©Carlos M. Pelaez, 2010
The US Policy Challenge of 27 Million Persons in Job Stress and the “Helicopter Drop of Money”
Carlos M. Pelaez
This comment relates the policy challenges of the US, in particular the job stress of 27 million persons, to the policy of quantitative easing by the Fed, consisting of buying long-term securities to lower their yields in an effort to induce increases by the private sector in physical capital, houses, consumer durables and the like. The contents are as follows:
I 26.6 Million Persons in Job Stress
II US Policy Challenge
III Quantitative Easing Two
IV Intended Effects of Quantitative Easing
V Actual Effects of Quantitative Easing
VI Global Devaluation War
VII Economic Indicators
VIII Interest Rates
IX Conclusion
References
I 26.6 Million Persons in Job Stress. There are 26.6 million persons in job stress in the US in Oct composed of: 14.8 million unemployed (of whom 6.2 million unemployed for 27 weeks or longer or 41.8 percent of total unemployed), 9.2 million “employed part-time for economic reasons” (because their hours were reduced or could not find a full-time job) and 2.6 million “marginally attached to the labor force” (who are not part of the labor force but are willing and available for work and had looked for employment in the past 12 months) (http://www.bls.gov/news.release/pdf/empsit.pdf). 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 and then remaining at 9.6 percent in the three months Aug to Oct. However, 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, 58.5 percent in Aug and Sep and 58.3 percent in Oct (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, 35.2 percent in Aug, 34.2 percent in Sep and 35.2 percent in Oct (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).
Total nonfarm payroll employment seasonally adjusted (SA) rose by 151,000 in Oct and private payroll employment rose by 159,000. Table 1 provides the monthly change in jobs in the prior strong contraction of 1981-1982 and the recovery in 1983 and in the contraction of 2008-2009 and in the recovery in 2009-2010. There is significant bias in the comparison. The civilian noninsitutional population was 174.2 million in 1983 and the civilian labor force 111.6 million, growing by 2009 to a civilian noninstitutional population of 235.8 million and civilian labor force of 154.1 million, that is, increasing by 35.4 percent and 38.1 percent, respectively (http://www.bls.gov/cps/cpsaat1.pdf). What is striking about the data in Table 1 is that the numbers of monthly increases in jobs in 1983 are several times higher than in 2010 even with population higher by 35.4 percent and labor force higher by 38.1 percent in 2010 relative to 1983 nearly three decades ago. Professor Michael Boskin of Stanford, former Chairman of the CEA, provides analysis of growth in cyclical expansions in an article for the Wall Street Journal (http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html ). The critical historical perspective is that average quarterly rates of growth in the expansions after a severe recession were incomparably higher than during the current expansion: 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, 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter in 1983 and only 3 percent in the first four quarters and 2.9 percent forecast in the first 12 quarters after the trough in the third quarter of 2009. GDP grew at the SA quarter-on-quarter yearly-equivalent rate of 1.7 percent in 2Q2010 and 2.0 percent in 3QQ2010. Growth has been mediocre in the five quarters of expansion beginning in 3Q2009 in comparison with earlier expansions and also in terms of what is required to reduce the job stress of 26.6 million persons.
Table 1, Monthly Change in Jobs, Number 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 | -1 | 143 |
| Sep | -87 | -181 | 1144 | 271 | -225 | -41 | 107 |
| Oct | -100 | -277 | 271 | -554 | -224 | 151 | 159 |
| 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
Important aspects of growth of payroll jobs from Oct 2009 to Oct 2010, not seasonally adjusted (NSA), are provided in Table 2. Total nonfarm employment increased by 626 thousand, consisting of growth of total private employment by 947 thousand and decline by 321 thousand of government employment. Manufacturing employment increased by 69 thousand while private service providing grew by 938 thousand. An important feature is that jobs in temporary help services increased by 377 thousand. Temporary help services rose by 451.000 since the low in Sep 2009 (http://www.bls.gov/news.release/pdf/empsit.pdf%202).
