Twenty Eight Million Unemployed or Underemployed, Stagnating Real Wages in Fractured Job Market, Collapse of United States Dynamism of Income Growth and Employment Creation, Global Financial Turbulence and World Economic and Trade Slowdown with Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011, 2012
Executive Summary
I Twenty Eight Million Unemployed or Underemployed
IA1 Summary of the Employment Situation
IA2 Number of People in Job Stress
IA3 Long-term and Cyclical Comparison of Employment
IA4 Job Creation
II Stagnating Real Wages
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 Twenty Eight Million Unemployed or Underemployed. Table ESI-1 consists of data and additional calculations using the BLS household survey, illustrating the possibility that the actual rate of unemployment could be 11.0 percent and the number of people in job stress could be around 28.1 million, which is 17.4 percent of the labor force. The first column provides for 2006 the yearly average population (POP), labor force (LF), participation rate or labor force as percent of population (PART %), employment (EMP), employment population ratio (EMP/POP %), unemployment (UEM), the unemployment rate as percent of labor force (UEM/LF Rate %) and the number of people not in the labor force (NLF). All data are unadjusted or not-seasonally-adjusted (NSA). The numbers in column 2006 are averages in millions while the monthly numbers for Aug 2011, Jul 2012 and Aug 2012 are in thousands, not seasonally adjusted. The average yearly participation rate of the population in the labor force was in the range of 66.0 percent minimum to 67.1 percent maximum between 2000 and 2006 with the average of 66.4 percent (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). Table ESI-1 provides the yearly labor force participation rate from 1979 to 2012. The objective of Table ESI-1 is to assess how many people could have left the labor force because they do not think they can find another job. Row “LF PART 66.2 %” applies the participation rate of 2006, almost equal to the rates for 2000 to 2006, to the noninstitutional civilian population in Jul and Aug 2012 and Aug 2011 to obtain what would be the labor force of the US if the participation rate had not changed. In fact, the participation rate fell to 64.6 percent by Jul 2011 and was 63.7 percent in Aug 2012 and 64.3 percent in Jul 2012, suggesting that many people simply gave up on finding another job. Row “∆ NLF UEM” calculates the number of people not counted in the labor force because they could have given up on finding another job by subtracting from the labor force with participation rate of 66.2 percent (row “LF PART 66.2%”) the labor force estimated in the household survey (row “LF”). Total unemployed (row “Total UEM”) is obtained by adding unemployed in row “∆NLF UEM” to the unemployed of the household survey in row “UEM.” The row “Total UEM%” is the effective total unemployed “Total UEM” as percent of the effective labor force in row “LF PART 66.2%.” The results are that: (1) there are an estimated 4.986 million unemployed in Aug 2012 who are not counted because they left the labor force on their belief they could not find another job (∆NLF UEM); (2) the total number of unemployed is effectively 17.682 million (Total UEM) and not 12.696 million (UEM) of whom many have been unemployed long term; (3) the rate of unemployment is 11.0 percent (Total UEM%) and not 8.2 percent, not seasonally adjusted, or 8.1 percent seasonally adjusted; and (4) the number of people in job stress is close to 28.1 million by adding the 4.986 million leaving the labor force because they believe they could not find another job. The row “In Job Stress” in Table ESI-1 provides the number of people in job stress not seasonally adjusted at 28.1 million in Aug 2012, adding the total number of unemployed (“Total UEM”), plus those involuntarily in part-time jobs because they cannot find anything else (“Part Time Economic Reasons”) and the marginally attached to the labor force (“Marginally attached to LF”). The final row of Table ESI-1 shows that the number of people in job stress is equivalent to 17.4 percent of the labor force in Aug 2012. The employment population ratio “EMP/POP %” dropped from 62.9 percent on average in 2006 to 58.5 percent in Aug 2011, 58.8 percent in Jul 2012 and 58.5 percent in Aug 2012; the number employed (EMP) dropped from 144 million to 142.558 million. What really matters for labor input in production and wellbeing is the number of people with jobs or the employment/population ratio, which has declined and does not show signs of increasing. There are several million fewer people working in 2012 than in 2006 and the number employed is not increasing. The number of hiring relative to the number unemployed measures the chances of becoming employed. The number of hiring in the US economy has declined by 17 million and does not show signs of increasing in an unusual recovery without hiring (http://cmpassocregulationblog.blogspot.com/2012/08/recovery-without-hiring-ten-million.html).
Table ESI-1, US, Population, Labor Force and Unemployment, NSA
| 2006 | Aug 2011 | Jul 2012 | Aug 2012 | |
| POP | 229 | 239,871 | 243,354 | 243,566 |
| LF | 151 | 154,344 | 156,526 | 156,255 |
| PART% | 66.2 | 64.3 | 64.3 | 63.7 |
| EMP | 144 | 140,335 | 143,126 | 142,558 |
| EMP/POP% | 62.9 | 58.5 | 58.8 | 58.5 |
| UEM | 7 | 14,008 | 13,400 | 12,696 |
| UEM/LF Rate% | 4.6 | 9.1 | 8.6 | 8.2 |
| NLF | 77 | 82,528 | 86,828 | 88,311 |
| LF PART 66.2% | 158,795 | 161,100 | 161,241 | |
| ∆NLF UEM | 4,451 | 4,574 | 4,986 | |
| Total UEM | 18,459 | 17,974 | 17,682 | |
| Total UEM% | 11.6 | 11.2 | 11.0 | |
| Part Time Economic Reasons | 8,604 | 8,316 | 7,842 | |
| Marginally Attached to LF | 2,575 | 2,529 | 2,561 | |
| In Job Stress | 29,638 | 28,819 | 28,085 | |
| People in Job Stress as % Labor Force | 18.7 | 17.9 | 17.4 |
Pop: population; LF: labor force; PART: participation; EMP: employed; UEM: unemployed; NLF: not in labor force; ∆NLF UEM: additional unemployed; Total UEM is UEM + ∆NLF UEM; Total UEM% is Total UEM as percent of LF PART 66.2%; In Job Stress = Total UEM + Part Time Economic Reasons + Marginally Attached to LF
Note: the first column for 2006 is in average millions; the remaining columns are in thousands; NSA: not seasonally adjusted
The labor force participation rate of 66.2% in 2006 is applied to current population to obtain LF PART 66.2%; ∆NLF UEM is obtained by subtracting the labor force with participation of 66.2 percent from the household survey labor force LF; Total UEM is household data unemployment plus ∆NLF UEM; and total UEM% is total UEM divided by LF PART 66.2%
Sources: US Bureau of Labor Statistics http://www.bls.gov/data/
In revealing research, Edward P. Lazear and James R. Spletzer (2012JHJul22) use the wealth of data in the valuable database and resources of the Bureau of Labor Statistics (http://www.bls.gov/data/) in providing clear thought on the nature of the current labor market of the United States. The critical issue of analysis and policy currently is whether unemployment is structural or cyclical. Structural unemployment could occur because of (1) industrial and demographic shifts; and (2) mismatches of skills and job vacancies in industries and locations. Consider the aggregate unemployment rate, Y, expressed in terms of share si of a demographic group in an industry i and unemployment rate yi of that demographic group (Lazear and Spletzer 2012JHJul22, 5-6):
Y = ∑isiyi (1)
This equation can be decomposed for analysis as (Lazear and Spletzer 2012JHJul22, 6):
∆Y = ∑i∆siy*i + ∑i∆yis*i (2)
The first term in (2) captures changes in the demographic and industrial composition of the economy ∆si multiplied by the average rate of unemployment y*i , or structural factors. The second term in (2) captures changes in the unemployment rate specific to a group, or ∆yi, multiplied by the average share of the group s*i, or cyclical factors. There are also mismatches in skills and locations relative to available job vacancies. A simple observation by Lazear and Spletzer (2012JHJul22) casts intuitive doubt on structural factors: the rate of unemployment jumped from 4.4 percent in the spring of 2007 to 10 percent in October 2009. By nature, structural factors should be permanent or occur over relative long periods. The revealing result of the exhaustive research of Lazear and Spletzer (2012JHJul22) is:
“The analysis in this paper and in others that we review do not provides any compelling evidence that there have been changes in the structure of the labor market that are capable of explaining the pattern of persistently high unemployment rates. The evidence points to primarily cyclic factors.”
Table ESI-2 and Chart ESI-1 provide the US labor force participation rate or percentage of the labor force in population. It is not likely that simple demographic trends caused the sharp decline during the global recession and failure to recover earlier levels. The civilian labor force participation rate dropped from the peak of 66.9 percent in Jul 2006 to 63.7 percent in Aug 2012 and even 63.4 percent in Jan and Apr 2012. The civilian labor force participation rate was 63.7 percent on an annual basis in 1979 and 63.7 percent in Nov 1980, reaching even 62.9 percent in both Apr and May 1979. The civilian labor force participation rate jumped with the recovery to 64.8 percent on an annual basis in 1985 and 65.9 percent in Jul 1985. Structural factors cannot explain these sudden changes vividly shown visually in the final segment of Chart ESI-1. Seniors would like to delay their retiring especially because of the adversities of financial repression on their savings. Labor force statistics are capturing the disillusion of potential workers of their chances in finding a job in what Lazear and Spletzer (2012JHJul22) characterize as accentuated cyclical factors.
Table ESI-1, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1979-2012
| Year | Jun | Jul | Aug | Annual |
| 1979 | 64.5 | 64.9 | 64.5 | 63.7 |
| 1980 | 64.6 | 65.1 | 64.5 | 63.8 |
| 1981 | 64.6 | 65.0 | 64.6 | 63.9 |
| 1982 | 64.8 | 65.3 | 64.9 | 64.0 |
| 1983 | 65.1 | 65.4 | 65.1 | 64.0 |
| 1984 | 65.5 | 65.9 | 65.2 | 64.4 |
| 1985 | 65.5 | 65.9 | 65.4 | 64.8 |
| 1986 | 66.3 | 66.6 | 66.1 | 65.3 |
| 1987 | 66.3 | 66.8 | 66.5 | 65.6 |
| 1988 | 66.7 | 67.1 | 66.8 | 65.9 |
| 1989 | 67.4 | 67.7 | 67.2 | 66.5 |
| 1990 | 67.4 | 67.7 | 67.1 | 66.5 |
| 1991 | 67.2 | 67.3 | 66.6 | 66.2 |
| 1992 | 67.6 | 67.9 | 67.2 | 66.4 |
| 1993 | 67.3 | 67.5 | 67.0 | 66.3 |
| 1994 | 67.2 | 67.5 | 67.2 | 66.6 |
| 1995 | 67.2 | 67.7 | 67.1 | 66.6 |
| 1996 | 67.4 | 67.9 | 67.2 | 66.8 |
| 1997 | 67.8 | 68.1 | 67.6 | 67.1 |
| 1998 | 67.7 | 67.9 | 67.3 | 67.1 |
| 1999 | 67.7 | 67.9 | 67.3 | 67.1 |
| 2000 | 67.7 | 67.6 | 67.2 | 67.1 |
| 2001 | 67.2 | 67.4 | 66.8 | 66.8 |
| 2002 | 67.1 | 67.2 | 66.8 | 66.6 |
| 2003 | 67.0 | 66.8 | 66.3 | 66.2 |
| 2004 | 66.5 | 66.8 | 66.2 | 66.0 |
| 2005 | 66.5 | 66.8 | 66.5 | 66.0 |
| 2006 | 66.7 | 66.9 | 66.5 | 66.2 |
| 2007 | 66.6 | 66.8 | 66.1 | 66.0 |
| 2008 | 66.6 | 66.8 | 66.4 | 66.0 |
| 2009 | 66.2 | 66.2 | 65.6 | 65.4 |
| 2010 | 65.1 | 65.3 | 65.0 | 64.7 |
| 2011 | 64.5 | 64.6 | 64.3 | 64.1 |
| 2012 | 64.3 | 64.3 | 63.7 |
Sources: US Bureau of Labor Statistics http://www.bls.gov/data/
Chart ESI-1, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1979-2011
Source: Bureau of Labor Statistics
ESII Recovery without Job Creation. The number of nonfarm jobs and private jobs created has been declining in the first five months of 2012 from 275,000 in Jan to 45,000 in Jun and 96,000 in Aug for total nonfarm jobs and from 277,000 in Jan to 63,000 in Jun and 103,000 in Aug for private jobs. Average new nonfarm jobs in the quarter Dec 2011 to Feb 2012 were 252,000 per month, declining to average 96,667 per month in the six months from Mar to Aug 2012. Average new private jobs in the quarter Dec 2011 to Feb 2012 were 255,000 per month, declining to 112,667 per month in the six months from Mar 2012 to Aug 2012. The US labor force stood at 154.812 million in Jul 2011 and at 156.526 million in Jul 2012, not seasonally adjusted, for increase of 1.714 million, or 142,833 per month. The average increase of 96,667 new nonfarm jobs per month in the US from Mar to Jul 2012 is insufficient even to absorb 142,833 new entrants per month into the labor force. There is not sufficient job creation to merely absorb new entrants in the labor force, worsening the stock of unemployed or underemployed in involuntary part-time jobs. Table ESII-1 provides the monthly change in jobs seasonally adjusted in the prior strong contraction of 1981-1982 and the recovery in 1983 into 1984 and in the contraction of 2008-2009 and in the recovery in 2009 to 2012. All revisions have been incorporated in Table ESII-1. The data in the recovery periods are in relief to facilitate comparison. There is significant bias in the comparison. The average yearly civilian noninstitutional population was 174.2 million in 1983 and the civilian labor force 111.6 million, growing by 2009 to an average yearly civilian noninstitutional population of 235.8 million and civilian labor force of 154.1 million, that is, increasing by 35.4 percent and 38.1 percent, respectively (http://www.bls.gov/data/). Total nonfarm payroll jobs in 1983 were 90.280 million, jumping to 94.530 million in 1984 while total nonfarm jobs in 2010 were 129.874 million declining from 130.807 million in 2009 (http://www.bls.gov/data/). What is striking about the data in Table ESII-1 is that the numbers of monthly increases in jobs in 1983 and 1984 are several times higher than in 2010 to 2011 even with population higher by 35.4 percent and labor force higher by 38.1 percent in 2009 relative to 1983 nearly three decades ago and total number of jobs in payrolls rose by 39.5 million in 2010 relative to 1983 or by 43.8 percent. Growth at 2.2 percent has been mediocre in the twelve quarters of expansion beginning in IIIQ2009 in comparison with 6.2 percent in earlier expansions (http://cmpassocregulationblog.blogspot.com/2012/09/collapse-of-united-states-dynamism-of.html) and also in terms of what is required to reduce the job stress of at least 24 million persons but likely close to 30 million. Some of the job growth and contraction in 2010 in Table ESII-1 is caused by the hiring and subsequent layoff of temporary workers for the 2010 census.
Table ESII-1, US, Monthly Change in Jobs, Number SA
| Month | 1981 | 1982 | 1983 | 2008 | 2009 | 2010 | Private |
| Jan | 95 | -327 | 225 | 41 | -818 | -40 | -40 |
| Feb | 67 | -6 | -78 | -84 | -724 | -35 | -27 |
| Mar | 104 | -129 | 173 | -95 | -799 | 189 | 141 |
| Apr | 74 | -281 | 276 | -208 | -692 | 239 | 193 |
| May | 10 | -45 | 277 | -190 | -361 | 516 | 84 |
| Jun | 196 | -243 | 378 | -198 | -482 | -167 | 92 |
| Jul | 112 | -343 | 418 | -210 | -339 | -58 | 92 |
| Aug | -36 | -158 | -308 | -274 | -231 | -51 | 128 |
| Sep | -87 | -181 | 1114 | -432 | -199 | -27 | 115 |
| Oct | -100 | -277 | 271 | -489 | -202 | 220 | 196 |
| Nov | -209 | -124 | 352 | -803 | -42 | 121 | 134 |
| Dec | -278 | -14 | 356 | -661 | -171 | 120 | 140 |
| 1984 | 2011 | Private | |||||
| Jan | 447 | 110 | 119 | ||||
| Feb | 479 | 220 | 257 | ||||
| Mar | 275 | 246 | 261 | ||||
| Apr | 363 | 251 | 264 | ||||
| May | 308 | 54 | 108 | ||||
| Jun | 379 | 84 | 102 | ||||
| Jul | 312 | 96 | 175 | ||||
| Aug | 241 | 85 | 52 | ||||
| Sep | 311 | 202 | 216 | ||||
| Oct | 286 | 112 | 139 | ||||
| Nov | 349 | 157 | 178 | ||||
| Dec | 127 | 223 | 234 | ||||
| 1985 | 2012 | Private | |||||
| Jan | 266 | 275 | 277 | ||||
| Feb | 124 | 259 | 254 | ||||
| Mar | 346 | 143 | 147 | ||||
| Apr | 195 | 68 | 85 | ||||
| May | 274 | 87 | 116 | ||||
| Jun | 145 | 45 | 63 | ||||
| Jul | 189 | 141 | 162 | ||||
| Aug | 193 | 96 | 103 | ||||
| Sep | 204 | ||||||
| Oct | 187 | ||||||
| Nov | 209 | ||||||
| Dec | 168 |
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
ESIII Manufacturing and Services Jobs. Table ESIII-1 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 Aug 2012, there were 133.092 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). Total private jobs of 112.349 million NSA in Aug 2012 accounted for 84.4 percent of total nonfarm jobs of 133.092 million, of which 12.074 million, or 10.8 percent of total private jobs and 9.1 percent of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 93.605 million NSA in Aug 2012, or 70.3 percent of total nonfarm jobs and 83.3 percent of total private-sector jobs. Manufacturing has share of 11.0 percent in US national income in IQ2011, as shown in Table ESIII-1. Most income in the US originates in services. Subsidies and similar measures designed to increase manufacturing jobs will not increase economic growth and employment and may actually reduce growth by diverting resources away from currently employment-creating activities because of the drain of taxation.
