 | -410 |
| 1961 | 10.3 | 7.1 | 54.4 | 36.1 | 115 |
| 1962 | 5.3 | 2.2 | 66.4 | 54.1 | -346 |
| 1963 | 1.6 | -1.4 | 78.4 | 75.2 | -244 |
| 1964 | 2.9 | -0.1 | 82.5 | 89.7 | 40 |
| 1965 | 2.7 | -0.6 | 67.6 | 62.0 | 331 |
| 1966 | 4.4 | 1.5 | 25.8 | 37.9 | 153 |
| 1967 | 4.9 | 2.0 | 33.9 | 28.7 | -245 |
| 1968 | 11.2 | 8.1 | 31.4 | 25.2 | 32 |
| 1969 | 9.9 | 6.9 | 22.4 | 18.2 | 549 |
| 1970 | 8.9 | 5.8 | 20.2 | 20.7 | 545 |
| 1971 | 13.3 | 10.2 | 29.8 | 22.0 | 530 |
Sources: Fundação Getúlio Vargas, Banco Central do Brasil and Pelaez and Suzigan (1981). Carlos Manuel Pelaez, História Econômica do Brasil: Um Elo entre a Teoria e a Realidade Econômica. São Paulo: Editora Atlas, 1979, 94.
IIIGB Adjustment during the Debt Crisis of the 1980s. Economic and financial risks in the euro area are increasingly being dominated by analytical and political disagreement on conflicts of fiscal adjustment, financial stability, economic growth and employment. Political development is beginning to push for alternative paths of policy. Blanchard (2012WEOApr) and Draghi (2012May3) provide analysis of appropriate directions of policy.
Blanchard (2012WEOApr) finds that interest rates close to zero in advanced economies have not induced higher economic growth because of two main factors—fiscal consolidation and deleveraging—that restrict economic growth in the short-term. First, Blanchard (2012WEOApr, XIII) finds that assuming a multiplier of unity of the fiscal deficit on GDP, decrease of the cyclically-adjusted deficit of advanced economies by 1 percent would reduce economic growth by one percentage point. Second, deleveraging by banks, occurring mainly in Europe, tightens credit supply with similar reduction of euro area economic growth by one percentage point in 2012. The baseline of the World Economic Outlook (WEO) of the IMF (2012WEOApr) for Apr 2012 incorporates both effects, which results in weak economic growth, in particular in Europe, and prolonged unemployment. An important analysis by Blanchard (2012WEOApr, XIII) is that “financial uncertainty, together with sharp shifts in risk appetite, has led to volatile capital flows.” Blanchard (2012WEOApr) still finds that the greatest vulnerability is another profound crisis in Europe (ECB). Crisis prevention should buttress the resilience of affected countries during those shifts in risk appetite. The role of the enhanced firewall of the IMF, European Union (EU) and European Central Bank is gaining time during which countries could engage in fiscal consolidation and structural reforms that would diminish the shifts in risk appetite, preventing devastating effects of financial crises. Volatility in capital flows is equivalent to volatility of valuations of risk financial assets. The challenge to the policy mix consists in balancing the adverse short-term effects of fiscal consolidation and deleveraging with the beneficial long-term effects of eliminating the vulnerability to shocks of risk aversion. Blanchard (2012WEOApr) finds that policy should seek short-term credibility while implementing measures that restrict the path of expenditures together with simultaneous development of institutions and rules that constrain deficits and spending in the future. There is similar policy challenge in deleveraging banks, which is required for sound lending institutions, but without causing an adverse credit crunch. Advanced economies face a tough policy challenge of increasing demand and potential growth.
The President of the European Central Bank (ECB) Mario Draghi (2012May3) also outlines the appropriate policy mix for successful adjustment:
“It is of utmost importance to ensure fiscal sustainability and sustainable growth in the euro area. Most euro area countries made good progress in terms of fiscal consolidation in 2011. While the necessary comprehensive fiscal adjustment is weighing on near-term economic growth, its successful implementation will contribute to the sustainability of public finances and thereby to the lowering of sovereign risk premia. In an environment of enhanced confidence in fiscal balances, private sector activity should also be fostered, supporting private investment and medium-term growth.
