Subpar Growth with Unemployment, Quantitative Easing Inducing Global Yield Hunt and World Devaluation War

 

Subpar Growth with Unemployment, Quantitative Easing Inducing Global Yield Hunt and World Devaluation War

Carlos M Pelaez

Continuing subpar growth with unemployment is discussed in (I) followed by analysis of quantitative easing inducing global yield hunt in (II), the ongoing world devaluation war in (III), economic indicators in (IV), interest rates in (V) and the conclusion in (VI). If you have difficulty in viewing the tables and illustrations go to: http://cmpassocregulationblog.blogspot.com/).

I Subpar Growth with Unemployment. The current “upswing” from the credit/dollar crisis and global recession is characterized by subpar growth relative to the recent sharp contractions in 1957-1959, 1973-1975 and 1979-1982 (see earlier post of Aug 8, Jobs, Growth and the Stimulus, for the contractions of 1957 and 1973 http://cmpassocregulationblog.blogspot.com/search?updated-max=2010-08-29T09%3A01%3A00-07%3A00&max-results=7). The sharp contraction of 1981-1982 was followed by sharp growth in 1983 with GDP growing at 5.1 percent in 1Q83, 9.3 percent in 2Q83, 8.1 percent in 3Q83 and 8.5 percent in 4Q83, as shown in Table 1. The first four quarters of expansion 2009-2010 have been mediocre in comparison and characterized not by an increase in consumption and production, or demand, but by changes in inventories. This subpar performance has been labeled recovery without “vigor” (http://www.federalreserve.gov/newsevents/speech/bernanke20100924a.htm).

 

Table 1, Quarterly Growth Rates of GDP, % Annual Equivalent SA

Quarter	1981	1982	1983	2008	2009	2010
I	8.6	-6.4	5.1	-0.7	-4.9	3.7
II	-3.2	2.2	9.3	0.6	-0.7	1.7
III	4.9	-1.5	8.1	-4.0	1.6
IV	-4.9	0.3	8.5	-6.8	5.0

Source: http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=1&Freq=Qtr&FirstYear=2008&LastYear=2010 

 

The key consequence of this lack of economic “vigor” is persistent job stress for 26.8 million persons: 14.8 million unemployed (of which 6.1 million for 27 weeks and over, or 41.2 percent of the unemployed), 9.5 million involuntary part-time workers who had their hours cut back or cannot find a full-time job and 2.5 million persons “marginally attached to the labor force” who wanted and were available for work and had search for a job in the past 12 months (http://www.bls.gov/news.release/pdf/empsit.pdf

). Another measurement is the unemployment population ratio, or number of persons in the noninstitutional or civilian population of working age who actually have a job, which has remained at 58.5 percent. While in the past three sharp contractions in the postwar period in 1957, 1973 and 1982 heavy losses during GDP contraction were followed by sharp rises in jobs created, the current “upswing” is characterized by inadequate job creation. The data of the establishment survey of the Bureau of Labor Statistics (BLS) are shown in Table 2 for the contraction and upswing of 1981-1983 and the current experience 2008-2010. The not seasonally adjusted (NSA) data for the BLS in 2010 show total nonfarm employment of 130,564,000 in Sep 2010 almost equal to 130,243,000 in Sep 2009, or a gain of 321,000 jobs and private nonfarm employment of 108,510,000 in Sep 2010 relative to 107,964,000 in Sep 2009 or a gain of 546,000 jobs or growth by 5.1 percent. The seasonally adjusted (SA) data of the establishment survey of the Bureau of Labor Statistics (BLS) are shown in Table 2 for the contraction and upswing of 1981-1983 and the current experience 2008-2010. The comparison of 1983 and 2010 in total change of nonfarm payrolls is partly distorted by the hump in the series for the temporary hiring and subsequent layoff of workers for Census 2010. The private sector monthly data for 2010 in the last column of Table 2, updated with the latest estimates and revisions, shows unusually weak job creation by business, which is the consequence of recovery without “vigor.” Individual information provides evidence that employers are reluctant to add full-time employees, resorting to part-time hiring (http://professional.wsj.com/article/SB10001424052748703927504575540410327958280.html?mod=wsjproe_hps_LEFTWhatsNews

