Jobless Recovery, 43 Million on Food Stamps, Rising Yields, Inflation and Dollar Devaluation

Jobless Recovery, 43 Million on Food Stamps, Rising Yields, Inflation and Dollar Devaluation

Carlos M. Pelaez

© Carlos M. Pelaez, 2010, 2011

The objective of this post is to analyze the jobless recovery in the US as revealed in the Bureau of Labor Statistics employment situation report, incorporating important adjustments to data, and the complex issues of monetary policy in an environment of rising yields, accelerating worldwide inflation and dollar devaluation. The contents are as follows:

I Jobless Recovery

II 43 Million on Food Stamps

III Monetary Policy

IV Rising Yields

V Inflation

VI Dollar Devaluation

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

I Jobless Recovery. Data in the employment situation report of the Bureau of Labor Statistics (BLS) for Jan 2011 (http://www.bls.gov/news.release/pdf/empsit.pdf) require careful analysis. The Commissioner of the BLS informs that (Hall 2011Jan, 3):

“There were routine annual adjustments to the data from our two surveys. The establishment survey data released today reflect the incorporation of annual benchmark revisions. Each year, we re-anchor our sample-based survey estimates to full universe counts of employment, primarily derived from administrative records of the unemployment insurance tax system. Household survey data for January reflect updated population estimates from the US Census Bureau.”

The BLS uses a “household survey” based on questionnaires of a sample of US households and an “establishment survey” based on a sample of payroll employment. The establishment survey is based on a larger sample with statistically significant estimates of month-to-month changes of employment of about 100,000 while the household survey is statistically significant for changes of about 400,000 but provides rich information on employment. Both surveys are required for thorough analysis and are among the most valuable short-term indicators of the US economy. The BLS explains the important changes made in Jan 2011 (http://www.bls.gov/news.release/pdf/empsit.pdf):

“Effective with data for January 2011, updated population estimates have been used in the household survey. Population estimates for the household survey are developed by the US Census Bureau. Each year, the Census Bureau updates the estimates to reflect new information and assumptions about the growth of the population during the decade. The population control adjustments introduced with household survey data for January 2011 were applied to the population base determined by Census 2000. The results from Census 2010 will not be incorporated into the household survey population controls until the release of data for January 2012. In accordance with usual practice, BLS will not revise the official household survey estimates for December 2010 and earlier months. The adjustment decreased the estimated size of the civilian noninstitutional population in December by 347,000, the civilian labor force by 504,000, and employment by 472,000; the new population estimates had a negligible impact on unemployment rates and most other percentage estimates.”

In addition, weather affected the data, as for example (Hall 2011Jan, 2): “construction employment continued to decline in January (-32,000). Severe weather in some parts of the country may have impacted employment and hours in this industry.” This is likely to have been the case also in several other economic activities. The conclusion is that (Hall 2011Jan, 3): “in summary, the unemployment rate declined to 9.0 percent in January, and nonfarm payroll employment changed little (+36,000).” It is possible for nonfarm payroll jobs to grow faster in Feb if weather is more benign.

The Bureau of Labor Statistics (BLS) released on Fri, Feb 4 the employment report showing a decrease in the seasonally adjusted rate of unemployment, or unemployed as percent of the labor force, from 9.4 percent in Dec 2010 to 9.0 percent in Jan 2011 (http://www.bls.gov/news.release/pdf/empsit.pdf). The number of people in job stress is 25.1 million composed of 13.9 million unemployed (of whom 6.2 million, or 43.8 percent, unemployed for 27 weeks or more), 8.4 million employed part-time for economic reasons (who suffered reductions in their work hours or could not find full-time employment) and 2.8 million who were marginally attached to the labor force (who were not in the labor force but wanted and were available for work) (Ibid, 2). The 25.1 million in job stress are not comparable relative to 26 million in Dec because of changes in population and labor force such as the decline in 600,000 in the unemployed from Dec to Jan. Additional information provides deeper insight. Table 1 consists of data and additional calculations using the BLS household survey, illustrating the possibility that the actual rate of unemployment could be 12 percent and the number of people in job stress could be closer to 30 million. The first column provides for 2006 the yearly average population (POP), labor force (LF), participation rate or labor force as percent of population (PART %), employment (EMP), the employment population ratio (EMP/POP %), unemployment (UEM), the unemployment rate as percent of labor force (UEM/LF Rate %) and the number of people not in the labor force (NLF). The numbers in column 2006 are averages in millions while the monthly numbers for Jan and Dec 2010 and Jan 2011 are in thousands, not seasonally adjusted. The average yearly participation rate of the population in the labor force was in the range of 62.0 percent minimum to 67.1 percent maximum between 2000 and 2006 with the average of 66.4 percent (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). The objective of Table 1 is to assess how many people have left the labor force because they do not think they can find another job. Row “LF PART 66.2 %” applies the participation rate of 2006, almost equal to the rates for 2000 to 2006, to the population in Jan and Dec 2010 and Jan 2011 to obtain what would be the labor force of the US if the participation rate had not changed. In fact, the participation rate fell to 64.1 percent by Dec 2010 and 63.9 percent in Jan 2011, suggesting that many people simply gave up on finding another job. Row “∆ NLF UEM” calculates the number of people not counted in the labor force because they could have given up on finding another job by subtracting from the labor force with participation rate of 66.2 percent (row LF PART 66.2%) the labor force estimated in the household survey (row LF). Total unemployed (row “Total UEM”) is obtained by adding unemployed in row “∆NLF UEM” to the unemployed of the household survey in row “UEM.” The last row is the effective total unemployed “Total UEM” as percent of the effective labor force in row “LF PART 66.2%.” The results are that: (1) there are an estimated 5.486 million unemployed who are not counted because they left the labor force on their belief they could not find another job; (2) the total number of unemployed is effectively 20.423 million and not 14.937 million of whom many have been unemployed long term; (3) the rate of unemployment is 12.9 percent and not 9.8 percent, not seasonally adjusted, or 9.0 percent seasonally annualized; and (4) the number of people in job stress is close to 30 million because of the 5.486 million leaving the labor force because they believe they could not find another job. The employment population ratio “EMP/POP %” dropped from 62.9 percent on average in 2006 to 57.6 percent in Jan 2011 and the number of employed dropped from 144 million to 137 million. There are almost six million less people working in 2011 than in 2006 and the number employed is not increasing.

Table 1, Population, Labor Force and Unemployment, NSA

	2006	Jan 2010	Dec 10	Jan 11
POP	229	236,832	238,889	238,704
LF	151	152,957	153,156	152,536
PART%	66.2	64.6	64.1	63.9
EMP	144	136,809	139,159	137,599
EMP/POP%	62.9	57.8	58.3	57.6
UEM	7	16,147	13,997	14,937
UEM/LF Rate%	4.6	10.6	9.1	9.8
NLF	77	83,876	85,733	86,168
LF PART 66.2%		156,782	158,144	158,022
∆NLF UEM		3,825	4,988	5,486
Total UEM		19,972	18,985	20,423
Total UEM%		12.7	12.0	12.9

Pop: population; LF: labor force; PART: participation; EMP: employed; UEM: unemployed; NLF: not in labor force; ∆NLF UEM: additional unemployed; Total UEM is UEM + ∆NLF UEM; Total UEM% is Total UEM as percent of LF PART 66.2%.

