CMP Associates Regulation Blog: Twenty Five to Thirty Million Unemployed or Underemployed, Falling Real Wages, Financial Risk Aversion, Slow Growth and Global Inflation

Twenty Five to Thirty Million Unemployed or Underemployed, Falling Real Wages, Financial Risk Aversion, Slow Growth and Global Inflation

Carlos M. Pelaez

Executive Summary

I Twenty Five to Thirty Million Unemployed or Underemployed

II Falling Real Wages

III Causes of the Fractured Labor Market

IV Financial Risk Aversion

V Global Inflation

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

Executive Summary

Economic indicators have been showing deceleration in the rate of economic growth in multiple regions, suggesting that growth of the world economy may be slowing. 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 11 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.

Analysis of the employment situation report of the US for Jun shows that: (1) there are an estimated 4.004 million unemployed who are not counted because they left the labor force on their belief they could not find another job; (2) the total number of unemployed is effectively 18.413 million and not 14.409 million of whom many have been unemployed long term; (3) the rate of unemployment is 11.6 percent and not 9.3 percent, not seasonally adjusted, or 9.2 percent seasonally adjusted; and (4) the number of people in job stress is close to 30 million by adding the 4.004 million leaving the labor force because they believe they could not find another job. The number of hiring relative to the number unemployed measures the chances of becoming employed. The number of hiring in the US economy has declined by 17 million and does not show signs of increasing (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html see section IV Hiring Collapse in http://cmpassocregulationblog.blogspot.com/2011/06/increasing-risk-aversion-analysis-of.html). The wage bill of the US, consisting of average hourly earnings multiplied by average hours worked, rose 2.5 percent in the 12 months ending in May, 2011, while CPI inflation was 3.6 percent for an inflation-adjusted decline of 1.1 percent. The job market of the US is fractured with 30 million in job stress, hiring collapse showing no exit from job stress and falling real wages. The pressure on the US social and health safety net is formidable.

I Twenty Five to Thirty Million Unemployed or Underemployed. The Bureau of Labor Statistics (BLS) released on Fri, Jul 8 the employment report showing an increase in the seasonally adjusted rate of unemployment, or unemployed as percent of the labor force, from 9.1 percent in May 2011 to 9.2 percent in Jun 2011 (http://www.bls.gov/news.release/pdf/empsit.pdf ). The number of people unemployed or unemployed in Table 1 is 25.3 million, compared with 24.7 million in May and 24.8 million in May 2010. The number of unemployed of 25.3 million in Jun is composed of 14.1 million unemployed (of whom 6.3 million, or 44.4 percent, unemployed for 27 weeks or more) compared with 13.9 million unemployed in May (of whom 6.2 million, or 44.5 percent, unemployed for 27 weeks or more), 8.6 million employed part-time for economic reasons (who suffered reductions in their work hours or could not find full-time employment) compared with 8.5 million in May and 2.7 million who were marginally attached to the labor force (who were not in the labor force but wanted and were available for work) compared with 2.2 million in May.

Table 1, People in Job Stress, Millions and % SA

	Apr	May	Jun
Unemployed Millions	13.747	13.914	14.087
Unemployed >27 weeks Millions	5.839	6.200	6.289
Unemployed >27 weeks %	42.5	44.5	44.4
Part Time Economic Reasons Millions	8.600	8.548	8.552
Marginally Attached Labor Force Millions	2.466	2.206	2.680
Job Stress Millions	24.813	24.668	25.319
Unemploy- ment Rate	9.0	9.1	9.2

Job Stress = Unemployed + Part Time Economic Reasons + Marginally Attached Labor Force

Source:

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

http://www.bls.gov/news.release/archives/empsit_05062011.pdf

http://www.bls.gov/news.release/archives/empsit_04012011.pdf

Additional information provides deeper insight. Table 2 consists of data and additional calculations using the BLS household survey, illustrating the possibility that the actual rate of unemployment could be 11.6 percent and the number of people in job stress could be closer to 30 million. The first column provides for 2006 the yearly average population (POP), labor force (LF), participation rate or labor force as percent of population (PART %), employment (EMP), employment population ratio (EMP/POP %), unemployment (UEM), the unemployment rate as percent of labor force (UEM/LF Rate %) and the number of people not in the labor force (NLF). The numbers in column 2006 are averages in millions while the monthly numbers for Jun 2010 and May and Jun 2011 are in thousands, not seasonally adjusted. The average yearly participation rate of the population in the labor force was in the range of 62.0 percent minimum to 67.1 percent maximum between 2000 and 2006 with the average of 66.4 percent (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). The objective of Table 2 is to assess how many people could have left the labor force because they do not think they can find another job. Row “LF PART 66.2 %” applies the participation rate of 2006, almost equal to the rates for 2000 to 2006, to the population in Jun 2010 and May and Jun 2011 to obtain what would be the labor force of the US if the participation rate had not changed. In fact, the participation rate fell to 65.1 percent by Jun 2010 and was 64.1 percent in May 2011 and 64.5 percent in Jun 2011, suggesting that many people simply gave up on finding another job. Row “∆ NLF UEM” calculates the number of people not counted in the labor force because they could have given up on finding another job by subtracting from the labor force with participation rate of 66.2 percent (row “LF PART 66.2%”) the labor force estimated in the household survey (row “LF”). Total unemployed (row “Total UEM”) is obtained by adding unemployed in row “∆NLF UEM” to the unemployed of the household survey in row “UEM.” The row “Total UEM%” is the effective total unemployed “Total UEM” as percent of the effective labor force in row “LF PART 66.2%.” The results are that: (1) there are an estimated 4.004 million unemployed who are not counted because they left the labor force on their belief they could not find another job (∆NLF UEM); (2) the total number of unemployed is effectively 18.413 million (Total UEM) and not 14.409 million (UEM) of whom many have been unemployed long term; (3) the rate of unemployment is 11.6 percent (Total UEM%) and not 9.3 percent, not seasonally adjusted, or 9.2 percent seasonally adjusted; and (4) the number of people in job stress is close to 30 million by adding the 4.004 million leaving the labor force because they believe they could not find another job. The last row of Table 2 provides the number of people in job stress (“In Job Stress) not seasonally adjusted at 29.693 million in Jun 2011, adding the total number of unemployed (“Total UEM”), plus those involuntarily in part-time jobs because they cannot find anything else (“Part Time Economic Reasons”) and the marginally attached to the labor force (“Marginally attached to LF”). The employment population ratio “EMP/POP %” dropped from 62.9 percent on average in 2006 to 58.9 percent in Jun 2010, 58.5 percent in May 2011 and 58.5 percent in Jun 2011 and the number of employed (EMP) dropped from 144 million to 140 million. What really matters for labor input in production and wellbeing is the number of people with jobs or the employment/population ratio, which has declined and does not show signs of increasing. There are almost four million fewer people working in 2011 than in 2006 and the number employed is not increasing. The number of hiring relative to the number unemployed measures the chances of becoming employed. The number of hiring in the US economy has declined by 17 million and does not show signs of increasing (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html see section IV Hiring Collapse in http://cmpassocregulationblog.blogspot.com/2011/06/increasing-risk-aversion-analysis-of.html).

Table 2, Population, Labor Force and Unemployment, NSA

	2006	Jun 2010	May 11	Jun 11
POP	229	237,690	239,313	239,489
LF	151	154,767	153,449	154,538
PART%	66.2	65.1	64.1	64.5
EMP	144	139,882	140,028	140,129
EMP/POP%	62.9	58.9	58.5	58.5
UEM	7	14,885	13,421	14,409
UEM/LF Rate%	4.6	9.6	8.7	9.3
NLF	77	82,923	85,864	84,951
LF PART 66.2%		157,351	158,425	158,542
∆NLF UEM		2,584	4,976	4,004
Total UEM		17,469	18,397	18,413
Total UEM%		11.1	11.6	11.6
Part Time Economic Reasons		8,734	8,144	8,600
Marginally Attached to LF		2,591	2,206	2,680
In Job Stress		28,794	28,747	29,693

Pop: population; LF: labor force; PART: participation; EMP: employed; UEM: unemployed; NLF: not in labor force; ∆NLF UEM: additional unemployed; Total UEM is UEM + ∆NLF UEM; Total UEM% is Total UEM as percent of LF PART 66.2%; In Job Stress = Total UEM + Part Time Economic Reasons + Marginally Attached to LF

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

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

Sources:

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

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

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

Total nonfarm payroll employment seasonally adjusted (SA) rose by 18,000 in Jun and private payroll employment rose by 57,000. Table 3 provides the monthly change in jobs seasonally adjusted in the prior strong contraction of 1981-1982 and the recovery in 1983 into 1984 and in the contraction of 2008-2009 and in the recovery in 2009 to 2011. All revisions have been incorporated in Table 3. The data in the recovery periods are in relief to facilitate comparison. There is significant bias in the comparison. The average yearly civilian noninstitutional population was 174.2 million in 1983 and the civilian labor force 111.6 million, growing by 2009 to an average yearly civilian noninstitutional population of 235.8 million and civilian labor force of 154.1 million, that is, increasing by 35.4 percent and 38.1 percent, respectively (http://www.bls.gov/cps/cpsaat1.pdf). Total nonfarm payroll jobs in 1983 were 90.280 million, jumping to 94.530 million in 1984 while total nonfarm jobs in 2010 were 129.818 million declining from 130.807 million in 2009 (http://www.bls.gov/webapps/legacy/cesbtab1.htm ). What is striking about the data in Table 3 is that the numbers of monthly increases in jobs in 1983 are several times higher than in 2010 even with population higher by 35.4 percent and labor force higher by 38.1 percent in 2009 relative to 1983 nearly three decades ago and total number of jobs in payrolls rose by 39.5 million in 2010 relative to 1983 or by 43.8 percent. Professor Michael Boskin of Stanford, former Chairman of the CEA, provides analysis of growth in cyclical expansions in an article for the Wall Street Journal (http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html ). The critical historical perspective is that average quarterly rates of growth in the expansions after a severe recession were incomparably higher than during the current expansion: 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975, 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter in 1983 and only 3 percent in the first four quarters and 2.9 percent forecast in the first 12 quarters after the trough in the third quarter of 2009. GDP grew at the SA quarter-on-quarter yearly-equivalent rate of 3.7 percent in IQ2010, 1.7 percent in IIQ2010, 2.6 percent in IIIQ2010, 3.1 percent in IVQ2010 and 1.9 percent in IQ2011. Growth has been mediocre in the six quarters of expansion beginning in IIIQ2009 in comparison with earlier expansions http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/06/financial-risk-aversion-slow-growth.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/05/mediocre-growth-world-inflation.html http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html http://cmpassocregulationblog.blogspot.com/2011/02/mediocre-growth-raw-materials-shock-and.html) and also in terms of what is required to reduce the job stress of at least 24 million persons but likely close to 30 million. Some of the job growth and contraction in 2010 in Table 3 is caused by the hiring and subsequent layoff of temporary workers for the 2010 census.

Table 3, Monthly Change in Jobs, Number SA

Month	1981	1982	1983	2008	2009	2010	Private
Jan	95	-327	225	13	-820	-39	-42
Feb	67	-6	-78	-83	-726	-35	-21
Mar	104	-129	173	-72	-796	192	144
Apr	74	-281	276	-185	-660	277	229
May	10	-45	277	-233	-386	458	48
Jun	196	-243	378	-178	-502	-192	65
Jul	112	-343	418	-231	-300	-49	93
Aug	-36	-158	-308	-267	-231	-59	110
Sep	-87	-181	1114	-434	-236	-29	109
Oct	-100	-277	271	-509	-221	171	143
Nov	-209	124	352	-802	-55	93	128
Dec	-278	-14	356	-619	-130	152	167
			1984			2011	Private
Jan			447			68	94
Feb			479			235	261
Mar			275			194	219
Apr			363			217	241
May			308			25	73
Jun			379			18	57
Jul			312
Aug			241
Sep			311
Oct			286
Nov			349
Dec			127

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

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

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

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

Important aspects of growth of payroll jobs from Jun 2010 to Jun 2011, not seasonally adjusted (NSA), are provided in Table 4. Total nonfarm employment increased by 1,171,000, consisting of growth of total private employment by 1,859,000 and decline by 688,000 of government employment. Monthly average growth of private payroll employment has been 154,917, which is mediocre relative to 24 to 30 million in job stress, while total nonfarm employment has grown on average by only 97,583 per month. Manufacturing employment increased by 176,000 while private service providing employment grew by 1,568,000. An important feature is that jobs in temporary help services increased by 163,000. This episode of jobless recovery is characterized by part-time jobs. An important characteristic is that the losses of government jobs have been highest in local government, 278,000 jobs lost, because of the higher number of employees in local government, 14.3 million relative to 4.9 million in state jobs and 2.8 million in federal jobs.

Table 4, Employees in Nonfarm Payrolls Not Seasonally Adjusted in Thousands

	Jun 2010	Jun 2011	Change
A Total Nonfarm	130,908	132,079	1,171
B Total Private	108,178	110,037	1,859
B1 Goods Producing	18,020	18,311	291
B1a Manu-facturing	11,608	11,784	176
B2 Private service providing	90,158	91,726	1,568
B2a Temporary help services	2,085	2,248	163
C Government	22,730	22,042	-688
C1 Federal	3,204	2,849	-355
C2 State	4,922	4,867	-55
C3 Local	14,604	14,326	-278

Note: A = B+C, B = B1 + B2, C=C1 + C2 + C3

Source:

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

The NBER dates recessions in the US from peaks to troughs as: IQ80 to IIIQ80, IIIQ81 to IV82 and IVQ07 to IIQ09 (http://www.nber.org/cycles/cyclesmain.html). Table 5 provides total annual level nonfarm employment in the US for the 1980s and the 2000s, which is different from 12 months comparisons. Nonfarm jobs rose by 4.853 million in 1982 to 1984, or 5.4 percent, and continued rapid growth in the rest of the decade. In contrast, nonfarm jobs are down by 7.780 million in 2010 relative to 2007 and fell by 989,000 in 2010 relative to 2009 even after six quarters of GDP growth. Monetary and fiscal stimuli have failed in increasing growth to rates required for mitigating job stress. The initial growth impulse reflects a flatter growth curve in the current expansion.

Table 5, Total Nonfarm Employment in Thousands

Year	Total Nonfarm	Year	Total Nonfarm
1980	90,528	2000	131,785
1981	91,289	2001	131,826
1982	89,677	2002	130,341
1983	90,280	2003	129,999
1984	94,530	2004	131,435
1985	97,511	2005	133,703
1986	99,474	2006	136,086
1987	102,088	2007	137,598
1988	105,345	2008	136,790
1989	108,014	2009	130,807
1990	109,487	2010	129,818

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

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

The Bureau of Labor Statistics (BLS) makes yearly revisions of its establishment survey (Harris 2011BA):

“With the release of data for January 2011, the Bureau of Labor Statistics (BLS) introduced its annual revision of national estimates of employment, hours, and earnings from the Current Employment Statistics (CES) monthly survey of nonfarm establishments. Each year, the CES survey realigns its sample-based estimates to incorporate universe counts of employment—a process known as benchmarking. Comprehensive counts of employment, or benchmarks, are derived primarily from unemployment insurance (UI) tax reports that nearly all employers are required to file with State Workforce Agencies.”

The number of not seasonally adjusted total private jobs in the US in Dec 2010 is 108.464 million, declining to 106.079 million in Jan 2011, or by 2.385 million, because of the adjustment of a different benchmark and not actual job losses. The not seasonally adjusted number of total private jobs in Dec 1984 is 80.250 million, declining to 78.704 million in Jan 1985, or by 1.546 million for the similar adjustment. Table 6 attempts to measure job losses and gains in the recessions and expansions of 1981-1985 and 2007-2011. The final ten rows provide job creation from May 1983 to May 1984 and from May 2010 to May 2011, that is, at equivalent stages of the recovery from two comparable strong recessions. The row “Change ∆%” for May 1983 to May 1984 shows an increase of total nonfarm jobs by 4.9 percent and of 5.9 percent for total private jobs. The row “Change ∆%” for May 2010 to May 2011 shows an increase of total nonfarm jobs by 0.7 percent and of 1.7 percent for total private jobs. The last two rows of Table 6 provide a calculation of the number of jobs that would have been created from May 2010 to May 2011 if the rate of job creation had been the same as from May 1983 to May 1984. If total nonfarm jobs had grown between May 2010 and May 2011 by 4.9 percent, as between May 1983 and May 1984, 6.409 million jobs would have been created in the past 12 months for a difference of 5.457 million more total nonfarm jobs relative to 0.952 million jobs actually created. If total private jobs had grown between May 2010 and May 2011 by 5.9 percent as between May 1983 and May 1984, 6.337 million private jobs would have been created for a difference of 4.539 million more total private jobs relative to 1.798 million jobs actually created.