). The World Economic Outlook of the IMF finds that “unemployment remains a major economic and social challenge. More than 210 million people across the globe may be unemployed, an increase of more than 30 million since 2007. Three-fourths of the increase has occurred in advanced economies” (http://www.imf.org/external/pubs/ft/survey/so/2010/RES100610A.htm ). The number of unemployed in the US in Aug 2007 was 7.088 million, increasing to 14.759 million in Aug 2010 (http://data.bls.gov/PDQ/servlet/SurveyOutputServlethttp://data.bls.gov/PDQ/servlet/SurveyOutputServlet). These data suggest that the US has 7 percent of the number of unemployed in the world, with population of only about 4.6 percent of world population (Pelaez and Pelaez, Globalization and the State, Vol. I, Table 1.2, 10 with population data from the World Bank), and the increase in unemployed of 7.7 million in the US is about 25.7 percent of the increase in unemployed of the world. The overall US economy contains a major social trauma in the form of about 27 million people in job stress and evidently without immediate relief, which is testing the limits of existing capacity in bridging these people to better times through the social and health safety net.

 

Table 2, Monthly Change in Jobs, Numbers SA

Month	1981	1982	1983	2008	2009	2010	Private
Jan	95	-327	225	-10	-779	14	16
Feb	67	-6	-78	-50	-1266	39	62
Mar	104	-129	173	-33	-213	208	158
Apr	74	-281	276	-149	-528	313	241
May	10	-45	277	-231	-387	432	51
Jun	196	-243	378	-193	-515	-175	61
Jul	112	-343	418	-210	-346	-66	117
Aug	-36	-158	-308	-334	-212	-57	93
Sep	-87	-181	1114	271	-225	-95	64
Oct	-100	-277	271	-554	-224
Nov	-209	124	352	-728	64
Dec	-278	-14	356	-673	-109

Source: http://data.bls.gov/PDQ/servlet/SurveyOutputServlet

http://www.bls.gov/schedule/archives/empsit_nr.htm#2010

http://www.bls.gov/news.release/pdf/empsit.pdf 

 

II Quantitative Easing Inducing Global Yield Hunt. The employment report for Sep appears to have sealed a second round of quantitative easing. The objective function of money managers is to maximize the returns of the funds under management subject to control of risks to preserve principal. There are multiple tools of risk management that are all subject to the uncertainty of predicting financial variables with which to project cash flows and returns on investment toward the future and then discount them to present value by use of an appropriate rate of discount. Investors are constantly calculating the risks and returns of their positions to adjust them to new information or views on the future. Economic policy in the United States during the current decade has been dominated by efforts to prevent deflation using two tools: (1) near zero fed funds rates; and (2) quantitative easing. When fed funds rates are at the “zero bound,” or almost at zero, the Fed can still ease money by quantitative easing. The Fed can inject bank reserves by expanding its balance sheet with the purchase of long-term Treasuries or other securities. The policy focus is on the quantity of reserves and not on the fed funds rate (Ben Bernanke and Vincent Reinhart, Conducting monetary policy at very low short-term interest rates, AER 92 (2004), 87, cited in Pelaez and Pelaez, Regulation of Banks and Finance, 224). Quantitative easing injects reserves that can result in rebalancing of portfolios by investors which increases prices of alternative long-term securities (Bernanke and Reinhart op.cit. 88). Investment and economic activity could be stimulated by lower long-term interest rates. Increasing reserves over what is needed can also create expectations on the willingness of the Fed in maintaining quantitative easing until improvement of the economy. There are substantial hurdles of implementation and communication of quantitative easing but the policy advice for central bankers is acting “preemptively and aggressively to avoid facing the complications raised by the zero lower bounds” (Bernanke and Reinhart op cit. 90). Innovation in central banking as in other economic activities is always productive but as with all new tools of policy there are operational hurdles even with optimistic empirical analysis (Bernanke, Reinhart and Sack, Monetary policy alternatives at the zero bound: an empirical assessment, BPEA 2004, cited with other literature on Japan in Pelaez and Pelaez, Regulation of Banks and Finance, 224, The Global Recession Risk, 95-107, and for more recent work on the current US experience see http://www.newyorkfed.org/research/staff_reports/sr441.pdf).

