Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011, 2012
Executive Summary
I Mediocre and Decelerating United States Economic Growth
II Stagnating Real Disposable Income and Consumption Expenditures and Financial Repression
IIA Stagnating Real Disposable Income and Consumption Expenditures
IIA1 Collapse of United States Dynamism of Income Growth and Employment Creation
IIB Financial Repression
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 Collapse of United States Dynamism of Income Growth and Employment Creation. 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 Japan and France within the G7 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 ESI-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 6.80 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 1.3 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 1.8 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 ESI-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 | 6.80 | 2.2 | |
| RDPI | 3.8 | 1.3 | |
| RDPI per Capita | 1.4 | 0.5 | |
| Population | 2.3 | 0.8 | |
| IVQ2007 to IIQ2012 | 19 | ||
| GDP | 1.8 | ||
| 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
There are four basic facts illustrating the current economic disaster of the United States: GDP maintained trend growth in the entire business cycle from IQ1980 to IV1985, including contractions and expansions, but is well below trend in the entire business cycle from IVQ2007 to IIQ2012, including contractions and expansions; per capita real disposable income exceeded trend growth in the 1980s but is substantially below trend in IIQ2012; the number of employed persons increased in the 1980s but declined into IIQ2012; and the number of full-time employed persons increased in the 1980s but declined into IIQ2012. There is a critical issue of whether the United States economy will be able in the future to attain again the level of activity and prosperity of projected trend growth. Growth at trend during the entire business cycles built the largest economy in the world but there may be an adverse, permanent tilt in United States economic performance and prosperity. Table ESI-2 provides data for analysis of these four basic facts.
1. Trend Growth.
i. As shown in Table ESI-2, actual GDP grew cumulatively 17.7 percent from IQ1980 to IVQ1985, which is relatively close to what trend growth would have been at 18.5 percent. Rapid growth at 5.7 percent annual rate on average per quarter during the expansion from IQ1983 to IVQ1985 erased the loss of GDP of 4.8 percent during the contraction and maintained trend growth at 3 percent over the entire cycle.
ii. In contrast, cumulative growth from IVQ2007 to IIQ2012 was 1.8 percent while trend growth would have been 14.2 percent. GDP in IIQ2012 at seasonally adjusted annual rate is estimated at $13,564.5 percent by the Bureau of Economic Analysis (BEA) (http://www.bea.gov/iTable/index_nipa.cfm) and would have been $15,218.3 billion, or $1,653 billion higher, had the economy grown at trend over the entire business cycle as it happened during the 1980s and throughout most of US history. There is $1.7 trillion of foregone GDP that would have been created as it occurred during past cyclical expansions, which explains why employment has not rebounded to even higher than before. There would not be recovery of full employment even with growth of 3 percent per year beginning immediately because the opportunity was lost to grow faster during the expansion from IIIQ2009 to IIQ2012 after the recession from IVQ2007 to IIQ2009. The United States has acquired a heavy social burden of unemployment and underemployment of 28.8 million people or 17.9 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html) that will not be diminished even with return to growth of GDP of 3 percent per year because of growth of the labor force by new entrants. The US labor force grew from 142.583 million in 2000 to 153.124 million in 2007 or by 7.4 percent at the average yearly rate of 1.0 percent per year. The civilian noninstitutional population increased from 212.577 million in 2000 to 231.867 million in 2007 or 9.1 percent at the average yearly rate of 1.3 percent per year (data from http://www.bls.gov/data/). Data for the past five years cloud accuracy because of the number of people discouraged from seeking employment. The noninstitutional population of the United States increased from 231.867 million in 2007 to 239.618 million in 2011 or by 3.3 percent while the labor force increased from 153.124 million in 2007 to 153.617 million in 2011 or by 0.3 percent (data from http://www.bls.gov/data/). People ceased to seek jobs because they do not believe that there is a job available for them (see http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html).
2. Decline of Per Capita Real Disposable Income.
i. In the entire business cycle from IQ1980 to IVQ1985 (see Table ESI-2), trend growth of per capita real disposable income, or what is left per person after inflation and taxes, grew cumulatively 17.7 percent, which is close to what would have been trend growth of 18.5 percent.
ii. In contrast, in the entire business cycle from IVQ2007 to IIQ2012, per capita real disposable income fell 0.2 percent while trend growth would have been 9.3 percent. Income available after inflation and taxes is lower than before the contraction after 12 consecutive quarters of GDP growth at mediocre rates relative to those prevailing during historical cyclical expansions.
3. Number of Employed Persons.
i. As shown in Table ESI-2, the number of employed persons increased over the entire business cycle from 81.280 million not seasonally adjusted (NSA) in IQ1980 to 88.757 million NSA in IVQ1985 or by 9.2 percent.
ii. In contrast, during the entire business cycle the number employed fell from 146.334 million in IVQ2007 to 143.202 million in IIQ2012 or by 2.1 percent. There are 28.8 million persons unemployed or underemployed, which is 17.9 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html).
4. Number of Full-time Employed Persons.
i. As shown in Table ESI-2, during the entire business cycle in the 1980s, including contractions and expansion, the number of employed full-time rose from 81.280 million NSA in IQ1980 to 88.757 million NSA in IVQ1985 or 9.2 percent.
ii. In contrast, during the entire current business cycle, including contraction and expansion, the number of persons employed full-time fell from 121.042 million in IVQ2007 to 116.024 million in IIQ2012 or by minus 4.1 percent.
Table ESI-2, US, GDP and Real Disposable Personal Income per Capita Actual and Trend Growth and Employment, 1980-1985 and 2007-2012, SAAR USD Billions, Millions of Persons and ∆%
| Period IQ1980 to IVQ1985 | |
| GDP SAAR USD Billions | |
| IQ1980 | 5,903.4 |
| IVQ1985 | 6,950.0 |
| ∆% IQ1980 to IVQ1985 | 17.7 |
| ∆% Trend Growth IQ1980 to IVQ1985 | 18.5 |
| Real Disposable Personal Income per Capita IQ1980 Chained 2005 USD | 18,938 |
| Real Disposable Personal Income per Capita IVQ1985 Chained 2005 USD | 21,687 |
| ∆% IQ1980 to IVQ1985 | 14.5 |
| ∆% Trend Growth | 12.1 |
| Employed Millions IQ1980 NSA End of Quarter | 98.527 |
| Employed Millions IV1985 NSA End of Quarter | 107.819 |
| ∆% Employed IQ1980 to IV1985 | 9.4 |
| Employed Full-time Millions IQ1980 NSA End of Quarter | 81.280 |
| Employed Full-time Millions IV1985 NSA End of Quarter | 88.757 |
| ∆% Full-time Employed IQ1980 to IV1985 | 9.2 |
| Period IVQ2007 to IIQ2012 | |
| GDP SAAR USD Billions | |
| IVQ2007 | 13,326.0 |
| IIQ2012 | 13,564.5 |
| ∆% IVQ2007 to IIQ2012 | 1.8 |
| ∆% IVQ2007 to IIQ2012 | 14.2 |
| Real Disposable Personal Income per Capita IVQ2007 Chained 2005USD | 32,837 |
| Real Disposable Personal Income per Capita IIQ2012 Chained 2005 USD | 32,778 |
| ∆% IVQ2007 to IIQ2012 | -0.2 |
| ∆% Trend Growth | 9.3 |
| Employed Millions IVQ2007 NSA End of Quarter | 146.334 |
| Employed Millions IIQ2012 NSA End of Quarter | 143.202 |
| ∆% Employed IVQ2007 to IIQ2012 | -2.1 |
| Employed Full-time Millions IVQ2007 NSA End of Quarter | 121.042 |
| Employed Full-time Millions IIQ2012 NSA End of Quarter | 116.024 |
| ∆% Full-time Employed IVQ2007 to IIQ2012 | -4.1 |
Note: GDP trend growth used is 3.0 percent per year and GDP per capita is 2.0 percent per year as estimated by Lucas (2011May) on data from 1870 to 2010.
Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm US Bureau of Labor Statistics http://www.bls.gov/data/
ESII Mediocre and Decelerating United States Economic Growth. The US is experiencing the first expansion from a recession after World War II without growth and without jobs. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle the economy compensated with higher growth in expansions the losses of contractions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The expansion since the third quarter of 2009 (IIIQ2009 (Jun)) to the latest available measurement for IIQ(2012) has been at the average annual rate of 2.2 percent per quarter in contrast with 6.2 percent on average in all expansions after World War II. As a result, there are 28.8 million unemployed in the United States for an effective unemployment rate of 17.9 percent (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html).
The economy of the US can be summarized in growth of economic activity or GDP as decelerating from mediocre growth of 2.4 percent on an annual basis in 2010 and 1.8 percent in 2011 to cumulative growth of 0.92 percent in the first two quarters of 2012, which is equivalent to 1.85 percent. This rate is well below 3 percent per year in trend from 1870 to 2010, which has been always recovered after events such as wars and recessions (Lucas 2011May). Growth is not only mediocre but sharply decelerating to a rhythm that is not consistent with reduction of unemployment and underemployment of 28.8 million people (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html). In the four quarters of 2011 and the first two quarters of 2012, US real GDP grew at the seasonally-adjusted annual equivalent rates of 0.1 percent in the first quarter of 2011 (IQ2011), 2.5 percent in IIQ2011, 1.3 percent in IIIQ2011, 4.1 percent in IVQ2011, 2.0 percent in IQ2012 and 1.7 percent in IIQ2012. The annual equivalent rate of growth of GDP for the four quarters of 2011 and the first two quarters of 2012 is 1.9 percent, obtained as follows. Discounting 0.1 percent to one quarter is 0.025 percent {[(1.001)1/4 -1]100 = 0.025}; discounting 2.5 percent to one quarter is 0.62 percent {[(1.025)1/4 – 1]100}; discounting 1.3 percent to one quarter is 0.32 percent {[(1.013)1/4 – 1]100}; discounting 4.1 percent to one quarter is 1.0 {[(1.04)1/4 -1]100; discounting 2.0 percent to one quarter is 0.50 percent {(1.020)1/4 -1]100); and discounting 1.7 percent to one quarter is 0.42 percent {[(1.017)1/4 -1]100}. Real GDP growth in the four quarters of 2011 and the first two quarters of 2012 accumulated to 2.9 percent {[(1.00025 x 1.0062 x 1.0032 x 1.010 x 1.005 x 1.0042)-1]100 = 2.9%}. This is equivalent to growth from IQ2011 to IIQ2012 obtained by dividing the seasonally-adjusted annual rate (SAAR) of IIQ2012 of $13,564.5 billion by the SAAR of IVQ2010 of $13,181.2(http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1 and Table I-6 below) and expressing as percentage {[($13,564.5/$13,181.2)-1]100 = 2.9%}. The growth rate in annual equivalent for the four quarters of 2011 and the first two quarters of 2012 is 1.9 percent {[(1.00025 x 1.0062 x 1.0032 x 1.010 x 1.005 x 1.0042)4/6 -1]100 =1.9%], or {[($13,564.5/$13,181.2)4/6 -1]100 = 1.9%} dividing the SAAR of IIQ2012 by the SAAR of IVQ2010 in Table I-6 below, obtaining the average for six quarters and the annual average for one year of four quarters. Growth in the first two quarters of 2012 accumulates to 0.92 percent {(1.02)1/4(1.017)1/4 = 0.92%}, which is equivalent to 1.85 percent per year {([(1.02)1/4(1.015)1/4 ]2 – 1)100 = 1.85%}. The US economy is still close to a standstill especially considering the GDP report in detail. Excluding growth at the SAAR of 2.5 percent in IIQ2011 and 4.1 percent in IVQ2011, the US economy grew at 1.3 percent in the remaining four quarters {1.00025x1.0032x1.005x1.0042 = 1.27%} with declining growth trend in three consecutive quarters from 4.1 percent in IVQ2011, to 2.0 percent in IQ2012 and 1.7 percent in IIQ2012. The Bureau of Economic Analysis (BEA) of the US Department of Commerce released on Wed Aug 29, 2012, the second estimate of GDP for IIQ2012 at 1.7 percent seasonally-adjusted annual rate (SAAR) (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_2nd.pdf), incorporating revisions of earlier estimates back to 2009.
Historical parallels are instructive but have all the limitations of empirical research in economics. The more instructive comparisons are not with the Great Depression of the 1930s but rather with the recessions in the 1950s, 1970s and 1980s. The growth rates and job creation in the expansion of the economy away from recession are subpar in the current expansion compared to others in the past. Four recessions are initially considered, following the reference dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles/cyclesmain.html ): IIQ1953-IIQ1954, IIIQ1957-IIQ1958, IIIQ1973-IQ1975 and IQ1980-IIIQ1980. The data for the earlier contractions illustrate that the growth rate and job creation in the current expansion are inferior. The sharp contractions of the 1950s and 1970s are considered in Table ESII-1, showing the Bureau of Economic Analysis (BEA) quarter-to-quarter, seasonally adjusted (SA), yearly-equivalent growth rates of GDP. The recovery from the recession of 1953 consisted of four consecutive quarters of high percentage growth rates from IIIQ1954 to IIIQ1955: 4.6, 8.3, 12.0, 6.8 and 5.4. The recession of 1957 was followed by four consecutive high percentage growth rates from IIIQ1958 to IIQ1959: 9.7, 9.7, 8.3 and 10.5. The recession of 1973-1975 was followed by high percentage growth rates from IIQ1975 to IIQ1976: 6.9, 5.3, 9.4 and 3.0. The disaster of the Great Inflation and Unemployment of the 1970, which made stagflation notorious, is even better in growth rates during the expansion phase in comparison with the current slow-growth recession.
Table ESII-1, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| IQ | IIQ | IIIQ | IVQ | |
| 1953 | 7.7 | 3.1 | -2.4 | -6.2 |
| 1954 | -1.9 | 0.5 | 4.6 | 8.3 |
| 1955 | 12.0 | 6.8 | 5.4 | 2.3 |
| 1957 | 2.5 | -1.0 | 3.9 | -4.1 |
| 1958 | -10.4 | 2.5 | 9.7 | 9.7 |
| 1959 | 8.3 | 10.5 | -0.5 | 1.4 |
| 1973 | 10.6 | 4.7 | -2.1/ | 3.9 |
| 1974 | 3.5 | 1.0 | -3.9 | 6.9 |
| 1975 | -4.8 | 3.1 | 6.9 | 5.3 |
| 1976 | 9.4 | 3.0 | 2.0 | 2.9 |
| 1979 | 0.7 | 0.4 | 2.9 | 1.1 |
| 1980 | 1.3 | -7.9 | -0.7 | 7.6 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ1982 are combined, the impact of lost GDP of 4.8 percent is more comparable to the latest revised 4.7 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.5 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). Table ESII-2 provides the Bureau of Economic Analysis (BEA) quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981 to 1982 and 2007 to 2009, using the latest major revision published on Jul 29, 2011 (http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf) and the revision back to 2009 (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_adv.pdf) and second estimate for IIQ2012 (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_2nd.pdf), which are available in the dataset of the US Bureau of Economic Analysis (http://www.bea.gov/iTable/index_nipa.cfm). There were four quarters of contraction in 1981-1982 ranging in rate from -1.5 percent to -6.4 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.3 percent to -8.9 percent. The striking difference is that in the first twelve quarters of expansion from IQ1983 to IIIQ1985, shown in Table ESII-2 in relief, GDP grew at the high quarterly percentage growth rates of 5.1, 9.3, 8.1, 8.5, 8.0, 7.1, 3.9, 3.3, 3.8, 3.4, 6.4 and 3.1 while the percentage growth rates in the first twelve quarters of expansion from IIIQ2009 to IIQ2012, shown in relief in Table ESII-2, were mediocre: 1.4, 4.0, 2.3, 2.2, 2.6, 2.4, 0.1, 2.5, 1.3, 4.1, 2.0 and 1.7. Asterisks denote the estimates that have been revised by the BEA in the first round of Jul 29, 2011 and double asterisks the revisions released on Jul 27, 2012. During the four quarters of 2011 GDP grew at annual equivalent rates of 0.1 percent in IQ2011, 2.5 percent in IIQ2011, 1.3 percent in IIIQ2011 and 4.1 percent in IVQ2011 (http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html). The rate of growth of the US economy decelerated from seasonally-adjusted annual equivalent of 4.1 percent in IVQ2011 to 2.0 percent in IQ2012 and 1.7 percent in IIQ2012. Inventory change contributed to initial growth but was rapidly replaced by growth in investment and demand in 1983. Inventory accumulation contributed 2.53 percentage points to the rate of growth of 4.1 percent in IVQ2011, which is the only relatively high rate from IQ2011 to IIQ2012. Economic growth and employment creation are decelerating rapidly during the first half of 2012.