At the same time, together with fiscal consolidation, growth and growth potential in the euro area need to be enhanced by decisive structural reforms. In this context, facilitating entrepreneurial activities, the start-up of new firms and job creation is crucial. Policies aimed at enhancing competition in product markets and increasing the wage and employment adjustment capacity of firms will foster innovation, promote job creation and boost longer-term growth prospects. Reforms in these areas are particularly important for countries which have suffered significant losses in cost competitiveness and need to stimulate productivity and improve trade performance.
In this context, let me make a few remarks on the adjustment process within the euro area. As we know from the experience of other large currency areas, regional divergences in economic developments are a normal feature. However, considerable imbalances have accumulated in the last decade in several euro area countries and they are now in the process of being corrected.
As concerns the monetary policy stance of the ECB, it has to be focused on the euro area. Our primary objective remains to maintain price stability over the medium term. This is the best contribution of monetary policy to fostering growth and job creation in the euro area.
Addressing divergences among individual euro area countries is the task of national governments. They must undertake determined policy actions to address major imbalances and vulnerabilities in the fiscal, financial and structural domains. We note that progress is being made in many countries, but several governments need to be more ambitious. Ensuring sound fiscal balances, financial stability and competitiveness in all euro area countries is in our common interest.”
Economic policy during the debt crisis of 1983 may be useful in analyzing the options of the euro area. Brazil successfully combined fiscal consolidation, structural reforms to eliminate subsidies and devaluation to parity. Brazil’s terms of trade, or export prices relative to import prices, deteriorated by 47 percent from 1977 to 1983 (Pelaez 1986, 46). Table III-12 provides selected economic indicators of the economy of Brazil from 1970 to 1985. In 1983, Brazil’s inflation was 164.9 percent, GDP fell 3.2 percent, idle capacity in manufacturing reached 24.0 percent and Brazil had an unsustainable foreign debt. US money center banks would have had negative capital if loans to emerging countries could have been marked according to loss given default and probability of default (for credit risk models see Pelaez and Pelaez (2005), International Financial Architecture, 134-54). Brazil’s current account of the balance of payments shrank from $16,310 million in 1982 to $6,837 million in 1983 because of the abrupt cessation of foreign capital inflows with resulting contraction of Brazil’s GDP by 3.2 percent. An important part of adjustment consisted of agile coordination of domestic production to cushion the impact of drastic reduction in imports. In 1984, Brazil had a surplus of $45 million in current account, the economy grew at 4.5 percent and inflation was stabilized at 232.9 percent.
Table III-12, Brazil, Selected Economic Indicators 1970-1985
| Inflation ∆% | GDP Growth ∆% | Idle Capacity in MFG % | BOP Current Account USD MM | |
| 1985 | 223.4 | 7.4 | 19.8 | -630 |
| 1984 | 232.9 | 4.5 | 22.6 | 45 |
| 1983 | 164.9 | -3.2 | 24.0 | -6,837 |
| 1982 | 94.0 | 0.9 | 15.2 | -16,310 |
| 1981 | 113.0 | -1.6 | 12.3 | -11,374 |
| 1980 | 109.2 | 7.2 | 3.5 | -12,886 |
| 1979 | 55.4 | 6.4 | 4.1 | -10,742 |
| 1978 | 38.9 | 5.0 | 3.3 | -6,990 |
| 1977 | 40.6 | 5.7 | 3.2 | -4,037 |
| 1976 | 40.4 | 9.7 | 0.0 | -6,013 |
| 1975 | 27.8 | 5.4 | 3.0 | -6,711 |
| 1974 | 29.1 | 9.7 | 0.1 | -7,122 |
| 1973 | 15.4 | 13.6 | 0.3 | -1,688 |
| 1972 | 17.7 | 11.1 | 6.5 | -1,489 |
| 1971 | 21.5 | 12.0 | 9.8 | -1,307 |
| 1970 | 19.3 | 8.8 | 12.2 | -562 |
Source: Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo, Editora Atlas, 1986, 86.