Note: the first column for 2006 is in average millions; the remaining columns are in thousands; NSA: not seasonally adjusted

The last four rows are calculated by applying the labor force participation of 66.2% in 2006 to current population to obtain LF PART 66.2%; ∆NLF UEM is obtained by subtracting the labor force with participation of 66.2 percent from the household survey labor force LF; Total UEM is household data unemployment plus ∆NLF UEM; and total UEM% is total UEM divided by LF PART 66.2%

Sources:

ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf

http://www.bls.gov/news.release/archives/empsit_12032010.pdf

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

Total nonfarm payroll employment seasonally adjusted (SA) rose by 36.000 in Jan and private payroll employment rose by 50,000. Revisions of Nov and Dec have increased payroll employment by about 40,000. Table 2 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. The data in the recovery periods are in relief to facilitate comparison. There is significant bias in the comparison. The average yearly civilian noninsitutional population was 174.2 million in 1983 and the civilian labor force 111.6 million, growing by 2009 to an average yearly 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 2 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 2009 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 IQ2010, 2.6 percent in IIIQ2010 and 3.2 percent in IVQ2010. Growth has been mediocre in the six quarters of expansion beginning in IIIQ2009 in comparison with earlier expansions (http://cmpassocregulationblog.blogspot.com/2010/12/economic-growth-stimulus-policy-rising.html) and also in terms of what is required to reduce the job stress of at least 25 million persons but likely close to 30 million. Some of the job growth and contraction in 2010 in Table 2 is caused by the hiring and subsequent layoff of temporary workers for the 2010 census.

Table 2, 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	-24	112
Oct	-100	-277	271	-554	-224	210	193
Nov	-209	124	352	-728	64	93	128
Dec	-278	-14	356	-673	-109	121	139
			1984			2011	Private
Jan			447			36	50

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 Jan 2010 to Jan 2011, not seasonally adjusted (NSA), are provided in Table 3. Total nonfarm employment increased by 855,000, consisting of growth of total private employment by 1,138,000 and decline by 283,000 of government employment. Monthly average growth of payroll employment has been only a mediocre 71.3 thousand. Manufacturing employment increased by 138,000 while private service providing grew by 1,178,000. An important feature is that jobs in temporary help services increased by 224,000. This episode of jobless recovery is characterized by part-time jobs.

Table 3, Employees in Nonfarm Payrolls Not Seasonally Adjusted in Thousands

	Jan 2010	Jan 2011	Change
A Total Nonfarm	127,309	128,164	855
B Total Private	104,933	106,071	1,138
B1 Goods Producing	17,206	17,296	90
B1a Manu-facturing	11,357	11,512	155
B2 Private service providing	87,727	88,775	1,048
B2a Temporary help services	1,835	2,059	224
C Government	22,376	22,093	-283

Note: A = B+C, B = B1 + B2

Source:

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

The NBER dates recessions in the US from peaks to troughs as: IQ80 to IIIQ80, IIIQ81 to IV82 and IVQ07 to IIQ09 (http://www.nber.org/cycles/cyclesmain.html). Table 4 provides total yearly nonfarm employment in the US for the 1980s and the 2000s. Nonfarm jobs rose by 4.853 million in 1982 to 1984, or 5.4 percent, and continued rapid growth in the rest of the decade. In contrast, nonfarm jobs are down by 7.779 million in 2010 relative to 2007 and fell by 988,000 in 2010 relative to 2009 even after six quarters of GDP growth. Monetary and fiscal stimuli have failed in increasing growth to rates required for mitigating job stress. Disruption of business models and decisions by onerous legislative restructuring and regulation prevented recovery of growth and employment as in earlier contractions.

Table 4, Total Nonfarm Employment in Thousands

Year	Total Nonfarm	Year	Total Nonfarm
1980	90,528	2000	131,785
1981	91,289	2001	131,826
1982	89,677	2002	130,341
1983	90,280	2003	129,999
1984	94,530	2004	131,435
1985	97,511	2005	133,703
1986	99,474	2006	136,086
1987	102,088	2007	137,598
1988	105,345	2008	136,790
1989	108,014	2009	130,807
1990	109,487	2010	129,819

Source: http://www.bls.gov/webapps/legacy/cesbtab1.htm

The highest average yearly percentage of unemployed to the labor force since 1940 was 14.6 percent in 1940 followed by 9.9 percent in 1941, 8.5 percent in 1975, 9.7 percent in 1982 and 9.6 percent in 1983 (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). The rate of unemployment remained at high levels in the 1930s, rising from 3.2 percent in 1929 to 22.9 percent in 1932 in one estimate and 23.6 percent in another with real wages increasing by 16.4 percent (Margo 1993, 43; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 214-5). There are alternative estimates of 17.2 percent or 9.5 percent for 1940 with real wages increasing by 44 percent. Employment declined sharply during the 1930s. The number of hours worked remained 29 percent in 1939 below the level of 1929 (Cole and Ohanian 1999). Private hours worked fell in 1939 to 25 percent of the level in 1929. The policy of encouraging collusion through the National Industrial Recovery Act (NIRA), to maintain high prices, together with the National Labor Relations Act (NLRA), to maintain high wages, prevented the US economy from recovering employment levels until Roosevelt abandoned these policies toward the end of the 1930s (for review of the literature analyzing the Great Depression see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 198-217). Recovery from economic contractions under various economic systems is unlikely to be promoted by hurried reforms, legislative restructurings and regulation that disturb business models.

II 43 Million on Food Stamps. The US Department of Agriculture provides support for households through its Supplemental Nutrition Assistance Program (SNAP), formerly known as food stamps. Households must meet eligibility criteria based on various tests that include resource and income tests (http://www.fns.usda.gov/snap/applicant_recipients/eligibility.htm). SNAP benefits are at $133.57 for individuals and $285.64 for households (http://www.fns.usda.gov/pd/34SNAPmonthly.htm). In fiscal year (2009), 33.5 million persons and 15.2 million households received benefits. The number of persons receiving benefits jumped to 40.4 million in fiscal year 2010, or by 20.2 percent, and then jumped again to 43.4 million, or by 7,4 percent in fiscal year 2011. The increase in the number of people receiving SNAP or food stamps between fiscal years 2009 and 2011is 29.6 percent and the cost increased from $50.5 billion in 2009 to $64.7 billion in 2010. Real Time Economics of the WSJ finds that about 14 percent of the US population received food stamps in Nov to buy groceries because of high unemployment and constrained increases in wages (http://blogs.wsj.com/economics/2011/02/05/number-of-the-week-businesses-unemployment-taxes-rise/). Prolonged unemployment is also affecting business. The share in wages of payments of employers to state unemployment-insurance funds rose 34 percent in 2010 and 37 percent when allowing for wage increases. The share of payments is below 1 percent but could be a higher proportion of profits. The WSJ finds that payments by business increase automatically with increases in the ratio of laid-off/employed labor and states have been increasing taxes. Estimates by the Office of Management and Budget show debt of state unemployment trust funds of $90 billion by 2013, compared with $3 billion in 2009 (Ibid).

