CMP Associates Regulation Blog: Risks of Zero Interest Rates, Mediocre United States Economic Growth, Twenty Eight Million Unemployed/Underemployed, United States Trade, United States Housing Collapse, World Economic Slowdown and Global Recession Risk: Part I

Risks of Zero Interest Rates, Mediocre United States Economic Growth, Twenty Eight Million Unemployed/Underemployed, United States Trade, United States Housing Collapse, World Economic Slowdown and Global Recession Risk

Carlos M. Pelaez

Executive Summary

I Mediocre and Decelerating United States Economic Growth

IA Mediocre and Decelerating United States Economic Growth

IA1 Contracting Real Private Fixed Investment

IA2 Swelling Undistributed Corporate Profits

IB Stagnating Real Disposable Income and Consumption Expenditures

IB1 Stagnating Real Disposable Income and Consumption Expenditures

IB2 Financial Repression

II Twenty Nine Million Unemployed or Underemployed

IIA1 Summary of the Employment Situation

IIA2 Number of People in Job Stress

IIA3 Long-term and Cyclical Comparison of Employment

IIA4 Job Creation

IIB Stagnating Real Wages

IIC United States International Trade

IID United States Housing Collapse

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 Mediocre United States Economic Growth

ESIII Contracting Real Private Fixed Investment

ESIV Swelling Undistributed Corporate Profits

ESV Stagnating Real Disposable Per Capita Income

ESVI Twenty Eight Million Unemployed or Underemployed

ESVII Insufficient Job Creation

ESVIII Stagnating Real Wages

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 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 (2013WEOOct) provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2013/02/), of the world financial system with its Global Financial Stability Report (GFSR) (IMF 2013GFSROct) (http://www.imf.org/External/Pubs/FT/GFSR/2013/02/index.htm) and of fiscal affairs with the Fiscal Monitor (IMF 2013FMOct) (http://www.imf.org/external/pubs/ft/fm/2013/02/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 10.8 percent in IIQ2011 to 7.4 percent in IVQ2011 and 5.7 percent in IQ2012, rebounding to 9.1 percent in IIQ2012, 8.2 percent in IIIQ2012 and 7.8 percent in IVQ2012. Annual equivalent growth in IQ2013 fell to 6.1 percent and to 7.8 percent in IIQ2013, rebounding to 9.1 percent in IIIQ2013 (http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html 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 28.1 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/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.htm).

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

Chart VIII-1 of the Board of Governors of the Federal Reserve System provides the rate on the overnight fed funds rate and the yields of the 10-year constant maturity Treasury and the Baa seasoned corporate bond. Table VIII-3 provides the data for selected points in Chart VIII-1. There are two important economic and financial events, illustrating the ease of inducing carry trade with extremely low interest rates and the resulting financial crash and recession of abandoning extremely low interest rates.

The Federal Open Market Committee (FOMC) lowered the target of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85). 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. 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). The FOMC implemented increments of 25 basis points of the fed funds target from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006, as shown in Chart VIII-1. The gradual exit from the first round of unconventional monetary policy from 1.00 percent in Jun 2004 to 5.25 percent in Jun 2006 caused the financial crisis and global recession.
On Dec 16, 2008, the policy determining committee of the Fed decided (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm): “The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.” Policymakers emphasize frequently that there are tools to exit unconventional monetary policy at the right time. At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states that: “The Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.” Perception of withdrawal of $2511 billion, or $2.5 trillion bank reserves (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1), would cause Himalayan increase in interest rates that would provoke another recession. There is no painless gradual or sudden exit from zero interest rates because reversal of exposures created on the commitment of zero interest rates forever.

In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):

“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differfrom each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”

Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and r^e the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+r^e). Thus, g = [(r/r^e) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dr^e>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (10

Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.