Chart III-2 provides the tortuous Phillips Circuit of Brazil from 1963 to 1987. There were no reliable consumer price index and unemployment data in Brazil for that period. Chart III-2 used the more reliable indicator of inflation, the wholesale price index, and idle capacity of manufacturing as a proxy of unemployment in large urban centers.
Chart III-2, Brazil, Phillips Circuit 1963-1987
Source:
©Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.
A key to success in stabilizing an economy with significant risk aversion is finding parity of internal and external interest rates. Brazil implemented fiscal consolidation and reforms that are advisable in explosive foreign debt environments. In addition, Brazil had the capacity to find parity in external and internal interest rates to prevent capital flight and disruption of balance sheets (for analysis of balance sheets, interest rates, indexing, devaluation, financial instruments and asset/liability management in that period see Pelaez and Pelaez (2007), The Global Recession Risk: Dollar Devaluation and the World Economy, 178-87). Table III-13 provides monthly percentage changes of inflation, devaluation and indexing and the monthly percent overnight interest rate. Parity was attained by means of a simple inequality:
Cost of Domestic Loan ≥ Cost of Foreign Loan
This ordering was attained in practice by setting the domestic interest rate of the overnight interest rate plus spread higher than indexing of government securities with lower spread than loans in turn higher than devaluation plus spread of foreign loans. Interest parity required equality of inflation, devaluation and indexing. Brazil devalued the cruzeiro by 30 percent in 1983 because the depreciation of the German mark DM relative to the USD had eroded the competitiveness of Brazil’s products in Germany and in competition with German goods worldwide. The database of the Board of Governors of the Federal Reserve System quotes DM 1.7829/USD on Mar 3 1980 and DM 2.4425/USD on Mar 15, 1983 (http://www.federalreserve.gov/releases/h10/hist/dat89_ge.htm) for devaluation of 37.0 percent. Parity of costs and rates of domestic and foreign loans and assets required ensuring that there would not be appreciation of the exchange rate, inducing capital flight in expectation of future devaluation that would have reversed stabilization. One of the main problems of adjustment of members of the euro area with high debts is that they cannot adjust the exchange rate because of the common euro currency. This is not an argument in favor of breaking the euro area because there would be also major problems of adjustment such as exiting the euro in favor of a new Drachma in the case of Greece. Another hurdle of adjustment in the euro area is that Brazil could have moved swiftly to adjust its economy in 1983 but the euro area has major sovereignty and distribution of taxation hurdles in moving rapidly.
Table III-13, Brazil, Inflation, Devaluation, Overnight Interest Rate and Indexing, Percent per Month, 1984
| 1984 | Inflation IGP ∆% | Devaluation ∆% | Overnight Interest Rate % | Indexing ∆% |
| Jan | 9.8 | 9.8 | 10.0 | 9.8 |
| Feb | 12.3 | 12.3 | 12.2 | 12.3 |
| Mar | 10.0 | 10.1 | 11.3 | 10.0 |
| Apr | 8.9 | 8.8 | 10.1 | 8.9 |
| May | 8.9 | 8.9 | 9.8 | 8.9 |
| Jun | 9.2 | 9.2 | 10.2 | 9.2 |
| Jul | 10.3 | 10.2 | 11.9 | 10.3 |
| Aug | 10.6 | 10.6 | 11.0 | 10.6 |
| Sep | 10.5 | 10.5 | 11.9 | 10.5 |
| Oct | 12.6 | 12.6 | 12.9 | 12.6 |
| Nov | 9.9 | 9.9 | 10.9 | 9.9 |
| Dec | 10.5 | 10.5 | 11.5 | 10.5 |
Source: Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo, Editora Atlas, 1986, 86.
© Carlos M. Pelaez, 2010, 2011, 2012
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