CMP Associates Regulation Blog: “And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course,” Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend, Stagnating Real Private Fixed Investment, Swelling Undistributed Corporate Profits, United States Housing, United States Commercial Banks Assets and Liabilities, World Cyclical Slow Growth and Global Recession Risk: Part I

“And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course,” Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend, Stagnating Real Private Fixed Investment, Swelling Undistributed Corporate Profits, United States Housing, United States Commercial Banks Assets and Liabilities, World Cyclical Slow Growth and Global Recession Risk

Carlos M. Pelaez

I Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend

IA Mediocre Cyclical United States Economic Growth

IA1 Stagnating Real Private Fixed Investment

IA2 Swelling Undistributed Corporate Profits

II United States Housing Collapse

IIA United States Commercial Banks Assets and Liabilities

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 Financial “Irrational Exuberance,” Increasing Interest Rate and Exchange Rate Risk, Duration Dumping, Competitive Devaluations, Steepening Yield Curve and Global Financial and Economic Risk

ESII Valuations of Risk Financial Assets

ESIII Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend

ESIV Stagnating Real Private Fixed Investment

ESV Swelling Undistributed Corporate Profits

ESVI United States Housing

ESVII United States Commercial Banks Assets and Liabilities

ESI “Financial “Irrational Exuberance,” Increasing Interest Rate and Exchange Rate Risk, Duration Dumping, Competitive Devaluations, 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. The National People’s Congress of China in Mar 2016 is reducing the GDP growth target to the range of 6.5 percent to 7.0 percent in guiding stable market expectations (http://news.xinhuanet.com/english/photo/2016-03/05/c_135157171.htm). President Xi Jinping announced on Nov 3, 2015 that “For China to double 2010 GDP and the per capita income of both urban and rural residents by 2010, annual growth for the 2016-2020 period must be at least 6.5 percent,” as quoted by Xinhuanet (http://news.xinhuanet.com/english/2015-11/03/c_134780377.htm). China lowered the growth target to approximately 7.0 percent in 2015, as analyzed by Xiang Bo, writing on “China lowers 2015 economic growth target to around 7 percent,” published on Xinhuanet on Mar 5, 2015 (http://news.xinhuanet.com/english/2015-03/05/c_134039341.htm). China had lowered its growth target to 7.5 percent per year. Lu Hui, writing on “China lowers GDP target to achieve quality economic growth, on Mar 12, 2012, published in Beijing by Xinhuanet (http://news.xinhuanet.com/english/china/2012-03/12/c_131461668.htm), informs that Premier Jiabao wrote in a government work report that the GDP growth target will be lowered to 7.5 percent to enhance the quality and level of development of China over the long term. The Third Plenary Session of the 18^th Central Committee of the Communist Party of China adopted unanimously on Nov 15, 2013, a new round of reforms with 300 measures (Xinhuanet, “China details reform decision-making process,” Nov 19, 2013 http://news.xinhuanet.com/english/china/2013-11/19/c_125722517.htm). Growth rates of GDP of China in a quarter relative to the same quarter a year earlier have been declining from 2011 to 2016. China’s GDP grew 1.8 percent in IQ2012, annualizing to 7.4 percent, and 8.1 percent relative to a year earlier. The GDP of China grew at 2.2 percent in IIQ2012, which annualizes to 9.1 percent, and 7.6 percent relative to a year earlier. China grew at 1.8 percent in IIIQ2012, which annualizes at 7.4 percent, and 7.5 percent relative to a year earlier. In IVQ2012, China grew at 1.9 percent, which annualizes at 7.8 percent, and 8.1 percent in IVQ2012 relative to IVQ2011. In IQ2013, China grew at 1.9 percent, which annualizes at 7.8 percent, and 7.9 percent relative to a year earlier. In IIQ2013, China grew at 1.7 percent, which annualizes at 7.0 percent, and 7.6 percent relative to a year earlier. China grew at 2.1 percent in IIIQ2013, which annualizes at 8.7 percent, and increased 7.9 percent relative to a year earlier. China grew at 1.6 percent in IVQ2013, which annualized to 7.0 percent, and 7.7 percent relative to a year earlier. China’s GDP grew 1.7 percent in IQ2014, which annualizes to 7.0 percent, and 7.4 percent relative to a year earlier. China’s GDP grew 1.8 percent in IIQ2014, which annualizes at 7.4 percent, and 7.5 percent relative to a year earlier. China’s GDP grew 1.9 percent in IIIQ2014, which is equivalent to 7.8 percent in a year, and 7.1 percent relative to a year earlier. The GDP of China grew 1.7 percent in IVQ2014, which annualizes at 7.0 percent, and 7.2 percent relative to a year earlier. The GDP of China grew at 1.6 percent in IQ2015, which annualizes at 6.6 percent, and 7.0 percent relative to a year earlier. The GDP of China grew 1.8 percent in IIQ2015, which annualizes at 7.4 percent, and increased 7.0 percent relative to a year earlier. In IIIQ2015, China’s GDP grew at 1.8 percent, which annualizes at 7.4 percent, and increased 6.9 percent relative to a year earlier. The GDP of China grew at 1.5 percent in IVQ2015, which annualizes at 6.1 percent, and increased 6.8 percent relative to a year earlier. The GDP of China grew 1.2 percent in IQ2016, which annualizes at 4.9 percent, and increased 6.7 percent relative to a year earlier. In IIQ2016, the GDP of China increased 1.8 percent, which annualizes to 7.4 percent, and increased 6.7 percent relative to a year earlier. There is decennial change in leadership in China (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). (http://cmpassocregulationblog.blogspot.com/2016/07/unresolved-us-balance-of-payments.html and earlier http://cmpassocregulationblog.blogspot.com/2016/04/imf-view-of-world-economy-and-finance.html and earlier http://cmpassocregulationblog.blogspot.com/2016/01/uncertainty-of-valuations-of-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2015/07/valuation-of-risk-financial-assets.html and earlier (http://cmpassocregulationblog.blogspot.com/2016/04/imf-view-of-world-economy-and-finance.html and earlier (http://cmpassocregulationblog.blogspot.com/2015/04/imf-view-of-economy-and-finance-united.html and earlier http://cmpassocregulationblog.blogspot.com/2015/01/competitive-currency-conflicts-world.html and earlier http://cmpassocregulationblog.blogspot.com/2014/10/financial-oscillations-world-inflation.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html and earlier 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). There is also ongoing political development in China during a decennial political reorganization with new leadership (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). Xinhuanet informs that Premier Wen Jiabao considers the need for macroeconomic stimulus, arguing that “we should continue to implement proactive fiscal policy and a prudent monetary policy, while giving more priority to maintaining growth” (http://news.xinhuanet.com/english/china/2012-05/20/c_131599662.htm). Premier Wen elaborates that “the country should properly handle the relationship between maintaining growth, adjusting economic structures and managing inflationary expectations” (http://news.xinhuanet.com/english/china/2012-05/20/c_131599662.htm). Bob Davis, writing on “At China’s NPC, Proposed Changes,” on Mar 5, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304732804579420743344553328?KEYWORDS=%22china%22&mg=reno64-wsj), analyzes the wide ranging policy changes in the annual work report by Prime Minister Li Keqiang to China’s NPC (National People’s Congress of the People’s Republic of China http://www.npc.gov.cn/englishnpc/news/). There are about sixty different fiscal and regulatory measures.
United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 23.6 million in job stress, fewer 10 million full-time jobs, high youth unemployment, historically low hiring and declining/stagnating real wages. Actual GDP is about two trillion dollars lower than trend GDP.
Economic Growth and Labor Markets in Advanced Economies. Advanced economies are growing slowly. There is still high unemployment in advanced economies.
World Inflation Waves. Inflation continues in repetitive waves globally (Section I and earlier http://cmpassocregulationblog.blogspot.com/2016/07/oscillating-valuations-of-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2016/06/fomc-projections-world-inflation-waves.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. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times).
Competitive Devaluations. Exchange rate struggles continue as zero interest rates and negative interest rates in advanced economies induce devaluation of their currencies with alternating episodes of revaluation.
Valuation and Volatility of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with oscillating volumes. The President of the European Central Bank (ECB), Mario Draghi, warned on Jun 3, 2015 that (http://www.ecb.europa.eu/press/pressconf/2015/html/is150603.en.html):

“But certainly one lesson is that we should get used to periods of higher volatility. At very low levels of interest rates, asset prices tend to show higher volatility…the Governing Council was unanimous in its assessment that we should look through these developments and maintain a steady monetary policy stance.”

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 mixed with reallocations of portfolios of risk financial assets

There are collateral effects of unconventional monetary policy. 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.

Dan Strumpf and Pedro Nicolaci da Costa, writing on “Fed’s Yellen: Stock Valuations ‘Generally are Quite High,’” on May 6, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/feds-yellen-cites-progress-on-bank-regulation-1430918155?tesla=y ), quote Chair Yellen at open conversation with Christine Lagarde, Managing Director of the IMF, finding “equity-market valuations” as “quite high” with “potential dangers” in bond valuations. The DJIA fell 0.5 percent on May 6, 2015, after the comments and then increased 0.5 percent on May 7, 2015 and 1.5 percent on May 8, 2015.

Fri May 1

Mon 4

Tue 5

Wed 6

Thu 7

Fri 8

DJIA

18024.06

-0.3%

1.0%

18070.40

0.3%

17928.20

-0.5%

-0.8%

17841.98

-1.0%

-0.5%

17924.06

-0.6%

0.5%

18191.11

0.9%

1.5%

There are two approaches in theory considered by Bordo (2012Nov20) and Bordo and Lane (2013). The first approach is in the classical works of Milton Friedman and Anna Jacobson Schwartz (1963a, 1987) and Karl Brunner and Allan H. Meltzer (1973). There is a similar approach in Tobin (1969). Friedman and Schwartz (1963a, 66) trace the effects of expansionary monetary policy into increasing initially financial asset prices: “It seems plausible that both nonbank and bank holders of redundant balances will turn first to securities comparable to those they have sold, say, fixed-interest coupon, low-risk obligations. But as they seek to purchase these they will tend to bid up the prices of those issues. Hence they, and also other holders not involved in the initial central bank open-market transactions, will look farther afield: the banks, to their loans; the nonbank holders, to other categories of securities-higher risk fixed-coupon obligations, equities, real property, and so forth.”

The second approach is by the Austrian School arguing that increases in asset prices can become bubbles if monetary policy allows their financing with bank credit. Professor Michael D. Bordo provides clear thought and empirical evidence on the role of “expansionary monetary policy” in inflating asset prices (Bordo2012Nov20, Bordo and Lane 2013). Bordo and Lane (2013) provide revealing narrative of historical episodes of expansionary monetary policy. Bordo and Lane (2013) conclude that policies of depressing interest rates below the target rate or growth of money above the target influences higher asset prices, using a panel of 18 OECD countries from 1920 to 2011. Bordo (2012Nov20) concludes: “that expansionary money is a significant trigger” and “central banks should follow stable monetary policies…based on well understood and credible monetary rules.” Taylor (2007, 2009) explains the housing boom and financial crisis in terms of expansionary monetary policy. Professor Martin Feldstein (2016), at Harvard University, writing on “A Federal Reserve oblivious to its effects on financial markets,” on Jan 13, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/a-federal-reserve-oblivious-to-its-effect-on-financial-markets-1452729166), analyzes how unconventional monetary policy drove values of risk financial assets to high levels. Quantitative easing and zero interest rates distorted calculation of risks with resulting vulnerabilities in financial markets.

Another hurdle of exit from zero interest rates is “competitive easing” that Professor Raghuram Rajan, governor of the Reserve Bank of India, characterizes as disguised “competitive devaluation” (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). The fed has been considering increasing interest rates. The European Central Bank (ECB) announced, on Mar 5, 2015, the beginning on Mar 9, 2015 of its quantitative easing program denominated as Public Sector Purchase Program (PSPP), consisting of “combined monthly purchases of EUR 60 bn [billion] in public and private sector securities” (http://www.ecb.europa.eu/mopo/liq/html/pspp.en.html). Expectation of increasing interest rates in the US together with euro rates close to zero or negative cause revaluation of the dollar (or devaluation of the euro and of most currencies worldwide). US corporations suffer currency translation losses of their foreign transactions and investments (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318) while the US becomes less competitive in world trade (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), Government Intervention in Globalization (2008c)). The DJIA fell 1.5 percent on Mar 6, 2015 and the dollar revalued 2.2 percent from Mar 5 to Mar 6, 2015. The euro has devalued 42.0 percent relative to the dollar from the high on Jul 15, 2008 to Aug 26, 2016.

Fri 27 Feb

Mon 3/2

Tue 3/3

Wed 3/4

Thu 3/5

Fri 3/6

USD/ EUR

1.1197

1.6%

0.0%

1.1185

0.1%

1.1176

0.2%

0.1%

1.1081

1.0%

0.9%

1.1030

1.5%

0.5%

1.0843

3.2%

1.7%

Chair Yellen explained the removal of the word “patience” from the advanced guidance at the press conference following the FOMC meeting on Mar 18, 2015 (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20150318.pdf):

“In other words, just because we removed the word “patient” from the statement doesn’t mean we are going to be impatient. Moreover, even after the initial increase in the target funds rate, our policy is likely to remain highly accommodative to support continued progress toward our objectives of maximum employment and 2 percent inflation.”

Exchange rate volatility is increasing in response of “impatience” in financial markets with monetary policy guidance and measures:

Fri Mar 6

Mon 9

Tue 10

Wed 11

Thu 12

Fri 13

USD/ EUR

1.0843

3.2%

1.7%

1.0853

-0.1%

1.0700

1.3%

1.4%

1.0548

2.7%

1.4%

1.0637

1.9%

-0.8%

1.0497

3.2%

1.3%

Fri Mar 13

Mon 16

Tue 17

Wed 18

Thu 19

Fri 20

USD/ EUR

1.0497

3.2%

1.3%

1.0570

-0.7%

1.0598

-1.0%

-0.3%

1.0864

-3.5%

-2.5%

1.0661

-1.6%

1.9%

1.0821

-3.1%

-1.5%

Fri Apr 24

Mon 27

Tue 28

Wed 29

Thu 30

May Fri 1

USD/ EUR

1.0874

-0.6%

-0.4%

1.0891

-0.2%

1.0983

-1.0%

-0.8%

1.1130

-2.4%

-1.3%

1.1223

-3.2%

-0.8%

1.1199

-3.0%

0.2%

In a speech at Brown University on May 22, 2015, Chair Yellen stated (http://www.federalreserve.gov/newsevents/speech/yellen20150522a.htm):

“For this reason, if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalizing monetary policy. To support taking this step, however, I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium term. After we begin raising the federal funds rate, I anticipate that the pace of normalization is likely to be gradual. The various headwinds that are still restraining the economy, as I said, will likely take some time to fully abate, and the pace of that improvement is highly uncertain.”

The US dollar appreciated 3.8 percent relative to the euro in the week of May 22, 2015:

Fri May 15

Mon 18

Tue 19

Wed 20

Thu 21

Fri 22

USD/ EUR

1.1449

-2.2%

-0.3%

1.1317

1.2%

1.1150

2.6%

1.5%

1.1096

3.1%

0.5%

1.1113

2.9%

-0.2%

1.1015

3.8%

0.9%

The Managing Director of the International Monetary Fund (IMF), Christine Lagarde, warned on Jun 4, 2015, that: (http://blog-imfdirect.imf.org/2015/06/04/u-s-economy-returning-to-growth-but-pockets-of-vulnerability/):

“The Fed’s first rate increase in almost 9 years is being carefully prepared and telegraphed. Nevertheless, regardless of the timing, higher US policy rates could still result in significant market volatility with financial stability consequences that go well beyond US borders. I weighing these risks, we think there is a case for waiting to raise rates until there are more tangible signs of wage or price inflation than are currently evident. Even after the first rate increase, a gradual rise in the federal fund rates will likely be appropriate.”

The President of the European Central Bank (ECB), Mario Draghi, warned on Jun 3, 2015 that (http://www.ecb.europa.eu/press/pressconf/2015/html/is150603.en.html):

The Chair of the Board of Governors of the Federal Reserve System, Janet L. Yellen, stated on Jul 10, 2015 that (http://www.federalreserve.gov/newsevents/speech/yellen20150710a.htm):

“Based on my outlook, I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy. But I want to emphasize that the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step. I currently anticipate that the appropriate pace of normalization will be gradual, and that monetary policy will need to be highly supportive of economic activity for quite some time. The projections of most of my FOMC colleagues indicate that they have similar expectations for the likely path of the federal funds rate. But, again, both the course of the economy and inflation are uncertain. If progress toward our employment and inflation goals is more rapid than expected, it may be appropriate to remove monetary policy accommodation more quickly. However, if progress toward our goals is slower than anticipated, then the Committee may move more slowly in normalizing policy.”

There is essentially the same view in the Testimony of Chair Yellen in delivering the Semiannual Monetary Policy Report to the Congress on Jul 15, 2015 (http://www.federalreserve.gov/newsevents/testimony/yellen20150715a.htm).

At the press conference after the meeting of the FOMC on Sep 17, 2015, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20150917.pdf 4):

“The outlook abroad appears to have become more uncertain of late, and heightened concerns about growth in China and other emerging market economies have led to notable volatility in financial markets. Developments since our July meeting, including the drop in equity prices, the further appreciation of the dollar, and a widening in risk spreads, have tightened overall financial conditions to some extent. These developments may restrain U.S. economic activity somewhat and are likely to put further downward pressure on inflation in the near term. Given the significant economic and financial interconnections between the United States and the rest of the world, the situation abroad bears close watching.”

Some equity markets fell on Fri Sep 18, 2015:

Fri Sep 11

Mon 14

Tue 15

Wed 16

Thu 17

Fri 18

DJIA

16433.09

2.1%

0.6%

16370.96

-0.4%

16599.85

1.0%

1.4%

16739.95

1.9%

0.8%

16674.74

1.5%

-0.4%

16384.58

-0.3%

-1.7%

Nikkei 225

18264.22

2.7%

-0.2%

17965.70

-1.6%

18026.48

-1.3%

0.3%

18171.60

-0.5%

0.8%

18432.27

0.9%

1.4%

18070.21

-1.1%

-2.0%

DAX

10123.56

0.9%

-0.9%

10131.74

0.1%

10188.13

0.6%

10227.21

1.0%

0.4%

10229.58

1.0%

0.0%

9916.16

-2.0%

-3.1%

Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. Chair Yellen, in a lecture on “Inflation dynamics and monetary policy,” on Sep 24, 2015 (http://www.federalreserve.gov/newsevents/speech/yellen20150924a.htm), states that (emphasis added):

· “The economic outlook, of course, is highly uncertain”

· “Considerable uncertainties also surround the outlook for economic activity”

· “Given the highly uncertain nature of the outlook…”

Is there a “science” or even “art” of central banking under this extreme uncertainty in which policy does not generate higher volatility of money, income, prices and values of financial assets?

Lingling Wei, writing on Oct 23, 2015, on China’s central bank moves to spur economic growth,” published in the Wall Street Journal (http://www.wsj.com/articles/chinas-central-bank-cuts-rates-1445601495), analyzes the reduction by the People’s Bank of China (http://www.pbc.gov.cn/ http://www.pbc.gov.cn/english/130437/index.html) of borrowing and lending rates of banks by 50 basis points and reserve requirements of banks by 50 basis points. Paul Vigna, writing on Oct 23, 2015, on “Stocks rally out of correction territory on latest central bank boost,” published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2015/10/23/stocks-rally-out-of-correction-territory-on-latest-central-bank-boost/), analyzes the rally in financial markets following the statement on Oct 22, 2015, by the President of the European Central Bank (ECB) Mario Draghi of consideration of new quantitative measures in Dec 2015 (https://www.youtube.com/watch?v=0814riKW25k&rel=0) and the reduction of bank lending/deposit rates and reserve requirements of banks by the People’s Bank of China on Oct 23, 2015. The dollar revalued 2.8 percent from Oct 21 to Oct 23, 2015, following the intended easing of the European Central Bank. The DJIA rose 2.8 percent from Oct 21 to Oct 23 and the DAX index of German equities rose 5.4 percent from Oct 21 to Oct 23, 2015.

Fri Oct 16

Mon 19

Tue 20

Wed 21

Thu 22

Fri 23

USD/ EUR

1.1350

0.1%

0.3%

1.1327

0.2%

1.1348

0.0%

-0.2%

1.1340

0.1%

1.1110

2.1%

2.0%

1.1018

2.9%

0.8%

DJIA

17215.97

0.8%

0.4%

17230.54

0.1%

17217.11

0.0%

-0.1%

17168.61

-0.3%

17489.16

1.6%

1.9%

17646.70

2.5%

0.9%

Dow Global

2421.58

0.3%

0.6%

2414.33

-0.3%

2411.03

-0.4%

-0.1%

2411.27

-0.4%

0.0%

2434.79

0.5%

1.0%

2458.13

1.5%

1.0%

DJ Asia Pacific

1402.31

1.1%

0.3%

1398.80

-0.3%

1395.06

-0.5%

-0.3%

1402.68

0.0%

0.5%

1396.03

-0.4%

-0.5%

1415.50

0.9%

1.4%

Nikkei 225

18291.80

-0.8%

1.1%

18131.23

-0.9%

18207.15

-0.5%

0.4%

18554.28

1.4%

1.9%

18435.87

0.8%

-0.6%

18825.30

2.9%

2.1%

Shanghai

3391.35

6.5%

1.6%

3386.70

-0.1%

3425.33

1.0%

1.1%

3320.68

-2.1%

-3.1%

3368.74

-0.7%

1.4%

3412.43

0.6%

1.3%

DAX

10104.43

0.1%

0.4%

10164.31

0.6%

10147.68

0.4%

-0.2%

10238.10

1.3%

0.9%

10491.97

3.8%

2.5%

10794.54

6.8%

2.9%

Ben Leubsdorf, writing on “Fed’s Yellen: December is “Live Possibility” for First Rate Increase,” on Nov 4, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/feds-yellen-december-is-live-possibility-for-first-rate-increase-1446654282) quotes Chair Yellen that a rate increase in “December would be a live possibility.” The remark of Chair Yellen was during a hearing on supervision and regulation before the Committee on Financial Services, US House of Representatives (http://www.federalreserve.gov/newsevents/testimony/yellen20151104a.htm) and a day before the release of the employment situation report for Oct 2015 (Section I). The dollar revalued 2.4 percent during the week. The euro has devalued 42.0 percent relative to the dollar from the high on Jul 15, 2008 to Aug 26, 2016.