The Fed lowered its target rate of fed funds from 6.50 percent on May 16, 2000, to 6.00 percent on Jan 3, 2001, and then lowered the target continuously to 1.00 percent on Jun 25, 2003, raising the target by 25 basis points during 17 consecutive meetings of the Federal Open Market Committee (FOMC) beginning with a rate of 1.25 percent on Jun 30, 2004, and ending with 5.25 percent on Jun 29, 2006. The FOMC then lowered the target fed funds rate to 4.75 percent on Sep 18, 2007, and continued lowering aggressively until fixing it at 0 to 0.25 percent on Dec 16, 2008 (http://www.federalreserve.gov/monetarypolicy/openmarket.htm ). Quantitative easing in the first movement toward the zero bound with the target rate of 1 percent in Jun 2003 was in the form of the suspension of the issue of the 30-year Treasury for five years after 2001 with the objective of rebalancing portfolios of pension funds and similar investments with higher weight of 30-year mortgage-backed securities. The purchase of long-term mortgage-backed securities increased their prices or equivalently lowered their yields, leading to refinancing of mortgages that injected more funds to households in after-mortgage payments income than tax reductions. Fed policy during the credit crisis was not fundamentally different in principle with the fed funds rate lowered actually to 0 to 0.25 percent and quantitative easing in the form of aggressively expanding the balance sheet of the Fed. On Oct 6, the Fed balance sheet had credit of $2.3 trillion; the total Fed-owned portfolio of long term securities was $1.98 trillion composed of $752 billion of Treasury notes and bonds, $154 billion of federal agency debt securities and $1078 billion of mortgage-backed securities; and reserve balances at the Federal Reserve Banks were $997 billion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1 ). A measure of aggregate economic activity in the US, GDP, is about $14.8 trillion in 2010. The Fed balance sheet is about 15.5 percent of GDP and another trillion would bring it to 22.3 percent of GDP. The purchase by the Fed of $1.7 trillion in assets between Dec 2008 and Mar 2010 represented 22 percent of the outstanding $7.7 trillion of agency, MBS and Treasuries. In a different measurement, the Fed purchased $850 billion of 10-year equivalents in the three asset classes that represented more than 20 percent of $3.7 trillion outstanding (http://www.newyorkfed.org/research/staff_reports/sr441.pdf). The purchase of another trillion could bring the Fed purchases to more than 30 percent of 10-year equivalents in various asset classes. There may not be a painless exit from the bloated Fed balance sheet.