III Monetary Policy. Chairman Bernanke (2011Feb3) analyzed the economic outlook and monetary policy in a speech at the National Press Club. The general view of Bernanke is that the economy has strengthened in recent months but that growth is not sufficiently strong to significantly improve labor markets. The turnaround in the economy in the form of recovery is attributed by Bernanke (2011Feb3) to the stabilization of the financial system, effects of monetary and fiscal policies and strong restocking by companies. The economy weakened allegedly because of the lower pace of restocking, reduction of fiscal stimulus and sovereign debt issues in Europe. Bernanke (2011Feb3) is more optimistic on the recovery of the economy:

“More recently we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold. Improving household and business confidence, accommodative monetary policy and more-supportive financial conditions, including an apparent increase in the willingness of banks to make loans, seems likely to lead to a more rapid pace of economic recovery in 2011 than we saw last year.”

The Fed mandate of maximizing employment is not supported by current and future conditions in labor markets (Ibid):

“While indicators of spending and production have, on balance been encouraging, the job market has improved only slowly. Following the loss of about 8 ½ million jobs in 2008 and 2009, private-sector employment showed gains in 2010. However, these gains were barely sufficient to accommodate the inflow of recent graduates and other new entrants in the labor force. With output growth likely to be moderate for awhile and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level. Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.”

The other side of the Fed dual mandate of price stability is also not attained (Ibid):

“Overall inflation remains quite low: over the 12 months ending in December, prices for all the goods and services purchased by households increased by only 1.2 percent, down from 2.4 percent over the prior 12 months. Core inflation was only 0.7 percent in 2010, compared with around 2 ½ percent in 2007.”

Chairman Bernanke (2011Feb3) classifies monetary policy into two categories. First, conventional monetary policy consisted of the fed funds target of 0 to ¼ percent determined by the Federal Open Market Committee (FOMC) at its meeting on Dec 16, 2008 (http://federalreserve.gov/newsevents/press/monetary/20081216b.htm). Second, alternative monetary policy has been in the form of the purchase of long-term securities in the value of about $1.7 trillion from Dec 2008 to Mar 2009 and an additional $600 billion after Nov 3, 2010, a policy known as quantitative easing. The channels of the two types of monetary policy are somewhat different but the final outcome is equivalent. According to Bernanke, “conventional monetary policy easing works by lowering market expectations for the future path of short-term interest rates, which in turn, reduces the current level of long-term interest rates and contributes to an easing in broader financial conditions.” Quantitative easing, or purchases of long-term securities, puts “downward pressure directly on long-term interest rates.” Easing by conventional targets of low fed funds rates or by purchases of long-term securities is designed to “encourage spending by households and business,” or aggregate demand.

The Fed has repeated twice in the decade the policy of near zero interest rates and some form of quantitative easing. First, on the basis of fear of deflation that never materialized (Bernanke 2002), the Federal Open Market Committee (FOMC) lowered the fed funds rate target to 1 percent on Jun 25, 2003 (http://federalreserve.gov/boarddocs/press/monetary/2003/20030625/default.htm) and left it at that level until Jun 30, 2004 (http://federalreserve.gov/boarddocs/press/monetary/2004/20040630/default.htm) when it began to raise it by 17 consecutive increments of 25 basis points in FOMC meetings to reach 5.25 percent on Jun 29, 2006 (http://federalreserve.gov/newsevents/press/monetary/20060629a.htm). There was an initial form of quantitative easing in the suspension of the auction of 30-year bonds by Treasury with the objective of increasing prices of mortgage-backed securities that was equivalent to reducing mortgage rates. McKinnon (20011IN, 2011CWI) explains that the 1 percent target of fed funds rates caused a carry trade from these low rates to two classes of risk assets: (i) auction-traded assets such as commodities soared in value after 2003 and the dollar collapsed in value; and (ii) US home prices increased by over 50 percent from the beginning of 2003 to mid 2006 with a building boom that spread to countries such as the UK, Spain and Ireland. The origin of the credit/dollar crisis is explained by McKinnon (2011CWI, 2) as: “the residue of bad debts, particularly ongoing mortgage defaults, led to the banking crisis and global downturn of 2008 into 2009—all too painfully known.” The now available transcripts of the FOMC meeting on Jun 29, 30, 2005, discussing a presentation on housing, reveal the comments by the Vice-Chairman of the FOMC, Timothy Geithner: “It’s worth noting, though, that these risks—from a cliff in housing prices to a sharp increase in household savings, to a larger and more sustained oil shocks, to less favorable future productivity outcomes, to a sharp increase in risk premia or to declines in asset prices—in general are risks that we can’t really mitigate substantially ex ante through monetary policy” (FOMC 2005JM, 138; see also FOMC 2005PM). Participants of the FOMC meetings in 2005 interviewed by Bloomberg find that the Fed fueled the housing boom by the slow and predictable interest rate policy that added the term “measured” to the FOMC statements as the form of reducing policy accommodation in small increments (FOMC 2005JM, 124, 155, 159, 170; see http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aMsKd2nN3.sY). At the meeting of the FOMC on Jun 29/30, 2005, FRBSF economist John C. Williams estimated with unusual anticipation that the decline of house prices by 20 percent from those prevailing at that time would “reduce household wealth by $3.6 trillion (30% of current GDP)”(FOMC 2005PM, 26). The carry trade of “buying” money at near zero riskless interest rates and shorting the dollar to invest or take long risk positions caused a gigantic valuation of risk financial assets and real estate that is shown in Table 5. McKinnon (20011CWI, 2011IN) also observes the rapid depreciation of the dollar after 2003 that is now shown in Table 5 from $1.1423 on Jun 26, 2003 (using Federal Reserve data) to 1.5914 on Jul 14, 2008 (using WSJ data confirmed by Federal Reserve data) for a cumulative devaluation of 39.3 percent. The last row shows the increase of Dec to Dec consumer price inflation (CPI) rising from 1.9 percent in 2003 to 3.4 percent in 2005 and 4.1 percent in 2007. The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4).

