Global Economic Slowing, Stimulus/Policy Doubts and Financial Turbulence

Global Economic Slowing, Stimulus/Policy Doubts and Financial Turbulence

Carlos M Pelaez

This post relates the slowing global economy to doubts on stimulus and structural policy shocks and financial turbulence. The global economic slowdown is discussed in (I) and deceleration of US growth in (II). Stimulus doubts are analyzed in (III). Financial turbulence is considered in (IV) and interest rates in (V). A brief conclusion is in (VI). If you have difficulty in viewing the tables and illustrations go to: http://cmpassocregulationblog.blogspot.com/

I Global Economic Slowdown. There is growing concern but only limited information of deceleration of the major regions in the world economy.

GDP growth rates may not capture the growth concerns because quarterly growth combines both earlier more rapid growth and only a tail of possible deceleration in 2Q10. Table 1 provides quarterly rates of growth of GDP in the past four quarters seasonally adjusted (SA) relative to the prior quarter and not-seasonally adjusted (NSA) relative to the same quarter in the prior year. The deceleration is more evident in the case of the US that jumped ahead of the other major advanced economies but began to decelerate earlier. The strength of recovery of the euro zone is significantly caused by the dynamism of the German economy that jumped 2.2 percent in 2Q10 and 3.7 percent relative to a year earlier.

Table 1, Quarterly Rates of Growth of GDP %

SA from Prior Quarter                               NSA from Prior Year

	3Q09	4Q09	1Q10	2Q10	3Q09	4Q09	1Q10	2Q10
Euro Zone	0.4	0.1	0.2	1	-4.1	-2.1	0.6	1.7
Germany	0.7	0.3	0.5	2.2	-4.4	-2	2	3.7
France	0.3	0.6	0.2	0.6	-2.7	-0.5	1.2	1.7
USA	0.4	1.2	0.9	0.6	-2.7	0.2	2.4	3.2
Japan	0.1	1.1	1.2	na	-4.9	-1.4	4.2	na

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-13082010-BP/EN/2-13082010-BP-EN.PDF

There appears to be deceleration of industrial growth in the euro area in Jun relative to better performance in prior months with stronger performance in Germany than in the rest of the members of the euro area and the European Union. Industrial production in the euro area dropped 0.1 percent in Jun 2010 relative to May 2010 after increasing by 1.1 percent in May relative to Apr. In the 12 months ending in Jun 2010 industrial production grew by 8.2 percent in the euro area (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-12082010-AP/EN/4-12082010-AP-EN.PDF ). Germany’s industrial production dropped 0.5 percent from Jun relative to May but after increasing 3.3 percent in May, 1.1 percent in April and 2.6 percent in Mar. In the 12 months ending in Jun 2010, German industrial production grew 11.5 percent after 13.5 percent in May and 14.7 percent in Apr. France’s industrial production dropped 1.6 percent in Jun 2010 relative to May 2010 after increasing 1.9 percent in May and declining 0.4 percent in Apr. In the 12 months ending in Jun 2010, France’s industrial production grew 4.8 percent, declining from 8.5 percent in the prior two months. There were 23.1 million people unemployed in the European Union in Jun of whom 15.8 million in the euro area. The rate of unemployment of the euro area increased from 9.5 percent in Jun 2009 to 10.0 percent in Mar 2010, remaining at that level in Apr, May and Jun (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/3-30072010-AP/EN/3-30072010-AP-EN.PDF ).

Growth of world trade is critical in economic growth and reduction of unemployment. World recovery was apparently proceeding adequately as shown by excellent export data. Euro zone SA exports grew by 5.2 percent in Jun relative to May and imports by 4.3 percent (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/6-13082010-AP/EN/6-13082010-AP-EN.PDF ). Exports suggest strong world demand and imports rising internal demand. NSA exports of the euro area in Jan-Jun 2010 grew by 18 percent relative to the same period in 2009, which was also the rate of growth of imports.