Table ESIII-1, 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
ESIV Stagnating and Fluctuating Real Wages. Calculations using BLS data of inflation-adjusted average hourly earnings are shown in Table ESIV-1. The final column of Table ESIV-1 (“12 Month Real ∆%”) provides inflation-adjusted average hourly earnings of all employees in the US. Average hourly earnings rose above inflation throughout the first nine months of 2007 just before the global recession that began in the final quarter of 2007 when average hourly earnings lost to inflation. In contrast, average hourly earnings of all US workers have risen less than inflation in four months in 2010 and in all but the first month in 2011 and the loss accelerated at 1.8 percent in Sep 2011, declining to a real loss of 1.1 percent in Feb 2012 and 0.6 percent in Mar 2012. There was a gain of 0.5 percent in Apr 2012 in inflation-adjusted average hourly earnings but another fall of 0.6 percent in May 2012 followed by increases of 0.3 percent in Jun and 0.9 percent in Jul 2012. Real hourly earnings are oscillating in part because of world inflation waves caused by carry trades from zero interest rates to commodity futures (http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html).
Table ESIV-1, US, Average Hourly Earnings Nominal and Inflation Adjusted, Dollars and % NSA
| AHE ALL | 12 Month | ∆% 12 Month CPI | 12 Month | |
| 2007 | ||||
| Jan* | $20.70* | 4.2* | 2.1 | 2.1* |
| Feb* | $20.79* | 4.1* | 2.4 | 1.7* |
| Mar | $20.82 | 3.7 | 2.8 | 0.9 |
| Apr | $21.05 | 3.3 | 2.6 | 0.7 |
| May | $20.83 | 3.7 | 2.7 | 1.0 |
| Jun | $20.82 | 3.8 | 2.7 | 1.1 |
| Jul | $20.99 | 3.4 | 2.4 | 1.0 |
| Aug | $20.85 | 3.5 | 2.0 | 1.5 |
| Sep | $21.18 | 4.0 | 2.8 | 1.2 |
| Oct | $21.07 | 2.7 | 3.5 | -0.8 |
| Nov | $21.13 | 3.3 | 4.3 | -0.9 |
| Dec | $21.37 | 3.7 | 4.1 | -0.4 |
| 2010 | ||||
| Jan | $22.55 | 2.0 | 2.6 | -0.6 |
| Feb | $22.61 | 1.4 | 2.1 | -0.7 |
| Mar | $22.51 | 1.2 | 2.3 | -1.1 |
| Apr | $22.56 | 1.8 | 2.2 | -0.4 |
| May | $22.63 | 2.5 | 2.0 | 0.5 |
| Jun | $22.37 | 1.7 | 1.1 | 0.6 |
| Jul | $22.44 | 1.8 | 1.2 | 0.6 |
| Aug | $22.58 | 1.7 | 1.1 | 0.6 |
| Sep | $22.63 | 1.8 | 1.1 | 0.7 |
| Oct | $22.73 | 1.9 | 1.2 | 0.7 |
| Nov | $22.72 | 1.1 | 1.1 | 0.0 |
| Dec | $22.79 | 1.7 | 1.5 | 0.2 |
| 2011 | ||||
| Jan | $23.20 | 2.9 | 1.6 | 1.3 |
| Feb | $23.03 | 1.9 | 2.1 | -0.2 |
| Mar | $22.93 | 1.9 | 2.7 | -0.8 |
| Apr | $23.00 | 2.0 | 3.2 | -1.2 |
| May | $23.09 | 2.0 | 3.6 | -1.5 |
| Jun | $22.85 | 2.1 | 3.6 | -1.4 |
| Jul | $22.98 | 2.4 | 3.6 | -1.2 |
| Aug | $22.88 | 1.3 | 3.8 | -2.4 |
| Sep | $23.09 | 2.0 | 3.9 | -1.8 |
| Oct | $23.34 | 2.7 | 3.5 | -0.8 |
| Nov | $23.19 | 2.1 | 3.4 | -1.3 |
| Dec | $23.26 | 2.1 | 3.0 | -0.9 |
| 2012 | ||||
| Jan | $23.61 | 1.8 | 2.9 | -1.1 |
| Feb | $23.45 | 1.8 | 2.9 | -1.1 |
| Mar | $23.41 | 2.1 | 2.7 | -0.6 |
| Apr | $23.64 | 2.8 | 2.3 | 0.5 |
| May | $23.35 | 1.1 | 1.7 | -0.6 |
| Jun | $23.30 | 2.0 | 1.7 | 0.3 |
| Jul | $23.52 | 2.3 | 1.4 | 0.9 |
| Aug | $23.29 | 1.8 |
Note: AHE ALL: average hourly earnings of all employees; CPI: consumer price index; Real: adjusted by CPI inflation; NA: not available
*AHE of production and nonsupervisory employees because of unavailability of data for all employees
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
Average hourly earnings of all US employees in the US in constant dollars of 1982-1984 from the dataset of the US Bureau of Labor Statistics (BLS) are provided in Table ESIV-2. Average hourly earnings fell 0.5 percent after adjusting for inflation in the 12 months ending in Mar 2012 and gained 0.4 percent in the 12 months ending in Apr 2011 but then lost 0.6 percent in the 12 months ending in May 2012 with a gain of 0.3 percent in the 12 months ending in Jun 2012 and 1.0 percent in Jul 2012. Table ESIV-2 confirms the trend of deterioration of purchasing power of average hourly earnings in 2011 and into 2012 with 12-month percentage declines in four of the first seven months of 2012. Those who still work bring back home a paycheck that buys fewer goods than a year earlier and savings in bank deposits do not pay anything because of financial repression (Section IIB http://cmpassocregulationblog.blogspot.com/2012_09_01_archive.html).
Table ESIV-2, US, Average Hourly Earnings of All Employees NSA in Constant Dollars of 1982-1984
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul |
| 2006 | 10.05 | 10.11 | 9.92 | 9.88 | 9.97 | ||
| 2007 | 10.23 | 10.22 | 10.14 | 10.18 | 10.02 | 9.99 | 10.08 |
| 2008 | 10.11 | 10.12 | 10.11 | 10.00 | 9.91 | 9.84 | 9.77 |
| 2009 | 10.47 | 10.50 | 10.46 | 10.39 | 10.32 | 10.20 | 10.23 |
| 2010 | 10.41 | 10.43 | 10.34 | 10.35 | 10.37 | 10.26 | 10.29 |
| 2011 | 10.53 | 10.41 | 10.26 | 10.23 | 10.22 | 10.12 | 10.17 |
| 2012 | 10.42 | 10.30 | 10.21 | 10.27 | 10.16 | 10.15 | 10.27 |
| ∆% 12 Months | -1.0 | -1.1 | -0.5 | 0.4 | -0.6 | 0.3 | 1.0 |
Source: US Bureau of Labor Statistics
The deterioration of purchasing power of average hourly earnings of US workers is shown by Chart ESIV-1 of the US Bureau of Labor Statistics. Chart IB-2 plots average hourly earnings of all US employees in constant 1982-1984 dollars with evident decline from 2010 to 2012.
Chart ESIV-1, US, Average Hourly Earnings of All Employees in Constant Dollars of 1982-1984, SA 2006-2012
Source: US Bureau of Labor Statistics
Chart ESIV-2 provides 12-month percentage changes of average hourly earnings of all employees in constant dollars of 1982-1984, that is, adjusted for inflation. There was sharp contraction of inflation-adjusted average hourly earnings of US employees during parts of 2007 and 2008. Rates of change in 12 months became positive in parts of 2009 and 2010 but then became negative again in 2011 and now into 2012 with temporary increase in Apr 2012 that was reversed in May with another gain in Jun and Jul 2012.
Chart ESIV-2, Average Hourly Earnings of All Employees NSA 12-Month Percent Change, 1982-1984 Dollars, NSA 2007-2012
Source: US Bureau of Labor Statistics
Average weekly earnings of all US employees in the US in constant dollars of 1982-1984 from the dataset of the US Bureau of Labor Statistics (BLS) are provided in Table ESIV-3. Average weekly earnings fell 0.9 percent after adjusting for inflation in the 12 months ending in Sep 2011, increased 0.9 percent in the 12 months ending in Oct, fell 0.7 percent in the 12 months ending in Nov and 0.3 in the 12 months ending in Dec, declining 0.3 percent in the 12 months ending in Jan 2012 and 0.4 percent in the 12 months ending in Feb 2012. Average weekly earnings in constant dollars were flat in Mar 2012 relative to Mar 2011, increasing 0.04 percent. Average weekly earnings in constant dollars increased 1.6 percent in Apr 2012 relative to Apr 2011 but fell 1.4 percent in May 2012 relative to May 2011, increasing 0.3 percent in the 12 months ending in Jun and 2.1 percent in Jul 2012. Table ESIV-3 confirms the trend of deterioration of purchasing power of average weekly earnings in 2011 and into 2012 with oscillations according to carry trades causing world inflation waves (http://cmpassocregulationblog.blogspot.com/2012_09_01_archive.html). Those who still work bring back home a paycheck that buys fewer goods than a year earlier. The fractured US job market does not provide an opportunity for advancement as in past booms following recessions.
Table ESIV-3, US, Average Weekly Earnings of All Employees in Constant Dollars of 1982-1984, NSA 2007-2012
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul |
| 2006 | 343.71 | 349.78 | 340.12 | 341.91 | 347.97 | ||
| 2007 | 348.72 | 349.40 | 347.76 | 353.41 | 344.58 | 346.74 | 351.68 |
| 2008 | 345.92 | 346.21 | 351.70 | 344.13 | 340.77 | 343.40 | 337.06 |
| 2009 | 353.94 | 359.26 | 355.65 | 349.17 | 347.79 | 344.59 | 345.92 |
| 2010 | 350.71 | 350.51 | 349.60 | 351.84 | 356.80 | 349.97 | 352.02 |
| 2011 | 360.29 | 353.81 | 349.90 | 350.77 | 353.56 | 348.23 | 349.90 |
| 2012 | 359.36 | 352.27 | 350.04 | 356.52 | 348.50 | 349.28 | 357.26 |
| ∆% 12 M | -0.3 | -0.4 | 0.0 | 1.6 | -1.4 | 0.3 | 2.1 |
Source: US Bureau of Labor Statistics
Chart ESIV-3 provides average weekly earnings of all employees in constant dollars of 1982-1984. The same pattern emerges of sharp decline during the contraction, followed by recovery in the expansion and continuing fall from 2010 to 2011 and into 2012.
Chart ESIV-3, US, Average Weekly Earnings of All Employees in Constant Dollars of 1982-1984, SA 2006-2012
Source: US Bureau of Labor Statistics
Chart ESIV-4 provides 12-month percentage changes of average weekly earnings of all employees in the US in constant dollars of 1982-1984. There is the same pattern of contraction during the global recession in 2008 and then again trend of deterioration in the recovery without hiring and inflation waves in 2011 and 2012 (http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html).
Chart ESIV-4, US, Average Weekly Earnings of All Employees NSA in Constant Dollars of 1982-1984 12-Month Percent Change, NSA 2007-2011
Source: US Bureau of Labor Statistics
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. There were two critical risk factors in the week of Sep 7, 2012, that influenced world financial markets. (1) The European Central Bank (ECB) approved a new program of bond purchases under the name “Outright Monetary Transactions” (OMT). The ECB will purchase sovereign bonds of euro zone member countries that have a program of conditionality under the European Financial Stability Facility (EFSF) that is converting into the European Stability Mechanism (ESM). These programs provide enhancing the solvency of member countries in a transition period of structural reforms and fiscal adjustment. The purchase of bonds by the ECB would maintain debt costs of sovereigns at sufficiently low levels to permit adjustment under the EFSF/ESM programs. Purchases of bonds are not limited quantitatively with discretion by the ECB as to how much is necessary to support countries with adjustment programs. Another feature of the OMT of the ECB is sterilization of bond purchases: funds injected to pay for the bonds would be withdrawn or sterilized by ECB transactions. The statement by the European Central Bank on the program of OTM is as follows (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html):
“6 September 2012 - Technical features of Outright Monetary Transactions
As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) has today taken decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets that aim at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy. These will be known as Outright Monetary Transactions (OMTs) and will be conducted within the following framework:
Conditionality
A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.
The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.
Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.
Coverage
Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above. They may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access.
Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.
No ex ante quantitative limits are set on the size of Outright Monetary Transactions.
Creditor treatment
The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.
Sterilisation
The liquidity created through Outright Monetary Transactions will be fully sterilised.
Transparency
Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis. Publication of the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis.
Securities Markets Programme
Following today’s decision on Outright Monetary Transactions, the Securities Markets Programme (SMP) is herewith terminated. The liquidity injected through the SMP will continue to be absorbed as in the past, and the existing securities in the SMP portfolio will be held to maturity.”
(2) The weak employment situation report of the United States generated speculation of further measures by the Federal Open Market Committee (FOMC).
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.”
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. 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. The announcement of the OMT of bond-buying by the ECB together with weak employment creation in the US created risk appetite with the yield of the ten-year government bond of Spain collapsing to 5.708 percent on Sep 7 and the yield of the ten-year government bond of Italy to 5.008 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). 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. The almost simultaneous announcement of the bond-buying OMT of the ECB on Sep 6 and the weak employment report on Sep 7 suggesting further easing by the FOMC caused risk appetite shown by the increase in yields of government bonds of the US on Sep 7 to 1.668 percent for the ten-year note and 0.252 percent for the two-year while the two-year yield of Germany rose from -0.03 percent to 0.03 percent and the ten-year yield from 1.33 percent to 1.52 percent. Under zero interest rates for the monetary policy rate of the US, or fed funds rate, carry trades ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield is still around consumer price inflation of 1.4 percent in the 12 months ending in Jul (see subsection II United States Inflation at http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/07/world-inflation-waves-financial.html) and the expectation of higher inflation if risk aversion diminishes. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table ESV-1 provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.
Table ESV-1, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate
| US 2Y | US 10Y | DE 2Y | DE 10Y | USD/ EUR | |
| 9/7/12 | 0.252 | 1.668 | 0.03 | 1.52 | 1.2816 |
| 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 III-1A, US, Ten-Year and Two-Year Treasury Constant Maturity Yields Jul 31, 2001-Sep 6, 2012
Note: US Recessions in shaded areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
ESVI 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 ESVI-1 provides the data required for broader comparison of the cyclical expansions of IQ1983 to IVQ1985 and the current one from 2009 to 2012. First, in the 13 quarters from IQ1983 to IVQ1985, GDP increased 19.6 percent at the annual equivalent rate of 5.7 percent; real disposable personal income (RDPI) increased 14.5 percent at the annual equivalent rate of 4.3 percent; RDPI per capita increased 11.5 percent at the annual equivalent rate of 3.4 percent; and population increased 2.7 percent at the annual equivalent rate of 0.8 percent. Second, in the 12 quarters of the current cyclical expansion from IIIQ2009 to IIQ2012, GDP increased 6.80 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 ESVI-1, US, GDP, Real Disposable Personal Income, Real Disposable Income per Capita and Population in 1983-85 and 2007-2011, %
| # Quarters | ∆% | ∆% Annual Equivalent | |
| IQ1983 to IVQ1985 | 13 | ||
| GDP | 19.6 | 5.7 | |
| RDPI | 14.5 | 4.3 | |
| RDPI Per Capita | 11.5 | 3.4 | |
| Population | 2.7 | 0.8 | |
| IIIQ2009 to IIQ2012 | 12 | ||
| GDP | 6.80 | 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 ESVI-2 provides data for analysis of these four basic facts.
1. Trend Growth.
i. As shown in Table ESVI-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 ESVI-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 ESVI-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 ESVI-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 ESVI-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/
ESVII Global Financial and Economic Risk. The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task both for theory and measurement. The IMF provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2012/update/01/index.htm), of the world financial system with its Global Financial Stability Report (GFSR) (http://www.imf.org/external/pubs/ft/fmu/eng/2012/01/index.htm) and of fiscal affairs with the Fiscal Monitor (http://www.imf.org/external/pubs/ft/fm/2012/update/01/fmindex.htm). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider a summary of global economic and financial risks, which are analyzed in detail in the comments of this blog in Section VI Valuation of Risk Financial Assets, Table VI-4.
Economic risks include the following:
1. China’s Economic Growth. China is lowering its growth target to 7.5 percent per year. The growth rate of GDP of China in the second quarter of 2012 of 1.8 percent is equivalent to 7.4 percent per year.
