CMP Associates Regulation Blog

Similar behavior occurs in the rate of nonfarm hiring plot in Chart ESI-2. Recovery in early 2010 was followed by decline and stabilization at a lower level but with stability in monthly SA estimates of 3.2 in Sep 2011 to 3.2 in Jan 2012, increasing to 3.3 in May 2012. The rate not seasonally adjusted fell from 3.7 in Jun 2011 to 2.3 in Dec, climbing to 3.1 in Jan 2012 and 3.6 in May 2012. Rates of nonfarm hiring NSA were in the range of 2.8 (Dec) to 4.5 (Jun) in 2006.

Chart ESI-2, US, Rate Total Nonfarm Hiring, Month SA 2001-2012

Source: US Bureau of Labor Statistics

There is only milder improvement in total private hiring shown in Chart ESI-3. Hiring private (HP) rose in 2010 followed by stability and renewed increase in 2011. The number of private hiring seasonally adjusted fell from 4002 thousand in Sep 2011 to 3889 in Dec or by 2.8 percent, increasing to 3945 in Jan 2012 or decline by 1.4 relative to the level in Sep 2011 but increasing to 4063 in May 2012 or by 4.5 percent relative to Sep 2011. The number of private hiring not seasonally adjusted fell from 4130 in Sep 2011 to 2856 in Dec or by 30.8 percent, reaching 3782 in Jan 2012 or decline of 8.4 percent relative to Sep 2011 but increasing to 4469 in May 2012 or 8.2 percent relative to Sep 2011. Companies do not hire in the latter part of the year that explains the high seasonality in year-end employment data. For example, NSA private hiring fell from 4934 in Sep 2006 to 3635 in Dec 2006 or by 26.3 percent. Private hiring NSA data are useful in showing the huge declines from the period before the global recession. In Jul 2006 private hiring NSA was 5555, declining to 4293 in Jul 2011 or by 22.7 percent. The conclusion is that private hiring in the US is more than 20 percent below the hiring before the global recession. The main problem in recovery of the US labor market has been the low rate of growth of 2.4 percent in the eleven quarters of expansion of the economy from IIIQ2009 to IQ2012 compared with average 6.2 percent in prior expansions from contractions (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html). The US missed the opportunity to recover employment as in past cyclical expansions from contractions.

Chart ESI-3, US, Total Private Hiring Month SA 2011-2012

Source: US Bureau of Labor Statistics

Chart ESI-4 shows similar behavior in the rate of private hiring. The rate in 2011 in monthly SA data has not risen significantly above the peak in 2010. The rate seasonally adjusted fell from 3.6 in Sep 2011 to 3.5 in Dec 2011, increasing to 3.6 in Jan 2012 and 3.7 in May 2012. The rate not seasonally adjusted (NSA) fell from 3.8 in Sep 2011 to 2.6 in Dec 2011, increasing to revised 3.5 in Jan 2012 and 4.0 in May 2012. The NSA rate of private hiring fell from 4.9 in Jun 2006 to 3.6 in Jun 2009 but recovery was insufficient to only 4.1 in Jun 2011.

Chart ESI-4, US, Rate Total Private Hiring Month SA 2011-2011

Source: US Bureau of Labor Statistics

ESII Ten Million Fewer Full-Time Jobs. There is strong seasonality in US labor markets around the end of the year. The number employed part-time for economic reasons because they could not find full-time employment fell from 9.270 million in Sep 2011 to 8.210 million in Jun 2010, seasonally adjusted, or decline of 1.060 million in nine months, as shown in Table ESII-1. The number employed full-time increased from 112.479 million in Sep 2011 to 115.290 million in Mar 2012 or 2.811 million but then fell to 114.212 million in May 2012 or 1.078 million fewer full-time employed than in Mar 2012. There is a jump in the level of full-time SA to 114.573 million in Jun 2012 or 361,000 relative to May 2012. The number of employed part-time for economic reasons actually increased without seasonal adjustment from 8.271 million in Nov 2011 to 8.428 million in Dec 2011 or by 157,000 and then to 8.918 million in Jan 2012 or by an additional 490,000 for cumulative increase from Nov 2011 to Jan 2012 of 647,000. The level of employed part-time for economic reasons then fell from 8.918 million in Jan 2012 to 7.867 million in Mar 2012 or by 1.0151 million and to 7.694 million in Apr 2012 or 1.224 million fewer relative to Jan 2012. In May, the number employed part-time for economic reasons increased to 7.837 million SA or 143,000 more than in Apr 2012 and then to 8.394 million in Jun 2012 or 557,000 more than in May 2012. The number employed full time without seasonal adjustment fell from 113.138 million in Nov 2011 to 113.050 million in Dec 2011 or by 88,000 and fell further to 111.879 in Jan 2012 for cumulative decrease of 1.259 million. The number employed full-time not seasonally adjusted fell from 113.138 million in Nov 2011 to 112.587 million in Feb 2012 or by 551.000 but increased to 116.024 million in Jun 2012 or 2.886 million more full-time jobs than in Nov 2011. Comparisons over long periods require use of NSA data. The number with full-time jobs fell from a high of 123.219 million in Jul 2007 to 108.770 million in Jan 2010 or by 14.442 million. The number with full-time jobs in Jun 2012 is 116.024 million, which is lower by 7.2 million relative to the peak of 123.219 million in Jul 2007. There appear to be around 10 million less full-time jobs in the US than before the global recession. Growth at 2.4 percent on average in the eleven quarters of expansion from IIIQ2009 to IQ2012 compared with 6.2 percent on average in expansions from postwar cyclical contractions is the main culprit of the fractured US labor market (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html).

Table ESII-1, US, Employed Part-time for Economic Reasons, Thousands, and Full-time, Millions

	Part-time Thousands	Full-time Millions
Seasonally Adjusted
Jun 2012	8,210	114.573
May 2012	8,098	114.212
Apr 2012	7,853	111.478
Mar 2012	7,672	115.290
Feb 2012	8,119	114.408
Jan 2012	8,230	113.845
Dec 2011	8,098	113.765
Nov 2011	8,469	113.212
Oct 2011	8,790	112.841
Sep 2011	9,270	112.479
Aug 2011	8,787	112.406
Not Seasonally Adjusted
Jun 2012	8,394	116.024
May 2012	7,837	114.634
Apr 2012	7,694	113.999
Mar 2012	7,867	113.916
Feb 2012	8,455	112.587
Jan 2012	8,918	111.879
Dec 2011	8,428	113.050
Nov 2011	8,271	113.138
Oct 2011	8,258	113.456
Jun 2011	8,738	113.255
May 2011	8,270	112.618
Apr 2011	8,425	111.844
Mar 2011	8,737	111.186
Feb 2011	8,749	110.731
Jan 2011	9,187	110.373
Dec 2010	9,205	111.207
Nov 2010	8,670	111.348
Oct 2010	8,408	112.342
Jun 2010	8,867	113.856
May 2010	8,513	112.809
Apr 2010	8,921	111.391
Mar 2010	9,343	109.877
Feb 2010	9,282	109.100
Jan 2010	9,290	108.777 (low)
Dec 2009	9,354 (high)	109.875
Jun 2009	9,301	114.014
May 2009	8,785	113.083
Apr 2009	8,648	112.746
Mar 2009	9,305	112.215
Feb 2009	9,170	112.947
Jan 2009	8,829	113.815
Jun 2008	5,697	121.845
May 2008	5,096	120.809
Apr 2008	5,071	120.027
Mar 2008	5,038	119.875
Feb 2008	5,114	119.452
Jan 2008	5,340	119.322
Jul 2007	4,516	123.219 (high)
Jun 2007	4,469	122.250
May 2007	4,315	120.846
Apr 2007	4,205	119.609
Mar 2007	4,384	119.640
Feb 2007	4,417	119.041
Jan 2007	4,726	119.094
Sep 2006	3,735 (low)	120.780
Jun 2006	4,456	121.070
May 2006	3,968	118.925
Apr 2006	3,787	118.559
Mar 2006	4,097	117.693
Feb 2006	4,403	116.823
Jan 2006	4,597	116.395

Source: US Bureau of Labor Statistics

People lose their marketable job skills after prolonged unemployment and find increasing difficulty in finding another job. Chart ESII-1 shows the sharp rise in unemployed over 27 weeks and stabilization at an extremely high level.

Chart ESII-1, US, Number Unemployed for 27 Weeks or Over, Thousands SA Month 2001-2011

Sources: US Bureau of Labor Statistics

Chart ESII-2 shows the sharp rise in people marginally attached to the labor force after 2007 and subsequent stabilization. People marginally attached to the labor force “were not in the labor force, wanted and were available for work and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey” (http://www.bls.gov/news.release/pdf/empsit.pdf 2).

Chart ESII-2, US, Marginally Attached to the Labor Force, NSA Month 2001-2012

Sources: US Bureau of Labor Statistics

Chart ESII-3 reveals the fracture in the US labor market. The number of workers with full-time jobs not-seasonally-adjusted rose with fluctuations from 2002 to a peak in 2007, collapsing during the global recession. The terrible state of the job market is shown in the segment from 2009 to 2012 with fluctuations around the typical behavior of a stationary series: there is no improvement in the United States in creating full-time jobs.

Chart ESII-3, US, Full-time Employed, Thousands, NSA, 2001-2012

Sources: US Bureau of Labor Statistics

ESIII Youth Unemployment. The United States is experiencing high youth unemployment as in European economies. Table ESIII-1 provides the employment level for ages 16 to 24 years of age estimated by the Bureau of Labor Statistics. On an annual basis, youth employment fell from 20.041 million in 2006 to 17.362 million in 2011 or 2.679 million fewer youth jobs. During the seasonal peak months of youth employment in the summer from Jun to Aug, youth employment has fallen by more than two million jobs. There are two hardships behind these data. First, young people cannot find employment after finishing high-school and college, reducing prospects for achievement in older age. Second, students with more modest means cannot find employment to keep them in college.

Table ESIII-1, US, Employment Level 16-24 Years, Thousands, NSA

Year	Mar	Apr	May	Jun	Annual
2001	19800	19778	19648	21212	20088
2002	19091	19108	19484	20828	19683
2003	18709	18873	19032	20432	19351
2004	18752	19184	19237	20587	19630
2005	18989	19071	19356	20949	19770
2006	19291	19406	19769	21268	20041
2007	19538	19368	19457	21098	19875
2008	18745	19161	19254	20466	19202
2009	17564	17739	17588	18726	17601
2010	16587	16764	17039	17920	17077
2011	16898	16970	17045	18180	17362
2012	17301	17387	17681	18907

Sources: US Bureau of Labor Statistics

Chart ESIII-1 provides US employment level ages 16 to 24 years from 2002 to 2012. Employment level is sharply lower in Jun 2012 relative to the peak in 2007.

Chart ESIII-1, US, Employment Level 16-24 Years, Thousands SA, 2001-2012

Sources: US Bureau of Labor Statistics

Table ESIII-2 provides US unemployment level ages 16 to 24 years. The number unemployed ages 16 to 24 years increased from 2342 thousand in 2007 to 3634 thousand in 2011 or by 1.292 million. This situation may persist for many years.

Table ESIII-2, US, Unemployment Level 16-24 Years, Thousands NSA

Year	Mar	Apr	May	Jun	Annual
2001	2253	2095	2171	2775	2371
2002	2822	2515	2568	3167	2683
2003	2601	2572	2838	3542	2746
2004	2588	2387	2684	3191	2638
2005	2520	2398	2619	3010	2521
2006	2216	2092	2254	2860	2353
2007	2096	2074	2203	2883	2342
2008	2347	2196	2952	3450	2830
2009	3371	3321	3851	4653	3760
2010	3748	3803	3854	4481	3857
2011	3520	3365	3628	4248	3634
2012	3294	3175	3438	4180

Sources: US Bureau of Labor Statistics

Chart ESIII-2 provides the unemployment level ages 16 to 24 from 2002 to 2012. The level rose sharply from 2007 to 2010 with tepid improvement into 2012.

Chart ESIII-2, US, Unemployment Level 16-24 Years, Thousands SA, 2001-2012

Sources: US Bureau of Labor Statistics

Table ESIII-3 provides the rate of unemployment of young peoples in ages 16 to 24 years. The annual rate jumped from 10.5 percent in 2007 to 18.4 percent in 2010 and 17.3 percent in 2011. During the seasonal peak in Jul 2011 the rate of youth unemployed was 18.1 percent compared with 10.8 percent in Jun 2007.

Table ESIII-3, US, Unemployment Rate 16-24 Years, Thousands, NSA

Year	Mar	Apr	May	Jun	Annual
2001	10.2	9.6	10.0	11.6	10.6
2002	12.9	11.6	11.6	13.2	12.0
2003	12.2	12.0	13.0	14.8	12.4
2004	12.1	11.1	12.2	13.4	11.8
2005	11.7	11.2	11.9	12.6	11.3
2006	10.3	9.7	10.2	11.9	10.5
2007	9.7	9.7	10.2	12.0	10.5
2008	11.1	10.3	13.3	14.4	12.8
2009	16.1	15.8	18.0	19.9	17.6
2010	18.4	18.5	18.4	20.0	18.4
2011	17.2	16.5	17.5	18.9	17.3
2012	16.0	15.4	16.3	18.1

Sources: US Bureau of Labor Statistics

Chart ESIII-3 provides the BLS estimate of the not-seasonally-adjusted rate of youth unemployment for ages 16 to 24 years from 2002 to 2012. The rate of youth unemployment increased sharply during the global recession of 2008 and 2009 but has failed to drop to earlier lower levels during the eleven quarters of expansion of the economy since IIIQ2009.

Chart ESIII-3, US, Unemployment Rate 16-24 Years, Thousands, NSA, 2001-2012

Sources: US Bureau of Labor Statistics

Chart ESIII-4 provides longer perspective with the rate of youth unemployment in ages 16 to 24 years from 1948 to 2012. The rate of youth unemployment rose to 20 percent during the contractions of the early 1980s and also during the contraction of the global recession in 2008 and 2009. The data illustrate again the claim in this blog that the contractions of the early 1980s are the valid framework for comparison with the global recession of 2008 and 2009 instead of misleading comparisons with the 1930s. During the initial phase of recovery, the rate of youth unemployment 16 to 24 years NSA fell from 18.9 percent in Jun 1983 to 14.5 percent in Jun 1984 while the rate of youth unemployment 16 to 24 years was nearly the same during the expansion after IIIQ2009: 19.9 percent in Jun 2009, 20.0 percent in Jun 2010, 18.9 percent in Jun 2011 and 18.1 percent in Jun 2012. The difference originates in the vigorous seasonally-adjusted annual equivalent average rate of GDP growth of 5.7 percent during the recovery from IQ1983 to IVQ1985 compared with 2.4 percent on average during the first eleven quarters of expansion from IIIQ2009 to IQ2012 (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html). The fractured US labor market denies an early start for young people.

Chart ESIII-4, US, Unemployment Rate 16-24 Years, Percent NSA, 1948-2012

Sources: US Bureau of Labor Statistics

http://www.bea.gov/national/index.htm#gdp http://www.esri.cao.go.jp/en/sna/sokuhou/sokuhou_top.html http://www.stats.gov.cn/enGliSH/

ESIV United States International Trade. US exports and imports of goods not seasonally adjusted in Jan-May 2012 and Jan-May 2011 are shown in Table ESIV-1. The rate of growth of exports was 6.8 percent and 7.3 percent for imports. The US has partial hedge of commodity price increases in exports of agricultural commodities that fell 5.5 percent and of mineral fuels that increased 14.9 13.8 both because of higher prices of raw materials and commodities that are falling again currently because of shocks of risk aversion. The US exports an insignificant amount of crude oil. US exports and imports consist mostly of manufactured products, with less rapidly increasing prices. US manufactured exports rose 7.8 percent while imports rose 8.7 percent. Significant part of the US trade imbalance originates in imports of mineral fuels growing by 2.3 percent and crude oil increasing 6.9 percent with significant decline at the margin in oil prices. The limited hedge in exports of agricultural commodities and mineral fuels compared with substantial imports of mineral fuels and crude oil results in waves of deterioration of the terms of trade of the US, or export prices relative to import prices, originating in commodity price increases caused by carry trades from zero interest rates.

Table ESIV-1, US, Exports and Imports of Goods, Not Seasonally Adjusted Millions of Dollars and %

	Jan-May 2012 $ Millions	Jan-May 2011 $ Millions	∆%
Exports	640,521	599,620	6.8
Manufactured	424,019	393,214	7.8
Agricultural Commodities	57,080	60,248	-5.5
Mineral Fuels	56,198	49,379	13.8
Crude Oil	677	563	20.2
Imports	940,663	876,583	7.3
Manufactured	690,835	635,424	8.7
Agricultural Commodities	44,675	41,468	7.7
Mineral Fuels	187,349	183,109	2.3
Crude Oil	141,144	132,034	6.9

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

ESV World Economic Slowdown. Table ESV-1 provides the latest available estimates of GDP for the regions and countries followed in this blog. Growth is weak throughout most of the world. Japan’s GDP increased 1.2 percent in IQ2012 and 2.8 percent relative to a year earlier but part of the jump could be the low level a year earlier because of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Japan is experiencing difficulties with the overvalued yen because of worldwide capital flight originating in zero interest rates with risk aversion in an environment of softer growth of world trade. China grew at 1.8 percent in IIQ2012, which annualizes to 7.4 percent. Xinhuanet informs that Premier Wen Jiabao considers the need for macroeconomic stimulus, arguing that “we should continue to implement proactive fiscal policy and a prudent monetary policy, while giving more priority to maintaining growth” (http://news.xinhuanet.com/english/china/2012-05/20/c_131599662.htm). Premier Wen elaborates that “the country should properly handle the relationship between maintaining growth, adjusting economic structures and managing inflationary expectations” (http://news.xinhuanet.com/english/china/2012-05/20/c_131599662.htm). China’s GDP grew 7.6 percent in IIQ2012 relative to IQ2011. Growth rates of GDP of China in a quarter relative to the same quarter a year earlier have been declining from 2011 to 2012. GDP was flat in the euro area in IQ2012 and fell 0.1 percent relative to a year earlier. Germany’s GDP increased 0.5 percent in IQ2012 and 1.7 percent relative to a year earlier. US GDP increased 0.5 percent in IQ2012 and 2.0 percent relative to a year earlier (Section I http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html) but with substantial underemployment and underemployment (http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html) and weak hiring (Section I and earlier http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of.html).

Table ESV-1, Percentage Changes of GDP Quarter on Prior Quarter and on Same Quarter Year Earlier, ∆%

	IQ2012/IVQ2011	IQ2012/IQ2011
United States	0.5	2.0
Japan	1.2	2.8
Euro Area	0.0	-0.1
Germany	0.5	1.7
France	0.0	0.3
Italy	-0.8	-1.4
United Kingdom	-0.3	-0.1
	IIQ2012/IQ2012	IIQ2012/IIQ2011
China	1.8	7.6

Source: Country Statistical Agencies

Growth of GDP of China from a quarter relative to the same quarter a year earlier decelerated from 12.1 percent in IQ2010 to 7.6 percent in IIQ2012, as shown in Table ESV-2. Growth of GDP in a quarter relative to the prior quarter decelerated from 2.2 percent in IQ2011 or annual equivalent 9.1 percent to 1.8 percent in both IQ2012 and IIQ 2012 or annual equivalent 7.4 percent. Secondary industry activity growth in a quarter relative to the same quarter a year earlier decelerated from growth of 14.5 percent in IQ2010 to 8.3 percent in IIQ2012.

Table ESV-2, China, Growth Rate of GDP, ∆% Relative to a Year Earlier and ∆% Relative to Prior Quarter

	IQ 2011	IIQ 2011	IIIQ 2011	IVQ 2011	IQ 2012	IIQ 2012
GDP	9.7	9.5	9.1	8.9	8.1	7.6
Primary Industry	3.5	3.2	3.8	4.5	3.8	4.3
Secondary Industry	11.1	11.0	10.8	10.6	9.1	8.3
Tertiary Industry	9.1	9.2	9.0	8.9	7.5	7.7
GDP ∆% Relative to a Prior Quarter	2.2	2.3	2.4	1.9	1.8	1.8
	IQ 2010	IIQ 2010	IIIQ 2010	IVQ 2010
GDP	12.1	11.2	10.7	12.1
Primary Industry	3.8	3.6	4.0	3.8
Secondary Industry	14.5	13.3	12.6	14.5
Tertiary Industry	10.5	9.9	9.7	10.5

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/pressrelease/t20120713_402817907.htm

ESVI Flight to Government Securities of the United States, Germany and Japan. There was significant improvement in ten-year yields of bonds of the government of Italy, declining to 5.796 percent on Fri Jun 29, 2012 and of ten-year yields of bonds of the government of Spain, declining to 6.347 percent on Fri Jun 29 from earlier yields exceeding 7 percent (http://professional.wsj.com/mdc/public/page/2_3022-govtbonds.html?mod=mdc_bnd_pglnk). Yields on sovereign debt backed up again with the yield of the ten-year bond of the government of Spain increasing to 6.872 percent on Jul 6, 2012 but declining to 6.618 percent on Jul 13, and of the ten-year bond of Italy rising to 6.020 percent on Jul 6 and deteriorating to 6.054 percent on Jul 13 (http://professional.wsj.com/mdc/public/page/2_3022-govtbonds.html?mod=mdc_bnd_pglnk). Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Increasing aversion is captured by decrease of the yield of the ten-year Treasury and the two- and ten-year government bonds of Germany. Table ESVI-1 provides yields of US and German governments bonds and the rate of USD/EUR. Yields of US and German government bonds decline during shocks of risk aversion and the dollar strengthens in the form of fewer dollars required to buy one euro. The yield of the US ten-year Treasury note fell from 2.202 percent on Aug 26, 2011 to 1.49 percent on Jul 13, 2012, reminiscent of experience during the Treasury-Fed accord of the 1940s that placed a ceiling on long-term Treasury debt (Hetzel and Leach 2001), while the yield of the ten-year government bond of Germany fell from 2.16 percent to 1.26 percent. The US dollar strengthened significantly from USD 1.450/EUR on Aug 26, 2011, to USD 1.2248 on Jul 13, 2012, or by 15.5 percent. Under zero interest rates for the monetary policy rate of the US, or fed funds rate, carry trades ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield is still at a level well below consumer price inflation of 1.7 percent in the 12 months ending in May (see subsection IB United States Inflation http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars.html and ealier http://cmpassocregulationblog.blogspot.com/2012/05/world-inflation-waves-monetary-policy.html) and the expectation of higher inflation if risk aversion diminishes. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table ESVI-1 provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.

Table ESVI-1, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate

	US 2Y	US 10Y	DE 2Y	DE 10Y	USD/ EUR
7/13/12	0.24	1.49	-0.04	1.26	1.2248
7/6/12	0.272	1.548	-0.01	1.33	1.2288
6/29/12	0.305	1.648	0.12	1.58	1.2661
6/22/12	0.309	1.676	0.14	1.58	1.2570
6/15/12	0.272	1.584	0.07	1.44	1.2640
6/8/12	0.268	1.635	0.04	1.33	1.2517
6/1/12	0.248	1.454	0.01	1.17	1.2435
5/25/12	0.291	1.738	0.05	1.37	1.2518
5/18/12	0.292	1.714	0.05	1.43	1.2780
5/11/12	0.248	1.845	0.09	1.52	1.2917
5/4/12	0.256	1.876	0.08	1.58	1.3084
4/6/12	0.31	2.058	0.14	1.74	1.3096
3/30/12	0.335	2.214	0.21	1.79	1.3340
3/2/12	0.29	1.977	0.16	1.80	1.3190
2/24/12	0.307	1.977	0.24	1.88	1.3449
1/6/12	0.256	1.957	0.17	1.85	1.2720
12/30/11	0.239	1.871	0.14	1.83	1.2944
8/26/11	0.20	2.202	0.65	2.16	1.450
8/19/11	0.192	2.066	0.65	2.11	1.4390
6/7/10	0.74	3.17	0.49	2.56	1.192
3/5/09	0.89	2.83	1.19	3.01	1.254
12/17/08	0.73	2.20	1.94	3.00	1.442
10/27/08	1.57	3.79	2.61	3.76	1.246
7/14/08	2.47	3.88	4.38	4.40	1.5914
6/26/03	1.41	3.55	NA	3.62	1.1423

Note: DE: Germany

Source:

http://www.bloomberg.com/markets/

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

http://www.federalreserve.gov/releases/h15/data.htm

http://www.bundesbank.de/Navigation/EN/Statistics/Time_series_databases/Macro_economic_time_series/macro_economic_time_series_node.html?anker=GELDZINS

http://www.ecb.int/stats/money/long/html/index.en.html

Chart ESVI-1 of the Board of Governors of the Federal Reserve System provides the ten-year and two-year Treasury constant maturity yields. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe.

Chart ESVI-1, US, Ten-Year and Two-Year Treasury Constant Maturity Yields 2001-2012

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/update/

ESVII World Inflation Waves. Inflation in advanced economies has been fluctuating in waves at the production level alternation of surges and moderation of commodity price shocks. Table ESVII-1 provides month and 12-month percentage rates of inflation of Japan’s corporate goods price index (CGPI). Inflation measured by the CGPI fell 0.6 percent in Jun and fell 1.3 percent in 12 months. Measured by 12-month rates, CGPI inflation increased from minus 0.2 percent in Jul 2010 to a high of 2.2 percent in Jul 2011 and to much lower 0.3 percent in Mar 2012, minus 0.4 percent in Apr 2012, minus 0.7 percent in May 2012 and minus 1.3 percent in Jun 2012. Calendar-year inflation for 2011 is 1.5 percent, which is the highest after declines in 2009 and 2010 but lower than 4.6 percent in the commodity shock driven by zero interest rates during the global recession in 2008. Inflation of the corporate goods prices follows waves similar to those in other indices around the world (Section I and earlier at http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars.html). In the first wave, annual equivalent inflation reached 5.9 percent in Jan-Apr, driven by commodity price shocks of the carry trade from zero interest rates to commodity futures. In the second wave, carry trades were unwound because of risk aversion caused by the European debt crisis, resulting in average annual equivalent deflation of 1.2 percent in May-Jun. In the third wave, renewed risk aversion caused annual equivalent decline of the CGPI of minus 2.2 percent in Jul-Nov. In the fourth wave, continuing risk aversion resulted in annual equivalent inflation of minus 0.6 percent in Dec 2011 to Jan 2012. In the fifth wave, renewed risk appetite resulted in annual equivalent inflation of 3.3 percent in Feb-Apr 2012. Finally, in the sixth wave, annual equivalent inflation dropped to minus 6.4 percent in May-Jun 2012. Unconventional monetary policies of zero interest rates and quantitative easing have created a difficult environment for economic and financial decisions with significant inflation volatility.

Table ESVII-1, Japan, Corporate Goods Price Index (CGPI) ∆%

	Month	Year
Jun 2012	-0.6	-1.3
May	-0.5	-0.7
AE ∆% May-Jun	-6.4
Apr	0.1	-0.4
Mar	0.5	0.3
Feb 2012	0.2	0.4
AE ∆% Feb-Apr	3.3
Jan	-0.1	0.3
Dec 2011	0.0	0.8
AE ∆% Dec-Jan	-0.6
Nov	-0.1	1.3
Oct	-0.8	1.3
Sep	-0.2	2.0
Aug	-0.1	2.2
Jul	0.3	2.2
AE ∆% Jul-Nov	-2.2
Jun	0.0	1.9
May	-0.2	1.6
AE ∆% May-Jun	-1.2
Apr	0.8	1.8
Mar	0.6	1.3
Feb	0.1	0.7
Jan	0.4	0.6
AE ∆% Jan-Apr	5.9
Dec 2010	0.5	1.2
Nov	-0.1	0.9
Oct	-0.1	0.9
Sep	0.0	-0.1
Aug	-0.1	0.0
Jul	0.0	-0.2
Calendar Year
2011		1.5
2010		-0.1
2009		-5.3
2008		4.6

AE: annual equivalent

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html#

Chart ESVII-1 of the Bank of Japan provides year-on-year percentage changes of the domestic and services Corporate Goods Price Index (CGPI) of Japan. Percentage changes of inflation of services are not as sharp as those of goods. Japan had the same sharp waves of inflation during the 1970s as in the US (see Table IV-7 at http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real_09.html). Inflation also collapsed in the beginning of the 1980s as a result of tight monetary policy in the US with focus on inflation instead of on the gap of actual relative to potential output. The areas in shade correspond to the dates of cyclical recessions. The salient event is the sharp rise of inflation of the domestic goods CGPI in 2008 during the global recession that was purely the result of carry trades from fed funds rates collapsing to zero to long positions in commodity futures in an environment of relaxed financial risk appetite. The panic of toxic assets in banks to be withdrawn by the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009) drove unusual risk aversion with unwinding of carry trades of exposures in commodities and other risk financial assets. Carry trades returned once TARP was clarified as providing capital to financial institutions and stress tests verified the soundness of US banks. The return of carry trades explains the rise of CGPI inflation after mid 2009. Inflation of the CGPI fluctuated with zero interest rates in alternating episodes of risk aversion and risk appetite.

Chart ESVII-1, Japan, Domestic Corporate Goods Price and Services Index, Year-on-Year Percentage Change, 1980-2012

Notes: Blue: Domestic Corporate Goods Price Index All Commodities; Red: Corporate Price Services Index

Source: Bank of Japan

http://www.stat-search.boj.or.jp/ssi/cgi-bin/famecgi2?cgi=$graphwnd_en

There is similar behavior of year-on-year percentage changes of the US producer price index from 1980 to 2012 in Chart ESVII-2 of the US Bureau of Labor Statistics as in Chart ESVII-1 with the domestic goods CGPI. The US producer price index increased together with the CGPI driven by the period of one percent fed funds rates from 2003 to 2004 inducing carry trades into commodity futures and other risk financial assets and the slow adjustment in increments of 25 basis points at every FOMC meeting from Jun 2004 to Jun 2006. There is also the same increase in inflation in 2008 during the global recession followed by collapse because of unwinding positions during risk aversion and new rise of inflation during risk appetite.