Fri Oct 30

Mon 2

Tue 3

Wed 4

Thu 5

Fri 6

USD/ EUR

1.1007

0.1%

-0.3%

1.1016

-0.1%

1.0965

0.4%

0.5%

1.0867

1.3%

0.9%

1.0884

1.1%

-0.2%

1.0742

2.4%

1.3%

The release on Nov 18, 2015 of the minutes of the FOMC (Federal Open Market Committee) meeting held on Oct 28, 2015 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20151028.htm) states:

“Most participants anticipated that, based on their assessment of the current economic situation and their outlook for economic activity, the labor market, and inflation, these conditions [for interest rate increase] could well be met by the time of the next meeting. Nonetheless, they emphasized that the actual decision would depend on the implications for the medium-term economic outlook of the data received over the upcoming intermeeting period… It was noted that beginning the normalization process relatively soon would make it more likely that the policy trajectory after liftoff could be shallow.”

Markets could have interpreted a symbolic increase in the fed funds rate at the meeting of the FOMC on Dec 15-16, 2015 (http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm) followed by “shallow” increases, explaining the sharp increase in stock market values and appreciation of the dollar after the release of the minutes on Nov 18, 2015:

Fri Nov 13

Mon 16

Tue 17

Wed 18

Thu 19

Fri 20

USD/ EUR

1.0774

-0.3%

0.4%

1.0686

0.8%

1.0644

1.2%

0.4%

1.0660

1.1%

-0.2%

1.0735

0.4%

-0.7%

1.0647

1.2%

0.8%

DJIA

17245.24

-3.7%

-1.2%

17483.01

1.4%

17489.50

1.4%

0.0%

17737.16

2.9%

1.4%

17732.75

2.8%

0.0%

17823.81

3.4%

0.5%

DAX

10708.40

-2.5%

-0.7%

10713.23

0.0%

10971.04

2.5%

2.4%

10959.95

2.3%

-0.1%

11085.44

3.5%

1.1%

11119.83

3.8%

0.3%

In testimony before The Joint Economic Committee of Congress on Dec 3, 2015 (http://www.federalreserve.gov/newsevents/testimony/yellen20151203a.htm), Chair Yellen reiterated that the FOMC (Federal Open Market Committee) “anticipates that even after employment and inflation are near mandate-consistent levels, economic condition may, for some time, warrant keeping the target federal funds rate below the Committee views as normal in the longer run.” Todd Buell and Katy Burne, writing on “Draghi says ECB could step up stimulus efforts if necessary,” on Dec 4, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/draghi-says-ecb-could-step-up-stimulus-efforts-if-necessary-1449252934), analyze that the President of the European Central Bank (ECB), Mario Draghi, reassured financial markets that the ECB will increase stimulus if required to raise inflation the euro area to targets. The USD depreciated 3.1 percent on Thu Dec 3, 2015 after weaker than expected measures by the European Central Bank. DJIA fell 1.4 percent on Dec 3 and increased 2.1 percent on Dec 4. DAX fell 3.6 percent on Dec 3.

Fri Nov 27

Mon 30

Tue 1

Wed 2

Thu 3

Fri 4

USD/ EUR

1.0594

0.5%

0.2%

1.0565

0.3%

1.0634

-0.4%

-0.7%

1.0616

-0.2%

0.2%

1.0941

-3.3%

-3.1%

1.0885

-2.7%

0.5%

DJIA

17798.49

-0.1%

17719.92

-0.4%

17888.35

0.5%

1.0%

17729.68

-0.4%

-0.9%

17477.67

-1.8%

-1.4%

17847.63

0.3%

2.1%

DAX

11293.76

1.6%

-0.2%

11382.23

0.8%

11261.24

-0.3%

-1.1%

11190.02

-0.9%

-0.6%

10789.24

-4.5%

-3.6%

10752.10

-4.8%

-0.3%

At the press conference following the meeting of the FOMC on Dec 16, 2015, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20151216.pdf page 8):

“And we recognize that monetary policy operates with lags. We would like to be able to move in a prudent, and as we've emphasized, gradual manner. It's been a long time since the Federal Reserve has raised interest rates, and I think it's prudent to be able to watch what the impact is on financial conditions and spending in the economy and moving in a timely fashion enables us to do this.”

The implication of this statement is that the state of the art is not accurate in analyzing the effects of monetary policy on financial markets and economic activity. The US dollar appreciated and equities fluctuated:

Fri Dec 11

Mon 14

Tue 15

Wed 16

Thu 17

Fri 18

USD/ EUR

1.0991

-1.0%

-0.4%

1.0993

0.0%

1.0932

0.5%

0.6%

1.0913

0.7%

0.2%

1.0827

1.5%

0.8%

1.0868

1.1%

-0.4%

DJIA

17265.21

-3.3%

-1.8%

17368.50

0.6%

17524.91

1.5%

0.9%

17749.09

2.8%

1.3%

17495.84

1.3%

-1.4%

17128.55

-0.8%

-2.1%

DAX

10340.06

-3.8%

-2.4%

10139.34

-1.9%

10450.38

-1.1%

3.1%

10469.26

1.2%

0.2%

10738.12

3.8%

2.6%

10608.19

2.6%

-1.2%

On January 29, 2016, the Policy Board of the Bank of Japan introduced a new policy to attain the “price stability target of 2 percent at the earliest possible time” (https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf). The new framework consists of three dimensions: quantity, quality and interest rate. The interest rate dimension consists of rates paid to current accounts that financial institutions hold at the Bank of Japan of three tiers zero, positive and minus 0.1 percent. The quantitative dimension consists of increasing the monetary base at the annual rate of 80 trillion yen. The qualitative dimension consists of purchases by the Bank of Japan of Japanese government bonds (JGBs), exchange traded funds (ETFs) and Japan real estate investment trusts (J-REITS). The yen devalued sharply relative to the dollar and world equity markets soared after the new policy announced on Jan 29, 2016:

Fri 22

Mon 25

Tue 26

Wed 27

Thu 28

Fri 29

JPY/ USD

118.77

-1.5%

-0.9%

118.30

0.4%

118.42

0.3%

-0.1%

118.68

0.1%

-0.2%

118.82

0.0%

-0.1%

121.13

-2.0%

-1.9%

DJIA

16093.51

0.7%

1.3%

15885.22

-1.3%

16167.23

0.5%

1.8%

15944.46

-0.9%

-1.4%

16069.64

-0.1%

0.8%

16466.30

2.3%

2.5%

Nikkei

16958.53

-1.1%

5.9%

17110.91

0.9%

16708.90

-1.5%

-2.3%

17163.92

1.2%

2.7%

17041.45

0.5%

-0.7%

17518.30

3.3%

2.8%

Shanghai

2916.56

0.5%

1.3

2938.51

0.8%

2749.79

-5.7%

-6.4%

2735.56

-6.2%

-0.5%

2655.66

-8.9%

-2.9%

2737.60

-6.1%

3.1%

DAX

9764.88

2.3%

2.0%

9736.15

-0.3%

9822.75

0.6%

0.9%

9880.82

1.2%

0.6%

9639.59

-1.3%

-2.4%

9798.11

0.3%

1.6%

In testimony on the Semiannual Monetary Policy Report to the Congress on Feb 10-11, 2016, Chair Yellen (http://www.federalreserve.gov/newsevents/testimony/yellen20160210a.htm) states: “U.S. real gross domestic product is estimated to have increased about 1-3/4 percent in 2015. Over the course of the year, subdued foreign growth and the appreciation of the dollar restrained net exports. In the fourth quarter of last year, growth in the gross domestic product is reported to have slowed more sharply, to an annual rate of just 3/4 percent; again, growth was held back by weak net exports as well as by a negative contribution from inventory investment.”

Jon Hilsenrath, writing on “Yellen Says Fed Should Be Prepared to Use Negative Rates if Needed,” on Feb 11, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/yellen-reiterates-concerns-about-risks-to-economy-in-senate-testimony-1455203865), analyzes the statement of Chair Yellen in Congress that the FOMC (Federal Open Market Committee) is considering negative interest rates on bank reserves. The Wall Street Journal provides yields of two and ten-year sovereign bonds with negative interest rates on shorter maturities where central banks pay negative interest rates on excess bank reserves:

Sovereign Yields 2/12/16	Japan	Germany	USA
2 Year	-0.168	-0.498	0.694
10 Year	0.076	0.262	1.744

On Mar 10, 2016, the European Central Bank (ECB) announced (1) reduction of the refinancing rate by 5 basis points to 0.00 percent; decrease the marginal lending rate to 0.25 percent; reduction of the deposit facility rate to 0,40 percent; increase of the monthly purchase of assets to €80 billion; include nonbank corporate bonds in assets eligible for purchases; and new long-term refinancing operations (https://www.ecb.europa.eu/press/pr/date/2016/html/pr160310.en.html). The President of the ECB, Mario Draghi, stated in the press conference (https://www.ecb.europa.eu/press/pressconf/2016/html/is160310.en.html): “How low can we go? Let me say that rates will stay low, very low, for a long period of time, and well past the horizon of our purchases…We don’t anticipate that it will be necessary to reduce rates further. Of course, new facts can change the situation and the outlook.”

The dollar devalued relative to the euro and open stock markets traded lower after the announcement on Mar 10, 2016, but stocks rebounded on Mar 11:

Fri 4

Mon 7

Tue 8

Wed 9

Thu10

Fri 11

USD/ EUR

1.1006

-0.7%

-0.4%

1.1012

-0.1%

1.1013

-0.1%

0.0%

1.0999

0.1%

1.1182

-1.6%

-1.7%

1.1151

-1.3%

0.3%

DJIA

17006.77

2.2%

0.4%

17073.95

0.4%

16964.10

-0.3%

-0.6%

17000.36

0.0%

0.2%

16995.13

-0.1%

0.0%

17213.31

1.2%

1.3%

DAX

9824.17

3.3%

0.7%

9778.93

-0.5%

0.5%

9692.82

-1.3%

-0.9%

9723.09

-1.0%

0.3%

9498.15

-3.3%

-2.3%

9831.13

0.1%

3.5%

In the address to the Jackson Hole symposium on Aug 26, 2016, Chair Yellen states: “I believe the case for an increase in in federal funds rate has strengthened in recent months…And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course” (http://www.federalreserve.gov/newsevents/speech/yellen20160826a.htm). In a speech at the World Affairs Council of Philadelphia, on Jun 6, 2016 (http://www.federalreserve.gov/newsevents/speech/yellen20160606a.htm), Chair Yellen finds that “there is considerable uncertainty about the economic outlook.” There are fifteen references to this uncertainty in the text of 18 pages double-spaced. In the Semiannual Monetary Policy Report to the Congress on Jun 21, 2016, Chair Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20160621a.htm), “Of course, considerable uncertainty about the economic outlook remains.” Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. Is there a “science” or even “art” of central banking under this extreme uncertainty in which policy does not generate higher volatility of money, income, prices and values of financial assets?

Chart VIII-1, Fed Funds Rate and Yields of Ten-year Treasury Constant Maturity and Baa Seasoned Corporate Bond, Jan 2, 2001 to Aug 25, 2016

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	0.089	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
5/29/14	0.09	2.45	4.69
6/05/14	0.09	2.59	4.83
6/12/14	0.09	2.58	4.79
6/19/14	0.10	2.64	4.83
6/26/14	0.10	2.53	4.71
7/2/14	0.10	2.64	4.84
7/10/14	0.09	2.55	4.75
7/17/14	0.09	2.47	4.69
7/24/14	0.09	2.52	4.72
7/31/14	0.08	2.58	4.75
8/7/14	0.09	2.43	4.71
8/14/14	0.09	2.40	4.69
8/21/14	0.09	2.41	4.69
8/28/14	0.09	2.34	4.57
9/04/14	0.09	2.45	4.70
9/11/14	0.09	2.54	4.79
9/18/14	0.09	2.63	4.91
9/25/14	0.09	2.52	4.79
10/02/14	0.09	2.44	4.76
10/09/14	0.08	2.34	4.68
10/16/14	0.09	2.17	4.64
10/23/14	0.09	2.29	4.71
11/13/14	0.09	2.35	4.82
11/20/14	0.10	2.34	4.86
11/26/14	0.10	2.24	4.73
12/04/14	0.12	2.25	4.78
12/11/14	0.12	2.19	4.72
12/18/14	0.13	2.22	4.78
12/23/14	0.13	2.26	4.79
12/30/14	0.06	2.20	4.69
1/8/15	0.12	2.03	4.57
1/15/15	0.12	1.77	4.42
1/22/15	0.12	1.90	4.49
1/29/15	0.11	1.77	4.35
2/05/15	0.12	1.83	4.43
2/12/15	0.12	1.99	4.53
2/19/15	0.12	2.11	4.64
2/26/15	0.11	2.03	4.47
3/5/215	0.11	2.11	4.58
3/12/15	0.11	2.10	4.56
3/19/15	0.12	1.98	4.48
3/26/15	0.11	2.01	4.56
4/03/15	0.12	1.92	4.47
4/9/15	0.12	1.97	4.50
4/16/15	0.13	1.90	4.45
4/23/15	0.13	1.96	4.50
5/1/15	0.08	2.05	4.65
5/7/15	0.13	2.18	4.82
5/14/15	0.13	2.23	4.97
5/21/15	0.12	2.19	4.94
5/28/15	0.12	2.13	4.88
6/04/15	0.13	2.31	5.03
6/11/15	0.13	2.39	5.10
6/18/15	0.14	2.35	5.17
6/25/15	0.13	2.40	5.20
7/1/15	0.13	2.43	5.26
7/9/15	0.13	2.32	5.20
7/16/15	0.14	2.36	5.24
7/23/15	0.13	2.28	5.13
7/30/15	0.14	2.28	5.16
8/06/15	0.14	2.23	5.15
8/20/15	0.15	2.09	5.13
8/27/15	0.14	2.18	5.33
9/03/15	0.14	2.18	5.35
9/10/15	0.14	2.23	5.35
9/17/15	0.14	2.21	5.39
9/25/15	0.14	2.13	5.29
10/01/15	0.13	2.05	5.36
10/08/15	0.13	2.12	5.40
10/15/15	0.13	2.04	5.33
10/22/15	0.12	2.04	5.30
10/29/15	0.12	2.19	5.40
11/05/15	0.12	2.26	5.44
11/12/15	0.12	2.32	5.51
11/19/15	0.12	2.24	5.44
11/25/15	0.12	2.23	5.44
12/03/15	0.13	2.33	5.51
12/10/15	0.14	2.24	5.43
12/17/15	0.37	2.24	5.45
12/23/15	0.36	2.27	5.53
12/30/15	0.35	2.31	5.54
1/07/2016	0.36	2.16	5.44
01/14/16	0.36	2.10	5.46
01/20/16	0.37	2.01	5.41
01/29/16	0.38	2.00	5.48
02/04/16	0.38	1.87	5.40
02/11/16	0.38	1.63	5.26
02/18/16	0.38	1.75	5.37
02/25/16	0.37	1.71	5.27
03/03/16	0.37	1.83	5.30
03/10/16	0.36	1.93	5.23
03/17/16	0.37	1.91	5.11
03/24/16	0.37	1.91	4.97
03/31/16	0.25	1.78	4.90
04/07/16	0.37	1.70	4.76
04/14/16	0.37	1.80	4.79
04/21/16	0.37	1.88	4.79
04/28/16	0.37	1.84	4.73
05/05/16	0.37	1.76	4.62
05/12/16	0.37	1.75	4.66
05/19/16	0.37	1.85	4.70
05/26/16	0.37	1.83	4.69
06/02/16	0.37	1.81	4.64
06/09/16	0.37	1.68	4.53
06/16/16	0.38	1.57	4.47
06/23/16	0.39	1.74	4.60
06/30/16	0.36	1.49	4.41
07/07/16	0.40	1.40	4.19
07/14/16	0.40	1.53	4.23
07/21/16	0.40	1.57	4.25
07/28/16	0.40	1.52	4.20
08/04/16	0.40	1.51	4.27
08/11/16	0.40	1.57	4.27
08/18/16	0.40	1.53	4.23
08/25/16	0.40	1.58	4.21

Source: Board of Governors of the Federal Reserve System

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

Chart VIII-2 of the Board of Governors of the Federal Reserve System provides the rate of US dollars (USD) per euro (EUR), USD/EUR. The rate depreciated from USD 1.1200/EUR on Aug 19, 2015 to USD 1.1326/EUR on Aug 19, 2016 or 1.1 percent. The euro has devalued 42.0 percent relative to the dollar from the high on Jul 15, 2008 to Aug 26, 2016. US corporations with foreign transactions and net worth experience losses in their balance sheets in converting revenues from depreciated currencies to the dollar. Corporate profits with IVA and CCA decreased at $123.0 billion in IQ2015 and increased at $70.5 billion in IIQ2015. Corporate profits with IVA and CCA decreased at $33.1 billion in IIIQ2015. Corporate profits with IVA and CCA decreased at $17.0 billion in IIIQ2015. Corporate profits with IVA and CCA decreased at $127.9 billion in IVQ2015 and increased at $66.0 billion in IQ2016. Corporate profits with IVA and CCA fell at $24.1 billion in IIQ2016. Profits after tax with IVA and CCA decreased at $3.3 billion in IIIQ2015. Profits after tax with IVA and CCA fell at $172.7 billion in IVQ2015 and increased at $113.4 billion in IQ2016. Profits after tax with IVA and CCA fell at $36.3 billion in IIQ2016. There is increase in corporate profits from devaluing the dollar with unconventional monetary policy of zero interest rates and decrease of corporate profits in revaluing the dollar with attempts at “normalization” or increases in interest rates. Conflicts arise while other central banks differ in their adjustment process. The current account deficit seasonally adjusted increases from 2.3 percent of GDP in IVQ2014 to 2.7 percent in IQ2015. The current account deficit increases to 2.7 percent of GDP in IQ2015 and decreases to 2.5 percent of GDP in IIQ2015. The deficit increases to 2.9 percent of GDP in IIIQ2015, easing to 2.8 percent of GDP in IVQ2015. The net international investment position decreases from minus $7.0 trillion in IVQ2014 to minus $6.8 trillion in IQ2015, decreasing at minus $6.7 trillion in IIQ2015. The net international investment position increases to minus 7.3 trillion in IIIQ2015 and increases to minus $7.4 trillion in IVQ2015. The BEA explains as follows (http://www.bea.gov/newsreleases/international/intinv/2016/pdf/intinv415.pdf):

“The U.S. net international investment position at the end of the fourth quarter of 2015 was -$7,356.8 billion (preliminary) as the value of U.S. liabilities exceeded the value of U.S. assets (chart 1, table 1). At the end of the third quarter, the net investment position was -$7,311.6 billion (revised). The U.S. net international investment position was -$7,356.8 billion (preliminary) at the end of 2015 compared with -$7,019.7 billion at the end of 2014. The $337.1 billion decrease in the net position reflected a $1,387.3 billion decrease in the value of U.S. assets that exceeded a $1,050.2 billion decrease in the value of U.S. liabilities. The U.S. net international investment position decreased 4.8 percent from the end of 2014 to the end of 2015, compared with a 31.8 percent decrease from the end of 2013 to the end of 2014.”

The BEA explains further (http://www.bea.gov/newsreleases/international/intinv/2016/pdf/intinv415.pdf): “U.S. assets were $23,208.3 billion at the end of 2015 compared with $24,595.5 billion at the end of 2014. The $1,387.3 billion decrease reflected an $826.9 billion decrease in the value of financial derivatives, mostly in single-currency interest rate contracts, and a $560.4 billion decrease in the value of assets excluding financial derivatives. U.S. assets excluding financial derivatives were $20,810.6 billion at the end of 2015 compared with $21,371.0 billion at the end of 2014. The $560.4 billion decrease was mostly attributable to the depreciation of major foreign currencies against the U.S. dollar that lowered the value of U.S. assets in dollar terms. U.S. liabilities were $30,565.1 billion at the end of 2015 compared with $31,615.2 billion at the end of 2014. The $1,050.2 billion decrease reflected an $810.1 billion decrease in the value of financial derivatives, mostly in single-currency interest rate contracts, and a $240.0 billion decrease in the value of liabilities excluding financial derivatives. U.S. liabilities excluding financial derivatives were $28,224.5 billion at the end of 2015 compared with $28,464.6 billion at the end of 2014. The $240.0 billion decrease was mostly attributable to decreases in U.S. equity and bond prices that lowered the value of portfolio investment liabilities.”

Chart VIII-2, Exchange Rate of US Dollars (USD) per Euro (EUR), Aug 19, 2015 to Aug 19, 2016

Source: Board of Governors of the Federal Reserve System

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

Chart VIII-3 of the Board of Governors of the Federal Reserve System provides the yield of the 10-year Treasury constant maturity note from 1.87 percent on May 25, 2016 to 1.58 percent on Aug 25, 2016. There is turbulence in financial markets originating in a combination of intentions of normalizing or increasing US policy fed funds rate, quantitative easing in Europe and Japan and increasing perception of financial/economic risks.