Table 2, Employees in Nonfarm Payrolls Not Seasonally Adjusted in Thousands
| Oct 2009 | Oct 2010 | Change | |
| A Total Nonfarm | 130,889 | 131,515 | 626 |
| B Total Private | 107,996 | 108,943 | 947 |
| B1 Goods Producing | 18,353 | 18,362 | 9 |
| B1a Manufacturing | 11,674 | 11,743 | 69 |
| B2 Private service providing | 89,643 | 90,581 | 938 |
| B2a Temporary help services | 1,921 | 2,298 | 377 |
| C Government | 22,893 | 22,572 | -321 |
Note: A = B+C, B = B1 + B2
Source: http://www.bls.gov/news.release/pdf/empsit.pdf
II US Policy Challenge. The main challenge of policy is providing effective relief from job stress to 26.6 million people. There are six aspects of the policy challenge. First, the National Bureau of Economic Research (NBER) provides reference dates for beginning and end of recessions in traditional and valuable research and analysis. The NBER finds that the recession began in Dec 2007 and ended in Jun 2009 (http://www.nber.org/cycles/sept2010.html). There is still significant weakness in real estate, employment and confidence similar to levels during the recession. In the first nine months of 2005 the annual rate of housing starts NSA was 1,649,999 (http://www.census.gov/const/newresconst_200509.pdf Table 1). In the first nine months of 2010 the annual rate of housing starts NSA was 464,800 (http://www.census.gov/const/newresconst_201009.pdf Table 1). The decline in housing starts between Sep 2010 and Sep 2005 is 71.8 percent, a number with magnitude rarely found in physical data. The annual rate of new house sales NSA in the first nine months of 2005 was 995,000 (http://www.census.gov/const/newressales_200509.pdf Table 1, 2). The annual rate of new house sales NSA in the first nine months of 2010 was 257,000 (http://www.census.gov/const/newressales.pdf Table 1, 2). The decline in new house sales between Sep 2010 and Sep 2005 is 74.2 percent. Foreclosure problems and weak employment markets are adding to the difficulty in recovering the real estate sector. The job stress of 26.6 million persons is frustrating consumption, production and investment. Business and consumer confidence has not recovered from the low levels during the recession in the same way as in other expansions. Second, demand in the form of investment and consumption is not recovering as rapidly as in past cyclical expansions with resulting low rates of GDP growth. Third, the monetary policy of zero interest rates and the experiment with quantitative easing created a duration trap of long-term debt securities such that expectations of rapidly rising rates in an improving economy could slow future growth. Fourth, fiscal policy of increasing expenditures to 24.7 percent of GDP while revenue declined to 14.8 percent of GDP in 2009 created record deficits and debt/GDP ratios since World War II (http://www.cbo.gov/ftpdocs/112xx/doc11231/frontmatter.shtml). The expectation of future tax increases has added to the uncertainty, frustrating growth of investment and consumption. Fifth, profound legislative restructurings and regulation disrupted business models with resulting frustration of investment decisions and hiring. The minutes of the Federal Open Market Committee (FOMC) contain the following statement: “A number of participants reported that business contacts again indicated that uncertainty about future taxes, regulation and health care costs made them reluctant to expand their workforces. Instead, business had continued to meet growth in demand for their products largely through productivity gains and by increasing existing employees’ hours” (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20100810.pdf).
III Quantitative Easing Two. The diagnosis of the FOMC in its statement of Nov 3 is of a weak economy in which employers are “reluctant to add to payrolls” together with stable long-term expectations and declining trend of underlying inflation in recent quarters (http://www.federalreserve.gov/newsevents/press/monetary/20101103a.htm). Section 2A of the Federal Reserve Act mandates the FOMC to maintain maximum employment and price stability (http://www.federalreserve.gov/aboutthefed/section2a.htm). The FOMC decided to implement two policy measures to comply with its dual mandate. First, the FOMC “will maintain the target range for the federal funds rate at 0 to ¼ percent” and issued guidance that economic conditions “are likely to warrant exceptionally low levels for the federal funds rate for an extended period” (Ibid). Second, the FOMC decided to implement another round of quantitative easing with the intention of purchasing “a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month” (Ibid). There is also an open-ended flexibility in the new program of quantitative easing: “the Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability” (Ibid). The Open Market Trading Desk of the Federal Reserve Bank of New York (FRBNY) estimates that the reinvestment from the current level of the portfolio of long-term securities in the Fed balance sheet will be between $250 billion and $350 billion by the second quarter of 2011. The total purchases by the Desk at the FRBNY will amount to $850 to $900 billion at the “average purchase pace of roughly $110 billion per month, representing about $75 billion per month associated with additional purchases and roughly $35 billion per month associated with reinvestment purchases” (http://www.newyorkfed.org/markets/opolicy/operating_policy_101103.html). The Desk also provides the distribution in percentages of the purchases from Treasuries with maturity ranging from 1 ½ years to 30 years and also 1 ½ to 30 years of TIPS (Treasury Inflation Protected Securities). Based on the planned distribution “the Desk anticipated that the assets purchased will have an average duration of between 5 and 6 years” (Ibid).