Chart ESVII-2, US, Producer Price Index Finished Goods, Year-on-Year Percentage Change, 1980-2012

Source: US Bureau of Labor Statistics

http://www.stat-search.boj.or.jp/ssi/cgi-bin/famecgi2?cgi=$graphwnd_en

Finer detail is provided by Chart ESVII-3 of the domestic CGPI from 2008 to 2012. The CGPI rose almost vertically in 2008 as the collapse of fed funds rates toward zero drove exposures in commodities and other risk financial assets because of risk appetite originating in the belief that the financial crisis was restricted to structured financial products and not to contracts negotiated in commodities and other exchanges. The panic with toxic assets in banks to be removed by TARP (Cochrane and Zingales 2009) caused unwinding carry trades in flight to US government obligations that drove down commodity prices and price indexes worldwide. Apparent resolution of the European debt crisis of 2010 drove risk appetite in 2011 with new carry trades from zero fed funds rates into commodity futures and other risk financial assets. Domestic CGPI inflation returned in waves with upward slopes during risk appetite and downward slopes during risk aversion.

Chart ESVII-3, Japan, Domestic Corporate Goods Price Index, Monthly, 2008-2012

Source: Bank of Japan

There is similar behavior of the US producer price index from 2008 to 2012 in Chart ESVII-4 as in the domestic CGPI in Chart ESVII-3. A major difference is the strong long-term trend in the US producer price index with oscillations originating mostly in bouts of risk aversion such as the downward slope in the final segment in Chart ESVII-4. Carry trades from zero interest rates to commodity futures and other risk financial assets drive the upward trend of the US producer price index while oscillations originate in alternating episodes of risk aversion and risk appetite.

Chart ESVII-4, US, Producer Price Index Finished Goods, Monthly, 2008-2012

Source: US Bureau of Labor Statistics

http://www.stat-search.boj.or.jp/ssi/cgi-bin/famecgi2?cgi=$graphwnd_en

There was milder increase in Japan’s export corporate goods price index during the global recession in 2008 but similar sharp decline during the bank balance sheets effect in late 2008, as shown in Chart ESVII-5 of the Bank of Japan. Japan exports industrial goods whose prices have been less dynamic than those of commodities and raw materials. As a result, the export CGPI in Chart ESVII-5 trends down with oscillations after a brief rise in the final part of the recession in 2009.

Chart ESVII-5, Japan, Export Corporate Goods Price Index, Monthly, 2008-2012

Source: Bank of Japan

Japan imports primary commodities and raw materials. As a result, the import corporate goods price index in Chart ESVII-6 shows an upward trend after the rise during the global recession in 2008 driven by carry trades from fed funds rates collapsing to zero into commodity futures and decline during risk aversion from late 2008 into beginning of 2008 originating in doubts about soundness of US bank balance sheets. More careful measurement should show that the terms of trade of Japan, export prices relative to import prices, declined during the commodity shocks originating in unconventional monetary policy. The decline of the terms of trade restricted potential growth of income in Japan.

Chart ESVII-6, Japan, Import Corporate Goods Price Index, Monthly, 2008-2012

Source: Bank of Japan

http://www.stat-search.boj.or.jp/ssi/cgi-bin/famecgi2?cgi=$graphwnd_en

ESVIII Stagnating Real Disposable Income per Capita. Table ESVIII-1 provides the data required for broader comparison of the cyclical expansions of IQ1983 to IVQ1985 and the current one from 2009 to 2012. First, in the 13 quarters from IQ1983 to IVQ1985, GDP increased 19.6 percent at the annual equivalent rate of 5.7 percent; real disposable personal income (RDPI) increased 14.5 percent at the annual equivalent rate of 4.3 percent; RDPI per capita increased 11.5 percent at the annual equivalent rate of 3.4 percent; and population increased 2.7 percent at the annual equivalent rate of 0.8 percent. Second, in the 11 quarters of the current cyclical expansion from IIIQ2009 to IQ2012, GDP increased 6.7 percent at the annual equivalent rate of 2.4 percent; real disposable personal income (RDPI) increased 2.5 percent at the annual equivalent rate of 0.9 percent; RDPI per capita increased 0.4 percent at the annual equivalent rate of 0.1 percent; and population increased 2.1 percent at the annual equivalent rate of 0.8 percent. Third, since the beginning of the recession in IVQ2007 to IQ2012, GDP increased 1.2 percent, or barely above the level before the recession; real disposable personal income increased 2.7 percent; population increased 3.5 percent; and real disposable personal income per capita is 0.8 percent lower than the level before the recession. Real disposable personal income is the actual take home pay after inflation and taxes and real disposable income per capita is what is left per inhabitant. The current cyclical expansion is the worst in the period after World War II in terms of growth of economic activity and income. The United States grew during its history at high rates of per capita income that made its economy the largest in the world. That dynamism is disappearing.

Table ESVIII-1, US, GDP, Real Disposable Personal Income, Real Disposable Income per Capita and Population in 1983-85 and 2007-2011, %

	# Quarters	∆%	∆% Annual Equivalent
IQ1983 to IVQ1985	13
GDP		19.6	5.7
RDPI		14.5	4.3
RDPI Per Capita		11.5	3.4
Population		2.7	0.8
IIIQ2009 to IQ2012	11
GDP		6.7	2.4
RDPI		2.5	0.9
RDPI per Capita		0.4	0.1
Population		2.1	0.8
IVQ2007 to IQ2012	18
GDP		1.2
RDPI		2.7
RDPI per Capita		-0.8
Population		3.5

RDPI: Real Disposable Personal Income

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

ESIX Conflicts of Exchange Rates. Table ESIX-1 provides 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 VI-4 in the text, the dollar has devalued again to USD 1.2248/EUR on Jul 13, 2012 or by 2.8 percent {[(1.2248/1.192)-1]100 = 2.8%}. 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. Risk aversion erodes devaluation of the dollar. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD subsequently revaluing 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 6.3868/USD on Fri Jul 13, 2012, or by an additional 6.4 percent, for cumulative revaluation of 22.8 percent.

Table ESIX-1, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate

USD/EUR	12/26/03	7/14/08	6/07/10	7/13/ /2012
Rate	1.1423	1.5914	1.192	1.2248
CNY/USD	01/03 2000	07/21 2005	7/15 2008	7/13/ 2012
Rate	8.2798	8.2765	6.8211	6.3868
Weekly Rates	6/22/2012	6/29/2012	7/6/2012	7/13/ 2012
CNY/USD	6.3650	6.3552	6.3658	6.3868
∆% from Earlier Week*	0.0	0.2	-0.2	-0.3

*Negative sign is depreciation, positive sign is appreciation

Source:

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

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

The Dow Jones Newswires informs on Oct 15 that the premier of China Wen Jiabao announced that the Chinese yuan will not be further appreciated to prevent adverse effects on exports (http://professional.wsj.com/article/SB10001424052970203914304576632790881396896.html?mod=WSJ_hp_LEFTWhatsNewsCollection). Table ESIX-2 provides the CNY/USD rate from Oct 28, 2011 to Jul 13, 2012 in selected intervals. The CNY/USD revalued by 0.9 percent from Oct 28, 2012 to Apr 27, 2012. After depreciation of 0.5 percent in the week of Jun 5 and 0.1 percent in the week of Jun 8 but appreciation of 0.1 percent in the week of Jun 15 and no change in the week of Jun 22 but revaluation of 0.2 percent in the week of Jun 29 (see Table ESIX-1), the CNY has appreciated 0.1 percent relative to Oct 28, 2011, as shown in Table ESIX-2. The CNY devalued by 0.2 percent relative to the USD in the week of Jul 6, 2012 and an additional 0.3 percent in the week of Jul 13, 2012, such that, as shown in Table ESIX-2, there is marginal devaluation of 0.4 percent of the CNY relative to the USD by Jul 13, 2012. Meanwhile, the Senate of the US is proceeding with a bill on China’s trade that could create a confrontation but may not be approved by the entire Congress.

Table EIX-2, Renminbi Yuan US Dollar Rate

	CNY/USD	∆% from 10/28/2011
7/13/12	6.3868	-0.4
7/6/12	6.3658	-0.1%
6/29/12	6.3552	0.1
6/22/12	6.3650	-0.1
6/15/12	6.3678	-0.1
6/8/2012	6.3752	-0.3
6/1/2012	6.3708	-0.2
4/27/2012	6.3016	0.9
3/23/2012	6.3008	0.9
2/3/2012	6.3030	0.9
12/30/2011	6.2940	1.0
11/25/2011	6.3816	-0.4
10/28/2011	6.3588	-

Source:

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

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

Chart ESIX-1 of the Board of Governors of the Federal Reserve System provides the CNY/USD exchange rate from 2009 to 2012. China fixed the CNY/USD rate until Jun 7, 2010, to avoid adverse effects on its economy from the global recession, which is shown as a horizontal segment from 2009 until mid 2010. China then continued the policy of appreciation of the CNY relative to the USD with oscillations until the beginning of 2012 when the rate began to move sideways followed by a final upward slope of devaluation that is measured in Table VI-2A. Revaluation of the CNY relative to the USD by 22.8 percent by Jul 13, 2012 has not reduced the trade surplus of China but reversal of the policy of revaluation could result in international confrontation.

Chart ESIX-1, Chinese Yuan (CNY) per US Dollar (USD) 2009-2012

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/datadownload/Choose.aspx?rel=H10

ESX Global Financial and Economic Risk. The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task both for theory and measurement. The IMF provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2012/update/01/index.htm), of the world financial system with its Global Financial Stability Report (GFSR) (http://www.imf.org/external/pubs/ft/fmu/eng/2012/01/index.htm) and of fiscal affairs with the Fiscal Monitor (http://www.imf.org/external/pubs/ft/fm/2012/update/01/fmindex.htm). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider a summary of global economic and financial risks, which are analyzed in detail in the comments of this blog in Section VI Valuation of Risk Financial Assets, Table VI-4.

Economic risks include the following:

1. China’s Economic Growth. China is lowering its growth target to 7.5 percent per year. The growth rate of GDP of China in the second quarter of 2012 of 1.8 percent is equivalent to 7.4 percent per year.

2. United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 28.6 million in job stress, fewer 10 million full-time jobs, high youth unemployment, historically-low hiring and declining real wages.

3. Economic Growth and Labor Markets in Advanced Economies. Advanced economies are growing slowly. There is still high unemployment in advanced economies.

4. World Inflation Waves. Inflation continues in repetitive waves globally (see http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars.html).

A list of financial uncertainties includes:

1. Euro Area Survival Risk. The resilience of the euro to fiscal and financial doubts on larger member countries is still an unknown risk.

2. Foreign Exchange Wars. Exchange rate struggles continue as zero interest rates in advanced economies induce devaluation of their currencies.

3. Valuation of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with lower volumes.

4. Duration Trap of the Zero Bound. The yield of the US 10-year Treasury rose from 2.031 percent on Mar 9, 2012, to 2.294 percent on Mar 16, 2012. Considering a 10-year Treasury with coupon of 2.625 percent and maturity in exactly 10 years, the price would fall from 105.3512 corresponding to yield of 2.031 percent to 102.9428 corresponding to yield of 2.294 percent, for loss in a week of 2.3 percent but far more in a position with leverage of 10:1. Min Zeng, writing on “Treasurys fall, ending brutal quarter,” published on Mar 30, 2012, in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303816504577313400029412564.html?mod=WSJ_hps_sections_markets), informs that Treasury bonds maturing in more than 20 years lost 5.52 percent in the first quarter of 2012.

5. Credibility and Commitment of Central Bank Policy. There is a credibility issue of the commitment of monetary policy (Sargent and Silber 2012Mar20).

6. Carry Trades. Commodity prices driven by zero interest rates have resumed their increasing path with fluctuations caused by intermittent risk aversion.

It is in this context of economic and financial uncertainties that decisions on portfolio choices of risk financial assets must be made. 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 VI-1 in the text 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 now complicated by political developments, 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 now with realization of growth standstill. 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 driven by the carry trade from zero interest rates with fluctuations provoked by events of risk aversion or the “sharp shifts in risk appetite” of Blanchard (2012WEOApr, XIII). Table ESX-1, 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.” There was sharp recovery after around Jul 2010 in the last column “∆% Trough to 7/13/12,” which has been recently stalling or reversing amidst profound risk aversion. “Let’s twist again” monetary policy during the week of Sep 23 caused deep worldwide risk aversion and selloff of risk financial assets (http://cmpassocregulationblog.blogspot.com/2011/09/imf-view-of-world-economy-and-finance.html http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html). Monetary policy was designed to increase risk appetite but instead suffocated risk exposures. There has been rollercoaster fluctuation in risk aversion and financial risk asset valuations: surge in the week of Dec 2, 2011, mixed performance of markets in the week of Dec 9, renewed risk aversion in the week of Dec 16, end-of-the-year relaxed risk aversion in thin markets in the weeks of Dec 23 and Dec 30, mixed sentiment in the weeks of Jan 6 and Jan 13 2012 and strength in the weeks of Jan 20, Jan 27 and Feb 3 followed by weakness in the week of Feb 10 but strength in the weeks of Feb 17 and 24 followed by uncertainty on financial counterparty risk in the weeks of Mar 2 and Mar 9. All financial values have fluctuated with events such as the surge in the week of Mar 16 on favorable news of Greece’s bailout even with new risk issues arising in the week of Mar 23 but renewed risk appetite in the week of Mar 30 because of the end of the quarter and the increase in the firewall of support of sovereign debts in the euro area. New risks developed in the week of Apr 6 with increase of yields of sovereign bonds of Spain and Italy, doubts on Fed policy and weak employment report. Asia and financial entities are experiencing their own risk environments. Financial markets were under stress in the week of Apr 13 because of the large exposure of Spanish banks to lending by the European Central Bank and the annual equivalent growth rate of China’s GDP of 7.4 percent in IQ2012 [(1.018)⁴], which was repeated in IIQ2012. There was strength again in the week of Apr 20 because of the enhanced IMF firewall and Spain placement of debt, continuing into the week of Apr 27. Risk aversion returned in the week of May 4 because of the expectation of elections in Europe and the new trend of deterioration of job creation in the US. Europe’s sovereign debt crisis and the fractured US job market continued to influence risk aversion in the week of May 11. Politics in Greece and banking issues in Spain were important factors of sharper risk aversion in the week of May 18. Risk aversion continued during the week of May 25 and exploded in the week of Jun 1. Expectations of stimulus by central banks caused valuation of risk financial assets in the week of Jun 8 and in the week of Jun 15. Expectations of major stimulus were frustrated by minor continuance of maturity extension policy in the week of Jun 22 together with doubts on the silent bank run in highly indebted euro area member countries. There was a major rally of valuations of risk financial assets in the week of Jun 29 with the announcement of new measures on bank resolutions by the European Council. New doubts surfaced in the week of Jul 6, 2012 on the implementation of the bank resolution mechanism and on the outlook for the world economy because of interest rate reductions by the European Central, Bank of England and People’s Bank of China. Risk appetite returned in the week of July 13 in relief that economic data suggests continuing high growth in China. The highest valuations in column “∆% Trough to 7/13/12” are by US equities indexes: DJIA 31.9 percent and S&P 500 32.7 percent, driven by stronger earnings and economy in the US than in other advanced economies but with doubts on the relation of business revenue to the weakening economy and fractured job market. The DJIA reached 13,331.77 in intraday trading on Mar 16, which is the highest level in 52 weeks (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). The carry trade from zero interest rates to leveraged positions in risk financial assets had proved strongest for commodity exposures but US equities have regained leadership. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 7/13/12” had double digit gains relative to the trough around Jul 2, 2010 but now most valuations of equity indexes show increase of less than 10 percent: China’s Shanghai Composite is 8.3 percent below the trough; STOXX 50 of Europe is 6.2 percent above the trough; Japan’s Nikkei Average is 1.3 percent below the trough; DJ Asia Pacific TSM is 3.1 percent above the trough; Dow Global is 5.6 percent above the trough; and NYSE Financial is 4.6 percent above the trough. DJ UBS Commodities is 13.2 percent above the trough. DAX is 15.6 percent above the trough. Japan’s Nikkei Average is 1.3 percent below the trough on Aug 31, 2010 and 23.4 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 8724.12 on Fri Jul 13, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 14.9 percent lower than 10,254.43 on Mar 11, 2011, on the date of the Tōhoku or Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 2.8 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 7/13/12” in Table ESX-1 shows that there were increases of valuations of risk financial assets in the week of Jul 13, 2012 such as 0.5 for New York Stock Exchange Financial, 0.7 percent for STOXX 50 of European equities and 2.3 percent for DAX of German equities. DJ UBS Commodities increased 2.5 percent. Other valuations decreased such as 0.9 percent for Dow Global, 2.6 percent for DJ Asia Pacific, 3.3 percent for Nikkei Average and 1.7 percent for Shanghai Composite. The DJIA was flat and S&P 500 increased 0.2 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table ESX-1 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 7/13/12” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Jul 13, 2012. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 7/13/12” but also relative to the peak in column “∆% Peak to 7/13/12.” There are now only three equity indexes above the peak in Table ESX-1: DJIA 14.0 percent, S&P 500 11.5 percent and DAX 3.6 percent. There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 16.7 percent, Nikkei Average by 23.4 percent, Shanghai Composite by 30.9 percent, DJ Asia Pacific by 9.8 percent, STOXX 50 by 10.0 percent and Dow Global by 13.8 percent. DJ UBS Commodities Index is now 3.2 percent below the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul 2010 because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. An intriguing issue is the difference in performance of valuations of risk financial assets and economic growth and employment. Paul A. Samuelson (http://www.nobelprize.org/nobel_prizes/economics/laureates/1970/samuelson-bio.html) popularized the view of the elusive relation between stock markets and economic activity in an often-quoted phrase “the stock market has predicted nine of the last five recessions.” In the presence of zero interest rates forever, valuations of risk financial assets are likely to differ from the performance of the overall economy. The interrelations of financial and economic variables prove difficult to analyze and measure.

Table ESX-1, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 7/13 /12	∆% Week 7/6/13	∆% Trough to 7/13 12
DJIA	4/26/ 10	7/2/10	-13.6	14.0	0.0	31.9
S&P 500	4/23/ 10	7/20/ 10	-16.0	11.5	0.2	32.7
NYSE Finance	4/15/ 10	7/2/10	-20.3	-16.7	0.5	4.6
Dow Global	4/15/ 10	7/2/10	-18.4	-13.8	-0.9	5.6
Asia Pacific	4/15/ 10	7/2/10	-12.5	-9.8	-2.6	3.1
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-23.4	-3.3	-1.3
China Shang.	4/15/ 10	7/02 /10	-24.7	-30.9	-1.7	-8.3
STOXX 50	4/15/10	7/2/10	-15.3	-10.0	0.7	6.2
DAX	4/26/ 10	5/25/ 10	-10.5	3.6	2.3	15.6
Dollar Euro	11/25 2009	6/7 2010	21.2	19.0	0.3	-2.8
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-3.2	2.5	13.2
10-Year T Note	4/5/ 10	4/6/10	3.986	1.49

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

I Recovery without Hiring. Professor Edward P. Lazear (2012Jan19) at Stanford University finds that recovery of hiring in the US to peaks attained in 2007 requires an increase of hiring by 30 percent while hiring levels have increased by only 4 percent since Jan 2009. The high level of unemployment with low level of hiring reduces the statistical probability that the unemployed will find a job. According to Lazear (2012Jan19), the probability of finding a new job currently is about one third of the probability of finding a job in 2007. Improvements in labor markets have not increased the probability of finding a new job. Lazear (2012Jan19) quotes an essay coauthored with James R. Spletzer forthcoming in the American Economic Review on the concept of churn. A dynamic labor market occurs when a similar amount of workers is hired as those who are separated. This replacement of separated workers is called churn, which explains about two-thirds of total hiring. Typically, wage increases received in a new job are higher by 8 percent. Lazear (2012Jan19) argues that churn has declined 35 percent from the level before the recession in IVQ2007. Because of the collapse of churn there are no opportunities in escaping falling real wages by moving to another job. As this blog argues, there are meager chances of escaping unemployment because of the collapse of hiring and those employed cannot escape falling real wages by moving to another job (http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html). Lazear and Spletzer (2012Mar, 1) argue that reductions of churn reduce the operational effectiveness of labor markets. Churn is part of the allocation of resources or in this case labor to occupations of higher marginal returns. The decline in churn can harm static and dynamic economic efficiency. Losses from decline of churn during recessions can affect an economy over the long-term by preventing optimal growth trajectories because resources are not used in the occupations where they provide highest marginal returns. Lazear and Spletzer (2012Mar 7-8) conclude that: “under a number of assumptions, we estimate that the loss in output during the recession [of 2007 to 2009] and its aftermath resulting from reduced churn equaled $208 billion. On an annual basis, this amounts to about .4% of GDP for a period of 3½ years.”

There are two additional facts discussed below: (1) there are about ten million fewer full-time jobs currently than before the recession of 2008 and 2009; and (2) the extremely high and rigid rate of youth unemployment is denying an early start to young people ages 16 to 24 years. There are four subsections. IA Hiring Collapse provides the data and analysis on the weakness of hiring in the United States economy. IB Labor Underutilization provides the measures of labor underutilization of the Bureau of Labor Statistics (BLS). Statistics on the decline of full-time employment are in IC Ten Million Fewer Full-time Jobs. ID Youth Unemployment provides the data on high unemployment of ages 16 to 24 years.

IA Hiring Collapse. An important characteristic of the current fractured labor market of the US is the closing of the avenue for exiting unemployment and underemployment normally available through dynamic hiring. Another avenue that is closed is the opportunity for advancement in moving to new jobs that pay better salaries and benefits again because of the collapse of hiring in the United States. Those who are unemployed or underemployed cannot find a new job even accepting lower wages and no benefits. The employed cannot escape declining inflation-adjusted earnings because there is no hiring. The objective of this section is to analyze hiring and labor underutilization in the United States.

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

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

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

Hiring in the nonfarm sector (HNF) has declined from 69.4 million in 2004 to 50.1 million in 2011 or by 19.3 million while hiring in the private sector (HP) has declined from 59.5 million in 2006 to 46.9 million in 2011 or by 12.6 million, as shown in Table I-1. The ratio of nonfarm hiring to employment (RNF) has fallen from 47.2 in 2005 to 38.1 in 2011 and in the private sector (RHP) from 52.1 in 2006 to 42.9 in 2011. The collapse of hiring in the US has not been followed by dynamic labor markets because of the low rate of economic growth of 2.4 percent in the first eleven quarters of expansion from IIIQ2009 to IQ2012 compared with 6.2 percent in prior cyclical expansions (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html).

Table I-1, US, Annual Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US and Percentage of Total Employment

Percentage of Total Employment

	HNF	Rate RNF	HP	Rate HP
2001	62,948	47.8	58,825	53.1
2002	58,583	44.9	54,759	50.3
2003	56,451	43.4	53,056	48.9
2004	69,367	45.9	56,617	51.6
2005	63,150	47.2	59,372	53.1
2006	63,773	46.9	59,494	52.1
2007	62,421	45.4	58,035	50.3
2008	55,166	40.3	51,606	45.2
2009	46,398	35.5	43,052	39.8
2010	48,647	37.5	44,826	41.7
2011	50,083	38.1	46,869	42.9

Source: Bureau of Labor Statistics http://www.bls.gov/jlt/data.htm

Chart I-1 provides the yearly levels of total nonfarm hiring (NFH) in Table I-1. The fall of hiring during the contraction of 2007 to 2009 was much stronger than in the shallow recession of 2001 with GDP contraction of only 0.4 percent from Mar 2001 (IQ2001) to Dec 2001 (IVQ 2001) compared with 5.1 percent contraction in the much longer recession from Dec 2007 (IVQ2007) to Jun 2009 (IIQ2009) (http://www.nber.org/cycles/cyclesmain.html). Recovery is tepid.

Chart I-1, US, Level Total Nonfarm Hiring (HNF), Yearly, 2001-2011

Source: US Bureau of Labor Statistics

Chart I-2 shows the ratio or rate of nonfarm hiring to employment (RNF) that also fell much more in the recession of 2007 to 2009 than in the shallow recession of 2001. Recovery is weak.

Chart I-2, US, Rate Total Nonfarm Hiring (HNF), Yearly, 2001-2011

Source: US Bureau of Labor Statistics

Yearly percentage changes of total nonfarm hiring (HNF) are provided in Table I-2. There were much milder declines in 2002 of 6.9 percent and 3.6 percent in 2003 followed by strong rebounds of 6.9 percent in 2004 and 4.6 percent in 2005. In contrast, the contractions of nonfarm hiring in the recession after 2007 were much sharper in percentage points: 2.1 in 2007, 11.6 in 2008 and 15.9 percent in 2009. On a yearly basis, nonfarm hiring grew 4.8 percent in 2010 relative to 2009 and 3.0 percent in 2011.

Table I-2, US, Annual Total Nonfarm Hiring (HNF), Yearly Percentage Change, 2001-2011

Year	Annual
2002	-6.9
2003	-3.6
2004	6.9
2005	4.6
2006	1.0
2007	-2.1
2008	-11.6
2009	-15.9
2010	4.8
2011	3.0

Source: US Bureau of Labor Statistics

Chart I-3 plots yearly percentage changes of nonfarm hiring. Percentage declines after 2007 were quite sharp.

Chart I-3, US, Annual Total Nonfarm Hiring (HNF), Yearly Percentage Change, 2001-2011

Source: US Bureau of Labor Statistics

Total private hiring (HP) yearly data are provided in Chart I-4. There has been sharp contraction of total private hiring in the US and only milder recovery in 2011 than in 2010.

Chart I-4, US, Total Private Hiring, Yearly, 2001-2011

Source: US Bureau of Labor Statistics

Chart I-5 plots the rate of total private hiring relative to employment (RHP). The rate collapsed during the global recession after 2007 with insufficient recovery.

Chart I-5, US, Rate Total Private Hiring, Yearly, 2001-2011

Source: US Bureau of Labor Statistics

Total nonfarm hiring (HNF), total private hiring (HP) and their respective rates are provided for the month of May in the years from 2001 to 2012 in Table I-3. Hiring numbers are in thousands. There is some recovery in HNF from 4177 thousand (or 4.2 million) in May 2009 to 4577 thousand in May 2011 and 4796 thousand in May 2012 for cumulative gain of 14.8 percent. The levels in May 2010 and May 2012 are coincidentally almost equal at 4786 and 4796 thousand, respectively. HP rose from 3896 thousand in May 2009 to 4297 thousand in May 2011 and 4469 thousand in May 2012 for cumulative gain of 14.7 percent. HNF has fallen from 5986 in May 2006 to 4796 in May 2012 or by 19.9 percent. HP has fallen from 5619 in May 2006 to 4469 in May 2012 or by 20.5 percent. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.

Table I-3, US, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment Not Seasonally Adjusted

	HNF	Rate RNF	HP	Rate HP
2001 May	5894	4.4	5498	4.9
2002 May	5314	4.1	4955	4.5
2003 May	4968	3.8	4687	4.3
2004 May	5343	4.0	5048	4.6
2005 May	5736	4.3	5411	4.8
2006 May	5986	4.4	5619	4.9
2007 May	5788	4.2	5394	4.7
2008 May	5122	3.7	4803	4.2
2009 May	4177	3.2	3896	3.6
2010 May	4786	3.7	4030	3.8
2011 May	4577	3.5	4297	3.9
2012 May	4796	3.6	4469	4.0

Source: US Bureau of Labor Statistics http://www.bls.gov/jlt/data.htm

Chart I-6 provides total nonfarm hiring on a monthly basis from 2001 to 2012. Nonfarm hiring rebounded in early 2010 but then fell and stabilized at a lower level than the early peak not-seasonally adjusted (NSA) of 4786 in May 2010. Nonfarm hiring fell again in Dec 2011 to 3038 from 3844 in Nov and to revised 3633 in Feb 2012, increasing to 4127 in Mar 2012, 4490 in Apr 2012 and 4796 in May 2012. Chart I-6 provides seasonally-adjusted (SA) monthly data. The number of seasonally-adjusted hires in Aug 2011 was 4221 thousand, increasing to revised 4444 thousand in Feb 2012, or 5.3 percent, but falling to revised 4335 thousand in Mar 2012 and 4157 in Apr 2012, or cumulative decline of 1.1 percent relative to Aug 2011, increasing to 4361 in May 2012 for cumulative increase of 2.0 percent from 4276 in Sep 2012. The number of hires not seasonally adjusted was 4655 in Aug 2011, falling to 3038 in Dec but increasing to 4072 in Jan 2012, increasing to 4796 in May 2012. The number of nonfarm hiring not seasonally adjusted fell by 34.7 percent from 4655 in Aug 2011 to 3038 in Dec 2011 in a yearly-repeated seasonal pattern.

Chart I-6, US, Total Nonfarm Hiring (HNF), 2001-2012 Month SA

Source: US Bureau of Labor Statistics

Similar behavior occurs in the rate of nonfarm hiring plot in Chart I-7. Recovery in early 2010 was followed by decline and stabilization at a lower level but with stability in monthly SA estimates of 3.2 in Sep 2011 to 3.2 in Jan 2012, increasing to 3.3 in May 2012. The rate not seasonally adjusted fell from 3.7 in Jun 2011 to 2.3 in Dec, climbing to 3.1 in Jan 2012 and 3.6 in May 2012. Rates of nonfarm hiring NSA were in the range of 2.8 (Dec) to 4.5 (Jun) in 2006.

