Duration Dumping and Peaking Valuations of Risk Financial Assets, World Inflation Waves, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, Unresolved US Balance of Payments Deficits and Fiscal Imbalance, Household Income at 1995 Levels, Forty-six Million in Poverty and Forty-eight Million without Health Insurance, United States Industrial Production, World Economic Slowdown and Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013
Executive Summary
I World Inflation Waves
IA Appendix: Transmission of Unconventional Monetary Policy
IA1 Theory
IA2 Policy
IA3 Evidence
IA4 Unwinding Strategy
IB United States Inflation
IC Long-term US Inflation
ID Current US Inflation
IE Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation
II United States Industrial Production
IIA Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities
IIA1 United States Unsustainable Deficit/Debt
IIA2 Unresolved US Balance of Payments Deficits
IIB Household Income at 1995 Levels, 46 Million in Poverty and 48 Million without Health Insurance
III World Financial Turbulence
IIIA Financial Risks
IIIE Appendix Euro Zone Survival Risk
IIIF Appendix on Sovereign Bond Valuation
IV Global Inflation
V World Economic Slowdown
VA United States
VB Japan
VC China
VD Euro Area
VE Germany
VF France
VG Italy
VH United Kingdom
VI Valuation of Risk Financial Assets
VII Economic Indicators
VIII Interest Rates
IX Conclusion
References
Appendixes
Appendix I The Great Inflation
IIIB Appendix on Safe Haven Currencies
IIIC Appendix on Fiscal Compact
IIID Appendix on European Central Bank Large Scale Lender of Last Resort
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
Executive Summary
Contents of Executive Summary
ESI Increasing Interest Rate Risk, Tapering Quantitative Easing, Duration Dumping, Steepening Yield Curve and Global Financial and Economic Risk
ESII Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates
ESIII Household Income at 1995 Levels, 46 Million in Poverty and 48 Million without Health Insurance
ESIV Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities
ESV United States Unsustainable Fiscal Deficit/Debt
ESVI United States Industrial Production
ESVII World Inflation Waves
ESI Increasing Interest Rate Risk, Tapering Quantitative Easing, Duration Dumping, Steepening Yield Curve and 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 for both theory and measurement. The IMF (2012WEOOct) provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2012/02/index.htm), of the world financial system with its Global Financial Stability Report (GFSR) (IMF 2012GFSROct) (http://www.imf.org/external/pubs/ft/gfsr/2012/02/index.htm) and of fiscal affairs with the Fiscal Monitor (IMF 2012FMOct) (http://www.imf.org/external/pubs/ft/fm/2012/02/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:
- China’s Economic Growth. China is lowering its growth target to 7.5 percent per year. China’s GDP growth decelerated significantly from annual equivalent 10.4 percent in IIQ2011 to 7.4 percent in IVQ2011 and 6.2 percent in IQ2012, rebounding to 8.7 percent in IIQ2012, 8.2 percent in IIIQ2012 and 7.8 percent in IVQ2012. Annual equivalent growth in IQ2013 fell to 6.6 percent and to 7.0 percent in IIQ2013 (See Subsection VC and earlier at http://cmpassocregulationblog.blogspot.com/2013/07/tapering-quantitative-easing-policy-and_7005.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/01/recovery-without-hiring-world-inflation.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/10/world-inflation-waves-stagnating-united_21.html).
- United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 28.3 million in job stress, fewer 10 million full-time jobs, high youth unemployment, historically low hiring and declining/stagnating real wages.
- Economic Growth and Labor Markets in Advanced Economies. Advanced economies are growing slowly. There is still high unemployment in advanced economies.
- World Inflation Waves. Inflation continues in repetitive waves globally (http://cmpassocregulationblog.blogspot.com/2013/08/duration-dumping-and-peaking-valuations_18.html)
A list of financial uncertainties includes:
- Euro Area Survival Risk. The resilience of the euro to fiscal and financial doubts on larger member countries is still an unknown risk.
- Foreign Exchange Wars. Exchange rate struggles continue as zero interest rates in advanced economies induce devaluation of their currencies.
- Valuation of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with lower volumes.
- 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.
- Credibility and Commitment of Central Bank Policy. There is a credibility issue of the commitment of monetary policy (Sargent and Silber 2012Mar20).
- Carry Trades. Commodity prices driven by zero interest rates have resumed their increasing path with fluctuations caused by intermittent risk aversion
Professionals use a variety of techniques in measuring interest rate risk (Fabozzi, Buestow and Johnson, 2006, Chapter Nine, 183-226):
- Full valuation approach in which securities and portfolios are shocked by 50, 100, 200 and 300 basis points to measure their impact on asset values
- Stress tests requiring more complex analysis and translation of possible events with high impact even if with low probability of occurrence into effects on actual positions and capital
- Value at Risk (VaR) analysis of maximum losses that are likely in a time horizon
- Duration and convexity that are short-hand convenient measurement of changes in prices resulting from changes in yield captured by duration and convexity
- Yield volatility
Analysis of these methods is in Pelaez and Pelaez (International Financial Architecture (2005), 101-162) and Pelaez and Pelaez, Globalization and the States, Vol. (I) (2008a), 78-100). Frederick R. Macaulay (1938) introduced the concept of duration in contrast with maturity for analyzing bonds. Duration is the sensitivity of bond prices to changes in yields. In economic jargon, duration is the yield elasticity of bond price to changes in yield, or the percentage change in price after a percentage change in yield, typically expressed as the change in price resulting from change of 100 basis points in yield. The mathematical formula is the negative of the yield elasticity of the bond price or –[dB/d(1+y)]((1+y)/B), where d is the derivative operator of calculus, B the bond price, y the yield and the elasticity does not have dimension (Hallerbach 2001). The duration trap of unconventional monetary policy is that duration is higher the lower the coupon and higher the lower the yield, other things being constant. Coupons and yields are historically low because of unconventional monetary policy. Duration dumping during a rate increase may trigger the same crossfire selling of high duration positions that magnified the credit crisis. Traders reduced positions because capital losses in one segment, such as mortgage-backed securities, triggered haircuts and margin increases that reduced capital available for positioning in all segments, causing fire sales in multiple segments (Brunnermeier and Pedersen 2009; see Pelaez and Pelaez, Regulation of Banks and Finance (2008b), 217-24). Financial markets are currently experiencing fear of duration resulting from the debate within and outside the Fed on tapering quantitative easing. Table VIII-2 provides the yield curve of Treasury securities on Sep 20, 2013, Sep 5, 2013, May 1, 2013, Sep 20, 2012 and Sep 20, 2006. There is ongoing steepening of the yield curve for longer maturities, which are also the ones with highest duration. The 10-year yield increased from 1.45 percent on Jul 26, 2012 to 2.98 percent on Sep 5, 2013, as measured by the United States Treasury. Assume that a bond with maturity in 10 years were issued on Sep 5, 2013 at par or price of 100 with coupon of 1.45 percent. The price of that bond would be 86.8530 with instantaneous increase of the yield to 2.98 percent for loss of 13.1 percent and far more with leverage. Losses absorb capital available for positioning, triggering crossfire sales in multiple asset classes (Brunnermeier and Pedersen 2009). Chris Dieterich, writing on “Bond investors turn to cash,” on Jul 25, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323971204578625900935618178.html), uses data of the Investment Company Institute (http://www.ici.org/) in showing withdrawals of $43 billion in taxable mutual funds in Jun, which is the largest in history, with flows into cash investments such as $8.5 billion in the week of Jul 17 into money-market funds.
Table VIII-2, United States, Treasury Yields
| 9/13/13 | 9/05/13 | 5/01/13 | 9/13/12 | 9/13/06 | |
| 1 M | 0.01 | 0.03 | 0.03 | 0.10 | 4.78 |
| 3 M | 0.01 | 0.02 | 0.06 | 0.10 | 4.91 |
| 6 M | 0.02 | 0.06 | 0.08 | 0.13 | 5.08 |
| 1 Y | 0.13 | 0.16 | 0.11 | 0.17 | 4.99 |
| 2 Y | 0.45 | 0.52 | 0.20 | 0.24 | 4.80 |
| 3 Y | 0.87 | 0.97 | 0.30 | 0.32 | 4.72 |
| 5 Y | 1.71 | 1.85 | 0.65 | 0.65 | 4.70 |
| 7 Y | 2.32 | 2.45 | 1.07 | 1.12 | 4.72 |
| 10 Y | 2.90 | 2.98 | 1.66 | 1.75 | 4.77 |
| 20 Y | 3.59 | 3.64 | 2.44 | 2.53 | 4.97 |
| 30 Y | 3.84 | 3.88 | 2.83 | 2.95 | 4.90 |
Source: United States Treasury http://www.treasury.gov/resource-center/data-chart-center/Pages/index.aspx
Interest rate risk is increasing in the US. Chart VI-13 of the Board of Governors provides the conventional mortgage rate for a fixed-rate 30-year mortgage. The rate stood at 5.87 percent on Jan 8, 2004, increasing to 6.79 percent on Jul 6, 2006. The rate bottomed at 3.35 percent on May 2, 2013. Fear of duration risk in longer maturities such as mortgage-backed securities caused continuing increases in the conventional mortgage rate that rose to 4.51 percent on Jul 11, 2013 and 4.50 percent on Sep 19, 2013, which is the last data point in Chart VI-13.
Chart VI-13, US, Conventional Mortgage Rate, Jan 8, 2004 to Sep 19, 2013
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
The major reason and channel of transmission of unconventional monetary policy is through expectations of inflation. Fisher (1930) provided theoretical and historical relation of interest rates and inflation. Let in be the nominal interest rate, ir the real or inflation-adjusted interest rate and πe the expectation of inflation in the time term of the interest rate, which are all expressed as proportions. The following expression provides the relation of real and nominal interest rates and the expectation of inflation:
(1 + ir) = (1 + in)/(1 + πe) (1)
That is, the real interest rate equals the nominal interest rate discounted by the expectation of inflation in time term of the interest rate. Fisher (1933) analyzed the devastating effect of deflation on debts. Nominal debt contracts remained at original principal interest but net worth and income of debtors contracted during deflation. Real interest rates increase during declining inflation. For example, if the interest rate is 3 percent and prices decline 0.2 percent, equation (1) calculates the real interest rate as:
(1 +0.03)/(1 – 0.02) = 1.03/(0.998) = 1.032
That is, the real rate of interest is (1.032 – 1) 100 or 3.2 percent. If inflation were 2 percent, the real rate of interest would be 0.98 percent, or about 1.0 percent {[(1.03/1.02) -1]100 = 0.98%}.
The yield of the one-year Treasury security was quoted in the Wall Street Journal at 0.114 percent on Fri May 17, 2013 (http://online.wsj.com/mdc/page/marketsdata.html?mod=WSJ_topnav_marketdata_main). The expected rate of inflation πe in the next twelve months is not observed. Assume that it would be equal to the rate of inflation in the past twelve months estimated by the Bureau of Economic Analysis (BLS) at 1.1 percent (http://www.bls.gov/cpi/). The real rate of interest would be obtained as follows:
(1 + 0.00114)/(1 + 0.011) = (1 + rr) = 0.9902
That is, ir is equal to 1 – 0.9902 or minus 0.98 percent. Investing in a one-year Treasury security results in a loss of 0.98 percent relative to inflation. The objective of unconventional monetary policy of zero interest rates is to induce consumption and investment because of the loss to inflation of riskless financial assets. Policy would be truly irresponsible if it intended to increase inflationary expectations or πe. The result could be the same rate of unemployment with higher inflation (Kydland and Prescott 1977).
Current focus is on tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Market are overreacting to the so-called “paring” of outright purchases of $85 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Sep 18, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):
“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored” (emphasis added).
There is a critical phrase in the statement of Sep 19, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm): “but mortgage rates have risen further.” Did the increase of mortgage rates influence the decision of the FOMC not to taper? Is FOMC “communication” and “guidance” successful?
In delivering the biannual report on monetary policy (Board of Governors 2013Jul17), Chairman Bernanke (2013Jul17) advised Congress that:
“Instead, we are providing additional policy accommodation through two distinct yet complementary policy tools. The first tool is expanding the Federal Reserve's portfolio of longer-term Treasury securities and agency mortgage-backed securities (MBS); we are currently purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. We are using asset purchases and the resulting expansion of the Federal Reserve's balance sheet primarily to increase the near-term momentum of the economy, with the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. We have made some progress toward this goal, and, with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low--our second tool--to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability.
The Committee's decisions regarding the asset purchase program (and the overall stance of monetary policy) depend on our assessment of the economic outlook and of the cumulative progress toward our objectives. Of course, economic forecasts must be revised when new information arrives and are thus necessarily provisional.”
Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities).
The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. Indefinite financial repression induces carry trades with high leverage, risks and illiquidity.
A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html). Matt Jarzemsky, writing on Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 15,451.09
on Fri Sep 13, 2013, which is higher by 9.1 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 8.8 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs.
Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
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. The DJIA has increased 59.5 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to Sep 20, 2013; S&P 500 has gained 67.2 percent; and DAX 53.0 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 9/20/13” had double digit gains relative to the trough around Jul 2, 2010 followed by negative performance but now some valuations of equity indexes show varying behavior: China’s Shanghai Composite is 8.0 percent below the trough; Japan’s Nikkei Average is 67.1 percent above the trough; DJ Asia Pacific TSM is 25.6 percent above the trough; Dow Global is 37.9 percent above the trough; STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 22.0 percent above the trough; and NYSE Financial Index is 43.1 percent above the trough. DJ UBS Commodities is 3.5 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 53.0 percent above the trough. Japan’s Nikkei Average is 67.1 percent above the trough on Aug 31, 2010 and 29.4 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 14,742.42 on Fri Sep 20, 2013 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 43.8 percent higher 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 13.5 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 9/20/13” in Table VI-4 shows decrease of 2.0 percent in the week for China’s Shanghai Composite. DJ Asia Pacific increased 2.6 percent. NYSE Financial increased 1.7 percent in the week. DJ UBS Commodities decreased 0.8 percent. Dow Global increased 2.1 percent in the week of Sep 20, 2013. The DJIA increased 0.5 percent and S&P 500 increased 1.3 percent. DAX of Germany increased 2.0 percent. STOXX 50 increased 0.7 percent. The USD depreciated 1.7 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 VI-4 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 9/20/13” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Sep 20, 2013. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 9/20/13” but also relative to the peak in column “∆% Peak to 9/20/13.” There are now several equity indexes above the peak in Table VI-4: DJIA 37.9 percent, S&P 500 40.5 percent, DAX 37.0 percent, Dow Global 12.5 percent, DJ Asia Pacific 10.0 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 14.0 percent, Nikkei Average 29.4 percent and STOXX 50 3.3 percent. There is only one equity index below the peak: Shanghai Composite by 30.7 percent. DJ UBS Commodities Index is now 11.5 percent below the peak. The US dollar strengthened 10.6 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. Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. In IQ1980, gross private domestic investment in the US was $951.6 billion of 2009 dollars, growing to $1,143.0 billion in IVQ1986 or 20.1 percent. Real gross private domestic investment in the US decreased 2.9 percent from $2,605.2 billion of 2009 dollars in IVQ2007 to $2,529.2 billion in IIQ2013. Real private fixed investment fell 5.0 percent from $2,586.3 billion of 2009 dollars in IVQ2007 to $2,455.8 billion in IIQ2013. Growth of real private investment in is mediocre for all but four quarters from IIQ2011 to IQ2012 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). Profits after taxes with inventory valuation adjustment (IVA) and capital consumption adjustment (CCA) increased by 100.3 percent in nominal terms from IVQ2007 to IQ2013 while net dividends increased 24.6 percent and undistributed corporate profits swelled 280.2 percent from $107.7 billion in IQ2007 to $409.5 billion in IIQ2013 and changed signs from minus $55.9 billion in current dollars in IVQ2007. The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Corporate profits with IVA and CCA fell $26.6 billion in IQ2013 after increasing $34.9 billion in IVQ2012 and $13.9 billion in IIIQ2012. Corporate profits with IVA and CCA rebounded with $78.3 billion in IIQ2013. Profits after tax with IVA and CCA fell $1.7 billion in IQ2013 after increasing $40.8 billion in IVQ2012 and $4.5 billion in IIIQ2012. In IIQ2013, profits after tax with IVA and CCA increased $67.8 billion. Anticipation of higher taxes in the “fiscal cliff” episode caused increase of $120.9 billion in net dividends in IVQ2012 followed with adjustment in the form of decrease of net dividends by $103.8 billion in IQ2013, rebounding with $273.8 billion in IIQ2013. There is similar decrease of $80.1 billion in undistributed profits with IVA and CCA in IVQ2012 followed by increase of $102.1 billion in IQ2013 and decline of $205.9 billion in IIQ2013. Undistributed profits of US corporations swelled 280.2 percent from $107.7 billion IQ2007 to $409.5 billion in IIQ2013 and changed signs from minus $55.9 billion in billion in IVQ2007 (Section IA2). In IQ2013, corporate profits with inventory valuation and capital consumption adjustment fell $26.6 billion relative to IVQ2012, from $2047.2 billion to $2020.6 billion at the quarterly rate of minus 1.3 percent. In IIQ2013, corporate profits with IVA and CCA increased $78.3 billion from $2020.6 billion in IQ2013 to $2098.9 billion at the quarterly rate of 3.9 percent (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf). Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment. The investment decision of US business is fractured.
It may be quite painful to exit QE→∞ or use of the balance sheet of the central together with zero interest rates forever. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:
Where Rτ is expected revenue in the time horizon from τ =1 to T; Cτ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that interest rates increase without bound, then V → 0, or
![clip_image002[1]](http://lh3.ggpht.com/-sKr8HvFxCac/Uj9biVn6R-I/AAAAAAAAgXo/Z8Y5vX3IVSI/s1600-h/clip_image002%25255B1%25255D%25255B2%25255D.gif "clip_image002[1]"){kind=small}
declines. Equally, decline in expected revenue from the stock or project, Rτ, causes decline in valuation. 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 VI-4, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 9/20/ /13 | ∆% Week 9/20/13 | ∆% Trough to 9/20/ 13 | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 37.9 | 0.5 | 59.5 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 40.5 | 1.3 | 67.2 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | 14.0 | 1.7 | 43.1 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | 12.5 | 2.1 | 37.9 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | 10.0 | 2.6 | 25.6 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | 29.4 | 2.3 | 67.1 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -30.7 | -2.0 | -8.0 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | 3.3 | 0.7 | 22.0 |
| DAX | 4/26/ | 5/25/ | -10.5 | 37.0 | 2.0 | 53.0 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 10.6 | -1.7 | -13.5 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | -11.5 | -0.8 | 3.5 |
| 10-Year T Note | 4/5/ | 4/6/10 | 3.986 | 2.784 | 2.734 |
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
ESII Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates. Long-term economic growth in Japan significantly improved by increasing competitiveness in world markets. Net trade of exports and imports is an important component of the GDP accounts of Japan. Table VB-9 provides quarterly data for net trade, exports and imports of Japan. Net trade had strong positive contributions to GDP growth in Japan in all quarters from IQ2007 to IIQ2009 with exception of IVQ2008, IIIQ2008 and IQ2009. The US recession is dated by the National Bureau of Economic Research (NBER) as beginning in IVQ2007 (Dec) and ending in IIQ2009 (Jun) (http://www.nber.org/cycles/cyclesmain.html). Net trade contributions helped to cushion the economy of Japan from the global recession. Net trade deducted from GDP growth in seven of the nine quarters from IVQ2010 IQ2012. The only strong contribution of net trade was 3.4 percent in IIIQ2011. Net trade added 1.6 percentage points to GDP growth in IQ2013 and 0.7 percentage points in IIQ2013. Private consumption assumed the role of driver of Japan’s economic growth but should moderate as in most mature economies.