IV Intended Effects of Quantitative Easing. There are two approaches to quantitative easing. First, the intended effect of quantitative easing is to increase aggregate demand by large scale purchases of long-term securities in order to reduce long-term interest rates that can increase aggregate demand by increasing investment in physical capital goods. The momentous contribution of James Tobin (1969) provides a framework for analyzing these intended effects. This framework analyzes the determination of market-clearing rates of returns and volumes in the capital accounts of economic units, sectors and the economy as a whole. The model specifies the determinants of the demand and supply of these assets and how prices of assets and rates of return clear markets. Money is one of the assets and the commercial banking system one of many sectors. National wealth is the sum of private total wealth plus net government debt, obtained by summing the columns of assets in a balance sheet of the economy. Tobin’s q variable is the ratio of the market value of capital to the reproduction cost of capital. The concept of capital extends to houses, plants, equipment, durable goods and others (Tobin 1969, 29). Money, M, in Tobin’s complete model of money, physical capital, securities and banks is “high-powered money,” consisting of currency held by the public and reserves of commercial banks at the Fed. Tobin derives the sensitivity of q to M as ∂q/∂M > 0, that is, an increase in base money, M, causes an increase in q, which is the price of the market value of capital to its reproduction cost. Current production and asset accumulation increase (see also Pelaez and Suzigan 1978, 120-3). According to Tobin (1969, 25-6): “the essential characteristic is that the interest on money is exogenously fixed by law or convention, while the rate of return on securities is endogenous, market determined. If the roles of the two assets in this respect were reversed, so also would be the economic impacts of changing their supplies. The way for the central bank to achieve an expansionary monetary impact would be to buy money with securities!” The effect of an increase in the supply of an asset with non-fixed rate is a change in its own rate of return. When the rate of return is determined exogenously, as in the case of outside money, the adjustment is by changes in the rates of return of other assets or equivalently their prices. Large scale purchases of securities, or quantitative easing, inject high-powered money or bank reserves in exchange for withdrawal of the supply of duration-rich bonds, reducing their rates of return or increasing their prices. The intended effect is to lower the reproduction cost of capital, or long-term borrowing costs, such that Tobin’s q or its expectation increases, augmenting the demand for physical assets such as plant, equipment, houses, durables goods and the like.
Second, in contrast to monetary policy in the form of open market purchases of public debt, “a Friedman-style ‘helicopter drop of money’ would be considered a combination of fiscal and monetary policy, as it involved a capital transfer from the monetary authority to the recipients” (Buiter and Panigirtzoglou 2003, 725; see Buiter 2004). Using a general equilibrium model, Buiter (2003, 46) finds that “the monetary-fiscal policy combination that always succeeds in stimulating aggregate demand” is “the tax cut financed by printing money.” The “helicopter drop of money” is merely a parable used by Friedman (1969) to consider an exogenous increase in money in a model in which the optimal amount of money is that resulting in a zero nominal interest rate. With expenditures at a historical peacetime high of 25 percent of GDP, tax reduction financed by helicopter drop may not be an option.