Table ESII-2, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| Q | 1981 | 1982 | 1983 | 1984 | 2008 | 2009 | 2010 |
| I | 8.6 | -6.4 | 5.1 | 8.0 | -1.8* | -5.3** | 2.3** |
| II | -3.2 | 2.2 | 9.3 | 7.1 | 1.3* | -0.3** | 2.2** |
| III | 4.9 | -1.5 | 8.1 | 3.9 | -3.7* | 1.4** | 2.6** |
| IV | -4.9 | 0.3 | 8.5 | 3.3 | -8.9* | 4.0** | 2.4** |
| 1985 | 2011 | ||||||
| I | 3.8 | 0.1** | |||||
| II | 3.4 | 2.5** | |||||
| III | 6.4 | 1.3** | |||||
| IV | 3.1 | 4.1** | |||||
| 1986 | 2012 | ||||||
| I | 3.9 | 2.0** | |||||
| II | 1.6 | 1.7 | |||||
| III | 3.9 | ||||||
| IV | 1.9 |
*Revision of Jul 29, 2011 **Revision of Jul 27, 2012
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart ESII-1 of the Bureau of Economic Analysis (BEA) provides strong growth of real quarterly GDP in the US between 1947 and 1999. There is an evident acceleration of the rate of GDP growth in the 1990s as shown by a much sharper slope of the growth curve. Cobet and Wilson (2002) define labor productivity as the value of manufacturing output produced per unit of labor input used (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). Between 1950 and 2000, labor productivity in the US grew less rapidly than in Germany and Japan. The major part of the increase in productivity in Germany and Japan occurred between 1950 and 1973 while the rate of productivity growth in the US was relatively subdued in several periods. While Germany and Japan reached their highest growth rates of productivity before 1973, the US accelerated its rate of productivity growth in the second half of the 1990s. Between 1950 and 2000, the rate of productivity growth in the US of 2.9 percent per year was much lower than 6.3 percent in Japan and 4.7 percent in Germany. Between 1995 and 2000, the rate of productivity growth of the US of 4.6 percent exceeded that of Japan of 3.9 percent and the rate of Germany of 2.6 percent.
Chart ESII-1, US, Real GDP 1947-1999
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart ESII-2 provides the growth of real quarterly GDP in the US between 1947 and 2011. The drop of output in the recession from IVQ2007 to IIQ2009 has been followed by anemic recovery compared with return to trend at 3.0 percent from 1870 to 2010 after events such as wars and recessions (Lucas 2011May) and a standstill that can lead to growth recession, or low rates of economic growth, but perhaps even another contraction or conventional recession.
Chart ESII-2, US, Real GDP 1947-2011
Source:
US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart ESII-3 provides real GDP percentage change on the quarter a year earlier for 1983-1984. The objective is simply to compare expansion in two recoveries from sharp contractions as shown in Table I-2. Growth rates in the early phase of the recovery in 1983 and 1984 were very high, which is the opportunity to reduce unemployment that has characterized cyclical expansion in the postwar US economy.
Chart ESII-3, Real GDP Percentage Change on Quarter a Year Earlier 1983-1985
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In contrast, growth rates in the comparable first eleven quarters of expansion from 2009 to 2012 in Chart ESII-4 have been mediocre. As a result, growth has not provided the exit from unemployment and underemployment as in other cyclical expansions in the postwar period. Growth rates did not rise in V shape as in earlier expansions and then declined close to the standstill of growth recessions.
Chart ESII-4, US, Real GDP Percentage Change on Quarter a Year Earlier 2009-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Table ESII-3 provides the change in real GDP in the United States in the 1930s, 1980s and 2000s. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). Data are available for the 1930s only on a yearly basis. US GDP fell 4.8 percent in the two recessions (1) from IQ1980 to IIIQ1980 and (2) from III1981 to IVQ1981 to IVQ1982 and 4.7 percent cumulatively in the recession from IVQ2007 to IIQ2009. It is instructive to compare the first two years of the expansions in the 1980s and the current expansion. GDP grew at 4.5 percent in 1983 and 7.2 percent in 1984 while GDP grew at 2.4 percent in 2010, 1.8 percent in 2011 and at 2.0 percent in IQ2012 relative to IQ2011 and 1.5 percent in IIQ2012 relative to IQ2012. Growth in the first two quarters of 2012 accumulates to 0.87 percent, which is equivalent to 1.75 percent per year, decelerating from 2.4 percent annual growth in 2011. GDP grew at 4.1 percent in 1985 and 3.5 percent in 1986 while the forecasts of participants of the Federal Open Market Committee (FOMC) are in the range of 1.9 to 2.4 percent in 2012 and 2.2 to 2.8 percent in 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120620.pdf).
Table ESII-3, US, Percentage Change of GDP in the 1930s, 1980s and 2000s, ∆%
| Year | GDP ∆% | Year | GDP ∆% | Year | GDP ∆% |
| 1930 | -8.6 | 1980 | -0.3 | 2000 | 4.1 |
| 1931 | -6.5 | 1981 | 2.5 | 2001 | 1.1 |
| 1932 | -13.1 | 1982 | -1.9 | 2002 | 1.8 |
| 1933 | -1.3 | 1983 | 4.5 | 2003 | 2.5 |
| 1934 | 10.9 | 1984 | 7.2 | 2004 | 3.5 |
| 1935 | 8.9 | 1985 | 4.1 | 2005 | 3.1 |
| 1936 | 13.1 | 1986 | 3.5 | 2006 | 2.7 |
| 1937 | 5.1 | 1987 | 3.2 | 2007 | 1.9 |
| 1938 | -3.4 | 1988 | 4.1 | 2008 | -0.3 |
| 1930 | 8.1 | 1989 | 3.6 | 2009 | -3.1 |
| 1940 | 8.8 | 1990 | 1.9 | 2010 | 2.4 |
| 1941 | 17.1 | 1991 | -0.2 | 2011 | 1.8 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart ESII-5 provides percentage change of GDP in the US during the 1930s. There is vast literature analyzing the Great Depression (Pelaez and Pelaez, Regulation of Banks and Finance (2009), 198-217). Cole and Ohanian (1999) find that US real per capita output was 11 percent lower in 1939 than in 1929 while the typical expansion of real per capita output in the US during a decade is 31 percent. Private hours worked in the US were 25 percent lower in 1939 than in 1929.
Chart ESII-5, US, Percentage Change of GDP in the 1930s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In contrast, Chart ESII-6 shows rapid recovery from the recessions in the 1980s. High growth rates in the initial quarters of expansion eliminated the unemployment and underemployment created during the contraction. The economy then returned to grow at the trend of expansion, interrupted by another contraction in 1991.
Chart ESII-6, US, Percentage Change of GDP in the 1980s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart ESII-7 provides the rates of growth during the 2000s. Growth rates in the initial eleven quarters of expansion have been relatively lower than during recessions after World War II. As a result, unemployment and underemployment continue at the rate of 17.9 percent of the US labor force (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html).
Chart ESII-7, US, Percentage Change of GDP in the 2000s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Characteristics of the four cyclical contractions are provided in Table ESII-4 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.8 percent, which is almost equal to the decline of 4.7 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). The comparison of the global recession after 2007 with the Great Depression is entirely misleading.
Table ESII-4, US, Number of Quarters, Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions
| Number of Quarters | Cumulative Percentage Contraction | Average Percentage Rate | |
| IIQ1953 to IIQ1954 | 4 | -2.5 | -0.63 |
| IIIQ1957 to IIQ1958 | 3 | -3.1 | -9.0 |
| IQ1980 to IIIQ1980 | 2 | -2.2 | -1.1 |
| IIIQ1981 to IVQ1982 | 4 | -2.7 | -0.67 |
| IVQ2007 to IIQ2009 | 6 | -4.7 | -0.80 |
Source: Business Cycle Reference Dates: http://www.nber.org/cycles/cyclesmain.html
Data: http://www.bea.gov/iTable/index_nipa.cfm
Table ESII-5 shows the extraordinary contrast between the mediocre average annual equivalent growth rate of 2.2 percent of the US economy in the twelve quarters of the current cyclical expansion from IIIQ2009 to IIQ2012 and the average of 6.2 percent in the four earlier cyclical expansions. BEA data show the US economy in standstill with annual growth of 2.4 percent in 2010 percent decelerating to 1.8 percent annual growth in 2011 (http://www.bea.gov/iTable/index_nipa.cfm) and cumulative 0.92 percent in the first half of 2012 {(1.02)1/4(1.017)1/4 = 0.92%}, which is equivalent to 1.85 percent per year {([(1.02)1/4(1.015)1/4 ]2 – 1)100 = 1.85%}. The expansion of IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent.
Table ESII-5, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions
| Number | Cumulative Growth ∆% | Average Annual Equivalent Growth Rate | |
| IIIQ 1954 to IQ1957 | 11 | 12.6 | 4.4 |
| IIQ1958 to IIQ1959 | 5 | 10.2 | 8.1 |
| IIQ1975 to IVQ1976 | 8 | 9.5 | 4.6 |
| IQ1983 to IV1985 | 13 | 19.6 | 5.7 |
| Average Four Above Expansions | 6.2 | ||
| IIIQ2009 to IIQ2012 | 12 | 6.80 | 2.2 |
Source: Business Cycle Reference Dates: http://www.nber.org/cycles/cyclesmain.html
Data: http://www.bea.gov/iTable/index_nipa.cfm
Chart ESII-8 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.
Chart ESII-8, US, Real GDP, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart ESII-9 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2012. The economy has underperformed during the first twelve quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.
Chart ESII-9, US, Real GDP, 2007-2012
Source: http://www.bea.gov/iTable/index_nipa.cfm
http://www.bea.gov/iTable/index_nipa.cfm
As shown in Tables ESII-4 and ESII-5 above the loss of real GDP in the US during the contraction was 5.1 percent but the gain in the cyclical expansion has been only 6.80 percent (last row in Table ESII-5), using all latest revisions. As a result, the level of real GDP in IIQ2012 with the first estimate and revisions is only higher by 1.8 percent than the level of real GDP in IVQ2007. Table ESII-6 provides in the second column real GDP in billions of chained 2005 dollars. The third column provides the percentage change of the quarter relative to IVQ2007; the fourth column provides the percentage change relative to the prior quarter; and the final fifth column provides the percentage change relative to the same quarter a year earlier. The contraction actually concentrated in two quarters: decline of 2.3 percent in IVQ2008 relative to the prior quarter and decline of 1.3 percent in IQ2009 relative to IVQ2008. The combined fall of GDP in IVQ2008 and IQ2009 was 3.6 percent {[(1-0.23) x (1-0.13) -1]100 = -3.6%}, or {[(IIQ2009 $12,711.0)/(IIIQ2008 $13,186.9) – 1]100 = -3.6%}. Those two quarters coincided with the worst effects of the financial crisis. GDP fell 0.1 percent in IIQ2009 but grew 0.4 percent in IIIQ2009, which is the beginning of recovery in the cyclical dates of the NBER. Most of the recovery occurred in four successive quarters from IVQ2009 to IIQ2010 of growth of 1.0 percent in IVQ2009 and equal growth at 0.6 percent in IQ2010, IIQ2010, IIIQ2010 and IVQ2010 for cumulative growth in those three quarters of 3.4 percent, obtained by accumulating the quarterly rates {[(1.01 x 1.006 x 1.006 x 1.006 x 1.006) – 1]100 = 3.4%} or {[(IVQ2010 $13,181.2)/(IIIQ2009 $12,746.7) – 1]100 = 3.4%}. The economy lost momentum already in 2010 growing at 0.6 percent in each quarter, or annual equivalent 2.4 per cent {[(1.006)4 – 1]100 = 2.4%}, compared with annual equivalent 4.0 percent in IV2009 {[(1.01)4 – 1]100 = 4.0%}. The economy then stalled during the first half of 2011 with growth of 0.0025 percent in IQ2011 and 0.6 percent in IIQ2011 for combined annual equivalent rate of 1.2 percent {(1.00025 x 1.006)2}. The economy grew 0.3 percent in IIIQ2011 for annual equivalent growth of 1.2 percent in the first three quarters {(1.00025 x 1.006 x 1.003)4/3}. Growth picked up in IVQ2011 with 1.0 percent relative to IIIQ2011. Growth in a quarter relative to a year earlier in Table ESII-6 slows from over 2.4 percent during three consecutive quarters from IIQ2010 to IVQ2010 to 1.8 percent in IQ2011, 1.9 percent in IIQ2011, 1.6 percent in IIIQ2011 and 2.0 percent in IVQ2011. As shown below, growth of 1.0 percent in IVQ2011 was partly driven by inventory accumulation. In IQ2012, GDP grew 0.5 percent relative to IVQ2011 and 2.4 percent relative to IQ2011, decelerating to 0.4 percent in IIQ2012 and 2.3 percent relative to IIQ2011. Rates of a quarter relative to the prior quarter capture better deceleration of the economy than rates on a quarter relative to the same quarter a year earlier. The critical question for which there is not yet definitive solution is whether what lies ahead is continuing growth recession with the economy crawling and unemployment/underemployment at extremely high levels or another contraction or conventional recession. Forecasts of various sources continued to maintain high growth in 2011 without taking into consideration the continuous slowing of the economy in late 2010 and the first half of 2011. The sovereign debt crisis in the euro area is one of the common sources of doubts on the rate and direction of economic growth in the US but there is weak internal demand in the US with almost no investment and spikes of consumption driven by burning saving because of financial repression forever in the form of zero interest rates.
Table ESII-6, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%
| Real GDP, Billions Chained 2005 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| IVQ2007 | 13,326.0 | NA | NA | 2.2 |
| IQ2008 | 13,266.8 | -0.4 | -0.4 | 1.6 |
| IIQ2008 | 13,310.5 | -0.1 | 0.3 | 1.0 |
| IIIQ2008 | 13,186.9 | -1.0 | -0.9 | -0.6 |
| IVQ2008 | 12,883.5 | -3.3 | -2.3 | -3.3 |
| IQ2009 | 12,711.0 | -4.6 | -1.3 | -4.2 |
| IIQ2009 | 12,701.0 | -4.7 | -0.1 | -4.6 |
| IIIQ2009 | 12,746.7 | -4.3 | 0.4 | -3.3 |
| IV2009 | 12,873.1 | -3.4 | 1.0 | -0.1 |
| IQ2010 | 12,947.6 | -2.8 | 0.6 | 1.9 |
| IIQ2010 | 13,019.6 | -2.3 | 0.6 | 2.5 |
| IIIQ2010 | 13,103.5 | -1.7 | 0.6 | 2.8 |
| IVQ2010 | 13,181.2 | -1.1 | 0.6 | 2.4 |
| IQ2011 | 13,183.8 | -1.1 | 0.0 | 1.8 |
| IIQ2011 | 13,264.7 | -0.5 | 0.6 | 1.9 |
| IIIQ2011 | 13,306.9 | -0.1 | 0.3 | 1.6 |
| IV2011 | 13,441.0 | 0.9 | 1.0 | 2.0 |
| IQ2012 | 13,506.4 | 1.4 | 0.5 | 2.4 |
| IIQ2012 | 13,564.5 | 1.8 | 0.4 | 2.3 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
ESIII Financial Repression. As Friedman (1970, 27) argues on who are harmed by interest rate controls under Regulation Q that caused interest rates below inflation:
“These are the people who have the fewest alternative ways to invest their limited assets and are least sophisticated about the alternatives.”
Chart ESIII-1 of the Bureau of Economic Analysis (BEA) provides quarterly savings as percent of disposable income or the US savings rate from 1980 to 2012. There was a long-term downward sloping trend from 12 percent in the early 1980s to less than 2 percent in 2005-2006. The savings rate then rose during the contraction and also in the expansion. In 2011 and into 2012 the savings rate declined as consumption is financed with savings in part because of the disincentive or frustration of receiving a few pennies for every $10,000 of deposits in a bank. The savings rate increased in the final segment of Chart ESIII-1 in 2012.The objective of monetary policy is to reduce borrowing rates to induce consumption but it has collateral disincentive of reducing savings. The zero interest rate of monetary policy is a tax on saving. This tax is highly regressive, meaning that it affects the most people with lower income or wealth and retirees. The long-term decline of savings rates in the US has created a dependence on foreign savings to finance the deficits in the federal budget and the balance of payments.
Chart ESIII-1, US, Personal Savings as a Percentage of Disposable Personal Income, Quarterly, 1980-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart ESIII-2 of the US Bureau of Economic Analysis provides personal savings as percent of personal disposable income, or savings ratio, from Jan 2007 to Jun 2012. The uncertainties caused by the global recession resulted in sharp increase in the savings ratio that peaked at 8.3 percent in May 2008 (http://www.bea.gov/iTable/index_nipa.cfm). The second highest ratio occurred at 6.7 percent in May 2009. There was another rising trend until 5.8 percent in Jun 2010 and then steady downward trend until trough of 3.2 percent in Jan 2012, which was followed by an upward trend with 4.2 percent in Jul 2012, marginally lower than 4.3 percent in Jun 2012. Permanent manipulation of the entire spectrum of interest rates with monetary policy measures distorts the compass of resource allocation with inferior outcomes of future growth, employment and prosperity and dubious redistribution of income and wealth affecting the most people without vast capital and relations to manage their savings.
