CMP Associates Regulation Blog: Financial Risk Aversion, Hiring Collapse and Global Inflation, Trade and Growth

Financial Risk Aversion, Hiring Collapse and Global Inflation, Trade and Growth

Carlos M. Pelaez

Executive Summary

I Financial Risk Aversion

II Hiring Collapse

III Global Inflation

IV Trade and Growth

V Valuation of Risk Financial Assets

VI Economic Indicators

VII Interest Rates

VIII Conclusion

References

Executive Summary

Hiring in the US nonfarm sector has declined from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million while hiring in the private sector has declined from 60.4 million in 2006 to 43.3 million in 2010 or by 17.1 million. An important characteristic of the labor market in the US is that the latest available monthly statistics show hiring in the nonfarm sector has declined from 6.010 million in May 2006 to 4.531 million in May 2011, or by 1.479 million, and hiring in the private sector has fallen from 5.631 million in May 2006 to 4.250 million in May 2011, or by 1.381 million. Hiring in the nonfarm sector of 4.531 million in May 2011 is almost unchanged relative to 4.746 million in May 2010 and hiring in the private sector in May 2011 of 4.250 million is lower by 1.256 million than 5.506 million in May 2001. The US labor market is fractured, creating fewer opportunities to exit job stress of unemployment and underemployment of 25 to 30 million people and declining inflation-adjusted wages in the midst of fast increases in prices of everything. There are major financial vulnerabilities in the international financial system that could stress again global financial markets.

An article in Real Time Economics of the Wall Street Journal on Jul 16 on “Number of the week: 5% unemployment could be a decade away” (http://blogs.wsj.com/economics/2011/07/16/number-of-the-week-5-unemployment-could-be-over-a-decade-away/) provides an approximation of the number of months that would be required for the economy to return to the 5 percent unemployment rate of 2007. The current unemployment rate for Jun is 9.2 percent, with 14.1 million unemployed, on the basis of the household survey. Job creation in the first half of 2011 was 757,000 jobs, on the basis of the establishment survey. Assuming that job creation is approximately the same in the household survey as in the establishment survey, there would be a gain of 1.6 million new jobs in the year forward from Jun 2011 to Jun 2012. Real Time Economics adds to the calculation the growth of the labor force projected by the Census as 1.4 million people aged 16 and over. Employment would grow by 1.6 million while the labor force would grow by 1.4 million, reducing unemployment by only 200,000 that would still leave the rate of unemployment at 8.9 percent. Under those assumptions about employment growth and labor force growth, the rate of unemployment of 5 percent would only be attained in Dec 2024. Another recession would create a setback in the calculations. An important issue is that there are an additional 4 million unemployed who are not counted because they abandoned the hope of finding another job, such that the total unemployment in Jun is more likely to be closer to 18.4 million. To that would have to be added 8.6 million barely making a living in part-time jobs because they cannot find anything better and 2.7 million marginally attached to the labor force. The total number of people in job stress in the US is 29.693 million in Jun 2011 (http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html). The US is suffering a suffocating unemployment and underemployment stress that would require much faster growth than that experienced in the weakest recovery from a recession since World War II. Faster growth is the only form of reigniting the fractured US labor market

I Financial Risk Aversion. The past two months have been characterized by unusual financial turbulence. Table 1, updated with every comment in this blog, provides beginning values on Jul 11 and daily values throughout the week ending on Jul 15. All data are for New York time at 5 PM. The first three rows provide three key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. In a sign of financial risk aversion, the dollar appreciated 0.7 percent relative to the euro by Jul 15, with outflow of funds from risk financial assets. The dollar appreciated in the prior week by 1.8 percent relative to the euro because of renewed fears of default in Greece that could have adverse repercussions in sovereign debts of other countries in Europe’s “periphery” as well as in “core countries” through exposures of banks. A combination of renewed fears of default, downgrade of Ireland, rise in bond spreads and declining bank stocks in Italy, the weak employment report of the US and alerts on downgrading of US debt in case of failure of increase of the federal debt limit were important factors in the appreciation of the dollar by Jul 15. The Japanese yen appreciated during the week reaching JPY 79.13/USD by Fr Jul 15, which is quite strong as the currency is used as safe haven from world risks while fears of another Japanese and G7 intervention subsided. The Swiss franc appreciated 2.6 percent during the week, reaching CHF 0.816/USD on Fri Jul 15, which reflects risk aversion by funds flowing away from risk positions to temporarily benefitting from safe haven in a strong deposit and investment market.

Table 1, Daily Valuation of Risk Financial Assets

	Jul 11	Jul 12	Jul 13	Jul 14	Jul 15
USD/ EUR	1.4031 1.6%	1.3978 1.9%	1.4151 0.8%	1.4140 0.8%	1.4157 0.7%
JPY/ USD	80.2535 0.4%	79.3495 1.6%	78.9945 2.0%	79.1535 1.8%	79.13 1.8%
CHF/ USD	0.8355 0.3%	0.8315 0.8%	0.8187 2.3%	0.8163 2.6%	0.816 2.6%
10 Year T Note Yield	2.92	2.88	2.88	2.95	2.905
2 Year T Note Yield	0.36	0.36	0.35	0.37	0.356
10 Year German Bond Yield	2.67	2.71	2.75	2.74	2.70
DJIA	-1.2% -1.2%	-1.7% -0.5%	-1.3% 0.4%	-1.7% -0.4%	-1.4% 0.3%
DJ Global	-2.1% -2.1%	-2.9% -0.9%	-1.9% 1.1%	-2.5% -0.6%	-2.5% 0.01%
DAX	-2.3% -2.3%	-3.1% -0.8%	-1.8% 1.3%	-2.5% -0.7%	-2.5% 0.1%
DJ Asia Pacific	-1.0% -1.0%	-2.6% -1.6%	-1.4% 1.2%	-1.7% -0.3%	-1.6% 0.1%
WTI $/b	95.14 -1.3% -1.3%	96.790 0.4% 1.7%	97.86 1.5% 1.1%	95.940 -0.5% -1.9%	97.430 1.1% 1.6%
Brent $/b	117.10 -1.1% -1.1%	117.19 -1.0% 0.1%	118.76 0.3% 1.3%	116.43 –1.6% -1.9%	117.66 -0.6% 1.1%
Gold $/ounce	1554.00 0.7% 0.7%	1569.70. 1.7% 1.0%	1581.90 2.5% 0.8%	1586.00 2.7% 0.3%	1594.20 3.3% 0.5%

Note: For the exchange rates the percentage is the cumulative change since Fri the prior week; for the exchange rates appreciation is a positive percentage and depreciation a negative percentage; USD: US dollar; JPY: Japanese Yen; CHF: Swiss Franc; AUD: Australian dollar; B: barrel; for the four stock indexes and prices of oil and gold the upper line is the percentage change since the past week and the lower line the percentage change from the prior day;

Source: http://noir.bloomberg.com/intro_markets.html

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

The three sovereign bond yields in Table 1 capture renewed risk aversion in the flight away from risk financial assets toward the safety of US Treasury securities and German securities. The 2-year US Treasury note is highly attractive because of minimal duration or sensitivity to price change and its yield continued fluctuating in a tight low range between 0.356 and 0.37 percent. There is generalized expectation in financial markets, shown by normal bid/coverage ratios in the auctions of three, ten and thirty year US Treasury bonds, that there will not be default of US debt because of political failure to raise the debt limit. Much the same is true of the 10-year Treasury note and the 10-year bond of the government of Germany, falling to 2.905 percent for the 10-year Treasury note and to 2.70 percent for the 10-year government bond of Germany by Fri Jul 15 because of the combination of weak economy in the US and renewed fears on Greece and other sovereigns in Europe. Section V Valuation of Risk Financial Assets provides more details and comparisons of performance in peaks and troughs.

The upper row in the stock indexes in Table 1 measures the percentage cumulative change since the closing level in the prior week on Jul 8 and the lower row measures the daily percentage change. Performance of equities markets was weak. The DJ Global index fell 1.4 percent in the week with the effects of the employment report in the US, additional weak economic reports and the doubts on highly-indebted countries in Europe with the DAX of Germany losing 2.5 percent in the week. The DJ Asia Pacific index fell 1.6 percent in the week.

The final block of Table 1 shows strong performance of gold and weak performance of the oil indexes. Brent lost 0.6 percent in the week even after gaining 1.1 percent on Fri Jul 15, and WTI gained 1.1 percent, gaining 1.6 percent on Fri Jul 15 after release of the bank stress tests in Europe. Increasing risk appetite appears to have stimulated the carry trade. Gold gained 3.3 percent by Fri Jul 15 with some investors believing gold can hedge adverse economic conditions.

Useful dimensions of the world, regions and individual countries are provided in Table 2. The IMF measures world output in 2010 at $57,920.3 billion of which $31,891.5 billion, or 55.1 percent, is contributed by the “major advanced economies,” or Group of 7 (G7), consisting of the Canada, France, Germany, Italy, Japan, the United Kingdom (UK) and the United States (for the G7 see Pelaez and Pelaez, International Financial Architecture (2005), 63-96). There are four factors of financial uncertainty in the world economy originating in the regions and countries in Table 2.

Table 2, World and Selected Regional and Country GDP and Fiscal Situation

	GDP USD 2010 USD Billions	Primary Net Lending Borrowing % GDP 2010	General Government Net Debt % GDP 2010
World	57,920.3
Euro Zone	12,192.8	-3.6	64.3
Portugal	229.3	-4.6	79.1
Ireland	204.3	-29.7	69.4
Greece	305.4	-3.2	142.0
Spain	1,409.9	-7.8	48.8
Major Advanced Economies G7	31,891.5	-6.9	74.4
United States	14,657.8	-10.6	64.8
UK	2,247.5	-8.6	69.4
Germany	3,315.6	-3.3	53.8
France	2,582.5	-7.7	74.6
Japan	5,458.9	-9.5	117.5
Canada	1,574.1	-5.5	32.2
Italy	2,055.1	-4.6	99.6
China	5,878.3	-2.6	17.7

Source: http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx

First, European sovereign risks. There are euro zone countries that are relatively sound in terms of fiscal situations and financial variables, especially spreads of sovereign bonds and government debts and deficits, such as France and Germany. Three euro zone countries have engaged in bailouts within the mechanism created by the European Union, IMF and European Central Banks: Portugal, Ireland and Greece. The combined GDPs of Portugal, Ireland and Greece add to $739 billion, which represents only 6.1 percent of the euro zone GDP of $12,192.8 billion, shown in Table 2. The problem is in the exposure of European banks to the bailed out countries and of banks worldwide to the bailed out countries and to the European banks. These exposures are much more important in relative terms of propagating financial stress than the combined GDP of the bailed out countries. The turmoil during the week of Jul 15 manifested in the form of increases in the sovereign bond spreads and declines in the stock markets and bank stocks of Spain and Italy. The addition of the GDP of Spain and Italy to the bailed-out countries totals $4204 billion, which is equivalent to 34.5 percent of euro zone GDP. There were three types of events in the week of Jul 15, 2011 that affected both the bailed out countries and Italy and Spain. (1) Moody’s Investors Service (2011Jul11) finds that there will not be open-ended or unlimited support for the bailed-out countries. The test for access to the European Financial Stability Fund (EFSF) and in the future from the European Stability Mechanism (ESM) is that countries must meet tests of solvency. In cases tests are not met, support is not immediate and requires participation of the private sector. Moody’s Investors Services (2011Jul11) finds that: “The prospect of any form of private sector participation in debt relief is obviously negative for holders of distressed sovereign debt. That increasingly negative outlook, alongside the challenges in achieving financial consolidation objectives, lies behind our recent downgrades of Greece and Portugal and our ongoing assessment of countries facing similar challenges.” Moody’s Investor Services (2011Jul12) “downgraded Ireland’s foreign- and local-currency government bond ratings by one notch to Ba1 from Baa3. The outlook of ratings remains negative.” The rationale for the downgrade is that Ireland may need further “official financing” when its program with the European Union and IMF ends at year-end 2013. Such official financing is being tied under the ESM by private sector participation that will be a negative for creditors. (2) Italy’s spreads of its sovereign bonds, stock market and bank market valuations oscillated during the week of Jul 15. David Cottle writing on Jul 12 on “Italy fears rattle Europe’s markets” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303812104576441302547119220.html?mod=WSJPRO_hpp_LEFTTopStories) informs that Italy’s “total capital market debt” is €1598 billion, approximately $2.2 trillion, which is the largest in the euro zone and the third largest in the world after the US and Japan. There is a cushion in that only €88 billion mature in 2011 and €190 billion mature in 2012. Perhaps the major source of concern for propagation of turbulence in Italy is that French banks had $392.6 billion in Italian government and private debt at the end of 2010, according to Bank for International Settlements (BIS) data, as informed by Fabio Benedetti-Valentini, writing on Jul 12, 2011, on “French banks face greatest Italian risk” published by Bloomberg (http://www.bloomberg.com/news/2011-07-12/france-s-bnp-credit-agricole-on-frontline-with-italian-risk.html). There is a funding test for Italian banks in 2012 as its two largest lenders have maturing debt of around €55.4 billion, as informed by Elisa Martinuzzi and Charles Penty writing on Jul 14 on “Italian banks face funding squeeze” published by Bloomberg (http://www.bloomberg.com/news/2011-07-13/italian-banks-face-funding-squeeze-as-crisis-enters-new-phase.html). (3) The European Banking Authority released the stress tests of banks on July 15 with the following results (EBA 2011Jul15):

“Based on end 2010 information only, the EBA exercise shows that 20 banks would fall below the 5% CT1 threshold over the two-year horizon of the exercise. The overall shortfall would total EUR26.8 bn.

However, the EBA allowed specific capital actions in the first four months of 2011 (through the end of April) to be considered in the results. Banks were therefore incentivised to strengthen their capital positions ahead of the stress test.

Between January and April 2011 a further amount of some EUR50bn of capital was raised on a net basis.

