CMP Associates Regulation Blog: IMF View, World Inflation Waves, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, United States Industrial Production, Collapse of United States Dynamism of Income Growth and Employment Creation, World Cyclical Slow Growth and Global Recession Risk: Part I

IMF View, World Inflation Waves, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, United States Industrial Production, Collapse of United States Dynamism of Income Growth and Employment Creation, World Cyclical Slow Growth and Global Recession Risk

Carlos M. Pelaez

Executive Summary

I World Inflation Waves

IA Appendix: Transmission of Unconventional Monetary Policy

IB1 Theory

IB2 Policy

IB3 Evidence

IB4 Unwinding Strategy

IB United States Inflation

IC Long-term US Inflation

ID Current US Inflation

IE Theory and Reality of Economic History, Cyclical Slow Growth Not Secular Stagnation and Monetary Policy Based on Fear of Deflation

IB Collapse of United States Dynamism of Income Growth and Employment Creation

II IMF View

IIA United States Industrial Production

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 IMF View

ESIII World Inflation Waves

ESIV Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates

ESV United States Industrial Production

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 provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/ns/cs.aspx?id=29), of the world financial system with its Global Financial Stability Report (GFSR) (http://www.imf.org/external/pubs/ft/gfsr/index.htm) and of fiscal affairs with the Fiscal Monitor (http://www.imf.org/external/ns/cs.aspx?id=262). 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 5.7 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 6.1 percent and to 7.4 percent in IIQ2013, rebounding to 9.5 percent in IIIQ2013. Annual equivalent growth was 7.0 percent in IVQ2013, declining to 5.7 percent in IQ2014 (Section VC and earlier http://cmpassocregulationblog.blogspot.com/2014/01/capital-flows-exchange-rates-and.html and earlier 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). There is also concern about indebtedness, move to devaluation and deep policy reforms.
United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 28.2 million in job stress, fewer 10 million full-time jobs, high youth unemployment, historically low hiring and declining/stagnating real wages. Actual GDP is about two trillion dollars lower than trend GDP.
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 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/03/interest-rate-risks-world-inflation.html and earlier http://cmpassocregulationblog.blogspot.com/2014/02/squeeze-of-economic-activity-by-carry.html). There is growing concern on capital outflows and currency depreciation of emerging markets.

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 with alternating episodes of revaluation.
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 by the penalty in the form of low interest rates and unsound credit decisions. 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 (http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040630/default.htm) to 5.25 percent in Jun 2006 (http://www.federalreserve.gov/newsevents/press/monetary/20060629a.htm) 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 $2671 billion, or $2.7 trillion, of 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 differ from 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 (Friedman 1957). 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 (1)

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 Apr 17, 2014

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
11/26/13	0.09	2.74	5.34 (11/26/13)
12/5/13	0.09	2.88	5.47
12/11/13	0.09	2.89	5.42
12/18/13	0.09	2.94	5.36
12/26/13	0.08	3.00	5.37
1/1/2014	0.08	3.00	5.34
1/8/2014	0.07	2.97	5.28
1/15/2014	0.07	2.86	5.18
1/22/2014	0.07	2.79	5.11
1/30/2014	0.07	2.72	5.08
2/6/2014	0.07	2.73	5.13
2/13/2014	0.06	2.73	5.12
2/20/14	0.07	2.76	5.15
2/27/14	0.07	2.65	5.01
3/6/14	0.08	2.74	5.11
3/13/14	0.08	2.66	5.05
3/20/14	0.08	2.79	5.13
3/27/14	0.08	2.69	4.95
4/3/14	0.08	2.80	5.04
4/10/14	0.08	2.65	4.89
4/17/14	0.09	2.73	4.89

Source: Board of Governors of the Federal Reserve System

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

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 Mar 19, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140319a.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 remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.” (emphasis added).

How long is “considerable time”? At the press conference following the meeting on Mar 19, 2014, Chair Yellen answered a question of Jon Hilsenrath of the Wall Street Journal explaining “In particular, the Committee has endorsed the view that it anticipates that will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates. And of course on our present path, well, that's not utterly preset. We would be looking at next, next fall. So, I think that's important guidance” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140319.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”

Chart S provides the yield of the two-year Treasury constant maturity from Mar 17, 2014, two days before the guidance of Chair Yellen on Mar 19, 2014, to Apr 17, 2014. Chart SA provides the yield of the ten-year Treasury constant maturity in the same dates. Both yields increased right after the guidance of Chair Yellen. The two-year yield remain at a higher level than before while the ten-year yield fell and increased again. There could be more immediate impact on two-year yields of an increase in the fed funds rates but the effects would spread throughout the term structure of interest rates (Cox, Ingersoll and Ross 1981, 1985, Ingersoll 1987). Both yields converged toward earlier levels in the week of Apr 17, 2014 with reallocation of portfolios of risk financial assets away from equities and into bonds and commodities.

Chart S, US, Yield of Two-Year Treasury Constant Maturity, Mar 17 to Apr 17, 2014

Source: Board of Governors of the Federal Reserve System

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

Chart SA, US, Yield of Ten-Year Treasury Constant Maturity, Mar 17 to Apr 17, 2014

Source: Board of Governors of the Federal Reserve System

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

At a speech on Mar 31, 2014, Chair Yellen analyzed labor market conditions as follows (http://www.federalreserve.gov/newsevents/speech/yellen20140331a.htm):

“And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress. The first of those goals is maximum sustainable employment, the highest level of employment that can be sustained while maintaining a stable inflation rate. Most of my colleagues on the Federal Open Market Committee and I estimate that the unemployment rate consistent with maximum sustainable employment is now between 5.2 percent and 5.6 percent, well below the 6.7 percent rate in February.

Let me explain what I mean by that word "slack" and why it is so important.

Slack means that there are significantly more people willing and capable of filling a job than there are jobs for them to fill. During a period of little or no slack, there still may be vacant jobs and people who want to work, but a large share of those willing to work lack the skills or are otherwise not well suited for the jobs that are available. With 6.7 percent unemployment, it might seem that there must be a lot of slack in the U.S. economy, but there are reasons why that may not be true.”

It is quite difficult to measure inflationary expectations because they tend to break abruptly from past inflation. There could still be an influence of past and current inflation in the calculation of future inflation by economic agents. Table VIII-1 provides inflation of the CPI. In the three months Jan 2014 to Mar 2014, CPI inflation for all items seasonally adjusted was 1.6 percent in annual equivalent, obtained by calculating accumulated inflation from Jan 2013 to Mar 2014 and compounding for a full year. In the 12 months ending in Mar 2014, CPI inflation of all items not seasonally adjusted was 1.5 percent. Inflation in Mar 2014 seasonally adjusted was 0.2 percent relative to Feb 2014, or 2.4 percent annual equivalent (http://www.bls.gov/cpi/). The second row provides the same measurements for the CPI of all items excluding food and energy: 1.7 percent in 12 months and 1.6 percent in annual equivalent Dec 2013-Feb 2014. The Wall Street Journal provides the yield curve of US Treasury securities (http://professional.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3000). The shortest term is 0.023 percent for one month, 0.030 percent for three months, 0.056 percent for six months, 0.096 percent for one year, 0.403 percent for two years, 0.912 percent for three years, 1.734 percent for five years, 2.301 percent for seven years, 2.723 percent for ten years and 3.521 percent for 30 years. The Irving Fisher (1930) definition of real interest rates is approximately the difference between nominal interest rates, which are those estimated by the Wall Street Journal, and the rate of inflation expected in the term of the security, which could behave as in Table VIII-1. Inflation in Mar 2014 is low in 12 months because of the unwinding of carry trades from zero interest rates to commodity futures prices but could ignite again with subdued risk aversion. Real interest rates in the US have been negative during substantial periods in the past decade while monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”

Negative real rates of interest distort calculations of risk and returns from capital budgeting by firms, through lending by financial intermediaries to decisions on savings, housing and purchases of households. Inflation on near zero interest rates misallocates resources away from their most productive uses and creates uncertainty of the future path of adjustment to higher interest rates that inhibit sound decisions.

Table VIII-1, US, Consumer Price Index Percentage Change 12 Months NSA and Annual Equivalent

	∆% 12 Months Mar 2014/Mar 2013 NSA	∆% Annual Equivalent Jan 2014 to Mar 2014 SA
CPI All Items	1.5	1.6
CPI ex Food and Energy	1.7	1.6

Source: Bureau of Labor Statistics

http://www.bls.gov/cpi/

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 State, 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 and riskier asset classes resulting from the debate within and outside the Fed on tapering quantitative easing. Table VIII-2 provides the yield curve of Treasury securities on Apr 17, 2014, Dec 31, 2013, May 1, 2013, Apr 17, 2013 and Apr 17, 2006. There is oscillating 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 3.04 percent on Dec 31, 2013 and 2.63 percent on Apr 11, 2014, as measured by the United States Treasury. Assume that a bond with maturity in 10 years were issued on Dec 31, 2013, at par or price of 100 with coupon of 1.45 percent. The price of that bond would be 86.3778 with instantaneous increase of the yield to 3.04 percent for loss of 13.6 percent and far more with leverage. Assume that the yield of a bond with exactly ten years to maturity and coupon of 2.73 percent as occurred on Apr 17, 2013 would jump instantaneously from yield of 2.73 percent on Apr 17, 2014 to 5.01 percent as occurred on Apr 17, 2006 when the economy was closer to full employment. The price of the hypothetical bond issued with coupon of 2.73 percent would drop from 100 to 82.2368 after an instantaneous increase of the yield to 5.01 percent. The price loss would be 17.8 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

	4/17/14	12/31/13	5/01/13	4/17/13	4/17/06
1 M	0.02	0.01	0.03	0.05	4.55
3 M	0.03	0.07	0.06	0.06	4.72
6 M	0.05	0.10	0.08	0.09	4.93
1 Y	0.11	0.13	0.11	0.13	4.93
2 Y	0.43	0.38	0.20	0.24	4.91
3 Y	0.91	0.78	0.30	0.35	4.91
5 Y	1.75	1.75	0.65	0.71	4.93
7 Y	2.31	2.45	1.07	1.13	4.96
10 Y	2.73	3.04	1.66	1.73	5.01
20 Y	3.27	3.72	2.44	2.51	5.25
30 Y	3.52	3.96	2.83	2.89	5.08

M: Months; Y: Years

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 with amplifying fluctuations. 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 4.27 percent on Apr 17, 2014, which is the last data point in Chart VI-13. Shayndi Raice and Nick Timiraos, writing on “Banks cut as mortgage boom ends,” on Jan 9, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303754404579310940019239208), analyze the drop in mortgage applications to a 13-year low, as measured by the Mortgage Bankers Association.

Chart VI-13, US, Conventional Mortgage Rate, Jan 8, 2004 to Apr 17, 2014

Source: Board of Governors of the Federal Reserve System

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

There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table VI-7G when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table VI-7G shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.

Table VI-7G, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994

1994	FF	30Y	30P	10Y	10P	MOR	CPI
Jan	3.00	6.29	100	5.75	100	7.06	2.52
Feb	3.25	6.49	97.37	5.97	98.36	7.15	2.51
Mar	3.50	6.91	92.19	6.48	94.69	7.68	2.51
Apr	3.75	7.27	88.10	6.97	91.32	8.32	2.36
May	4.25	7.41	86.59	7.18	88.93	8.60	2.29
Jun	4.25	7.40	86.69	7.10	90.45	8.40	2.49
Jul	4.25	7.58	84.81	7.30	89.14	8.61	2.77
Aug	4.75	7.49	85.74	7.24	89.53	8.51	2.69
Sep	4.75	7.71	83.49	7.46	88.10	8.64	2.96
Oct	4.75	7.94	81.23	7.74	86.33	8.93	2.61
Nov	5.50	8.08	79.90	7.96	84.96	9.17	2.67
Dec	6.00	7.87	81.91	7.81	85.89	9.20	2.67

Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months

Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t

Chart VI-14 provides the overnight fed funds rate, the yield of the 10-year Treasury constant maturity bond, the yield of the 30-year constant maturity bond and the conventional mortgage rate from Jan 1991 to Dec 1996. In Jan 1991, the fed funds rate was 6.91 percent, the 10-year Treasury yield 8.09 percent, the 30-year Treasury yield 8.27 percent and the conventional mortgage rate 9.64 percent. Before monetary policy tightening in Oct 1993, the rates and yields were 2.99 percent for the fed funds, 5.33 percent for the 10-year Treasury, 5.94 for the 30-year Treasury and 6.83 percent for the conventional mortgage rate. After tightening in Nov 1994, the rates and yields were 5.29 percent for the fed funds rate, 7.96 percent for the 10-year Treasury, 8.08 percent for the 30-year Treasury and 9.17 percent for the conventional mortgage rate.