Table VB-9, Japan, Contributions to Changes in Real GDP, Seasonally Adjusted Annual Rates (SAAR), %
| Net Trade | Exports | Imports | |
| 2013 | |||
| I | 1.6 | 2.2 | -0.7 |
| II | 0.7 | 1.7 | -1.0 |
| 2012 | |||
| I | 0.3 | 1.6 | -1.3 |
| II | -1.0 | -0.1 | -0.9 |
| III | -2.7 | -2.7 | 0.0 |
| IV | -0.2 | -1.6 | 1.3 |
| 2011 | |||
| I | -1.2 | -0.5 | -0.7 |
| II | -4.1 | -4.5 | 0.4 |
| III | 3.4 | 5.4 | -2.0 |
| IV | -2.8 | -1.7 | -1.1 |
| 2010 | |||
| I | 2.1 | 3.5 | -1.3 |
| II | 0.2 | 2.7 | -2.5 |
| III | 0.3 | 1.2 | -0.9 |
| IV | -0.3 | 0.2 | -0.5 |
| 2009 | |||
| I | -4.4 | -16.4 | 12.0 |
| II | 7.5 | 4.7 | 2.7 |
| III | 2.1 | 5.2 | -3.1 |
| IV | 2.8 | 4.2 | -1.4 |
| 2008 | |||
| I | 1.2 | 2.2 | -1.0 |
| II | 0.5 | -1.6 | 2.1 |
| III | -0.1 | 0.1 | -0.1 |
| IV | -11.4 | -10.2 | -1.2 |
| 2007 | |||
| I | 1.2 | 1.7 | -0.5 |
| II | 0.8 | 1.6 | -0.8 |
| III | 2.0 | 1.4 | 0.6 |
| IV | 1.4 | 2.1 | -0.7 |
Source: http://www.esri.cao.go.jp/en/sna/sokuhou/sokuhou_top.html
There was milder increase in Japan’s export corporate goods price index during the global recession in 2008 but similar sharp decline during the bank balance sheets effect in late 2008, as shown in Chart VB-1 of the Bank of Japan. Japan exports industrial goods whose prices have been less dynamic than those of commodities and raw materials. As a result, the export CGPI on the yen basis in Chart IV-5 trends down with oscillations after a brief rise in the final part of the recession in 2009. The export corporate goods price index on the yen basis fell from 104.9 in Jun 2009 to 94.0 in Jan 2012 or minus 10.4 percent and increased to 106.0 in Aug 2013 for a gain of 12.8 percent relative to Jan 2012 and 1.0 percent relative to Jun 2009. The choice of Jun 2009 is designed to capture the reversal of risk aversion beginning in Sep 2008 with the announcement of toxic assets in banks that would be withdrawn with the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009). Reversal of risk aversion in the form of flight to the USD and obligations of the US government opened the way to renewed carry trades from zero interest rates to exposures in risk financial assets such as commodities. Japan exports industrial products and imports commodities and raw materials.
Chart VB-1, Japan, Export Corporate Goods Price Index, Monthly, Yen Basis, 2008-2013
Source: Bank of Japan
http://www.stat-search.boj.or.jp/index_en.html
Chart VB-1A provides the export corporate goods price index on the basis of the contract currency. The export corporate goods price index on the basis of the contract currency increased from 97.9 in Jun 2009 to 103.1 in Apr 2012 or 5.3 percent but dropped to 100.2 in Apr 2013 or minus 2.8 percent relative to Apr 2012 and gained 1.0 percent to 98.9 in Aug 2013 relative to Jun 2009.
Chart VB-1A, Japan, Export Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2013
Source: Bank of Japan
http://www.stat-search.boj.or.jp/index_en.html
Japan imports primary commodities and raw materials. As a result, the import corporate goods price index on the yen basis in Chart VB-2 shows an upward trend after declining from the increase during the global recession in 2008 driven by carry trades from fed funds rates. The index increases with carry trades from zero interest rates into commodity futures and declines during risk aversion from late 2008 into beginning of 2008 originating in doubts about soundness of US bank balance sheets. More careful measurement should show that the terms of trade of Japan, export prices relative to import prices, declined during the commodity shocks originating in unconventional monetary policy. The decline of the terms of trade restricted potential growth of income in Japan. The import corporate goods price index on the yen basis increased from 93.5 in Jun 2009 to 113.1 in Apr 2012 or 21.0 percent and to 121.8 in Aug 2013 or gain of 7.7 percent relative to Apr 2012 and 30.3 percent relative to Jun 2009.
Chart VB-2, Japan, Import Corporate Goods Price Index, Monthly, Yen Basis, 2008-2013
Source: Bank of Japan
http://www.stat-search.boj.or.jp/index_en.html
Chart VB-2A provides the import corporate goods price index on the contract currency basis. The import corporate goods price index on the basis of the contract currency increased from 86.2 in Jun 2009 to 119.5 in Apr 2012 or 38.6 percent and to 112.2 in Aug 2013 or minus 6.1 percent relative to Apr 2012 and gain of 30.2 percent relative to Jun 2009. There is evident deterioration of the terms of trade of Japan: the export corporate goods price index on the basis of the contract currency increased 5.3 percent from Jun 2009 to Apr 2012 while the import corporate goods price index increased 38.6 percent. Prices of Japan’s exports of corporate goods, mostly industrial products, increased only 5.3 percent from Jun 2009 to Apr 2012, while imports of corporate goods, mostly commodities and raw materials increased 38.6 percent. Unconventional monetary policy induces carry trades from zero interest rates to exposures in commodities that squeeze economic activity of industrial countries by increases in prices of imported commodities and raw materials during periods without risk aversion. Reversals of carry trades during periods of risk aversion decrease prices of exported commodities and raw materials that squeeze economic activity in economies exporting commodities and raw materials. Devaluation of the dollar by unconventional monetary policy could increase US competitiveness in world markets but economic activity is squeezed by increases in prices of imported commodities and raw materials. Unconventional monetary policy causes instability worldwide instead of the mission of central banks of promoting financial and economic stability.
Chart VB-2A, Japan, Import Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2013
Source: Bank of Japan
http://www.stat-search.boj.or.jp/index_en.html
Table VB-10 provides the Bank of Japan’s Corporate Goods Price indexes of exports and imports on the yen and contract bases from Jan 2008 to Aug 2013. There are oscillations of the indexes that are shown vividly in the four charts above. For the entire period from Jan 2008 to Aug 2013, the export index on the contract currency basis decreased 0.3 percent and decreased 8.2 percent on the yen basis. For the entire period from Jan 2008 to Aug 2013, the import index increased 11.4 percent on the contract currency basis and increased 2.4 percent on the yen basis. The charts show sharp deteriorations in relative prices of exports to prices of imports during multiple periods. Price margins of Japan’s producers are subject to periodic squeezes resulting from carry trades from zero interest rates of monetary policy to exposures in commodities.
Table VB-10, Japan, Exports and Imports Corporate Goods Price Index, Contract Currency Basis and Yen Basis
| Month | Exports Contract | Exports Yen | Imports Contract Currency | Imports Yen |
| 2008/01 | 99.2 | 115.5 | 100.7 | 119.0 |
| 2008/02 | 99.8 | 116.1 | 102.4 | 120.6 |
| 2008/03 | 100.5 | 112.6 | 104.5 | 117.4 |
| 2008/04 | 101.6 | 115.3 | 110.1 | 125.2 |
| 2008/05 | 102.4 | 117.4 | 113.4 | 130.4 |
| 2008/06 | 103.5 | 120.7 | 119.5 | 140.3 |
| 2008/07 | 104.7 | 122.1 | 122.6 | 143.9 |
| 2008/08 | 103.7 | 122.1 | 123.1 | 147.0 |
| 2008/09 | 102.7 | 118.3 | 117.1 | 137.1 |
| 2008/10 | 100.2 | 109.6 | 109.1 | 121.5 |
| 2008/11 | 98.6 | 104.5 | 97.8 | 105.8 |
| 2008/12 | 97.9 | 100.6 | 89.3 | 93.0 |
| 2009/01 | 98.0 | 99.5 | 85.6 | 88.4 |
| 2009/02 | 97.5 | 100.1 | 85.7 | 89.7 |
| 2009/03 | 97.3 | 104.2 | 85.2 | 93.0 |
| 2009/04 | 97.6 | 105.6 | 84.4 | 93.0 |
| 2009/05 | 97.5 | 103.8 | 84.0 | 90.8 |
| 2009/06 | 97.9 | 104.9 | 86.2 | 93.5 |
| 2009/07 | 97.5 | 103.1 | 89.2 | 95.0 |
| 2009/08 | 98.3 | 104.4 | 89.6 | 95.8 |
| 2009/09 | 98.3 | 102.1 | 91.0 | 94.7 |
| 2009/10 | 98.0 | 101.2 | 91.0 | 94.0 |
| 2009/11 | 98.4 | 100.8 | 92.8 | 94.8 |
| 2009/12 | 98.3 | 100.7 | 95.4 | 97.5 |
| 2010/01 | 99.4 | 102.2 | 97.0 | 100.0 |
| 2010/02 | 99.7 | 101.6 | 97.6 | 99.8 |
| 2010/03 | 99.7 | 101.8 | 97.0 | 99.2 |
| 2010/04 | 100.5 | 104.6 | 99.9 | 104.6 |
| 2010/05 | 100.7 | 102.9 | 101.7 | 104.9 |
| 2010/06 | 100.1 | 101.6 | 100.0 | 102.3 |
| 2010/07 | 99.4 | 99.0 | 99.9 | 99.8 |
| 2010/08 | 99.1 | 97.3 | 99.5 | 97.5 |
| 2010/09 | 99.4 | 97.0 | 100.0 | 97.2 |
| 2010/10 | 100.1 | 96.4 | 100.5 | 95.8 |
| 2010/11 | 100.7 | 97.4 | 102.6 | 98.2 |
| 2010/12 | 101.2 | 98.3 | 104.4 | 100.6 |
| 2011/01 | 102.1 | 98.6 | 107.2 | 102.6 |
| 2011/02 | 102.9 | 99.5 | 109.0 | 104.3 |
| 2011/03 | 103.5 | 99.6 | 111.8 | 106.3 |
| 2011/04 | 104.1 | 101.7 | 115.9 | 111.9 |
| 2011/05 | 103.9 | 99.9 | 118.8 | 112.4 |
| 2011/06 | 103.8 | 99.3 | 117.5 | 110.5 |
| 2011/07 | 103.6 | 98.3 | 118.3 | 110.2 |
| 2011/08 | 103.6 | 96.6 | 118.6 | 108.1 |
| 2011/09 | 103.7 | 96.1 | 117.0 | 106.2 |
| 2011/10 | 103.0 | 95.2 | 116.6 | 105.6 |
| 2011/11 | 101.9 | 94.8 | 115.4 | 105.4 |
| 2011/12 | 101.5 | 94.5 | 116.1 | 106.2 |
| 2012/01 | 101.8 | 94.0 | 115.0 | 104.2 |
| 2012/02 | 102.4 | 95.8 | 115.8 | 106.4 |
| 2012/03 | 102.9 | 99.2 | 118.3 | 112.9 |
| 2012/04 | 103.1 | 98.7 | 119.5 | 113.1 |
| 2012/05 | 102.2 | 96.3 | 118.1 | 109.9 |
| 2012/06 | 101.4 | 95.0 | 115.2 | 106.7 |
| 2012/07 | 100.6 | 94.0 | 112.0 | 103.6 |
| 2012/08 | 100.8 | 94.1 | 112.4 | 103.6 |
| 2012/09 | 100.9 | 94.0 | 114.7 | 105.2 |
| 2012/10 | 101.0 | 94.7 | 113.8 | 105.2 |
| 2012/11 | 100.9 | 95.9 | 113.3 | 106.6 |
| 2012/12 | 100.7 | 98.0 | 113.6 | 109.7 |
| 2013/01 | 101.0 | 102.5 | 114.0 | 115.5 |
| 2013/02 | 101.5 | 105.9 | 114.9 | 120.4 |
| 2013/03 | 101.3 | 106.7 | 115.2 | 122.2 |
| 2013/04 | 100.2 | 107.5 | 114.3 | 124.0 |
| 2013/05 | 99.6 | 109.1 | 112.7 | 125.4 |
| 2013/06 | 99.2 | 106.1 | 112.2 | 121.4 |
| 2013/07 | 99.0 | 107.3 | 111.8 | 123.0 |
2013/08 98.9 106.0 112.2 121.8
Source: Bank of Japan http://www.stat-search.boj.or.jp/index_en.html
Further insight into inflation of the corporate goods price index (CGPI) of Japan is provided in Table VB-11. Petroleum and coal with weight of 5.7 percent increased 1.8 percent in Aug 2013 and increased 16.0 percent in 12 months. Japan exports manufactured products and imports raw materials and commodities such that the country’s terms of trade, or export prices relative to import prices, deteriorate during commodity price increases. In contrast, prices of production machinery, with weight of 3.1 percent, decreased 0.3 percent in Aug 2013 and increased 0.5 percent in 12 months. In general, most manufactured products have been experiencing negative or low increases in prices while inflation rates have been high in 12 months for products originating in raw materials and commodities. Ironically, unconventional monetary policy of zero interest rates and quantitative easing that intended to increase aggregate demand and GDP growth deteriorated the terms of trade of advanced economies with adverse effects on real income. There are now inflation effects of the intentional policy of devaluing the yen.
Table VB-11, Japan, Corporate Goods Prices and Selected Components, % Weights, Month and 12 Months ∆%
| Aug 2013 | Weight | Month ∆% | 12 Month ∆% |
| Total | 1000.0 | 0.3 | 2.4 |
| Food, Beverages, Tobacco, Feedstuffs | 137.5 | 0.1 | 1.5 |
| Petroleum & Coal | 57.4 | 1.8 | 16.0 |
| Production Machinery | 30.8 | -0.3 | 0.5 |
| Electronic Components | 31.0 | -0.4 | -1.1 |
| Electric Power, Gas & Water | 52.7 | 0.6 | 8.5 |
| Iron & Steel | 56.6 | 0.1 | -0.8 |
| Chemicals | 92.1 | 0.2 | 4.9 |
| Transport | 136.4 | -0.1 | -1.3 |
Source: Bank of Japan http://www.boj.or.jp/en/
Percentage point contributions to change of the corporate goods price index (CGPI) in Aug 2013 are provided in Table VB-12 divided into domestic, export and import segments. In the domestic CGPI, increasing 0.3 percent in Aug 2013, the energy shock is evident in the contribution of 0.13 percentage points by electric power, gas and water in new carry trades of exposures in commodity futures. The exports CGPI decreased 0.1 percent on the basis of the contract currency with deduction of 0.15 percentage points by electric and electronic products. The imports CGPI increased 0.4 percent on the contract currency basis. Petroleum, coal and natural gas contributed 0.23 percentage points. Shocks of risk aversion cause unwinding carry trades that result in declining commodity prices with resulting downward pressure on price indexes. The volatility of inflation adversely affects financial and economic decisions worldwide.
Table VB-12, Japan, Percentage Point Contributions to Change of Corporate Goods Price Index
| Groups Aug 2013 | Contribution to Change Percentage Points |
| A. Domestic Corporate Goods Price Index | Monthly Change: |
| Petroleum & Coal Products | 0.13 |
| Electric Power, Gas & Water | 0.04 |
| Nonferrous Metals | 0.03 |
| Business Oriented Machinery | 0.03 |
| Scrap & Waste | 0.02 |
| Agriculture, Forestry & Fishery Products | 0.02 |
| Chemicals & Related Products | 0.02 |
| Electronic Components & Devices | -0.01 |
| B. Export Price Index | Monthly Change: |
| Electric & Electronic Products | -0.15 |
| Transportation Equipment | -0.03 |
| Chemicals & Related Products | 0.04 |
| Other Primary Products & Manufactured Goods | 0.03 |
| C. Import Price Index | Monthly Change:0.4 % contract currency basis |
| Petroleum, Coal & Natural Gas | 0.23 |
| General Purpose, Production & Business Oriented Machinery | 0.07 |
| Textiles | 0.04 |
| Metals & Related Products | 0.03 |
| Transportation Equipment | -0.02 |
| Electric & Electronic Products | -0.02 |
Source: Bank of Japan http://www.boj.or.jp/en/
http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1308.pdf
There are two categories of responses in the Empire State Manufacturing Survey of the Federal Reserve Bank of New York (http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html): current conditions and expectations for the next six months. There are responses in the survey for two types of prices: prices received or inputs of production and prices paid or sales prices of products. Table IV-5 provides indexes for the two categories and within them for the two types of prices from Jan 2011 to Sep 2013. The index of current prices paid or costs of inputs increased from 16.13 in Dec 2012 to 21.51 in Sep 2013 while the index of current prices received or sales prices increased from 1.08 in Dec 2012 to 8.6 in Sep 2013. The index of future prices paid or expectations of costs of inputs in the next six months fell from 51.61 in Dec 2012 to 39.78 in Sep 2013 while the index of future prices received or expectation of sales prices in the next six months fell from 25.81 in Dec 2012 to 24.73 in Sep 2013. Prices of sales of finished products are less dynamic than prices of costs of inputs during waves of increases. Prices of costs of costs of inputs fall less rapidly than prices of sales of finished products during waves of price decreases. As a result, margins of prices of sales less costs of inputs oscillate with typical deterioration against producers, forcing companies to manage tightly costs and labor inputs.
Table IV-5, US, FRBNY Empire State Manufacturing Survey, Diffusion Indexes, Prices Paid and Prices Received, SA
| Current Prices Paid | Current Prices Received | Six Months Prices Paid | Six Months Prices Received | |
| Sep 2013 | 21.51 | 8.6 | 39.78 | 24.73 |
| Aug | 20.48 | 3.61 | 40.96 | 19.28 |
| Jul | 17.39 | 1.09 | 28.26 | 11.96 |
| Jun | 20.97 | 11.29 | 45.16 | 17.74 |
| May | 20.45 | 4.55 | 29.55 | 14.77 |
| Apr | 28.41 | 5.68 | 44.32 | 14.77 |
| Mar | 25.81 | 2.15 | 50.54 | 23.66 |
| Feb | 26.26 | 8.08 | 44.44 | 13.13 |
| Jan | 22.58 | 10.75 | 38.71 | 21.51 |
| Dec 2012 | 16.13 | 1.08 | 51.61 | 25.81 |
| Nov | 14.61 | 5.62 | 39.33 | 15.73 |
| Oct | 17.20 | 4.30 | 44.09 | 24.73 |
| Sep | 19.15 | 5.32 | 40.43 | 23.40 |
| Aug | 16.47 | 2.35 | 31.76 | 14.12 |
| Jul | 7.41 | 3.70 | 35.80 | 16.05 |
| Jun | 19.59 | 1.03 | 34.02 | 17.53 |
| May | 37.35 | 12.05 | 57.83 | 22.89 |
| Apr | 45.78 | 19.28 | 50.60 | 22.89 |
| Mar | 50.62 | 13.58 | 66.67 | 32.10 |
| Feb | 25.88 | 15.29 | 62.35 | 34.12 |
| Jan | 26.37 | 23.08 | 53.85 | 30.77 |
| Dec 2011 | 24.42 | 3.49 | 56.98 | 36.05 |
| Nov | 18.29 | 6.10 | 36.59 | 25.61 |
| Oct | 22.47 | 4.49 | 40.45 | 17.98 |
| Sep | 32.61 | 8.70 | 53.26 | 22.83 |
| Aug | 28.26 | 2.17 | 42.39 | 15.22 |
| Jul | 43.33 | 5.56 | 51.11 | 30.00 |
| Jun | 56.12 | 11.22 | 55.10 | 19.39 |
| May | 69.89 | 27.96 | 68.82 | 35.48 |
| Apr | 57.69 | 26.92 | 56.41 | 38.46 |
| Mar | 53.25 | 20.78 | 71.43 | 36.36 |
| Feb | 45.78 | 16.87 | 55.42 | 27.71 |
| Jan | 35.79 | 15.79 | 60.00 | 42.11 |
Source: http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html
Price indexes of the Federal Reserve Bank of Philadelphia Outlook Survey are provided in Table IV-6. As inflation waves throughout the world (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/08/duration-dumping-and-peaking-valuations.html), indexes of both current and expectations of future prices paid and received were quite high until May 2011. Prices paid, or inputs, were more dynamic, reflecting carry trades from zero interest rates to commodity futures. All indexes softened after May 2011 with even decline of prices received in Aug 2011 during the first round of risk aversion. Current and future price indexes have increased again but not back to the levels in the beginning of 2011 because of risk aversion frustrating carry trades even under zero interest rates. The index of prices paid or prices of inputs increased from 23.5 in Dec 2012 to 25.3 in Sep 2013. The index of current prices received was minus 3.3 in May 2013, indicating decrease of prices received. The index of current prices received increased from 12.4 in Dec 2012 to 12.7 in Sep 2013. The index of future prices paid fell to 43.1 in Sep 2013 from 45.8 in Dec 2012, indicating expectation of lower pressure of increases of input prices, while the index of future prices received increased from 25.6 in Dec 2012 to 31.7 in Sep 2013. Expectations are incorporating faster increases in prices of inputs or costs of production than of sales of produced goods, forcing companies to manage tightly costs and labor inputs.