Chart I-7, US, Rate Total Nonfarm Hiring, Month SA 2001-2012

Source: US Bureau of Labor Statistics

There is only milder improvement in total private hiring shown in Chart I-8. Hiring private (HP) rose in 2010 followed by stability and renewed increase in 2011. The number of private hiring seasonally adjusted fell from 4002 thousand in Sep 2011 to 3889 in Dec or by 2.8 percent, increasing to 3945 in Jan 2012 or decline by 1.4 relative to the level in Sep 2011 but increasing to 4063 in May 2012 or by 4.5 percent relative to Sep 2011. The number of private hiring not seasonally adjusted fell from 4130 in Sep 2011 to 2856 in Dec or by 30.8 percent, reaching 3782 in Jan 2012 or decline of 8.4 percent relative to Sep 2011 but increasing to 4469 in May 2012 or 8.2 percent relative to Sep 2011. Companies do not hire in the latter part of the year that explains the high seasonality in year-end employment data. For example, NSA private hiring fell from 4934 in Sep 2006 to 3635 in Dec 2006 or by 26.3 percent. Private hiring NSA data are useful in showing the huge declines from the period before the global recession. In Jul 2006 private hiring NSA was 5555, declining to 4293 in Jul 2011 or by 22.7 percent. The conclusion is that private hiring in the US is more than 20 percent below the hiring before the global recession. The main problem in recovery of the US labor market has been the low rate of growth of 2.4 percent in the eleven quarters of expansion of the economy from IIIQ2009 to IQ2012 compared with average 6.2 percent in prior expansions from contractions (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html). The US missed the opportunity to recover employment as in past cyclical expansions from contractions.

Chart I-8, US, Total Private Hiring Month SA 2011-2012

Source: US Bureau of Labor Statistics

Chart I-9 shows similar behavior in the rate of private hiring. The rate in 2011 in monthly SA data has not risen significantly above the peak in 2010. The rate seasonally adjusted fell from 3.6 in Sep 2011 to 3.5 in Dec 2011, increasing to 3.6 in Jan 2012 and 3.7 in May 2012. The rate not seasonally adjusted (NSA) fell from 3.8 in Sep 2011 to 2.6 in Dec 2011, increasing to revised 3.5 in Jan 2012 and 4.0 in May 2012. The NSA rate of private hiring fell from 4.9 in Jun 2006 to 3.6 in Jun 2009 but recovery was insufficient to only 4.1 in Jun 2011.

Chart I-9, US, Rate Total Private Hiring Month SA 2011-2011

Source: US Bureau of Labor Statistics

The JOLTS report of the Bureau of Labor Statistics also provides total nonfarm job openings (TNF JOB), TNF JOB rate and TNF LD (layoffs and discharges) shown in Table I-4 for the month of May from 2001 to 2012. The final column provides annual TNF LD for the years from 2001 to 2011. Nonfarm job openings fell from a peak of 4520 in May 2006 to 3669 in May 2012 or by 18.8 percent while the rate dropped from 3.2 to 2.7. Nonfarm layoffs and discharges (TNF LD) rose from 1672 in May 2006 to 1913 in May 2009 or by 14.4 percent. The annual data show layoffs and discharges rising from 21.2 million in 2006 to 26.8 million in 2009 or by 26.4 percent.

Table I-4, US, Job Openings and Total Separations, Thousands NSA

	TNF JOB	TNF JOB Rate	TNF LD	TNF LD Year
May 2001	4550	3.3	1680	24499
May 2002	3547	3.6	1622	22922
May 2003	3165	2.4	1592	23294
May 2004	3672	2.7	1521	22802
May 2005	3922	2.8	1637	22185
May 2006	4520	3.2	1672	21157
May 2007	4513	3.2	1524	22142
May 2008	3958	2.8	1613	24166
May 2009	2403	1.8	1913	26783
May 2010	2842	2.1	1560	21784
May 2011	3074	2.3	1578	20718
May 2012	3669	2.7	1608

Notes: TNF JOB: Total Nonfarm Job Openings; LD: Layoffs and Discharges

Source: US Bureau of Labor Statistics http://www.bls.gov/jlt/data.htm

Chart I-10 shows monthly job openings rising from the trough in 2009 to a high in the beginning of 2010. Job openings then stabilized into 2011 but have surpassed the peak of 3057 in Nov 2010 with 3642 seasonally adjusted in May 2012, which is higher by 4.0 percent than 3501 in Sep 2011 and higher by 5.7 percent relative to 3447 in Apr 2012. The high of job openings not seasonally adjusted in 2010 was 3221 in Oct 2010 that was surpassed by 3659 in Oct 2011, increasing to 3669 in May 2012. The level of job openings not seasonally adjusted fell to 2912 in Nov 2011 or by 17.9 percent relative to 3546 in Sep 2011. There is here again the strong seasonality of year-end labor data. Job openings NSA fell from 4678 in Oct 2006 to 2547 in Oct 2009 or by 45.6 percent, recovering to 3221 in Oct 2010 or by 26.5 percent, which is still 21.8 percent lower at 3659 in Oct 2011 relative to Oct 2006. The level of job openings of 3669 in May 2011 NSA is lower by 18.8 percent relative to 4520 in May 2006. Again, the main problem in recovery of the US labor market has been the low rate of growth of 2.4 percent in the eleven quarters of expansion of the economy since IIIQ2009 compared with average 6.2 percent in prior expansions from contractions (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html). The US missed the opportunity to recover employment as in past cyclical expansions from contractions.

Chart I-10, US Job Openings, Thousands NSA, 2001-2012

Source: US Bureau of Labor Statistics

The rate of job openings in Chart I-11 shows similar behavior. The rate seasonally adjusted rose from 2.1 percent in Jan 2011 to 2.6 percent in Dec 2011 and 2.7 in May 2012. The rate not seasonally adjusted rose from the high of 2.6 in Apr 2010 to 2.7 in Jul 2011 and 2.7 in all months from Jan to May 2012. The rate of job openings NSA fell from 3.2 in May 2007 to 1.8 in May 2009, recovering insufficiently to 2.7 in May 2012.

Chart I-11, US, Rate of Job Openings, NSA, 2001-2012

Source: US Bureau of Labor Statistics

Total separations are shown in Chart I-12. Separations are much lower in 2012 than before the global recession.

Chart I-12, US, Total Separations, Month SA, 2001-2012

Source: US Bureau of Labor Statistics

Yearly total separations are shown in Chart I-13. Separations are much lower in 2011 than before the global recession.

Chart I-13, US, Total Separations, Annual, 2001-2011

Source: US Bureau of Labor Statistics

Table I-5 provides total nonfarm total separations from 2001 to 2011. Separations fell from 61.6 million in 2006 to 47.6 million in 2010 or by 14.0 million and 48.2 million in 2011 or by 13.4 million.

Table I-5, US, Total Nonfarm Total Separations, Thousands, 2001-2011

Year	Annual
2001	64765
2002	59190
2003	56487
2004	58340
2005	60733
2006	61565
2007	61162
2008	58601
2009	51527
2010	47641
2011	48242

Source: US Bureau of Labor Statistics

Monthly data of layoffs and discharges reach a peak in early 2009, as shown in Chart I-14. Layoffs and discharges dropped sharply with the recovery of the economy in 2010 and 2011 once employers reduced their job count to what was required for cost reductions and loss of business.

Chart I-14, US, Total Nonfarm Layoffs and Discharges, Monthly SA, 2011-2012

Source: US Bureau of Labor Statistics

Layoffs and discharges in Chart I-15 rose sharply to a peak in 2009. There was pronounced drop into 2010 and 2011.

Chart I-15, US, Total Nonfarm Layoffs and Discharges, Annual, 2001-2011

Source: US Bureau of Labor Statistics

Table I-6 provides annual nonfarm layoffs and discharges from 2001 to 2011. Layoffs and discharges peaked at 26.8 million in 2009 and then fell to 20.7 million in 2011, by 6.1 million, or 22.8 percent.

Table I-6, US, Total Nonfarm Layoffs and Discharges, 2001-2011

Year	Annual
2001	24499
2002	22922
2003	23294
2004	22802
2005	22185
2006	21157
2007	22142
2008	24166
2009	26783
2010	21784
2011	20718

Source: US Bureau of Labor Statistics

IB Labor Underutilization. The Bureau of Labor Statistics also provides alternative measures of labor underutilization shown in Table I-7. The most comprehensive measure is U6 that consists of total unemployed plus total employed part time for economic reasons plus all marginally attached workers as percent of the labor force. U6 not seasonally annualized has risen from 8.2 percent in 2006 to 15.1 in Apr 2012.

Table I-7, US, Alternative Measures of Labor Underutilization NSA %

	U1	U2	U3	U4	U5	U6
2012
Jun	4.5	4.4	8.4	8.9	9.9	15.1
May	4.7	4.3	7.9	8.4	9.3	14.3
Apr	4.8	4.3	7.7	8.3	9.1	14.1
Mar	4.9	4.8	8.4	8.9	9.7	14.8
Feb	4.9	5.1	8.7	9.3	10.2	15.6
Jan	4.9	5.4	8.8	9.4	10.5	16.2
2011
Dec	4.8	5.0	8.3	8.8	9.8	15.2
Nov	4.9	4.7	8.2	8.9	9.7	15.0
Oct	5.0	4.8	8.5	9.1	10.0	15.3
Sep	5.2	5.0	8.8	9.4	10.2	15.7
Aug	5.2	5.1	9.1	9.6	10.6	16.1
Jul	5.2	5.2	9.3	10.0	10.9	16.3
Jun	5.1	5.1	9.3	9.9	10.9	16.4
May	5.5	5.1	8.7	9.2	10.0	15.4
Apr	5.5	5.2	8.7	9.2	10.1	15.5
Mar	5.7	5.8	9.2	9.7	10.6	16.2
Feb	5.6	6.0	9.5	10.1	11.1	16.7
Jan	5.6	6.2	9.8	10.4	11.4	17.3
Dec 2010	5.4	5.9	9.1	9.9	10.7	16.6
2011	5.3	5.3	8.9	9.5	10.4	15.9
2010	5.7	6.0	9.6	10.3	11.1	16.7
2009	4.7	5.9	9.3	9.7	10.5	16.2
2008	2.1	3.1	5.8	6.1	6.8	10.5
2007	1.5	2.3	4.6	4.9	5.5	8.3
2006	1.5	2.2	4.6	4.9	5.5	8.2
2005	1.8	2.5	5.1	5.4	6.1	8.9
2004	2.1	2.8	5.5	5.8	6.5	9.6
2003	2.3	3.3	6.0	6.3	7.0	10.1
2002	2.0	3.2	5.8	6.0	6.7	9.6
2001	1.2	2.4	4.7	4.9	5.6	8.1
2000	0.9	1.8	4.0	4.2	4.8	7.0

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

Source: US Bureau of Labor Statistics

Monthly seasonally adjusted measures of labor underutilization are provided in Table I-8. U6 climbed from 16.2 percent in Aug 2011 to 16.4 percent in Sep 2011 and then fell to 14.5 percent in Apr 2012, increasing to 14.9 percent in Jun 2012. Unemployment is an incomplete measure of the stress in US job markets. A different calculation in this blog is provided by using the participation rate in the labor force before the global recession. This calculation shows 28.6 million in job stress of unemployment/underemployment in Jun 2012, not seasonally adjusted, corresponding to 17.8 percent of the labor force (http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html Table I-4).

Table I-8, US, Alternative Measures of Labor Underutilization SA %

	U1	U2	U3	U4	U5	U6
Jun 2012	4.6	4.6	8.2	8.7	9.7	14.9
May	4.6	4.5	8.2	8.7	9.6	14.8
Apr	4.5	4.4	8.1	8.7	9.5	14.5
Mar	4.6	4.5	8.2	8.7	9.6	14.9
Feb	4.8	4.7	8.3	8.9	9.8	15.1
Jan	4.9	4.7	8.3	8.9	9.9	16.6
Dec 2011	5.0	4.9	8.5	9.1	10.0	15.2
Nov	5.0	4.9	8.7	9.3	10.2	15.6
Oct	5.1	5.1	8.9	9.5	10.4	16.0
Sep	5.3	5.2	9.0	9.6	10.5	16.4
Aug	5.3	5.3	9.1	9.6	10.6	16.2
Jul	5.3	5.3	9.1	9.7	10.7	16.1
Jun	5.3	5.4	9.1	9.7	10.7	16.2
May	5.3	5.4	9.0	9.5	10.3	15.8
Apr	5.2	5.3	9.0	9.6	10.4	15.9
Mar	5.3	5.4	8.9	9.4	10.3	15.7
Feb	5.4	5.4	9.0	9.6	10.6	15.9
Jan	5.5	5.5	9.1	9.7	10.7	16.1

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

Chart I-16 provides U6 on a monthly basis from 2001 to 2012. There was a steep climb from 2007 into 2009 and then this measure of unemployment and underemployment stabilized at that high level but declined into 2012. The low of U16 SA was 7.9 percent in Dec 2006 and the peak was 17.2 percent in Oct 2009. The low NSA was 7.6 percent in Oct 2006 and the peak was 18.0 percent in Jan 2010.

Chart I-16, US, U6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons % LF plus all marginally attached workers as % of Labor Force, Month, SA, 2001-2012

Source: US Bureau of Labor Statistics

Chart I-17 provides the number employed part-time for economic reasons or who cannot find full-time employment. There are sharp declines at the end of 2009, 2010 and 2011.

Chart I-17, US, Working Part-time for Economic Reasons

Thousands, Month SA 2001-2012

Sources: US Bureau of Labor Statistics

There is strong seasonality in US labor markets around the end of the year. The number employed part-time for economic reasons because they could not find full-time employment fell from 9.270 million in Sep 2011 to 8.210 million in Jun 2010, seasonally adjusted, or decline of 1.060 million in nine months, as shown in Table I-9. The number employed full-time increased from 112.479 million in Sep 2011 to 115.290 million in Mar 2012 or 2.811 million but then fell to 114.212 million in May 2012 or 1.078 million fewer full-time employed than in Mar 2012. There is a jump in the level of full-time SA to 114.573 million in Jun 2012 or 361,000 relative to May 2012. The number of employed part-time for economic reasons actually increased without seasonal adjustment from 8.271 million in Nov 2011 to 8.428 million in Dec 2011 or by 157,000 and then to 8.918 million in Jan 2012 or by an additional 490,000 for cumulative increase from Nov 2011 to Jan 2012 of 647,000. The level of employed part-time for economic reasons then fell from 8.918 million in Jan 2012 to 7.867 million in Mar 2012 or by 1.0151 million and to 7.694 million in Apr 2012 or 1.224 million fewer relative to Jan 2012. In May, the number employed part-time for economic reasons increased to 7.837 million SA or 143,000 more than in Apr 2012 and then to 8.394 million in Jun 2012 or 557,000 more than in May 2012. The number employed full time without seasonal adjustment fell from 113.138 million in Nov 2011 to 113.050 million in Dec 2011 or by 88,000 and fell further to 111.879 in Jan 2012 for cumulative decrease of 1.259 million. The number employed full-time not seasonally adjusted fell from 113.138 million in Nov 2011 to 112.587 million in Feb 2012 or by 551.000 but increased to 116.024 million in Jun 2012 or 2.886 million more full-time jobs than in Nov 2011. Comparisons over long periods require use of NSA data. The number with full-time jobs fell from a high of 123.219 million in Jul 2007 to 108.770 million in Jan 2010 or by 14.442 million. The number with full-time jobs in Jun 2012 is 116.024 million, which is lower by 7.2 million relative to the peak of 123.219 million in Jul 2007. There appear to be around 10 million less full-time jobs in the US than before the global recession. Growth at 2.4 percent on average in the eleven quarters of expansion from IIIQ2009 to IQ2012 compared with 6.2 percent on average in expansions from postwar cyclical contractions is the main culprit of the fractured US labor market (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html).

Table I-9, US, Employed Part-time for Economic Reasons, Thousands, and Full-time, Millions

	Part-time Thousands	Full-time Millions
Seasonally Adjusted
Jun 2012	8,210	114.573
May 2012	8,098	114.212
Apr 2012	7,853	111.478
Mar 2012	7,672	115.290
Feb 2012	8,119	114.408
Jan 2012	8,230	113.845
Dec 2011	8,098	113.765
Nov 2011	8,469	113.212
Oct 2011	8,790	112.841
Sep 2011	9,270	112.479
Aug 2011	8,787	112.406
Not Seasonally Adjusted
Jun 2012	8,394	116.024
May 2012	7,837	114.634
Apr 2012	7,694	113.999
Mar 2012	7,867	113.916
Feb 2012	8,455	112.587
Jan 2012	8,918	111.879
Dec 2011	8,428	113.050
Nov 2011	8,271	113.138
Oct 2011	8,258	113.456
Jun 2011	8,738	113.255
May 2011	8,270	112.618
Apr 2011	8,425	111.844
Mar 2011	8,737	111.186
Feb 2011	8,749	110.731
Jan 2011	9,187	110.373
Dec 2010	9,205	111.207
Nov 2010	8,670	111.348
Oct 2010	8,408	112.342
Jun 2010	8,867	113.856
May 2010	8,513	112.809
Apr 2010	8,921	111.391
Mar 2010	9,343	109.877
Feb 2010	9,282	109.100
Jan 2010	9,290	108.777 (low)
Dec 2009	9,354 (high)	109.875
Jun 2009	9,301	114.014
May 2009	8,785	113.083
Apr 2009	8,648	112.746
Mar 2009	9,305	112.215
Feb 2009	9,170	112.947
Jan 2009	8,829	113.815
Jun 2008	5,697	121.845
May 2008	5,096	120.809
Apr 2008	5,071	120.027
Mar 2008	5,038	119.875
Feb 2008	5,114	119.452
Jan 2008	5,340	119.322
Jul 2007	4,516	123.219 (high)
Jun 2007	4,469	122.250
May 2007	4,315	120.846
Apr 2007	4,205	119.609
Mar 2007	4,384	119.640
Feb 2007	4,417	119.041
Jan 2007	4,726	119.094
Sep 2006	3,735 (low)	120.780
Jun 2006	4,456	121.070
May 2006	3,968	118.925
Apr 2006	3,787	118.559
Mar 2006	4,097	117.693
Feb 2006	4,403	116.823
Jan 2006	4,597	116.395

Source: US Bureau of Labor Statistics

People lose their marketable job skills after prolonged unemployment and find increasing difficulty in finding another job. Chart I-18 shows the sharp rise in unemployed over 27 weeks and stabilization at an extremely high level.

Chart I-18, US, Number Unemployed for 27 Weeks or Over, Thousands SA Month 2001-2011

Sources: US Bureau of Labor Statistics

Another segment of U6 consists of people marginally attached to the labor force who continue to seek employment but less frequently on the frustration there may not be a job for them. Chart I-19 shows the sharp rise in people marginally attached to the labor force after 2007 and subsequent stabilization.

Chart I-19, US, Marginally Attached to the Labor Force, NSA Month 2001-2012

Sources: US Bureau of Labor Statistics

IC Ten Million Fewer Full-time Jobs. Chart I-20 reveals the fracture in the US labor market. The number of workers with full-time jobs not-seasonally-adjusted rose with fluctuations from 2002 to a peak in 2007, collapsing during the global recession. The terrible state of the job market is shown in the segment from 2009 to 2012 with fluctuations around the typical behavior of a stationary series: there is no improvement in the United States in creating full-time jobs.

Chart I-20, US, Full-time Employed, Thousands, NSA, 2001-2012

Sources: US Bureau of Labor Statistics

ID Youth Unemployment. The United States is experiencing high youth unemployment as in European economies. Table I-10 provides the employment level for ages 16 to 24 years of age estimated by the Bureau of Labor Statistics. On an annual basis, youth employment fell from 20.041 million in 2006 to 17.362 million in 2011 or 2.679 million fewer youth jobs. During the seasonal peak months of youth employment in the summer from Jun to Aug, youth employment has fallen by more than two million jobs. There are two hardships behind these data. First, young people cannot find employment after finishing high-school and college, reducing prospects for achievement in older age. Second, students with more modest means cannot find employment to keep them in college.

Table I-10, US, Employment Level 16-24 Years, Thousands, NSA

Year	Mar	Apr	May	Jun	Annual
2001	19800	19778	19648	21212	20088
2002	19091	19108	19484	20828	19683
2003	18709	18873	19032	20432	19351
2004	18752	19184	19237	20587	19630
2005	18989	19071	19356	20949	19770
2006	19291	19406	19769	21268	20041
2007	19538	19368	19457	21098	19875
2008	18745	19161	19254	20466	19202
2009	17564	17739	17588	18726	17601
2010	16587	16764	17039	17920	17077
2011	16898	16970	17045	18180	17362
2012	17301	17387	17681	18907

Sources: US Bureau of Labor Statistics

Chart I-21 provides US employment level ages 16 to 24 years from 2002 to 2012. Employment level is sharply lower in Jun 2012 relative to the peak in 2007.

Chart I-21, US, Employment Level 16-24 Years, Thousands SA, 2001-2012

Sources: US Bureau of Labor Statistics

Table I-11 provides US unemployment level ages 16 to 24 years. The number unemployed ages 16 to 24 years increased from 2342 thousand in 2007 to 3634 thousand in 2011 or by 1.292 million. This situation may persist for many years.

Table I-11, US, Unemployment Level 16-24 Years, Thousands NSA

Year	Mar	Apr	May	Jun	Annual
2001	2253	2095	2171	2775	2371
2002	2822	2515	2568	3167	2683
2003	2601	2572	2838	3542	2746
2004	2588	2387	2684	3191	2638
2005	2520	2398	2619	3010	2521
2006	2216	2092	2254	2860	2353
2007	2096	2074	2203	2883	2342
2008	2347	2196	2952	3450	2830
2009	3371	3321	3851	4653	3760
2010	3748	3803	3854	4481	3857
2011	3520	3365	3628	4248	3634
2012	3294	3175	3438	4180

Sources: US Bureau of Labor Statistics

Chart I-22 provides the unemployment level ages 16 to 24 from 2002 to 2012. The level rose sharply from 2007 to 2010 with tepid improvement into 2012.

Chart I-22, US, Unemployment Level 16-24 Years, Thousands SA, 2001-2012

Sources: US Bureau of Labor Statistics

Table I-12 provides the rate of unemployment of young peoples in ages 16 to 24 years. The annual rate jumped from 10.5 percent in 2007 to 18.4 percent in 2010 and 17.3 percent in 2011. During the seasonal peak in Jul 2011 the rate of youth unemployed was 18.1 percent compared with 10.8 percent in Jun 2007.

Table I-12, US, Unemployment Rate 16-24 Years, Thousands, NSA

Year	Mar	Apr	May	Jun	Annual
2001	10.2	9.6	10.0	11.6	10.6
2002	12.9	11.6	11.6	13.2	12.0
2003	12.2	12.0	13.0	14.8	12.4
2004	12.1	11.1	12.2	13.4	11.8
2005	11.7	11.2	11.9	12.6	11.3
2006	10.3	9.7	10.2	11.9	10.5
2007	9.7	9.7	10.2	12.0	10.5
2008	11.1	10.3	13.3	14.4	12.8
2009	16.1	15.8	18.0	19.9	17.6
2010	18.4	18.5	18.4	20.0	18.4
2011	17.2	16.5	17.5	18.9	17.3
2012	16.0	15.4	16.3	18.1

Sources: US Bureau of Labor Statistics

Chart I-23 provides the BLS estimate of the not-seasonally-adjusted rate of youth unemployment for ages 16 to 24 years from 2002 to 2012. The rate of youth unemployment increased sharply during the global recession of 2008 and 2009 but has failed to drop to earlier lower levels during the eleven quarters of expansion of the economy since IIIQ2009.

Chart I-23, US, Unemployment Rate 16-24 Years, Thousands, NSA, 2001-2012

Sources: US Bureau of Labor Statistics

Chart I-24 provides longer perspective with the rate of youth unemployment in ages 16 to 24 years from 1948 to 2012. The rate of youth unemployment rose to 20 percent during the contractions of the early 1980s and also during the contraction of the global recession in 2008 and 2009. The data illustrate again the claim in this blog that the contractions of the early 1980s are the valid framework for comparison with the global recession of 2008 and 2009 instead of misleading comparisons with the 1930s. During the initial phase of recovery, the rate of youth unemployment 16 to 24 years NSA fell from 18.9 percent in Jun 1983 to 14.5 percent in Jun 1984 while the rate of youth unemployment 16 to 24 years was nearly the same during the expansion after IIIQ2009: 19.9 percent in Jun 2009, 20.0 percent in Jun 2010, 18.9 percent in Jun 2011 and 18.1 percent in Jun 2012. The difference originates in the vigorous seasonally-adjusted annual equivalent average rate of GDP growth of 5.7 percent during the recovery from IQ1983 to IVQ1985 compared with 2.4 percent on average during the first eleven quarters of expansion from IIIQ2009 to IQ2012 (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html). The fractured US labor market denies an early start for young people.

Chart I-24, US, Unemployment Rate 16-24 Years, Percent NSA, 1948-2012

Sources: US Bureau of Labor Statistics

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

II United States International Trade. There are two subsections: IIA United States International Trade Balance and IIB United States Import and Export Prices.

IIA United States International Trade Balance. The United States Census Bureau has released revisions of trade statistics from Jan 2009 to Mar 2012 (http://www.census.gov/foreign-trade/Press-Release/2011pr/final_revisions/). Table IIA-1 provides the trade balance of the US and monthly growth of exports and imports seasonally adjusted. The US trade balance improved from deficit of $52,617 million in Mar 2012 to deficit of $50,597 billion in Apr 2012 and lower deficit of $48,684 in May with growth of exports of 0.2 percent better than growth of imports of minus 1.7 percent. The deterioration of the trade deficit from $45,433 million in Feb to $52,617 million in Mar resulted from growth of exports of 2.5 percent while imports jumped 5.2 percent. The US trade balance had improved from deficit of $52,947 million in Jan 2012 to lower deficit of $45,433 million in Feb 2012 mostly because of decline of imports by 2.6 percent while exports increased 0.8 percent. The US trade balance deteriorated sharply from Nov 2011 to Jan 2012 with growth of imports by cumulative 3.2 percent and cumulative decline of exports of 0.1 percent, resulting in deficits of $48,835 million in Nov, $51,748 million in Dec and $52,947 million in Jan, which are the highest since $50,234 million in Jun 2011. In the months of Jun to Oct 2011, exports increased 1.8 percent while imports increased 0.5 percent, resulting in improvement of the trade deficit from $50,234 million in Jun to $45,703 million in Oct. The trade balance deteriorated from cumulative deficit of $493,737 million in Jan-Dec 2010 to deficit of $559,880 million in Jan-Dec 2011.

Table IIA-1, US, Trade Balance of Goods and Services Seasonally Adjusted Millions of Dollars and ∆%

	Trade Balance	Exports	Month ∆%	Imports	Month ∆%
May 2012	-48,684	183,092	0.2	231,776	-0.7
Apr	-50,597	182,733	-0.9	233,330	-1.6
Mar	-52,617	184,443	2.5	237,061	5.2
Feb	-45,433	179,969	0.8	225,402	-2.6
Jan	-52,947	178,509	0.4	231,455	0.9
Dec 2011	-51,748	177,751	0.6	229,499	1.8
Nov	-48,835	176,710	-1.1	225,545	0.5
Oct	-45,703	178,742	-1.0	224,445	-0.3
Sep	-44,467	180,629	1.3	225,096	0.9
Aug	-44,775	178,382	0.0	223,157	-0.3
Jul	-45,580	178,339	3.3	223,919	0.4
Jun	-50,234	172,664	-1.7	222,988	-0.2
May	-47,669	175,673	0.0	223,343	1.9
Apr	-43,556	175,662	0.9	219,218	0.1
Mar	-44,902	174,169	4.6	219,071	3.7
Feb	-44,801	166,545	-0.9	211,346	-2.0
Jan	-47,523	168,098	1.6	215,621	4.6
Dec 2010	-40,677	165,499	1.7	206,176	2.2
Jan-Dec 2011	-559,880	2,103,367		2,663,247
Jan-Dec 2010	-494,737	1,842,485		2,337,222

Note: Trade Balance of Goods and Services = Exports of Goods and Services less Imports of Goods and Services. Trade balance may not add exactly because of errors of rounding and seasonality.

Table IIA-2 provides the US international trade balance, exports and imports on an annual basis from 1992 to 2011. The trade balance deteriorated sharply over the long term. The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US increased from $119.9 billion in IQ2011, or 3.2 percent of GDP to $137.3 billion in IQ2012, or 3.6 percent of GDP (http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars_17.html). The ratio of the current account deficit to GDP has stabilized around 3 percent of GDP compared with much higher percentages before the recession (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71).

Table IIA-2, US, International Trade Balance, Exports and Imports SA, Millions of Dollars

Period	Balance	Exports	Imports
Total
Annual
1992	-39,212	616,882	656,094
1993	-70,311	642,863	713,174
1994	-98,493	703,254	801,747
1995	-96,384	794,387	890,771
1996	-104,065	851,602	955,667
1997	-108,273	934,453	1,042,726
1998	-166,140	933,174	1,099,314
1999	-263,160	967,008	1,230,168
2000	-376,749	1,072,783	1,449,532
2001	-361,771	1,007,726	1,369,496
2002	-417,432	980,879	1,398,311
2003	-490,984	1,023,519	1,514,503
2004	-605,357	1,163,146	1,768,502
2005	-708,624	1,287,441	1,996,065
2006	-753,288	1,459,823	2,213,111
2007	-696,728	1,654,561	2,351,289
2008	-698,338	1,842,682	2,541,020
2009	-379,154	1,578,945	1,958,099
2010	-494,737	1,842,485	2,337,222
2011	-559,880	2,103,367	2,663,247

Source: http://www.census.gov/foreign-trade/

Chart IIA-1 of the US Census Bureau of the Department of Commerce shows that the trade deficit (gap between exports and imports) fell during the economic contraction after 2007 but has grown again during the expansion. There was slight improvement at the margin from Jul to Oct 2011 but new increase in the gap from Nov 2011 to Jan 2012 and again in Mar as exports grow less rapidly than imports. There is improvement in Apr 2012 with imports declining at a faster rate of 1.6 percent than decline of exports by 0.9 percent and growth of exports of 0.2 percent in May 2012. Weaker world and internal demand and fluctuating commodity price increases explain the declining or less dynamic changes in exports and imports in Chart IIA-1

Chart IIA-1, US Balance, Exports and Imports of Goods and Services $ Billions

Source: US Census Bureau

http://www.census.gov/briefrm/esbr/www/esbr042.html

The balance of international trade in goods of the US seasonally-adjusted is shown in Table IIA-3. The US has a dynamic surplus in services that reduces the large deficit in goods for a still very sizeable deficit in international trade of goods and services. The balance in international trade of goods deteriorated from $63.0 billion in May 2011 to $63.5 billion in May 2012. Deterioration of the goods balance in May 2012 relative to May 2011 occurred mostly in the non petroleum balance, exports less imports of goods other than petroleum, while there was improvement in the sizeable petroleum balance, exports less imports of petroleum goods. Exports rose 4.6 percent with non-petroleum exports growing 4.2 percent. Total imports rose 3.4 percent with petroleum imports declining 9.8 percent and non-petroleum imports increasing 7.2 percent.

