CMP Associates Regulation Blog: United States Commercial Banks Assets and Liabilities, Collapse of United States Dynamism of Income Growth and Employment Creation, United States Housing Collapse, World Cyclical Slow Growth and Global Recession Risk: Part I

United States Commercial Banks Assets and Liabilities, Collapse of United States Dynamism of Income Growth and Employment Creation, United States Housing Collapse, World Cyclical Slow Growth and Global Recession Risk

Carlos M. Pelaez

Executive Summary

I United States Commercial Banks Assets and Liabilities

IIA1 Transmission of Monetary Policy

IIB1 Functions of Banks

IIC United States Commercial Banks Assets and Liabilities

IID 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 United States Housing Collapse

III World Financial Turbulence

IIIA Financial Risks

IIIE Appendix Euro Zone Survival Risk

IIIF Appendix on Sovereign Bond Valuation

IV Global Inflation

V World Economic Slowdown

VA United States

VB Japan

VC China

VD Euro Area

VE Germany

VF France

VG Italy

VH United Kingdom

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

Appendixes

Appendix I The Great Inflation

IIIB Appendix on Safe Haven Currencies

IIIC Appendix on Fiscal Compact

IIID Appendix on European Central Bank Large Scale Lender of Last Resort

IIIG Appendix on Deficit Financing of Growth and the Debt Crisis

IIIGA Monetary Policy with Deficit Financing of Economic Growth

IIIGB Adjustment during the Debt Crisis of the 1980s

Executive Summary

Contents of Executive Summary

ESI Increasing Interest Rate Risk, Tapering Quantitative Easing, Duration Dumping, Steepening

Yield Curve and Global Financial and Economic Risk

ESII United States Commercial Banks Assets and Liabilities

ESIII United States Housing Collapse

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

ESV World Cyclical Slow Growth and International Trade

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 (http://cmpassocregulationblog.blogspot.com/2014/04/imf-view-world-inflation-waves-squeeze.html 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 27.4 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 (http://cmpassocregulationblog.blogspot.com/2014/05/world-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2014/04/imf-view-world-inflation-waves-squeeze.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 May 22, 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
4/24/14	0.10	2.70	4.84
5/1/14	0.09	2.63	4.77
5/8/14	0.08	2.61	4.79
5/15/14	0.09	2.50	4.72
5/22/14	0.09	2.56	4.81

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 Apr 30, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140430a.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 May 22, 2014. Chart SA provides the yields of the five, seven, ten and thirty-year Treasury constant maturity in the same dates. 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). Yields converged toward slightly lower earlier levels in the week of Apr 24, 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 May 15, 2014

Source: Board of Governors of the Federal Reserve System

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

Chart SA, US, Yield of Seven-Year, Ten-Year and Thirty-Year Treasury Constant Maturity, Mar 17 to May 15, 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 Feb 2014 to Apr 2014, CPI inflation for all items seasonally adjusted was 2.4 percent in annual equivalent, obtained by calculating accumulated inflation from Feb 2013 to Apr 2014 and compounding for a full year. In the 12 months ending in Apr 2014, CPI inflation of all items not seasonally adjusted was 2.0 percent. Inflation in Apr 2014 seasonally adjusted was 0.3 percent relative to Mar 2014, or 3.7 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: 1.8 percent in 12 months and 2.0 percent in annual equivalent Feb 2013-Apr 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 0.036 percent for one month, 0.036 percent for three months, 0.053 percent for six months, 0.089 percent for one year, 0.347 percent for two years, 0.779 percent for three years, 1.529 percent for five years, 2.070 percent for seven years, 2.536 percent for ten years and 3.398 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 Apr 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 Apr 2014/Apr 2013 NSA	∆% Annual Equivalent Feb 2014 to Apr 2014 SA
CPI All Items	2.0	1.6
CPI ex Food and Energy	1.8	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 May 23, 2014, Dec 31, 2013, May 1, 2013, May 23, 2013 and May 23, 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 2.54 percent on May 23, 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 2.54 percent as occurred on May 16, 2013 would jump instantaneously from yield of 2.54 percent on May 23, 2014 to 5.07 percent as occurred on May 23, 2006 when the economy was closer to full employment. The price of the hypothetical bond issued with coupon of 2.54 percent would drop from 100 to 80.3448 after an instantaneous increase of the yield to 5.07 percent. The price loss would be 15.7 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

	5/16/14	12/31/13	5/01/13	5/16/13	5/16/06
1 M	0.02	0.01	0.03	0.00	4.76
3 M	0.03	0.07	0.06	0.03	4.83
6 M	0.05	0.10	0.08	0.08	4.99
1 Y	0.10	0.13	0.11	0.12	4.98
2 Y	0.39	0.38	0.20	0.23	4.96
3 Y	0.81	0.78	0.30	0.37	4.97
5 Y	1.57	1.75	0.65	0.79	4.99
7 Y	2.10	2.45	1.07	1.25	5.03
10 Y	2.54	3.04	1.66	1.87	5.10
20 Y	3.09	3.72	2.44	2.69	5.36
30 Y	3.37	3.96	2.83	3.09	5.22

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 4.14 percent on May 22, 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. Nick Timiraos, writing on “Demand for home loans plunges,” on Apr 24, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304788404579522051733228402?mg=reno64-wsj), analyzes data in Inside Mortgage Finance that mortgage lending of $235 billion in IQ2014 is 58 percent lower than a year earlier and 23 percent below IVQ2013. Mortgage lending collapsed to the lowest level in 14 years. In testimony before the Committee on the Budget of the US Senate on May 8, 2004, Chair Yellen provides analysis of the current economic situation and outlook (http://www.federalreserve.gov/newsevents/testimony/yellen20140507a.htm): “One cautionary note, though, is that readings on housing activity--a sector that has been recovering since 2011--have remained disappointing so far this year and will bear watching.”

Chart VI-13, US, Conventional Mortgage Rate, Jan 8, 2004 to May 22, 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 1.3630/EUR on May 23, 2014 or by 14.3 percent {[(1.3630/1.192)-1]100 = 14.3%}. 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 6.2354/USD on Fri May 23, 2014, or by an additional 8.6 percent, for cumulative revaluation of 24.7 percent. The final row of Table VI-2 shows: devaluation of 0.1 in the week of May 2, 2014; revaluation of 0.5 percent in the week of May 9, 2014; devaluation of 0.1 percent the week of May 16, 2014; and change of 0.0 percent in the week of May 23, 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	5/23/14
Rate	1.1423	1.5914	1.192	1.3630
CNY/USD	01/03 2000	07/21 2005	7/15 2008	5/23/ 2014
Rate	8.2798	8.2765	6.8211	6.2354
Weekly Rates	5/2/2014	5/9/2014	5/16/2014	5/23/ 2014
CNY/USD	6.2595	6.2281	6.2340	6.2354
∆% from Earlier Week*	-0.1	0.5	-0.1	0.0

*Negative sign is depreciation; positive sign is appreciation

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

Chart VI-3 provides three indexes of the US Dollars (USD) from Jan 4, 1995 to May 16, 2014.

Chart VI-3A provides the overnight fed funds rate and yields of the three-month constant maturity Treasury bill, the ten-year constant maturity Treasury note and Moody’s Baa bond from Jan 4, 1995 to May 22, 2014. The first phase from 1995 to 2001 shows sharp trend of appreciation of the USD while interest rates remained at relatively high levels. The dollar revalued partly because of the emerging market crises that provoked inflows of financial investment into the US and partly because of a deliberate strong dollar policy. DeLong and Eichengreen (2001, 4-5) argue:

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 May 16, 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 6.2327/USD on May 16, 2014, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD by 24.7 percent by May 23, 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-May 16, 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 May 16, 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 6.2327/USD on May 16, 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-May 16, 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 May 16, 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 6.2327 on May 16, 2014, or devaluation of 3.2 percent.

Chart VI-1B, Chinese Yuan (CNY) per US Dollar (US), Business Days, Oct 28, 2011-May 16, 2014

Source: Board of Governors of the Federal Reserve System

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

“That context was an economic and political strategy that emphasized private investment as the engine for U.S. economic growth. Both components of this term, "private" and "investment," had implications for the administration’s international economic strategy. From the point of view of investment, it was important that international events not pressure on the Federal Reserve to raise interest rates, since this would have curtailed capital formation and vitiated the effects of the administration’s signature achievement: deficit reduction. A strong dollar -- or rather a dollar that was not expected to weaken -- was a key component of a policy which aimed at keeping the Fed comfortable with low interest rates. In addition, it was important to create a demand for the goods and services generated by this additional productive capacity. To the extent that this demand resided abroad, administration officials saw it as important that the process of increasing international integration, of both trade and finance, move forward for the interest of economic development in emerging markets and therefore in support of U.S. economic growth.”

The process of integration consisted of restructuring “international financial architecture” (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Debtors and Creditors (2005)). Policy concerns subsequently shifted to the external imbalances, or current account deficits, and internal imbalances, or government deficits (Pelaez and Pelaez, The Global Recession Risk: Dollar Devaluation and the World Economy (2007)). Fed policy consisted of lowering the policy rate or fed funds rate, which is close to the marginal cost of funding of banks, toward zero during the past decade. Near zero interest rates induce carry trades of selling dollar debt (borrowing), shorting the USD and investing in risk financial assets. Without risk aversion, near zero interest rates cause devaluation of the dollar. Chart VI-3A shows the weakening USD between the recession of 2001 and the contraction after IVQ2007. There was a flight to dollar assets and especially obligations of the US government after Sep 2008. Cochrane and Zingales (2009) show that flight was coincident with proposals of TARP (Troubled Asset Relief Program) to withdraw “toxic assets” in US banks (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a) and Regulation of Banks and Finance (2009b)). There are shocks to globalization in the form of regulation, trade and devaluation wars and breakdown of international cooperation (Pelaez and Pelaez, Globalization and the State: Vol. I (2008a), Globalization and the State: Vol. II (2008b) and Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c)). As evident in Chart VI-3A, there is no exit from near zero interest rates without a financial crisis and economic contraction, verified by the increase of interest rates from 1 percent in Jun 2004 to 5.25 percent in Jun 2006. 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). 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 VI-3A. 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. There are conflicts on exchange rate movements among central banks. There is concern of declining inflation in the euro area and appreciation of the euro. In the “Introductory statement to the press conference,” on May 8, 2014, the President of the European Central Bank Mario Draghi states (http://www.ecb.europa.eu/press/pressconf/2014/html/is140508.en.html):

“We will maintain a high degree of monetary accommodation and act swiftly, if required, with further monetary policy easing. We firmly reiterate that we continue to expect the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on an overall subdued outlook for inflation extending into the medium term, given the broad-based weakness of the economy, the high degree of unutilised capacity, and subdued money and credit creation. The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation. Further information and analysis concerning the outlook for inflation and the availability of bank loans to the private sector will be available in early June.”

Chart VI-3, US Dollar Currency Indexes, Jan 4, 1995-May 16, 2014

Source: Board of Governors of the Federal Reserve System

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

Chart VI-3A, US, Overnight Fed Funds Rate, Yield of Three-Month Treasury Constant Maturity, Yield of Ten-Year Treasury Constant Maturity and Yield of Moody’s Baa Bond, Jan 4, 1995 to May 22, 2014

Source: Board of Governors of the Federal Reserve System

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

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 May 16, 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 12.9220/USD on May 16, 2014.

Chart VI-4A, Mexican Peso (MXN) per US Dollar (USD), Nov 8, 1993 to May 16, 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 Apr 10, 2014, 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 May 16, 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 58.6200/USD on May 16, 2014.

Chart VI-4B, Indian Rupee (INR) per US Dollar (USD), Jan 2, 1973 to May 16, 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 101.5000/USD on May 16, 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. Gerard Baker and Jacob M. Shlesinger, writing on “Bank of Japan’s Kuroda signals impatience with Abe government,” on May 23, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303480304579579311491068756?KEYWORDS=bank+of+japan+kuroda&mg=reno64-wsj), analyze concerns of the Governor of the Bank of Japan Haruhiko Kuroda that the JPY has strengthened relative to the USD, partly eroding earlier depreciation. 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-May 16, 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 2.2115/USD on May 16, 2014. 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 2.2115/USD on May 16, 2014 for depreciation of 43.8 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 May 16, 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 May 16, 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/20140430a.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 May, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $20 billion per month rather than $25 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $25 billion per month rather than $30 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).”

In testimony before the Committee on the Budget of the US Senate on May 8, 2004, Chair Yellen provides analysis of the current economic situation and outlook (http://www.federalreserve.gov/newsevents/testimony/yellen20140507a.htm):

“The economy has continued to recover from the steep recession of 2008 and 2009. Real gross domestic product (GDP) growth stepped up to an average annual rate of about 3-1/4 percent over the second half of last year, a faster pace than in the first half and during the preceding two years. Although real GDP growth is currently estimated to have paused in the first quarter of this year, I see that pause as mostly reflecting transitory factors, including the effects of the unusually cold and snowy winter weather. With the harsh winter behind us, many recent indicators suggest that a rebound in spending and production is already under way, putting the overall economy on track for solid growth in the current quarter. One cautionary note, though, is that readings on housing activity--a sector that has been recovering since 2011--have remained disappointing so far this year and will bear watching.

Conditions in the labor market have continued to improve. The unemployment rate was 6.3 percent in April, about 1-1/4 percentage points below where it was a year ago. Moreover, gains in payroll employment averaged nearly 200,000 jobs per month over the past year. During the economic recovery so far, payroll employment has increased by about 8-1/2 million jobs since its low point, and the unemployment rate has declined about 3-3/4 percentage points since its peak.

While conditions in the labor market have improved appreciably, they are still far from satisfactory. Even with recent declines in the unemployment rate, it continues to be elevated. Moreover, both the share of the labor force that has been unemployed for more than six months and the number of individuals who work part time but would prefer a full-time job are at historically high levels. In addition, most measures of labor compensation have been rising slowly--another signal that a substantial amount of slack remains in the labor market.

Inflation has been quite low even as the economy has continued to expand. Some of the factors contributing to the softness in inflation over the past year, such as the declines seen in non-oil import prices, will probably be transitory. Importantly, measures of longer-run inflation expectations have remained stable. That said, the Federal Open Market Committee (FOMC) recognizes that inflation persistently below 2 percent--the rate that the Committee judges to be most consistent with its dual mandate--could pose risks to economic performance, and we are monitoring inflation developments closely.