Table 5, Volatility of Assets

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
∆%	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 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	6/26/03	7/14/08	6/03/10	8/13/10
Rate	1.1423	1.5914	1.2126	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
	2003	2005	2007	2010
CPI	1.9	3.4	4.1	1.5

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

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

http://federalreserve.gov/releases/h10/Hist/dat00_eu.htm

ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

Second, as explained by Bernanke (2011Feb3), the Fed has maintained the fed funds rate at 0 to ¼ percent since Dec 16, 2008, and engaged in two rounds of quantitative easing. McKinnon (2011CWI, 1) finds policy in this shock as: “the Fed has set U.S. short-term interest rates at essentially zero since Sep 2008 followed in 2010 by QEs 1&2 [quantitative easing 1, Dec 2008 to Mar 2009, and 2, after Nov 3] to drive down long rates.” The result of monetary policy (Ibid, 1) is that: “just in 2010 alone, all items in The Economist’s dollar commodity price index rose 33.5 percent, while the industrial raw materials component soared a remarkable 37.4 percent.” Chairman Bernanke (2010WP) explained on Nov 4 the objectives of purchasing an additional $600 billion of long-term Treasury securities and reinvesting maturing principal and interest in the Fed portfolio. Long-term interest rates fell and stock prices rose when investors anticipated the new round of quantitative easing. Growth would be promoted by easier lending such as for refinancing of home mortgages and more investment by lower corporate bond yields. Consumers would experience higher confidence as their wealth in stocks rose, increasing outlays. Income and profits would rise and, in a “virtuous circle,” support higher economic growth. Yellen (2011AS, 6) broadens the effects of quantitative easing by adding dollar devaluation: “there are several distinct channels through which these purchases tend to influence aggregate demand, including a reduced cost of credit to consumers and businesses, a rise in asset prices that boosts household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.” There are two problems with this analysis of quantitative easing: (i) the general equilibrium model of Tobin (1969) as extended by Andrés et al (2004) consists of a set of j = 1,2,∙∙∙m portfolio balance equations for i = 1,2,∙∙∙n capital assets, A_ij = f(r, x), where r is the 1xn vector of rates of return (interest plus capital gains) r_i and x the vector of other relevant variables (Tobin 1969, 5). Fed policy chooses only three of n capital assets that can be stimulated by Fed policy, adding the last two only after quantitative easing on Nov 3, 2010: (a) long-term securities that are close substitutes of securitization of loans to lower their rates and stimulate investment and consumption of aggregate demand; (b) the US stock market to increase perceived wealth of households in the effort to increase consumption and home buying and construction; and (c) devaluation of the dollar to improve the trade account in the effort to grow the economy by net exports. In practice, the Fed cannot anticipate the carry trade from zero interest rates to the other n-3 capital assets, or actually to the entire n capital assets, including multiple risk financial assets such as auction-traded commodities, currencies and foreign stocks; and (ii) world markets for financial assets have been shocked by bouts of risk aversion resulting from sovereign risk issues in Europe; increase of inflation in China that prompts tight monetary policies that can reduce growth of the Chinese economy, affecting world financial markets, Asian economies and the world economy; and uncertainties about growth in the US in an expansion phase characterized by legislative restructurings, implementation of intrusive regulation, record deficits/government debt and increasing expectations of taxation and sharp increases in interest rates rising from zero. Zero interest rates constitute a necessary condition for higher valuations of capital assets especially risk financial assets in an upward trend, in what McKinnon calls the “Bernanke shock,” but with sharp fluctuations originating in the shocks in Europe, China and the US. A sufficient condition for the “trend is my friend” stimulus to carry trade from zero interest rates to risk financial asset valuations is subdued risk aversion from the shocks in Europe, China and the US. Investors have learned from the losses of the credit/dollar crisis or by avoiding the losses and are more cautious than before, implementing strategies of buying and rapidly realizing profits. Table 6, updated for every comment in this blog, illustrates the carry trade, which is now trading more opportunistically on a learning curve far ahead of that of the Fed. The trend observed by McKinnon resulted in a rise of valuations of risk financial assets that reached a peak in the second half of Apr. Sovereign risk issues in Europe caused significant risk aversion that lasted until early Jul, which is shown in the fourth column of Table 6, “∆% to Trough,” in sharp declines of all risk financial assets, most of which are in the n-3 segment not mentioned in policy analysis by the Fed and are traded in auction markets such as global stocks, commodities and currencies. The appreciation of the dollar by 21.2 percent shows the flight into temporary safety of dollar assets that caused a collapse of long-term yields of dollar-denominated securities such as Treasury notes and bonds. The final column, “∆% Trough to 1/21/11,” shows the trend of carry trade from zero interest rates in the US to long leveraged positions in risk financial assets all of which soared in valuations except for devaluation of the dollar by 13.9 percent after subdued sovereign risks in Europe.

Table 6, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 2/ 4/11	∆% Week 1/ 28 /11	∆% Trough to 2/ 4/11
DJIA	4/26/ 10	7/2/10	-13.6	7.9	2.3	24.8
S&P 500	4/23/ 10	7/20/ 10	-16.0	7.7	2.7	28.2
NYSE Finance	4/15/ 10	7/2/10	-20.3	-2.2	2.9	22.8
Dow Global	4/15/ 10	7/2/10	-18.4	4.8	2.3	28.5
Asia Pacific	4/15/ 10	7/2/10	-12.5	8.9	1.4	24.4
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-7.5	1.8	19.5
China Shang.	4/15/ 10	7/02 /10	-24.7	-11.6	1.7	17.5
STOXX 50	4/15/10	7/2/10	-15.3	0.2	2.2	18.3
DAX	4/26/ 10	5/25/ 10	-10.5	13.9	1.6	27.3
Dollar Euro	11/25 2009	6/7 2010	21.2	10.2	0.2	-13.9
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	13.1	1.7	32.2
10-Year Tre.	4/5/ 10	4/6/10	3.986	3.640

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.

Table 7, updated with for comment, provides percentage changes of the DJIA and S&P 500 on a weekly basis and relative to the peak around Apr 26 that was followed by the downtrend caused by sovereign risk issues in Europe. There was continued recovery after around Jul 2, interrupted again by the second round of sovereign risk issues in late Nov. The trend of risk financial assets is motivated mainly by the combination of near zero interest rates and quantitative easing by the Fed and other major central banks. Central banks do not have control of what risk financial assets are influenced by monetary policy. It is erroneous to contend that monetary policy in the US is causing the stock market boom, introduced only as a possible effect by Bernanke (2010WP) and Yellen (2011AS), without also inducing even more profitable carry trades in commodities and currencies.