The intentions of policy have differed with their actual consequences. The intention of the Fed in lowering rates to zero or near zero percent is to stimulate investment, consumption, production and employment. The stimulus of monetary policy works by providing nearly unlimited amounts of credit at close to zero interest rates for short-dated funds and at long-term rates below what they would have been without quantitative easing in an effort of flattening the yield curve. The consequences 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. The Fed distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. The policy has been inspired by fear of deflation. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the structured investment vehicles (SIV) created off-balance sheet to issue short-term commercial paper to purchase risky 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). Adjustable-rate mortgages (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 perceived risk because the Fed 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. The housing subsidy of $221 billion per year created the impression of ever increasing house prices. 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 Fed put option on wealth, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the Fed put on wealth 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 consequences of the global hunt for yields created by monetary and housing policy are shown in Table 3. The second column shows a dramatic rise of 87.8 percent in the Dow Jones Industrial Average (DJIA) from 2002 to 2007, a more modest increase in the NYSE financial index of 42.3 percent in 2004-2007, an increase in the Shanghai Composite index of 444.2 percent in 2005-7, a rise in the STOXX Europe 50 index of 93.5 percent in 2003-2007, and an increase in the UBS commodity index by 165.5 percent in 2002-2008. The zero or near zero interest rates fostered significant volatility by the carry trade from low yielding currencies into fixed income, commodities, currencies, emerging stocks and any type of speculative position such as the price of oil rising to $149/barrel in 2008 during a global contraction (Pelaez and Pelaez, Globalization and the State, Vol. II, 203-4, Government Intervention in Globalization, 70-4). The 10-year Treasury traded at 3.112 percent on Jun 16, 2003, rising to 5.297 on Jun 12, 2007, collapsing to 2.247 on Dec 31, 2008 and rising to 3.986 percent on Apr 5, 2010. New house sales peaked historically at 1,283,000 in 2005, declining to 375,000 in 2009 while the median price jumped from $169,000 in 2000 to $247,000 in 2007 to fall to $203,000 in Jul 2010. The other two columns show the decline of risk financial assets during the credit crisis and the incomplete current recovery. The combination of short-term zero interest rates, quantitative easing and housing subsidy caused a worldwide hunt for yields that ended in a world financial crash and serious distortions in risk/return calculations.

 

Table 3, Volatility of Assets

DJIA	10/08/02- 10/01/07	10/01/07- 3/4/09	3/4/09- 4/16/10
∆%	87.8	-51.2	60.3
NYSE Financial	1/15/04- 6/13/07	6/13/07- 3/4/09	3/4/09- 4/16/10
∆%	42.3	-75.9	121.1
Shanghai Composite	6/10/05- 10/15/07	10/15/07- 10/30/08	10/30/08- 7/30/09
∆%	444.2	-70.8	85.3
STOXX Europe 50	3/10/03- 7/25/07	7/25/07- 3/9/09	3/9/09- 4/21/10
∆%	93.5	-57.9	64.3
UBS Commodity	1/23/02- 7/1/08	7/1/08- 2/23/09	2/23/09- 1/6/10
∆%	165.5	-56.4	41.4
10-Year Treasury	6/16/03	6/12/07	12/31/08	4/5/10
%	3.112	5.297	2.247	3.986
Dollar/euro	7/14/08	6/03/10	8/3/10
USD/EUR	1.59	1.216	1.323
New House	1963	1977	2005	2009
Sales 1000s	560	819	1283	375
New House	2000	2007	2009	2010
Median Price $1000	169	247	217	203

Sources: http://online.wsj.com/mdc/page/marketsdata.html

http://www.census.gov/const/www/newressalesindex_excel.html

 

In an article for the Financial Times on the Bernanke put, Michael Mackenzie and David Oakley perceptively capture the investors’ mantra of not going opposite the Fed with its trillion-dollar liquidity injections, observing that the dollar is collapsing while everything else, such as the Thai baht, UK gilt, gold, crude prices and whatever, is rising (http://www.ft.com/cms/s/0/c0c362a6-d304-11df-9ae9-00144feabdc0.html). Sovereign risk doubts in Europe are continuing; skepticism of double-digit growth of GDP in China still exists; and US economic data show weak economic conditions and persistent unemployment. Temporarily, risk exposures are divorced from economic performance to take advantage of perhaps another trillion dollars of bank reserves injected by the Fed via purchases of long-term securities. Table 4 shows the sharp rally of almost everything with the exception of the collapsing dollar. Is there a stealth devaluation target of monetary policy to promote economic growth by increasing exports? Or is it just a convenient side effect? Perhaps it could even be justified by the Fed’s objective of full employment and price stability, which in this case is avoiding deflation and unemployment. Equity markets have risen with full “vigor” from the trough on early July for double-digit increases in three months; commodities have rallied with oil venturing above $82/barrel; the 10-year Treasury dropped from 3.986 percent on Apr 5 to 2.396 percent on Oct 8 for a price increase of about 15 percent; while the dollar has dropped 14.5 percent from Jun 25, as shown in Table 4. A part of the rally in financial variables, with worldwide carry trade of shorting the dollar while borrowing short term at US near-zero interest rates, is caused by the expectation of quantitative easing.