Looking ahead, I expect that economic activity will expand at a somewhat faster pace this year than it did last year, that the unemployment rate will continue to decline gradually, and that inflation will begin to move up toward 2 percent. A faster rate of economic growth this year should be supported by reduced restraint from changes in fiscal policy, gains in household net worth from increases in home prices and equity values, a firming in foreign economic growth, and further improvements in household and business confidence as the economy continues to strengthen. Moreover, U.S. financial conditions remain supportive of growth in economic activity and employment.”

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 (http://cmpassocregulationblog.blogspot.com/2014/04/global-financial-instability-recovery.html 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 16,606.27 on Fri May 23, 2014, which is higher by 17.2 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 17.0 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 71.4 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to May 23, 2014; S&P 500 has gained 85.9 percent and DAX 72.3 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 5/23/14” 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 14.6 percent below the trough. Japan’s Nikkei Average is 63.9 percent above the trough. DJ Asia Pacific TSM is 26.8 percent above the trough. Dow Global is 49.8 percent above the trough. STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 31.8 percent above the trough. NYSE Financial Index is 49.7 percent above the trough. DJ UBS Commodities is 9.5 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 72.3 percent above the trough. Japan’s Nikkei Average is 63.9 percent above the trough on Aug 31, 2010 and 26.9 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 14,462.17 on Fri May 23, 2014 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 41.0 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 14.3 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 5/23/14” in Table VI-4 shows increase of 0.4 percent in the week for China’s Shanghai Composite. DJ Asia Pacific increased 1.1 percent. NYSE Financial increased 1.0 percent in the week. DJ UBS Commodities increased 0.4 percent. Dow Global increased 0.7 percent in the week of May 23, 2014. The DJIA increased 0.7 percent and S&P 500 increased 1.2 percent. DAX of Germany increased 1.4 percent. STOXX 50 decreased 0.1 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 5/23/14” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to May 23, 2014. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 5/23/14” but also relative to the peak in column “∆% Peak to 5/23/14.” There are now several equity indexes above the peak in Table VI-4: DJIA 48.2 percent, S&P 500 56.1 percent, DAX 54.3 percent, Dow Global 22.2 percent, DJ Asia Pacific 11.0 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 19.2 percent, Nikkei Average 26.9 percent and STOXX 50 11.6 percent. There is only one equity index below the peak: Shanghai Composite by 35.7 percent. DJ UBS Commodities Index is now 6.4 percent below the peak. The US dollar strengthened 9.9 percent relative to the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul 2010 because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010.

Tom Lauricella, writing on Mar 31, 2014, on “Stock investors see hints of a stronger quarter,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304157204579473513864900656?mod=WSJ_smq0314_LeadStory&mg=reno64-wsj), finds views of stronger earnings among many money managers with positive factors for equity markets in continuing low interest rates and US economic growth. There is important information in the Quarterly Markets review of the Wall Street Journal (http://online.wsj.com/public/page/quarterly-markets-review-03312014.html) foir IQ2014. 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 $1,174.6 billion in IIIQ1987 or 23.4 percent. Real gross private domestic investment in the US decreased 0.1 percent from $2,605.2 billion of 2009 dollars in IVQ2007 to $2,602.0 billion in IQ2014. As shown in Table IAI-2, real private fixed investment fell 3.6 percent from $2,586.3 billion of 2009 dollars in IVQ2007 to $2,493.3 billion in IQ2014. Growth of real private investment in Table IA1-2 is mediocre for all but four quarters from IIQ2011 to IQ2012 (Section I and earlier 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 5/23/ /14	∆% Week 5/23/14	∆% Trough to 5/23/ 14
DJIA	4/26/ 10	7/2/10	-13.6	48.2	0.7	71.4
S&P 500	4/23/ 10	7/20/ 10	-16.0	56.1	1.2	85.9
NYSE Finance	4/15/ 10	7/2/10	-20.3	19.2	1.0	49.7
Dow Global	4/15/ 10	7/2/10	-18.4	22.2	0.7	49.8
Asia Pacific	4/15/ 10	7/2/10	-12.5	11.0	1.1	26.8
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	26.9	2.6	63.9
China Shang.	4/15/ 10	7/02 /10	-24.7	-35.7	0.4	-14.6
STOXX 50	4/15/10	7/2/10	-15.3	11.6	-0.1	31.8
DAX	4/26/ 10	5/25/ 10	-10.5	54.3	1.4	72.3
Dollar Euro	11/25 2009	6/7 2010	21.2	9.9	0.5	-14.3
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-6.4	0.4	9.5
10-Year T Note	4/5/ 10	4/6/10	3.986	2.784	2.532

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 United States Commercial Banks Assets and Liabilities. Selected assets and liabilities of US commercial banks, not seasonally adjusted, in billions of dollars, from Report H.8 of the Board of Governors of the Federal Reserve System are in Table I-1. Data are not seasonally adjusted to permit comparison between Apr 2013 and Apr 2014. Total assets of US commercial banks grew 7.7 percent from $13,315.4 billion in Apr 2013 to $14,380.7 billion in Apr 2014. US GDP in 2013 is estimated at $16,799.7 billion (http://www.bea.gov/iTable/index_nipa.cfm). Thus, total assets of US commercial banks are equivalent to around 85 percent of US GDP. Bank credit grew 2.9 percent from $10,036.6 billion in Apr 2013 to $10,332.8 billion in Apr 2014. Securities in bank credit increased 0.7 percent from $2760.5 billion in Apr 2013 to $27778.7 billion in Apr 2014. A large part of securities in banking credit consists of US Treasury and agency securities, decreasing 0.5 percent from $1880.1 billion in Apr 2013 to $1871.0 billion in Apr 2014. Credit to the government that issues or backs Treasury and agency securities of $1871.0 billion in Apr 2014 is about 18.1 percent of total bank credit of US commercial banks of $10,332.8 billion. Mortgage-backed securities, providing financing of home loans, decreased 1.9 percent, from $1366.1 billion in Apr 2013 to $1340.3 billion in Apr 2014. Loans and leases are relatively more dynamic, growing 3.8 percent from $7276.1 billion in Apr 2013 to $7554.1 billion in Apr 2014. The only dynamic class is commercial and industrial loans, growing 10.5 percent from Apr 2013 to Apr 2014 and providing $1696.6 billion or 22.5 percent of total loans and leases of $7554.1 billion in Apr 2014. Real estate loans increased 0.5 percent, providing $3555.4 billion in Apr 2014 or 47.1 percent of total loans and leases. Consumer loans increased 2.7 percent, providing $1149.2 billion in Apr 2014 or 15.2 percent of total loans. Cash assets are measured to “include vault cash, cash items in process of collection, balances due from depository institutions and balances due from Federal Reserve Banks” (http://www.federalreserve.gov/releases/h8/current/default.htm). Cash assets in US commercial banks increased 41.0 percent from $1945.6 billion in Apr 2013 to $2742.8 billion in Apr 2014 but a single year of the series masks exploding cash in banks because of unconventional monetary policy, which is discussed below. Bank deposits increased 7.6 percent from $9376.4 billion in Apr 2013 to $10,089.2 billion in Apr 2014. The difference between bank deposits and total loans and leases in banks increased from $2100.3 billion in Apr 2013 to $2535.1 billion in Apr 2014 or by $434.8 billion. Securities in bank credit increased by $18.2 billion from $2760.5 billion in Apr 2013 to $2778.7 billion in Apr 2014 and Treasury and agency securities decreased by $9.1 billion from $1880.1 billion in Apr 2013 to $1871.0 billion in Apr 2014. Loans and leases increased $278.0 billion from $7276.1 billion in Apr 2013 to $7554.1 billion in Apr 2014. Banks expanded both lending and investment in lower risk securities partly because of the weak economy and credit disappointments during the global recession that has resulted in an environment of fewer sound lending opportunities. Investing in securities with high duration, or price elasticity of yields, is riskier because of the increase in yields that can cause loss of principal as investors shift away from bond funds into money market funds invested in short-term assets. Lower interest rates resulting from monetary policy may not necessarily encourage higher borrowing in the current loss of dynamism of the US economy with real disposable income per capita in IQ2014 higher by only 3.3 percent than in IVQ2007 (Table IB-2 IX Conclusion and extended analysis in IB Collapse of United States Dynamism of Income Growth and Employment Creation) in contrast with 13.7 percent higher if the economy had performed in long-term growth of per capita income in the United States at 2 percent per year from 1870 to 2010 (Lucas 2011May). In contrast, growth of real disposable income per capita grew cumulatively 15.5 percent in the cycle from IQ1980 to IIIQ1987 that was close to trend growth of 17.2 percent.

Table I-1, US, Assets and Liabilities of Commercial Banks, NSA, Billions of Dollars

	Apr 2013	Apr 2014	∆%
Total Assets	13,315.4	14,380.7	7.7
Bank Credit	10,036.6	10,332.8	2.9
Securities in Bank Credit	2760.5	2778.7	0.7
Treasury & Agency Securities	1880.1	1871.0	-0.5
Mortgage-Backed Securities	1366.1	1340.3	-1.9
Loans & Leases	7276.1	7554.1	3.8
Real Estate Loans	3539.1	3555.4	0.5
Commercial Real Estate Loans	1433.5	1526.5	6.5
Consumer Loans	1119.4	1149.2	2.7
Commercial & Industrial Loans	1535.8	1696.6	10.5
Other Loans & Leases	1081.8	1152.9	6.6
Cash Assets*	1945.6	2742.8	41.0
Total Liabilities	11,831.3	12,825.4	8.4
Deposits	9376.4	10,089.2	7.6
Residual (Assets less Liabilities)	1520.2	1555.3	NA

Note: balancing item of residual assets less liabilities not included

*”Includes vault cash, cash items in process of collection, balances due from depository institutions and balances due from Federal Reserve Banks.”

Source: Board of Governors of the Federal Reserve System

Benchmarked to Sep 2013

http://www.federalreserve.gov/releases/h8/current/default.htm

Seasonally adjusted annual equivalent rates (SAAR) of change of selected assets and liabilities of US commercial banks from the report H.8 of the Board of Governors of the Federal Reserve System are in Table I-2 annually from 2009 to 2013 and for Mar 2014 and Apr 2014. The global recession had strong impact on bank assets as shown by declines of total assets of 6.0 percent in 2009 and 2.6 percent in 2010. Loans and leases fell 10.2 percent in 2009 and 5.7 percent in 2010. Commercial and industrial loans fell 18.4 percent in 2009 and 8.9 percent in 2010. Unconventional monetary policy caused an increase of cash assets of banks of 159.2 percent in 2008, 49.5 percent in 2009 and 47.7 percent in 2011 followed by decline by 2.2 percent in 2012. Cash assets of banks increased 55.2 percent in 2013. Cash assets of banks increased at the SAAR of 22.5 percent in Aug 2012 but contraction by 49.6 percent in Sep 2012 and 6.3 percent in Oct 2012. Cash assets of banks increased at 56.0 percent in Nov 2012, minus 7.8 percent in Dec 2012, 38.8 percent in Jan 2013, 66.2 percent in Feb 2013, 66.0 percent in Mar 2013 and 14.5 percent in Apr 2013. Cash assets of banks increased at the SAAR of 63.2 percent in May 2013, 42.4 percent in Jun 2013, 28.6 percent in Jul 2013, 71.5 percent in Aug 2013, 57.5 percent in Sep 2013 and 50.2 percent in Oct 2013. Cash assets of banks increased at the rate of 29.0 percent in Nov 2013 and fell at 1.5 percent in Dec 2013. Cash assets of banks increased at 20.1 percent in Jan 2014 and at 21.7 percent in Feb 2014. Cash assets of banks increased at 36.7 percent in Mar 2014 and at 2.1 percent in Apr 2014. Acquisitions of securities for the portfolio of the central bank injected reserves in depository institutions that banks held as cash and reserves at the central bank because of the lack of sound lending opportunities and the adverse expectations in the private sector on doing business. The truly dynamic investment of banks has been in securities in bank credit: growing at the SAAR of 15.4 percent in Jul 2012, 2.6 percent in Aug 2012, 5.3 percent in Sep 2012, 4.7 percent in Oct 2012, 1.7 percent in Nov 2012 and 20.5 percent in Dec 2012. There were declines of securities in bank credit at 1.1 percent in Jan 2013, 3.2 percent in Feb 2013 and 2.7 percent in Mar 2013 but growth of 1.5 percent in Apr 2013. Securities in bank credit fell at the SAAR of 2.6 percent in May 2013 and 5.7 percent in Jun 2013. Securities in bank credit fell at the SAAR of 11.9 percent in Jul 2013 and at 8.3 percent in Aug 2013. Securities in bank credit fell at the SAAR of 6.8 percent in Sep 2013 and increased at 3.0 percent in Oct 2013. Securities in bank credit increased at 5.2 percent in Nov 2013 and at 10.5 percent in Dec 2013. Securities in bank credit increased at 4.1 percent in Jan 2014 and at 6.1 percent in Feb 2014. Securities in bank credit increased at 7.7 percent in Mar 2014 and at 3.5 percent in Apr 2014. Fear of loss of principal in securities with high duration or price elasticity of yield is shifting investments away from bonds into cash and other assets with less price risk. Positions marked to market in balance sheets experience sharp declines. Throughout the crisis banks allocated increasing part of their assets to the safety of Treasury and agency securities, or credit to the US government and government-backed credit: with growth of 13.5 percent in 2009 and 15.2 percent in 2010 and at the rate of 16.3 percent in Jul 2012, declining to the rate of 3.4 percent in Aug 2012, 2.1 percent in Sep 2012 and 0.7 percent in Oct 2012. Treasury and agency securities in bank credit fell at the rate of 0.8 percent in Nov 2012, increasing at 17.2 percent in Dec 2012. Treasury and agency securities in bank credit fell at 5.9 percent in Jan 2013, 3.1 percent in Feb 2013, 7.0 percent in Mar 2013 and 5.4 percent in Apr 2013 and 8.3 percent in May 2013. Treasury and agency securities in US commercial banks fell at the SAAR of 6.8 percent in Jun 2013, 19.7 percent in Jul 2013 and 15.7 percent in Aug 2013. Treasury and agency securities fell at the SAAR of 5.6 percent in Sep 2013 and increased at 1.3 percent in Oct 2013. Treasury and agency securities increased at 5.6 percent in Nov 2013 and at 8.9 percent in Dec 2013. Treasury and agency securities increased at 4.2 percent in Jan 2014 and at 7.7 percent in Feb 2014. Treasury and agency securities increased at 10.0 percent in Mar 2014 and at 8.9 percent in Apr 2014. Increases in yield result in capital losses that may explain less interest in holding securities with higher duration. Deposits grew at the rate of 10.5 percent in Jul 2012, with the rate declining as for most assets of commercial banks to the rate of 6.2 percent in Aug 2012 but increasing to 7.2 percent in Sep 2012, 8.4 percent in Oct 2012, 5.7 percent in Nov 2012, 18.7 percent in Dec 2012, 2.7 percent in Jan 2013. Deposits grew at the rate of 4.4 percent in Feb 2013, 7.7 percent in Mar 2013, 3.5 percent in Apr 2013 and 2.4 percent in May 2013. Deposits increased at the SAAR of 6.3 percent in Jun 2013, 8.0 percent in Jul 2013 and 3.5 percent in Aug 2013. Deposits grew at the rate of 7.2 percent in Sep 2013 and at 9.0 percent in Oct 2013. Deposits grew at 9.1 percent in Nov 2013 and at 9.1 percent in Dec 2013. Deposits increased at 8.7 percent in Jan 2014 and at 9.5 percent in Feb 2014. Deposits grew at 5.5 percent in Mar 2014 and at 9.3 percent in Apr 2014. The credit intermediation function of banks is broken because of adverse expectations on future business and cannot be fixed by monetary and fiscal policy. Incentives to business and consumers are more likely to be effective in this environment in recovering willingness to assume risk on the part of the private sector, which is the driver of growth and job creation.