Table 7, Percentage Changes of DJIA and S&P 500 in Selected Dates

2010	∆% DJIA from earlier date	∆% DJIA from Apr 26	∆% S&P 500 from earlier date	∆% S&P 500 from Apr 26
Apr 26
May 6	-6.1	-6.1	-6.9	-6.9
May 26	-5.2	-10.9	-5.4	-11.9
Jun 8	-1.2	-11.3	2.1	-12.4
Jul 2	-2.6	-13.6	-3.8	-15.7
Aug 9	10.5	-4.3	10.3	-7.0
Aug 31	-6.4	-10.6	-6.9	-13.4
Nov 5	14.2	2.1	16.8	1.0
Nov 30	-3.8	-3.8	-3.7	-2.6
Dec 17	4.4	2.5	5.3	2.6
Dec 23	0.7	3.3	1.0	3.7
Dec 31	0.03	3.3	0.07	3.8
Jan 7	0.8	4.2	1.1	4.9
Jan 14	0.9	5.2	1.7	6.7
Jan 21	0.7	5.9	-0.8	5.9
Jan 28	-0.4	5.5	-0.5	5.3
Feb 4	2.3	7.9	2.7	8.1

Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3004

IV Rising Yields. Quantitative easing is supposedly an easily reversible policy. Chairman Bernanke (2011Feb3) argues that “it bears emphasizing that we have the necessary tools to smoothly and effectively exit from the asset purchase program at the appropriate time.” On Feb 2, 2011, the line “Reserve Bank credit” in the Fed’s balance sheet stood at $2452 billion, or $2.5 trillion, with a portfolio of long-term securities of $2222 billion, or $2.2 trillion, consisting of $1061 billion of Treasury notes and bonds, $52 billion of inflation-indexed notes and bonds, $144 billion of federal agency securities and $965 billion of mortgage-backed securities, with “reserve balances with Federal Reserve Banks of $1088, or $1.1 trillion (http://federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The tools include raising interest rates paid by the Fed on deposits at the Federal Reserve Banks of $1.1 trillion, currently at 0.25 percent per year. There are other tools such as reverse sale and repurchase agreements, redemption and selling the securities. Table 8, updated with every comment, provides data from actual experience of the duration trap in which monetary policy has been caught. The yields in the column “yield” are those observed at the close of market on the dates in column “date;” column “price” is the equivalent price at the observed yield of a 10-year Treasury note paying semiannual coupon of 2.625 percent and maturing in exactly ten years; and the column “∆% 11/04/10” is the percentage price relative to that prevailing on Nov 4, 2010, one day after the Fed announced the second round of quantitative easing. In the first round of near zero interest rates, the yield of the 10-year Treasury rose from 3.112 percent on Jun 10, 2003, to 5.297 percent on Jun 12, 2007, for a loss in price of 17.1 percent. If the yield on Nov 4 of 2.481 percent were to back up to 5.297 percent, the price loss would be 21.5 percent. The 10-year yield has backed up from 2.481 percent on Nov 4 to 3.640 percent on Feb 4, or 115 basis points, for a price loss of 9.4 percent even with the Fed buying $75 billion of Treasury securities every week, which means that yields could have backed up even more. Repressing yields by buying Treasury securities merely sanctions a higher jump in yields in the future when Fed credibility is exhausted and quantitative easing is likely replaced by quantitative tightening. There is no exit from the zero interest rate cum quantitative easing policy of the Fed without sharp increases in interest rates. There is no knowledge theoretically, empirically and operationally to manage monetary policy to maintain inflation in a neighborhood of 2 percent while the unemployment rate is around 5 percent. Bernanke (2011Feb3) argues that Congress should take measures to manage record government deficits and debt/GDP ratios. The challenge is that in addition to disruption of business models policy has induced expectations of rising taxes and interest rates that will flatten the expansion path of the economy.

Table 8, Yield, Price and Percentage Change to November 4, 2010 of Ten-Year Treasury Note

Date	Yield	Price	∆% 11/04/10
05/01/01	5.510	78.0582	-22.9
06/10/03	3.112	95.8452	-5.3
06/12/07	5.297	79.4747	-21.5
12/19/08	2.213	104.4981	3.2
12/31/08	2.240	103.4295	2.1
03/19/09	2.605	100.1748	-1.1
06/09/09	3.862	89.8257	-11.3
10/07/09	3.182	95.2643	-5.9
11/27/09	3.197	95.1403	-6.0
12/31/09	3.835	90.0347	-11.1
02/09/10	3.646	91.5239	-9.6
03/04/10	3.605	91.8384	-9.3
04/05/10	3.986	88.8726	-12.2
08/31/10	2.473	101.3338	0.08
10/07/10	2.385	102.1224	0.8
10/28/10	2.658	99.7119	-1.5
11/04/10	2.481	101.2573	-
11/15/10	2.964	97.0867	-4.1
11/26/10	2.869	97.8932	-3.3
12/03/10	3.007	96.7241	-4.5
12/10/10	3.324	94.0982	-7.1
12/15/10	3.517	92.5427	-8.6
12/17/10	3.338	93.9842	-7.2
12/23/10	3.397	93.5051	-7.7
12/31/10	3.228	94.3923	-6.7
01/07/11	3.322	94.1146	-7.1
01/14/11	3.323	94.1064	-7.1
01/21/11	3.414	93.4687	-7.7
01/28/11	3.323	94.1064	-7.1
02/04/11	3.640	91.750	-9.4

Note: price is calculated for an artificial 10-year note paying semi-annual coupon and maturing in ten years using the actual yields traded on the dates

Source:

http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3020

V Inflation. Bernanke (2011Feb3) finds that some visible prices such as gasoline have increased recently and that “prices of many commodities have risen lately, largely as a result of the very strong demand from fast-growing emerging market economies, coupled, in some cases, with constraints on supply.” “The Fed on the cusp of worldwide inflation” is an entirely different argument by McKinnon (2001CWI, 2011INF) than the “printing money” argument and is derived from perceptive comparison of the 1970s commodity shocks with the near-zero interest rate Greenspan-Bernanke shock of 2003-2004 and the Bernanke shock that is still ongoing. In the view of McKinnon, emerging countries are flooded with carry trades into their capital markets and currencies that their central banks sterilize by issuing base money to buy the inflow of dollars, creating downward pressure on interest rates. Sterilization of the growth of money and capital controls can be used “but these measures are hard to enforce” (McKinnon 2011CWI, 1). The key to the three shocks of 1971, 2003-2004 and currently is that “primary commodity prices register enhanced inflationary expectations more quickly because speculators can easily bid for long positions in organized commodity future markets” (McKinnon 2011CWI, 1). The risks cannot be ignored (McKinnon 2011CWI, 2). The Fed raised interest rates to 22 percent in Jul 1981 and inflation receded in the US. Inflows of funds attracted by improved conditions in the US appreciated the dollar that became overvalued, causing a large deficit in current account jointly with the internal deficit. Cheaper imports of manufactures resulted in the US rust belt. The lesson from this experience is that US inflation is processed with a long lag and has costly consequences for the economy and employment.

Table 9 provides CPI inflation in a large variety of countries. There is inflation everywhere with the possible exceptions of Japan and the US. Most countries have emerged with significant fiscal imbalances partly because of the reduction of revenue and the increase in expenses during the global recession. There is a valid concern if the US will escape inflation with hard consequences of its control on the economy and employment that could be more harmful than the second fear of deflation in less than ten years that has not materialized except in counterfactual exercises.