 

Table 4, Stocks, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% to 10/08	∆%Week 10/08	∆% T to 10/8
DJIA	4/26/10	7/2/10	-13.6	-1.7	1.6	13.6
S&P 500	4/23/10	7/2/10	-16.0	-4.3	1.6	13.9
NYSE Financial	4/15/10	7/2/10	-20.3	-10.1	1.7	12.8
Dow Global	4/15/10	7/2/10	-18.4	-4.3	2.3	17.3
Asia Pacific	4/15/10	7/2/10	-12.5	1.9	2.2	16.5
Shanghai	4/15/10	7/2/10	-24.7	-13.5	3.1	14.9
STOXX Europe	4/15/10	7/2/10	-15.3	-7.3	1.4	9.5
Dollar	11/15 /10	6/25/10	22.3	8.5	-1.2	-14.5
DJ-UBS Comm.	1/6/10	7/2/10	-14.5	-0.4	3.8	16.5
10-Year Treasury	4/5/10	4/6/10	3.986	2.396

T: trough

Source: http://online.wsj.com/mdc/page/marketsdata.html

 

Another part of the frenzy in risk markets is related to the uncertainty in business observed by Richard W. Fisher, president of the Federal Reserve Bank of Dallas (http://www.dallasfed.org/news/speeches/fisher/2010/fs101007.cfm):

Business leaders I interview cite nonmonetary factors—fiscal policy and regulatory constraints or worse, uncertainty going forward—and better opportunities for earning a return on investment elsewhere as inhibiting their willingness to commit to expansion in the US. Tax and regulatory uncertainty—combined with a now well-inculcated culture of driving all resources, including labor, to their most productive use at least cost—does not bode well for a rapid diminution of unemployment and the concomitant expansion of demand. If the fiscal and regulatory authorities are able to dispel the angst that businesses are reporting, further accommodation might not even be needed. The key is to remove or reduce the tax and regulatory uncertainties that act as an impediment to businesses responding to an increase in final demand. I think most all would consider this to be a far more desirable outcome than being saddled with a bloated Fed balance sheet

The expectation of a pause in legal restructuring of business models and regulation after Nov together with the use of $3 trillion of cash by corporations in attractive consolidation opportunities by mergers and acquisitions could be driving equity markets. The pause in policy induced changes in business models may also restore confidence in business, investment and hiring decisions.

IV World Devaluation War. Based on the experience of the Great Depression, the celebrated economist Joan Robinson argues that: “in times of general unemployment a game of beggar-my-neighbour is played between the nations, each one endeavouring to throw a larger share of the burden upon the others (Joan Robinson, “Beggar-my-neighbour remedies for unemployment,” Essays in the Theory of Employment, Oxford, Basil Blackwell, 1947, 156). Devaluation is one of the tools used in these policies (Ibid, 157). There have been government interventions by national monetary authorities throughout the world to maintain the competitiveness of their currencies and complaints of foreign exchange wars. The sharp fluctuation of selected foreign exchange rates is shown in Table 5. The euro devalued by 33.4 percent relative to the US dollar from Jul 2008 to Jun 2010 but has gained 14.4 percent recently. The Japanese yen has revalued by 25.5 percent since Jun 2008. The Australian dollar is one of several “commodity currencies,” characterized by high domestic interest rate differentials and correspondingly strong foreign exchange rates, recovering from significant devaluation to about even. Commodity or high-yielding currencies receive foreign capital inflows through the carry trade, which consists of short positions on the low-yielding currency, such as the US dollar, and long positions in fixed income, commodities and emerging market stocks (Pelaez and Pelaez, Globalization and the State, Vol. II, 203-4, Government Intervention in Globalization, 70-4). Japan entered into quantitative easing in an effort to devalue the yen relative to the dollar but the effort is being frustrated by the expectations in markets of further quantitative easing in the US. The International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund (IMFC) issued a statement on Oct 8 underscoring “our strong commitment to continue working collaboratively to secure strong, sustainable and balanced growth and to refrain from policy actions that would detract from this shared goal” with one of the priorities being working “toward a more balanced pattern of global growth, recognizing the responsibilities of surplus and deficit countries” while addressing “the challenges of large and volatile capital movements, which can be disruptive” (http://www.imf.org/external/np/sec/pr/2010/pr10379.htm ). The managing director of the IMF, Dominique Strauss-Khan, warns about obstacles to the operation of the international monetary system: “tensions and risks have been building up in its operations, which manifest themselves in large official reserve accumulation, persistent global imbalances, and capital flow and exchange rate volatility” (http://www.imf.org/external/np/pp/eng/2010/100110c.pdf ). The interpretation of these statements is that there is no agreement by major countries on the world currency war (http://www.ft.com/cms/s/0/ec9e9390-d3e6-11df-a902-00144feabdc0.html