V Actual Effects of Quantitative Easing. There have been two rounds of unconventional monetary policy in fear of a liquidity trap of threat of deflation when the nominal interest rate is zero and monetary policy does not increase output and employment. In the first round, the Fed lowered the interest rate to 1 percent in Jun 2003 and left it at that level until Jun 2004. A type of quantitative easing consisted of suspending the auction of 30-year Treasuries with the objective of rebalancing portfolios to match long-term liabilities with 30-year mortgage-backed securities such as in matching benefit liabilities and income from assets in retirement plans and annuities. The intended effect besides refinancing mortgages was lowering long-term borrowing costs to induce increases in acquisition of capital assets such as houses, plant, equipment, durable goods and others. The housing subsidy of $221 billion per year and the purchase or guarantee of $1.6 trillion of nonprime mortgages by Fannie Mae and Freddie Mac with leverage of 75:1 augmented the stimulus of monetary policy to build more houses than warranted by the availability of creditworthy buyers. Private capital accounts or wealth in the Tobin (1969) model swelled. Economic agents interpreted the stimulus to be permanent, creating the expectation that the Fed had issued an illusory put option or floor on wealth. The result of this first round of near-zero interest rates and housing stimulus was to distort the calculation of risks and returns by households, business and government. The belief in a floor on wealth induced high leverage, excessive risk, minimum liquidity because of its high opportunity cost or foregone yield and unsound credit decisions that caused the credit/dollar crisis and global recession (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).
The consequences of the global hunt for yields induced 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, jump in the Nikkei Average by 131.2 percent between 2003 and 2007, rise in the STOXX Europe 50 index of 93.5 percent in 2003-2007, and increase in the UBS commodity index by 165.5 percent in 2002-2008. Zero or near zero interest rates induced 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 (2009b), 203-4, Government Intervention in Globalization (2009c), 70-4). The 10-year Treasury traded at 3.112 percent on Jun 16, 2003, rising to 5.297 percent on Jun 12, 2007, collapsing to 2.247 percent 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. Central bank policy induced the financing of nearly everything with short-dated funding at very low interest rates. When year-end consumer price inflation rose from 1.9 percent in 2003 to 3.3 percent in 2004, 3.4 percent in 2005, 2.5 percent in 2006 and 4.1 percent in 2008 (ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt), the FOMC increased the target on the fed funds rate by 17 consecutive rounds of 25 basis points in meetings from Jun 2004 to Jun 2006, raising the rate from 1 percent to 5.25 percent. The combination of short-term zero interest rates, similar effects to quantitative easing by suspending the auction of 30-year Treasuries and housing subsidy caused a worldwide hunt for yields that ended in a world financial crash, global recession and serious distortions in risk/return calculations.
| DJIA | 10/08/02- 10/01/07 | 10/01/07- 3/4/09 | 3/4/09- 4/6/10 | |
∆% | 87.8 | -51.2 | 60.3 | |
| NYSE Financial | 1/15/04- 6/13/07 | 6/13/07- 3/4/09 | 3/4/09- 4/16/07 | |
∆% | 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 | |
∆% | 442.2 | -70.8 | 85.3 | |
| Nikkei Average | 5/01/03- 2/23/07 | 2/23/07- 3/06/09 | 3/06/09- 4/01/10 | |
∆% | 131.3 | -60.6 | 56.8 | |
| 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 Com. | 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 | 6/10/03 | 6/12/07 | 12/31/08 | 4/5/10 |
∆% | 3.112 | 5.297 | 2.247 | 3.986 |
| USD/EUR | 7/14/08 | 6/07/10 | 8/13/10 | |
| Rate | 1.59 | 1.192 | 1.323 | |
| New House | 1963 | 1977 | 2005 | 2009 |
| Sales 1000s | 560 | 819 | 1283 | 375 |
| New House | 2000 | 2007 | 2009 | 2010 |
| Median Price $1000s | 169 | 247 | 217 | 203 |
Sources: http://online.wsj.com/mdc/page/marketsdata.html
http://www.census.gov/const/www/newressalesindex_excel.html
The second round of unconventional monetary policy is ongoing with the fed funds target rate at 0 to ¼ percent and a Fed balance sheet moving toward $3 trillion. The critical issue in the second round of quantitative easing is that it is attempting to increase the capital accounts of the private sector that is unwilling to invest, consume and take risks because of the legislative restructurings, regulation and expected increases in taxes and interest rates. The hunt for yields is resulting in devaluation of the dollar relative to the euro by 17.7 percent since Jun 7, 2010 while nearly every financial asset has increased by high double-digit percentages, shown in Table 4. After two months of statements by members of the FOMC that further “action” would be needed, markets were expecting more unconventional measures after the election of Nov 2. There are two distinct features of the new round of unconventional monetary policy: (1) the Fed apparently favors a symmetric inflation target that would require increasing inflation toward 2 percent per year as measured by the core PCE index; and (2) purchases of securities are being evaluated periodically in FOMC meetings. Lowering long-term returns on financial assets may eventually conflict with an unexpected annualized inflation above “1.99” percent. What happens if inflation is reported in a month at an annual-equivalent rate of 4.5 percent? When year-end consumer price inflation rose from 1.9 percent in 2003 to 3.3 percent in 2004, 3.4 percent in 2005, 2.5 percent in 2006 and 4.1 percent in 2008 (ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt), the FOMC increased the target on the fed funds rate by 17 consecutive rounds of 25 basis points in meetings from Jun 2004 to Jun 2006, raising the rate from 1 percent to 5.25 percent while the 10-year Treasury jumped from 3.112 on Jun 6 2003 to 5.297 percent on Jun 12, 2007. The symmetric inflation target has created a duration trap of substantial principal losses in high-duration portfolios or a dangerous “exit strategy” for quantitative easing.