Table 9, CPI Inflation and Government Deficit as Percent of GDP

	CPI 2006	CPI 2010	Deficit 2008 % GDP	Deficit 2010 % GDP
Euro Area	2.2	2.2	-2.6	-4.6
Advanced Economies	1.9	1.1	-3.8	-6.8
Germany	1.8	1.9	-1.6	-3.1
France	1.9	2.0	-3.1	-5.0
USA	2.5	1.5	-4.9	-8.9
UK	2.3	3.7	-5.6	-7.9
Japan	0.2	0.0	-3.6	-7.6
China	2.5	4.6	7.7	3.5
Brazil	3.1	5.9	-3.5	-1.6
Russia	9.0	8.8	4.5	-4.3
India	6.7	8.43	-6.1	-9.6
Korea	2.1	3.5	1.7	1.4
Singapore	0.8	4.6	5.2	2.4
Taiwan	0.7	1.25	-2.4	-3.8
Indonesia	3.1	6.96	-1.6	-1.5
Thailand	3.5	3.0	0.1	-2.7

Sources: IMF PIN

http://www.imf.org/external/pubs/ft/weo/2010/02/weodata/index.aspx

http://www.imf.org/external/np/sec/pn/2011/pn1102.htm

http://www.gks.ru/bgd/free/B00_25/IssWWW.exe/Stg/d000/000710.HTM

http://www.stat.go.jp/english/data/cpi/1581.htm

http://www.stats.gov.cn/english/statisticaldata/monthlydata/t20101227_402693597.htm

http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-14012011-BP/EN/2-14012011-BP-EN.PDF

http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&language=en&pcode=tsieb060&tableSelection=1&footnotes=yes&labeling=labels&plugin=1

ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

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

http://www.bcb.gov.br/?INDICATORS

In an interview with the Dow Jones Newswire, John Lipsky, First Deputy Managing Director of the IMF, finds that many emerging countries are near full capacity utilization while still maintaining the monetary and fiscal stimulus used during the recession (http://professional.wsj.com/article/SB10001424052748704709304576124882613711642.html?mod=WSJPRO_hps_LEFTWhatsNews). There is need for tightening monetary and fiscal policy. Chairman Bernanke argues that it is unfair to blame monetary policy in the US for inflation resulting from excess demand in emerging markets (http://professional.wsj.com/article/SB10001424052748704709304576124882613711642.html?mod=WSJPRO_hps_LEFTWhatsNews). Purchasing managers’ indexes for emerging Asia continue to show strong economic activity but with concerns for inflation rising to 4.6 percent in Singapore (after GDP growth of 14.7 percent in 2010), 3.5 percent in Korea, 6.96 percent in Indonesia and 4.6 percent in China after 5.1 percent in Nov. Most countries are tightening monetary policy (http://www.ft.com/cms/s/0/fa8d5ca2-1757-11e0-badd-00144feabdc0.html#axzz1Cbriqfmx). The price components of the purchasing managers’ indexes show rising inflation (http://professional.wsj.com/article/SB10001424052748703439504576116823803454788.html

). There is worldwide increase in food prices. The Food and Agriculture Organization (FAO) of the UN tracks monthly changes in global food prices with the FAO food price index finding that (http://www.fao.org/news/story/en/item/50519/icode/):

“The index averaged 231 points in January and was up 3.4 percent from December 2010. This is the highest level (both in real and nominal terms) since FAO started measuring food prices in 1990. Prices of all monitored commodity groups registered strong gains in January, except for meat, which remained unchanged.”

Roubini (2011SR) warns of possible stagflation resulting from a Middle East event based on the argument that three out of the last five global recessions originated directly in oil price shocks and oil shocks were a factor in the other two: (1) The Yom Kippur War in 1973 resulted in sharp increases in oil prices that caused global stagflation; (2) the Iranian Revolution of 1980 also resulted in similar oil price increases that generated stagflation and the two recessions of the 1980s; (3) the invasion of Kuwait by Iraq caused an increase in oil prices when the US was already falling into recession because of the savings and loans failures; (4) the recession of 2001 also had some effects from unrest in the Middle East with more modest oil shock; and (5) the recession of 2007 also had an effect of oil prices rising to $148/barrel in the summer of 2008. Roubini (2011SR) finds that before events in the Middle East oil prices had been rising above $90/barrel because of the wall of liquidity propelled by zero interest rates and quantitative easing. The producer price index of the euro area rose 0.8 percent in Dec 2010 relative to Nov and 5.3 percent relative to Dec 2009; excluding energy, prices for total industry rose 3.3 percent in Dec 2010 compared with Dec 2009 (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-02022011-AP/EN/4-02022011-AP-EN.PDF). The energy shock may be already affecting general prices. The flash estimate of euro area annual inflation in Jan is 2.4 percent (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-31012011-AP/EN/2-31012011-AP-EN.PDF), which is higher than the target of 2 percent of the European Central Bank.

Inflation may not be dismissed in the US. The Wall Street Journal informs that investors have been selling exposures to nominal bonds, which decline in value when interest rates increase, as shown in Table 8, and investing in floating rate loans financing corporate buyouts that pay interest rates increases (http://professional.wsj.com/article/SB10001424052748704254304576116542382205656.html?mod=WSJPRO_hps_LEFTWhatsNews). The price index of the ISM manufacturing index for Jan rose by 9 points from 72.5 in Dec to 81.5 in Jan (http://www.ism.ws/about/MediaRoom/newsreleasedetail.cfm?ItemNumber=21061). The price index of the nonmanufacturing index for Jan of the ISM rose by 2.6 points from 69.5 in Dec to 72.1 in Jan (http://www.ism.ws/about/MediaRoom/newsreleasedetail.cfm?ItemNumber=21075). The Chicago purchasing managers’ index shows that prices paid registered the highest level since Jul 2008 (https://www.ism-chicago.org/chapters/ism-ismchicago/files/ISM-C%20January%2020111296485496453.pdf). Retail sales rose in Jan by 4.2 percent, according to the Wall Street Journal on the basis of the Thomson Reuters index of 28 big chain stores but retailers are facing rapidly increasing costs (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-31012011-AP/EN/2-31012011-AP-EN.PDF). Higher costs are clouding the outlook for retailers because the necessary price increases may deter consumers from continued buying while consumer budgets may be squeezed by food and energy price increases (Ibid). Individual commodities provide evidence of potential inflation. The price of cotton has jumped 19 percent in 2011 and outstanding contracts in ICE have increased by 21 percent; higher cotton prices are squeezing profit margins of mills, commodity merchants and apparel producers (http://professional.wsj.com/article/SB10001424052748703652104576122001071740950.html?mod=WSJPRO_hps_LEFTWhatsNews). The Fed is facing a tough intertemporal consistency problem as to whether continuing with quantitative easing to maintain expectations required for economic growth may throw monetary policy behind the inflation curve, eroding the Fed’s credibility in inflation control. There are not sufficiently effective operational methods of implementing a dual mandate of employment and price stability such that aggressive policy impulses may worsen both employment and price stability.