Table 6, Total Nonfarm and Total Private Jobs Destroyed and Subsequently Created in Two Recessions IIIQ1981-IVQ1982 and IVQ2007-IIQ2009, Thousands and Percent

	Total Nonfarm Jobs	Total Private Jobs
06/1981 #	92,288	75,969
11/1982 #	89,482	73,260
Change #	-2,806	-2,709
Change ∆%	-3.0	-3.6
12/1982 #	89,383	73,185
05/1984 #	94,471	78,049
Change #	5,088	4,864
Change ∆%	5.7	6.6
11/2007 #	139,090	116,291
05/2009 #	131,626	108,601
Change %	-7,464	-7,690
Change ∆%	-5.4	-6.6
12/2009 #	130,178	107,338
05/2011 #	131,753	108,494
Change #	1,575	1,156
Change ∆%	1.2	1.1
05/1983 #	90,005	73,667
05/1984 #	94,471	78,049
Change #	4,466	4,382
Change ∆%	4.9	5.9
05/2010 #	130,801	107,405
05/2011 #	131,753	109,203
Change #	952	1,798
Change ∆%	0.7	1.7
Change # by ∆% as in 05/1984 to 05/1985	6,409*	6,337**
Difference in Jobs that Would Have Been Created	5,457 = 6,409-952	4,539 = 6,337-1,798

*[(130,801x1.049)-130,801] = 6,409 thousand

**[(107,405)x1.059 – 107,405] = 6,337 thousand

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

II Falling Real Wages. The wage bill is the average weekly hours times the earnings per hour. Table 7 provides the estimates by the BLS of earnings per hour seasonally adjusted, increasing from $22.57/hour in Jun 2010 to $22.99/hour in Jun 2011, or by 1.9 percent. There is disappointment in financial markets about the pace of wage increases because of rising food and energy costs. Average private weekly earnings increased slightly by $18.92 from $769.64 in Jun 2010 to $788.56 in May 2011 or by 2.5 percent. Earnings per hour fell from $23.00 in May 2011 to $22.99 in Jun 2011 and average weekly earnings declined from $791.20 in May, 2011 to $788.56 in Jun, 2011. The number of average weekly hours rose from 34.1 in Jun 2010 to 34.3 percent in Jun 2011, or by 0.6 percent. The wage bill before taxes rose by 2.5 percent (1.019 times 1.006). The wage bill rose 2.5 percent in the 12 months ending in May, 2011 [($23.00x34.4)/($22.57x34.2) while CPI inflation was 3.6 percent for an inflation-adjusted decline of 1.1 percent {[(1.025/1.036)-1]100}. Energy and food price increases are similar to a “silent tax” that is highly regressive, harming the most those with lowest incomes. There are concerns that the wage bill would deteriorate in purchasing power because of the raw materials shock in the form of increases in prices of commodities such as the 29.7 percent steady increase in the DJ-UBS Commodity Index from Jul 2, 2010 to Jun Jul 8, 2011 (see Table 32). The charts of four commodity price indexes by Bloomberg show steady increase since Jul 2, 2010 that was interrupted briefly only in Nov with the sovereign issues in Europe triggered by Ireland, in Mar by the earthquake and tsunami in Japan and in the beginning of May by the decline in oil prices (http://www.bloomberg.com/markets/commodities/futures/).

Table 7, Earnings per Hour and Average Weekly Hours SA

Earnings per Hour	Jun 10	Apr 11	May 11	Jun 11
Total Private	$22.57	$22.93	$23.00	$22.99
Goods Producing	$23.99	$24.34	$24.41	$24.41
Service Providing	$22.23	$22.59	$22.66	$22.65
Average Weekly Earnings
Total Private	$769.64	$788.79	$791.20	$788.56
Goods Producing	$947.61	$971.17	$978.84	$973.96
Service Providing	$733.59	$752.25	$752.31	$751.98
Average Weekly Hours
Total Private	34.1	34.4	34.4	34.3
Goods Producing	39.5	39.9	40.1	39.9
Service Providing	33.0	33.3	33.2	33.2

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

Average hourly earnings in the first four months of 2007, 2010 and 2011 are shown in Table 8 together with their 12-months change, CPI 12 month inflation and 12-month percentage changes in CPI inflation-adjusted average hourly earnings. Nominal changes of hourly earnings in 2007 were high and compensated for CPI inflation as shown by positive changes in 12 months real or CPI inflation-adjusted average hourly earnings. In 2010 and 2011, real average hourly earnings have been falling with acceleration in Mar because of the high headline CPI inflation of 2.7 percent, accelerating in Apr to 3.2 percent and in May to 3.6 percent. Headline CPI inflation in the first five months of 2011 accumulated to an annual equivalent 4.9 percent. CPI inflation excluding food and energy accumulated to annual equivalent 2.4 percent in the first five months of 2011.

Table 8, Average Hourly Earnings Nominal and Inflation Adjusted, Dollars and % NSA

	AHE ALL	12 Month Nominal ∆%	∆% 12 Month CPI	12 Month Real ∆%
2007
Jan*	$20.70*	4.2*	2.1	2.1*
Feb*	$20.79*	4.1*	2.4	1.7*
Mar	$20.78	3.6	2.8	0.8
Apr	$20.85	3.5	2.6	0.7
May	$20.89	3.8	2.7	1.1
Jun	$21.00	3.8	2.7	1.1
2010
Jan	$22.44	1.9	2.6	-0.7
Feb	$22.48	1.9	2.1	-0.2
Mar	$22.48	1.8	2.3	-0.5
Apr	$22.52	1.8	2.2	-0.4
May	$22.57	1.9	2.0	-0.1
Jun	$22.57	1.8	1.1	0.7
2011
Jan	$22.86	1.9	1.6	0.3
Feb	$22.88	1.8	2.1	-0.3
Mar	$22.89	1.8	2.7	-0.9
Apr	$22.93	1.8	3.2	-1.4
May	$23.00	1.9	3.6	-1.6
Jun	$22.99	1.9

Note: AHE ALL: average hourly earnings of all employees; CPI: consumer price index; Real: adjusted by CPI inflation; NA: not available

*AHE of production and nonsupervisory employees because of unavailability of data for all employees

Source: http://data.bls.gov/cgi-bin/surveymost?bls

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

III Causes of the Fractured Labor Market. Various explanations of the fractured labor market argue that recent one-time factors caused the weak employment situation report for Jun. The various causal candidates are (1) seasonal factors; (2) supply chain disruption by the earthquake/tsunami in Japan; and (3) adverse winter weather followed by tornadoes. These interpretations are contradicted by zero growth of real disposable personal income (RDPI) in the first five months of 2011, as shown in Table 9, because tough winter weather was sporadic and localized, the earthquake/tsunami occurred in Mar and only some sectors of the economy were affected and tornadoes were concentrated in time and geography. The economy slowed at the turn of the year and not only in the US but also worldwide. There is no value in the argument that companies stopped hiring caused by negotiations on avoiding government shutdown and debt limit increase because of generalized belief in late hour agreements. The argument that employment is a lagging indicator of recessions is also not very convincing because the economy has been expanding during eight consecutive quarters. The fact is that growth and employment creation have been mediocre in this expansion in comparison with past expansions after similar contractions. There is active debate on the policies that could promote growth and employment (see subsection IIIC Composition of Policy Measures in http://cmpassocregulationblog.blogspot.com/2011/06/financial-risk-aversion-slow-growth.html).

Table 9, Percentage Change from Prior Month Seasonally Adjusted of Personal Income, Disposable Income and Personal Consumption Expenditures %

	NPI	NDPI	RDPI	NPCE	RPCE
2011
May	0.3	0.2	0.1	0.0	-0.1
Apr	0.3	0.2	-0.1	0.3	-0.1
Mar	0.4	0.4	0.0	0.6	0.2
Feb	0.4	0.3	-0.1	0.8	0.4
Jan	1.1	0.5	0.1	0.4	0.0
Jan-May 2011	2.5	1.4	0.0	2.1	0.4
Jan-May 2011 A	6.2	3.9	0.0	5.2	0.9
2010
Dec	0.4	0.4	0.2	0.4	0.1
Nov	0.2	0.2	0.1	0.3	0.3
Oct	0.4	0.3	0.1	0.7	0.5
IVQ10	1.0	0.9	0.4	1.4	0.9
IVQ010 A	4.1	3.7	1.6	5.7	3.7

Notes: NPI: current dollars personal income; NDPI: current dollars disposable personal income; RDPI: chained (2005) dollars DPI; NPCE: current dollars personal consumption expenditures; RPCE: chained (2005) dollars PCE; A: annual equivalent; IVQ2010: fourth quarter 2010; A: annual equivalent