Table I-2, US, Selected Assets and Liabilities of Commercial Banks, at Break Adjusted, Seasonally Adjusted Annual Rate, ∆%

	2009	2010	2011	2012	2013	Mar 2014	Apr 2014
Total Assets	-6.0	-2.6	5.3	2.6	7.2	12.0	5.0
Bank Credit	-6.7	-2.6	1.8	4.0	1.1	8.3	7.0
Securities in Bank Credit	6.2	6.9	1.8	7.5	-1.9	7.7	3.5
Treasury & Agency Securities	13.5	15.2	3.0	8.6	-5.6	10.0	8.9
Other Securities	-4.3	-7.2	-0.7	5.2	6.5	3.4	-7.1
Loans & Leases	-10.2	-5.7	1.7	2.8	2.2	8.6	8.2
Real Estate Loans	-5.7	-5.6	-3.7	-1.1	-1.0	1.3	5.1
Commercial Real Estate Loans	-4.7	-8.9	-6.3	-1.2	4.4	3.5	8.9
Consumer Loans	-3.2	-6.8	-1.2	1.2	3.5	3.8	10.5
Commercial & Industrial Loans	-18.4	-8.9	8.6	11.4	7.7	13.3	12.4
Other Loans & Leases	-23.0	0.4	20.1	6.9	4.4	29.6	9.3
Cash Assets	49.5	-7.8	47.7	-2.2	55.2	36.7	2.1
Total Liabilities	-7.1	-3.3	5.5	2.3	8.1	11.3	6.2
Deposits	5.2	2.4	6.7	7.1	6.4	5.5	9.3

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h8/current/default.htm

ESIII United States Housing Collapse. Data and other information continue to provide depressed conditions in the US housing market in a longer perspective, with recent improvement at the margin. Table IIB-1 shows sales of new houses in the US at seasonally adjusted annual equivalent rate (SAAR). House sales fell in seventeen of forty months from Jan 2011 to Apr 2014 but mostly concentrated in Jan-Feb 2011 and May-Aug 2011. In Jan-Apr 2012, house sales increased at the annual equivalent rate of 11.8 percent and at 22.3 percent in May-Sep 2012. There was significant strength in Sep-Dec 2011 with annual equivalent rate of 48.4 percent. Sales of new houses fell 7.0 percent in Oct 2012 with increase of 9.5 percent in Nov 2012. Sales of new houses rebounded 13.5 percent in Jan 2013 with annual equivalent rate of 62.9 percent from Oct 2012 to Jan 2013 because of the increase of 13.5 percent in Jan 2013. New house sales fell at annual equivalent 16.1 percent in Feb-Mar 2013. New house sales weakened, increasing at 0.8 percent in annual equivalent from Apr to Dec 2013 with significant volatility illustrated by decline of 20.0 percent in Jul 2013 and increase of 12.8 percent in Oct 2013. House sales fell 0.7 percent in Dec 2013. New house sales increased 3.4 percent in Jan 2014 and fell 4.4 percent in Feb 2014 and 6.9 percent in Mar 201. New house sales increased 6.4 percent in Apr 2014 with with annual equivalent rate of minus 6.1 percent in Jan-Apr 2014. Robbie Whelan and Conor Dougherty, writing on “Builders fuel home sale rise,” on Feb 26, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324338604578327982067761860.html), analyze how builders have provided financial assistance to home buyers, including those short of cash and with weaker credit background, explaining the rise in new home sales and the highest gap between prices of new and existing houses. The 30-year conventional mortgage rate increased from 3.40 on Apr 25, 2013 to 4.58 percent on Aug 22, 2013 (http://www.federalreserve.gov/releases/h15/data.htm), which could also be a factor in recent weakness with improvement after the rate fell to 4.26 in Nov 2013. The conventional mortgage rate rose to 4.48 percent on Dec 26, 2013 and fell to 4.32 percent on Jan 30, 2014. The conventional mortgage rate increased to 4.37 percent on Feb 26, 2014 and 4.40 percent on Mar 27, 2014. The conventional mortgage rate fell to 4.14 percent on Apr 22, 2014. The conventional mortgage rate measured in a survey by Freddie Mac (http://www.freddiemac.com/pmms/release.html) is the “contract interest rate on commitments for fixed-rate first mortgages” (http://www.federalreserve.gov/releases/h15/data.htm).

Table IIB-1, US, Sales of New Houses at Seasonally-Adjusted (SA) Annual Equivalent Rate, Thousands and %

	SA Annual Rate Thousands	∆%
Apr 2014	433	6.4
Mar	407	-6.9
Feb	437	-4.4
Jan	457	3.4
AE ∆% Jan-Apr		-6.1
Dec 2013	442	-0.7
Nov	445	-1.1
Oct	450	12.8
Sep	399	5.3
Aug	379	3.3
Jul	367	-20.0
Jun	459	6.5
May	431	-4.6
Apr	452	2.7
AE ∆% Apr-Dec		0.8
Mar	440	-1.8
Feb	448	-1.1
AE ∆% Feb-Mar		-16.1
Jan	453	13.5
Dec 2012	399	1.8
Nov	392	9.5
Oct	358	-7.0
AE ∆% Oct-Jan		62.9
Sep	385	2.7
Aug	375	1.6
Jul	369	2.5
Jun	360	-2.7
May	370	4.5
AE ∆% May-Sep		22.3
Apr	354	0.0
Mar	354	-3.3
Feb	366	9.3
Jan	335	-1.8
AE ∆% Jan-Apr		11.8
Dec 2011	341	4.0
Nov	328	3.8
Oct	316	3.9
Sep	304	1.7
AE ∆% Sep-Dec		48.4
Aug	299	1.0
Jul	296	-1.7
Jun	301	-1.3
May	305	-1.6
AE ∆% May-Aug		-10.3
Apr	310	3.3
Mar	300	11.1
Feb	270	-12.1
Jan	307	-5.8
AE ∆% Jan-Apr		-14.2
Dec 2010	326	13.6

AE: Annual Equivalent

Source: US Census Bureau

http://www.census.gov/construction/nrs/

There is additional information of the report of new house sales in Table IIB-2. The stock of unsold houses stabilized in Apr-Aug 2011 at average 4.7 monthly equivalent sales at current sales rates and then dropped to 4.6 in Jul-Aug 2012, increasing to 4.9 in Oct 2012, 4.6 in Nov 2012 and 4.5 percent in Dec 2012. Inventories dropped to 3.9 in Jan 2013 and 4.1 in Feb 2013. Inventories stabilized at 4.2-4.5 in Mar-Jun 2013 and increased to 5.6 in Jul 2013. Inventories fell to 5.5 in Aug 2013 and 5.5 in Sep 2013 but fell to 4.9 in Oct 2013. Inventories stood at 5.0 in Nov 2013 and 5.1 in Dec 2013. Inventories fell to 5.0 in Jan 2014 and increased to 5.1 in Feb 2014. Inventories rose to 5.6 in Mar 2014, declining to 5.3 in Apr 2014. Robbie Whelan and Conor Dougherty, writing on “Builders fuel home sale rise,” on Feb 26, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324338604578327982067761860.html), find that inventories of houses have declined as investors acquire distressed houses of higher quality. Median and average house prices oscillate. In Apr 2014, median prices of new houses sold not seasonally adjusted (NSA) decreased 2.1 percent after increasing 6.5 percent in Mar 2014. Average prices decreased 2.0 percent in Apr 2014 and increased 1.5 percent in Mar 2014. Between Dec 2010 and Apr 2014 median prices increased 14.3 percent, partly concentrated in an increase of 6.5 percent in Mar 2014, and average prices increased 9.7 percent, with increase of 1.5 percent in Mar 2014. Between Dec 2010 and Dec 2012, median prices increased 7.1 percent and average prices increased 2.6 percent. Price increases concentrated in 2012 with increase of median prices of 18.2 percent from Dec 2011 to Dec 2012 and of average prices of 13.8 percent. Median prices increased 6.8 percent from Dec 2012 to Apr 2014, with increase of 6.5 percent in Mar 2014, while average prices increased 7.0 percent, with increase of 1.5 percent in Mar 2014. Robbie Williams, writing on “New homes hit record as builders cap supply,” on May 24, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323475304578500973445311276.html?mod=WSJ_economy_LeftTopHighlights), finds that homebuilders are continuing to restrict the number of new homes for sale. Restriction of available new homes for sale increases prices paid by buyers.

Table IIB-2, US, New House Stocks and Median and Average New Homes Sales Price

	Unsold* Stocks in Equiv. Months of Sales SA %	Median New House Sales Price USD NSA	Month ∆%	Average New House Sales Price USD NSA	Month ∆%
Apr 2014	5.3	275,800	-2.1	320,100	-2.0
Mar	5.6	281,700	6.5	326,700	1.5
Feb	5.1	264,500	-2.0	322,000	-4.5
Jan	5.0	269,800	-2.1	337,300	5.0
Dec 2013	5.1	275,500	-0.6	321,200	-4.3
Nov	5.0	277,100	4.8	335,600	0.0
Oct	4.9	264,300	-2.0	335,700	4.4
Sep	5.5	269,800	5.7	321,400	3.4
Aug	5.5	255,300	-2.6	310,800	-5.8
Jul	5.6	262,200	0.9	329,900	7.8
Jun	4.2	259,800	-1.5	306,100	-2.5
May	4.5	263,700	-5.6	314,000	-6.8
Apr	4.3	279,300	8.5	337,000	12.3
Mar	4.2	257,500	-2.9	300,200	-3.9
Feb	4.1	265,100	5.4	312,500	1.8
Jan	3.9	251,500	-2.6	306,900	2.6
Dec 2012	4.5	258,300	5.4	299,200	2.9
Nov	4.6	245,000	-0.9	290,700	1.9
Oct	4.9	247,200	-2.9	285,400	-4.1
Sep	4.5	254,600	0.6	297,700	-2.6
Aug	4.6	253,200	6.7	305,500	8.2
Jul	4.6	237,400	2.1	282,300	3.9
Jun	4.8	232,600	-2.8	271,800	-3.2
May	4.7	239,200	1.2	280,900	-2.4
Apr	4.9	236,400	-1.4	287,900	1.5
Mar	4.9	239,800	0.0	283,600	3.5
Feb	4.8	239,900	8.2	274,000	3.1
Jan	5.3	221,700	1.4	265,700	1.1
Dec 2011	5.3	218,600	2.0	262,900	5.2
Nov	5.7	214,300	-4.7	250,000	-3.2
Oct	6.0	224,800	3.6	258,300	1.1
Sep	6.3	217,000	-1.2	255,400	-1.5
Aug	6.5	219,600	-4.5	259,300	-4.1
Jul	6.7	229,900	-4.3	270,300	-1.0
Jun	6.6	240,200	8.2	273,100	3.9
May	6.6	222,000	-1.2	262,700	-2.3
Apr	6.7	224,700	1.9	268,900	3.1
Mar	7.2	220,500	0.2	260,800	-0.8
Feb	8.1	220,100	-8.3	262,800	-4.7
Jan	7.3	240,100	-0.5	275,700	-5.5
Dec 2010	7.0	241,200	9.8	291,700	3.5

*Percent of new houses for sale relative to houses sold

Source: US Census Bureau

http://www.census.gov/construction/nrs/

The depressed level of residential construction and new house sales in the US is evident in Table IIB-3 providing new house sales not seasonally adjusted in Jan-Apr of various years. Sales of new houses are virtually the same in Jan-Apr 2014 relative to Jan-Apr 2013 with decline of 2.6 percent. Sales of new houses in Jan-Apr 2014 are substantially lower than in any year between 1963 and 2013 with the exception of the years from 2009 to 2012. There are only four increases of 22.3 percent relative to Jan-Apr 2012, 46.5 percent relative to Jan-Apr 2011, 15.6 percent relative to Jan-Apr 2010 and 27.6 percent relative to Jan-Apr 2009. Sales of new houses in Jan-Apr 2014 are lower by 22.1 percent relative to Jan-Apr 2008, 50.2 percent relative to 2007, 61.6 percent relative to 2006 and 66.7 percent relative to 2005. The housing boom peaked in 2005 and 2006 when increases in fed funds rates to 5.25 percent in Jun 2006 from 1.0 percent in Jun 2004 affected subprime mortgages that were programmed for refinancing in two or three years on the expectation that price increases forever would raise home equity. Higher home equity would permit refinancing under feasible mortgages incorporating full payment of principal and interest (Gorton 2009EFM; see other references in http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Sales of new houses in Jan-Apr 2014 relative to the same period in 2004 fell 65.0 percent and 57.3 percent relative to the same period in 2003. Similar percentage declines are also observed for 2014 relative to years from 2000 to 2004. Sales of new houses in Jan-Mar 2014 fell 30.2 per cent relative to the same period in 1995. The population of the US was 179.3 million in 1960 and 281.4 million in 2000 (Hobbs and Stoops 2002, 16). Detailed historical census reports are available from the US Census Bureau at (http://www.census.gov/population/www/censusdata/hiscendata.html). The US population reached 308.7 million in 2010 (http://2010.census.gov/2010census/data/). The US population increased by 129.4 million from 1960 to 2010 or 72.2 percent. The final row of Table IIB-3 reveals catastrophic data: sales of new houses in Jan-Apr 2014 of 148 thousand units are lower by 14.5 percent relative to 173 thousand units of houses sold in Jan-Apr 1963, the first year when data become available. The civilian noninstitutional population increased from 123.360 million in Dec 1963 to 246.745 million in Dec 2013, or 100.0 percent (http://www.bls.gov/data/). The Bureau of Labor Statistics (BLS) defines the civilian noninstitutional population (http://www.bls.gov/lau/rdscnp16.htm#cnp): “The civilian noninstitutional population consists of persons 16 years of age and older residing in the 50 States and the District of Columbia who are not inmates of institutions (for example, penal and mental facilities and homes for the aged) and who are not on active duty in the Armed Forces.”