Chart VIII-1, Fed Funds Rate and Yields of Ten-year Treasury Constant Maturity and Baa Seasoned Corporate Bond, Jan 2, 2001 to Nov 21, 2013

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/

Table VIII-3, Selected Data Points in Chart VIII-1, % per Year

	Fed Funds Overnight Rate	10-Year Treasury Constant Maturity	Seasoned Baa Corporate Bond
1/2/2001	6.67	4.92	7.91
10/1/2002	1.85	3.72	7.46
7/3/2003	0.96	3.67	6.39
6/22/2004	1.00	4.72	6.77
6/28/2006	5.06	5.25	6.94
9/17/2008	2.80	3.41	7.25
10/26/2008	0.09	2.16	8.00
10/31/2008	0.22	4.01	9.54
4/6/2009	0.14	2.95	8.63
4/5/2010	0.20	4.01	6.44
2/4/2011	0.17	3.68	6.25
7/25/2012	0.15	1.43	4.73
5/1/13	0.14	1.66	4.48
9/5/13	0.08	2.98	5.53
11/21/2013	0.09	2.79	5.44
11/27/13	0.09	2.74	5.34 (11/26/13)

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/

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 Dec 6, 2013, Sep 5, 2013, May 1, 2013, Dec 6, 2012 and Nov 6, 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. Assume that the yield of a bond with exactly ten years to maturity and coupon of 2.88 percent as occurred on Dec 6, 2013 would jump instantaneously from yield of 2.88 percent on Dec 6, 2013 to 4.48 percent as occurred on Dec 6, 2006 when the economy was closer to full employment. The price of the hypothetical bond issued with coupon of 2.75 percent would drop from 100 to 87.2168 after an instantaneous increase of the yield to 4.48 percent. The price loss would be 12.8 percent. Losses absorb capital available for positioning, triggering crossfire sales in multiple asset classes (Brunnermeier and Pedersen 2009). What is the path of adjustment of zero interest rates on fed funds and artificially low bond yields? There is no painless exit from unconventional monetary policy. 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

	12/6/13	9/05/13	5/01/13	12/6/12	12/6/06
1 M	0.03	0.03	0.03	0.07	4.91
3 M	0.06	0.02	0.06	0.10	4.99
6 M	0.10	0.06	0.08	0.14	5.05
1 Y	0.13	0.16	0.11	0.18	4.90
2 Y	0.30	0.52	0.20	0.25	4.59
3 Y	0.64	0.97	0.30	0.32	4.48
5 Y	1.51	1.85	0.65	0.60	4.44
7 Y	2.23	2.45	1.07	1.00	4.44
10 Y	2.88	2.98	1.66	1.59	4.48
20 Y	3.63	3.64	2.44	2.33	4.69
30 Y	3.90	3.88	2.83	2.76	4.60

Source: United States Treasury

http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

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, 4.58 percent on Aug 22, 2013 and 4.46 percent on Dec 5, 2013, which is the last data point in Chart VI-13.

Chart VI-13, US, Conventional Mortgage Rate, Jan 8, 2004 to Dec 5, 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 i_n be the nominal interest rate, i_r the real or inflation-adjusted interest rate and π^e 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 + i_r) = (1 + i_n)/(1 + π^e) (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 π^e 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 + r_r) = 0.9902

That is, i_r 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 π^e. 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 Oct 30, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20131030a.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?

At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states needs and intentions of policy:

“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time.

For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”

W = Y/r (10

The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). There is currently population growth in the ages of 16 to 24 years but not enough job creation and discouragement of job searches for all ages (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html). This is merely another case of theory without reality with dubious policy proposals.

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 σ_y and prices σ_p. 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 16,020.20

on Fri Nov 29, 2013, which is higher by 13.1 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 12.8 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs.