Once capital-raising actions in 2011 are added, the EBA’s 2011 stress test exercise shows that eight banks fall below the capital threshold of 5% CT1R over the two-year time horizon, with an overall CT1 shortfall of EUR2.5bn. In addition, 16 banks display a CT1R of between 5% and 6%.”

Patrick Jenkins, Banking Editor of the Financial Times, writing on Jul 15 on “Banks’ stress tests pass rate under fire” published in the Financial Times (http://www.ft.com/intl/cms/s/0/dc111364-aefa-11e0-bb89-00144feabdc0.html#axzz1S4mkHrZz) raises the issue if the tests are robust enough to recover confidence on banks as only nine of the 91 banks tested had shortfalls of capital. An important result is the 16 banks with capital above 5 percent and below 6 percent. Thus, the total banks required to increase capital is 24 (EBA 2011PR). Guy Dinmore writing on Jul 15 on “Italian parliament passes €45 billion cuts package” published in the Financial Times (http://www.ft.com/intl/cms/s/0/bbef9be0-aef6-11e0-bb89-00144feabdc0.html#axzz1S4mkHrZz) informs that the parliament of Italy approved an austerity package of €45 billion that will eliminate the government deficit by 2014 but the public debt of Italy reached a new high in May of €1900 billion (or about $2690 billion). Joshua Chaffin writing on Jul 15 on “Eurozone summit raises hopes for deal on Greece” published by the Financial Times (http://www.ft.com/intl/cms/s/0/bac09dc2-af10-11e0-bb89-00144feabdc0.html#axzz1S4mkHrZz) informs that the leaders of the euro zone will participate in a summit on Jul 12 to find agreement on the second bailout of Greece together with measures for resolution of the widening sovereign debt problems in Europe.

Second, United States. Weakening economic conditions in the US in eight quarters of mediocre growth with 25 to 30 million people in job stress (http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html) also create bouts of financial turbulence. Current discussions on increasing the limit of Treasury debt are generally expected to produce an agreement. In a rare event (Moody’s 2011Jul13):

“Moody’s Investors Service has placed the Aaa bond rating of the government of the United States on review for possible downgrade given the rising possibility that the statutory debt limit will not be raised on a timely basis, leading to a default on US Treasury obligations. In conjunction with this action, Moody’s has placed on review for possible downgrade the Aaa rating of financial institutions directly linked to the US government: Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks. We have also placed on review for possible downgrade securities either guaranteed by, backed by collateral securities issued by, or otherwise directly linked to the US government or the affected financial institutions. The review of the US government’s bond rating is prompted by the possibility that the debt limit will not be raised in time to prevent a missed payment of interest or principal on outstanding bonds and notes. As such, there is a small but rising risk of a short-lived default.”

Moody’s (2011Jul13MC) separates municipal debt securities in two categories: (1) “directly linked Aaa credits” that “have been placed on review for possible downgrade, affecting more than 7,000 ratings (sale, debt or maturity level) with about $130 billion of original par amount” and will follow further rating actions on the US government; and (2) “indirectly linked Aaa credits” on which there are no “explicit guarantees or support from the US government.” The indirectly linked are being classified into “vulnerable” that will be classified for rating review and “resilient” that will not be classified for rating review.

Standard & Poor’s (2011Jul14) placed the US AAA long-term and A-1+ short term sovereign credit ratings on “CreditWatch with negative implications.” With the CreditWatch, Standard & Poor’s (2011Jul14) is signaling a chance of “one-in-two” that it could “lower the long-term rating on the US within the next 90 days.” The CreditWatch negative assignment is based on the view of significant uncertainty on the creditworthiness of the US. Standard & Poor’s (2011Jul14) finds that the political debate in the US after two months of negotiation on the debt ceiling has “only become more entangled” in a confrontation of views on fiscal policy. There is risk, according to Standard & Poor’s (2011Jul14), of the “policy stalemate enduring beyond any near-term agreement to raise the debt ceiling.” As a result, S&P finds that it may lower the ratings in the next three months. If there is no agreement between Congress and the Administration on “a credible solution to the rising US government debt burden,” Standard and Poor’s (2011Jul14) could “lower the long-term rating on the US by one or more notches into the ‘AA’ category in the next three months.” The risks of “payment default” on US debt are “small” but “increasing.” Brief default could force classification by S&P of US debt in “selective default” or “SD,” which means that the US would default some but not all debt obligations while continuing current in the remaining debt obligations.

The US is facing a tough budget/debt quagmire. The Congressional Budget Office (CBO 2011LTBO) extends the projections of the US budget beyond the ten-year window in terms of two scenarios. (1), Table 3 provides projections of the budget and debt for the “extended-baseline scenario,” which is based on the following assumptions (CBO 2011LTBO, 2):

“The current-law assumption of the extended-baseline scenario implies that many adjustments that lawmakers have routinely made in the past—such as changes to the AMT and to the Medicare program’s payments to physicians—will not be made again. Because of the structure of current tax law, federal revenues would grow significantly faster than GDP over the long run under this scenario, ultimately rising well above the levels that U.S. taxpayers have seen in the past.”

Table 3, CBO Long-term Budget Outlook Extended-Baseline Scenario, % of GDP

	2011	2021	2035
Spending	24.1	23.9	27.4
Primary	22.7	20.5	23.3
SS	4.8	5.3	6.1
Medicare	3.7	4.1	5.9
Medicaid	1.9	2.8	3.5
Other	12.3	8.3	7.8
Interest	1.4	3.4	4.1
Revenues	14.8	20.8	23.2
Deficit	–9.3	-3.1	-4.2
Primary	–7.9	0.3	-0.1
Debt	69	76	84

Primary spending is spending other than interest payments. Primary deficit or surplus is revenue less primary spending.

Source: http://www.cbo.gov/ftpdocs/122xx/doc12212/06-21-Long-Term_Budget_Outlook.pdf

The scenarios require assumptions about economic variables, in particular “real wage growth for workers covered by social security, growth in consumer price index, nominal wage growth for workers covered by social security, average real annual interest rate, average annual unemployment rate and real GDP” (CBO 2011LTBO Excel worksheet). Table 3 provides spending divided in primary spending and interest payments and the resulting concepts of primary balance equal to revenue less primary spending and total balance or revenue less total spending. Debt held by the public increases from 69 percent of GDP in 2011, much higher than 40 percent of GDP in 2008, to 76 percent of GDP in 2021 and 84 percent of GDP in 2035. Albert Einstein is attributed phrases such as “compound interest is the greatest mathematical discovery of all time” and “the most powerful force in the universe is compound interest.” An important aspect of Table 3 is that interest payments on the debt held by the public increase from 1.4 percent of GDP in 2011 to 3.4 percent of GDP in 2021 and to 4.1 percent of GDP in 2035. Spending on categories other than social security, Medicare and Medicaid shrinks from 12.3 percent of GDP in 2011 to 8.3 percent of GDP in 2021 and to 7.8 percent in 2035.

Correspondingly, the combined share of social security, Medicare and Medicaid in spending increases from 10.4 percent of GDP in 2011 to 15.5 percent of GDP in 2035 with combined Medicare and Medicaid explaining most of the increase with a jump from 5.6 percent of GDP to 9.4 percent of GDP while social security only increases its share from 4.8 percent of GDP in 2011 to 6.1 percent in 2035. Revenue as a percent of GDP has been on average 18.6 percent in the past 40 years and there is skepticism if it can increase above 20 percent of GDP. The alternative-baseline scenario in Table 3 projects revenue as percent of GDP at 20 percent of GDP in 2015 and 2016 and then exceeding 20 percent permanently, rising to 30.6 percent of GDP in 2085 (see the Excel spreadsheet accompanying CBO 2011LTBO).

(2), Table 4 provides fiscal projections under an alternative fiscal scenario, which is based on the following assumptions (CBO 2011LTBO, 2):

“The alternative fiscal scenario embodies several changes to current law that would continue certain tax and spending policies that people have grown accustomed to (because the policies are in place now or have been in place recently). Versions of some of the changes assumed in the scenario—such as those related to the tax cuts originally enacted in 2001, the AMT, certain other tax provisions, and Medicare’s payments to physicians—have regularly been enacted in the past and are widely expected to be made in some form over the next few years. After 2021, the alternative fiscal scenario also incorporates modifications to several provisions of current law that might be difficult to sustain for a long period. Thus, the scenario includes changes to certain restraints on the growth of spending for Medicare and to indexing provisions that would slow the growth of federal subsidies for health insurance coverage. In addition, the scenario includes unspecified changes in tax law that would keep revenues constant as a share of GDP after 2021.”

Table 4, CBO Long-term Budget Outlook Alternative Fiscal Scenario, % of GDP

	2011	2021	2035
Spending	24.1	25.9	33.9
Primary	22.7	21.5	25.0
SS	4.8	5.3	6.1
Medicare	3.7	4.3	6.7
Medicaid	1.9	2.8	3.7
Other	12.3	9.1	8.5
Interest	1.4	4.4	8.9
Revenues	14.8	18.4	18.4
Deficit	-9.3	-7.5	-15.5
Primary	-7.9	-3.1	-6.6
Debt	69	101	187

Primary spending is spending other than interest payments. Primary deficit or surplus is revenue less primary spending.

Source: http://www.cbo.gov/ftpdocs/122xx/doc12212/06-21-Long-Term_Budget_Outlook.pdf

An important distinguishing characteristic of the alternative fiscal scenario in Table 4 is the much sharper increase in debt held by the public from 69 percent of GDP in 2011 to 101 percent of GDP in 2021 and 187 percent of GDP in 2035. Accordingly, interest payments on the debt jump from 1.4 percent of GDP in 2011 to 8.9 percent of GDP in 2035. In contrast with the extended-baseline scenario, the alternative fiscal scenario fixes revenue as percent of GDP at 18.4 percent after 2035.

Fiscal projections by the CBO incorporate a host of assumptions on demographic variables, such as the rate of growth and consumption of the US population, economic variables, interest rates, labor market factors, real GDP and earnings per worker. The CBO (2011LTBO) analyzes how the performance of the economy would be affected by an increase in debt held by the public over 76 percent of GDP, which is used as benchmark economic conditions. A Solow-type model (after Solow 1956, 1989; see Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 11-16) is used for measuring effects on the economy of fiscal policies under the two scenarios. The method is discussed in CBO (2011PBB, Appendix A, 31-7). The calculations by the CBO (2011LTO, 28-31) are shown in Table 5. The impact is much softer on GDP than on GNP because “the change in GDP does not reflect the increased future outflow of profits and interest generated by the additional capital inflow” (CBO 2011LTO, 28). The striking result in Table 11 is the sharp reduction of GNP by 2035 of 6.7 percentage points to 17.6 percentage points over what it would be under the benchmark debt level of 76 percent and of GDP from 2.4 percentage points to 9.9 percentage points.

Table 5, Effects on GNP and GDP of Fiscal Policies in CBO’s Scenarios in Percentage Difference from Benchmark Level

	2025	2035
Extended Baseline
GNP	-0.2 to –0.4	-0.5 to –1.6
GDP	(-0.05 to 0.05 to –0,2	-0.2 to –1.3
Alternative Fiscal
GNP	-2.2 to –5.7	-6.8 to –17.6
GDP	-0.4 to –3.1	-2.4 to –9.9

Source: http://www.cbo.gov/ftpdocs/122xx/doc12212/06-21-Long-Term_Budget_Outlook.pdf

Two alternative strands of thought on policies for the current slow growth and weak hiring are considered in an earlier comment (http://cmpassocregulationblog.blogspot.com/2011_06_01_archive.html). Summers (2011Jul12) argues in an article in the Financial Times that a budget deal increasing GDP by 1 percent that will slowly disappear to 0 percent during a decade would increase GDP by 0.5 percent in the decade, representing 4 million job years and government revenue of $400 billion. In this view, the economy is in a liquidity trap because of the near-zero policy interest rate such that fiscal policy would have more than normal effects. Summers (2011Jul12) argues that a budget deal with continuing reductions of payroll taxes, extended unemployment benefits and infrastructure maintenance could add 2 percent to GDP. Timing is critical and the budget deal should be pushed forward immediately. Blinder (2011Jul12) in an article in the Wall Street Journal finds that the US has a national employment emergency. Adjusting the budget should be a task after solving the jobs problem. There are no magical solutions to this problem, according to Blinder (2011Jul12), not costless ones in the form of the inexistent free lunch. There are expenses in job creation either by reducing taxes or increasing expenditures. Blinder (2011Jul12) proposes the marrying of a “new jobs tax credit” with tax incentives for repatriation of profits held abroad by corporations. In his example, a corporation paying $1.5 billion in wages under Social Security would receive a tax credit for repatriation of profits if it increased the wages paid under Social Security by $100 million to $1.6 billion. The $100 million of repatriated profits held abroad would pay taxes at the rate of 5 to 10 percent instead of the usual corporate rate of 35 percent. The company would save between $25 million to $30 million and would have a powerful incentive to create jobs.

Reinhart and Rogoff (2011Jul14) provide succinct analysis of their new research on debt (Reinhart and Rogoff 2011CEPR with references to new research), extending their now classic monumental research on financial crisis (Reinhart and Rogoff 2009TD). Their database consists of public debt for 44 countries in about 200 years with 3700 observations of multiple relevant variables including central government balances. Economic models consist of structures or systems of simultaneous equations but data are observed under the influence of many variables such that identifying causes and effects is quite difficult. Reinhart and Rogoff (2011CEPR, 2011Jul14) concludes that there is a threshold approximately around 90 percent of GDP above which higher debt inhibits economic growth. There are relatively few cases of debt/GDP ratios above 90 percent of GDP and even fewer above 120 percent of GDP. It is quite likely that when debt reaches a point of explosion pressure mounts on politicians to increase taxes, reduce expenditures and rely on inflation or financial repression to reduce debt/GDP ratios. The conclusion of this monumental research is that debt/GDP explosions are as important in the current environment as in other circumstances in the past.

Third, natural disasters and geopolitical events. A critical natural disaster was the earthquake/tsunami of Japan on Mar 11 that not only caused significant harm to the country but also supply chain disruptions worldwide. An important geopolitical event was regime change movements in the Middle East.