2. United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 28.1 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/2012/08/world-inflation-waves-loss-of-dynamism.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 ESVII-4, 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 9/7/12,” 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. Risk appetite returned in the week of Sep 7, 2012, with the announcement of the bond-buying program of OMT (Outright Monetary Transactions) on Sep 6, 2012, by the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). The highest valuations in column “∆% Trough to 9/7/12” are by US equities indexes: DJIA 37.4 percent and S&P 500 40.6 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 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 9/7/12” 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 10.7 percent below the trough; Japan’s Nikkei Average is 0.5 percent above the trough; DJ Asia Pacific TSM is 6.1 percent above the trough; Dow Global is 13.2 percent above the trough; STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 11.1 percent above the trough; and NYSE Financial is 12.0 percent above the trough. DJ UBS Commodities is 18.8 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 27.2 percent above the trough. Japan’s Nikkei Average is 0.5 percent above the trough on Aug 31, 2010 and 22.1 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 8871.55 on Fri Sep 7, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 13.5 percent lower than 10,254.43 on Mar 11, 2011, on the date of the Tōhoku or Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 7.5 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 9/7/12” in Table ESVII-1 shows that there were increases of valuations of risk financial assets in the week of Sep 7, 2012 such as 1.7 percent for STOXX 50, 1.0 percent DJ Asia Pacific TSM, 0.4 percent Japan’s Nikkei Average and 3.1 percent for Dow Global. NYSE Financial gained 3.7 percent and DAX increased 3.5 percent in the week. DJ UBS Commodities increased 0.8 percent. China’s Shanghai Composite increased 3.9 percent. The DJIA increased 1.6 percent and S&P 500 increased 2.2 percent. The USD depreciated 1.9 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 ESVII-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 9/7/12” 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 9/7/12” but also relative to the peak in column “∆% Peak to 9/7/12.” There are now only three equity indexes above the peak in Table ESVII-1: DJIA 18.8 percent, S&P 500 18.1 percent and DAX 13.9 percent. There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 10.8 percent, Nikkei Average by 22.1 percent, Shanghai Composite by 32.8 percent, DJ Asia Pacific by 7.1 percent, STOXX 50 by 5.9 percent and Dow Global by 7.6 percent. DJ UBS Commodities Index is now 1.5 percent above the peak. The US dollar strengthened 15.3 percent relative to the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul 2010 because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. An intriguing issue is the difference in performance of valuations of risk financial assets and economic growth and employment. Paul A. Samuelson (http://www.nobelprize.org/nobel_prizes/economics/laureates/1970/samuelson-bio.html) popularized the view of the elusive relation between stock markets and economic activity in an often-quoted phrase “the stock market has predicted nine of the last five recessions.” In the presence of zero interest rates forever, valuations of risk financial assets are likely to differ from the performance of the overall economy. The interrelations of financial and economic variables prove difficult to analyze and measure.
Table VII-4, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 9/7/ /12 | ∆% Week 9/7/12 | ∆% Trough to 9/7/ 12 | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 18.8 | 1.6 | 37.4 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 18.1 | 2.2 | 40.6 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | -10.8 | 3.7 | 12.0 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | -7.6 | 3.1 | 13.2 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | -7.1 | 1.0 | 6.1 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | -22.1 | 0.4 | 0.5 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -32.8 | 3.9 | -10.7 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -5.9 | 1.7 | 11.1 |
| DAX | 4/26/ | 5/25/ | -10.5 | 13.9 | 3.5 | 27.2 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 15.3 | -1.9 | -7.5 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | 1.5 | 0.8 | 18.8 |
| 10-Year T Note | 4/5/ | 4/6/10 | 3.986 | 1.668 |
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 Twenty Eight Million Unemployed or Underemployed. The employment situation report of the Bureau of Labor Statistics (BLS) of the US Department of Labor released in the first Fri of every month is critical in the analysis of social and economic conditions in the US. The objective of this section is to analyze the report released on Aug 7, 2012, for Aug 2012 (http://www.bls.gov/news.release/pdf/empsit.pdf). The analysis of the employment situation of the US is divided into two sections. I Twenty Million Unemployed or Underemployed provides the key data on employment and job creation contained in the BLS report. These data are complemented by the BLS report on hiring, job openings and separations to be released on Tue Sep 11, 2012 (http://www.bls.gov/jlt/), which will be analyzed in this blog’s comment of Aug 16 with the latest report analyzed in the blog comment for Aug 12, 2012 (http://cmpassocregulationblog.blogspot.com/2012/08/recovery-without-hiring-ten-million.html). II Stagnating Real Wages analyzes wages and hours worked. IA1 Summary of the Employment Situation provides brief analysis of the employment situation. IA2 Number of People in Job Stress provides the calculation of people unemployed or underemployed in the US using the estimates of the BLS. IA3 Long-term and Cyclical Comparison of Employment provides the comparison with long-term and relevant cyclical experience in the US. IA4 Creation of Jobs analyzes the establishment survey of the BLS that provides job creation in nonfarm payrolls. Hourly and weekly earnings and hours worked are analyzed in the following section II Stagnating Real Wages.
IA1 Summary of the Employment Situation. The Bureau of Labor Statistics (BLS) of the US Department of Labor provides both seasonally-adjusted (SA) and not-seasonally adjusted (NSA) or unadjusted data with important uses (Bureau of Labor Statistics 2012Feb3; 2011Feb11):
“Most series published by the Current Employment Statistics program reflect a regularly recurring seasonal movement that can be measured from past experience. By eliminating that part of the change attributable to the normal seasonal variation, it is possible to observe the cyclical and other nonseasonal movements in these series. Seasonally adjusted series are published monthly for selected employment, hours, and earnings estimates.”
Table I-1 provides the summary statistics of the employment situation report of the BLS. The first four rows provide the data from the establishment report of creation of nonfarm payroll jobs and remuneration of workers (for analysis of the differences in employment between the establishment report and the household survey see Abraham, Haltiwanger, Sandusky and Spletzer 2009). Total nonfarm payroll employment seasonally adjusted (SA) increased 96,000 in Aug 2012 and private payroll employment rose 103,000. The number of nonfarm jobs and private jobs created has been declining in the first five months of 2012 from 275,000 in Jan to 45,000 in Jun and 96,000 in Aug for total nonfarm jobs and from 277,000 in Jan to 63,000 in Jun and 103,000 in Aug for private jobs. Average new nonfarm jobs in the quarter Dec 2011 to Feb 2012 were 252,000 per month, declining to average 96,667 per month in the six months from Mar to Aug 2012. Average new private jobs in the quarter Dec 2011 to Feb 2012 were 255,000 per month, declining to 112,667 per month in the six months from Mar 2012 to Aug 2012. The US labor force stood at 154.812 million in Jul 2011 and at 156.526 million in Jul 2012, not seasonally adjusted, for increase of 1.714 million, or 142,833 per month. The average increase of 96,667 new nonfarm jobs per month in the US from Mar to Jul 2012 is insufficient even to absorb 142,833 new entrants per month into the labor force. There is not sufficient job creation to merely absorb new entrants in the labor force, worsening the stock of unemployed or underemployed in involuntary part-time jobs. Subsection IA4 Job Creation analyzes the types of jobs created. Average hourly earnings in Aug 2012 were $23.29 not seasonally adjusted (NSA), increasing 1.8 percent relative to Aug 2011 and remaining unchanged relative to Jul 2012 seasonally adjusted. In Jul 2012, average hourly earnings not seasonally adjusted were $23.52, increasing 2.3 percent relative to Jul 2011 and increasing 0.1 percent seasonally adjusted relative to Jun 2012. These are nominal changes in workers’ wages. The following row “average hourly earnings in constant dollars” provides hourly wages in constant dollars calculated by the BLS or what is called “real wages” adjusted for inflation. Data are not available for Aug because the prices indexes of the BLS for Aug will only be released on Sep 14 (http://www.bls.gov/cpi/), which will be covered in this blog’s comment on Aug 19. The second column provides changes in real wages for Jul. Average hourly earnings adjusted for inflation or in constant dollars increased 1.0 percent in Jul 2012 relative to Jul 2011 but have been decreasing during many consecutive months. World inflation waves in bouts of risk aversion (http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html) mask declining trend of real wages. The fractured labor market of the US is characterized by high levels of unemployment and underemployment together with falling real wages or wages adjusted for inflation. The following section II Stagnating Real Wages provides more detailed analysis. Average weekly hours of US workers not seasonally adjusted remained at 34.4. Another headline number widely followed is the unemployment rate or number of people unemployed as percent of the labor force. The unemployment rate calculated in the household survey decreased from 8.3 percent in Jul 2012 to 8.1 percent in Aug 2012 but mainly because of the reduction of the US labor force by 271,000 (see Table I-4 below) as people ceased their job searches believing there are no jobs available for them. This blog provides with every employment situation report the number of people in the US in job stress or unemployed plus underemployed calculated without seasonal adjustment (NSA) at 28.1 million in Aug 2012 and 28.8 million in Jul 2012. The final row in Table I-1 provides the number in job stress as percent of the actual labor force calculated at 17.4 percent in Aug 2012 and 17.9 percent in Jul 2012. Almost one in every five workers in the US is unemployed or underemployed. The combination of high number of people in job stress, falling or stagnating real wages and high number of people in poverty constitutes a socio-economic disaster.
Table I-1, US, Summary of the Employment Situation Report SA
| Aug 2012 | Jul 2012 | |
| New Nonfarm Payroll Jobs | 96,000 | 141,000 |
| New Private Payroll Jobs | 103,000 | 162,000 |
| Average Hourly Earnings | $23.52 SA ∆% Aug 12/Aug 11 NSA: 2.0 ∆% Aug 12/Jul 12 SA: 0.0 | $23.53 SA ∆% Jul 12/Jul 11 NSA: 2.3 ∆% Jul 12/Jun 12 SA: 0.1 |
| Average Hourly Earnings in Constant Dollars | NA | $10.27 ∆% Jul 2012/Jul 2011: 1.0 |
| Average Weekly Hours | 34.4 | 34.4 |
| Unemployment Rate Household Survey % of Labor Force SA | 8.1 | 8.3 |
| Number in Job Stress Unemployed and Underemployed Blog Calculation | 28.1 million NSA | 28.8 million NSA |
| In Job Stress as % Labor Force | 17.4 | 17.9 |
Source: US Bureau of Labor Statistics http://www.bls.gov/news.release/empsit.nr0.htm http://www.bls.gov/data/ See Tables I-2, I-3, I-4, I-8, IB-1, IB-3 and IB-4.
IA2 Number of People in Job Stress. There are two approaches to calculating the number of people in job stress. The first approach consists of calculating the number of people in job stress unemployed or underemployed with the raw data of the employment situation report as in Table I-2. The data are seasonally adjusted (SA). The first three rows provide the labor force and unemployed in millions and the unemployment rate of unemployed as percent of the labor force. There is increase in the number unemployed from 12.749 million in Jun 2012 to 12.794 million in Jul 2012 or increase of 45,000 and decrease to 12.544 million in Aug 2012 for decrease of 205.000 from Jun to Aug 2012. Thus, the rate of unemployment increases from 8.2 percent in Jun 2012 to 8.3 percent in Jul, decreasing to 8.1 percent in Aug 2012. The labor force SA decreased from 155.163 million in Jun 2012 to 155.013 million in Jul 2012 or by 150,000 and decreased to 154.645 in Aug 2012 for decrease of 518,000 relative to Jun 2012. People dropping out of the labor force because they believe there are not jobs for them are actually unemployed but not counted as they stopped their job searches. An important aspect of unemployment is its persistence with 5.185 million in Jul who had been unemployed for 27 weeks or more, constituting 40.5 percent of the unemployed and 5.033 million in Aug or 40.1 percent of total unemployed. The longer the period of unemployment the lower are the chances of finding another job. Another key characteristic of the current labor market is the high number of people trying to subsist with part-time jobs because they cannot find full-time employment or part-time for economic reasons. The BLS explains as follows: “these individuals were working part time because their hours had been cut back or because they were unable to find a full-time job” (http://www.bls.gov/news.release/pdf/empsit.pdf 2). The number of part-time for economic reasons increased from 8.210 million in Jun 2012 to 8.246 million in Jul 2012 or by 36,000 but declined to 8.031 million in Aug 2012. Another category consists of people marginally attached to the labor force who have sought employment at some point but believe there may not be another job for them. The BLS explains as follows: “these individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey” (http://www.bls.gov/news.release/pdf/empsit.pdf 2). The number in job stress unemployed or underemployed of 23.136 million in Aug is composed of 12.544 million unemployed (of whom 5.033 million, or 40.1 percent, unemployed for 27 weeks or more) compared with 12.794 million unemployed in Jul (of whom 5.185 million, or 40.5 percent, unemployed for 27 weeks or more), 8.031 million employed part-time for economic reasons in JAug (who suffered reductions in their work hours or could not find full-time employment) compared with 8.246 million in Jul and 2.561 million who were marginally attached to the labor force in Aug (who were not in the labor force but wanted and were available for work) compared with 2.529 million in Jul. The final row in Table I-2 provides the number in job stress as percent of the labor force: 14.9 percent in Aug, which is marginally lower than 15.2 percent in Jul and 15.1 percent in Jun.
Table I-2, US, People in Job Stress, Millions and % SA
| 2012 | Aug 2012 | Jul 2012 | Jun 2012 |
| Labor Force Millions | 154.645 | 155.013 | 155.163 |
| Unemployed | 12.544 | 12.794 | 12.749 |
| Unemployment Rate (unemployed as % labor force) | 8.1 | 8.3 | 8.2 |
| Unemployed ≥27 weeks | 5.033 | 5.185 | 5.370 |
| Unemployed ≥27 weeks % | 40.1 | 40.5 | 42.1 |
| Part Time for Economic Reasons ∆ Aug 2012/Dec 2011: -7 thousand ∆ Aug 2012/Sep 2011: -0.759 million | 8.031 | 8.246 | 8.210 |
| Marginally ∆Aug 2012/Sep 2011: +50 thousand ∆Aug 2012/Dec 2011: 21 thousand | 2.561 | 2.529 | 2.483 |
| Job Stress ∆Mar 12/Dec 11: -948 thousand ∆Feb 12/Sep 11: -2.145 million | 23.136 | 23.569 | 23.442 |
| In Job Stress as % Labor Force | 14.9 | 15.2 | 15.1 |
Job Stress = Unemployed + Part Time Economic Reasons + Marginally Attached Labor Force
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
Table I-3 repeats the data in Table I-2 but including May and additional data. What really matters is the number of people with jobs or the total employed. The final row of Table I-3 provides people employed as percent of the population or employment to population ratio. The number has remained relatively constant around 58.6 percent, decreasing to 58.3 in Aug 2012.
Table I-3, US, Unemployment and Underemployment, SA, Millions and Percent
| Aug 2012 | Jul 2012 | Jun 2012 | May 2012 | |
| Labor Force | 154.645 | 155.013 | 155.163 | 155.007 |
| Unemployed | 12.544 | 12.794 | 12.749 | 12.720 |
| UNE Rate % | 8.1 | 8.3 | 8.2 | 8.2 |
| Part Time Economic Reasons | 8.031 | 8.246 | 8.210 | 8.098 |
| Marginally Attached to Labor Force | 2.561 | 2.529 | 2.483 | 2.423 |
| In Job Stress | 23.136 | 23.569 | 23.442 | 23.241 |
| In Job Stress % Labor Force | 14.9 | 15.2 | 15.1 | 14.9 |
| Employed | 142.101 | 142.220 | 142.415 | 142.287 |
| Employment % Population | 58.3 | 58.4 | 58.6 | 58.6 |
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
The second approach is considered in the balance of this subsection. Charts I-1 to I-12 explain the reasons for considering another approach to calculating job stress in the US. Chart I-1 of the Bureau of Labor Statistics provides the level of employment in the US from 2001 to 2012. There was a big drop of the number of people employed from 147.315 million at the peak in Jul 2007 (NSA) to 136.809 million at the trough in Jan 2010 (NSA) with 10.506 million fewer people employed. Recovery has been anemic compared with the shallow recession of 2001 that was followed by nearly vertical growth in jobs. The number employed in Aug 2012 was 142.558 million (NSA) or 4.757 million fewer people with jobs relative to the peak of 147.315 million in Jul 2007.
Chart I-1, US, Employed, Thousands, SA, 2001-2012
Source: Bureau of Labor Statistics
Chart I-2 of the Bureau of Labor Statistics provides 12-month percentage changes of the number of people employed in the US from 2001 to 2012. There was recovery in 2010 and 2011 but not sufficient to recover lost jobs. There are many people in the US who had jobs before the global recession who are not working now.
Chart I-2, US, Employed, 12-Month Percentage Change NSA, 2001-2012
Source: Bureau of Labor Statistics
The foundation of the second approach derives from Chart I-3 of the Bureau of Labor Statistics providing the level of the civilian labor force in the US. The civilian labor force consists of people who are available and willing to work and who have searched for employment recently. The labor force of the US grew from 142.828 million in Jan 2001 to 156.255 million in Jul 2009 but has declined to 153.905 million in Apr 2012, 154.998 million in May 2012, 156.385 million in Jun 2012, 156.526 million in Jul and 155.255 million in Aug 2012, all numbers not seasonally adjusted. Chart 1-3 shows the flattening of the curve of expansion of the labor force and its decline in 2010 and 2011. The level of the labor force in the US has stagnated. The key issue is whether the decline in participation of the population in the labor force is the result of people giving up on finding another job.