Table IIB-3, US, Sales of New Houses Not Seasonally Adjusted, Thousands and %

	Not Seasonally Adjusted Thousands
Jan-Apr 2014	148
Jan-Apr 2013	152
∆% Jan-Apr 2014/Jan-Apr 2013	-2.6*
Jan-Apr 2012	121
∆% Jan-Apr 2014/Jan-Apr 2012	22.3
Jan-Apr 2011	101
∆% Jan-Apr 2013/Jan-Apr 2011	46.5
Jan-Apr 2010	128
∆% Jan-Apr 2014/ Jan-Apr 2010	15.6
Jan-Apr 2009	116
∆% Jan-Apr 2014/ Jan-Apr 2009	27.6
Jan-Apr 2008	190
∆% Jan-Apr 2014/ Jan-Apr 2008	-22.1
Jan-Mar 2007	297
∆% Jan-Apr 2013/ Jan-Apr 2007	-50.2
Jan-Apr 2006	385
∆% Jan-Apr 2013/Jan-Apr 2006	-61.6
Jan-Apr 2005	444
∆% Jan-Apr 2013/Jan-Apr 2005	-66.7
Jan-Apr 2004	423
∆% Jan-Apr 2013/Jan-Apr 2004	-65.0
Jan-Mar 2003	347
∆% Jan-Apr 2013/ Jan-Apr 2003	-57.3
Jan-Apr 2002	326
∆% Jan-Apr 2013/ Jan-Apr 2002	-54.6
Jan-Apr 2001	335
∆% Jan-Apr 2013/ Jan-Apr 2001	-55.8
Jan-Apr 2000	311
∆% Jan-Apr 2013/ Jan-Apr 2000	-52.4
Jan-Apr 1995	212
∆% Jan-Apr 2013/ Jan-Apr 1995	-30.2
Jan-Apr 1963	173
∆% Jan-Apr 2013/ Jan-Apr 1963	-14.5

*Computed using unrounded data

Source: US Census Bureau

http://www.census.gov/construction/nrs/

Table IIB-4 provides the entire available annual series of new house sales from 1963 to 2013. The revised level of 306 thousand new houses sold in 2011 is the lowest since 560 thousand in 1963 in the 48 years of available data while the level of 368 thousand in 2012 is only higher than 323 thousand in 2010. The level of sales of new houses of 429 thousand in 2013 is the lowest from 1963 to 2009 with exception of 412 thousand in 1982. The population of the US increased 129.4 million from 179.3 million in 1960 to 308.7 million in 2010, or 72.2 percent. The civilian noninstitutional population of the US increased from 122.416 million in 1963 to 245.679 million in 2013 or 100.7 percent (http://www.bls.gov/data/). The Bureau of Labor Statistics (BLS) defines the civilian noninstitutional population (http://www.bls.gov/lau/rdscnp16.htm#cnp): “The civilian noninstitutional population consists of persons 16 years of age and older residing in the 50 States and the District of Columbia who are not inmates of institutions (for example, penal and mental facilities and homes for the aged) and who are not on active duty in the Armed Forces.”

The civilian noninstitutional population is the universe of the labor force. In fact, there is no year from 1963 to 2013 in Table IIA-4 with sales of new houses below 400 thousand with the exception of the immediately preceding years of 2009, 2010, 2011 and 2012.

Table IIB-4, US, New Houses Sold, NSA Thousands

1963	560
1964	565
1965	575
1966	461
1967	487
1968	490
1969	448
1970	485
1971	656
1972	718
1973	634
1974	519
1975	549
1976	646
1977	819
1978	817
1979	709
1980	545
1981	436
1982	412
1983	623
1984	639
1985	688
1986	750
1987	671
1988	676
1989	650
1990	534
1991	509
1992	610
1993	666
1994	670
1995	667
1996	757
1997	804
1998	886
1999	880
2000	877
2001	908
2002	973
2003	1,086
2004	1,203
2005	1,283
2006	1,051
2007	776
2008	485
2009	375
2010	323
2011	306
2012	368
2013	429

Source: US Census Bureau

http://www.census.gov/construction/nrs/

Chart IIB-1 of the US Bureau of the Census shows the sharp decline of sales of new houses in the US. Sales rose temporarily until about mid 2010 but then declined to a lower plateau followed by increase and stability.

Chart IIB-1, US, New One-Family Houses Sold in the US, SAAR (Seasonally Adjusted Annual Rate)

Source: US Census Bureau

http://www.census.gov/briefrm/esbr/www/esbr051.html

Percentage changes and average rates of growth of new house sales for selected periods are shown in Table IIB-5. The percentage change of new house sales from 1963 to 2013 is minus 23.4 percent. Between 1991 and 2001, sales of new houses rose 78.4 percent at the average yearly rate of 6.0 percent. Between 1995 and 2005 sales of new houses increased 92.4 percent at the yearly rate of 6.8 percent. There are similar rates in all years from 2000 to 2005. The boom in housing construction and sales began in the 1980s and 1990s. The collapse of real estate culminated several decades of housing subsidies and policies to lower mortgage rates and borrowing terms (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009b), 42-8). Sales of new houses sold in 2013 fell 35.7 percent relative to the same period in 1995 and 66.6 percent relative to 2005.

Table IIB-5, US, Percentage Change and Average Yearly Rate of Growth of Sales of New One-Family Houses

	∆%	Average Yearly % Rate
1963-2013	-23.4	NA
1991-2001	78.4	6.0
1995-2005	92.4	6.8
2000-2005	46.3	7.9
1995-2013	-35.7	NA
2000-2013	-51.1	NA
2005-2013	-66.6	NA

NA: Not Applicable

Source: US Census Bureau

http://www.census.gov/construction/nrs/

Chart IIB-2 of the US Bureau of the Census provides the entire monthly sample of new houses sold in the US between Jan 1963 and Apr 2014 without seasonal adjustment. The series is almost stationary until the 1990s. There is sharp upward trend from the early 1990s to 2005-2006 after which new single-family houses sold collapse to levels below those in the beginning of the series in the 1960s.

Chart IIB-2, US, New Single-family Houses Sold, NSA, 1963-2014

Source: US Census Bureau

http://www.census.gov/construction/nrs/

Chart IIB-5 of the Board of Governors of the Federal Reserve System provides the rate for the 30-year conventional mortgage, the yield of the 30-year Treasury bond and the rate of the overnight federal funds rate, monthly, from 1971 to 2014. All rates decline throughout the period from the Great Inflation of the 1970s through the following Great Moderation and until currently. In Apr 1971, the fed funds rate was 4.15 percent and the conventional mortgage rate 7.31 percent. In November 2012, the fed funds rate was 0.16 percent, the yield of the 30-year Treasury 2.80 percent and the conventional mortgage rate 3.35. The final segment shows an increase in the yield of the 30-year Treasury to 3.61 percent in July 2013 with the fed funds rate at 0.09 percent and the conventional mortgage at 4.37 percent. The final data point shows marginal decrease of the conventional mortgage rate to 4.34 percent in Apr 2014 with the yield of the 30-year Treasury bond at 3.52 percent and overnight rate on fed funds at 0.09 percent. The recent increase in interest rates if sustained could affect the US real estate market. 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. Nick Timiraos, writing on “Demand for home loans plunges,” on Apr 24, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304788404579522051733228402?mg=reno64-wsj), analyzes data in Inside Mortgage Finance that mortgage lending of $235 billion in IQ2014 is 58 percent lower than a year earlier and 23 percent below IVQ2013. Mortgage lending collapsed to the lowest level in 14 years. In testimony before the Committee on the Budget of the US Senate on May 8, 2004, Chair Yellen provides analysis of the current economic situation and outlook (http://www.federalreserve.gov/newsevents/testimony/yellen20140507a.htm): “One cautionary note, though, is that readings on housing activity--a sector that has been recovering since 2011--have remained disappointing so far this year and will bear watching.”

Chart IIB-5, US, Thirty-year Conventional Mortgage, Thirty-year Treasury Bond and Overnight Federal Funds Rate, Monthly, 1954-2014

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H15/default.htm

Table IIB-8 provides the monthly data in Chart IIB-5 from Dec 2012 to Apr 2014. While the fed funds rate fell from 0.16 percent in Dec 2012 to 0.07 percent in Jan 2014, the yield of the constant maturity 30-year Treasury bond rose from 2.88 percent in Dec 2012 to 3.77 percent in Jan 2014 and the conventional mortgage rate increased from 3.35 percent in Dec 2012 to 4.43 percent in Jan 2014. In Apr 2014, the fed funds rate stabilized at 0.09 percent with decline to 3.52 percent of the 30-year yield and stability at 4.34 percent of the conventional mortgage rate.

Table IIB-8, US, Fed Funds Rate, Thirty Year Treasury Bond and Conventional Mortgage Rate, Monthly, Percent Per Year, Dec 2012 to Apr 2014

Month	Fed Funds Rate	Yield of Thirty-Year Treasury Constant Maturity Bond	Rate of Thirty-Year Conventional Mortgage
2012-12	0.16	2.88	3.35
2013-01	0.14	3.08	3.41
2013-02	0.15	3.17	3.53
2013-03	0.14	3.16	3.57
2013-04	0.15	2.93	3.45
2013-05	0.11	3.11	3.54
2013-06	0.09	3.4	4.07
2013-07	0.09	3.61	4.37
2013-08	0.08	3.76	4.46
2013-09	0.08	3.79	4.49
2013-10	0.09	3.68	4.19
2013-11	0.08	3.8	4.26
2013-12	0.09	3.89	4.46
2014-01	0.07	3.77	4.43
2014-02	0.07	3.66	4.30
2014-03	0.08	3.62	4.34
2014-04	0.09	3.52	4.34

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H15/default.htm

ESIV Collapse of United States Dynamism of Income Growth and Employment Creation. Lucas (2011May) estimates US economic growth in the long-term at 3 percent per year and about 2 percent per year in per capita terms. There are displacements from this trend caused by events such as wars and recessions but the economy grows much faster during the expansion, compensating for the contraction and maintaining trend growth over the entire cycle. Historical US GDP data exhibit remarkable growth: Lucas (2011May) estimates an increase of US real income per person by a factor of 12 in the period from 1870 to 2010. The explanation by Lucas (2011May) of this remarkable growth experience is that government provided stability and education while elements of “free-market capitalism” were an important driver of long-term growth and prosperity. Lucas sharpens this analysis by comparison with the long-term growth experience of G7 countries (US, UK, France, Germany, Canada, Italy and Japan) and Spain from 1870 to 2010. Countries benefitted from “common civilization” and “technology” to “catch up” with the early growth leaders of the US and UK, eventually growing at a faster rate. Significant part of this catch up occurred after World War II. Lucas (2011May) finds that the catch up stalled in the 1970s. The analysis of Lucas (2011May) is that the 20-40 percent gap that developed originated in differences in relative taxation and regulation that discouraged savings and work incentives in comparison with the US. A larger welfare and regulatory state, according to Lucas (2011May), could be the cause of the 20-40 percent gap. Cobet and Wilson (2002) provide estimates of output per hour and unit labor costs in national currency and US dollars for the US, Japan and Germany from 1950 to 2000 (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). The average yearly rate of productivity change from 1950 to 2000 was 2.9 percent in the US, 6.3 percent for Japan and 4.7 percent for Germany while unit labor costs in USD increased at 2.6 percent in the US, 4.7 percent in Japan and 4.3 percent in Germany. From 1995 to 2000, output per hour increased at the average yearly rate of 4.6 percent in the US, 3.9 percent in Japan and 2.6 percent in Germany while unit labor costs in USD fell at minus 0.7 percent in the US, 4.3 percent in Japan and 7.5 percent in Germany. There was increase in productivity growth in Japan and France within the G7 in the second half of the 1990s but significantly lower than the acceleration of 1.3 percentage points per year in the US. The key indicator of growth of real income per capita, which is what a person earns after inflation, measures long-term economic growth and prosperity. A refined concept would include real disposable income per capita, which is what a person earns after inflation and taxes.