Chart ESIII-2, US, Personal Savings as a Percentage of Disposable Income, Monthly 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
ESIV World Economic and Trade Slowdown. Table ESIV-3 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-3, 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 (Section VB at http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with_26.html). 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. 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. Charles Forelle, writing on “Judgment days arrive for euro crisis,” on Aug 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444772804577621212619274608.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes critical events after the return of holidays in Sep: (1) ECB meeting on Sep 6 when details of bond buying may be revealed; (2) presentation by Greece on Sep 9 of new budget austerity measures to representatives of the European Union, European Central Bank and IMF; (3) ruling on Sep 12 by the German Constitutional Court on the constitutionality of the European Stability Mechanism (ESM); (4) elections in the Netherlands on Sep 12; and various meetings in the second-half of Sep of European finance ministers and leaders. Jon Hilsenrath, writing on “Fed sets stage for stimulus,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443864204577623220212805132.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the essay presented by Chairman Bernanke at the Jackson Hole meeting of central bankers, as defending past stimulus with unconventional measures of monetary policy that could be used to reduce extremely high unemployment. Chairman Bernanke (2012JHAug31, 18-9) does support further unconventional monetary policy impulses if required by economic conditions (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm):
“Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
Professor John H Cochrane (2012Aug31), at the University of Chicago Booth School of Business, writing on “The Federal Reserve: from central bank to central planner,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444812704577609384030304936.html?mod=WSJ_hps_sections_opinion), analyzes that the departure of central banks from open market operations into purchase of assets with risks to taxpayers and direct allocation of credit subject to political influence has caused them to abandon their political independence and accountability. Cochrane (2012Aug31) finds a return to the proposition of Milton Friedman in the 1960s that central banks can cause inflation and macroeconomic instability.
Mario Draghi (2012Aug29), President of the European Central Bank, also reiterated the need of exceptional and unconventional central bank policies (http://www.ecb.int/press/key/date/2012/html/sp120829.en.html):
“Yet it should be understood that fulfilling our mandate sometimes requires us to go beyond standard monetary policy tools. When markets are fragmented or influenced by irrational fears, our monetary policy signals do not reach citizens evenly across the euro area. We have to fix such blockages to ensure a single monetary policy and therefore price stability for all euro area citizens. This may at times require exceptional measures. But this is our responsibility as the central bank of the euro area as a whole.
The ECB is not a political institution. But it is committed to its responsibilities as an institution of the European Union. As such, we never lose sight of our mission to guarantee a strong and stable currency. The banknotes that we issue bear the European flag and are a powerful symbol of European identity.”
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. On Aug 31, the yield of the 10-year sovereign bond of Italy rose to 5.787 percent and that of Spain to 6.832 percent. 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 moved 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 trend was interrupted with decline of the yield of the ten-year Treasury note to 1.543 percent on Aug 31, 2012, and of the ten-year German bond to 1.33 percent. 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. Further risk aversion is captured by decline of yield of the two-year Treasury note to 0.225 percent on Aug 31, 2012, and to -0.03 percent for the two-year sovereign bond of Germany while the USD moved in opposite direction, depreciating to USD 1.2575/EUR. 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 | |
| 8/31/12 | 0.225 | 1.543 | -0.03 | 1.33 | 1.2575 |
| 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 Aug 1, 2001-Aug 30, 2012
Note: US Recessions in shaded areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
ESVI Global Financial and Economic Risk. The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task both for theory and measurement. The IMF provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2012/update/01/index.htm), of the world financial system with its Global Financial Stability Report (GFSR) (http://www.imf.org/external/pubs/ft/fmu/eng/2012/01/index.htm) and of fiscal affairs with the Fiscal Monitor (http://www.imf.org/external/pubs/ft/fm/2012/update/01/fmindex.htm). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider a summary of global economic and financial risks, which are analyzed in detail in the comments of this blog in Section VI Valuation of Risk Financial Assets, Table VI-4.
Economic risks include the following:
1. China’s Economic Growth. China is lowering its growth target to 7.5 percent per year. The growth rate of GDP of China in the 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 8/31/12,” 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. Bernanke (2012JHAug31) and Draghi (2012Aug29) generated risk enthusiasm in the week of Aug 31, 2012. The highest valuations in column “∆% Trough to 8/31/12” are by US equities indexes: DJIA 35.1 percent and S&P 500 37.6 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 8/31/12” 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 14.1 percent below the trough; Japan’s Nikkei Average is 0.2 percent above the trough; DJ Asia Pacific TSM is 5.0 percent above the trough; Dow Global is 9.8 percent above the trough; STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 9.2 percent above the trough; and NYSE Financial is 8.0 percent above the trough. DJ UBS Commodities is 17.8 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 0.2 percent above the trough on Aug 31, 2010 and 22.4 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 8839.91 on Fri Aug 31, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 13.8 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 5.5 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 8/31/12” in Table ESVI-1 shows that there were decreases of valuations of risk financial assets in the week of Aug 31, 2012 such as 0.9 percent for STOXX 50, 2.0 percent DJ Asia Pacific TSM, 2.5 percent Japan’s Nikkei Average and 0.8 percent for Dow Global. NYSE Financial gained 0.1 percent and DAX was unchanged in the week. DJ UBS Commodities increased 0.5 percent. China’s Shanghai Composite fell 2.1 percent. The DJIA decreased 0.5 percent and S&P 500 decreased 0.3 percent. The USD depreciated 0.5 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 8/31/12” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Aug 31, 2012. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 8/31/12” but also relative to the peak in column “∆% Peak to 8/31/12.” There are now only three equity indexes above the peak in Table ESVI-1: DJIA 16.8 percent, S&P 500 15.5 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 14.0 percent, Nikkei Average by 22.4 percent, Shanghai Composite by 35.3 percent, DJ Asia Pacific by 8.1 percent, STOXX 50 by 7.5 percent and Dow Global by 10.4 percent. DJ UBS Commodities Index is now 0.7 percent above the peak. The US dollar strengthened 16.9 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 8/31/ /12 | ∆% Week 8/31/12 | ∆% Trough to 8/31/ 12 | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 16.8 | -0.5 | 35.1 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 15.5 | -0.3 | 37.6 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | -14.0 | 0.1 | 8.0 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | -10.4 | -0.8 | 9.8 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | -8.1 | -2.0 | 5.0 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | -22.4 | -2.5 | 0.2 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -35.3 | -2.1 | -14.1 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -7.5 | -0.9 | 9.2 |
| DAX | 4/26/ | 5/25/ | -10.5 | 10.1 | 0.0 | 22.9 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 16.9 | -0.5 | -5.5 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | 0.7 | 0.5 | 17.8 |
| 10-Year T Note | 4/5/ | 4/6/10 | 3.986 | 1.543 |
T: trough; Dollar: positive sign appreciation relative to euro (less dollars paid per euro), negative sign depreciation relative to euro (more dollars paid per euro)
Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
I Mediocre and Decelerating United States Economic Growth. The US is experiencing the first expansion from a recession after World War II without growth and without jobs. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle the economy compensated with higher growth in expansions the losses of contractions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The expansion since the third quarter of 2009 (IIIQ2009 (Jun)) to the latest available measurement for IIQ(2012) has been at the average annual rate of 2.2 percent per quarter in contrast with 6.2 percent on average in all expansions after World War II. As a result, there are 28.8 million unemployed in the United States for an effective unemployment rate of 17.9 percent (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html).
The economy of the US can be summarized in growth of economic activity or GDP as decelerating from mediocre growth of 2.4 percent on an annual basis in 2010 and 1.8 percent in 2011 to cumulative growth of 0.92 percent in the first two quarters of 2012, which is equivalent to 1.85 percent. This rate is well below 3 percent per year in trend from 1870 to 2010, which has been always recovered after events such as wars and recessions (Lucas 2011May). Growth is not only mediocre but sharply decelerating to a rhythm that is not consistent with reduction of unemployment and underemployment of 28.8 million people (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html). In the four quarters of 2011 and the first two quarters of 2012, US real GDP grew at the seasonally-adjusted annual equivalent rates of 0.1 percent in the first quarter of 2011 (IQ2011), 2.5 percent in IIQ2011, 1.3 percent in IIIQ2011, 4.1 percent in IVQ2011, 2.0 percent in IQ2012 and 1.7 percent in IIQ2012. The annual equivalent rate of growth of GDP for the four quarters of 2011 and the first two quarters of 2012 is 1.9 percent, obtained as follows. Discounting 0.1 percent to one quarter is 0.025 percent {[(1.001)1/4 -1]100 = 0.025}; discounting 2.5 percent to one quarter is 0.62 percent {[(1.025)1/4 – 1]100}; discounting 1.3 percent to one quarter is 0.32 percent {[(1.013)1/4 – 1]100}; discounting 4.1 percent to one quarter is 1.0 {[(1.04)1/4 -1]100; discounting 2.0 percent to one quarter is 0.50 percent {(1.020)1/4 -1]100); and discounting 1.7 percent to one quarter is 0.42 percent {[(1.017)1/4 -1]100}. Real GDP growth in the four quarters of 2011 and the first two quarters of 2012 accumulated to 2.9 percent {[(1.00025 x 1.0062 x 1.0032 x 1.010 x 1.005 x 1.0042)-1]100 = 2.9%}. This is equivalent to growth from IQ2011 to IIQ2012 obtained by dividing the seasonally-adjusted annual rate (SAAR) of IIQ2012 of $13,564.5 billion by the SAAR of IVQ2010 of $13,181.2(http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1 and Table I-6 below) and expressing as percentage {[($13,564.5/$13,181.2)-1]100 = 2.9%}. The growth rate in annual equivalent for the four quarters of 2011 and the first two quarters of 2012 is 1.9 percent {[(1.00025 x 1.0062 x 1.0032 x 1.010 x 1.005 x 1.0042)4/6 -1]100 =1.9%], or {[($13,564.5/$13,181.2)4/6 -1]100 = 1.9%} dividing the SAAR of IIQ2012 by the SAAR of IVQ2010 in Table I-6 below, obtaining the average for six quarters and the annual average for one year of four quarters. Growth in the first two quarters of 2012 accumulates to 0.92 percent {(1.02)1/4(1.017)1/4 = 0.92%}, which is equivalent to 1.85 percent per year {([(1.02)1/4(1.015)1/4 ]2 – 1)100 = 1.85%}. The US economy is still close to a standstill especially considering the GDP report in detail. Excluding growth at the SAAR of 2.5 percent in IIQ2011 and 4.1 percent in IVQ2011, the US economy grew at 1.3 percent in the remaining four quarters {1.00025x1.0032x1.005x1.0042 = 1.27%} with declining growth trend in three consecutive quarters from 4.1 percent in IVQ2011, to 2.0 percent in IQ2012 and 1.7 percent in IIQ2012. The Bureau of Economic Analysis (BEA) of the US Department of Commerce released on Wed Aug 29, 2012, the second estimate of GDP for IIQ2012 at 1.7 percent seasonally-adjusted annual rate (SAAR) (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_2nd.pdf), incorporating revisions of earlier estimates back to 2009. The objective of this section is analyzing US economic growth. There is initial brief discussion of the concept of “slow-growth recession” followed by comparison of the current growth experience of the US with earlier expansions after past deep contractions and consideration of recent performance.
The concept of growth recession was popular during the stagflation from the late 1960s to the early 1980s. The economy of the US underperformed with several recession episodes in “stop and go” fashion of policy and economic activity while the rate of inflation rose to the highest in a peacetime period (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/05/global-inflation-seigniorage-monetary.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html Appendix I; see Taylor 1993, 1997, 1999, 1998LB, 2012Mar27, 2012Mar28, 2012FP, 2012JMCB). A growth recession could be defined as a period in which economic growth is insufficient to move the economy toward full employment of humans, equipment and other productive resources. The US is experiencing a dramatic slow growth recession with 28.819 million people in job stress, consisting of an effective number of unemployed of 17.974 million, 8.316 million employed part-time because they cannot find full employment and 2.529 million marginally attached to the labor force (see Table I-4 http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html). The discussion of the growth recession issue in the 1970s by two recognized economists of the twentieth century, James Tobin and Paul A. Samuelson, is worth recalling.
In analysis of the design of monetary policy in 1974, Tobin (1974, 219) finds that the forecast of the President’s Council of Economic Advisers (CEA) was also the target such that monetary policy would have to be designed and implemented to attain that target. The concern was with maintaining full employment as provided in the Employment Law of 1946 (http://www.law.cornell.edu/uscode/15/1021.html http://uscode.house.gov/download/pls/15C21.txt http://www.eric.ed.gov/PDFS/ED164974.pdf) see http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html), which also created the CEA. Tobin (1974, 219) describes the forecast/target of the CEA for 1974:
“The expected and approved path appears to be quarter-to-quarter rates of growth of real gross national product in 1974 of roughly -0.5, 0.1, and 1 percent, with unemployment rising to about 5.6 percent in the second quarter and remaining there the rest of the year. The rate of price inflation would fall shortly in the second quarter, but rise slightly toward the end of the year.”
Referring to monetary policy design, Tobin (1974, 221) states: “if interest rates remain stable or rise during the current (growth) recession and recovery, this will be a unique episode in business cycle annals.” Subpar economic growth is often called a “growth recession.” The critically important concept is that economic growth is not sufficient to move the economy toward full employment, creating the social and economic adverse outcome of idle capacity and unemployed and underemployed workers, much the same as currently.
The unexpected incidence of inflation surprises during growth recessions is considered by Samuelson (1974, 76):
“Indeed, if there were in Las Vegas or New York a continuous casino on the money GNP of 1974’s fourth quarter, it would be absurd to think that the best economic forecasters could improve upon the guess posted there. Whatever knowledge and analytical skill they possess would already have been fed into the bidding. It is a manifest contradiction to think that most economists can be expected to do better than their own best performance. I am saying that the best forecasters have been poor in predicting the general price level’s movements and level even a year ahead. By Valentine’s Day 1973 the best forecasters were beginning to talk of the growth recession that we now know did set in at the end of the first quarter. Aside from their end-of-1972 forecasts, the fashionable crowd has little to blame itself for when it comes to their 1973 real GNP projections. But, of course, they did not foresee the upward surge of food and decontrolled industrial prices. This has been a recurring pattern: surprise during the event at the virulence of inflation, wisdom after the event in demonstrating that it did, after all, fit with past patterns of experience.”
Economists are known for their forecasts being second only to those of astrologers. Accurate forecasts are typically realized for the wrong reasons. In contrast with meteorologists, economists do not even agree on what happened. There is not even agreement on what caused the global recession and why the economy has reached a perilous standstill.
Historical parallels are instructive but have all the limitations of empirical research in economics. The more instructive comparisons are not with the Great Depression of the 1930s but rather with the recessions in the 1950s, 1970s and 1980s. The growth rates and job creation in the expansion of the economy away from recession are subpar in the current expansion compared to others in the past. Four recessions are initially considered, following the reference dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles/cyclesmain.html ): IIQ1953-IIQ1954, IIIQ1957-IIQ1958, IIIQ1973-IQ1975 and IQ1980-IIIQ1980. The data for the earlier contractions illustrate that the growth rate and job creation in the current expansion are inferior. The sharp contractions of the 1950s and 1970s are considered in Table I-1, showing the Bureau of Economic Analysis (BEA) quarter-to-quarter, seasonally adjusted (SA), yearly-equivalent growth rates of GDP. The recovery from the recession of 1953 consisted of four consecutive quarters of high percentage growth rates from IIIQ1954 to IIIQ1955: 4.6, 8.3, 12.0, 6.8 and 5.4. The recession of 1957 was followed by four consecutive high percentage growth rates from IIIQ1958 to IIQ1959: 9.7, 9.7, 8.3 and 10.5. The recession of 1973-1975 was followed by high percentage growth rates from IIQ1975 to IIQ1976: 6.9, 5.3, 9.4 and 3.0. The disaster of the Great Inflation and Unemployment of the 1970, which made stagflation notorious, is even better in growth rates during the expansion phase in comparison with the current slow-growth recession.
Table I-1, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| IQ | IIQ | IIIQ | IVQ | |
| 1953 | 7.7 | 3.1 | -2.4 | -6.2 |
| 1954 | -1.9 | 0.5 | 4.6 | 8.3 |
| 1955 | 12.0 | 6.8 | 5.4 | 2.3 |
| 1957 | 2.5 | -1.0 | 3.9 | -4.1 |
| 1958 | -10.4 | 2.5 | 9.7 | 9.7 |
| 1959 | 8.3 | 10.5 | -0.5 | 1.4 |
| 1973 | 10.6 | 4.7 | -2.1/ | 3.9 |
| 1974 | 3.5 | 1.0 | -3.9 | 6.9 |
| 1975 | -4.8 | 3.1 | 6.9 | 5.3 |
| 1976 | 9.4 | 3.0 | 2.0 | 2.9 |
| 1979 | 0.7 | 0.4 | 2.9 | 1.1 |
| 1980 | 1.3 | -7.9 | -0.7 | 7.6 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ1982 are combined, the impact of lost GDP of 4.8 percent is more comparable to the latest revised 4.7 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.5 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). Table I-2 provides the Bureau of Economic Analysis (BEA) quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981 to 1982 and 2007 to 2009, using the latest major revision published on Jul 29, 2011 (http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf) and the revision back to 2009 (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_adv.pdf) and second estimate for IIQ2012 (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_2nd.pdf), which are available in the dataset of the US Bureau of Economic Analysis (http://www.bea.gov/iTable/index_nipa.cfm). There were four quarters of contraction in 1981-1982 ranging in rate from -1.5 percent to -6.4 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.3 percent to -8.9 percent. The striking difference is that in the first twelve quarters of expansion from IQ1983 to IIIQ1985, shown in Table I-2 in relief, GDP grew at the high quarterly percentage growth rates of 5.1, 9.3, 8.1, 8.5, 8.0, 7.1, 3.9, 3.3, 3.8, 3.4, 6.4 and 3.1 while the percentage growth rates in the first twelve quarters of expansion from IIIQ2009 to IIQ2012, shown in relief in Table I-2, were mediocre: 1.4, 4.0, 2.3, 2.2, 2.6, 2.4, 0.1, 2.5, 1.3, 4.1, 2.0 and 1.7. Asterisks denote the estimates that have been revised by the BEA in the first round of Jul 29, 2011 and double asterisks the revisions released on Jul 27, 2012. During the four quarters of 2011 GDP grew at annual equivalent rates of 0.1 percent in IQ2011, 2.5 percent in IIQ2011, 1.3 percent in IIIQ2011 and 4.1 percent in IVQ2011 (http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html). The rate of growth of the US economy decelerated from seasonally-adjusted annual equivalent of 4.1 percent in IVQ2011 to 2.0 percent in IQ2012 and 1.7 percent in IIQ2012. Inventory change contributed to initial growth but was rapidly replaced by growth in investment and demand in 1983. Inventory accumulation contributed 2.53 percentage points to the rate of growth of 4.1 percent in IVQ2011, which is the only relatively high rate from IQ2011 to IIQ2012. Economic growth and employment creation are decelerating rapidly during the first half of 2012.