Chart I-3, US, Civilian Labor Force, Thousands, SA, 2001-2012
Source: Bureau of Labor Statistics
Chart I-4 of the Bureau of Labor Statistics provides 12-month percentage changes of the level of the labor force in the US. The rate of growth fell almost instantaneously with the global recession and became negative from 2009 to 2011. The labor force of the US collapsed and did not recover.
Chart I-4, US, Civilian Labor Force, Thousands, NSA, 12-month Percentage Change, 2001-2012
Source: Bureau of Labor Statistics
Chart I-5 of the Bureau of Labor Statistics provides the labor force participation rate in the US or labor force as percent of the population. The labor force participation rate of the US fell from 66.8 percent in Jan 2001 to 63.7 percent NSA in Jul 2012, all numbers not seasonally adjusted. The annual labor force participation rate for 1979 was 63.7 percent and also 63.7 percent in Nov 1980 during sharp economic contraction. This comparison is further elaborated below. Chart I-5 shows an evident downward trend beginning with the global recession that has continued throughout the recovery beginning in IIIQ2009. The critical issue is whether people left the workforce of the US because they believe there is no longer a job for them.
Chart I-5, Civilian Labor Force Participation Rate, Percent of Population in Labor Force SA, 2001-2012
Source: Bureau of Labor Statistics
Chart I-6 of the Bureau of Labor Statistics provides the level of unemployed in the US. The number unemployed rose from the trough of 6.272 million in Oct 2006 to the peak of 15.991 million in Feb 2010, declining to 13.400 million in Jul 2012 and 12.696 million in Aug 2012, all numbers not seasonally adjusted.
Chart I-6, US, Unemployed, Thousands, SA, 2001-2012
Source: Bureau of Labor Statistics
Chart I-7 of the Bureau of Labor Statistics provides the rate of unemployment in the US or unemployed as percent of the labor force. The rate of unemployment of the US rose from 4.7 percent in Jan 2001 to 6.5 percent in Jun 2003, declining to 4.1 percent in Oct 2006. The rate of unemployment jumped to 10.6 percent in Jan 2010 and declined to 8.2 percent in Aug 2012, all numbers not seasonally adjusted.
Chart I-7, US, Unemployment Rate, SA, 2001-2012
Source: Bureau of Labor Statistics
Chart I-8 of the Bureau of Labor Statistics provides 12-month percentage changes of the level of unemployed. There was a jump of 81.8 percent in Apr 2009 with subsequent decline and negative rates since 2010. On an annual basis, the level of unemployed rose 59.8 percent in 2009 and 26.1 percent in 2008 with increase of 3.9 percent in 2010 and decline of 7.3 percent in 2011.
Chart I-8, US, Unemployed, 12-month Percentage Change, NSA, 2001-2012
Source: Bureau of Labor Statistics
Chart I-9 of the Bureau of Labor Statistics provides the number of people in part-time occupations because of economic reasons, that is, because they cannot find full-time employment. The number underemployed in part-time occupations not seasonally adjusted rose from 3.732 million in Jan 2001 to 5.270 million in Jan 2004, falling to 3.787 million in Apr 2006. The number underemployed seasonally adjusted jumped to 9.130 million in Nov 2009, falling to 8.098 million in Dec 2011 but increasing to 8.230 million in Jan 2012 and 8.119 million in Feb 2012 but then falling to 7.853 million in Apr 2012 and increasing to 8.246 million in Jul 2012 and 8.031 million in Aug 2012. Without seasonal adjustment the number employed part-time for economic reasons reached 9.354 million in Dec 2009, declining to 8.918 million in Jan 2012 and 7.842 million in Aug 2012. The longer the period in part-time jobs the worst are the chances of finding another full-time job.
Chart I-9, US, Part-Time for Economic Reasons, Thousands, SA, 2001-2012
Source: Bureau of Labor Statistics
Chart I-10 of the Bureau of Labor Statistics repeats the behavior of unemployment. The 12-month rate of the level of people at work part-time for economic reasons jumped 84.7 percent in Mar 2009 and declined subsequently. The declines have been insufficient to reduce significantly the number of people who cannot shift from part-time to full-time employment. On an annual basis, the number of part-time for economic reasons increased 33.5 percent in 2008 and 51.7 percent in 2009, declining 0.4 percent in 2010 and 3.5 percent in 2011.
Chart I-10, US, Part-Time for Economic Reasons NSA 12-Month Percentage Change, 2001-2011
Source: Bureau of Labor Statistics
Chart I-11 of the Bureau of Labor Statistics provides the same pattern of the number marginally attached to the labor force jumping to significantly higher levels during the global recession and remaining at historically high levels. The number marginally attached to the labor force not seasonally adjusted increased from 1.295 million in Jan 2001 to 1.691 million in Feb 2004. The number of marginally attached to the labor force fell to 1.299 million in Sep 2006 and increased to 2.486 million in Dec 2009. The number marginally attached to the labor force was 2.540 million in Dec 2011, increasing to 2.809 million in Jan 2012, falling to 2.608 million in Feb 2012, 2.352 million in Mar 2012, 2.363 million in Apr 2012, 2.483 million in May 2012, 2.529 million in Jun 2012, 2.529 million in Jul 2012 and 2.561 million in Aug 2012.
Chart I-11, US, Marginally-Attached to the Labor Force, Thousands, NSA, 2001-2012
Source: Bureau of Labor Statistics
Chart I-12 provides 12-month percentage changes of the marginally attached to the labor force from 2001 to 2012. There was a jump of 56.1 percent in May 2009 during the global recession followed by declines in percentage changes but insufficient negative changes. On an annual basis, the number of marginally attached to the labor force increased in four consecutive years: 15.7 percent in 2008, 37.9 percent in 2009, 11.7 percent in 2010 and 3.5 percent in 2011.
Chart I-12, US, Marginally-Attached to the Labor Force 12-Month Percentage Change, NSA, 2001-2012
Source: Bureau of Labor Statistics
Table I-4 consists of data and additional calculations using the BLS household survey, illustrating the possibility that the actual rate of unemployment could be 11.0 percent and the number of people in job stress could be around 28.1 million, which is 17.4 percent of the labor force. The first column provides for 2006 the yearly average population (POP), labor force (LF), participation rate or labor force as percent of population (PART %), employment (EMP), employment population ratio (EMP/POP %), unemployment (UEM), the unemployment rate as percent of labor force (UEM/LF Rate %) and the number of people not in the labor force (NLF). All data are unadjusted or not-seasonally-adjusted (NSA). The numbers in column 2006 are averages in millions while the monthly numbers for Aug 2011, Jul 2012 and Aug 2012 are in thousands, not seasonally adjusted. The average yearly participation rate of the population in the labor force was in the range of 66.0 percent minimum to 67.1 percent maximum between 2000 and 2006 with the average of 66.4 percent (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). Table I-4b provides the yearly labor force participation rate from 1979 to 2012. The objective of Table I-4 is to assess how many people could have left the labor force because they do not think they can find another job. Row “LF PART 66.2 %” applies the participation rate of 2006, almost equal to the rates for 2000 to 2006, to the noninstitutional civilian population in Jul and Aug 2012 and Aug 2011 to obtain what would be the labor force of the US if the participation rate had not changed. In fact, the participation rate fell to 64.6 percent by Jul 2011 and was 63.7 percent in Aug 2012 and 64.3 percent in Jul 2012, suggesting that many people simply gave up on finding another job. Row “∆ NLF UEM” calculates the number of people not counted in the labor force because they could have given up on finding another job by subtracting from the labor force with participation rate of 66.2 percent (row “LF PART 66.2%”) the labor force estimated in the household survey (row “LF”). Total unemployed (row “Total UEM”) is obtained by adding unemployed in row “∆NLF UEM” to the unemployed of the household survey in row “UEM.” The row “Total UEM%” is the effective total unemployed “Total UEM” as percent of the effective labor force in row “LF PART 66.2%.” The results are that: (1) there are an estimated 4.986 million unemployed in Aug 2012 who are not counted because they left the labor force on their belief they could not find another job (∆NLF UEM); (2) the total number of unemployed is effectively 17.682 million (Total UEM) and not 12.696 million (UEM) of whom many have been unemployed long term; (3) the rate of unemployment is 11.0 percent (Total UEM%) and not 8.2 percent, not seasonally adjusted, or 8.1 percent seasonally adjusted; and (4) the number of people in job stress is close to 28.1 million by adding the 4.986 million leaving the labor force because they believe they could not find another job. The row “In Job Stress” in Table I-4 provides the number of people in job stress not seasonally adjusted at 28.1 million in Aug 2012, adding the total number of unemployed (“Total UEM”), plus those involuntarily in part-time jobs because they cannot find anything else (“Part Time Economic Reasons”) and the marginally attached to the labor force (“Marginally attached to LF”). The final row of Table I-4 shows that the number of people in job stress is equivalent to 17.4 percent of the labor force in Aug 2012. The employment population ratio “EMP/POP %” dropped from 62.9 percent on average in 2006 to 58.5 percent in Aug 2011, 58.8 percent in Jul 2012 and 58.5 percent in Aug 2012; the number employed (EMP) dropped from 144 million to 142.558 million. What really matters for labor input in production and wellbeing is the number of people with jobs or the employment/population ratio, which has declined and does not show signs of increasing. There are several million fewer people working in 2012 than in 2006 and the number employed is not increasing. The number of hiring relative to the number unemployed measures the chances of becoming employed. The number of hiring in the US economy has declined by 17 million and does not show signs of increasing in an unusual recovery without hiring (http://cmpassocregulationblog.blogspot.com/2012/08/recovery-without-hiring-ten-million.html).
Table I-4, US, Population, Labor Force and Unemployment, NSA
| 2006 | Aug 2011 | Jul 2012 | Aug 2012 | |
| POP | 229 | 239,871 | 243,354 | 243,566 |
| LF | 151 | 154,344 | 156,526 | 156,255 |
| PART% | 66.2 | 64.3 | 64.3 | 63.7 |
| EMP | 144 | 140,335 | 143,126 | 142,558 |
| EMP/POP% | 62.9 | 58.5 | 58.8 | 58.5 |
| UEM | 7 | 14,008 | 13,400 | 12,696 |
| UEM/LF Rate% | 4.6 | 9.1 | 8.6 | 8.2 |
| NLF | 77 | 82,528 | 86,828 | 88,311 |
| LF PART 66.2% | 158,795 | 161,100 | 161,241 | |
| ∆NLF UEM | 4,451 | 4,574 | 4,986 | |
| Total UEM | 18,459 | 17,974 | 17,682 | |
| Total UEM% | 11.6 | 11.2 | 11.0 | |
| Part Time Economic Reasons | 8,604 | 8,316 | 7,842 | |
| Marginally Attached to LF | 2,575 | 2,529 | 2,561 | |
| In Job Stress | 29,638 | 28,819 | 28,085 | |
| People in Job Stress as % Labor Force | 18.7 | 17.9 | 17.4 |
Pop: population; LF: labor force; PART: participation; EMP: employed; UEM: unemployed; NLF: not in labor force; ∆NLF UEM: additional unemployed; Total UEM is UEM + ∆NLF UEM; Total UEM% is Total UEM as percent of LF PART 66.2%; In Job Stress = Total UEM + Part Time Economic Reasons + Marginally Attached to LF
Note: the first column for 2006 is in average millions; the remaining columns are in thousands; NSA: not seasonally adjusted
The labor force participation rate of 66.2% in 2006 is applied to current population to obtain LF PART 66.2%; ∆NLF UEM is obtained by subtracting the labor force with participation of 66.2 percent from the household survey labor force LF; Total UEM is household data unemployment plus ∆NLF UEM; and total UEM% is total UEM divided by LF PART 66.2%
Sources: US Bureau of Labor Statistics http://www.bls.gov/data/
In revealing research, Edward P. Lazear and James R. Spletzer (2012JHJul22) use the wealth of data in the valuable database and resources of the Bureau of Labor Statistics (http://www.bls.gov/data/) in providing clear thought on the nature of the current labor market of the United States. The critical issue of analysis and policy currently is whether unemployment is structural or cyclical. Structural unemployment could occur because of (1) industrial and demographic shifts; and (2) mismatches of skills and job vacancies in industries and locations. Consider the aggregate unemployment rate, Y, expressed in terms of share si of a demographic group in an industry i and unemployment rate yi of that demographic group (Lazear and Spletzer 2012JHJul22, 5-6):
Y = ∑isiyi (1)
This equation can be decomposed for analysis as (Lazear and Spletzer 2012JHJul22, 6):
∆Y = ∑i∆siy*i + ∑i∆yis*i (2)
The first term in (2) captures changes in the demographic and industrial composition of the economy ∆si multiplied by the average rate of unemployment y*i , or structural factors. The second term in (2) captures changes in the unemployment rate specific to a group, or ∆yi, multiplied by the average share of the group s*i, or cyclical factors. There are also mismatches in skills and locations relative to available job vacancies. A simple observation by Lazear and Spletzer (2012JHJul22) casts intuitive doubt on structural factors: the rate of unemployment jumped from 4.4 percent in the spring of 2007 to 10 percent in October 2009. By nature, structural factors should be permanent or occur over relative long periods. The revealing result of the exhaustive research of Lazear and Spletzer (2012JHJul22) is:
“The analysis in this paper and in others that we review do not provides any compelling evidence that there have been changes in the structure of the labor market that are capable of explaining the pattern of persistently high unemployment rates. The evidence points to primarily cyclic factors.”
Table I-4b and Chart 12-b provide the US labor force participation rate or percentage of the labor force in population. It is not likely that simple demographic trends caused the sharp decline during the global recession and failure to recover earlier levels. The civilian labor force participation rate dropped from the peak of 66.9 percent in Jul 2006 to 63.7 percent in Aug 2012 and even 63.4 percent in Jan and Apr 2012. The civilian labor force participation rate was 63.7 percent on an annual basis in 1979 and 63.7 percent in Nov 1980, reaching even 62.9 percent in both Apr and May 1979. The civilian labor force participation rate jumped with the recovery to 64.8 percent on an annual basis in 1985 and 65.9 percent in Jul 1985. Structural factors cannot explain these sudden changes vividly shown visually in the final segment of Chart 12b. Seniors would like to delay their retiring especially because of the adversities of financial repression on their savings. Labor force statistics are capturing the disillusion of potential workers of their chances in finding a job in what Lazear and Spletzer (2012JHJul22) characterize as accentuated cyclical factors.
Table I-4b, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1979-2012
| Year | Jun | Jul | Aug | Annual |
| 1979 | 64.5 | 64.9 | 64.5 | 63.7 |
| 1980 | 64.6 | 65.1 | 64.5 | 63.8 |
| 1981 | 64.6 | 65.0 | 64.6 | 63.9 |
| 1982 | 64.8 | 65.3 | 64.9 | 64.0 |
| 1983 | 65.1 | 65.4 | 65.1 | 64.0 |
| 1984 | 65.5 | 65.9 | 65.2 | 64.4 |
| 1985 | 65.5 | 65.9 | 65.4 | 64.8 |
| 1986 | 66.3 | 66.6 | 66.1 | 65.3 |
| 1987 | 66.3 | 66.8 | 66.5 | 65.6 |
| 1988 | 66.7 | 67.1 | 66.8 | 65.9 |
| 1989 | 67.4 | 67.7 | 67.2 | 66.5 |
| 1990 | 67.4 | 67.7 | 67.1 | 66.5 |
| 1991 | 67.2 | 67.3 | 66.6 | 66.2 |
| 1992 | 67.6 | 67.9 | 67.2 | 66.4 |
| 1993 | 67.3 | 67.5 | 67.0 | 66.3 |
| 1994 | 67.2 | 67.5 | 67.2 | 66.6 |
| 1995 | 67.2 | 67.7 | 67.1 | 66.6 |
| 1996 | 67.4 | 67.9 | 67.2 | 66.8 |
| 1997 | 67.8 | 68.1 | 67.6 | 67.1 |
| 1998 | 67.7 | 67.9 | 67.3 | 67.1 |
| 1999 | 67.7 | 67.9 | 67.3 | 67.1 |
| 2000 | 67.7 | 67.6 | 67.2 | 67.1 |
| 2001 | 67.2 | 67.4 | 66.8 | 66.8 |
| 2002 | 67.1 | 67.2 | 66.8 | 66.6 |
| 2003 | 67.0 | 66.8 | 66.3 | 66.2 |
| 2004 | 66.5 | 66.8 | 66.2 | 66.0 |
| 2005 | 66.5 | 66.8 | 66.5 | 66.0 |
| 2006 | 66.7 | 66.9 | 66.5 | 66.2 |
| 2007 | 66.6 | 66.8 | 66.1 | 66.0 |
| 2008 | 66.6 | 66.8 | 66.4 | 66.0 |
| 2009 | 66.2 | 66.2 | 65.6 | 65.4 |
| 2010 | 65.1 | 65.3 | 65.0 | 64.7 |
| 2011 | 64.5 | 64.6 | 64.3 | 64.1 |
| 2012 | 64.3 | 64.3 | 63.7 |
Sources: US Bureau of Labor Statistics http://www.bls.gov/data/
Chart 12b, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1979-2011
Source: Bureau of Labor Statistics
IA3 Long-term and Cyclical Comparison of Employment. There is initial discussion here of long-term employment trends followed by cyclical comparison. Growth and employment creation have been mediocre in the expansion beginning in Jul IIIQ2009 from the contraction between Dec IVQ2007 and Jun IIQ2009 (http://www.nber.org/cycles.html). A series of charts from the database of the Bureau of Labor Statistics (BLS) provides significant insight. Chart I-13 provides the monthly employment level of the US from 1948 to 2012. The number of people employed has trebled. There are multiple contractions throughout the more than six decades but followed by resumption of the strong upward trend. The contraction after 2007 is deeper and followed by a flatter curve of job creation. Economic growth is much lower in the current expansion at 2.2 percent relative to average 6.2 percent in expansions following earlier contractions.