Chart VIII-3, Yield of Ten-year Constant Maturity Treasury, May 25, 2016 to Aug 25, 2016

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 ¼ to ½ percent with gradual consideration of further rate increases (http://www.federalreserve.gov/newsevents/press/monetary/20160727a.htm): “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to 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 and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data” (emphasis added).

There is concern at the Federal Open Market Committee (FOMC) with the world economy and financial markets (http://www.federalreserve.gov/newsevents/press/monetary/20160127a.htm): “The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook” (emphasis added). This concern should include the effects on dollar revaluation of competitive easing by other central banks such as quantitative and qualitative easing with negative nominal interest rates (https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf).

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 Aug 25, 2016. Chart SA provides the yields of the 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. There is ongoing reshuffling of portfolios to hedge against geopolitical events and world/regional economic performance.

Chart S, US, Yield of Two-Year Treasury Constant Maturity, Mar 17, 2014 to Aug 25, 2016

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, 2014 to Aug 25, 2016

Source: Board of Governors of the Federal Reserve System

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

Chair Yellen states (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.”

Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart VI-1B for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart VI-1B cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s. The loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy. This interpretation is consistent with the case of the 24 emerging market economies analyzed by Reinhart and Rogoff (2010GTD, 4), concluding that “higher debt levels are associated with significantly higher levels of inflation in emerging markets. Median inflation more than doubles (from less than seven percent to 16 percent) as debt rises from the low (0 to 30 percent) range to above 90 percent. Fiscal dominance is a plausible interpretation of this pattern.”

The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:

“So, inflation is caused by ‘tightness’ and deflation by ‘slack’ in the economy. This is not just a cause and forecasting variable, it is the cause, because given ‘slack’ we apparently do not have to worry about inflation from other sources, notwithstanding the weak correlation of [Phillips circuits]. These statements [by the Fed] do mention ‘stable inflation expectations. How does the Fed know expectations are ‘stable’ and would not come unglued once people look at deficit numbers? As I read Fed statements, almost all confidence in ‘stable’ or ‘anchored’ expectations comes from the fact that we have experienced a long period of low inflation (adaptive expectations). All these analyses ignore the stagflation experience in the 1970s, in which inflation was high even with ‘slack’ markets and little ‘demand, and ‘expectations’ moved quickly. They ignore the experience of hyperinflations and currency collapses, which happen in economies well below potential.”

Yellen (2014Aug22) states that “Historically, slack has accounted for only a small portion of the fluctuations in inflation. Indeed, unusual aspects of the current recovery may have shifted the lead-lag relationship between a tightening labor market and rising inflation pressures in either direction.”

Chart VI-1B provides the tortuous Phillips Circuit of Brazil from 1963 to 1987. There were no reliable consumer price index and unemployment data in Brazil for that period. Chart VI-1B used the more reliable indicator of inflation, the wholesale price index, and idle capacity of manufacturing as a proxy of unemployment in large urban centers.

ChVI1-B, Brazil, Phillips Circuit, 1963-1987

Source:

©Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.

The minutes of the meeting of the Federal Open Market Committee (FOMC) on Sep 16-17, 2014, reveal concern with global economic conditions (http://www.federalreserve.gov/monetarypolicy/fomcminutes20140917.htm):

“Most viewed the risks to the outlook for economic activity and the labor market as broadly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.”

There is similar concern in the minutes of the meeting of the FOMC on Dec 16-17, 2014 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20141217.htm):

“In their discussion of the foreign economic outlook, participants noted that the implications of the drop in crude oil prices would differ across regions, especially if the price declines affected inflation expectations and financial markets; a few participants said that the effect on overseas employment and output as a whole was likely to be positive. While some participants had lowered their assessments of the prospects for global economic growth, several noted that the likelihood of further responses by policymakers abroad had increased. Several participants indicated that they expected slower economic growth abroad to negatively affect the U.S. economy, principally through lower net exports, but the net effect of lower oil prices on U.S. economic activity was anticipated to be positive.”

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 from May 2016 to Jul 2016, CPI inflation for all items seasonally adjusted was 1.6 percent in annual equivalent, obtained by calculating accumulated inflation from May 2016 to Jul 2016 and compounding for a full year. In the 12 months ending in Jul 2016, CPI inflation of all items not seasonally adjusted was 0.8 percent. Inflation in Jul 2016 not seasonally adjusted was 0.0 percent relative to Jun 2016, or 0.0 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: 2.2 percent in 12 months, 2.0 percent in annual equivalent May 2016-Jul 2016 and 0.1 percent in Jul 2016 or 1.2 percent in annual equivalent. 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 0.266 percent for one month, 0.327 percent for three months, 0.470 percent for six months, 0.612 percent for one year, 0.845 percent for two years, 0.962 percent for three years, 1.238 percent for five years, 1.502 percent for seven years, 1.633 percent for ten years and 2.290 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 Jan 2016 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 I-3, US, Consumer Price Index Percentage Changes 12 months NSA and Annual

	% RI	∆% 12 Months Jul 2016/Jul 2015 NSA	∆% Annual Equivalent May 2015 to Jul 2016 SA	∆% Jul 2016/Jun 2016 SA
CPI All Items	100.000	0.8	1.6	0.0
CPI ex Food and Energy	78.975	2.2	2.0	0.1

Source: US 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 Aug 26, 2016, Dec 31, 2013, May 1, 2013, Aug 26, 2015 and Aug 25, 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 1.62 percent on Aug 26, 2016, 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 1.62 percent would jump instantaneously from yield of 1.62 percent on Aug 26, 2016 to 4.79 percent as occurred on Aug 25, 2006 when the economy was closer to full employment. The price of the hypothetical bond issued with coupon of 1.62 percent would drop from 100 to 75.0443 after an instantaneous increase of the yield to 4.79 percent. The price loss would be 25.0 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

	8/26/16	12/31/13	5/01/13	8/26/15	8/25/06
1 M	0.28	0.00	0.03	0.03	5.17
3 M	0.34	0.01	0.06	0.06	5.11
6 M	0.47	0.07	0.08	0.20	5.16
1 Y	0.62	0.25	0.11	0.35	5.06
2 Y	0.84	0.56	0.20	0.67	4.86
3 Y	0.96	0.91	0.30	0.98	4.79
5 Y	1.23	1.43	0.65	1.49	4.76
7 Y	1.49	1.80	1.07	1.90	4.76
10 Y	1.62	3.04	1.66	2.18	4.79
20 Y	1.96	3.72	2.44	2.64	5.01
30 Y	2.29	3.96	2.83	2.94	4.93

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 3.43 percent on Aug 25, 2016, which is the last data point in Chart VI-13. The current decline of yields is encouraging a surge in mortgage applications that could be reversed in a new increase. 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 Aug 25, 2016

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 provides the Euro/Dollar (EUR/USD) 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 revalued to USD 1.1197 EUR on Aug 26, 2016 or by 6.1 percent {[(1.1197/1.192)-1]100 = -6.1%}. 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 6.6685/USD on Fri Aug 26, 2016, or by an additional 2.2 percent, for cumulative revaluation of 19.4 percent. The final row of Table VI-2 shows: revaluation of 0.2 percent in the week of Aug 5, 2016; change of 0.0 percent in the week of Aug 12, 2016; devaluation of 0.2 percent in the week of Aug 19, 2016; and devaluation of 0.2 percent in the week of Aug 26. 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	08/26/16
Rate	1.1423	1.5914	1.192	1.1197
CNY/USD	01/03 2000	07/21 2005	7/15 2008	08/26/16
Rate	8.2765	8.2765	6.8211	6.6685
Weekly Rates	08/05/2016	08/12/2016	08/19/2016	08/26/16
CNY/USD	6.6438	6.6408	6.6523	6.6685
∆% from Earlier Week*	0.2	0.0	-0.2	-0.2

*Negative sign is depreciation; positive sign is appreciation

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

Professor Edward P Lazear (2013Jan7), writing on “Chinese ‘currency manipulation’ is not the problem,” on Jan 7, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323320404578213203581231448.html), provides clear thought on the role of the yuan in trade between China and the United States and trade between China and Europe. There is conventional wisdom that Chinese exchange rate policy causes the loss of manufacturing jobs in the United States, which is shown by Lazear (2013Jan7) to be erroneous. The fact is that manipulation of the CNY/USD rate by China has only minor effects on US employment. Lazear (2013Jan7) shows that the movement of monthly exports of China to its major trading partners, United States and Europe, since 1995 cannot be explained by the fixing of the CNY/USD rate by China. The period is quite useful because it includes rapid growth before 2007, contraction until 2009 and weak subsequent expansion. Chart VI-1 of the Board of Governors of the Federal Reserve System provides the CNY/USD exchange rate from Jan 3, 1995 to Aug 19, 2016 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 6.6515/USD on Aug 19, 2016, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD by 19.4 percent by Aug 26, 2016 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. The final segment shows decline or revaluation with another upward move 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-Aug 19, 2016

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 Aug 19, 2016. 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 6.6515/USD on Aug 19, 2016. 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-Aug 19, 2016

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 finer details with the rate of Chinese Yuan (CNY) to the US Dollar (USD) from Oct 28, 2011 to Aug 19, 2016. There have been alternations of revaluation and devaluation. The initial data point is CNY 6.5370 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 1.4 percent. Another devaluation is from CNY 6.0402/USD on Jan 21, 2014 to CNY 6.6515/USD on Aug 19, 2016, or devaluation of 10.1 percent. The United States Treasury estimates US government debt held by private investors at $10,970 billion in Mar 2016. China’s holding of US Treasury securities represent 11.3 percent of US government marketable interest-bearing debt held by private investors (http://www.fms.treas.gov/bulletin/index.html). Min Zeng, writing on “China plays a big role as US Treasury yields fall,” on Jul 16, 2004, published in the Wall Street Journal (http://online.wsj.com/articles/china-plays-a-big-role-as-u-s-treasury-yields-fall-1405545034?tesla=y&mg=reno64-wsj), finds that acceleration in purchases of US Treasury securities by China has been an important factor in the decline of Treasury yields in 2014. Japan decreased its holdings from $1197.1 billion in Jun 2015 to $1147.7 billion in Jun 2016 or 4.1 percent. The combined holdings of China and Japan in Jun 2016 add to $2388.5 billion, which is equivalent to 21.8 percent of US government marketable interest-bearing securities held by investors of $10,970 billion in Mar 2016 (http://www.fms.treas.gov/bulletin/index.html). Total foreign holdings of Treasury securities increased from $6163.1 billion in Jun 2015 to $6281.0 billion in Jun 2016, or 1.9 percent. The US continues to finance its fiscal and balance of payments deficits with foreign savings (see Pelaez and Pelaez, The Global Recession Risk (2007)). A point of saturation of holdings of US Treasury debt may be reached as foreign holders evaluate the threat of reduction of principal by dollar devaluation and reduction of prices by increases in yield, including possibly risk premium. Shultz et al (2012) find that the Fed financed three-quarters of the US deficit in fiscal year 2011, with foreign governments financing significant part of the remainder of the US deficit while the Fed owns one in six dollars of US national debt. Concentrations of debt in few holders are perilous because of sudden exodus in fear of devaluation and yield increases and the limit of refinancing old debt and placing new debt. In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):

“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”

Chart VI-1B, Chinese Yuan (CNY) per US Dollar (US), Business Days, Oct 28, 2011-Aug 19, 2016

Source: Board of Governors of the Federal Reserve System

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

There are major ongoing and unresolved realignments of exchange rates in the international financial system as countries and regions seek parities that can optimize their productive structures. Seeking exchange rate parity or exchange rate optimizing internal economic activities is complex in a world of unconventional monetary policy of zero interest rates and even negative nominal interest rates of government obligations such as negative yields for the two-year government bond of Germany. Regulation, trade and devaluation conflicts should have been expected from a global recession (Pelaez and Pelaez (2007), The Global Recession Risk, Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008a)): “There are significant grounds for concern on the basis of this experience. International economic cooperation and the international financial framework can collapse during extreme events. It is unlikely that there will be a repetition of the disaster of the Great Depression. However, a milder contraction can trigger regulatory, trade and exchange wars” (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 181). Chart VI-2 of the Board of Governors of the Federal Reserve System provides the key exchange rate of US dollars (USD) per euro (EUR) from Jan 4, 1999 to Aug 19, 2016. US recession dates are in shaded areas. The rate on Jan 4, 1999 was USD 1.1812/EUR, declining to USD 0.8279/EUR on Oct 25, 2000, or appreciation of the USD by 29.9 percent. The rate depreciated 21.9 percent to USD 1.0098/EUR on Jul 22, 2002. There was sharp devaluation of the USD of 34.9 percent to USD 1.3625/EUR on Dec 27, 2004 largely because of the 1 percent interest rate between Jun 2003 and Jun 2004 together with a form of quantitative easing by suspension of auctions of the 30-year Treasury, which was equivalent to withdrawing supply from markets. Another depreciation of 17.5 percent took the rate to USD 1.6010/EUR on Apr 22, 2008, already inside the shaded area of the global recession. The flight to the USD and obligations of the US Treasury appreciated the dollar by 22.3 percent to USD 1.2446/EUR on Oct 27, 2008. In the return of the carry trade after stress tests showed sound US bank balance sheets, the rate depreciated 21.2 percent to USD 1.5085/EUR on Nov 25, 2009. The sovereign debt crisis of Europe in the spring of 2010 caused sharp appreciation of 20.7 percent to USD 1.1959/EUR on Jun 6, 2010. Renewed risk appetite depreciated the rate 24.4 percent to USD 1.4875/EUR on May 3, 2011. The rate appreciated 5.3 percent to USD 1.1326/EUR on Aug 19, 2016, which is the last point in Chart VI-2. 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-2, US Dollars (USD) per Euro (EUR), Jan 4, 1999 to Aug 19, 2016

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-3 provides three indexes of the US Dollars (USD) from Jan 4, 1995 to Aug 19, 2016.

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 Jul 7, 2016. Chart VI-3B 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 5, 2001 to Aug 25, 2016. 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:

“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-3 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.

Chart VI-3, US Dollar Currency Indexes, Jan 4, 1995-Aug 19, 2016

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 Jul 7, 2016

Source: Board of Governors of the Federal Reserve System

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

Chart VI-3B provides the yield of the Treasury three-month and the ten-year constant maturity, the fed funds rate and the yield of the Moody’s Baa bond from Jan 5, 2001 to Aug 25, 2016. The final data point is for Aug 25, 2016 with the fed funds rate at 0.40 percent, the three-month constant maturity Treasury at 0.33 percent, the ten-year constant maturity Treasury at 1.58 percent and the Baa bond at 4.21 percent.

Chart VI-3B, 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 5, 2001 to Aug 25, 2016

Source: Board of Governors of the Federal Reserve System

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

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 Aug 19, 2016. 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 is MXN 18.2525/USD on Aug 19, 2016.

Chart VI-4A, Mexican Peso (MXN) per US Dollar (USD), Nov 8, 1993 to Aug 19, 2016

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 Aug 19, 2016. 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 67.1300/USD on Aug 19, 2016.

Chart VI-4B, Indian Rupee (INR) per US Dollar (USD), Jan 2, 1973 to Aug 19, 2016

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-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 100.2400/USD on Aug 19, 2016 for appreciation of 19.2 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-Aug 19, 2016

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

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

The causes of the financial crisis and global recession were 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 3.2219/USD on Aug 19, 2016. 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 3.2219/USD on Aug 19, 2016 for depreciation of 109.6 percent. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-6, Brazilian Real (BRL) per US Dollar (USD) Jan 4, 1999 to Aug 19, 2016

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 on Sep 21, 2001 relative to Mar 3, 1999.

Chart VI-7, Brazilian Real (BRL) per US Dollar (USD), Jan 2, 1995 to Aug 19, 2016

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).

Focus is shifting from 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. Markets overreacted to the so-called “paring” of outright purchases to $15 billion of securities per month for the balance sheet of the Fed.

In the Semiannual Monetary Policy Report to Congress on Feb 24, 2015, Chair Yellen analyzes the timing of interest rate increases (http://www.federalreserve.gov/newsevents/testimony/yellen20150224a.htm):

“The FOMC's assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee's judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting. Provided that labor market conditions continue to improve and further improvement is expected, the Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when, on the basis of incoming data, the Committee is reasonably confident that inflation will move back over the medium term toward our 2 percent objective.”

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.”

At the press conference following the meeting on Dec 17, 2014, Chair Yellen answered a question by Jon Hilseranth of the Wall Street Journal explaining “patience” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20141217.pdf):

“So I did say that this statement that the committee can be patient should be interpreted as meaning that it is unlikely to begin the normalization process, for at least the next couple of meetings. Now that doesn't point to any preset or predetermined time at which normalization is -- will begin. There are a range of views on the committee, and it will be dependent on how incoming data bears on the progress, the economy is making. First of all, I want to emphasize that no meeting is completely off the table in the sense that if we do see faster progress toward our objectives than we currently expect, then it is possible that the process of normalization would occur sooner than we now anticipated. And of course the converse is also true. So at this point, we think it unlikely that it will be appropriate, that we will see conditions for at least the next couple of meetings that will make it appropriate for us to decide to begin normalization. A number of committee participants have indicated that in their view, conditions could be appropriate by the middle of next year. But there is no preset time.”

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.

Yellen (2014Aug22) provides comprehensive review of the theory and measurement of labor markets. 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”

Yellen (2014Aug22) finds that the unemployment rate is not sufficient in determining slack:

“One convenient way to summarize the information contained in a large number of indicators is through the use of so-called factor models. Following this methodology, Federal Reserve Board staff developed a labor market conditions index from 19 labor market indicators, including four I just discussed. This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.”

Yellen (2014Aug22) restates that the FOMC determines monetary policy on newly available information and interpretation of labor markets and inflation and does not follow a preset path:

“But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter. Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate. As I have noted many times, monetary policy is not on a preset path. The Committee will be closely monitoring incoming information on the labor market and inflation in determining the appropriate stance of monetary policy.”

There is similar concern in the minutes of the meeting of the FOMC on Dec 16-17, 2014 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20141217.htm):

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.”

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/2016/08/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/oscillating-valuations-of-risk.html). This is merely another case of theory without reality with dubious policy proposals. The current reality is cyclical slow growth.

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 http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html). 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. A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2016/01/unconventional-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2015/01/peaking-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2014/01/theory-and-reality-of-secular.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 18,395.40 on Aug 26, 2016, which is higher by 29.9 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 29.6 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial assets have been approaching or exceeding historical highs.

Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):

So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly” (emphasis added).

In a speech at the IMF on Jul 2, 2014, Chair Yellen analyzed the link between monetary policy and financial risks (http://www.federalreserve.gov/newsevents/speech/yellen20140702a.htm):

“Monetary policy has powerful effects on risk taking. Indeed, the accommodative policy stance of recent years has supported the recovery, in part, by providing increased incentives for households and businesses to take on the risk of potentially productive investments. But such risk-taking can go too far, thereby contributing to fragility in the financial system. This possibility does not obviate the need for monetary policy to focus primarily on price stability and full employment--the costs to society in terms of deviations from price stability and full employment that would arise would likely be significant. In the private sector, key vulnerabilities included high levels of leverage, excessive dependence on unstable short-term funding, weak underwriting of loans, deficiencies in risk measurement and risk management, and the use of exotic financial instruments that redistributed risk in nontransparent ways.”

Yellen (2014Jul14) warned again at the Committee on Banking, Housing and Urban Affairs on Jul 15, 2014:

“The Committee recognizes that low interest rates may provide incentives for some investors to “reach for yield,” and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance. More broadly, the financial sector has continued to become more resilient, as banks have continued to boost their capital and liquidity positions, and growth in wholesale short-term funding in financial markets has been modest” (emphasis added).

Greenspan (1996) made similar warnings:

“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy” (emphasis added).

Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. What is the success in evaluating deviations of valuations of risk financial assets from “historical norms”? What are the consequences on economic activity and employment of deviations of valuations of risk financial assets from those “historical norms”? What are the policy tools and their effectiveness in returning valuations of risk financial assets to their “historical norms”?

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. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.

The Communiqué of the Istanbul meeting of G20 Finance Ministers and Central Bank Governors on February 10, 2015, sanctions the need of unconventional monetary policy with warning on collateral effects (http://www.g20.utoronto.ca/2015/150210-finance.html):

“We agree that consistent with central banks' mandates, current economic conditions require accommodative monetary policies in some economies. In this regard, we welcome that central banks take appropriate monetary policy action. The recent policy decision by the ECB aims at fulfilling its price stability mandate, and will further support the recovery in the euro area. We also note that some advanced economies with stronger growth prospects are moving closer to conditions that would allow for policy normalization. In an environment of diverging monetary policy settings and rising financial market volatility, policy settings should be carefully calibrated and clearly communicated to minimize negative spillovers.”

Professor Raguram G Rajan, governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation. Rajan (2005) anticipated the risks of the world financial crisis. Professor John B. Taylor (2014Jul15, 2014Jun26) building on advanced research (Taylor (1993, 1998LB, 1999, 1998LB, 1999, 2007JH, 2008Nov, 2009, 2012JMCB, 2014Jan3) finds that a monetary policy rule would function best in promoting an environment of low inflation and strong economic growth with stability of financial markets. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html).