Table IB-1 provides the data required for broader comparison of long-term and cyclical performance of the United States economy. Revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) provide important information on long-term growth and cyclical behavior. First, Long-term performance. Using annual data, US GDP grew at the average rate of 3.3 percent per year from 1929 to 2013 and at 3.2 percent per year from 1947 to 2013. Real disposable income grew at the average yearly rate of 3.2 percent from 1929 to 2013 and at 3.7 percent from 1947 to 1999. Real disposable income per capita grew at the average yearly rate of 2.0 percent from 1929 to 2013 and at 2.3 percent from 1947 to 1999. US economic growth was much faster during expansions, compensating contractions in maintaining trend growth for whole cycles. Using annual data, US real disposable income grew at the average yearly rate of 3.5 percent from 1980 to 1989 and real disposable income per capita at 2.6 percent. The US economy has lost its dynamism in the current cycle: real disposable income grew at the yearly average rate of 1.3 percent from 2006 to 2013 and real disposable income per capita at 0.5 percent. Real disposable income grew at the average rate of 1.2 percent from 2007 to 2013 and real disposable income per capita at 0.4 percent. Table IB-1 illustrates the contradiction of long-term growth with the proposition of secular stagnation (Hansen 1938, 1938, 1941 with early critique by Simons (1942). Secular stagnation would occur over long periods. Table IB-1 also provides the corresponding rates of population growth that is only marginally lower at 0.8 to 0.9 percent recently from 1.1 percent over the long-term. GDP growth fell abruptly from 2.6 percent on average from 2000 to 2006 to 1.1 percent from 2006 to 2013 and 1.0 percent from 2007 to 2013 and real disposable income growth fell from 2.9 percent on average from 2000 to 2006 to 1.3 percent from 2006 to 2013. The decline of real per capita disposable income is even sharper from average 2.0 percent from 2000 to 2006 to 0.5 percent from 2006 to 2013 and 0.4 percent from 2007 to 2013 while population growth was 0.8 percent on average. Lazear and Spletzer (2012JHJul122) provide theory and measurements showing that cyclic factors explain currently depressed labor markets. This is also the case of the overall economy. Second, first four quarters of expansion. Growth in the first four quarters of expansion is critical in recovering loss of output and employment occurring during the contraction. In the first four quarters of expansion from IQ1983 to IVQ1983: GDP increased 7.8 percent, real disposable personal income 5.3 percent and real disposable income per capita 4.4 percent. In the first four quarters of expansion from IIIQ2009 to IIQ2010: GDP increased 2.7 percent, real disposable personal income 0.3 percent and real disposable income per capita decreased 0.5 percent. Third, first 19 quarters of expansion. In the expansion from IQ1983 to IIIQ1987: GDP grew 25.6 percent at the annual equivalent rate of 4.9 percent; real disposable income grew 20.5 percent at the annual equivalent rate of 4.0 percent; and real disposable income per capita grew 15.5 percent at the annual equivalent rate of 3.1 percent. In the expansion from IIIQ2009 to IQ2014: GDP grew 11.1 percent at the annual equivalent rate of 2.2 percent; real disposable income grew 6.9 percent at the annual equivalent rate of 1.4 percent; and real disposable personal income per capita grew 3.3 percent at the annual equivalent rate of 0.7 percent. Fourth, entire quarterly cycle. In the entire cycle combining contraction and expansion from IQ1980 to IIIQ1987: GDP grew 25.4 percent at the annual equivalent rate of 2.9 percent; real disposable personal income 27.4 percent at the annual equivalent rate of 3.1 percent; and real disposable personal income per capita 18.5 percent at the annual equivalent rate of 2.1 percent. In the entire cycle combining contraction and expansion from IVQ2007 to IQ2014: GDP grew 6.3 percent at the annual equivalent rate of 1.0 percent; real disposable personal income 8.6 percent at the annual equivalent rate of 1.3 percent; and real disposable personal income per capita 3.5 percent at the annual equivalent rate of 0.5 percent. The United States grew during its history at high rates of per capita income that made its economy the largest in the world. That dynamism is disappearing. Bordo (2012 Sep27) and Bordo and Haubrich (2012DR) provide strong evidence that recoveries have been faster after deeper recessions and recessions with financial crises, casting serious doubts on the conventional explanation of weak growth during the current expansion allegedly because of the depth of the contraction of 4.3 percent from IVQ2007 to IIQ2009 and the financial crisis. The proposition of secular stagnation should explain a long-term process of decay and not the actual abrupt collapse of the economy and labor markets currently.

Table IB-1, US, GDP, Real Disposable Personal Income, Real Disposable Income per Capita and Population in 1983-85 and 2007-2013, %

Long-term Average ∆% per Year	GDP	Population
1929-2013	3.3	1.1
1947-2013	3.2	1.2
1947-1999	3.6	1.3
2000-2013	1.8	0.9
2000-2006	2.6	0.9
2006-2013	1.1	0.8
2007-2013	1.0	0.8
Long-term Average ∆% per Year	Real Disposable Income	Real Disposable Income per Capita	Population
1929-2013	3.2	2.0	1.1
1947-1999	3.7	2.3	1.3
2000-2013	2.1	1.2	0.9
2000-2006	2.9	2.0	0.9
2006-2013	1.3	0.5	0.8
2007-2013	1.2	0.4	0.8
Whole Cycles Average ∆% per Year
1980-1989	3.5	2.6	0.9
2006-2013	1.3	0.5	0.8
2007-2013	1.2	0.4	0.8
Comparison of Cycles	# Quarters	∆%	∆% Annual Equivalent
GDP
I83 to IV83 IQ83 to IQ87 IQ83 to IIQ87	4 17 18
I83 to IV83 I83 to IQ87 I83 to II87 I83 to III87	4 17 18 19	7.8 23.1 24.5 25.6	7.8 5.0 5.0 4.9
RDPI
I83 to IV83 I83 to I87 I83 to III87	4 17 19	5.3 19.5 20.5	5.3 4.3 4.0
RDPI Per Capita
I83 to IV83 I83 to I87 I83 to III87	4 17 19	4.4 15.1 15.5	4.4 3.4 3.1
Whole Cycle IQ1980 to IIIQ1987
GDP	32	25.4	2.9
RDPI	32	27.4	3.1
RDPI per Capita	32	18.5	2.1
Population	32	7.5	0.9
GDP
III09 to II10 III09 to I14	4 19	2.7 11.1	2.7 2.2
RDPI
III09 to II10 III09 to I14	4 19	0.3 6.9	0.3 1.4
RDPI per Capita
III09 to II10 III09 to I14	4 19	-0.5 3.3	-0.5 0.7
Population
II09 to II010 III09 to I14	4 19	0.8 3.6	0.8 0.8
IVQ2007 to IQ2014	26
GDP	26	6.3	1.0
RDPI	26	8.6	1.3
RDPI per Capita	26	3.5	0.5
Population	26	5.0	0.7

RDPI: Real Disposable Personal Income

Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm

There are seven basic facts illustrating the current economic disaster of the United States:

GDP maintained trend growth in the entire business cycle from IQ1980 to IIIQ1987, including contractions and expansions. GDP is well below trend in the entire business cycle from IVQ2007 to IQ2014, including contractions and expansions
Per capita real disposable income exceeded trend growth in the 1980s but is substantially below trend in IQ2014
Level of employed persons increased in the 1980s but declined into IQ2014
Level of full-time employed persons increased in the 1980s but declined into IQ2014
Level unemployed, unemployment rate and employed part-time for economic reasons fell in the recovery from the recessions in the 1980s but not substantially in the recovery since IIIQ2009
Wealth of households and nonprofit organizations soared in the 1980s but stagnated in real terms into IVQ2013
Gross private domestic investment increased sharply from IQ1980 to IIIQ1987 but gross private domestic investment stagnated and private fixed investment fell from IVQ2007 into IQ2014

There is a critical issue of the United States economy will be able in the future to attain again the level of activity and prosperity of projected trend growth. Growth at trend during the entire business cycles built the largest economy in the world but there may be an adverse, permanent weakness in United States economic performance and prosperity. Table IB-2 provides data for analysis of these seven basic facts. The seven blocks of Table IB-2 are separated initially after individual discussion of each one followed by the full Table IB-2.

1. Trend Growth.

i. As shown in Table IB-2, actual GDP grew cumulatively 25.0 percent from IQ1980 to IIIQ1987, which is relatively close to what trend growth would have been at 26.7 percent. Real GDP grew 25.4 percent from IVQ1979 to IIIQ1987. Rapid growth at the average annual rate of 4.9 percent per quarter during the expansion from IQ1983 to IIIQ1987 erased the loss of GDP of 4.6 percent during the contraction and maintained trend growth at 2.9 percent for GDP and 3.1 percent for real disposable personal income over the entire cycle.

ii. In contrast, cumulative growth from IVQ2007 to IQ2014 was 6.3 percent while trend growth would have been 21.2 percent. GDP in IQ2014 at seasonally adjusted annual rate is $15,946.6 billion as estimated by the Bureau of Economic Analysis (BEA) (http://www.bea.gov/iTable/index_nipa.cfm) and would have been $18,175.3 billion, or $2228.7 billion higher, had the economy grown at trend over the entire business cycle as it happened during the 1980s and throughout most of US history. There is about $2.2 trillion of foregone GDP that the economy would have created as it occurred during past cyclical expansions, which explains why employment net of population growth has not rebounded to even higher than before. There would not be recovery of full employment even with growth of 3 percent per year beginning immediately because the opportunity was lost to grow faster during the expansion from IIIQ2009 to IVQ2013 after the recession from IVQ2007 to IIQ2009. The United States has acquired a heavy social burden of unemployment and underemployment of 27.4 million people or 16.8 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/04/interest-rate-risks-twenty-eight.html) that will not diminish significantly even with return to growth of GDP of 3 percent per year because of growth of the labor force by new entrants. The ratio of the labor force of 154.871 million in Jul 2007 to the noninstitutional population of 231.958 million in Jul 2007 was 66.8 percent while the ratio of the labor force of 154.845 million in Apr 2014 to the noninstitutional population of 247.439 million in Apr 2014 was 62.6 percent. The labor force of the US in Apr 2014 corresponding to 66.8 percent of participation in the population would be 165.289 million (0.668 x 247.439). The difference between the measured labor force in Apr 2014 of 154.845 million and the labor force in Apr 2014 with participation rate of 66.8 percent (as in Jul 2007) of 165.289 million is 10.444 million. The level of the labor force in the US has stagnated and is 10.444 million lower than what it would have been had the same participation rate been maintained. Millions of people have abandoned their search for employment because they believe there are no jobs available for them. The key issue is whether the decline in participation of the population in the labor force is the result of people giving up on finding another job. (http://cmpassocregulationblog.blogspot.com/2014/05/rules-discretionary-authorities-and.html). The key issue is whether the decline in participation of the population in the labor force is the result of people giving up on finding another job. Structural change in demography occurs over relatively long periods and not suddenly as shown by Edward P. Lazear and James R. Spletzer (2012JHJul22). There is an abrupt cyclical event and no evidence for secular stagnation and similar propositions.

Period IQ1980 to IIIQ1987
GDP SAAR USD Billions
IQ1980	6,517.9
IIIQ1987	8,149.4
∆% IQ1980 to IIIQ1987 (25.4 percent from IVQ1979 $6496.8 billion)	25.0
∆% Trend Growth IQ1980 to IIIQ1987	26.7

Period IVQ2007 to IQ2014
GDP SAAR USD Billions
IVQ2007	14,996.1
IQ2014	15,946.6
∆% IVQ2007 to IQ2014 Actual	6.3
∆% IVQ2007 to IQ2014 Trend	21.2

2. Stagnating Per Capita Real Disposable Income

i. In the entire business cycle from IQ1980 to IIIQ1987, as shown in Table IB-2, growth of per capita real disposable income, or what is left per person after inflation and taxes, grew cumulatively 18.5 percent, which is close to what would have been trend growth of 17.2 percent.

ii. In contrast, in the entire business cycle from IVQ2007 to IQ2014, per capita real disposable income increased 3.5 percent while trend growth would have been 13.7 percent. Income available after inflation and taxes is about the same or lower as before the contraction after 19 consecutive quarters of GDP growth at mediocre rates relative to those prevailing during historical cyclical expansions. In IVQ2012, nominal disposable personal income grew at the SAAR of 10.7 percent and real disposable personal income at 9.0 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0314.pdf) The BEA explains as follows: “Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf pages 1-2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0113.pdf). The Bureau of Economic Analysis explains as (http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf 2-3): “The January estimate of employee contributions for government social insurance reflected the expiration of the “payroll tax holiday,” that increased the social security contribution rate for employees and self-employed workers by 2.0 percentage points, or $114.1 billion at an annual rate. For additional information, see FAQ on “How did the expiration of the payroll tax holiday affect personal income for January 2013?” at www.bea.gov. The January estimate of employee contributions for government social insurance also reflected an increase in the monthly premiums paid by participants in the supplementary medical insurance program, in the hospital insurance provisions of the Patient Protection and Affordable Care Act, and in the social security taxable wage base.”

The increase was provided in the “fiscal cliff” law H.R. 8 American Taxpayer Relief Act of 2012 (http://www.gpo.gov/fdsys/pkg/BILLS-112hr8eas/pdf/BILLS-112hr8eas.pdf).

In IQ2013, personal income fell at the SAAR of minus 4.1 percent; real personal income excluding current transfer receipts at minus 7.2 percent; and real disposable personal income at minus 7.9 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0314.pdf). The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):

“The February and January changes in disposable personal income (DPI) mainly reflected the effect of special factors in January, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to November and to December in anticipation of changes in individual tax rates.”

In IIQ2013, personal income grew at 4.7 percent, real personal income excluding current transfer receipts at 5.6 percent and real disposable income at 4.1 percent (http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0314.pdf). In IIIQ2013, personal income grew at 4.0 percent, real personal income excluding current transfers at 1.9 percent and real disposable income at 3.0 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0314.pdf ). In IVQ2013, personal income grew at 2.2 percent and real disposable income at 0.8 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0314.pdf). In IQ2014, personal income grew at 3.5 percent in nominal terms and 1.1 percent in real terms excluding current transfer receipts while nominal disposable income grew at 3.3 percent and real disposable income at 1.9 percent (http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0314.pdf).

Period IQ1980 to IIIQ1987

Real Disposable Personal Income per Capita IQ1980 Chained 2009 USD	20,242
Real Disposable Personal Income per Capita IIIQ1987 Chained 2009 USD	23,978
∆% IQ1980 to IIIQ1987 (18.5 percent from IVQ1982 $20,230)	18.5
∆% Trend Growth	17.2

Period IVQ2007 to IQ2014

Real Disposable Personal Income per Capita IVQ2007 Chained 2009 USD	35,823
Real Disposable Personal Income per Capita IQ2014 Chained 2009 USD	37,061
∆% IVQ2007 to IQ2014	3.5
∆% Trend Growth	13.7

3. Number of Employed Persons

i. As shown in Table IB-2, the number of employed persons increased over the entire business cycle from 98.527 million not seasonally adjusted (NSA) in IQ1980 to 113.027 million NSA in IIIQ1987 or by 14.7 percent.

ii. In contrast, during the entire business cycle the number employed fell from 146.334 million in IVQ2007 to 145.090 million in IQ2014 or by 0.9 percent. There are 27.4 million persons unemployed or underemployed, which is 16.8 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html).