Chart I-13, US, Employment Level, Thousands, 1948-2012
Source: US Bureau of Labor Statistics
The steep and consistent curve of growth of the US labor force is shown in Chart I-14. The contraction beginning in Dec 2007 flattened the path of the US civilian labor force and is now followed by a flatter curve during the current expansion.
Chart I-14, US, Civilian Labor Force, 1948-2012, Thousands
Source: US Bureau of Labor Statistics
Chart I-15 for the period from 1948 to 2012. The labor force participation rate is influenced by numerous factors such as the age of the population. There is no comparable episode in the postwar economy to the sharp collapse of the labor force participation rate in Chart I-15 during the contraction and subsequent expansion after 2007. Aging can reduce the labor force participation rate as many people retire but many may have decided to work longer as their wealth and savings have been significantly reduced. There is an important effect of many people just exiting the labor force because they believe there is no job available for them.
Chart I-15, US, Civilian Labor Force Participation Rate, 1948-2012, %
Source: US Bureau of Labor Statistics
The number of unemployed in the US jumped from 5.8 million in May 1979 to 12.1 million in Dec 1982, by 6.3 million, or 108.6 percent. The number of unemployed jumped from 6.7 million in Mar 2007 to 15.6 million in Oct 2009, by 8.9 million, or 132.8 percent. These are the two episodes with steepest increase in the level of unemployment in Chart I-16.
Chart I-16, US, Unemployed, 1948-2012, Thousands
Source: US Bureau of Labor Statistics
Chart I-17 provides the rate of unemployment of the US from 1948 to 2012. The peak of the series is 10.8 percent in both Nov and Dec 1982. The second highest rates are 10.1 percent in Oct 2009 and 9.9 percent in both Nov and Dec 2009.
Chart I-17, US, Unemployment Rate, 1948-2012
Source: US Bureau of Labor Statistics
Chart I-18 provides the number unemployed for 27 weeks and over from 1948 to 2012. The number unemployed for 27 weeks and over jumped from 510,000 in Dec 1978 to 2.9 million in Jun 1983, by 2.4 million, or 480 percent. The number of unemployed 27 weeks or over jumped from 1.1 million in May 2007 to 6.7 million in Jun 2010, by 5.6 million, or 509 percent.
Chart I-18, US, Unemployed for 27 Weeks or More, 1948-2012, Thousands
Source: US Bureau of Labor Statistics
The employment-population ratio in Chart I-19 is an important indicator of wellbeing in labor markets, measuring the number of people with jobs. The US employment-population ratio fell from 63.4 in Dec 2006 to 58.6 in Jul 2011 and stands at 58.5 NSA in Aug 2012. There is no comparable decline during an expansion in Chart I-19.
Chart I-19, US, Employment-Population Ratio, 1948-2012
Source: US Bureau of Labor Statistics
The number of people at work part-time for economic reasons because they cannot find full-time employment is provided in Chart I-20. The number of people at work part-time for economic reasons jumped from 3.7 million in Sep 2006 to a high of 9.4 million in Dec 2009 and 9.2 million in Jan 2011, or by 5.2 million, or 148.6 percent, all numbers not seasonally adjusted. Earlier increases in the 1980s and after the tough recession of 1991 were followed by rapid decrease that is still absent in the current expansion. The drop by 1,172,000 of seasonally-adjusted data from Sep to Dec 2011 while actual data without seasonal adjustment show decrease by 113,000 is not very credible.
Chart I-20, US, Part-Time for Economic Reasons, 1955-2012, Thousands
Source: US Bureau of Labor Statistics
Table I-5 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-5, 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
Characteristics of the four cyclical contractions are provided in Table I-6 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-6, 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-7 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-7, 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
A group of charts from the database of the Bureau of Labor Statistics facilitate the comparison of employment in the 1980s and 2000s. The long-term charts and tables from I-5 to I-7 in the discussion above confirm the view that the comparison of the current expansion should be with that in the 1980s because of similar dimensions. Chart I-21 provides the level of employment in the US between 1979 and 1989. Employment surged after the contraction and grew rapidly during the decade.
Chart I-21, US, Employed, Thousands, 1979-1989
Source: US Bureau of Labor Statistics
The number employed in the US fell from 146.406 million in Aug 2007 to 142.558 million in Aug 2012, by 3.848 million, or 2.6 percent, using not-seasonally-adjusted data. Chart I-22 shows tepid recovery early in 2010 followed by near stagnation and marginal expansion.
![clip_image014[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesEA8FD4\image100.png "clip_image014[1]")
Chart I-22, US, Employed, Thousands, 2001-2012
Source: US Bureau of Labor Statistics
There was a steady upward trend in growth of the civilian labor force between 1979 and 1989 as shown in Chart I-23. There were fluctuations but strong long-term dynamism over an entire decade.
Chart I-23, US, Civilian Labor Force, Thousands, 1979-1989
Source: US Bureau of Labor Statistics
The civilian labor force in Chart I-24 grew steadily on an upward trend in the 2000s until it contracted together with the economy after 2007. There has not been recovery during the expansion but rather decline and marginal turn of the year into 2012 expansion.
![clip_image018[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesEA8FD4\image104.png "clip_image018[1]")
Chart I-24, US, Civilian Labor Force, Thousands, 2001-2012
Source: US Bureau of Labor Statistics
The rate of participation of the labor force in population stagnated during the stagflation and conquest of inflation in the late 1970s and early 1980s, as shown in Chart I-25. Recovery was vigorous during the expansion and lasted through the remainder of the decade.
Chart I-25, US, Civilian Labor Force Participation Rate, 1979-1989, %
Source: US Bureau of Labor Statistics
The rate of participation in the labor force declined after the recession of 2001 and stagnated until 2007, as shown in Chart I-26. The rate of participation in the labor force continued to decline both during the contraction after 2007 and the expansion after 2009 with marginal expansion at the turn of the year into 2012, which is reversed and insufficiently recovered at the tail of the curve.
![clip_image022[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesEA8FD4\image116.png "clip_image022[1]")
Chart I-26, US, Civilian Labor Force Participation Rate, 2001-2012, %
Source: US Bureau of Labor Statistics
Chart I-27 provides the number unemployed during the 1980s. The number unemployed peaked at 12.051 million in Dec 1982 seasonally adjusted and 12.517 in Jan 1983 million not seasonally adjusted, declining to 8.358 million in Dec 1984 seasonally adjusted and 7.978 million not seasonally adjusted during the first two years of expansion from the contraction. The number unemployed then fell to 6.667 million in Dec 1989 seasonally adjusted and 6.300 million not seasonally adjusted.
Chart I-27, US, Unemployed Thousands 1979-1989
Source: US Bureau of Labor Statistics
Chart I-28 provides the number unemployed from 2001 to 2012. Using seasonally adjusted data, the number unemployed rose from 6.727 million in Oct 2006 to 15.421 million in Oct 2009, declining to 13.097 million in Dec 2011 and to 12.544 million in Aug 2012. Using data not seasonally adjusted, the number unemployed rose from 6.272 million in Oct 2006 to 16.147 million in Jan 2010, declining to 12.696 million in Aug 2012.
![clip_image024[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesEA8FD4\image108.png "clip_image024[1]")
Chart I-28, US, Unemployed Thousands 2001-2012
Source: US Bureau of Labor Statistics
The rate of unemployment peaked at 10.8 percent in both Nov and Dec 1982 seasonally adjusted, as shown in Chart I-29. The rate of unemployment dropped sharply during the expansion after 1984 and continued to decline during the rest of the decade to 5.4 percent in Dec 1989. Using not seasonally adjusted data, the rate of unemployment peaked at 11.4 percent in Jan 1983, declining to 7.0 percent in Dec 1984 and 5.1 percent in Dec 1989.
Chart I-29, US, Unemployment Rate, 1979-1989, %
Source: US Bureau of Labor Statistics
The rate of unemployment in the US seasonally adjusted jumped from 4.4 percent in May 2007 to 10.0 percent in Oct 2009 and 9.9 percent in both Nov and Dec 2009, as shown in Chart I-30. The rate of unemployment fluctuated at around 9.0 percent in 2011 with the somewhat less credible 8.7 percent in Nov 2011 because of the decrease of the labor force by 120,000 from 154.057 million Oct to 153.937 million in Nov and then declined to 8.5 percent in Dec 2011 with decline of 50,000 of the labor force from 153.937 million in Nov to 153.887 million Dec 2011. The rate of unemployment then fell to 8.3 percent in Jan and Feb 2012 and fell to 8.2 percent in Mar 2012 and 8.1 percent in Apr 2012 with another decline of the labor force. With another decline of the labor force the rate fell to 8.1 percent in Aug 2012. Using not seasonally adjusted data, the rate of unemployment rose from 4.3 percent in Apr and May 2007 to 10.6 percent in Jan 2010, declining to 8.1 percent in Aug 2012.
![clip_image026[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesEA8FD4\image112.png "clip_image026[1]")
Chart I-30, US, Unemployment Rate, 2001-2012, %
Source: US Bureau of Labor Statistics
The employment population ratio seasonally adjusted fell from around 60.1 in Dec 1979 to 57.1 in both Feb and Mar 1983, as shown in Chart I-31. The employment population ratio seasonally adjusted rose back to 59.9 in Dec 1984 and reached 63.0 later in the decade in Dec 1989. Using not seasonally adjusted data, the employment population ratio dropped from 60.4 percent in Oct 1979 to 56.1 percent in Jan 1983, increasing to 59.8 in Dec 1984 and to 62.9 percent in Dec 1989.
Chart I-31, US, Employment Population Ratio, 1979-1989, %
Source: US Bureau of Labor Statistics
The US employment-population ratio seasonally adjusted has fallen from 63.4 in Dec 2006 to 58.5 in Dec 2011 and Jan 2012, increasing to 58.6 percent in Feb 2012 and falling back to 58.5 percent in Mar 2012 and 58.4 percent in Apr 2012 but rising to 58.6 percent in May and Jun 2012, falling back to 58.4 percent in Jul 2012 and 58.3 percent in Aug 2012, as shown in Chart I-32. The employment population-ratio has stagnated during the expansion. Using not seasonally adjusted data, the employment population ratio fell from 63.6 percent in Jul 2006 to 57.6 percent in Jan 2011 and 58.5 percent in Aug 2012.
Chart I-32, US, Employment Population Ratio, 2001-2012, %
Source: US Bureau of Labor Statistics
The number unemployed for 27 weeks or over peaked at 2.885 million in Jun 1983 as shown in Chart I-33. The number unemployed for 27 weeks or over fell sharply during the expansion to 1.393 million in Dec 1984 and continued to decline throughout the 1980s to 0.635 million in Dec 1989.
Chart I-33, US, Number Unemployed for 27 Weeks or More 1979-1989, Thousands
Source: US Bureau of Labor Statistics
The number unemployed for 27 weeks or over, seasonally adjusted, increased sharply during the contraction as shown in Chart I-34 from 1.131 million in Nov 2006 to 6.730 in Apr 2010. The number of unemployed for 27 weeks remained at around 6 million during the expansion compared with somewhat above 1 million before the contraction, falling to 5.033 million in Jul 2012 seasonally adjusted and also 5.033 million not seasonally adjusted.
Chart I-34, US, Number Unemployed for 27 Weeks or More, 2001-2012, Thousands
Source: US Bureau of Labor Statistics
The number of persons working part-time for economic reasons because they cannot find full-time work peaked during the contraction at 6.857 million in Oct 1982, as shown in Chart I-35. The number of persons at work part-time for economic reasons fell sharply during the expansion to 5.797 million in Dec 1984 and continued to fall throughout the decade to 4.817 million in Dec 1989.
Chart I-35, US, Part-Time for Economic Reasons, 1979-1989, Thousands
Source: US Bureau of Labor Statistics
The number of people working part-time because they cannot find full-time employment, not seasonally adjusted, increased sharply during the contraction from 3.787 million in Apr 2006, not seasonally adjusted, to 9.354 million in Dec 2009, as shown in Chart I-36. The number of people working part-time because of failure to find an alternative occupation stagnated at a very high level during the expansion, declining to 7.842 million not seasonally adjusted in Aug 2012.
Chart I-36, US, Part-Time for Economic Reasons, 2001-2012, Thousands
Source: US Bureau of Labor Statistics
The number marginally attached to the labor force in Chart I-37 jumped from 1.252 million in Dec 2006 to 2.730 million in Feb 2011, remaining at a high level of 2.540 million in Dec 2011, 2.809 million in Jan 2012, 2.608 million in Feb 2012, 2.352 million in Mar 2012, 2.363 million in Apr 2012 and increase to 2.423 million in May 2012, 2.483 million in Jun 2012, 2.529 million in Jul 2012 and 2.561 million in Aug 2012.
![clip_image034[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesEA8FD4\image152.png "clip_image034[1]")
Chart I-37, US, Marginally Attached to the Labor Force, 2001-2012
Source: US Bureau of Labor Statistics
The number of nonfarm jobs and private jobs created has been declining in the first five months of 2012 from 275,000 in Jan to 45,000 in Jun and 96,000 in Aug for total nonfarm jobs and from 277,000 in Jan to 63,000 in Jun and 103,000 in Aug for private jobs. Average new nonfarm jobs in the quarter Dec 2011 to Feb 2012 were 252,000 per month, declining to average 96,667 per month in the six months from Mar to Aug 2012. Average new private jobs in the quarter Dec 2011 to Feb 2012 were 255,000 per month, declining to 112,667 per month in the six months from Mar 2012 to Aug 2012. The US labor force stood at 154.812 million in Jul 2011 and at 156.526 million in Jul 2012, not seasonally adjusted, for increase of 1.714 million, or 142,833 per month. The average increase of 96,667 new nonfarm jobs per month in the US from Mar to Jul 2012 is insufficient even to absorb 142,833 new entrants per month into the labor force. There is not sufficient job creation to merely absorb new entrants in the labor force, worsening the stock of unemployed or underemployed in involuntary part-time jobs. Table I-8 provides the monthly change in jobs seasonally adjusted in the prior strong contraction of 1981-1982 and the recovery in 1983 into 1984 and in the contraction of 2008-2009 and in the recovery in 2009 to 2012. All revisions have been incorporated in Table I-8. The data in the recovery periods are in relief to facilitate comparison. There is significant bias in the comparison. The average yearly civilian noninstitutional population was 174.2 million in 1983 and the civilian labor force 111.6 million, growing by 2009 to an average yearly civilian noninstitutional population of 235.8 million and civilian labor force of 154.1 million, that is, increasing by 35.4 percent and 38.1 percent, respectively (http://www.bls.gov/data/). Total nonfarm payroll jobs in 1983 were 90.280 million, jumping to 94.530 million in 1984 while total nonfarm jobs in 2010 were 129.874 million declining from 130.807 million in 2009 (http://www.bls.gov/data/). What is striking about the data in Table I-8 is that the numbers of monthly increases in jobs in 1983 and 1984 are several times higher than in 2010 to 2011 even with population higher by 35.4 percent and labor force higher by 38.1 percent in 2009 relative to 1983 nearly three decades ago and total number of jobs in payrolls rose by 39.5 million in 2010 relative to 1983 or by 43.8 percent. Growth at 2.2 percent has been mediocre in the twelve quarters of expansion beginning in IIIQ2009 in comparison with 6.2 percent in earlier expansions (http://cmpassocregulationblog.blogspot.com/2012/09/collapse-of-united-states-dynamism-of.html) and also in terms of what is required to reduce the job stress of at least 24 million persons but likely close to 30 million. Some of the job growth and contraction in 2010 in Table I-8 is caused by the hiring and subsequent layoff of temporary workers for the 2010 census.