Percentage change month to month seasonally adjusted

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

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

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

http://www.bea.gov/newsreleases/national/pi/2011/pi0211.htm

The argument that earlier recessions have not been accompanied by banking and financial turmoil is devoid of facts because the sovereign debt crisis of 1982 nearly bankrupted the money center banks of the US. Double digit inflation rates plagued the 1970s with the economy running in “stop and go” episodes (see http://cmpassocregulationblog.blogspot.com/2011_04_01_archive.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). The Fed raised the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm). The rate of unemployment rose to 9.7 percent in 1982. Several countries that had borrowed for financing balance of payments deficits declared moratoriums on their foreign debts, impairing balance sheets of money-center banks (see, for example, in vast literature, Krugman 1994). The increase in interest rates to deal with stagflation caught the banking industry with short-dated funding and long-term fixed-rate assets. In a parallel of what could happen when monetary policy abandons its near zero interest rates, 1150 US commercial banks, close to 8 percent of the industry, failed, almost twice the number of banks that failed since establishment of the FDIC in 1934 until 1983 (Benston and Kaufman 1997, 139; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7). More than 900 savings and loans associations, equivalent to around 25 percent of the industry, had to be closed, merged or placed in conservatorship (Ibid). Taxpayer funds in the value of $150 billion were used in the resolution of failed savings and loans institutions. In terms of relative dimensions, $150 billion was equivalent to 2.6 percent of GDP of $5800 billion in 1990 and 3.6 percent of GDP of $4217 billion in 1985 (http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=5&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=1980&LastYear=1990&3Place=N&Update=Update&JavaBox=no). The equivalent in terms of 2.6 to 3.6 percent of US GDP in 2010 of $14,657 billion would be $381 billion to $528 billion (data from Ibid). Wide swings in interest rates resulting from aggressive monetary policy can wreck the balance sheets of families, financial institutions and companies while posing another recession risk. While it is true that monetary policy can increase interest rates instantaneously, the increase from zero percent toward much higher levels to contain inflation can have devastating effects on the world economy.

IV Financial Risk Aversion. The past two months have been characterized by unusual financial turbulence. Table 10, updated with every comment in this blog, provides beginning values on Jul 4 and daily values throughout the week ending on Jul 8. 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 1.8 percent relative to the euro, with outflow of funds from risk financial assets. The dollar depreciated in the prior week by 2.3 percent relative to the euro because of relaxation of 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 and the weak employment report of the US were important factors in the appreciation of the dollar by Jul 8. The Japanese yen depreciated during the week reaching JPY 81.2193/USD by Thu Jul 7 but appreciated by 0.2 percent by Fr Jul 8 to JPY 80.61/USD, which is still 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 1.3 percent during the week, reaching CHF 0.838/USD on Fri Jul 8, 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 10, Daily Valuation of Risk Financial Assets

	Jul 4	Jul 5	Jul 6	Jul 7	Jul 8
USD/ EUR	1.4532 -0.1%	1.4419 0.7%	1.4316 1.4%	1.4360 1.1%	1.4260 1.8%
JPY/ USD	80.828 -0.06	81.1095 -0.4%	80.909 -0.2%	81.2193 -0.5%	80.61 0.2%
CHF/ USD	0.8481 0.1%	0.8411 0.9%	0.8395 1.1%	0.8448 0.5%	0.838 1.3%
10 Year T Note Yield	3.18	3.12	3.10	3.14	3.022
2 Year T Note Yield	0.47	0.43	0.42	0.47	0.392
10 Year German Bond Yield	3.02	3.01	2.93	2.97	2.83
DJIA	Closed	-0.1% -0.1%	0.3% 0.5%	1.1% 0.7%	0.6% -0.5%
DJ Global	0.4% 0.4%	0.03% -0.3%	-0.3% -0.3%	0.4% 0.7%	-0.3% -0.7
DAX	0.3% 0.3%	0.3% -0.05%	0.2% -0.1%	0.7% 0.5%	-0.2% -0.9%
DJ Asia Pacific	1.2% 1.2%	1.0% -0.2%	1.3% 0.3%	1.3% -0.02%	2.1% 0.7%
WTI $/b	95.00 0.3% 0.3%	96.84 2.3% 1.9%	96.66 2.1% -0.2%	98.55 4.1% 2.0%	96.37 1.8% -2.2%
Brent $/b	113.39 1.7% 1.7%	113.51 1.8% 0.1%	113.95 2.2% 0.4%	118.19 6.0% 3.7%	118.33 6.1% 0.1%
Gold $/ounce	1496.50 0.7% %	1516.402.0% 1.3%	1528.70 2.8% 0.8%	1531.70 3.0% 0.2%	1543.60 3.8% 0.8%

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 10 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 fluctuated between 0.42 and 0.47 percent but collapsed to 0.392 percent on Fri July 8 because of risk aversion caused by the weak employment report. Much the same is true of the 10-year Treasury note and the 10-year bond of the government of Germany, falling to 3.022 percent for the 10-year Treasury note and to 2.83 percent for the 10-year government bond of Germany in the week of Fri Jul 8 because of the combination of the weak employment report in the US and renewed fears on Greece in Europe. Section VI Valuation of Risk Financial Assets provides more details and comparisons of performance in peaks and troughs.

The upper line in the stock indexes in Table 10 measures the percentage cumulative change since the closing level in the prior week on Jul 1 and the lower line measures the daily percentage change. Performance of equities markets was mixed. The DJ Global index fell 0.3 percent in the week with the effects of the employment report in the US on Fri July 8 and the doubts on highly-indebted countries in Europe with the DAX losing 0.2 percent in the week. The DJ Asia Pacific index climbed 2.1 percent in the week and escaped the decline on Fri Jul 8 because of the rally caused by optimism on the ADP private-sector job reports and decline in initial unemployment insurance claims both revealed on Thu Jul 7.

The final block of Table 10 shows the strong performance of the oil indexes. Brent gained 6.1 percent in the week, with decline of only 0.1 percent on Fri Jul 8, and WTI gained 1.8 percent, falling 2.2 percent on Fri Jul 8 after release of the weak employment situation report. Increasing risk appetite appears to have stimulated the carry trade. Gold gained 3.8 percent by Fri Jul 8.

The International Monetary Fund (IMF) provides loans in the forms of “arrangements” that stipulate policies and specific implementation measures for a borrowing country to adjust its balance of payments (see Pelaez and Pelaez, International Financial Architecture (2005), 69-71). The borrowing country designs policy and measures in consultations with the IMF. The loans are released in installments approved by the Executive Board of the IMF. The largest loans are provided by the Stand-By Arrangement (SBA). Typical terms of SBAs are between 12 and 18 months with repayment in normal cases between 2 ½ and 4 years. On May 9, 2010, the Executive Board of the IMF approved a three-year SBA to Greece in the value of 26.4 billion in the IMF’s currency or unit of account special drawing rights (SDR, see Pelaez and Pelaez, International Financial Architecture (2005), 68), about €30 billion, to support the country in its program of adjustment and transformation (http://www.imf.org/external/np/sec/pr/2010/pr10187.htm). The IMF immediately released SDR 4.8 billion or about €5.5 billion in a joint program with the European Union that totaled immediate financial assistance of €20 billion. The IMF SBA is part of a program with the European Union in total support value of €110 billion provided over three years. IMF commitments are equivalent to 3200 percent of Greece’s quota. The press release by the IMF on May 9, 2010 states the objectives of the program and expected results (http://www.imf.org/external/np/sec/pr/2010/pr10187.htm):

“’The Greek government should be commended for committing to an historic course of action that will give this proud nation a chance of rising above its current troubles and securing a better future for the Greek people,’ IMF Managing Director Dominique Strauss-Kahn stated. ‘Today, the IMF has demonstrated its commitment to doing what it can to help Greece and its people. The road ahead will be difficult, but the government has designed a credible program that is economically well-balanced, socially well-balanced—with protection for the most vulnerable groups—and achievable. Implementation is now the key. Together with our partners in the European Union, we are providing an unprecedented level of support to help Greece in this effort and—over time--to help restore growth, jobs, and higher living standards.’”

On Jul 8, 2011, the Executive Board of the IMF approved immediate disbursement of SDR 2.9 billion or about €3.2 billion for total IMF disbursements of SDR 15.6 billion or about €17.4 billion (http://www.imf.org/external/np/sec/pr/2011/pr11273.htm). The Managing Director of the IMF and Chair of its Executive Board, Christine Lagarde, stated (http://www.imf.org/external/np/sec/pr/2011/pr11273.htm):

“The authorities have made progress in the fiscal area. A new medium-term strategy was approved, defining the measures required to reduce the general government deficit below 3 percent of GDP by 2014. The strategy confronts difficult issues, including the generous terms of public sector employment, the possibility to close inefficient public entities, and tax evasion. Steadfast and timely implementation will be crucial, together with complementary institutional reforms improving revenue administration and public financial management.”