Inflation is not the only vulnerability of worldwide recovery. Table 10 shows dollar GDP and ratios of debt and current account to GDP for a variety of countries. There are vulnerabilities in multiple regions. Europe has economic/political dilemmas in organizing a permanent and effective solution to sovereign risk issues that spread from the indebted countries to the larger economies via bank and capital markets exposures. Stephen Fidler quotes Knight Capital Americas’ estimate that maturing debt of euro zone government is €315 billion and that of the region’s banks €228 billion (http://professional.wsj.com/article/SB10001424052748703652104576122192237126536.html?mod=WSJPRO_hps_LEFTWhatsNews). There were hopes in financial markets that the summit of European leaders would strengthen the European Financial Stability Fund (EFSF) in an effort to engage in an effective solution of the sovereign risk issues. The proposal of two leading countries in the euro area to coordinate policies and enhance competitiveness may not find consensus, eroding the effort to enhance the EFSF (http://www.ft.com/cms/s/0/792a5ace-306c-11e0-8d80-00144feabdc0.html#axzz1CZjpoGUX http://professional.wsj.com/article/SB10001424052748704709304576123751044549920.html?mod=WSJPRO_hps_LEFTWhatsNews). US economic recovery is proceeding but at a pace that does not reduce job stress. Emerging countries are dealing with higher inflation that requires tough measures. Doubts on the capacity of China to maintain double-digit growth while controlling inflation continue to affect financial markets. Japan is being squeezed by a strong exchange rate and weak internal demand.

Table 10, GDP, Debt/GDP and Current Account/GDP for Selected Countries

	GDP $ Billions	Debt/ GDP 2010 %	Debt/ GDP 2015 %	Current Account % GDP 2010	Current Account % GDP 2015
Euro Area	12,067	53.4	67.4	0.2	0.2
Germany	3,652	58.7	61.8	6.1	3.9
France	2,865	74.5	78.7	-1.8	-1.8
Portugal	224	79.9	93.6	-9.9	-8.4
Ireland	204	55.2	71.4	-2.7	-1.2
Italy	2,037	98.9	99.5	-2.9	-2.4
Greece	305	109.5	112.6	-10.8	-4.0
Spain	1,275	54.1	72.6	-5.2	-4.3
Belgium	461	91.4	100.1	0.5	4.1
USA	14,870	65.8	84.7	-3.2	-3.4
UK	2,259	68.8	76.0	-2.2	-1.1
Japan	6,517	120.7	153.4	3.1	1.9
China	5,745	19.1	13.9	4.7	7.8
Brazil	2,023	36.7	30.8	-2.6	-3.3
Russia	1,477	11.1	14.6	4.7	1.3
India	1,430	71.8	67.2	-3.1	-2.2

Source: http://www.imf.org/external/pubs/ft/weo/2010/02/weodata/index.aspx

VII Dollar Devaluation. An essay by Chairman Bernanke in 1999 on Japanese monetary policy received attention in the press, stating that (Bernanke 2000, 165):

“Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and experiment—in short, to do whatever it took to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done”

Quantitative easing has never been proposed by Chairman Bernanke or other economists as certain science without adverse effects. What has not been mentioned in the press is another suggestion to the Bank of Japan (BOJ) by Chairman Bernanke in the same essay that is very relevant to current events and the contentious issue of ongoing devaluation wars (Ibid, 161):

“Because the BOJ has a legal mandate to pursue price stability, it certainly could make a good argument that, with interest rates at zero, depreciation of the yen is the best available tool for achieving its mandated objective. The economic validity of the beggar-thy-neighbor thesis is doubtful, as depreciation creates trade—by raising home country income—as well as diverting it. Perhaps not all those who cite the beggar-thy-neighbor thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery. A yen trading at 100 to the dollar is in no one’s interest”

Chairman Bernanke is referring to the argument by Joan Robinson based on the experience of the Great Depression 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 (Robinson 1947, 156). Devaluation is one of the tools used in these policies (Ibid, 157). Banking crises dominated the experience of the United States, but countries that recovered were those devaluing early such that competitive devaluations rescued many countries from a recession as strong as that in the US (see references to Ehsan Choudhri, Levis Kochin and Barry Eichengreen in Pelaez and Pelaez, Regulation of Banks and Finance, 205-9; for the case of Brazil that devalued early in the Great Depression recovering with an increasing trade balance see Pelaez, 1968, 1972; Brazil devalued and abandoned the gold standard during crises in the historical period as shown by Pelaez 1976, Pelaez and Suzigan 1981). Beggar-my-neighbor policies did work for individual countries but the criticism of Joan Robinson was that it was not optimal for the world as a whole.

Table 11, updated with every comment, shows the sharp appreciation relative to the dollar of most currencies in the world, which is far higher than the Fed’s objective of attaining by quantitative easing “a moderate change in the foreign exchange value of the dollar that provides support to net exports,” as revealed for the first time by Yellen (2011AS, 6). Quantitative easing combined with zero interest rates began by postulating that that the resulting reduction of costs to business and consumers would generate investment and consumption, or aggregate demand, that would recover economic conditions and hiring. Bernanke (2010WP) introduced the perception of increased wealth resulting from a boom in stock market valuations that would motivate consumption by households feeling wealthier. The US has the right and independence to use monetary and fiscal policy to promote employment and price stability. From the point of view of the countries and regions in Table 11, unilateral competitive devaluation of the dollar by zero interest rates and quantitative easing turns adjustment of their economies tougher because of loss of competitiveness of their exports and inability to manage their domestic interest rates for internal adjustment. The complaints of those countries are not that different from the complaint of the US that the undervaluation of the yuan by China could be one of several factors in the current account deficit of the US that is mirrored by the current account surplus of China. Emerging markets may be another source of financial turbulence. The withdrawal of funds from emerging markets’ equity funds in the past week was $7 billion, which is the highest in over three years; 2010 flows into emerging market equities were a record $95 billion; emerging market equities have declined by 3 percent in 2011; and emerging market equity funds hold $720 billion (http://www.ft.com/cms/s/0/bb58668a-307a-11e0-8d80-00144feabdc0.html#axzz1CZjpoGUX). An exodus from emerging markets could affect world financial markets. It is questionable if the policy of devaluing the dollar by zero interest rates and quantitative easing is in the interest of the US especially under current circumstances because of four reasons. First, the Fed fails to sustain a trend of dollar devaluation because of reversed revaluations caused by the dollar being a reserve currency that causes flight into dollar-denominated assets when vulnerabilities exacerbate such as the sovereign risk issues in Europe, China’s growth/inflation tradeoff and geopolitical events. A sustained trend instead of fluctuations is required to promote US exports. Second, dollar devaluation could be passed through to domestic prices, feeding US inflation and adding to the silent tax of increases in energy and food prices. Third, trading partners may retaliate against the US by imposing restrictions on imports of US goods. The reduction in world trade and resulting loss of welfare was a major concern of Joan Robinson. Fourth, Romer and Romer (2004) find that a one percentage point tightening of monetary policy is associated with a 4.3 percent decline in industrial production. There is no change in inflation in the first 22 months after monetary policy tightening when it begins to decline steadily, with decrease by 6 percent after 48 months (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 102). Even if there were one hundred percent confidence in reducing inflation by monetary policy, it could take a prolonged period with adverse effects on economic activity. Certainty does not occur in economic policy, which is characterized by costs that cannot be anticipated. The effects of zero interest rates and quantitative easing may well occur with the economy in expansion because of different factors, turning inflation control into a Volcker 1981 instead of a Roosevelt 1930s moment. The current encouraging economic indicators are not a response to the second round of quantitative easing because they occurred simultaneously and may be more likely the result of Nov elections that were widely anticipated in creating a pause in legislative restructurings.