Table I-8, US, Monthly Change in Jobs, Number SA
| Month | 1981 | 1982 | 1983 | 2008 | 2009 | 2010 | Private |
| Jan | 95 | -327 | 225 | 41 | -818 | -40 | -40 |
| Feb | 67 | -6 | -78 | -84 | -724 | -35 | -27 |
| Mar | 104 | -129 | 173 | -95 | -799 | 189 | 141 |
| Apr | 74 | -281 | 276 | -208 | -692 | 239 | 193 |
| May | 10 | -45 | 277 | -190 | -361 | 516 | 84 |
| Jun | 196 | -243 | 378 | -198 | -482 | -167 | 92 |
| Jul | 112 | -343 | 418 | -210 | -339 | -58 | 92 |
| Aug | -36 | -158 | -308 | -274 | -231 | -51 | 128 |
| Sep | -87 | -181 | 1114 | -432 | -199 | -27 | 115 |
| Oct | -100 | -277 | 271 | -489 | -202 | 220 | 196 |
| Nov | -209 | -124 | 352 | -803 | -42 | 121 | 134 |
| Dec | -278 | -14 | 356 | -661 | -171 | 120 | 140 |
| 1984 | 2011 | Private | |||||
| Jan | 447 | 110 | 119 | ||||
| Feb | 479 | 220 | 257 | ||||
| Mar | 275 | 246 | 261 | ||||
| Apr | 363 | 251 | 264 | ||||
| May | 308 | 54 | 108 | ||||
| Jun | 379 | 84 | 102 | ||||
| Jul | 312 | 96 | 175 | ||||
| Aug | 241 | 85 | 52 | ||||
| Sep | 311 | 202 | 216 | ||||
| Oct | 286 | 112 | 139 | ||||
| Nov | 349 | 157 | 178 | ||||
| Dec | 127 | 223 | 234 | ||||
| 1985 | 2012 | Private | |||||
| Jan | 266 | 275 | 277 | ||||
| Feb | 124 | 259 | 254 | ||||
| Mar | 346 | 143 | 147 | ||||
| Apr | 195 | 68 | 85 | ||||
| May | 274 | 87 | 116 | ||||
| Jun | 145 | 45 | 63 | ||||
| Jul | 189 | 141 | 162 | ||||
| Aug | 193 | 96 | 103 | ||||
| Sep | 204 | ||||||
| Oct | 187 | ||||||
| Nov | 209 | ||||||
| Dec | 168 |
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
Charts numbered from I-38 to I-41 from the database of the Bureau of Labor Statistics provide a comparison of payroll survey data for the contractions and expansions in the 1980s and after 2007. Chart I-38 provides total nonfarm payroll jobs from 2001 to 2012. The sharp decline in total nonfarm jobs during the contraction after 2007 has been followed by initial stagnation and then inadequate growth in the first six months of 2012.
Chart I-38, US, Total Nonfarm Payroll Jobs SA 2001-2012
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
Total nonfarm payroll jobs grew rapidly during the expansion in 1983 and 1984 as shown in Chart I-39. Nonfarm payroll jobs continued to grow at high rates during the remainder of the 1980s.
Chart I-39, US, Total Nonfarm Payroll Jobs SA 1979-1989
Source: US Bureau of Labor Statistics
Most job creation in the US is by the private sector. Chart I-40 shows the sharp destruction of private payroll jobs during the contraction after 2007. There has been growth after 2010 but insufficient to recover higher levels of employment prevailing before the contraction. At current rates, recovery of employment may spread over several years in contrast with past expansions of the business cycle in the US.
Chart I-40, US, Total Private Payroll Jobs SA 2001-2012
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
In contrast, growth of private payroll jobs in the US recovered vigorously during the expansion in 1983 through 1985, as shown in Chart I-41. Rapid growth of creation of private jobs continued throughout the 1980s.
Chart I-41, US, Total Private Payroll Jobs SA 1979-1989
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
IA4 Creation of Jobs. Types of jobs created, and not only the pace of job creation, may be important. Aspects of growth of payroll jobs from Aug 2011 to Aug 2012, not seasonally adjusted (NSA), are provided in Table I-9. Total nonfarm employment increased by 1,814,000 (row A, column Change), consisting of growth of total private employment by 1,963,000 (row B, column Change) and decline by 149,000 of government employment (row C, column Change). Monthly average growth of private payroll employment has been 163,583, which is mediocre relative to 24 to 30 million in job stress, while total nonfarm employment has grown on average by only 151,167 per month, which barely keeps with 142,833 new entrants per month in the labor force. These monthly rates of job creation are insufficient to meet the demands of new entrants in the labor force and thus perpetuate unemployment and underemployment. Manufacturing employment increased by 200,000, at the monthly rate of 16,667, while private service providing employment grew by 1,710,000, at the monthly rate of 142,500. An important feature in Table I-9 is that jobs in professional and business services increased by 564,000 with temporary help services increasing by 211,000. This episode of jobless recovery is characterized by part-time jobs and creation of jobs that are inferior to those that have been lost. Monetary and fiscal stimuli fail to increase consumption in a fractured job market. The segment leisure and hospitality added 34,000 jobs in Aug and 305,000 in 12 months. An important characteristic is that the losses of government jobs have been high in local government, 74,000 jobs lost in the past twelve months (row C3 Local), because of the higher number of employees in local government, 13.2 million relative to 4.8 million in state jobs and 2.8 million in federal jobs.
Table I-9, US, Employees in Nonfarm Payrolls Not Seasonally Adjusted, in Thousands
| Aug 2011 | Aug 2012 | Change | |
| A Total Nonfarm | 131,278 | 133,092 | 1,814 |
| B Total Private | 110,386 | 112,349 | 1,963 |
| B1 Goods Producing | 18,491 | 18,744 | 253 |
| B1a Manufacturing | 11,874 | 12,074 | 200 |
| B2 Private service providing | 91,895 | 93,605 | 1,710 |
| B2a Wholesale Trade | 5,564 | 5,664 | 100 |
| B2b Retail Trade | 14,686 | 14,770 | 84 |
| B2c Transportation & Warehousing | 4,269 | 4,356 | 87 |
| B2d Financial Activities | 7,726 | 7,793 | 67 |
| B2e Professional and Business Services | 17,514 | 18,078 | 564 |
| B2e1 Temporary help services | 2,348 | 2,559 | 211 |
| B2f Health Care & Social Assistance | 16,665 | 17,004 | 339 |
| B2g Leisure & Hospitality | 13,979 | 14,284 | 305 |
| C Government | 20,892 | 20,743 | -149 |
| C1 Federal | 2,864 | 2,819 | -45 |
| C2 State | 4,804 | 4,774 | -30 |
| C3 Local | 13,224 | 13,150 | -74 |
Note: A = B+C, B = B1 + B2, C=C1 + C2 + C3
Source: US Bureau of Labor Statistics http://www.bls.gov/news.release/empsit.nr0.htm
Greater detail on the types of jobs created is provided in Table I-10 with data for Jun and Jul 2012. Strong seasonal effects are shown by the significant difference between seasonally-adjusted (SA) and not-seasonally-adjusted (NSA) data. The purpose of adjusting for seasonality is to isolate nonseasonal effects. The 96,000 jobs SA total nonfarm jobs created in Aug relative to Jul actually correspond to job increase of 252,000 jobs NSA, as shown in row A. The 103,000 total private payroll jobs SA created in Aug relative to Jul actually correspond to increase of 166,000 jobs NSA in Aug. Adjustment for seasonality isolates nonseasonal effects that suggest improvement from Dec 2011 to Aug 2012. The analysis of NSA job creation in the prior Table I-9 does show improvement over the 12 months ending in Aug 2012 that is not clouded by seasonal variations but significant reduction in number of jobs created. In fact, the 12-month rate of job creation without seasonal adjustment is stronger indication of marginal improvement in the US job market but that is insufficient to even make a dent in about 30 million people unemployed or underemployed.
Table I-10, US, Employees on Nonfarm Payrolls and Selected Industry Detail, Thousands, SA
| Jul 2012 SA | Aug 2012 SA | ∆ | Jul 2012 NSA | Aug 2012 NSA | ∆ | |
| A Total Nonfarm | 133,204 | 133,300 | 96 | 132,840 | 133,092 | 252 |
| B Total Private | 111,297 | 111,400 | 103 | 112,183 | 112,349 | 166 |
| B1 Goods Producing | 18,339 | 18,323 | -16 | 18,687 | 18,744 | 57 |
| B1a Constr. | 5,514 | 5,515 | 1 | 5,779 | 5,813 | 34 |
| B Mfg | 11,985 | 11,970 | -15 | 12,053 | 12,074 | 21 |
| B2 Private Service Providing | 92,958 | 93,077 | 119 | 93,496 | 93,605 | 109 |
| B2a Wholesale Trade | 5,639 | 5,647 | 8 | 5,672 | 5,664 | -8 |
| B2b Retail Trade | 14,745 | 14,751 | 6 | 14,753 | 14,769 | 16 |
| B2c Couriers & Mess. | 659 | 660 | 1 | 660 | 662 | 2 |
| B2d Health-care & Social Assistance | 17,002 | 17,024 | 22 | 16,965 | 17,004 | 39 |
| B2De Profess. & Business Services | 17,930 | 17,958 | 28 | 17,997 | 18,078 | 81 |
| B2De1 Temp Help Services | 2,529 | 2,524 | -5 | 2,510 | 2,559 | 49 |
| B2f Leisure & Hospit. | 13,625 | 13,659 | 34 | 14,278 | 14,284 | 6 |
Notes: ∆: Absolute Change; Constr.: Construction; Mess.: Messengers; Temp: Temporary; Hospit.: Hospitality. SA aggregates do not add because of seasonality.
Source: US Bureau of Labor Statistics http://www.bls.gov/news.release/empsit.nr0.htm
Table I-11 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 Aug 2012, there were 133.092 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). Total private jobs of 112.349 million NSA in Aug 2012 accounted for 84.4 percent of total nonfarm jobs of 133.092 million, of which 12.074 million, or 10.8 percent of total private jobs and 9.1 percent of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 93.605 million NSA in Aug 2012, or 70.3 percent of total nonfarm jobs and 83.3 percent of total private-sector jobs. Manufacturing has share of 11.0 percent in US national income in IQ2011, as shown in Table I-11. 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-11, 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
The NBER dates recessions in the US from peaks to troughs as: IQ80 to IIIQ80, IIIQ81 to IV82 and IVQ07 to IIQ09 (http://www.nber.org/cycles/cyclesmain.html). Table I-12 provides total annual level nonfarm employment in the US for the 1980s and the 2000s, which is different from 12 months comparisons. Nonfarm jobs rose by 4.853 million in 1982 to 1984, or 5.4 percent, and continued rapid growth in the rest of the decade. In contrast, nonfarm jobs are down by 7.724 million in 2010 relative to 2007 and fell by 933,000 in 2010 relative to 2009 even after six quarters of GDP growth. Monetary and fiscal stimuli have failed in increasing growth to rates required for mitigating job stress. The initial growth impulse reflects a flatter growth curve in the current expansion.
Table I-12, US, Total Nonfarm Employment in Thousands
| Year | Total Nonfarm | Year | Total Nonfarm |
| 1980 | 90,528 | 2000 | 131,785 |
| 1981 | 91,289 | 2001 | 131,826 |
| 1982 | 89,677 | 2002 | 130,341 |
| 1983 | 90,280 | 2003 | 129,999 |
| 1984 | 94,530 | 2004 | 131,435 |
| 1985 | 97,511 | 2005 | 133,703 |
| 1986 | 99,474 | 2006 | 136,086 |
| 1987 | 102,088 | 2007 | 137,598 |
| 1988 | 105,345 | 2008 | 136,790 |
| 1989 | 108,014 | 2009 | 130,807 |
| 1990 | 109,487 | 2010 | 129,874 |
| 1991 | 108,374 | 2011 | 131,359 |
Source: http://www.bls.gov/data/
The highest average yearly percentage of unemployed to the labor force since 1940 was 14.6 percent in 1940 followed by 9.9 percent in 1941, 8.5 percent in 1975, 9.7 percent in 1982 and 9.6 percent in 1983 (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). The rate of unemployment remained at high levels in the 1930s, rising from 3.2 percent in 1929 to 22.9 percent in 1932 in one estimate and 23.6 percent in another with real wages increasing by 16.4 percent (Margo 1993, 43; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 214-5). There are alternative estimates of 17.2 percent or 9.5 percent for 1940 with real wages increasing by 44 percent. Employment declined sharply during the 1930s. The number of hours worked remained in 1939 at 29 percent below the level of 1929 (Cole and Ohanian 1999). Private hours worked fell in 1939 to 25 percent of the level in 1929. The policy of encouraging collusion through the National Industrial Recovery Act (NIRA), to maintain high prices, together with the National Labor Relations Act (NLRA), to maintain high wages, prevented the US economy from recovering employment levels until Roosevelt abandoned these policies toward the end of the 1930s (for review of the literature analyzing the Great Depression see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 198-217).
The Bureau of Labor Statistics (BLS) makes yearly revisions of its establishment survey (Harris 2011BA):
“With the release of data for January 2011, the Bureau of Labor Statistics (BLS) introduced its annual revision of national estimates of employment, hours, and earnings from the Current Employment Statistics (CES) monthly survey of nonfarm establishments. Each year, the CES survey realigns its sample-based estimates to incorporate universe counts of employment—a process known as benchmarking. Comprehensive counts of employment, or benchmarks, are derived primarily from unemployment insurance (UI) tax reports that nearly all employers are required to file with State Workforce Agencies.”
The number of not seasonally adjusted total private jobs in the US in Dec 2010 is 108.464 million, declining to 106.079 million in Jan 2011, or by 2.385 million, because of the adjustment of a different benchmark and not actual job losses. The not seasonally adjusted number of total private jobs in Dec 1984 is 80.250 million, declining to 78.704 million in Jan 1985, or by 1.546 million for the similar adjustment. Table I-13 attempts to measure job losses and gains in the recessions and expansions of 1981-1985 and 2007-2011. The final ten rows provide job creation from May 1983 to May 1984 and from May 2010 to May 2011, that is, at equivalent stages of the recovery from two comparable strong recessions. The row “Change ∆%” for May 1983 to May 1984 shows an increase of total nonfarm jobs by 4.9 percent and of 5.9 percent for total private jobs. The row “Change ∆%” for May 2010 to May 2011 shows an increase of total nonfarm jobs by 0.7 percent and of 1.7 percent for total private jobs. The last two rows of Table 7 provide a calculation of the number of jobs that would have been created from May 2010 to May 2011 if the rate of job creation had been the same as from May 1983 to May 1984. If total nonfarm jobs had grown between May 2010 and May 2011 by 4.9 percent, as between May 1983 and May 1984, 6.409 million jobs would have been created in the past 12 months for a difference of 5.457 million more total nonfarm jobs relative to 0.952 million jobs actually created. If total private jobs had grown between May 2010 and May 2011 by 5.9 percent as between May 1983 and May 1984, 6.337 million private jobs would have been created for a difference of 4.539 million more total private jobs relative to 1.798 million jobs actually created.
Table I-13, US, Total Nonfarm and Total Private Jobs Destroyed and Subsequently Created in
Two Recessions IIIQ1981-IVQ1982 and IVQ2007-IIQ2009, Thousands and Percent
| Total Nonfarm Jobs | Total Private Jobs | |
| 06/1981 # | 92,288 | 75,969 |
| 11/1982 # | 89,482 | 73,260 |
| Change # | -2,806 | -2,709 |
| Change ∆% | -3.0 | -3.6 |
| 12/1982 # | 89,383 | 73,185 |
| 05/1984 # | 94,471 | 78,049 |
| Change # | 5,088 | 4,864 |
| Change ∆% | 5.7 | 6.6 |
| 11/2007 # | 139,090 | 116,291 |
| 05/2009 # | 131,626 | 108,601 |
| Change % | -7,464 | -7,690 |
| Change ∆% | -5.4 | -6.6 |
| 12/2009 # | 130,178 | 107,338 |
| 05/2011 # | 131,753 | 108,494 |
| Change # | 1,575 | 1,156 |
| Change ∆% | 1.2 | 1.1 |
| 05/1983 # | 90,005 | 73,667 |
| 05/1984 # | 94,471 | 78,049 |
| Change # | 4,466 | 4,382 |
| Change ∆% | 4.9 | 5.9 |
| 05/2010 # | 130,801 | 107,405 |
| 05/2011 # | 131,753 | 109,203 |
| Change # | 952 | 1,798 |
| Change ∆% | 0.7 | 1.7 |
| Change # by ∆% as in 05/1984 to 05/1985 | 6,409* | 6,337** |
| Difference in Jobs that Would Have Been Created | 5,457 = | 4,539 = |
*[(130,801x1.049)-130,801] = 6,409 thousand
**[(107,405)x1.059 – 107,405] = 6,337 thousand
Source: http://www.bls.gov/data/
II Stagnating Real Wages. The wage bill is the product of average weekly hours times the earnings per hour. Table II-1 provides the estimates by the Bureau of Labor Statistics (BLS) of earnings per hour seasonally adjusted, increasing from $23.12/hour in Aug 2011 to $23.52/hour in Aug 2012, or by 1.7 percent. There has been disappointment about the pace of wage increases because of rising food and energy costs that inhibit consumption and thus sales and similar concern about growth of consumption that accounts for about 70 percent of GDP. Growth of consumption by decreasing savings by means of controlling interest rates in what is called financial repression may not be lasting and sound for personal finances (See Section IIB at http://cmpassocregulationblog.blogspot.com/2012/09/collapse-of-united-states-dynamism-of.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs.html http://cmpassocregulationblog.blogspot.com/2012/04/mediocre-growth-with-high-unemployment.html http://cmpassocregulationblog.blogspot.com/2012/04/mediocre-economic-growth-falling-real.html http://cmpassocregulationblog.blogspot.com/2012/03/mediocre-economic-growth-flattening.html http://cmpassocregulationblog.blogspot.com/2012/01/mediocre-economic-growth-financial.html http://cmpassocregulationblog.blogspot.com/2011/12/slow-growth-falling-real-disposable.html http://cmpassocregulationblog.blogspot.com/2011/11/us-growth-standstill-falling-real.html http://cmpassocregulationblog.blogspot.com/2011/10/slow-growth-driven-by-reducing-savings.html). Average hourly earnings seasonally adjusted were virtually flat from $23.53 in Jul 2012 to $23.52 in Aug 2012 or decreasing by 0.04 percent. Average private weekly earnings increased $16.07 from $793.02 in Aug 2011 to $809.09 in Aug 2012 or 2.0 percent and decreased from $809.43 in Jul 2012 to $809.09 in Aug 2012 or 0.04 percent. The inflation-adjusted wage bill can only be calculated for Jul, which is the most recent month for which there are estimates of the consumer price index. Earnings per hour (not-seasonally-adjusted (NSA)) rose from $22.98 in Jul 2011 to $23.52 in Jul 2012 or by 2.3 percent (http://www.bls.gov/data/; see Table II-3 below). Data NSA are more suitable for comparison over a year. Average weekly hours NSA were 34.4 in Jul 2011 and 34.8 in Jul 2012 (http://www.bls.gov/data/; see Table II-2 below). The wage bill rose 2.3 percent in the 12 months ending in Jun 2012:
{[(wage bill in Jul 2012)/(wage bill in Jul 2011)]-1}100 =
{[($23.52x34.8)/($22.98x34.4)]-1]}100
= {[($818.49/$790.51)]-1}100 = 3.5%
CPI inflation was 1.4 percent in the 12 months ending in Jul 2012 (http://www.bls.gov/cpi/) for an inflation-adjusted wage-bill change of 2.1 percent :{[(1.035/1.014)-1]100}. The wage bill for Aug 2012 before inflation adjustment increased 3.5 percent relative to the wage bill for Aug 2011:
{[(wage bill in Jul 2012)/(wage bill in Jul 2011)]-1}100 =
{[($23.29x34.5)/($22.88x34.4)]-1]}100
= {[($803.51/$787.07)]-1}100 = 2.1%
Average hourly earnings increased 1.8 percent from Aug 2011 to Aug 2012 {[($23.29/22.88) – 1]100 = 2.3%] while hours worked increased 0.3 percent {[(34.5/34.4) – 1]100 = 0.3%}. The increase of the wage bill is the product of the increase of hourly earnings of 1.8 percent and of hours worked of 0.3 percent {[(1.018x1.003) -1]100 = 2.1%}.