Fourth, China tradeoff of growth and inflation. Financial turbulence has also originated in increasing inflation in China with threats to the country’s economic growth. There is discussion of this other financial vulnerability below in Section III Global Inflation.

II Hiring Collapse. An appropriate measure of job stress is considered by Blanchard and Katz (1997, 53):

“The right measure of the state of the labor market is the exit rate from unemployment, defined as the number of hires divided by the number unemployed, rather than the unemployment rate itself. What matters to the unemployed is not how many of them there are, but how many of them there are in relation to the number of hires by firms.”

The natural rate of unemployment and the similar NAIRU are quite difficult to estimate in practice (Ibid; see Ball and Mankiw 2002).

The Bureau of Labor Statistics (BLS) created the Job Openings and Labor Turnover Survey (JOLTS) with the purpose that (http://www.bls.gov/jlt/jltover.htm#purpose):

“These data serve as demand-side indicators of labor shortages at the national level. Prior to JOLTS, there was no economic indicator of the unmet demand for labor with which to assess the presence or extent of labor shortages in the United States. The availability of unfilled jobs—the jobs opening rate—is an important measure of tightness of job markets, parallel to existing measures of unemployment.”

The BLS collects data from about 16,000 US business establishments in nonagricultural industries through the 50 states and DC. The data are released monthly and constitute an important complement to other data provided by the BLS.

Hiring in the nonfarm sector (HNF) has declined from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million while hiring in the private sector (HP) has declined from 60.4 million in 2006 to 43.3 million in 2010 or by 17.1 million, as shown in Table 6. The ratio of nonfarm hiring to unemployment (RNF) has fallen from 47.7 in 2006 to 36.4 in 2010 and in the private sector (RHP) from 52.9 in 2006 to 40.3 in 2010 (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html).

Table 6, Annual Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US and Percentage of Total Employment

	HNF	Rate RNF	HP	Rate HP
2001	63,766	48.4	59,374	53.6
2002	59,797	45.9	55,665	51.1
2003	57,787	44.5	54,082	49.9
2004	61,624	46.9	57,534	52.4
2005	64,498	48.2	60,444	54.0
2006	64,870	47.7	60,419	52.9
2007	63,326	46.0	58,760	50.9
2008	53,986	39.5	50,286	44.0
2009	45,372	34.7	41,966	38.8
2010	47,234	36.4	43,299	40.3

Source: http://www.bls.gov/jlt/data.htm

Table 7 provides total HNF and HP in the month of May from 2001 to 2011. An important characteristic of the labor market in the US is that HNF has declined from 6.010 million in May 2006 to 4.531 million in May 2011, or by 1.479 million, and HP has fallen from 5.631 million in May 2006 to 4.250 million in May 2011, or by 1.381 million. HNF of 4.531 million in May 2011 is almost unchanged relative to 4.746 million in May 2010 and HP in May 2011 of 4.250 million is lower by 1.256 million than 5.506 million in May 2001. The US labor market is fractured, creating fewer opportunities to exit job stress of unemployment and underemployment of 25 to 30 million people and declining inflation-adjusted wages in the midst of fast increases in prices of everything (http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/06/unemployment-and-underemployment-of-24.html http://cmpassocregulationblog.blogspot.com/2011/05/job-stress-of-24-to-30-million-falling.html http://cmpassocregulationblog.blogspot.com/2011/04/twenty-four-to-thirty-million-in-job_03.html).

Table 7, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment in May Not Seasonally Adjusted

	HNF	Rate RNF	HP	Rate HP
2001 May	5898	4.4	5506	4.9
2002 May	5434	4.1	5065	4.6
2003 May	5093	3.9	4794	4.4
2004 May	5486	4.2	5183	4.7
2005 May	5775	4.3	5444	4.9
2006 May	6010	4.4	5631	4.9
2007 May	5836	4.2	5421	4.7
2008 May	5135	3.7	4816	4.2
2009 May	4186	3.2	3906	3.6
2010 May	4746	3.6	3398	3.7
2011 May	4531	3.4	4250	3.9

Source: http://www.bls.gov/jlt/data.htm

The Bureau of Labor Statistics (BLS) also calculates alternative measures of labor underutilization for the US and all states. Table 8 shows six measure of underutilization described in the note. There is dramatic rise in the broad measure of labor underutilization, U6, or total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons as percent of the labor force plus all marginally attached workers. This blog provides the numerator of U6 after the release of every employment situation report by the BLS. The number for Jun is 25.319 million in job stress (see Table 1 in http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/06/unemployment-and-underemployment-of-24.html) but using a different rate of participation of the population in the labor force the number could be 29.693 million (see Table 2 and discussion in http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html http://cmpassocregulationblog.blogspot.com/2011/06/unemployment-and-underemployment-of-24.html).

Table 8, Alternative Measures of Labor Underutilization %

	U1	U2	U3	U4	U5	U6
IIQ10 to IQ11	5.6	5.8	9.4	10.1	10.9	16.5
2010	5.7	6.0	9.6	10.3	11.1	16.7
2009	4.7	5.9	9.3	9.7	10.5	16.2
2008	2.1	3.1	5.8	6.1	6.8	10.5
2007	1.5	2.3	4.6	4.9	5.5	8.3
2006	1.5	2.2	4.6	4.9	5.5	5.6

Note: LF: labor force; U1, persons unemployed 15 weeks % LF; U2, job losers and persons who completed temporary jobs %LF; U3, total unemployed % LF; U4, total unemployed plus discouraged workers, plus all other marginally attached workers; % LF plus discouraged workers; U5, total unemployed, plus discouraged workers, plus all other marginally attached workers % LF plus all marginally attached workers; U6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons % LF plus all marginally attached workers

Source: http://www.bls.gov/lau/stalt11q1.htm

Seasonally-adjusted measures of labor underutilization for Jun 2010 and Feb to Mar 2011 are provided in Table 9. The more comprehensive measure is U6 consisting of total unemployed plus all marginally attached workers plus total employed part-time for economic reasons as percent of the labor force plus all marginally attached workers. U6 has increased SA from 15.9 in Feb 2011 to 16.2 in Jun 2011.

Table 9, Alternative Measures of Labor Underutilization SA %

	Jun 2010	Feb 2011	Mar 2011	Apr 2011	May 2011	Jun 2011
U1	5.8	5.3	5.3	5.1	5.3	5.3
U2	5.9	5.4	5.4	5.3	5.4	5.4
U3	9.5	8.9	8.8	9.0	9.1	9.2
U4	10.2	9.5	9.4	9.5	9.5	9.8
U5	11.0	10.5	10.3	10.4	10.3	10.7
U6	16.5	15.9	15.7	15.9	15.8	16.2

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

An article in Real Time Economics of the Wall Street Journal on Jul 16 on “Number of the week: 5% unemployment could be a decade away” (http://blogs.wsj.com/economics/2011/07/16/number-of-the-week-5-unemployment-could-be-over-a-decade-away/) provides an approximation of the number of months that would be required for the economy to return to the 5 percent unemployment rate of 2007. The current unemployment rate for Jun is 9.2 percent, with 14.1 million unemployed, on the basis of the household survey. Job creation in the first half of 2011 was 757,000 jobs, on the basis of the establishment survey. Assuming that job creation is approximately the same in the household survey as in the establishment survey, there would be a gain of 1.6 million new jobs in the year forward from Jun 2011 to Jun 2012. Real Time Economics adds to the calculation the growth of the labor force projected by the Census as 1.4 million people aged 16 and over. Employment would grow by 1.6 million while the labor force would grow by 1.4 million, reducing unemployment by only 200,000 that would still leave the rate of unemployment at 8.9 percent. Under those assumptions about employment growth and labor force growth, the rate of unemployment of 5 percent would only be attained in Dec 2024. Another recession would create a setback in the calculations. Another issue is that there appears to be an additional 4 million unemployed who are not counted because they abandoned the hope of finding another job, such that the total unemployment in Jun is more likely to be closer to 18.4 million. To that would have to be added 8.6 million barely making a living in part-time jobs because they cannot find anything better and 2.7 million marginally attached to the labor force. The total number of people in job stress in the US is 29.693 million in Jun 2011 (http://cmpassocregulationblog.blogspot.com/2011/07/twenty-five-to-thirty-million.html). The US is suffering a suffocating unemployment and underemployment stress that would require much faster growth than that experienced in the weakest recovery from a recession since World War II.

II Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. The JP Morgan Global PMI, compiled by Markit, provides an important reading of the world economy, analyzed by Markit’s Chief Economist Chris Williamson (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/global_economy_11_07_07.pdf). The JP Morgan Global PMI, compiled by Markit, registered the weakest quarter of private sector output growth in manufacturing and services since IIIQ2009, when the world economy began recovering, falling from 52.7 in May to 52.2 in Jun. Japan recovered sharply from the Mar earthquake/tsunami but the JP Morgan Global PMI compiled by Markit shows that the index is significantly lower in Jun than in May, being consistent with world GDP growth at the low annual rate of 2 percent. Japan’s sharp recovery has been compensated in the index by weak IIQ2011 growth in the US, with Jun being at the lowest in 22 months, and similar weakness in the euro zone and the UK. Growth has also weakened in the BRIC countries of Brazil, Russia, India and China. The JP Morgan Global PMI compiled by Markit shows that world manufacturing exports have nearly stagnated with the worst performance since Jul 2009. The softness of the economy is worldwide and persistent.

Table 10 updated with every post, provides the latest annual data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly-indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of the sovereign risk issues (http://www.ft.com/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1G67TzFqs). Aaron Back and Jason Dean writing on Jul 9, 2011 on “China price watchers predict another peak” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304793504576433443699064616.html?mod=WSJ_hp_LEFTWhatsNewsCollection) inform that China’s CPI inflation jumped to 6.4 per cent in Jun relative to a year earlier, much higher than 5.5 percent in May but many economists believe that inflation could decline in the second half of the year. Comparisons with high rates of CPI inflation late in 2010 will likely result in lower 12 months rates of inflation later in 2011. Jamil Anderlini writing on Jul 9, 2011, on “China inflation hits three-year high” published by the Financial Times (http://www.ft.com/intl/cms/s/0/693daad2-aa1d-11e0-958c-00144feabdc0.html#axzz1Repz5K5o) informs that food prices increased 14.4 percent in the 12 months ending in Jun. Core non-food prices increased 3 percent in the 12 months ending in Jun, which is the highest rate in five years, suggesting inflation is spreading in the economy. Headline CPI inflation rose 0.3 percent in Jun relative to May but prices excluding food were stable, which could signal decelerating inflation. Aaron Back writing on Jul 6, 2011 on “China raises interest rates” published by the Wall Street Journal Asia Business (http://professional.wsj.com/article/SB10001424052702303544604576429393824293666.html?mod=WSJ_hp_LEFTWhatsNewsCollection) informs that the People’s Bank of China raised the one-year lending rate from 6.31 percent to 6.56 percent and the one-year deposit rate to 3.5 percent from 3.25 percent. This was the fifth increase in interest rates in 2010 and 2011. The People’s Bank of China has raised the reserve requirements of banks six times in 2011. The concern with inflation in China is that it could be a factor in a “hard landing” of the economy with growth lower than 7 percent. The lending rate may not be negative in real terms if during the next 12 months inflation falls below the yearly rate of 6.5 percent. An issue is China is the use of generous credit growth to prevent the impact of the global recession on China. Deposit rates of 3.5 percent are likely to be lower than forward inflation, stimulating the purchase of speculative assets such as housing and also goods that may rise more than expected inflation. Martin Vaughan writing on July 5, 2011 on “Moody’s warns on China debt” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304803104576427062691548064.html?mod=WSJ_hp_LEFTWhatsNewsCollection) informs of the warning by Moody’s Investors Service that China’s National Audit Office (NAO) understated CNY 3.5 trillion or $541 billion of bank loans to local governments. That portion of loans has poor documentation and highest exposure to delinquencies. NAO has concluded that banks have lent CNY 8.5 trillion to local government. A critical issue in China is the percentage of those loans that could become nonperforming and the impact that could occur on bank capital and solvency. The report by Moody’s Investors Service “estimates that the Chinese banking system’s economic nonperforming loans could reach between 8% and 12% of total loans, compared to 5% to 8% in the agency’s base case, and 10% to 18% in its stress case” (http://www.moodys.com/research/Moodys-Scale-of-problem-loans-to-Chinese-local-governments-greater?lang=en&cy=global&docid=PR_222068). A hard landing in China could have adverse repercussions in the regional economy of Asia and throughout the world’s financial markets and economy. The combination of a hard landing in China with sovereign risk difficulties in Europe and further slowing of the US economy could have strong, unpredictable effects. Jamil Anderlini writing from Shanghai on Jul 10, 2011 on “Trade data show China economy slowing” published by the Financial Times (http://www.ft.com/intl/cms/s/0/eeedc000-aabc-11e0-b4d8-00144feabdc0.html#axzz1Repz5K5o) informs that Chinese imports grew at 19.3 percent in June 2011 relative to Jun 2010, which is significantly below the 12-month rate of 28.4 percent in May. China’s industrial activity appears to be decelerating as suggested by lower imports of commodities such as crude oil, aluminum and iron ore, all falling in the 12 months ending in Jun 2011. China’s imports of crude oil fell 11.5 percent in Jun 2011 relative to Jun 2010 and copper imports grew in Jun but were lower than a year earlier. China’s exports grew 17.9 percent in Jun from a year earlier to a monthly record of $162 billion. The trade surplus of China in Jun of $22.3 billion was higher than $13 billion in May and may reignite the complaints about China’s exchange rate policy. Simon Rabinovitch writing on Jul 12 on “China’s foreign reserves climb by $153 billion” published by the Financial Times (http://www.ft.com/intl/cms/s/0/13c382e6-ac59-11e0-bac9-00144feabdc0.html#axzz1Repz5K5o) informs that China’s foreign reserves rose by $153 billion in IIQ2011 after increasing $197 billion in IQ2011, reaching $3197 billion, which is around 50 percent of GDP and three times higher than reserves by any other country. The trade surplus contributed $47 billion of the increase of reserves of $153 billion in IIQ2011 with the remainder originating mostly in investment inflows and interest earnings. Aaron Back writing on Jul 13 on “China growth suggests tightening ahead” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304223804576443493415667206.html?mod=WSJ_hp_LEFTWhatsNewsCollection) analyzes new data on China showing fast expansion of the economy that could signal further tightening measures. China’s GDP grew at 9.5 percent in IIQ2011, which is lower than 9.7 percent in IQ2011. Most countries report GDP growth as seasonally adjusted quarterly rates converted in annual equivalent. The adjustment of Chinese data for seasonality in annual equivalent results in GDP growth of 9.1 in IIQ2011 compared with 8.7 percent growth in IQ2011. The growth rate of GDP of China in IIQ2011 increased slightly to 2.2 percent in that quarter. Industrial production rose to the 12-month rate in Jun of 15.1 percent, which is higher than 13.3 percent in May. Real estate investment in Jan-Jun 2011 rose to CNY 2.625 trillion, equivalent to about $405 billion, which is higher by 32.9 percent relative to Jan-Jun 2010. Sales of commercial and residential property sales in Jan-Jun 2011 rose 24.1 percent relative to 2010, which is higher than 18.1 percent in Jan-May