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. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). The DJIA has increased 89.9 percent since the trough of the sovereign debt crisis in Europe on Jul 16, 2010 to Aug 26, 2016; S&P 500 has gained 112.1 percent and DAX 86.7 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 8/26/16” 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 28.8 percent above the trough. Japan’s Nikkei Average is 85.4 percent above the trough. DJ Asia Pacific TSM is 26.3 percent above the trough. Dow Global is 44.0 percent above the trough. STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 24.6 percent above the trough. NYSE Financial Index is 47.1 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 86.7 percent above the trough. Japan’s Nikkei Average is 85.4 percent above the trough on Aug 31, 2010 and 43.5 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 16,360.71 on Aug 26, 2016 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 59.5 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 appreciated 6.1 percent relative to the euro. The dollar devalued before the new bout of sovereign risk issues in Europe. The column “∆% week to 8/26/16” in Table VI-4 shows

decrease of 1.2 percent in the week for China’s Shanghai Composite. The Nikkei decreased 1.1 percent. DJ Asia Pacific decreased 1.3 percent. NYSE Financial increased 0.5 percent in the week. Dow Global decreased 0.1 percent in the week of Aug 26, 2016. The DJIA decreased 0.8 percent and S&P 500 decreased 0.7 percent. DAX of Germany increased 0.4 percent. STOXX 50 increased 0.8 percent. The USD appreciated 1.1 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 8/26/16” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Aug 26, 2016. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 8/26/16” but also relative to the peak in column “∆% Peak to 8/26/16.” There are now several equity indexes above the peak in Table VI-4: DJIA 64.2 percent, S&P 500 78.2 percent, DAX 67.2 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 17.2 percent, Dow Global 17.5 percent, and Nikkei Average 43.5 percent. Shanghai Composite is 3.0 percent below the peak; STOXX 50 is 5.5 percent above the peak; and DJ Asia Pacific TSM is 10.6 percent above the peak. The Shanghai Composite increased 55.5 percent from March 12, 2014, to Aug 26, 2016. The US dollar strengthened 26.0 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. Sharp and continuing strengthening of the dollar is affecting balance sheets of US corporations with foreign operations (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318). The Federal Open Market Committee (FOMC) is following “financial and international developments” as part of the process of framing interest rate policy (http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm). Kate Linebaugh, writing on “Corporate profits set to shrink for fourth consecutive quarter,” on Jul 17, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/corporate-profits-set-to-shrink-for-fourth-consecutive-quarter-1468799278), quotes forecasts of Thomson Reuters of 4.7 decline of adjusted earnings per share in the S&P 500 index in IIQ2016 relative to a year earlier. That would be the fourth consecutive quarterly decline. Theo Francis and Kate Linebaugh, writing on “US corporate profits on pace for third straight decline,” on Apr 28, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/u-s-corporate-profits-on-pace-for-third-straight-decline-1461872242), analyze three consecutive quarters of decline of corporate earnings and revenue in companies in S&P 500. They quote Thomson Reuters on expected decline of earnings of 6.1 percent in IQ2016 based on 55 percent of reporting companies. Weakness of economic activity shows in decline of revenues in IQ2016 of 1.4 percent, increasing 1.7 percent excluding energy, and contraction of profits of 0.5 percent. Justin Lahart, writing on “S&P 500 Earnings: far worse than advertised,” on Feb 24, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/s-p-500-earnings-far-worse-than-advertised-1456344483), analyzes S&P 500 earnings in 2015. Under data provided by companies, earnings increased 0.4 percent in 2015 relative to 2014 but under GAAP (Generally Accepted Accounting Principles), earnings fell 12.7 percent, which is the worst decrease since 2008. Theo Francis e Kate Linebaugh, writing on Oct 25, 2015, on “US Companies Warn of Slowing Economy, published in the Wall Street Journal (http://www.wsj.com/articles/u-s-companies-warn-of-slowing-economy-1445818298) analyze the first contraction of earnings and revenue of big US companies. Production, sales and employment are slowing in a large variety of companies with some contracting. Corporate profits also suffer from revaluation of the dollar that constrains translation of foreign profits into dollar balance sheets. Francis and Linebaugh quote Thomson Reuters that analysts expect decline of earnings per share of 2.8 percent in IIIQ2015 relative to IIIQ2014 based on reports by one third of companies in the S&P 500. Sales would decline 4.0% in a third quarter for the first joint decline of earnings per share and revenue in the same quarter since IIIQ2009. Dollar revaluation also constrains corporate results.

Inyoung Hwang, writing on “Fed optimism spurs record bets against stock volatility,” on Aug 21, 2014, published in Bloomberg.com (http://www.bloomberg.com/news/2014-08-21/fed-optimism-spurs-record-bets-against-stock-voalitlity.html), informs that the S&P 500 is trading at 16.6 times estimated earnings, which is higher than the five-year average of 14.3 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) for 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. Future company cash flows derive from investment projects. In IQ1980, real gross private domestic investment in the US was $951.6 billion of chained 2009 dollars, growing to $1,257.7 billion in IVQ1989 or 32.2 percent. Real gross private domestic investment in the US increased 6.3 percent from $2605.2 billion in IVQ2007 to $2,769.9 billion in IIQ2016. Real private fixed investment increased 7.1 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,769.0 billion in IIQ2016. Private fixed investment fell relative to IVQ2007 in all quarters preceding IIQ2014 and fell 0.6 percent in IIQ2016. Growth of real private investment is mediocre for all but four quarters from IIQ2011 to IQ2012. The investment decision of United States corporations is fractured in the current economic cycle in preference of cash.

There are three aspects. First, there is decrease in corporate profits. Corporate profits with IVA and CCA decreased at $17.0 billion in IIIQ2015. Corporate profits with IVA and CCA decreased at $127.9 billion in IVQ2015 and increased at $66.0 billion in IQ2016. Corporate profits with IVA and CCA fell at $24.1 billion in IIQ2016. Profits after tax with IVA and CCA decreased at $3.3 billion in IIIQ2015. Profits after tax with IVA and CCA fell at $172.7 billion in IVQ2015 and increased at $113.4 billion in IQ2016. Profits after tax with IVA and CCA fell at $36.3 billion in IIQ2016. Net dividends increased at $13.8 billion in IIIQ2015. Net dividends fell at $20.8 billion in IVQ2015 and increased at $7.3 billion in IQ2016. Net dividends fell at $8.2 billion in IIQ2016. Undistributed profits with IVA and CCA decreased at $17.0 billion in IIIQ2015. Undistributed corporate profits with IVA and CCA fell at $152.0 billion in IVQ2015 and increased at $106.1 billion in IQ2016. Undistributed corporate profits fell at $28.1 billion in IIQ2016. . Undistributed corporate profits swelled 159.0 percent from $107.7 billion in IQ2007 to $278.9 billion in IIQ2016 and changed signs from minus $55.9 billion in current dollars in IVQ2007. 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. Second, sharp and continuing strengthening of the dollar is affecting balance sheets of US corporations with foreign operations (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318) and the overall US economy. The bottom part of Table IA1-9 provides the breakdown of corporate profits with IVA and CCA in domestic industries and the rest of the world. Corporate profits with IVA and CCA fell at $127.9 billion in IVQ2015 with decrease of domestic industries at $149.8 billion, mostly because of decrease of nonfinancial business at $131.7 billion, and increase of profits from operations in the rest of the world at $22.0 billion. Receipts from the rest of the world fell at $19.9 billion. Corporate profits with IVA and CCA increased at $66.0 billion in IQ2016 with increase of domestic industries at $92.9 billion. Profits from operations from the rest of the world fell at $26.9 billion and payments to the rest of the world increased at $35.6 billion. Corporate profits with IVA and CCA decreased at $24.1 billion in IIQ2016. Profits from domestic industries fell at $51.0 billion and profits from nonfinancial business fell at $58.2 billion. Profits from the rest of the world increased at $26.9 billion. Total corporate profits with IVA and CCA were $2009.4 billion in IIQ2016 of which $1612.9 billion from domestic industries, or 80.3 percent of the total, and $396.5 billion, or 19.7 percent, from the rest of the world. Nonfinancial corporate profits of $1232.7 billion account for 61.3 percent of the total. Third, there is reduction in the use of corporate cash for investment. Vipal Monga, David Benoit and Theo Francis, writing on “Companies send more cash back to shareholders,” published on May 26, 2015 in the Wall Street Journal (http://www.wsj.com/articles/companies-send-more-cash-back-to-shareholders-1432693805?tesla=y), use data of a study by Capital IQ conducted for the Wall Street Journal. This study shows that companies in the S&P 500 reduced investment in plant and equipment to median 29 percent of operating cash flow in 2013 from 33 percent in 2003 while increasing dividends and buybacks to median 36 percent in 2013 from 18 percent in 2003. 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 8/26/ /16	∆% Week 8/26/16	∆% Trough to 8/26/ 16
DJIA	4/26/ 10	7/2/10	-13.6	64.2	-0.8	89.9
S&P 500	4/23/ 10	7/20/ 10	-16.0	78.2	-0.7	112.1
NYSE Finance	4/15/ 10	7/2/10	-20.3	17.2	0.5	47.1
Dow Global	4/15/ 10	7/2/10	-18.4	17.5	-0.1	44.0
Asia Pacific	4/15/ 10	7/2/10	-12.5	10.6	-1.3	26.3
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	43.5	-1.1	85.4
China Shang.	4/15/ 10	7/02 /10	-24.7	-3.0	-1.2	28.8
STOXX 50	4/15/10	7/2/10	-15.3	5.5	0.8	24.6
DAX	4/26/ 10	5/25/ 10	-10.5	67.2	0.4	86.7
Dollar Euro	11/25 2009	6/7 2010	21.2	26.0	1.1	6.1
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	NA	NA	NA
10-Year T Note	4/5/ 10	4/6/10	3.986	2.784	1.635

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 Valuations of Risk Financial Assets. The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.1326/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Aug 19, appreciating to USD 1.1320/EUR on Mon Aug 22, 2016, or by 0.1 percent. The dollar appreciated because fewer dollars, 1.1320, were required on Mon Aug 22 to buy one euro than $1.1326 on Fri Aug 19. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.1326/EUR on Aug 19. The second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Aug 19, to the last business day of the current week, in this case Aug 26, such as appreciation of 1.1 percent to USD 1.1197/EUR by Aug 26. The third row provides the percentage change from the prior business day to the current business day. For example, the USD appreciated (denoted by positive sign) by 1.1 percent from the rate of USD 1.1326/EUR on Fri Aug 19 to the rate of USD 1.1197/EUR on Aug 26 {[(1.1197/1.1326) - 1]100 = -1.1%}. The dollar appreciated (denoted by positive sign) by 0.8 percent from the rate of USD 1.1286 on

Thu Aug 25 to USD 1.1197/EUR on Fri Aug 26 {[(1.1197/1.1286) -1]100 = -0.8%}. Other factors constant, increasing risk aversion causes appreciation of the dollar relative to the euro, with rising uncertainty on European and global sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from higher yielding risk assets to the safety of dollar-denominated assets.

There is mixed performance in equity indexes with several indexes in Table III-1 decreasing in the week ending on Aug 26, 2016, after wide swings caused by reallocations of investment portfolios worldwide. Stagnating revenues, corporate cash hoarding, effects of currency oscillations on corporate earnings and declining investment are causing reevaluation of discounted net earnings with deteriorating views on the world economy and United States fiscal sustainability but investors have been driving indexes higher. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). DJIA decreased 0.3 percent on Aug 26, decreasing 0.8 percent in the week. Germany’s DAX increased 0.6 percent on Aug 26 and increased 0.4 percent in the week. Dow Global increased 0.1 percent on Aug 26 and decreased 0.1 percent in the week. Japan’s Nikkei Average decreased 1.2 percent on Aug 26 and decreased 1.1 percent in the week as the yen continues oscillating but relatively weaker and the stock market gains in expectations of success of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Dow Asia Pacific TSM decreased 1.2 percent on Aug 26 and decreased 1.3 percent in the week. Shanghai Composite that decreased 1.0 percent on Mar 8 and decreased 1.7 percent in the week of Mar 8, falling below 2000 at 1974.38 on Mar 12, 2014 but closing at 3070.31 on Aug 26, 2016, for increase of 0.1 percent and decreasing 1.2 percent in the week. The Shanghai Composite increased 55.5 percent from March 12, 2014 to Aug 26, 2016. There is deceleration with oscillations of the world economy that could affect corporate revenue and equity valuations, causing fluctuations in equity markets with increases during favorable risk appetite. The global hunt for yield induced by central bank policy rates of near zero percent motivates wide portfolio reshufflings among classes of risk financial assets.

Commodities were mixed in the week of Aug 26, 2016. Table III-1 shows that WTI decreased 1.8 percent in the week of Aug 26 while Brent decreased 1.9 percent in the week with turmoil in oil producing regions but lack of action by OPEC. Gold increased 0.1 percent on Aug 26 and decreased 1.4 percent in the week.

Table III-I, Weekly Financial Risk Assets Aug 22 to Aug 26, 2016

Fri 19

Mon 22

Tue 23

Wed 24

Thu 25

Fri 26

USD/ EUR

1.1326

-1.5%

0.2%

1.1320

0.1%

1.1307

0.2%

0.1%

1.1266

0.5%

0.4%

1.1286

0.4%

-0.2%

1.1197

1.1%

0.8%

JPY/ USD

100.21

1.1%

-0.3%

100.33

-0.1%

100.24

0.0%

0.1%

100.45

-0.2%

100.53

-0.3%

-0.1%

101.83

-1.6%

-1.3%

CHF/ USD

0.9607

1.4%

-0.7%

0.9622

-0.2%

0.9634

-0.3%

-0.1%

0.9669

-0.6%

-0.4%

0.9678

-0.7%

-0.1%

0.9782

-1.8%

-1.1%

CHF/ EUR

1.0880

0.0%

-0.4%

1.0892

-0.1%

1.0893

-0.1%

0.0%

1.0893

-0.1%

0.0%

1.0922

-0.4%

-0.3%

1.0952

-0.7%

-0.3%

USD/ AUD

0.7626

1.3113

-0.3%

-0.8%

0.7626

1.3113

0.0%

0.7616

1.3130

-0.1%

0.7613

1.3135

-0.2%

0.0%

0.7618

1.3127

-0.1%

0.1%

0.7563

1.3222

-0.8%

-0.7%

10Y Note

1.580

1.538

1.553

1.556

1.576

1.635

2Y Note

0.742

0.750

0.762

0.785

0.845

German Bond

2Y -0.61 10Y -0.03

2Y -0.62 10Y -0.09

2Y -0.63 10Y -0.07

2Y -0.61 10Y -0.07

DJIA

18552.57

-0.1%

-0.2%

18529.42

-0.1%

18547.30

0.0%

0.1%

18481.48

-0.4%

18448.41

-0.6%

-0.2%

18395.40

-0.8%

-0.3%

Dow Global

2455.47

0.4%

-0.2%

2456.20

0.0%

2467.44

0.5%

2458.57

0.1%

-0.4%

2450.62

-0.2%

-0.3%

2452.13

-0.1%

0.1%

DJ Asia Pacific

1465.60

-0.7%

-0.2%

1464.43

-0.1%

1466.13

0.0%

0.1%

1463.72

-0.1%

-0.2%

1463.60

-0.1%

0.0%

1446.33

-1.3%

-1.2%

Nikkei

16545.82

-2.2%

0.4%

16598.19

0.3%

16497.36

-0.3%

-0.6%

16597.30

0.3%

0.6%

16555.95

0.1%

-0.2%

16360.71

-1.1%

-1.2%

Shanghai

3108.10

1.9%

0.1%

3084.81

-0.7%

3089.71

-0.6%

0.2%

3085.88

-0.7%

-0.1%

3068.33

-1.3%

-0.6%

3070.31

-1.2%

0.1%

DAX

10544.36

-1.6%

-0.6%

10494.35

-0.5%

10592.88

0.5%

0.9%

10622.97

0.7%

0.3%

10529.59

-0.1%

-0.9%

10587.77

0.4%

0.6%

DJ UBS Comm.

WTI $/B

48.52

9.1%

0.6%

47.05

-3.0%

48.10

-0.9%

2.2%

46.77

-3.6%

-2.8%

47.33

-2.5%

1.2%

47.64

-1.8%

0.7%

Brent $/B

50.88

8.3%

0.0%

49.16

-3.4%

49.96

-1.8%

1.6%

49.05

-3.6%

-1.8%

49.67

-2.4%

1.3%

49.92

-1.9%

0.5%

44Gold $/OZ

1340.4

0.3%

-0.8%

1337.7

-0.2%

1340.6

0.0%

0.2%

1324.4

-1.2%

1320.1

-1.5%

-0.3%

1321.5

-1.4%

0.1%

Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss

Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce

Sources: http://www.bloomberg.com/markets/

http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

The euro has devalued 42.0 percent relative to the dollar from the high on Jul 15, 2008 to Aug 26, 2016. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). The British pound (GBP) devalued 5.7 percent from the trough of ₤1.388 on Jan 2, 2009 to ₤1.3136 on Aug 26, 2016 and devalued 52.7 percent from the high of ₤2.006 on Sep 15, 2008. Such similar event actually occurred in the week of Sep 23, 2011 reversing the devaluation of the dollar in the form of sharp appreciation of the dollar relative to other currencies from all over the world including the offshore Chinese yuan market. The Bank of England reduced the Bank Rate to 0.25 percent on Aug 4, 2016, and announced new measures of quantitative easing (http://www.bankofengland.co.uk/publications/Pages/news/2016/008.aspx).

Table VI-6, Exchange Rates

	Peak	Trough	∆% P/T	Aug 26, 2016	∆% T Aug 26, 2016	∆% P Aug 26, 2016
EUR USD	7/15 2008	6/7 2010		8/26/ 2016
Rate	1.59	1.192		1.1197
∆%			-33.4		-6.5	-42.0
USD GBP	7/15 2008	1/2/ 2009		8/26/ 2016
Rate	2.006	1.388		1.3136
∆%			-44.5		-5.7	-52.7

ESIII Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.1 percent on average in the cyclical expansion in the 28 quarters from IIIQ2009 to IIQ2016. 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 second estimate of GDP for IIQ2016 (http://www.bea.gov/newsreleases/national/gdp/2016/pdf/gdp2q16_2nd.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2016/07/business-fixed-investment-has-been-soft.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/financial-asset-values-rebound-from.html). 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, 5.0 percent from IQ1983 to IVQ1987, 4.9 percent from IQ1983 to IIQ1988, 4.8 percent from IQ1983 to IIIQ1988, 4.8 percent from IQ1983 to IVQ1988, 4.8 percent from IQ1983 to IQ1989, 4.7 percent from IQ1983 to IIQ1989, 4.7 percent from IQ1983 to IIIQ1989, 4.5 percent from IQ1983 to IVQ1989 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2016/07/business-fixed-investment-has-been-soft.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/financial-asset-values-rebound-from.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2016 would have accumulated to 28.6 percent. GDP in IIQ2016 would be $19,279.5 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2709.3 billion than actual $16,570.2 billion. There are about two trillion dollars of GDP less than at trend, explaining the 23.6 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.0 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2016/08/global-competitive-easing-or.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/fluctuating-valuations-of-risk.html). US GDP in IIQ2016 is 14.1 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,570.2 billion in IIQ2016 or 10.5 percent at the average annual equivalent rate of 1.2 percent. Professor John H. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. Cochrane (2016May02) measures GDP growth in the US at average 3.5 percent per year from 1950 to 2000 and only at 1.76 percent per year from 2000 to 2015 with only at 2.0 percent annual equivalent in the current expansion. Cochrane (2016May02) proposes drastic changes in regulation and legal obstacles to private economic activity. 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. There is similar behavior in manufacturing. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.1 percent per year from Jul 1919 to Jul 2016. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 140.6556 in Jul 2016. The actual index NSA in Jul 2016 is 101.8529, which is 27.6 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Dec 2015. Using trend growth of 2.1 percent per year, the index would increase to 129.3674 in Jul 2016. The output of manufacturing at 101.8529 in Jul 2016 is 21.3 percent below trend under this alternative calculation.

The economy of the US can be summarized in growth of economic activity or GDP as fluctuating from mediocre growth of 2.5 percent on an annual basis in 2010 to 1.6 percent in 2011, 2.2 percent in 2012, 1.7 percent in 2013, 2.4 percent in 2014 and 2.6 percent in 2015. The following calculations show that actual growth is around 2.1 percent per year. The rate of growth of 1.2 percent in the entire cycle from 2007 to 2015 is well below 3 percent per year in trend from 1870 to 2010, which the economy of the US always attained for entire cycles in expansions after events such as wars and recessions (Lucas 2011May). 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. Table Summary provides relevant data.

Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita

	GDP
Long-Term
1929-2015	3.2
1947-2015	3.2
Whole Cycles
1980-1989	3.5
2006-2015	1.3
2007-2015	1.2
Cyclical Contractions ∆%
IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982	-4.7
IVQ2007 to IIQ2009	-4.2
Cyclical Expansions Average Annual Equivalent ∆%
IQ1983 to IVQ1985 IQ1983-IQ1986 IQ1983-IIIQ1986 IQ1983-IVQ1986 IQ1983-IQ1987 IQ1983-IIQ1987 IQ1983-IIIQ1987 IQ1983 to IVQ1987 IQ1983 to IQ1988 IQ1983 to IIQ1988 IQ1983 to IIIQ1988 IQ1983 to IVQ1988 IQ1983 to IQ1989 IQ1983 to IIQ1989 IQ1983 to IIIQ1989 IQ1983 to IVQ1989	5.9 5.7 5.4 5.2 5.0 5.0 4.9 5.0 4.9 4.9 4.8 4.8 4.8 4.7 4.7 4.5
First Four Quarters IQ1983 to IVQ1983	7.8
IIIQ2009 to IIQ2016	2.1
First Four Quarters IIIQ2009 to IIQ2010	2.7
	Real Disposable Income	Real Disposable Income per Capita
Long-Term
1929-2015	3.2	2.0
1947-1999	3.7	2.3
Whole Cycles
1980-1989	3.5	2.6
2006-2015	1.7	0.9

Source: Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace around 2.1 percent per year. Table Summary GDP provides the data.