Table IIA-3, US, International Trade in Goods Balance, Exports and Imports $ Millions and ∆% SA

	May 2012	May 2011	∆%
Total Balance	-63,533	-63,038
Petroleum	-24,932	-29,878
Non Petroleum	-37,941	-32,170
Total Exports	130,718	124,910	4.6
Petroleum	10,395	9,274	12.1
Non Petroleum	119,018	114,185	4.2
Total Imports	194,251	187,948	3.4
Petroleum	35,327	39,151	-9.8
Non Petroleum	156,959	146,355	7.2

Details may not add because of rounding and seasonal adjustment

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

US exports and imports of goods not seasonally adjusted in Jan-May 2012 and Jan-May 2011 are shown in Table IIA-4. The rate of growth of exports was 6.8 percent and 7.3 percent for imports. The US has partial hedge of commodity price increases in exports of agricultural commodities that fell 5.5 percent and of mineral fuels that increased 14.9 13.8 both because of higher prices of raw materials and commodities that are falling again currently because of shocks of risk aversion. The US exports an insignificant amount of crude oil. US exports and imports consist mostly of manufactured products, with less rapidly increasing prices. US manufactured exports rose 7.8 percent while imports rose 8.7 percent. Significant part of the US trade imbalance originates in imports of mineral fuels growing by 2.3 percent and crude oil increasing 6.9 percent with significant decline at the margin in oil prices. The limited hedge in exports of agricultural commodities and mineral fuels compared with substantial imports of mineral fuels and crude oil results in waves of deterioration of the terms of trade of the US, or export prices relative to import prices, originating in commodity price increases caused by carry trades from zero interest rates.

Table IIA-4, US, Exports and Imports of Goods, Not Seasonally Adjusted Millions of Dollars and %

	Jan-May 2012 $ Millions	Jan-May 2011 $ Millions	∆%
Exports	640,521	599,620	6.8
Manufactured	424,019	393,214	7.8
Agricultural Commodities	57,080	60,248	-5.5
Mineral Fuels	56,198	49,379	13.8
Crude Oil	677	563	20.2
Imports	940,663	876,583	7.3
Manufactured	690,835	635,424	8.7
Agricultural Commodities	44,675	41,468	7.7
Mineral Fuels	187,349	183,109	2.3
Crude Oil	141,144	132,034	6.9

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

IIB Import Export Prices. Chart IIB-1 provides prices of total US imports 2001-2012. Prices fell during the contraction of 2001. Import price inflation accelerated after unconventional monetary policy of near zero interest rates in 2003-2004 and quantitative easing by withdrawing supply with the suspension of 30-year Treasury bond auctions. Slow pace of adjusting fed funds rates from 1 percent by increments of 25 basis points in 17 consecutive meetings of the Federal Open Market Committee (FOMC) between Jun 2004 and Jun 2006 continued to give impetus to carry trades. The reduction of fed funds rates toward zero in 2008 fueled a spectacular global hunt for yields that caused commodity price inflation in the middle of a global recession. After risk aversion in 2009 because of the announcement of TARP (Troubled Asset Relief Program) creating anxiety on “toxic assets” in bank balance sheets (see Cochrane and Zingales 2009), prices collapsed because of unwinding carry trades. Renewed price increases returned with zero interest rates and quantitative easing. Monetary policy impulses in massive doses have driven inflation and valuation of risk financial assets in wide fluctuations over a decade.

Chart IIB-1, US, Prices of Total US Imports 2001=100, 2001-2012

Chart IIB-2 provides 12-month percentage changes of prices of total US imports from 2001 to 2012. The only plausible explanation for the wide oscillations is by the carry trade originating in unconventional monetary policy. Import prices jumped in 2008 during deep and protracted global recession driven by carry trades from zero interest rates to long, leveraged positions in commodity futures. Carry trades were unwound during the financial panic in the final quarter of 2008 that resulted in flight to government obligations. Import prices jumped again in 2009 with subdued risk aversion because US banks did not have unsustainable toxic assets. Import prices then fluctuated as carry trades were resumed during periods of risk appetite and unwound during risk aversion resulting from the European debt crisis.

Chart IIB-2, US, Prices of Total US Imports, 12-Month Percentage Changes, 2001-2012

Chart IIB-3 provides prices of US imports from 1982 to 2012. There is no similar episode to that of the increase of commodity prices in 2008 during a protracted and deep global recession with subsequent collapse during a flight into government obligations. Trade prices have been driven by carry trades created by unconventional monetary policy in the past decade.

Chart IIB-3, US, Prices of Total US Imports, 2001=100, 1982-2012

Chart IIB-4 provides 12-month percentage changes of US total imports from 1982 to 2012. There have not been wide consecutive oscillations as the ones during the global recession of IVQ2007 to IIQ2009.

Chart IIB-4, US, Prices of Total US Imports, 12-Month Percentage Changes, 1982-2012

Chart IIB-5 provides the index of US export prices from 2001 to 2012. Import and export prices have been driven by impulses of unconventional monetary policy in massive doses. The most recent segment in Chart IIB-5 shows declining trend resulting from a combination of the world economic slowdown and the decline of commodity prices as carry trade exposures are unwound because of risk aversion to the sovereign debt crisis in Europe.

Chart IIB-5, US, Prices of Total US Exports, 2001=100, 2001-2012

Chart IIB-6 provides prices of US total exports from 1982 to 2012. The rise before the global recession from 2003 to 2008, driven by carry trades, is also unique in the series and is followed by another steep increase after risk aversion moderated in IQ2009.

Chart IIB-6, US, Prices of Total US Exports, 2001=100, 1982-2012

Chart IIB-7 provides 12-month percentage changes of total US exports from 1982 to 2012. The uniqueness of the oscillations around the global recession of IVQ2007 to IIQ2009 is clearly revealed.

Chart IIB-7, US, Prices of Total US Exports, 12-Month Percentage Changes, 1982-2012

Twelve-month percentage changes of US prices of exports and imports are provided in Table IIB-1. Import prices have been driven since 2003 by unconventional monetary policy of near zero interest rates influencing commodity prices according to moods of risk aversion. In a global recession without risk aversion until the panic of Sep 2008 with flight to government obligations, import prices rose 21.3 percent in the twelve months ending in Jun 2008 and fell 17.5 percent in the 12 months ending in Jun 2009 when risk aversion developed in 2008 until mid 2009. Import prices rose again sharply in Jun 2010 by 4.3 percent and in Jun 2011 by 13.6 percent in the presence of zero interest rates with relaxed mood of risk aversion until carry trades were unwound in May 2011 and prior months. There is similar behavior of prices of imports ex fuels, exports and exports ex agricultural goods but less pronounced than for commodity-rich prices dominated by carry trades from zero interest rates. A critical event resulting from unconventional monetary policy driving higher commodity prices by carry trades is the deterioration of the terms of trade, or export prices relative to import prices, that has adversely affected US real income growth relative to what it would have been in the absence of unconventional monetary policy. Europe, Japan and other advanced economies have experienced similar deterioration of their terms of trade. Because of unwinding carry trades of commodity futures as a result of risk aversion, import prices fell 2.6 in the 12 months ending in Jun 2012, export prices fell 2.1 percent and prices of nonagricultural exports fell 1.6 percent. Imports excluding fuel increased 0.6 percent in the 12 months ending in Jun 2012.

Table IIB-1, US, Twelve-Month Percentage Rates of Change of Prices of Exports and Imports

	Imports	Imports Ex Fuels	Exports	Exports Non-Ag
Jun 2012	-2.6	0.6	-2.1	-1.6
Jun 2011	13.6	5.0	10.1	8.0
Jun 2010	4.3	2.9	3.7	4.4
Jun 2009	-17.5	-4.5	-6.6	-5.9
Jun 2008	21.3	6.4	8.7	6.5
Jun 2007	2.3	2.1	4.3	3.2
Jun 2006	7.4	2.2	4.2	4.6
Jun 2005	7.4	2.1	3.2	3.8
Jun 2004	5.7	2.4	3.9	2.8
Jun 2003	2.2	0.4	1.5	0.9
Jun 2002	-3.6	NA	-1.4	-1.5
Jun 2001	-2.6	NA	-0.7	-0.7

Source: Bureau of Labor Statistics

Chart IB-8 shows the US monthly import price index of all commodities excluding fuels from 2001 to 2011. All curves of nominal values follow the same behavior under the influence of unconventional monetary policy. Zero interest rates without risk aversion result in jumps of nominal values while under strong risk aversion even with zero interest rates there are declines of nominal values.

Chart IIB-8, US, Import Price Index All Commodities Excluding Fuels, 2001=100, 2001-2012

Source: US Bureau of Labor Statistics

Chart IB-9 provides 12-month percentage changes of the US import price index excluding fuels between 2001 and 2012. There is the same behavior of carry trades driving up without risk aversion and down with risk aversion prices of raw materials, commodities and food in international trade during the global recession of IVQ2007 to IIQ2009 and in previous and subsequent periods.

Chart IIB-9, US, Import Price Index All Commodities Excluding Fuels, 12-Month Percentage Changes, 2002-2012

Source: US Bureau of Labor Statistics

Chart IIB-10 provides the monthly US import price index ex petroleum from 2001 to 2012. Prices including or excluding commodities follow the same fluctuations and trends originating in impulses of unconventional monetary policy of zero interest rates.

Chart IIB-10, US, Import Price Index ex Petroleum, 2001=100, 2001-2012

Source: US Bureau of Labor Statistics

Chart IIB-11 provides the US import price index ex petroleum from 1982 to 2012. There is the same unique hump in 2008 caused by carry trades from zero interest rates to prices of commodities and raw materials.

Chart IIB-11, US, Import Price Index ex Petroleum, 2001=100, 1982-2012

Source: US Bureau of Labor Statistics

Chart IIB-12 provides 12-month percentage changes of the import price index ex petroleum from 1986 to 2012. The oscillations caused by the carry trade in increasing prices of commodities and raw materials without risk aversion and subsequently decreasing them during risk aversion are quite unique.

Chart IIB-12, US, Import Price Index ex Petroleum, 12-Month Percentage Changes, 1986-2012

Source: US Bureau of Labor Statistics

http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RCLC1&f=D

Chart IIB-13 of the US Energy Information Administration provides the price of the crude oil futures contract from 1985 to 2012. There is the same hump in 2008 as in all charts caused by the common factor of carry trades from zero interest rates to commodity futures positions with risk appetite and subsequent decline when carry trades were unwound during shocks of risk aversion.

Chart IIB-13, US, Crude Oil Futures Contract

Source: US Energy Information Administration

The price index of US imports of petroleum and petroleum products in shown in Chart IIB-14. There is similar behavior of the curves all driven by the same impulses of monetary policy.

Chart IIB-14, US, Import Price Index of Petroleum and Petroleum Products, 2001=100, 2001-2012

Source: US Bureau of Labor Statistics

Chart IIB-15 provides the price index of petroleum and petroleum products from 1982 to 2012. The rise in prices during the global recession in 2008 and the decline after the flight to government obligations is unique in the history of the series. Increases in prices of trade in petroleum and petroleum products were induced by carry trades and declines by unwinding carry trades in flight to government obligations.

Chart IIB-15, US, Import Price Index of Petroleum and Petroleum Products, 2001=100, 1982-2012

Source: US Bureau of Labor Statistics

Chart IIB-16 provides 12-month percentage changes of the price index of US imports of petroleum and petroleum products from 1982 to 2012. There were wider oscillations in this index from 1999 to 2001 (see Barsky and Killian 2004 for an explanation).

Chart IIB-16, US, Import Price Index of Petroleum and Petroleum Products, 12-Month Percentage Changes, 1982-2012

Source: US Bureau of Labor Statistics

The price index of US exports of agricultural commodities is in Chart IC-17 from 2001 to 2012. There are similar fluctuations and trends as in all other price index originating in unconventional monetary policy repeated over a decade. The most recent segment in 2011 has declining trend in a new flight from risk resulting from the sovereign debt crisis in Europe followed by another decline in Jun 2012.

Chart IIB-17, US, Exports Price Index of Agricultural Commodities, 2001=100, 2001-2012

Source: US Bureau of Labor Statistics

Chart IIB-18 provides the price index of US exports of agricultural commodities from 1982 to 2012. The increase in 2008 in the middle of deep, protracted contraction was induced by unconventional monetary policy. The decline from 2008 into 2009 was caused by unwinding carry trades in a flight to government obligations. The increase into 2011 and current pause were also induced by unconventional monetary policy in waves of increases during relaxed risk aversion and declines during unwinding of positions because of aversion to financial risk.

Chart IIB-18, US, Exports Price Index of Agricultural Commodities, 2001=100, 1982-2012

Source: US Bureau of Labor Statistics

Chart IIB-19 provides 12-month percentage changes of the index of US exports of agricultural commodities from 1986 to 2012. The wide swings in 2008, 2009 and 2011 are only explained by unconventional monetary policy inducing carry trades from zero interest rates to commodity futures and reversals during risk aversion.

Chart IIB-19, US, Exports Price Index of Agricultural Commodities, 12-Month Percentage Changes, 1986-2012

Source: US Bureau of Labor Statistics

Chart IIB-20 shows the export price index of nonagricultural commodities from 2001 to 2012. Unconventional monetary policy of zero interest rates drove price behavior during the past decade. Policy has been based on the myth of stimulating the economy by climbing the negative slope of an imaginary short-term Phillips curve.

Chart IIB-20, US, Exports Price Index of Nonagricultural Commodities, 2001=100, 2001-2012

Source: US Bureau of Labor Statistics

Chart IIB-21 provides a longer perspective of the price index of US nonagricultural commodities from 1982 to 2012. Increases and decreases around the global contraction after 2007 were caused by carry trade induced by unconventional monetary policy.

Chart IIB-21, US, Exports Price Index of Nonagricultural Commodities, 2001=100, 1982-2012

Source: US Bureau of Labor Statistics

Finally, Chart IIB-22 provides 12-month percentage changes of the price index of US exports of nonagricultural commodities from 1986 to 2012. The wide swings before, during and after the global recession beginning in 2007 were caused by carry trades induced by unconventional monetary policy.

Chart IIB-22, US, Exports Price Index of Nonagricultural Commodities, 12-Month Percentage Changes, 1986-2012

Source: US Bureau of Labor Statistics

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

III World Financial Turbulence. Financial markets are being shocked by multiple factors including (1) world economic slowdown; (2) slowing growth in China with political development, Japan and world trade; (3) slow growth propelled by savings reduction in the US with high unemployment/underemployment, falling wages and hiring collapse; and (3) the outcome of the sovereign debt crisis in Europe. This section provides current data and analysis. Subsection IIIA Financial Risks provides analysis of the evolution of valuations of risk assets during the week. There are various appendixes at the end of this section for convenience of reference of material related to the euro area debt crisis. Some of this material is updated in Subsection IIIA when new data are available and then maintained in the appendixes for future reference until updated again in Subsection IIIA. Subsection IIIB Appendix on Safe Haven Currencies discusses arguments and measures of currency intervention. Subsection IIIC Appendix on Fiscal Compact provides analysis of the restructuring of the fiscal affairs of the European Union in the agreement of European leaders reached on Dec 9, 2011. Subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort considers the policies of the European Central Bank. Appendix IIIE Euro Zone Survival Risk analyzes the threats to survival of the European Monetary Union. Subsection IIIF Appendix on Sovereign Bond Valuation provides more technical analysis. Subsection IIIG Appendix on Deficit Financing of Growth and the Debt Crisis provides analysis of proposals to finance growth with budget deficits together with experience of the economic history of Brazil.

IIIA Financial Risks. The past half year has been characterized by financial turbulence, attaining unusual magnitude in recent months. Table III-1, updated with every comment in this blog, provides beginning values on Fr Jun 29 and daily values throughout the week ending on Fri Jul 6 of various financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Jun 29 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Jun 29, 2012”, first row “USD/EUR 1.2661 -0.7%,” provides the information that the US dollar (USD) depreciated 0.7 percent to USD 1.2661/EUR in the week ending on Fri Jun 29 relative to the exchange rate on Fri Jun 22. The first five asset rows provide five 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. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing waves of inflation. The most important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9 (European Council 2911Dec9), which is analyzed in IIIC Appendix on Fiscal Compact. European leaders reached a new agreement on Jan 30 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/127631.pdf) and another agreement on Jun 29, 2012 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf).

The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.2288/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Jul 6, depreciating to USD 1.2313/EUR on Mon Jul 9, or by 0.2 percent. The dollar depreciated because more dollars, $1.2313, were required on Mon Jul 9 to buy one euro than $1.2288 on Jul 6. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.2313/EUR on Jul 9; the second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Jul 6, to the last business day of the current week, in this case Fri Jul 13, such as appreciation by 0.3 percent to USD 1.2248/EUR by Jul 13; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD appreciated (denoted by positive sign) by 0.3 percent from the rate of USD 1.2288/EUR on Fri Jul 6 to the rate of USD 1.2248/EUR on Fri Jul 13 {[(1.2248/1.2288) – 1]100 = -0.3%} and depreciated (denoted by positive sign) by 0.4 percent from the rate of USD 1.2203 on Thu Jul 12 to USD 1.2248/EUR on Fri Jul 7 {[(1.2248/1.2203) -1]100 = 0.4%}. Other factors constant, appreciation of the dollar relative to the euro is caused by increasing risk aversion, with rising uncertainty on European sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from higher yielding risk financial assets to the safety of dollar investments. When risk aversion declines, funds have been moving away from safe assets in dollars to risk financial assets, depreciating the dollar.

Table III-I, Weekly Financial Risk Assets Jul 9-13, 2012

Fri Jul 6, 2012

M 9

Tue 10

W 11

Thu 12

Fr 13

USD/EUR

1.2288

2.9%

1.2313

-0.2%

1.2253

0.3%

0.5%

1.2241

0.4%

0.1%

1.2203

0.7%

0.3%

1.2248

0.3%

-0.4%

JPY/ USD

79.66

0.2%

79.56

0.1%

79.35

0.4%

0.3%

79.75

-0.1%

-0.5%

79.31

0.4%

0.6%

79.20

0.6%

0.1%

CHF/ USD

0.9774

-3.0%

0.9753

0.2%

0.9802

-0.3%

-0.5%

0.9811

-0.4%

-0.1%

0.9840

-0.7%

-0.3%

0.9805

-0.3%

0.4%

CHF/ EUR

1.2010

0.0%

1.2009

0.0%

1.2010

0.0%

1.2008

0.0%

1.2008

0.0%

1.2010

0.0%

USD/ AUD

1.0211

0.9793

-0.3%

1.0207

0.9792

0.0%

1.0185

0.9818

-0.3%

1.0251

0.9755

0.4%

0.6%

1.0130

0.9872

-0.8%

-1.2%

1.0227

0.9778

0.2%

0.9%

10 Year T Note

1.548

1.51

1.50

1.51

1.474

1.49

2 Year T Note

0.272

0.26

0.27

0.26

0.256

0.24

German Bond

2Y -0.01 10Y 1.33

2Y 0.00 10Y 1.32

2Y -0.02 10Y 1.27

2Y -0.04 10Y 1.23

2Y -0.04 10Y 1.26

DJIA

12772.47

-0.8%

12736.29

-0.3%

12653.12

-0.9%

-0.7%

12604.53

-1.3%

-0.4%

12573.27

-1.6%

-0.3%

12777.09

0.0%

1.6%

DJ Global

1814.28

-0.9%

1803.57

-0.6%

1794.99

-1.1%

-0.5%

1793.73

-1.1%

-0.1%

1774.42

-2.2%

-1.1%

1798.37

-0.9%

1.3%

DJ Asia Pacific

1211.53

1.2%

1195.03

-1.4%

1192.4

-1.6%

-0.2%

1191.39

-1.7%

-0.1%

1174.08

-3.1%

-1.5%

1179.82

-2.6%

0.5%

Nikkei

9020.75

0.2%

8896.88

-1.4%

8857.73

-1.8%

-0.4%

8851.00

-1.9%

-0.1%

8720.01

-3.3%

-1.5%

8724.12

-3.3%

0.0%

Shanghai

2223.58

-0.1%

2170.81

-2.4%

2164.44

-2.7%

-0.3%

2175.38

-2.2%

0.5%

2185.49

-1.7%

0.5%

2185.89

-1.7%

0.0%

DAX

6410.11

-0.1%

6387.57

-0.4%

6438.33

0.4%

0.8%

6453.85

0.7%

0.2%

6419.35

0.1%

-0.5%

6557.10

2.3%

2.2%

DJ UBS

Comm.

136.89

1.1%

139.64

2.0%

137.50

0.4%

-1.5%

138.30

1.0%

0.6%

138.80

1.4%

0.4%

140.34

2.5%

1.1%

WTI $ B

84.14

-0.9%

85.68

1.8%

84.20

0.1%

-1.7%

86.18

2.4%

86.55

2.9%

0.4%

87.10

2.5%

0.6%

Brent $/B

97.94

0.4%

99.91

2.0%

97.97

0.0%

-1.9%

100.74

2.9%

2.8%

101.81

3.9%

1.1%

102.40

4.6%

0.6%

Gold $/OZ

1583.2

-0.9%

1587.0

0.2%

1569.0

-0.9%

-1.1%

1576.2

-0.4%

0.4%

1556.3

-1.7%

-1.3%

1592.0

0.6%

2.3%

Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss

Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce

Sources: http://www.bloomberg.com/markets/

Charles Forelle and David Enrich, writing on “Euro-zone banks cut back lending,” on Jul 13, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303919504577524482252510066.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyze the new mechanics of interbank lending in the euro zone. In the older regime, the deficits of households, corporations and governments of highly-indebted members of the euro zone were financed by banks in their jurisdictions that received interbank loans from banks in the less indebted or financially-stronger countries. The increase of perceptions of default risk in counterparties in transactions among financial institutions constituted an important disruption of the international financial system during the financial crisis (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 217-24, 60, Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 155-7). Counterparty risk perceptions rose significantly in sale and repurchase agreements (SRP) in which the financing counterparty doubted the credit quality of the collateral and of the financed counterparty to repurchase the security. Another form of counterparty risk was the sharp increase in the LIBOR-OIS in which lending banks doubted the balance sheet of borrowing counterparty banks in uncollateralized interbank loans. The sovereign debt crisis in the euro zone caused sharp increases in the perception of counterparty risk evaluation by lending banks in financially-stronger jurisdictions of balance sheets and repayment capacity of borrowing banks in highly-indebted countries. Forelle and Enrich, “Euro zone banks cut back lending,” use central bank information showing that long-term financing by the European Central Bank (ECB) is filling the financing gap of banks in highly indebted countries with significant part of ECB lending simply returning as deposits in countries in stronger jurisdictions and also as deposits at the ECB. As a result, risk spreads of interest rates in highly indebted countries have increased relative to interest rates in stronger countries, which is a movement in opposite direction of what would be desired to resolve the euro zone financial crisis. Crisis resolution has moved to preventing banking instability that could accentuate the financial crisis and fiscal standing of highly-indebted countries.

Current financial risk is dominated by interest rate decisions of major central banks and the new program of rescue of banks and countries in the sovereign risk event in the euro zone. At the meeting of its Governing Council on Jul 5, 2010, the European Central Bank took the following policy measures (http://www.ecb.int/press/pr/date/2012/html/pr120705.en.html):

“5 July 2012 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.75%, starting from the operation to be settled on 11 July 2012.

2. The interest rate on the marginal lending facility will be decreased by 25 basis points to 1.50%, with effect from 11 July 2012.

3. The interest rate on the deposit facility will be decreased by 25 basis points to 0.00%, with effect from 11 July 2012.

The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.”

The President of the ECB Mario Draghi summarized the reasons for the policy measures as follows (http://www.ecb.int/press/pressconf/2012/html/is120705.en.html):

“Based on our regular economic and monetary analyses, we decided to cut the key ECB interest rates by 25 basis points. Inflationary pressure over the policy-relevant horizon has been dampened further as some of the previously identified downside risks to the euro area growth outlook have materialised. Consistent with this picture, the underlying pace of monetary expansion remains subdued. Inflation expectations for the euro area economy continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. At the same time, economic growth in the euro area continues to remain weak, with heightened uncertainty weighing on confidence and sentiment.”

The Bank of England decided on Jul 5, 2012 to increase its policy of quantitative easing (http://www.bankofengland.co.uk/publications/Pages/news/2012/066.aspx ):

“The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to increase the size of its asset purchase programme, financed by the issuance of central bank reserves, by £50 billion to a total of £375 billion.

UK output has barely grown for a year and a half and is estimated to have fallen in both of the past two quarters. The pace of expansion in most of the United Kingdom’s main export markets also appears to have slowed. Business indicators point to a continuation of that weakness in the near term, both at home and abroad. In spite of the progress made at the latest European Council, concerns remain about the indebtedness and competitiveness of several euro-area economies, and that is weighing on confidence here. The correspondingly weaker outlook for UK output growth means that the margin of economic slack is likely to be greater and more persistent.”

The People’s Bank of China (PBC) also cut interest rates simultaneously with the other major central banks (http://www.pbc.gov.cn/publish/english/955/2012/20120608171005950734495/20120608171005950734495_.html):

“The PBC has decided to cut RMB benchmark deposit and loan interest rates for financial institutions as of June 8, 2012. The one-year RMB benchmark deposit and loan interest rates will be lowered both by 0.25 percentage points. Adjustments are made correspondingly to benchmark interest rates on deposits and loans of other maturities and to deposit and loan interest rates on personal housing provident fund.”

Monetary authorities worldwide are assessing higher risks to the economy.

The key decisions of the summit of European Leaders with regards to resolving the sovereign debt issues are (http://www.european-council.europa.eu/home-page/highlights/summit-impact-on-the-eurozone?lang=en):

“Euro area summit statement

Eurozone heads of state or government decided:

to establish a single banking supervisory mechanism run the by the ECB, and, once this mechanism has been created,
to provide the European Stability Mechanism (ESM) with the possibility to inject funds into banks directly.

Spain's bank recapitalisation will begin under current rules, i.e. with assistance provided by the European Financial Stability Facility (EFSF) until the ESM becomes available. The funds will then be transferred to the ESM without gaining seniority status.

It was also agreed that EFSF/ESM funds can be used flexibly to buy bonds for member states that comply with common rules, recommendations and timetables.

The Eurogroup has been asked to implement these decisions by 9 July 2012.”

Valuations of risk financial assets increased sharply after the announcement of these decisions. The details will be crafted at a meeting on finance ministries of the European Union on Jul 9, 2012.

The definition of “banking panic” by Calomiris and Gorton (1991, 112) during the Great Depression in the US is:

“A banking panic occurs when bank debt holders at all or many banks in the banking system suddenly demand that banks convert their debt claims into cash (at par) to such an extent that the banks suspend convertibility of their debt into cash, or in the case of the United States, act collectively to avoid suspension of convertibility by issuing clearing house loan certificates.”

The financial panic during the credit crisis and global recession consisted of a run on the sale and repurchase agreements (SRP) of structured investment products (http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Cochrane and Zingales (2009) argue that the initial proposal for the Troubled Asset Relief Program (TARP) instead of the failure of Lehman Bros caused the flight into the dollar and Treasury securities. Washington Mutual experienced a silent run in the form of internet withdrawals. The current silent run in the euro area is from banks with challenged balance sheets in highly indebted member countries to banks and government securities in countries with stronger fiscal affairs. The analysis of the IMF 2012 Article IV Consultation focuses on this key policy priority of reversing the silent run on challenged euro area banks.

Jonathan House, writing on “Spanish banks need as much as €62 billion in new capital,” on Jun 21, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702304765304577480062972372858.html?mod=WSJ_hp_LEFTWhatsNewsCollection), informs that two independent studies estimate the needs new capital of Spain’s banks at €62, billion, around $78.8 billion, which will be used by the government of Spain in the request for financial assistance from the European Union during the meeting with finance ministers.

The European Central Bank (ECB) announced changes in acceptable collateral for refinancing (http://www.ecb.int/press/pr/date/2012/html/pr120622.en.html):

“On 20 June 2012 the Governing Council of the European Central Bank (ECB) decided on additional measures to improve the access of the banking sector to Eurosystem operations in order to further support the provision of credit to households and non-financial corporations.

The Governing Council has reduced the rating threshold and amended the eligibility requirements for certain asset-backed securities (ABSs). It has thus broadened the scope of the measures to increase collateral availability which were introduced on 8 December 2011 and which remain applicable.

In addition to the ABSs that are already eligible for use as collateral in Eurosystem operations, the Eurosystem will consider the following ABSs as eligible:

1. Auto loan, leasing and consumer finance ABSs and ABSs backed by commercial mortgages (CMBSs) which have a second-best rating of at least “single A” in the Eurosystem’s harmonised credit scale, at issuance and at all times subsequently. These ABSs will be subject to a valuation haircut of 16%.