Table 10, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates

	GDP	CPI	PPI	UNE
US	2.9	3.6	7.0	9.2
Japan	-0.7***	0.3	2.5	4.5
China	9.5	6.4	6.8
UK	1.8	4.5* RPI 5.2	5.7* output 17.0* input 12.8**	7.7
Euro Zone	2.5	2.7	6.2	9.9
Germany	4.8	2.4	6.1	6.0
France	2.2	2.3	6.0	9.5
Nether-lands	3.2	2.5	10.7	4.2
Finland	5.8	3.4	8.0	7.8
Belgium	3.0	3.4	9.7	7.3
Portugal	-0.7	3.3	5.9	12.4
Ireland	-1.0	1.2	5.3	14.0
Italy	1.0	3.0	4.8	8.1
Greece	-4.8	3.1	7.2	15.1
Spain	0.8	3.0	6.7	20.9

Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier

*Office for National Statistics

PPI http://www.statistics.gov.uk/pdfdir/ppi0711.pdf

CPI http://www.statistics.gov.uk/pdfdir/cpi0611.pdf

** Excluding food, beverage, tobacco and petroleum

http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-04042011-AP/EN/4-04042011-AP-EN.PDF

***Change from IQ2011 relative to IQ2010 http://www.esri.cao.go.jp/jp/sna/sokuhou/kekka/gaiyou/main_1.pdf

Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html

Table 11 provides the forecasts of the Federal Reserve Board Members and Federal Reserve Bank Presidents for the FOMC meeting in Jun. Inflation by the price index of personal consumption expenditures (PCE) was forecast for 2011 in the Apr meeting of the FOMC between 2.1 to 2.8 percent. Table 12 shows that the interval has narrowed to PCE headline inflation of between 2.3 and 2.5 percent. The FOMC focuses on core PCE inflation, which excludes food and energy. The Apr forecast of core PCE inflation was an interval between 1.3 and 1.6 percent. Table 11 shows the revision of this forecast in Jun to a higher interval between 1.5 and 1.8 percent. The Statement of the FOMC meeting on Jun 22 analyzes inflation as follows (http://www.federalreserve.gov/newsevents/press/monetary/20110622a.htm):

“Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

Table 11, Forecasts of PCE Inflation and Core PCE Inflation by the FOMC, %

	PCE Inflation	Core PCE Inflation
2011	2.3 to 2.5	1.5 to 1.8
2012	1.5 to 2.0	1.4 to 2.0
2013	1.5 to 2.0	1.4 to 2.0
Longer Run	1.7 to 2.0

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20110622.pdf

Japan’s corporate goods price index (CGPI), formerly wholesale price index (WPI), fell 0,1 percent in Jun, after falling 0.1 percent in May but increasing in all months in Jan-Apr. The annual equivalent rate of price increase in Jan-Jun is 4.1 percent and 2.5 percent year-on-year, as shown in Table 12. These are very high rates of price increase for Japan.

Table 12, Japan Corporate Goods Price Index (CGPI) ∆%

	Month	Year
Jun	-0.1	2.5
May	-0.1	2.2
Apr	0.9	2.5
Mar	0.6	2.0
Feb	0.2	1.7
Jan	0.5	1.5
AE ∆%	4.1

AE: annual equivalent

Source: http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1106.pdf

Table 13 shows the euro area’s harmonized index of consumer prices (HIPC). The change in Jun 2011 relative to Jun 2010 is 2.7 percent. HIPC inflation has stabilized around 2.7 to 2.8 percent in the months of Apr to Jun 2011 relative to a year earlier. Core inflation, excluding energy, food, alcohol and tobacco, is 1.8 percent for the 12 months ending in Jun and has been at that rate in the quarter Apr to Jun 2011 relative to a year earlier. Energy prices have been rising much faster in the consumption basket of the HIPC, moderating slightly to 10.9 percent in Jun and 11.1 percent in May compared with 12.5 percent in Apr and 13.0 percent in Mar. Housing and transportation have been experiencing higher inflation for consumers than food. The 12 months HIPC is the inflation indicator for the European Central Bank with target of maximum 2 percent, explaining the recent interest rate increases. Table 10 above uses HIPC data for the euro zone and its member countries as provided by Eurostat.

Table 13, Euro Area Harmonized Index of Consumer Prices 12 Months ∆%

	Jun 11 /Jun 10	May 11 /May 10	Apr 11 /Apr 10
All	2.7	2.7	2.8
Ex Energy, Food, Alcohol and Tobacco	1.8	1.8	1.8
Energy	10.9	11.1	12.5
Food	2.7	2.7	2.0
Housing	4.8	4.7	5.0
Transport	5.3	5.3	5.9

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-16062011-BP/EN/2-16062011-BP-EN.PDF

Table 14 provides consumer price index inflation in the UK. Inflation fell to 4.2 percent in Jun from 4.5 percent in the 12 months ending in Apr and May 2011, somewhat higher than 4.0 percent in the 12 months ending in Jan. The annual equivalent inflation in Jan-Jun, or what inflation would be in a full year if the cumulative rate in the first six months were repeated, is 4.5 percent, slightly higher than past 12 month inflation of 4.2 percent. The monthly rate dropped significantly from 1.0 percent in Apr to 0.2 percent in May and decline of 0.1 percent in Jun.

Table 14, UK Consumer Price Index ∆%

	Month	12 Months
Jun	-0.1	4.2
May	0.2	4.5
Apr	1.0	4.5
Mar	0.3	4.0
Feb	0.7	4.4
Jan	0.1	4.0
Jan-May AE ∆%	4.5

AE: annual equivalent

Surce: http://www.statistics.gov.uk/pdfdir/cpi0711.pdf

CPI inflation has risen moderately in France as shown in Table 15. The 12-month rate of 2.1 percent in Jun is only slightly higher than 1.8 percent in Jan. Much of the increase in inflation occurred in the quarter of Feb to Apr when energy and commodity prices were accelerating. Because of the rise in the quarter of Feb to Apr, the annual equivalent inflation rate in the first half of the year is 3.2 percent.

Table 15, France, Consumer Price Index ∆%

	Month	12 Months
Jun	0.1	2.1
May	0.1	2.0
Apr	0.3	2.1
Mar	0.8	2.0
Feb	0.5	1.6
Jan	-0.2	1.8
AE ∆%	3.2

Source: http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20110712

CPI inflation in Germany rose from 1.7 in the 12 months ending in Dec 2010 to 2.3 percent in the 12 months ending in Jun 2011, as shown in Table 16. Inflation was also higher in the quarter Feb to Apr as a result of commodity price increases but the rate fell significantly in the quarter Apr to June. The annual equivalent rate for the first six months of the year is 1.8 percent, which is lower than 2.3 percent in the 12 months ending in Jun.

Table 16, Germany, Consumer Price Index ∆%

	Month	12 Months
Jun	0.1	2.3
May	0.0	2.3
Apr	0.2	2.4
Mar	0.5	2.1
Feb	0.5	2.1
Jan	-0.4	2.0
Dec 2010	1.0	1.7
AE ∆%	1.8

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2011/07/PE11__260__611,templateId=renderPrint.psml

CPI inflation in Italy has been relatively higher than in France and Germany, as shown in Table 17. There is the same collapse of the monthly rate in Jun and May, caused by the decline in commodity prices. There was an increase in monthly inflation in Jan of 0.4 percent instead of a decline as in France and Germany. The 12-month rate of inflation has jumped from 1.9 percent in Dec 2010 to 2.7 percent in Jun 2011.

Table 17, Italy, Consumer Price Index ∆%

	Month	12 Months
Jun	0.1	2.7
May	0.1	2.6
Apr	0.5	2.6
Mar	0.4	2.5
Feb	0.3	2.4
Jan	0.4	2.1
Dec 2010	0.4	1.9
AE ∆%	3.7

Source: http://www.istat.it/salastampa/comunicati/in_calendario/precon/20110714_00/testointegrale20110714.pdf

CPI inflation is accelerating in the US as suggested by data in Table 18. The 12-month rate of increase of the CPI was 3.6 percent in Jun compared with an annual equivalent of 3.7 percent in Jan-Jun 2011. The 12-month rate of increase of the CPI in Dec 2010 was 1.5 percent and the average CPI rose 1.6 percent in 2010 relative to 2009. The 12-month rate of increase of the CPI in Dec 2007 was 4.1 percent and the average CPI rose 2.8 percent in 2007 relative to 2006 (ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt). The earlier “fear of deflation” in 2003-2004 that motivated near-zero interest rates ended in much higher inflation than 1.9 percent in the 12 months ending in Dec 2003 and 2.3 percent in the average of 2003 relative to 2002. The CPI excluding food and energy is rising less rapidly at 1.6 percent in 12 months but 2.6 percent annual equivalent in the first five months of 2011. The 12 months rates of increases are quite high for numerous items showing that commodity shocks have not been transitory but have occurred on a trend for nearly a year. The lowest increases in 12 months are for apparel, 1.0 percent, shelter 1.2 percent, and services less energy 1.6 percent. With the exception of energy, gasoline and transportation services, restrained by collapse of energy and commodity prices, annual equivalent rates for the first six months of 2011 exceed 12 months rates of increase.

Table 18, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent Jan-Jun 2011 ∆%

	∆% 12 Months Jun 2011/Jun 2010 NSA	∆% Annual Equivalent Jan-Jun 2011 SA
CPI All Items	3.6	3.7
CPI ex Food and Energy	1.6	2.6
Food	3.7	5.9
Food at Home	4.7	7.9
Food Away from Home	2.3	3.0
Energy	20.1	11.7
Gasoline	35.6	16.6
Fuel Oil	37.3	44.4
New Vehicles	4.0	8.3
Used Cars and Trucks	5.1	9.4
Medical Care Commodities	2.9	4.3
Services Less Energy Services	1.6	1.8
Apparel	1.0	2.1
Shelter	1.2	1.6
Transportation Services	3.1	3.2
Medical Care Services	2.9	3.2

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

An important feature of the Jun CPI of the US is the decline in energy, gasoline and fuel prices shown in Table 19. Gasoline prices, with heavy impact on budgets of the middle class, fell 6.8 percent in Jun relative to May after falling 2.0 percent in May relative to Apr; energy declined 4.4 percent in Jun after falling 1.0 percent in May; and fuel oil fell 2.2 percent in Jun after falling 0.8 percent in May. Normalization of refineries and lower prices of oil explain the decline in fuels and energy prices. The overall CPI fell 0.2 percent in Jun compared with increases of 0.2 percent in May, 0.4 percent in Apr and 0.5 percent in Mar. The CPI excluding food and energy rose 0.3 percent in both Jun and May and 0.2 percent for a quarterly annual equivalent rate of 3.2 percent, which is higher than 1.6 percent for headline CPI inflation. The annual equivalent rates of increase of various CPI components in the quarter Mar to Jun 2011 are still quite high.

Table 19, Monthly Percentage Change of Consumer Price Index SA and Annual Equivalent Apr-Jun 2011

	Jun	May	Apr	Mar-May AE
CPI All Items	-0.2	0.2	0.4	1.6
CPI ex Food and Energy	0.3	0.3	0.2	3.2
Food	0.2	0.4	0.4	4.1
Food at Home	0.2	0.5	0.5	4.9
Food Away from Home	0.3	0.2	0.3	3.2
Energy	-4.4	-1.0	2.2	-12.5
Gasoline	-6.8	-2.0	3.3	-20.8
Fuel Oil	-2.2	-0.8	3.2	0.5
New Vehicles	0.6	1.1	0.7	10.0
Used Cars and Trucks	1.6	1.1	1.2	16.8
Medical Care Commodities	-0.1	0.0	0.5	1.6
Services Less Energy Services	0.1	0.2	0.1	1.6
Apparel	1.4	1.2	0.2	11.8
Shelter	0.2	0.2	0.1	2.0
Transport-ation Services	-0.3	0.1	0.2	0.0
Medical Care Services	0.3	0.3	0.3	3.7

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

The relative importance or weights of items in the CPI are shown in Table 20. Food and transportation account for 32.1 percent of consumer expenditures and housing for 41.460 percent such that food, transportation and housing account for 73.56 percent of consumer expenditures. Housing is still in recession conditions and a significant part, 24.9 percent, consists of “owners’ equivalent rent,” which is a calculation of what owners would pay if they would rent their own house. The major categories are shown in relief. Motor fuel has risen sharply with gasoline increasing 35.6 percent in the 12 months ending in Jun but accounts for only 5.079 percent of CPI expenditures. Lower income families experience more stress from increases in food and fuel, which represent a higher proportion of their expenses.