The DJIA closed at 16,064.77 on Fri Nov 22, 2013, which is higher by 13.4 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 13.1 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 65.4 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to Dec 6, 2013; S&P 500 has gained 76.5 percent and DAX 61.8 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 12/6/13” 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 6.1 percent below the trough. Japan’s Nikkei Average is 73.4 percent above the trough. DJ Asia Pacific TSM is 24.7 percent above the trough. Dow Global is 42.1 percent above the trough. STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 23.2 percent above the trough. NYSE Financial Index is 47.0 percent above the trough. DJ UBS Commodities is 1.1 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 61.8 percent above the trough. Japan’s Nikkei Average is 73.4 percent above the trough on Aug 31, 2010 and 34.3 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 15,299.86 on Fri Dec 6, 2013 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 49.2 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 15.0 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 12/6/13” in Table VI-4 shows increase of 0.7 percent in the week for China’s Shanghai Composite. DJ Asia Pacific decreased 1.6 percent. NYSE Financial decreased 0.9 percent in the week. DJ UBS Commodities increased 0.9 percent. Dow Global decreased 1.3 percent in the week of Dec 6, 2013. The DJIA decreased 0.4 percent and S&P 500 changed 0.0 percent. DAX of Germany decreased 2.5 percent. STOXX 50 decreased 2.4 percent. The USD depreciated 0.8 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 12/6/13” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Dec 6, 2013. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 12/6/13” but also relative to the peak in column “∆% Peak to 12/6/13.” There are now several equity indexes above the peak in Table VI-4: DJIA 43.0 percent, S&P 500 48.3 percent, DAX 44.9 percent, Dow Global 15.9 percent, DJ Asia Pacific 9.2 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 17.1 percent, Nikkei Average 34.3 percent and STOXX 50 4.4 percent. There is only one equity index below the peak: Shanghai Composite by 29.3 percent. DJ UBS Commodities Index is now 13.5 percent below the peak. The US dollar strengthened 9.4 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 increased 0.7 percent from $2,605.2 billion of 2009 dollars in IVQ2007 to $2,624.6 billion in IIIQ2013. As shown in Table IAI-2, real private fixed investment fell 3.7 percent from $2,586.3 billion of 2009 dollars in IVQ2007 to $2,490.7 billion in IIIQ2013. Growth of real private investment is mediocre for all but four quarters from IIQ2011 to IQ2012 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html). 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 $66.8 billion in IIQ2013 and $38.3 billion in IIIQ2013. 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 $56.9 billion and $43.0 billion in IIIQ2013. 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 $273.5 billion in IIQ2013. Net dividends fell at $179.7 billion in IIIQ2013. 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 $216.6 billion in IIQ2013. Undistributed profits with IVA and CCA rose at $222.8 billion in IIIQ2013. Undistributed profits of US corporations swelled 394.4 percent from $107.7 billion IQ2007 to $532.5 billion in IIIQ2013 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 $66.8 billion from $2020.6 billion in IQ2013 to $2087.4 billion at the quarterly rate of 3.3 percent. Corporate profits with IVA and CCA increased $38.3 billion from $2087.4 billion in IIQ2013 to $2125.7 billion in IIIQ2013 at the annual rate of 1.8 percent. (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_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. 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:

clip_image003

Where R_τ is expected revenue in the time horizon from τ =1 to T; C_τ 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_image003

declines. Equally, decline in expected revenue from the stock or project, R_τ, 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 12/6/ /13	∆% Week 12/6/13	∆% Trough to 12/6/ 13
DJIA	4/26/ 10	7/2/10	-13.6	43.0	-0.4	65.4
S&P 500	4/23/ 10	7/20/ 10	-16.0	48.3	0.0	76.5
NYSE Finance	4/15/ 10	7/2/10	-20.3	17.1	-0.9	47.0
Dow Global	4/15/ 10	7/2/10	-18.4	15.9	-1.3	42.1
Asia Pacific	4/15/ 10	7/2/10	-12.5	9.2	-1.6	24.7
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	34.3	-2.3	73.4
China Shang.	4/15/ 10	7/02 /10	-24.7	-29.3	0.7	-6.1
STOXX 50	4/15/10	7/2/10	-15.3	4.4	-2.4	23.2
DAX	4/26/ 10	5/25/ 10	-10.5	44.9	-2.5	61.8
Dollar Euro	11/25 2009	6/7 2010	21.2	9.4	-0.8	-15.0
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-13.5	0.9	1.1
10-Year T Note	4/5/ 10	4/6/10	3.986	2.784	2.858

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 Mediocre United States Economic Growth. The US is experiencing the first expansion from a recession after World War II with stressing socioeconomic conditions:

Mediocre economic growth below potential and long-term trend, resulting in idle productive resources (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html)
Private fixed investment declining 3.7 percent in the entire cycle from IVQ2007 to IIIQ2013 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html)
Twenty eight million or 17.2 percent of the effective labor force unemployed or underemployed in involuntary part-time jobs with stagnating or declining real wages (Section II and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html)
Stagnating real disposable income per person or income per person after inflation and taxes (Section IB and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html)
Depressed hiring that does not afford an opportunity for reducing unemployment/underemployment and moving to better-paid jobs (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html)
Unsustainable government deficit/debt and balance of payments deficit (http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html)
Worldwide waves of inflation (http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html)
Deteriorating terms of trade and net revenue margins in squeeze of economic activity by carry trades induced by zero interest rates (http://cmpassocregulationblog.blogspot.com/2013/10/world-inflation-waves-regional-economic.html)
Financial repression of interest rates and credit affecting the most people without means and access to sophisticated financial investments with likely adverse effects on income distribution and wealth disparity (Section IB and earlier http /cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html)
47 million in poverty and 48 million without health insurance with family income adjusted for inflation regressing to 1995 levels (http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html
Net worth of households and nonprofits organizations declining by 0.9 percent after adjusting for inflation in the entire cycle from IVQ2007 to IIQ2013 in contrast with growth at 3.0 percent in real terms from 1945 to 2012 (http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html)

Valuations of risk financial assets approach historical highs. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. US economic growth has been at only 2.3 percent on average in the cyclical expansion in the 17 quarters from IIIQ2009 to IIIQ2013. 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://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_2nd.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf

http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) and the second estimate of GDP for IIIQ2013 (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_2nd.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 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent, 5.4 percent from IQ1983 to IIIQ1986 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html). As a result, there are 28.1 million unemployed or underemployed in the United States for an effective unemployment rate of 17.2 percent (Section II and earlier) http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-mediocre-united.html).

The economy of the US can be summarized in growth of economic activity or GDP as decelerating from mediocre growth of 2.5 percent on an annual basis in 2010 to 1.8 percent in 2011 to 2.8 percent in 2012. The following calculations show that actual growth is around 1.9 to 2.4 percent per year. This rate is well below 3 percent per year in trend from 1870 to 2010, which the economy of the US always attained for entire cycles in expansions after events such as wars and recessions (Lucas 2011May).

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 IIIQ1986 was 5.4 percent. In contrast, average annual equivalent growth in the expansion from IIIQ2009 to IIIQ2013 was only 2.3 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 IVQ1985 IQ1983-IQ1986 IQ1983-IIIQ1986 IQ1983-IV1986 IQ1983-IQ1987	5.9 5.7 5.4 5.2 5.0
First Four Quarters IQ1983 to IVQ1983	7.8
IIIQ2009 to IIIQ2013	2.3
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://www.bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0813.pdf

http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf

http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_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/gdp/2013/pdf/gdp2q13_3rd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0813.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_adv.pdf) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace from 1.9 to 2.4 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 three quarters of 2013 accumulated to 3.8 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IIIQ2013 of $15,819.0 billion by GDP in IVQ2011 of $15,242.1 billion and compounding by 4/7: {[($15,819.0/$15,242.1)^4/6 -1]100 = 2.1.

2. Average Annual Growth in the First Three Quarters of 2013. GDP growth in the first three quarters of 2013 accumulated to 1.6 percent that is equivalent to 2.4 percent in a year. This is obtained by dividing GDP in IIIQ2013 of $15,819.0 by GDP in IVQ2012 of $15,539.6 and compounding by 4/3: {[($15,819.0/$15,539.6)^4/3 -1]100 = 2.4%}. The US economy grew 1.8 percent in IIIQ2013 relative to the same quarter a year earlier in IIIQ2012. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is just at the borderline of contraction. The rate of growth of GDP in the second estimate of IIIQ2013 is 3.6 percent in seasonally adjusted annual rate (SAAR). Inventory accumulation contributed 1.68 percentage points to this rate of growth. The actual rate without this impulse of unsold inventories would have been 1.92 percent, or 0.5 percent in IIIQ2013, such that annual equivalent growth in 2013 is closer to 1.9 percent {[(1.003)(1.006)(1.005)^4/3-1]100 = 1.9%}, compounding the quarterly rates and converting into annual equivalent.