Period IQ1980 to IIIQ1987

Employed Millions IQ1980 NSA End of Quarter	98.527
Employed Millions IIIQ1987 NSA End of Quarter	113.027
∆% Employed IQ1980 to IIIQ1987	14.7

Period IVQ2007 to IQ2014

Employed Millions IVQ2007 NSA End of Quarter	146.334
Employed Millions IQ2014 NSA End of Quarter	145.090
∆% Employed IVQ2007 to IQ2014	-0.9

4. Number of Full-Time Employed Persons

i. As shown in Table IB-2, during the entire business cycle in the 1980s, including contractions and expansion, the number of employed full-time rose from 81.280 million NSA in IQ1980 to 93.771 million NSA in IIIQ1987 or 15.4 percent.

ii. In contrast, during the entire current business cycle, including contraction and expansion, the number of persons employed full-time fell from 121.042 million in IVQ2007 to 116.985 million in IQ2014 or by minus 3.4 percent.

4. Number of Full-time Employed Persons

Period IQ1980 to IIIQ1987

Employed Full-time Millions IQ1980 NSA End of Quarter	81.280
Employed Full-time Millions IIIQ1987 NSA End of Quarter	93.771
∆% Full-time Employed IQ1980 to IIIQ1987	15.4

Period IVQ2007 to IQ2014

Employed Full-time Millions IVQ2007 NSA End of Quarter	121.042
Employed Full-time Millions IQ2014 NSA End of Quarter	116.985
∆% Full-time Employed IVQ2007 to IQ2014	-3.4

5. Unemployed, Unemployment Rate and Employed Part-time for Economic Reasons.

i. As shown in Table IB-2 and in the following block, in the cycle from IQ1980 to IIIQ1987: (a) The rate of unemployment was slightly lower at 5.7 percent in IIIQ1987 relative to 6.6 percent in IQ1980. (b) The number unemployed decreased from 6.983 million in IQ1980 to 6.857 million in IIIQ1987 or 1.8 percent. (c) The number employed part-time for economic reasons increased 36.2 percent from 3.624 million in IQ1980 to 4.937 million in IIIQ1987.

ii. In contrast, in the economic cycle from IVQ2007 to IQ2014: (a) The rate of unemployment increased from 4.8 percent in IVQ2007 to 6.8 percent in IQ2014. (b) The number unemployed increased 42.9 percent from 7.371 million in IVQ2007 to 10.537 million in IQ2014. (c) The number employed part-time for economic reasons because they could not find any other job increased 56.9 percent from 4.750 million in IVQ2007 to 7.455 million in IQ2014. (d) U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA increased from 8.7 percent in IVQ2007 to 12.8 percent in IQ2014.

Period IQ1980 to IIIQ1987

Unemployment Rate IQ1980 NSA End of Quarter	6.6
Unemployment Rate IIIQ1987 NSA End of Quarter	5.7
Unemployed IQ1980 Millions End of Quarter	6.983
Unemployed IIIQ1987 Millions End of Quarter	6.857
∆%	-1.8
Employed Part-time Economic Reasons Millions IQ1980 End of Quarter	3.624
Employed Part-time Economic Reasons Millions IIIQ1987 End of Quarter	4.937
∆%	36.2

Period IVQ2007 to IQ2014

Unemployment Rate IVQ2007 NSA End of Quarter	4.8
Unemployment Rate IQ2014 NSA End of Quarter	6.8
Unemployed IVQ2007 Millions End of Quarter	7.371
Unemployed IQ2014 Millions End of Quarter	10.537
∆%	42.9
Employed Part-time Economic Reasons IVQ2007 Millions End of Quarter	4.750
Employed Part-time Economic Reasons Millions IQ2014 End of Quarter	7.455
∆%	56.9
U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA
IVQ2007	8.7
IQ2014	12.8

6. Wealth of Households and Nonprofit Organizations.

The comparison of net worth of households and nonprofit organizations in the entire economic cycle from IQ1980 (and from IVQ1979) to IQ1987 and from IVQ2007 to IIIQ2012 is provided in Table IIA-5. The data reveal the following facts for the cycles in the 1980s:

IVQ1979 to IIQ1987. Net worth increased 96.8 percent from IVQ1979 to IIQ1987, the all items CPI index increased 47.9 percent from 76.7 in Dec 1979 to 113.5 in Jun 1987 and real net worth increased 33.1 percent.
IQ1980 to IVQ1985. Net worth increased 65.4 percent, the all items CPI index increased 36.5 percent from 80.1 in Mar 1980 to 109.3 in Dec 1985 and real net worth increased 21.2 percent.
IVQ1979 to IVQ1985. Net worth increased 69.1 percent, the all items CPI index increased 42.5 percent from 76.7 in Dec 1979 to 109.3 in Dec 1985 and real net worth increased 18.7 percent.
IQ1980 to IIQ1987. Net worth increased 92.6 percent, the all items CPI index increased 41.7 percent from 80.1 in Mar 1980 to 113.5 in Jun 1987 and real net worth increased 35.9 percent.

There is disastrous performance in the current economic cycle:

IVQ2007 to IVQ2013. Net worth increased 19.1 percent, the all items CPI increased 11.0 percent from 210.036 in Dec 2007 to 233.049 in Dec 2013 and real or inflation adjusted net worth increased 7.3 percent.

The explanation is partly in the sharp decline of wealth of households and nonprofit organizations and partly in the mediocre growth rates of the cyclical expansion beginning in IIIQ2009. The US economy grew on average at 3.0 percent per year and 2.0 percent per capita from 1870 to 2010, as measured by Lucas (2011May). US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 19 quarters from IIIQ2009 to IQ2014. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the first estimate of GDP for IQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp1q14_adv.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,738.0 billion in IIQ2010 by GDP of $14,356.9 billion in IIQ2009 {[$14,738.0/$14,356.9 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html and earlier). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth under trend in the entire cycle from IVQ2007 to IQ2014 would have accumulated to 21.2 percent. GDP in IQ2014 would be $18,175.3 billion if the US had grown at trend, which is higher by $2,228.7 billion than actual $15,946.6 billion. There are about two trillion dollars of GDP less than under trend, explaining the 27.4 million unemployed or underemployed equivalent to actual unemployment of 16.8 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/04/interest-rate-risks-twenty-eight.html). US GDP grew from $14,996.1 billion in IVQ2007 in constant dollars to $15,946.6 billion in IQ2014 or 6.3 percent at the average annual equivalent rate of 1.0 percent. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation.

Period IQ1980 to IVQ1985
Net Worth of Households and Nonprofit Organizations USD Millions
IVQ1979 IQ1980	9,041.9 9,240.6
IVQ1985 IIIQ1986 IVQ1986 IQ1987 IIQ1987	15,285.4 16,295.1 16,846.5 17,509.9 17,795.9
∆ USD Billions IVQ1985 IIQ1987 IQ1980-IVQ1985 IQ1980-IIIQ1986 IQ1980-IVQ1986 IQ1980-IQ1987 IQ1980-IIQ1987	+6,243.5 ∆%69.1 R∆%18.7 +8,754.0 ∆%96.8 R∆%33.1 +6,044.8 ∆%65.4 R∆%21.2 +7,054.5 ∆%76.3 R∆%28.2 +7,605.9 ∆%82.3 R∆%32.2 +8,269.3 ∆%89.5 R∆%35.4 +8,555.3 ∆%92.6 R∆%35.9
Period IVQ2007 to IQ2013
Net Worth of Households and Nonprofit Organizations USD Millions
IVQ2007	67,752.8
IVQ2013	80,663.7
∆ USD Billions	+12,910.9 ∆%19.1 R∆%7.3

Net Worth = Assets – Liabilities. R∆% real percentage change or adjusted for CPI percentage change.

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: fourth quarter 2013. Washington, DC, Federal Reserve System, Mar 6. http://www.federalreserve.gov/releases/z1/Current/

7. Gross Private Domestic Investment.

i. The comparison of gross private domestic investment in the entire economic cycles from IQ1980 to IIIQ1987 and from IVQ2007 to IQQ2014 is in the following block and in Table IB-2. Gross private domestic investment increased from $951.6 billion in IQ1980 to $1,174.6 billion in IIIQ1987 or by 23.4 percent.

ii In the current cycle, gross private domestic investment decreased from $2,605.2 billion in IVQ2007 to $2,602.2 billion in IQ2014, or 0.1 percent. Private fixed investment fell from $2,586.3 billion in IVQ2007 to $2,493.2 billion in IQ2014, or decline by 3.6 percent.

Period IQ1980 to IIIQ1987
Gross Private Domestic Investment USD 2009 Billions
IQ1980	951.6
IIIQ1987	1,174.6
∆%	23.4
Period IVQ2007 to IQ2014
Gross Private Domestic Investment USD Billions
IVQ2007	2,605.2
IQ2014	2,602.0
∆%	-0.1
Private Fixed Investment USD 2009 Billions
IVQ2007	2,586.3
IQ2014	2,493.2
∆%	-3.6

Table IB-2, US, GDP and Real Disposable Personal Income per Capita Actual and Trend Growth and Employment, 1980-1985 and 2007-2012, SAAR USD Billions, Millions of Persons and ∆%


Period IQ1980 to IIIQ1987
GDP SAAR USD Billions
IQ1980	6,517.9
IIIQ1987	8,149.4
∆% IQ1980 to IIIQ1987 (25.4 percent from IVQ1979 $6496.8 billion)	25.0
∆% Trend Growth IQ1980 to IIIQ1987	26.7
Real Disposable Personal Income per Capita IQ1980 Chained 2009 USD	20,242
Real Disposable Personal Income per Capita IIIQ1987 Chained 2009 USD	23,978
∆% IQ1980 to IIIQ1987 (18.5 percent from IVQ1979 $20,230 billion)	18.5
∆% Trend Growth	17.2
Employed Millions IQ1980 NSA End of Quarter	98.527
Employed Millions IIIQ1987 NSA End of Quarter	113.027
∆% Employed IQ1980 to IIIQ1987	14.7
Employed Full-time Millions IQ1980 NSA End of Quarter	81.280
Employed Full-time Millions IIIQ1987 NSA End of Quarter	93.771
∆% Full-time Employed IQ1980 to IIIQ1987	15.4
Unemployment Rate IQ1980 NSA End of Quarter	6.6
Unemployment Rate IIIQ1987 NSA End of Quarter	5.7
Unemployed IQ1980 Millions NSA End of Quarter	6.983
Unemployed IIIQ1987 Millions NSA End of Quarter	6.857
∆%	-1.8
Employed Part-time Economic Reasons IQ1980 Millions NSA End of Quarter	3.624
Employed Part-time Economic Reasons Millions IIIQ1987 NSA End of Quarter	4.937
∆%	36.2
Net Worth of Households and Nonprofit Organizations USD Billions
IVQ1979	9,041.9
IIQ1987	17,795.9
∆ USD Billions	+8,754.0
∆% CPI Adjusted	33.1
Gross Private Domestic Investment USD 2009 Billions
IQ1980	951.6
IIIQ1987	1174.6
∆%	23.4
Period IVQ2007 to IQ2014
GDP SAAR USD Billions
IVQ2007	14,996.1
IQ2014	15,946.6
∆% IVQ2007 to IQ2014	6.3
∆% IVQ2007 to IQ2014 Trend Growth	21.2
Real Disposable Personal Income per Capita IVQ2007 Chained 2009 USD	35,823
Real Disposable Personal Income per Capita IQ2014 Chained 2009 USD	37,061
∆% IVQ2007 to IQ2014	3.5
∆% Trend Growth	13.7
Employed Millions IVQ2007 NSA End of Quarter	146.334
Employed Millions IQ2014 NSA End of Quarter	145.090
∆% Employed IVQ2007 to IQ2014	-0.9
Employed Full-time Millions IVQ2007 NSA End of Quarter	121.042
Employed Full-time Millions IQ2014 NSA End of Quarter	116.985
∆% Full-time Employed IVQ2007 to IQ2014	-3.4
Unemployment Rate IVQ2007 NSA End of Quarter	4.8
Unemployment Rate IQ2014 NSA End of Quarter	6.8
Unemployed IVQ2007 Millions NSA End of Quarter	7.371
Unemployed IQ2014 Millions NSA End of Quarter	10.537
∆%	42.9
Employed Part-time Economic Reasons IVQ2007 Millions NSA End of Quarter	4.750
Employed Part-time Economic Reasons Millions IQ2014 NSA End of Quarter	7.455
∆%	56.9
U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA
IVQ2007	8.7
IQ2014	12.8
Net Worth of Households and Nonprofit Organizations USD Billions
IVQ2007	67,752.8
IVQ2013	80.663.7
∆ USD Billions	12,910.9 ∆%19.1 R∆%7.3
Gross Private Domestic Investment USD Billions
IVQ2007	2,605.2
IQ2014	2,602.0
∆%	-0.1
Private Fixed Investment USD 2009 Billions
IVQ2007	2,586.3
IQ2014	2,493.3
∆%	-3.6

Note: GDP trend growth used is 3.0 percent per year and GDP per capita is 2.0 percent per year as estimated by Lucas (2011May) on data from 1870 to 2010.

Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm US Bureau of Labor Statistics http://www.bls.gov/data/. Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: fourth quarter 2013. Washington, DC, Federal Reserve System, Mar 6. http://www.federalreserve.gov/releases/z1/Current/

The Congressional Budget Office (CBO 2014BEOFeb4) estimates potential GDP, potential labor force and potential labor productivity provided in Table IB-3. The CBO estimates average rate of growth of potential GDP from 1950 to 2012 at 3.3 percent per year. The projected path is significantly lower at 2.1 percent per year from 2013 to 2024. The legacy of the economic cycle expansion from IIIQ2009 to IVQ2013 at 2.3 percent on average is in contrast with 4.9 percent on average in the expansion from IQ1983 to IIIQ1987 (http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html). Subpar economic growth may perpetuate unemployment and underemployment estimated at 27.4 million or 16.8 percent of the effective labor force in Apr 2014 (http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html

) with much lower hiring than in the period before the current cycle (http://cmpassocregulationblog.blogspot.com/2014/05/rules-discretionary-authorities-and.html).