Table I-2, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| Q | 1981 | 1982 | 1983 | 1984 | 2008 | 2009 | 2010 |
| I | 8.6 | -6.4 | 5.1 | 8.0 | -1.8* | -5.3** | 2.3** |
| II | -3.2 | 2.2 | 9.3 | 7.1 | 1.3* | -0.3** | 2.2** |
| III | 4.9 | -1.5 | 8.1 | 3.9 | -3.7* | 1.4** | 2.6** |
| IV | -4.9 | 0.3 | 8.5 | 3.3 | -8.9* | 4.0** | 2.4** |
| 1985 | 2011 | ||||||
| I | 3.8 | 0.1** | |||||
| II | 3.4 | 2.5** | |||||
| III | 6.4 | 1.3** | |||||
| IV | 3.1 | 4.1** | |||||
| 1986 | 2012 | ||||||
| I | 3.9 | 2.0** | |||||
| II | 1.6 | 1.7 | |||||
| III | 3.9 | ||||||
| IV | 1.9 |
*Revision of Jul 29, 2011 **Revision of Jul 27, 2012
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart I-1 of the Bureau of Economic Analysis (BEA) provides strong growth of real quarterly GDP in the US between 1947 and 1999. There is an evident acceleration of the rate of GDP growth in the 1990s as shown by a much sharper slope of the growth curve. Cobet and Wilson (2002) define labor productivity as the value of manufacturing output produced per unit of labor input used (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). Between 1950 and 2000, labor productivity in the US grew less rapidly than in Germany and Japan. The major part of the increase in productivity in Germany and Japan occurred between 1950 and 1973 while the rate of productivity growth in the US was relatively subdued in several periods. While Germany and Japan reached their highest growth rates of productivity before 1973, the US accelerated its rate of productivity growth in the second half of the 1990s. Between 1950 and 2000, the rate of productivity growth in the US of 2.9 percent per year was much lower than 6.3 percent in Japan and 4.7 percent in Germany. Between 1995 and 2000, the rate of productivity growth of the US of 4.6 percent exceeded that of Japan of 3.9 percent and the rate of Germany of 2.6 percent.
Chart I-1, US, Real GDP 1947-1999
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-2 provides the growth of real quarterly GDP in the US between 1947 and 2011. The drop of output in the recession from IVQ2007 to IIQ2009 has been followed by anemic recovery compared with return to trend at 3.0 percent from 1870 to 2010 after events such as wars and recessions (Lucas 2011May) and a standstill that can lead to growth recession, or low rates of economic growth, but perhaps even another contraction or conventional recession.
![clip_image004[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesDFDC20\RGDO4711chart%5b3%5d.png "clip_image004[1]")
Chart I-2, US, Real GDP 1947-2011
Source:
US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-3 provides real GDP percentage change on the quarter a year earlier for 1983-1984. The objective is simply to compare expansion in two recoveries from sharp contractions as shown in Table I-2. Growth rates in the early phase of the recovery in 1983 and 1984 were very high, which is the opportunity to reduce unemployment that has characterized cyclical expansion in the postwar US economy.
Chart I-3, Real GDP Percentage Change on Quarter a Year Earlier 1983-1985
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In contrast, growth rates in the comparable first eleven quarters of expansion from 2009 to 2012 in Chart I-4 have been mediocre. As a result, growth has not provided the exit from unemployment and underemployment as in other cyclical expansions in the postwar period. Growth rates did not rise in V shape as in earlier expansions and then declined close to the standstill of growth recessions.
Chart I-4, US, Real GDP Percentage Change on Quarter a Year Earlier 2009-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Table I-3 provides the change in real GDP in the United States in the 1930s, 1980s and 2000s. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). Data are available for the 1930s only on a yearly basis. US GDP fell 4.8 percent in the two recessions (1) from IQ1980 to IIIQ1980 and (2) from III1981 to IVQ1981 to IVQ1982 and 4.7 percent cumulatively in the recession from IVQ2007 to IIQ2009. It is instructive to compare the first two years of the expansions in the 1980s and the current expansion. GDP grew at 4.5 percent in 1983 and 7.2 percent in 1984 while GDP grew at 2.4 percent in 2010, 1.8 percent in 2011 and at 2.0 percent in IQ2012 relative to IQ2011 and 1.5 percent in IIQ2012 relative to IQ2012. Growth in the first two quarters of 2012 accumulates to 0.87 percent, which is equivalent to 1.75 percent per year, decelerating from 2.4 percent annual growth in 2011. GDP grew at 4.1 percent in 1985 and 3.5 percent in 1986 while the forecasts of participants of the Federal Open Market Committee (FOMC) are in the range of 1.9 to 2.4 percent in 2012 and 2.2 to 2.8 percent in 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120620.pdf).
Table I-3, US, Percentage Change of GDP in the 1930s, 1980s and 2000s, ∆%
| Year | GDP ∆% | Year | GDP ∆% | Year | GDP ∆% |
| 1930 | -8.6 | 1980 | -0.3 | 2000 | 4.1 |
| 1931 | -6.5 | 1981 | 2.5 | 2001 | 1.1 |
| 1932 | -13.1 | 1982 | -1.9 | 2002 | 1.8 |
| 1933 | -1.3 | 1983 | 4.5 | 2003 | 2.5 |
| 1934 | 10.9 | 1984 | 7.2 | 2004 | 3.5 |
| 1935 | 8.9 | 1985 | 4.1 | 2005 | 3.1 |
| 1936 | 13.1 | 1986 | 3.5 | 2006 | 2.7 |
| 1937 | 5.1 | 1987 | 3.2 | 2007 | 1.9 |
| 1938 | -3.4 | 1988 | 4.1 | 2008 | -0.3 |
| 1930 | 8.1 | 1989 | 3.6 | 2009 | -3.1 |
| 1940 | 8.8 | 1990 | 1.9 | 2010 | 2.4 |
| 1941 | 17.1 | 1991 | -0.2 | 2011 | 1.8 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart I-5 provides percentage change of GDP in the US during the 1930s. There is vast literature analyzing the Great Depression (Pelaez and Pelaez, Regulation of Banks and Finance (2009), 198-217). Cole and Ohanian (1999) find that US real per capita output was 11 percent lower in 1939 than in 1929 while the typical expansion of real per capita output in the US during a decade is 31 percent. Private hours worked in the US were 25 percent lower in 1939 than in 1929.
![clip_image010[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfiles2D17740\RGDPPcCh3041chart3.png "clip_image010[1]")
Chart I-5, US, Percentage Change of GDP in the 1930s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In contrast, Chart I-6 shows rapid recovery from the recessions in the 1980s. High growth rates in the initial quarters of expansion eliminated the unemployment and underemployment created during the contraction. The economy then returned to grow at the trend of expansion, interrupted by another contraction in 1991.
Chart I-6, US, Percentage Change of GDP in the 1980s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-7 provides the rates of growth during the 2000s. Growth rates in the initial eleven quarters of expansion have been relatively lower than during recessions after World War II. As a result, unemployment and underemployment continue at the rate of 17.9 percent of the US labor force (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html).
Chart I-7, US, Percentage Change of GDP in the 2000s
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Characteristics of the four cyclical contractions are provided in Table I-4 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.8 percent, which is almost equal to the decline of 4.7 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). The comparison of the global recession after 2007 with the Great Depression is entirely misleading.
Table I-4, US, Number of Quarters, Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions
| Number of Quarters | Cumulative Percentage Contraction | Average Percentage Rate | |
| IIQ1953 to IIQ1954 | 4 | -2.5 | -0.63 |
| IIIQ1957 to IIQ1958 | 3 | -3.1 | -9.0 |
| IQ1980 to IIIQ1980 | 2 | -2.2 | -1.1 |
| IIIQ1981 to IVQ1982 | 4 | -2.7 | -0.67 |
| IVQ2007 to IIQ2009 | 6 | -4.7 | -0.80 |
Source: Business Cycle Reference Dates: http://www.nber.org/cycles/cyclesmain.html
Data: http://www.bea.gov/iTable/index_nipa.cfm
Table I-5 shows the extraordinary contrast between the mediocre average annual equivalent growth rate of 2.2 percent of the US economy in the twelve quarters of the current cyclical expansion from IIIQ2009 to IIQ2012 and the average of 6.2 percent in the four earlier cyclical expansions. BEA data show the US economy in standstill with annual growth of 2.4 percent in 2010 percent decelerating to 1.8 percent annual growth in 2011 (http://www.bea.gov/iTable/index_nipa.cfm) and cumulative 0.92 percent in the first half of 2012 {(1.02)1/4(1.017)1/4 = 0.92%}, which is equivalent to 1.85 percent per year {([(1.02)1/4(1.015)1/4 ]2 – 1)100 = 1.85%}. The expansion of IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent.
Table I-5, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions
| Number | Cumulative Growth ∆% | Average Annual Equivalent Growth Rate | |
| IIIQ 1954 to IQ1957 | 11 | 12.6 | 4.4 |
| IIQ1958 to IIQ1959 | 5 | 10.2 | 8.1 |
| IIQ1975 to IVQ1976 | 8 | 9.5 | 4.6 |
| IQ1983 to IV1985 | 13 | 19.6 | 5.7 |
| Average Four Above Expansions | 6.2 | ||
| IIIQ2009 to IIQ2012 | 12 | 6.80 | 2.2 |
Source: Business Cycle Reference Dates: http://www.nber.org/cycles/cyclesmain.html
Data: http://www.bea.gov/iTable/index_nipa.cfm
Chart I-8 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.
Chart I-8, US, Real GDP, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-9 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2012. The economy has underperformed during the first twelve quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.
Chart I-9, US, Real GDP, 2007-2012
Source: http://www.bea.gov/iTable/index_nipa.cfm
http://www.bea.gov/iTable/index_nipa.cfm
As shown in Tables I-4 and I-5 above the loss of real GDP in the US during the contraction was 5.1 percent but the gain in the cyclical expansion has been only 6.80 percent (last row in Table I-5), using all latest revisions. As a result, the level of real GDP in IIQ2012 with the first estimate and revisions is only higher by 1.8 percent than the level of real GDP in IVQ2007. Table I-6 provides in the second column real GDP in billions of chained 2005 dollars. The third column provides the percentage change of the quarter relative to IVQ2007; the fourth column provides the percentage change relative to the prior quarter; and the final fifth column provides the percentage change relative to the same quarter a year earlier. The contraction actually concentrated in two quarters: decline of 2.3 percent in IVQ2008 relative to the prior quarter and decline of 1.3 percent in IQ2009 relative to IVQ2008. The combined fall of GDP in IVQ2008 and IQ2009 was 3.6 percent {[(1-0.23) x (1-0.13) -1]100 = -3.6%}, or {[(IIQ2009 $12,711.0)/(IIIQ2008 $13,186.9) – 1]100 = -3.6%}. Those two quarters coincided with the worst effects of the financial crisis. GDP fell 0.1 percent in IIQ2009 but grew 0.4 percent in IIIQ2009, which is the beginning of recovery in the cyclical dates of the NBER. Most of the recovery occurred in four successive quarters from IVQ2009 to IIQ2010 of growth of 1.0 percent in IVQ2009 and equal growth at 0.6 percent in IQ2010, IIQ2010, IIIQ2010 and IVQ2010 for cumulative growth in those three quarters of 3.4 percent, obtained by accumulating the quarterly rates {[(1.01 x 1.006 x 1.006 x 1.006 x 1.006) – 1]100 = 3.4%} or {[(IVQ2010 $13,181.2)/(IIIQ2009 $12,746.7) – 1]100 = 3.4%}. The economy lost momentum already in 2010 growing at 0.6 percent in each quarter, or annual equivalent 2.4 per cent {[(1.006)4 – 1]100 = 2.4%}, compared with annual equivalent 4.0 percent in IV2009 {[(1.01)4 – 1]100 = 4.0%}. The economy then stalled during the first half of 2011 with growth of 0.0025 percent in IQ2011 and 0.6 percent in IIQ2011 for combined annual equivalent rate of 1.2 percent {(1.00025 x 1.006)2}. The economy grew 0.3 percent in IIIQ2011 for annual equivalent growth of 1.2 percent in the first three quarters {(1.00025 x 1.006 x 1.003)4/3}. Growth picked up in IVQ2011 with 1.0 percent relative to IIIQ2011. Growth in a quarter relative to a year earlier in Table I-6 slows from over 2.4 percent during three consecutive quarters from IIQ2010 to IVQ2010 to 1.8 percent in IQ2011, 1.9 percent in IIQ2011, 1.6 percent in IIIQ2011 and 2.0 percent in IVQ2011. As shown below, growth of 1.0 percent in IVQ2011 was partly driven by inventory accumulation. In IQ2012, GDP grew 0.5 percent relative to IVQ2011 and 2.4 percent relative to IQ2011, decelerating to 0.4 percent in IIQ2012 and 2.3 percent relative to IIQ2011. Rates of a quarter relative to the prior quarter capture better deceleration of the economy than rates on a quarter relative to the same quarter a year earlier. The critical question for which there is not yet definitive solution is whether what lies ahead is continuing growth recession with the economy crawling and unemployment/underemployment at extremely high levels or another contraction or conventional recession. Forecasts of various sources continued to maintain high growth in 2011 without taking into consideration the continuous slowing of the economy in late 2010 and the first half of 2011. The sovereign debt crisis in the euro area is one of the common sources of doubts on the rate and direction of economic growth in the US but there is weak internal demand in the US with almost no investment and spikes of consumption driven by burning saving because of financial repression forever in the form of zero interest rates.
Table I-6, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%
| Real GDP, Billions Chained 2005 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| IVQ2007 | 13,326.0 | NA | NA | 2.2 |
| IQ2008 | 13,266.8 | -0.4 | -0.4 | 1.6 |
| IIQ2008 | 13,310.5 | -0.1 | 0.3 | 1.0 |
| IIIQ2008 | 13,186.9 | -1.0 | -0.9 | -0.6 |
| IVQ2008 | 12,883.5 | -3.3 | -2.3 | -3.3 |
| IQ2009 | 12,711.0 | -4.6 | -1.3 | -4.2 |
| IIQ2009 | 12,701.0 | -4.7 | -0.1 | -4.6 |
| IIIQ2009 | 12,746.7 | -4.3 | 0.4 | -3.3 |
| IV2009 | 12,873.1 | -3.4 | 1.0 | -0.1 |
| IQ2010 | 12,947.6 | -2.8 | 0.6 | 1.9 |
| IIQ2010 | 13,019.6 | -2.3 | 0.6 | 2.5 |
| IIIQ2010 | 13,103.5 | -1.7 | 0.6 | 2.8 |
| IVQ2010 | 13,181.2 | -1.1 | 0.6 | 2.4 |
| IQ2011 | 13,183.8 | -1.1 | 0.0 | 1.8 |
| IIQ2011 | 13,264.7 | -0.5 | 0.6 | 1.9 |
| IIIQ2011 | 13,306.9 | -0.1 | 0.3 | 1.6 |
| IV2011 | 13,441.0 | 0.9 | 1.0 | 2.0 |
| IQ2012 | 13,506.4 | 1.4 | 0.5 | 2.4 |
| IIQ2012 | 13,564.5 | 1.8 | 0.4 | 2.3 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Chart I-10 provides the percentage change of real GDP from the same quarter a year earlier from 1980 to 1989. There were two contractions almost in succession in 1980 and from 1981 to 1983. The expansion was marked by initial high rates of growth as in other recession in the postwar US period during which employment lost in the contraction was recovered. Growth rates continued to be high after the initial phase of expansion.
Chart I-10, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
The experience of recovery after 2009 is not as complete as during the 1980s. Chart I-11 shows the much lower rates of growth in the early phase of the current expansion and how they have sharply declined from an early peak. The US missed the initial high growth rates in cyclical expansions during which unemployment and underemployment are eliminated.