Chart VI-14, US, Overnight Fed Funds Rate, 10-Year Treasury Constant Maturity, 30-Year Treasury Constant Maturity and Conventional Mortgage Rate, Monthly, Jan 1991 to Dec 1996

Source: Board of Governors of the Federal Reserve System

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

Chart VI-15 of the Bureau of Labor Statistics provides the all items consumer price index from Jan 1991 to Dec 1996. There does not appear acceleration of consumer prices requiring aggressive tightening.

Chart VI-15, US, Consumer Price Index All Items, Jan 1991 to Dec 1996

Source: Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

Chart IV-16 of the Bureau of Labor Statistics provides 12-month percentage changes of the all items consumer price index from Jan 1991 to Dec 1996. Inflation collapsed during the recession from Jul 1990 (III) and Mar 1991 (I) and the end of the Kuwait War on Feb 25, 1991 that stabilized world oil markets. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). Policy tightening had adverse collateral effects in the form of emerging market crises in Mexico and Argentina and fixed income markets worldwide.

Chart VI-16, US, Consumer Price Index All Items, Twelve-Month Percentage Change, Jan 1991 to Dec 1996

Source: Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

Table VI-2 extracts four rows of Table VI-1 with the Dollar/EUR (USD/EUR) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 25.1 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul, 2010, shown in Table VI-4 below, the dollar has devalued again to USD 1.3813/EUR on Apr 18, 2014 or by 15.9 percent {[(1.3813/1.192)-1]100 = 15.9%}. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. Risk aversion erodes devaluation of the dollar. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD subsequently revaluing to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent. After fixing again the CNY to the dollar, China revalued to CNY 6.2377/USD on Fri Apr 18, 2014, or by an additional 8.6 percent, for cumulative revaluation of 24.6 percent. The final row of Table VI-2 shows: devaluation of 1.2 percent in the week of Mar 21, 2014; revaluation of 0.2 percent in the week of Mar 28, 2014; change of 0.0 percent the week of Apr 4, 2014; and no change in the week of Apr 11, 2014. There could be reversal of revaluation to devalue the Yuan.

Table VI-2, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate

USD/EUR	12/26/03	7/14/08	6/07/10	4/18/14
Rate	1.1423	1.5914	1.192	1.3813
CNY/USD	01/03 2000	07/21 2005	7/15 2008	4/18/ 2014
Rate	8.2798	8.2765	6.8211	6.2377
Weekly Rates	3/28/2014	4/4/2014	4/11/2014	4/18/ 2014
CNY/USD	6.2130	6.2130	6.2111	6.2377
∆% from Earlier Week*	0.2	0.0	0.0	-0.4

*Negative sign is depreciation; positive sign is appreciation

Source: http://professional.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000

Professor Edward P Lazear (2013Jan7), writing on “Chinese ‘currency manipulation’ is not the problem,” on Jan 7, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323320404578213203581231448.html), provides clear thought on the role of the yuan in trade between China and the United States and trade between China and Europe. There is conventional wisdom that Chinese exchange rate policy causes the loss of manufacturing jobs in the United States, which is shown by Lazear (2013Jan7) to be erroneous. The fact is that manipulation of the CNY/USD rate by China has only minor effects on US employment. Lazear (2013Jan7) shows that the movement of monthly exports of China to its major trading partners, United States and Europe, since 1995 cannot be explained by the fixing of the CNY/USD rate by China. The period is quite useful because it includes rapid growth before 2007, contraction until 2009 and weak subsequent expansion. Chart VI-1 of the Board of Governors of the Federal Reserve System provides the CNY/USD exchange rate from Jan 3, 1995 to Apr 11, 2014 together with US recession dates in shaded areas. China fixed the CNY/USD rate for a long period as shown in the horizontal segment from 1995 to 2005. There was systematic revaluation of 17.6 percent from CNY 8.2765 on Jul 21, 2005 to CNY 6.8211 on Jul 15, 2008. China fixed the CNY/USD rate until Jun 7, 2010, to avoid adverse effects on its economy from the global recession, which is shown as a horizontal segment from 2009 until mid 2010. China then continued the policy of appreciation of the CNY relative to the USD with oscillations until the beginning of 2012 when the rate began to move sideways followed by a final upward slope of devaluation that is measured in Table VI-2A but virtually disappeared in the rate of CNY 6.3589/USD on Aug 17, 2012 and was nearly unchanged at CNY 6.3558/USD on Aug 24, 2012. China then appreciated 0.2 percent in the week of Dec 21, 2012, to CNY 6.2352/USD for cumulative 1.9 percent revaluation from Oct 28, 2011 and left the rate virtually unchanged at CNY 6.2316/USD on Jan 11, 2013, appreciating to CNY 6.2111/USD on Apr 11, 2014, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD by 25.0 percent by Apr 4, 2014 has not reduced the trade surplus of China but reversal of the policy of revaluation could result in international confrontation. The interruption with upward slope in the final segment on the right of Chart VI-I is measured as virtually stability in Table VI-2A followed with decrease or revaluation and subsequent increase or devaluation. Linglin Wei, writing on “China intervenes to lower yuan,” on Feb 26, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304071004579406810684766716?KEYWORDS=china+yuan&mg=reno64-wsj), finds from informed sources that the central bank of China conducted the ongoing devaluation of the yuan with the objective of driving out arbitrageurs to widen the band of fluctuation. There is concern if the policy of revaluation is changing to devaluation.

Chart VI-1, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 3, 1995-Apr 11, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

Chart VI-1A provides the daily CNY/USD rate from Jan 5, 1981 to Apr 11, 2014. The exchange rate was CNY 1.5418/USD on Jan 5, 1981. There is sharp cumulative depreciation of 107.8 percent to CNY 3.2031 by Jul 2, 1986, continuing to CNY 5.8145/USD on Dec 29, 1993 for cumulative 277.1 percent since Jan 5, 1981. China then devalued sharply to CNY 8.7117/USD on Jan 7, 1994 for 49.8 percent relative to Dec 29, 1993 and cumulative 465.0 percent relative to Jan 5, 1981. China then fixed the rate at CNY 8.2765/USD until Jul 21, 2005 and revalued as analyzed in Chart VI-1. The final data point in Chart VI-1A is CNY 6.2111/USD on Apr 11, 2014. To be sure, China fixed the exchange rate after substantial prior devaluation. It is unlikely that the devaluation could have been effective after many years of fixing the exchange rate with high inflation and multiple changes in the world economy. The argument of Lazear (2013Jan7) is still valid in view of the lack of association between monthly exports of China to the US and Europe since 1995 and the exchange rate of China.

Chart VI-1A, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 5, 1981-Apr 11, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

Chart VI-1B provides fine details with the rate of Chinese Yuan (CNY) to the US Dollar (USD) from Oct 28, 2011 to Apr 11, 2014. There have been alternations of revaluation and devaluation. The initial data point is CNY 6.3570 on Oct 28, 2011. There is an episode of devaluation from CNY 6.2790 on Apr 30, 2012 to CNY 6.3879 on Jul 25, 2012, or devaluation of 1.7 percent. Another devaluation is from CNY 6.042/USD on Jan 4, 2014 to CNY 6.2111 on Apr 11, 2014, or devaluation of 2.8 percent.

Chart VI-1B, Chinese Yuan (CNY) per US Dollar (US), Business Days, Oct 28, 2011-Apr 11, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

Carry trades induced by zero interest rates increase capital flows into emerging markets that appreciate exchange rates. Portfolio reallocations away from emerging markets depreciate their exchange rates in reversals of capital flows. Chart VI-4A provides the exchange rate of the Mexican peso (MXN) per US dollar from Nov 8, 1993 to Apr 11, 2014. The first data point in Chart VI-4A is MXN 3.1520 on Nov 8, 1993. The rate devalued to 11.9760 on Nov 14, 1995 during emerging market crises in the 1990s and the increase of interest rates in the US in 1994 that stressed world financial markets (Pelaez and Pelaez, International Financial Architecture 2005, The Global Recession Risk 2007, 147-77). The MXN depreciated sharply to MXN 15.4060/USD on Mar 2, 2009, during the global recession. The rate moved to MXN 11.5050/USD on May 2, 2011, during the sovereign debt crisis in the euro area. The rate depreciated to 11.9760 on May 9, 2013. The final data point in the current flight from emerging markets is MXN 13.0740/USD on Apr 11, 2014.

Chart VI-4A, Mexican Peso (MXN) per US Dollar (USD), Nov 8, 1993 to Apr 11, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

There are collateral effects worldwide from unconventional monetary policy. In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Professor Rajan, in an interview with Kartik Goyal of Bloomberg (http://www.bloomberg.com/news/2014-01-30/rajan-warns-of-global-policy-breakdown-as-emerging-markets-slide.html), warns of breakdown of global policy coordination. Professor Willem Buiter (2014Feb4), a distinguished economist currently Global Chief Economist at Citigroup (http://www.willembuiter.com/resume.pdf), writing on “The Fed’s bad manners risk offending foreigners,” on Feb 4, 2014, published in the Financial Times (http://www.ft.com/intl/cms/s/0/fbb09572-8d8d-11e3-9dbb-00144feab7de.html#axzz2suwrwkFs), concurs with Raghuram Rajan. Buiter (2014Feb4) argues that international policy cooperation in monetary policy is both in the interest of the world and the United States. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows. In a speech at the Brookings Institution on Raghuram G. Rajan (2014Apr10, 1, 10) argues:

“As the world seems to be struggling back to its feet after the great financial crisis, I want to draw attention to an area we need to be concerned about: the conduct of monetary policy in this integrated world. A good way to describe the current environment is one of extreme monetary easing through unconventional policies. In a world where debt overhangs and the need for structural change constrain domestic demand, a sizeable portion of the effects of such policies spillover across borders, sometimes through a weaker exchange rate. More worryingly, it prompts a reaction. Such competitive easing occurs both simultaneously and sequentially, as I will argue, and both advanced economies and emerging economies engage in it. Aggregate world demand may be weaker and more distorted than it should be, and financial risks higher. To ensure stable and sustainable growth, the international rules of the game need to be revisited. Both advanced economies and emerging economies need to adapt, else I fear we are about to embark on the next leg of a wearisome cycle. A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have.”

Chart VI-4B provides the rate of the Indian rupee (INR) per US dollar (USD) from Jan 2, 1973 to Apr 11, 2014. The first data point is INR 8.0200 on Jan 2, 1973. The rate depreciated sharply to INR 51.9600 on Mar 3, 2009, during the global recession. The rate appreciated to INR 44.0300/USD on Jul 28, 2011 in the midst of the sovereign debt event in the euro area. The rate overshot to INR 68.8000 on Aug 28, 2013. The final data point is INR 60.1800/USD on Apr 11, 2014.

Chart VI-4B, Indian Rupee (INR) per US Dollar (USD), Jan 2, 1973 to Apr 11, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

ChVI-5 provides the exchange rate of JPY (Japan yen) per USD (US dollars). The first data point on the extreme left is JPY 357.7300/USD for Jan 4, 1971. The JPY has appreciated over the long term relative to the USD with fluctuations along an evident long-term appreciation. Before the global recession, the JPY stood at JPY 124.0900/USD on Jun 22, 2007. The use of the JPY as safe haven is evident by sharp appreciation during the global recession to JPY 110.48/USD on Aug 15, 2008, and to JPY 87.8000/USD on Jan 21, 2009. The final data point in Chart VI-5 is JPY 101.5600/USD on Apr 11, 2014 for appreciation of 18.2 percent relative to JPY 124.0900/USD on Jun 22, 2007 before the global recession and expansion characterized by recurring bouts of risk aversion. Takashi Nakamichi and Eleanor Warnock, writing on “Japan lashes out over dollar, euro,” on Dec 29, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323530404578207440474874604.html?mod=WSJ_markets_liveupdate&mg=reno64-wsj), analyze the “war of words” launched by Japan’s new Prime Minister Shinzo Abe and his finance minister Taro Aso, arguing of deliberate devaluations of the USD and EUR relative to the JPY, which are hurting Japan’s economic activity. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-5, Japanese Yen JPY per US Dollars USD, Monthly, Jan 4, 1971-Apr 11, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

Zero interest rates in the United States forever tend to depreciate the dollar against every other currency if there is no risk aversion preventing portfolio rebalancing toward risk financial assets, which include the capital markets and exchange rates of emerging-market economies. The objective of unconventional monetary policy as argued by Yellen 2011AS) is to devalue the dollar to increase net exports that increase US economic growth. Increasing net exports and internal economic activity in the US is equivalent to decreasing net exports and internal economic activity in other countries.