Energy and food price increases are similar to a “silent tax” that is highly regressive, harming the most those with lowest incomes. There are concerns that the wage bill would deteriorate in purchasing power because of renewed raw materials shock in the form of increases in prices of commodities such as the 31.1 percent steady increase in the DJ-UBS Commodity Index from Jul 2, 2010 to Sep 2, 2011. The charts of four commodity price indexes by Bloomberg show steady increase since Jul 2, 2010 that was interrupted briefly only in Nov 2010 with the sovereign issues in Europe triggered by Ireland, in Mar 2011 by the earthquake and tsunami in Japan and in the beginning of May 2011 by the decline in oil prices and sovereign risk difficulties in Europe (http://www.bloomberg.com/markets/commodities/futures/). Renewed risk aversion because of the sovereign risks in Europe has reduced the rate of increase of the DJ UBS commodity index to 18.8 percent on Sep 7, 2012, relative to Jul 2, 2010 (see Table VI-4). Inflation has been rising in waves with carry trades driven by zero interest rates to commodity futures during periods of risk appetite with interruptions during risk aversion (http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html). Inflation-adjusted wages fall sharply during carry trades from zero interest rates to long positions in commodity futures during periods of risk appetite.
Table II-1, US, Earnings per Hour and Average Weekly Hours SA
| Earnings per Hour | Aug 2011 | Jun 2012 | Jul 2012 | Aug 2012 |
| Total Private | $23.12 | $23.50 | $23.53 | $23.52 |
| Goods Producing | $23.43 | $24.73 | $24.76 | $24.74 |
| Service Providing | $22.81 | $23.21 | $23.24 | $23.23 |
| Average Weekly Earnings | ||||
| Total Private | $793.02 | $810.75 | $809.43 | $809.09 |
| Goods Producing | $972.31 | $991.67 | $995.35 | $989.60 |
| Service Providing | $757.29 | $772.89 | $773.89 | $773.56 |
| Average Weekly Hours | ||||
| Total Private | 34.3 | 34.5 | 34.4 | 34.4 |
| Goods Producing | 39.8 | 40.1 | 40.2 | 40.0 |
| Service Providing | 33.2 | 33.3 | 33.3 | 33.3 |
Source: US Bureau of Labor Statistics http://www.bls.gov/news.release/empsit.t18.htm
Table II-2 provides average weekly hours of all employees in the US from 2006 to 2012. Average weekly hours fell from 35.0 in Dec 2007 at the beginning of the contraction to 33.8 in Jun 2009, which was the last month of the contraction. Average weekly hours rose to 34.4 in Dec 2011 and oscillated to 34.5 in Aug 2012.
Table II-2, US, Average Weekly Hours of All Employees, NSA 2006-2012
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec |
| 2006 | 34.2 | 34.6 | 34.3 | 34.6 | 34.9 | 34.6 | 34.5 | 34.9 | 34.4 | 34.6 | ||
| 2007 | 34.1 | 34.2 | 34.3 | 34.7 | 34.4 | 34.7 | 34.9 | 34.7 | 35.0 | 34.5 | 34.5 | 35.0 |
| 2008 | 34.2 | 34.2 | 34.8 | 34.4 | 34.4 | 34.9 | 34.5 | 34.6 | 34.4 | 34.4 | 34.6 | 34.1 |
| 2009 | 33.8 | 34.2 | 34.0 | 33.6 | 33.7 | 33.8 | 33.8 | 34.3 | 33.7 | 33.8 | 34.3 | 33.9 |
| 2010 | 33.7 | 33.6 | 33.8 | 34.0 | 34.4 | 34.1 | 34.2 | 34.7 | 34.1 | 34.3 | 34.2 | 34.2 |
| 2011 | 34.2 | 34.0 | 34.1 | 34.3 | 34.6 | 34.4 | 34.4 | 34.4 | 34.4 | 34.9 | 34.4 | 34.4 |
| 2012 | 34.5 | 34.2 | 34.3 | 34.7 | 34.3 | 34.4 | 34.8 | 34.5 |
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
Chart II-1 provides average weekly hours monthly from Mar 2006 to May 2012. Average weekly hours remained relatively stable in the period before the contraction and fell sharply during the contraction as business could not support lower production with the same labor input. Average weekly hours rose rapidly during the expansion but have stabilized at a level below that prevailing before the contraction.
Chart II-1, US, Average Weekly Hours of All Employees, SA 2006-2012
Source: US Bureau of Labor Statistics
Calculations using BLS data of inflation-adjusted average hourly earnings are shown in Table II-3. The final column of Table II-3 (“12 Month Real ∆%”) provides inflation-adjusted average hourly earnings of all employees in the US. Average hourly earnings rose above inflation throughout the first nine months of 2007 just before the global recession that began in the final quarter of 2007 when average hourly earnings lost to inflation. In contrast, average hourly earnings of all US workers have risen less than inflation in four months in 2010 and in all but the first month in 2011 and the loss accelerated at 1.8 percent in Sep 2011, declining to a real loss of 1.1 percent in Feb 2012 and 0.6 percent in Mar 2012. There was a gain of 0.5 percent in Apr 2012 in inflation-adjusted average hourly earnings but another fall of 0.6 percent in May 2012 followed by increases of 0.3 percent in Jun and 0.9 percent in Jul 2012. Real hourly earnings are oscillating in part because of world inflation waves caused by carry trades from zero interest rates to commodity futures (http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html).
Table II-3, US, Average Hourly Earnings Nominal and Inflation Adjusted, Dollars and % NSA
| AHE ALL | 12 Month | ∆% 12 Month CPI | 12 Month | |
| 2007 | ||||
| Jan* | $20.70* | 4.2* | 2.1 | 2.1* |
| Feb* | $20.79* | 4.1* | 2.4 | 1.7* |
| Mar | $20.82 | 3.7 | 2.8 | 0.9 |
| Apr | $21.05 | 3.3 | 2.6 | 0.7 |
| May | $20.83 | 3.7 | 2.7 | 1.0 |
| Jun | $20.82 | 3.8 | 2.7 | 1.1 |
| Jul | $20.99 | 3.4 | 2.4 | 1.0 |
| Aug | $20.85 | 3.5 | 2.0 | 1.5 |
| Sep | $21.18 | 4.0 | 2.8 | 1.2 |
| Oct | $21.07 | 2.7 | 3.5 | -0.8 |
| Nov | $21.13 | 3.3 | 4.3 | -0.9 |
| Dec | $21.37 | 3.7 | 4.1 | -0.4 |
| 2010 | ||||
| Jan | $22.55 | 2.0 | 2.6 | -0.6 |
| Feb | $22.61 | 1.4 | 2.1 | -0.7 |
| Mar | $22.51 | 1.2 | 2.3 | -1.1 |
| Apr | $22.56 | 1.8 | 2.2 | -0.4 |
| May | $22.63 | 2.5 | 2.0 | 0.5 |
| Jun | $22.37 | 1.7 | 1.1 | 0.6 |
| Jul | $22.44 | 1.8 | 1.2 | 0.6 |
| Aug | $22.58 | 1.7 | 1.1 | 0.6 |
| Sep | $22.63 | 1.8 | 1.1 | 0.7 |
| Oct | $22.73 | 1.9 | 1.2 | 0.7 |
| Nov | $22.72 | 1.1 | 1.1 | 0.0 |
| Dec | $22.79 | 1.7 | 1.5 | 0.2 |
| 2011 | ||||
| Jan | $23.20 | 2.9 | 1.6 | 1.3 |
| Feb | $23.03 | 1.9 | 2.1 | -0.2 |
| Mar | $22.93 | 1.9 | 2.7 | -0.8 |
| Apr | $23.00 | 2.0 | 3.2 | -1.2 |
| May | $23.09 | 2.0 | 3.6 | -1.5 |
| Jun | $22.85 | 2.1 | 3.6 | -1.4 |
| Jul | $22.98 | 2.4 | 3.6 | -1.2 |
| Aug | $22.88 | 1.3 | 3.8 | -2.4 |
| Sep | $23.09 | 2.0 | 3.9 | -1.8 |
| Oct | $23.34 | 2.7 | 3.5 | -0.8 |
| Nov | $23.19 | 2.1 | 3.4 | -1.3 |
| Dec | $23.26 | 2.1 | 3.0 | -0.9 |
| 2012 | ||||
| Jan | $23.61 | 1.8 | 2.9 | -1.1 |
| Feb | $23.45 | 1.8 | 2.9 | -1.1 |
| Mar | $23.41 | 2.1 | 2.7 | -0.6 |
| Apr | $23.64 | 2.8 | 2.3 | 0.5 |
| May | $23.35 | 1.1 | 1.7 | -0.6 |
| Jun | $23.30 | 2.0 | 1.7 | 0.3 |
| Jul | $23.52 | 2.3 | 1.4 | 0.9 |
| Aug | $23.29 | 1.8 |
Note: AHE ALL: average hourly earnings of all employees; CPI: consumer price index; Real: adjusted by CPI inflation; NA: not available
*AHE of production and nonsupervisory employees because of unavailability of data for all employees
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
Average hourly earnings of all US employees in the US in constant dollars of 1982-1984 from the dataset of the US Bureau of Labor Statistics (BLS) are provided in Table II-4. Average hourly earnings fell 0.5 percent after adjusting for inflation in the 12 months ending in Mar 2012 and gained 0.4 percent in the 12 months ending in Apr 2011 but then lost 0.6 percent in the 12 months ending in May 2012 with a gain of 0.3 percent in the 12 months ending in Jun 2012 and 1.0 percent in Jul 2012. Table II-4 confirms the trend of deterioration of purchasing power of average hourly earnings in 2011 and into 2012 with 12-month percentage declines in four of the first seven months of 2012. Those who still work bring back home a paycheck that buys fewer goods than a year earlier and savings in bank deposits do not pay anything because of financial repression (Section IIB http://cmpassocregulationblog.blogspot.com/2012_09_01_archive.html).
Table II-4, US, Average Hourly Earnings of All Employees NSA in Constant Dollars of 1982-1984
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul |
| 2006 | 10.05 | 10.11 | 9.92 | 9.88 | 9.97 | ||
| 2007 | 10.23 | 10.22 | 10.14 | 10.18 | 10.02 | 9.99 | 10.08 |
| 2008 | 10.11 | 10.12 | 10.11 | 10.00 | 9.91 | 9.84 | 9.77 |
| 2009 | 10.47 | 10.50 | 10.46 | 10.39 | 10.32 | 10.20 | 10.23 |
| 2010 | 10.41 | 10.43 | 10.34 | 10.35 | 10.37 | 10.26 | 10.29 |
| 2011 | 10.53 | 10.41 | 10.26 | 10.23 | 10.22 | 10.12 | 10.17 |
| 2012 | 10.42 | 10.30 | 10.21 | 10.27 | 10.16 | 10.15 | 10.27 |
| ∆% 12 Months | -1.0 | -1.1 | -0.5 | 0.4 | -0.6 | 0.3 | 1.0 |
Source: US Bureau of Labor Statistics
The deterioration of purchasing power of average hourly earnings of US workers is shown by Chart II-2 of the US Bureau of Labor Statistics. Chart IB-2 plots average hourly earnings of all US employees in constant 1982-1984 dollars with evident decline from 2010 to 2012.
Chart II-2, US, Average Hourly Earnings of All Employees in Constant Dollars of 1982-1984, SA 2006-2012
Source: US Bureau of Labor Statistics
Chart II-3 provides 12-month percentage changes of average hourly earnings of all employees in constant dollars of 1982-1984, that is, adjusted for inflation. There was sharp contraction of inflation-adjusted average hourly earnings of US employees during parts of 2007 and 2008. Rates of change in 12 months became positive in parts of 2009 and 2010 but then became negative again in 2011 and now into 2012 with temporary increase in Apr 2012 that was reversed in May with another gain in Jun and Jul 2012.
Chart II-3, Average Hourly Earnings of All Employees NSA 12-Month Percent Change, 1982-1984 Dollars, NSA 2007-2012
Source: US Bureau of Labor Statistics
Average weekly earnings of all US employees in the US in constant dollars of 1982-1984 from the dataset of the US Bureau of Labor Statistics (BLS) are provided in Table II-5. Average weekly earnings fell 0.9 percent after adjusting for inflation in the 12 months ending in Sep 2011, increased 0.9 percent in the 12 months ending in Oct, fell 0.7 percent in the 12 months ending in Nov and 0.3 in the 12 months ending in Dec, declining 0.3 percent in the 12 months ending in Jan 2012 and 0.4 percent in the 12 months ending in Feb 2012. Average weekly earnings in constant dollars were flat in Mar 2012 relative to Mar 2011, increasing 0.04 percent. Average weekly earnings in constant dollars increased 1.6 percent in Apr 2012 relative to Apr 2011 but fell 1.4 percent in May 2012 relative to May 2011, increasing 0.3 percent in the 12 months ending in Jun and 2.1 percent in Jul 2012. Table II-5 confirms the trend of deterioration of purchasing power of average weekly earnings in 2011 and into 2012 with oscillations according to carry trades causing world inflation waves (http://cmpassocregulationblog.blogspot.com/2012_09_01_archive.html). Those who still work bring back home a paycheck that buys fewer goods than a year earlier. The fractured US job market does not provide an opportunity for advancement as in past booms following recessions.
Table II-5, US, Average Weekly Earnings of All Employees in Constant Dollars of 1982-1984, NSA 2007-2012
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul |
| 2006 | 343.71 | 349.78 | 340.12 | 341.91 | 347.97 | ||
| 2007 | 348.72 | 349.40 | 347.76 | 353.41 | 344.58 | 346.74 | 351.68 |
| 2008 | 345.92 | 346.21 | 351.70 | 344.13 | 340.77 | 343.40 | 337.06 |
| 2009 | 353.94 | 359.26 | 355.65 | 349.17 | 347.79 | 344.59 | 345.92 |
| 2010 | 350.71 | 350.51 | 349.60 | 351.84 | 356.80 | 349.97 | 352.02 |
| 2011 | 360.29 | 353.81 | 349.90 | 350.77 | 353.56 | 348.23 | 349.90 |
| 2012 | 359.36 | 352.27 | 350.04 | 356.52 | 348.50 | 349.28 | 357.26 |
| ∆% 12 M | -0.3 | -0.4 | 0.0 | 1.6 | -1.4 | 0.3 | 2.1 |
Source: US Bureau of Labor Statistics
Chart II-4 provides average weekly earnings of all employees in constant dollars of 1982-1984. The same pattern emerges of sharp decline during the contraction, followed by recovery in the expansion and continuing fall from 2010 to 2011 and into 2012.