An important issue in completing the bailout of Greece is the insistence by some members of the European Union of private-sector participation. The general idea is for the creditors of Greece to accept reductions in maturing debt that could be extended wholly or partly for maturity in the long run. This has been part of the discussion of international bailouts for quite some time (see Pelaez and Pelaez, International Financial Architecture (2005, 163-202). Stephen Fidler, Costas Paris and Neelabh Chaturvedi writing on Jul 4 on “S&P puts new obstacles in Greece’s path” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304760604576424961088825954.html?mod=WSJ_hp_LEFTWhatsNewsCollection) analyze the statement by Standard & Poor’s (SP) that the most important proposal for participation of the private sector could cause the classification of Greek debt in default. In that proposal, creditors would “voluntarily” roll over €30 billion into new bonds issued by Greece in order to reduce the cash contribution by the IMF and the European Union required to prevent another Greek crisis. S&P would lower some of the issues of Greece to SD (selective default) and a default “issue rating would be assigned to the maturing Greek government bonds upon their refinancing in 2011” (http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245311278832). Peter Spiegel and Patrick Jenkins writing on Jul 10, 2011, on “EU stance shifts on Greece default” published by the Financial Times (http://www.ft.com/intl/cms/s/0/5ffeabf0-ab09-11e0-b4d8-00144feabdc0.html#axzz1Repz5K5o) inform of early stages of negotiation of a possible shift on Greece debt. The new plan would reduce Greece’s bailout interest rates and buy back bonds from creditors. Greek bonds trade at discounts from face value such that the buybacks would be equivalent to a “voluntary haircut” on Greece’s sovereign debt. The objective would be to reduce Greek debt to more manageable levels that can eventually lead to normal funding by Greece in international financial markets. The remainder of the summer will be filled with meetings to discuss alternatives.

On Tue Jul 5, Moody’s Investors Service “downgraded Portugal’s long-term bond rating to Ba2 from Baa1 and assigned a negative outlook. Concurrently, Moody’s has also downgraded the government’s short-term debt rating to (P) Not-Prime from (P) Prime-2” (http://www.moodys.com/research/Moodys-downgrades-Portugal-to-Ba2-with-a-negative-outlook-from?docid=PR_222043). Sovereign risks were calmed by an important decision of the European Central Bank to continue providing liquidity assistance to credit operations of Portugal (http://www.ecb.int/press/pr/date/2011/html/pr110707_1.en.html):

“The Governing Council of the European Central Bank (ECB) has decided to suspend the application of the minimum credit rating threshold in the collateral eligibility requirements for the purposes of the Eurosystem’s credit operations in the case of marketable debt instruments issued or guaranteed by the Portuguese government. This suspension will be maintained until further notice.

The Portuguese government has approved an economic and financial adjustment programme, which has been negotiated with the European Commission, in liaison with the ECB, and the International Monetary Fund. The Governing Council has assessed the programme and considers it to be appropriate. This positive assessment and the strong commitment of the Portuguese government to fully implement the programme are the basis, also from a risk management perspective, for the suspension announced herewith.

The suspension applies to all outstanding and new marketable debt instruments issued or guaranteed by the Portuguese government.”

The European Banking Authority (EBA) announced the publication data of the European Union bank stress tests on Fri Jul 15, 2011. The tests are being conducted on 91 banks accounting for 65 percent of total assets of the banking sector. The tests evaluate the impact on banks of a “hypothetical adverse scenario” using “a common conservative stress testing benchmark for European banks.” According to the EBA (http://www.eba.europa.eu/News--Communications/Year/2011/The-EBA-announces-stress-test-publication-date.aspx):

“The test is being applied consistently across participating banks as part of a coordinated EU wide effort to improve transparency, identify vulnerabilities, inform policymakers and ensure appropriate measures are taken to address possible deficiencies.”

Credit and sovereign exposures will be released with the tests. The disclosure will include the results of the stress test on the balance sheet of Dec 2010 and details of the capital account of banks. Information will show the effects of strengthening banks’ capital by 2012 by raising equity. Decisions and measures of management to strengthen balance sheets will also be released. In addition, “the EBA expects the presentation of results to be accompanied by the announcement of relevant backstop measures for banks falling below the threshold and banks that may be deemed to have vulnerabilities or perceived by markets to be at risk” (http://www.eba.europa.eu/News--Communications/Year/2011/The-EBA-announces-stress-test-publication-date.aspx). There are important uses and limitations of stress tests as tool used by banks and also regulators, supervisors and the IMF (Pelaez and Pelaez, Globalization and the State Vol. I (2008b), 95-100, International Financial Architecture (2005), 113-6).

V 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 11 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.

Table 11, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates

	GDP	CPI	PPI	UNE
US	2.9	3.6	7.3	9.2
Japan	-0.7***	0.3	2.2	4.5
China	9.7	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	2.2	6.0	9.5
Nether-lands	3.2	2.4	10.7	4.2
Finland	5.8	3.4	8.0	7.8
Belgium	3.0	3.1	9.7	7.3
Portugal	-0.7	3.7	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	3.4	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 12 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 12 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 12, 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

The 12 months rate of increase of the UK’s index of output prices are shown in Table 13. The percentage change of the index of all prices jumped from 4.2 percent in Dec 2010 to over 5 percent in the first six months of 2011, rising by 5.7 percent in Jun. The percentage change in the total index excluding food, beverage and petroleum jumped from 2.7 percent in Dec 2010 to over 3 percent in the first six months of 2011, with 3.2 percent in Jun. Inflation of the total index excluding duties jumped from 4.0 percent in Dec 2010 to 5 percent or higher in the first six months of 2011, showing 5.8 percent in Jun.

Table 13, UK Output Prices 12 Months ∆% NSA

	All	Excluding Food, Beverage and Petroleum	All Excluding Duty
Dec 2010	4.2	2.7	4.0
2011
Jun	5.7	3.2	5.8
May	5.4	3.4	5.5
Apr	5.6	3.6	5.8
Mar	5.6	3.1	5.5
Feb	5.3	3.1	5.2
Jan	5.0	3.3	5.0

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

http://www.statistics.gov.uk/pdfdir/ppi0611.pdf

UK’s input prices rose at the 12-month rate of increase of 17.0 percent in Jun and at 12.8 percent excluding food, tobacco, beverages and petroleum, as shown in Table 14A. There has been an acceleration of input prices similar to that of output prices but the gap in rates of increase suggests a possible squeeze in profit margins. The highest rate of increase occurred in Apr with 17.9 percent for the total index and 12.2 percent with the exclusions. The decline in commodity prices especially petroleum appears to have had effects on the rhythm of increase of input prices. The index with exclusion is showing that food and petroleum increases are causing acceleration of inflation of core input prices.

Table 14A, UK Input Prices 12 Months ∆% NSA

	Materials and Fuels Purchased	Excluding Food, Tobacco, Beverages and Petroleum
2010 Dec	13.1	9.0
2011
Jun	17.0	12.8
May	16.1	11.2
Apr	17.9	12.2
Mar	14.8	10.3
Feb	14.9	10.7
Jan	14.2	10.5

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

http://www.statistics.gov.uk/pdfdir/ppi0611.pdf

Table 14B provides the monthly rates of increase of UK output and input prices. The impact of the drop in oil prices is shown in an increase of output prices by only 0.2 percent in May and drop of input prices by 1.7 percent. This behavior is observed in other advanced economies such as the US. Moreover, price increases moderated in Jun with 0.1 percent for output prices and 0.4 percent for input prices. If future inflation rates were to oscillate in the same fashion as in the first six months of 2011, yearly inflation would be 8.5 percent for output prices and 19.3 percent for input prices, as shown by the annual equivalent rates Jan-Jun in the first row of Table 14B.

Table 14B, UK Output and Input Prices ∆% NSA

	Output Prices	Input Prices
Annual Equivalent Jan-Jun	8.5	19.3
Jun	0.1	0.4
May	0.2	-1.7
Apr	1.1	2.8
Mar	1.1	3.8
Feb	0.5	1.4
Jan	1.1	2.3

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

Euro zone industrial producer prices fell 0.2 percent in May and rose 6.2 percent in 12 months as shown in Table 15. The total excluding energy rose a high 4.2 percent in 12 months and 0.2 percent in May. Energy fell 1.1 percent in May but was 11.9 percent higher in 12 months. There were milder increases in prices of durable goods, 1.9 percent in 12 months, but prices of non-durable consumer goods rose 0.3 percent in May and 3.7 percent in 12 months.

Table 15, Euro Zone Industrial Producer Prices ∆%

	May	12 months May
Total excluding construction	-0.2	6.2
Total excluding construction and energy	0.2	4.2
Intermediate goods	0.2	6.6
Energy	-1.1	11.9
Capital goods	0.0	1.2
Durable consumer goods	0.1	1.9
Non-durable consumer goods	0.3	3.7

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-04072011-AP/EN/4-04072011-AP-EN.PDF

The monthly inflation rates of euro zone headline industrial producer prices and excluding energy are shown in Table 16. The annual equivalent rates in the final row of Table 16 show that if the rates in the first five months were repeated for a year, total industrial prices would increase at 8.9 percent and at 6.2 percent excluding energy.