Continental territory, rich endowment of natural resources, investment in human capital, teaching and research universities, motivated labor force and entrepreneurial initiative provide Brazil with comparative advantages in multiple economic opportunities. Exchange rate parity is critical in achieving Brazil’s potential but is difficult in a world of zero interest rates. Chart IV-6 of the Board of Governors of the Federal Reserve System provides the rate of Brazilian real (BRL) per US dollar (USD) from BRL 1.2074/USD on Jan 4, 1999 to BRL 2.2075/USD on Apr 11, 2013. The rate reached BRL 3.9450/USD on Oct 10, 2002 appreciating 60.5 percent to BRL 1.5580/USD on Aug 1, 2008. The rate depreciated 68.1 percent to BRL 2.6187/USD on Dec 5, 2008 during worldwide flight from risk. The rate appreciated again by 41.3 percent to BRL 1.5375/USD on Jul 26, 2011. The final data point in Chart VI-6 is BRL 2.2075/USD on Apr 11, 2014 for depreciation of 43.6 percent. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-6, Brazilian Real (BRL) per US Dollar (USD) Jan 4, 1999 to Apr 11, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

Chart VI-7 of the Board of Governors of the Federal Reserve System provides the history of the BRL beginning with the first data point of BRL 0.8440/USD on Jan 2, 1995. The rate jumped to BRL 2.0700/USD on Jan 29, 1999 after changes in exchange rate policy and then to BRL 2.2000/USD on Mar 3, 1999. The rate depreciated 26.7 percent to BRL 2.7880/USD on Sep 21, 2001 relative to Mar 3, 1999.

Chart VI-7, Brazilian Real (BRL) per US Dollar (USD), Jan 2, 1995 to Apr 11, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

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 $55 billion of securities per month for the balance sheet of the Fed

(http://www.federalreserve.gov/newsevents/press/monetary/20140319a.htm):

“The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month. The Committee 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 and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.”

At a speech on Mar 31, 2014, Chair Yellen analyzed labor market conditions as follows (http://www.federalreserve.gov/newsevents/speech/yellen20140331a.htm):

Let me explain what I mean by that word "slack" and why it is so important.

Chair Yellen analyzes the view of inflation (http://www.federalreserve.gov/newsevents/speech/yellen20140416a.htm):

“Inflation, as measured by the price index for personal consumption expenditures, has slowed from an annual rate of about 2-1/2 percent in early 2012 to less than 1 percent in February of this year. This rate is well below the Committee's 2 percent longer-run objective. Many advanced economies are observing a similar softness in inflation.

To some extent, the low rate of inflation seems due to influences that are likely to be temporary, including a deceleration in consumer energy prices and outright declines in core import prices in recent quarters. Longer-run inflation expectations have remained remarkably steady, however. We anticipate that, as the effects of transitory factors subside and as labor market gains continue, inflation will gradually move back toward 2 percent.”

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? Will the FOMC increase purchases of mortgage-backed securities if mortgage rates increase?

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.”

In testimony on the Semiannual Monetary Policy Report to the Congress before the Committee on Financial Services, US House of Representatives, on Feb 11, 2014, Chair Janet Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20140211a.htm):

“Turning to monetary policy, let me emphasize that I expect a great deal of continuity in the FOMC's approach to monetary policy. I served on the Committee as we formulated our current policy strategy and I strongly support that strategy, which is designed to fulfill the Federal Reserve's statutory mandate of maximum employment and price stability. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. That said, purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. In December of last year and again this January, the Committee said that its current expectation--based on its assessment of a broad range of measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments--is that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the 2 percent goal. I am committed to achieving both parts of our dual mandate: helping the economy return to full employment and returning inflation to 2 percent while ensuring that it does not run persistently above or below that level (emphasis added).”

“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

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 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/03/global-financial-risks-recovery-without.html). This is merely another case of theory without reality with dubious policy proposals. The current reality is cyclical slow growth.

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). Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). If there were an infallible science of central banking, models and forecasts would provide accurate information to policymakers on the future course of the economy in advance. Such forewarning is essential to central bank science because of the long lag between the actual impulse of monetary policy and the actual full effects on income and prices many months and even years ahead (Romer and Romer 2004, Friedman 1961, 1953, Culbertson 1960, 1961, Batini and Nelson 2002). The transcripts of the Fed meetings in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm) analyzed by Jon Hilsenrath demonstrate that Fed policymakers frequently did not understand the current state of the US economy in 2008 and much less the direction of income and prices. The conclusion of Friedman (1953) is that monetary impulses increase financial and economic instability because of lags in anticipating needs of policy, taking policy decisions and effects of decisions. This is a fortiori true when untested unconventional monetary policy in gargantuan doses shocks the economy and financial markets.

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 16,408.54 on Fri Apr 18, 2014, which is higher by 15.8 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 15.6 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 69.4 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to Apr 18, 2014; S&P 500 has gained 82.4 percent and DAX 65.9 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 4/18/14” 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 12.0 percent below the trough. Japan’s Nikkei Average is 64.5 percent above the trough. DJ Asia Pacific TSM is 24.8 percent above the trough. Dow Global is 47.1 percent above the trough. STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 27.1 percent above the trough. NYSE Financial Index is 48.3 percent above the trough. DJ UBS Commodities is 11.0 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 65.9 percent above the trough. Japan’s Nikkei Average is 64.5 percent above the trough on Aug 31, 2010 and 27.4 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 14,516.27 on Fri Apr 18, 2014 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 41.6 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 15.9 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 4/18/14” in Table VI-4 shows decrease of 1.5 percent in the week for China’s Shanghai Composite. DJ Asia Pacific increased 0.7 percent. NYSE Financial increased 2.4 percent in the week. DJ UBS Commodities increased 0.9 percent. Dow Global increased 1.4 percent in the week of Apr 18, 2014. The DJIA increased 2.4 percent and S&P 500 increased 2.7 percent. DAX of Germany increased 1.0 percent. STOXX 50 increased 1.4 percent. The USD appreciated 0.5 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table 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 4/18/14” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Apr 18, 2014. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 4/18/14” but also relative to the peak in column “∆% Peak to 4/18/14.” There are now several equity indexes above the peak in Table VI-4: DJIA 46.4 percent, S&P 500 53.2 percent, DAX 48.6 percent, Dow Global 20.0 percent, DJ Asia Pacific 9.3 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 18.1 percent, Nikkei Average 27.4 percent and STOXX 50 7.7 percent. There is only one equity index below the peak: Shanghai Composite by 33.7 percent. DJ UBS Commodities Index is now 5.1 percent below the peak. The US dollar strengthened 8.7 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 $1,174.4 billion in IIQ1987 or 23.4 percent. Real gross private domestic investment in the US increased 1.5 percent from $2,605.2 billion of 2009 dollars in IVQ2007 to $2,643.3 billion in IVQ2013. As shown in Table IAI-2, real private fixed investment fell 2.9 percent from $2,586.3 billion of 2009 dollars in IVQ2007 to $2,511.2 billion in IVQ2013. Growth of real private investment in Table IA1-2 is mediocre for all but four quarters from IIQ2011 to IQ2012 (http://cmpassocregulationblog.blogspot.com/2014/03/financial-uncertainty-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-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 $39.2 billion in IIIQ2013. Corporate profits with IVA and CCA increased $47.1 billion in IVQ2013. 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 $39.5 billion in IIIQ2013. In IVQ2013, profits after tax with IVA and CCA increased $33.8 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 $273.5 billion in IIQ2013. Net dividends fell at $179.0 billion in IIIQ2013 and increased at $90.5 billion in IVQ2013. 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 $218.6 billion in IIIQ2013 and fell at $56.7 billion in IVQ2013. Undistributed profits of US corporations swelled 375.4 percent from $107.7 billion IQ2007 to $512.0 billion in IVQ2013 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 $39.2 billion from $2087.4 billion in IIQ2013 to $2126.6 billion in IIIQ2013 at the annual rate of 1.9 percent. Corporate profits with IVA and CCA increased at $47.1 billion in IVQ2013 from $2126.6 billion in IIIQ2013 to $2173.7 billion in IVQ2013 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp4q13_3rd.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:

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

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 4/18/ /14	∆% Week 4/18/14	∆% Trough to 4/18/ 14
DJIA	4/26/ 10	7/2/10	-13.6	46.4	2.4	69.4
S&P 500	4/23/ 10	7/20/ 10	-16.0	53.2	2.7	82.4
NYSE Finance	4/15/ 10	7/2/10	-20.3	18.1	2.4	48.3
Dow Global	4/15/ 10	7/2/10	-18.4	20.0	1.4	47.1
Asia Pacific	4/15/ 10	7/2/10	-12.5	9.3	0.7	24.8
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	27.4	4.0	64.5
China Shang.	4/15/ 10	7/02 /10	-24.7	-33.7	-1.5	-12.0
STOXX 50	4/15/10	7/2/10	-15.3	7.7	1.4	27.1
DAX	4/26/ 10	5/25/ 10	-10.5	48.6	1.0	65.9
Dollar Euro	11/25 2009	6/7 2010	21.2	8.7	0.5	-15.9
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-5.1	0.9	11.0
10-Year T Note	4/5/ 10	4/6/10	3.986	2.784	2.724

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 IMF View. The International Financial Institutions (IFI) consist of the International Monetary Fund, World Bank Group, Bank for International Settlements (BIS) and the multilateral development banks, which are the European Investment Bank, Inter-American Development Bank and the Asian Development Bank (Pelaez and Pelaez, International Financial Architecture (2005), The Global Recession Risk (2007), 8-19, 218-29, Globalization and the State, Vol. II (2008b), 114-48, Government Intervention in Globalization (2008c), 145-54). There are four types of contributions of the IFIs:

1. Safety Net. The IFIs contribute to crisis prevention and crisis resolution.

i. Crisis Prevention. An important form of contributing to crisis prevention is by surveillance of the world economy and finance by regions and individual countries. The IMF and World Bank conduct periodic regional and country evaluations and recommendations in consultations with member countries and also jointly with other international organizations. The IMF and the World Bank have been providing the Financial Sector Assessment Program (FSAP) by monitoring financial risks in member countries that can serve to mitigate them before they can become financial crises.

ii. Crisis Resolution. The IMF jointly with other IFIs provides assistance to countries in resolution of those crises that do occur. Currently, the IMF is cooperating with the government of Greece, European Union and European Central Bank in resolving the debt difficulties of Greece as it has done in the past in numerous other circumstances. Programs with other countries involved in the European debt crisis may also be developed.

2. Surveillance. The IMF conducts surveillance of the world economy, finance and public finance with continuous research and analysis. Important documents of this effort are the World Economic Outlook (http://www.imf.org/external/ns/cs.aspx?id=29), Global Financial Stability Report (http://www.imf.org/external/pubs/ft/gfsr/index.htm) and Fiscal Monitor (http://www.imf.org/external/ns/cs.aspx?id=262).

3. Infrastructure and Development. The IFIs also engage in infrastructure and development, in particular the World Bank Group and the multilateral development banks.

4. Soft Law. Significant activity by IFIs has consisted of developing standards and codes under multiple forums. It is easier and faster to negotiate international agreements under soft law that are not binding but can be very effective (on soft law see Pelaez and Pelaez, Globalization and the State, Vol. II (2008c), 114-25). These norms and standards can solidify world economic and financial arrangements.

The objective of this section is to analyze current projections of the IMF database for the most important indicators.