The economy of China is also showing some signs of possible slowdown. The July trade surplus was $28.7 billion, higher than $20 billion in Jun. However, the rate of growth of exports fells from 43.9 percent in Jun to 38.1 percent in Jul and the rate of increase of imports fell from 34.1 percent in Jun to 22.7 percent in Jul, raising the possibility of less dynamic internal demand. The prices of houses in China’s 70 largest cities did not change relative to June and the yearly rate of increase fell from 11.4 percent in Jun to 10.3 percent in July (http://www.ft.com/cms/s/0/0d5d0d32-a43f-11df-abf7-00144feabdc0.html ). There were mild declines in yearly rates in Jul relative to Jun: industrial output growth fell from 13.7 in Jun to 13.4 percent in Jul, urban fixed asset investment from 25.5 percent in Jun to 24.9 percent in Jul and retail sales 17.9 percent in Jul relative to 18.3 percent in Jun. The consumer price index in China rose to 3.3 percent on a year-on-year basis (http://www.ft.com/cms/s/0/98f852a0-a4fa-11df-8d8c-00144feabdc0.html

http://www.stats.gov.cn/english/newsandcomingevents/t20100811_402664373.htm ). GDP growth eased from year-on-year growth of 11.9 percent in the first quarter to 11.1 percent in the second quarter (http://www.stats.gov.cn/english/statisticaldata/Quarterlydata/ ).

II Deceleration of US Growth. This section considers the information obtained from economic indicators that are released monthly or weekly. The subsections analyze the trade deficit (II A), manufacturing and sales (II B), unemployment (II C) and consumer prices (II D).

II A Trade Deficit. The indicator that perhaps influenced markets the most was the trade deficit equal to: (exports of goods and services) less (imports of goods and services). Exports of goods and services in Jun were $150.5 billion and imports $200.3 billion for a trade deficit of $49.9 billion, which is much higher than the May revised trade deficit of $42.0 billion. In Jan-Jun 2010, the trade deficit reached $247.5 billion, much higher by $76.6 billion than $170.9 billion in Jan-Jun 2009. The trade deficit rose by $22.8 billion from Jun 2009 to Jun 2010, with exports rising by $22.6 billion or 17.7 percent and imports by $45.3 billion or 29.2 percent. However, exports of goods and services fell by $2.0 billion or 1.3 percent from $152.4 billion in May and imports grew by $5.9 billion or 3.0 percent from $194.4 billion in May. The increase in imports of goods from May to June was across many categories: $3.1 billion in consumer goods, $1.3 billion in automotive vehicles, parts and engines, $0.6 billion in other goods and $0.5 billion in capital goods. The increase in imports of goods from Jun 2009 to Jun 2010 was also across many categories: $12.8 billion in industrial supplies and materials, $9.3 billion in automotive vehicles, parts and engines, $9.1 billion in capital goods, $9.0 billion in consumer goods and others (http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf ). There are two issues relating to the trade deficit: (1) the downward impact of the trade deficit in the revision of GDP growth; and (2) the deteriorating external imbalance of the US.

First, the much higher trade deficit for Jun may lower the revised second estimate of the 2Q10 GDP growth rate to be released by the Bureau of Economic Analysis (BEA) on Aug 27. The apprehension in the market is about a sharp downward revision. Gross Domestic Product or GDP “measures the value of final goods and services produced in the United States” at market prices (http://www.bea.gov/national/pdf/nipa_primer.pdf ). The accounting identity of GDP identifies “the final goods and services purchased by persons, business, government, and foreigners” (Ibid, 4):

GDP = C + I + G + (X-M) = C + I + G + B           (1)

C is consumption, I investment, G government spending, X exports of goods and services, M imports of goods and services and B is the trade balance or difference of X less M. Consumption, which represents about 70 percent of GDP in the US, is measured as personal consumption expenditures (PCE) of goods and services by households and nonprofit institutions serving households. Investment is measured as gross private domestic investment, consisting of “purchases of fixed assets (equipment, software, and structures) by private business that contribute to production and have a useful life of more than one year, of purchases of homes by households, and of private business investment in inventories” (Ibid, 8). Exports are goods and services that US residents transfer or sell overseas. Imports must be deducted as “the value of imports is already included in the other expenditure components of GDP, because market transactions do not distinguish the source of goods and services. Therefore, imports must be deducted in order to derive a measure of total domestic output” (Ibid, 8). Thus, imports have a negative sign in equation (1). Government measures expenditures and gross investment by Federal, state and local government.