Chart I-11, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-12 provides growth rates from a quarter relative to the prior quarter during the 1980s. There is the same strong initial growth followed by a long period of sustained growth.
Chart I-12, Percentage Change of Real Gross Domestic Product from Prior Quarter 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-13 provides growth rates in a quarter relative to the prior quarter from 2007 to 2012. Growth in the current expansion after IIIQ2009 has not been as strong as in other postwar cyclical expansions.
Chart I-13, Percentage Change of Real Gross Domestic Product from Prior Quarter 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
The revised estimates and earlier estimates from IQ2008 to IQ2012 in seasonally adjusted annual equivalent rates are shown in Table I-7. The strongest revision is for IVQ2008 for which the contraction of GDP is revised from minus 6.8 percent to minus 8.9 percent. IQ2009 is also revised from contraction of minus 4.9 percent to minus 6.7 percent but then lowered to contraction of 5.3 percent. There is only minor revision in IIIQ2008 of the contraction of minus 4.0 percent to minus 3.7 percent. Growth of 5.0 percent in IV2009 is revised to 3.8 percent and then increased to 4.0 percent. Growth in IQ2010 is lowered from 3.9 percent to 2.3 percent. Growth in IIQ2010 is upwardly revised to 3.8 percent but then lowered to 2.2 percent. The revisions do not alter the conclusion that the current expansion is much weaker than historical sharp contractions since the 1950s and is now changing into slow growth recession with higher risks of contraction.
Table I-7, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA, Revised and Earlier Estimates
| Quarters | Revised Estimate Jul 27, 2012 | Revised Estimate Jul 29, 2011 | Earlier Estimate |
| 2008 | |||
| I | -1.8 | -0.7 | |
| II | 1.3 | 0.6 | |
| III | -3.7 | -4.0 | |
| IV | -8.9 | -6.8 | |
| 2009 | |||
| I | -5.3 | -6.7 | -4.9 |
| II | -0.3 | -0.7 | -0.7 |
| III | 1.4 | 1.7 | 1.6 |
| IV | 4.0 | 3.8 | 5.0 |
| 2010 | |||
| I | 2.3 | 3.9 | 3.7 |
| II | 2.2 | 3.8 | 1.7 |
| III | 2.6 | 2.5 | 2.6 |
| IV | 2.4 | 2.3 | 3.1 |
| 2011 | |||
| I | 0.1 | 0.4 | 1.9 |
| II | 2.5 | ||
| III | 1.3 | ||
| IV | 4.1 | ||
| 2012 | |||
| I | 2.0 | ||
| II | 1.7 |
Source: http://www.bea.gov/iTable/index_nipa.cfm
Contributions to the rate of growth of GDP in percentage points (PP) are provided in Table I-8. Aggregate demand, personal consumption expenditures (PCE) and gross private domestic investment (GDI) were much stronger during the expansion phase in IQ1983 to IIQ1984 than in IIIQ2009 to IIQ2012. GDI provided the impulse of growth in 1983 and 1984, which has not been the case from 2009 to 2012. The investment decision in the US economy has been frustrated in the current cyclical expansion. Growth of GDP in IIQ2012 of 1.7 percent at seasonally-adjusted annual rate (SAAR) consisted of positive contributions of 1.20 percentage points of personal consumption expenditures (PCE) + 0.40 percentage points of gross domestic investment (GDI) but inventory change deducting 0.23 percentage points (∆ PI) plus 0.32 percentage points of net exports (net trade or exports less imports) minus 0.18 percentage points of government consumption expenditures and gross investment (GOV). The contribution of PCE fell from 1.72 percentage points in IQ2012 to 1.20 percentage points in IIQ2012 as savings increased. The contribution of GDI decreased from 0.78 percentage points in IQ2012 to 0.40 percentage points in IIQ2012 with inventory accumulation deducting 0.23 percentage points in IIQ2012 relative to deduction of 0.39 percentage points in IQ2012. Growth in IVQ2011 was driven mainly by increase in private inventories of 2.53 percentage points.
Table I-8, US, Contributions to the Rate of Growth of GDP in Percentage Points
| GDP | PCE | GDI | ∆ PI | Trade | GOV | |
| 2012 | ||||||
| II | 1.7 | 1.20 | 0.40 | -0.23 | 0.32 | -0.18 |
| I | 2.0 | 1.72 | 0.78 | -0.39 | 0.06 | -0.60 |
| 2011 | ||||||
| I | 0.1 | 2.22 | -0.68 | -0.54 | 0.03 | -1.49 |
| II | 2.5 | 0.70 | 1.40 | 0.01 | 0.54 | -0.16 |
| III | 1.3 | 1.18 | 0.68 | -1.07 | 0.02 | -0.60 |
| IV | 4.1 | 1.45 | 3.72 | 2.53 | -0.64 | -0.43 |
| 2010 | ||||||
| I | 2.3 | 1.72 | 2.13 | 2.23 | -0.83 | -0.69 |
| II | 2.2 | 1.81 | 1.65 | 0.07 | -1.81 | 0.59 |
| III | 2.6 | 1.75 | 1.87 | 1.97 | -0.95 | -0.06 |
| IV | 2.4 | 2.84 | -0.75 | -1.61 | 1.24 | -0.94 |
| 2009 | ||||||
| I | -5.3 | -1.06 | -7.02 | -2.29 | 2.45 | 0.37 |
| II | -0.3 | -1.21 | -3.52 | -1.03 | 2.47 | 1.94 |
| III | 1.4 | 1.50 | -0.14 | 0.19 | -0.70 | 0.79 |
| IV | 4.0 | -0.01 | 3.85 | 4.55 | -0.05 | 0.23 |
| 1982 | ||||||
| I | -6.4 | 1.62 | -7.50 | -5.47 | -0.49 | -0.03 |
| II | 2.2 | 0.90 | -0.05 | 2.35 | 0.84 | 0.50 |
| III | -1.5 | 1.92 | -0.72 | 1.15 | -3.31 | 0.57 |
| IV | 0.3 | 4.64 | -5.66 | -5.48 | -0.10 | 1.44 |
| 1983 | ||||||
| I | 5.1 | 2.54 | 2.20 | 0.94 | -0.30 | 0.63 |
| II | 9.3 | 5.22 | 5.87 | 3.51 | -2.54 | 0.75 |
| III | 8.1 | 4.66 | 4.30 | 0.60 | -2.32 | 1.48 |
| IV | 8.5 | 4.20 | 6.84 | 3.09 | -1.17 | -1.35 |
| 1984 | ||||||
| I | 8.0 | 2.35 | 7.15 | 5.07 | -2.37 | 0.86 |
| II | 7.1 | 3.75 | 2.44 | -0.30 | -0.89 | 1.79 |
| III | 3.9 | 2.02 | 1.67 | 0.21 | -0.36 | 0.62 |
| IV | 3.3 | 3.38 | -1.26 | -2.50 | -0.58 | 1.75 |
| 1985 | ||||||
| I | 3.8 | 4.34 | -2.38 | -2.94 | 0.91 | 0.95 |
| II | 3.4 | 2.35 | 1.24 | 0.35 | -2.01 | 1.85 |
| III | 6.4 | 4.91 | -0.68 | -0.16 | -0.01 | 2.18 |
| IV | 3.1 | 0.54 | 2.72 | 1.45 | -0.68 | 0.50 |
Note: PCE: personal consumption expenditures; GDI: gross private domestic investment; ∆ PI: change in private inventories; Trade: net exports of goods and services; GOV: government consumption expenditures and gross investment; – is negative and no sign positive
GDP: percent change at annual rate; percentage points at annual rates
Source: http://www.bea.gov/iTable/index_nipa.cfm
The Bureau of Economic Analysis (BEA) (http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_2nd.pdf 1-2) explains growth of GDP in IIQ2012 in terms of positive growth contributions shown in Table I-9:
· Personal consumption expenditures (PCE) growing at 1.7 percent but with stagnant consumption of durable goods
· Exports growing at 6.0 percent
· Nonresidential fixed investment (NRFI) growing at 4.2 percent
· Residential fixed investment (RFI) growing at 8.9 percent
There were negative contributions in IIQ2012:
· Federal government spending (Federal GOV) declining at 0.1 percent
· Private inventory investment of minus 0.23 percentage points
· State and local government spending (State/Local GOV) falling at 1.4 percent
· Imports, which are deduction from growth, growing at 2.9 percent
The BEA explains deceleration in real GDP in IIQ2012 by:
· Deceleration in PCE from growth at 2.4 percent in IQ2012 to 1.7 percent in IIQ2012
· Deceleration in growth of NRFI from 7.5 percent in IQ2012 to 4.2 percent in IIQ2012
· Deceleration in growth of RFI from 20.5 percent in IQ2012 to 8.9 percent in IIQ2012
The BEA finds offsetting causes of deceleration in IIQ2012:
· Acceleration of private inventory investment from deduction of 0.39 percentage points in IQ2012 to deduction of 0.23 percentage points in IIQ2012
· Deceleration in contraction of government from minus 3.0 percent in IQ2012 to minus 0.9 percent in IIQ2012
· Deceleration in import growth from 3.1 percent in IQ2012 to 2.9 percent in IIQ2012
Acceleration in export growth from 4.4 percent in IQ2012 to 6.0 percent in IIQ2012
Table I-9, US, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase, %
| IIQ 2011 | IIIQ 2011 | IVQ 2011 | IQ 2012 | IIQ 2012 | |
| GDP | 2.5 | 1.3 | 4.1 | 2.0 | 1.7 |
| PCE | 1.0 | 1.7 | 2.0 | 2.4 | 1.7 |
| Durable Goods | -2.3 | 5.4 | 13.9 | 11.5 | 0.0 |
| NRFI | 14.5 | 19.0 | 9.5 | 7.5 | 4.2 |
| RFI | 4.1 | 1.4 | 12.1 | 20.5 | 8.9 |
| Exports | 4.1 | 6.1 | 1.4 | 4.4 | 6.0 |
| Imports | 0.1 | 4.7 | 4.9 | 3.1 | 2.9 |
| GOV | -0.8 | -2.9 | -2.2 | -3.0 | -0.9 |
| Federal GOV | 2.8 | -4.3 | -4.4 | -4.2 | -0.1 |
| State/Local GOV | -3.2 | -2.0 | -0.7 | -2.2 | -1.4 |
| ∆ PI (PP) | 0.01 | -1.07 | 2.53 | -0.39 | -0.23 |
| Final Sales of Domestic Product | 2.4 | 2.3 | 1.5 | 2.4 | 2.0 |
| Gross Domestic Purchases | 1.9 | 1.2 | 4.6 | 1.8 | 1.4 |
| Prices Gross | 3.5 | 2.3 | 0.9 | 2.5 | 0.8 |
| Prices of GDP | 2.6 | 3.0 | 0.4 | 2.0 | 1.6 |
| Prices of GDP Excluding Food and Energy | 2.6 | 2.1 | 0.9 | 2.6 | 1.4 |
| Prices of PCE | 3.6 | 2.3 | 1.1 | 2.5 | 0.7 |
| Prices of PCE Excluding Food and Energy | 2.3 | 1.9 | 1.3 | 2.2 | 1.8 |
| Prices of Market Based PCE | 3.8 | 2.6 | 1.2 | 2.5 | 0.6 |
| Prices of Market Based PCE Excluding Food and Energy | 2.3 | 2.1 | 1.5 | 2.2 | 1.7 |
| Real Disposable Personal Income* | 1.2 | 0.6 | 0.3 | 0.2 | 1.3 |
| Personal Savings As % Disposable Income | 4.6 | 3.9 | 3.4 | 3.6 | 4.0 |
Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in
private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income
*Percent change from quarter one year ago
Source: http://www.bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp2q12_2nd.pdf
Percentage shares of GDP are shown in Table I-10. PCE is equivalent to 71.0 percent of GDP and is under pressure with stagnant real disposable income, high levels of unemployment and underemployment and higher savings rates than before the global recession, temporarily interrupted by financial repression in the form of zero interest rates. Gross private domestic investment is also growing slowly even with about two trillions of dollars in cash holdings by companies. In a slowing world economy, it may prove more difficult to grow exports faster than imports to generate higher growth. Bouts of risk aversion revalue the dollar relative to most currencies in the world as investors increase their holdings of dollar-denominated assets.
Table I-10, US, Percentage Shares of GDP, %
| IIQ2012 | |
| GDP | 100.0 |
| PCE | 71.0 |
| Goods | 24.0 |
| Durable | 7.7 |
| Nondurable | 16.3 |
| Services | 47.0 |
| Gross Private Domestic Investment | 13.2 |
| Fixed Investment | 12.7 |
| NRFI | 10.4 |
| RFI | 2.4 |
| Change in Private | 0.4 |
| Net Exports of Goods and Services | -3.7 |
| Exports | 14.1 |
| Goods | 9.9 |
| Services | 4.1 |
| Imports | 17.7 |
| Goods | 14.8 |
| Services | 2.9 |
| Government | 19.6 |
| Federal | 7.8 |
| State and Local | 11.8 |
PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment
Source: http://www.bea.gov/iTable/index_nipa.cfm
Table I-11 shows percentage point (PP) contributions to the annual levels of GDP growth in the earlier recessions 1958-1959, 1975-1976, 1982-1983 and 2009, 2010 and 2011. The data incorporate the new revisions released by the BEA on Jul 29, 2011 and Jul 27, 2012 and the first estimate of 2012 GDP released on Jul 27, 2012. The most striking contrast is in the rates of growth of annual GDP in the expansion phases of 7.2 percent in 1959, 4.5 percent in 1983 followed by 7.2 percent in 1984 and 4.1 percent in 1985 but only 2.4 percent in 2010 after six consecutive quarters of growth and 1.8 percent in 2011 after ten consecutive quarters of expansion. Annual levels also show much stronger growth of PCEs in the expansions after the earlier contractions than in the expansion after the global recession of 2007. Gross domestic investment was much stronger in the earlier expansions than in 2010 and 2011.
Table I-11, US, Percentage Point Contributions to the Annual Growth Rate of GDP
| GDP | PCE | GDI | ∆ PI | Trade | GOV | |
| 1958 | -0.9 | 0.54 | -1.25 | -0.18 | -0.89 | 0.70 |
| 1959 | 7.2 | 3.61 | 2.80 | 0.86 | 0.00 | 0.76 |
| 1975 | -0.2 | 1.40 | -2.98 | -1.27 | 0.89 | 0.48 |
| 1976 | 5.4 | 3.51 | 2.84 | 1.41 | -1.08 | 0.10 |
| 1982 | -1.9 | 0.86 | -2.55 | -1.34 | -0.60 | 0.35 |
| 1983 | 4.5 | 3.65 | -1.45 | 0.29 | -1.35 | 0.76 |
| 1984 | 7.2 | 3.43 | 4.63 | 1.95 | -1.58 | 0.70 |
| 1985 | 4.1 | 3.32 | -0.17 | -1.06 | -0.42 | 1.41 |
| 2009 | -3.1 | -1.36 | -3.59 | -0.78 | 1.14 | 0.74 |
| 2010 | 2.4 | 1.28 | 1.50 | 1.52 | -0.52 | 0.14 |
| 2011 | 1.8 | 1.79 | 0.62 | -0.14 | 0.07 | -0.67 |
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
Table I-12 provides more detail of the contributions to growth of GDP from 2009 to 2011 using annual-level data. PCEs contributed 1.28 PPs to GDP growth in 2010 of which 0.82 percentage points (PP) in goods and 0.46 PP in services. Gross private domestic investment (GPDI) deducted 3.59 PPs of GDP growth in 2009 of which -2.80 PPs by fixed investment and -0.78 PPs of inventory change (∆PI) and added 1.50 PPs of GPDI in 2010 of which minus 0.03 PPs of fixed investment and 1.52 PPs of inventory accumulation (∆PI). Trade, or exports of goods and services net of imports, contributed 1.14 PPs in 2009 of which exports deducted 1.14 PPs and imports added 2.28 PPs. In 2010, trade deducted 0.52 PPs with exports contributing 1.29 PPs and imports deducting 1.81 PPs likely benefitting from dollar devaluation. In 2009, government added 0.74 PP of which 0.46 PPs by the federal government and 0.28 PPs by state and local government; in 2010, government added 0.14 PPs of which 0.37 PPs by the federal government with state and local government deducting 0.23 PPs. The final column of Table II-12 provides the estimate for 2011. PCE contributed 1.79 PPs in 2011 after 1.28 PPs in 2010. The breakdown into goods and services is similar. Gross private domestic investment contributed 1.50 PPs in 2010 with addition of 1.52 PPs of change of private inventories but the contribution of gross private domestic investment was only 0.62 PPs in 2011. Net exports of goods and services contributed marginally in 2011 with 0.07 PPs. Government deducted 0.67 PPs in 2011. The expansion since IIIQ2009 has been characterized by weak contributions of aggregate demand, which is the sum of personal consumption expenditures plus gross private domestic investment. The US did not recover strongly from the global recessions as typical in past cyclical expansions. Recovery tends to be more sluggish as the expansion matures. At the margin in IVQ2011 the acceleration of expansion was driven by inventory accumulation instead of aggregate demand of consumption and investment. Growth of PCE was partly the result of burning savings because of financial repression, which may not be sustainable in the future.