Table I-1 is constructed with the database of the IMF (http://www.imf.org/external/ns/cs.aspx?id=28) to show GDP in dollars in 2012 and the growth rate of real GDP of the world and selected regional countries from 2013 to 2016. The data illustrate the concept often repeated of “two-speed recovery” of the world economy from the recession of 2007 to 2009. The IMF has changed its forecast of the world economy to 3.0 percent in 2013 but accelerating to 3.6 percent in 2014, 3.9 percent in 2015 and 3.9 percent in 2016. Slow-speed recovery occurs in the “major advanced economies” of the G7 that account for $34,543 billion of world output of $72,106 billion, or 47.9 percent, but are projected to grow at much lower rates than world output, 2.0 percent on average from 2013 to 2016 in contrast with 3.6 percent for the world as a whole. While the world would grow 15.2 percent in the four years from 2013 to 2016, the G7 as a whole would grow 8.5 percent. The difference in dollars of 2012 is rather high: growing by 15.2 percent would add around $11.0 trillion of output to the world economy, or roughly, two times the output of the economy of Japan of $5,938 billion but growing by 8.5 percent would add $6.1 trillion of output to the world, or about the output of Japan in 2012. The “two speed” concept is in reference to the growth of the 150 countries labeled as emerging and developing economies (EMDE) with joint output in 2012 of $27,080 billion, or 37.6 percent of world output. The EMDEs would grow cumulatively 21.9 percent or at the average yearly rate of 5.1 percent, contributing $5.9 trillion from 2013 to 2016 or the equivalent of somewhat less than the GDP of $8,229 billion of China in 2012. The final four countries in Table I-1 often referred as BRIC (Brazil, Russia, India, China), are large, rapidly growing emerging economies. Their combined output in 2012 adds to $14,340 billion, or 19.9 percent of world output, which is equivalent to 41.5 percent of the combined output of the major advanced economies of the G7.

Table I-1, IMF World Economic Outlook Database Projections of Real GDP Growth

	GDP USD 2012	Real GDP ∆% 2013	Real GDP ∆% 2014	Real GDP ∆% 2015	Real GDP ∆% 2016
World	72,106	3.0	3.6	3.9	3.9
G7	34,543	1.4	2.2	2.3	2.3
Canada	1,821	2.0	2.3	2.4	2.4
France	2,613	0.3	1.0	1.5	1.7
DE	3,428	0.5	1.7	1.6	1.4
Italy	2,014	-1.8	0.6	1.1	1.3
Japan	5,938	1.5	1.4	1.0	0.7
UK	2,484	1.8	2.9	2.5	2.4
US	16,245	1.9	2.8	3.0	3.0
Euro Area	12,192	-0.5	1.2	1.5	1.5
DE	3,428	0.5	1.7	1.6	1.4
France	2,613	0.3	1.0	1.5	1.7
Italy	2,014	-1.8	0.6	1.1	1.3
POT	212	-1.4	1.2	1.5	1.7
Ireland	211	-0.3	1.7	2.5	2.5
Greece	249	-3.9	0.6	2.9	3.7
Spain	1,323	-1.2	0.9	1.0	1.1
EMDE	27,080	4.7	4.9	5.3	5.4
Brazil	2,248	2.3	1.8	2.7	3.0
Russia	2,004	1.3	1.3	2.3	2.5
India	1,859	4.4	5.4	6.4	6.5
China	8,229	7.7	7.5	7.3	7.0

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries); POT: Portugal

Source: IMF World Economic Outlook databank http://www.imf.org/external/ns/cs.aspx?id=28

Continuing high rates of unemployment in advanced economies constitute another characteristic of the database of the WEO (http://www.imf.org/external/ns/cs.aspx?id=28). Table I-2 is constructed with the WEO database to provide rates of unemployment from 2012 to 2016 for major countries and regions. In fact, unemployment rates for 2013 in Table I-2 are high for all countries: unusually high for countries with high rates most of the time and unusually high for countries with low rates most of the time. The rates of unemployment are particularly high in 2013 for the countries with sovereign debt difficulties in Europe: 16.3 percent for Portugal (POT), 13.1 percent for Ireland, 27.3 percent for Greece, 26.4 percent for Spain and 12.2 percent for Italy, which is lower but still high. The G7 rate of unemployment is 7.1 percent. Unemployment rates are not likely to decrease substantially if slow growth persists in advanced economies.

Table I-2, IMF World Economic Outlook Database Projections of Unemployment Rate as Percent of Labor Force

	% Labor Force 2012	% Labor Force 2013	% Labor Force 2014	% Labor Force 2015	% Labor Force 2016
World	NA	NA	NA	NA	NA
G7	7.4	7.1	6.7	6.5	6.3
Canada	7.3	7.0	7.0	6.9	6.8
France	10.2	10.8	11.0	10.7	10.3
DE	5.5	5.3	5.2	5.2	5.2
Italy	10.7	12.2	12.4	11.9	11.1
Japan	4.3	4.0	3.9	3.9	3.9
UK	8.0	7.6	6.9	6.6	6.3
US	8.1	7.4	6.4	6.2	6.1
Euro Area	11.4	12.1	11.9	11.6	11.1
DE	5.5	5.3	5.2	5.2	5.2
France	10.2	10.8	11.0	10.7	10.3
Italy	10.7	12.2	12.4	11.9	11.1
POT	15.7	16.3	15.7	15.1	14.5
Ireland	14.7	13.1	11.2	10.5	10.1
Greece	24.2	27.3	26.3	24.4	21.4
Spain	25.0	26.4	25.5	24.9	24.2
EMDE	NA	NA	NA	NA	NA
Brazil	5.5	5.4	5.6	5.8	6.0
Russia	5.5	5.5	6.2	6.2	6.0
India	NA	NA	NA	NA	NA
China	4.1	4.1	4.1	4.1	4.1

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/ns/cs.aspx?id=28

The database of the WEO (http://www.imf.org/external/ns/cs.aspx?id=28) is used to construct the debt/GDP ratios of regions and countries in Table I-3. The concept used is general government debt, which consists of central government debt, such as Treasury debt in the US, and all state and municipal debt. Net debt is provided for all countries except for the only available gross debt for China, Russia and India. The net debt/GDP ratio of the G7 increases from 86.0 in 2012 to 86.9 in 2016. G7 debt is pulled by the high debt of Japan that grows from 129.5 percent of GDP in 2012 to 142.4 percent of GDP in 2016. US general government debt increases from 80.1 percent of GDP in 2012 to 82.9 percent of GDP in 2016. Debt/GDP ratios of countries with sovereign debt difficulties in Europe are particularly worrisome. General government net debts of Italy, Ireland Greece and Portugal exceed 100 percent of GDP or are expected to exceed 100 percent of GDP by 2016. The only country with relatively lower debt/GDP ratio is Spain with 52.7 in 2012 but growing to 71.9 in 2016. Fiscal adjustment, voluntary or forced by defaults, may squeeze further economic growth and employment in many countries as analyzed by Blanchard (2012WEOApr). Defaults could feed through exposures of banks and investors to financial institutions and economies in countries with sounder fiscal affairs.

Table I-3, IMF World Economic Outlook Database Projections, General Government Net Debt as Percent of GDP

	% Debt/ GDP 2012	% Debt/ GDP 2013	% Debt/ GDP 2014	% Debt/ GDP 2015	% Debt/ GDP 2016
World	NA	NA	NA	NA	NA
G7	86.0	86.3	87.0	87.2	86.9
Canada	36.7	38.5	39.5	39.9	39.8
France	84.0	87.6	89.5	89.8	89.0
DE	58.1	55.7	52.9	49.9	46.8
Italy	106.1	110.7	112.4	111.2	109.0
Japan	129.5	134.1	137.1	140.0	142.4
UK	81.4	83.1	84.4	85.7	85.4
US	80.1	81.3	82.3	82.7	82.9
Euro Area	70.2	72.4	73.2	72.6	71.3
DE	58.1	55.7	52.9	49.9	46.8
France	84.0	87.6	89.5	89.8	89.0
Italy	106.1	110.7	112.4	111.2	109.0
POT	114.0	118.4	119.9	119.2	117.2
Ireland	92.8	100.3	103.5	103.4	101.5
Greece	153.5	168.5	169.3	166.9	159.6
Spain	52.7	60.4	65.7	69.4	71.9
EMDE*	35.6	34.5	33.3	32.8	32.2
Brazil	35.3	33.6	33.3	32.9	32.5
Russia*	12.7	13.4	13.0	13.0	12.4
India*	66.6	66.7	65.3	64.0	62.7
China*	26.1	22.4	20.2	18.7	17.6

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries); *General Government Gross Debt as percent of GDP

Source: IMF World Economic Outlook databank http://www.imf.org/external/ns/cs.aspx?id=28

The primary balance consists of revenues less expenditures but excluding interest revenues and interest payments. It measures the capacity of a country to generate sufficient current revenue to meet current expenditures. There are various countries with primary surpluses in 2012: Germany 1.9 percent, Italy 2.3 percent, Brazil 2.1 percent and Russia 0.8 percent. There are also various countries with expected primary surpluses by 2016: Greece 4.5 percent, Italy 4.5 percent and so on. Most countries in Table I-4 face significant fiscal adjustment in the future without “fiscal space.” Investors in government securities may require higher yields when the share of individual government debts hit saturation shares in portfolios. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:

(M_t + B_t)/P_t = E_t∫(1/R_t_{, t+τ})s_t_+τdτ (1)

Equation (1) expresses the monetary, M_t, and debt, B_t, liabilities of the government, divided by the price level, P_t, in terms of the expected value discounted by the ex-post rate on government debt, R_t_{, t+τ}, of the future primary surpluses s_t_+τ, which are equal to T_t_+τ – G_t_+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post R_t_{, t+τ}. Expectations by investors of future primary balances of indebted governments may be less optimistic than those in Table I-4 because of government revenues constrained by low growth and government expenditures rigid because of entitlements. Political realities may also jeopardize structural reforms and fiscal austerity.

Table I-4, IMF World Economic Outlook Database Projections of Primary General Government Net Lending/Borrowing as Percent of GDP

	% GDP 2012	% GDP 2013	% GDP 2014	% GDP 2015	% GDP 2016
World	NA	NA	NA	NA	NA
G7	-4.7	-3.4	-2.7	-1.9	-1.3
Canada	-2.8	-2.6	-2.2	-1.6	-1.2
France	-2.4	-2.2	-1.7	-1.0	-0.2
DE	1.9	1.7	1.6	1.4	1.7
Italy	2.3	2.0	2.3	3.3	4.5
Japan	-7.8	-7.6	-6.4	-5.5	-4.4
UK	-5.6	-4.5	-3.5	-1.9	-0.2
US	-6.3	-4.1	-3.2	-2.4	-2.2
Euro Area	-1.0	-0.4	-0.1	0.5	1.2
DE	1.9	1.7	1.6	1.4	1.7
France	-2.4	-2.2	-1.7	-1.0	-0.2
Italy	2.3	2.0	2.3	3.3	4.5
POT	-2.6	-0.7	0.3	1.9	2.4
Ireland	-5.2	-3.4	-0.7	1.5	2.4
Greece	-1.3	1.5	1.5	3.0	4.5
Spain	-8.1	-4.2	-2.8	-1.7	-0.6
EMDE*	-1.6	-2.2	-2.3	-2.1	-2.0
Brazil	2.1	1.9	1.9	3.1	3.1
Russia	0.8	-0.8	-0.2	-0.3	0.03
India	-3.1	-2.6	-2.6	-2.3	-2.2
China*	-2.2	-1.9	-2.0	-1.6	-1.3

*General Government Net Lending/Borrowing

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/ns/cs.aspx?id=28

The database of the World Economic Outlook of the IMF (http://www.imf.org/external/ns/cs.aspx?id=28) is used to obtain government net lending/borrowing as percent of GDP in Table I-5. Interest on government debt is added to the primary balance to obtain overall government fiscal balance in Table I-4. For highly indebted countries there is an even tougher challenge of fiscal consolidation. Adverse expectations on the success of fiscal consolidation may drive up yields on government securities that could create hurdles to adjustment, growth and employment.