Table IB-3, US, Congressional Budget Office History and Projections of Potential GDP of US Overall Economy, ∆%

	Potential GDP	Potential Labor Force	Potential Labor Productivity*
Average Annual ∆%
1950-1973	3.9	1.6	2.3
1974-1981	3.2	2.5	0.8
1982-1990	3.2	1.6	1.6
1991-2001	3.2	1.3	1.9
2002-2012	2.2	0.8	1.4
2007-2012	1.7	0.6	1.1
Total 1950-2012	3.3	1.5	1.8
Projected Average Annual ∆%
2013-2018	2.1	0.6	1.5
2019-2024	2.1	0.5	1.6
2013-2024	2.1	0.5	1.6

*Ratio of potential GDP to potential labor force

Source: CBO (2014BEOFeb4), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014.

Chart IB-1 of the Congressional Budget Office (CBO 2013BEOFeb5) provides actual and potential GDP of the United States from 2000 to 2011 and projected to 2024. Lucas (2011May) estimates trend of United States real GDP of 3.0 percent from 1870 to 2010 and 2.2 percent for per capita GDP. The United States successfully returned to trend growth of GDP by higher rates of growth during cyclical expansion as analyzed by Bordo (2012Sep27, 2012Oct21) and Bordo and Haubrich (2012DR). Growth in expansions following deeper contractions and financial crises was much higher in agreement with the plucking model of Friedman (1964, 1988). The unusual weakness of growth at 2.2 percent on average from IIIQ2009 to IQ2014 during the current economic expansion in contrast with 4.9 percent on average in the cyclical expansion from IQ1983 to IIIQ1987 (http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html) cannot be explained by the contraction of 4.3 percent of GDP from IVQ2007 to IIQ2009 and the financial crisis. Weakness of growth in the expansion is perpetuating unemployment and underemployment of 27.4 million or 16.8 percent of the labor force as estimated for Mar 2014 (http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html). There is no exit from unemployment/underemployment and stagnating real wages because of the collapse of hiring (http://cmpassocregulationblog.blogspot.com/2014/05/rules-discretionary-authorities-and.html). The US economy and labor markets collapsed without recovery. Abrupt collapse of economic conditions can be explained only with cyclic factors (Lazear and Spletzer 2012Jul22) and not by secular stagnation (Hansen 1938, 1939, 1941 with early dissent by Simons 1942).

Chart IB-1, US, Congressional Budget Office, Actual and Projections of Potential GDP, 2000-2024, Trillions of Dollars

Source: Congressional Budget Office, CBO (2013BEOFeb5). The last year in common in both projections is 2017. The revision lowers potential output in 2017 by 7.3 percent relative to the projection in 2007.

Chart IB-2 provides differences in the projections of potential output by the CBO in 2007 and more recently on Feb 4, 2014, which the CBO explains in CBO (2014Feb28).

Chart IB-2, Congressional Budget Office, Revisions of Potential GDP

Source: Congressional Budget Office, 2014Feb 28. Revisions to CBO’s Projection of Potential Output since 2007. Washington, DC, CBO, Feb 28, 2014.

Chart IB-3 provides actual and projected potential GDP from 2000 to 2024. The gap between actual and potential GDP disappears at the end of 2017 (CBO2014Feb4). GDP increases in the projection at 2.5 percent per year.

Chart IB-3, Congressional Budget Office, GDP and Potential GDP

Source: CBO (2013BEOFeb5), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014.

ESV World Cyclical Slow Growth and International Trade. Table V-3 provides the latest available estimates of GDP for the regions and countries followed in this blog from IQ2012 to IVQ2013 available now for all countries. There are preliminary estimates for all countries for IQ2014. Growth is weak throughout most of the world.

Japan. The GDP of Japan increased 0.9 percent in IQ2012, 3.8 percent at SAAR (seasonally adjusted annual rate) and 3.2 percent relative to a year earlier but part of the jump could be the low level a year earlier because of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Japan is experiencing difficulties with the overvalued yen because of worldwide capital flight originating in zero interest rates with risk aversion in an environment of softer growth of world trade. Japan’s GDP fell 0.6 percent in IIQ2012 at the seasonally adjusted annual rate (SAAR) of minus 2.2 percent, which is much lower than 3.8 percent in IQ2012. Growth of 3.2 percent in IIQ2012 in Japan relative to IIQ2011 has effects of the low level of output because of Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Japan’s GDP contracted 0.8 percent in IIIQ2012 at the SAAR of minus 3.0 percent and decreased 0.2 percent relative to a year earlier. Japan’s GDP increased 0.1 percent in IVQ2012 at the SAAR of 0.2 percent and decreased 0.3 percent relative to a year earlier. Japan grew 1.2 percent in IQ2013 at the SAAR of 4.9 percent and increased 0.1 percent relative to a year earlier. Japan’s GDP increased 0.9 percent in IIQ2013 at the SAAR of 3.5 percent and increased 1.3 percent relative to a year earlier. Japan’s GDP grew 0.3 percent in IIIQ2013 at the SAAR of 1.3 percent and increased 2.4 percent relative to a year earlier. In IVQ2013, Japan’s GDP increased 0.1 percent at the SAAR of 0.3 percent, increasing 2.5 percent relative to a year earlier. Japan’s GDP increased 1.5 percent in IQ2014 at the SAAR of 5.9 percent and increased 3.0 percent relative to a year earlier.
China. China’s GDP grew 1.4 percent in IQ2012, annualizing to 5.7 percent, and 8.1 percent relative to a year earlier. The GDP of China grew at 2.1 percent in IIQ2012, which annualizes to 8.7 percent and 7.6 percent relative to a year earlier. China grew at 2.0 percent in IIIQ2012, which annualizes at 8.2 percent and 7.4 percent relative to a year earlier. In IVQ2012, China grew at 1.9 percent, which annualizes at 7.8 percent, and 7.9 percent in IVQ2012 relative to IVQ2011. In IQ2013, China grew at 1.5 percent, which annualizes at 6.1 percent and 7.7 percent relative to a year earlier. In IIQ2013, China grew at 1.8 percent, which annualizes at 7.4 percent and 7.5 percent relative to a year earlier. China grew at 2.3 percent in IIIQ2013, which annualizes at 9.5 percent and 7.8 percent relative to a year earlier. China grew at 1.7 percent in IVQ2013, which annualized to 7.0 percent and 7.7 percent relative to a year earlier. China’s GDP grew 1.4 percent in IQ2014, which annualizes to 5.7 percent, and 7.4 percent relative to a year earlier. There is decennial change in leadership in China (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). Growth rates of GDP of China in a quarter relative to the same quarter a year earlier have been declining from 2011 to 2014.
Euro Area. GDP fell 0.1 percent in the euro area in IQ2012 and decreased 0.2 in IQ2012 relative to a year earlier. Euro area GDP contracted 0.3 percent IIQ2012 and fell 0.5 percent relative to a year earlier. In IIIQ2012, euro area GDP fell 0.2 percent and declined 0.7 percent relative to a year earlier. In IVQ2012, euro area GDP fell 0.5 percent relative to the prior quarter and fell 1.0 percent relative to a year earlier. In IQ2013, the GDP of the euro area fell 0.2 percent and decreased 1.1 percent relative to a year earlier. The GDP of the euro area increased 0.3 percent in IIQ2013 and fell 0.6 percent relative to a year earlier. In IIIQ2013, euro area GDP increased 0.1 percent and fell 0.3 percent relative to a year earlier. The GDP of the euro area increased 0.2 percent in IVQ2013 and increased 0.5 percent relative to a year earlier. In IQ2014, the GDP of the euro area increased 0.2 percent and 0.9 percent relative to a year earlier.
Germany. The GDP of Germany increased 0.7 percent in IQ2012 and 1.8 percent relative to a year earlier. In IIQ2012, Germany’s GDP decreased 0.1 percent and increased 0.6 percent relative to a year earlier but 1.1 percent relative to a year earlier when adjusted for calendar (CA) effects. In IIIQ2012, Germany’s GDP increased 0.2 percent and 0.4 percent relative to a year earlier. Germany’s GDP contracted 0.5 percent in IVQ2012 and changed 0.0 percent relative to a year earlier. In IQ2013, Germany’s GDP changed 0.0 percent and fell 1.6 percent relative to a year earlier. In IIQ2013, Germany’s GDP increased 0.7 percent and 0.9 percent relative to a year earlier. The GDP of Germany increased 0.3 percent in IIIQ2013 and 1.1 percent relative to a year earlier. In IVQ2013, Germany’s GDP increased 0.4 percent and 1.3 percent relative to a year earlier. The GDP of Germany increased 0.8 percent in IQ2014 and 2.5 percent relative to a year earlier.
United States. Growth of US GDP in IQ2012 was 0.9 percent, at SAAR of 3.7 percent and higher by 3.3 percent relative to IQ2011. US GDP increased 0.3 percent in IIQ2012, 1.2 percent at SAAR and 2.8 percent relative to a year earlier. In IIIQ2012, US GDP grew 0.7 percent, 2.8 percent at SAAR and 3.1 percent relative to IIIQ2011. In IVQ2012, US GDP grew 0.0 percent, 0.1 percent at SAAR and 2.0 percent relative to IVQ2011. In IQ2013, US GDP grew at 1.1 percent SAAR, 0.3 percent relative to the prior quarter and 1.3 percent relative to the same quarter in 2013. In IIQ2013, US GDP grew at 2.5 percent in SAAR, 0.6 percent relative to the prior quarter and 1.6 percent relative to IIQ2012. US GDP grew at 4.1 percent in SAAR in IIIQ2013, 1.0 percent relative to the prior quarter and 2.0 percent relative to the same quarter a year earlier (Section I and earlier 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) with weak hiring (http://cmpassocregulationblog.blogspot.com/2014/04/global-financial-instability-recovery.html). In IVQ2013, US GDP grew 0.7 percent at 2.6 percent SAAR and 2.6 percent relative to a year earlier. In IQ2013, US GDP grew 0.0 percent, 2.3 percent relative to a year earlier and 0.1 percent at SAAR.
United Kingdom. In IQ2012, UK GDP changed 0.0 percent, increasing 0.6 percent relative to a year earlier. UK GDP fell 0.4 percent in IIQ2012 and increased 0.1 percent relative to a year earlier. UK GDP increased 0.8 percent in IIIQ2012 and increased 0.3 percent relative to a year earlier. UK GDP fell 0.2 percent in IVQ2012 relative to IIIQ2012 and increased 0.2 percent relative to a year earlier. UK GDP increased 0.4 percent in IQ2013 and 0.5 percent relative to a year earlier. UK GDP increased 0.8 percent in IIQ2013 and 1.7 percent relative to a year earlier. In IIIQ2013, UK GDP increased 0.8 percent and 1.8 percent relative to a year earlier. UK GDP increased 0.7 percent in IVQ2013 and 2.7 percent relative to a year earlier. In IQ2014, UK GDP increased 0.8 percent and 3.1 percent relative to a year earlier.
Italy. Italy has experienced decline of GDP in nine consecutive quarters from IIIQ2011 to IIIQ2013. Italy’s GDP fell 1.1 percent in IQ2012 and declined 1.7 percent relative to IQ2011. Italy’s GDP fell 0.5 percent in IIQ2012 and declined 2.4 percent relative to a year earlier. In IIIQ2012, Italy’s GDP fell 0.4 percent and declined 2.6 percent relative to a year earlier. The GDP of Italy contracted 0.9 percent in IVQ2012 and fell 2.8 percent relative to a year earlier. In IQ2013, Italy’s GDP contracted 0.6 percent and fell 2.4 percent relative to a year earlier. Italy’s GDP fell 0.3 percent in IIQ2013 and 2.1 percent relative to a year earlier. The GDP of Italy decreased 0.1 percent in IIIQ2013 and declined 1.9 percent relative to a year earlier. Italy’s GDP increased 0.1 percent in IVQ2013 and decreased 0.9 percent relative to a year earlier. In IQ2014, Italy’s GDP decreased 0.1 percent and fell 0.5 percent relative to a year earlier.
France. France’s GDP increased 0.2 percent in IQ2012 and increased 0.6 percent relative to a year earlier. France’s GDP decreased 0.3 percent in IIQ2012 and increased 0.4 percent relative to a year earlier. In IIIQ2012, France’s GDP increased 0.3 percent and increased 0.5 percent relative to a year earlier. France’s GDP fell 0.3 percent in IVQ2012 and changed 0.0 percent relative to a year earlier. In IQ2013, France GDP changed 0.0 percent and declined 0.2 percent relative to a year earlier. The GDP of France increased 0.6 percent in IIQ2013 and 0.7 percent relative to a year earlier. France’s GDP decreased 0.1 percent in IIIQ2013 and increased 0.3 percent relative to a year earlier. The GDP of France increased 0.2 percent in IVQ2013 and 0.8 percent relative to a year earlier. In IVQ2014, France’s GDP changed 0.0 percent and increased 0.8 percent relative to a year earlier.