2. Residential mortgage-backed securities (RMBSs), securities backed by loans to small and medium-sized enterprises (SMEs), auto loan, leasing and consumer finance ABSs and CMBSs which have a second-best rating of at least “triple B” in the Eurosystem’s harmonised credit scale, at issuance and at all times subsequently. RMBSs, securities backed by loans to SMEs, and auto loan, leasing and consumer finance ABSs would be subject to a valuation haircut of 26%, while CMBSs would be subject to a valuation haircut of 32%.

The risk control framework with higher haircuts applicable to the newly eligible ABS aims at ensuring risk equalisation across asset classes and maintaining the risk profile of the Eurosystem.

The newly eligible ABSs must also satisfy additional requirements which will be specified in the legal act to be adopted Thursday, 28 June 2012. The measures will take effect as soon as the relevant legal act enters into force.”

There was significant improvement in ten-year yields of bonds of the government of Italy, declining to 5.796 percent on Fri Jun 29, 2012 and of ten-year yields of bonds of the government of Spain, declining to 6.347 percent on Fri Jun 29 from earlier yields exceeding 7 percent (http://professional.wsj.com/mdc/public/page/2_3022-govtbonds.html?mod=mdc_bnd_pglnk). Yields on sovereign debt backed up again with the yield of the ten-year bond of the government of Spain increasing to 6.872 percent on Jul 6, 2012 but declining to 6.618 percent on Jul 13, and of the ten-year bond of Italy rising to 6.020 percent on Jul 6 and deteriorating to 6.054 percent on Jul 13 (http://professional.wsj.com/mdc/public/page/2_3022-govtbonds.html?mod=mdc_bnd_pglnk). Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Increasing aversion is captured by decrease of the yield of the ten-year Treasury and the two- and ten-year government bonds of Germany. Table III-1A provides yields of US and German governments bonds and the rate of USD/EUR. Yields of US and German government bonds decline during shocks of risk aversion and the dollar strengthens in the form of fewer dollars required to buy one euro. The yield of the US ten-year Treasury note fell from 2.202 percent on Aug 26, 2011 to 1.49 percent on Jul 13, 2012, reminiscent of experience during the Treasury-Fed accord of the 1940s that placed a ceiling on long-term Treasury debt (Hetzel and Leach 2001), while the yield of the ten-year government bond of Germany fell from 2.16 percent to 1.26 percent. The US dollar strengthened significantly from USD 1.450/EUR on Aug 26, 2011, to USD 1.2248 on Jul 13, 2012, or by 15.5 percent. Under zero interest rates for the monetary policy rate of the US, or fed funds rate, carry trades ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield is still at a level well below consumer price inflation of 1.7 percent in the 12 months ending in May (see subsection IB United States Inflation http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars.html and ealier http://cmpassocregulationblog.blogspot.com/2012/05/world-inflation-waves-monetary-policy.html) and the expectation of higher inflation if risk aversion diminishes. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table III-1A provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.

Table III-1A, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate

	US 2Y	US 10Y	DE 2Y	DE 10Y	USD/ EUR
7/13/12	0.24	1.49	-0.04	1.26	1.2248
7/6/12	0.272	1.548	-0.01	1.33	1.2288
6/29/12	0.305	1.648	0.12	1.58	1.2661
6/22/12	0.309	1.676	0.14	1.58	1.2570
6/15/12	0.272	1.584	0.07	1.44	1.2640
6/8/12	0.268	1.635	0.04	1.33	1.2517
6/1/12	0.248	1.454	0.01	1.17	1.2435
5/25/12	0.291	1.738	0.05	1.37	1.2518
5/18/12	0.292	1.714	0.05	1.43	1.2780
5/11/12	0.248	1.845	0.09	1.52	1.2917
5/4/12	0.256	1.876	0.08	1.58	1.3084
4/6/12	0.31	2.058	0.14	1.74	1.3096
3/30/12	0.335	2.214	0.21	1.79	1.3340
3/2/12	0.29	1.977	0.16	1.80	1.3190
2/24/12	0.307	1.977	0.24	1.88	1.3449
1/6/12	0.256	1.957	0.17	1.85	1.2720
12/30/11	0.239	1.871	0.14	1.83	1.2944
8/26/11	0.20	2.202	0.65	2.16	1.450
8/19/11	0.192	2.066	0.65	2.11	1.4390
6/7/10	0.74	3.17	0.49	2.56	1.192
3/5/09	0.89	2.83	1.19	3.01	1.254
12/17/08	0.73	2.20	1.94	3.00	1.442
10/27/08	1.57	3.79	2.61	3.76	1.246
7/14/08	2.47	3.88	4.38	4.40	1.5914
6/26/03	1.41	3.55	NA	3.62	1.1423

Note: DE: Germany

Source:

http://www.bloomberg.com/markets/

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

http://www.federalreserve.gov/releases/h15/data.htm

http://www.bundesbank.de/Navigation/EN/Statistics/Time_series_databases/Macro_economic_time_series/macro_economic_time_series_node.html?anker=GELDZINS

http://www.ecb.int/stats/money/long/html/index.en.html

Chart III-1A of the Board of Governors of the Federal Reserve System provides the ten-year and two-year Treasury constant maturity yields. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe.

Chart III-1A, US, Ten-Year and Two-Year Treasury Constant Maturity Yields 2001-2012

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/update/

Equity indexes in Table III-1 mostly weakened in the week of Jul 13, with the exception of Germany, as a result of doubt on the agreement reached in the summit of European leaders and prospects on the economy implicit in the concerted reduction of interest rates by the European Central Bank and People’s Bank of China with increasing quantitative easing by the Bank of England. Germany’s Dax increased 2.3 percent probably in relief that China’s growth did not collapse while DJIA was flat in the week of Jul 13, rallying 1.6 percent on Fri Jul 13. Dow Global fell 0.9 percent, rallying 1.3 percent on Fri Jul 13. Japan’s Nikkei Average fell 2.6 percent. Dow Asia Pacific TSM fell 2.6 percent in the week of Jul 13 while Shanghai Composite fell 1.7 percent.

Commodities strengthened during the week of Jul 13, 2012, as shown in Table III-1. The DJ UBS Commodities Index rose 2.5 percent. WTI gained 2.5 percent while Brent increased 4.6 percent. Gold increased 2.3 percent.

Risk aversion during the week of Mar 2, 2012, was dominated by the long-term refinancing operations (LTRO) of the European Central Bank. LTROs and related principles are analyzed in subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort. First, as analyzed by David Enrich, writing on “ECB allots €529.5 billion in long-term refinancing operations,” published on Feb 29, 2012 by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203986604577252803223310964.html?mod=WSJ_hp_LEFTWhatsNewsCollection), the ECB provided a second round of three-year loans at 1.0 percent to about 800 banks. The earlier round provided €489 billion to more than 500 banks. Second, the ECB sets the fixed-rate for main refinancing operations at 1.00 percent and the overnight deposit facility at 0.25 percent (http://www.ecb.int/home/html/index.en.html) for negative spread of 75 basis points. That is, if a bank borrows at 1.0 percent for three years through the LTRO and deposits overnight at the ECB, it incurs negative spread of 75 basis points. An alternative allocation could be to lend for a positive spread to other banks. Richard Milne, writing on “Banks deposit record cash with ECB,” on Mar 2, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/9798fd36-644a-11e1-b30e-00144feabdc0.html#axzz1nxeicB6H), provides important information and analysis that banks deposited a record €776.9 billion at the ECB on Fri Mar 2 at interest receipt of 0.25 percent, just two days after receiving €529.5 billion of LTRO loans at interest cost of 1.0 percent. The main issue here is whether there is ongoing perceptions of high risks in counterparties in financial transactions that froze credit markets in 2008 (see Pelaez and Pelaez, Regulation of Banks and Finance (2009a), 57-60, 217-27, Financial Regulation after the Global Recession (2009b), 155-67). Richard Milne and Mary Watkins, writing on “European finance: the leaning tower of perils,” on Mar 27, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/82205f6e-7735-11e1-baf3-00144feab49a.html#axzz1qOqWaqF2), raise concerns that the large volume of LTROs can create future problems for banks and the euro area. An important issue is if the cheap loans at 1 percent for three-year terms finance the carry trade into securities of the governments of banks. Balance sheets of banks may be stressed during future sovereign-credit events. Sam Jones, writing on “ECB liquidity fuels high stakes hedging,” on Apr 4, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/cb74d63a-7e75-11e1-b009-00144feab49a.html#axzz1qyDYxLjS), analyzes unusually high spreads in government bond markets in Europe that could have been caused by LTROs. There has been active relative value arbitrage of these spreads similar to the strategies of Long-Term Capital Management (LTCM) of capturing high spreads in mortgage-backed securities jointly with hedges in Treasury securities (on LTCM see Pelaez and Pelaez, International Financial Architecture (2005), 108-12, 87-9, The Global Recession Risk (2007) 12-3, 102, 176, Globalization and the State, Vol. I (2008a), 59-64).

Table III-1B provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the LTROs. Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increased from €546,747 million on Dec 31, 2010, to €870,130 million on Dec 28, 2011 and €1,243,549 million on Jul 6, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,845,330 million in the statement of Jul 6.

Table III-1B, Consolidated Financial Statement of the Eurosystem, Million EUR

	Dec 31, 2010	Dec 28, 2011	Jul 6, 2012
1 Gold and other Receivables	367,402	419,822	433,779
2 Claims on Non Euro Area Residents Denominated in Foreign Currency	223,995	236,826	261,048
3 Claims on Euro Area Residents Denominated in Foreign Currency	26,941	95,355	54,213
4 Claims on Non-Euro Area Residents Denominated in Euro	22,592	25,982	16,874
5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro	546,747	879,130	1,243,549
6 Other Claims on Euro Area Credit Institutions Denominated in Euro	45,654	94,989	184,197
7 Securities of Euro Area Residents Denominated in Euro	457,427	610,629	601,781
8 General Government Debt Denominated in Euro	34,954	33,928	30,041
9 Other Assets	278,719	336,574	259,523
TOTAL ASSETS	2,004, 432	2,733,235	3,085,006
Memo Items
Sum of 5 and 7	1,004,174	1,489,759	1,845,330
Capital and Reserves	78,143	85,748	85,748

Source: European Central Bank

http://www.ecb.int/press/pr/wfs/2011/html/fs110105.en.html

http://www.ecb.int/press/pr/wfs/2011/html/fs111228.en.html

http://www.ecb.int/press/pr/wfs/2012/html/fs120710.en.html

There is extremely important information in Table III-1C for the current sovereign risk crisis in the euro zone. Table III-1C provides the structure of regional and country relations of Germany’s exports and imports with newly available data for May 2012. German exports to other European Union (EU) members are 57.9 percent of total exports in May 2012 and 58.1 percent in Jan-May 2012. Exports to the euro area are 41.8 percent in May and 38.7 percent in Jan-May. Exports to third countries are 42.1 percent of the total in May and 41.8 percent in Jan-May. There is similar distribution for imports. Economic performance in Germany is closely related to its high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of its high share in exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.

Table III-1C, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	May 2012 € Billions	May 12-Month ∆%	Jan–May 2012 € Billions	Jan-May 2012/ Jan-May 2011 ∆%
Total Exports	92.5	0.5	455.6	4.2
A. EU Members	53.6 % 57.9	-1.5	265.3 % 58.1	0.8
Euro Area	38.7 % 41.8	-2.3	176.5 % 38.7	-0.1
Non-euro Area	17.8 % 19.2	0.2	88.7 % 19.5	3.7
B. Third Countries	38.9 % 42.1	3.4	190.3 % 41.8	9.4
Total Imports	77.2	-0.2	380.4	2.6
C. EU Members	49.5 % 64.1	0.4	241.5 % 63.5	2.8
Euro Area	34.8 % 45.1	-0.6	169.7 % 44.6	2.4
Non-euro Area	14.7 % 19.0	2.7	71.7 % 18.8	3.7
D. Third Countries	27.7 % 35.9	-1.2	139.0 % 36.5	2.2

Notes: Total Exports = A+B; Total Imports = C+D

Source:

Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/PressServices/Press/pr/2012/07/PE12_234_51.html;jsessionid=F17A2975B2055CEED1CE790F42961BFF.cae2

IIIB Appendix on Safe Haven Currencies. Safe-haven currencies, such as the Swiss franc (CHF) and the Japanese yen (JPY) have been under threat of appreciation but also remained relatively unchanged. A characteristic of the global recession would be struggle for maintaining competitiveness by policies of regulation, trade and devaluation (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation War (2008c)). Appreciation of the exchange rate causes two major effects on Japan.

1. Trade. Consider an example with actual data (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 70-72). The yen traded at JPY 117.69/USD on Apr 2, 2007 and at JPY 102.77/USD on Apr 2, 2008, or appreciation of 12.7 percent. This meant that an export of JPY 10,000 to the US sold at USD 84.97 on Apr 2, 2007 [(JPY 10,000)/(USD 117.69/USD)], rising to USD 97.30 on Apr 2, 2008 [(JPY 10,000)/(JPY 102.77)]. If the goods sold by Japan were invoiced worldwide in dollars, Japanese’s companies would suffer a reduction in profit margins of 12.7 percent required to maintain the same dollar price. An export at cost of JPY 10,000 would only bring JPY 8,732 when converted at JPY 102.77 to maintain the price of USD 84.97 (USD 84.97 x JPY 102.77/USD). If profit margins were already tight, Japan would be uncompetitive and lose revenue and market share. The pain of Japan from dollar devaluation is illustrated by Table 58 in the Nov 6 comment of this blog (http://cmpassocregulationblog.blogspot.com/2011/10/slow-growth-driven-by-reducing-savings.html): The yen traded at JPY 110.19/USD on Aug 18, 2008 and at JPY 75.812/USD on Oct 28, 2011, for cumulative appreciation of 31.2 percent. Cumulative appreciation from Sep 15, 2010 (JPY 83.07/USD) to Oct 28, 2011 (JPY 75.812) was 8.7 percent. The pain of Japan from dollar devaluation continues as illustrated by Table VI-6 in Section VII Valuation of Risk Financial Assets: The yen traded at JPY 110.19/USD on Aug 18, 2008 and at JPY 78.08/USD on Dec 23, 2011, for cumulative appreciation of 29.1 percent. Cumulative appreciation from Sep 15, 2010 (JPY 83.07/USD) to Dec 23, 2011 (JPY 78.08) was 6.0 percent.

2. Foreign Earnings and Investment. Consider the case of a Japanese company receiving earnings from investment overseas. Accounting the earnings and investment in the books in Japan would also result in a loss of 12.7 percent. Accounting would show fewer yen for investment and earnings overseas.

There is a point of explosion of patience with dollar devaluation and domestic currency appreciation. Andrew Monahan, writing on “Japan intervenes on yen to cap sharp rise,” on Oct 31, 2011, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204528204577009152325076454.html?mod=WSJPRO_hpp_MIDDLETopStories), analyzes the intervention of the Bank of Japan, at request of the Ministry of Finance, on Oct 31, 2011. Traders consulted by Monahan estimate that the Bank of Japan sold JPY 7 trillion, about $92.31 billion, against the dollar, exceeding the JPY 4.5 trillion on Aug 4, 2011. The intervention caused an increase of the yen rate to JPY 79.55/USD relative to earlier trading at a low of JPY 75.31/USD. The JPY appreciated to JPY76.88/USD by Fri Nov 18 for cumulative appreciation of 3.4 percent from JPY 79.55 just after the intervention. The JPY appreciated another 0.3 percent in the week of Nov 18 but depreciated 1.1 percent in the week of Nov 25. There was mild depreciation of 0.3 percent in the week of Dec 2 that was followed by appreciation of 0.4 percent in the week of Dec 9. The JPY was virtually unchanged in the week of Dec 16 with depreciation of 0.1 percent but depreciated by 0.5 percent in the week of Dec 23, appreciating by 1.5 percent in the week of Dec 30. Historically, interventions in yen currency markets have been unsuccessful (Pelaez and Pelaez, The Global Recession Risk (2007), 107-109). Interventions are even more difficult currently with daily trading of some $4 trillion in world currency markets. Risk aversion with zero interest rates in the US diverts hot capital movements toward safe-haven currencies such as Japan, causing appreciation of the yen. Mitsuru Obe, writing on Nov 25, on “Japanese government bonds tumble,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204452104577060231493070676.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the increase in yields of the Japanese government bond with 10 year maturity to a high for one month of 1.025 percent at the close of market on Nov 25. Thin markets in after-hours trading may have played an important role in this increase in yield but there may have been an effect of a dreaded reduction in positions of bonds by banks under pressure of reducing assets. The report on Japan sustainability by the IMF (2011JSRNov23, 2), analyzes how rising yields could threaten Japan:

· “As evident from recent developments, market sentiment toward sovereigns with unsustainably large fiscal imbalances can shift abruptly, with adverse effects on debt dynamics. Should JGB yields increase, they could initiate an adverse feedback loop from rising yields to deteriorating confidence, diminishing policy space, and a contracting real economy.

· Higher yields could result in a withdrawal of liquidity from global capital markets, disrupt external positions and, through contagion, put upward pressure on sovereign bond yields elsewhere.”

Exchange rate controls by the Swiss National Bank (SNB) fixing the rate at a minimum of CHF 1.20/EUR (http://www.snb.ch/en/mmr/reference/pre_20110906/source/pre_20110906.en.pdf) has prevented flight of capital into the Swiss franc. The Swiss franc remained unchanged relative to the USD in the week of Dec 23 and appreciated 0.2 percent in the week of Dec 30 relative to the USD and 0.5 percent relative to the euro, as shown in Table II-1. Risk aversion is evident in the depreciation of the Australian dollar by cumulative 2.5 percent in the week of Fr Dec 16 after no change in the week of Dec 9. In the week of Dec 23, the Australian dollar appreciated 1.9 percent, appreciating another 0.5 percent in the week of Dec 30 as shown in Table II-1. Risk appetite would be revealed by carry trades from zero interest rates in the US and Japan into high yielding currencies such as in Australia with appreciation of the Australian dollar (see Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 202-4, Pelaez and Pelaez, Government Intervention in Globalization (2008c), 70-4).

IIIC Appendix on Fiscal Compact. There are three types of actions in Europe to steer the euro zone away from the threats of fiscal and banking crises: (1) fiscal compact; (2) enhancement of stabilization tools and resources; and (3) bank capital requirements. The first two consist of agreements by the Euro Area Heads of State and government while the third one consists of measurements and recommendations by the European Banking Authority.

1. Fiscal Compact. The “fiscal compact” consists of (1) conciliation of fiscal policies and budgets within a “fiscal rule”; and (2) establishment of mechanisms of governance, monitoring and enforcement of the fiscal rule.

i. Fiscal Rule. The essence of the fiscal rule is that “general government budgets shall be balanced or in surplus” by compliance of members countries that “the annual structural deficit does not exceed 0.5% of nominal GDP” (European Council 2011Dec9, 3). Individual member states will create “an automatic correction mechanism that shall be triggered in the event of deviation” (European Council 2011Dec9, 3). Member states will define their automatic correction mechanisms following principles proposed by the European Commission. Those member states falling into an “excessive deficit procedure” will provide a detailed plan of structural reforms to correct excessive deficits. The European Council and European Commission will monitor yearly budget plans for consistency with adjustment of excessive deficits. Member states will report in anticipation their debt issuance plans. Deficits in excess of 3 percent of GDP and/or debt in excess of 60 percent of GDP will trigger automatic consequences.

ii. Policy Coordination and Governance. The euro area is committed to following common economic policy. In accordance, “a procedure will be established to ensure that all major economic policy reforms planned by euro area member states will be discussed and coordinated at the level of the euro area, with a view to benchmarking best practices” (European Council 2011Dec9, 5). Governance of the euro area will be strengthened with regular euro summits at least twice yearly.

2. Stabilization Tools and Resources. There are several enhancements to the bailouts of member states.

i. Facilities. The European Financial Stability Facility (EFSF) will use leverage and the European Central Bank as agent of its market operations. The European Stability Mechanism (ESM) or permanent bailout facility will be operational as soon as 90 percent of the capital commitments are ratified by member states. The ESM is planned to begin in Jul 2012.

ii. Financial Resources. The overall ceiling of the EFSF/ESM of €500 billion (USD 670 billion) will be reassessed in Mar 2012. Measures will be taken to maintain “the combined effective lending capacity of EUR 500 billion” (European Council 2011Dec9, 6). Member states will “consider, and confirm within 10 days, the provision of additional resources for the IMF of up to EUR 200 billion (USD 270 billion), in the form of bilateral loans, to ensure that the IMF has adequate resources to deal with the crisis. We are looking forward to parallel contributions from the international community” (European Council 2011Dec9, 6). Matthew Dalton and Matina Stevis, writing on Dec 20, 2011, on “Euro Zone Agrees to New IMF Loans,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204791104577107974167166272.html?mod=WSJPRO_hps_MIDDLESecondNews), inform that at a meeting on Dec 20, finance ministers of the euro-zone developed plans to contribute €150 billion in bilateral loans to the IMF as provided in the agreement of Dec 9. Bailouts “will strictly adhere to the well established IMF principles and practices.” There is a specific statement on private sector involvement and its relation to recent experience: “We clearly reaffirm that the decisions taken on 21 July and 26/27 October concerning Greek debt are unique and exceptional; standardized and identical Collective Action clauses will be included, in such a way as to preserve market liquidity, in the terms and conditions of all new euro government bonds” (European Council 2011Dec9, 6). Will there be again “unique and exceptional” conditions? The ESM is authorized to take emergency decisions with “a qualified majority of 85% in case the Commission and the ECB conclude that an urgent decision related to financial assistance is needed when the financial and economic sustainability of the euro area is threatened” (European Council 2011Dec9, 6).

3. Bank Capital. The European Banking Authority (EBA) finds that European banks have a capital shortfall of €114.7 billion (http://stress-test.eba.europa.eu/capitalexercise/Press%20release%20FINAL.pdf). To avoid credit difficulties, the EBA recommends “that the credit institutions build a temporary capital buffer to reach a 9% Core Tier 1 ratio by 30 June 2012” (http://stress-test.eba.europa.eu/capitalexercise/EBA%20BS%202011%20173%20Recommendation%20FINAL.pdf 6). Patrick Jenkins, Martin Stabe and Stanley Pignal, writing on Dec 9, 2011, on “EU banks slash sovereign holdings,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/a6d2fd4e-228f-11e1-acdc-00144feabdc0.html#axzz1gAlaswcW), analyze the balance sheets of European banks released by the European Banking Authority. They conclude that European banks have reduced their holdings of riskier sovereign debt of countries in Europe by €65 billion from the end of 2010 to Sep 2011. Bankers informed that the European Central Bank and hedge funds acquired those exposures that represent 13 percent of their holdings of debt to Greece, Ireland, Italy, Portugal and Spain, which are down to €513 billion by the end of IIIQ2011.

The members of the European Monetary Union (EMU), or euro area, established the European Financial Stability Facility (EFSF), on May 9, 2010, to (http://www.efsf.europa.eu/about/index.htm):

“Provide loans to countries in financial difficulties
Intervene in the debt primary and secondary markets. Intervention in the secondary market will be only on the basis of an ECB analysis recognising the existence of exceptional financial market circumstances and risks to financial stability
Act on the basis of a precautionary programme
Finance recapitalisations of financial institutions through loans to governments”

The EFSF will be replaced by the permanent European Stability Mechanism (ESM) in 2013. On Mar 30, 2012, members of the euro area reached an agreement providing for sufficient funding required in rescue programs of members countries facing funding and fiscal difficulties and the transition from the EFSF to the ESM. The agreement of Mar 30, 2012 of the euro area members provides for the following (http://www.consilium.europa.eu/media/1513204/eurogroup_statement_30_march_12.pdf):

· Acceleration of ESM paid-in capital. The acceleration of paid-in capital for the ESM provides for two tranches paid in 2012, in July and Oct; another two tranches in 2013; and a final tranche in the first half of 2014. There could be acceleration of paid-in capital is required to maintain a 15 percent relation of paid-in capital and the outstanding issue of the ESM

· ESM Operation and EFSF transition. ESM will assume all new rescue programs beginning in Jul 2012. EFSF will administer programs begun before initiation of ESM activities. There will be a transition period for the EFSF until mid 2013 in which it can engage in new programs if required to maintain the full lending limit of €500 billion.

· Increase of ESM/EFSF lending limit. The combined ceiling of the ESM and EFSF will be increased to €700 billion to facilitate operation of the transition of the EFSF to the ESM. The ESM lending ceiling will be €500 billion by mid 2013. The combined lending ceiling of the ESM and EFSF will continue to €700 billion

· Prior lending. The bilateral Greek loan facility of €53 billion and €49 billion of the EFSF have been paid-out in supporting programs of countries: “all together the euro area is mobilizing an overall firewall of approximately EUR 800 billion, more than USD 1 trillion” (http://www.consilium.europa.eu/media/1513204/eurogroup_statement_30_march_12.pdf)

· Bilateral IMF contributions. Members of the euro area have made commitments of bilateral contributions to the IMF of €150 billion

A key development in the bailout of Greece is the approval by the Executive Board of the International Monetary Fund (IMF) on Mar 15, 2012, of a new four-year financing in the value of €28 billion to be disbursed in equal quarterly disbursements (http://www.imf.org/external/np/tr/2012/tr031512.htm). The sovereign debt crisis of Europe has moderated significantly with the elimination of immediate default of Greece. New economic and financial risk factors have developed, which are covered in VI Valuation of Risk Financial Assets and V World Economic Slowdown.

IIID Appendix on European Central Bank Large Scale Lender of Last Resort. European Central Bank. The European Central Bank (ECB) has been pressured to assist in the bailouts by acquiring sovereign debts. The ECB has been providing liquidity lines to banks under pressure and has acquired sovereign debts but not in the scale desired by authorities. In an important statement to the European Parliament, the President of the ECB Mario Draghi (2011Dec1) opened the possibility of further ECB actions but after a decisive “fiscal compact:”

“What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.

Just as we effectively have a compact that describes the essence of monetary policy – an independent central bank with a single objective of maintaining price stability – so a fiscal compact would enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively.

We might be asked whether a new fiscal compact would be enough to stabilise markets and how a credible longer-term vision can be helpful in the short term. Our answer is that it is definitely the most important element to start restoring credibility.

Other elements might follow, but the sequencing matters. And it is first and foremost important to get a commonly shared fiscal compact right. Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term. After all, investors are themselves often taking decisions with a long time horizon, especially with regard to government bonds.

A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations.”

An important statement of Draghi (2011Dec15) focuses on the role of central banking: “You all know that the statutes of the ECB inherited this important principle and that central bank independence and the credible pursuit of price stability go hand in hand.”

Draghi (2011Dec19) explains measures to ensure “access to funding markets” by euro zone banks:

§ “We have decided on three-year refinancing operations to support the supply of credit to the euro area economy. These measures address the risk that persistent financial markets tensions could affect the capacity of euro area banks to obtain refinancing over longer horizons.

§ Earlier, in October, the Governing Council had already decided to have two more refinancing operations with a maturity of around one year.

§ Also, it was announced then that in all refinancing operations until at least the first half of 2012 all liquidity demand by banks would be fully allotted at fixed rate.

§ Funding via the covered bonds market was also facilitated by the ECB deciding in October to introduce a new Covered Bond Purchase Programme of €40 billion.

§ Funding in US dollar is facilitated by lowering the pricing on the temporary US dollar liquidity swap arrangements.”

Lionel Barber and Ralph Atkins interviewed Mario Draghi on Dec 14 with the transcript published in the Financial Times on Dec 18 (http://www.ft.com/intl/cms/s/0/25d553ec-2972-11e1-a066-00144feabdc0.html#axzz1gzoHXOj6) as “FT interview transcript: Mario Draghi.” A critical question in the interview is if the new measures are a European version of quantitative easing. Draghi analyzes the difference between the measures of the European Central Bank (ECB) and quantitative easing such as in Japan, US and UK:

1. The measures are termed “non-standard” instead of “unconventional.” While quantitative easing attempts to lower the yield of targeted maturities, the three-year facility operates through the “bank channel.” Quantitative easing would not be feasible because the ECB is statutorily prohibited of funding central governments. The ECB would comply with its mandate of medium-term price stability.

2. There is a critical difference in the two programs. Quantitative easing has been used as a form of financial repression known as “directed lending.” For example, the purchase of mortgage-backed securities more recently or the suspension of the auctions of 30-year bonds in response to the contraction early in the 2000s has the clear objective of directing spending to housing. The ECB gives the banks entire discretion on how to use the funding within their risk/return decisions, which could include purchase of government bonds.

The question on the similarity of the ECB three-year lending facility and quantitative easing is quite valid. Tracy Alloway, writing on Oct 10, 2011, on “Investors worry over cheap ECB money side effects,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/d2f87d16-f339-11e0-8383-00144feab49a.html#axzz1hAqMH1vn), analyzes the use of earlier long-term refinancing operations (LTRO) of the ECB. LTROs by the ECB in Jun, Sep and Dec 2009 lent €614 billion at 1 percent. Alloway quotes estimates of Deutsche Bank that banks used €442billion to acquire assets with higher yields. Carry trades developed from LTRO funds at 1 percent into liquid investments at a higher yield to earn highly profitable spreads. Alloway quotes estimates of Morgan Stanley that European debt of GIIPS (Greece, Ireland, Italy, Portugal and Spain) in European bank balance sheets is €700 billion. Tracy Alloway, writing on Dec 21, 2011, on “Demand for ECB loans rises to €489bn,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/d6ddd0ae-2bbd-11e1-98bc-00144feabdc0.html#axzz1hAqMH1vn), informs that European banks borrowed the largest value of €489 billion in all LTROs of the ECB. Tom Fairless and David Cottle, writing on Dec 21, 2011, on “ECB sees record refinancing demand,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204464404577111983838592746.html?mod=WSJPRO_hpp_LEFTTopStories), inform that the first of three operations of the ECB lent €489.19 billion, or $639.96 billion, to 523 banks. Three such LTROs could add to $1.9 trillion, which is not far from the value of quantitative easing in the US of $2.5 trillion. Fairless and Cottle find that there could be renewed hopes that banks could use the LTROs to support euro zone bond markets. It is possible that there could be official moral suasion by governments on banks to increase their holdings of government bonds or at least not to sell existing holdings. Banks are not free to choose assets in evaluation of risk and returns. Floods of cheap money at 1 percent per year induce carry trades to high-risk assets and not necessarily financing of growth with borrowing and lending decisions constrained by shocks of confidence.