Table I-5, IMF World Economic Outlook Database Projections of General Government Net Lending/Borrowing as Percent of GDP

	% GDP 2012	% GDP 2013	% GDP 2014	% GDP 2015	% GDP 2016
World	NA	NA	NA	NA	NA
G7	-7.3	-5.9	-5.1	-4.4	-3.9
Canada	-3.4	-3.0	-2.5	-2.0	-1.5
France	-4.8	-4.2	-3.7	-3.0	-2.1
DE	0.1	0.0	0.0	-0.1	0.2
Italy	-2.9	-3.0	-2.7	-1.8	-0.8
Japan	-8.7	-8.4	-7.3	-6.4	-5.4
UK	-7.9	-5.8	-5.3	-4.1	-2.9
US	-9.7	-7.3	-6.4	-5.6	-5.6
Euro Area	-3.7	-3.0	-2.6	-2.0	-1.4
DE	0.1	0.0	0.0	-0.1	0.2
France	-4.8	-4.2	-3.7	-3.0	-2.1
Italy	-2.9	-3.0	-2.7	-1.8	-0.8
POT	-6.4	-4.9	-4.0	-2.5	-2.0
Ireland	-8.2	-7.4	-5.1	-3.0	-2.4
Greece	-6.3	-2.6	-2.7	-1.9	-0.7
Spain	-10.6	-7.2	-5.9	-4.9	-3.9
EMDE	-1.6	-2.2	-2.3	-2.1	-2.0
Brazil	-2.7	-3.3	-3.3	-2.5	-2.6
Russia	0.4	-1.3	-0.7	-0.8	-0.5
India	-7.4	-7.3	-7.2	-7.0	-6.8
China	-2.2	-1.9	-2.0	-1.6	-1.3

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/ns/cs.aspx?id=28

There were some hopes that the sharp contraction of output during the global recession would eliminate current account imbalances. Table I-6 constructed with the database of the WEO (http://www.imf.org/external/ns/cs.aspx?id=28) shows that external imbalances have been maintained in the form of current account deficits and surpluses. China’s current account surplus is 2.3 percent of GDP for 2012 and is projected to climb to 2.6 percent of GDP in 2016. At the same time, the current account deficit of the US is 2.8 percent of GDP in 2012 and is projected at 3.0 percent of GDP in 2016. The current account surplus of Germany is 7.4 percent for 2012 and remains at a high 6.7 percent of GDP in 2016. Japan’s current account surplus is 1.0 percent of GDP in 2012 and increases to 1.3 percent of GDP in 2016.

Table I-6, IMF World Economic Outlook Databank Projections, Current Account of Balance of Payments as Percent of GDP

	% CA/ GDP 2012	% CA/ GDP 2013	% CA/ GDP 2014	% CA/ GDP 2015	% CA/ GDP 2016
World	NA	NA	NA	NA	NA
G7	-1.0	-0.7	-0.6	-0.7	-0.7
Canada	-3.4	-3.2	-2.6	-2.5	-2.4
France	-2.2	-1.6	-1.7	-1.0	-0.6
DE	7.4	7.5	7.3	7.1	6.7
Italy	-0.4	0.8	1.1	1.1	0.7
Japan	1.0	0.7	1.2	1.3	1.3
UK	-3.7	-3.3	-2.7	-2.2	-1.7
US	-2.8	-1.9	-2.8	-3.0	-3.0
Euro Area	2.0	2.9	3.0	3.1	3.1
DE	7.4	7.5	7.3	7.1	6.7
France	-2.2	-1.6	-1.7	-1.0	-0.6
Italy	-0.4	0.8	1.1	1.1	0.7
POT	-2.0	0.5	0.8	1.2	1.4
Ireland	4.4	6.6	6.4	6.5	6.5
Greece	-2.4	0.7	0.9	0.3	0.4
Spain	-1.1	0.7	0.8	1.3	1.8
EMDE	1.4	0.7	0.8	0.6	0.4
Brazil	-2.4	-3.6	-3.6	-3.7	-3.6
Russia	3.6	1.6	2.1	1.6	1.4
India	-4.7	-2.0	-2.4	-2.5	-2.6
China	2.3	2.1	2.2	2.4	2.6

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/ns/cs.aspx?id=28

The G7 meeting in Washington on Apr 21 2006 of finance ministers and heads of central bank governors of the G7 established the “doctrine of shared responsibility” (G7 2006Apr):

“We, Ministers and Governors, reviewed a strategy for addressing global imbalances. We recognized that global imbalances are the product of a wide array of macroeconomic and microeconomic forces throughout the world economy that affect public and private sector saving and investment decisions. We reaffirmed our view that the adjustment of global imbalances:

Is shared responsibility and requires participation by all regions in this global process;
Will importantly entail the medium-term evolution of private saving and investment across countries as well as counterpart shifts in global capital flows; and
Is best accomplished in a way that maximizes sustained growth, which requires strengthening policies and removing distortions to the adjustment process.

In this light, we reaffirmed our commitment to take vigorous action to address imbalances. We agreed that progress has been, and is being, made. The policies listed below not only would be helpful in addressing imbalances, but are more generally important to foster economic growth.

In the United States, further action is needed to boost national saving by continuing fiscal consolidation, addressing entitlement spending, and raising private saving.
In Europe, further action is needed to implement structural reforms for labor market, product, and services market flexibility, and to encourage domestic demand led growth.
In Japan, further action is needed to ensure the recovery with fiscal soundness and long-term growth through structural reforms.

Others will play a critical role as part of the multilateral adjustment process.

In emerging Asia, particularly China, greater flexibility in exchange rates is critical to allow necessary appreciations, as is strengthening domestic demand, lessening reliance on export-led growth strategies, and actions to strengthen financial sectors.

In oil-producing countries, accelerated investment in capacity, increased economic diversification, enhanced exchange rate flexibility in some cases.

Other current account surplus countries should encourage domestic consumption and investment, increase micro-economic flexibility and improve investment climates.

We recognized the important contribution that the IMF can make to multilateral surveillance.”

The concern at that time was that fiscal and current account global imbalances could result in disorderly correction with sharp devaluation of the dollar after an increase in premiums on yields of US Treasury debt (see Pelaez and Pelaez, The Global Recession Risk (2007)). The IMF was entrusted with monitoring and coordinating action to resolve global imbalances. The G7 was eventually broadened to the formal G20 in the effort to coordinate policies of countries with external surpluses and deficits.

The database of the WEO (http://www.imf.org/external/ns/cs.aspx?id=28) is used to contract Table I-7 with fiscal and current account imbalances projected for 2014 and 2016. The WEO finds the need to rebalance external and domestic demand (IMF 2011WEOSep xvii):

“Progress on this front has become even more important to sustain global growth. Some emerging market economies are contributing more domestic demand than is desirable (for example, several economies in Latin America); others are not contributing enough (for example, key economies in emerging Asia). The first set needs to restrain strong domestic demand by considerably reducing structural fiscal deficits and, in some cases, by further removing monetary accommodation. The second set of economies needs significant currency appreciation alongside structural reforms to reduce high surpluses of savings over investment. Such policies would help improve their resilience to shocks originating in the advanced economies as well as their medium-term growth potential.”

The IMF (2012WEOApr, XVII) explains decreasing importance of the issue of global imbalances as follows:

“The latest developments suggest that global current account imbalances are no longer expected to widen again, following their sharp reduction during the Great Recession. This is largely because the excessive consumption growth that characterized economies that ran large external deficits prior to the crisis has been wrung out and has not been offset by stronger consumption in .surplus economies. Accordingly, the global economy has experienced a loss of demand and growth in all regions relative to the boom years just before the crisis. Rebalancing activity in key surplus economies toward higher consumption, supported by more market-determined exchange rates, would help strengthen their prospects as well as those of the rest of the world.”

Table I-7, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2011 Dollar GDP

	GDP $B 2014	FD %GDP 2014	CAD %GDP 2014	Debt %GDP 2014	FD%GDP 2016	CAD%GDP 2016	Debt %GDP 2016
US	17528	-3.2	-2.8	82.3	-2.2	-3.0	82.9
Japan	4846	-6.4	1.2	137.1	-4.4	1.3	142.4
UK	2828	-3.5	-2.7	84.4	-0.2	-1.7	85.4
Euro	12685	-0.1	3.0	73.2	1.2	3.1	71.3
Ger	3876	1.6	7.3	52.9	1.7	6.7	46.8
France	2886	-1.7	-1.7	89.5	-0.2	-0.6	89.0
Italy	2172	2.3	1.1	112.4	4.5	0.7	109.0
Can	1769	-2.2	-2.6	39.5	-1.2	-2.4	39.8
China	10028	-2.0	2.2	20.2	-1.3	2.6	17.6
Brazil	2216	1.9	-3.6	33.3	3.1	-3.6	32.5

Note: GER = Germany; Can = Canada; FD = fiscal deficit; CAD = current account deficit

FD is primary except total for China; Debt is net except gross for China

Source: IMF World Economic Outlook databank

http://www.imf.org/external/ns/cs.aspx?id=28

Brazil faced in the debt crisis of 1982 a more complex policy mix. Between 1977 and 1983, Brazil’s terms of trade, export prices relative to import prices, deteriorated 47 percent and 36 percent excluding oil (Pelaez 1987, 176-79; Pelaez 1986, 37-66; see Pelaez and Pelaez, The Global Recession Risk (2007), 178-87). Brazil had accumulated unsustainable foreign debt by borrowing to finance balance of payments deficits during the 1970s. Foreign lending virtually stopped. The German mark devalued strongly relative to the dollar such that Brazil’s products lost competitiveness in Germany and in multiple markets in competition with Germany. The resolution of the crisis was devaluation of the Brazilian currency by 30 percent relative to the dollar and subsequent maintenance of parity by monthly devaluation equal to inflation and indexing that resulted in financial stability by parity in external and internal interest rates avoiding capital flight. With a combination of declining imports, domestic import substitution and export growth, Brazil followed rapid growth in the US and grew out of the crisis with surprising GDP growth of 4.5 percent in 1984.

The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the Subsection IIIF Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 30, 2011, the yield of the 2-year bond of the government of Greece was quoted around 100 percent. In contrast, the 2-year US Treasury note traded at 0.239 percent and the 10-year at 2.871 percent while the comparable 2-year government bond of Germany traded at 0.14 percent and the 10-year government bond of Germany traded at 1.83 percent. There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt exceeding 100 percent of GDP, which is the third largest in the world after the US and Japan. Appendix IIIE links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).

Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.

Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:

“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”

If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.

The prospects of survival of the euro zone are dire. Table I-8 is constructed with IMF World Economic Outlook database (http://www.imf.org/external/ns/cs.aspx?id=28) for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2014.

Table I-8, World and Selected Regional and Country GDP and Fiscal Situation

	GDP 2014 USD Billions	Primary Net Lending Borrowing % GDP 2014	General Government Net Debt % GDP 2014
World	76,776
Euro Zone	13,416	-0.1	73.2
Portugal	231	0.3	119.9
Ireland	230	-0.7	103.5
Greece	249	1.5	169.3
Spain	1,415	-2.8	65.7
Major Advanced Economies G7	35,904	-2.7	87.0
United States	17,528	-3.2	82.3
UK	2,828	-3.5	84.4
Germany	3,876	1.6	52.9
France	2,886	-1.7	89.5
Japan	4,846	-6.4	137.1
Canada	1,769	-2.2	39.5
Italy	2,172	2.3	112.4
China	10,028	-2.0*	20.2**

*Net Lending/borrowing**Gross Debt

Source: IMF World Economic Outlook http://www.imf.org/external/ns/cs.aspx?id=28

The data in Table I-8 are used for some very simple calculations in Table I-9. The column “Net Debt USD Billions 2014” in Table I-9 is generated by applying the percentage in Table I-8 column “General Government Net Debt % GDP 2014” to the column “GDP 2014 USD Billions.” The total debt of France and Germany in 2014 is $4633.4 billion, as shown in row “B+C” in column “Net Debt USD Billions 2014” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $4307.7 billion, adding rows D+E+F+G+H in column “Net Debt USD billions 2014.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table I-9. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $8941.1 billion, which would be equivalent to 132.2 percent of their combined GDP in 2014. Under this arrangement, the entire debt of selected members of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 230.7 percent if including debt of France and 164.0 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks. Analysis of fiscal stress is quite difficult without including another global recession in an economic cycle that is already mature by historical experience.

Table I-9, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %

	Net Debt USD Billions 2014	Debt as % of Germany Plus France GDP	Debt as % of Germany GDP
A Euro Area	9,820.5
B Germany	2,050.4		$8941.1 as % of $3876 =230.7% $6358.1 as % of $3876 =164.0%
C France	2,583.0
B+C	4,633.4	GDP $6,762.0 Total Debt $8941.1 Debt/GDP: 132.2%
D Italy	2,441.3
E Spain	929.7
F Portugal	277.0
G Greece	421.6
H Ireland	238.1
Subtotal D+E+F+G+H	4,307.7

Source: calculation with IMF data IMF World Economic Outlook databank

http://www.imf.org/external/ns/cs.aspx?id=28

World trade projections of the IMF are in Table I-10. There is increasing growth of the volume of world trade of goods and services from 3.0 percent in 2013 to 5.3 percent in 2015 and 5.7 percent on average from 2016 to 2019. World trade would be slower for advanced economies while emerging and developing economies (EMDE) experience faster growth. World economic slowdown would be more challenging with lower growth of world trade.