Table IV-6, US, Federal Reserve Bank of Philadelphia Business Outlook Survey, Current and Future Prices Paid and Prices Received, SA
| Current Prices Paid | Current Prices Received | Future Prices Paid | Future Prices Received | |
| Dec-10 | 44.3 | 6.6 | 59.6 | 25.3 |
| Jan-11 | 48.9 | 11.9 | 58.3 | 34.4 |
| Feb-11 | 58.9 | 13.1 | 62.1 | 33.3 |
| Mar-11 | 57.5 | 16.8 | 60.2 | 31.8 |
| Apr-11 | 49.4 | 19.8 | 54.2 | 32.4 |
| May-11 | 47.7 | 18.5 | 52.7 | 27.6 |
| Jun-11 | 38.9 | 8.1 | 38.3 | 6.8 |
| Jul-11 | 35.6 | 6.0 | 49.6 | 16.7 |
| Aug-11 | 23.3 | -4.7 | 44.3 | 22.7 |
| Sep-11 | 31.6 | 7.6 | 41.8 | 21.8 |
| Oct-11 | 25.4 | 4.1 | 44.5 | 28.4 |
| Nov-11 | 26.3 | 7.6 | 39.0 | 29.1 |
| Dec-11 | 27.5 | 8.2 | 46.7 | 23.5 |
| Jan-12 | 27.1 | 7.9 | 47.2 | 21.9 |
| Feb-12 | 30.2 | 9.7 | 43.5 | 28.6 |
| Mar-12 | 14.3 | 5.4 | 35.9 | 22 |
| Apr-12 | 16.0 | 5.3 | 33.3 | 18.6 |
| May-12 | 5.4 | -2.2 | 37.2 | 8.3 |
| Jun-12 | 5.4 | -3.4 | 29.6 | 16.6 |
| Jul-12 | 10.3 | 4.2 | 29.3 | 19.6 |
| Aug-12 | 15.7 | 4.7 | 38.0 | 23.9 |
| Sep-12 | 15.4 | 4.0 | 42.8 | 27.4 |
| Oct-12 | 20.6 | 8.4 | 48.1 | 16.1 |
| Nov-12 | 27.9 | 7.5 | 50.7 | 14 |
| Dec-12 | 23.5 | 12.4 | 45.8 | 25.6 |
| Jan-13 | 14.7 | -1.1 | 34.3 | 21.7 |
| Feb-13 | 8.9 | -0.5 | 26.4 | 25.4 |
| Mar-13 | 8.5 | -0.8 | 30.9 | 16.6 |
| Apr-13 | 3.1 | -7.5 | 26.6 | 8.3 |
| May-13 | 6.9 | -3.3 | 30.7 | 18.2 |
| Jun-13 | 22.5 | 14.6 | 26.4 | 23.5 |
| Jul-13 | 21.5 | 7.0 | 42.1 | 23.9 |
| Aug-13 | 17.3 | 9.9 | 38.7 | 23.0 |
| Sep-13 | 25.3 | 12.7 | 43.1 | 31.7 |
Source:
Source: Federal Reserve Bank of Philadelphia
http://philadelphiafed.org/index.cfm
Chart IV-1 of the Business Outlook Survey of the Federal Reserve Bank of Philadelphia Outlook Survey provides the diffusion index of current prices paid or prices of inputs from 2006 to 2013. Recession dates are in shaded areas. In the middle of deep global contraction after IVQ2007, input prices continued to increase in speculative carry trades from central bank policy rates falling toward zero into commodities futures. The index peaked above 70 in the second half of 2008. Inflation of inputs moderated significantly during the shock of risk aversion in late 2008, even falling briefly into contraction territory below zero during several months in 2009 in the flight away from risk financial assets into US government securities (Cochrane and Zingales 2009) that unwound carry trades. Return of risk appetite induced carry trade with significant increase until return of risk aversion in the first round of the European sovereign debt crisis in Apr 2010. Carry trades returned during risk appetite in expectation that the European sovereign debt crisis was resolved. The various inflation waves originating in carry trades induced by zero interest rates with alternating episodes of risk aversion are mirrored in the prices of inputs after 2011, in particular after Aug 2012 with the announcement of the Outright Monetary Transactions Program of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). Subsequent risk aversion and flows of capital away from commodities into stocks and high-yield bonds caused sharp decline in the index of prices paid followed by another recent rebound.
Chart IV-1, Federal Reserve Bank of Philadelphia Business Outlook Survey Current Prices Paid Diffusion Index SA
Source: Federal Reserve Bank of Philadelphia
http://www.philadelphiafed.org/index.cfm
Chart IV-2 of the Federal Reserve Bank of Philadelphia Outlook Survey provides the diffusion index of current prices received from 2006 to 2013. The significant difference between the index of current prices paid in Chart IV-1 and the index of current prices received in Chart IV-2 is that increases in prices paid are significantly sharper than increases in prices received. There were several periods of negative readings of prices received from 2010 to 2013 but none of prices paid. Prices paid relative to prices received deteriorate most of the time largely because of the carry trades from zero interest rates to commodity futures. Profit margins of business are compressed intermittently by fluctuations of commodity prices induced by unconventional monetary policy of zero interest rates, frustrating production, investment and hiring decisions of business, which is precisely the opposite outcome desired by unconventional monetary policy.
Chart IV-2, Federal Reserve Bank of Philadelphia Business Outlook Survey Current Prices Received Diffusion Index SA
Source: Federal Reserve Bank of Philadelphia
http://www.philadelphiafed.org/index.cfm
ESIII Household Income at 1995 Levels, 46 Million in Poverty and 48 Million without Health Insurance. The objective of this section is to analyze newly released data by the US Census Bureau on income, poverty and health insurance (DeNavas-Walt, Proctor and Smith 2013). This report depicts 2012 household income of the US in constant 2012 dollars regressing to the level of 1995. The number of people in poverty in the US in 2012 is 46.496 million, equivalent to 15.0 percent of the population, which is the same as 15.0 percent in 1982 and higher than any percentage since 17.3 percent in 1965 with exception of isolated years in the range of 15.1 to 15.2 percent. The number of people without health insurance in 2012 is 47.951 million, which is equivalent to 15.7 percent of the population. Although the economy recovered throughout 2011 and 2012, income and poverty deteriorated while lack of health insurance remained nearly unchanged. Increasing poverty and lack of health insurance challenge the social and health safety net because of a sudden jump of needs for social and health services on capacity that provide those needs that is fixed in the short run while growth of the economy requires absorbing labor input and maintaining health of the stock of human capital. Part of the explanation of the dramatically poor socio-economic indicators of the US could be explained by the sharp economic contraction from IV2007 to IIQ2009 but part originates in the worst recovery in a cyclical expansion during the postwar period (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html).
The report of the US Bureau of the Census on Income, poverty and health insurance coverage in the United States: 2012 provides highly valuable socio-economic information and analysis (DeNavas-Walt, Proctor and Smith 2013). Table IIB-1 provides years of high percentage of people below poverty in the US. Data for 2006 to 2009 are included to provide a framework of reference for the current deterioration. The series has two high points of 15.1 percent of the population in poverty in 2010 and 1993 exceeded only by 15.2 percent in 1983. The prior high numbers of poverty are found in 1960 to 1965 with 17.3 percent in 1965 and higher numbers going to 22.4 percent in 1959. The number of people in poverty in the US in 2012 was 46.496 million, which has increased by 10.036 million from 36.460 million in 2006. The fractured job market with 28.3 million unemployed or underemployed because they cannot find full-time jobs (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html) and decline of hiring by 11.8 million (http://cmpassocregulationblog.blogspot.com/2013/09/recovery-without-hiring-ten-million.html) prevents exit from poverty. Inflation-adjusted average weekly wages stagnated.
Table IIB-1, US, Historical High Percentage of People below Poverty, Thousands and Percent
| Total Population | Number Below Poverty | Percent Below Poverty | |
| 2012 | 310,648 | 46,496 | 15.0 |
| 2011 | 308,456 | 46,247 | 15.0 |
| 2010 | 306,130 | 46,343 | 15.1 |
| 2009 | 303,820 | 43,569 | 14.3 |
| 1993 | 259,278 | 39,265 | 15.1 |
| 1983 | 231,700 | 35,303 | 15.2 |
| 1982 | 229,412 | 34,398 | 15.0 |
| 1965 | 191,413 | 33,185 | 17.3 |
| 1964 | 189,710 | 36,055 | 19.0 |
| 1963 | 187,258 | 36,436 | 19.5 |
| 1962 | 184,276 | 38,625 | 21.0 |
| 1961 | 181,277 | 39,628 | 21.9 |
| 1960 | 179,503 | 39,851 | 22.2 |
| 1959 | 176,557 | 39,490 | 22.4 |
| Memo | |||
| 2009 | 303,820 | 43,569 | 14.3 |
| 2008 | 301,041 | 38,829 | 13.2 |
| 2007 | 298,699 | 37,276 | 12.5 |
| 2006 | 296,450 | 36,460 | 12.3 |
Source: DeNavas-Walt, Proctor and Smith (2013).
Millions in poverty in the calendar year in which the recession ended and in the first calendar year after the recession are provided in Table IIB-2. There have been increases in the number of people in poverty in the first calendar years after the recessions since 1980. The brief recession of Jan to Jul 1980 experienced the highest increase in the first calendar year of 1.0 percent and 2.550 million more in poverty. In the three recessions before 1980 shown in Table IIB-2, the number of people in poverty fell in the first calendar year after the end of the recession.
Table IIB-2, US, Millions in Poverty in the Calendar Year in which Recession Ended and in the First Calendar Year after Recession, Millions and ∆%
| Millions | % | Millions | % | Change | % Points | |
| Dec 2007 to Jun 2009 | ||||||
| 2009 | 43.569 | 14.3 | ||||
| 2010 | 46.343 | 15.1 | 2.774 | 0.8 | ||
| Mar 2001 to Nov 2001 | ||||||
| 2001 | 32.907 | 11.7 | ||||
| 2002 | 34.570 | 12.1 | 1.663 | 0.4 | ||
| Jul 1990 to Mar 1991 | ||||||
| 1991 | 35.708 | 14.2 | ||||
| 1992 | 38.014 | 14.8 | 2.306 | 0.6 | ||
| Jul 1981 to Nov 1982 | ||||||
| 1982 | 34.398 | 15.0 | ||||
| 1983 | 35.303 | 15.2 | 0.905 | 0.2 | ||
| Jan 1980 to July 1980 | ||||||
| 1980 | 29.272 | 13.0 | ||||
| 1981 | 31.822 | 14.0 | 2.550 | 1.0 | ||
| Nov 1973 to Mar 1975 | ||||||
| 1975 | 25.877 | 12.3 | ||||
| 1976 | 24.975 | 11.8 | -0.902 | -0.5 | ||
| Dec 1960 to Nov 1970 | ||||||
| 1970 | 25.420 | 12.6 | ||||
| 1971 | 25.559 | 12.5 | -0.139 | -0.1 | ||
| Apr 1960 to Feb 1961 | ||||||
| 1961 | 39.628 | 21.9 | ||||
| 1962 | 38.625 | 21.0 | -1.003 | -0.9 |
Source: DeNavas-Walt, Proctor and Smith (2013).
Another dramatic fact revealed by DeNavas-Walt, Proctor and Smith (2013) is the increase in the number people without health insurance shown in Table IIB-3 at 49.951 million for 2010. Approximately 16.3 percent of the US population did not have health insurance in 2010. There was marginal improvement with 47.951 million without health insurance in 2012, corresponding to 15.4 percent of the population.
Table IIB-3, US, People without Health Insurance in the Final Year of Recession and in the First Calendar Year after Recession Ended, Millions and Percent
| Millions Without Health Insurance | Percent of Population | |
| Recession Dec 2007 to Jun 2009 | ||
| 2009 | 49.985 | 16.4 |
| 2010 | 49.951 | 16.3 |
| Change/2009 | 0.919 | -0.1 % Points |
| 2012 | 47.951 | 15.7 |
| Change/2009 | -2.034 | -0.7 % Points |
| Recession Mar 2001 to Nov 2001 | ||
| 2001 | 38.023 | 13.5 |
| 2002 | 39.776 | 13.9 |
| Change | 1.753 | 0.4 |
| Recession Jul 1990 to Mar 1991 | ||
| 1991 | 35.445 | 14.1 |
| 1992 | 38.641 | 15.0 |
| Change | 3.196 | 0.9 |
Source: DeNavas-Walt, Proctor and Smith (2013).
The population of the US increased by 14.292 million from 296.824 million in 2006 to 311.116 million in 2012, as shown in Table IIB-4. The number uncovered by health insurance increased by 2.737 million between 2006 and 2012. The loss of private health insurance coverage by 5.130 million from 2006 to 2012 was partially compensated by an increase in government coverage by 21.150 million.
Table IIB-4, US, Population, Private and Government Health Insurance and Uncovered by Health Insurance, Thousands and Percent, 2006-2011
| Population | Private | Govern- | Uncovered | |
| 2012 | 311,116 | 198,812 | 101,493 | 47,951 |
| 2011 | 308,827 | 197,323 | 99,497 | 48,614 |
| 2010 | 306,553 | 196,147 | 95,525 | 49,951 |
| 2009 | 304,280 | 196,245 | 93,245 | 48,985 |
| 2008 | 301,483 | 202,626 | 87,586 | 44,780 |
| 2007 | 299,106 | 203,903 | 83,147 | 44,088 |
| 2006 | 296,824 | 203,942 | 80,343 | 45,214 |
Source: DeNavas-Walt, Proctor and Smith (2012Sep).
Median household income in the US fell 8.3 percent from $55,627 in 2007 to $51,017 in 2012, as shown in Table IIB-5. Median income fell in all years. Median income fell 4.3 percent in 2012 relative to 2009 even after three years of recovery of the economy.
Table IIB-5, US, Median Household Income, 2012 Dollars and ∆%
| 2012 | 2011 | 2010 | 2009 | 2007 | |
| Total Number of Households | 122,459 | 121,084 | 119,927 | 117,538 | 116,783 |
| Median Income Dollars | 51,017 | 51,100 | 51,892 | 53,285 | 55,627 |
| ∆% 2012/2009 | -4.3 | ||||
| ∆% 2011/2009 | -4.1 | ||||
| ∆% 2012/2007 | -8.3 | ||||
| ∆% 2011/2007 | -8.1 |
Source: DeNavas-Walt, Proctor and Smith (2013).
Numbers of households in the US, median income in constant 2012 dollars and mean income also in 2012 dollars are provided in Table IIB-6. There is a dramatic fact in Table IIB-6: inflation-adjusted median household income in the US is higher in all years from 1996 to 2011 than the $51,017 of 2012. The contraction and low rate of growth in the expansion have resulted in the destruction of the progress in household income accomplished in 17 years of technological advance and use of humans, machines and natural resources in economic activity. The median measures the center of the middle class of the US that is no better off after 17 years of efforts. There is sharp contrast with the 1980s. Rapid economic growth after the contraction from Jul 1981 to Nov 1982 (http://www.nber.org/cycles.html) resulted in an increase of household median income from $45,760 in 1983 to $51,681 in 1989, or by 12.9 percent. Another fact of Table IA-6 is that household income in 2012 of $51,017 is virtually the same as $51,681 in 1989. The typical household in the US is not better off than in 1989, which is separated from the present by 23 years of efforts.
Table IIB-6, Median and Mean Household Income in 2011 Adjusted Dollars
| Year | # Households | Median Income 2012 Dollars | Mean Income 2012 Dollars |
| 2012 | 122,459 | 51,017 | 71,274 |
| 2011 | 121,084 | 51,100 | 71,133 |
| 2010 | 119,927 | 51,892 | 70,970 |
| 2009 | 117,538 | 53,285 | 72,767 |
| 2008 | 117,181 | 53,644 | 72,968 |
| 2007 | 116,783 | 55,627 | 74,869 |
| 2006 | 116,011 | 54,892 | 75,810 |
| 2005 | 114,384 | 54,486 | 74,502 |
| 2004 | 113,343 | 53,891 | 73,501 |
| 2003 | 112,000 | 54,079 | 73,741 |
| 2002 | 111,278 | 54,127 | 73,837 |
| 2001 | 109,297 | 54,766 | 75,491 |
| 2000 | 108,209 | 55,987 | 76,180 |
| 1999 | 106,434 | 56,080 | 75,428 |
| 1998 | 103,874 | 54,702 | 72,947 |
| 1997 | 102,528 | 52,784 | 70,880 |
| 1996 | 101,018 | 51,720 | 68,668 |
| 1995 | 99,627 | 50,978 | 67,228 |
| 1994 | 98,990 | 49,429 | 66,081 |
| 1993 | 97,107 | 48,884 | 64,824 |
| 1992 | 96,426 | 49,122 | 62,277 |
| 1991 | 95,669 | 49,529 | 62,347 |
| 1990 | 94,312 | 50,994 | 63,698 |
| 1989 | 93,347 | 51,681 | 65,295 |
| 1988 | 92,830 | 50,776 | 63,443 |
| 1987 | 91,124 | 50,389 | 62,664 |
| 1986 | 89,479 | 49,764 | 61,482 |
| 1985 | 88,458 | 48,063 | 59,149 |
| 1984 | 86,789 | 47,181 | 57,808 |
| 1983 | 85,407 | 45,760 | 55,654 |
| 1982 | 83,918 | 46,082 | 55,535 |
| 1981 | 83,527 | 46,205 | 55,200 |
| 1980 | 82,368 | 46,985 | 55,881 |
Source: DeNavas-Walt, Proctor and Smith (2013).
The percentage change in median household income and the change in number of workers with earnings in the first calendar years after recessions are provided in Table IIB-7. The first calendar year after the end of recession in 2010 is by far the worst of any such year in recessions since 1970. Household median income fell 2.6 percent from 2009 to 2010 and the number of workers with earnings fell by 1.334 million. The first calendar year 2010 after the end of recession in 2009 is the only in the recessions back to 1970 in which there was decline of the number of workers with earnings and the one with lowest increase in full-time year-round workers.
Table IIB-7, Percentage Change in Median Household Income and Change in Number of Workers with Earnings in First Calendar Years after Recessions, ∆% and Thousands
| Median Household Income ∆% | Change in Number of Workers with Earnings Thousands | Change in Full-time Year-round Workers | |
| Recession Dec 2007 to June 2009 | |||
| 2010 | -2.6 | -1,334 | 192 |
| Recession Mar 2001 to Nov 2001 | |||
| 2002 | -1.2 | 470 | 286 |
| Recession Jul 1990 to Mar 1991 | |||
| 1992 | -0.8 | 1,692 | 1,468 |
| Recession Jul 1981 to Nov 1982 | |||
| 1983 | -0.7 | 1,696 | 2,887 |
| Recession Jan 1980 to Jul 1980 | |||
| 1981 | -1.7 | 995 | 362 |
| Recession Nov 1973 to Mar 1975 | |||
| 1976 | 1.7 | 2,821 | 1,538 |
| Recession Dec 1960 to Nov 1970 | |||
| 1971 | -1.0 | 1,277 | 1,213 |
Source:
DeNavas-Walt, Proctor and Smith (2013).
ESIV Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities. The current account of the US balance of payments is provided in Table IIA2-1 for IIQ2012 and IIQ2013. The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US not seasonally adjusted decreased from $118.3 billion in IIQ2012 to $104.6 billion in IIQ2013. The current account deficit seasonally adjusted at annual rate fell from 2.7 percent of GDP in IIQ2012 to 2.5 percent of GDP in IQ2013 and 2.4 percent of GDP in IIQ2013. The ratio of the current account deficit to GDP has stabilized around 3 percent of GDP compared with much higher percentages before the recession but is combined now with much higher imbalance in the Treasury budget (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71).
Table IIA2-1, US, Balance of Payments, Millions of Dollars NSA
| IIQ2012 | IIQ2013 | Difference | |
| Goods Balance | -191,299 | -178,171 | 13,128 |
| X Goods | 395,151 | 400,113 | 1.3 ∆% |
| M Goods | -586,450 | -578,283 | -1.4 ∆% |
| Services Balance | 45,836 | 52,588 | 6,752 |
| X Services | 160,060 | 167,200 | 4.5 ∆% |
| M Services | -114,224 | -114,612 | 0.3 ∆% |
| Balance Goods and Services | -145,464 | -125,582 | 19,882 |
| Balance Income | 58,505 | 53,507 | -4,998 |
| Unilateral Transfers | -31,381 | -32,493 | -1,112 |
| Current Account Balance | -118,340 | -104,568 | 13,772 |
| % GDP | IIQ2012 | IIQ2013 | IQ2013 |
| 2.7 | 2.4 | 2.5 |
X: exports; M: imports
Balance on Current Account = Balance on Goods and Services + Balance on Income + Unilateral Transfers
Source: Bureau of Economic Analysis http://www.bea.gov/international/index.htm#bop
In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):
“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”
The alternative fiscal scenario of the CBO (2012NovCDR, 2013Sep17) resembles an economic world in which eventually the placement of debt reaches a limit of what is proportionately desired of US debt in investment portfolios. This unpleasant environment is occurring in various European countries.