Table 4, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% to 11/5 | ∆% Week 11/5 | ∆% T to 11/5 | |
| DJIA | 4/26/10 | 7/2/10 | -13.6 | 2.1 | 2.9 | 18.1 |
| S&P 500 | 4/23/10 | 7/20/10 | -16.0 | 0.7 | 3.5 | 19.9 |
| NYSE Finance | 4/15/10 | 7/2/10 | -20.3 | -6.7 | 5.0 | 17.2 |
| Dow Global | 4/15/10 | 7/2/10 | -18.4 | 0.0 | 3.3 | 22.6 |
| Asia Pacific | 4/15/10 | 7/2/10 | -12.5 | 5.5 | 3.9 | 20.4 |
| Japan Nikkei Average | 4/05/10 | 8/31/10 | -22.5 | -15.5 | 4.6 | 9.1 |
| China Shanghai | 4/15/10 | 7/2/10 | -24.7 | -1.1 | 5.1 | 31.3 |
| STOXX Europe 50 | 4/15/10 | 7/2/10 | -15.3 | -3.9 | 2.5 | 13.4 |
| DAX | 4/26/10 | 5/25/10 | -10.5 | 6.7 | 2.3 | 19.1 |
| Dollar EUR | 11/25 2009 | 6/7 2010 | 21.2 | 7.3 | -0.6 | -17.7 |
| DJ UBS Comm. | 1/6/10 | 7/2/10 | -14.5 | 5.6 | 4.0 | 23.6 |
| 10-Year Treasury | 4/5 2010 | 10/29 2010 | 3.986 | 2.539 |
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://online.wsj.com/mdc/page/marketsdata.html
VI Global Devaluation War. Research by the Federal Reserve Bank of St. Louis finds that the dollar declined on average by 6.56 percent in the events of quantitative easing, ranging from depreciation of 10.8 percent relative to the Japanese yen to 3.6 percent relative to the pound sterling (http://research.stlouisfed.org/wp/2010/2010-018.pdf). A critical assumption of Rudiger Dornbusch in his celebrated analysis of overshooting (http://www.imf.org/external/np/speeches/2001/kr/112901.pdf) is “that exchange rates and asset markets adjust fast relative to goods markets” (Rudiger Dornbusch 1976, 1162). The market response of a monetary expansion is “to induce an immediate depreciation in the exchange rate and accounts therefore for fluctuations in the exchange rate and the terms of trade. During the adjustment process, rising prices may be accompanied by an appreciating exchange rate so that the trend behavior of exchange rates stands potentially in strong contrast with the cyclical behavior of exchange rates and prices” (Ibid, 1162). The volatility of the exchange rate “is needed to temporarily equilibrate the system in response to monetary shocks, because underlying national prices adjust so slowly” (http://www.imf.org/external/np/speeches/2001/kr/112901.pdf 3). The exchange rate “is identified as a critical channel for the transmission of monetary policy to aggregate demand for domestic output” (Dornbusch, op. cit., 1162). The question in (3) above is whether the fact of quantitative easing will reverse part of the devaluation of the dollar that has already occurred. Table 4 shows sharp appreciation of many currencies relative to the dollar. Senior officials of major exporting countries in the G20 such as Brazil, China and Germany complain of the effects of US quantitative easing in appreciating their currencies (http://professional.wsj.com/article/SB10001424052748704353504575596203544367856.html?mod=wsjproe_hps_LEFTWhatsNews). An agreement with China on adjusting global imbalances is less likely because of exchange rate policy confrontation (http://www.ft.com/cms/s/0/03567a28-e8a3-11df-a383-00144feab49a.html#axzz14YAEdh5O). Dollar devaluation would fit the policy intentions of the Fed of raising inflation toward the symmetric 2 percent inflation target while also stimulating net exports to stimulate economic activity and employment. In fact, the Fed may find that devaluation of the dollar causes the desired inflation together with employment creation via export growth. Chairman Bernanke finds dollar devaluation against gold to have been important in preventing further deflation in the 1930s (http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm):