1. Average Annual Growth in the Past Eighteen Quarters. GDP growth in the four quarters of 2012, the four quarters of 2013, the four quarters of 2014, the four quarters of Q2015 and the two quarters of 2016 accumulated to 9.1 percent. This growth is equivalent to 2.0 percent per year, obtained by dividing GDP in IIQ2016 of $16,570.2 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/18: {[($16,570.2/$15,190.3)^4/18 -1]100 = 2.0 percent}.

2. Average Annual Growth in the Past Four Quarters. GDP growth in the four quarters of IIQ2015 to IIQ2016 accumulated to 1.2 percent that is equivalent to 1.2 percent in a year. This is obtained by dividing GDP in IIQ2016 of $16,570.2 billion by GDP in IIQ2015 of $16,374.2 billion and compounding by 4/4: {[($16,570.2/$16,374.2)^4/4 -1]100 = 1.2%}. The US economy grew 1.2 percent in IIQ2016 relative to the same quarter a year earlier in IIQ2015. Growth was at annual equivalent 4.0 percent in IIQ2014 and 5.0 percent IIIQ2014 and only at 2.3 percent in IVQ2014. GDP grew at annual equivalent 2.0 percent in IQ2015, 2.6 percent in IIQ2015, 2.0 percent in IIIQ2015 and 0.9 percent in IVQ2015. GDP grew at annual equivalent 0.8 percent in IQ2016 and at 1.1 percent annual equivalent in IIQ2016. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is in the borderline of contraction, and negative in IQ2014. US GDP fell 0.3 percent in IQ2014. The rate of growth of GDP in the revision of IIIQ2013 is 3.1 percent in seasonally adjusted annual rate (SAAR).

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

	Real GDP, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	14,991.8	NA	0.4	1.9
IVQ2011	15,190.3	1.3	1.1	1.7
IQ2012	15,291.0	2.0	0.7	2.8
IIQ2012	15,362.4	2.5	0.5	2.5
IIIQ2012	15,380.8	2.6	0.1	2.4
IVQ2012	15,384.3	2.6	0.0	1.3
IQ2013	15,491.9	3.3	0.7	1.3
IIQ2013	15,521.6	3.5	0.2	1.0
IIIQ2013	15,641.3	4.3	0.8	1.7
IVQ2013	15,793.9	5.4	1.0	2.7
IQ2014	15,747.0	5.0	-0.3	1.6
IIQ2014	15,900.8	6.1	1.0	2.4
IIIQ2014	16,094.5	7.4	1.2	2.9
IVQ2014	16,186.7	8.0	0.6	2.5
IQ2015	16,269.0	8.5	0.5	3.3
IIQ2015	16,374.2	9.2	0.6	3.0
IIIQ2015	16,454.9	9.8	0.5	2.2
IVQ2015	16,490.7	10.0	0.2	1.9
IQ2016	16,525.0	10.2	0.2	1.6
IIQ2016	16,570.2	10.6	0.3	1.2
Cumulative ∆% IQ2012 to IIQ2016	9.1		9.2
Annual Equivalent ∆%	2.0		2.0

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

Chart GDP of the US Bureau of Economic Analysis provides the rates of growth of GDP at SAAR (seasonally adjusted annual rate) in the 16 quarters from IIIQ2012 to IIQ2016. Growth has been fluctuating.

Chart GDP, Seasonally Adjusted Quarterly Rates of Growth of United States GDP, ∆%

Source: US Bureau of Economic Analysis

http://www.bea.gov/newsreleases/national/gdp/gdp_glance.htm

The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ1982 are combined, the impact of lost GDP of 4.7 percent is more comparable to the latest revised 4.2 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.4 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7 and revisions in http://bea.gov/iTable/index_nipa.cfm). Table I-2 provides the Bureau of Economic Analysis (BEA) quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981 to 1982 and 2007 to 2009, using the latest major revision published on Jul 27, 2016 and the first estimate for IIQ2016 GDP (http://www.bea.gov/newsreleases/national/gdp/2016/pdf/gdp2q16_adv.pdf), which are available in the dataset of the US Bureau of Economic Analysis (http://www.bea.gov/iTable/index_nipa.cfm). There were four quarters of contraction in 1981-1982 ranging in rate from -1.4 percent to -6.5 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.5 percent to -8.2 percent. The striking difference is that in the first twenty-eight quarters of expansion from IQ1983 to IVQ1989, shown in Table I-2 in relief, GDP grew at the high quarterly percentage growth rates of 5.3, 9.4, 8.1, 8.5, 8.2, 7.2, 4.0, 3.2, 4.0, 3.7, 6.4, 3.0, 3.8, 1.9, 4.1, 2.1, 2.8, 4.6, 3.7, 6.8, 2.3, 5.4, 2.3, 5.4, 4.1, 3.2, 3.0, 0.9, 4.5 and 1.6. The National Bureau of Economic Research dates another cycle from Jul 1990 (IIIQ1981) to Mar 1991 (IQ1991) (http://www.nber.org/cycles.html), showing in Table III-1 with weaker performance in IIQ1990 and IIIQ1990 and contraction of 3.4 percent in IVQ1990. In contrast, the percentage growth rates in the first twenty-eight quarters of expansion from IIIQ2009 to IQ2016 shown in relief in Table I-2 were mediocre: 1.3, 3.9, 1.7, 3.9, 2.7, 2.5, -1.5, 2.9, 0.8, 4.6, 2.7, 1.9, 0.5, 0.1, 2.8, 0.8, 3.1, 4.0, minus 1.2, 4.0, 5.0, 2.3, 2.0, 2.6, 2.0, 0.9, 0.8 and 1.1. Economic growth and employment creation continued at slow rhythm during 2012 and in 2013-2016 while much stronger growth would be required in movement to full employment. The cycle is now long by historical standards and growth rates are typically weaker in the final periods of cyclical expansions.

Table I-2, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA

Q	1981	1982	1983	1984	2008	2009	2010
I	8.5	-6.5	5.3	8.2	-2.7	-5.4	1.7
II	-2.9	2.2	9.4	7.2	2.0	-0.5	3.9
III	4.7	-1.4	8.1	4.0	-1.9	1.3	2.7
IV	-4.6	0.4	8.5	3.2	-8.2	3.9	2.5
				1985			2011
I				4.0			-1.5
II				3.7			2.9
III				6.4			0.8
IV				3.0			4.6
				1986			2012
I				3.8			2.7
II				1.9			1.9
III				4.1			0.5
IV				2.1			0.1
				1987			2013
I				2.8			2.8
II				4.6			0.8
III				3.7			3.1
IV				6.8			4.0
				1988			2014
I				2.3			-1.2
II				5.4			4.0
III				2.3			5.0
IV				5.4			2.3
				1989			2015
I				4.1			2.0
II				3.2			2.6
III				3.0			2.0
IV				0.9			0.9
				1990			2016
I				4.5			0.8
II				1.6			1.1
III				0.1
IV				-3.4

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

Characteristics of the four cyclical contractions are in Table I-4 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.7 percent, which is almost equal to the decline of 4.2 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.4 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7 and revisions in http://bea.gov/iTable/index_nipa.cfm). The comparison of the global recession after 2007 with the Great Depression is entirely misleading.

Table I-4, US, Number of Quarters, GDP Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions

	Number of Quarters	Cumulative Percentage Contraction	Average Percentage Rate
IIQ1953 to IIQ1954	3	-2.4	-0.8
IIIQ1957 to IIQ1958	3	-3.0	-1.0
IVQ1973 to IQ1975	5	-3.1	-0.6
IQ1980 to IIIQ1980	2	-2.2	-1.1
IIIQ1981 to IVQ1982	4	-2.5	-0.64
IVQ2007 to IIQ27009	6	-4.2	-0.72

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

Table I-5 shows the mediocre average annual equivalent growth rate of 2.1 percent of the US economy in the twenty-eight quarters of the current cyclical expansion from IIIQ2009 to IIQ2016. In sharp contrast, the average growth rate of GDP was:

5.7 percent in the first thirteen quarters of expansion from IQ1983 to IQ1986
5.4 percent in the first fifteen quarters of expansion from IQ1983 to IIIQ1986
5.2 percent in the first sixteen quarters of expansion from IQ1983 to IVQ1986
5.0 percent in the first seventeen quarters of expansion from IQ1983 to IQ1987
5.0 percent in the first eighteen quarters of expansion from IQ1983 to IIQ1987
4.9 percent in the first nineteen quarters of expansion from IQ1983 to IIIQ1987
5.0 percent in the first twenty quarters of expansion from IQ1983 to IVQ1987
4.9 percent in the first twenty-first quarters of expansion from IQ1983 to IQ1988
4.9 percent in the first twenty-two quarters of expansion from IQ1983 to IIQ1988
4.8 percent in the first twenty-three quarters of expansion from IQ1983 to IIIQ1988
4.8 percent in the first twenty-four quarters of expansion from IQ1983 to IVQ1988
4.8 percent in the first twenty-five quarters of expansion from IQ1983 to IQ1989
4.7 percent in the first twenty-six quarters of expansion from IQ1983 to IIQ1989
4.7 percent in the first twenty-seven quarters of expansion from IQ1983 to IIIQ1989
4.5 percent in the first twenty-eight quarters of expansion from IQ1093 to IVQ1989

The line “average first four quarters in four expansions” provides the average growth rate of 7.7 percent with 7.8 percent from IIIQ1954 to IIQ1955, 9.2 percent from IIIQ1958 to IIQ1959, 6.1 percent from IIIQ1975 to IIQ1976 and 7.8 percent from IQ1983 to IVQ1983. The United States missed this opportunity of high growth in the initial phase of recovery. BEA data show the US economy in standstill with annual growth of 2.5 percent in 2010 decelerating to 1.6 percent annual growth in 2011, 2.2 percent in 2012, 1.7 percent in 2013, 2.4 percent in 2014 and 2.6 percent in 2015 (http://www.bea.gov/iTable/index_nipa.cfm) The expansion from IQ1983 to IQ1986 was at the average annual growth rate of 5.7 percent, 5.2 percent from IQ1983 to IVQ1986, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987, 4.9 percent from IQ1983 to IQ1988, 4.9 percent from IQ1983 to IIQ1988, 4.8 percent from IQ1983 to IIIQ1988. 4.8 percent from IQ1983 to IVQ1988, 4.8 percent from IQ1983 to IQ1989, 4.7 percent from IQ1983 to IIQ1989, 4.7 percent from IQ1983 to IIIQ1989. 4.5 percent from IQ1983 to IVQ1989 and at 7.8 percent from IQ1983 to IVQ1983. GDP grew 2.7 percent in the first four quarters of the expansion from IIIQ2009 to IIQ2010. GDP growth in the four quarters of 2012, the four quarters of 2013, the four quarters of 2014, the four quarters of Q2015, IQ2016 and IIQ2016 accumulated to 9.1 percent. This growth is equivalent to 2.0 percent per year, obtained by dividing GDP in IIQ2016 of $16,570.2 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/18: {[($16,570.2/$15,190.3)^4/18 -1]100 = 2.0 percent}.

Table I-5 shows that GDP grew 15.4 percent in the first twenty-eight quarters of expansion from IIIQ2009 to IIQ2016 at the annual equivalent rate of 2.1 percent.

Table I-5, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions

	Number of Quarters	Cumulative Growth ∆%	Average Annual Equivalent Growth Rate
IIIQ 1954 to IQ1957	11	12.8	4.5
First Four Quarters IIIQ1954 to IIQ1955	4	7.8
IIQ1958 to IIQ1959	5	10.0	7.9
First Four Quarters IIIQ1958 to IIQ1959	4	9.2
IIQ1975 to IVQ1976	8	8.3	4.1
First Four Quarters IIIQ1975 to IIQ1976	4	6.1
IQ1983-IQ1986 IQ1983-IIIQ1986 IQ1983-IVQ1986 IQ1983-IQ1987 IQ1983-IIQ1987 IQ1983 to IIIQ1987 IQ1983 to IVQ1987 IQ1983 to IQ1988 IQ1983 to IIQ1988 IQ1983 to IIIQ1988 IQ1983 to IVQ1988 IQ1983 to IQ1989 IQ1983 to IIQ1989 IQ1983 to IIIQ1989 IQ1983 to IVQ1989	13 15 16 17 18 19 20 21 22 23 24 25 26 27 28	19.9 21.6 22.3 23.1 24.5 25.6 27.7 28.4 30.1 30.9 32.6 34.0 35.0 36.0 36.3	5.7 5.4 5.2 5.0 5.0 4.9 5.0 4.9 4.9 4.8 4.8 4.8 4.7 4.7 4.5
First Four Quarters IQ1983 to IVQ1983	4	7.8
Average First Four Quarters in Four Expansions*		7.7
IIIQ2009 to IIQ2016	28	15.4	2.1
First Four Quarters IIIQ2009 to IIQ2010		2.7

*First Four Quarters: 7.8% IIIQ1954-IIQ1955; 9.2% IIIQ1958-IIQ1959; 6.1% IIIQ1975-IQ1976; 7.8% IQ1983-IVQ1983

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

Chart I-8 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.

Chart I-8, US, Real GDP, 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-9 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2016. The economy has underperformed during the first twenty-eight quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.

Chart I-9, US, Real GDP, 2007-2016

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

As shown in Tables I-4 and I-5 above the loss of real GDP in the US during the contraction was 4.2 percent but the gain in the cyclical expansion has been only 15.4 percent (first to the last row in Table I-5), using all latest revisions. As a result, the level of real GDP in IIQ2016 with the second estimate and revisions is higher by only 10.5 percent than the level of real GDP in IVQ2007.

The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2016 would have accumulated to 28.6 percent. GDP in IIQ2016 would be $19,279.5 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2709.3 billion than actual $16,570.2 billion. There are about two trillion dollars of GDP less than at trend, explaining the 23.6 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.0 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2016/08/global-competitive-easing-or.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/fluctuating-valuations-of-risk.html). US GDP in IIQ2016 is 14.1 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,570.2 billion in IIQ2016 or 10.5 percent at the average annual equivalent rate of 1.2 percent. Professor John H. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. Cochrane (2016May02) measures GDP growth in the US at average 3.5 percent per year from 1950 to 2000 and only at 1.76 percent per year from 2000 to 2015 with only at 2.0 percent annual equivalent in the current expansion. Cochrane (2016May02) proposes drastic changes in regulation and legal obstacles to private economic activity. 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. There is similar behavior in manufacturing. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.1 percent per year from Jul 1919 to Jul 2016. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 140.6556 in Jul 2016. The actual index NSA in Jul 2016 is 101.8529, which is 27.6 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Dec 2015. Using trend growth of 2.1 percent per year, the index would increase to 129.3674 in Jul 2016. The output of manufacturing at 101.8529 in Jul 2016 is 21.3 percent below trend under this alternative calculation.

Table I-6 shows that the contraction actually concentrated in two quarters: decline of 2.1 percent in IVQ2008 relative to the prior quarter and decline of 1.4 percent in IQ2009 relative to IVQ2008. The combined fall of GDP in IVQ2008 and IQ2009 was 3.5 percent {[(1-0.021) x (1-0.014) -1]100 = -3.5%}, or {[(IQ2009 $14,375.0)/(IIIQ2008 $14,891.6) – 1]100 = -3.5%} except for rounding. Those two quarters coincided with the worst effects of the financial crisis (Cochrane and Zingales 2009). GDP fell 0.1 percent in IIQ2009 but grew 0.3 percent in IIIQ2009, which is the beginning of recovery in the cyclical dates of the NBER. Most of the recovery occurred in five successive quarters from IVQ2009 to IVQ2010 of growth of 1.0 percent in IVQ2009, 0.4 percent in IQ2010, 1.0 percent in IIQ2010 and nearly equal growth at 0.7 percent in IIIQ2010 and 0.6 percent in IVQ2010 for cumulative growth in those five quarters of 3.8 percent, obtained by accumulating the quarterly rates {[(1.01 x 1.004 x 1.01 x 1.007 x 1.006) – 1]100 = 3.8%} or {[(IVQ2010 $14,939.0)/(IIIQ2009 $14,402.5) – 1]100 = 3.7%} with minor rounding difference. The economy then stalled during the first half of 2011 with decline of 0.4 percent in IQ2011 and growth of 0.7 percent in IIQ2011 for combined annual equivalent rate of 0.6 percent {(0.996 x 1.007)²}. The economy grew 0.2 percent in IIIQ2011 for annual equivalent growth of 0.7 percent in the first three quarters {[(0.996 x 1.007 x 1.002)^4/3 -1]100 = 0.7%}. Growth picked up in IVQ2011 with 1.1 percent relative to IIIQ2011. Growth in a quarter relative to a year earlier in Table I-6 slows from over 2.7 percent during three consecutive quarters from IIQ2010 to IVQ2010 to 1.9 percent in IQ2011, 1.7 percent in IIQ2011, 1.2 percent in IIIQ2011 and 1.7 percent in IVQ2011. As shown below, growth of 1.1 percent in IVQ2011 was partly driven by inventory accumulation. In IQ2012, GDP grew 0.7 percent relative to IVQ2011 and 2.8 percent relative to IQ2011, decelerating to 0.5 percent in IIQ2012 and 2.5 percent relative to IIQ2011 and 0.1 percent in IIIQ2012 and 2.4 percent relative to IIIQ2011. Growth was 0.0 percent in IVQ2012 with 1.3 percent relative to a year earlier but mostly because of deduction of 1.54 percentage points of inventory divestment and 0.42 percentage points of reduction of one-time national defense expenditures. Growth was 0.7 percent in IQ2013 and 1.3 percent relative to IQ2012 in large part because of burning savings to consume caused by financial repression of zero interest rates. There is similar growth of 0.2 percent in IIQ2013 and 1.0 percent relative to a year earlier. In IIIQ2013, GDP grew 0.8 percent relative to the prior quarter and 1.7 percent relative to the same quarter a year earlier with inventory accumulation contributing 1.60 percentage points to growth at 3.1 percent SAAR in IIIQ2013. GDP increased 1.0 percent in IVQ2013 and 2.7 percent relative to a year earlier. GDP fell 0.3 percent in IQ2014 and grew 1.6 percent relative to a year earlier. Inventory divestment deducted 1.89 percentage points from GDP growth in IQ2014. GDP grew 1.0 percent in IIQ2014, 2.4 percent relative to a year earlier and at 4.0 SAAR with inventory change contributing 0.67 percentage points. GDP grew 1.2 percent in IIIQ2014 and 2.9 percent relative to a year earlier. GDP grew 0.6 percent in IVQ2014 and 2.5 percent relative to a year earlier. GDP increased 0.5 percent in IQ2015 and increased 3.3 percent relative to a year earlier partly because of low level during contraction of 0.3 percent in IQ2014. GDP grew 0.6 percent in IIQ2015 and 3.0 percent relative to a year earlier. GDP grew 0.5 percent in IIIQ2015 and 2.2 percent relative to a year earlier. GDP grew 0.2 percent in IVQ2015 and increased 1.9 percent relative to a year earlier. GDP grew 0.2 percent in IQ2016 and increased 1.6 percent relative to a year earlier. GDP grew 0.3 percent in IIQ2016 and increased 1.2 percent relative to a year earlier. Rates of a quarter relative to the prior quarter capture better deceleration of the economy than rates on a quarter relative to the same quarter a year earlier. The critical question for which there is not yet definitive solution is whether what lies ahead is continuing growth recession with the economy crawling and unemployment/underemployment at extremely high levels or another contraction or conventional recession. Forecasts of various sources continued to maintain high growth in 2011 without taking into consideration the continuous slowing of the economy in late 2010 and the first half of 2011. The sovereign debt crisis in the euro area and growth in China are common sources of doubts on the rate and direction of economic growth in the US. There is weak internal demand in the US with almost no investment and spikes of consumption driven by burning saving because of financial repression in the form of zero interest rates and bloated balance sheet of the Fed.

Table I-6, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2009 Dollars and ∆%

	Real GDP, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	14,991.8	NA	0.4	1.9
IQ2008	14,889.5	-0.7	-0.7	1.1
IIQ2008	14,963.4	-0.2	0.5	0.8
IIIQ2008	14,891.6	-0.7	-0.5	-0.3
IVQ2008	14,577.0	-2.8	-2.1	-2.8
IQ2009	14,375.0	-4.1	-1.4	-3.5
IIQ2009	14,355.6	-4.2	-0.1	-4.1
IIIQ2009	14,402.5	-3.9	0.3	-3.3
IV2009	14,541.9	-3.0	1.0	-0.2
IQ2010	14,604.8	-2.6	0.4	1.6
IIQ2010	14,745.9	-1.6	1.0	2.7
IIIQ2010	14,845.5	-1.0	0.7	3.1
IVQ2010	14,939.0	-0.4	0.6	2.7
IQ2011	14,881.3	-0.7	-0.4	1.9
IIQ2011	14,989.6	0.0	0.7	1.7
IIIQ2011	15,021.1	0.2	0.2	1.2
IVQ2011	15,190.3	1.3	1.1	1.7
IQ2012	15,291.0	2.0	0.7	2.8
IIQ2012	15,362.4	2.5	0.5	2.5
IIIQ2012	15,380.8	2.6	0.1	2.4
IVQ2012	15,384.3	2.6	0.0	1.3
IQ2013	15,491.9	3.3	0.7	1.3
IIQ2013	15,521.6	3.5	0.2	1.0
IIIQ2013	15,641.3	4.3	0.8	1.7
IVQ2013	15,793.9	5.4	1.0	2.7
IQ2014	15,747.0	5.0	-0.3	1.6
IIQ2014	15,900.8	6.1	1.0	2.4
IIIQ2014	16,094.5	7.4	1.2	2.9
IVQ2014	16,186.7	8.0	0.6	2.5
IQ2015	16,269.0	8.5	0.5	3.3
IIQ2015	16,374.2	9.2	0.6	3.0
IIIQ2015	16,454.9	9.8	0.5	2.2
IVQ2015	16,490.7	10.0	0.2	1.9
IQ2016	16,525.0	10.2	0.2	1.6
IIQ2016	16,570.2	10.5	0.3	1.2

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

Chart I-10 provides the percentage change of real GDP from the same quarter a year earlier from 1980 to 1989. There were two contractions almost in succession in 1980 and from 1981 to 1983. The expansion was marked by initial high rates of growth as in other recession in the postwar US period during which employment lost in the contraction was recovered. Growth rates continued to be high after the initial phase of expansion.