The current real value of government debt plus monetary liabilities depends on the expected discounted values of future primary surpluses or difference between tax revenue and government expenditure excluding interest payments (Cochrane 2011Jan, 27, equation (16)). There is a point when adverse expectations about the capacity of the government to generate primary surpluses to honor its obligations can result in increases in interest rates on government debt.
This analysis suggests that there may be a point of saturation of demand for United States financial liabilities without an increase in interest rates on Treasury securities. A risk premium may develop on US debt. Such premium is not apparent currently because of distressed conditions in the world economy and international financial system. Risk premiums are observed in the spread of bonds of highly indebted countries in Europe relative to bonds of the government of Germany.
The issue of global imbalances centered on the possibility of a disorderly correction (Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State Vol. II (2008b) 183-94, Government Intervention in Globalization (2008c), 167-71). Such a correction has not occurred historically but there is no argument proving that it could not occur. The need for a correction would originate in unsustainable large and growing United States current account deficits (CAD) and net international investment position (NIIP) or excess of financial liabilities of the US held by foreigners net relative to financial liabilities of foreigners held by US residents. The IMF estimated that the US could maintain a CAD of two to three percent of GDP without major problems (Rajan 2004). The threat of disorderly correction is summarized by Pelaez and Pelaez, The Global Recession Risk (2007), 15):
“It is possible that foreigners may be unwilling to increase their positions in US financial assets at prevailing interest rates. An exit out of the dollar could cause major devaluation of the dollar. The depreciation of the dollar would cause inflation in the US, leading to increases in American interest rates. There would be an increase in mortgage rates followed by deterioration of real estate values. The IMF has simulated that such an adjustment would cause a decline in the rate of growth of US GDP to 0.5 percent over several years. The decline of demand in the US by four percentage points over several years would result in a world recession because the weakness in Europe and Japan could not compensate for the collapse of American demand. The probability of occurrence of an abrupt adjustment is unknown. However, the adverse effects are quite high, at least hypothetically, to warrant concern.”
The United States could be moving toward a situation typical of heavily indebted countries, requiring fiscal adjustment and increases in productivity to become more competitive internationally. The CAD and NIIP of the United States are not observed in full deterioration because the economy is well below potential. There are two complications in the current environment relative to the concern with disorderly correction in the first half of the past decade. In the release of Jun 14, 2013, the Bureau of Economic Analysis (http://www.bea.gov/newsreleases/international/transactions/2013/pdf/trans113.pdf) informs of revisions of US data on US international transactions since 1999:
“The statistics of the U.S. international transactions accounts released today have been revised for the first quarter of 1999 to the fourth quarter of 2012 to incorporate newly available and revised source data, updated seasonal adjustments, changes in definitions and classifications, and improved estimating methodologies.”
Table IIA2-2 provides data on the US fiscal and balance of payments imbalances. In 2007, the federal deficit of the US was $161 billion corresponding to 1.1 percent of GDP while the Congressional Budget Office (CBO 2013Sep11) estimates the federal deficit in 2012 at $1087 billion or 6.8 percent of GDP. The combined record federal deficits of the US from 2009 to 2012 are $5090 billion or 31.6 percent of the estimate of GDP for fiscal year 2012 implicit in the CBO (CBO 2013Sep11) estimate of debt/GDP. The deficits from 2009 to 2012 exceed one trillion dollars per year, adding to $5.090 trillion in four years, using the fiscal year deficit of $1087 billion for fiscal year 2012, which is the worst fiscal performance since World War II. Federal debt in 2007 was $5035 billion, less than the combined deficits from 2009 to 2012 of $5090 billion. Federal debt in 2012 was 70.1 percent of GDP (CBO 2013Sep11). This situation may worsen in the future (CBO 2013Sep17):
“Between 2009 and 2012, the federal government recorded the largest budget deficits relative to the size of the economy since 1946, causing federal debt to soar. Federal debt held by the public is now about 73 percent of the economy’s annual output, or gross domestic product (GDP). That percentage is higher than at any point in U.S. history except a brief period around World War II, and it is twice the percentage at the end of 2007. If current laws generally remained in place, federal debt held by the public would decline slightly relative to GDP over the next several years, CBO projects. After that, however, growing deficits would ultimately push debt back above its current high level. CBO projects that federal debt held by the public would reach 100 percent of GDP in 2038, 25 years from now, even without accounting for the harmful effects that growing debt would have on the economy. Moreover, debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely.
The gap between federal spending and revenues would widen steadily after 2015 under the assumptions of the extended baseline, CBO projects. By 2038, the deficit would be 6½ percent of GDP, larger than in any year between 1947 and 2008, and federal debt held by the public would reach 100 percent of GDP, more than in any year except 1945 and 1946. With such large deficits, federal debt would be growing faster than GDP, a path that would ultimately be unsustainable.
Incorporating the economic effects of the federal policies that underlie the extended baseline worsens the long-term budget outlook. The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues and higher interest payments. With those effects included, debt under the extended baseline would rise to 108 percent of GDP in 2038.”
Table IIA2-2, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and %
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |
| Goods & | -699 | -702 | -384 | -499 | -557 | -535 |
| Income | 101 | 146 | 124 | 178 | 233 | 224 |
| UT | -115 | -125 | -122 | -128 | -134 | -130 |
| Current Account | -713 | -681 | -382 | -449 | -458 | -440 |
| NGDP | 14480 | 14720 | 14418 | 14958 | 15534 | 16245 |
| Current Account % GDP | -4.9 | -4.6 | -2.6 | -3.0 | -2.9 | -2.7 |
| NIIP | -1796 | -3260 | -2275 | -2250 | -3730 | -3863 |
| US Owned Assets Abroad | 18400 | 19464 | 18558 | 20555 | 21636 | 21638 |
| Foreign Owned Assets in US | 20196 | 22724 | 20833 | 22805 | 25366 | 25501 |
| NIIP % GDP | -12.4 | -22.1 | -15.8 | -15.0 | -24.0 | -23.8 |
| Exports | 2487 | 2654 | 2185 | 2523 | 2874 | 2987 |
| NIIP % | -72 | -123 | -104 | -89 | -130 | -129 |
| DIA MV | 5274 | 3102 | 4322 | 4809 | 4514 | 5249 |
| DIUS MV | 3551 | 2486 | 2995 | 3422 | 3510 | 3924 |
| Fiscal Balance | -161 | -459 | -1413 | -1294 | -1296 | -1087 |
| Fiscal Balance % GDP | -1.1 | -3.1 | -9.8 | -8.7 | -8.4 | -6.8 |
| Federal Debt | 5035 | 5803 | 7545 | 9019 | 10128 | 11281 |
| Federal Debt % GDP | 35.1 | 39.3 | 52.3 | 61.0 | 65.8 | 70.1 |
| Federal Outlays | 2729 | 2983 | 3518 | 3456 | 3598 | 3537 |
| ∆% | 2.8 | 9.3 | 17.9 | -1.8 | 4.1 | -1.7 |
| % GDP | 19.0 | 20.2 | 24.4 | 23.4 | 23.4 | 22.0 |
| Federal Revenue | 2568 | 2524 | 2105 | 2162 | 2302 | 2450 |
| ∆% | 6.7 | -1.7 | -16.6 | 2.7 | 6.5 | 6.4 |
| % GDP | 17.9 | 17.1 | 14.6 | 14.6 | 15.0 | 15.2 |
Sources:
Notes: UT: unilateral transfers; NGDP: nominal GDP or in current dollars; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. There are minor discrepancies in the decimal point of percentages of GDP between the balance of payments data and federal debt, outlays, revenue and deficits in which the original number of the CBO source is maintained. These discrepancies do not alter conclusions. Budget http://www.cbo.gov/ Balance of Payments and NIIP http://www.bea.gov/international/index.htm#bop Gross Domestic Product, Bureau of Economic Analysis (BEA). http://www.bea.gov/iTable/index_nipa.cfm
Table IIA2-3 provides quarterly estimates NSA of the external and internal imbalances of the United States. The current account deficit seasonally adjusted falls from 3.0 percent of GDP in IQ2012 to 2.5 percent in IQ2013. The net international investment position increases from $3.9 trillion in IQ2012 to $4.3 trillion in IQ2013.
Table IIA2-3, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and % NSA
| IQ2012 | IIQ2012 | IIIQ2012 | IVQ2012 | IQ2013 | |
| Goods & | -122 | -145 | -144 | -122 | -100 |
| Income | 55 | 58 | 55 | 55 | 52 |
| UT | -33 | -31 | -33 | -32 | -34 |
| Current Account | -100 | -118 | -122 | -99 | -82 |
| Current Account % GDP | -3.0 | -2.7 | -2.6 | -2.5 | -2.5 |
| NIIP | -3886 | -4332 | -4109 | -3863 | -4277 |
| US Owned Assets Abroad | 21349 | 20948 | 21551 | 21638 | 21619 |
| Foreign Owned Assets in US | -25235 | -25280 | -25660 | -25501 | -25896 |
| DIA MV | 4976 | 4679 | 5059 | 5249 | 5518 |
| DIUS MV | 3856 | 3765 | 3962 | 3924 | 4261 |
Sources:
Notes: UT: unilateral transfers; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value..
Sources: US Bureau of Economic Analysis http://www.bea.gov/international/index.htm#bop
Chart IIA2-1 of the Board of Governors of the Federal Reserve System provides the overnight Fed funds rate on business days from Jul 1, 1954 at 1.13 percent through Jan 10, 1979, at 9.91 percent per year, to Sep 19, 2013, at 0.09 percent per year. US recessions are in shaded areas according to the reference dates of the NBER (http://www.nber.org/cycles.html). In the Fed effort to control the “Great Inflation” of the 1930s (see http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html), the fed funds rate increased from 8.34 percent on Jan 3, 1979 to a high in Chart IIA2-1 of 22.36 percent per year on Jul 22, 1981 with collateral adverse effects in the form of impaired savings and loans associations in the United States, emerging market debt and money-center banks (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7; Pelaez 1986, 1987). Another episode in Chart IIA2-1 is the increase in the fed funds rate from 3.15 percent on Jan 3, 1994, to 6.56 percent on Dec 21, 1994, which also had collateral effects in impairing emerging market debt in Mexico and Argentina and bank balance sheets in a world bust of fixed income markets during pursuit by central banks of non-existing inflation (Pelaez and Pelaez, International Financial Architecture (2005), 113-5). Another interesting policy impulse is the reduction of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of equally non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85), followed by increments of 25 basis points from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006 in Chart IIA2-1. Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).
The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever-increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). A final episode in Chart IIA2-1 is the reduction of the fed funds rate from 5.41 percent on Aug 9, 2007, to 2.97 percent on October 7, 2008, to 0.12 percent on Dec 5, 2008 and close to zero throughout a long period with the final point at 0.09 percent on Sep 19, 2013. Evidently, this behavior of policy would not have occurred had there been theory, measurements and forecasts to avoid these violent oscillations that are clearly detrimental to economic growth and prosperity without inflation. Current policy consists of forecast mandate of maintaining policy accommodation until the forecast of the rate of unemployment reaches 6.5 percent and the rate of personal consumption expenditures excluding food and energy reaches 2.5 percent (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm). It is a forecast mandate because of the lags in effect of monetary policy impulses on income and prices (Romer and Romer 2004). The intention is to reduce unemployment close to the “natural rate” (Friedman 1968, Phelps 1968) of around 5 percent and inflation at or below 2.0 percent. If forecasts were reasonably accurate, there would not be policy errors. A commonly analyzed risk of zero interest rates is the occurrence of unintended inflation that could precipitate an increase in interest rates similar to the Himalayan rise of the fed funds rate from 9.91 percent on Jan 10, 1979, at the beginning in Chart IIA2-1, to 22.36 percent on Jul 22, 1981. There is a less commonly analyzed risk of the development of a risk premium on Treasury securities because of the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). There is not a fiscal cliff or debt limit issue ahead but rather free fall into a fiscal abyss. The combination of the fiscal abyss with zero interest rates could trigger the risk premium on Treasury debt or Himalayan hike in interest rates.
Chart IIA2-1, US, Fed Funds Rate, Business Days, Jul 1, 1954 to Sep 19, 2013, Percent per Year
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
ESV United States Unsustainable Fiscal Deficit/Debt. Table IIA1-1 of the CBO (2012NovMBR, 2013BEOFeb5, 2013HBDFFeb5, 2013MEFFeb5, 2013Aug12) shows the significant worsening of United States fiscal affairs from 2007-2008 to 2009-2012. The deficit of $1.1 trillion in fiscal-year 2012 was the fourth consecutive federal deficit exceeding one trillion dollars. All four deficits are the highest in share of GDP since 1946 (CBO 2012MBR, 2013HBDFeb5, 2013Aug12, 2013AugHBD).
Table IAI-1, US, Budget Fiscal Year Totals, Billions of Dollars and % GDP
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |
| Receipts | 2568 | 2524 | 2105 | 2163 | 2302 | 2450 |
| Outlays | 2729 | 2983 | 3518 | 3456 | 3599 | 3538 |
| Deficit | -161 | -459 | 1413 | 1294 | 1296 | 1087 |
| % GDP | -1.1 | -3.1 | -9.8 | -8.7 | -8.4 | -6.8 |
Source: CBO (2012NovMBR), CBO (2013BEOFeb5), CBO (2013HBDFeb5), CBO (2013Aug12).
Table IIA1-2 provides additional information required for understanding the deficit/debt situation of the United States. The table is divided into three parts: federal fiscal data for the years from 2009 to 2012; federal fiscal data for the years from 2005 to 2008; and Treasury debt held by the public from 2005 to 2012. Total revenues of the US from 2009 to 2012 accumulate to $9021 billion, or $9.0 trillion, while expenditures or outlays accumulate to $14,109 billion, or $14.1 trillion, with the deficit accumulating to $5090 billion, or $5.1 trillion. Revenues decreased 6.5 percent from $9653 billion in the four years from 2005 to 2008 to $9021 billion in the years from 2009 to 2012. Decreasing revenues were caused by the global recession from IVQ2007 (Dec) to IIQ2009 (Jun) and also by growth of only 2.2 percent on average in the cyclical expansion from IIIQ2009 to IVQ2012. In contrast, the expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). Because of mediocre GDP growth, there are 28.3 million unemployed or underemployed in the United States for an effective unemployment rate of 17.4 percent (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). Weakness of growth and employment creation is analyzed in IB Collapse of United States Dynamism of Income Growth and Employment Creation (http://cmpassocregulationblog.blogspot.com/2013/08/interest-rate-risks-duration-dumping.html). In contrast with the decline of revenue, outlays or expenditures increased 30.2 percent from $10,839 billion, or $10.8 trillion, in the four years from 2005 to 2008, to $14,109 billion, or $14.1 trillion, in the four years from 2009 to 2012. Increase in expenditures by 30.2 percent while revenue declined by 6.5 percent caused the increase in the federal deficit from $1186 billion in 2005-2008 to $5090 billion in 2009-2012. Federal revenue was 14.9 percent of GDP on average in the years from 2009 to 2012, which is well below 17.4 percent of GDP on average from 1973 to 2012. Federal outlays were 23.3 percent of GDP on average from 2009 to 2012, which is well above 20.4 percent of GDP on average from 1973 to 2012. The lower part of Table I-2 shows that debt held by the public swelled from $5803 billion in 2008 to $11,281 billion in 2012, by $5478 billion or 94.4 percent. Debt held by the public as percent of GDP or economic activity jumped from 39.3 percent in 2008 to 70.1 percent in 2012, which is well above the average of 38.0 percent from 1973 to 2012. The United States faces tough adjustment because growth is unlikely to recover, creating limits on what can be obtained by increasing revenues, while continuing stress of social programs restricts what can be obtained by reducing expenditures.
Table IIA1-2, US, Treasury Budget and Debt Held by the Public, Billions of Dollars and Percent of GDP
| Receipts | Outlays | Deficit (-), Surplus (+) | |
| $ Billions | |||
| 2012 | 2,450 | 3,537 | -1,087 |
| Fiscal Year 2011 | 2,303 | 3,598 | -1,296 |
| Fiscal Year 2010 | 2,163 | 3,456 | -1,294 |
| Fiscal Year 2009 | 2,105 | 3,518 | -1,413 |
| Total 2009-2012 | 9,021 | 14,109 | -5,090 |
| Average % GDP 2009-2012 | 14.9 | 23.3 | -8.4 |
| Fiscal Year 2008 | 2,524 | 2,983 | -459 |
| Fiscal Year 2007 | 2,568 | 2,729 | -161 |
| Fiscal Year 2006 | 2,407 | 2,655 | -248 |
| Fiscal Year 2005 | 2,154 | 2,472 | -318 |
| Total 2005-2008 | 9,653 | 10,839 | -1,186 |
| Average % GDP 2005-2008 | 17.3 | 19.5 | -2.1 |
| Debt Held by the Public | Billions of Dollars | Percent of GDP | |
| 2005 | 4,592 | 35.6 | |
| 2006 | 4,829 | 35.3 | |
| 2007 | 5,035 | 35.1 | |
| 2008 | 5,803 | 39.3 | |
| 2009 | 7,545 | 52.3 | |
| 2010 | 9,019 | 61.0 | |
| 2011 | 10,128 | 65.8 | |
| 2012 | 11,281 | 70.1 |
Source: http://www.fms.treas.gov/mts/index.html CBO (2012NovMBR). CBO (2011AugBEO); Office of Management and Budget 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB; CBO. 2011JanBEO. Budget and Economic Outlook. Washington, DC, Jan. CBO. 2012AugBEO. Budget and Economic Outlook. Washington, DC, Aug 22. CBO. 2012Jan31. Historical budget data. Washington, DC, Jan 31. CBO. 2012NovCDR. Choices for deficit reduction. Washington, DC. Nov. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO (2013Aug12). 2013AugHBD. Historical budget data—August 2013. Washington, DC, Congressional Budget Office, Aug.
Unusually low economic growth of average 2.2 percent of GDP in the current expansion (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html) has had adverse impact on revenue generation. The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). Because of mediocre GDP growth, there are 28.3 million unemployed or underemployed in the United States for an effective unemployment rate of 17.4 percent (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). The impact of low growth on employment creation and labor market hiring is discussed in Subsection IB Collapse of United States Dynamism of Income Growth and Employment (http://cmpassocregulationblog.blogspot.com/2013/08/interest-rate-risks-duration-dumping.html). Table IIAI-3 provides total United States federal receipts from 2010 to 2012. Individual income taxes of $1132 billion, or $1.1 trillion, increased 25.9 percent from 2010 to 2012 and account for 46.2 percent of US total receipts in 2012. Total receipts stood at 15.2 percent of GDP in 2012, which is lower than 17.4 percent in the past 40 years (CBO 2013Aug12Av).
Table IIA1-3, United States, Total Receipts, Billions of Dollars and ∆%
| Major Source | 2010 | 2011 | 2012 | ∆% 2011-2012 |
| Individual Income Taxes | 899 | 1092 | 1132 | 3.7 |
| Corporate Income Taxes | 191 | 181 | 242 | 33.7 |
| Social Insurance | 865 | 819 | 845 | 3.2 |
| Other | 208 | 210 | 231 | 10.0 |
| Total | 2163 | 2302 | 2450 | 6.4 |
| % of GDP | 14.6 | 15.0 | 15.2 | NA |
Source: CBO (2012NovMBR), CBO (2013BEOFeb5), CBO 2013HBDFeb5), CBO (2013Aug12).