Table 16, Euro zone Industrial Producer Prices ∆%

	Total Excluding Construction	Total Excluding Construction and Energy
Jan	1.3	0.9
Feb	0.8	0.6
Mar	0.8	0.4
Apr	0.9	0.4
May	-0.2	0.2
Jan-May Annual Equivalent	8.9	6.2

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-04072011-AP/EN/4-04072011-AP-EN.PDF

Germany has successfully restructured its economy toward competitiveness in international trade. Table 17 provides the 12 months rate of increase of imports of Germany in Jan to Apr of 2011. The high rates of increases in nominal values contain an important inflation component that is led by food, raw materials and semi finished products.

Table 17, Germany, Imports 12 Months ∆%

	Total	Food	Ind	Raw Mat	Semi-Fin	Fin Prod
Apr	18.7	13.8	17.6	40.2	30.7	12.2
Mar	15.6	10.7	14.5	29.5	24.8	11.1
Feb	25.7	17.2	27.7	48.2	41.6	22.9
Jan	22.8	17.6	26.6	48.4	37.4	21.9

Ind: Industry; Raw Mat: raw materials; Semi Fin: Semi-finished products; Fin Prod: finished products

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/ForeignTrade/Content100/ahl110j.psml

A similar pattern is found in Germany’s 12 months rates of increase of exports shown in Table 18. The high double-digit increases in nominal values include an inflation component. Export growth began to decelerate in Mar and Apr.

Table 18, Germany, Exports 12 Months ∆%

	Total	Food	Ind	Raw Mat	Semi-Fin	Fin Prod
Apr	12.4	15.2	11.1	43.2	7.3	11.0
Mar	14.7	10.7	13.9	62.5	27.4	12.6
Feb	20.0	16.3	20.8	60.8	27.6	19.9
Jan	23.2	17.4	24.9	70.8	39.7	23.4

Ind: Industry; Raw Mat: raw materials; Semi Fin: Semi-finished products; Fin Prod: finished products

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/ForeignTrade/Content100/ahl210j.psml

The terms of trade measure export prices relative to import prices. Deterioration of the terms of trade, with import prices rising faster than export prices, causes decline of real national income. Table 19 shows that the unit value of German imports has been rising much faster than the unit value of German exports. The final column in Table 19 shows the 12 months rates of deterioration of Germany’s terms of trade. The advanced economies are experiencing deteriorations in their terms of trade resulting from the increase in commodity prices. Zero interest rates encourage carry trade in the form of shorting short-term debt and the dollar and going long in leveraged positions with derivatives on commodities and other risk financial assets. The resulting surge of commodity prices actually tends to worsen economic conditions in countries following unconventional monetary policy of zero interest rates via deterioration in the terms of trade

Table 19, Germany, Unit Value of Imports and Exports and Terms of Trade 12 Months ∆%

	Imports Unit Value	Exports Unit Value	Terms of Trade
2011
Apr	8.7	4.5	-3.9
Mar	11.9	4.6	-6.6
Feb	7.9	4.5	-3.1
Jan	9.3	4.7	-4.3
2010
Dec	10.5	6.4	-3.8
Nov	11.6	5.4	-5.5
Oct	8.2	4.0	-3.8
Sep	7.6	3.9	-3.5
Aug	6.3	2.8	-3.3
Jul	5.6	2.4	-3.0

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/ForeignTrade/Content75/ahl310j.psml

The Markit Eurozone Composite PMI^® finds that growth in the euro zone in Jun is at the lowest in 20 months since Oct 2009 (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/EZ_Composite_ENG_1107_PR.pdf). Growth slowed in Jun in the core countries of France and Germany and Spain and Italy fell back into contraction. Creation of jobs in the euro zone is at the lowest in eight months with falls in headcounts in Italy, Spain and Ireland. The only good news is reduction of cost pressures since the peak in Mar. A critical issue in advanced economies is the weakness of internal demand. Table 20 shows the disappointing performance of retail sales in the euro zone, with decline of 1.1 percent in May and sales in May 2011 lower by 1.9 percent relative to May 2010. The annual equivalent decline of sales in Jan-May is minus 2.7 percent.

Table 20, Retail Sales in Euro Zone ∆%

	Month ∆%	12 Months ∆%
Jan	0.2	0.6
Feb	0.2	1.1
Mar	-0.9	-1.4
Apr	0.7	0.8
May	-1.1	-1.9
Jan-May Annual Equivalent	-2.7

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-05072011-AP/EN/4-05072011-AP-EN.PDF

The argument by Lorenzo Bini Smaghi (2011Jun1, 2011Mar4; see http://cmpassocregulationblog.blogspot.com/2011/06/unemployment-and-underemployment-of-24.html) that inflation of food and energy has been increasing on a strong long-term trend and not in transitory surges with quick reversals is supported by Table 21. As argued by Smaghi (2011Jun1) inflation of food prices rose steadily at the average rate of 7.5 percent during the past decade with interruptions only in 2002 and 2009. The 12 months rates of increases in the first six months of 2011 have ranged from a low of 32.4 percent in Jan to 42.2 percent in Apr with 39.0 percent in Jun.

Table 21, Food Price Index of the Food and Agriculture Organization ∆%

	∆%
2001	3.3
2002	-3.2
2003	8.9
2004	14.3
2005	4.5
2006	8.5
2007	25.2
2008	25.8
2009	-21.5
2010	17.8
2010/2000	105.6
Average Yearly Percentage Rate 2000-2010	7.5
∆% 12 months 2011
Jan	32.4
Feb	39.1
Mar	41.7
Apr	42.2
May	41.2
Jun	39.0

Source: http://www.fao.org/worldfoodsituation/wfs-home/foodpricesindex/en/ The 12 month rates Jan to Apr 2011 are from the Excel dataset that can be downloaded in that page. The percentage change for May is different in the two sources and unavailable in the site.

The combined Markit/CIPS UK PMI^TM surveys suggest higher growth in Jun but are consistent with decelerating GDP growth of 0.3 percent in IIQ2011 compared with 0.5 percent in IQ2011 (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/UK_economy_11_07_05.pdf). Table 22 shows that industrial production in the UK fell 0.8 percent from May 2010 to May 2011. Manufacturing grew 2.8 percent in the 12 months ending in May 2011. The quarter Mar-May 2011 relative to Mar-May 2010 shows decline of industrial production by 0.6 percent but growth of manufacturing by 2.1 percent. Production increased by 0.9 percent in May 2011 relative to Apr and manufacturing grew by 1.8 percent. The worrisome measurement is in the final row of Table 22 with Mar-May decline of industrial production by 1.5 percent and of manufacturing by 0.2 percent.

Table 22, UK Industrial Production and Manufacturing ∆%

	Industrial Production	Manufacturing
May 2011/May 2010	-0.8	2.8
Mar-May 2011/Mar-May 2010	-0.6	2.1
May 2011/Apr 2011	0.9	1.8
Mar-May 2011/Dec 2010-Feb 2011	-1.5	-0.2

Source:

http://www.statistics.gov.uk/pdfdir/iop0711.pdf

Growth of components of industrial production in the UK is shown in Table 23. The decline of total production is caused by the decline in mining of 18.0 percent and in energy of 3.3 percent. Mining fell 5.6 percent from Apr to May 2011.

Table 23, UK Industrial Production

	May 2011/May 2010	May 2011/Apr 2011
Total Production	-0.8	0.9
Mining	-18.0	-5.6
Manufacturing	2.8	1.8
Energy	-3.3	1.6

Source: http://www.statistics.gov.uk/pdfdir/iop0711.pdf

The Markit Eurozone Composite PMI^® shows that output in Germany at 56.3 in Jun is the lowest in eight months (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/EZ_Composite_ENG_1107_PR.pdf). Germany’s industrial production fell by 0.3 percent in Apr but rebounded by 1.2 percent in May, as shown in Table 24. The annual equivalent rate of growth of industrial production of Germany in the first five months of 2011 is 10.5 percent.

Table 24, Germany, Industrial Production ∆%

	12 Months NSA	Month SA
May	21.0	1.2
Apr	7.2	-0.3
Mar	10.9	1.1
Feb	17.2	1.8
Jan	17.4	0.4
Annual Equivalent		10.5

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/Production/Content100/kpi117x12,templateId=renderPrint.psml

The JP Morgan Global PMI, compiled by Markit finds stagnation of world trade in Jun (http://www.markit.com/assets/en/docs/commentary/markit-economics/2011/jul/global_economy_11_07_07.pdf). Germany’s manufacturing orders in Table 25 confirm weakening international demand. Foreign manufacturing orders in Germany fell 5.8 percent in May relative to Apr while domestic or home manufacturing orders jumped by 11.3 percent. Manufacturing orders are highly volatile because of the influence of large-value items in individual months. The second row of Table 25 “AE Jan-May” shows the annual equivalent rates for the first five months and also for the first four months, excluding May. Weakening world demand for goods and services could have adverse effects on growth of the world economy.