Chart I-10, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

The experience of recovery after 2009 is not as complete as during the 1980s. Chart I-11 shows the much lower rates of growth in the early phase of the current expansion and sharp decline from an early peak. The US missed the initial high growth rates in cyclical expansions that eliminate unemployment and underemployment.

Chart I-11, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 2007-2016

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-12 provides growth rates from a quarter relative to the prior quarter during the 1980s. There is the same strong initial growth followed by a long period of sustained growth.

Chart I-12, Percentage Change of Real Gross Domestic Product from Prior Quarter 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-13 provides growth rates in a quarter relative to the prior quarter from 2007 to 2016. Growth in the current expansion after IIIQ2009 has not been as strong as in other postwar cyclical expansions.

Chart I-13, Percentage Change of Real Gross Domestic Product from Prior Quarter 2007-2016

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

The Bureau of Economic Analysis (BEA) (pages 1-2) explains growth of GDP in IIQ2016 as follows (http://www.bea.gov/newsreleases/national/gdp/2016/pdf/gdp2q16_2nd.pdf):

“Real gross domestic product increased at an annual rate of 1.1 percent in the second quarter of 2016 (table 1), according to the "second" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 0.8 percent.

The GDP estimate released today is based on more complete source data than were available for the "advance" estimate issued last month. In the advance estimate, the increase in real GDP was 1.2 percent. With this second estimate for the second quarter, the general picture of economic growth remains the same; revisions to the components of GDP are small (see "Updates to GDP" on page 2).

The increase in real GDP in the second quarter primarily reflected positive contributions from personal consumption expenditures (PCE) and exports that were partly offset by negative contributions from private inventory investment, residential fixed investment, state and local government spending and nonresidential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased (table 2).

The acceleration in real GDP in the second quarter primarily reflected an acceleration in PCE, a smaller decrease in nonresidential fixed investment, an upturn in exports, and a smaller decrease in federal government spending. These were partly offset by a larger decrease in private inventory investment and downturns in state and local government spending, in residential fixed investment, and in imports.”

There are positive contributions to growth in IIQ2016 shown in Table I-9:

Personal consumption expenditures (PCE) growing at 4.4 percent
Growth of durable goods at 9.9 percent
Growth of exports at 1.2 percent

There were negative contributions in IIQ2016:

Nonresidential fixed investment contracting at 0.9 percent
Residential fixed investment contracting at 7.7 percent
Federal government expenditures contracting at 1.5 percent with national defense expenditures contracting at 3.1 percent, deducting 0.12 percentage points from growth
Deduction of 1.26 percentage points by inventory change (∆PI PP) in IIQ2016

The BEA explains acceleration in real GDP growth in IIQ2016 by:

Growth of consumption of durable goods at 9.9 percent in IIQ2016 compared with contraction at 0.6 percent in IQ2016
Growth of personal consumption expenditures at 4.4 percent in IIQ2016 compared with 1.6 percent in IQ2016
Growth of exports at 1.2 percent in IIQ2016 compared with decline at 0.7 percent in IQ2016
Contraction of expenditures of national defense expenditures at 3.1 percent in IIQ2016 compared with contraction at 3.2 percent in IQ2016

The BEA finds offsetting decelerating factors:

· Contraction of residential fixed investment at 7.7 percent in IIQ2016 compared with growth at 7.8 percent in the prior quarter

· Contraction of expenditures by state and local government at 2.2 percent in IIQ2016 compared with growth at 3.5 percent in the prior quarter

· Growth of imports at 0.3 percent in IIQ2016 compared with contraction at 0.6 percent in IQ2016

An important aspect of growth in the US is the decline in growth of real disposable personal income, or what is left after taxes and inflation, which decreased at the rate of 0.5 percent in IIIQ2013 compared with a year earlier. Contraction of real disposable income of 2.8 percent in IVQ2013 relative to a year earlier is largely due to comparison with an artificially higher level in anticipations of income in Nov and Dec 2012 to avoid increases in taxes in 2013, an episode known as “fiscal cliff.” Real disposable personal income increased 2.5 percent in IQ2014 relative to a year earlier and 3.2 percent in IIQ2014 relative to a year earlier. Real disposable personal income increased 3.7 percent in IIIQ2014 relative to a year earlier and 4.5 percent in IVQ2014 compared with a year earlier. Real disposable personal income grew 3.9 percent in IQ2015 relative to a year earlier partly because of contraction of energy prices and increased at 3.6 percent in IIQ2015. Real disposable personal income grew at 3.3 percent in IIIQ2015 relative to a year earlier and at 3.0 percent in IVQ2015 relative to a year earlier. Real disposable income grew at 3.1 percent in IQ2016 relative to a year earlier and at 2.7 percent in IIQ2016 relative to a year earlier. The effects of financial repression, or zero interest, are vividly shown in the decline of the savings rate, or personal saving as percent of disposable income from 9.2 percent in IVQ2012 to 5.3 percent in IIIQ2013 and 4.7 percent in IVQ2013. The savings rate eased to 5.3 percent in IQ2014, increasing to 5.7 percent in IIQ2014 and stabilizing to 5.7 percent in IIIQ2014. The savings rate fell to 5.6 percent in IVQ2014, increasing to 5.5 percent in IQ2015. The savings rate increased to 5.7 percent in IIQ2015, 5.9 percent in IIIQ2015 and 6.0 percent in IVQ2015. The savings ratio moved to 6.1 percent in IQ2016 and 5.7 percent in IIQ2016. Anticipation of income in IVQ2012 to avoid higher taxes in 2013 caused increases in income and savings while higher payroll taxes in 2013 restricted income growth and savings in IQ2013. Zero interest rates induce risky investments with high leverage and can contract balance sheets of families, business and financial institutions when interest rates inevitably increase in the future. There is a tradeoff of weaker economy in the future when interest rates increase by meager growth in the present with forced consumption by zero interest rates. Microeconomics consists of the analysis of allocation of scarce resources to alternative and competing ends. Zero interest rates cloud he calculus of risk and returns in consumption and investment, disrupting decisions that maintain the economy in its long-term growth path.

Table I-9, US, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase, %

	IIQ 2015	IIIQ 2015	IVQ 2015	IQ2016	IIQ 2016
GDP	2.6	2.0	0.9	0.8	1.1
PCE	2.9	2.7	2.3	1.6	4.4
Durable Goods	7.6	6.2	4.0	-0.6	9.9
NRFI	1.6	3.9	-3.3	-3.4	-0.9
RFI	14.9	12.6	11.5	7.8	-7.7
Exports	2.9	-2.8	-2.7	-0.7	1.2
Imports	2.9	1.1	0.7	-0.6	0.3
GOV	3.2	1.9	1.0	1.6	-1.5
Federal GOV	0.2	1.0	3.8	-1.5	-0.3
National Defense	-0.5	-1.2	4.4	-3.2	-3.1
Cont to GDP Growth % Points	-0.02	-0.05	0.17	-0.13	-0.12
State/Local GOV	5.1	2.5	-0.6	3.5	-2.2
∆ PI (PP)	-0.52	-0.57	-0.36	-0.41	-1.26
Final Sales of Domestic Product	3.2	2.6	1.2	1.2	2.4
Gross Domestic Purchases	2.6	2.4	1.3	0.8	1.0
Prices Gross Domestic Purchases	1.5	1.3	0.4	0.3	-1.6
Prices of GDP	2.3	1.3	0.8	0.5	2.3
Prices of GDP Excluding Food and Energy	1.8	1.4	0.9	1.5	2.1
Prices of PCE	1.8	1.1	0.4	0.3	2.0
Prices of PCE Excluding Food and Energy	1.8	1.4	1.2	2.1	1.8
Prices of Market Based PCE	1.7	0.8	0.2	-0.2	1.8
Prices of Market Based PCE Excluding Food and Energy	1.6	1.1	1.1	1.8	1.6
Real Disposable Personal Income*	3.6	3.3	3.0	3.1	2.7
Personal Saving As % Disposable Income	5.7	5.9	6.0	6.1	5.7

Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in

private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income

*Percent change from quarter one year ago

Source: Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

ESIV Stagnating Real Private Fixed Investment. The United States economy has grown at the average yearly rate of 3 percent per year and 2 percent per year in per capita terms from 1870 to 2010, as measured by Lucas (2011May). An important characteristic of the economic cycle in the US has been rapid growth in the initial phase of expansion after recessions. Inferior performance of the US economy and labor markets is the critical current issue of analysis and policy design. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.1 percent on average in the cyclical expansion in the 28 quarters from IIIQ2009 to IIQ2016. 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 second estimate of GDP for IIQ2016 (http://www.bea.gov/newsreleases/national/gdp/2016/pdf/gdp2q16_2nd.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2016/07/business-fixed-investment-has-been-soft.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/financial-asset-values-rebound-from.html). 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, 5.0 percent from IQ1983 to IVQ1987, 4.9 percent from IQ1983 to IIQ1988, 4.8 percent from IQ1983 to IIIQ1988, 4.8 percent from IQ1983 to IVQ1988, 4.8 percent from IQ1983 to IQ1989, 4.7 percent from IQ1983 to IIQ1989, 4.7 percent from IQ1983 to IIIQ1989, 4.5 percent from IQ1983 to IVQ1989 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2016/07/business-fixed-investment-has-been-soft.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/financial-asset-values-rebound-from.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2016 would have accumulated to 28.6 percent. GDP in IIQ2016 would be $19,279.5 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2709.3 billion than actual $16,570.2 billion. There are about two trillion dollars of GDP less than at trend, explaining the 23.6 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.0 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2016/08/global-competitive-easing-or.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/fluctuating-valuations-of-risk.html). US GDP in IIQ2016 is 14.1 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,570.2 billion in IIQ2016 or 10.5 percent at the average annual equivalent rate of 1.2 percent. Professor John H. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. Cochrane (2016May02) measures GDP growth in the US at average 3.5 percent per year from 1950 to 2000 and only at 1.76 percent per year from 2000 to 2015 with only at 2.0 percent annual equivalent in the current expansion. Cochrane (2016May02) proposes drastic changes in regulation and legal obstacles to private economic activity. 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. There is similar behavior in manufacturing. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.1 percent per year from Jul 1919 to Jul 2016. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 140.6556 in Jul 2016. The actual index NSA in Jul 2016 is 101.8529, which is 27.6 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Dec 2015. Using trend growth of 2.1 percent per year, the index would increase to 129.3674 in Jul 2016. The output of manufacturing at 101.8529 in Jul 2016 is 21.3 percent below trend under this alternative calculation.

Table IA1-1 provides quarterly seasonally adjusted annual rates (SAAR) of growth of private fixed investment for the recessions of the 1980s and the current economic cycle. In the cyclical expansion beginning in IQ1983 (http://www.nber.org/cycles.html), real private fixed investment in the United States grew at the average annual rate of 14.7 percent in the first eight quarters from IQ1983 to IVQ1984. Growth rates fell to an average of 2.2 percent in the following eight quarters from IQ1985 to IVQ1986 and to an average of 1.9 percent in the 12 quarters of 1985, 1986 and 1987. The average rate of growth in the four quarters of 1988 was 3.7 percent. There were only four quarters of contraction of private fixed investment from IQ1983 to IVQ1987. The National Bureau of Economic Research dates another cycle from Jul 1990 (IIIQ1981) to Mar 1991 (IQ1991) (http://www.nber.org/cycles.html), showing in Table III-1 with contractions of fixed investment in the final three quarters of 1990. There is quite different behavior of private fixed investment in the twenty-eight quarters of cyclical expansion from IIIQ2009 to IIQ2016. The average annual growth rate in the first eight quarters of expansion from IIIQ2009 to IIQ2011 was 3.2 percent, which is significantly lower than 14.7 percent in the first eight quarters of expansion from IQ1983 to IVQ1984. There is only strong growth of private fixed investment in the four quarters of expansion from IIQ2011 to IQ2012 at the average annual rate of 12.5 percent. Growth has fallen from the SAAR of 17.3 percent in IIIQ2011 to 0.1 percent in IIIQ2012, recovering to 6.9 percent in IVQ2012 and increasing to 7.0 percent in IQ2013. The SAAR of fixed investment fell to 2.9 percent in IIIQ2013 and to 6.6 percent in IVQ2013. The SAAR of fixed investment decreased to 5.3 percent in IQ2014. Fixed investment grew at the SAAR of 7.2 percent in IIQ2014 and at 7.4 percent in IIIQ2014. Fixed investment grew at 1.3 percent in IVQ2014, 3.7 percent in IQ2015 and 4.3 percent in IIQ2015. Fixed investment grew at 5.7 percent in IIIQ2015 and fell at 0.2 percent in IVQ2015. Fixed investment contracted at 0.9 percent in IQ2016 and fell at 2.5 percent in IIQ2016. Sudeep Reddy and Scott Thurm, writing on “Investment falls off a cliff,” on Nov 18, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324595904578123593211825394.html?mod=WSJPRO_hpp_LEFTTopStories) analyze the decline of private investment in the US and inform that a review by the Wall Street Journal of filing and conference calls finds that 40 of the largest publicly traded corporations in the US have announced intentions to reduce capital expenditures in 2012.

Table IA1-1, US, Quarterly Growth Rates of Real Private Fixed Investment, % Annual Equivalent SA

Q	1981	1982	1983	1984	2008	2009	2010
I	3.8	-12.2	9.4	13.1	-7.1	-27.4	0.8
II	3.2	-12.1	16.0	16.6	-5.5	-14.2	13.6
III	0.1	-9.3	24.4	8.2	-12.1	-0.5	-0.4
IV	-1.5	0.2	24.3	7.3	-23.9	-2.8	8.5
				1985			2011
I				3.7			-0.9
II				5.2			8.2
III				-1.6			17.3
IV				7.8			9.9
				1986			2012
I				1.1			14.7
II				0.1			6.9
III				-1.8			0.1
IV				3.1			6.9
				1987			2013
I				-6.7			7.0
II				6.3			4.3
III				7.1			2.9
IV				-0.2			6.6
				1988			2014
I				0.2			5.3
II				8.1			7.2
III				1.9			7.4
IV				4.8			1.3
				1989			2015
IQ				3.6			3.7
IIQ				0.5			4.3
IIIQ				7.2			5.7
IVQ				-5.0			-0.2
				1990			2016
IQ				4.8			-0.9
IIQ				-7.7			-2.5
IIIQ				-3.3
IVQ				-9.8

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

Chart IA1-1 of the US Bureau of Economic Analysis (BEA) provides seasonally adjusted annual rates of growth of real private fixed investment from 1981 to 1989. Growth rates recovered sharply during the first eight quarters, which was essential in returning the economy to trend growth and eliminating unemployment and most underemployment accumulated during the contractions.

Chart IA1-1, US, Real Private Fixed Investment, Seasonally-Adjusted Annual Rates Percent Change from Prior Quarter, 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Weak behavior of real private fixed investment from 2007 to 2016 is in Chart IA1-2. Growth rates of real private fixed investment were much lower during the initial phase of the current economic cycle and have entered sharp trend of decline.

Chart IA1-2, US, Real Private Fixed Investment, Seasonally-Adjusted Annual Rates Percent Change from Prior Quarter, 2007-2016

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Table IA1-2 provides real private fixed investment at seasonally adjusted annual rates from IVQ2007 to IIQ2016 or for the complete economic cycle. The first column provides the quarter, the second column percentage change relative to IVQ2007, the third column the quarter percentage change in the quarter relative to the prior quarter and the final column percentage change in a quarter relative to the same quarter a year earlier. In IQ1980, real gross private domestic investment in the US was $951.6 billion of chained 2009 dollars, growing to $1,257.7 billion in IVQ1989 or 32.2 percent. Real gross private domestic investment in the US increased 6.3 percent from $2605.2 billion in IVQ2007 to $2,769.9 billion in IIQ2016. As shown in Table IAI-2, real private fixed investment increased 7.1 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,769.0 billion in IIQ2016. Private fixed investment fell relative to IVQ2007 in all quarters preceding IIQ2014 and fell 0.6 percent in IIQ2016. Growth of real private investment in Table IA1-2 is mediocre for all but four quarters from IIQ2011 to IQ2012. The investment decision of United States corporations is fractured in the current economic cycle in preference of cash.

Table IA1-2, US, Real Private Fixed Investment and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions of Chained 2009 Dollars and ∆%

	Real PFI, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	2586.3	NA	-0.9	-1.4
IQ2008	2539.1	-1.8	-1.8	-3.0
IIQ2008	2503.4	-3.2	-1.4	-4.6
IIIQ2008	2424.1	-6.3	-3.2	-7.1
IV2008	2263.8	-12.5	-6.6	-12.5
IQ2009	2089.3	-19.2	-7.7	-17.7
IIQ2009	2011.0	-22.2	-3.7	-19.7
IIIQ2009	2008.4	-22.3	-0.1	-17.1
IVQ2009	1994.1	-22.9	-0.7	-11.9
IQ2010	1997.9	-22.8	0.2	-4.4
IIQ2010	2062.8	-20.2	3.2	2.6
IIIQ2010	2060.8	-20.3	-0.1	2.6
IVQ2010	2103.1	-18.7	2.1	5.5
IQ2011	2098.4	-18.9	-0.2	5.0
IIQ2011	2140.2	-17.2	2.0	3.8
IIIQ2011	2227.5	-13.9	4.1	8.1
IVQ2011	2280.6	-11.8	2.4	8.4
IQ2012	2360.4	-8.7	3.5	12.5
IIQ2012	2399.8	-7.2	1.7	12.1
IIIQ2012	2400.4	-7.2	0.0	7.8
IVQ2012	2441.0	-5.6	1.7	7.0
IQ2013	2482.7	-4.0	1.7	5.2
IIQ2013	2508.8	-3.0	1.1	4.5
IIIQ2013	2526.7	-2.3	0.7	5.3
IVQ2013	2567.2	-0.7	1.6	5.2
IQ2014	2600.5	0.5	1.3	4.7
IIQ2014	2646.1	2.3	1.8	5.5
IIIQ2014	2693.4	4.1	1.8	6.6
IVQ2014	2702.3	4.5	0.3	5.3
IQ2015	2727.2	5.4	0.9	4.9
IIQ2015	2756.0	6.6	1.1	4.2
IIIQ2015	2794.5	8.1	1.4	3.8
IVQ2015	2793.3	8.0	0.0	3.4
IQ2016	2786.7	7.7	-0.2	2.2
IIQ2016	2769.0	7.1	-0.6	0.5

PFI: Private Fixed Investment

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

Chart IA1-3 provides real private fixed investment in chained dollars of 2009 from 2007 to 2016. Real private fixed investment increased 7.1 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,769.0 billion in IIQ2016.

Chart IA1-3, US, Real Private Fixed Investment, Billions of Chained 2009 Dollars, IQ2007 to IIQ2016

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart IA1-4 provides real gross private domestic investment in chained dollars of 2009 from 1980 to 1989. Real gross private domestic investment climbed 32.2 percent to $1,257.7 billion of 2009 dollars in IVQ1989 above the level of $951.6 billion in IQ1980.

Chart IA1-4, US, Real Gross Private Domestic Investment, Billions of Chained 2009 Dollars at Seasonally Adjusted Annual Rate, 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart IA1-5 provides real gross private domestic investment in the United States in billions of chained dollars of 2009 from 2006 to 2016. Real gross private domestic investment reached a level of $2,769.9 billion in IIQ2016, which was only 6.3 percent higher than the level of $2605.2 billion in IVQ2007 (http://www.bea.gov/iTable/index_nipa.cfm).

Chart IA1-5, US, Real Gross Private Domestic Investment, Billions of Chained 2009 Dollars at Seasonally Adjusted Annual Rate, 2007-2016

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

ESV Swelling Undistributed Corporate Profits. Table IA1-5 provides value added of corporate business, dividends and corporate profits in billions of current dollars at seasonally adjusted annual rates (SAAR) in IVQ2007 and IIQ2016 together with percentage changes. The last three rows of Table IA1-5 provide gross value added of nonfinancial corporate business, consumption of fixed capital and net value added in billions of chained 2009 dollars at SAARs. Deductions from gross value added of corporate profits down the rows of Table IA1-5 end with undistributed corporate profits. Profits after taxes with inventory valuation adjustment (IVA) and capital consumption adjustment (CCA) increased by 69.5 percent in nominal terms from IVQ2007 to IIQ2016 while net dividends increased 15.3 percent and undistributed corporate profits swelled 159.0 percent from $107.7 billion in IQ2007 to $278.9 billion in IIQ2016 and changed signs from minus $55.9 billion in current dollars in IVQ2007. The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Gross value added of nonfinancial corporate business adjusted for inflation increased 14.7 percent from IVQ2007 to IIQ2016, which is much lower than nominal increase of 28.4 percent in the same period for gross value added of total corporate business.