Table I-10, IMF, Projections of World Trade, USD Billions, USD/Barrel and Annual ∆%

	2013	2014	2015	Average ∆% 2016-2019
World Trade Volume (Goods and Services)	3.0	4.3	5.3	5.7
Exports Goods & Services	3.1	4.5	5.3	5.7
Imports Goods & Services	2.9	4.2	5.2	5.7
World Trade Value of Exports Goods & Services USD Billion	23,083	23,990	25,123	Average ∆% 2006-2015 20,390
Value of Exports of Goods USD Billion	18,591	19,281	20,132	Average ∆% 2006-2015 16,396
Average Oil Price USD/Barrel	104.07	104.17	97.92	Average ∆% 2006-2015 88.84
Average Annual ∆% Export Unit Value of Manufactures	-1.1	-0.3	-0.4	Average ∆% 2006-2015 1.4
Exports of Goods & Services	2013	2014	2015	Average ∆% 2016-2019
Euro Area	1.4	3.4	4.2	4.7
EMDE	4.4	5.0	6.2	6.2
G7	1.4	3.9	4.5	4.9
Imports Goods & Services
Euro Area	0.3	2.8	3.5	4.7
EMDE	5.6	5.2	6.3	6.4
G7	1.1	3.2	4.2	4.9
Terms of Trade of Goods & Services
Euro Area	-0.3	-0.2	-0.7	-0.1
EMDE	0.7	-0.4	-0.6	-0.4
G7	0.7	-0.044	0.3	0.0
Terms of Trade of Goods
Euro Area	0.8	-0.044	0.1	-0.2
EMDE	-0.6	-0.9	-0.9	-0.8
G7	-0.1	-0.3	-0.9	-0.7

Notes: Commodity Price Index includes Fuel and Non-fuel Prices; Commodity Industrial Inputs Price includes agricultural raw materials and metal prices; Oil price is average of WTI, Brent and Dubai

Source: International Monetary Fund World Economic Outlook databank

http://www.imf.org/external/ns/cs.aspx?id=28

ESIII World Inflation Waves. 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 2012-2014 shows neatly multiple waves. (1) In Jan-Apr 2011, without risk aversion, US producer prices rose at the annual equivalent rate of 10.4 percent. (2) After risk aversion, producer prices increased in the US at the annual equivalent rate of 1.2 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 4.1 percent. (4) Under the pressure of risk aversion because of the European debt crisis, US producer prices increased at the annual equivalent rate of minus 0.4 percent in Oct-Dec 2011. (5) Inflation of producer prices returned with 2.8 percent annual equivalent in Jan-Mar 2012. (6) With return of risk aversion from the European debt crisis, producer prices fell at the annual equivalent rate of 4.1 percent in Apr-May 2012. (7) New positions in commodity futures even with continuing risk aversion caused annual equivalent inflation of 0.6 percent in Jun-Jul 2012. (8) 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. (9) Renewed risk aversion caused unwinding of carry trades of zero interest rates to commodity futures exposures with annual equivalent inflation of minus 2.8 percent in Oct-Dec 2012. (10) In Jan-Feb 2013, producer prices rose at the annual equivalent rate of 6.2 percent with more relaxed risk aversion at the margin. (11) Return of risk aversion resulted in annual equivalent inflation of minus 6.4 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 4.0 percent in annual equivalent in May-Aug 2013. (13) Continuing reallocation of investment portfolios away from commodities into equities is causing downward pressure on prices. In Sep-Nov 2013, the US producer price index fell at the annual equivalent rate of 0.0 percent. (14) Renewed carry trades caused annual equivalent inflation of 5.3 percent in US producer prices in Dec 2013-Feb 2014. (15) Annual equivalent inflation of producer prices was minus 1.2 percent in Mar 2014. 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 ten producer-price indexes in Table IA-1 for seven countries (two for the US and 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 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. Inflation of producer prices returned in the US and Japan in Dec 2013-Jan 2014. Lower inflation recently originates in portfolio reallocations away from commodity exposures into equities. 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 monetary policy perpetuates 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). Inflation of producer prices returned in the US and Japan in Dec 2013-Jan 2014 and fell in Mar 2014 as part of the general instability of economic and financial variables originating in unconventional monetary policy.

Table IA-1, Annual Equivalent Rates of Producer Price Indexes

INDEX 2011-2014	AE ∆%
US Producer Finished Goods Price Index
AE ∆% Mar 2014	-1.2
AE ∆% Dec 2013-Feb 2014	5.3
AE ∆% Sep-Nov 2013	0.0
AE ∆% May-Aug 2013	4.0
AE ∆% Mar-Apr 2013	-6.4
AE ∆% Jan-Feb 2013	6.2
AE ∆% Oct-Dec 2012	-2.8
AE ∆% Aug-Sep 2012	12.7
AE ∆% Jun-Jul 2012	0.6
AE ∆% Apr-May 2012	-4.1
AE ∆% Jan-Mar 2012	2.8
AE ∆% Oct-Dec 2011	-0.4
AE ∆% Jul-Sep 2011	4.1
AE ∆% May-Jun 2011	1.2
AE ∆% Jan-Apr 2011	10.4
US Final Demand Producer Price Index
AE ∆% Mar 2014	6.2
AE ∆% Dec 2013-Feb 2014	0.4
AE ∆% Sep-Nov 2013	1.2
AE ∆% May-Aug 2013	1.8
AE ∆% Mar-Apr 2013	-0.6
AE ∆% Jan-Feb 2013	1.8
AE ∆% Oct-Dec 2012	1.2
AE ∆% Aug-Sep 2012	5.5
AE ∆% Jun-Jul 2012	-1.2
AE ∆% Apr-May 2012	0.6
AE ∆% Jan-Mar 2012	3.7
AE ∆% Oct-Dec 2011	-0.8
AE ∆% Jul-Sep 2011	3.2
AE ∆% May-Jun 2011	2.4
AE ∆% Jan-Apr 2011	7.1
Japan Corporate Goods Price Index
AE ∆% Feb-Mar 2014	-0.6
AE ∆% Dec 2013-Jan 2014	2.4
AE ∆% Oct-Nov 2013	-0.6
AE ∆% Dec 2012-Sep 2013	3.3
AE ∆% Oct-Nov 2012	-3.0
AE ∆% Aug-Sep 2012	2.4
AE ∆% May-Jul 2012	-5.5
AE ∆% Feb-Apr 2012	2.0
AE ∆% Dec 2011-Jan 2012	-0.6
AE ∆% Jul-Nov 2011	-2.1
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-Apr 2011	5.8
China Producer Price Index
AE ∆% Oct 2013-Mar 2014	-1.2
AE ∆% Aug-Sep 2013	1.8
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 ∆% Jan-Feb	-3.0
AE ∆% Dec 2013	2.4
AE ∆% Oct-Nov 2013	-3.0
AE ∆% Jul-Sep 2013	1.6
AE ∆% Mar-Jun 2013	-3.5
AE ∆% Jan-Feb 2013	2.4
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Sep-Oct 2012	0.6
AE ∆% Jul-Aug 2012	6.8
AE ∆% Apr-Jun 2012	-2.4
AE ∆% Jan-Mar 2012	7.9
AE ∆% Oct-Dec 2011	0.4
AE ∆% Jul-Sep 2011	2.4
AE ∆% May-Jun 2011	0.0
AE ∆% Jan-Apr 2011	11.3
Germany Producer Price Index
AE ∆% Jan-Mar 2014	-1.6 NSA -2.4 SA
AE ∆% Dec 2013	1.2 NSA 2.4 SA
AE ∆% Oct-Nov 2013	-1.8 NSA –1.8 SA
AE ∆% Sep 2013	3.7 NSA 0.0 SA
AE ∆% May-Aug 2013	-1.8 NSA –0.6 SA
AE ∆% Feb-Apr 2013	-2.4 NSA –2.8 SA
AE ∆% Jan 2013	7.4 NSA 1.2 SA
AE ∆% Oct-Dec 2012	-0.8 NSA 0.8 SA
AE ∆% Aug-Sep 2012	4.3 NSA 2.4 SA
AE ∆% May-Jul 2012	-2.8 NSA –0.4 SA
AE ∆% Feb-Apr 2012	4.9 NSA 2.4 SA
AE ∆% Dec 2011-Jan 2012	0.0 NSA –0.6 SA
AE ∆% Oct-Nov 2011	0.6 NSA 1.8 SA
AE ∆% Jul-Sep 2011	2.4 NSA 3.2 SA
AE ∆% May-Jun 2011	0.6 NSA 3.7 SA
AE ∆% Jan-Apr 2011	10.4 NSA 6.2 SA
France Producer Price Index for the French Market
AE ∆% Jan-Feb	-4.1
AE ∆% Nov-Dec 2013	4.3
AE ∆% Oct 2013	-2.4
AE ∆% Jul-Sep 2013	4.9
AE ∆% Apr-Jun 2013	-10.7
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 ∆% Oct 2013-Feb 2014	-2.9
AE ∆% Jun-Sep 2013	0.3
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 ∆% Jan-Mar 2014	2.4
AE ∆% Sep-Dec 2013	-1.5
AE ∆% Jun-Aug 2013	2.0
AE ∆% Apr-May 2013	-0.6
AE ∆% Jan-Mar 2013	4.9
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Jul-Oct 2012	3.0
AE ∆% May-Jun 2012	-3.5
AE ∆% Feb-Apr 2012	5.3
AE ∆% Nov 2011-Jan-2012	1.2
AE ∆% May-Oct 2011	1.6
AE ∆% Jan-Apr 2011	10.0
UK Input Prices
AE ∆% Jan-Mar 2014	-7.7
AE ∆% Dec 2013	3.7
AE ∆% Aug-Nov 2013	-8.4
AE ∆% Jul 2013	18.2
AE ∆% Mar-Jun 2013	-9.5
AE ∆% Jan-Feb 2013	24.6
AE ∆% Sep-Dec 2012	3.0
AE ∆% Aug 2012	23.9
AE ∆% Apr-Jul 2012	-16.1
AE ∆% Jan-Mar 2012	14.9
AE ∆% Nov-Dec 2011	0.0
AE ∆% May-Oct 2011	-1.3
AE ∆% Jan-Apr 2011	30.6
AE ∆% Oct-Dec 2010	31.8

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.istat.it/en/

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 4.9 percent. (2) Risk aversion caused the collapse of inflation to annual equivalent 2.4 percent in May-Jun 2011. (3) Risk appetite drove the rate of consumer price inflation in the US to 3.2 percent in Jul-Sep 2011. (4) Gloomier views of carry trades caused the collapse of inflation in Oct-Nov 2011 to annual equivalent 1.2 percent. (5) Consumer price inflation resuscitated with increased risk appetite at annual equivalent of 1.8 percent in Dec 2011 to Jan 2012. (6) Consumer price inflation returned at 2.8 percent annual equivalent in Feb-Apr 2012. (7) Under renewed risk aversion, annual equivalent consumer price inflation in the US was minus 0.4 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 minus 0.4 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 7.4 percent in Feb 2013 in a mood of relaxed risk aversion. (11) Inflation fell at 2.4 percent annual equivalent in Mar-Apr 2013. (12) Inflation rose at 2.2 percent in annual equivalent in May-Sep 2013. (13) Inflation moderated at the annual equivalent rate of 0.6 percent in Oct-Nov 2013. (14) Inflation returned at annual equivalent 1.8 percent in Dec 2013-Mar 2014. 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 4.6 percent in Jul-Oct 2013, falling at 1.2 percent in annual equivalent in Nov 2013. As in many countries, inflation in China surged at 7.4 percent annual equivalent in Dec 201-Feb 2014 with significant effects of local increases in food prices. Annual equivalent inflation in China fell at 5.8 percent in Mar 2014. 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 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 3.7 percent in Aug-Sep 2013. Euro zone inflation fell at the annual equivalent rate of 2.4 percent in Oct-Nov 2013. Euro zone inflation jumped at 4.9 percent annual equivalent in Dec 2013 as in many countries worldwide. Inflation in the euro zone fell at annual equivalent 12.4 percent in Dec 2013 and increased at annual equivalent 7.4 percent in Feb-Mar 2014. 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 3.0 percent for output prices and 23.9 percent for input prices in 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 3.4 percent in Aug-Dec 2013. CPI inflation fell at annual equivalent 7.0 percent in Jan 2014. Consumer price inflation in the UK returned at annual equivalent 4.3 percent in Feb-Mar 2014.