Table 11, Exchange Rates

	Peak	Trough	∆% P/T	Feb 4 2011	∆% T Feb 4	∆% P Feb 4
EUR USD	7/15 2008	6/7 2010		2/4/ 2011
Rate	1.59	1.192		1.358
∆%			-33.4		8.6	-21.9
JPY USD	8/18 2008	9/15 2010		2/4 2011
Rate	110.19	83.07		82.16
∆%			24.6		1.1	25.4
CHF USD	11/21 2008	12/8 2009		2/4 2011
Rate	1.225	1.025		0.957
∆%			16.3		6.6	21.9
USD GBP	7/15 2008	1/2/ 2009		2/4 2011
Rate	2.006	1.388		1.611
∆%			-44.5		13.8	-24.5
USD AUD	7/15 2008	10/27 2008		2/4 2011
Rate	1.0215	1.6639		1.013
∆%			-62.9		40.7	3.4
ZAR USD	10/22 2008	8/15 2010		2/4 2011
Rate	11.578	7.238		7.237
∆%			37.5		0.01	37.5
SGD USD	3/3 2009	8/9 2010		2/4 2011
Rate	1.553	1.348		1.275
∆%			13.2		5.4	17.9
HKD USD	8/15 2008	12/14 2009		2/4 2011
Rate	7.813	7.752		7.786
∆%			0.8		-0.4	0.3
BRL USD	12/5 2008	4/30 2010		2/4 2011
Rate	2.43	1.737		1.673
∆%			28.5		3.7	31.1
CZK USD	2/13 2009	8/6 2010		2/4 2011
Rate	22.19	18.693		17.658
∆%			15.7		5.5	20.4
SEK USD	3/4 2009	8/9 2010		2/4 2011
Rate	9.313	7.108		6.477
∆%			23.7		8.9	30.5

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

VIII. Economic Indicators. Economic activity is strengthening worldwide. Personal income increased 0.4 percent in Dec relative to Nov after 0.3 percent in Oct and 3.8 percent from Dec 2009 to Dec 2010; personal consumption expenditures (PCE) rose 0.7 percent in Dec relative to Nov and 4.1 percent from Dec 2009 to Dec 2010; and inflation of PCE excluding food and energy rose 0.7 percent in the 12 months ending in Dec 2010. Real disposable income, or income net of taxes after adjusting by inflation, rose 0.4 percent from Nov to Dec (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm). PCE inflation without excluding food and energy rose 0.3 percent in Dec, which if compounded 12 periods would accumulate to 3.7 percent. The Chicago purchasing managers’ index increased from 66.8 in Dec to 68.8 in Jan with new orders increasing from 71.3 in Dec to 75.7 in Jan (https://www.ism-chicago.org/chapters/ism-ismchicago/files/ISM-C%20January%2020111296485496453.pdf). The ISM general index of manufacturing rose from 58.5 in Dec to 60.8 in Jan, which is the highest level since 61.4 in May 2004, and new orders increased from 62.0 in Dec to 67.8 in Jan (http://www.ism.ws/about/MediaRoom/newsreleasedetail.cfm?ItemNumber=21061). The general index of the nonmanufacturing ISM increased from 59.4 in Dec to 57.1 in Jan and the index of new orders rose from 61.4 in Dec to 64.9 in Jan (http://www.ism.ws/ISMReport/NonMfgROB.cfm ). All the manufacturing purchasing managers’ indexes of many countries worldwide compiled by the WSJ registered expansion in Jan with the exception of one country (http://blogs.wsj.com/economics/2011/02/01/world-wide-factory-activity-by-country-13/). The euro area unemployment rate remained at 10.0 percent in Dec 2010, without change from Nov (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/3-01022011-AP/EN/3-01022011-AP-EN.PDF). The volume of retail trade fell 0.6 percent from Nov to Dec 2010 and fell 0.9 percent relative to Dec 2009 (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-03022011-AP/EN/4-03022011-AP-EN.PDF ).

IX Interest Rates. The US curve of Treasury yields shows now an evident upward shift and slope from the 6-month bill to the 30-year bond. The 10-year Treasury yield rose to 3.64 percent on Fri, Feb 4 from 3.33 percent a week ago and 3.42 percent a month before, which is surprising because the 10-year yield has declined during financial, economic and political events such as the Middle East unrest as funds flow into the safety of dollar-denominated assets. The 30-year yield rose to 4.73 percent from 4.53 percent a week earlier and 4.53 percent also a month earlier. The yield of the 10-year government bond of Germany rose to 3.26 percent for widening negative spread of 38 basis points relative to the comparable Treasury (http://markets.ft.com/markets/bonds.asp). The US Treasury note maturing on 11/20 with coupon of 2.63 percent traded at a price of 91.66 or equivalent yield of 3.65 percent (http://markets.ft.com/ft/markets/reports/FTReport.asp?dockey=GOV-040211).

X Conclusion. The rate of unemployment in the US in Jan could be in a range between 9.0 percent seasonally adjusted, 9.8 percent not seasonally adjusted and 12.9 percent not seasonally adjusted but taking into account those who left the labor force because they believed they could not find another job. Weather effects and required changes in the data of the BLS prevent comparisons of numbers of workers from Dec to Jan. The unusual current jobless recovery is illustrated by the creation of 4.8 million jobs between 1982 and 1984 while 6.9 million jobs have been lost between 2008 and 2010, as shown in Table 3. The numbers of people receiving food stamps have risen from 33.5 million to 43.4 million between 2009 and 2011 while increases in food and energy, partly created by Fed policy, have imposed a silent tax on the population that is regressive on people of modest means. There is inflation everywhere in the world. Euro zone producer prices excluding energy are increasing at the annual rate of 3.3 percent and consumer prices at 2.4 percent. Inflation in the US is detected in purchasing managers’ indexes, gas prices, costs of wholesalers and retailers. Fed policy may not have impact on employment, as revealed by rising yields even under repression by Fed purchases, and the dubious and belated extension of the argument in support of quantitative easing from lower costs of investment and consumption in the initial version to stock market effects and dollar devaluation in the new version introduced after quantitative easing on Nov 3, 2010. Quantitative easing may have to be reversed sooner than expected into quantitative tightening if costs to producers and merchants eventually increase final consumer prices. (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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© Carlos M. Pelaez, 2010, 2011