Table I-12, US, Contributions to Growth of Gross Domestic Product in Percentage Points
| 2009 | 2010 | 2011 | |
| GDP Growth ∆% | -3.1 | 2.4 | 1.8 |
| Personal Consumption Expenditures (PCE) | -1.36 | 1.28 | 1.79 |
| Goods | -0.69 | 0.82 | 0.89 |
| Durable | -0.41 | 0.45 | 0.53 |
| Nondurable | -0.28 | 0.37 | 0.36 |
| Services | -0.67 | 0.46 | 0.90 |
| Gross Private Domestic Investment (GPDI) | -3.59 | 1.50 | 0.62 |
| Fixed Investment | -2.80 | -0.03 | 0.76 |
| Nonresidential | -2.08 | 0.07 | 0.80 |
| Structures | -0.85 | -0.50 | 0.07 |
| Equipment, software | -1.23 | 0.56 | 0.72 |
| Residential | -0.73 | -0.09 | -0.03 |
| Change Private Inventories | -0.78 | 1.52 | -0.14 |
| Net Exports of Goods and Services | 1.14 | -0.52 | 0.07 |
| Exports | -1.14 | 1.29 | 0.87 |
| Goods | -1.05 | 1.11 | 0.65 |
| Services | -0.10 | 0.18 | 0.22 |
| Imports | 2.28 | -1.81 | -0.80 |
| Goods | 2.19 | -1.74 | -0.72 |
| Services | 0.09 | -0.07 | -0.08 |
| Government Consumption Expenditures and Gross Investment | 0.74 | 0.14 | -0.67 |
| Federal | 0.46 | 0.37 | -0.23 |
| National Defense | 0.31 | 0.17 | -0.15 |
| Nondefense | 0.16 | 0.20 | -0.09 |
| State and Local | 0.28 | -0.23 | -0.43 |
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
Table I-13 provides national income by industry without capital consumption adjustment (WCCA). “Private industries” or economic activities have share of 86.5 percent in US national income in IQ2012 and 86.4 percent in IIQ2012. Most of US national income is in the form of services. In Jul 2012, there were 132.868 million nonfarm jobs NSA in the US, according to estimates of the establishment survey of the Bureau of Labor Statistics (BLS) (http://www.bls.gov/news.release/pdf/empsit.pdf Table B-1, 28). Total private jobs of 112.192 million NSA in Jul 2012 accounted for 84.4 percent of total nonfarm jobs of 132.868 million, of which 12.050 million, or 10.7 percent of total private jobs and 9.1 percent of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 93.507 million NSA in Jul 2012, or 70.4 percent of total nonfarm jobs and 83.4 percent of total private-sector jobs. Manufacturing has share of 11.0 percent in US national income in IQ2011, as shown in Table I-13. Most income in the US originates in services. Subsidies and similar measures designed to increase manufacturing jobs will not increase economic growth and employment and may actually reduce growth by diverting resources away from currently employment-creating activities because of the drain of taxation.
Table I-13, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total
| SAAR IQ2012 | % Total | SAAR | % Total | |
| National Income WCCA | 13,788.3 | 100.0 | 13,873.7 | 100.0 |
| Domestic Industries | 13,573.4 | 98.4 | 13,639.1 | 98.3 |
| Private Industries | 11,922.7 | 86.5 | 11,985.9 | 86.4 |
| Agriculture | 134.0 | 1.0 | ||
| Mining | 211.0 | 1.5 | ||
| Utilities | 211.9 | 1.5 | ||
| Construction | 585.6 | 4.3 | ||
| Manufacturing | 1521.9 | 11.0 | ||
| Durable Goods | 865.2 | 6.3 | ||
| Nondurable Goods | 656.6 | 4.8 | ||
| Wholesale Trade | 831.6 | 6.0 | ||
| Retail Trade | 947.5 | 6.9 | ||
| Transportation & WH | 416.5 | 3.0 | ||
| Information | 486.7 | 3.5 | ||
| Finance, insurance, RE | 2301.3 | 16.7 | ||
| Professional, BS | 1955.0 | 14.2 | ||
| Education, Health Care | 1380.8 | 10.0 | ||
| Arts, Entertainment | 541.1 | 3.9 | ||
| Other Services | 397.9 | 2.9 | ||
| Government | 1650.7 | 12.0 | 1653.3 | 11.9 |
| Rest of the World | 214.9 | 1.6 | 234.6 | 1.7 |
Notes: SSAR: Seasonally-Adjusted Annual Rate; WCCA: Without Capital Consumption Adjustment by Industry; WH: Warehousing; RE, includes rental and leasing: Real Estate; Art, Entertainment includes recreation, accommodation and food services; BS: business services
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
II Stagnating Real Disposable Income and Consumption Expenditures and Financial Repression. Subsection IIA Stagnating Real Disposable Income and Consumption Expenditures provides analysis of the personal income and consumption outlays of the Bureau of Economic Analysis (BEA) for Jul 2012. Subsection IIB Repression of Savings analyzes financial repression and how it is affecting savings and wealth allocation in the US.
Subsection IIA Stagnating Real Disposable Income and Consumption Expenditures. The data on personal income and consumption have been revised back to 2003 as it the case of the national accounts (GDP revisions, which are covered in http://cmpassocregulationblog.blogspot.com/2012/07/decelerating-united-states-recovery.html). The release of the Bureau of Economic Analysis (BEA) for personal income and outlays for Jun 2012 available on Jul 31, 2012 provides “the results of the annual revision of national and product accounts (NIPAs), beginning with estimates for Jan 2009” (http://www.bea.gov/newsreleases/national/pi/2012/pdf/pi0612.pdf). All revisions are incorporated in this subsection as provided in the latest Personal Income and Outlays: July 2012 released on Aug 30, 2012 (http://www.bea.gov/newsreleases/national/pi/2012/pdf/pi0712.pdf) and in the interactive dataset of the Bureau of Economic Analysis (BEA) (http://www.bea.gov/iTable/index_nipa.cfm). Table IIA-1 provides monthly and annual equivalent percentage changes, seasonally adjusted, of current dollars or nominal personal income (NPI), current dollars or nominal disposable personal income (NDPI), real or constant chained (2005) dollars DPI (RDPI), current dollars nominal personal consumption expenditures (NPCE) and constant or chained (2005) dollars PCE. There are waves of changes in personal income and expenditures in Table IIA-1 that correspond somewhat to inflation waves observed worldwide (http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html) because of the influence through price indexes. In the first wave in Jan-Apr 2011 with relaxed risk aversion, nominal personal income (NPI) increased at the annual equivalent rate of 8.4 percent, nominal disposable personal income (NDPI) at 5.8 percent and nominal personal consumption expenditures (NPCE) at 6.5. Real disposable income (RDPI) increased at the annual equivalent rate of 1.5 percent and real personal consumption expenditures (RPCE) rose at annual equivalent 2.4 percent. In the second wave in May-Aug under risk aversion, NPI rose at annual equivalent 0.9 percent, NPDI at 1.2 percent and NPCE at 2.7 percent. RDPI contracted at 1.5 percent annual equivalent and RPCE crawled at 0.3 percent annual equivalent. With mixed shocks of risk aversion in the third wave from Sep to Dec, NPI rose at 1.5 percent annual equivalent, NDPI at 0.9 percent and NPCE at 2.7 percent. RDPI increased at 0.3 percent annual equivalent and RPCE at 1.8 percent annual equivalent. In the fourth wave from Jan to Mar 2012, NPI increased at 7.9 percent annual equivalent and NDPI at 4.5 percent. Real disposable income (RDPI) is more dynamic in the revisions, growing at 4.5 percent annual equivalent and RPCE at 2.8 percent. The policy of repressing savings with zero interest rates stimulated growth of nominal consumption (NPCE) at the annual equivalent rate of 6.6 percent and real consumption (RPCE) at 2.8 percent. In the fifth wave in Apr-Jul 2012, NPI increased at annual equivalent 3.4 percent, NDPI at 3.0 percent and RDPI at 3.4 percent. Financial repression failed to stimulate consumption with NPCE growing at 1.5 percent annual equivalent and RPCE at 1.8 percent. The revisions of GDP lowered growth during the expansion from average annual equivalent of 2.4 per quarter from IIQ2009 to IQ2011 to average 2.2 percent annual equivalent from IIQ2009 to IIQ2012. The US economy began to decelerate in mid 2010 and has not recovered the pace of growth in the early expansion phase. Growth in the first two quarters of 2012 accumulates to 0.87 percent {(1.02)1/4(1.017)1/4 = 0.92%}, which is equivalent to 1.85 percent per year {([(1.02)1/4(1.017)1/4]2 – 1)100 = 1.85%}. Surprisingly, the revised data for personal income and personal consumption are much stronger than earlier. RDPI stagnated in Jan-Dec 2011 with the latest revised data compared with growth of 3.3 percent in Jan-Dec 2010 but grew at annual equivalent 4.5 percent in Jan-Mar 2012 and 3.4 percent in Apr-Jul. The salient deceleration is the decline of the annual equivalent rate of NPCE to 1.5 percent annual equivalent in Apr-Jul 2012 and of RPCE to 1.8 percent.
Table IIA-1, US, Percentage Change from Prior Month Seasonally Adjusted of Personal Income, Disposable Income and Personal Consumption Expenditures %
| NPI | NDPI | RDPI | NPCE | RPCE | |
| 2012 | |||||
| Jul | 0.3 | 0.3 | 0.3 | 0.4 | 0.4 |
| Jun | 0.3 | 0.3 | 0.2 | 0.0 | -0.1 |
| May | 0.3 | 0.3 | 0.5 | -0.2 | 0.0 |
| Apr | 0.2 | 0.1 | 0.1 | 0.3 | 0.3 |
| AE ∆% Apr-Jul | 3.4 | 3.0 | 3.4 | 1.5 | 1.8 |
| Mar | 0.5 | 0.5 | 0.2 | 0.3 | 0.0 |
| Feb | 0.7 | 0.6 | 0.3 | 0.8 | 0.4 |
| Jan | 0.9 | 0.9 | 0.6 | 0.5 | 0.3 |
| AE ∆% Jan-Mar | 8.7 | 8.3 | 4.5 | 6.6 | 2.8 |
| 2011 | |||||
| ∆% Jan-Dec 2011* | 3.6 | 2.5 | 0.0 | 4.2 | 1.7 |
| Dec | 0.3 | 0.3 | 0.2 | 0.1 | 0.0 |
| Nov | -0.2 | -0.3 | -0.3 | 0.1 | 0.0 |
| Oct | 0.3 | 0.3 | 0.3 | 0.2 | 0.2 |
| Sep | 0.1 | 0.0 | -0.1 | 0.5 | 0.4 |
| AE ∆% Sep-Dec | 1.5 | 0.9 | 0.3 | 2.7 | 1.8 |
| Aug | 0.0 | 0.0 | -0.3 | 0.2 | -0.1 |
| Jul | 0.1 | 0.2 | -0.1 | 0.7 | 0.5 |
| Jun | 0.2 | 0.2 | 0.1 | -0.1 | -0.2 |
| May | 0.0 | 0.0 | -0.2 | 0.1 | -0.1 |
| AE ∆% May-Aug | 0.9 | 1.2 | -1.5 | 2.7 | 0.3 |
| Apr | 0.3 | 0.3 | 0.0 | 0.4 | 0.0 |
| Mar | 0.1 | 0.1 | -0.3 | 0.7 | 0.3 |
| Feb | 0.4 | 0.4 | 0.0 | 0.6 | 0.3 |
| Jan | 1.9 | 1.1 | 0.8 | 0.4 | 0.2 |
| AE ∆% Jan-Apr | 8.4 | 5.8 | 1.5 | 6.5 | 2.4 |
| 2010 | |||||
| ∆% Jan-Dec 2010** | 5.3 | 4.9 | 3.3 | 4.4 | 2.8 |
| Dec | 0.7 | 0.7 | 0.4 | 0.4 | 0.2 |
| Nov | 0.2 | 0.2 | 0.1 | 0.5 | 0.4 |
| Oct | 0.4 | 0.3 | 0.1 | 0.6 | 0.4 |
| IVQ2010∆% | 1.3 | 1.2 | 0.6 | 1.5 | 1.0 |
| IVQ2010 AE ∆% | 5.3 | 4.9 | 2.4 | 6.6 | 4.1 |
Notes: NPI: current dollars personal income; NDPI: current dollars disposable personal income; RDPI: chained (2005) dollars DPI; NPCE: current dollars personal consumption expenditures; RPCE: chained (2005) dollars PCE; AE: annual equivalent; IVQ2010: fourth quarter 2010; A: annual equivalent
Percentage change month to month seasonally adjusted
*∆% Dec 2011/Dec 2010 **∆% Dec 2010/Dec 2009
Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
Further information on income and consumption is provided by Table IIA-2. The 12-month rates of increase of RDPI and RPCE in 2011 show a sharp trend of deterioration of RDPI from over 3 percent in the final four months of 2010 to less than 3 percent at the end of IQ2011 and then collapsing to a range of 0.9 to 0.0 percent in Jun-Dec 2011. The revision of Jul 31, 2012 shows decline of RDPI of 0.2 percent in the 12 months ending in Jan 2012 and marginal increase of 0.1 percent in the 12 months ending in Feb 2012. The significant difference is continuing growth of 12-month percentage changes of RDPI with 1.6 percent in Jun 2012 and 2.0 percent in Jul 2012. RPCE growth decelerated less sharply from close to 3 percent in IVQ 2010 to 1.6 percent in Mar 2012 and 2.0 percent in Jul 2012. Subdued growth of RPCE could affect revenues of business. Growth rates of personal consumption have weakened. Goods and especially durable goods have been driving growth of PCE as shown by the much higher 12-month rates of growth of real goods PCE (RPCEG) and durable goods real PCE (RPCEGD) than services real PCE (RPCES). The faster expansion of industry in the economy is derived from growth of consumption of goods and in particular of consumer durable goods while growth of consumption of services is much more moderate. The 12-month rates of growth of RPCEGD have fallen from more than 10 percent in several months from Sep 2010 to Feb 2011 to the range of 6.5 to 8.8 percent in Jan-Jul 2012. RPCEG growth rates have fallen from around 5 percent late in 2010 and early Jan-Feb 2011 to the range of 2.4 to 3.5 percent in Jan-Jul 2012. There are limits to sustained growth on the basis of financial repression in an environment of weak labor markets and real labor remuneration.
Table IIA-2, Real Disposable Personal Income and Real Personal Consumption Expenditures Percentage Change from the Same Month a Year Earlier %
| RDPI | RPCE | RPCEG | RPCEGD | RPCES | |
| 2012 | |||||
| Jul | 2.0 | 2.0 | 3.3 | 8.0 | 1.3 |
| Jun | 1.6 | 2.1 | 3.5 | 8.8 | 1.3 |
| May | 1.5 | 2.0 | 3.0 | 7.4 | 1.4 |
| Apr | 0.8 | 1.8 | 2.4 | 6.5 | 1.6 |
| Mar | 0.7 | 1.6 | 2.6 | 6.6 | 1.1 |
| Feb | 0.1 | 1.9 | 2.7 | 7.4 | 1.5 |
| Jan | -0.2 | 1.8 | 2.6 | 6.8 | 1.4 |
| 2011 | |||||
| Dec | 0.0 | 1.7 | 2.5 | 6.0 | 1.3 |
| Nov | 0.3 | 1.9 | 2.6 | 5.8 | 1.5 |
| Oct | 0.7 | 2.3 | 3.2 | 5.9 | 1.8 |
| Sep | 0.5 | 2.4 | 3.4 | 7.0 | 2.0 |
| Aug | 0.4 | 2.1 | 2.6 | 5.3 | 1.9 |
| Jul | 0.9 | 2.8 | 4.1 | 6.4 | 2.1 |
| Jun | 0.9 | 2.4 | 3.4 | 5.3 | 1.9 |
| May | 1.0 | 2.6 | 3.9 | 6.5 | 2.0 |
| Apr | 1.8 | 3.0 | 4.7 | 8.2 | 2.1 |
| Mar | 2.6 | 3.0 | 4.2 | 7.8 | 2.4 |
| Feb | 3.4 | 3.1 | 5.5 | 11.3 | 1.9 |
| Jan | 3.5 | 3.1 | 5.5 | 11.0 | 1.9 |
| 2010 | |||||
| Dec | 3.3 | 2.8 | 4.7 | 9.0 | 1.9 |
| Nov | 3.5 | 3.2 | 5.1 | 8.8 | 2.2 |
| Oct | 3.7 | 2.7 | 5.3 | 10.8 | 1.5 |
| Sep | 3.2 | 2.5 | 4.7 | 9.1 | 1.4 |
Notes: RDPI: real disposable personal income; RPCE: real personal consumption expenditures (PCE); RPCEG: real PCE goods; RPCEGD: RPCEG durable goods; RPCES: RPCE services
Numbers are percentage changes from the same month a year earlier
Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-1 shows US real personal consumption expenditures (RPCE) between 1995 and 2012. There is an evident drop in RPCE during the global recession in 2007 to 2009 but the slope is flatter during the current recovery than in the period before 2007.