Table V-3, Percentage Changes of GDP Quarter on Prior Quarter and on Same Quarter Year Earlier, ∆%

	IQ2012/IVQ2011	IQ2012/IQ2011
United States	QOQ: 0.9 SAAR: 3.7	3.3
Japan	QOQ: 0.9 SAAR: 3.8	3.2
China	1.4	8.1
Euro Area	-0.1	-0.2
Germany	0.7	1.8
France	0.2	0.6
Italy	-1.1	-1.7
United Kingdom	0.0	0.6
	IIQ2012/IQ2012	IIQ2012/IIQ2011
United States	QOQ: 0.3 SAAR: 1.2	2.8
Japan	QOQ: -0.6 SAAR: -2.2	3.2
China	2.1	7.6
Euro Area	-0.3	-0.5
Germany	-0.1	0.6 1.1 CA
France	-0.3	0.4
Italy	-0.5	-2.4
United Kingdom	-0.4	0.1
	IIIQ2012/ IIQ2012	IIIQ2012/ IIIQ2011
United States	QOQ: 0.7 SAAR: 2.8	3.1
Japan	QOQ: –0.8 SAAR: –3.0	-0.2
China	2.0	7.4
Euro Area	-0.2	-0.7
Germany	0.2	0.4
France	0.3	0.5
Italy	-0.4	-2.6
United Kingdom	0.8	0.3
	IVQ2012/IIIQ2012	IVQ2012/IVQ2011
United States	QOQ: 0.0 SAAR: 0.1	2.0
Japan	QOQ: 0.1 SAAR: 0.2	-0.3
China	1.9	7.9
Euro Area	-0.5	-1.0
Germany	-0.5	0.0
France	-0.3	0.0
Italy	-0.9	-2.8
United Kingdom	-0.2	0.2
	IQ2013/IVQ2012	IQ2013/IQ2012
United States	QOQ: 0.3 SAAR: 1.1	1.3
Japan	QOQ: 1.2 SAAR: 4.9	0.1
China	1.5	7.7
Euro Area	-0.2	-1.1
Germany	0.0	-1.6
France	0.0	-0.2
Italy	-0.6	-2.4
UK	0.4	0.5
	IIQ2013/IQ2013	IIQ2013/IIQ2012
United States	QOQ: 0.6 SAAR: 2.5	1.6
Japan	QOQ: 0.9 SAAR: 3.5	1.3
China	1.8	7.5
Euro Area	0.3	-0.6
Germany	0.7	0.9
France	0.6	0.7
Italy	-0.3	-2.1
UK	0.8	1.7
	IIIQ2013/IIQ2013	III/Q2013/ IIIQ2012
USA	QOQ: 1.0 SAAR: 4.1	2.0
Japan	QOQ: 0.3 SAAR: 1.3	2.4
China	2.3	7.8
Euro Area	0.1	-0.3
Germany	0.3	1.1
France	-0.1	0.3
Italy	-0.1	-1.9
UK	0.8	1.8
	IVQ2013/IIIQ2013	IVQ2013/IVQ2012
USA	QOQ: 0.7 SAAR: 2.6	2.6
Japan	QOQ: 0.1 SAAR: 0.3	2.5
China	1.7	7.7
Euro Area	0.2	0.5
Germany	0.4	1.3
France	0.2	0.8
Italy	0.1	-0.9
UK	0.7	2.7
	IQ2014/IVQ2013	IQ2014/IQ2013
USA	QOQ 0.0 SAAR 0.1	2.3
Japan	QOQ: 1.5 SAAR: 5.9	3.0
China	1.4	7.4
Euro Area	0.2	0.9
Germany	0.8	2.5
France	0.0	0.8
Italy	-0.1	-0.5
UK	0.8	3.1

QOQ: Quarter relative to prior quarter; SAAR: seasonally adjusted annual rate

Source: Country Statistical Agencies http://www.census.gov/aboutus/stat_int.html

Table V-4 provides two types of data: growth of exports and imports in the latest available months and in the past 12 months; and contributions of net trade (exports less imports) to growth of real GDP.

Japan. Japan provides the most worrisome data (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/05/financial-volatility-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/03/interest-rate-risks-world-inflation.html and earlier http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html and earlier http://cmpassocregulationblog.blogspot.com/2014/02/mediocre-cyclical-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/12/tapering-quantitative-easing-mediocre.html and earlier http://cmpassocregulationblog.blogspot.com/2013/11/risks-of-zero-interest-rates-world.html http://cmpassocregulationblog.blogspot.com/2013/11/global-financial-risk-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations_8763.html http://cmpass ocregulationblog.blogspot.com/2013/08/interest-rate-risks-duration-dumping.html and earlier http://cmpassocregulationblog.blogspot.com/2013/07/duration-dumping-steepening-yield-curve.html and earlier http://cmpassocregulationblog.blogspot.com/2013/06/paring-quantitative-easing-policy-and_4699.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/05/united-states-commercial-banks-assets.html and earlier http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2013/03/united-states-commercial-banks-assets.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/02/world-inflation-waves-united-states.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/02/thirty-one-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html and earlier http://cmpassocregulationblog.blogspot.com/2012/11/contraction-of-united-states-real_25.html and for GDP http://cmpassocregulationblog.blogspot.com/2013/09/recovery-without-hiring-ten-million.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/duration-dumping-and-peaking-valuations.html and earlier http://cmpassocreulationblog.blogspot.com/2013/02/recovery-without-hiring-united-states.html). In Apr 2014, Japan’s exports grew 5.1 percent in 12 months while imports increased 3.4 percent. The second part of Table V-4 shows that net trade deducted 1.3 percentage points from Japan’s growth of GDP in IIQ2012, deducted 2.2 percentage points from GDP growth in IIIQ2012 and deducted 0.5 percentage points from GDP growth in IVQ2012. Net trade added 0.4 percentage points to GDP growth in IQ2012, 1.7 percentage points in IQ2013 and 0.5 percentage points in IIQ2013. In IIIQ2013, net trade deducted 2.0 percentage points from GDP growth in Japan. Net trade ducted 2.2 percentage points from GDP growth in Japan in IVQ2013. Net trade deducted 1.1 percentage point from GDP growth of Japan in IQ2014.
China. In Apr 2014, China exports increased 0.9 percent relative to a year earlier and imports increased 0.8 percent.
Germany. Germany’s exports decreased 1.8 percent in the month of Mar 2014 and increased 1.9 percent in the 12 months ending in Mar 2014. Germany’s imports decreased 0.9 percent in the month of Mar and increased 5.6 percent in the 12 months ending in Mar. Net trade contributed 0.8 percentage points to growth of GDP in IQ2012, contributed 0.3 percentage points in IIQ2012, contributed 0.3 percentage points in IIIQ2012, deducted 0.5 percentage points in IVQ2012, deducted 0.3 percentage points in IQ2013 and added 0.1 percentage points in IIQ2013. Net traded deducted 0.5 percentage points from Germany’s GDP growth in IIIQ2013 and added 0.4 percentage points to GDP growth in IVQ2013. Net trade added 0.1 percentage points to GDP growth in IQ2014.
United Kingdom. Net trade deducted 0.7 percentage points from UK value added in IQ2012, deducted 0.8 percentage points in IIQ2012, added 0.9 percentage points in IIIQ2012 and subtracted 0.4 percentage points in IVQ2012. In IQ2013, net trade added 0.5 percentage points to UK’s growth of value added and contributed 0.0 percentage points in IIQ2013. In IIIQ2013, net trade deducted 1.1 percentage points from UK growth. Net trade contributed 1.0 percentage points to UK value added in IVQ2013. Net trade contributed 0.0 percentage points to UK value added in IQ2014.
France. France’s exports increased 0.6 percent in Mar 2014 while imports increased 3.4 percent. Net traded added 0.1 percentage points to France’s GDP in IIIQ2012 and 0.1 percentage points in IVQ2012. Net trade deducted 0.1 percentage points from France’s GDP growth in IQ2013 and added 0.2 percentage points in IIQ2013, deducting 0.5 percentage points in IIIQ2013. Net trade added 0.3 percentage points to France’s GDP in IVQ2013 and deducted 0.2 percentage points in IQ2014.
United States. US exports increased 2.1 percent in Mar 2014 and goods exports increased 2.6 percent in Jan-Mar 2014 relative to a year earlier. Net trade deducted 0.03 percentage points from GDP growth in IIIQ2012 and added 0.68 percentage points in IVQ2012. Net trade deducted 0.28 percentage points from US GDP growth in IQ2013 and deducted 0.07 percentage points in IIQ2013. Net traded added 0.14 percentage points to US GDP growth in IIIQ2013. Net trade added 0.99 percentage points to US GDP growth in IVQ2013. Net trade deducted 0.83 percent from US GDP growth in IQ2014. Industrial production decreased 0.6 percent in Apr 2014 after increasing 0.9 percent in Mar 2014 and increasing 1.1 percent in Feb 2014, 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 decreased 0.6 percent in April 2014 after having risen about 1 percent in both February and March. In April, manufacturing output fell 0.4 percent. The index had increased substantially in February and March following a decrease in January; severe weather had restrained production early in the quarter. The output of utilities dropped 5.3 percent in April, as demand for heating returned toward normal levels. The production at mines increased 1.4 percent following a gain of 2.0 percent in March. At 102.7 percent of its 2007 average, total industrial production in April was 3.5 percent above its level of a year earlier. The capacity utilization rate for total industry decreased 0.7 percentage point in April to 78.6 percent, a rate that is 1.5 percentage points below its long-run (1972–2013) average.”

In the six months ending in Apr 2014, United States national industrial production accumulated increase of 2.0 percent at the annual equivalent rate of 4.1 percent, which is higher than growth of 3.5 percent in the 12 months ending in Apr 2014. Excluding growth of 1.1 percent in Feb 2014 (revised from 1.2 percent in the prior estimate), growth in the remaining five months from Nov to Apr 2014 accumulated to 1.0 percent or 2.2 percent annual equivalent. Industrial production fell in two of the past six months. Business equipment accumulated growth of 2.2 percent in the six months from Nov 2013 to Apr 2014 at the annual equivalent rate of 4.4 percent, which is higher than growth of 4.1 percent in the 12 months ending in Apr 2014. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “The capacity utilization rate for total industry decreased 0.7 percentage point in April to 78.6 percent, a rate that is 1.5 percentage points below its long-run (1972–2013) average.” United States industry apparently decelerated to a lower growth rate with possible acceleration in the past few months.

Manufacturing decreased 0.4 percent in Apr 2014 after increasing 0.7 percent in Mar 2014 and increasing 1.5 percent in Feb 2014 seasonally adjusted, increasing 2.5 percent not seasonally adjusted in the 12 months ending in Apr 2014. Manufacturing grew cumulatively 1.4 percent in the six months ending in Apr 2014 or at the annual equivalent rate of 2.8 percent. Excluding the increase of 1.5 percent in Feb 2014 (revised from 1.4 percent in the prior estimate), manufacturing accumulated growth of -0.1 percent from Nov 2013 to Apr 2014 or at the annual equivalent rate of -0.3 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.”

Manufacturing output fell 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increased 19.9 percent from the trough in Apr 2009 to Dec 2013. Manufacturing grew 22.3 percent from the trough in Apr 2009 to Apr 2014. Manufacturing output in Apr 2014 is 4.5 percent below the peak in Jun 2007.

Table V-4, Growth of Trade and Contributions of Net Trade to GDP Growth, ∆% and % Points

	Exports M ∆%	Exports 12 M ∆%	Imports M ∆%	Imports 12 M ∆%
USA	2.1 Mar	2.6 Jan-Mar	1.1 Mar	1.8 Jan-Mar
Japan		Apr 2014 5.1 Mar 2014 1.8 Feb 2014 9.5 Jan 2014 9.5 Dec 2013 15.3 Nov 2013 18.4 Oct 2013 18.6 Sep 2013 11.5 Aug 2013 14.7 Jul 2013 12.2 Jun 2013 7.4 May 2013 10.1 Apr 2013 3.8 Mar 2013 1.1 Feb 2013 -2.9 Jan 2013 6.4 Dec -5.8 Nov -4.1 Oct -6.5 Sep -10.3 Aug -5.8 Jul -8.1		Apr 2013 3.4 Mar 2014 18.1 Feb 2014 9.0 Jan 2014 25.0 Dec 2013 24.7 Nov 2013 21.1 Oct 2013 26.1 Sep 2013 16.5 Aug 2013 16.0 Jul 2013 19.6 Jun 2013 11.8 May 2013 10.0 Apr 2013 9.4 Mar 2013 5.5 Feb 2013 7.3 Jan 2013 7.3 Dec 1.9 Nov 0.8 Oct -1.6 Sep 4.1 Aug -5.4 Jul 2.1
China		2014 0.9 Apr -6.6 Mar -18.1 Feb 10.6 Jan 2013 4.3 Dec 12.7 Nov 5.6 Oct -0.3 Sep 7.2 Aug 5.1 Jul -3.1 Jun 1.0 May 14.7 Apr 10.0 Mar 21.8 Feb 25.0 Jan		2014 0.8 Apr -11.3 Mar 10.1 Feb 10.0 Jan 2013 8.3 Dec 5.3 Nov 7.6 Oct 7.4 Sep 7.0 Aug 10.9 Jul -0.7 Jun -0.3 May 16.8 Apr 14.1 Mar -15.2 Feb 28.8 Jan
Euro Area	-0.7 12-M Mar	1.0 Jan-Mar	2.5 12-M Mar	-0.1 Jan-Mar
Germany	-1.8 Mar CSA	1.9 Mar	-0.9 Mar CSA	5.6 Mar
France Mar	0.6	0.5	3.4	1.1
Italy Mar	-0.8	1.2	-1.0	-1.3
UK	2.8 Mar	-2.7 Jan-Mar 14 /Jan-Mar 13	1.6 Mar	-2.8 Jan-Mar 14 13/Jan-Mar 13
Net Trade % Points GDP Growth	% Points
USA	IQ2014 -0.83 IVQ2013 0.99 IIIQ2013 0.14 IIQ2013 -0.07 IQ2013 -0.28 IVQ2012 +0.68 IIIQ2012 -0.03 IIQ2012 +0.10 IQ2012 +0.44
Japan	0.4 IQ2012 -1.3 IIQ2012 -2.2 IIIQ2012 -0.5 IVQ2012 1.7 IQ2013 0.5 IIQ2013 -2.0 IIIQ2013 -2.2 IVQ2013 -1.1 IQ2014
Germany	IQ2012 0.8 IIQ2012 0.4 IIIQ2012 0.3 IVQ2012 -0.5 IQ2013 -0.3 IIQ2013 0.1 IIIQ2013 -0.5 IVQ2013 0.4 IQ2014 0.1
France	0.1 IIIQ2012 0.1 IVQ2012 -0.1 IQ2013 0.2 IIQ2013 -0.5 IIIQ2013 0.3 IVQ2013 -0.2 IQ2014
UK	-0.7 IQ2012 -0.8 IIQ2012 +0.9 IIIQ2012 -0.4 IVQ2012 0.5 IQ2013 0.0 IIQ2013 -1.1 IIIQ2013 1.0 IVQ2013 0.0 IQ2014

Sources: Country Statistical Agencies http://www.census.gov/foreign-trade/ http://www.bea.gov/iTable/index_nipa.cfm

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Monday, May 26, 2014

United States Commercial Banks Assets and Liabilities, Collapse of United States Dynamism of Income Growth and Employment Creation, United States Housing Collapse, World Cyclical Slow Growth and Global Recession Risk: Part I

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