Chart II-4, US, Average Weekly Earnings of All Employees in Constant Dollars of 1982-1984, SA 2006-2012
Source: US Bureau of Labor Statistics
Chart II-5 provides 12-month percentage changes of average weekly earnings of all employees in the US in constant dollars of 1982-1984. There is the same pattern of contraction during the global recession in 2008 and then again trend of deterioration in the recovery without hiring and inflation waves in 2011 and 2012 (http://cmpassocregulationblog.blogspot.com/2012_09_01_archive.html http://cmpassocregulationblog.blogspot.com/2012/07/world-inflation-waves-financial.html http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars.html http://cmpassocregulationblog.blogspot.com/2012/05/world-inflation-waves-monetary-policy.html http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of.html http://cmpassocregulationblog.blogspot.com/2012/04/fractured-labor-market-with-hiring.html http://cmpassocregulationblog.blogspot.com/2012/03/global-financial-and-economic-risk.html http://cmpassocregulationblog.blogspot.com/2012/02/world-inflation-waves-united-states.html http://cmpassocregulationblog.blogspot.com/2012/01/world-inflation-waves-united-states.html http://cmpassocregulationblog.blogspot.com/2012/01/recovery-without-hiring-united-states.html).
Chart II-5, US, Average Weekly Earnings of All Employees NSA in Constant Dollars of 1982-1984 12-Month Percent Change, NSA 2007-2011
Source: US Bureau of Labor Statistics
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 31 and daily values throughout the week ending on Sep 7 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 31 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Aug 31, 2012”, first row “USD/EUR 1.2575 -0.5%,” provides the information that the US dollar (USD) depreciated 0.5 percent to USD 1.2575/EUR in the week ending on Fri Aug 31 relative to the exchange rate on Fri Aug 24. 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 1.2575/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Aug 31, depreciating to USD 1.2592/EUR on Mon Sep 3, or by 0.1 percent. The dollar depreciated because more dollars, $1.2592, were required on Mon Sep 3 to buy one euro than $1.2575 on Aug 31. 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 1.2575/EUR on Aug 31; 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 31, to the last business day of the current week, in this case Fri Sep 7, such as depreciation by 1.9 percent to USD 1.2816/EUR by Sep 7; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (denoted by negative sign) by 1.9 percent from the rate of USD 1.2575/EUR on Fri Aug 31 to the rate of USD 1.2816/EUR on Fri Sep 7 {[(1.2816/1.2575) – 1]100 = 1.9%} and depreciated (denoted by negative sign) by 1.5 percent from the rate of USD 1.2631 on Thu Sep 6 to USD 1.2816/EUR on Fri Sep 7 {[(1.2816/1.2631) -1]100 = 1.5%}. 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 Sep 3 to Sep 7, 2012
| Fri Aug 31, 2012 | M 3 | Tue 4 | W 5 | Thu 6 | Fr 7 |
| USD/EUR 1.2575 -0.5% | 1.2592 -0.1% -0.1% | 1.2565 0.1% 0.2% | 1.2600 -0.2% -0.3% | 1.2631 -0.4% -0.2% | 1.2816 -1.9% -1.5% |
| JPY/ USD 78.38 0.3% | 78.26 0.2% 0.2% | 78.41 0.0% -0.2% | 78.39 0.0% 0.0% | 78.86 -0.6% -0.6% | 78.26 0.2% 0.8% |
| CHF/ USD 0.9551 0.5% | 0.9536 0.2% 0.2% | 0.9559 -0.1% -0.2% | 0.9556 -0.1% 0.0% | 0.9536 0.2% 0.2% | 0.9441 1.2% 1.0% |
| CHF/ EUR 1.2008 0.0% | 1.2009 0.0% 0.0% | 1.2011 0.0% 0.0% | 1.2041 -0.3% -0.2% | 1.2051 -0.4% -0.1% | 1.2107 -0.8% -0.5% |
| USD/ AUD 1.0324 0.9686 -0.8% | 1.0247 0.9759 -0.8% -0.8% | 1.0225 0.9780 -1.0% -0.2% | 1.0193 0.9811 -1.3% -0.3% | 1.0283 0.9725 -0.4% -0.9% | 1.0387 0.9627 0.6% 1.0% |
| 10 Year T Note 1.543 | 1.55 | 1.573 | 1.59 | 1.673 | 1.668 |
| 2 Year T Note 0.225 | 0.22 | 0.228 | 0.23 | 0.26 | 0.252 |
| German Bond 2Y -0.03 10Y 1.33 | 2Y -0.04 10Y 1.38 | 2Y -0.04 10Y 1.42 | 2Y -0.01 10Y 1.48 | 2Y 0.04 10Y 1.55 | 2Y 0.03 10Y 1.52 |
| DJIA 13090.84 -0.5% | 13090.84 -0.5% 0.7% | 13035.94 -0.4% -0.4% | 13047.48 -0.3% 0.1% | 13292.00 1.5% 1.9% | 13306.64 1.6% 0.1% |
| DJ Global 1869.92 -0.8% | 1873.31 0.2% 0.2% | 1863.72 -0.3% -0.5% | 1860.57 -0.5% -0.2% | 1897.32 1.5% 2.0% | 1928.12 3.1% 1.6% |
| DJ Asia Pacific 1201.75 -2.0% | 1201.70 0.0% 0.0% | 1196.92 -0.4% -0.4% | 1183.04 -1.6% -1.2% | 1184.09 -1.5% 0.1% | 1214.05 1.0% 2.5% |
| Nikkei 8839.91 -2.5% | 8783.89 -0.6% -0.6% | 8775.51 -0.7% -0.1% | 8679.82 -1.8% -1.1% | 8680.57 -1.8% 0.0% | 8871.65 0.4% 2.2% |
| Shanghai 2047.52 -2.1% | 2059.15 0.6% 0.6% | 2043.65 -0.2% -0.8% | 2037.68 -0.5% -0.3% | 2051.92 0.2% 0.7% | 2127.76 3.9% 3.7% |
| DAX 6970.79 0.0% | 7014.83 0.6% 0.6% | 6932.58 -0.5% -1.2% | 6964.69 -0.1% 0.5% | 7167.33 2.8% 2.9% | 7214.50 3.5% 0.7% |
| DJ UBS Comm. 146.03 0.5% | 146.03 0.5% 0.7% | 146.57 0.4% 0.4% | 146.65 0.4% -0.6% | 145.99 0.0% -0.5% | 147.26 0.8% 0.9% |
| WTI $ B 96.47 0.3% | 97.05 0.6% 0.6% | 94.91 1.6% -2.2% | 95.91 -0.6% 1.1% | 94.97 -1.6% -1.0% | 96.29 -0.2% 1.4% |
| Brent $/B 114.92 1.2% | 115.78 0.7% 0.7% | 113.96 -0.8% -1.6% | 113.61 -1.1% -0.3% | 113.12 -1.6% -0.4% | 114.25 -0.6% 1.0% |
| Gold $/OZ 1687.6 0.9% | 1694.9 0.4% 0.4% | 1692.6 0.3% -0.1% | 1695.5 0.5% 0.2% | 1703.5 0.9% 0.5% | 1740.5 3.1% 2.2% |
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. There were two critical risk factors in the week of Sep 7, 2012, that influenced world financial markets. (1) The European Central Bank (ECB) approved a new program of bond purchases under the name “Outright Monetary Transactions” (OMT). The ECB will purchase sovereign bonds of euro zone member countries that have a program of conditionality under the European Financial Stability Facility (EFSF) that is converting into the European Stability Mechanism (ESM). These programs provide enhancing the solvency of member countries in a transition period of structural reforms and fiscal adjustment. The purchase of bonds by the ECB would maintain debt costs of sovereigns at sufficiently low levels to permit adjustment under the EFSF/ESM programs. Purchases of bonds are not limited quantitatively with discretion by the ECB as to how much is necessary to support countries with adjustment programs. Another feature of the OMT of the ECB is sterilization of bond purchases: funds injected to pay for the bonds would be withdrawn or sterilized by ECB transactions. The statement by the European Central Bank on the program of OTM is as follows (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html):
“6 September 2012 - Technical features of Outright Monetary Transactions
As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) has today taken decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets that aim at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy. These will be known as Outright Monetary Transactions (OMTs) and will be conducted within the following framework:
Conditionality
A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.
The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.
Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.
Coverage
Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above. They may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access.
Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.
No ex ante quantitative limits are set on the size of Outright Monetary Transactions.
Creditor treatment
The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.
Sterilisation
The liquidity created through Outright Monetary Transactions will be fully sterilised.
Transparency
Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis. Publication of the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis.
Securities Markets Programme
Following today’s decision on Outright Monetary Transactions, the Securities Markets Programme (SMP) is herewith terminated. The liquidity injected through the SMP will continue to be absorbed as in the past, and the existing securities in the SMP portfolio will be held to maturity.”
(2) The weak employment situation report of the United States generated speculation of further measures by the Federal Open Market Committee (FOMC).
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.”
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. 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. The announcement of the OMT of bond-buying by the ECB together with weak employment creation in the US created risk appetite with the yield of the ten-year government bond of Spain collapsing to 5.708 percent on Sep 7 and the yield of the ten-year government bond of Italy to 5.008 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). 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. The almost simultaneous announcement of the bond-buying OMT of the ECB on Sep 6 and the weak employment report on Sep 7 suggesting further easing by the FOMC caused risk appetite shown by the increase in yields of government bonds of the US on Sep 7 to 1.668 percent for the ten-year note and 0.252 percent for the two-year while the two-year yield of Germany rose from -0.03 percent to 0.03 percent and the ten-year yield from 1.33 percent to 1.52 percent. Under zero interest rates for the monetary policy rate of the US, or fed funds rate, carry trades ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield is still around consumer price inflation of 1.4 percent in the 12 months ending in Jul (see subsection II United States Inflation at http://cmpassocregulationblog.blogspot.com/2012/08/world-inflation-waves-loss-of-dynamism.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/07/world-inflation-waves-financial.html) and the expectation of higher inflation if risk aversion diminishes. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table III-1A provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.
Table III-1A, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate
| US 2Y | US 10Y | DE 2Y | DE 10Y | USD/ EUR | |
| 9/7/12 | 0.252 | 1.668 | 0.03 | 1.52 | 1.2816 |
| 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 Jul 31, 2001-Sep 6, 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 rallied in the week ending on Sep 7, 2012 with the announcement of the bond-buying OMT of the ECB on Sep 6 and prospects of further Fed easing because of the disappointing employment report released on Sep 7. DJIA increased 0.1 percent on Sep 7 and 1.6 percent in the week but mostly a gain of 1.5 percent on Sep 6 after announcement of the ECB bond-buying program. Germany’s Dax increased 2.9 percent on Thu Sep 6 and 3.5 percent in the week. Dow Global increased 2.0 percent on Sep 6, 1.6 percent on Sep 7 and 3.1 percent in the week. Japan’s Nikkei Average increased 2.2 percent on Fri Sep 7 and increased 2.2 percent in the week. Dow Asia Pacific TSM increased 2.5 percent on Sep 7 and increased 1.0 percent in the week while Shanghai Composite jumped 3.9 percent in the week, increasing 3.7 percent on Fri Sep 7 on expectation of new government stimulus. 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 increased 0.9 percent on Fri Sep 7 and increased 0.8 percent in the week, as shown in Table III-1. WTI increased 1.4 percent on Fri Sep 7 with higher expectations of further monetary policy stimulus and decreased 0.2 percent in the week while Brent increased 1.0 percent on Fri Sep 7 and decreased 0.6 percent in the week. Gold increased 2.2 percent on Fri Sep 7 and increased 3.1 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 €1,209,287 million on Aug 31, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,809,125 million in the statement of Aug 31. 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 31, 2012 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 433,778 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 262,946 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 49,048 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 19,172 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 1,209,827 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 218,803 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 599,298 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 30,041 |
| 9 Other Assets | 278,719 | 336,574 | 261,857 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 3,084,769 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,809,125 |
| 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/fs120904.en.html
There is extremely important information in Table III-1C for the current sovereign risk crisis in the euro zone. Table III-1C provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Jul 2012. German exports to other European Union (EU) members are 55.3 percent of total exports in Jul 2012 and 57.6 percent in Jan-Jul 2012. Exports to the euro area are 36.4 percent in Jul and 38.2 percent in Jan-Jul. Exports to third countries are 44.7 percent of the total in Jul and 42.4 percent in Jan-Jul. There is similar distribution for imports. Exports to non-euro countries are growing at 6.9 percent in Jul 2012 and 4.8 percent in Jan-Jul 2012 while exports to the euro area are growing 3.2 percent in Jul and decreasing 0.6 percent in Jan-Jul 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-1C, Germany, Structure of Exports and Imports by Region, € Billions and ∆%
| Jul 2012 | Jul 12-Month | Jan–Jul 2012 € Billions | Jan-Jul 2012/ | |
| Total | 93.6 | 9.2 | 644.1 | 5.4 |
| A. EU | 51.8 % 55.3 | 4.4 | 370.9 % 57.6 | 1.2 |
| Euro Area | 34.1 % 36.4 | 3.2 | 246.0 % 38.2 | -0.6 |
| Non-euro Area | 17.6 % 18.8 | 6.9 | 124.9 % 19.4 | 4.8 |
| B. Third Countries | 41.8 % 44.7 | 15.9 | 273.2 % 42.4 | 11.8 |
| Total Imports | 76.7 | 1.9 | 533.8 | 2.3 |
| C. EU Members | 49.3 % 64.3 | 5.6 | 340.0 % 63.7 | 2.5 |
| Euro Area | 34.7 % 45.2 | 6.7 | 239.5 % 44.9 | 2.2 |
| Non-euro Area | 14.6 % 19.0 | 3.3 | 100.5 % 18.8 | 3.3 |
| D. Third Countries | 27.4 % 35.7 | -4.2 | 193.8 % 36.3 | 1.9 |
Notes: Total Exports = A+B; Total Imports = C+D
Source:
Statistisches Bundesamt Deutschland https://www.destatis.de/EN/PressServices/Press/pr/2012/09/PE12_303_51.html;jsessionid=807581660CF67FED0FC729A83F38D5FB.cae2 https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.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 €1,209,287 million on Aug 31, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,809,125 million in the statement of Aug 31. 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 31, 2012 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 433,778 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 262,946 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 49,048 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 19,172 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 1,209,827 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 218,803 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 599,298 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 30,041 |
| 9 Other Assets | 278,719 | 336,574 | 261,857 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 3,084,769 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,809,125 |
| 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/fs120904.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 III-9 for the current sovereign risk crisis in the euro zone. Table III-9 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Jul 2012. German exports to other European Union (EU) members are 55.3 percent of total exports in Jul 2012 and 57.6 percent in Jan-Jul 2012. Exports to the euro area are 36.4 percent in Jul and 38.2 percent in Jan-Jul. Exports to third countries are 44.7 percent of the total in Jul and 42.4 percent in Jan-Jul. There is similar distribution for imports. Exports to non-euro countries are growing at 6.9 percent in Jul 2012 and 4.8 percent in Jan-Jul 2012 while exports to the euro area are growing 3.2 percent in Jul and decreasing 0.6 percent in Jan-Jul 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 ∆%
| Jul 2012 | Jul 12-Month | Jan–Jul 2012 € Billions | Jan-Jul 2012/ | |
| Total | 93.6 | 9.2 | 644.1 | 5.4 |
| A. EU | 51.8 % 55.3 | 4.4 | 370.9 % 57.6 | 1.2 |
| Euro Area | 34.1 % 36.4 | 3.2 | 246.0 % 38.2 | -0.6 |
| Non-euro Area | 17.6 % 18.8 | 6.9 | 124.9 % 19.4 | 4.8 |
| B. Third Countries | 41.8 % 44.7 | 15.9 | 273.2 % 42.4 | 11.8 |
| Total Imports | 76.7 | 1.9 | 533.8 | 2.3 |
| C. EU Members | 49.3 % 64.3 | 5.6 | 340.0 % 63.7 | 2.5 |
| Euro Area | 34.7 % 45.2 | 6.7 | 239.5 % 44.9 | 2.2 |
| Non-euro Area | 14.6 % 19.0 | 3.3 | 100.5 % 18.8 | 3.3 |
| D. Third Countries | 27.4 % 35.7 | -4.2 | 193.8 % 36.3 | 1.9 |
Notes: Total Exports = A+B; Total Imports = C+D
Source:
Statistisches Bundesamt Deutschland https://www.destatis.de/EN/PressServices/Press/pr/2012/09/PE12_303_51.html;jsessionid=807581660CF67FED0FC729A83F38D5FB.cae2 https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
IIIF Appendix on Sovereign Bond Valuation. There are two approaches to government finance and their implications: (1) simple unpleasant monetarist arithmetic; and (2) simple unpleasant fiscal arithmetic. Both approaches illustrate how sovereign debt can be perceived riskier under profligacy.
First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:
D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)
Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,
{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:
N(t+1) = (1+n)N(t), n>-1 (2)
The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:
B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)
On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.
Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (4)
Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+τ. The second equation of Cochrane (2011Jan, 5) is:
MtV(it, ·) = PtYt (5)
Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):
“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”
An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.
There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:
(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress
(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality
(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.
© Carlos M. Pelaez, 2010, 2011, 2012
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