). An important proposal is to return to a framework similar to the doctrine of “shared responsibility” that originated in the Apr 2006 meeting of the IMFC (http://www.g7.utoronto.ca/finance/fm060421.htm cited in Pelaez and Pelaez, The Global Recession Risk, 8-11 and extensively analyzed in that volume; for analysis of the IMF see Pelaez and Pelaez, International Financial Architecture, Globalization and the State, Vol. II, 114-25, 192-7, Government Intervention in Globalization, 145-50). The IMF is the critical vehicle for coordination, monitoring and technical advice to avoid currency tensions and will advise policies of national adjustment without adverse repercussions in other countries (http://noir.bloomberg.com/apps/news?pid=20601087&sid=a6oYjItJmDZE&pos=1 ).

 

Table 5, Exchange Rates

	Peak	Trough	∆% P/T	10/8/10	∆% T 10/8/10	∆% P 10/8/10
EUR USD	7/15/08	6/8/10		10/8/10
Rate	1.59	1.192		1.3929
∆%			-33.4		14.4	-14.2
USD JPY	8/18/08	9/15/10		10/8/10
Rate	110.19	83.0		82.08
∆%			24.6		1.2	25.5
USD CHF	11/21 /08	12/8/09		10/8/10
Rate	1.225	1.025		0.9639
∆%			-16.3		-5.9	-21.3
GBP USD	7/15/08	1/2/09		10/8/10
Rate	2.006	1.388		1.5957
∆%			-44.5		12.9	-25.7
AUD USD	7/15/08	10/27 /08		10/8/10
Rate	0.979	0.601		0.9861
∆%			-62.9		39.1	-0.7

Symbols: USD: US dollar; EUR: euro; JPY: Japanese yen; CHF: Swiss franc; GBP: UK pound; AUD: Australian dollar; P: peak; T: trough

Note: percentages calculated with currencies expressed in units of domestic currency per dollar; negative sign means devaluation and no sign appreciation

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

 