Table Summary GDP, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%

	Real GDP, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
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	15,679.7	4.6	0.6	1.6
IIIQ2013	15,819.0	5.5	0.9	1.8
Cumulative ∆% IQ2012 to IIIQ2013	3.8		3.8
Annual Equivalent ∆%	2.1		2.1

Source: US Bureau of Economic Analysis

	Number of Quarters	Cumulative Growth ∆%	Average Annual Equivalent Growth Rate
IIIQ 1954 to IQ1957	11	12.8	4.5
First Four Quarters IIIQ1954 to IIQ1955	4	7.8
IIQ1958 to IIQ1959	5	10.0	7.9
First Four Quarters IIIQ1958 to IIQ1959	4	9.2
IIQ1975 to IVQ1976	8	8.3	4.1
First Four Quarters IIIQ1975 to IIQ1976	4	6.1
IQ1983-IQ1986 IQ1983-IIIQ1986 IQ1983-IVQ1986 IQ1983-IQ1987	13 15 16 17	19.9 21.6 22.3 23.1	5.7 5.4 5.2 5.0
First Four Quarters IQ1983 to IVQ1983	4	7.8
Average First Four Quarters in Four Expansions*		7.7
IIIQ2009 to IIIQ2013	17	10.2	2.3
First Four Quarters IIIQ2009 to IIQ2010		2.7

	Real PFI, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	2586.3	NA	-1.2	-1.4
IQ2008	2539.1	-1.8	-1.8	-3.0
IIQ2008	2503.4	-3.2	-1.4	-4.6
IIIQ2008	2424.1	-6.3	-3.2	-7.1
IV2008	2263.8	-12.5	-6.6	-12.5
IQ2009	2089.3	-19.2	-7.7	-17.7
IIQ2009	2011.0	-22.2	-3.7	-19.7
IIIQ2009	2008.4	-22.3	-0.1	-17.1
IVQ2009	1994.1	-22.9	-0.7	-11.9
IQ2010	1997.9	-22.8	0.2	-4.4
IIQ2010	2062.8	-20.2	3.2	2.6
IIIQ2010	2060.8	-20.3	-0.1	2.6
IVQ2010	2103.1	-18.7	2.1	5.5
IQ2011	2100.7	-18.8	-0.1	5.1
IIQ2011	2144.4	-17.1	2.1	4.0
IIIQ2011	2219.8	-14.2	3.5	7.7
IVQ2011	2273.4	-12.1	2.4	8.1
IQ2012	2320.8	-10.3	2.1	10.5
IIQ2012	2347.9	-9.2	1.2	9.5
IIIQ2012	2363.5	-8.6	0.7	6.5
IVQ2012	2429.1	-6.1	2.8	6.8
IQ2013	2420.0	-6.4	-0.4	4.3
IIQ2013	2458.4	-4.9	1.6	4.7
IIIQ2013	2,490.7	-3.7	1.3	5.4

	IIIQ2013	IIIQ2006	IIIQ2000
Gross Private Domestic Investment	16.2	19.3	19.8
Fixed Investment	15.3	18.7	19.3
Nonresidential	12.2	12.9	14.6
Structures	2.8	3.1	3.2
Equipment and Software	5.5	6.2	7.5
Intellectual Property	3.8	3.7	4.0
Residential	3.2	5.8	4.7
Change in Private Inventories	0.9	0.6	0.6