Total outlays of the federal government of the United States have grown to extremely high levels. Table IIA1-4 of the CBO (2013Aug12) provides total outlays in 2006 and 2012. Total outlays of $3537.1 billion in 2012, or $3.5 trillion, are higher by $882 billion, or $0.9 trillion, relative to $2655.1 billion in 2006, or $2.7 trillion. Outlays have grown from 19.4 percent of GDP in 2007 to 22.0 percent of GDP in 2012. Outlays as percent of GDP were on average 20.4 percent from 1973 to 2012 and receipts as percent of GDP were on average 17.4 percent of GDP. It has proved extremely difficult to increase receipts above 19 percent of GDP. Mandatory outlays increased from $1411.8 billion in 2006 to $2031.3 billion in 2012, by $619.5 billion. The final row shows that the total of social security, Medicare, Medicaid, Income Security, net interest and defense absorbs 79.6 percent of US total outlays. There has been no meaningful constraint of spending, which is quite difficult because of the rigid structure of social programs.
Table IIA1-4, US, Central Government Total Revenue and Outlays, Billions of Dollars and Percent
| 2006 | % Total | 2012 | % Total | |
| I TOTAL REVENUE $B | 2406.9 | 100.0 | 2450.2 | 100.0 |
| % GDP | 17.6 | 15.2 | ||
| Individual Income Taxes $B | 1043.9 | 1132.2 | ||
| % GDP | 7.6 | 7.0 | ||
| Corporate Income Taxes $B | 353.9 | 243.2 | ||
| % GDP | 2.6 | 1.5 | ||
| Social Insurance Taxes | 837.8 | 845.3 | ||
| % GDP | 6.1 | 5.3 | ||
| II TOTAL OUTLAYS | 2655.1 | 3537.1 | ||
| % GDP | 19.4 | 22.0 | ||
| Discretionary | 1016.6 | 1285.4 | ||
| % GDP | 7.4 | 8.0 | ||
| Defense | 520.0 | 670.5 | ||
| % GDP | 3.8 | 4.2 | ||
| Nondefense | 496.7 | 614.8 | ||
| % GDP | 3.6 | 3.8 | ||
| Mandatory | 1411.8 | 2031.3 | ||
| % GDP | 10.3 | 12.6 | ||
| Social Security | 543.9 | 767.7 | ||
| % GDP | 4.0 | 4.8 | ||
| Medicare | 376.8 | 551.2 | ||
| % GDP | 2.8 | 3.4 | ||
| Medicaid | 180.6 | 250.5 | ||
| % GDP | 1.3 | 1.6 | ||
| Income Security | 200.1 | 353.7 | ||
| % GDP | 1.5 | 2.2 | ||
| Offsetting Receipts | -144.1 | -210.0 | ||
| % GDP | -1.1 | -1.3 | ||
| Net Interest | 226.6 | 220.4 | ||
| % GDP | 1.7 | 1.4 | ||
| Defense +Medicare | 2048.0 | 77.1* | 2814.0 | 79.6* |
| % GDP | 15.0 | 17.5 |
*Percent of Total Outlays
Source: CBO (2013Aug12). 2013AugHBD. Historical budget data—August 2013. Washington, DC, Congressional Budget Office, Aug.
The US is facing a major fiscal challenge. Table IIA1-5 provides federal revenues, expenditures, deficit and debt as percent of GDP and the yearly change in GDP in the eight decades from 1930 to 2011. The most recent period of debt exceeding 90 percent of GDP based on yearly observations in Table IIA1-5 is between 1944 and 1948. The data in Table IIA-15 use the earlier GDP estimates of the Bureau of Economic Analysis (BEA) until 1972 for the ratios to GDP of revenue, expenditures, deficit and debt and the revised CBO (2013Aug12) after 1973 that incorporate the new BEA GDP estimates (http://www.bea.gov/iTable/index_nipa.cfm). The percentage change of GDP is based on the new BEA estimates. The debt/GDP ratio actually rose to 106.2 percent of GDP in 1945 and to 108.7 percent of GDP in 1946. GDP fell revised 11.6 percent in 1946, which is only matched in Table I-5 by the decline of revised 12.9 percent in 1932. Part of the decline is explained by the bloated US economy during World War II, growing at revised 17.7 percent in 1941, 18.9 percent in 1942 and 17.0 percent in 1943. Expenditures as a share of GDP rose to their highest in the series: 43.6 percent in 1943, 43.6 percent in 1944 and 41.9 percent in 1945. The repetition of 43.6 percent in 1943 and 1944 is in the original source of Table IIA1-5. During the Truman administration from Apr 1945 to Jan 1953, the federal debt held by the public fell systematically from the peak of 108.7 percent of GDP in 1946 to 61.6 percent of GDP in 1952. During the Eisenhower administration from Jan 1953 to Jan 1961, the federal debt held by the public fell from 58.6 percent of GDP in 1953 to 45.6 percent of GDP in 1960. The Truman and Eisenhower debt reductions were facilitated by diverse factors such as low interest rates, lower expenditure/GDP ratios that could be attained again after lowering war outlays and less rigid structure of mandatory expenditures than currently. There is no subsequent jump of debt as the one from revised 39.3 percent of GDP in 2008 to 65.8 percent of GDP in 2011 and at 70.1 percent in 2012.
Table IIA1-5, United States Central Government Revenue, Expenditure, Deficit, Debt and GDP Growth 1930-2011
| Rev | Exp | Deficit | Debt | GDP | |
| 1930 | 4.2 | 3.4 | 0.8 | -8.5 | |
| 1931 | 3.7 | 4.3 | -0.6 | -6.4 | |
| 1932 | 2.8 | 6.9 | -4.0 | -12.9 | |
| 1933 | 3.5 | 8.0 | -4.5 | -1.3 | |
| 1934 | 4.8 | 10.7 | -5.9 | 10.8 | |
| 1935 | 5.2 | 9.2 | -4.0 | 8.9 | |
| 1936 | 5.0 | 10.5 | -5.5 | 12.9 | |
| 1937 | 6.1 | 8.6 | -2.5 | 5.1 | |
| 1938 | 7.6 | 7.7 | -0.1 | -3.3 | |
| 1939 | 7.1 | 10.3 | -3.2 | 8.0 | |
| 1940s | |||||
| 1940 | 6.8 | 9.8 | -3.0 | 44.2 | 8.8 |
| 1941 | 7.6 | 12.0 | -4.3 | 42.3 | 17.7 |
| 1942 | 10.1 | 24.3 | -14.2 | 47.0 | 18.9 |
| 1943 | 13.3 | 43.6 | -30.3 | 70.9 | 17.0 |
| 1944 | 20.9 | 43.6 | -22.7 | 88.3 | 8.0 |
| 1945 | 20.4 | 41.9 | -21.5 | 106.2 | -1.0 |
| 1946 | 17.7 | 24.8 | -7.2 | 108.7 | -11.6 |
| 1947 | 16.5 | 14.8 | 1.7 | 96.2 | -1.1 |
| 1948 | 16.2 | 11.6 | 4.6 | 84.3 | 4.1 |
| 1949 | 14.5 | 14.3 | 0.2 | 79.0 | -0.5 |
| 1950s | |||||
| 1950 | 14.4 | 15.6 | -1.1 | 80.2 | 8.7 |
| 1951 | 16.1 | 14.2 | 1.9 | 66.9 | 8.1 |
| 1952 | 19.0 | 19.4 | -0.4 | 61.6 | 4.1 |
| 1953 | 18.7 | 20.4 | -1.7 | 58.6 | 4.7 |
| 1954 | 18.5 | 18.8 | -0.3 | 59.5 | -0.6 |
| 1955 | 16.5 | 17.3 | -0.8 | 57.2 | 7.1 |
| 1956 | 17.5 | 16.5 | 0.9 | 52.0 | 2.1 |
| 1957 | 17.7 | 17.0 | 0.8 | 48.6 | 2.1 |
| 1958 | 17.3 | 17.9 | -0.6 | 49.2 | -0.7 |
| 1959 | 16.2 | 18.8 | -2.6 | 47.9 | 6.9 |
| 1960s | |||||
| 1960 | 17.8 | 17.8 | 0.1 | 45.6 | 2.6 |
| 1961 | 17.8 | 18.4 | -0.6 | 45.0 | 2.6 |
| 1962 | 17.6 | 18.8 | -1.3 | 43.7 | 6.1 |
| 1963 | 17.8 | 18.6 | -0.8 | 42.4 | 4.4 |
| 1964 | 17.6 | 18.5 | -0.9 | 40.0 | 5.8 |
| 1965 | 17.0 | 17.2 | -0.2 | 37.9 | 6.5 |
| 1966 | 17.3 | 17.8 | -0.5 | 34.9 | 6.6 |
| 1967 | 18.4 | 19.4 | -1.1 | 32.9 | 2.7 |
| 1968 | 17.6 | 20.5 | -2.9 | 33.9 | 4.9 |
| 1969 | 19.7 | 19.4 | 0.3 | 29.3 | 3.1 |
| 1970s | |||||
| 1970 | 19.0 | 19.3 | -0.3 | 28.0 | 0.2 |
| 1971 | 17.3 | 19.5 | -2.1 | 28.1 | 3.3 |
| 1972 | 17.6 | 19.6 | -2.0 | 27.4 | 5.2 |
| 1973 | 17.0 | 18.1 | -1.1 | 25.1 | 5.6 |
| 1974 | 17.7 | 18.1 | -0.4 | 23.1 | -0.5 |
| 1975 | 17.3 | 20.6 | -3.3 | 24.5 | -0.2 |
| 1976 | 16.6 | 20.8 | -4.1 | 26.7 | 5.4 |
| 1977 | 17.5 | 20.2 | -2.6 | 27.1 | 4.6 |
| 1978 | 17.5 | 20.1 | -2.6 | 26.6 | 5.6 |
| 1979 | 18.0 | 19.6 | -1.6 | 24.9 | 3.2 |
| 1980s | |||||
| 1980 | 18.5 | 21.1 | -2.6 | 25.5 | -0.2 |
| 1981 | 19.1 | 21.6 | -2.5 | 25.2 | 2.6 |
| 1982 | 18.6 | 22.5 | -3.9 | 27.9 | -1.9 |
| 1983 | 17.0 | 22.8 | -5.9 | 32.1 | 4.6 |
| 1984 | 16.9 | 21.5 | -4.7 | 33.1 | 7.3 |
| 1985 | 17.2 | 22.2 | -5.0 | 35.3 | 4.2 |
| 1986 | 17.0 | 21.8 | -4.9 | 38.4 | 3.5 |
| 1987 | 17.9 | 21.0 | -3.1 | 39.5 | 3.5 |
| 1988 | 17.6 | 20.6 | -3.0 | 39.8 | 4.2 |
| 1989 | 17.8 | 20.5 | -2.7 | 39.3 | 3.7 |
| 1990s | |||||
| 1990 | 17.4 | 21.2 | -3.7 | 40.8 | 1.9 |
| 1991 | 17.3 | 21.7 | -4.4 | 44.0 | -0.1 |
| 1992 | 17.0 | 21.5 | -4.5 | 46.6 | 3.6 |
| 1993 | 17.0 | 20.7 | -3.8 | 47.8 | 2.7 |
| 1994 | 17.5 | 20.3 | -2.8 | 47.7 | 4.0 |
| 1995 | 17.8 | 20.0 | -2.2 | 47.5 | 2.7 |
| 1996 | 18.2 | 19.6 | -1.3 | 46.8 | 3.8 |
| 1997 | 18.6 | 18.9 | -0.3 | 44.5 | 4.5 |
| 1998 | 19.2 | 18.5 | 0.8 | 41.6 | 4.4 |
| 1999 | 19.2 | 17.9 | 1.3 | 38.2 | 4.8 |
| 2000s | |||||
| 2000 | 19.9 | 17.6 | 2.3 | 33.6 | 4.1 |
| 2001 | 18.8 | 17.6 | 1.2 | 31.4 | 1.0 |
| 2002 | 17.0 | 18.5 | -1.5 | 32.5 | 1.8 |
| 2003 | 15.7 | 19.1 | -3.3 | 34.5 | 2.8 |
| 2004 | 15.6 | 19.0 | -3.4 | 35.5 | 3.8 |
| 2005 | 16.7 | 19.2 | -2.5 | 35.6 | 3.4 |
| 2006 | 17.6 | 19.4 | -1.8 | 35.3 | 2.7 |
| 2007 | 17.9 | 19.0 | -1.1 | 35.1 | 1.8 |
| 2008 | 17.1 | 20.2 | -3.1 | 39.3 | -0.3 |
| 2009 | 14.6 | 24.4 | -9.8 | 52.3 | -2.8 |
| 2010s | |||||
| 2010 | 14.6 | 23.4 | -8.7 | 61.0 | 2.5 |
| 2011 | 15.0 | 23.4 | -8.4 | 65.8 | 1.8 |
| 2012 | 15.2 | 22.0 | -6.8 | 70.1 | 2.8 |
Sources:
Office of Management and Budget. 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB. CBO (2012JanBEO). CBO (2012Jan31). CBO (2012AugBEO). CBO (2013BEOFeb5). CBO2013HBDFeb5), CBO (2013Aug12).
Table IIA1-6 provides 40-year average ratios of fiscal variables to GDP before and after the revision by the Bureau of Economic Analysis (BEA) in Aug 2013 (http://www.bea.gov/iTable/index_nipa.cfm). The ratios are equal or slightly higher because of the addition of intellectual property to GDP estimates. There are no major changes.
Table IIA1-6, US, Congressional Budget Office, 40-Year Averages of Revenues and Outlays Before and After Update of the US National Income Accounts by the Bureau of Economic Analysis, % of GDP
| Before Update | After Update | |
| Revenues | ||
| Individual Income Taxes | 8.2 | 7.9 |
| Social Insurance Taxes | 6.2 | 6.0 |
| Corporate Income Taxes | 1.9 | 1.9 |
| Other | 1.6 | 1.6 |
| Total Revenues | 17.9 | 17.4 |
| Outlays | ||
| Mandatory | 10.2 | 9.9 |
| Discretionary | 8.6 | 8.4 |
| Net Interest | 2.2 | 2.2 |
| Total Outlays | 21.0 | 20.4 |
| Deficit | -3.1 | -3.0 |
| Debt Held by the Public | 39.2 | 38.0 |
Source: CBO (2013Aug12Av). Kim Kowaleski and Amber Marcellino.
The capital budgeting decision of business requires the calculation of present value of projects. This calculation consists of a projection toward the horizon of planning of revenues net of costs, which are discounted to present value by the weighted average cost of capital. Business invests in the projects with highest net present value. The nonpartisan Congressional Budget Office (CBO) provides a similar service. Congress and the administration send budget proposals and legislation for evaluation by the CBO of their effects on federal government revenues, expenditures, deficit or surpluses and debt. The CBO does not provide its own policy proposals but analyzes alternative policies. The CBO uses state of the art knowledge but significant uncertainty remains because of the hurdle of projecting financial and economic variables to the future.
Table IIA1-7 provides the latest exercise by the CBO (2013BEOFeb5, 2012AugBEO, CBO2012NovCDR, 2013Sep11) of projecting the fiscal accounts of the US. Table IIA1-7 extends data back to 1995 with the projections of the CBO from 2013 to 2023, using the new estimates of the Bureau of Economic Analysis of US GDP (http://www.bea.gov/iTable/index_nipa.cfm). Budget analysis in the US uses a ten-year horizon. The significant event in the data before 2011 is the budget surpluses from 1998 to 2001, from 0.8 percent of GDP in 1998 to 2.3 percent of GDP in 2000. Debt held by the public fell from 46.1 percent of GDP in 1995 to 31.4 percent of GDP in 2001.
Table IIA1-7, US, CBO Baseline Budget Outlook 2013-2023
| Out | Out | Deficit | Deficit | Debt | Debt | |
| 1995 | 1,516 | 20.0 | -164 | -2.2 | 3,604 | 47.5 |
| 1996 | 1,560 | 19.6 | -107 | -1.3 | 3,734 | 46.8 |
| 1997 | 1,601 | 18.9 | -22 | -0.3 | 3,772 | 44.5 |
| 1998 | 1,652 | 18.5 | +69 | +0.8 | 3,721 | 41.6 |
| 1999 | 1,702 | 17.9 | +126 | +1.3 | 3,632 | 38.2 |
| 2000 | 1,789 | 17.6 | +236 | +2.3 | 3,410 | 33.6 |
| 2001 | 1,863 | 17.6 | +128 | +1.2 | 3,320 | 31.4 |
| 2002 | 2,011 | 18.5 | -158 | -1.5 | 3,540 | 32.5 |
| 2003 | 2,159 | 19.1 | -378 | -3.3 | 3,913 | 34.5 |
| 2004 | 2,293 | 19.0 | -413 | -3.4 | 4,295 | 35.5 |
| 2005 | 2,472 | 19.2 | -318 | -2.5 | 4,592 | 35.6 |
| 2006 | 2,655 | 19.4 | -248 | -1.8 | 4,829 | 35.3 |
| 2007 | 2,729 | 19.0 | -161 | -1.1 | 5,035 | 35.1 |
| 2008 | 2,983 | 20.2 | -459 | -3.1 | 5,803 | 39.3 |
| 2009 | 3,518 | 24.4 | -1,413 | -9.8 | 7,545 | 52.3 |
| 2010 | 3,456 | 23.4 | -1,294 | -8.7 | 9,019 | 61.0 |
| 2011 | 3,598 | 23.4 | -1,296 | -8.4 | 10,128 | 65.8 |
| 2012 | 3,537 | 22.0 | -1,087 | -6.8 | 11,281 | 70.1 |
| 2013 | 3,455 | 20.8 | -642 | -3.9 | 12,036 | 72.5 |
| 2014 | 3,602 | 20.9 | -560 | -3.3 | 12,685 | 73.6 |
| 2015 | 3,777 | 20.7 | -378 | -2.1 | 13,156 | 72.1 |
| 2016 | 4,038 | 20.8 | -432 | -2.2 | 13,666 | 70.3 |
| 2017 | 4,261 | 20.6 | -482 | -2.3 | 14,223 | 68.8 |
| 2018 | 4,485 | 20.7 | -542 | -2.5 | 14,827 | 68.4 |
| 2019 | 4,752 | 21.0 | -648 | -2.9 | 15,537 | 68.6 |
| 2020 | 5,012 | 21.2 | -733 | -3.1 | 16,330 | 69.0 |
| 2021 | 5,275 | 21.4 | -782 | -3.2 | 17,168 | 69.6 |
| 2022 | 5,620 | 21.8 | -889 | -3.5 | 18,118 | 70.4 |
| 2023 | 5,855 | 21.8 | -895 | -3.3 | 19,070 | 71.1 |
| 2014 to 2018 | 20,163 | 20.7 | -2,394 | -2.5 | NA | NA |
| 2014 | 46,677 | 21.1 | -6,340 | -2.9 | NA | NA |
Note: Out = outlays
Sources: CBO (2011AugBEO); Office of Management and Budget. 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB; CBO. 2011JanBEO. Budget and Economic Outlook. Washington, DC, Jan. CBO. 2012AugBEO. Budget and Economic Outlook. Washington, DC, Aug 22. CBO. 2012Jan31. Historical budget data. Washington, DC, Jan 31. CBO. 2012NovCDR. Choices for deficit reduction. Washington, DC. Nov. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO (2013Sep11).
Table IIA1-8 provides baseline CBO projections of federal revenues, outlays, deficit and debt as percent of GDP. The adjustment depends on increasing revenues from 15.0 percent of GDP in 2011 to 18.5 percent of GDP in 2023, which is above the 40-year average of 17.4 percent of GDP while outlays fall from 23.4 percent of GDP in 2011 to 21.8 percent of GDP in 2023. The last row of Table IIA1-8 provides the CBO estimates of averages for 1973 to 2012 of 17.4 percent for revenues/GDP, 20.4 percent for outlays/GDP and 38.0 percent for debt/GDP. The United States faces tough adjustment of its fiscal accounts.
Table IIA1-8, US, Baseline CBO Projections of Federal Government Revenues, Outlays, Deficit and Debt as Percent of GDP
| Revenues | Outlays | Deficit | Debt | |
| 2011 | 15.0 | 23.4 | -8.4 | 65.8 |
| 2012 | 15.2 | 22.0 | -6.8 | 70.1 |
| 2013 | 17.0 | 20.8 | -3.9 | 72.5 |
| 2014 | 17.7 | 20.9 | -3.3 | 73.6 |
| 2015 | 18.6 | 20.7 | -2.1 | 72.1 |
| 2016 | 18.5 | 20.8 | -2.2 | 70.3 |
| 2017 | 18.3 | 20.6 | -2.3 | 68.8 |
| 2018 | 18.2 | 20.7 | -2.5 | 68.4 |
| 2019 | 18.1 | 21.0 | -2.9 | 68.6 |
| 2020 | 18.1 | 21.2 | -3.1 | 69.0 |
| 2021 | 18.2 | 21.4 | -3.2 | 69.6 |
| 2022 | 18.4 | 21.8 | -3.5 | 70.4 |
| 2023 | 18.5 | 21.8 | -3.3 | 71.0 |
| Total 2014-2018 | 18.3 | 20.7 | -2.5 | NA |
| Total 2014-2023 | 18.3 | 21.1 | -2.9 | NA |
| Average | 17.4 | 20.4 | -3.0 | 38.0 |
Source: CBO (2012AugBEO). CBO (2012NovCDR). CBO (2013BEOFeb5). CBO 2013HBDFeb5), CBO (2013Sep11), CBO (2013Aug12Av). Kim Kowaleski and Amber Marcellino.