Table 20, Relative Importance, 2007-2008 Weights, of Components in the Consumer Price Index, US City Average, Dec 2010

All Items	100.000
Food and Beverages	14.792
Food	13.742
Food at home	7.816
Food away from home	5.926
Housing	41.460
Shelter	31.955
Rent of primary residence	5.925
Owners’ equivalent rent	24.905
Apparel	3.601
Transportation	17.308
Private Transportation	16.082
New vehicles	3.513
Used cars and trucks	2.055
Motor fuel	5.079
Gasoline	4.865
Medical Care	6.627
Medical care commodities	1.633
Medical care services	4.994
Recreation	6.293
Education and Communication	6.421
Other Goods and Services	3.497

Source: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiri2010.txt

The 12-month rates of increase of PCE price indexes are shown in Table 21. These data are released at the end of the month while the CPI and PPI are released in mid month. Headline 12-month PCE inflation (PCE) has accelerated from slightly over 1 percent in the latter part of 2010 to 2.2 percent in Apr and 2.5 percent in May. Monetary policy uses PCE inflation excluding food and energy (PCEX) on the basis of research showing that current PCEX is a better indicator of headline PCE a year ahead than current headline PCE inflation. The explanation is that commodity price shocks are “mean reverting,” returning to their long-term means after spiking during shortages caused by climatic factors, geopolitical events and the like. Inflation of PCE goods (PCEG) has accelerated sharply reaching 4.6 percent in May, in spite of 12-month declining inflation of PCE durable goods (PCEG-D) while PCE services inflation (PCES) has remained around 1.3 to 1.5 percent. The last two columns of Table 21 show PCE food inflation (PCEF) and PCE energy inflation (PCEE) that have been rising sharply, especially for energy. Monetary policy expects these increases to revert with its indicator PCEX returning to levels that are acceptable for continuing monetary accommodation.

Table 21, Percentage Change in 12 Months of Prices of Personal Consumption Expenditures ∆%

	PCE	PCEG	PCEG -D	PCES	PCEX	PCEF	PCEE
2011
May	2.5	4.6	-0.7	1.5	1.2	3.5	22.1
Apr	2.2	4.0	-1.1	1.4	1.1	3.2	19.6
Mar	1.9	3.0	-1.6	1.3	0.9	2.9	15.3
Feb	1.6	2.1	-1.4	1.3	0.9	2.4	11.1
Jan	1.2	1.2	-1.9	1.3	0.8	1.7	6.7
2010
Dec	1.1	1.0	-2.2	1.2	0.7	1.2	7.4
Nov	1.0	0.6	-2.0	1.3	0.8	1.3	4.0
Oct	1.2	0.8	-1.8	1.4	0.9	1.3	6.3
Sep	1.3	0.5	-1.4	1.7	1.1	1.3	4.2
Aug	1.4	0.6	-1.0	1.7	1.2	0.7	4.0

Notes: percentage changes in price index relative to the same month a year earlier of PCE: personal consumption expenditures; PCEG: PCE goods; PCEG-D: PCE durable goods; PCEX: PCE excluding food and energy; PCEF: PCE food; PCEE: PCE energy goods and services

Source: http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi0511.pdf

http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi0311.pdf

http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi0411.pdf

The role of devil’s advocate is played by data in Table 22. Headline PCE inflation (PCE) has jumped to 1.6 percent cumulative in the first four months of 2011, which is equivalent to 3.9 percent annual, with PCEG jumping to 3.0 percent cumulative and 7.4 percent annual equivalent, PCEG-D rising 0.8 percent cumulative or 1.9 percent annual, and PCES rising to 0.9 percent cumulative and 2.2 percent annual. PCEX, used in monetary policy, rose to 1.1 percent cumulative or 2.7 percent annual. PCEF has increased by 3.0 percent cumulative, which is equivalent in a full year to 7.4 percent. PCEE has risen to 10.9 percent cumulative or 28.3 percent annual equivalent with decline by 1.2 percent in May.

Table 22, Monthly and Jan-May PCE Inflation and Annual Equivalent Jan-May 2011 and Sep-Dec 2010 ∆%

	PCE	PCEG	PCEG -D	PCES	PCEX	PCEF	PCEE
2011
Jan-May 2011	1.6	3.0	0.8	0.9	1.1	3.0	10.9
Jan-May 2011 AE	3.9	7.4	1.9	2.2	2.7	7.4	28.3
May	0.2	0.0	0.2	0.2	0.3	0.3	-1.2
Apr	0.3	0.6	0.3	0.2	0.2	0.4	2.3
Mar	0.4	0.8	0.0	0.2	0.2	0.8	3.7
Feb	0.4	0.8	0.2	0.2	0.2	0.8	3.5
Jan	0.3	0.8	0.1	0.1	0.2	0.7	2.3
Sep-Dec 2010	0.7	1.1	-0.9	0.9	0.1	0.5	7.9
Sep-Dec 2010 AE	2.1	3.3	-2.7	2.7	0.3	1.5	25.5
Dec	0.3	0.6	-0.3	0.1	0.0	0.1	4.1
Nov	0.1	0.0	-0.3	0.1	0.1	0.0	0.1
Oct	0.2	0.4	-0.2	0.1	0.0	0.1	2.7
Sep	0.1	0.1	-0.1	0.0	0.0	0.3	0.8

Notes:AE: annual equivalent; percentage changes in a month relative to the same month for the same symbols as in Table.

Source: http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi0511.pdf

http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi0311.pdf

http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi0411.pdf

An important characteristic of producer price index (PPI) inflation in Table 23 is relatively high monthly rates for the PPI excluding food and energy. Annual equivalent PPI inflation in Jan-Jun 2011 was 8.3 percent while the annual equivalent rate excluding food and energy settled at 3.7 percent. The 12-month rate of increase of the PPI was 3.8 percent in Dec 2010, jumping to 7.0 percent in the 12 months ending in Jun 2011 (http://www.bls.gov/news.release/pdf/ppi.pdf). The PPI fell 0.4 percent in Jun after increasing only 0.2 percent in May. Instead of mean reversion, the behavior of producer prices has been steady increase on a trend with oscillations caused by episodes of risk aversion in financial markets that reduce positioning of commodity derivatives and other risk financial assets in the carry trade from zero interest rates. Monetary policy creates its own inflation through the carry trade that stimulates commodity futures prices.

Table 23, Producer Price Index ∆%

	Total	Excluding Food and Energy
SA
Jun	-0.4	0.3
May	0.2	0.2
Apr	0.8	0.3
Mar	0.9	0.3
Feb	1.5	0.2
Jan	1.0	0.5
Dec 2010	0.9	0.2
Annual Equivalent Jan-Jun	8.3	3.7
NSA 12 Months Jun	7.0	2.4
NSA 12 Months May	7.3	2.1
NSA 12 Months Apr	6.8	2.1

Source: http://www.bls.gov/news.release/ppi.nr0.htm

Current price increases from May into June and then into Jul and the expectation for the next six months fell significantly in the Empire State Manufacturing Survey of the Federal Reserve Bank of New York shown in Table 24. Indexes for prices paid or inputs and prices received or sales, current or expected in six months, and percentages of responses of higher prices are significantly lower in Jul compared with May. The indexes are still relatively high but the rhythm of price increases is moderating. The expectation for six months of prices received shows rebound of inflationary expectations in percentage responses of higher prices and in the index.

Table 24, FRBNY Empire State Manufacturing Survey, Prices Paid and Prices Received, SA

	Higher	Same	Lower	Index
Current
Prices Paid
May	69.89	30.11	0.00	69.89
Jun	58.16	39.80	2.04	56.12
Jul	47.78	47.78	4.44	43.33
Prices Received
May	33.33	61.29	5.38	27.96
Jun	17.35	76.53	6.12	11.22
Jul	14.44	76.67	8.89	5.56
Six Months
Prices Paid
May	70.97	26.88	2.15	68.82
Jun	58.16	38.78	3.06	55.10
Jul	56.67	37.78	5.56	51.11
Prices Received
May	40.86	53.76	5.38	35.48
Jun	30.61	58.16	11.22	19.39
Jul	38.89	52.22	8.89	30.00

Source: http://www.newyorkfed.org/survey/empire/july2011.pdf

Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart 1 for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart 1 cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s; the loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy. The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:

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

Chart 1, Brazil, Phillips Circuit 1963-1987

©Carlos Manuel Pelaez, O cruzado e o austral. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.

DeLong (1997, 247-8) shows that the 1970s were the only peacetime period of inflation in the US without parallel in the prior century. The price level in the US drifted upward since 1896 with jumps resulting from the two world wars: “on this scale, the inflation of the 1970s was as large an increase in the price level relative to drift as either of this century’s major wars” (DeLong, 1997, 248). Monetary policy focused on accommodating higher inflation, with emphasis solely on the mandate of promoting employment, has been blamed as deliberate or because of model error or imperfect measurement for creating the Great Inflation (http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). As DeLong (1997) shows, the Great Inflation began in the mid 1960s, well before the oil shocks of the 1970s (see also the comment to DeLong 1997 by Taylor 1997, 276-7). Table 25 provides the change in GDP, CPI and the rate of unemployment from 1960 to 1990. There are three waves of inflation (1) in the second half of the 1960s; (2) from 1973 to 1975; and (3) from 1978 to 1981. In one of his multiple important contributions to understanding the Great Inflation, Meltzer (2005) distinguishes between one-time price jumps, such as by oil shocks, and a “maintained” inflation rate. Meltzer (2005) uses a dummy variable to extract the one-time oil price changes, resulting in a maintained inflation rate that was never higher than 8 to 10 percent in the 1970s. There is revealing analysis of the Great Inflation and its reversal by Meltzer (2005, 2010a, 2010b).

Table 25, US Annual Rate of Growth of GDP and CPI and Unemployment Rate 1960-1982

	∆% GDP	∆% CPI	UNE
1960	2.5	1.4	6.6
1961	2.3	0.7	6.0
1962	6.1	1.3	5.5
1963	4.4	1.6	5.5
1964	5.8	1.0	5.0
1965	6.4	1.9	4.0
1966	6.5	3.5	3.8
1967	2.5	3.0	3.8
1968	4.8	4.7	3.4
1969	3.1	6.2	3.5
1970	0.2	5.6	6.1
1971	3.4	3.3	6.0
1972	5.3	3.4	5.2
1973	5.8	8.7	4.9
1974	-0.6	12.3	7.2
1975	-0.2	6.9	8.2
1976	5.4	4.9	7.8
1977	4.6	6.7	6.4
1978	5.6	9.0	6.0
1979	3.1	13.3	6.0
1980	-0.3	12.5	7.2
1981	2.5	8.9	8.5
1982	-1.9	3.8	10.8
1983	4.5	3.8	8.3
1984	7.2	3.9	7.3
1985	4.1	3.8	7.0
1986	3.5	1.1	6.6
1987	3.2	4.4	5.7
1988	4.1	4.4	5,3
1989	3.6	4.6	5.4
1990	1.9	6.1	6.3

Note: GDP: Gross Domestic Product; CPI: consumer price index; UNE: rate of unemployment; CPI and UNE are at year end instead of average to obtain a complete series

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

http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=2&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=2009&LastYear=2010&3Place=N&Update=Update&JavaBox=no

http://www.bls.gov/web/empsit/cpseea01.htm

http://data.bls.gov/pdq/SurveyOutputServlet

There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table 26 when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table 26 shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.

Table 26, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994

1994	FF	30Y	30P	10Y	10P	MOR	CPI
Jan	3.00	6.29	100	5.75	100	7.06	2.52
Feb	3.25	6.49	97.37	5.97	98.36	7.15	2.51
Mar	3.50	6.91	92.19	6.48	94.69	7.68	2.51
Apr	3.75	7.27	88.10	6.97	91.32	8.32	2.36
May	4.25	7.41	86.59	7.18	88.93	8.60	2.29
Jun	4.25	7.40	86.69	7.10	90.45	8.40	2.49
Jul	4.25	7.58	84.81	7.30	89.14	8.61	2.77
Aug	4.75	7.49	85.74	7.24	89.53	8.51	2.69
Sep	4.75	7.71	83.49	7.46	88.10	8.64	2.96
Oct	4.75	7.94	81.23	7.74	86.33	8.93	2.61
Nov	5.50	8.08	79.90	7.96	84.96	9.17	2.67
Dec	6.00	7.87	81.91	7.81	85.89	9.20	2.67

Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months

Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t

Table 27, updated with every blog comment, provides in the second column the yield at the close of market of the 10-year Treasury note on the date in the first column. The price in the third column is calculated with the coupon of 2.625 percent of the 10-year note current at the time of the second round of quantitative easing after Nov 3, 2010 and the final column “∆% 11/04/10” calculates the percentage change of the price on the date relative to that of 101.2573 at the close of market on Nov 4, 2010, one day after the decision on quantitative easing by the Fed on Nov 3, 2010. Prices with the new coupon of 3.63 percent in recent auctions (http://www.treasurydirect.gov/instit/annceresult/press/preanre/2011/2011.htm) are not comparable to prices in Table 27. The highest yield in the decade was 5.510 percent on May 1, 2001 that would result in a loss of principal of 22.9 percent relative to the price on Nov 4. The Fed has created a “duration trap” of bond prices. Duration is the percentage change in bond price resulting from a percentage change in yield or what economists call the yield elasticity of bond price. Duration is higher the lower the bond coupon and yield, all other things constant. This means that the price loss in a yield rise from low coupons and yields is much higher than with high coupons and yields. Intuitively, the higher coupon payments offset part of the price loss. Prices/yields of Treasury securities were affected by the combination of Fed purchases for its program of quantitative easing and also by the flight to dollar-denominated assets because of geopolitical risks in the Middle East, subsequently by the tragic earthquake and tsunami in Japan and now again by the sovereign risk doubts in Europe. The yield of 2.905 percent at the close of market on Fr Jul 15, 2011, would be equivalent to price of 97.5851 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price loss of 3.6 percent relative to the price on Nov 4, 2010, one day after the decision on the second program of quantitative easing. If inflation accelerates, yields of Treasury securities may rise sharply. Yields are not observed without special yield-lowering effects such as the flight into dollars caused by the events in the Middle East, continuing purchases of Treasury securities by the Fed, the tragic earthquake and tsunami affecting Japan and recurring fears on European sovereign credit issues. Important causes of the rise in yields shown in Table 27 are expectations of rising inflation and US government debt estimated to exceed 70 percent of GDP in 2012 (http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html), rising from 40.8 percent of GDP in 2008, 53.5 percent in 2009 (Table 2 in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html) and 69 percent in 2011. On Jul 13, 2011, the line “Reserve Bank credit” in the Fed balance sheet stood at $2862 billion, or $2.9 trillion, with portfolio of long-term securities of $2626 billion, or $2.6 trillion, consisting of $1537 billion Treasury nominal notes and bonds, $65 billion of notes and bonds inflation-indexed, $115 billion Federal agency debt securities and $909 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $1685 billion or $1.7 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). There is no simple exit of this trap created by the highest monetary policy accommodation in US history together with the highest deficits and debt in percent of GDP since World War II. Risk aversion from various sources, discussed in section I, has been affecting financial markets for several weeks. The risk is that in a reversal of risk aversion that has been typical in this cyclical expansion of the economy yields of Treasury securities may back up sharply.