	IVQ2007	IIIQ2013	∆%
Current Billions of Dollars Seasonally Adjusted Annual Rates (SAAR)
Gross Value Added of Corporate Business	8,165.9	9,513.8	16.5
Consumption of Fixed Capital	1,216.5	1,428.7	17.4
Net Value Added	6,949.4	8,085.1	16.3
Compensation of Employees	4,945.8	5,414.0	9.5
Taxes on Production and Imports Less Subsidies	688.5	754.9	9.6
Net Operating Surplus	1,315.1	1,916.2	45.7
Net Interest and Misc	204.2	117.1	-42.7
Business Current Transfer Payment Net	68.9	93.2	35.3
Corporate Profits with IVA and CCA Adjustments	1,042.0	1,705.9	63.7
Taxes on Corporate Income	408.8	413.4	1.1
Profits after Tax with IVA and CCA Adjustment	633.2	1,292.4	104.1
Net Dividends	689.1	760.0	10.3
Undistributed Profits with IVA and CCA Adjustment	-55.9	532.5	NA
Billions of Chained USD 2009 SAAR
Gross Value Added of Nonfinancial Corporate Business	7,519.3	7,919.9	5.3
Consumption of Fixed Capital	1,066.0	1,172.8	10.0
Net Value Added	6,453.4	6,747.1	4.6

	IQ1980	IVQ1986	∆%
Current Billions of Dollars Seasonally Adjusted Annual Rates (SAAR)
Gross Value Added of Corporate Business	1,654.1	2,756.0	66.6
Consumption of Fixed Capital	200.5	357.7	78.4
Net Value Added	1,453.6	2,398.4	65.0
Compensation of Employees	1,072.9	1,765.1	64.5
Taxes on Production and Imports Less Subsidies	121.5	224.5	84.8
Net Operating Surplus	259.2	408.7	57.7
Net Interest and Misc.	50.4	106.0	110.3
Business Current Transfer Payment Net	11.5	26.3	128.7
Corporate Profits with IVA and CCA Adjustments	197.2	276.4	40.2
Taxes on Corporate Income	97.0	118.5	22.2
Profits after Tax with IVA and CCA Adjustment	100.2	158.0	57.7
Net Dividends	40.9	89.4	118.6
Undistributed Profits with IVA and CCA Adjustment	59.3	68.5	15.5
Billions of Chained USD 2009 SAAR
Gross Value Added of Nonfinancial Corporate Business	2,952.3	3,704.6	25.5
Consumption of Fixed Capital	315.6	428.0	35.6
Net Value Added	2,636.7	3,276.6	24.3

	IVQ2007	IIIQ2013
Price per Unit of Real Gross Value Added of Nonfinancial Corporate Business	0.961	1.052
Compensation of Employees (Unit Labor Cost)	0.577	0.600
Unit Nonlabor Cost	0.270	0.294
Consumption of Fixed Capital	0.140	0.157
Taxes on Production and Imports less Subsidies plus Business Current Transfer Payments (net)	0.093	0.098
Net Interest and Misc. Payments	0.037	0.039
Corporate Profits with IVA and CCA Adjustment (Unit Profits from Current Production)	0.114	0.157
Taxes on Corporate Income	0.038	0.033
Profits after Tax with IVA and CCA Adjustment	0.076	0.123
	IQ1980	IVQ1986
Price per Unit of Real Gross Value Added of Nonfinancial Corporate Business	0.518	0.678
Compensation of Employees (Unit Labor Cost)	0.340	0.436
Unit Nonlabor Cost	0.124	0.181
Consumption of Fixed Capital	0.064	0.087
Taxes on Production and Imports less Subsidies plus Business Current Transfer Payments (net)	0.042	0.064
Net Interest and Misc. Payments	0.018	0.030
Corporate Profits with IVA and CCA Adjustment (Unit Profits from Current Production)	0.055	0.060
Taxes on Corporate Income	0.026	0.023
Profits after Tax with IVA and CCA Adjustment	0.029	0.037

RDPI Average ∆%
1929-2012	3.2
1947-1999	3.7
1999-2012	2.4
1999-2006	3.2
1980-1989	3.5
2006-2012	1.4
RDPIPC Average ∆%
1929-2012	2.0
1947-1999	2.3
1999-2012	1.5
1999-2006	2.2
1980-1989	2.6
2006-2012	0.6