Table IIA1-9 provides the long-term budget outlook of the CBO for 2013, 2023 and 2038. Revenues increase from 17.0 percent of GDP in 2013 to 19.7 percent in 2038. The growing stock of debt raises net interest spending from 1.3 percent of GDP in 2013 to 3.1 percent in 2023 and 4.9 percent 2038. Total spending increases from 20.8 percent of GDP in 2013 to 26.2 percent in 2038. Federal debt held by the public rises to 100.0 percent of GDP in 2038. US fiscal affairs are in an unsustainable path with tough rigidities in spending and revenues.
Table IIA1-9, Congressional Budget Office, Long-term Budget Outlook, % of GDP
| 2013 | 2023 | 2038 | |
| Revenues | 17.0 | 18.5 | 19.7 |
| Total Noninterest Spending | 19.5 | 18.8 | 21.3 |
| Social Security | 4.9 | 5.3 | 6.2 |
| Medicare | 3.0 | 3.3 | 4.9 |
| Medicaid, CHIP and Exchange Subsidies | 1.7 | 2.6 | 3.2 |
| Other | 10.0 | 7.6 | 7.1 |
| Net Interest | 1.3 | 3.1 | 4.9 |
| Total Spending | 20.8 | 21.8 | 26.2 |
| Revenues Minus Total Noninterest Spending | -2.5 | -0.3 | -1.6 |
| Revenues Minus Total Spending | -3.9 | -3.3 | -6.4 |
| Federal Debt Held by the Public | 73.0 | 71.0 | 100.0 |
Source: CBO (2013Sep17). The 2013 long-term budget outlook. Washington, DC, Congressional Budget Office, Sep 17.
Chart I-1 provides actual federal debt held by the public as percent of GDP from 1790 to 2012 and projected by the CBO (2013Sep17) from 2013 to 2038. The ratio of debt to GDP climbed from 42.3 percent in 1941 to a peak of 108.7 percent in 1946 because of the Second World War. The ratio of debt to GDP declined to 80.2 percent in 1950 and 66.9 percent in 1951 because of unwinding war effort, economy growing to capacity and less rigid mandatory expenditures. The ratio of debt to GDP of 70.1 percent in 2012 is the highest in the United States since 1950. The CBO (2013BEOFeb5) projects the ratio of debt of GDP of the United States to reach 100.0 percent in 2038, which will be more than double the average ratio of 38.0 percent in 1973-2012. The misleading debate on the so-called “fiscal cliff” has disguised the unsustainable path of United States fiscal affairs.
Chart IIA1-1, Congressional Budget Office, Federal Debt Held by the Public, Extended Baseline Projection, % of GDP
Source: CBO. 2013Sep17. The 2013 long-term budget outlook. Washington, DC, Congressional Budget Office, Sep 17.
ESVI United States Industrial Production. Industrial production increased 0.4 percent in Aug 2013 after changing 0.0 percent in Jul 2013 and increasing 0.1 percent in Jun 2013, as shown in Table II-1, with all data seasonally adjusted. The report of the Board of Governors of the Federal Reserve System states (http://www.federalreserve.gov/releases/g17/Current/default.htm):
“Industrial production advanced 0.4 percent in August after having been unchanged in July; the gains in August were broadly based. Following a decrease in July of 0.4 percent, which was steeper than previously reported, manufacturing production rose 0.7 percent in August. The output of mines moved up 0.3 percent, its fifth consecutive monthly increase, and the production of utilities fell 1.5 percent, its fifth consecutive monthly decrease. At 99.4 percent of its 2007 average, total industrial production in August was 2.7 percent above its year-earlier level. “
In the six months ending in Aug 2013, United States national industrial production accumulated increase of 0.6 percent at the annual equivalent rate of 1.2 percent, which is much lower than growth of 2.7 percent in the 12 months ending in Aug 2013. Excluding growth of 0.4 percent in Aug 2013, growth in the remaining five months from Mar 2012 to Jul 2013 accumulated to 0.2 percent or 0.5 percent annual equivalent. Industrial production stagnated in three of the past six months and fell in one. Business equipment accumulated growth of 0.4 percent in the six months from Mar to Aug 2013 at the annual equivalent rate of 0.8 percent, which is much lower than growth of 2.5 percent in the 12 months ending in Aug 2013. Growth of business equipment accumulated minus 0.5 percent from Mar to July 2013 at the annual equivalent rate of minus 1.2 percent. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for the industrial sector increased 0.2 percentage point in August to 77.8 percent, a rate 0.6 percentage point above its level of a year earlier and 2.4 percentage points below its long-run (1972-2012) average.” United States industry is apparently decelerating.
Table II-1, US, Industrial Production and Capacity Utilization, SA, ∆%
| 2012-2013 | Aug 13 | Jul 13 | Jun 13 | May 13 | Apr 13 | Mar 13 | Jun 13/ Jun 12 |
| Total | 0.4 | 0.0 | 0.1 | 0.1 | -0.3 | 0.3 | 2.7 |
| Market | |||||||
| Final Products | 0.5 | -0.5 | 0.4 | -0.2 | -0.5 | 0.6 | 2.1 |
| Consumer Goods | 0.3 | -0.5 | 0.3 | -0.2 | -0.7 | 0.8 | 2.3 |
| Business Equipment | 0.9 | -0.9 | 0.7 | -0.3 | -0.1 | 0.1 | 2.5 |
| Non | 0.1 | -0.5 | 0.1 | 0.0 | -0.5 | 0.0 | 1.7 |
| Construction | 0.3 | 0.5 | 0.7 | -0.5 | -1.1 | -1.1 | 5.3 |
| Materials | 0.4 | 0.5 | -0.1 | 0.4 | -0.2 | 0.1 | 3.4 |
| Industry Groups | |||||||
| Manufacturing | 0.7 | -0.4 | 0.3 | 0.2 | -0.4 | -0.2 | 2.6 |
| Mining | 0.3 | 2.4 | 0.5 | 0.8 | 0.8 | -0.2 | 7.5 |
| Utilities | -1.5 | -1.3 | -2.0 | -1.8 | -1.6 | 5.0 | -3.9 |
| Capacity | 77.8 | 77.6 | 77.8 | 77.8 | 77.8 | 78.2 | 1.8 |
Sources: Board of Governors of the Federal Reserve System http://www.federalreserve.gov/releases/g17/Current/default.htm
Manufacturing increased 0.7 percent in Aug 2013 after decreasing 0.4 percent in Jul 2013 and increasing 0.3 percent in Jul 2013 seasonally adjusted, increasing 2.5 percent not seasonally adjusted in 12 months ending in Aug 2013, as shown in Table II-2. Manufacturing grew cumulatively 0.2 percent in the six months ending in Jul 2013 or at the annual equivalent rate of 0.4 percent. Excluding the increase of 0.7 percent in Aug 2013, manufacturing accumulated growth of minus 0.5 percent from Mar 2013 to Jul 2013 or at the annual equivalent rate of minus 1.2 percent. Table II-2 provides a longer perspective of manufacturing in the US. There has been evident deceleration of manufacturing growth in the US from 2010 and the first three months of 2011 into more recent months as shown by 12 months rates of growth. Growth rates appeared to be increasing again closer to 5 percent in Apr-Jun 2012 but deteriorated. The rates of decline of manufacturing in 2009 are quite high with a drop of 18.2 percent in the 12 months ending in Apr 2009. Manufacturing recovered from this decline and led the recovery from the recession. Rates of growth appeared to be returning to the levels at 3 percent or higher in the annual rates before the recession but the pace of manufacturing fell steadily in the past six months with some weakness at the margin. The Board of Governors of the Federal Reserve System conducted the annual revision of industrial production released on Mar 22, 2013 (http://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm):
“The Federal Reserve has revised its index of industrial production (IP) and the related measures of capacity and capacity utilization. Measured from fourth quarter to fourth quarter, total IP is now reported to have increased 0.7 percentage point less in 2011 than was previously published. The revisions to IP for other years were smaller: Compared to the previous estimates, industrial production fell slightly less in 2008 and 2009 and increased slightly less in 2010 and 2012. At 97.7 percent of its 2007 average, the index in the fourth quarter of 2012 now stands 0.4 percent below its previous estimate. With these revisions, IP is still estimated to have advanced about 6 percent in 2010, the first full year following the trough in June 2009 of the most recent recession, but it is now estimated to have risen about 3 percent both in 2011 and in 2012. Since the trough of the recession, total IP has reversed about 90 percent of its peak-to-trough decline.”
The bottom part of Table II-2 shows decline of manufacturing by 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increased by 16.8 percent from the trough in Apr 2009 to Dec 2012. Manufacturing grew 21.1 percent from the trough in Apr 2009 to Aug 2013. Manufacturing output in Aug 2013 is 5.4 percent below the peak in Jun 2007.
Table II-2, US, Monthly and 12-Month Rates of Growth of Manufacturing ∆%
| Month SA ∆% | 12-Month NSA ∆% | |
| Aug 2013 | 0.7 | 2.5 |
| Jul | -0.4 | 1.4 |
| Jun | 0.3 | 1.4 |
| May | 0.2 | 1.7 |
| Apr | -0.4 | 2.1 |
| Mar | -0.2 | 1.8 |
| Feb | 0.6 | 1.9 |
| Jan | -0.1 | 2.4 |
| Dec 2012 | 0.9 | 3.0 |
| Nov | 1.4 | 3.3 |
| Oct | -0.4 | 2.1 |
| Sep | 0.1 | 3.1 |
| Aug | -0.7 | 3.5 |
| Jul | 0.2 | 4.0 |
| Jun | 0.4 | 5.0 |
| May | -0.2 | 4.8 |
| Apr | 0.6 | 5.1 |
| Mar | -0.5 | 3.9 |
| Feb | 0.6 | 5.3 |
| Jan | 1.1 | 4.2 |
| Dec 2011 | 1.0 | 3.8 |
| Nov | 0.0 | 3.2 |
| Oct | 0.6 | 3.1 |
| Sep | 0.4 | 3.0 |
| Aug | 0.3 | 2.4 |
| Jul | 0.7 | 2.5 |
| Jun | 0.1 | 2.1 |
| May | 0.3 | 1.9 |
| Apr | -0.8 | 3.1 |
| Mar | 0.7 | 4.9 |
| Feb | 0.0 | 5.4 |
| Jan | 0.2 | 5.6 |
| Dec 2010 | 0.6 | 6.2 |
| Nov | 0.2 | 5.3 |
| Oct | 0.1 | 6.6 |
| Sep | 0.1 | 7.0 |
| Aug | 0.1 | 7.4 |
| Jul | 0.7 | 7.8 |
| Jun | 0.0 | 9.3 |
| May | 1.5 | 8.9 |
| Apr | 1.0 | 7.1 |
| Mar | 1.3 | 4.9 |
| Feb | 0.1 | 1.3 |
| Jan | 1.1 | 1.2 |
| Dec 2009 | 0.0 | -3.1 |
| Nov | 1.2 | -6.1 |
| Oct | 0.1 | -9.1 |
| Sep | 0.8 | -10.6 |
| Aug | 1.2 | -13.6 |
| Jul | 1.3 | -15.2 |
| Jun | -0.3 | -17.6 |
| May | -1.1 | -17.6 |
| Apr | -0.7 | -18.2 |
| Mar | -1.8 | -17.3 |
| Feb | -0.1 | -16.1 |
| Jan | -2.9 | -16.4 |
| Dec 2008 | -3.4 | -14.0 |
| Nov | -2.3 | -11.3 |
| Oct | -0.6 | -9.0 |
| Sep | -3.5 | -8.6 |
| Aug | -1.4 | -5.1 |
| Jul | -1.1 | -3.5 |
| Jun | -0.6 | -3.1 |
| May | -0.4 | -2.4 |
| Apr | -1.1 | -1.1 |
| Mar | -0.3 | -0.5 |
| Feb | -0.6 | 0.9 |
| Jan | -0.4 | 2.3 |
| Dec 2007 | 0.2 | 2.0 |
| Nov | 0.5 | 3.4 |
| Oct | -0.3 | 2.8 |
| Sep | 0.6 | 3.0 |
| Aug | -0.4 | 2.6 |
| Jul | 0.2 | 3.4 |
| Jun | 0.3 | 2.9 |
| May | 0.0 | 3.1 |
| Apr | 0.7 | 3.6 |
| Mar | 0.8 | 2.4 |
| Feb | 0.4 | 1.6 |
| Jan | -0.5 | 1.3 |
| Dec 2006 | 2.7 | |
| Dec 2005 | 3.4 | |
| Dec 2004 | 4.0 | |
| Dec 2003 | 1.7 | |
| Dec 2002 | 2.4 | |
| Dec 2001 | -5.5 | |
| Dec 2000 | 0.4 | |
| Dec 1999 | 5.4 | |
| Average ∆% Dec 1986-Dec 2012 | 2.3 | |
| Average ∆% Dec 1986-Dec 1999 | 4.3 | |
| Average ∆% Dec 1999-Dec 2006 | 1.3 | |
| Average ∆% Dec 1999-Dec 2012 | 0.4 | |
| ∆% Peak 103.0005 in 06/2007 to 93.9456 in 12/2012 | -8.8 | |
| ∆% Peak 103.0005 on 06/2007 to Trough 80.4617 in 4/2009 | -21.9 | |
| ∆% Trough 80.4617 in 04/2009 to 93.9456 in 12/2012 | 16.8 | |
| ∆% Trough 80.4617 in 04/2009 to 97.4442 in 8/2013 | 21.1 | |
| ∆% Peak 103.0005 on 06/2007 to Trough 97.4442 in 8/2013 | -5.4 |
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/default.htm
United States manufacturing output from 1919 to 2012 on a monthly basis is in Chart II-4 of the Board of Governors of the Federal Reserve System. The second industrial revolution of Jensen (1993) is quite evident in the acceleration of the rate of growth of output given by the sharper slope in the 1980s and 1990s. Growth was robust after the shallow recession of 2001 but dropped sharply during the global recession after IVQ2007. Manufacturing output recovered sharply but has not reached earlier levels and is losing momentum at the margin.
Chart II-4, US, Manufacturing Output, 1919-2013
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/default.htm
Manufacturing jobs increased 614,000 in Aug 2013 relative to Jul 2013, seasonally adjusted (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). Manufacturing jobs not seasonally adjusted increased 15,000 from Aug 2012 to Aug 2013 or at the average monthly rate of 1,250. There are effects of the weaker economy and international trade together with the yearly adjustment of labor statistics. Industrial production increased 0.4 percent in Aug 2013 after changing 0.0 percent in Jul 2013 and increasing 0.1 percent in Jun 2013, as shown in Table II-1, with all data seasonally adjusted. The report of the Board of Governors of the Federal Reserve System states (http://www.federalreserve.gov/releases/g17/Current/default.htm):
“Industrial production advanced 0.4 percent in August after having been unchanged in July; the gains in August were broadly based. Following a decrease in July of 0.4 percent, which was steeper than previously reported, manufacturing production rose 0.7 percent in August. The output of mines moved up 0.3 percent, its fifth consecutive monthly increase, and the production of utilities fell 1.5 percent, its fifth consecutive monthly decrease. At 99.4 percent of its 2007 average, total industrial production in August was 2.7 percent above its year-earlier level. “
In the six months ending in Aug 2013, United States national industrial production accumulated increase of 0.6 percent at the annual equivalent rate of 1.2 percent, which is much lower than growth of 2.7 percent in the 12 months ending in Aug 2013. Excluding growth of 0.4 percent in Aug 2013, growth in the remaining five months from Mar 2012 to Jul 2013 accumulated to 0.2 percent or 0.5 percent annual equivalent. Industrial production stagnated in three of the past six months and fell in one. Business equipment accumulated growth of 0.4 percent in the six months from Mar to Aug 2013 at the annual equivalent rate of 0.8 percent, which is much lower than growth of 2.5 percent in the 12 months ending in Aug 2013. Growth of business equipment accumulated minus 0.5 percent from Mar to July 2013 at the annual equivalent rate of minus 1.2 percent. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for the industrial sector increased 0.2 percentage point in August to 77.8 percent, a rate 0.6 percentage point above its level of a year earlier and 2.4 percentage points below its long-run (1972-2012) average.” United States industry is apparently decelerating.
Manufacturing increased 0.7 percent in Aug 2013 after decreasing 0.4 percent in Jul 2013 and increasing 0.3 percent in Jul 2013 seasonally adjusted, increasing 2.5 percent not seasonally adjusted in 12 months ending in Aug 2013, as shown in Table II-2. Manufacturing grew cumulatively 0.2 percent in the six months ending in Jul 2013 or at the annual equivalent rate of 0.4 percent. Excluding the increase of 0.7 percent in Aug 2013, manufacturing accumulated growth of minus 0.5 percent from Mar 2013 to Jul 2013 or at the annual equivalent rate of minus 1.2 percent.
Table II-3 provides national income by industry without capital consumption adjustment (WCCA). “Private industries” or economic activities have share of 86.6 percent in IQ2013. Most of US national income is in the form of services. In Aug 2013, there were 135.961 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/empsit.nr0.htm Table B-1). Total private jobs of 115.218 million NSA in Aug 2013 accounted for 84.7 percent of total nonfarm jobs of 135.961 million, of which 12.063 million, or 10.5 percent of total private jobs and 8.9 percent of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 96.174 million NSA in Aug 2013, or 70.7 percent of total nonfarm jobs and 83.5 percent of total private-sector jobs. Manufacturing has share of 10.9 percent in US national income in IQ2013, as shown in Table II-3. 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 II-3, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total
| SAAR IQ2013 | % Total | SAAR | % Total | |
| National Income WCCA | 14,354.5 | 100.0 | 14,480.5 | 100.0 |
| Domestic Industries | 14,117.1 | 98.3 | 14,223.1 | 98.2 |
| Private Industries | 12,432.9 | 86.6 | 12,542.6 | 86.6 |
| Agriculture | 226.4 | 1.6 | ||
| Mining | 247.6 | 1.7 | ||
| Utilities | 209.1 | 1.5 | ||
| Construction | 618.2 | 4.3 | ||
| Manufacturing | 1568.1 | 10.9 | ||
| Durable Goods | 878.8 | 6.1 | ||
| Nondurable Goods | 689.2 | 4.8 | ||
| Wholesale Trade | 870.0 | 6.1 | ||
| Retail Trade | 971.4 | 6.8 | ||
| Transportation & WH | 434.0 | 3.0 | ||
| Information | 496.0 | 3.5 | ||
| Finance, Insurance, RE | 2418.9 | 16.8 | ||
| Professional, BS | 1973.6 | 13.7 | ||
| Education, Health Care | 1423.7 | 9.9 | ||
| Arts, Entertainment | 569.7 | 4.0 | ||
| Other Services | 406.1 | 2.8 | ||
| Government | 1684.3 | 11.7 | 1680.5 | 11.6 |
| Rest of the World | 237.4 | 1.7 | 257.4 | 1.8 |
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: US Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm
ESVII World Inflation Waves. This section provides analysis and data on world inflation waves.
The critical fact of current world financial markets is the combination of “unconventional” monetary policy with intermittent shocks of financial risk aversion. There are two interrelated unconventional monetary policies. First, unconventional monetary policy consists primarily of reducing short-term policy interest rates toward the “zero bound” such as fixing the fed funds rate at 0 to ¼ percent by decision of the Federal Open Market Committee (FOMC) since Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). Fixing policy rates at zero is the strongest measure of monetary policy with collateral effects of inducing carry trades from zero interest rates to exposures in risk financial assets such as commodities, exchange rates, stocks and higher yielding fixed income. Second, unconventional monetary policy also includes a battery of measures in also reducing long-term interest rates of government securities and asset-backed securities such as mortgage-backed securities.