Table IA1-5, US, Value Added of Corporate Business, Corporate Profits and Dividends, IVQ2007-IIQ2016

	IVQ2007	IIQ2016	∆%
Current Billions of Dollars Seasonally Adjusted Annual Rates (SAAR)
Gross Value Added of Corporate Business	8,165.9	10,484.9	28.4
Consumption of Fixed Capital	1,216.5	1,558.5	28.1
Net Value Added	6,949.4	8,926.4	28.4
Compensation of Employees	4,945.8	6,133.1	24.0
Taxes on Production and Imports Less Subsidies	688.5	839.4	21.9
Net Operating Surplus	1,315.1	1,953.9	48.6
Net Interest and Misc	204.2	194.8	-4.6
Business Current Transfer Payment Net	68.9	146.3	112.3
Corporate Profits with IVA and CCA Adjustments	1,042.0	1,612.9	54.8
Taxes on Corporate Income	408.8	539.7	32.0
Profits after Tax with IVA and CCA Adjustment	633.2	1,073.1	69.5
Net Dividends	689.1	794.3	15.3
Undistributed Profits with IVA and CCA Adjustment	-55.9	278.9	NA ∆% 159.0 relative to 107.7 in IQ2007
Billions of Chained USD 2009 SAAR
Gross Value Added of Nonfinancial Corporate Business	7,519.3	8,621.9	14.7
Consumption of Fixed Capital	1,066.0	1,285.8	20.6
Net Value Added	6,453.4	7,336.1	13.7

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Table IA1-6 provides comparable United States value added of corporate business, corporate profits and dividends from IQ1980 to IVQ1989. There is significant difference both in nominal and inflation-adjusted data. Between IQ1980 and IVQ1989, profits after tax with IVA and CCA increased 85.9 percent with dividends growing 198.8 percent and undistributed profits increasing 8.1 percent. There was much higher inflation in the 1980s than in the current cycle. For example, the consumer price index increased 57.4 percent from Mar 1980 to Dec 1989 but only 14.8 percent between Dec 2007 and Jun 2016 (http://www.bls.gov/cpi/data.htm). The comparison is still valid in terms of inflation-adjusted data: gross value added of nonfinancial corporate business adjusted for inflation increased 41.7 percent between IQ1980 and IVQ1989 but only 14.7 percent between IVQ2007 and IIQ2016 while net value added adjusted for inflation increased 40.6 percent between IQ1980 and IVQ1989 but only 13.7 percent between IVQ2007 and IIQ2016.

Table IA1-6, US, Value Added of Corporate Business, Corporate Profits and Dividends, IQ1980-IVQ1989

	IQ1980	IVQ1989	∆%
Current Billions of Dollars Seasonally Adjusted Annual Rates (SAAR)
Gross Value Added of Corporate Business	1,654.1	3,373.6	104.0
Consumption of Fixed Capital	200.5	437.6	118.3
Net Value Added	1,453.6	2,936.0	102.0
Compensation of Employees	1,072.9	2,163.9	101.7
Taxes on Production and Imports Less Subsidies	121.5	272.9	124.6
Net Operating Surplus	259.2	499.3	92.6
Net Interest and Misc.	50.4	137.9	173.6
Business Current Transfer Payment Net	11.5	34.6	200.9
Corporate Profits with IVA and CCA Adjustments	197.2	326.8	65.7
Taxes on Corporate Income	97.0	140.5	44.8
Profits after Tax with IVA and CCA Adjustment	100.2	186.3	85.9
Net Dividends	40.9	122.2	198.8
Undistributed Profits with IVA and CCA Adjustment	59.3	64.1	8.1
Billions of Chained USD 2009 SAAR
Gross Value Added of Nonfinancial Corporate Business	2,952.3	4,183.8	41.7
Consumption of Fixed Capital	315.6	477.1	51.2
Net Value Added	2,636.7	3,706.7	40.6

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Chart IA1-14 of the US Bureau of Economic Analysis provides quarterly corporate profits after tax and undistributed profits with IVA and CCA from 1979 to 2016. There is tightness between the series of quarterly corporate profits and undistributed profits in the 1980s with significant gap developing from 1988 and to the present with the closest approximation peaking in IVQ2005 and surrounding quarters. These gaps widened during all recessions including in 1991 and 2001 and recovered in expansions with exceptionally weak performance in the current expansion.

Chart IA1-14, US, Corporate Profits after Tax and Undistributed Profits with Inventory Valuation Adjustment and Capital Consumption Adjustment, Quarterly, 1979-2016

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Table IA1-7 provides price, costs and profit per unit of gross value added of nonfinancial domestic corporate income for IVQ2007 and IIQ2016 in the upper block and for IQ1980 and IVQ1989 in the lower block. Compensation of employees or labor costs per unit of gross value added of nonfinancial domestic corporate income hardly changed from 0.577 in IVQ2007 to 0.626 in IIQ2016 in a fractured labor market but increased from 0.340 in IQ1980 to 0.472 in IVQ1989 in a more vibrant labor market. Unit nonlabor costs increased mildly from 0.270 per unit of gross value added in IVQ2007 to 0.294 in IIQ2016 but increased from 0.124 in IQ1980 to 0.199 in IVQ1989 in an economy closer to full employment of resources. Profits after tax with IVA and CCA per unit of gross value added of nonfinancial domestic corporate income increased from 0.076 in IVQ2007 to 0.099 in IIQ2016 and from 0.029 in IQ1980 to 0.038 in IVQ1989.

Table IA1-7, US, Price, Costs and Profit per Unit of Gross Value Added of Nonfinancial Domestic Corporate Income

	IVQ2007	IIQ2016
Price per Unit of Real Gross Value Added of Nonfinancial Corporate Business	0.961	1.056
Compensation of Employees (Unit Labor Cost)	0.577	0.626
Unit Nonlabor Cost	0.270	0.294
Consumption of Fixed Capital	0.140	0.159
Taxes on Production and Imports less Subsidies plus Business Current Transfer Payments (net)	0.093	0.099
Net Interest and Misc. Payments	0.037	0.036
Corporate Profits with IVA and CCA Adjustment (Unit Profits from Current Production)	0.114	0.136
Taxes on Corporate Income	0.038	0.037
Profits after Tax with IVA and CCA Adjustment	0.076	0.099
	IQ1980	IVQ1989
Price per Unit of Real Gross Value Added of Nonfinancial Corporate Business	0.518	0.732
Compensation of Employees (Unit Labor Cost)	0.340	0.472
Unit Nonlabor Cost	0.124	0.199
Consumption of Fixed Capital	0.064	0.093
Taxes on Production and Imports less Subsidies plus Business Current Transfer Payments (net)	0.042	0.066
Net Interest and Misc. Payments	0.018	0.040
Corporate Profits with IVA and CCA Adjustment (Unit Profits from Current Production)	0.055	0.061
Taxes on Corporate Income	0.026	0.023
Profits after Tax with IVA and CCA Adjustment	0.029	0.038

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Chart IA1-15 provides quarterly profits after tax with IVA and CCA per unit of gross value added of nonfinancial domestic corporate income from 1980 to 2016. In an environment of idle labor and other productive resources nonfinancial corporate income increased after tax profits with IVA and CCA per unit of gross value added at a faster pace in the weak economy from IVQ2007 to IVQ2015 than in the vibrant expansion following the cyclical contractions of the 1980s. Part of the profits was distributed as dividends and significant part was retained as undistributed profits in the current economic cycle with frustrated investment decision.

Chart IA1-15, US, Profits after Tax with Inventory Valuation Adjustment and Capital Consumption Adjustment per Unit of Gross Value Added of Nonfinancial Domestic Corporate Income, 1980-2016

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Table IA1-8 provides percentage changes of corporate profits in 2014 and 2015 and seasonally adjusted annual rates of change of corporate profits from IIIQ2015 to IIQ2016. Corporate profits with IVA and CCA increased at 5.9 percent in 2014, increasing at 3.5 percent after taxes and fell at 3.0 percent in 2015 and decreased at 5.3 percent after taxes. Corporate profits with IVA and CCA decreased at 0.8 percent in IIIQ2015 and decreased after taxes at 0.2 percent in IIIQ2015. Corporate profits with IVA and CCA fell at 6.1 percent in IVQ2015 and fell at 11.0 percent after taxes. Corporate profits with IVA and CCA increased at 3.4 percent in IQ2016 and at 8.1 percent after taxes. Corporate profits with IVA and CCA decreased at 1.2 percent in IIQ2016 and decreased at 2.4 percent after taxes. Corporate profits with IVA and CCA decreased 4.9 percent in IIQ2016 relative to IIQ2015 and profits after tax with IVA and CCA decreased 6.3 percent in IIQ2016 relative to IIQ2015. Net dividends increased at 1.4 percent in IIIQ2015. Net dividends fell at 2.1 percent in IVQ2015 and increased at 0.8 percent in IQ2016. Net dividends fell at 0.9 percent in IIQ2016. Net dividends decreased 0.8 percent in IIQ2016 relative to a year earlier. Undistributed profits fell at 2.8 percent in IIIQ2015. Undistributed profits fell at 25.8 percent in IVQ2015 and increased at 24.3 percent in IQ2016. Undistributed profits fell at 5.2 percent in IIQ2016. Undistributed profits decreased at 15.0 percent in IIQ2016 relative to IIQ2015.

Table IA1-8, Quarterly Seasonally Adjusted Annual Equivalent Percentage Rates of Change of Corporate Profits, ∆%

	2014	2015	IIIQ 2015	IVQ 2015	IQ 2016	IIQ 2016	IIQ16/ IIQ15
Corporate Profits with IVA and CCA	5.9	-3.0	-0.8	-6.1	3.4	-1.2	-4.9
Corporate Income Taxes	13.9	4.0	-2.5	8.5	-8.3	2.3	-0.7
After Tax Profits with IVA and CCA	3.5	-5.3	-0.2	-11.0	8.1	-2.4	-6.3
Net Dividends	4.4	0.1	1.4	-2.1	0.8	-0.9	-0.8
Und Profits with IVA and CCA	2.0	-13.2	-2.8	-25.8	24.3	-5.2	-15.0

Source: US Bureau of Economic Analysis

http://bea.gov/iTable/index_nipa.cfm

Table IA1-9 provides change from prior quarter of the level of seasonally adjusted annual rates of US corporate profits. There are three aspects. First, there is decrease in corporate profits. Corporate profits with IVA and CCA decreased at $17.0 billion in IIIQ2015. Corporate profits with IVA and CCA decreased at $127.9 billion in IVQ2015 and increased at $66.0 billion in IQ2016. Corporate profits with IVA and CCA fell at $24.1 billion in IIQ2016. Profits after tax with IVA and CCA decreased at $3.3 billion in IIIQ2015. Profits after tax with IVA and CCA fell at $172.7 billion in IVQ2015 and increased at $113.4 billion in IQ2016. Profits after tax with IVA and CCA fell at $36.3 billion in IIQ2016. Net dividends increased at $13.8 billion in IIIQ2015. Net dividends fell at $20.8 billion in IVQ2015 and increased at $7.3 billion in IQ2016. Net dividends fell at $8.2 billion in IIQ2016. Undistributed profits with IVA and CCA decreased at $17.0 billion in IIIQ2015. Undistributed corporate profits with IVA and CCA fell at $152.0 billion in IVQ2015 and increased at $106.1 billion in IQ2016. Undistributed corporate profits fell at $28.1 billion in IIQ2016. . Undistributed corporate profits swelled 159.0 percent from $107.7 billion in IQ2007 to $278.9 billion in IIQ2016 and changed signs from minus $55.9 billion in current dollars in IVQ2007. 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. Second, sharp and continuing strengthening of the dollar is affecting balance sheets of US corporations with foreign operations (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318) and the overall US economy. The bottom part of Table IA1-9 provides the breakdown of corporate profits with IVA and CCA in domestic industries and the rest of the world. Corporate profits with IVA and CCA fell at $127.9 billion in IVQ2015 with decrease of domestic industries at $149.8 billion, mostly because of decrease of nonfinancial business at $131.7 billion, and increase of profits from operations in the rest of the world at $22.0 billion. Receipts from the rest of the world fell at $19.9 billion. Corporate profits with IVA and CCA increased at $66.0 billion in IQ2016 with increase of domestic industries at $92.9 billion. Profits from operations from the rest of the world fell at $26.9 billion and payments to the rest of the world increased at $35.6 billion. Corporate profits with IVA and CCA decreased at $24.1 billion in IIQ2016. Profits from domestic industries fell at $51.0 billion and profits from nonfinancial business fell at $58.2 billion. Profits from the rest of the world increased at $26.9 billion. Total corporate profits with IVA and CCA were $2009.4 billion in IIQ2016 of which $1612.9 billion from domestic industries, or 80.3 percent of the total, and $396.5 billion, or 19.7 percent, from the rest of the world. Nonfinancial corporate profits of $1232.7 billion account for 61.3 percent of the total. Third, there is reduction in the use of corporate cash for investment. Vipal Monga, David Benoit and Theo Francis, writing on “Companies send more cash back to shareholders,” published on May 26, 2015 in the Wall Street Journal (http://www.wsj.com/articles/companies-send-more-cash-back-to-shareholders-1432693805?tesla=y), use data of a study by Capital IQ conducted for the Wall Street Journal. This study shows that companies in the S&P 500 reduced investment in plant and equipment to median 29 percent of operating cash flow in 2013 from 33 percent in 2003 while increasing dividends and buybacks to median 36 percent in 2013 from 18 percent in 2003.

Table IA1-9, Change from Prior Quarter of Level of Seasonally Adjusted Annual Equivalent Rates of Corporate Profits, Billions of Dollars

	2014	2015	IIIQ 2015	IVQ 2015	IQ 2016	IIQ 2016
Corporate Profits with IVA and CCA	119.2	-64.0	-17.0	-127.9	66.0	-24.1
Corporate Income Taxes	65.0	21.1	-13.8	44.9	-47.4	12.2
After Tax Profits with IVA and CCA	54.1	-85.0	-3.3	-172.7	113.4	-36.3
Net Dividends	41.2	0.8	13.8	-20.8	7.3	-8.2
Und Profits with IVA and CCA	12.9	-85.8	-17.0	-152.0	106.1	-28.1
Corporate Profits with IVA and CCA	119.2	-64.0	-17.0	-127.9	66.0	-24.1
Domestic Industries	120.1	-38.8	-8.9	-149.8	92.9	-51.0
Financial	52.7	8.5	-17.1	-18.2	8.1	7.2
Nonfinancial	67.4	-47.3	8.2	-131.7	84.8	-58.2
Rest of the World	-0.9	-25.2	-8.1	22.0	-26.9	26.9
Receipts from Rest of the World	23.7	-40.0	-9.5	-19.9	8.7	19.8
Payments to the Rest of the World	24.5	-14.8	-1.4	-41.9	35.6	-7.1

Source: Bureau of Economic Analysis

http://bea.gov/iTable/index_nipa.cfm

ESVI United States Housing. 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 24 of 67 months from Jan 2011 to Jul 2016 with monthly declines of 5 in 2011, 4 in 2012, 4 in 2013, 6 in 2014, 3 in 2015 and 2 in 2016. 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 10.8 percent in Jan 2013 with annual equivalent rate of 51.5 percent from Oct 2012 to Jan 2013 because of the increase of 10.8 percent in Jan 2013. New house sales increased at annual equivalent 9.9 percent in Feb-Mar 2013. New house sales weakened, decreasing at 2.3 percent in annual equivalent from Apr to Dec 2013 with significant volatility illustrated by decline of 18.8 percent in Jul 2013 and increase of 11.3 percent in Oct 2013. New house sales fell 1.1 percent in Dec 2013. New house sales increased 1.4 percent in Jan 2014 and fell 5.4 percent in Feb 2014, decreasing 3.1 percent in Mar 2014. New house sales decreased 2.2 percent in Apr 2014 and increased 12.7 percent in May 2014. New house sales fell 8.0 percent in Jun 2014 and decreased 3.4 percent in Jul 2014. New house sales jumped 11.7 percent in Aug 2014 and increased 3.8 percent in Sep 2014. New House sales increased 1.7 percent in Oct 2014 and fell 5.9 percent in Nov 2014. House sales fell at the annual equivalent rate of 2.6 percent in Sep-Nov 2014. New house sales increased 10.3 percent in Dec 2014 and increased 6.5 percent in Jan 2015. Sales of new houses increased 4.8 percent in Feb 2015 and fell 10.7 percent in Mar 2015. House sales increased 2.0 percent in Apr 2015. The annual equivalent rate in Dec 2014-Apr 2015 was 31.6 percent. New house sales increased 1.4 percent in May 2015 and fell 6.9 percent in Jun 2015, increasing 5.5 percent in Jul 2015. New house sales fell at annual equivalent 1.6 percent in May-Jul 2015. New house sales increased 1.4 percent in Aug 2015 and fell 9.5 percent in Sep 2015. New house sales decreased at annual equivalent 40.3 percent in Aug-Sep 2015. New house sales increased 4.6 percent in Oct 2015 and increased 6.3 percent in Nov 2015, increasing 5.9 percent in Dec 2015. New house sales increased at the annual equivalent rate of 92.2 percent in Oct-Dec 2015. New house sales decreased 2.2 percent in Jan 2016 at the annual equivalent rate of minus 23.4 percent. New house sales decreased 0.2 percent in Feb 2016 and increased 2.3 percent in Mar 2016. New house sales jumped at 6.1 percent in Apr 2016. New house sales increased at the annual equivalent rate of 37.7 percent in Feb-Apr 2016. New house sales increased 0.4 percent in May 2016 and increased 1.7 percent in Jun 2016. New house sales jumped 12.4 percent in Jul 2016. New house sales increased at the annual equivalent rate of 73.5 percent in May-Jul 2016. There are with wide monthly oscillations. 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, stabilizing at 4.14 on Jun 26, 2014. The conventional mortgage rate stood at 3.93 percent on Aug 20, 2015 and at 3.91 percent on Sep 17, 2015. The conventional mortgage rate was at 3.79 percent on Oct 22, 2015. The conventional mortgage rate was 3.97 percent on Nov 20, 2015. The conventional mortgage rate was 3.97 percent on Dec 18, 2015, and 3.92 percent on Jan 14, 2016. The conventional mortgage rate was 3.65 percent on Feb 19, 2016. The commercial mortgage rate was 3.73 percent on Mar 17, 2016 and 3.59 percent on Apr 21, 2016. The conventional mortgage rate was 3.58 on May 19, 2016. The conventional mortgage rate was 3.54 percent on Jun 19, 2016 and 3.45 percent on Jul 21, 2016. The conventional mortgage rate was 3.43 percent on Aug 18, 2016. 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	∆%
Jul 2016	654	12.4
Jun	582	1.7
May 2016	572	0.4
AE ∆% May-Jul		73.5
Apr	570	6.1
Mar	537	2.3
Feb	525	-0.2
AE ∆% Feb-Apr		37.7
Jan	526	-2.2
AE ∆% Jan		-23.4
Dec 2015	538	5.9
Nov	508	6.3
Oct	478	4.6
AE ∆% Oct-Dec		92.2
Sep	457	-9.5
Aug	505	1.4
AE ∆% Aug-Sep		-40.3
Jul	498	5.5
Jun	472	-6.9
May	507	1.4
AE ∆% May-Jul		-1.6
Apr	500	2.0
Mar	490	-10.7
Feb	549	4.8
Jan	524	6.5
Dec 2014	492	10.3
AE ∆% Dec-Apr		31.6
Nov	446	-5.9
Oct	474	1.7
Sep	466	3.8
AE ∆% Sep-Nov		-2.6
Aug	449	11.7
Jul	402	-3.4
Jun	416	-8.0
May	452	12.7
Apr	401	-2.2
Mar	410	-3.1
Feb	423	-5.4
Jan	447	1.4
AE ∆% Jan-Aug		2.6
Dec 2013	441	-1.1
Nov	446	0.5
Oct	444	11.3
Sep	399	5.0
Aug	380	1.1
Jul	376	-18.8
Jun	463	7.7
May	430	-4.7
Apr	451	0.4
AE ∆% Apr-Dec		-2.3
Mar	449	2.3
Feb	439	-0.7
AE ∆% Feb-Mar		9.9
Jan	442	10.8
Dec 2012	399	1.8
Nov	392	9.5
Oct	358	-7.0
AE ∆% Oct-Jan		51.5
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/

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-Jul of various years. Sales of new houses are higher in Jan-Jul 2016 relative to Jan-Jul 2015 with increase of 12.8 percent. Sales of new houses are higher in Jan-Jul 2016 relative to Jan-Jul 2014 with increase of 34.4 percent. Sales of new houses in Jan-Jul 2016 are substantially lower than in any year between 1971 and 2016 with the exception of the years from 2008 to 2015. There are only six other increases of 31.3 percent relative to Jan-Jul 2013, 57.8 percent relative to Jan-Jul 2012, 91.3 percent relative to Jan-Jul 2011, 69.2 percent relative to Jan-Jul 2010, 56.4 percent relative to Jan-Jul 2009 and 7.6 percent relative to Jan-Jul 2008. Sales of new houses in Jan-Jul 2016 are lower by 31.9 percent relative to Jan-Jul 2007, 47.3 percent relative to 2006, 55.8 percent relative to 2005 and 52.4 percent relative to 2004. 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-Jul 2016 relative to the same period in 2003 fell 46.2 percent and 39.3 percent relative to the same period in 2002. Similar percentage declines are also for 2016 relative to years from 2000 to 2004. Sales of new houses in Jan-Jul 2016 fell 12.7 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 estimate of the US population is 418.8 million in 2015. The US population increased by 133.6 percent from 1960 to 2015. The final row of Table IIB-3 reveals catastrophic data: sales of new houses in Jan-May 2016 of 352 thousand units are lower by 11.8 percent relative to 399 thousand units of houses sold in Jan-May 1971, seven years after data become available. The civilian noninstitutional population increased from 122.416 million in 1963 to 250.801 million in 2015, or 104.9 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-Jul 2016	352
Jan-Jul 2015	312
∆% Jan-Jul 2016/Jan-Jul 2015	12.8
Jan-Jul 2014	262
∆% Jan-Jul 2016/Jan-Jul 2014	34.4
Jan-Jul 2013	268
∆% Jan-Jul 2016/Jan-Jul 2013	31.3
Jan-Jul 2012	223
∆% Jan-Jul 2016/Jan-Jul 2012	57.8
Jan-Jul 2011	184
∆% Jan-Jul 2016/Jan-Jul 2011	91.3
Jan-Jul 2010	208
∆% Jan-Jul 2016/ Jan-Jul 2010	69.2
Jan-Jul 2009	225
∆% Jan-Jul 2016/ Jan-Jul 2009	56.4
Jan-Jul 2008	327
∆% Jan-Jul 2016/ Jan-Jul 2008	7.6
Jan-Jul 2007	517
∆% Jan-Jul 2016/ Jan-Jul 2007	-31.9
Jan-Jul 2006	668
∆% Jan-Jul 2016/Jan-Jul 2006	-47.3
Jan-Jul 2005	796
∆% Jan-Jul 2016/Jan-Jul 2005	-55.8
Jan-Jul 2004	739
∆% Jan-Jul 2016/Jan-Jul 2004	-52.4
Jan-Jul 2003	654
∆% Jan-Jul 2016/ Jan-Jul 2003	-46.2
Jan-Jul 2002	580
∆% Jan-Jul 2016/ Jan-Jul 2002	-39.3
Jan-Jul 2001	570
∆% Jan-Jul 2016/ Jan-Jul 2001	-38.2
Jan-Jul 2000	535
∆% Jan-Jul 2016/ Jan-Jul 2000	-34.2
Jan-Jul 1995	403
∆% Jan-Jul 2016/ Jan-Jul 1995	-12.7
Jan-Jul 1971	399
∆% Jan-Jul 2016/ Jan-Jul 1971	-11.8

*Computed using unrounded data

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 Jul 2016 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.