	2006	Nov 2012	Oct 2013	Nov 2013
POP	229	244.174	246,381	246,567
LF	151	154,953	154,918	155,046
PART%	66.2	63.5	62.9	62.9
EMP	144	143,549	144,144	144,775
EMP/POP%	62.9	58.8	58.5	58.7
UEM	7	11,404	10,773	10,271
UEM/LF Rate%	4.6	7.4	7.0	6.6
NLF	77	89,221	91,463	91,521
LF PART 66.2%		161,643	163,104	163,227
∆NLF UEM		6,690	8,186	8,181
Total UEM		18,094	18,959	18,452
Total UEM%		11.2	11.6	11.3
Part Time Economic Reasons		7,994	7,700	7,563
Marginally Attached to LF		2,505	2,283	2,096
In Job Stress		28,593	28,942	28,111
People in Job Stress as % Labor Force		17.7	17.7	17.2

Year	Apr	May	Jun	Jul	Aug	Sep	Oct	Nov	Dec	Annual
1979	62.9	62.9	64.5	64.9	64.5	63.8	64.0	63.8	63.8	63.7
1980	63.2	63.5	64.6	65.1	64.5	63.6	63.9	63.7	63.4	63.8
1981	63.6	63.9	64.6	65.0	64.6	63.5	64.0	63.8	63.4	63.9
1982	63.3	63.9	64.8	65.3	64.9	64.0	64.1	64.1	63.8	64.0
1983	63.2	63.4	65.1	65.4	65.1	64.3	64.1	64.1	63.8	64.0
1984	63.7	64.3	65.5	65.9	65.2	64.4	64.6	64.4	64.3	64.4
1985	64.3	64.6	65.5	65.9	65.4	64.9	65.1	64.9	64.6	64.8
1986	64.6	65.0	66.3	66.6	66.1	65.3	65.5	65.4	65.0	65.3
1987	64.9	65.6	66.3	66.8	66.5	65.5	65.9	65.7	65.5	65.6
1988	65.3	65.5	66.7	67.1	66.8	65.9	66.1	66.2	65.9	65.9
1989	65.9	66.2	67.4	67.7	67.2	66.3	66.6	66.7	66.3	66.5
1990	66.1	66.5	67.4	67.7	67.1	66.4	66.5	66.3	66.1	66.5
1991	66.0	66.0	67.2	67.3	66.6	66.1	66.1	66.0	65.8	66.2
1992	66.0	66.4	67.6	67.9	67.2	66.3	66.2	66.2	66.1	66.4
1993	65.6	66.3	67.3	67.5	67.0	66.1	66.4	66.3	66.2	66.3
1994	66.0	66.5	67.2	67.5	67.2	66.5	66.8	66.7	66.5	66.6
1995	66.4	66.4	67.2	67.7	67.1	66.5	66.7	66.5	66.2	66.6
1996	66.2	66.7	67.4	67.9	67.2	66.8	67.1	67.0	66.7	66.8
1997	66.7	67.0	67.8	68.1	67.6	67.0	67.1	67.1	67.0	67.1
1998	66.6	67.0	67.7	67.9	67.3	67.0	67.1	67.1	67.0	67.1
1999	66.7	67.0	67.7	67.9	67.3	66.8	67.0	67.0	67.0	67.1
2000	67.0	67.0	67.7	67.6	67.2	66.7	66.9	66.9	67.0	67.1
2001	66.7	66.6	67.2	67.4	66.8	66.6	66.7	66.6	66.6	66.8
2002	66.4	66.5	67.1	67.2	66.8	66.6	66.6	66.3	66.2	66.6
2003	66.2	66.2	67.0	66.8	66.3	65.9	66.1	66.1	65.8	66.2
2004	65.7	65.8	66.5	66.8	66.2	65.7	66.0	66.1	65.8	66.0
2005	65.8	66.0	66.5	66.8	66.5	66.1	66.2	66.1	65.9	66.0
2006	65.8	66.0	66.7	66.9	66.5	66.1	66.4	66.4	66.3	66.2
2007	65.7	65.8	66.6	66.8	66.1	66.0	66.0	66.1	65.9	66.0
2008	65.7	66.0	66.6	66.8	66.4	65.9	66.1	65.8	65.7	66.0
2009	65.4	65.5	66.2	66.2	65.6	65.0	64.9	64.9	64.4	65.4
2010	64.9	64.8	65.1	65.3	65.0	64.6	64.4	64.4	64.1	64.7
2011	63.9	64.1	64.5	64.6	64.3	64.2	64.1	63.9	63.8	64.1
2012	63.4	63.8	64.3	64.3	63.7	63.6	63.8	63.5	63.4	63.7
2013	63.1	63.5	64.0	64.0	63.4	63.2	62.9	62.9