When inflation is low, the central bank lowers interest rates to stimulate aggregate demand in the economy, which consists of consumption and investment. When inflation is subdued and unemployment high, monetary policy would lower interest rates to stimulate aggregate demand, reducing unemployment. When interest rates decline to zero, unconventional monetary policy would consist of policies such as large-scale purchases of long-term securities to lower their yields. Long-term asset-backed securities finance a major portion of credit in the economy. Loans for purchasing houses, automobiles and other consumer products are bundled in securities that in turn are sold to investors. Corporations borrow funds for investment by issuing corporate bonds. Loans to small businesses are also financed by bundling them in long-term bonds. Securities markets bridge the needs of higher returns by savers obtaining funds from investors that are channeled to consumers and business for consumption and investment. Lowering the yields of these long-term bonds could lower costs of financing purchases of consumer durables and investment by business. The essential mechanism of transmission from lower interest rates to increases in aggregate demand is portfolio rebalancing. Withdrawal of bonds in a specific maturity segment or directly in a bond category such as currently mortgage-backed securities causes reductions in yields that are equivalent to increases in the prices of the bonds. There can be secondary increases in purchases of those bonds in private portfolios in pursuit of their increasing prices. Lower yields translate into lower costs of buying homes and consumer durables such as automobiles and also lower costs of investment for business. There are two additional intended routes of transmission.
1. Unconventional monetary policy or its expectation can increase stock market valuations (Bernanke 2010WP). Increases in equities traded in stock markets can augment perceptions of the wealth of consumers, inducing increases in consumption.
2. Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can cause increases in net exports of the US that increase aggregate economic activity (Yellen 2011AS).
Monetary policy can lower short-term interest rates quite effectively. Lowering long-term yields is somewhat more difficult. The critical issue is that monetary policy cannot ensure that increasing credit at low interest cost increases consumption and investment. There is a large variety of possible allocation of funds at low interest rates from consumption and investment to multiple risk financial assets. Monetary policy does not control how investors will allocate asset categories. A critical financial practice is to borrow at low short-term interest rates to invest in high-risk, leveraged financial assets. Investors may increase in their portfolios asset categories such as equities, emerging market equities, high-yield bonds, currencies, commodity futures and options and multiple other risk financial assets including structured products. If there is risk appetite, the carry trade from zero interest rates to risk financial assets will consist of short positions at short-term interest rates (or borrowing) and short dollar assets with simultaneous long positions in high-risk, leveraged financial assets such as equities, commodities and high-yield bonds. Low interest rates may induce increases in valuations of risk financial assets that may fluctuate in accordance with perceptions of risk aversion by investors and the public. During periods of muted risk aversion, carry trades from zero interest rates to exposures in risk financial assets cause temporary waves of inflation that may intensify instead of preventing financial instability. During periods of risk aversion such as fears of disruption of world financial markets and the global economy resulting from events such as collapse of the European Monetary Union, carry trades are unwound with sharp deterioration of valuations of risk financial assets. More technical discussion is in IA Appendix: Transmission of Unconventional Monetary Policy.
Symmetric inflation targets are temporarily of secondary priority in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output. Monetary easing by unconventional measures, including zero interest rates and outright purchases of securities for the portfolio of the central bank, is now open ended in perpetuity, or QE→∞, as provided in the statement of the meeting of the Federal Open Market Committee (FOMC) on Sep 13, 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm):
“To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):
“I think the best way to provide forward guidance is by tying our policy actions to explicit measures of economic performance. There are many ways of doing this, including setting a target for the level of nominal GDP. But recognizing the difficult nature of that policy approach, I have a more modest proposal: I think the Fed should make it clear that the federal funds rate will not be increased until the unemployment rate falls below 7 percent. Knowing that rates would stay low until significant progress is made in reducing unemployment would reassure markets and the public that the Fed would not prematurely reduce its accommodation.
Based on the work I have seen, I do not expect that such policy would lead to a major problem with inflation. But I recognize that there is a chance that the models and other analysis supporting this approach could be wrong. Accordingly, I believe that the commitment to low rates should be dropped if the outlook for inflation over the medium term rises above 3 percent.
The economic conditionality in this 7/3 threshold policy would clarify our forward policy intentions greatly and provide a more meaningful guide on how long the federal funds rate will remain low. In addition, I would indicate that clear and steady progress toward stronger growth is essential.”
Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:
“I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Price Index) inflation over the next two to three years, would be appropriate.”
The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):
“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
Unconventional monetary policy will remain in perpetuity, or QE→∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE→∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at around 1.8 percent, which is well below 3.0 percent estimated by Lucas (2011May) from 1870 to 2010. Unconventional monetary policy interprets the dual mandate of low inflation and maximum employment as mainly a “growth mandate” of forcing economic growth in the US at a rate that generates full employment. A hurdle to this “growth mandate” is that US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 16 quarters from IIIQ2009 to IIQ2013. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,738.0 billion in IIQ2010 by GDP of $14,356.9 billion in IIQ2009 {[$14,738.0/$14,356.9 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). Because of mediocre GDP growth, there are 28.3 million unemployed or underemployed in the United States for an effective unemployment rate of 17.4 percent (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). Zero interest rates and quantitative easing did not provide the impulse for growth and were not required in past successful cyclical expansions.
First, total nonfarm payroll employment seasonally adjusted (SA) increased 169,000 in Aug 2013 and private payroll employment rose 152,000. The average number of nonfarm jobs created in Jan-Aug 2012 was 178,625 while the average number of private jobs created in Jan-Aug 2013 was 180,250, or increase by 0.9 percent. The average number of private jobs created in the US in Jan-Aug 2012 was 181,750 while the average in Jan-Aug 2013 was 185,625, or increase by 2.1 percent. The US labor force increased from 153.617 million in 2011 to 154.975 million in 2012 by 1.358 million or 113,167 per month. The average increase of nonfarm jobs in the eight months from Jan to Aug 2013 was 178,625, which is a rate of job creation inadequate to reduce significantly unemployment and underemployment in the United States because of 113,167 new entrants in the labor force per month with 28.3 million unemployed or underemployed. The difference between the average increase of 178,625 new private nonfarm jobs per month in the US from Jan to Aug 2013 and the 113,167 average monthly increase in the labor force from 2011 to 2012 is 65,458 monthly new jobs net of absorption of new entrants in the labor force. There are 28.3 million in job stress in the US currently. Creation of 65,458 new jobs per month net of absorption of new entrants in the labor force would require 433 months to provide jobs for the unemployed and underemployed (28.348 million divided by 65,458) or 36 years (433 divided by 12). The civilian labor force of the US in Aug 2013 not seasonally adjusted stood at 155.971 million with 11.462 million unemployed or effectively 18.316 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 162.825 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 1.3 years (1 million divided by product of 65,458 by 12, which is 785,496). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.799 million (0.05 times labor force of 155.971 million) for new net job creation of 3.663 million (11.462 million unemployed minus 7.799 million unemployed at rate of 5 percent) that at the current rate would take 4.7 years (3.663 million divided by 0.785496). Under the calculation in this blog, there are 18.316 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 162.825 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.586 million jobs net of labor force growth that at the current rate would take 12.9 years (18.316 million minus 0.05(162.825 million) = 10.175 million divided by 0.785596, using LF PART 66.2% and Total UEM in Table I-4). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. The number employed in the US fell from 147.315 million in Jul 2007 to 144.509 million in Aug 2013, by 2.806 million, or decline of 1.9 percent, while the civilian noninstitutional or economically active population increased from 231.958 million in Jul 2007 to 245.959 million in Aug 2013, by 14.001 million or increase of 6.0 percent, using not seasonally adjusted data. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs. The United States economy has grown at the average yearly rate of 3 percent per year and 2 percent per year in per capita terms from 1870 to 2010, as measured by Lucas (2011May). An important characteristic of the economic cycle in the US has been rapid growth in the initial phase of expansion after recessions. Inferior performance of the US economy and labor markets is the critical current issue of analysis and policy design.
Second, revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) provide important information on long-term growth and cyclical behavior. Table Summary provides relevant data.
- Long-term. US GDP grew at the average yearly rate of 3.3 percent from 1929 to 2012 and at 3.2 percent from 1947 to 2012. There were periodic contractions or recessions in this period but the economy grew at faster rates in the subsequent expansions, maintaining long-term economic growth at trend.
- Cycles. The combined contraction of GDP in the two almost consecutive recessions in the early 1980s is 4.7 percent. The contraction of US GDP from IVQ2007 to IIQ2009 during the global recession was 4.3 percent. The critical difference in the expansion is growth at average 7.8 percent in annual equivalent in the first four quarters of recovery from IQ1983 to IVQ1983. The average rate of growth of GDP in four cyclical expansions in the postwar period is 7.7 percent. In contrast, the rate of growth in the first four quarters from IIIQ2009 to IIQ2010 was only 2.7 percent. Average annual equivalent growth in the expansion from IQ1983 to IQ1986 was 5.7 percent. In contrast, average annual equivalent growth in the expansion from IIIQ2009 to IIQ2013 was only 2.7 percent. The US appears to have lost its dynamism of income growth and employment creation.
Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita
| GDP | ||
| Long-Term | ||
| 1929-2012 | 3.3 | |
| 1947-2012 | 3.2 | |
| Cyclical Contractions ∆% | ||
| IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982 | -4.7 | |
| IVQ2007 to IIQ2009 | -4.3 | |
| Cyclical Expansions Average Annual Equivalent ∆% | ||
| IQ1983 to IQ1986 | 5.7 | |
| First Four Quarters IQ1983 to IVQ1983 | 7.8 | |
| IIIQ2009 to IIQ2013 | 2.2 | |
| First Four Quarters IIIQ2009 to IIQ2010 | 2.7 | |
| Real Disposable Income | Real Disposable Income per Capita | |
| Long-Term | ||
| 1929-2012 | 3.2 | 2.0 |
| 1947-1999 | 3.7 | 2.3 |
| Whole Cycles | ||
| 1980-1989 | 3.5 | 2.6 |
| 2006-2012 | 1.4 | 0.6 |
Source: Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf
The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace from 1.8 to 1.9 percent per year. Table Summary GDP provides the data.
1. Average Annual Growth in the Past Six Quarters. GDP growth in the four quarters of 2012 and the first two quarters of 2013 accumulated to 2.9 percent. This growth is equivalent to 1.9 percent per year, obtained by dividing GDP in IIQ2013 of $15,681.0 by GDP in IVQ2011 of $15,242.1 and compounding by 4/6: {[($15,681.0/$15,242.1)4/6 -1]100 = 1.9.
2. Average Annual Growth in the First Two Quarters of 2013. GDP growth in the first two quarters of 2013 accumulated to 0.9 percent that is equivalent to 1.8 percent in a year. This is obtained by dividing GDP in IIQ2013 of $15,681.0 by GDP in IVQ2012 of $15,539.6 and compounding by 4/2: {[($15,681.0/$15,539.6)4/2 -1]100 =1.8%}. The US economy grew 1.6 percent in IIQ2013 relative to the same quarter a year earlier in IIQ2012. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is just at the borderline of contraction.
Table Summary GDP, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%
| Real GDP, Billions Chained 2005 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| IVQ2007 | 14,996.1 | NA | NA | 1.9 |
| IVQ2011 | 15,242.1 | 1.6 | 1.2 | 2.0 |
| IQ2012 | 15,381.6 | 2.6 | 0.9 | 3.3 |
| IIQ2012 | 15,427.7 | 2.9 | 0.3 | 2.8 |
| IIIQ2012 | 15,534.0 | 3.6 | 0.7 | 3.1 |
| IVQ2012 | 15,539.6 | 3.6 | 0.0 | 2.0 |
| IQ2013 | 15,583.9 | 3.9 | 0.3 | 1.3 |
| IIQ2013 | 15,681.0 | 4.6 | 0.6 | 1.6 |
| Cumulative ∆% IQ2012 to IIQ2013 | 2.9 | 2.8 | ||
| Annual Equivalent ∆% | 1.9 | 1.9 |
Source: US Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf
In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is concern of the production and employment costs of controlling future inflation. Even if there is no inflation, QE→∞ cannot be abandoned because of the fear of rising interest rates. The economy would operate in an inferior allocation of resources and suboptimal growth path, or interior point of the production possibilities frontier where the optimum of productive efficiency and wellbeing is attained, because of the distortion of risk/return decisions caused by perpetual financial repression. Not even a second-best allocation is feasible with the shocks to efficiency of financial repression in perpetuity.
The major reason and channel of transmission of unconventional monetary policy is through expectations of inflation. Fisher (1930) provided theoretical and historical relation of interest rates and inflation. Let in be the nominal interest rate, ir the real or inflation-adjusted interest rate and πe the expectation of inflation in the time term of the interest rate, which are all expressed as proportions. The following expression provides the relation of real and nominal interest rates and the expectation of inflation:
(1 + ir) = (1 + in)/(1 + πe) (1)
That is, the nominal interest rate equals the real interest rate discounted by the expectation of inflation in time term of the interest rate. Fisher (1933) analyzed the devastating effect of deflation on debts. Nominal debt contracts remained at original principal interest but net worth and income of debtors contracted during deflation. Real interest rates increase during declining inflation. For example, if the interest rate is 3 percent and prices decline 0.2 percent, equation (1) calculates the real interest rate as:
(1 +0.03)/(1 – 0.02) = 1.03/(0.998) = 1.032
That is, the real rate of interest is (1.032 – 1) 100 or 3.2 percent. If inflation were 2 percent, the real rate of interest would be 0.98 percent, or about 1.0 percent {[(1.03/1.02) -1]100 = 0.98%}.
The yield of the one-year Treasury security was quoted in the Wall Street Journal at 0.114 percent on Fri May 17, 2013 (http://online.wsj.com/mdc/page/marketsdata.html?mod=WSJ_topnav_marketdata_main). The expected rate of inflation πe in the next twelve months is not observed. Assume that it would be equal to the rate of inflation in the past twelve months estimated by the Bureau of Economic Analysis (BLS) at 1.1 percent (http://www.bls.gov/cpi/). The real rate of interest would be obtained as follows:
(1 + 0.00114)/(1 + 0.011) = (1 + rr) = 0.9902
That is, ir is equal to 1 – 0.9902 or minus 0.98 percent. Investing in a one-year Treasury security results in a loss of 0.98 percent relative to inflation. The objective of unconventional monetary policy of zero interest rates is to induce consumption and investment because of the loss to inflation of riskless financial assets. Policy would be truly irresponsible if it intended to increase inflationary expectations or πe. The result could be the same rate of unemployment with higher inflation (Kydland and Prescott 1977).
Friedman (1953) analyzed the effects of full-employment economic policy on economic stability. There are two critical issues. First, there are lags in effect of monetary policy on aggregate income and prices (Friedman 1961, Culbertson 1960, 1961, Batini and Nelson 2002, Romer and Romer 2004). Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Second, concrete knowledge on the functioning of the economy is inadequate. The result of shocking the economy with policies at the wrong time could be an increase in instability. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities).
Carry trades from zero interest rates to highly leveraged exposures in risk financial assets characterize the current environment. Some analytical aspects of the carry trade are instructive (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 101-5, Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 202-4), Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 70-4). Consider the following symbols: Rt is the exchange rate of a country receiving carry trade denoted in units of domestic currency per dollars at time t of initiation of the carry trade; Rt+τ is the exchange of the country receiving carry trade denoted in units of domestic currency per dollars at time t+τ when the carry trade is unwound; if is the domestic interest rate of the high-yielding country where investment will be made; iusd is the interest rate on short-term dollar debt assumed to be 0.5 percent per year; if >iusd, which expresses the fact that the interest rate on the foreign country is much higher than that in short-term USD (US dollars); St is the dollar value of the investment principal; and π is the dollar profit from the carry trade. The investment of the principal St in the local currency debt of the foreign country provides a profit of:
π = (1 + if)(RtSt)(1/Rt+τ) – (1 + iusd)St (2)
The profit from the carry trade, π, is nonnegative when:
(1 + if)/ (1 + iusd) ≥ Rt+τ/Rt (3)
In words, the difference in interest rate differentials, left-hand side of inequality (3), must exceed the percentage devaluation of the currency of the host country of the carry trade, right hand side of inequality (3). The carry trade must earn enough in the host-country interest rate to compensate for depreciation of the host-country at the time of return to USD. A simple example explains the vulnerability of the carry trade in fixed-income. Let if be 0.10 (10 percent), iusd 0.005 (0.5 percent), St USD100 and Rt CUR 1.00/USD. Adopt the fixed-income rule of months of 30 days and years of 360 days. Consider a strategy of investing USD 100 at 10 percent for 30 days with borrowing of USD 100 at 0.5 percent for 30 days. At time t, the USD 100 are converted into CUR 100 and invested at [(30/360)10] equal to 0.833 percent for thirty days. At the end of the 30 days, assume that the rate Rt+30 is still CUR 1/USD such that the return amount from the carry trade is USD 0.833. There is still a loan to be paid [(0.005)(30/360)USD100] equal to USD 0.042. The investor receives the net amount of USD 0.833 minus USD 0.042 or US 0.791. The rate of return on the investment of the USD 100 is 0.791 percent, which is equivalent to the annual rate of return of 9.49 percent {(0.791)(360/30)}. This is incomparably better than earning 0.5 percent. There are alternatives of hedging by buying forward the exchange for conversion back into USD.
What really matters in the statement of the Federal Open Market Committee (FOMC) on Sep 18, 2013, is interest rates of fed funds at 0 to ¼ percent for the foreseeable future, even with paring of purchases of longer term bonds for the portfolio of the Fed (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):
“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent” (emphasis added).
Another critical concern in the statement of the FOMC on Sep 18, 2013, is on the effects of tapering expectations on interest rates (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):
“Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth” (emphasis added).
Carry trades induced by zero interest rates increase the volatility of inflation σp and real income σy. World inflation waves originating in carry trades from zero interest rates to commodity futures and options deteriorate the sales prices of producing and investing companies net of costs of inputs and real income of consumers. The main objective of monetary policy is providing for financial stability. Unconventional monetary policy creates economic instability with higher volatilities of prices and real income as well as financial instability with major oscillations of risk financial assets. Carry trades induced by zero interest rates cause alternating improvements and deteriorations of net margins of sales prices less costs of raw materials and real income of consumers, disrupting decisions on production, investment and consumption.
Table IA-1 provides annual equivalent rates of inflation for producer price indexes followed in this blog of countries and regions that account for close to three quarters of world output. The behavior of the US producer price index in 2011 and into 2012-2013 shows neatly multiple waves. (1) In Jan-Apr 2011, without risk aversion, US producer prices rose at the annual equivalent rate of 10.0 percent. (2) After risk aversion, producer prices increased in the US at the annual equivalent rate of 1.8 percent in May-Jun 2011. (3) From Jul to Sep 2011, under alternating episodes of risk aversion, producer prices increased at the annual equivalent rate of 4.9 percent. (4) Under the pressure of risk aversion because of the European debt crisis, US producer prices increased at the annual equivalent rate of 0.6 percent in Oct-Nov 2011. (5) From Dec 2011 to Jan 2012, US producer were flat at the annual equivalent rate of 0.0 percent. (6) Inflation of producer prices returned with 2.4 percent annual equivalent in Feb-Mar 2012. (7) With return of risk aversion from the European debt crisis, producer prices fell at the annual equivalent rate of 4.7 percent in Apr-May 2012. (8) New positions in commodity futures even with continuing risk aversion caused annual equivalent inflation of 3.0 percent in Jun-Jul 2012. (9) Relaxed risk aversion because of announcement of sovereign bond buying by the European Central Bank induced carry trades that resulted in annual equivalent producer price inflation in the US of 12.7 percent in Aug-Sep 2012. (10) Renewed risk aversion caused unwinding of carry trades of zero interest rates to commodity futures exposures with annual equivalent inflation of minus 3.2 percent in Oct-Dec 2012. (10) In Jan-Feb 2013, producer prices rose at the annual equivalent rate of 5.5 percent with more relaxed risk aversion at the margin. (11) Return of risk aversion resulted in annual equivalent inflation of minus 7.5 percent in Mar-Apr 2013 with worldwide portfolio reallocation toward equities and high-yield bonds and away from commodity exposures. (12) Inflation of producer prices returned at 4.9 percent in annual equivalent in May-Aug 2013. Resolution of the European debt crisis if there is not an unfavorable growth event with political development in China would result in jumps of valuations of risk financial assets. Increases in commodity prices would cause the same high producer price inflation experienced in Jan-Apr 2011 and Aug-Sep 2012. An episode of exploding commodity prices could ignite inflationary expectations that would result in an inflation phenomenon of costly resolution. There are nine producer-price indexes in Table IA-1 for seven countries (two for the UK) and one region (euro area) showing very similar behavior. Zero interest rates without risk aversion cause increases in commodity prices that in turn increase input prices at a faster pace than output prices. Producer price inflation rose at very high rates during the first part of 2011 for the US, Japan, China, Euro Area, Germany, France, Italy and the UK when risk aversion was contained. With the increase in risk aversion in May and Jun 2011, inflation moderated because carry trades were unwound. Producer price inflation returned after Jul 2011, with alternating bouts of risk aversion. In the final months of the year producer price inflation collapsed because of the disincentive to exposures in commodity futures resulting from fears of resolution of the European debt crisis. There is renewed worldwide inflation in the early part of 2012 with subsequent collapse because of another round of sharp risk aversion and relative portfolio reallocation away from commodities and into equities and high-yield bonds. Sharp worldwide jump in producer prices occurred recently because of the combination of zero interest rates forever or QE→∞ with temporarily relaxed risk aversion. Producer prices were moderating or falling in the final months of 2012 because of renewed risk aversion that causes unwinding of carry trades from zero interest rates to commodity futures exposures. In the first months of 2013, new carry trades caused higher worldwide inflation. Unconventional monetary policy fails in stimulating the overall real economy, merely introducing undesirable instability because monetary authorities cannot control allocation of floods of money at zero interest rates to carry trades into risk financial assets. The economy is constrained in a suboptimal allocation of resources that is perpetuated along a continuum of short-term periods. The result is long-term or dynamic inefficiency in the form of a trajectory of economic activity that is lower than what would be attained with rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html).