IV Economic Indicators. Short-term economic indicators continue to show moderate expansion of the economy relative to earlier sharp contractions, which is insufficient to recover job losses. Manufacturers’ new orders SA fell 0.5 percent in Aug, following an increase by 0.5 percent in Jul but after declining 0.6 percent in Jun and falling 1.8 percent in May. Orders excluding transportation rose by 0.9 percent in Aug. Inventories rose 0.1 percent in Aug, increasing in seven of the last eight months. New orders for manufactured durable goods fell 1.5 percent in Aug after falling 1.2 percent in Jul (http://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf ). Aug sales of merchant wholesalers SA rose 0.5 percent on a monthly basis and 12.4 percent from a year earlier. Sales of durable goods rose 0.5 percent in Aug and 14.4 percent from a year earlier while nondurable goods sales increased by 0.5 percent and 10.8 percent from a year earlier. Inventories of merchant wholesalers rose 0.8 percent in Aug and 5 percent from a year earlier while durable goods inventories rose 0.6 percent in Aug and 2.3 percent from a year earlier (http://www2.census.gov/wholesale/pdf/mwts/currentwhl.pdf ). The nonmanufacturing/purchasing managers’ index of the Institute for Supply Management rose 1.7 from 51.5 in Aug to 53.2 in Sep. While the business activity/production index fell 1.6 from 54.4 in Aug to 52.8 in Sep, new orders rose by 2.5 from 52.4 in Aug to 54.9 in Sep and employment by 2 from 48.2 in Aug to 50.2 in Sep (http://www.ism.ws/ISMReport/NonMfgROB.cfm ). The Fed reported a decline of consumer credit at the annual rate of 1.75 percent in Aug, with revolving credit falling at the annual rate of 7.25 percent and nonrevolving credit increasing at the annual rate of 1.2 percent (http://www.federalreserve.gov/releases/g19/Current/ ). The pending home sales index of the National Association of Realtors, a forward-looking indicator of contracts that typically close with a two-month lag, rose by 4.3 percent in Aug and is above the Aug 2009 index by 20.1 percent (http://www.realtor.org/press_room/news_releases/2010/10/pending_show ). Initial claims of unemployment insurance SA were 445,000 in the week ending Oct 2, declining by 11,000 from 456,000 in the prior week while the four-week moving average was 455,750 for a decline of 3000 from the prior week of 458,750. Initial claims NSA fell by 1532 to 371,004 in the week of Oct relative to 372,536 in the prior week (http://www.dol.gov/opa/media/press/eta/ui/current.htm ).

V Interest Rates. The US yield curve continues to shift downwardly in expectation of quantitative easing that aims to flatten its shape. The 10-year Treasury yield fell to 2.4 percent on Oct 8 from 2.52 percent a week earlier and 2.76 percent a month before. The 10-year German government bond traded at 2.26 percent for a negative spread of only 13 basis points relative to the comparable Treasury as yields of Treasuries fell in expectation of quantitative easing. The US Treasury with coupon of 2.63 percent and maturing on 8/20 traded on Oct 8 at price of 102.13 or yield of 2.38 percent (http://markets.ft.com/ft/markets/reports/FTReport.asp?dockey=GOV-081010 ). If the yield were to back up to 3.986 percent as in Apr 6, the price for settlement on Oct 11 would be 88.9135 for a principal loss of 12.9 percent. There is a duration trap of quantitative easing in that duration, or price sensitivity of bond price to changes in yield (yield elasticity of price), is higher for low yields and coupons. An outflow of fixed income funds to equity funds because of pause in restructuring and regulation plus more mergers and acquisitions could cause major losses in fixed income positions resulting from rising yields.

VI Conclusion. The Fed appears decided on embarking in another wave of quantitative easing, using its balance sheet to purchase long-term securities with the objective of lowering their yields and stimulating consumption, investment and hiring. The earlier attempt of this policy in 2003-2004 resulted in a global hunt for yields and careless risk/return calculations that caused the credit/dollar crisis and global recession. The essential driver of the financial crisis was the pricing of risk at near zero induced by the illusory monetary policy put, or floor, on financial assets and on real assets such as housing through the fake guarantee and low cost of mortgages. The mere expectation of quantitative easing is causing portfolio reallocations worldwide with rise in returns on risk exposures in part through the carry trade of zero interest rates of the US by shorting the dollar and going long in commodities and riskier stocks. Further quantitative easing will seal the trap of duration that yield increases will result in proportionately larger declines in securities’ prices which would be magnified by fire sales in multiple classes of assets financed in sale and repurchase agreements. The world currency war is proliferating by quantitative easing that has devalued the dollar, triggering defensive purchases of all types of assets by Japan to devalue the yen. While most national exchange rate policies fail, the dollar successfully weakens and the renminbi remains relatively fixed to the dollar. Weak economic growth and employment creation create political conflicts in seeking coordination and technical advice from the international financial institutions. This environment resembles, with significant differences, the troubled world of “beggar-my-neighbor remedies” for unemployment created by uncoordinated national policies with adverse repercussions on the welfare of all nations analyzed by Joan Robinson (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 )