Table 27, 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
02/11/11	3.643	91.5319	-9.6
02/18/11	3.582	92.0157	-9.1
02/25/11	3.414	93.3676	-7.8
03/04/11	3.494	92.7235	-8.4
03/11/11	3.401	93.4727	-7.7
03/18/11	3.273	94.5115	-6.7
03/25/11	3.435	93.1935	-7.9
04/01/11	3.445	93.1129	-8.0
04/08/11	3.576	92.0635	-9.1
04/15/11	3.411	93.3874	-7.8
04/22/11	3.402	93.4646	-7.7
04/29/11	3.290	94.3759	-6.8
05/06/11	3.147	95.5542	-5.6
05/13/11	3.173	95.3387	-5.8
05/20/11	3.146	95.5625	-5.6
05/27/11	3.068	96.2089	-4.9
06/03/11	2.990	96.8672	-4.3
06/10/11	2.973	97.0106	-4.2
06/17/11	2.937	97.3134	-3.9
06/24/11	2.872	97.8662	-3.3
07/01/11	3.186	95.2281	-5.9
07/08/11	3.022	96.5957	-4.6
07/15/11	2.905	97.5851	-3.6

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 and the coupon of 2.625% on 11/04/10

Source:

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

IV Trade and Growth. The relationship of trade, capital flows and economic growth has been the subject of intensive research. The gains from international trade and the role of trade in employment and conservation of resources are also widely researched (see Pelaez and Pelaez, Globalization and the State Vol. I (2009a), Globalization and the State Vol. II (2009b) and Government Intervention in Globalization (2009c)). Trade has been an important driver of growth in the past decade; trade contracted during the global recession; and trade has been driving growth in the expansion. The JP Morgan Global PMI compiled by Markit shows that world manufacturing exports have nearly stagnated with the worst performance since Jul 2009 (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/global_economy_11_07_07.pdf).

The forecasts of world output and trade growth in the revised Jun World Economic Outlook of the IMF are shown in Table 28. World output contracted by 0.5 percent in 2009 and then rebounded with growth of 5.1 percent in 2010 with the IMF projecting growth of 4.3 percent in 2011 and 4.5 percent in 2012. The contraction of 0.5 percent in 2009 is actually a much higher loss when adding GDP growth of 4 percent or more that would have occurred in the absence of the global recession. Table 28 shows strong impact of the global recession in the form of contraction of world trade by 10.8 percent. The advanced economies suffered much more with declines of 12.0 percent in exports and 12.5 percent in imports but the impact on emerging and developing economies was also strong with contraction of both exports and imports by 7.9 percent. Output growth of 5.1 percent was accompanied by double-digit increases in trade, 12.4 percent, and exports and imports of advanced economies and emerging and developing economies. Projections for 2011 and 2012 are for more moderate growth after the initial jump in 2010. New data on growth and trade are discussed below in the remainder of this section.

Table 28, IMF Forecasts of Growth of World Output and World Trade ∆%

	2009	2010	2011	2012
Output	-0.5	5.1	4.3	4.5
Trade	-10.8	12.4	8.2	6.7
Exports
Advanced Economies	-12.0	12.3	6.8	6.1
Emerging Developing	-7.9	12.8	11.2	8.3
Imports
Advanced Economies	-12.5	11.6	6.0	5.1
Emerging Developing	-7.9	13.7	12.1	9.0

Source: http://www.imf.org/external/pubs/ft/weo/2011/update/02/index.htm

Japan’s index of tertiary industry activity covers significant part of economic activity with multiple segments: public utilities (electricity, gas, heat supply and water), information/communications, transport/postal, finance/insurance, real estate, accommodations, eating/drinking services, living-related, personal services, amusement services, learning support, medical health care/welfare, compound services and multiple services (http://www.meti.go.jp/statistics/tyo/sanzi/result/pdf/hv37903_201105j.pdf). Table 29 provides Japan’s tertiary activity index. Japan’s economy had soft conditions at the turn of the year with declines in the tertiary activity index of 0.2 percent in Dec and 0.1 percent in Jan but monthly growth resumed with 0.8 percent in Feb and 12-month rate of 2.0 percent. The earthquake/tsunami on Mar 11 caused a drop of tertiary activity of 5.9 percent with 12-month performance falling by 3.1 percent. The V-shaped recovery of Japan is shown by growth of 2.5 percent in tertiary activity in Apr and 0.9 percent in May such that the 12-month rate of tertiary activity shows decline of only 0.4 percent.

Table 29, Japan, Tertiary Activity Index ∆%

	Month ∆% SA	12 Months ∆% NSA
May	0.9	-0.4
Apr	2.5	-2.5
Mar	-5.9	-3.1
Feb	0.8	2.0
Jan	-0.1	1.1
Dec 2010	-0.2	1.8

Source: http://www.meti.go.jp/statistics/tyo/sanzi/result/pdf/hv37903_201105j.pdf

Industrial production in the euro zone is growing at the annual equivalent rate of 2.4 percent in Jan-May, as shown in Table 30. With the exception of 0.5 percent in Feb and 0.2 percent in May, industry has actually grown at only 0.1 percent per month in Jan-May. Durable goods production fell 0.5 percent in May and nondurable goods production fell 0.4 percent.

Table 30, Euro Zone Industrial Production Month ∆%

	May	Apr	Mar	Feb	Jan	AE ∆%
Total	0.1	0.2	0.1	0.5	0.1	2.4
Inter-me-diate	-0.1	-0.1	0.1	0.5	2.4	6.9
Energy	0.9	-4.0	0.3	-1.4	-4.7	-19.6
Capital Goods	0.6	0.6	-0.6	2.2	-2.2	1.3
Durable	-0.5	0.9	0.1	0.7	1.2	5.9
Non-durable	-0.4	0.4	0.7	1.0	-0.1	3.9

AE: Annual Equivalent

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-13072011-AP/EN/4-13072011-AP-EN.PDF

Euro zone 12-months rates of growth of industrial production fell sharply from 9.1 percent in Dec 2010 to 4.0 percent in May 2011, as shown in Table 31. The decline in rates of growth is across all segments of production.

Table 31, Euro Zone Industrial Production 12-Month ∆%

	May	Apr	Mar	Feb	Jan	Dec
Total	4.0	5.3	5.9	7.8	6.4	9.1
Inter-me-diate	4.4	5.6	7.9	10.3	9.9	8.2
Energy	-6.7	-5.6	-2.1	-2.8	-1.9	7.3
Capital Goods	9.3	10.3	11.4	14.9	13.0	17.1
Durable	1.2	4.7	2.6	3.4	2.3	2.9
Non-durable	2.1	4.0	1.0	2.7	0.9	2.0

AE: Annual Equivalent

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-13072011-AP/EN/4-13072011-AP-EN.PDF

Manufacturing is showing better performance in France than industry as a whole, as shown in Table 32. Year on year growth of manufacturing is 4.8 percent compared with 2.9 percent for industry dragged down by decline in mining of 8.3 percent.

Table 32, France, Industrial Production ∆%

	May/Apr	Apr/Mar	QOQ	YOY
Industry	2.0	-0.5	0.1	2.9
Manufac- turing	1.5	0.1	0.9	4.8
Mining	5.7	-4.3	-5.3	-8.3
Construc- ion	-1.0	1.3	3.3	1.4

Note: QOQ: quarter on quarter; YOY: year on year

Source: http://www.insee.fr/en/indicateurs/ind10/20110711/IPI_201105_anglais.pdf

Exports of the euro area rose 19.7 percent in the first five months of 2011 relative to the first five months of 2010, as shown in Table 33, while imports rose 20.9 percent. Exports in May 2011 rose by 20.9 percent relative to May 2010 and imports increased by 16.2 percent. High nominal growth rates of international trade reflect high rates of world inflation.

Table 33, Exports and Imports of the Euro Area, Billions of Euros and Percent, NSA

	Exports	Imports
Jan-May 2011	703.5	725.3
Jan-May 2010	587.7	599.8
∆%	19.7	20.9
May 2011	148.1	148.1
May 2010	122.5	127.4
∆%	20.9	16.2

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/6-15072011-AP/EN/6-15072011-AP-EN.PDF

UK merchandise trade data in Table 34 suggest deceleration of the economy in the initial two months, Apr and May, of IIQ2011. Import volume fell sharply in three consecutive months Mar through May, suggesting deceleration of domestic demand because of lower growth at the margin. Export volume fell 1.9 percent in May after strong performance in IQ2011. Export prices fell 1.7 percent in May, much faster than the fall of 0.4 percent in import prices, reversing the trend of improvement of the terms of trade (export prices/import prices) since the beginning of the year.

Table 34, UK Merchandise Trade ∆%

	Export Volume	Import Volume	Export Prices	Import Prices
May	-1.9	-2.2	-1.7	-0.4
Apr	0.8	-4.5	1.7	1.4
Mar	4.6	-2.2	2.3	1.8
Feb	5.0	1.6	0.4	0.2
Jan	4.2	3.9	1.1	0.9
2010	10.8	11.5	5.7	6.3
2009	-12.3	-12.6	2.7	3.5
2008	1.3	-1.8	13.8	12.7
2007	-10.3	-2.7	0.3	0.9
2006	11.5	10.5	2.5	3.4
2005	8.9	7.0	4.4	4.5

Source: http://www.statistics.gov.uk/pdfdir/trd0711.pdf

There are mixed results in the UK labor market report for quarter Mar-May in Table 35. The unemployment rate remains at 7.7 percent; the number employed increased by 88,000; and the number unemployed fell by 26.000 to 2.45 million. The earnings growth rate of 2.3 percent is below inflation and does not set pressure on the monetary policy committee of the Bank of England. The adverse part of the report is the rise by 88,000 to 1.25 million of persons who work part-time because they cannot find another job, which is the highest level since 1992. The global recession has resulted in high rates of unemployment and underemployment. Another adverse aspect is the rise in the claimant count by 24,500 with rate of 4.7 percent.

Table 35, UK Labor Market Statistics

	Quarter Mar-May 2011
Unemployment Rate	7.7%
Number Unemployed	-26,000 (2.45 million)
Inactivity Rate 16-64 Years of Age	23.2%
Employment Rate	70.7%
Number Employed	+88,000
Earnings Growth Rates Year on Year	2.3%
Part-Time Because No Other Job Available	+88,000 (1.25 million, highest since 1992)
	Jun 2011
Claimant Count	+24,500 (rate: 4.7%)

Source: http://www.statistics.gov.uk/pdfdir/lmsuk0711.pdf

There was concern during the week in the worsening trade balance from $43,625 million in Apr to $50,227 million in May, resulting from growth of imports by 2.6 percent while imports fell by 0.6 percent, as shown in Table 36. Declines in oil prices may improve the Jun balance of trade, reducing the impact of the trade account in the calculation of GDP. The trade balance has deteriorated in Jan-May 2011 by $31,373 million relative to Jan-May 2010.

Table 36, Trade Balance of Goods and Services Seasonally Adjusted Millions of Dollars

	Trade Balance	Exports	Imports
May	-50,227	174,860	225,087
Apr	-43,625	175,821	219,446
Mar	-46,824	173,390	220,215
Feb	-46,047	165,245	211,292
Jan	-47,925	167,582	215,507
Jan-May 2011	-234,648	856,898	1,091,547
Jan-May 2010	-203,275	736,312	939,587

Source: http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf

Inflation is also showing in nominal dollar values of international trade. Table 37 provides Jan-May 2010 and Jan-May 2011 exports and imports in nominal dollar values and their percentage changes. Exports rose by 19.0 percent and imports by 18.8 percent. The only decline is for US exports of crude oil, which are $559 million and have share of only 0.09 percent in total exports of $606,146 million and the decline was caused by lower exported volume. All categories expanded by double digits percentages.

Table 37, Exports and Imports of Goods, Not Seasonally Adjusted Millions of Dollars and %

	Jan- May 2011 $ Millions	Jan-May 2010 $ Millions	∆%
Exports	606,146	509,305	19.0
Manu- factured	392,487	348,934	12.5
Agricultural Commodities	60,209	45,263	33.0
Mineral Fuels	48,938	30,875	58.5
Crude Oil	559	793	-29.5
Imports	886,400	745,855	18.8
Manu- factured	633,810	542,641	16.8
Agricultural Commodities	41,346	34,133	21.1
Mineral Fuels	183,474	146,732	25.0
Crude Oil	132,044	105,910	24.7

Source: http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf

Inflation of prices of exports and imports in the 12 months ending in Jun and in annual equivalent for the first five months is shown in Table 38. There are major percentage changes in most categories with four exceptions for imports: (1) consumer goods, which would affect the CPI, rose by only 1.1 percent in 12 months but by 2.1 percent in annual equivalent in Mar-Jun; (2) capital goods rose 1.5 percent in 12 months and only 1.5 percent in annual equivalent; (3) automotive vehicles, parts and engines increased 2.9 percent in 12 months but 5.2 percent in annual equivalent; and (4) durables manufactured fell 0.5 percent in 12 months and rose only 1.2 percent in annual equivalent. High increases in export prices are concentrated on agricultural goods with 31.2 percent in 12 months but 3.8 percent in annual equivalent in Mar-Jun mainly because of decline by 2.2 percent in May in less favorable carry trade environment. Non-agricultural prices rose a high 7.8 percent in 12 months and 8.4 percent in annual equivalent in Mar-Jun. The highest 12-month and Mar-Jun annual equivalent rates are for industrial supplies and materials and consumer goods excluding autos. There is inflation in prices of traded goods worldwide.