Chart IIA-1, US, Real Personal Consumption Expenditures, Quarterly Seasonally Adjusted at Annual Rates 1995-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Percent changes from the prior period in seasonally-adjusted annual equivalent quarterly rates (SAAR) of real personal consumption expenditures (RPCE) are provided in Chart IIA-2 from 1995 to 2012. The average rate could be visualized as a horizontal line. Although there are not yet sufficient observations, it appears from Chart IIA-2 that the average rate of growth of RPCE was higher before the recession than during the past twelve quarters of expansion that began in IIIQ2009.
Chart IIA-2, Percent Change from Prior Period in Real Personal Consumption Expenditure, Quarterly Seasonally Adjusted at Annual Rates 1995-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Personal income and its disposition are shown in Table IIA-3. The latest revisions have changed movements in two forms: (1) more dynamism in personal and disposable income; (2) stronger trend of increase of the savings rate. Disposable personal income in current dollars or without adjusting for inflation increased from the annual rate of $11,609.1 billion in Dec 2011 to $11,962.6 billion in Jul 2012, or by 3.1 percent or at annual equivalent 5.3 percent. Nominal wage and salary disbursements increased from the annual rate of $6687.6 billion in Dec 2011 to $$6920.4 billion in Jul 2012, or by 3.5 percent or at annual equivalent rate of 6.0 percent. From Dec 2010 to Dec 2011, wage and salary disbursements increased 3.2 percent and disposable personal income 2.5 percent. Personal savings as percent of disposable personal income, or savings rate, fell from 4.9 percent in Dec 2010 to 3.4 percent in Dec 2011 but climbed back to 4.2 percent in Jul 2012. Revised data suggest that economic weakness originates in increasing savings but fractured labor markets (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html) and weak hiring (http://cmpassocregulationblog.blogspot.com/2012/08/recovery-without-hiring-ten-million.html) are ignored in such interpretation.
Table IIA-3, US, Personal Income and its Disposition, Seasonally Adjusted at Annual Rates $ Billions
| Personal | Wages & | Personal | DPI | Savings | |
| Jul 2012 | 13,447.9 | 6,920.4 | 1,485.3 | 11,962.6 | 4.2 |
| Jun 2012 | 13,405.6 | 6,904.1 | 1,482.9 | 11,922.7 | 4.3 |
| Change Jul/Jun | 42.3 ∆% 0.3 | 16.3 ∆% 0.2 | 2.4 ∆% 0.2 | 39.9 ∆% 0.3 | |
| May 2012 | 13,359.5 | 6,874.9 | 1,474.1 | 11,885.3 | 4.0 |
| Change Jun/ May | 46.1 ∆% 0.3 | 29.2 ∆% 0.4 | 8.8 ∆% 0.6 | 37.4 ∆% 0.6 | |
| Apr 2012 | 13,322.2 | 6,867.0 | 1,467.0 | 11,855.2 | 3.6 |
| Change May/ Apr | 37.3 ∆% 0.3 | 7.9 ∆% 0.1 | 7.1 ∆% 0.5 | 30.1 ∆% 0.3 | |
| Mar | 13,298.3 | 6,869.4 | 1,460.6 | 11,837.7 | 3.7 |
| Change Apr/ Mar | 23.9 ∆% 0.2 | -2.4 ∆% 0.0 | 6.4 ∆% 0.4 | 17.5 ∆% 0.1 | |
| Feb 2012 | 13,234.7 | 6,831.5 | 1,452.0 | 11,782.7 | 3.5 |
| Change Mar/ Feb | 63.6 ∆% 0.5 | 37.9 ∆% 0.6 | 8.6 ∆% 0.6 | 55.0 ∆% 0.5 | |
| Jan | 13,148.4 | 6,776.7 | 1,439.6 | 11,708.8 | 3.7 |
| Change Feb/Jan | 86.3 ∆% 0.7 | 54.8 ∆% 0.8 | 12.4 ∆% 0.9 | 73.9 ∆% 0.6 | |
| Dec 2011 | 13,032.2 | 6,687.6 | 1,423.1 | 11,609.1 | 3.4 |
| Change Jan/Dec | 116.2 ∆% 0.9 | 89.1 ∆% 1.3 | 16.5 | 99.7 | |
| Dec 2010 | 12,574.1 | 6,482.8 | 1,243.5 | 11,330.6 | 4.9 |
| Change Dec 2011/ Dec 2010 | 458.1 ∆% 3.6 | 204.8 ∆% 3.2 | 179.6 ∆% 14.4 | 278.5 ∆% 2.5 |
Note: The change in nominal disposable income from May to Jun is 0.6 percent using Table 1, page 5 of BEA’s Personal Income and Outlays: July 2012 (http://www.bea.gov/newsreleases/national/pi/2012/pdf/pi0712.pdf) and in the BEA database (http://www.bea.gov/iTable/index_nipa.cfm). In BEA’s Personal Income and Outlays: July 2012, page 1, the change of nominal disposable income from May to Jun appears as 0.3 percent and also in Table 5, page 9 (http://www.bea.gov/newsreleases/national/pi/2012/pdf/pi0712.pdf). Source: US Bureau of Economic Analysis http://www.bea.gov/newsreleases/national/pi/2012/pdf/pi0712.pdf http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-3 provides personal income in the US between 1980 and 1989. These data are not adjusted for inflation that was still high in the 1980s in the exit from the Great Inflation of the 1960s and 1970s. Personal income grew steadily during the 1980s after recovery from two recessions from Jan IQ1980 to Jul IIIQ1980 and from Jul IIIQ1981 to Nov IVQ1982 (http://www.nber.org/cycles.html) with combined drop of GDP by 4.8 percent.
Chart IIA-3, US, Personal Income, Billion Dollars, Quarterly Seasonally Adjusted at Annual Rates, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
A different evolution of personal income is shown in Chart IIA-4. Personal income also fell during the recession from Dec IVQ2007 to Jun IIQ2009 (http://www.nber.org/cycles.html). Growth of personal income during the expansion has been tepid even with the new revisions.
Chart IIA-4, US, Personal Income, Current Billions of Dollars, Quarterly Seasonally Adjusted at Annual Rates, 2007-2012
Source:
http://www.bea.gov/iTable/index_nipa.cfm
Real or inflation-adjusted disposable personal income is provided in Chart IIA-5 from 1980 to 1989. Real disposable income after allowing for taxes and inflation grew steadily at high rates during the entire decade.
Chart IIA-5, US, Real Disposable Income, Billions of Chained 2005 Dollars, Quarterly Seasonally Adjusted at Annual Rates 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Much weaker performance of real disposable income is evident in Chart IIA-6. There was initial recovery in 2010 and then income after inflation and taxes stagnated into 2011. There is more dynamism with the new revisions for the first half of 2012.
Chart IIA-6, US, Real Disposable Income, Billions of Chained 2005 Dollars, Seasonally Adjusted at Annual Rates, 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-7 provides percentage quarterly changes in real disposable income from the preceding period at seasonally-adjusted annual rates from 1980 to 1989. Rates of change were high during the decade with few negative changes.
Chart IIA-7, US, Real Disposable Income Percentage Change from Preceding Period at Quarterly Seasonally-Adjusted Annual Rates, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-8 provides percentage quarterly changes in real disposable income from the preceding period at seasonally-adjusted annual rates from 2007 to 2012. There has been a period of positive rates followed by decline of rates and then negative and low rates in 2011. Recovery in 2012 has not recovered the dynamism of the brief early phase of expansion.
Chart, IIA-8, US, Real Disposable Income, Percentage Change from Preceding Period at Seasonally-Adjusted Annual Rates, 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In the latest available report, the Bureau of Economic Analysis (BEA) estimates US personal income in Jul 2012 at the seasonally adjusted annual rate of $13,447.9 billion, as shown in Table IIA-3 above (see page 6, Table 1 at http://www.bea.gov/newsreleases/national/pi/2012/pdf/pi0712.pdf). The major portion of personal income is compensation of employees of $8609.4 billion, or 64.0 percent of the total. Wage and salary disbursements are $6,920.4 billion, of which $5,719.9 billion by private industries and supplements to wages and salaries of $1,688.9 billion (employer contributions to pension and insurance funds are $1,173.2 billion and contributions to social insurance are $515.7 billion). In Jul 1985, US personal income was $3,494.2 billion at SAAR (http://www.bea.gov/iTable/index_nipa.cfm). Compensation of employees was $2,410.7 billion, or 69.0 percent of the total. Wage and salary disbursement were $1,981.2 billion of which $1607.0 billion by private industries. Supplements to wages and salaries were $429.5 billion with employer contributions to pension and insurance funds of $282.0 billion of which $147.5 billion to government social insurance. Chart IIA-9 provides US wage and salary disbursement by private industries in the 1980s. Growth was robust after the interruption of the recessions.
Chart IIA-9, US, Wage and Salary Disbursement, Private Industries, Quarterly, Seasonally Adjusted at Annual Rates Billions of Dollars, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-10 shows US wage and salary disbursement of private industries from 2007 to 2012. There is a drop during the contraction followed by initial recovery in 2010 and then the current much weaker relative performance in 2011 and 2012.
Chart IIA-10, US, Wage and Salary Disbursement, Private Industries, Quarterly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-11 provides finer detail with monthly wage and salary disbursement of private industries from 2007 to 2012. There is decline during the contraction and a period of mild recovery followed by stagnation and recent recovery that is weaker than in earlier expansion periods of the business cycle.
Chart IIA-11, US, Wage and Salary Disbursement, Private Industries, Monthly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-12 provides monthly real disposable personal income per capita from 1980 to 1989. This is the ultimate measure of well being in receiving income by obtaining the value per inhabitant. The measure cannot adjust for the distribution of income. Real disposable personal income per capital grew rapidly during the expansion after 1983 and continued growing during the rest of the decade.
Chart IIA-12, US, Real Disposable Per Capita Income, Monthly, Seasonally Adjusted at Annual Rates, Billions of Dollars 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-13 provides monthly real disposable personal per capita income from 2007 to 2012. There was initial recovery from the drop during the global recession followed by stagnation.
Chart IIA-13, US, Real Disposable Per Capita Income, Monthly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
IIA1 Collapse of United States Dynamism of Income Growth and Employment Creation. 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 Japan and France within the G7 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 IIA-4 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 6.80 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 1.3 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 1.8 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 IIA-4, 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 | 6.80 | 2.2 | |
| RDPI | 3.8 | 1.3 | |
| RDPI per Capita | 1.4 | 0.5 | |
| Population | 2.3 | 0.8 | |
| IVQ2007 to IIQ2012 | 19 | ||
| GDP | 1.8 | ||
| 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
There are four basic facts illustrating the current economic disaster of the United States: GDP maintained trend growth in the entire business cycle from IQ1980 to IV1985, including contractions and expansions, but is well below trend in the entire business cycle from IVQ2007 to IIQ2012, including contractions and expansions; per capita real disposable income exceeded trend growth in the 1980s but is substantially below trend in IIQ2012; the number of employed persons increased in the 1980s but declined into IIQ2012; and the number of full-time employed persons increased in the 1980s but declined into IIQ2012. There is a critical issue of whether the United States economy will be able in the future to attain again the level of activity and prosperity of projected trend growth. Growth at trend during the entire business cycles built the largest economy in the world but there may be an adverse, permanent tilt in United States economic performance and prosperity. Table IIA-5 provides data for analysis of these four basic facts.
1. Trend Growth.
i. As shown in Table IIA-5, actual GDP grew cumulatively 17.7 percent from IQ1980 to IVQ1985, which is relatively close to what trend growth would have been at 18.5 percent. Rapid growth at 5.7 percent annual rate on average per quarter during the expansion from IQ1983 to IVQ1985 erased the loss of GDP of 4.8 percent during the contraction and maintained trend growth at 3 percent over the entire cycle.
ii. In contrast, cumulative growth from IVQ2007 to IIQ2012 was 1.8 percent while trend growth would have been 14.2 percent. GDP in IIQ2012 at seasonally adjusted annual rate is estimated at $13,564.5 percent by the Bureau of Economic Analysis (BEA) (http://www.bea.gov/iTable/index_nipa.cfm) and would have been $15,218.3 billion, or $1,653 billion higher, had the economy grown at trend over the entire business cycle as it happened during the 1980s and throughout most of US history. There is $1.7 trillion of foregone GDP that would have been created as it occurred during past cyclical expansions, which explains why employment has not rebounded to even higher than before. There would not be recovery of full employment even with growth of 3 percent per year beginning immediately because the opportunity was lost to grow faster during the expansion from IIIQ2009 to IIQ2012 after the recession from IVQ2007 to IIQ2009. The United States has acquired a heavy social burden of unemployment and underemployment of 28.8 million people or 17.9 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html) that will not be diminished even with return to growth of GDP of 3 percent per year because of growth of the labor force by new entrants. The US labor force grew from 142.583 million in 2000 to 153.124 million in 2007 or by 7.4 percent at the average yearly rate of 1.0 percent per year. The civilian noninstitutional population increased from 212.577 million in 2000 to 231.867 million in 2007 or 9.1 percent at the average yearly rate of 1.3 percent per year (data from http://www.bls.gov/data/). Data for the past five years cloud accuracy because of the number of people discouraged from seeking employment. The noninstitutional population of the United States increased from 231.867 million in 2007 to 239.618 million in 2011 or by 3.3 percent while the labor force increased from 153.124 million in 2007 to 153.617 million in 2011 or by 0.3 percent (data from http://www.bls.gov/data/). People ceased to seek jobs because they do not believe that there is a job available for them (see http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html).
2. Decline of Per Capita Real Disposable Income.
i. In the entire business cycle from IQ1980 to IVQ1985, trend growth of per capita real disposable income, or what is left per person after inflation and taxes, grew cumulatively 17.7 percent, which is close to what would have been trend growth of 18.5 percent.
ii. In contrast, in the entire business cycle from IVQ2007 to IIQ2012, per capita real disposable income fell 0.2 percent while trend growth would have been 9.3 percent. Income available after inflation and taxes is lower than before the contraction after 12 consecutive quarters of GDP growth at mediocre rates relative to those prevailing during historical cyclical expansions.
3. Number of Employed Persons.
i. As shown in Table IIA-5, the number of employed persons increased over the entire business cycle from 81.280 million not seasonally adjusted (NSA) in IQ1980 to 88.757 million NSA in IVQ1985 or by 9.2 percent.
ii. In contrast, during the entire business cycle the number employed fell from 146.334 million in IVQ2007 to 143.202 million in IIQ2012 or by 2.1 percent. There are 28.8 million persons unemployed or underemployed, which is 17.9 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2012/08/twenty-nine-million-unemployed-or.html).
4. Number of Full-time Employed Persons.
i. As shown in Table IIA-5, during the entire business cycle in the 1980s, including contractions and expansion, the number of employed full-time rose from 81.280 million NSA in IQ1980 to 88.757 million NSA in IVQ1985 or 9.2 percent.
ii. In contrast, during the entire current business cycle, including contraction and expansion, the number of persons employed full-time fell from 121.042 million in IVQ2007 to 116.024 million in IIQ2012 or by minus 4.1 percent.
Table IIA-5, US, GDP and Real Disposable Personal Income per Capita Actual and Trend Growth and Employment, 1980-1985 and 2007-2012, SAAR USD Billions, Millions of Persons and ∆%
| Period IQ1980 to IVQ1985 | |
| GDP SAAR USD Billions | |
| IQ1980 | 5,903.4 |
| IVQ1985 | 6,950.0 |
| ∆% IQ1980 to IVQ1985 | 17.7 |
| ∆% Trend Growth IQ1980 to IVQ1985 | 18.5 |
| Real Disposable Personal Income per Capita IQ1980 Chained 2005 USD | 18,938 |
| Real Disposable Personal Income per Capita IVQ1985 Chained 2005 USD | 21,687 |
| ∆% IQ1980 to IVQ1985 | 14.5 |
| ∆% Trend Growth | 12.1 |
| Employed Millions IQ1980 NSA End of Quarter | 98.527 |
| Employed Millions IV1985 NSA End of Quarter | 107.819 |
| ∆% Employed IQ1980 to IV1985 | 9.4 |
| Employed Full-time Millions IQ1980 NSA End of Quarter | 81.280 |
| Employed Full-time Millions IV1985 NSA End of Quarter | 88.757 |
| ∆% Full-time Employed IQ1980 to IV1985 | 9.2 |
| Period IVQ2007 to IIQ2012 | |
| GDP SAAR USD Billions | |
| IVQ2007 | 13,326.0 |
| IIQ2012 | 13,564.5 |
| ∆% IVQ2007 to IIQ2012 | 1.8 |
| ∆% IVQ2007 to IIQ2012 | 14.2 |
| Real Disposable Personal Income per Capita IVQ2007 Chained 2005USD | 32,837 |
| Real Disposable Personal Income per Capita IIQ2012 Chained 2005 USD | 32,778 |
| ∆% IVQ2007 to IIQ2012 | -0.2 |
| ∆% Trend Growth | 9.3 |
| Employed Millions IVQ2007 NSA End of Quarter | 146.334 |
| Employed Millions IIQ2012 NSA End of Quarter | 143.202 |
| ∆% Employed IVQ2007 to IIQ2012 | -2.1 |
| Employed Full-time Millions IVQ2007 NSA End of Quarter | 121.042 |
| Employed Full-time Millions IIQ2012 NSA End of Quarter | 116.024 |
| ∆% Full-time Employed IVQ2007 to IIQ2012 | -4.1 |
Note: GDP trend growth used is 3.0 percent per year and GDP per capita is 2.0 percent per year as estimated by Lucas (2011May) on data from 1870 to 2010.
Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm US Bureau of Labor Statistics http://www.bls.gov/data/
IIB Financial Repression. McKinnon (1973) and Shaw (1974) argue that legal restrictions on financial institutions can be detrimental to economic development. “Financial repression” is the term used in the economic literature for these restrictions (see Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 81-6). Interest rate ceilings on deposits and loans have been commonly used. Prohibition of payment of interest on demand deposits and ceilings on interest rates on time deposits were imposed by the Banking Act of 1933. These measures were justified by arguments that the banking panic of the 1930s was caused by competitive rates on bank deposits that led banks to engage in high-risk loans (Friedman, 1970, 18; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 74-5). The objective of policy was to prevent unsound loans in banks. Savings and loan institutions complained of unfair competition from commercial banks that led to continuing controls with the objective of directing savings toward residential construction. Friedman (1970, 15) argues that controls were passive during periods when rates implied on demand deposit were zero or lower and when Regulation Q ceilings on time deposits were above market rates on time deposits. The Great Inflation or stagflation of the 1960s and 1970s changed the relevance of Regulation Q.
Most regulatory actions trigger compensatory measures by the private sector that result in outcomes that are different from those intended by regulation (Kydland and Prescott 1977). Banks offered services to their customers and loans at rates lower than market rates to compensate for the prohibition to pay interest on demand deposits (Friedman 1970, 24). The prohibition of interest on demand deposits was eventually lifted in recent times. In the second half of the 1960s, already in the beginning of the Great Inflation (DeLong 1997), market rates rose above the ceilings of Regulation Q because of higher inflation. Nobody desires savings allocated to time or savings deposits that pay less than expected inflation. This is a fact currently with zero interest rates and consumer price inflation of 1.4 percent in the 12 months ending in Jul (http://www.bls.gov/cpi/) but rising during waves of carry trades from zero interest rates to commodity futures exposures (http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html). Funding problems motivated compensatory measures by banks. Money-center banks developed the large certificate of deposit (CD) to accommodate increasing volumes of loan demand by customers. As Friedman (1970, 25) finds:
“Large negotiable CD’s were particularly hard hit by the interest rate ceiling because they are deposits of financially sophisticated individuals and institutions who have many alternatives. As already noted, they declined from a peak of $24 billion in mid-December, 1968, to less than $12 billion in early October, 1969.”
Banks created different liabilities to compensate for the decline in CDs. As Friedman (1970, 25; 1969) explains:
“The most important single replacement was almost surely ‘liabilities of US banks to foreign branches.’ Prevented from paying a market interest rate on liabilities of home offices in the United States (except to foreign official institutions that are exempt from Regulation Q), the major US banks discovered that they could do so by using the Euro-dollar market. Their European branches could accept time deposits, either on book account or as negotiable CD’s at whatever rate was required to attract them and match them on the asset side of their balance sheet with ‘due from head office.’ The head office could substitute the liability ‘due to foreign branches’ for the liability ‘due on CDs.”
Friedman (1970, 26-7) predicted the future:
“The banks have been forced into costly structural readjustments, the European banking system has been given an unnecessary competitive advantage, and London has been artificially strengthened as a financial center at the expense of New York.”
In short, Depression regulation exported the US financial system to London and offshore centers. What is vividly relevant currently from this experience is the argument by Friedman (1970, 27) that the controls affected the most people with lower incomes and wealth who were forced into accepting controlled-rates on their savings that were lower than those that would be obtained under freer markets. As Friedman (1970, 27) argues:
“These are the people who have the fewest alternative ways to invest their limited assets and are least sophisticated about the alternatives.”
Chart IIB-1 of the Bureau of Economic Analysis (BEA) provides quarterly savings as percent of disposable income or the US savings rate from 1980 to 2012. There was a long-term downward sloping trend from 12 percent in the early 1980s to less than 2 percent in 2005-2006. The savings rate then rose during the contraction and also in the expansion. In 2011 and into 2012 the savings rate declined as consumption is financed with savings in part because of the disincentive or frustration of receiving a few pennies for every $10,000 of deposits in a bank. The savings rate increased in the final segment of Chart IIB-1 in 2012.The objective of monetary policy is to reduce borrowing rates to induce consumption but it has collateral disincentive of reducing savings. The zero interest rate of monetary policy is a tax on saving. This tax is highly regressive, meaning that it affects the most people with lower income or wealth and retirees. The long-term decline of savings rates in the US has created a dependence on foreign savings to finance the deficits in the federal budget and the balance of payments.
![clip_image020[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfiles2D17740\SRQ8012chart3.png "clip_image020[1]")
Chart IIB-1, US, Personal Savings as a Percentage of Disposable Personal Income, Quarterly, 1980-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIB-2 of the US Bureau of Economic Analysis provides personal savings as percent of personal disposable income, or savings ratio, from Jan 2007 to Jun 2012. The uncertainties caused by the global recession resulted in sharp increase in the savings ratio that peaked at 8.3 percent in May 2008 (http://www.bea.gov/iTable/index_nipa.cfm). The second highest ratio occurred at 6.7 percent in May 2009. There was another rising trend until 5.8 percent in Jun 2010 and then steady downward trend until trough of 3.2 percent in Jan 2012, which was followed by an upward trend with 4.2 percent in Jul 2012, marginally lower than 4.3 percent in Jun 2012. Permanent manipulation of the entire spectrum of interest rates with monetary policy measures distorts the compass of resource allocation with inferior outcomes of future growth, employment and prosperity and dubious redistribution of income and wealth affecting the most people without vast capital and relations to manage their savings.
Chart IIB-2, US, Personal Savings as a Percentage of Disposable Income, Monthly 2007-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
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 24 and daily values throughout the week ending on Aug 31 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 24 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Aug 24, 2012”, first row “USD/EUR 1.2512 -1.4%,” provides the information that the US dollar (USD) depreciated 1.4 percent to USD 1.2512/EUR in the week ending on Fri Aug 24 relative to the exchange rate on Fri Aug 17. 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 1.2512/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Aug 24, appreciating to USD 1.2498/EUR on Mon Aug 27, or by 0.1 percent. The dollar appreciated because fewer dollars, $1.2498, were required on Mon Aug 27 to buy one euro than $1.2512 on Aug 24. 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 1.2512/EUR on Aug 24; 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 24, to the last business day of the current week, in this case Fri Aug 31, such as depreciation by 0.5 percent to USD 1.2575/EUR by Aug 31; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (denoted by negative sign) by 0.5 percent from the rate of USD 1.2512/EUR on Fri Aug 24 to the rate of USD 1.2575/EUR on Fri Aug 31 {[(1.2575/1.2512) – 1]100 = 0.5%} and depreciated (denoted by negative sign) by 0.5 percent from the rate of USD 1.2509 on Thu Aug 30 to USD 1.2575/EUR on Fri Aug 31 {[(1.2575/1.2509) -1]100 = 0.5%}. 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 27 to Aug 31, 2012
| Fri Aug 24, 2012 | M 27 | Tue 28 | W 29 | Thu 30 | Fr 31 |
| USD/EUR 1.2512 -1.4% | 1.2498 0.1% 0.1% | 1.2564 -0.4% -0.5% | 1.2532 -0.2% 0.3% | 1.2509 0.0% 0.2% | 1.2575 -0.5% -0.5% |
| JPY/ USD 78.65 1.1% | 78.76 -0.1% -0.1% | 78.51 0.2% 0.3% | 78.71 -0.1% -0.3% | 78.65 0.0% 0.1% | 78.38 0.3% 0.3% |
| CHF/ USD 0.9597 1.4% | 0.9611 -0.1% -0.1% | 0.9559 0.4% 0.5% | 0.9584 0.1% -0.3% | 0.9600 0.0% -0.2% | 0.9551 0.5% 0.5% |
| CHF/ EUR 1.2008 0.0% | 1.2011 0.0% 0.0% | 1.2009 0.0% 0.0% | 1.2010 0.0% 0.0% | 1.2009 0.0% 0.0% | 1.2008 0.0% 0.0% |
| USD/ AUD 1.0404 0.9612 -0.1% | 1.0363 0.9650 -0.4% -0.4% | 1.0372 0.9641 -0.3% 0.1% | 1.0351 0.9661 -0.5% -0.2% | 1.0291 0.9717 -1.1% -0.6% | 1.0324 0.9686 -0.8% 0.3% |
| 10 Year T Note 1.684 | 1.65 | 1.63 | 1.65 | 1.62 | 1.543 |
| 2 Year T Note 0.266 | 0.26 | 0.26 | 0.27 | 0.25 | 0.225 |
| German Bond 2Y -0.01 10Y 1.35 | 2Y 0.00 10Y 1.35 | 2Y -0.01 10Y 1.34 | 2Y 0.00 10Y 1.38 | 2Y -0.04 10Y 1.32 | 2Y -0.03 10Y 1.33 |
| DJIA 13157.97 -0.9% | 13124.67 -0.3% -0.3% | 13102.99 -0.4% -0.2% | 13107.48 -0.4% 0.0% | 13000.71 -1.2% -0.8% | 13090.84 -0.5% 0.7% |
| DJ Global 1885.92 -0.4% | 1886.53 0.0% 0.0% | 1882.41 -0.2% -0.2% | 1879.16 -0.4% -0.2% | 1859.77 -1.4% -1.0% | 1869.92 -0.8% 0.5% |
| DJ Asia Pacific 1226.75 -0.2% | 1222.55 -0.3% -0.3% | 1216.29 -0.8% -0.5% | 1216.45 -0.8% 0.0% | 1206.73 -1.6% -0.8% | 1201.75 -2.0% -0.4% |
| Nikkei 9070.76 -1.0% | 9085.39 0.2% 0.2% | 9033.29 -0.4% -0.6% | 9069.81 0.0% 0.4% | 8983.78 -0.9% -0.9% | 8839.91 -2.5% -1.6% |
| Shanghai 2092.10 -1.1% | 2055.71 -1.7% -1.7% | 2073.15 -0.9% 0.8% | 2053.23 -1.9% -1.0% | 2052.58 -1.9% 0.0% | 2047.52 -2.1% -0.2% |
| DAX 6971.07 -1.0% | 7047.45 1.1% 1.1% | 7002.68 0.5% -0.6% | 7010.57 0.6% 0.1% | 6895.49 -1.1% -1.6% | 6970.79 0.0% 1.1% |
| DJ UBS Comm. 145.36 1.6% | 144.69 -0.5% -0.5% | 144.41 -0.7% -0.2% | 145.23 -0.1% 0.6% | 145.040 -0.2% -0.1% | 146.03 0.5% 0.7% |
| WTI $ B 96.15 0.1% | 95.74 -0.4% -0.4% | 96.07 -0.1% 0.3% | 95.49 -0.7% -0.6% | 94.75 -1.5% -0.8% | 96.47 0.3% 1.8% |
| Brent $/B 113.59 -0.1% | 112.51 -0.9% -0.9% | 112.54 -0.9% 0.0% | 112.68 -0.8% 0.1% | 112.79 -0.7% 0.1% | 114.92 1.2% 1.9% |
| Gold $/OZ 1672.9 3.3% | 1666.0 -0.4% -0.4% | 1669.2 -0.2% 0.2% | 1663.0 -0.6% -0.4% | 1657.8 -0.9% -0.3% | 1687.6 0.9% 1.8% |
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. Charles Forelle, writing on “Judgment days arrive for euro crisis,” on Aug 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444772804577621212619274608.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes critical events after the return of holidays in Sep: (1) ECB meeting on Sep 6 when details of bond buying may be revealed; (2) presentation by Greece on Sep 9 of new budget austerity measures to representatives of the European Union, European Central Bank and IMF; (3) ruling on Sep 12 by the German Constitutional Court on the constitutionality of the European Stability Mechanism (ESM); (4) elections in the Netherlands on Sep 12; and various meetings in the second-half of Sep of European finance ministers and leaders. Jon Hilsenrath, writing on “Fed sets stage for stimulus,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443864204577623220212805132.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the essay presented by Chairman Bernanke at the Jackson Hole meeting of central bankers, as defending past stimulus with unconventional measures of monetary policy that could be used to reduce extremely high unemployment. Chairman Bernanke (2012JHAug31, 18-9) does support further unconventional monetary policy impulses if required by economic conditions (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm):
“Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
Professor John H Cochrane (2012Aug31), at the University of Chicago Booth School of Business, writing on “The Federal Reserve: from central bank to central planner,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444812704577609384030304936.html?mod=WSJ_hps_sections_opinion), analyzes that the departure of central banks from open market operations into purchase of assets with risks to taxpayers and direct allocation of credit subject to political influence has caused them to abandon their political independence and accountability. Cochrane (2012Aug31) finds a return to the proposition of Milton Friedman in the 1960s that central banks can cause inflation and macroeconomic instability.
Mario Draghi (2012Aug29), President of the European Central Bank, also reiterated the need of exceptional and unconventional central bank policies (http://www.ecb.int/press/key/date/2012/html/sp120829.en.html):
“Yet it should be understood that fulfilling our mandate sometimes requires us to go beyond standard monetary policy tools. When markets are fragmented or influenced by irrational fears, our monetary policy signals do not reach citizens evenly across the euro area. We have to fix such blockages to ensure a single monetary policy and therefore price stability for all euro area citizens. This may at times require exceptional measures. But this is our responsibility as the central bank of the euro area as a whole.
The ECB is not a political institution. But it is committed to its responsibilities as an institution of the European Union. As such, we never lose sight of our mission to guarantee a strong and stable currency. The banknotes that we issue bear the European flag and are a powerful symbol of European identity.”
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).
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. On Aug 31, the yield of the 10-year sovereign bond of Italy rose to 5.787 percent and that of Spain to 6.832 percent. 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 moved 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 trend was interrupted with decline of the yield of the ten-year Treasury note to 1.543 percent on Aug 31, 2012, and of the ten-year German bond to 1.33 percent. 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. Further risk aversion is captured by decline of yield of the two-year Treasury note to 0.225 percent on Aug 31, 2012, and to -0.03 percent for the two-year sovereign bond of Germany while the USD moved in opposite direction, depreciating to USD 1.2575/EUR. 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 | |
| 8/31/12 | 0.225 | 1.543 | -0.03 | 1.33 | 1.2575 |
| 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.
Chart III-1A, US, Ten-Year and Two-Year Treasury Constant Maturity Yields Aug 1, 2001-Aug 30, 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 31, 2012 with anxiety of what will happen in Sep 2012 after the return form summer holidays. DJIA increased 0.7 percent on Aug 31 after the release of the Jackson Hole presentation by Chairman Bernanke (2012JHAug31) (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm) but still lost 0.5 percent in the week. Germany’s Dax increased 1.1 percent on Fri Aug 31 but was unchanged in the week. Dow Global increased 0.5 percent on Aug 31 and decreased 0.8 percent in the week. Japan’s Nikkei Average decreased 1.6 percent on Fri Aug 31 with and decreased 2.5 percent in the week. Dow Asia Pacific TSM decreased 0.4 percent on Aug 31 and declined 2.0 percent in the week while Shanghai Composite fell 2.1 percent in the week, decreasing 0.2 percent on Fri Aug 31. 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 0.7 percent on Fri Aug 31 with the release of the Jackson Hole presentation of Chairman Bernanke (2012JHAug31) (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm) and increased 0.5 percent in the week, as shown in Table III-1. WTI increased 1.8 percent on Fri Aug 31 with higher expectations of further monetary policy stimulus and increased 0.3 percent in the week while Brent increased 1.9 percent on Fri Aug 31 and increased 1.2 percent in the week. Gold increased 1.8 percent on Fri Aug 31 and increased 0.9 percent in the week.
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 €1,2008,236 million on Aug 24, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,807,850 million in the statement of Aug 24. There is high credit risk in these transactions with capital of only €85,750 million as analyzed by Cochrane (2012Aug31).
Table III-1B, Consolidated Financial Statement of the Eurosystem, Million EUR
| Dec 31, 2010 | Dec 28, 2011 | Aug 24, 2012 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 433,779 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 262,394 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 50,605 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 18,047 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 1,208,236 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 215,042 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 599,614 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 30,041 |
| 9 Other Assets | 278,719 | 336,574 | 262,694 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 3,080,452 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,807,850 |
| Capital and Reserves | 78,143 | 85,748 | 85,750 |
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/fs120828.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.
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.
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.”
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 €1,2008,236 million on Aug 24, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,807,850 million in the statement of Aug 24. There is high credit risk in these transactions with capital of only €85,750 million as analyzed by Cochrane (2012Aug31).
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 24, 2012 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 433,779 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 262,394 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 50,605 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 18,047 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 1,208,236 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 215,042 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 599,614 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 30,041 |
| 9 Other Assets | 278,719 | 336,574 | 262,694 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 3,080,452 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,807,850 |
| Capital and Reserves | 78,143 | 85,748 | 85,750 |
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/fs120828.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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