The BEA provides SA changes in GDP from a quarter to the prior quarter converted to the equivalent annual percentage rate. Table 2 second row, “Total,” provides the BEA estimates of GDP as SA quarterly gross rates of GDP in annual equivalent percentage rates. Market participants were already concerned that GDP grew mostly because of changes in inventories instead of by private investment and PCEs or actual internal demand. Growth rates of GDP are lower than in the first four quarters in past recessions with persistent job stress of 27 million persons and the rate for 2Q10 of 2.4 percent could signal deceleration of growth of the economy. The remaining rows below Total provide the breakdown of the growth rates in percentage point contributions  by the various sectors. The row “net exports” of goods and services is the contribution in percentage points by the trade balance or in this case trade deficit of exports of goods and services less imports of goods and services. In 2Q10, the trade deficit was responsible for a decrease of the growth rate of GDP of 2.78 percentage points. The revised estimate for 2Q10 to be released on Aug 27 will include the sharp trade deficit in Jun and may lower the growth rate of GDP. The hopeful sign in GDP growth was an increase in spending on equipment and software in 2Q10 at the inflation-adjusted rate of 21.9 percent, following 20.4 percent in the first quarter. There are doubts if this investment is mainly because of business replacing depreciated equipment and implementing previously postponed plans to increase efficiency instead of deliberate increases in production and hiring (http://professional.wsj.com/article/SB10001424052748704164904575421403221676016.html?mod=wsjproe_hps_LEFTWhatsNews

). The revision of 2Q10 GDP growth could consolidate the view of a declining growth rate that will not alleviate job stress in weak US labor markets.

Table 2, Percentage Point Contributions to the Growth Rate of GDP

Segment	3Q09	4Q09	1Q10	2Q10
Total	1.6	5.0	3.7	2.4
PCE	1.41	0.69	1.33	1.15
Gross Investment	1.22	2.7	3.044	3.14
Fixed Investment	0.12	-0.12	0.39	2.09
Change Inventories	1.1	2.83	2.64	1.05
Net Exports	-1.37	1.9	-0.31	-2.78
Gov	0.33	-0.28	-0.32	0.88

Source: http://bea.gov/national/nipaweb/TableView.asp?SelectedTable=2&FirstYear=2009&LastYear=2010&Freq=Qtr

Second, the trade deficit of the US improved significantly in 2009 but has deteriorated in 2010. The external imbalance of the US could place a growth constraint because of the need for simultaneous adjustment of an unsustainable internal debt and a deteriorating net international investment position or external indebtedness (on external imbalance in the US see Pelaez and Pelaez, International Financial Architecture, The Global Recession Risk and Globalization and the State, Vol. II, 182-210, Government Intervention in Globalization, 167-81).

II B Manufacturing and Sales. Short-term indicators continue to show weakness in sales and manufacturing. Sales of merchant wholesalers fell by 0.7 percent in Jun relative to May after declining by 0.5 percent in May relative to Apr but were higher by 12.9 percent from the level in Jun 2009 (http://www2.census.gov/wholesale/pdf/mwts/currentwhl.pdf ). Retail and goods services sales rose by 0.4 percent in Jul relative to Jun and stood 5.5 percent higher than in Jul 2009. The May/Apr estimate was lowered from -0.5 percent to -0.3 percent. The increase in sales was mostly due to an increase in motor vehicles and parts of 1.6 percent. Sales excluding motor vehicles and parts grew by only 0.2 percent from Jun to Jul after falling 0.1 percent from May to Jun (http://www.census.gov/retail/marts/www/marts_current.pdf ). The combined value of distributive trade sales and manufacturers’ shipment, adjusted for seasonal factors and differences in trading days, fell by 0.6 percent from May to Jun 2010, standing 9.2 percent above Jun 2009. Manufacturers’ and trade inventories rose by 0.3 percent from May into Jun because of declining sales (http://www.census.gov/mtis/www/data/pdf/mtis_current.pdf ).