Table 25, Germany Manufacturing Orders ∆%

	Total 12 M	Total M	Foreign 12 M	Foreign M	Home 12 M	Home M
AE Jan-May		16.2 Exclud-ing May 14.4		-6.0 Exclud-ing May 10.7		48.7 Exclud-ing May 19.1
May	23.0	1.8	15.9	-5.8	31.3	11.3
Apr	7.3	2.9	10.5	3.5	3.4	2.2
Mar	8.8	-2.7	11.6	-2.9	5.5	-2.6
Feb	21.1	1.9	24.8	1.7	16.9	2.1
Jan	20.1	2.5	23.6	1.2	16.0	4.3

AE: annual equivalent; M: month

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/OrdersRecieved/Content100/kae211x12,templateId=renderPrint.psml

Altman and Esentato (2011Jun20) argue that the financial destiny of the euro will be decided in Italy because of the substantial sovereign debt of about $2 trillion. A bailout of Italy may be just too large for the IMF and the European Union. The proper evaluation of individual countries in circumventing debt crises, according to Altman and Esentato (2011Jun20), requires measurements of the strength of their private sectors. In their analysis they find various adverse factors such as high government debt, slow-growing economy, aging population and political vagaries. Altman and Esentato (2011Jun20) also find multiple positive advantages such as tourism, fashion industry, various very powerful companies, improving banks and dynamic smaller companies. The evaluation of these positive and adverse factors is not clear. Italy’s industrial production fell 0.6 percent in May and grew 1.8 percent in the 12 months ending in May, as shown in Table 26. The annual equivalent rate of growth in the first five months of 2011 is 2.1 percent. Hintz and Deda (2011Jun30), at Moody’s Analytics Capital Markets Research, estimate widening credit default swap (CDS) spreads in Jun for various Italian banks.

Table 26, Italy, Industrial Production

	Month ∆%	12 Months ∆%
May	-0.6	1.8
Apr	1.1	3.8
Mar	0.7	3.4
Feb	1.4	2.4
Jan	-1.7	0.4
Jan-May Annual Equivalent	2.1

Source: http://www.istat.it/salastampa/comunicati/in_calendario/prodind/20110708_00/testointegrale20110708.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 27 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 27, 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 28 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 28 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 28, 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 29, 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 29. 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 3.022 percent at the close of market on Fr Jul 8, 2011, would be equivalent to price of 96.5957 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price loss of 4.6 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 29 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 6, 2011, the line “Reserve Bank credit” in the Fed balance sheet stood at $2854 billion, or $2.8 trillion, with portfolio of long-term securities of $2620 billion, or $2.6 trillion, consisting of $1531 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 $1660 billion or $1.6 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 29, 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

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

VI 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 30 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 30 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 19.6 percent by Fri Jul 8, 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 30 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 30, 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	07/08 /2011
Rate	1.1423	1.5914	1.192	1.426
CNY/USD	01/03 2000	07/21 2005	7/15 2008	07/08 2011
Rate	8.2798	8.2765	6.8211	6.4645
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 30A extracts four rows of Table 30 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 32 below, the dollar has devalued again to USD 1.426/EUR or by 19.6 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 6.4645/USD on Fri Jul 8, 2011, or by an additional 5.2 percent, for cumulative revaluation of 21.9 percent.

Table 30A, 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	07/08 /2011
Rate	1.1423	1.5914	1.192	1.426
CNY/USD	01/03 2000	07/21 2005	7/15 2008	07/08 2011
Rate	8.2798	8.2765	6.8211	6.4645

Source: Table 30.

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 31. 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 31, 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 30 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 32, 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 07/08/11” with all risk financial assets in the range from 11.9 percent for European stocks to 31.4 percent for the US S&P 500. Japan has significantly improved performance rising 14.9 percent above the trough. The Nikkei Average closed at 10,137.73 on Fri Jul 8, only 1.1 percent below 10,254.43 on Mar 11 on the date of the earthquake and 10.1 percent above the lowest Fri closing on Mar 18 of 9206.75. The dollar devalued by 19.6 percent and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 07/08/2011” shows mixed performance of financial assets. The Dow Global lost 0.3 percent with greater strength in Asia, especially the gain of 2.7 in Japan while DJIA gained 0.6 percent and S&P rose 0.6 percent but STOXX 50 of Europe fell 0.4 percent and DAX of Germany lost 0.2 percent. The DJ UBS Commodity Index gained 2.5 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 but the week of Fr Jul 8 showed support of currently high valuations of risk financial assets. There is a fundamental change in Table 32 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 7/08/11” 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 7/08/11” but also relative to the peak in column “∆% Peak to 7/08/11.” There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 7.3 percent, Nikkei Average by 11.0 percent but mostly because of the earthquake/tsunami, Shanghai Composite by 11.6 percent and STOXX 50 by 5.2 percent. The gainers relative to the peak in Apr 2010 are: DAX by 16.9 percent, Asia Pacific by 8.4 percent, S&P 500 by 10.4 percent, DJIA by 12.9 percent, Dow Global by 2.9 percent and the DJ UBS Commodities Index by 10.9 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 32, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 7/ 08/11	∆% Week 7/ 08/11	∆% Trough to 7/ 08/11
DJIA	4/26/ 10	7/2/10	-13.6	12.9	0.6	30.7
S&P 500	4/23/ 10	7/20/ 10	-16.0	10.4	0.3	31.4
NYSE Finance	4/15/ 10	7/2/10	-20.3	-7.3	-1.5	16.3
Dow Global	4/15/ 10	7/2/10	-18.4	2.9	-0.3	26.2
Asia Pacific	4/15/ 10	7/2/10	-12.5	8.4	2.1	23.8
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-11.0	2.7	14.9
China Shang.	4/15/ 10	7/02 /10	-24.7	-11.6	1.4	17.4
STOXX 50	4/15/10	7/2/10	-15.3	-5.2	-0.4	11.9
DAX	4/26/ 10	5/25/ 10	-10.5	16.9	-0.2	30.6
Dollar Euro	11/25 2009	6/7 2010	21.2	5.8	1.8	-19.6
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	10.9	2.5	29.7
10-Year Tre.	4/5/ 10	4/6/10	3.986	3.022

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 33 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 now 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. Earnings next week would have to come strong enough to compensate for the weakening economy.

Table 33, 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

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

Table 34, 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 34, Exchange Rates

	Peak	Trough	∆% P/T	Jul 8, 2011	∆% T Jul 8 2011	∆% P Jul8 2011
EUR USD	7/15 2008	6/7 2010		7/08 2011
Rate	1.59	1.192		1.426
∆%			-33.4		16.4	-11.5
JPY USD	8/18 2008	9/15 2010		7/08 2011
Rate	110.19	83.07		80.61
∆%			24.6		2.9	26.8
CHF USD	11/21 2008	12/8 2009		7/08 2011
Rate	1.225	1.025		0.838
∆%			16.3		18.2	31.6
USD GBP	7/15 2008	1/2/ 2009		7/08 2011
Rate	2.006	1.388		1.606
∆%			-44.5		13.6	-24.9
USD AUD	7/15 2008	10/27 2008		7/08 2011
Rate	1.0215	1.6639		1.075
∆%			-62.9		44.1	8.9
ZAR USD	10/22 2008	8/15 2010		7/08 2011
Rate	11.578	7.238		6.699
∆%			37.5		7.4	42.1
SGD USD	3/3 2009	8/9 2010		7/08 2011
Rate	1.553	1.348		1.22
∆%			13.2		9.5	21.4
HKD USD	8/15 2008	12/14 2009		7/08 2011
Rate	7.813	7.752		7.782
∆%			0.8		-0.4	0.4
BRL USD	12/5 2008	4/30 2010		7/08 2011
Rate	2.43	1.737		1.562
∆%			28.5		10.1	35.7
CZK USD	2/13 2009	8/6 2010		7/08 2011
Rate	22.19	18.693		16.912
∆%			15.7		9.5	23.8
SEK USD	3/4 2009	8/9 2010		7/08 2011
Rate	9.313	7.108		6.379
∆%			23.7		10.3	31.5
CNY USD	7/20 2005	7/15 2008		7/08 2011
Rate	8.2765	6.8211		6.4645
∆%			17.6		5.2	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

VII Economic Indicators. The nonmanufacturing index of the Institute for Supply Management fell 1.3 percentage points from 54.6 in May to 53.3 in Jun. New Orders fell 3.2 percentage points from 56.8 in May to 53.6 in June. Prices fell 8.7 percentage points from 69.6 in May to 60.9 (http://ism.ws/ISMReport/NonMfgROB.cfm). The nonmanufacturing sector is growing at a slower rate and prices are increasing at a slower rate.