Month	1981	1982	1983	2008	2009	2010	Private
Jan	95	-327	225	14	-794	-13	-17
Feb	67	-6	-78	-85	-695	-40	-26
Mar	104	-129	173	-79	-830	154	111
Apr	74	-281	276	-215	-704	229	170
May	10	-45	277	-186	-352	521	102
Jun	196	-243	378	-169	-472	-130	94
Jul	112	-343	418	-216	-351	-86	103
Aug	-36	-158	-308	-270	-210	-37	129
Sep	-87	-181	1114	-459	-233	-43	113
Oct	-100	-277	271	-472	-170	228	188
Nov	-209	-124	352	-775	-21	144	154
Dec	-278	-14	356	-705	-220	95	114
			1984			2011	Private
Jan			447			69	80
Feb			479			196	243
Mar			275			205	223
Apr			363			304	303
May			308			115	183
Jun			379			209	177
Jul			312			78	206
Aug			241			132	129
Sep			311			225	256
Oct			286			166	174
Nov			349			174	197
Dec			127			230	249
			1985			2012	Private
Jan			266			311	323
Feb			124			271	265
Mar			346			205	208
Apr			195			112	120
May			274			125	152
Jun			145			87	78
Jul			189			153	177
Aug			193			165	131
Sep			204			138	118
Oct			187			160	217
Nov			209			247	256
Dec			168			219	224
			1985			2013	Private
Jan			123			148	164
Feb			107			332	319
Mar			93			142	154
Apr			188			199	188
May			125			176	187
Jun			-93			172	194
Jul			318			89	100
Aug			113			238	207
Sep			346			175	168
Oct			187			200	214
Nov			186			203	196
Dec			204

Year	Mar	Apr	May	Jun	Jul	Aug	Sep	Oct
2006	10.05	10.11	9.92	9.89	9.97	9.88	10.03	10.17
2007	10.14	10.18	10.02	9.99	10.08	10.03	10.16	10.08
2008	10.11	10.00	9.91	9.84	9.77	9.83	9.94	10.06
2009	10.47	10.40	10.32	10.20	10.23	10.29	10.30	10.32
2010	10.35	10.35	10.38	10.27	10.29	10.34	10.36	10.39
2011	10.26	10.22	10.22	10.12	10.17	10.10	10.17	10.30
2012	10.21	10.28	10.16	10.15	10.27	10.11	10.24	10.18
∆%12M	-0.5	0.6	-0.6	0.3	1.0	0.1	0.7	-1.2
2013	10.25	10.30	10.22	10.26	10.20	10.18	10.33	10.30
∆%12M	0.4	0.2	0.6	1.1	-0.7	0.7	0.9	1.2

Year	May	Jun	Jul	Aug	Sep	Oct
2006	340.12	342.08	347.97	341.76	346.19	354.88
2007	344.58	346.74	351.68	347.98	355.72	347.92
2008	340.93	343.40	337.06	340.18	341.83	345.95
2009	347.94	344.59	345.92	352.80	347.04	348.83
2010	356.97	350.13	352.02	358.90	353.27	356.47
2011	353.56	348.08	349.75	347.42	349.93	359.60
2012	348.65	349.28	357.26	348.93	357.44	349.20
∆%12M	-1.4	0.3	2.1	0.4	2.1	-2.9
2013	350.59	357.96	350.93	352.25	360.40	354.39
∆%12M	0.6	2.5	-1.8	1.0	0.8	1.5

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Monday, December 9, 2013

Risks of Zero Interest Rates, Mediocre United States Economic Growth, Twenty Eight Million Unemployed/Underemployed, United States Trade, United States Housing Collapse, World Economic Slowdown and Global Recession Risk: Part I

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