Table 38, Prices of Exports and Imports 12 Months Jun and Annual Equivalent Jan-Jun 2011, %

	12 Month ∆%Jun 2011	Annual ∆%Equivalent Mar-Jun 2011
Imports	13.6	16.3
Fuel	46.9	52.9
Nonfuel	4.8	5.5
Capital Goods	1.5	1.5
Automotive vehicles, parts & engines	2.9	5.2
Consumer Goods Ex Automotive	1.1	2.1
Durables Manufactured	-0.5	1.2
Non-Manufactured Consumer Goods	9.3	13.6
Exports	9.9	8.4
Agricultural	31.2	3.8
Non-Agricultural	7.8	8.7
Industrial Supplies and Materials	19.8	16.3
Capital Goods	1.1	1.8
Automotive vehicles, parts & engines	1.5	2.7
Consumer Goods Excluding Autos	5.2	8.1
Nondurable Manufactured	2.6	3.7
Durables Manufactured	4.2	2.1

Source:

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

http://www.bls.gov/news.release/archives/ximpim_06102011.pdf

V Valuation of Risk Financial Assets. 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). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

Table 39 shows the phenomenal impulse to valuations of risk financial assets originating in the initial shock of near zero interest rates in 2003-2004 with the fed funds rate at 1 percent, in fear of deflation that never materialized, and quantitative easing in the form of suspension of the auction of 30-year Treasury bonds to lower mortgage rates. World financial markets were dominated by monetary and housing policies in the US. Between 2002 and 2008, the DJ UBS Commodity Index rose 165.5 percent largely because of the unconventional monetary policy encouraging carry trade from low US interest rates to long leveraged positions in commodities, exchange rates and other risk financial assets. The charts of risk financial assets show sharp increase in valuations leading to the financial crisis and then profound drops that are captured in Table 39 by percentage changes of peaks and troughs. The first round of quantitative easing and near zero interest rates depreciated the dollar relative to the euro by 39.3 percent between 2003 and 2008, with revaluation of the dollar by 25.1 percent from 2008 to 2010 in the flight to dollar-denominated assets in fear of world financial risks and then devaluation of the dollar by 18.8 percent by Fri Jul 15, 2011. Dollar devaluation is a major vehicle of monetary policy in reducing the output gap that is implemented in the probably erroneous belief that devaluation will not accelerate inflation. The last row of Table 39 shows CPI inflation in the US rising from 1.9 percent in 2003 to 4.1 percent in 2007 even as monetary policy increased the fed funds rate from 1 percent in Jun 2004 to 5.25 percent in Jun 2006.

Table 39, 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	6/07/10	0715 /2011
Rate	1.1423	1.5914	1.192	1.416
CNY/USD	01/03 2000	07/21 2005	7/15 2008	07/15 2011
Rate	8.2798	8.2765	6.8211	6.4620
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

http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm

Table 39A extracts four rows of Table 39 with the Dollar/Euro (USD/EUR) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 25.1 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul, 2010, shown in Table 41 below, the dollar has devalued again to USD 1.416/EUR or by 18.8 percent. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD until it revalued to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent and after fixing it again to the dollar, revalued to CNY 6.4620/USD on Fri Jul 15, 2011, or by an additional 5.3 percent, for cumulative revaluation of 21.9 percent.

Table 39A, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate

USD/EUR	6/26/03	7/14/08	6/07/10	07/15 /2011
Rate	1.1423	1.5914	1.192	1.416
CNY/USD	01/03 2000	07/21 2005	7/15 2008	07/15 2011
Rate	8.2798	8.2765	6.8211	6.4620

Source: Table 39.

Dollar devaluation did not eliminate the US current account deficit, which is projected by the International Monetary Fund (IMF) at 3.2 percent of GDP in 2011 and also in 2012, as shown in Table 40. Revaluation of the CNY has not reduced the current account surplus of China, which is projected by the IMF to increase from 5.7 percent of GDP in 2011 to 6.3 percent of GDP in 2012.

Table 40, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2011 Dollar GDP

	GDP $B	FD %GDP 2011	CAD %GDP 2011	Debt %GDP 2011	FD%GDP 2012	CAD%GDP 2012	Debt %GDP 2012
US	15227	-10.6	-3.2	64.8	-10.8	-3.2	72.4
Japan	5821	-9.9	2.3	127.8	-8.4	2.3	135.1
UK	2471	-8.6	-2.4	75.1	-6.9	-1.9	78.6
Euro	12939	-4.4	0.03	66.9	-3.6	0.05	68.2
Ger	3519	-2.3	5.1	54.7	-1.5	4.6	54.7
France	2751	-6.0	-2.8	77.9	-5.0	-2.7	79.9
Italy	2181	-4.3	-3.4	100.6	-3.5	-2.9	100.4
Can	1737	-4.6	-2.8	35.1	-2.8	-2.6	36.3
China	6516	-1.6	5.7	17.1	-0.9	6.3	16.3
Brazil	2090	-2.4	-2.6	39.9	-2.6	-2.9	39.4

Note: GER = Germany; Can = Canada; FD = fiscal deficit; CAD = current account deficit

Source: http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx

There is a new carry trade that learned from the losses after the crisis of 2007 or learned from the crisis how to avoid losses. The sharp rise in valuations of risk financial assets shown in Table 39 above after the first policy round of near zero fed funds and quantitative easing by the equivalent of withdrawing supply with the suspension of the 30-year Treasury auction was on a smooth trend with relatively subdued fluctuations. The credit crisis and global recession have been followed by significant fluctuations originating in sovereign risk issues in Europe, doubts of continuing high growth and accelerating inflation in China, events such as in the Middle East and Japan and legislative restructuring, regulation, insufficient growth, falling real wages, depressed hiring and high job stress of unemployment and underemployment in the US. The “trend is your friend” motto of traders has been replaced with a “hit and realize profit” approach of managing positions to realize profits without sitting on positions. There is a trend of valuation of risk financial assets with fluctuations provoked by events of risk aversion. Table 41, which is updated for every comment of this blog, shows the deep contraction of valuations of risk financial assets after the Apr 2010 sovereign risk issues in the fourth column “∆% to Trough” and the sharp recovery after around Jul 2010 in the last column “∆% Trough to 07/15/11” with all risk financial assets in the range from 9.5 percent for the European stocks index STOXX 50 to 32.7 percent for the DJ UBS Commodity Index. Japan has significantly improved performance rising 13.0 percent above the trough. The Nikkei Average closed at 9972.50 on Fri Jul 15, only 2.7 percent below 10,254.43 on Mar 11 on the date of the earthquake and 8.3 percent above the lowest Fri closing on Mar 18 of 9206.75. The dollar depreciated by 18.8 percent and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 07/15/2011” shows mixed performance of financial assets. The Dow Global lost 2.5 percent with losses in all stock indexes in Table 41 with the exception of gain of 0.8 percent in the Shanghai Composite. The Nikkei Average fell 1.6 percent, DJIA lost 1.4 percent and S&P fell 2.1 percent. The STOXX 50 of Europe fell 2.1 percent and DAX of Germany lost 2.5 percent amidst high uncertainties on European sovereign risks. The DJ UBS Commodity Index gained 2.3 percent in the week. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with caution instead of more aggressive risk exposures. There is a fundamental change in Table 41 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 7/15/11” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event. Most financial risk assets had gained not only relative to the trough as shown in column “∆% Trough to 7/15/11” but also relative to the peak in column “∆% Peak to 7/15/11.” There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 10.7 percent, Nikkei Average by 12.5 percent, Shanghai Composite by 10.9 percent and STOXX 50 by 7.2 percent. The gainers relative to the peak in Apr 2010 are: DAX by 14.0 percent, Asia Pacific by 6.6 percent, S&P 500 by 8.1 percent, DJIA by 11.4 percent, Dow Global by only 0.4 percent and the DJ UBS Commodities Index by 13.5 percent. The factors of risk aversion have adversely affected the performance of financial risk assets. The performance relative to the peak in Apr is more important than the performance relative to the trough around early Jul because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. Aggressive tightening of monetary policy to maintain the credibility of inflation not rising above 2 percent—in contrast with timid “measured” policy during the adjustment in Jun 2004 to Jun 2006 after the earlier round of near zero interest rates—may cause another credit/dollar crisis and stress on the overall world economy. The choices may prove tough and will magnify effects on financial variables because of the corner in which policy has been driven by aggressive impulses that have resulted in the fed funds rate of 0 to ¼ percent and holdings of long-term securities close to 30 percent of Treasury securities in circulation.

Table 41, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 7/ 15/11	∆% Week 7/ 15/11	∆% Trough to 7/ 15/11
DJIA	4/26/ 10	7/2/10	-13.6	11.4	-1.4	28.8
S&P 500	4/23/ 10	7/20/ 10	-16.0	8.1	-2.1	28.7
NYSE Finance	4/15/ 10	7/2/10	-20.3	-10.7	-3.6	12.1
Dow Global	4/15/ 10	7/2/10	-18.4	0.4	-2.5	23.1
Asia Pacific	4/15/ 10	7/2/10	-12.5	6.6	-1.6	21.8
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-12.5	-1.6	13.0
China Shang.	4/15/ 10	7/02 /10	-24.7	-10.9	0.8	18.4
STOXX 50	4/15/10	7/2/10	-15.3	-7.2	-2.1	9.5
DAX	4/26/ 10	5/25/ 10	-10.5	14.0	-2.5	27.3
Dollar Euro	11/25 2009	6/7 2010	21.2	6.4	0.7	-18.8
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	13.5	2.3	32.7
10-Year Tre.	4/5/ 10	4/6/10	3.986	2.905

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 .

Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. Table 42 shows a gain by Apr 29, 2011 in the DJIA of 14.3 percent and of the S&P 500 of 12.5 percent since Apr 26, 2010, around the time when sovereign risk issues in Europe began to be acknowledged in financial risk asset valuations. There were still fluctuations. Reversals of valuations are possible during aggressive changes in interest rate policy. The stock market of the US then entered a period of six consecutive weekly declines interrupted by a week of advance and then another decline in the week of Jun 24. In the week of May 6, return of risk aversion, resulted in moderation of the valuation of the DJIA to 12.8 percent and that of the S&P 500 to 10.6 percent. There was further loss of dynamism in the week of May 13 with the DJIA reducing its gain to 12.4 percent and the S&P 500 to 10.4 percent. Further declines lowered the gain to 11.7 percent in the DJIA and to 10.0 in the S&P 500 by Fri May 20. By Fri May 27 the gains were further reduced to 11.0 percent for the DJIA and 9.8 percent for the S&P 500. In the fifth consecutive week of declines in the week of Fri June 3, the DJIA fell 2.3 percent, reducing the cumulative gain to 8.4 percent, and the S&P 500 also lost 2.3 percent, resulting in cumulative gain of 7.3 percent. The DJIA lost another 1.6 percent and the S&P 500 also 2.2 percent in the week of Jun 10, reducing the cumulative gain to 6.7 percent for the DJIA and of 4.9 percent for the S&P 500. The DJIA gained 0.4 percent in the week of Jun 17, to break the round of six consecutive weekly declines, rising 7.1 percent relative to Apr 26, 2010, while the S&P moved sideways by 0.04 percent, with gain of 4.9 percent relative to Apr 26, 2010. In the week of Jun 24, the DJIA lost 0.6 percent and the S&P lost 0.2 percent. The DJIA had lost 6.8 percent between Apr 29 and Jun 10, 2011, and the S&P 500 lost 6.9 percent. The losses were almost gained back in the week of Jul 1 with the DJIA gaining 12.3 percent and the S&P 500 10.5 percent. There were gains of 0.6 percent for the DJIA and 0.3 percent in the week of Jul 8 even with turmoil around sovereign risk issues in Europe and an abnormally weak employment situation report released on Fri Jul 8. The DJIA closed on Fri Jul 8 only 1.2 percent lower than the closing on Fri Apr 29 and the S&P 500 closed only 1.5 percent below the level of Apr 29. Continuing risk aversion as a result of sovereign risk uncertainty in Europe influenced the loss of 1.4 percent by the DJIA in the week of Jul 15, reducing the cumulative gain to 11.4 percent and much sharper loss by the S&P 500 of 2.1 percent with reduction of the cumulative gain by 8.6 percent.