Sales of Merchant wholesalers except manufacturers’ sales branches and offices, not adjusted for seasonality or prices, grew 15.3 percent in Jan-May 2011 relative to Jan-May 2010, as shown in Table 35. Significant part of this nominal growth is caused by inflation. Durables sales rose 12.4 percent and not durable sales grew 17.6 percent. Commodity-related sales of farm products rose 46.8 percent and petroleum products grew 37.8 percent. Petroleum wholesale sales account for 27.8 percent of not durable sales and 15.7 percent of total wholesale sales. The sum petroleum and groceries sales adds to $532 billion equivalent to 49.4 percent of not durable sales and 27.9 percent of total wholesale sales, growing by 24 percent in the first five months of 2011 relative to the first five months of 2010. Inflation is present throughout the entire production and distribution chain.

Table 35, Sales of Merchant Wholesalers Except Manufacturers’ Sales Branches and Offices, Billions of Dollars and ∆% % NSA

	Jan-May 2011 $ B	Jan-May 2010 $ B	∆%
US Total	1,910	1,657	15.3
Durable	833	741	12.4
Automotive	130	119	9.2
Prof. Equip.	147	139	5.8
Comp. Equip.	78	72	8.3
Electrical	157	139	12.9
Machinery	138	114	21.0
Not Durable	1,077	916	17.6
Drugs	166	153	8.5
Apparel	52	50	4.0
Groceries	233	212	9.9
Farm Products	113	77	46.8
Petroleum	299	217	37.8
Petroleum plus Groceries	532	429	24.0

Sources: http://www2.census.gov/wholesale/pdf/mwts/currentwhl.pdf

Table 36 shows the total value of manufacturers’ shipments and new orders, seasonally adjusted. Factory orders are very volatile because of strong oscillations caused by large-value items, such as civilian aircraft. The percentages changes for May/Apr and Apr/Mar are quite weak while those for Mar/Feb are much stronger. The last row shows, for example, the wide swing in new orders for nondefense aircraft that fell 29.0 percent in Apr/Mar and rose 36.5 percent in May/Apr. Automobiles show decline of 6.2 percent in both new orders and shipments probably as a result of the interruption of supplies from Japan because of the earthquake.

Table 36, Value of Manufacturers’ Shipments and New Orders, SA, %

	May/Apr ∆%	Apr/Mar ∆%	Mar/Feb ∆%
Total
S	0.1	-0.4	3.1
NO	0.8	-0.9	3.8
Excluding Transport
S	0.2	0.0	2.9
NO	0.2	0.2	2.9
Excluding Defense
S	0.1	-0.3	3.2
NO	0.7	-0.9	3.6
Durable Goods
S	0.4	-1.4	3.1
NO	2.1	-2.5	4.6
Transport Equipment
S	-0.5	-3.7	5.1
NO	6.3	-9.3	10.6
Automobiles
S	-0.4	-7.9	11.2
Motor Vehicles
S	2.0	-6.2	8.0
NO	2.0	-6.2	7.3
Nondefense Aircraft
S	-2.4	-2.0	2.5
NO	36.5	-29.0	2.3

Note: S: shipments; NO: new orders; Transport: transportation

Source: http://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf

Table 37 provides the percentage change of the value of manufacturers’ shipments and new orders, not adjusted for seasonality or price, in Jan through May 2011 relative to Jan through May 2010. Automobiles rose by only 4.8 percent, raising the issue of whether part of the deceleration of manufacturing originates in supply interruptions caused by the earthquake/tsunami of Japan on Mar 11. The double-digit percentage increases of nominal values suggest that part of growth is inflation.

Table 37, Value of Manufacturers’ Shipments and New Orders, NSA, %

	Jan-Apr 2011/Jan-Apr 2010 ∆%
Total
S	11.4
NO	12.5
Excluding Transport
S	12.3
NO	12.7
Excluding Defense
S	12.4
NO	13.2
Durable Goods
S	7.6
NO	9.8
Transport Equipment
S	4.3
NO	10.4
Automobiles
S	5.2
Nondefense Aircraft
S	7.4
NO	28.3

Note: S: shipments; NO: new orders; Transport: transportation

Source: http://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf

Table 38 provides the data on consumer credit in the Fed report. The rate of growth of total consumer credit in IQ2011 was 2.3 percent, increasing to 2.8 percent in Apr and 2.5 percent in May. Growth originated mostly in nonrevolving credit increasing at the annual equivalent rate of 4.8 percent in Apr while revolving credit fell at the annual rate of 1.3 percent. There is here a combination of the effects of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD) (http://www.gpo.gov/fdsys/pkg/PLAW-111publ24/pdf/PLAW-111publ24.pdf) that reduced credit limits and increased interest rates for most cardholders while cards of many debtors with lower credit scores were cancelled together with the flight to thriftiness by debtors because of economic and tax uncertainties. Revolving credit grew by 5.1 percent annual equivalent in May while the rate of growth of non-revolving credit fell to 1.3 percent.

Table 38, Consumer Credit Seasonally Adjusted Annual Percentage Rate and Billions of Dollars

	1Q2011	Mar	Apr	May
∆%
Total	2.3	2.2	2.8	2.5
Revol-ving	-5.0	-0.5	-1.3	5.1
Non-revol -ving	6.0	3.5	4.8	1.3
$ Billions
Total	2421.4	2421.4	2427.1	2432.2
Revol-ving	790.6	790.6	789.8	793.1
Non-revol -ving	1630.8	1630.8	1637.3	1639.1

Source: http://www.federalreserve.gov/releases/g19/current/g19.htm

The Energy Information Administration Weekly Petroleum Status Report is summarized in Table 39. Crude oil stocks fell to 358.6 million barrels in the week of Jul 1 from 359.6 million barrels in the week of Jun 24 and are higher by 0.4 million barrels than in the week of Jul 2, 2010. The world crude oil price fell to $104.39/barrel in the week of Jul 1 from $107.82/barrel in the week of Jun 24, but is 41.9 percent higher than $73.54/barrel in the week of Jul 2, 2010. The price of regular motor gasoline of $3.579/gallon on Jul 4, 2011 was 31.3 percent higher than $2.726/gallon on Jul 5, 2010.

Table 39, Energy Information Administration Weekly Petroleum Status Report

	07/01/11	06/24/11	07/2/10
Crude Oil Stocks Million B	358.6	359.5	358.2
Crude Oil* Imports Thousand Barrels/Day	9,095	8,782	9,643
Motor Gasoline Million B	212.5	213.2	219.4
Distillate Fuel Oil Million B	142.1	142.3	159.7
World Crude Oil Price $/B	104.39	107.82	73.54
	07/04/11	06/27/11	07/05/10
Regular Motor Gasoline $/G	3.579	3.574	2.726

*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 14,000 to reach 418,000 in the week of Jul 2 from 432,000 in the week of Jun 25, as shown in Table 40. Claims not seasonally adjusted rose 10,165 to reach 416,798 in the week of Jul 2 from 406,633 in the week of Jun 25. The labor market is not showing improvement with claims around 400,000, seasonally adjusted or not.

Table 40, Initial Claims for Unemployment Insurance

	SA	NSA	4-week MA SA
Jul 2	418,000	416,798	424,750
Jun 25	432,000	406,633	427,750
Change	-14,000	+10,165	-3,000
Jun 18	429,000	394,286	426,250
Prior Year	460,000	470,366	467,250

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

Source: http://www.dol.gov/opa/media/press/eta/ui/current.htm

VIII 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 41 provides inflation of the CPI. In Jan-May 2011, CPI inflation for all items seasonally adjusted was 4.9 percent in annual equivalent, that is, compounding inflation in the first five months and assuming it would be repeated during three consecutive four-month periods. In the 12 months ending in May, CPI inflation of all items not seasonally adjusted was 3.6 percent. The second raw provides the same measurements for the CPI of all items excluding food and energy: 2.4 percent annual equivalent in Jan-May and 1.5 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 0.02 percent for three months or virtually zero, 0.06 percent for six months, 0.16 percent for 12 months, 0.39 percent for two years, 0.68 percent for three years, 1.58 percent for five years, 2.33 percent for seven years, 3.03 percent for ten years and 4.28 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 41. 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 41, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent Jan-May 2011 ∆%

	∆% 12 Months May 2011/May 2010 NSA	∆% Annual Equivalent Jan-May 2011 SA
CPI All Items	3.6	4.9
CPI ex Food and Energy	1.5	2.4

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

IX Conclusion. Economic indicators are suggesting slowing economic growth in the world economy. Lower growth is causing softer labor markets at a time when inflation is threatening. (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 10, 2011

Twenty Five to Thirty Million Unemployed or Underemployed, Falling Real Wages, Financial Risk Aversion, Slow Growth and Global Inflation

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