The LTROs of the ECB are not very different from the liquidity facilities of the Fed during the financial crisis. Kohn (2009Sep10) finds that the trillions of dollars in facilities provided by the Fed (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-64, Regulation of Banks and Finance (2009b), 224-7) could fall under normal principles of “lender of last resort” of central banks:

“The liquidity measures we took during the financial crisis, although unprecedented in their details, were generally consistent with Bagehot's principles and aimed at short-circuiting these feedback loops. The Federal Reserve lends only against collateral that meets specific quality requirements, and it applies haircuts where appropriate. Beyond the collateral, in many cases we also have recourse to the borrowing institution for repayment. In the case of the TALF, we are backstopped by the Treasury. In addition, the terms and conditions of most of our facilities are designed to be unattractive under normal market conditions, thus preserving borrowers' incentives to obtain funds in the market when markets are operating normally. Apart from a very small number of exceptions involving systemically important institutions, such features have limited the extent to which the Federal Reserve has taken on credit risk, and the overall credit risk involved in our lending during the crisis has been small.

In Ricardo's view, if the collateral had really been good, private institutions would have lent against it. However, as has been recognized since Bagehot, private lenders, acting to protect themselves, typically severely curtail lending during a financial crisis, irrespective of the quality of the available collateral.The central bank--because it is not liquidity constrained and has the infrastructure in place to make loans against a variety of collateral--is well positioned to make those loans in the interest of financial stability, and can make them without taking on significant credit risk, as long as its lending is secured by sound collateral. A key function of the central bank is to lend in such circumstances to contain the crisis and mitigate its effects on the economy.”

The Bagehot (1873) principle is that central banks should provide a safety net, lending to temporarily illiquid but solvent banks and not to insolvent banks (see Cline 2001, 2002; Pelaez and Pelaez, International Financial Architecture (2005), 175-8). Kohn (2009Apr18) characterizes “quantitative easing” as “large scale purchases of assets:”

“Another aspect of our efforts to affect financial conditions has been the extension of our open market operations to large-scale purchases of agency mortgage-backed securities (MBS), agency debt, and longer-term Treasury debt. We initially announced our intention to undertake large-scale asset purchases last November, when the federal funds rate began to approach its zero lower bound and we needed to begin applying stimulus through other channels as the economic contraction deepened. These purchases are intended to reduce intermediate- and longer-term interest rates on mortgages and other credit to households and businesses; those rates influence decisions about investments in long-lived assets like houses, consumer durable goods, and business capital. In ordinary circumstances, the typically quite modest volume of central bank purchases and sales of such assets has only small and temporary effects on their yields. However, the extremely large volume of purchases now underway does appear to have substantially lowered yields. The decline in yields reflects "preferred habitat" behavior, meaning that there is not perfect arbitrage between the yields on longer-term assets and current and expected short-term interest rates. These preferences are likely to be especially strong in current circumstances, so that long-term asset prices rise and yields fall as the Federal Reserve acquires a significant portion of the outstanding stock of securities held by the public.”

Non-standard ECB policy and unconventional Fed policy have a common link in the scale of implementation or policy doses. Direct lending by the central bank to banks is the function “large scale lender of last resort.” If there is moral suasion by governments to coerce banks into increasing their holdings of government bonds, the correct term would be financial repression.

An important additional measure discussed by Draghi (2011Nov19) is relaxation on the collateral pledged by banks in LTROs:

“Some banks’ access to refinancing operations may be restricted by lack of eligible collateral. To overcome this, a temporary expansion of the list of collateral has been decided. Furthermore, the ECB intends to enhance the use of bank loans as collateral in Eurosystem operations. These measures should support bank lending, by increasing the amount of assets on euro area banks’ balance sheets that can be used to obtain central bank refinancing.”

There are collateral concerns about European banks. David Enrich and Sara Schaefer Muñoz, writing on Dec 28, on “European bank worry: collateral,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203899504577126430202451796.html?mod=WSJPRO_hpp_LEFTTopStories), analyze the strain on bank funding from a squeeze in the availability of high-quality collateral as guarantee in funding. High-quality collateral includes government bonds and investment-grade non-government debt. There could be difficulties in funding for a bank without sufficient available high-quality collateral to offer in guarantee of loans. It is difficult to assess from bank balance sheets the availability of sufficient collateral to support bank funding requirements. There has been erosion in the quality of collateral as a result of the debt crisis and further erosion could occur. Perceptions of counterparty risk among financial institutions worsened the credit/dollar crisis of 2007 to 2009. The banking theory of Diamond and Rajan (2000, 2001a, 2001b) and the model of Diamond Dybvig (1983, 1986) provide the analysis of bank functions that explains the credit crisis of 2007 to 2008 (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 155-7, 48-52, Regulation of Banks and Finance (2009b), 52-66, 217-24). In fact, Rajan (2005, 339-41) anticipated the role of low interest rates in causing a hunt for yields in multiple financial markets from hedge funds to emerging markets and that low interest rates foster illiquidity. Rajan (2005, 341) argued:

“The point, therefore, is that common factors such as low interest rates—potentially caused by accommodative monetary policy—can engender excessive tolerance for risk on both sides of financial transactions.”

A critical function of banks consists of providing transformation services that convert illiquid risky loans and investment that the bank monitors into immediate liquidity such as unmonitored demand deposits. Credit in financial markets consists of the transformation of asset-backed securities (SRP) constructed with monitoring by financial institutions into unmonitored immediate liquidity by sale and repurchase agreements (SRP). In the financial crisis financial institutions distrusted the quality of their own balance sheets and those of their counterparties in SRPs. The financing counterparty distrusted that the financed counterparty would not repurchase the assets pledged in the SRP that could collapse in value below the financing provided. A critical problem was the unwillingness of banks to lend to each other in unsecured short-term loans. Emse Bartha, writing on Dec 28, on “Deposits at ECB hit high,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204720204577125913779446088.html?mod=WSJ_hp_LEFTWhatsNewsCollection), informs that banks deposited €453.034 billion, or $589.72 billion, at the ECB on Dec 28, which is a record high in two consecutive days. The deposit facility is typically used by banks when they do prefer not to extend unsecured loans to other banks. In addition, banks borrowed €6.225 billion from the overnight facility on Dec 28, when in normal times only a few hundred million euro are borrowed. The collateral issues and the possible increase in counterparty risk occurred a week after large-scale lender of last resort by the ECB in the value of €489 billion in the prior week. The ECB may need to extend its lender of last resort operations.

The financial reform of the United States around the proposal of a national bank by Alexander Hamilton (1780) to develop the money economy with specialization away from the barter economy is credited with creating the financial system that brought prosperity over a long period (see Pelaez 2008). Continuing growth and prosperity together with sound financial management earned the US dollar the role as reserve currency and the AAA rating of its Treasury securities. McKinnon (2011Dec18) analyzes the resolution of the European debt crisis by comparison with the reform of Alexander Hamilton. Northern states of the US had financed the revolutionary war with the issue of paper notes that were at risk of default by 1890. Alexander Hamilton proposed the purchase of the states’ paper notes by the Federal government without haircuts. McKinnon (2011Dec18) describes the conflicts before passing the assumption bill in 1790 for federal absorption of the debts of states. Other elements in the Hamilton reform consisted of creation of a market for US Treasury bonds by their use as paid-in capital in the First Bank of the United States. McKinnon (2011Dec18) finds growth of intermediation in the US by the branching of the First Bank of the United States throughout several states, accepting deposits to provide commercial short-term credit. The reform consolidated the union of states, fiscal credibility for the union and financial intermediation required for growth. The reform also introduced low tariffs and an excise tax on whisky to service the interest on the federal debt. Trade relations among members of the euro zone are highly important to economic activity. There are two lessons drawn by McKinnon (2011Dec18) from the experience of Hamilton for the euro zone currently. (1) The reform of Hamilton included new taxes for the assumption of debts of states with concrete provisions for their credibility. (2) Commercial lending was consolidated with a trusted bank both for accepting private deposits and for commercial lending, creating the structure of financial intermediation required for growth.

IIIE Appendix Euro Zone Survival Risk. Markets have been dominated by rating actions of Standard & Poor’s Ratings Services (S&PRS) (2012Jan13) on 16 members of the European Monetary Union (EMU) or eurozone. The actions by S&PRS (2012Jan13) are of several types:

1. Downgrades by two notches of long-term credit ratings of Cyprus (from BBB/Watch/NegA-3+ to BB+/Neg/B), Italy (from A/Watch Neg/A-1 to BBB+/Neg/A-2), Portugal (from BBB-/Watch Neg/A-3 to BB/Neg/B) and Spain (from AA-/Watch Neg/A-1+ to A/Neg/A-1).

2. Downgrades by one notch of long-term credit ratings of Austria (from AAA/Watch Neg/A-1+ to AA+/Neg/A-1+), France (from AAA/Watch Neg/A-1+ to AA+/Neg A-1+), Malta (from A/Watch, Neg/A-1 to A-/Neg/A-2), Slovakia (from A+/Watch Neg/A-1 to A/Stable/A-1) and Slovenia (AA-/Watch Neg/A-1+ to A+/Neg/A-1).

3. Affirmation of long-term ratings of Belgium (AA/Neg/A-1+), Estonia (AA-/Neg/A-1+), Finland (AAA/Neg/A-1+), Germany (AAA/Stable/A-1+), Ireland (BBB+/Neg/A-2), Luxembourg (AAA/Neg/A-1+) and the Netherlands (AAA/Neg/A-1+) with removal from CreditWatch.

4. Negative outlook on the long-term credit ratings of Austria, Belgium, Cyprus, Estonia, Finland, France, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia and Spain, meaning that S&PRS (2012Jan13) finds that the ratings of these sovereigns have a chance of at least 1-to-3 of downgrades in 2012 or 2013.

S&PRS (2012Jan13) finds that measures by European policymakers may not be sufficient to contain sovereign risks in the eurozone. The sources of stress according to S&PRS (2012Jan13) are:

1. Worsening credit environment

2. Increases in risk premiums for many eurozone borrowers

3. Simultaneous attempts at reducing debts by both eurozone governments and households

4. More limited perspectives of economic growth

5. Deepening and protracted division among Europe’s policymakers in agreeing to approaches to resolve the European debt crisis

There is now only one major country in the eurozone with AAA rating of its long-term debt by S&PRS (2012Jan13): Germany. IIIE Appendix Euro Zone Survival Risk analyzes the hurdle of financial bailouts of euro area members by the strength of the credit of Germany alone. The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is abouy $3531.6 billion. There is some simple “unpleasant bond arithmetic.” Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is about $7385.1 billion, which would be equivalent to 126.3 percent of their combined GDP in 2010. Under this arrangement the entire debt of the euro zone including debt of France and Germany would not have nil probability of default. Debt as percent of Germany’s GDP would exceed 224 percent if including debt of France and 165 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Charles Forelle, writing on Jan 14, 2012, on “Downgrade hurts euro rescue fund,” published by the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204409004577159210191567778.html), analyzes the impact of the downgrades on the European Financial Stability Facility (EFSF). The EFSF is a special purpose vehicle that has not capital but can raise funds to be used in bailouts by issuing AAA-rated debt. S&P may cut the rating of the EFSF to the new lowest rating of the six countries with AAA rating, which are now down to four with the downgrades of France and Austria. The other rating agencies Moody’s and Fitch have not taken similar action. On Jan, S&PRS (2012Jan16) did cut the long-term credit rating of the EFSF to AA+ and affirmed the short-term credit rating at A-+. The decision is derived from the reduction in credit rating of the countries guaranteeing the EFSF. In the view of S&PRS (2012Jan16), there are not sufficient credit enhancements after the reduction in the creditworthiness of the countries guaranteeing the EFSF. The decision could be reversed if credit enhancements were provided.

The flow of cash from safe havens to risk financial assets is processed by carry trades from zero interest rates that are frustrated by episodes of risk aversion or encouraged with return of risk appetite. European sovereign risk crises are closely linked to the exposures of regional banks to government debt. An important form of financial repression consists of changing the proportions of debt held by financial institutions toward higher shares in government debt. The financial history of Latin America, for example, is rich in such policies. Bailouts in the euro zone have sanctioned “bailing in” the private sector, which means that creditors such as banks will participate by “voluntary” reduction of the principal in government debt (see Pelaez and Pelaez, International Financial Architecture (2005), 163-202). David Enrich, Sara Schaeffer Muñoz and Patricia Knowsmann, writing on “European nations pressure own banks for loans,” on Nov 29, 2011, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204753404577066431341281676.html?mod=WSJPRO_hpp_MIDDLETopStories), provide important data and analysis on the role of banks in the European sovereign risk crisis. They assemble data from various sources showing that domestic banks hold 16.2 percent of Italy’s total government securities outstanding of €1,617.4 billion, 22.9 percent of Portugal’s total government securities of €103.9 billion and 12.3 percent of Spain’s total government securities of €535.3 billion. Capital requirements force banks to hold government securities to reduce overall risk exposure in balance sheets. Enrich, Schaeffer Muñoz and Knowsmann find information that governments are setting pressures on banks to acquire more government debt or at least to stop selling their holdings of government debt.

Bond auctions are also critical in episodes of risk aversion. David Oakley, writing on Jan 3, 2012, on “Sovereign issues draw euro to crunch point,” published by the Financial Times (http://www.ft.com/intl/cms/s/0/63b9d7ca-2bfa-11e1-98bc-00144feabdc0.html#axzz1iLNRyEbs), estimates total euro area sovereign issues in 2012 at €794 billion, much higher than the long-term average of €670 billion. Oakley finds that the sovereign issues are: Italy €220 billion, France €197 billion, Germany €178 billion and Spain €81 billion. Bond auctions will test the resilience of the euro. Victor Mallet and Robin Wigglesworth, writing on Jan 12, 2012, on “Spain and Italy raise €22bn in debt sales,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/e22c4e28-3d05-11e1-ae07-00144feabdc0.html#axzz1j4euflAi), analyze debt auctions during the week. Spain placed €10 billion of new bonds with maturities in 2015 and 2016, which was twice the maximum planned for the auction. Italy placed €8.5 billion of one-year bills at average yield of 2.735 percent, which was less than one-half of the yield of 5.95 percent a month before. Italy also placed €3.5 billion of 136-day bills at 1.64 percent. There may be some hope in the sovereign debt market. The yield of Italy’s 10-year bond dropped from around 7.20 percent on Jan 9 to about 6.70 percent on Jan 13 and then to around 6.30 percent on Jan 20. The yield of Spain’s 10-year bond fell from about 6.60 percent on Jan 9 to around 5.20 percent on Jan 13 and then to 5.50 percent on Jan 20.

A combination of strong economic data in China analyzed in subsection VC and the realization of the widely expected downgrade could explain the strength of the European sovereign debt market. Emese Bartha, Art Patnaude and Nick Cawley, writing on January 17, 2012, on “European T-bills see solid demand,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204555904577166363369792848.html?mod=WSJPRO_hpp_LEFTTopStories), analyze successful auctions treasury bills by Spain and Greece. A day after the downgrade, the EFSF found strong demand on Jan 17 for its six-month debt auction at the yield of 0.2664 percent, which is about the same as sovereign bills of France with the same maturity.

There may be some hope in the sovereign debt market. The yield of Italy’s 10-year bond dropped from around 7.20 percent on Jan 9 to about 6.70 percent on Jan 13 and then to around 6.30 percent on Jan 20. The yield of Spain’s 10-year bond fell from about 6.60 percent on Jan 9 to around 5.20 percent on Jan 13 and then to 5.50 percent on Jan 20. Paul Dobson, Emma Charlton and Lucy Meakin, writing on Jan 20, 2012, on “Bonds show return of crisis once ECB loans expire,” published in Bloomberg (http://www.bloomberg.com/news/2012-01-20/bonds-show-return-of-crisis-once-ecb-loans-expire-euro-credit.html), analyze sovereign debt and analysis of market participants. Large-scale lending of last resort by the European Central Bank, considered in VD Appendix on European Central Bank Large Scale Lender of Last Resort, provided ample liquidity in the euro zone for banks to borrow at 1 percent and lend at higher rates, including to government. Dobson, Charlton and Meakin trace the faster decline of yields of short-term sovereign debt relative to decline of yields of long-term sovereign debt. The significant fall of the spread of short relative to long yields could signal concern about the resolution of the sovereign debt while expanding lender of last resort operations have moderated relative short-term sovereign yields. Normal conditions would be attained if there is definitive resolution of long-term sovereign debt that would require fiscal consolidation in an environment of economic growth.

Charles Forelle and Stephen Fidler, writing on Dec 10, 2011, on “Questions place EU pact,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203413304577087562993283958.html?mod=WSJPRO_hpp_LEFTTopStories#project%3DEUSUMMIT121011%26articleTabs%3Darticle), provide data, information and analysis of the agreement of Dec 9. There are multiple issues centering on whether investors will be reassured that the measures have reduced the risks of European sovereign obligations. While the European Central Bank has welcomed the measures, it is not yet clear of its future role in preventing erosion of sovereign debt values.

Another complicating factor is whether there will be further actions on sovereign debt ratings. On Dec 5, 2011, four days before the conclusion of the meeting of European leaders, Standard & Poor’s (2011Dec5) placed the sovereign ratings of 15 members of the euro zone on “CreditWatch with negative implications.” S&P finds five conditions that trigger the action: (1) worsening credit conditions in the euro area; (2) differences among member states on how to manage the debt crisis in the short run and on measures to move toward enhanced fiscal convergence; (3) household and government debt at high levels throughout large parts of the euro area; (4) increasing risk spreads on euro area sovereigns, including those with AAA ratings; and (5) increasing risks of recession in the euro zone. S&P also placed the European Financial Stability Facility (EFSF) in CreditWatch with negative implications (http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245325307963). On Dec 9, 2011, Moody’s Investors Service downgraded the ratings of the three largest French banks (http://www.moodys.com/research/Moodys-downgrades-BNP-Paribass-long-term-ratings-to-Aa3-concluding--PR_232989 http://www.moodys.com/research/Moodys-downgrades-Credit-Agricole-SAs-long-term-ratings-to-Aa3--PR_233004 http://www.moodys.com/research/Moodys-downgrades-Socit-Gnrales-long-term-ratings-to-A1--PR_232986 ).

Improving equity markets and strength of the euro appear related to developments in sovereign debt negotiations and markets. Alkman Granitsas and Costas Paris, writing on Jan 29, 2012, on “Greek debt deal, new loan agreement to finish next week,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204573704577189021923288392.html?mod=WSJPRO_hpp_LEFTTopStories), inform that Greece and its private creditors were near finishing a deal of writing off €100 billion, about $132 billion, of Greece’s debt depending on the conversations between Greece, the euro area and the IMF on the new bailout. An agreement had been reached in Oct 2011 for a new package of fresh money in the amount of €130 billion to fill needs through 2015 but was contingent on haircuts reducing Greece’s debt from 160 percent of GDP to 120 percent of GDP. The new bailout would be required to prevent default by Greece of €14.4 billion maturing on Mar 20, 2012. There has been increasing improvement of sovereign bond yields. Italy’s ten-year bond yield fell from over 6.30 percent on Jan 20, 2012 to slightly above 5.90 percent on Jan 27. Spain’s ten-year bond yield fell from slightly above 5.50 percent on Jan 20 to just below 5 percent on Jan 27.

An important difference, according to Beim (2011Oct9), between large-scale buying of bonds by the central bank between the Federal Reserve of the US and the European Central Bank (ECB) is that the Fed and most banks do not buy local and state government obligations with lower creditworthiness. The European Monetary Union (EMU) that created the euro and the ECB did not include common fiscal policy and affairs. Thus, EMU cannot issue its own treasury obligations. The line “Reserve bank credit” in the Fed balance sheet for Jan 25, 2012, is $2902 billion of which $2570 billion consisting of $1565 billion US Treasury notes and bonds, $68 billion inflation-indexed bonds and notes, $101 billion Federal agency debt securities and $836 billion mortgage-backed securities (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The Fed has been careful in avoiding credit risk in its portfolio of securities. The 11 exceptional liquidity facilities of several trillion dollars created during the financial crisis (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-62) have not resulted in any losses. The Fed has used unconventional monetary policy without credit risk as in classical central banking.

Beim (2011Oct9, 6) argues:

“In short, the ECB system holds more than €1 trillion of debt of the banks and governments of the 17 member states. The state-by-state composition of this debt is not disclosed, but the events of the past year suggest that a disproportionate fraction of these assets are likely obligations of stressed countries. If a significant fraction of the €1 trillion were to be restructured at 40-60% discounts, the ECB would have a massive problem: who would bail out the ECB?

This is surely why the ECB has been so shrill in its antagonism to the slightest mention of default and restructuring. They need to maintain the illusion of risk-free sovereign debt because confidence in the euro itself is built upon it.”

Table III-2 provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the LTROs. Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increased from €546,747 million on Dec 31, 2010, to €870,130 million on Dec 28, 2011 and €1,243,549 million on Jul 6, 2012. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has increased to €1,845,330 million in the statement of Jul 6.

This sum is roughly what concerns Beim (2012Oct9) because of the probable exposure relative to capital to institutions and sovereigns with higher default risk. To be sure, there is no precise knowledge of the composition of the ECB portfolio of loans and securities with weights and analysis of the risks of components. Javier E. David, writing on Jan 16, 2012, on “The risks in ECB’s crisis moves,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204542404577158753459542024.html?mod=WSJ_hp_LEFTWhatsNewsCollection), informs that the estimated debt of weakest euro zone sovereigns held by the ECB is €211 billion, with Greek debt in highest immediate default risk being only 17 percent of the total. Another unknown is whether there is high risk collateral in the €489 billion three-year loans to credit institutions at 1 percent interest rates. The potential risk is the need for recapitalization of the ECB that could find similar political hurdles as the bailout fund EFSF. There is a recurring issue of whether the ECB should accept a haircut on its portfolio of Greek bonds of €40 billion acquired at discounts from face value. An article on “Haircut for the ECB? Not so fast,” published by the Wall Street Journal on Jan 28, 2012 (http://blogs.wsj.com/davos/2012/01/28/haircut-for-the-ecb-not-so-fast/), informs of the remarks by Mark Carney, Governor of the Bank of Canada and President of the Financial Stability Board (FSB) (http://www.financialstabilityboard.org/about/overview.htm), expressing what appears to be correct doctrine that there could conceivably be haircuts for official debt but that such a decision should be taken by governments and not by central banks.

Table III-2, Consolidated Financial Statement of the Eurosystem, Million EUR

	Dec 31, 2010	Dec 28, 2011	Jul 6, 2012
1 Gold and other Receivables	367,402	419,822	433,779
2 Claims on Non Euro Area Residents Denominated in Foreign Currency	223,995	236,826	261,048
3 Claims on Euro Area Residents Denominated in Foreign Currency	26,941	95,355	54,213
4 Claims on Non-Euro Area Residents Denominated in Euro	22,592	25,982	16,874
5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro	546,747	879,130	1,243,549
6 Other Claims on Euro Area Credit Institutions Denominated in Euro	45,654	94,989	184,197
7 Securities of Euro Area Residents Denominated in Euro	457,427	610,629	601,781
8 General Government Debt Denominated in Euro	34,954	33,928	30,041
9 Other Assets	278,719	336,574	259,523
TOTAL ASSETS	2,004, 432	2,733,235	3,085,006
Memo Items
Sum of 5 and 7	1,004,174	1,489,759	1,845,330
Capital and Reserves	78,143	85,748	85,748

Source: European Central Bank

http://www.ecb.int/press/pr/wfs/2011/html/fs110105.en.html

http://www.ecb.int/press/pr/wfs/2011/html/fs111228.en.html

http://www.ecb.int/press/pr/wfs/2012/html/fs120710.en.html

Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. That success would be assured with growth of the Italian economy. A critical problem is that the common euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surplus that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Newly available data in Table III-3 providing Italy’s trade with regions and countries supports the argument of Caballero and Giavazzi (2012Jan15). Italy’s exports to the European Monetary Union (EMU) are only 42.7 percent of the total. Exports to the non-European Union area are growing at 8.0 percent in Apr 2012 relative to Apr 2011 while those to EMU are falling at 0.5 percent.

Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%

Apr 2012	Exports % Share	∆% Jan-Apr 2012/ Jan-Apr 2011	Imports % Share	Imports ∆% Jan-Apr 2012/ Jan-Apr 2011
EU	56.0	0.5	53.3	-7.6
EMU 17	42.7	-0.5	43.2	-7.1
France	11.6	0.6	8.3	-4.7
Germany	13.1	3.3	15.6	-10.3
Spain	5.3	-9.3	4.5	-9.9
UK	4.7	8.9	2.7	-16.4
Non EU	44.0	8.0	46.7	-3.7
Europe non EU	13.3	12.4	11.1	-4.7
USA	6.1	7.9	3.3	5.4
China	2.7	-10.7	7.3	-22.3
OPEC	4.7	18.2	8.6	20.1
Total	100.0	3.7	100.0	-5.7

Notes: EU: European Union; EMU: European Monetary Union (euro zone)

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/64824

Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €325 million with the 17 countries of the euro zone (EMU 17) in Apr and deficit of €667 million in Jan-Apr. Depreciation to parity could permit greater competitiveness in improving the trade surpluses of €2469 million in Jan-Apr with Europe non European Union and of €3415 million with the US. There is significant rigidity in the trade deficits in Jan-Apr of €5187 million with China and €8039 million with members of the Organization of Petroleum Exporting Countries (OPEC).

Table III-4, Italy, Trade Balance by Regions and Countries, Millions of Euro

Regions and Countries	Trade Balance Apr 2012 Millions of Euro	Trade Balance Cumulative Jan-Apr 2012 Millions of Euro
EU	702	3,434
EMU 17	-325	-667
France	848	3,820
Germany	-521	-1,882
Spain	93	834
UK	715	2,855
Non EU	-904	-7,052
Europe non EU	605	2,469
USA	1,279	3,415
China	-1,076	-5,187
OPEC	-1,877	-8,039
Total	-202	-3,617

Notes: EU: European Union; EMU: European Monetary Union (euro zone)

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/64824

Growth rates of Italy’s trade and major products are provided in Table III-5 for the period Mar 2012 relative to Mar 2011. Growth rates of imports are negative with the exception of energy. The higher rate of growth of exports of 3.7 percent relative to imports of minus 5.7 percent may reflect weak demand in Italy with GDP declining during three consecutive quarters from IIIQ2011 through IQ2012.

Table III-5, Italy, Exports and Imports % Share of Products in Total and ∆%

	Exports Share %	Exports ∆% Jan-Apr 2012/ Jan-Apr 2011	Imports Share %	Imports ∆% Jan-Apr 2012/ Jan-Apr 2011
Consumer Goods	28.9	4.7	25.0	-2.8
Durable	5.9	0.8	3.0	-9.8
Non Durable	23.0	5.7	22.0	-1.8
Capital Goods	32.2	1.9	20.8	-13.9
Inter- mediate Goods	34.3	2.6	34.5	-13.0
Energy	4.7	17.3	19.7	13.0
Total ex Energy	95.3	3.0	80.3	-10.2
Total	100.0	3.7	100.0	-5.7

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/64824

Table III-6 provides Italy’s trade balance by product categories in Apr 2012 and cumulative Jan-Apr 2012. Italy’s trade balance excluding energy generated surplus of €5351 million in Apr 2012 and €19,377 million in Jan-Apr 2012 but the energy trade balance created deficit of €5553 million in Apr 2012 and €22,994 million in Jan-Apr 2012. The overall deficit in Apr 2012 was €202 million but there was an overall deficit of €3617 million in Jan-Apr 2012. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.

Table III-6, Italy, Trade Balance by Product Categories, € Millions

	Mar 2012	Cumulative Jan-Mar 2012
Consumer Goods	788	4,286
Durable	867	3,510
Nondurable	-80	776
Capital Goods	4,452	14,072
Intermediate Goods	112	1,019
Energy	-5,553	-22,994
Total ex Energy	5,351	19,377
Total	-202	-3,617

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/64824

Brazil’s terms of trade, export prices relative to import prices, deteriorated 47 percent and 36 percent excluding oil (Pelaez 1987, 176-79; Pelaez 1986, 37-66; see Pelaez and Pelaez, The Global Recession Risk (2007), 178-87). Brazil had accumulated unsustainable foreign debt by borrowing to finance balance of payments deficits during the 1970s. Foreign lending virtually stopped. The German mark devalued strongly relative to the dollar such that Brazil’s products lost competitiveness in Germany and in multiple markets in competition with Germany. The resolution of the crisis was devaluation of the Brazilian currency by 30 percent relative to the dollar and subsequent maintenance of parity by monthly devaluation equal to inflation and indexing that resulted in financial stability by parity in external and internal interest rates avoiding capital flight. With a combination of declining imports, domestic import substitution and export growth, Brazil followed rapid growth in the US and grew out of the crisis with surprising GDP growth of 4.5 percent in 1984.

The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the following Subsection IIID Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 30 the yield of the 2-year bond of the government of Greece was quoted around 100 percent. In contrast, the 2-year US Treasury note traded at 0.239 percent and the 10-year at 2.871 percent while the comparable 2-year government bond of Germany traded at 0.14 percent and the 10-year government bond of Germany traded at 1.83 percent. There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt of 120 percent of GDP, which is the third largest in the world after the US and Japan. Appendix IIIE links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).

Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.

Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:

“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”

If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.

The prospects of survival of the euro zone are dire. Table III-7 is constructed with IMF World Economic Outlook database (http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/index.aspx) for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2010.