Chart IIB-2, US, New Single-family Houses Sold, NSA, 1963-2016

Source: US Census Bureau

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

ESVII 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 Jul 2015 and Jul 2016. Total assets of US commercial banks grew 4.3 percent from $15,337.0 billion in Jul 2015 to $15,992.3 billion in Jul 2016. The Bureau of Economic Analysis (BEA) estimates US GDP in 2015 at $18,036.6 billion (http://www.bea.gov/iTable/index_nipa.cfm). Thus, total assets of US commercial banks are equivalent to over 80 percent of US GDP. Bank credit grew 7.6 percent from $11,330.6 billion in Jul 2015 to $12,187.1 billion in Jul 2016. Securities in bank credit increased 7.1 percent from $3022 billion in Jul 2015 to $3236 billion in Jul 2016. A large part of securities in banking credit consists of US Treasury and agency securities, increasing 9.2 percent from $2133 billion in Jul 2015 to $2329 billion in Jul 2016. Credit to the government that issues or backs Treasury and agency securities of $2329 billion in Jul 2016 is about 19.1 percent of total bank credit of US commercial banks of $12,187.1 billion. Mortgage-backed securities, providing financing of home loans, increased 8.8 percent, from $1487 billion in Jul 2015 to $1618 billion in Jul 2016. Loans and leases are relatively dynamic, growing 7.7 percent from $8309 billion in Jul 2015 to $8951 billion in Jul 2016. A dynamic class is commercial and industrial loans, growing 9.5 percent from Jul 2015 to Jul 2016 and providing $2061 billion or 23.0 percent of total loans and leases of $8951 billion in Jul 2016. Real estate loans increased 7.1 percent, providing $4029 billion in Jul 2016 or 45.0 percent of total loans and leases. Consumer loans increased 8.8 percent, providing $1330 billion in Jul 2016 or 14.9 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 decreased 8.1 percent from $2696 billion in Jul 2015 to $2477 billion in Jul 2016 but a single year of the series masks exploding cash in banks because of unconventional monetary policy, which is discussed below. Bank deposits increased 4.3 percent from $10,756 billion in Jul 2015 to $11,216 billion in Jul 2016. The difference between bank deposits and total loans and leases in banks decreased from $2447 billion in Jul 2015 to $2265 billion in Jul 2016 or by $182 billion. Securities in bank credit increased by $214 billion from $3022 billion in Jul 2015 to $3236 billion in Jul 2016 and Treasury and agency securities increased by $196 billion from $2133 billion in Jul 2015 to $2329 billion in Jul 2016. Loans and leases increased $642 billion from $8309 billion in Jul 2015 to $8951 billion in Jul 2016. 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. Real disposable income per capita in IQ2016 is higher by only 8.1 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 17.7 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, real disposable income per capita grew cumulatively 25.1 percent in the cycle from IQ1980 to IIIQ1989 that was close to trend growth of 21.9 percent.

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

	Jul 2015	Jul 2016	∆%
Total Assets	15,337.0	15,992.3	4.3
Bank Credit	11,330.6	12,187.1	7.6
Securities in Bank Credit	3022	3236	7.1
Treasury & Agency Securities	2133	2329	9.2
Mortgage-Backed Securities	1487	1618	8.8
Loans & Leases	8309	8951	7.7
Real Estate Loans	3761	4029	7.1
Commercial Real Estate Loans	1701	1893	11.3
Consumer Loans	1222	1330	8.8
Commercial & Industrial Loans	1883	2061	9.5
Other Loans & Leases	1443	1531	6.1
Cash Assets*	2696	2477	-8.1
Total Liabilities	13,688	14,254	4.1
Deposits	10,756	11,216	4.3
Residual (Assets less Liabilities)	1649	1738	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

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 2011 to 2015 and for Jun 2016 and Jul 2016. 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 18.7 percent in 2009 and 9.2 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 48.1 percent in 2011 followed by decline by 2.2 percent in 2012. Cash assets of banks increased 54.5 percent in 2013 and 12.2 percent in 2014, decreasing 8.1 percent in 2015. 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 20.5 percent in Feb 2014. Cash assets of banks increased at 24.4 percent in Mar 2014 and at 8.1 percent in Apr 2014. Cash assets of banks increased at 3.5 percent in May 2014 and 29.8 percent in Jun 2014. Cash assets of banks increased at 8.4 percent in Jul 2014 and 16.0 percent in Aug 2014. Cash assets of banks increased at 16.8 percent in Sep 2014. Cash assets of banks increased at 2.9 percent in Oct 2014 and fell at 1.0 percent in Nov 2014. Cash assets of banks fell at 32.1 percent in Dec 2014. Cash assets of banks increased at 5.0 percent in Jan 2015, declining at 14.1 percent in Feb 2015 and increasing at 5.3 percent in Mar 2015. Cash assets of banks fell at 1.9 percent in Apr 2015 and at 31.4 percent in May 2015. Cash assets of banks fell at 29.0 percent in Jun 2015 and increased at 8.8 percent in Jul 2015. Cash assets of banks increased at 11.8 percent in Aug 2015 and fell at 29.2 percent in Sep 2015. Cash assets of banks increased at 51.2 percent in Oct 2015 and fell at 33.0 percent in Nov 2015. Cash assets of banks fell at 37.7 percent in Dec 2015 and fell at 14.0 percent in Jan 2016. Cash assets of banks increased at 9.0 percent in Feb 2016 and fell at 4.6 percent in Mar 2016. Cash assets of banks increased at 12.7 percent in Apr 2016 and fell at 4.4 percent in May 2016. Cash assets of banks fell at 18.4 percent in Jun 2016 and fell at 9.6 percent in Jul 2016. 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 8.3 percent in Feb 2014. Securities in bank credit increased at 7.8 percent in Mar 2014 and at 4.4 percent in Apr 2014. Securities in bank credit increased at 10.1 percent in May 2014 and at 7.9 percent in Jun 2014. Securities in bank credit increased at 10.1 percent in Jul 2014, at 0.3 percent in Aug 2014 and at 7.6 percent in Sep 2014. Securities in bank credit increased at 2.8 percent in Oct 2014 and at 5.3 percent in Nov 2014. Securities in bank credit jumped at 19.1 percent in Dec 2014. Securities in bank credit increased at 11.2 percent in Jan 2015 and at 7.8 percent in Feb 2015. Securities in bank credit increased at 0.5 percent in Mar 2015 and increased at 7.9 percent in Apr 2015. Securities in bank credit increased at 11.3 percent in May 2015 and at 0.8 percent in Jun 2015. Securities in bank credit fell at 1.9 percent in Jul 2015. Securities in bank credit increased at 5.2 percent in Aug 2015 and fell at 3.5 percent in Sep 2015. Securities in bank credit increased at 5.8 percent in Oct 2015 and increased at 6.5 percent in Nov 2015, increasing at 9.0 percent in Dec 2015. Securities in bank credit increased at 10.7 percent in Jan 2016 and changed at 0.0 percent in Feb 2016. Securities in bank credit increased at 0.8 percent in Mar 2016 and increased at 10.1 percent in Apr 2016. Securities in bank credit increased at 9.0 percent in May 2016 and increased at 7.0 percent in Jun 2016. Securities in bank credit increased at 15.7 percent in Jul 2016. 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 15.4 percent in 2010. Treasury and agency securities in bank credit increased 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 8.1 percent in Feb 2014. Treasury and agency securities increased at 9.3 percent in Mar 2014 and at 7.9 percent in Apr 2014. Treasury and agency securities increased at 17.4 percent in May 2014 and 10.1 percent in Jun 2014. Treasury and agency securities increased at 14.6 percent in Jul 2014, at 6.4 percent in Aug 2014 and at 19.5 percent in Sep 2014. Treasury and agency securities increased at 9.3 percent in Oct 2014 and at 6.5 percent in Nov 2014. Treasury and agency securities jumped at 24.0 percent in Dec 2014, 15.3 percent in Jan 2015 and 9.9 percent in Feb 2015, decreasing at 0.5 percent in Mar 2015. Treasury and agency securities increased at 8.1 percent in Apr 2015, at 18.3 percent in May 2015 and at 1.2 percent in Jun 2015. Treasury and agency securities fell at 0.4 percent in Jul 2015, increasing at 8.2 percent in Aug 2015 and decreasing at 0.2 percent in Sep 2015. Treasury and agency securities increased at 9.7 percent in Oct 2015 and increased at 9.0 percent in Nov 2015, increasing at 12.0 percent in Dec 2015. Treasury and agency securities increased at 12.3 percent in Jan 2016 and fell at 0.9 percent in Feb 2016. Treasury and agency securities fell at 1.4 percent in Mar 2016 and increased at 13.4 percent in Apr 2016. Treasury and agency securities increased at 11.5 percent in May 2016 and increased at 4.8 percent in Jun 2016. Treasury and agency securities increased at 19.9 percent in Jul 2016. 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 9.6 percent in Feb 2014. Deposits grew at 6.7 percent in Mar 2014 and at 8.4 percent in Apr 2014. Deposits grew at 7.9 percent in May and 3.4 percent in Jun 2014. Deposits increased at 7.2 percent in Jul 2014, at 1.5 percent in Aug 2014 and at 9.9 percent in Sep 2014. Deposits fell at 4.4 percent in Oct 2014 and increased at 9.8 percent in Nov 2014. Deposits increased at 8.2 percent in Dec 2014, 7.0 percent in Jan 2015, 11.3 percent in Feb 2015 and 5.7 percent in Mar 2015. Deposits fell at 1.1 percent in Apr 2015 and increased at 4.8 percent in May 2015 and at 5.6 percent in Jun 2015. Deposits increased at 5.5 percent in Jul 2015, increasing at 7.3 percent in Aug 2015 and increasing at 0.6 percent in Sep 2015. Deposits increased at 6.0 percent in Oct 2015 and increased at 2.4 percent in Nov 2015. Deposits fell at 4.0 percent in Dec 2015 and increased at 5.4 percent in Jan 2016. Deposits increased at 6.2 percent in Feb 2016 and increased at 7.9 percent in Mar 2016. Deposits increased at 5.2 percent in Apr 2016 and increased at 4.3 percent in May 2016, increasing at 7.0 percent in Jun 2016. Deposits increased at 1.3 percent in Jul 2016. 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, ∆%

	2011	2012	2013	2014	2015	Jun 2016	Jul 2016
Total Assets	5.2	2.6	7.1	7.4	3.4	4.2	6.9
Bank Credit	1.6	4.1	1.3	6.9	7.1	5.9	9.9
Securities in Bank Credit	1.9	7.6	-1.5	7.1	5.8	7.0	15.7
Treasury & Agency Securities	3.2	8.4	-5.2	11.8	8.7	4.8	19.9
Other Securities	-0.9	5.8	6.8	-2.3	-0.8	12.7	5.0
Loans & Leases	1.5	2.9	2.3	6.8	7.6	5.6	7.8
Real Estate Loans	-3.7	-1.1	-1.0	2.5	5.0	5.7	8.6
Commercial Real Estate Loans	-6.3	-1.2	4.5	6.8	9.9	10.3	10.1
Consumer Loans	-1.8	0.6	3.2	5.3	5.7	8.1	7.9
Commercial & Industrial Loans	8.6	11.6	6.9	12.0	10.3	3.1	4.8
Other Loans & Leases	18.6	8.1	6.0	14.6	13.1	6.4	9.7
Cash Assets	48.1	-2.2	54.5	12.2	-8.1	-18.4	-9.6
Total Liabilities	5.5	2.3	8.2	7.6	3.3	5.7	5.6
Deposits	6.7	7.2	6.4	6.4	4.9	7.0	1.3

Source: Board of Governors of the Federal Reserve System

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

Chart I-16 and Chart I-16A are quite revealing in analyzing the state of bank credit in the US economy. The upper curves are (1) deposits and (2) loans and leases in bank credit. Historically since 1973, the level and rate of change of deposits and loans and leases in bank credit were almost identical. The lower two curves are Treasury and agency securities in bank credit and cash assets with treasury and agency securities moving closely with cash assets until the 1990s when Treasury and agency securities exceeded cash assets. There is convergence in the final segment after cash assets exceeded treasury and agency securities. The shaded area of the recession from IV2007 to IIQ2009 shows a break in the level and rate of movement of the series. Deposits continued to expand rapidly through the recession and the following expansion period. Loans and leases fell and barely recovered the level of trend before the recession while deposits moved nearly vertically well above the level before the recession. While Treasury and agency securities in bank credit continued to expand at a higher rate, reaching a level well above that before the recession, cash assets jumped as the counterpart of excess reserves in banks that financed quantitative easing or massive outright purchases of securities for the balance sheet of the Fed. Unconventional monetary policy of zero interest rates and outright purchases of securities caused sharp increases of deposits, cash assets and Treasury and agency securities in bank credit but not in loans and leases. There is much discussion about the almost impossible task of evaluating monetary policy in terms of costs and benefits. Before the financial crisis, Chairman Greenspan (2004) analyzes monetary policy and its limitations (see Pelaez and Pelaez, The Global Recession Risk (2007), 13-4, 212-13) that do not differ from those of private financial institutions:

“The Federal Reserve’s experiences over the past two decades make it clear that uncertainty is not just a pervasive feature of the monetary policy landscape; it is the defining characteristic of that landscape. The term “uncertainty” is meant here to encompass both “Knightian uncertainty,” in which the probability distribution of outcomes is unknown, and “risk,” in which uncertainty of outcomes is delimited by a known probability distribution. In practice, one is never quite sure what type of uncertainty one is dealing with in real time, and it may be best to think of a continuum ranging from well-defined risks to the truly unknown.

As a consequence, the conduct of monetary policy in the United States has come to involve, at its core, crucial elements of risk management. This conceptual framework emphasizes understanding as much as possible the many sources of risk and uncertainty that policymakers face, quantifying those risks when possible, and assessing the costs associated with each of the risks. In essence, the risk management approach to monetary policymaking is an application of Bayesian decision making.

This framework also entails devising, in light of those risks, a strategy for policy directed at maximizing the probabilities of achieving over time our goals of price stability and the maximum sustainable economic growth that we associate with it. In designing strategies to meet our policy objectives, we have drawn on the work of analysts, both inside and outside the Fed, who over the past half century have devoted much effort to improving our understanding of the economy and its monetary transmission mechanism. A critical result has been the identification of a relatively small set of key relationships that, taken together, provide a useful approximation of our economy’s dynamics. Such an approximation underlies the statistical models that we at the Federal Reserve employ to assess the likely influence of our policy decisions.

However, despite extensive efforts to capture and quantify what we perceive as the key macroeconomic relationships, our knowledge about many of the important linkages is far from complete and, in all likelihood, will always remain so. Every model, no matter how detailed or how well designed, conceptually and empirically, is a vastly simplified representation of the world that we experience with all its intricacies on a day-to-day basis.

Given our inevitably incomplete knowledge about key structural aspects of an ever-changing economy and the sometimes asymmetric costs or benefits of particular outcomes, a central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path. The decision makers then need to reach a judgment about the probabilities, costs, and benefits of the various possible outcomes under alternative choices for policy.”

Risk management tools are as likely to fail in private financial institutions as in central banks because of the difficulty of modeling risk during uncertainty. There is no such thing as riskless financial management. “Whale” trades at official institutions causing wide swings of financial and economic variables do not receive the same attention as those in large private banking institutions such as the teapot storm over JP Morgan Chase.

The post of this blog on Nov 8, 2009 is currently relevant (http://cmpassocregulationblog.blogspot.com/2009/11/how-big-bank-carlos-manuel-pelaezs.html):

Sunday, November 8, 2009

How Big a Bank
Carlos Manuel Peláez's Latest Blog Posts
How Big a Bank
5:56 PM PST, November 8, 2009
Agendas of financial regulation in parliaments, international official institutions and monetary authorities include limits on the size of banks or how big a bank should be. These proposals imply that regulators would decide the total value of assets held by banks. Assets would have to be weighted by risk, which is the best practice applied in the Basel capital accords. Regulators would decide not only the total value of assets but also the structure or percentage share of assets by risk class and credit rating such as how much in consumer credit, real estate lending, securities holding, corporate lending and so on. If the regulators decide on the total value of assets and their risk, they effectively micro manage bank decisions on risk and return. Managers would only implement regulatory criteria with little decision power on how best to reward shareholder capital. Regulators would mandate maximum assets and their risk distribution by leverage, credit and liquidity regulation. There are two concerns on the regulation of how big a bank should be. First, there is the issue of best practice in bank management and its consequences for financing prosperity. Banking is characterized by declining costs because of bulky fixed investments required for initiation of lines of business (Pelaez and Pelaez, Regulation of Banks and Finance, 82-9, Financial Regulation after the Global Recession, 63-9). There has been a new industrial/technological revolution in the past three decades centered on information technology (IT). Banking is highly intensive in the creation, processing, transmission and decision use of information. The first transaction of a $100 million IT facility costs $100 million but the hundred millionth costs only one dollar. Competitive banking requires a large volume of transactions to reach the minimum cost of operations. At the time of the call report for the implementation of Basel II in 2006, 11 banking organizations had total assets of $4.6 trillion, equivalent to 44 percent of total US banking assets of $10.5 trillion, and about $978 billion in foreign assets, equivalent to 96 percent of US foreign banking assets of $1 trillion (Pelaez and Pelaez, Globalization and the State: Vol. II, 147). Concentration likely increased during the credit/dollar crisis and its reversal by regulation could cause another confidence shock. The regulation of how big a bank should be would disrupt investment in the best practice of using technology and delivery of products at lowest cost by US banking organizations. It would also undermine the competitiveness of US banks in international business, violating the essential principle of the Basel capital accords of maintaining fair competitive international banking. Second, the regulation of how big a bank should be is based on an inadequate interpretation of the credit crisis/global recession. The panic of confidence in financial markets is commonly attributed to the failure of Lehman Bros. in September 2008. Cochrane and Zingales have shown that the crisis of confidence originated in the proposal of the Troubled Asset Relief Program (TARP) of $700 billion two weeks after the failure of Lehman Bros. TARP was proposed in negative terms of: withdraw "toxic" assets from bank balance sheets of banks or there would be an economic catastrophe similar to the Great Depression. Counterparty risk perception rose sharply because of fear of banking panics, paralyzing sale and repurchase transactions and causing illiquidity of multiple market segments. The "toxin" was introduced by zero interest rates in 2003-4 that induced high leverage and risk, low liquidity and imprudent credit together with the purchase or guarantee of $1.6 trillion of nonprime mortgages by Fannie and Freddie on the good faith and credit of the US. Regulatory micro management of the volume and structure of risk of banks and financial markets will weaken banks, reducing the volume of credit required for steering the world economy from currently low levels of activity. It will also restructure markets with arbitrary concession of monopolistic power to less efficient banks, creating vulnerabilities to new crises. There is need for less intrusive regulation that induces a sustainable path of prosperity, using effectively the staff, expertise and resources of existing regulatory agencies.

Chart I-16, US, Deposits, Loans and Leases in Bank Credit, Cash Assets and Treasury and Agency Securities in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, Monthly, 1973-2016, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

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

Chart I-16A, Deposits, Loans and Leases in Bank Credit, Cash Assets and Treasury and Agency Securities in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, Monthly, 1995-2016, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

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

CMP Associates Regulation Blog

Followers

Blog Archive

About Me

Sunday, August 28, 2016

No comments:

Post a Comment