Table IA-1, Annual Equivalent Rates of Producer Price Indexes
| INDEX 2011-2013 | AE ∆% |
| US Producer Price Index | |
| AE ∆% May-Aug 2013 | 4.9 |
| AE ∆% Mar-Apr 2013 | -7.5 |
| AE ∆% Jan-Feb 2013 | 5.5 |
| AE ∆% Oct-Dec 2012 | -3.2 |
| AE ∆% Aug-Sep 2012 | 12.7 |
| AE ∆% Jun-Jul 2012 | 3.0 |
| AE ∆% Apr-May 2012 | -4.7 |
| AE ∆% Feb-Mar 2012 | 2.4 |
| AE ∆% Dec 2011-Jan-2012 | 0.0 |
| AE ∆% Oct-Nov 2011 | 0.6 |
| AE ∆% Jul-Sep 2011 | 4.9 |
| AE ∆% May-Jun 2011 | 1.8 |
| AE ∆% Jan-Apr 2011 | 10.0 |
| Japan Corporate Goods Price Index | |
| AE ∆% Dec 2012-Aug 2013 | 3.5 |
| AE ∆% Oct-Nov 2012 | -3.0 |
| AE ∆% Aug-Sep 2012 | 3.0 |
| AE ∆% May-Jul 2012 | -5.8 |
| AE ∆% Feb-Apr 2012 | 2.0 |
| AE ∆% Dec 2011-Jan 2012 | -0.6 |
| AE ∆% Jul-Nov 2011 | -2.2 |
| AE ∆% May-Jun 2011 | -1.2 |
| AE ∆% Jan-Apr 2011 | 5.9 |
| China Producer Price Index | |
| AE ∆% Aug 2013 | 1.2 |
| AE ∆% Mar-Jul 2013 | -4.9 |
| AE ∆% Jan-Feb 2013 | 2.4 |
| AE ∆% Nov-Dec 2012 | -1.2 |
| AE ∆% Oct 2012 | 2.4 |
| AE ∆% May-Sep 2012 | -5.8 |
| AE ∆% Feb-Apr 2012 | 2.4 |
| AE ∆% Dec 2011-Jan 2012 | -2.4 |
| AE ∆% Jul-Nov 2011 | -3.1 |
| AE ∆% Jan-Jun 2011 | 6.4 |
| Euro Zone Industrial Producer Prices | |
| AE ∆% Jul 2013 | 3.7 |
| AE ∆% Mar-Jun 2013 | -3.3 |
| AE ∆% Jan-Feb 2013 | 3.7 |
| AE ∆% Nov-Dec 2012 | -2.4 |
| AE ∆% Sep-Oct 2012 | 0.6 |
| AE ∆% Jul-Aug 2012 | 7.4 |
| AE ∆% Apr-Jun 2012 | -2.0 |
| AE ∆% Jan-Mar 2012 | 8.3 |
| AE ∆% Oct-Dec 2011 | 0.4 |
| AE ∆% Jul-Sep 2011 | 2.8 |
| AE ∆% May-Jun 2011 | -0.6 |
| AE ∆% Jan-Apr 2011 | 11.4 |
| Germany Producer Price Index | |
| AE ∆% May-Jul 2013 | -1.6 NSA 1.2 SA |
| AE ∆% Feb-Apr 2013 | -2.0 NSA –2.8 SA |
| AE ∆% Jan 2013 | 10.0 NSA 2.4 SA |
| AE ∆% Oct-Dec 2012 | -1.6 NSA 1.2 SA |
| AE ∆% Aug-Sep 2012 | 4.9 NSA 4.3 SA |
| AE ∆% May-Jul 2012 | -2.8 NSA –1.2 SA |
| AE ∆% Feb-Apr 2012 | 4.9 NSA 2.4 SA |
| AE ∆% Dec 2011-Jan 2012 | 1.2 NSA –0.6 SA |
| AE ∆% Oct-Nov 2011 | 1.8 NSA 2.4 SA |
| AE ∆% Jul-Sep 2011 | 2.8 NSA 2.8 SA |
| AE ∆% May-Jun 2011 | 0.6 NSA 4.3 SA |
| AE ∆% Jan-Apr 2011 | 10.4 NSA 6.5 SA |
| France Producer Price Index for the French Market | |
| AE ∆% Jul 2013 | 8.7 |
| AE ∆% Apr-Jun 2013 | -10.3 |
| AE ∆% Jan-Mar 2013 | 4.9 |
| AE ∆% Nov-Dec 2012 | -4.1 |
| AE ∆% Jul-Oct 2012 | 7.4 |
| AE ∆% Apr-Jun 2012 | -4.3 |
| AE ∆% Jan-Mar 2012 | 6.2 |
| AE ∆% Oct-Dec 2011 | 2.8 |
| AE ∆% Jul-Sep 2011 | 3.7 |
| AE ∆% May-Jun 2011 | -1.8 |
| AE ∆% Jan-Apr 2011 | 10.4 |
| Italy Producer Price Index | |
| AE ∆% Jun-Jul 2013 | 3.0 |
| AE ∆% Apr-May 2013 | -3.5 |
| AE ∆% Feb-Mar 2013 | 1.2 |
| AE ∆% Sep 2012-Jan 2013 | -5.2 |
| AE ∆% Jul-Aug 2012 | 9.4 |
| AE ∆% May-Jun 2012 | -0.6 |
| AE ∆% Mar-Apr 2012 | 6.8 |
| AE ∆% Jan-Feb 2012 | 8.1 |
| AE ∆% Oct-Dec 2011 | 2.0 |
| AE ∆% Jul-Sep 2011 | 4.9 |
| AE ∆% May-Jun 2011 | 1.8 |
| AE ∆% Jan-April 2011 | 10.7 |
| UK Output Prices | |
| AE ∆% Jun-Aug 2013 | 1.2 |
| AE ∆% Apr-May 2013 | -1.8 |
| AE ∆% Jan-Mar 2013 | 5.3 |
| AE ∆% Nov-Dec 2012 | -3.0 |
| AE ∆% Jul-Oct 2012 | 4.0 |
| AE ∆% May-Jun 2012 | -5.3 |
| AE ∆% Feb-Apr 2012 | 7.9 |
| AE ∆% Nov 2011-Jan-2012 | 1.6 |
| AE ∆% May-Oct 2011 | 2.0 |
| AE ∆% Jan-Apr 2011 | 12.0 |
| UK Input Prices | |
| AE ∆% Aug 2013 | -2.4 |
| AE ∆% Jun-Jul 2013 | 8.7 |
| AE ∆% Mar-May 2013 | -11.4 |
| AE ∆% Jan-Feb 2013 | 28.3 |
| AE ∆% Sep-Dec 2012 | 1.5 |
| AE ∆% Jul-Aug 2012 | 14.0 |
| AE ∆% Apr-Jun 2012 | -21.9 |
| AE ∆% Jan-Mar 2012 | 18.1 |
| AE ∆% Nov-Dec 2011 | -1.2 |
| AE ∆% May-Oct 2011 | -3.1 |
| AE ∆% Jan-Apr 2011 | 35.6 |
AE: Annual Equivalent
Sources: http://www.bls.gov/cpi/ http://www.boj.or.jp/en/
http://www.stats.gov.cn/enGliSH/
http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database
https://www.destatis.de/EN/Homepage.html
http://www.insee.fr/en/default.asp
http://www.ons.gov.uk/ons/index.html
Similar world inflation waves are in the behavior of consumer price indexes of six countries and the euro zone in Table IA-2. US consumer price inflation shows similar waves. (1) Under risk appetite in Jan-Apr 2011, consumer prices increased at the annual equivalent rate of 4.6 percent. (2) Risk aversion caused the collapse of inflation to annual equivalent 3.0 percent in May-Jun 2011. (3) Risk appetite drove the rate of consumer price inflation in the US to 3.3 percent in Jul-Sep 2011. (4) Gloomier views of carry trades caused the collapse of inflation in Oct-Nov 2011 to annual equivalent 0.6 percent. (5) Consumer price inflation resuscitated with increased risk appetite at annual equivalent of 1.2 percent in Dec 2011 to Jan 2012. (6) Consumer price inflation returned at 2.4 percent annual equivalent in Feb-Apr 2012. (7) Under renewed risk aversion, annual equivalent consumer price inflation in the US was 0.0 percent in May-Jul 2012. (8) Inflation jumped to annual equivalent 4.9 percent in Aug-Oct 2012. (9) Unwinding of carry trades caused negative annual equivalent inflation of 0.8 percent in Nov 2012-Jan 2013 but some countries experienced higher inflation in Dec 2012 and Jan 2013. (10) Inflation jumped again with annual equivalent inflation of 8.7 percent in Feb 2013 in a mood of relaxed risk aversion. (11) Inflation fell at 3.5 percent annual equivalent in Mar-Apr 2013. (12) Inflation rose at 2.7 percent in annual equivalent in May-Jul 2013. Inflationary expectations can be triggered in one of these episodes of accelerating inflation because of commodity carry trades induced by unconventional monetary policy of zero interest rates in perpetuity or QE→∞ in almost continuous time. Alternating episodes of increase and decrease of inflation introduce uncertainty in household planning that frustrates consumption and home buying. Announcement of purchases of impaired sovereign bonds by the European Central Bank relaxed risk aversion that induced carry trades into commodity exposures, increasing prices of food, raw materials and energy. There is similar behavior in all the other consumer price indexes in Table IA-2. China’s CPI increased at annual equivalent 8.3 percent in Jan-Mar 2011, 2.0 percent in Apr-Jun, 2.9 percent in Jul-Nov and resuscitated at 5.8 percent annual equivalent in Dec 2011 to Mar 2012, declining to minus 3.9 percent in Apr-Jun 2012 but resuscitating at 4.1 percent in Jul-Sep 2012, declining to minus 1.2 percent in Oct 2012 and 0.0 percent in Oct-Nov 2012. High inflation in China at annual equivalent 5.5 percent in Nov-Dec 2012 is attributed to inclement winter weather that caused increases in food prices. Continuing pressure of food prices caused annual equivalent inflation of 12.2 percent in China in Dec 2012 to Feb 2013. Inflation in China fell at annual equivalent 10.3 percent in Mar 2013 and increased at annual equivalent 2.4 percent in Apr 2013. Adjustment to lower food prices caused annual equivalent inflation of minus 7.0 percent in May 2013 and minus 3.5 percent in annual equivalent in May-Jun 2013. Inflation in China returned at annual equivalent 3.8 percent in Jul-Aug 2013. The euro zone harmonized index of consumer prices (HICP) increased at annual equivalent 5.2 percent in Jan-Apr 2011, minus 2.4 percent in May-Jul 2011, 4.3 percent in Aug-Dec 2011, minus 3.0 percent in Dec 2011-Jan 2012 and then 9.6 percent in Feb-Apr 2012, falling to minus 2.8 percent annual equivalent in May-Jul 2012 but resuscitating at 5.3 percent in Aug-Oct 2012. The recent shock of risk aversion forced minus 2.4 percent annual equivalent in Nov 2012. As in several European countries, annual equivalent inflation jumped to 4.9 percent in the euro area in Dec 2012. The HICP price index fell at annual equivalent 11.4 percent in Jan 2013 and increased at 10.0 percent in Feb-Mar 2013. As in most countries and regions, euro zone inflation fell at the annual equivalent rate of 1.2 percent in Apr 2013. Prices in the euro zone rose at 1.2 percent in May-Jun 2013. Inflation in the euro zone fell at annual equivalent 5.8 percent in Jul 2013. Inflation returned in the euro zone at annual equivalent 1.2 percent in Aug 2013. The price indexes of the largest members of the euro zone, Germany, France and Italy, and the euro zone as a whole, exhibit the same inflation waves. The United Kingdom CPI increased at annual equivalent 6.5 percent in Jan-Apr 2011, falling to only 0.4 percent in May-Jul 2011 and then increasing at 4.6 percent in Aug-Nov 2011. UK consumer prices fell at 0.6 percent annual equivalent in Dec 2011 to Jan 2012 but increased at 6.2 percent annual equivalent from Feb to Apr 2012. In May-Jun 2012, with renewed risk aversion, UK consumer prices fell at the annual equivalent rate of minus 3.0 percent. Inflation returned in the UK at average annual equivalent of 4.5 percent in Jul-Dec 2012 with inflation in Oct 2012 caused mostly by increases of university tuition fees. Inflation returned at 4.5 percent annual equivalent in Jul-Dec 2012 and was higher in annual equivalent inflation of producer prices in the UK in Jul-Oct 2012 at 4.0 percent for output prices and 14.0 percent for input prices in Jul-Aug 2012 (see Table IA-1). Consumer prices in the UK fell at annual equivalent 5.8 percent in Jan 2013. Inflation returned in the UK with annual equivalent 4.3 percent in Feb-May 2013 and fell at 1.2 percent in Jun-Jul 2013. UK annual equivalent inflation returned at 4.9 percent in Aug 2013.
Table IA-2, Annual Equivalent Rates of Consumer Price Indexes
| Index 2011-2013 | AE ∆% |
| US Consumer Price Index | |
| AE ∆% May-Aug 2013 | 2.7 |
| AE ∆% Mar-Apr 2013 | -3.5 |
| AE ∆% Feb 2013 | 8.7 |
| AE ∆% Nov 2012-Jan 2013 | -0.8 |
| AE ∆% Aug-Oct 2012 | 4.9 |
| AE ∆% May-Jul 2012 | 0.0 |
| AE ∆% Feb-Apr 2012 | 2.4 |
| AE ∆% Dec 2011-Jan 2012 | 1.2 |
| AE ∆% Oct-Nov 2011 | 0.6 |
| AE ∆% Jul-Sep 2011 | 3.3 |
| AE ∆% May-Jun 2011 | 3.0 |
| AE ∆% Jan-Apr 2011 | 4.6 |
| China Consumer Price Index | |
| AE ∆% Jul-Aug 2013 | 3.8 |
| AE ∆% May-Jun 2013 | -3.5 |
| AE ∆% Apr 2013 | 2.4 |
| AE ∆% Mar 2013 | -10.3 |
| AE ∆% Dec 2012-Feb 2013 | 12.2 |
| AE ∆% Oct-Nov 2012 | 0.0 |
| AE ∆% Jul-Sep 2012 | 4.1 |
| AE ∆% Apr-Jun 2012 | -3.9 |
| AE ∆% Dec 2011-Mar 2012 | 5.8 |
| AE ∆% Jul-Nov 2011 | 2.9 |
| AE ∆% Apr-Jun 2011 | 2.0 |
| AE ∆% Jan-Mar 2011 | 8.3 |
| Euro Zone Harmonized Index of Consumer Prices | |
| AE ∆% Aug 2013 | 1.2 |
| AE ∆% Jul 2013 | -5.8 |
| AE ∆% May-Jun 2013 | 1.2 |
| AE ∆% Apr 2013 | -1.2 |
| AE ∆% Feb-Mar 2013 | 10.0 |
| AE ∆% Jan 2013 | -11.4 |
| AE ∆% Dec 2012 | 4.9 |
| AE ∆% Nov 2012 | -2.4 |
| AE ∆% Aug-Oct 2012 | 5.3 |
| AE ∆% May-Jul 2012 | -2.8 |
| AE ∆% Feb-Apr 2012 | 9.6 |
| AE ∆% Dec 2011-Jan 2012 | -3.0 |
| AE ∆% Aug-Nov 2011 | 4.3 |
| AE ∆% May-Jul 2011 | -2.4 |
| AE ∆% Jan-Apr 2011 | 5.2 |
| Germany Consumer Price Index | |
| AE ∆% May-Aug 2013 | 3.0 NSA 2.7 SA |
| AE ∆% Apr 2013 | -5.8 NSA 0.0 SA |
| AE ∆% Feb-Mar 2013 | 6.8 NSA 1.2 SA |
| AE ∆% Jan 2013 | -5.8 NSA –1.2 SA |
| AE ∆% Sep-Dec 2012 | 1.5 NSA 1.5 SA |
| AE ∆% Jul-Aug 2012 | 4.9 NSA 3.0 SA |
| AE ∆% May-Jun 2012 | -1.2 NSA 0.6 SA |
| AE ∆% Feb-Apr 2012 | 4.5 NSA 2.4 SA |
| AE ∆% Dec 2011-Jan 2012 | 0.6 NSA 1.8 SA |
| AE ∆% Jul-Nov 2011 | 1.7 NSA 1.9 SA |
| AE ∆% May-Jun 2011 | 0.6 NSA 3.0 SA |
| AE ∆% Feb-Apr 2011 | 3.0 NSA 2.4 SA |
| France Consumer Price Index | |
| AE ∆% Aug 2013 | 6.2 |
| AE ∆% Jul 2013 | -3.5 |
| AE ∆% May-Jun 2013 | 1.8 |
| AE ∆% Apr 2013 | -1.2 |
| AE ∆% Feb-Mar 2013 | 6.8 |
| AE ∆% Nov 2012-Jan 2013 | -1.6 |
| AE ∆% Aug-Oct 2012 | 2.8 |
| AE ∆% May-Jul 2012 | -2.4 |
| AE ∆% Feb-Apr 2012 | 5.3 |
| AE ∆% Dec 2011-Jan 2012 | 0.0 |
| AE ∆% Aug-Nov 2011 | 3.0 |
| AE ∆% May-Jul 2011 | -1.2 |
| AE ∆% Jan-Apr 2011 | 4.3 |
| Italy Consumer Price Index | |
| AE ∆% Dec 2012-Aug 2013 | 2.1 |
| AE ∆% Sep-Nov 2012 | -0.8 |
| AE ∆% Jul-Aug 2012 | 3.0 |
| AE ∆% May-Jun 2012 | 1.2 |
| AE ∆% Feb-Apr 2012 | 5.7 |
| AE ∆% Dec 2011-Jan 2012 | 4.3 |
| AE ∆% Oct-Nov 2011 | 3.0 |
| AE ∆% Jul-Sep 2011 | 2.4 |
| AE ∆% May-Jun 2011 | 1.2 |
| AE ∆% Jan-Apr 2011 | 4.9 |
| UK Consumer Price Index | |
| AE ∆% Aug 2013 | 4.9 |
| AE ∆% Jun-Jul 2013 | -1.2 |
| AE ∆% Feb-May 2013 | 4.3 |
| AE ∆% Jan 2013 | -5.8 |
| AE ∆% Jul-Dec 2012 | 4.5 |
| AE ∆% May-Jun 2012 | -3.0 |
| AE ∆% Feb-Apr 2012 | 6.2 |
| AE ∆% Dec 2011-Jan 2012 | -0.6 |
| AE ∆% Aug-Nov 2011 | 4.6 |
| AE ∆% May-Jul 2011 | 0.4 |
| AE ∆% Jan-Apr 2011 | 6.5 |
AE: Annual Equivalent
Sources: http://www.bls.gov/cpi/
http://www.stats.gov.cn/enGliSH/
http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database
https://www.destatis.de/EN/Homepage.html
http://www.insee.fr/en/default.asp
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013
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