Table III-7, World and Selected Regional and Country GDP and Fiscal Situation

	GDP 2012 USD Billions	Primary Net Lending Borrowing % GDP 2012	General Government Net Debt % GDP 2012
World	69,660
Euro Zone	12,586	-0.5	70.3
Portugal	221	0.1	110.9
Ireland	210	-4.4	102.9
Greece	271	-1.0	153.2
Spain	1,398	-3.6	67.0
Major Advanced Economies G7	34,106	-4.8	88.3
United States	15,610	-6.1	83.7
UK	2,453	-5.3	84.2
Germany	3,479	1.0	54.1
France	2,712.0	-2.2	83.2
Japan	5,981	-8.9	135.2
Canada	1,805	-3.1	35.4
Italy	2,067	2.9	102.3
China	7992	-1.3*	22.0**

*Net Lending/borrowing**Gross Debt

Source: http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/weoselgr.aspx

The data in Table III-7 are used for some very simple calculations in Table III-8. The column “Net Debt USD Billions” in Table III-8 is generated by applying the percentage in Table III-7 column “General Government Net Debt % GDP 2010” to the column “GDP USD Billions.” The total debt of France and Germany in 2012 is $4138.5 billion, as shown in row “B+C” in column “Net Debt USD Billions” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $3927.8 billion, adding rows D+E+F+G+H in column “Net Debt USD billions.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table III-8. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $8066.3 billion, which would be equivalent to 130.3 percent of their combined GDP in 2012. Under this arrangement the entire debt of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 231.9 percent if including debt of France and 167.0 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks.

Table III-8, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %

	Net Debt USD Billions	Debt as % of Germany Plus France GDP	Debt as % of Germany GDP
A Euro Area	8,847.9
B Germany	1,882.1		$8066.3 as % of $3479 =231.9% $5809.9 as % of $3479 =167.0%
C France	2,256.4
B+C	4,138.5	GDP $6,191.0 Total Debt $8066.3 Debt/GDP: 130.3%
D Italy	2,114.5
E Spain	936.7
F Portugal	245.3
G Greece	415.2
H Ireland	216.1
Subtotal D+E+F+G+H	3,927.8

Source: calculation with IMF data http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/index.aspx

There is extremely important information in Table VE-9 for the current sovereign risk crisis in the euro zone. Table VE-9 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for May 2012. German exports to other European Union (EU) members are 57.9 percent of total exports in May 2012 and 58.1 percent in Jan-May 2012. Exports to the euro area are 41.8 percent in May and 38.7 percent in Jan-May. Exports to third countries are 42.1 percent of the total in May and 41.8 percent in Jan-May. There is similar distribution for imports. Economic performance in Germany is closely related to its high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of its high share in exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.

Table III-9, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	May 2012 € Billions	May 12-Month ∆%	Jan–May 2012 € Billions	Jan-May 2012/ Jan-May 2011 ∆%
Total Exports	92.5	0.5	455.6	4.2
A. EU Members	53.6 % 57.9	-1.5	265.3 % 58.1	0.8
Euro Area	38.7 % 41.8	-2.3	176.5 % 38.7	-0.1
Non-euro Area	17.8 % 19.2	0.2	88.7 % 19.5	3.7
B. Third Countries	38.9 % 42.1	3.4	190.3 % 41.8	9.4
Total Imports	77.2	-0.2	380.4	2.6
C. EU Members	49.5 % 64.1	0.4	241.5 % 63.5	2.8
Euro Area	34.8 % 45.1	-0.6	169.7 % 44.6	2.4
Non-euro Area	14.7 % 19.0	2.7	71.7 % 18.8	3.7
D. Third Countries	27.7 % 35.9	-1.2	139.0 % 36.5	2.2

Notes: Total Exports = A+B; Total Imports = C+D

Source:

Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/PressServices/Press/pr/2012/07/PE12_234_51.html;jsessionid=F17A2975B2055CEED1CE790F42961BFF.cae2

IIIF Appendix on Sovereign Bond Valuation. There are two approaches to government finance and their implications: (1) simple unpleasant monetarist arithmetic; and (2) simple unpleasant fiscal arithmetic. Both approaches illustrate how sovereign debt can be perceived riskier under profligacy.

First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:

D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)

Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,

{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:

N(t+1) = (1+n)N(t), n>-1 (2)

The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:

B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)

On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.

Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:

(M_t + B_t)/P_t = E_t∫(1/R_t_{, t+τ})s_t_+τdτ (4)

Equation (4) expresses the monetary, M_t, and debt, B_t, liabilities of the government, divided by the price level, P_t, in terms of the expected value discounted by the ex-post rate on government debt, R_t_{, t+τ}, of the future primary surpluses s_t_+τ, which are equal to T_t_+τ – G_t_+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post R_t_{, t+τ}. The second equation of Cochrane (2011Jan, 5) is:

M_tV(i_t, ·) = P_tY_t (5)

Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):

“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”

An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.

There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:

(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress

(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality

(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.

IIIG Appendix on Deficit Financing of Growth and the Debt Crisis. This section is divided into two subsections. Subsection IIIGA Monetary Policy with Deficit Financing of Economic Growth analyzes proposals to promote economic growth with government deficits financed by monetary policy. Subsection IIIGB Adjustment during the Debt Crisis of the 1980s provides the routes of adjustment of Brazil during the debt crisis after 1983.

IIIGA Monetary Policy with Deficit Financing of Economic Growth. The advice of Bernanke (2000, 159-161, 165) to the Bank of Japan (BOJ) to reignite growth and employment in the economy consisted of zero interest rates and commitment to a high inflation target as proposed by Krugman (1999):

“I agree that this approach would be helpful, in that it would give private decision makers more information about the objectives of monetary policy. In particular, a target in the 3-4 percent range for inflation to be maintained for a number of years, would confirm not only that the BOJ is intent on moving safely away from a deflationary regime but also that it intends to make up some of the ‘price-level gap’ created by 8 years of zero or negative inflation. In stating an inflation target of, say, 3-4 percent, the BOJ would be giving the direction in which it will attempt to move the economy. The important question, of course, is whether a determined Bank of Japan would be able to depreciate the yen. I am not aware of any previous historical episode, including the period of very low interest rates in the 1930s, in which a central bank has been unable to devaluate its currency. There is strong presumption that vigorous intervention by the BOJ, together with appropriate announcements to influence market expectations, could drive down the value of the yen significantly. Further, there seems little reason not to try this strategy. The ‘worst’ that could happen would be that the BOJ would greatly increase its holdings of reserve assets. Perhaps not all of those who cite the beggar-thy-neighbor thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery. Franklin D. Roosevelt was elected president of the United States in 1932 with the mandate to get the country out of the Depression. In the end, his most effective actions were the same ones that Japan needs to take—namely, rehabilitation of the banking system and devaluation of the currency.”

Bernanke (2002) also finds devaluation to be a powerful policy instrument to move the economy away from deflation and weak economic and financial conditions:

“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.¹⁷ The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”

Krugman (2012Apr24) finds that this advice of then Professor Bernanke (2000) is relevant to current monetary policy in the US. The relevance would be in a target of inflation in the US of 4 percent, which was the rate prevailing in the late years of the Reagan Administration. The liquidity trap is defined by Krugman (1998, 141) “as a situation in which conventional monetary policies have become impotent, because nominal interest rates are at or near zero: injecting monetary base into the economy has no effect, because base and bonds are viewed by the private sector as perfect substitutes.” The adversity of the liquidity trap in terms of weakness in output and employment can be viewed as an economy experiencing deflation that cannot be contained by increases in the monetary base, or currency held by the public plus reserves held by banks at the central bank. The argument of monetary neutrality is that an increase in money throughout all future periods will increase prices by the same proportion. According to Krugman (1998, 142), the liquidity trap occurs because the public does not expect that the central bank will continue the monetary expansion once inflation returns to a certain level. Expectations are critical in explaining the liquidity trap and have been shaped by the continued fight against inflation by central banks during several decades with the possible exception of Japan beginning with the lost decade when deflation became the relevant policy concern. In this framework, monetary policy is ineffectual if perceived by the public as temporary. Credible monetary policy is perceived by the public as permanent deliberate increase in prices or output: “if the central bank can credibly promise to be irresponsible—that is, convince the market that it will in fact allow prices to rise sufficiently—it can bootstrap the economy out of the trap” (Krugman 1998, 161).

Fed Chairman Bernanke (2012Apr25, 7-8) argues that there is no conflict between his advice to the Bank of Japan as Princeton Professor Bernanke (2000) and current monetary policy by the Federal Open Market Committee (FOMC):

“So there’s this view circulating [Princeton Professor Paul Krugman at http://www.nytimes.com/2012/04/29/magazine/chairman-bernanke-should-listen-to-professor-bernanke.html?pagewanted=all] that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. Our—my views and our policies today are completely consistent with the views that I held at that time. I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation—that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer—are not exhausted, there are still other things that the central bank can do to create additional accommodation. Now, looking at the current situation in United States, we are not in deflation. When deflation became a significant risk in late 2010, or at least a modest risk in late 2010, we used additional balance sheet tools to help return inflation close to the 2 percent target. Likewise, we have been aggressive and creative in using non-federal-funds-rate-centered tools to achieve additional accommodation for the U.S. economy. So the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation, and, clearly, when you’re in deflation and in recession, then both sides of your mandates, so to speak, are demanding additional accommodation. In this case, it’s—we are not in deflation, we have an inflation rate that’s close to our objective. Now, why don’t we do more? Well, first I would again reiterate that we are doing a great deal; policy is extraordinarily accommodative. We—and I won’t go through the list again, but you know all the things that we have done to try to provide support to the economy. I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction—a slightly increased pace of reduction in the unemployment rate? The view of the Committee is that that would be very reckless. We have—we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been be able to take strong accommodative actions in the last four or five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.”

Chairman Bernanke (2012Apr 25, 10-11) explains current FOMC policy:

“So it’s not a ceiling, it’s a symmetric objective, and we attempt to bring inflation close to 2 percent. And in particular, if inflation were to jump for whatever reason—and we don’t have, obviously don’t have perfect control of inflation—we’ll try to return inflation to 2 percent at a pace which takes into account the situation with respect to unemployment. The risk of higher inflation—you say 2½ percent; well, 2½ percent expected change might involve a distribution of outcomes, some of which might be much higher than 2½ percent. And the concern we have is that if inflation were to run well above 2 percent for a protracted period, that the credibility and the well-anchored inflation expectations, which are such a valuable asset of the Federal Reserve, might become eroded, in which case we would in fact have less rather than more flexibility to use accommodative monetary policy to achieve our employment goals. I would cite to you, just as an example, if you look at Vice Chair Yellen’s paper, which she gave—or speech, which she gave a couple of weeks ago, where she described a number of ways of looking at the late 2014 guidance. She showed there some so-called optimal policy rules that come from trying to get the best possible outcomes from our quantitative econometric models, and what you see, if you look at that, is that the best possible outcomes, assuming perfect certainty, assuming perfect foresight—very unrealistic assumptions—still involve inflation staying quite close to 2 percent. So there is no presumption even in our econometric models that you need inflation well above target in order to make progress on unemployment.”

In perceptive analysis of growth and macroeconomics in the past six decades, Rajan (2012FA) argues that “the West can’t borrow and spend its way to recovery.” The Keynesian paradigm is not applicable in current conditions. Advanced economies in the West could be divided into those that reformed regulatory structures to encourage productivity and others that retained older structures. In the period from 1950 to 2000, Cobet and Wilson (2002) find that US productivity, measured as output/hour, grew at the average yearly rate of 2.9 percent while Japan grew at 6.3 percent and Germany at 4.7 percent (see Pelaez and Pelaez, The Global Recession Risk (2007), 135-44). In the period from 1995 to 2000, output/hour grew at the average yearly rate of 4.6 percent in the US but at lower rates of 3.9 percent in Japan and 2.6 percent in the US. Rajan (2012FA) argues that the differential in productivity growth was accomplished by deregulation in the US at the end of the 1970s and during the 1980s. In contrast, Europe did not engage in reform with the exception of Germany in the early 2000s that empowered the German economy with significant productivity advantage. At the same time, technology and globalization increased relative remunerations in highly-skilled, educated workers relative to those without skills for the new economy. It was then politically appealing to improve the fortunes of those left behind by the technological revolution by means of increasing cheap credit. As Rajan (2012FA) argues:

“In 1992, Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, partly to gain more control over Fannie Mae and Freddie Mac, the giant private mortgage agencies, and partly to promote affordable homeownership for low-income groups. Such policies helped money flow to lower-middle-class households and raised their spending—so much so that consumption inequality rose much less than income inequality in the years before the crisis. These policies were also politically popular. Unlike when it came to an expansion in government welfare transfers, few groups opposed expanding credit to the lower-middle class—not the politicians who wanted more growth and happy constituents, not the bankers and brokers who profited from the mortgage fees, not the borrowers who could now buy their dream houses with virtually no money down, and not the laissez-faire bank regulators who thought they could pick up the pieces if the housing market collapsed. The Federal Reserve abetted these shortsighted policies. In 2001, in response to the dot-com bust, the Fed cut short-term interest rates to the bone. Even though the overstretched corporations that were meant to be stimulated were not interested in investing, artificially low interest rates acted as a tremendous subsidy to the parts of the economy that relied on debt, such as housing and finance. This led to an expansion in housing construction (and related services, such as real estate brokerage and mortgage lending), which created jobs, especially for the unskilled. Progressive economists applauded this process, arguing that the housing boom would lift the economy out of the doldrums. But the Fed-supported bubble proved unsustainable. Many construction workers have lost their jobs and are now in deeper trouble than before, having also borrowed to buy unaffordable houses. Bankers obviously deserve a large share of the blame for the crisis. Some of the financial sector’s activities were clearly predatory, if not outright criminal. But the role that the politically induced expansion of credit played cannot be ignored; it is the main reason the usual checks and balances on financial risk taking broke down.”

In fact, Raghuram G. Rajan (2005) anticipated low liquidity in financial markets resulting from low interest rates before the financial crisis that caused distortions of risk/return decisions provoking the credit/dollar crisis and global recession from IVQ2007 to IIQ2009. Near zero interest rates of unconventional monetary policy induced excessive risks and low liquidity in financial decisions that were critical as a cause of the credit/dollar crisis after 2007. Rajan (2012FA) argues that it is not feasible to return to the employment and income levels before the credit/dollar crisis because of the bloated construction sector, financial system and government budgets.

Proposals for higher inflation target of 4 percent for FOMC monetary policy are based on the view that interest rates are too high in real terms because the nominal rate is already at zero and cannot be lowered further. Rajan (2012May8) argues that higher inflation targets by the FOMC need not increase aggregate demand as proposed in those policies because of various factors:

· Pension Crisis. Baby boomers close to retirement calculate that their savings are not enough at current interest rates and may simply save more. Many potential retirees are delaying retirement in order to save what is required to provide for comfortable retirement.

· Regional Income and Debt Disparities. Unemployment, indebtedness and income growth differ by regions in the US. It is not feasible to relocate demand around the country such that decreases in real interest rates may not have aggregate demand effects.

· Inflation Expectations. Rajan (2012May) argues that there is not much knowledge about how people form expectations. Increasing the FOMC target to 4 percent could erode control of monetary policy by the central bank. More technical analysis of this issue, which could be merely repetition of inflation surprise in the US Great Inflation of the 1970s, is presented in Appendix IIA.

· Frictions. Keynesian economics is based on rigidities of wages and benefits in economic activities but there may be even more important current inflexibilities such as moving when it is not possible to sell and buy a house.

Thomas J. Sargent and William L. Silber, writing on “The challenges of the Fed’s bid for transparency,” on Mar 20, published in the Financial Times (http://www.ft.com/intl/cms/s/0/778eb1ce-7288-11e1-9c23-00144feab49a.html#axzz1pexRlsiQ), analyze the costs and benefits of transparency by the Fed. In the analysis of Sargent and Silber (2012Mar20), benefits of transparency by the Fed will exceed costs if the Fed is successful in conveying to the public what policies would be implemented and how forcibly in the presence of unforeseen economic events. History has been unkind to policy commitments. The risk in this case is if the Fed would postpone adjustment because of political pressures as has occurred in the past or because of errors of evaluation and forecasting of economic and financial conditions. Both political pressures and errors abounded in the unhappy stagflation of the 1970s also known as the US Great Inflation (see 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 and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB). The challenge of the Fed, in the view of Sargent and Silber 2012Mar20), is to convey to the public the need to deviate from the commitment to interest rates of zero to ¼ percent because conditions have changed instead of unwarranted inaction or policy changes. Errors have abounded such as a critical cause of the global recession pointed by Sargent and Silber (2012Mar20): “While no president is known to have explicitly pressurized Mr. Bernanke’s predecessor, Alan Greenspan, he found it easy to maintain low interest rates for too long, fuelling the credit boom and housing bubble that led to the financial crisis in 2008.” Sargent and Silber (2012Mar20) also find need of commitment of fiscal authorities to consolidation needed to attain sustainable path of debt. Further analysis is provided in Appendix IIA Inflation Surprise and Appendix IIB Unpleasant Monetarist Arithmetic at http://cmpassocregulationblog.blogspot.com/2012/05/world-inflation-waves-monetary-policy.html.

According to an influential school of thought, the interrelation of growth and inflation in Latin America is complex, preventing analysis of whether inflation promotes or restricts economic growth (Seers 1962, 191). In this view, there are multiple structural factors of inflation. Successful economic policy requires a development program that ameliorates structural weaknesses. Policy measures in developed countries are not transferable to developing economies.

In extensive research and analysis, Kahil (1973) finds no evidence of the role of structural factors in Brazilian inflation from 1947 to 1963. In fact, Kahil (1973, 329) concludes:

“The immediate causes of the persistent and often violent rise in prices, with which Brazil was plagued from the last month of 1948 to the early months of 1964, are pretty obvious: large and generally growing public deficits, together with too rapid an expansion of bank credit in the first years and, later, exaggerated and more and more frequent increases in the legal minimum wages.”

Kahil (1973, 334) analyzes the impact of inflation on the economy and society of Brazil:

“The real incomes of the various social classes alternately suffered increasingly frequent and sharp fluctuations: no sooner had a group succeeded in its struggle to restore its real income to some previous peak than it witnessed its erosion with accelerated speed; and it soon became apparent to all that the success of any important group in raising its real income, through government actions or by other means, was achieved only by reducing theirs. Social harmony, the general climate of euphoria, and also enthusiasm for government policies, which had tended to prevail until the last months of 1958, gave way in the following years of galloping inflation to intense political and social conflict and to profound disillusionment with public policies. By 1963 when inflation reached its runaway stage, the economy had ceased to grow, industry and transport were convulsed by innumerable strikes, and peasants were invading land in the countryside; and the situation further worsened in the first months of 1964.”

Professor Nathiel H. Leff (1975) at Columbia University identified another important contribution of Kahil (1975, Chapter IV“The supply of capital,” 127-185) of key current relevance to current proposals to promote economic growth and employment by raising inflation targets:

“Contrary to the assertions of some earlier writers on this topic, Kahil concludes that inflation did not lead to accelerated capital formation in Brazil.”

In econometric analysis of Brazil’s inflation from 1947 to 1980, Barbosa (1987) concludes:

“The most important result, based on the empirical evidence presented here, is that in the long run inflation is a monetary phenomenon. It follows that the most challenging task for Brazilian society in the near future is to shape a monetary-fiscal constitution that precludes financing much of the budget deficits through the inflation tax.”

Experience with continuing fiscal deficits and money creation tend to show accelerating inflation. Table III-10 provides average yearly rates of growth of two definitions of the money stock, M1, and M2 that adds also interest-paying deposits. The data were part of a research project on the monetary history of Brazil using the NBER framework of Friedman and Schwartz (1963, 1970) and Cagan (1965) as well as the institutional framework of Rondo E. Cameron (1967, 1972) who inspired the research (Pelaez 1974, 1975, 1976a,b, 1977, 1979, Pelaez and Suzigan 1978, 1981). The data were also used to test the correct specification of money and income following Sims (1972; see also Williams et al. 1976) as well as another test of orthogonality of money demand and supply using covariance analysis. The average yearly rates of inflation are high for almost any period in 1861-1970, even when prices were declining at 1 percent in 19^th century England, and accelerated to 27.1 percent in 1945-1970. There may be concern in an uncontrolled deficit monetized by sharp increases in base money. The Fed may have desired to control inflation at 2 percent after lowering the fed funds rate to 1 percent in 2003 but inflation rose to 4.1 percent in 2007. There is not “one hundred percent” confidence in controlling inflation because of the lags in effects of monetary policy impulses and the equally important lags in realization of the need for action and taking of action and also the inability to forecast any economic variable. Romer and Romer (2004) find that a one percentage point tightening of monetary policy is associated with a 4.3 percent decline in industrial production. There is no change in inflation in the first 22 months after monetary policy tightening when it begins to decline steadily, with decrease by 6 percent after 48 months (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 102). Even if there were one hundred percent confidence in reducing inflation by monetary policy, it could take a prolonged period with adverse effects on economic activity. Certainty does not occur in economic policy, which is characterized by costs that cannot be anticipated.

Table III-10, Brazil, Yearly Growth Rates of M1, M2, Nominal Income (Y), Real Income (y), Real Income per Capita (y/n) and Prices (P)

	M1	M2	Y	y	y/N	P
1861-1970	9.3	6.2	10.2	4.6	2.4	5.8
1861-1900	5.4	5.9	5.9	4.4	2.6	1.6
1861-1913	4.7	4.7	5.3	4.4	2.4	0.1
1861-1929	5.5	5.6	6.4	4.3	2.3	2.1
1900-1970	13.9	13.9	15.2	4.9	2.6	10.3
1900-1929	8.9	8.9	10.8	4.2	2.1	6.6
1900-1945	8.6	9.1	9.2	4.3	2.2	4.9
1920-1970	17.8	17.3	19.4	5.3	2.8	14.1
1920-1945	8.3	8.7	7.5	4.3	2.2	3.2
1920-1929	5.4	6.9	11.1	5.3	3.3	5.8
1929-1939	8.9	8.1	11.7	6.3	4.1	5.4
1945-1970	30.3	29.2	33.2	6.1	3.1	27.1

Note: growth rates are obtained by regressions of the natural logarithms on time. M1 and M2 definitions of the money stock; Y nominal GDP; y real GDP; y/N real GDP per capita; P prices.

Source: See Pelaez and Suzigan (1978), 143; M1 and M2 from Pelaez and Suzigan (1981); money income and real income from Contador and Haddad (1975) and Haddad (1974); prices by the exchange rate adjusted by British wholesale prices until 1906 and then from Villela and Suzigan (1973); national accounts after 1947 from Fundação Getúlio Vargas.

Chart III-1 shows in semi-logarithmic scale from 1861 to 1970 in descending order two definitions of income velocity, money income, M1, M2, an indicator of prices and real income.

Chart III-1, Brazil, Money, Income and Prices 1861-1970.

Source: © Carlos Manuel Pelaez and Wilson Suzigan. 1981. História Monetária do Brasil Segunda Edição. Coleção Temas Brasileiros. Brasília: Universidade de Brasília, 21.

Table III-11 provides yearly percentage changes of GDP, GDP per capita, base money, prices and the current account in millions of dollars during the acceleration of inflation after 1947. There was an explosion of base money or the issue of money and three waves of inflation identified by Kahil (1973). Inflation accelerated together with issue of money and political instability from 1960 to 1964. There must be a role for expectations in inflation but there is not much sound knowledge and measurement as Rajan (2012May8) argues. There have been inflation waves documented in periodic comments in this blog (http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs.html) . The risk is ignition of adverse expectations at the crest of one of worldwide inflation waves. Lack of credibility of the commitment by the FOMC to contain inflation could ignite such perverse expectations. Deficit financing of economic growth can lead to inflation and financial instability.

Table III-11, Brazil, GDP, GDP per Capita, Base Money, Prices and Current Account of the Balance of Payments, ∆% and USD Millions, 1947-1971

	GDP ∆%	GDP per Capita ∆%	Base Money ∆%	Prices ∆%	Current Account BOP USD Millions
1947	2.4	0.1	-1.4	14.0	162
1948	7.4	4.9	4.6	7.6	-24
1949	6.6	4.2	14.5	4.0	-74
1950	6.5	4.0	23.0	10.0	52
1951	5.9	2.9	15.3	21.9	-291
1952	8.7	5.6	17.7	10.2	-615
1953	2.5	-0.5	15.5	12.1	16
1954	10.1	6.9	23.4	31.0	-203
1955	6.9	3.8	18.0	14.0	17
1956	3.2	0.2	16.9	21.6	194
1957	8.1	4.9	30.5	13.9	-180
1958	7.7	4.6	26.1	10.4	-253
1959	5.6	2.5	32.3	37.7	-154
1960	9.7	6.5	42.4	27.6	-410
1961	10.3	7.1	54.4	36.1	115
1962	5.3	2.2	66.4	54.1	-346
1963	1.6	-1.4	78.4	75.2	-244
1964	2.9	-0.1	82.5	89.7	40
1965	2.7	-0.6	67.6	62.0	331
1966	4.4	1.5	25.8	37.9	153
1967	4.9	2.0	33.9	28.7	-245
1968	11.2	8.1	31.4	25.2	32
1969	9.9	6.9	22.4	18.2	549
1970	8.9	5.8	20.2	20.7	545
1971	13.3	10.2	29.8	22.0	530

Sources: Fundação Getúlio Vargas, Banco Central do Brasil and Pelaez and Suzigan (1981). Carlos Manuel Pelaez, História Econômica do Brasil: Um Elo entre a Teoria e a Realidade Econômica. São Paulo: Editora Atlas, 1979, 94.

IIIGB Adjustment during the Debt Crisis of the 1980s. Economic and financial risks in the euro area are increasingly being dominated by analytical and political disagreement on conflicts of fiscal adjustment, financial stability, economic growth and employment. Political development is beginning to push for alternative paths of policy. Blanchard (2012WEOApr) and Draghi (2012May3) provide analysis of appropriate directions of policy.

Blanchard (2012WEOApr) finds that interest rates close to zero in advanced economies have not induced higher economic growth because of two main factors—fiscal consolidation and deleveraging—that restrict economic growth in the short-term. First, Blanchard (2012WEOApr, XIII) finds that assuming a multiplier of unity of the fiscal deficit on GDP, decrease of the cyclically-adjusted deficit of advanced economies by 1 percent would reduce economic growth by one percentage point. Second, deleveraging by banks, occurring mainly in Europe, tightens credit supply with similar reduction of euro area economic growth by one percentage point in 2012. The baseline of the World Economic Outlook (WEO) of the IMF (2012WEOApr) for Apr 2012 incorporates both effects, which results in weak economic growth, in particular in Europe, and prolonged unemployment. An important analysis by Blanchard (2012WEOApr, XIII) is that “financial uncertainty, together with sharp shifts in risk appetite, has led to volatile capital flows.” Blanchard (2012WEOApr) still finds that the greatest vulnerability is another profound crisis in Europe (ECB). Crisis prevention should buttress the resilience of affected countries during those shifts in risk appetite. The role of the enhanced firewall of the IMF, European Union (EU) and European Central Bank is gaining time during which countries could engage in fiscal consolidation and structural reforms that would diminish the shifts in risk appetite, preventing devastating effects of financial crises. Volatility in capital flows is equivalent to volatility of valuations of risk financial assets. The challenge to the policy mix consists in balancing the adverse short-term effects of fiscal consolidation and deleveraging with the beneficial long-term effects of eliminating the vulnerability to shocks of risk aversion. Blanchard (2012WEOApr) finds that policy should seek short-term credibility while implementing measures that restrict the path of expenditures together with simultaneous development of institutions and rules that constrain deficits and spending in the future. There is similar policy challenge in deleveraging banks, which is required for sound lending institutions, but without causing an adverse credit crunch. Advanced economies face a tough policy challenge of increasing demand and potential growth.

The President of the European Central Bank (ECB) Mario Draghi (2012May3) also outlines the appropriate policy mix for successful adjustment:

“It is of utmost importance to ensure fiscal sustainability and sustainable growth in the euro area. Most euro area countries made good progress in terms of fiscal consolidation in 2011. While the necessary comprehensive fiscal adjustment is weighing on near-term economic growth, its successful implementation will contribute to the sustainability of public finances and thereby to the lowering of sovereign risk premia. In an environment of enhanced confidence in fiscal balances, private sector activity should also be fostered, supporting private investment and medium-term growth.

At the same time, together with fiscal consolidation, growth and growth potential in the euro area need to be enhanced by decisive structural reforms. In this context, facilitating entrepreneurial activities, the start-up of new firms and job creation is crucial. Policies aimed at enhancing competition in product markets and increasing the wage and employment adjustment capacity of firms will foster innovation, promote job creation and boost longer-term growth prospects. Reforms in these areas are particularly important for countries which have suffered significant losses in cost competitiveness and need to stimulate productivity and improve trade performance.

In this context, let me make a few remarks on the adjustment process within the euro area. As we know from the experience of other large currency areas, regional divergences in economic developments are a normal feature. However, considerable imbalances have accumulated in the last decade in several euro area countries and they are now in the process of being corrected.

As concerns the monetary policy stance of the ECB, it has to be focused on the euro area. Our primary objective remains to maintain price stability over the medium term. This is the best contribution of monetary policy to fostering growth and job creation in the euro area.

Addressing divergences among individual euro area countries is the task of national governments. They must undertake determined policy actions to address major imbalances and vulnerabilities in the fiscal, financial and structural domains. We note that progress is being made in many countries, but several governments need to be more ambitious. Ensuring sound fiscal balances, financial stability and competitiveness in all euro area countries is in our common interest.”