Table IA-2, Annual Equivalent Rates of Consumer Price Indexes

Index 2011-2014	AE ∆%
US Consumer Price Index
AE ∆% Dec 2013-Mar 2014	1.8
AE ∆% Oct-Nov 2013	0.6
AE ∆% May-Sep 2013	2.2
AE ∆% Mar-Apr 2013	-2.4
AE ∆% Feb 2013	7.4
AE ∆% Nov 2012-Jan 2013	-0.4
AE ∆% Aug-Oct 2012	4.9
AE ∆% May-Jul 2012	-0.4
AE ∆% Feb-Apr 2012	2.8
AE ∆% Dec 2011-Jan 2012	1.8
AE ∆% Oct-Nov 2011	1.2
AE ∆% Jul-Sep 2011	3.2
AE ∆% May-Jun 2011	2.4
AE ∆% Jan-Apr 2011	4.9
China Consumer Price Index
AE ∆% Mar 2014	-5.8
AE ∆% Dec 2013-Feb 2014	7.4
AE ∆% Nov 2013	-1.2
AE ∆% Jul-Oct 2013	4.6
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 ∆% Feb-Mar	7.4
AE ∆% Jan	-12.4
AE ∆% Dec 2013	4.9
AE ∆% Oct-Nov 2013	-2.4
AE ∆% Aug-Sep 2013	3.7
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 ∆% Feb-Mar 2014	4.9 NSA 0.0 SA
AE ∆% Jan 2014	-7.0 NSA 0.0 SA
AE ∆% Nov-Dec 2013	3.7 NSA 2.4 SA
AE ∆% Oct 2013	-2.4 NSA 0.0 SA
AE ∆% Aug-Sep 2013	0.0 NSA 0.0 SA
AE ∆% May-Jul 2013	4.1 NSA 3.2 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 0.0 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 ∆% Feb-Mar 2014	6.8
AE ∆% Jan 2014	-7.0
AE ∆% Dec 2013	3.7
AE ∆% Sep-Nov 2013	-1.6
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 ∆% Feb-Mar 2014	0.0
AE ∆% Dec 2013-Jan 2014	2.4
AE ∆% Sep-Nov 2013	-3.2
AE ∆% Dec 2012-Aug 2013	2.0
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 ∆% Feb-Mar	4.3
AE ∆% Jan 2014	-7.0
AE ∆% Aug-Dec 2013	3.4
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.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.istat.it/en/

http://www.ons.gov.uk/ons/index.html

ESIV 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-3 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 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 3.8 percent in IIIQ2011. Net trade added 1.7 percentage points to GDP growth in IQ2013 and 0.6 percentage points in IIQ2013 but deducted 2.0 percentage points in IIIQ2013 and deducted 2.1 percentage points in IVQ2013. Private consumption assumed the role of driver of Japan’s economic growth but should moderate as in most mature economies.

Table VB-3, Japan, Contributions to Changes in Real GDP, Seasonally Adjusted Annual Rates (SAAR), %

	Net Trade	Exports	Imports
2013
I	1.7	2.4	-0.7
II	0.6	1.7	-1.2
III	-2.0	-0.4	-1.6
IV	-2.1	0.2	-2.4
2012
I	0.4	1.7	-1.3
II	-1.3	-0.3	-0.9
III	-2.2	-2.5	0.2
IV	-0.5	-1.7	1.3
2011
I	-1.1	-0.4	-0.7
II	-4.4	-4.7	0.3
III	3.8	5.7	-1.9
IV	-3.0	-1.9	-1.1
2010
I	2.1	3.5	-1.3
II	0.1	2.6	-2.6
III	0.5	1.4	-0.9
IV	-0.4	0.1	-0.5
2009
I	-4.4	-16.4	12.0
II	7.4	4.7	2.7
III	2.2	5.3	-3.0
IV	2.7	4.1	-1.4
2008
I	1.1	2.1	-1.0
II	0.5	-1.6	2.1
III	0.1	0.2	-0.1
IV	-11.5	-10.2	-1.2
2007
I	1.1	1.7	-0.5
II	0.7	1.6	-0.8
III	2.1	1.5	0.6
IV	1.4	2.0	-0.7

Source: Japan Economic and Social Research Institute, Cabinet Office

http://www.esri.cao.go.jp/index-e.html

http://www.esri.cao.go.jp/en/sna/sokuhou/sokuhou_top.html

Chart IV-5A 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 0.7 percent to 98.6 in Mar 2014 relative to Jun 2009.

Chart IV-5A, Japan, Export Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2014

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 IV-6 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 (for the relation of terms of trade and growth see Pelaez (1979, 1976a)). 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 127.4 in Mar 2014 or gain of 12.6 percent relative to Apr 2012 and 36.3 percent relative to Jun 2009.

Chart IV-6, Japan, Import Corporate Goods Price Index, Monthly, Yen Basis, 2008-2014

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html

Chart IV-6A 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 113.4 in Mar 2014 or minus 5.1 percent relative to Apr 2012 and gain of 31.6 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 0.7 percent from Jun 2009 to Mar 2014 while the import corporate goods price index increased 31.6 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 IV-6A, Japan, Import Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2014

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html

Table IV-6 provides the Bank of Japan’s Corporate Goods Price indexes of exports and imports on the yen and contract bases from Jan 2008 to Mar 2014. There are oscillations of the indexes that are shown vividly in the four charts above. For the entire period from Jan 2008 to Mar 2014, the export index on the contract currency basis decreased 0.6 percent and decreased 5.5 percent on the yen basis. For the entire period from Jan 2008 to Mar 2014, the import price index increased 12.6 percent on the contract currency basis and increased 7.1 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 IV-6, Japan, Exports and Imports Corporate Goods Price Index, Contract Currency Basis and Yen Basis

Month	Exports Contract Currency	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	102.3	96.3	118.1	109.8
2012/06	101.4	95.0	115.2	106.7
2012/07	100.6	94.0	112.0	103.5
2012/08	100.9	94.1	112.4	103.6
2012/09	101.0	94.1	114.7	105.2
2012/10	101.1	94.7	113.8	105.2
2012/11	100.9	95.9	113.2	106.5
2012/12	100.7	98.0	113.4	109.5
2013/01	101.0	102.4	113.8	115.4
2013/02	101.5	105.9	114.8	120.2
2013/03	101.3	106.6	115.1	122.0
2013/04	100.2	107.5	114.1	123.8
2013/05	99.6	109.1	112.6	125.3
2013/06	99.2	106.1	112.0	121.2
2013/07	99.1	107.5	111.6	122.8
2013/08	99.0	106.1	111.7	121.2
2013/09	99.0	107.2	112.9	123.9
2013/10	99.2	106.7	113.0	122.8
2013/11	99.1	108.0	113.1	124.9
2013-12	99.1	110.4	113.8	129.0
2014-01	99.2	110.7	114.4	130.1
2014-02	98.9	109.3	113.8	127.7
2014-03	98.6	109.1	113.4	127.4

Source: Bank of Japan

http://www.boj.or.jp/en/statistics/index.htm/

Chart IV-7, Japan, Domestic Corporate Goods Price Index, Monthly, 1970-2014

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html

The producer price index of the US from 1970 to 2014 in Chart IV-8 shows various periods of more rapid or less rapid inflation but no bumps. The major event is the decline in 2008 when risk aversion because of the global recession caused the collapse of oil prices from $148/barrel to less than $80/barrel with most other commodity prices also collapsing. The event had nothing in common with explanations of deflation but rather with the concentration of risk exposures in commodities after the decline of stock market indexes. Eventually, there was a flight to government securities because of the fears of insolvency of banks caused by statements supporting proposals for withdrawal of toxic assets from bank balance sheets in the Troubled Asset Relief Program (TARP), as explained by Cochrane and Zingales (2009). The bump in 2008 with decline in 2009 is consistent with the view that zero interest rates with subdued risk aversion induce carry trades into commodity futures.

Chart IV-8, US, Producer Price Index Finished Goods, Monthly, 1970-2014

Source: US Bureau of Labor Statistics

http://www.bls.gov/ppi/

Further insight into inflation of the corporate goods price index (CGPI) of Japan is provided in Table IV-7. Petroleum and coal with weight of 5.7 percent increased 0.5 percent in Mar 2014 and increased 5.6 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 0.1 percent in Mar 2014 and decreased 0.2 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 (for analysis of terms of trade and growth see Pelaez (1979, 1976a). There are now inflation effects of the intentional policy of devaluing the yen.

Table IV-7, Japan, Corporate Goods Prices and Selected Components, % Weights, Month and 12 Months ∆%

Mar 2014	Weight	Month ∆%	12 Month ∆%
Total	1000.0	0.0	1.7
Food, Beverages, Tobacco, Feedstuffs	137.5	0.0	0.6
Petroleum & Coal	57.4	0.5	5.6
Production Machinery	30.8	-0.1	-0.2
Electronic Components	31.0	-0.1	-2.4
Electric Power, Gas & Water	52.7	0.9	12.6
Iron & Steel	56.6	-0.1	5.2
Chemicals	92.1	-0.2	1.9
Transport Equipment	136.4	-0.1	-0.4

Source: Bank of Japan

http://www.boj.or.jp/en/statistics/index.htm/

http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1403.pdf

http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1402.pdf

Percentage point contributions to change of the corporate goods price index (CGPI) in Feb 2014 are provided in Table IV-8 divided into domestic, export and import segments. In the domestic CGPI, changing 0.0 percent in Mar 2014, the energy shock is evident in the contribution of 0.04 percentage points by petroleum and coal products in new carry trades of exposures in commodity futures. The exports CGPI decreased 0.3 percent on the basis of the contract currency with deduction of 0.06 percentage points by electric and electronic products. The imports CGPI decreased 0.4 percent on the contract currency basis. Petroleum, coal and natural gas products deducted 0.34 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 IV-8, Japan, Percentage Point Contributions to Change of Corporate Goods Price Index

Groups Mar 2014	Contribution to Change Percentage Points
A. Domestic Corporate Goods Price Index	Monthly Change: 0.0%
Electric Power, Gas & Water	0.06
Petroleum & Coal Products	0.04
Information & Communications Equipment	0.01
Scrap & Waste	-0.06
Nonferrous Metals	-0.05
Chemicals & Related Products	-0.02
Agriculture, Forestry & Fishery Products	-0.01
B. Export Price Index	Monthly Change: -0.3 % contract currency
Chemicals & Related Products	-0.10
Other Primary Products & Manufactured Goods	-0.06
General Purpose, Production & Business Oriented Machinery	-0.06
Electric & Electronic Products	-0.06%
Metals & Related Products	-0.04
C. Import Price Index	Monthly Change: -0.4% contract currency basis
Petroleum, Coal & Natural Gas	-0.34
Metals & Related Products	-0.11
Chemicals & Related Products	-0.04
Foodstuffs & Feedstuffs	0.11

Source: Bank of Japan

http://www.boj.or.jp/en/statistics/index.htm/

http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1403.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 Apr 2014. The index of current prices paid or costs of inputs increased from 16.13 in Dec 2012 to 22.45 in Apr 2014 while the index of current prices received or sales prices increased from 1.08 in Dec 2012 to 10.2 in Apr 2014. The farther the index is from the area of no change at zero, the faster the rate of change. Prices paid or of inputs at 22.45 in Apr 2014 are expanding at faster pace than prices received or of sales of products at 10.20. 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 33.67 in Apr 2014 while the index of future prices received or expectation of sales prices in the next six months decreased from 25.81 in Dec 2012 to 14.29 in Apr 2014. Priced paid or of inputs are expected to increase at a faster pace in the next six months than prices received or prices of sales products. 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. Instability of sales/costs margins discourages investment and hiring.