“There have been times when exchange rate policy has been an effective weapon against deflation. A striking example from US history is Franklin Roosevelt’s 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the US deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market”
Table 5, Exchange Rates
| Peak | Trough | ∆% P/T | Nov 5 2010 | ∆% T Nov 5 | ∆% P Nov 5 | |
| EUR USD | 7/15 2008 | 6/07 2010 | 11/5 2010 | |||
| Rate | 1.59 | 1.192 | 1.394 | |||
| ∆% | -33.4 | 15.0 | -13.3 | |||
| JPY USD | 8/18 2008 | 9/15 2010 | 11/5 2010 | |||
| Rate | 110.9 | 83.07 | 80.37 | |||
| ∆% | 24.6 | 2.2 | 26.3 | |||
| CHF USD | 11/21 2008 | 12/8 2009 | 11/5 2010 | |||
| Rate | 1.225 | 1.025 | 0.984 | |||
| ∆% | 16.3 | 6.2 | 21.5 | |||
| USD GBP | 7/15 2008 | 1/2/ 2009 | 11/5 2010 | |||
| Rate | 2.006 | 1.388 | 1.604 | |||
| ∆% | -44.5 | 14.2 | -23.9 | |||
| USD AUD | 7/15 2008 | 10/27 2008 | 11/5 2010 | |||
| Rate | 0.979 | 0.601 | 0.983 | |||
| ∆% | -62.9 | 40.8 | 3.5 | |||
| ZAR USD | 10/22 2008 | 8/15 2010 | 11/5 2010 | |||
| Rate | 11.578 | 7.238 | 6.985 | |||
| ∆% | 37.5 | 6.5 | 41.5 | |||
| SGD USD | 3/3 2009 | 8/9 2010 | 11/5 2010 | |||
| Rate | 1.553 | 1.348 | 1.293 | |||
| ∆% | 13.2 | 4.7 | 17.3 | |||
| HKD USD | 8/15 2008 | 12/14 2009 | 10/29 2010 | |||
| Rate | 7.813 | 7.752 | 7.75 | |||
| ∆% | 0.8 | 0.01 | 0.8 | |||
| BRL USD | 12/5 2008 | 4/30 2010 | 10/29 2010 | |||
| Rate | 2.43 | 1.737 | 1.702 | |||
| ∆% | 28.5 | 3.5 | 31.0 | |||
| CZK USD | 2/13 2009 | 8/6 2010 | 11/5 2010 | |||
| Rate | 22.19 | 18.693 | 17.628 | |||
| ∆% | 15.7 | 6.5 | 21.3 | |||
| SEK USD | 3/4 2009 | 8/9 2010 | 11/5 2010 | |||
| Rate | 9.313 | 7.108 | 6.667 | |||
| ∆% | 23.7 | 6.9 | 29.0 |
Symbols: USD: US dollar; EUR: euro; JPY: Japanese yen; CHF: Swiss franc; GBP: UK pound; AUD: Australian dollar; ZAR: South African rand; SGD: Singapore dollar; HKD: Hong Kong dollar; BRL: Brazil real; CZK: Czech koruna; SEK: Swedish krona; 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
VII Economic Indicators. The rate of growth of industry is strengthening again while personal income weakened, consumer credit continues to decline and employment markets are weak. Personal income declined by 0.1 percent in Sep and inflation-adjusted disposable income fell 0.3 percent while personal consumption expenditures (PCE) rose by 0.2 percent and by 0.1 percent in real terms. The PCE price index excluding food and energy, used by the Fed, increased less than 0.1 percent in Sep after increasing 0.1 percent in Aug (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm). The purchasing managers index (PMI) for industry of the ISM increased by 2.5 to 56.9 with excellent increases of new orders by 7.8 to 58.9 and of production by 6.2 to 62.7 (http://www.ism.ws/ISMReport/MfgROB.cfm). PMI indexes were also strong in China, Euro Zone, Germany, the UK and other countries (http://blogs.wsj.com/economics/2010/11/02/world-wide-factory-activity-by-country-10/). The ISM nonmanufacturing index rose by 1.1 to 54.3, business activity/production by 5.6 to 58.4 and new orders by 1.8 to 56.7 (http://www.ism.ws/ISMReport/NonMfgROB.cfm). New orders for all manufacturing industries in the first nine months of 2010 NSA increased 13.0 percent relative to the same period in 2009 and 15.1 percent for durable goods industries (http://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf). Initial jobless claims SA for the week ending in Oct 30 were 457,000, increasing by 20,000 over the previous week (http://www.dol.gov/opa/media/press/eta/ui/current.htm). Jobless claims have fluctuated at a high level around 450,000 throughout 2010. The index of pending home sales of the National Association of Realtors, a forward looking indicator, fell 1.8 percent based on contracts signed in Sep (http://www.realtor.org/press_room/news_releases/2010/11/phs_slips). Consumer credit fell at an annual rate of 1.5 percent in the third quarter with revolving credit falling at 8.75 percent and non-revolving credit increasing at 2.5 percent. Consumer credit rose at the annual rate of 1 percent in Sep (http://www.federalreserve.gov/releases/g19/Current/).
VIII Interest Rates. The 10-year yield at 2.54 percent was lower on Nov 5 than 2.62 percent a week earlier but higher than 2.4 percent a month before. The 10-year government bond of Germany was 2.41 percent for a negative spread of only 13 basis points relative to the comparable Treasury (http://markets.ft.com/markets/bonds.asp). The Treasury with coupon of 2.63 percent maturing on 08/20 traded on Nov 5 at a price of 100.73 or equivalent yield of 2.54 percent (http://markets.ft.com/ft/markets/reports/FTReport.asp?dockey=GOV-051110). That bond would settle for price of 89.1005 on Nov 8 if the yield were to back up to 3.986 percent traded on Apr 5 for a loss of 11.5 percent, illustrating the risks for bond markets of quantitative easing. If the yield were to back up to 5.297 percent traded on Jun 12, 2007, as shown in Table 2, the price for settlement on Nov 8 would be 79.8374 for a loss of 20.7 percent.
IX. Conclusion. The elegant theory of Tobin (1969) finds that increases in base money, currency held by the public and reserves of banks deposited at the Fed, causes increases in Tobin’s q, or the market value of capital relative to its reproduction cost. The private sector would try to obtain higher market value by acquiring plant, equipment, houses and consumer durables and so on, increasing aggregate demand, growth of GDP and employment creation. The first round of quantitative easing and near-zero interest rates in 2003-2004 caused a global hunt for yields that was an important factor in the credit/dollar crisis and global recession. The current round of quantitative easing and zero interest rates is provoking similar global hunt for yields but is running against adverse expectations in the private sector because of legislative restructurings, regulation and expectations of increases in taxes and interest rates that may prevent the intended increase in growth and employment. The duration trap of the symmetric 2 percent inflation target may prevent an orderly exit strategy of the swollen Fed balance sheet moving toward $3 trillion (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 )
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Pelaez, Carlos M. and Carlos A. Pelaez. 2008b. Globalization and the State: Vol. II. Basingstoke: Palgrave Macmillan. http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10
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Pelaez, Carlos M. and Carlos A. Pelaez. 2009b. Regulation of Banks and Finance. Basingstoke: Palgrave Macmillan.http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10
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©Carlos M. Pelaez, 2010
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