II C Unemployment. The job market continues to show significant weakness when compared to sharp growth of GDP and employment creation after past sharp contractions. The information from the initial weekly claims for unemployment insurance is continuing job stress. In the week ending on Aug, SA initial claims for unemployment insurance rose by 2000 to reach 484,000 over the prior week’s revised number of 482,000. The four-week moving average rose by 14,250 to reach 473,500 relative to the prior week’s 459,250. The SA initial claims were 557,000 a year ago but have stabilized around 450,000 since the beginning of the year. NSA initial claims rose by 18,862 from 402,135 in the week of Jul 31 to 420,997 in the week of Aug 7. NSA initial claims stood at 564.500 a year ago (http://www.dol.gov/opa/media/press/eta/ui/current.htm ). There is important analysis and data in a must-read essay by Henry Olsen in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052748704388504575419280283794598.html ). The unemployment rate increased from 9.4 percent in Jul 2009 to 10.1 percent in Oct 2009, declining to 9.5 percent in Jul 2010 but the percentage of the adult noninstitutional (or civilian) population having a job declined steadily from 59.3 percent in Jul 2009 to 58.4 percent in Jul 2010 (http://www.bls.gov/web/empsit/cpseea3.pdf ). Olsen argues that the unemployment rate measures those without a job who are actively seeking one but the civilian employment/population ratio is superior in detecting job stress because it measures the percentage of people with a job irrespective of whether they are searching for one. In a good economy more people search for jobs but a bad economy discourages job searches. Growth of the population requires more jobs for adults. A traumatic aspect of job stress is that the percent of employment of the civilian population ages 16 to 19 fell from 37.9 percent in Jul 2009 to 34.6 percent in Jul 2010 (http://www.bls.gov/web/empsit/cpseea3.pdf ). The media is full of anecdotal information of hard times with retirees returning to the labor force and competing with teenagers who are just beginning to seek a place in society. The civilian employment/population ratio was slightly above 63 percent in 2007 such that the decrease to 58.4 percent in Jul 2010 with 238 million working-age noninstitutionalized civilians leads to the conclusion that 12 million jobs were lost (http://professional.wsj.com/article/SB10001424052748704388504575419280283794598.html ). This drama conflicts with the design and claims that the stimulus “saved” or created millions of jobs. In the upswing after the recession of 1979-82, the employment ratio jumped from 57 to 63 percent in 1990. The policy shift requires focus on promoting the proper incentives for rapid job creation by the private sector (Ibid).

II D Consumer Prices.The SA consumer price index rose by 0.3 percent in Jul from Jun. The NSA adjusted increase in the 12 months ending in Jul was 1.2 percent (http://www.bls.gov/news.release/pdf/cpi.pdf ).

III Stimulus. The Federal Open market Committee (FOMC) on Aug 10 states that “the pace of economic recovery is likely to be more modest in the near term than had been anticipated” (http://www.federalreserve.gov/newsevents/press/monetary/20100810a.htm ). The FOMC maintained the fed funds target of 0 to 0.25 percent and stated that “economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period” (Ibid). In the effort to ensure recovery with price stability the FOMC “will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature” (Ibid). Variations of this policy together with the eventual need for unwinding the Fed’s balance sheet were revealed by the FOMC minutes of the Jun meeting (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20100623.pdf ). Theoretical and empirical research develops a policy of quantitative easing or increases in the balance sheet of the central bank and its concentration in long-term securities to lower long-term interest rates (http://www.federalreserve.gov/pubs/feds/2004/200448/200448pap.pdf see Pelaez and Pelaez, The Global Recession Risk, 95-107, Pelaez and Pelaez, Regulation of Banks and Finance, 224-7, Financial Regulation after the Global Recession, 157-62). The value of the current balance sheet of the Fed is $2.3 trillion with a portfolio of $1.99 trillion of long-term securities, consisting of $712 billion of Treasury notes and bonds, $1119 billion of mortgage-backed securities and $159 billion of Federal agency debt securities (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1 ). Quantitative easing can be interpreted as injecting huge amounts of bank reserves by purchasing long-term securities that could lead to lowering long-term interest rates as portfolios are rebalanced toward long-term fixed income securities, causing a decrease in their prices equivalent to lower yields. Policy would flatten the yield curve with long-term yields dropping toward the zero fed funds rate. This policy is almost identical to that before the credit crisis. The Fed lowered the fed funds rate to 1 percent in Jun 2003 and maintained it at that level with the forward guidance that it would remain at low levels indefinitely and kept it at 1 percent until Jun 2004. Treasury suspended the issue of 30-year bonds from 2001 to 2005 with the intention similar to quantitative easing of channeling duration-matching funds in pension funds from 30-year Treasuries to investment in mortgage-backed securities that would raise the price, equivalent to lowering the yield, to attain the elusive flat curve with all yields close to the zero bound. The $201 billion yearly subsidy of housing ensured continuing investment in long-term mortgage-backed securities. Fannie and Freddie jumped into the policy of affordable housing for all and purchased or guaranteed $1.6 trillion of nonprime mortgages. Monetary policy created the illusion of selling a put on wealth or equivalently a ceiling on interest rates. The combination of these policies eroded calculations of risk and return, increasing leverage, decreasing liquidity by encouraging financing of everything in overnight sale and repurchase agreements and mispricing credit and rate risk, causing the credit 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 repeated policy of fed funds interest rates of 0 to 0.25 percent combined with 11 credit facilities at the Fed and the more observable $2.3 trillion Fed balance sheet did not prevent another Great Depression and may have complicated world financial stability with the carry trade from zero US interest rates by shorting the dollar and simultaneously taking long positions in high-yielding currencies, commodity futures and equities (Pelaez and Pelaez, Globalization and the State, Vol. II, 203-4, Government Intervention in Globalization, 70-4). The instability of oil prices rising to $149/barrel and then collapsing below $60/barrel and fluctuating financial variables may have cancelled any beneficial effects of exotic monetary policy based on weak state of the art in analysis of current economic conditions and forecasting the future. Boldness is not an assurance of success. There is a new element of uncertainty that dooms bold monetary stimulus. Even if fiscal and monetary stimulus were successful in a different environment, they would fail in the present one because attempts to increase demand by stimulus are offset by uncertainty of business and households resulting from inopportune legislative restructuring of business models, regulatory shocks and mandates. The credit volume-reducing and rate-increasing effects of the Dodd-Frank financial regulation act cloud every business and personal decision with suffocating uncertainty on interest rates and access to credit. Monetary and fiscal stimulus only contributes to worse expectations about future increases in taxes and interest rates that can slow down spending and the economy by exacerbating uncertainty in financial and economic decisions.