Economic policy during the debt crisis of 1983 may be useful in analyzing the options of the euro area. Brazil successfully combined fiscal consolidation, structural reforms to eliminate subsidies and devaluation to parity. Brazil’s terms of trade, or export prices relative to import prices, deteriorated by 47 percent from 1977 to 1983 (Pelaez 1986, 46). Table III-12 provides selected economic indicators of the economy of Brazil from 1970 to 1985. In 1983, Brazil’s inflation was 164.9 percent, GDP fell 3.2 percent, idle capacity in manufacturing reached 24.0 percent and Brazil had an unsustainable foreign debt. US money center banks would have had negative capital if loans to emerging countries could have been marked according to loss given default and probability of default (for credit risk models see Pelaez and Pelaez (2005), International Financial Architecture, 134-54). Brazil’s current account of the balance of payments shrank from $16,310 million in 1982 to $6,837 million in 1983 because of the abrupt cessation of foreign capital inflows with resulting contraction of Brazil’s GDP by 3.2 percent. An important part of adjustment consisted of agile coordination of domestic production to cushion the impact of drastic reduction in imports. In 1984, Brazil had a surplus of $45 million in current account, the economy grew at 4.5 percent and inflation was stabilized at 232.9 percent.

Table III-12, Brazil, Selected Economic Indicators 1970-1985

	Inflation ∆%	GDP Growth ∆%	Idle Capacity in MFG %	BOP Current Account USD MM
1985	223.4	7.4	19.8	-630
1984	232.9	4.5	22.6	45
1983	164.9	-3.2	24.0	-6,837
1982	94.0	0.9	15.2	-16,310
1981	113.0	-1.6	12.3	-11,374
1980	109.2	7.2	3.5	-12,886
1979	55.4	6.4	4.1	-10,742
1978	38.9	5.0	3.3	-6,990
1977	40.6	5.7	3.2	-4,037
1976	40.4	9.7	0.0	-6,013
1975	27.8	5.4	3.0	-6,711
1974	29.1	9.7	0.1	-7,122
1973	15.4	13.6	0.3	-1,688
1972	17.7	11.1	6.5	-1,489
1971	21.5	12.0	9.8	-1,307
1970	19.3	8.8	12.2	-562

Source: Carlos 21.5Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo, Editora Atlas, 1986, 86.

Chart III-2 provides the tortuous Phillips Circuit of Brazil from 1963 to 1987. There were no reliable consumer price index and unemployment data in Brazil for that period. Chart III-2 used the more reliable indicator of inflation, the wholesale price index, and idle capacity of manufacturing as a proxy of unemployment in large urban centers.

Chart III-2, Brazil, Phillips Circuit 1963-1987

Source:

©Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.

A key to success in stabilizing an economy with significant risk aversion is finding parity of internal and external interest rates. Brazil implemented fiscal consolidation and reforms that are advisable in explosive foreign debt environments. In addition, Brazil had the capacity to find parity in external and internal interest rates to prevent capital flight and disruption of balance sheets (for analysis of balance sheets, interest rates, indexing, devaluation, financial instruments and asset/liability management in that period see Pelaez and Pelaez (2007), The Global Recession Risk: Dollar Devaluation and the World Economy, 178-87). Table III-13 provides monthly percentage changes of inflation, devaluation and indexing and the monthly percent overnight interest rate. Parity was attained by means of a simple inequality:

Cost of Domestic Loan ≥ Cost of Foreign Loan

This ordering was attained in practice by setting the domestic interest rate of the overnight interest rate plus spread higher than indexing of government securities with lower spread than loans in turn higher than devaluation plus spread of foreign loans. Interest parity required equality of inflation, devaluation and indexing. Brazil devalued the cruzeiro by 30 percent in 1983 because the depreciation of the German mark DM relative to the USD had eroded the competitiveness of Brazil’s products in Germany and in competition with German goods worldwide. The database of the Board of Governors of the Federal Reserve System quotes DM 1.7829/USD on Mar 3 1980 and DM 2.4425/USD on Mar 15, 1983 (http://www.federalreserve.gov/releases/h10/hist/dat89_ge.htm) for devaluation of 37.0 percent. Parity of costs and rates of domestic and foreign loans and assets required ensuring that there would not be appreciation of the exchange rate, inducing capital flight in expectation of future devaluation that would have reversed stabilization. One of the main problems of adjustment of members of the euro area with high debts is that they cannot adjust the exchange rate because of the common euro currency. This is not an argument in favor of breaking the euro area because there would be also major problems of adjustment such as exiting the euro in favor of a new Drachma in the case of Greece. Another hurdle of adjustment in the euro area is that Brazil could have moved swiftly to adjust its economy in 1983 but the euro area has major sovereignty and distribution of taxation hurdles in moving rapidly.

Table III-13, Brazil, Inflation, Devaluation, Overnight Interest Rate and Indexing, Percent per Month, 1984

1984	Inflation IGP ∆%	Devaluation ∆%	Overnight Interest Rate %	Indexing ∆%
Jan	9.8	9.8	10.0	9.8
Feb	12.3	12.3	12.2	12.3
Mar	10.0	10.1	11.3	10.0
Apr	8.9	8.8	10.1	8.9
May	8.9	8.9	9.8	8.9
Jun	9.2	9.2	10.2	9.2
Jul	10.3	10.2	11.9	10.3
Aug	10.6	10.6	11.0	10.6
Sep	10.5	10.5	11.9	10.5
Oct	12.6	12.6	12.9	12.6
Nov	9.9	9.9	10.9	9.9
Dec	10.5	10.5	11.5	10.5

Source: Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo, Editora Atlas, 1986, 86.

IV Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table IV-1, updated with every blog comment, 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 sovereign risk issues (Peter Spiegel and Quentin Peel, “Europe: Northern Exposures,” Financial Times, Mar 9, 2011 http://www.ft.com/intl/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1gAlaswcW). Newly available data on inflation is considered below in this section. Data in Table IV-1 for the euro zone and its members are updated from information provided by Eurostat but individual country information is provided in this section as soon as available, following Table IV-1. Data for other countries in Table IV-1 are also updated with reports from their statistical agencies. Economic data for major regions and countries is considered in Section V World Economic Slowdown following with individual country and regional data tables.

Table IV-1, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates

	GDP	CPI	PPI	UNE
US	2.0	1.7	0.7	8.2
Japan	2.8	0.2	-1.3	4.4
China	8.9	2.2	-2.1
UK	-0.2	2.8* RPI 3.1	2.3* output 2.0** input -2.3*	8.2
Euro Zone	-0.1	2.4	2.3	11.1
Germany	1.2	2.2	2.1	5.6
France	0.3	2.3	2.2	10.1
Nether-lands	-1.3	2.5	2.6	5.1
Finland	1.7	3.1	2.1	7.6
Belgium	0.5	2.6	2.5	7.2
Portugal	-2.2	2.7	3.2	15.2
Ireland	NA	1.9	2.1	14.6
Italy	-1.3	3.5	2.3	10.1
Greece	-6.2	0.9	5.1	NA
Spain	-0.4	1.9	3.2	24.6

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 http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/may-2012/index.html **Core

PPI http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/june-2012/index.html

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

Table IV-1 shows the simultaneous occurrence of low growth, inflation and unemployment in advanced economies. The US grew at 2.0 percent in IQ2012 relative to IQ2011 (Table 8, p 11 in http://www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp1q12_3rd.pdf See http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html). Japan’s GDP fell 0.6 percent in IVQ2011 relative to IVQ2010 and contracted 1.8 percent in IIQ2011 relative to IIQ2010 because of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 but grew at the seasonally-adjusted annual rate (SAAR) of 7.8 percent in IIIQ2011, increasing at the SAAR of 0.1 percent in IVQ 2011 and 4.7 percent in IQ2012 (see Section VB at http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs_04.html); the UK grew at minus 0.3 percent in IQ2012 relative to IVQ2011 and GDP fell 0.2 percent in IQ2012 relative to IQ2011 (see Section VB http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states_03.html); and the Euro Zone grew at 0.0 percent in IQ2012 relative to IVQ2011 and fell 0.1 percent in IQ2012 relative to IQ2011 (see Section VD http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities_10.html and http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-06062012-AP/EN/2-06062012-AP-EN.PDF ). These are stagnating or “growth recession” rates, which are positive or about nil growth rates instead of contractions but insufficient to recover employment. The rates of unemployment are quite high: 8.2 percent in the US but 17.8 percent for unemployment/underemployment or job stress of 28.6 million (see Table I-4 in http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html and earlier http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs.html http://cmpassocregulationblog.blogspot.com/2012/05/recovery-without-jobs-twenty-eight.html http://cmpassocregulationblog.blogspot.com/2012/04/thirty-million-unemployed-or.html), 4.4 percent for Japan (see Section VB http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states_03.html), 8.2 percent for the UK with high rates of unemployment for young people (see the labor statistics of the UK in Subsection VH http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of_24.html) and 11.1 percent in the Euro Zone (section VD http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real_6867.html ). Twelve-month rates of inflation have been quite high, even when some are moderating at the margin: 1.7 percent in the US, 0.2 percent for Japan, 2.2 percent for China, 2.4 percent for the Euro Zone and 2.8 percent for the UK (see Section IV http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of_24.html). Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. There are six key interrelated vulnerabilities in the world economy that have been causing global financial turbulence: (1) sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings (see Section III in this post and the earlier post http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html); (2) the tradeoff of growth and inflation in China now with change in growth strategy to domestic consumption instead of investment and political developments in a decennial transition; (3) slow growth by repression of savings with de facto interest rate controls (see http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html), weak hiring with the loss of 10 million full-time jobs (see Section I and earlier http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of.html) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (see Section IB http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real.html); (4) the timing, dose, impact and instruments of normalizing monetary and fiscal policies (see IV Budget/Debt Quagmire in http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies; (5) the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 that had repercussions throughout the world economy because of Japan’s share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) geopolitical events in the Middle East.

In the effort to increase transparency, the Federal Open Market Committee (FOMC) provides both economic projections of its participants and views on future paths of the policy rate that in the US is the federal funds rate or interest on interbank lending of reserves deposited at Federal Reserve Banks. These projections and views are discussed initially followed with appropriate analysis.

The statement of the FOMC at the conclusion of its meeting on Jun 25, 2012, revealed the following policy intentions (http://www.federalreserve.gov/newsevents/press/monetary/20120125a.htm):

“Release Date: January 25, 2012

Information received since the Federal Open Market Committee met in December suggests that the economy has been expanding moderately, notwithstanding some slowing in global growth. While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed. Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects economic growth over coming quarters to be modest and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that over coming quarters, inflation will run at levels at or below those consistent with the Committee's dual mandate.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates 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 at least through late 2014.

The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.”

There are several important issues in this statement.

1. Mandate. The FOMC 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”

2. Extending Average Maturity of Holdings of Securities. The statement of Apr 25, 2012, invokes the mandate that inflation is subdued but employment below maximum such that further accommodation is required. Accommodation consists of low interest rates. The new “Operation Twist” (http://cmpassocregulationblog.blogspot.com/2011_09_01_archive.html http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html) or restructuring the portfolio of securities of the Fed by selling short-dated securities and buying long-term securities has the objective of reducing long-term interest rates.

3. Continuing Maturity Extension Program. This program is discussed in Section II Twist Again Extension. The statement affirms: “The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative.”

4. Target of Fed Funds Rate. The FOMC continues to maintain the target of fed funds rate at 0 to ¼ percent.

5. Advance Guidance. The FOMC increases transparency by advising on the expectation of the future path of fed funds rate. This guidance is the view that conditions such as “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 at least through late 2014.”

6. Monitoring and Policy Focus. The FOMC reconsiders its policy continuously in accordance with available information: “The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.”

Table IV-2 provides economic projections of governors of the Board of Governors of the Federal Reserve and regional presidents of Federal Reserve Banks released at the meeting of Jun 20, 2012. The Fed releases the data with careful explanations (http://www.federalreserve.gov/newsevents/press/monetary/20120620b.htm). Columns “∆% GDP,” “∆% PCE Inflation” and “∆% Core PCE Inflation” are changes “from the fourth quarter of the previous year to the fourth quarter of the year indicated.” The GDP report for IQ2012 is analyzed in a prior blog post together with the PCE inflation data from the report on personal income and outlays (http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs.html). The Bureau of Economic Analysis (BEA) provides the second estimate of IQ2012 GDP with the third estimate to be released on Jun 28 (http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm). PCE inflation is the index of personal consumption expenditures (PCE) of the report of the Bureau of Economic Analysis (BEA) on “Personal Income and Outlays” (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm), which is analyzed in this blog as soon as available (for the latest report for Apr see http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm and http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs.html). The next report on “Personal Income and Outlays” for May will be released at 8:30 AM on Jun 29, 2012. PCE core inflation consists of PCE inflation excluding food and energy. Column “UNEMP %” is the rate of unemployment measured as the average civilian unemployment rate in the fourth quarter of the year. The Bureau of Labor Statistics (BLS) provides the Employment Situation Report with the civilian unemployment rate in the first Friday of every month, which is analyzed in this blog (the May report is analyzed at http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs.html). The report for Jun will be released on July 6, 2012 (http://www.bls.gov/cps/). “Longer term projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy” (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120620.pdf).

It is instructive to focus on 2012, as 2013, 2014 and longer term are too far away, and there is not much information on what will happen in 2013 and beyond. The central tendency should provide reasonable approximation of the view of the majority of members of the FOMC but the second block of numbers provides the range of projections by FOMC participants. The first row for each year shows the projection introduced after the meeting of Jun 20, 2012, and the second row “PR” the projection of the Apr 25, 2012 meeting. There are three major changes in the view.

1. Growth “∆% GDP.” The FOMC has reduced the forecast of GDP growth in 2012 from 3.3 to 3.7 percent in Jun 2011 to 2.5 to 2.9 percent in Nov 2011 and 2.2 to 2.7 percent at the Jan 25 meeting but increased it to 2.4 to 2.9 percent at the Apr 25, 2012 meeting, reducing it to 1.9 to 2.4 percent at the Jun 20, 2012 meeting.

2. Rate of Unemployment “UNEM%.” The FOMC increased the rate of unemployment from 7.8 to 8.2 percent in Jun 2011 to 8.5 to 8.7 percent in Nov 2011 but has reduced it to 8.2 to 8.5 percent at the Jan 25 meeting and further down to 7.8 to 8.0 percent at the Apr 25, 2012 meeting but increased it to 8.0 to 8.2 percent at the Jun 20, 2012 meeting.

3. Inflation “∆% PCE Inflation.” The FOMC changed the forecast of personal consumption expenditures (PCE) inflation from 1.5 to 2.0 percent in Jun 2011 to virtually the same of 1.4 to 2.0 percent in Nov 2011 but has reduced it to 1.4 to 1.8 percent at the Jan 25 meeting but increased it to 1.9 to 2.0 percent at the Apr 25, 2012 meeting, reducing it to 1.2 to 1.7 percent at the Jun 20, 2012 meeting.

4. Core Inflation “∆% Core PCE Inflation.” Core inflation is PCE inflation excluding food and energy. There is again not much of a difference of the projection for 2012 in Jun 2011 of 1.4 to 2.0 percent and the Nov 2011 projection of 1.5 to 2.0 percent, which has been reduced slightly to 1.5 to 1.8 percent at the Jan 25 meeting but increased to 1.8 to 2.0 percent at the Apr 25, 2012 meeting, reducing it to 1.7 to 2.0 percent at the Jun 20, 2012 meeting.

Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents in FOMC, June 2012 and April 2012

	∆% GDP	UNEM %	∆% PCE Inflation	∆% Core PCE Inflation
Central Tendency
2012 Apr PR	1.9 to 2.4 2.4 to 2.9	8.0 to 8.2 7.8 to 8.0	1.2 to 1.7 1.9 to 2.0	1.7 to 2.0 1.8 to 2.0
2013 Apr PR	2.2 to 2.8 2.7 to 3.1	7.5 to 8.0 7.3 to 7.7	1.5 to 2.0 1.6 to 2.0	1.6 to 2.0 1.7 to 2.0
2014 Apr PR	3.0 to 3.5 3.1 to 3.6	7.0 to 7.7 6.7 to 7.4	1.5 to 2.0 1.7 to 2.0	1.6 to 2.0 1.8 to 2.0
Longer Run Apr PR	2.3 to 2.5 2.3 to 2.6	5.2 to 6.0 5.2 to 6.0	2.0 2.0
Range
2012 Apr PR	1.6 to 2.5 2.1 to 3.0	7.8 to 8.4 7.8 to 8.2	1.2 to 2.0 1.8 to 2.3	1.7 to 2.0 1.7 to 2.0
2013 Apr PR	2.2 to 3.5 2.4 to 3.8	7.0 to 8.1 7.0 to 8.1	1.5 to 2.1 1.5 to 2.1	1.4 to 2.1 1.6 to 2.1
2014 Apr PR	2.8 to 4.0 2.9 to 4.3	6.3 to 7.7 6.3 to 7.7	1.5 to 2.2 1.5 to 2.2	1.5 to 2.2 1.7 to 2.2
Longer Run Apr PR	2.2 to 3.0 2.2 to 3.0	4.9 to 6.3 4.9 to 6.0	2.0 2.0

Notes: UEM: unemployment; PR: Projection

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120620.pdf

Another important decision at the FOMC meeting on Jan 25, 2012, is formal specification of the goal of inflation of 2 percent per year but without specific goal for unemployment (http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm):

“Following careful deliberations at its recent meetings, the Federal Open Market Committee (FOMC) has reached broad agreement on the following principles regarding its longer-run goals and monetary policy strategy. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.

The FOMC is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.

Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances.

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants' estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC's Summary of Economic Projections. For example, in the most recent projections, FOMC participants' estimates of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent, roughly unchanged from last January but substantially higher than the corresponding interval several years earlier.

In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate. ”

The probable intention of this specific inflation goal is to “anchor” inflationary expectations. Massive doses of monetary policy of promoting growth to reduce unemployment could conflict with inflation control. Economic agents could incorporate inflationary expectations in their decisions. As a result, the rate of unemployment could remain the same but with much higher rate of inflation (see Kydland and Prescott 1977 and Barro and Gordon 1983; 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). Strong commitment to maintaining inflation at 2 percent could control expectations of inflation.

The FOMC continues its efforts of increasing transparency that can improve the credibility of its firmness in implementing its dual mandate. Table IV-3 provides the views by participants of the FOMC of the levels at which they expect the fed funds rate in 2012, 2013, 2014 and the in the longer term. Table IV-3 is inferred from a chart provided by the FOMC with the number of participants expecting the target of fed funds rate (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120620.pdf). There are 16 participants expecting the rate to remain at 0 to ¼ percent in 2012 and only three to be higher. Not much change is expected in 2013 either with 13 participants anticipating the rate at the current target of 0 to ¼ percent and only six expecting higher rates. The rate would still remain at 0 to ¼ percent in 2014 for six participants with five expecting the rate to be in the range of 0.5 to 1 percent and five participants expecting rates from 1 to 2.0 percent but only three with rates exceeding 2.0 percent. This table is consistent with the guidance statement of the FOMC that rates will remain at low levels until late in 2014.

Table IV-3, US, Views of Target Federal Funds Rate at Year-End of Federal Reserve Board Members and Federal Reserve Bank Presidents Participating in FOMC, June 20, 2012

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120620.pdf

Additional information is provided in Table IV-4 with the number of participants expecting increasing interest rates in the years from 2012 to 2015. It is evident from Table IV-4 that the prevailing view in the FOMC is for interest rates to continue at low levels in future years. This view is consistent with the economic projections of low economic growth, relatively high unemployment and subdued inflation provided in Table IV-2.

Table IV-4, US, Views of Appropriate Year of Increasing Target Federal Funds Rate of Federal Reserve Board Members and Federal Reserve Bank Presidents Participating in FOMC, June 20, 2012

Appropriate Year of Increasing Target Fed Funds Rate	Number of Participants
2012	3
2013	3
2014	7
2015	6

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120620.pdf

The producer price index of the US from 1960 to 2012 in Chart IV-1 shows various periods of more rapid or less rapid inflation but no bumps. The major event is the decline in 2008 when risk aversion because of the global recession caused the collapse of oil prices from $148/barrel to less than $80/barrel with most other commodity prices also collapsing. The event had nothing in common with explanations of deflation but rather with the concentration of risk exposures in commodities after the decline of stock market indexes. Eventually, there was a flight to government securities because of the fears of insolvency of banks caused by statements supporting proposals for withdrawal of toxic assets from bank balance sheets in the Troubled Asset Relief Program (TARP), as explained by Cochrane and Zingales (2009). The bump in 2008 with decline in 2009 is consistent with the view that zero interest rates with subdued risk aversion induce carry trades into commodity futures.

Chart IV-1, US, Producer Price Index, Finished Goods, NSA, 1960-2012

Source: US Bureau of Labor Statistics

Chart IV-2 provides 12-month percentage changes of the producer price index from 1960 to 2012. The distinguishing event in Chart IV-2 is the Great Inflation of the 1970s. The shape of the two-hump Bactrian camel of the 1970s resembles the double hump from 2007 to 2012.

Chart IV-2, US, Producer Price Index, Finished Goods, 12-Month Percentage Change, NSA, 1960-2012

Source: US Bureau of Labor Statistics

The producer price index excluding food and energy from 1973 to 2012, the first historical date of availability in the dataset of the Bureau of Labor Statistics (BLS), shows similarly dynamic behavior as the overall index, as shown in Chart IV-3. There is no evidence of persistent deflation in the US PPI.

Chart IV-3, US Producer Price Index, Finished Goods Excluding Food and Energy, NSA, 1973-2012

Source: US Bureau of Labor Statistics

Chart IV-4 provides 12-month percentage rates of change of the finished goods index excluding food and energy. The dominating characteristic is the Great Inflation of the 1970s. The double hump illustrates how inflation may appear to be subdued and then returns with strength.

Chart IV-4, US Producer Price Index, Finished Goods Excluding Food and Energy, 12-Month Percentage Change, NSA, 1974-2012

Source: US Bureau of Labor Statistics

The producer price index of energy goods from 1974 to 2012 is provided in Chart IV-5. The first jump occurred during the Great Inflation of the 1970s analyzed in various comments of this blog (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html 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) and in Appendix I. There is relative stability of producer prices after 1986 with another jump and decline in the late 1990s into the early 2000s. The episode of commodity price increases during a global recession in 2008 could only have occurred with interest rates dropping toward zero, which stimulated the carry trade from zero interest rates to leveraged positions in commodity futures. Commodity futures exposures were dropped in the flight to government securities after Sep 2008. Commodity future exposures were created again when risk aversion diminished around Mar 2011 after the finding that US bank balance sheets did not have the toxic assets that were mentioned in proposing TARP in Congress (see Cochrane and Zingales 2009). Fluctuations in commodity prices and other risk financial assets originate in carry trade when risk aversion ameliorates.

Chart IV-5, US, Producer Price Index, Finished Energy Goods, NSA, 1974-2012

Source: US Bureau of Labor Statistics

Chart IV-6 shows 12-month percentage changes of the producer price index of finished energy goods from 1975 to 2012. This index is only available after 1974 and captures only one of the humps of energy prices during the Great Inflation. Fluctuations in energy prices have occurred throughout history in the US but without provoking deflation. Two cases are the decline of oil prices in 2001 to 2002 that has been analyzed by Barsky and Kilian (2004) and the collapse of oil prices from over $140/barrel with shock of risk aversion to the carry trade in Sep 2008.

Chart IV-6, US, Producer Price Index, Finished Energy Goods, 12-Month Percentage Change, NSA, 1974-2012

Source: US Bureau of Labor Statistics

Headline and core producer price indexes are in Table IV-5. The headline PPI SA increased 0.1 percent in Jun 2012 and 0.7 percent NSA in the 12 months ending in Jun 2012. The core PPI SA increased 0.2 percent in Jun 2012 and rose 2.6 percent in 12 months. Analysis of annual equivalent rates of change shows inflation waves similar to those worldwide. In the first wave, the absence of risk aversion from the sovereign risk crisis in Europe motivated the carry trade from zero interest rates into commodity futures that caused the average equivalent rate of 9.7 percent in the headline PPI in Jan-Apr 2011 and 4.0 percent in the core PPI. In the second wave, commodity futures prices collapsed in May 2011 with the return of risk aversion originating in the sovereign risk crisis of Europe. The annual equivalent rate of headline PPI inflation collapsed to 1.2 percent in May-Jun but the core annual equivalent inflation rate was much higher at 3.0 percent. In the third wave, headline PPI inflation resuscitated with annual equivalent at 6.6 percent in Jul-Sep 2011 and core PPI inflation at 4.1 percent. Core PPI inflation was persistent throughout 2011, jumping from annual equivalent at 2.4 percent in the first four months of 2010 to 4.7 percent in 12 months ending in Dec 2012. Unconventional monetary policy is based on the proposition that core rates reflect more fundamental inflation and are thus better predictors of the future. In practice, the relation of core and headline inflation is as difficult to predict as future inflation (see IIID Supply Shocks in http://cmpassocregulationblog.blogspot.com/2011_05_01_archive.html). In the fourth wave, risk aversion originating in the lack of resolution of the European debt crisis caused unwinding of carry trades with annual equivalent headline PPI inflation of minus 1.2 percent in Oct-Nov 2011 and 0.6 percent in the core annual equivalent. In the fifth wave from Dec 2011 to Jan 2012, annual equivalent inflation was 1.2 percent for the headline index but 4.9 percent for the core index excluding food and energy. In the sixth wave, annual equivalent inflation in Feb-Mar 2012 was 1.8 percent for the headline PPI and 3.0 percent for the core. In the seventh wave, renewed risk aversion caused reversal of carry trade commodity exposures with annual equivalent headline inflation of minus 7.0 percent in Apr-May 2012 while core PPI inflation was at annual equivalent 2.4 percent. An eighth wave could be beginning in Jun 2012 with 0.1 percent headline and 0.2 percent core in Jun 2012. It is almost impossible to forecast PPI inflation and its relation to CPI inflation. “Inflation surprise” by monetary policy could be proposed to climb along a downward sloping Phillips curve, resulting in higher inflation but lower unemployment (see Kydland and Prescott 1977, Barro and Gordon 1983 and past comments of this blog 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 http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). The architects of monetary policy would require superior inflation forecasting ability compared to forecasting naivety by everybody else. In practice, we are all naïve in forecasting inflation and other economic variables and events.

Table IV-5, US, Headline and Core PPI Inflation Monthly SA and 12-Month NSA ∆%

	Finished Goods SA Month	Finished Goods NSA 12 months	Finished Core SA Month	Finished Core NSA 12 months
Jun 2012	0.1	0.7	0.2	2.6
May 2012	-1.0	0.7	0.2	2.7
Apr	-0.2	1.9	0.2	2.7
AE ∆% Apr-May	-7.0		2.4
Mar	-0.1	2.8	0.2	2.9
Feb	0.4	3.4	0.1	3.1
AE ∆% Feb-Mar	1.8		1.8
Jan	0.3	4.1	0.6	3.1
Dec 2011	-0.1	4.7	0.2	3.0
AE ∆% Dec-Jan	1.2		4.9
Nov	0.1	5.6	0.1	3.0
Oct	-0.3	5.8	0.0	2.9
AE ∆% Oct-Nov	-1.2		0.6
Sep	0.9	7.0	0.3	2.8
Aug	0.2	6.6	0.2	2.7
Jul	0.5	7.1	0.5	2.7
AE ∆% Jul-Sep	6.6		4.1
Jun	0.1	6.9	0.3	2.3
May	0.1	7.1	0.2	2.1
AE ∆% May-Jun	1.2		3.0
Apr	0.7	6.6	0.3	2.3
Mar	0.5	5.6	0.3	2.0
Feb	1.1	5.4	0.2	1.8
Jan	0.8	3.6	0.5	1.6
AE ∆% Jan-Apr	9.7		4.0
Dec 2010	0.9	3.8	0.2	1.4
Nov	0.4	3.4	-0.1	1.2
Oct	0.8	4.3	-0.2	1.6
Sep	0.4	3.9	0.2	1.6
Aug	0.7	3.3	0.2	1.3
Jul	0.2	4.1	0.2	1.5
Jun	-0.2	2.7	0.1	1.1
May	-0.2	5.1	0.3	1.3
Apr	-0.1	5.4	0.1	0.9
Mar	0.5	5.9	0.2	0.9
Feb	-0.6	4.2	0.0	1.0
Jan	1.0	4.5	0.3	1.0

Note: Core: excluding food and energy; AE: annual equivalent

Source: US Bureau of Labor Statistics

The US producer price index NSA from 2000 to 2012 is shown in Chart IV-7. There are two episodes of decline of the PPI during recessions in 2001 and in 2008. Barsky and Kilian (2004) consider the 2001 episode as one in which real oil prices were declining when recession began. Recession and the fall of commodity prices instead of generalized deflation explain the behavior of US inflation in 2008.

Chart IV-7, US, Producer Price Index, NSA, 2000-2012

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the PPI NSA from 2000 to 2012 are shown in Chart IV-8. It may be possible to forecast trends a few months in the future under adaptive expectations but turning points are almost impossible to anticipate especially when related to fluctuations of commodity prices in response to risk aversion. In a sense, monetary policy has been tied to behavior of the PPI in the negative 12-month rates in 2001 to 2003 and then again in 2009 to 2010. Monetary policy following deflation fears caused by commodity price fluctuations would introduce significant volatility and risks in financial markets and eventually in consumption and investment.

Chart IV-8, US, Producer Price Index, 12-Month Percentage Change NSA, 2000-2012

Source: US Bureau of Labor Statistics

The US PPI excluding food and energy from 2000 to 2012 is shown in Chart IV-9. There is here again a smooth trend of inflation instead of prolonged deflation as in Japan.

Chart IV-9, US, Producer Price Index Excluding Food and Energy, NSA, 2000-2012

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the producer price index excluding food and energy are shown in Chart IV-10. Fluctuations replicate those in the headline PPI. There is an evident trend of increase of 12 months rates of core PPI inflation in 2011 but lower rates in the beginning of 2012.

Chart IV-10, US, Producer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2000-2012

Source: US Bureau of Labor Statistics