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
Apr 2014	22.45	10.20	33.67	14.29
Mar	21.18	2.35	43.53	25.88
Feb	25.00	15.00	40.00	23.75
Jan	36.59	13.41	45.12	23.17
Dec 2013	15.66	3.61	48.19	27.71
Nov	17.11	-3.95	42.11	17.11
Oct	21.69	2.41	45.78	25.30
Sep	21.51	8.60	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 2011	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 in Table IV-6. As inflation waves throughout the world (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/03/interest-rate-risks-world-inflation.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 intensity 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 decreased from 20.6 in Dec 2012 to 11.3 in Apr 2014. The index of current prices received was minus 7.2 in Apr 2013, indicating decrease of prices received. The index of current prices received decreased from 10.9 in Dec 2012 to 4.3 in Apr 2014. The farther the index is from the area of no change at zero, the faster the rate of change. The index of current prices paid or costs of inputs at 11.3 in Apr 2014 indicates faster increase than the index of current prices received or sales prices of production at 4.3. The index of future prices paid decreased to 35.1 in Apr 2014 from 41.9 in Dec 2012 while the index of future prices received decreased from 27.3 in Dec 2012 to 13.0 in Apr 2014. Expectations are incorporating faster increases in prices of inputs or costs of production, 35.1 in Apr 2014, than of sales prices of produced goods, 13.0 in Apr 2014, forcing companies to manage tightly costs and labor inputs. Volatility of margins of sales/costs discourages investment and hiring.

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
10-Dec	42.6	6.00	56.8	25.7
11-Jan	47.9	12.1	58.7	34.1
11-Feb	61.1	13.2	62.6	30.7
11-Mar	57.6	17	62.1	32.4
11-Apr	50.9	20.8	55.3	33.7
11-May	49.3	20.5	54.6	28.5
11-Jun	38.9	7.7	41.6	6.8
11-Jul	35.6	6.3	48.3	16.7
11-Aug	24.6	-4	45.2	23.4
11-Sep	32	7.1	40.9	22.2
11-Oct	24.3	2.8	42.9	27.8
11-Nov	22.8	6.3	35.4	28.3
11-Dec	25	7	43.1	24.7
12-Jan	25.3	8	47.5	20.8
12-Feb	31.9	9.4	43.4	24.8
12-Mar	14.1	5.3	37.8	22.6
12-Apr	18.1	6.2	35.2	20.2
12-May	7.7	0.7	39.5	9.7
12-Jun	5.5	-3.7	34.8	16.9
12-Jul	10.8	4.9	27.9	20.3
12-Aug	18	5.6	39.5	25
12-Sep	15.8	3.5	42.2	27.5
12-Oct	19.9	7.1	45.8	15.3
12-Nov	23.6	6.5	47.6	12.8
12-Dec	20.6	10.9	41.9	27.3
13-Jan	11.8	-1.6	33.9	20
13-Feb	10.6	-1.3	25.4	20.6
13-Mar	7.6	-1.3	32.4	16.8
13-Apr	5	-7.2	28.9	9.9
13-May	9.7	0.2	33.5	19.9
13-Jun	23.7	14.6	33.3	24.3
13-Jul	22.7	8	41	25.6
13-Aug	20.4	11.1	40.7	24.5
13-Sep	25.9	12.5	43	31.6
13-Oct	21	12.8	43.1	34.6
13-Nov	25.4	9	43.5	38.1
13-Dec	16.4	10.8	39.1	34.8
14-Jan	18.7	5.1	35.3	11.8
14-Feb	14.2	7.6	18.2	16.3
14-Mar	13.9	4.3	29.4	15.9
14-Apr	11.3	4.3	35.1	13

Source: Federal Reserve Bank of Philadelphia

http://www.phil.frb.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 2014. 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 with marginal decline and new increase. The index falls in the final segment but there are no episodes of contraction after 2009.

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 2014. 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 2014 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 pursued 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

ESV United States Industrial Production. Industrial production increased 0.7 percent in Mar 2014 after increasing 1.2 percent in Feb 2013 and decreasing 0.2 percent in Jan 2014, as shown in Table I-1, with all data seasonally adjusted. The Federal Reserve completed its annual revision of industrial production and capacity utilization on Mar 28, 2014 (http://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm ). The report of the Board of Governors of the Federal Reserve System states (http://www.federalreserve.gov/releases/g17/Current/default.htm):

“Industrial production increased 0.7 percent in March after having advanced 1.2 percent in February. The rise in February was higher than previously reported primarily because of stronger gains for durable goods manufacturing and for mining. For the first quarter as a whole, industrial production moved up at an annual rate of 4.4 percent, just slightly slower than in the fourth quarter of 2013. In March, the output of manufacturing rose 0.5 percent, the output of utilities increased 1.0 percent, and the output of mines gained 1.5 percent. At 103.2 percent of its 2007 average, total industrial production in March was 3.8 percent above its level of a year earlier. Capacity utilization for total industry increased in March to 79.2 percent, a rate that is 0.9 percentage point below its long-run (1972–2013) average but 1.2 percentage points higher than a year prior.”

In the six months ending in Mar 2014, United States national industrial production accumulated increase of 2.4 percent at the annual equivalent rate of 4.9 percent, which is higher than growth of 3.8 percent in the 12 months ending in Feb 2014. Excluding growth of 1.2 percent in Jan 2014 (revised from 0.6 percent in the prior estimate), growth in the remaining five months from Oct to Mar 2013 accumulated to 1.2 percent or 2.9 percent annual equivalent. Industrial production fell in one of the past six months. Business equipment accumulated growth of 1.7 percent in the six months from Oct 2013 to Mar 2014 at the annual equivalent rate of 3.4 percent, which is higher than growth of 3.2 percent in the 12 months ending in Mar 2014. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for total industry increased in March to 79.2 percent, a rate that is 0.9 percentage point below its long-run (1972–2013) average but 1.2 percentage points higher than a year prior.” United States industry apparently decelerated to a lower growth rate with possible acceleration in the past few months.

Table I-1, US, Industrial Production and Capacity Utilization, SA, ∆%

2013-2014	Mar 14	Feb 14	Jan 14	Dec 13	Nov 13	Oct 13	Feb 14/ Feb 13
Total	0.7	1.2	-0.2	0.1	0.5	0.1	3.8
Market Groups
Final Products	0.7	1.4	-0.5	0.4	0.2	0.3	3.2
Consumer Goods	0.7	1.3	-0.7	0.8	0.4	0.5	3.2
Business Equipment	0.5	2.0	0.0	-0.6	-0.2	0.0	3.2
Non Industrial Supplies	0.5	1.2	-0.1	0.1	0.3	0.4	3.6
Construction	0.2	1.0	-0.2	-0.6	0.4	0.8	2.9
Materials	0.9	0.9	0.0	-0.1	0.9	-0.2	4.3
Industry Groups
Manufacturing	0.5	1.4	-0.9	0.1	0.3	0.4	2.8
Mining	1.5	0.9	0.8	0.2	0.8	-2.0	7.9
Utilities	1.0	-0.3	3.4	0.1	1.9	1.5	4.4
Capacity	79.2	78.8	78.1	78.4	78.5	78.2	2.2

Sources: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/g17/Current/default.htm

Manufacturing increased 0.5 percent in Mar 2014 after increasing 1.4 percent in Mar 2014 and decreasing 0.9 percent in Jan 2014 seasonally adjusted, increasing 3.4 percent not seasonally adjusted in the 12 months ending in Mar 2014, as shown in Table I-2. Manufacturing grew cumulatively 1.8 percent in the six months ending in Mar 2014 or at the annual equivalent rate of 3.6 percent. Excluding the increase of 1.4 percent in Feb 2014 (revised from 0.9 percent in the prior estimate), manufacturing accumulated growth of 0.4 percent from Oct 2013 to Mar 2014 or at the annual equivalent rate of 0.9 percent. Table I-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 strength at the margin. The Board of Governors of the Federal Reserve System conducted the annual revision of industrial production released on Mar 28, 2014 (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. The annual revision for 2014 was more limited than in recent years because the source data required to extend the annual benchmark indexes of production into 2012 were mostly unavailable. Consequently, the IP indexes published with this revision are very little changed from previous estimates. Measured from fourth quarter to fourth quarter, total IP is now reported to have increased about 3 1/3 percent in each year from 2011 to 2013. Relative to the rates of change for total IP published earlier, the new rates are 1/2 percentage point higher in 2012 and little changed in any other year. Total IP still shows a peak-to-trough decline of about 17 percent for the most recent recession, and it still returned to its pre-recession peak in the fourth quarter of 2013.”

The bottom part of Table I-2 shows decline of manufacturing by 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increase by 20.0 percent from the trough in Apr 2009 to Dec 2013. Manufacturing grew 23.5 percent from the trough in Apr 2009 to Mar 2014. Manufacturing output in Mar 2014 is 3.6 percent below the peak in Jun 2007.

Table I-2, US, Monthly and 12-Month Rates of Growth of Manufacturing ∆%

	Month SA ∆%	12-Month NSA ∆%
Mar 2014	0.5	3.4
Feb	1.4	2.6
Jan	-0.9	1.5
Dec 2013	0.1	2.1
Nov	0.3	2.8
Oct	0.4	3.7
Sep	0.3	2.8
Aug	0.7	2.9
Jul	-0.4	1.7
Jun	0.3	2.3
May	0.3	2.4
Apr	-0.2	2.7
Mar	0.1	2.6
Feb	0.6	2.5
Jan	-0.2	2.9
Dec 2012	0.7	3.8
Nov	1.3	3.8
Oct	-0.4	2.6
Sep	0.2	3.5
Aug	-0.5	3.8
Jul	0.4	4.3
Jun	0.4	5.0
May	-0.2	4.9
Apr	0.8	5.1
Mar	-0.3	3.8
Feb	0.6	5.1
Jan	1.0	4.0
Dec 2011	0.7	3.5
Nov	-0.1	2.9
Oct	0.5	3.0
Sep	0.4	2.9
Aug	0.3	2.3
Jul	0.8	2.6
Jun	0.1	2.1
May	0.2	1.9
Apr	-0.6	3.2
Mar	0.7	4.9
Feb	0.0	5.4
Jan	0.2	5.7
Dec 2010	0.4	6.3
Nov	0.2	5.4
Oct	0.1	6.6
Sep	0.1	6.9
Aug	0.1	7.4
Jul	0.8	7.8
Jun	0.0	9.3
May	1.5	8.8
Apr	0.9	7.0
Mar	1.3	4.8
Feb	-0.1	1.3
Jan	1.1	1.2
Dec 2009	-0.1	-3.1
Nov	1.0	-6.0
Oct	0.2	-9.1
Sep	0.8	-10.6
Aug	1.0	-13.6
Jul	1.4	-15.2
Jun	-0.3	-17.7
May	-1.1	-17.6
Apr	-0.7	-18.2
Mar	-1.8	-17.3
Feb	-0.3	-16.1
Jan	-2.9	-16.4
Dec 2008	-3.4	-13.9
Nov	-2.4	-11.3
Oct	-0.6	-8.9
Sep	-3.4	-8.5
Aug	-1.2	-5.0
Jul	-1.1	-3.5
Jun	-0.6	-3.1
May	-0.5	-2.4
Apr	-1.1	-1.1
Mar	-0.3	-0.6
Feb	-0.6	0.9
Jan	-0.4	2.2
Dec 2007	0.1	1.9
Nov	0.5	3.3
Oct	-0.4	2.8
Sep	0.5	2.9
Aug	-0.4	2.6
Jul	0.2	3.5
Jun	0.3	3.0
May	-0.1	3.1
Apr	0.7	3.6
Mar	0.8	2.5
Feb	0.4	1.6
Jan	-0.5	1.3
Dec 2006		2.7
Dec 2005		3.5
Dec 2004		3.8
Dec 2003		2.0
Dec 2002		2.4
Dec 2001		-5.7
Dec 2000		0.7
Dec 1999		5.3
Average ∆% Dec 1986-Dec 2013		2.3
Average ∆% Dec 1986-Dec 2012		2.3
Average ∆% Dec 1986-Dec 1999		4.2
Average ∆% Dec 1999-Dec 2006		1.3
Average ∆% Dec 1999-Dec 2013		0.6
∆% Peak 103.0351 in 06/2007 to 96.4466 in 12/2013		-6.4
∆% Peak 103.0351 in 06/2007 to Trough 80.4551 in 4/2009		-21.9
∆% Trough 80.4551 in 04/2009 to 96.4466 in 12/2013		20.0
∆% Trough 80.4451 in 04/2009 to 99.3214 in 3/2013		23.5
∆% Peak 103.0351 on 06/2007 to 99.3214 in 3/2014		-3.6

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/g17/Current/default.htm

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Sunday, April 20, 2014

IMF View, World Inflation Waves, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, United States Industrial Production, Collapse of United States Dynamism of Income Growth and Employment Creation, World Cyclical Slow Growth and Global Recession Risk: Part I

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