IV Financial Turbulence. Financial turbulence is increasing again as a result of the doubts on the world economy and global financial markets. Table 3 provides a summary of turbulence in stocks, commodities, the dollar and Treasury yields. The columns provide the dates of the recent peaks and troughs of financial variables and the percentage change from recent peak to trough, peak to Aug 13 and change in the week ending on Aug 13. Equities indexes fell in all major stock exchanges with the Global Dow losing 4.2 percent. The dollar appreciated to $1.276/euro, reversing the depreciation of earlier weeks. Commodity prices fell and oil trended toward $75/barrel. The 10-year Treasury collapsed to 2.679 percent partly because of the use of highly-rated fixed income as safe haven in the flight out of risk exposures; perhaps the expectation of further quantitative easing also caused decline in yields.

Table 3, Stocks, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	% Trough	% 8/13	Week 8/13
DJIA	26-Apr	2-Jul	-13.6	-8.0	-3.3
S&P 500	23-Apr	2-Jul	-16	-11.3	-3.8
NYSE Fin	15-Apr	2-Jul	-20.3	-15.1	-5.3
Dow Global	15-Apr	2-Jul	-18.4	-12.4	-4.2
Asia Pacific	15-Apr	2-Jul	-12.5	-7.8	-3.5
Shanghai	15-Apr	2-Jul	-24.7	-17.6	-1.9
Europe STOXX	15-Apr	2-Jul	-15.3	-7.7	-0.4
Dollar	25-Nov	25-Jun	22.3	18.6	4.1
USB Com	6-Jan	2-Jul	-14.5	-8.5	-1.9
10 Year T	5-Apr	6-Aug	3.986	2.679

Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=topnav_2_3004

V Interest Rates. The US yield curve shifted downwardly with the 10-year Treasury declining to 2.68 percent from 2.82 percent a week earlier and 2.97 percent in the prior month (http://markets.ft.com/markets/bonds.asp?ftauth=1281886564580 ). Risk exposures moved also to the safe haven of the 10-year government bond of Germany that traded at 2.39 percent equivalent to a negative spread of 29 basis points relative to the comparable Treasury.

VI Conclusion. Monetary and fiscal stimulus merely causes expectations of future increases in taxes and interest rates. A policy shift encouraging growth and job creation by the private sector will be more effective in promoting wellbeing. There is significant value in the explanation of why there is not more hiring by the owner of a business employing 83 persons in New Jersey. The cost of hiring a high-school graduate, “Sally,” employed for 15 years in this entrepreneur’s business, is $74,000 per year of which the employee “Sally” receives gross pay of $59,000 and net pay after deductions of $44,000 (http://professional.wsj.com/article/SB10001424052748704017904575409733776372738.html

). The exotic stimulus and legislative restructurings and regulation ignore that their short-run effects are denying many people like this entrepreneur the opportunity to thrive in an innovative knowledge business and people like “Sally” the opportunity to enter into formal society with a high-school degree and millions of other people like “Sally” who lost their jobs and cannot find another one. The alleged long-term benefits of the restructurings cannot be measured but the short-term employment costs and personal stress are staggering. (Go to http://cmpassocregulationblog.blogspot.com/ http://sites.google.com/site/economicregulation/carlos-m-pelaez)

http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10 )