Table 42, 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
Feb 11	1.5	9.5	1.4	9.7
Feb 18	0.9	10.6	1.0	10.8
Feb 25	-2.1	8.3	-1.7	8.9
Mar 4	0.3	8.6	0.1	9.0
Mar 11	-1.0	7.5	-1.3	7.6
Mar 18	-1.5	5.8	-1.9	5.5
Mar 25	3.1	9.1	2.7	8.4
Apr 1	1.3	10.5	1.4	9.9
Apr 8	0.03	10.5	-0.3	9.6
Apr 15	-0.3	10.1	-0.6	8.9
Apr 22	1.3	11.6	1.3	10.3
Apr 29	2.4	14.3	1.9	12.5
May 6	-1.3	12.8	-1.7	10.6
May 13	-0.3	12.4	-0.2	10.4
May 20	-0.7	11.7	-0.3	10.0
May 27	-0.6	11.0	-0.2	9.8
Jun 3	-2.3	8.4	-2.3	7.3
Jun 10	-1.6	6.7	-2.2	4.9
Jun 17	0.4	7.1	0.04	4.9
Jun 24	-0.6	6.5	-0.2	4.6
Jul 1	5.4	12.3	5.6	10.5
Jul 8	0.6	12.9	0.3	10.9
Jul 15	-1.4	11.4	-2.1	8.6

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

Table 43, updated with every post, shows that exchange rate valuations affect a large variety of countries, in fact, almost the entire world, in magnitudes that cause major problems for domestic monetary policy and trade flows. Joe Leahy writing on Jul 1 from São Paulo on “Brazil fears economic fallout as real soars” published in the Financial Times (http://www.ft.com/intl/cms/s/0/8430cd36-a40c-11e0-8b4f-00144feabdc0.html#axzz1Qt9Zxqcy) informs that the Brazilian real traded at the strongest level relative to the dollar since floating in 1999 with the strong currency eroding the country’s competitiveness in industrial products. Dollar devaluation is expected to continue because of zero fed funds rate, expectations of rising inflation and the large budget deficit of the federal government (http://professional.wsj.com/article/SB10001424052748703907004576279321350926848.html?mod=WSJ_hp_LEFTWhatsNewsCollection) but with interruptions caused by risk aversion events.

Table 43, Exchange Rates

	Peak	Trough	∆% P/T	Jul 15, 2011	∆% T Jul 15 2011	∆% P Jul 15 2011
EUR USD	7/15 2008	6/7 2010		7/15 2011
Rate	1.59	1.192		1.416
∆%			-33.4		15.8	-12.3
JPY USD	8/18 2008	9/15 2010		7/15 2011
Rate	110.19	83.07		79.13
∆%			24.6		4.7	28.2
CHF USD	11/21 2008	12/8 2009		7/15 2011
Rate	1.225	1.025		0.816
∆%			16.3		20.4	33.4
USD GBP	7/15 2008	1/2/ 2009		7/15 2011
Rate	2.006	1.388		1.613
∆%			-44.5		13.9	-24.4
USD AUD	7/15 2008	10/27 2008		7/15 2011
Rate	1.0215	1.6639		1.064
∆%			-62.9		43.5	7.9
ZAR USD	10/22 2008	8/15 2010		7/15 2011
Rate	11.578	7.238		6.87
∆%			37.5		5.1	40.7
SGD USD	3/3 2009	8/9 2010		7/15 2011
Rate	1.553	1.348		1.219
∆%			13.2		9.6	21.5
HKD USD	8/15 2008	12/14 2009		7/15 2011
Rate	7.813	7.752		7.794
∆%			0.8		-0.5	0.2
BRL USD	12/5 2008	4/30 2010		7/15 2011
Rate	2.43	1.737		1.576
∆%			28.5		9.3	35.1
CZK USD	2/13 2009	8/6 2010		7/15 2011
Rate	22.19	18.693		17.257
∆%			15.7		7.7	22.2
SEK USD	3/4 2009	8/9 2010		7/15 2011
Rate	9.313	7.108		6.485
∆%			23.7		8.8	30.3
CNY USD	7/20 2005	7/15 2008		7/15 2011
Rate	8.2765	6.8211		6.4620
∆%			17.6		5.3	21.9

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; CNY: Chinese yuan; 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

http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm

VI Economic Indicators. The economy of the US is growing slowly with significant disruption in labor markets. The Fed report on industrial production in Table 44 reveals significant weakness across market, groups and over time. Industrial production rose 0.2 percent in Jun while manufacturing remained unchanged after 0.1 in May and decline of 0.5 percent in Apr. Total industrial production in Jun is at 93.1 percent of the average for 2007. The rate of utilization of capacity in total industry was unchanged at 76.7 percent in Jun, which is 2.2 percentage points higher than a year earlier but remains 3.7 percent below the average from 1972 to 2010. The 12-month rates of growth in Jun of 3.4 percent for total industry and 3.7 percent for manufacturing are higher than the weak monthly performance shown in Table 44. The Fed’s report states (http://www.federalreserve.gov/releases/g17/current/):

“Industrial production increased 0.2 percent in June after having edged down 0.1 percent in May. For the second quarter as a whole, total industrial production increased at an annual rate of 0.8 percent. Manufacturing output was unchanged in June. In the second quarter, supply chain disruptions following the earthquake in Japan curtailed the production of motor vehicles and parts and restrained output in related industries; the production index for overall manufacturing was little changed for the quarter.”

Table 44, Industrial Production and Capacity Utilization, SA %

	Jun	May	Apr	Mar	Jun 2011/ Jun 2010
Total	0.2	-0.1	-0.1	0.7	3.4
Markets
Final Products	-0.2	0.1	0.0	0.2	3.1
Consu-mer Goods	0.0	-0.3	-0.1	0.3	1.4
Business Equip-ment	-0.7	1.2	-0.3	-0.3	7.7
Non Industry Supplies	0.2	-0.1	-0.1	0.8	1.4
Cons- truction	0.3	1.1	0.1	1.2	4.0
Mat- erials	0.5	-0.3	-0.2	1.1	4.3
Groups
Manu- facturing	0.0	0.1	-0.5	0.6	3.7
Mining	0.5	0.7	0.3	1.7	6.1
Utilities	0.9	-2.0	1.4	-0.3	-1.5
Capacity	76.7	76.7	76.8	77.0	0.4

Sources: http://www.federalreserve.gov/releases/g17/current/

There is also significant weakness in the Federal Reserve Bank of New York’s Empire State Manufacturing Index for Jul in Table 45. The index of general business conditions was negative at minus 3.76. New orders fell deeper into negative territory to minus 5.45. The number of employees fell to barely positive at 1.11, implying stability of employment but the average employee workweek fell to minus 15.56. The bright aspect of the report is the second block of data showing improved expectations for the next six months.

Table 45, New York Federal Reserve Bank Empire State Manufacturing Survey Index

	Jun	Jul
Current Conditions
General Business Conditions	-7.79	-3.76
New Orders	-3.61	-5.45
Shipments	-8.02	2.22
Unfilled Orders	0.00	-12.22
Inventories	1.02	-5.56
# Employees	10.20	1.11
Average Employee Workweek	-2.04	-15.56
Expectations Six Months
General Business Conditions	22.45	32.22
New Orders	15.31	25.56
Shipments	17.35	30.00
Unfilled Orders	-9.18	5.56
Inventories	-9.18	1.1
# Employees	6.12	17.78
Average Employee Workweek	-2.04	2.22

Source: http://www.newyorkfed.org/survey/empire/july2011.pdf

The Treasury budget in the fiscal year to Jun 2011 is shown in Table 46. The deficit declined slightly by 3.3 percent relative to the same period in 2010. At $970,524 million the deficit is certain to exceed $1 trillion for the third consecutive year and is programmed to exceed $1 trillion in 2012. Even with the weakening recovery receipts are growing at 8.6 percent relative to 2010 and outlays by 3.9 percent. Individual income taxes have grown by 24.3 percent in the fiscal year to Jun in 2011 relative to 2010.

Table 46, Treasury Budget in Fiscal Year to Jun Millions Dollars

	2011	2010	∆%
Receipts	1,734,033	1,596,995	8.6
Outlays	2,704,557	2,601,023	3.9
Deficit	-970,524	-1,004,028	-3.3
Individual Income Taxes	814,922	655,374	24.3

Source: http://www.fms.treas.gov/mts/mts0611.pdf

The percentage changes of sales of manufacturers, retailers and merchant wholesalers in Table 47 are not adjusted for price change. Total business sales rose 13.2 percent in May 2011 relative to May 2010 not adjusting for seasonality or price changes with sales of manufacturers increasing by 13.1 percent, sales of retailers growing by 8.3 percent and those of merchant wholesalers increasing by 18.0 percent. Here again is the presence of inflation as part of the increases is caused by prices and part by volumes. All nominal values are rising with inflation.

Table 47, Percentage Changes for Sales of Manufacturers, Retailers and Merchant Wholesalers

	May 11/ Apr 11 ∆% SA	Apr 11/ Mar 11 ∆% SA	May 11/ May 10 ∆% NSA
Total Business	-0.1	0.1	13.2
Manu- facturers	0.1	-0.4	13.1
Retailers	-0.2	0.3	8.3
Merchant Whole- salers	-0.2	0.5	18.0

Source: http://www.census.gov/mtis/www/data/pdf/mtis_current.pdf

The advance report on retail and food services sales by the US Census Bureau is found in Table 48. The aggregate for retail and food services is weak in the monthly increase of only 0.1 percent in Jun relative to May and decline by 0.1 percent in May relative to Apr, with a 12-month rate of growth of 8.1 percent that may mask some inflation. The aggregate excluding motor vehicles and parts did not grow in Jun, increased by 0.2 percent in May relative to Apr and rose 7.9 percent relative to Jun 2010. Gasoline station sales fell 1.3 percent probably consisting of a mix of reduced consumption and fall in prices but the increase relative to a year earlier is 23.6 percent. Retail sales dropped 1.1 percent in Jun but after increasing by 3 percent in May and are higher by 8.5 percent relative to a year earlier.

Table 48, Percentage Change in Monthly Sales for Retail and Food Services SA

	Jun/May	May/Apr	12 Months ∆%
Retail and Food Services	0.1	-0.1	8.1
Excluding Motor Vehicles and Parts	0.0	0.2	7.9
Motor Vehicles & Parts	0.8	-1.8	8.9
Retail	-1.1	3.0	8.5
Building Materials	1.3	0.5	7.8
Food and Beverage	0.3	-0.1	6.5
Grocery	0.3	-0.1	6.8
Health & Personal Care Stores	-0.2	1.2	4.1
Clothing & Clothing Accessories Stores	0.7	0.0	6.5
Gasoline Stations	-1.3	0.5	23.6

Source: http://www.census.gov/retail/marts/www/marts_current.pdf

The Energy Information Administration Weekly Petroleum Status Report is summarized in Table 49. Crude oil stocks fell to 355.6 million barrels in the week of Jul 8 from 358.6 million barrels in the week of Jul 1 and are higher by 2.4 million barrels than in the week of Jul 9, 2010. The world crude oil price increased to $109.37/barrel in the week of Jul 8 from $104.39/barrel in the week of Jul 1 and is 52.5 percent higher than $71.72/barrel in the week of Jul 9, 2010. The price of regular motor gasoline of $3.641/gallon on Jul 8, 2011 was 33.9 percent higher than $2.718/gallon on Jul 9, 2010.

Table 49, Energy Information Administration Weekly Petroleum Status Report

	07/08/11	07/01/11	07/09/10
Crude Oil Stocks Million B	355.5	358.6	353.1
Crude Oil* Imports Thousand Barrels/Day	9,185	9,095	9,539
Motor Gasoline Million B	211.7	212.5	221.0
Distillate Fuel Oil Million B	145.0	142.1	162.6
World Crude Oil Price $/B	109.37	104.39	71.72
	07/08/11	07/01/11	07/09/10
Regular Motor Gasoline $/G	3.641	3.579	2.718

*Four weeks ending on the date

B: barrels; G: gallon

Source: http://www.eia.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/pdf/highlights.pdf

Initial claims for unemployment insurance seasonally adjusted fell 22,000 to reach 405,000 in the week of Jul 9 from 427,000 in the week of Jul 2, as shown in Table 50. Claims not seasonally adjusted, or the actual estimate, rose 45,031 to reach 470,671 in the week of Jul 9 from 425,640 in the week of Jul 2. The labor market is not showing improvement with claims around 400,000, seasonally adjusted or not.

Table 50, Initial Claims for Unemployment Insurance

	SA	NSA	4-week MA SA
Jul 9	405,000	470,671	423,250
Jul 2	427,000	425,640	427,000
Change	-22,000	+45,031	-3,750
Jun 25	432,000	406,633	427,750
Prior Year	440,000	515,991	458,750

Note: SA: seasonally adjusted; NSA: not seasonally adjusted; MA: moving average

Source: http://www.istat.it/salastampa/comunicati/in_calendario/precon/20110714_00/testointegrale20110714.pdf

VII Interest Rates. It is quite difficult to measure inflationary expectations because they tend to break abruptly from past inflation. There could still be an influence of past and current inflation in the calculation of future inflation by economic agents. Table 51 provides inflation of the CPI. In Jan-Jun 2011, CPI inflation for all items seasonally adjusted was 3.7 percent in annual equivalent, that is, compounding inflation in the first six months and assuming it would be repeated during the second half of 2011. In the 12 months ending in Jun, CPI inflation of all items not seasonally adjusted was 3.6 percent. The second row provides the same measurements for the CPI of all items excluding food and energy: 2.6 percent annual equivalent in Jan-May and 1.6 percent in 12 months. Bloomberg provides the yield curve of US Treasury securities (http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/). The lowest yield is 0.01 percent for three months or virtually zero, 0.04 percent for six months, 0.14 percent for 12 months, 0.35 percent for two years, 0.62 percent for three years, 1.44 percent for five years, 2.18 percent for seven years, 2.91 percent for ten years and 4.25 percent for 30 years. The Irving Fisher definition of real interest rates is approximately the difference between nominal interest rates, which are those estimated by Bloomberg, and the rate of inflation expected in the term of the security, which could behave as in Table 51. Real interest rates in the US have been negative during substantial periods in the past decade while monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”

Negative real rates of interest distort calculations of risk and returns from capital budgeting by firms, through lending by financial intermediaries to decisions on savings, housing and purchases of households. Inflation on near zero interest rates misallocates resources away from their most productive uses and creates uncertainty of the future path of adjustment to higher interest rates that inhibit sound decisions.

Table 51, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent Jan-May 2011 ∆%

	∆% 12 Months Jun 2011/Jun 2010 NSA	∆% Annual Equivalent Jan-Jun 2011 SA
CPI All Items	3.6	3.7
CPI ex Food and Energy	1.6	2.6

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

VIII Conclusion. The US labor market is fractured in a slowing world economy in an environment of multiple financial vulnerabilities

(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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Sunday, July 17, 2011

Financial Risk Aversion, Hiring Collapse and Global Inflation, Trade and Growth

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