Recovery without Jobs, Stagnating Real Disposable per Capita Income and World Economy Growth Standstill with Global Recession Risk: Part III

 

Recovery without Jobs, Stagnating Real Disposable per Capita Income and World Economy Growth Standstill with Global Recession Risk

Carlos M. Pelaez

© Carlos M. Pelaez, 2010, 2011, 2012

Executive Summary

I Twenty Eight Million Unemployed and Underemployed and Stagnating Real Wages

IA Twenty Eight Million Unemployed or Underemployed

IA1 Summary of the Employment Situation

IA2 Number of People in Job Stress

IA3 Long-term and Cyclical Comparison of Employment

IA4 Job Creation

IB Stagnating Real Wages

II Stagnating Real Disposable Income and Consumption Expenditures and Financial Repression

IIA Stagnating Real Disposable Income and Consumption Expenditures

IIB Financial Repression

III World Financial Turbulence

IIIA Financial Risks

IIIB Appendix on Safe Haven Currencies

IIIC Appendix on Fiscal Compact

IIID Appendix on European Central Bank Large Scale Lender of Last Resort

IIIE Appendix Euro Zone Survival Risk

IIIF Appendix on Sovereign Bond Valuation

IIIG Appendix on Deficit Financing of Growth and the Debt Crisis

IIIGA Monetary Policy with Deficit Financing of Economic Growth

IIIGB Adjustment during the Debt Crisis of the 1980s

IV Global Inflation

V World Economic Slowdown

VA United States

VB Japan

VC China

VD Euro Area

VE Germany

VF France

VG Italy

VH United Kingdom

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

Appendix I The Great Inflation

 

VC China. China estimates an index of nonmanufacturing purchasing managers on the basis of a sample of 1200 nonmanufacturing enterprises across the country (http://www.stats.gov.cn/english/pressrelease/t20120704_402815668.htm). Table CIPMS provides this index and components from Jan to Jun 2012. The index fell from 57.3 in Mar to 55.2 in May but climbed to 56.7 in Jun, which is lower than 58.0 in Mar and 57.3 in Feb but higher than in any other of the months in 2012.

Table CIPMS, China, Nonmanufacturing Index of Purchasing Managers, %, Seasonally Adjusted

	Total Index	New Orders	Interm. Input Prices	Subs Prices	Exp
Jun	56.7	53.7	52.1	48.6	65.5
May	55.2	52.5	53.6	48.5	65.4
Apr	56.1	52.7	57.9	50.3	66.1
Mar	58.0	53.5	60.2	52.0	66.6
Feb	57.3	52.7	59.0	51.2	63.8
Jan	55.7	52.2	58.2	51.1	65.3

Notes: Interm.: Intermediate; Subs: Subscription; Exp: Business Expectations

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/pressrelease/t20120704_402815668.htm

Chart CIPMS provides China’s nonmanufacturing purchasing managers’ index from Jun 2011 to Jun 2012. There was slowing of the general index in Apr 2012 after the increase in Jan-Mar 2012 and further decline to 55.2 in May 2012 but increase to 56.7 in Jun 2012.

Chart CIPMS, China, Nonmanufacturing Index of Purchasing Managers, Seasonally Adjusted

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/pressrelease/t20120704_402815668.htm

China estimates a manufacturing index of purchasing managers on the basis of a sample of 820 enterprises (http://www.stats.gov.cn/english/pressrelease/t20120703_402815318.htm). Chart CIPMM provides the index from Jun 2011 to Jun 2012. There is deceleration from 52.0 in May 2011 to marginal contraction at 49.0 in Nov 2011. Manufacturing activity recovered to 53.3 in Apr 2012 but then declined to 50.4 in May 2012 and 50.2 in Jun 2012, which is the lowest in a year with exception of contraction at 49.0 in Nov 2011.

Chart CIPMM, China, Manufacturing Index of Purchasing Managers, Seasonally Adjusted

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/pressrelease/t20120703_402815318.htm

The HSBC China Services PMI^™, compiled by Markit, moderating business activity in China with the HSBC Composite Output, combining manufacturing and services, decreasing from 51.9 in May to 50.6 in Jun, which is the lowest level in three months with contraction in manufacturing and slower activity in services (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9788). Hongbin Qu, Chief Economist, China and Co-Head of Asian Economic Research at HSBC, finds weak employment growth, suggesting that with lower inflation there is room for further stimulus (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9788).The HSBC Purchasing Managers’ Index^™ (PMI^™), compiled by Markit, fell slightly to 48.2 in Jun from 48.4 in May, for the lowest reading in IIQ2012 since IQ2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9721). Hongbin Qu, Chief Economist, China and Co-Head of Asian Economic Research at HSBC, finds continuing slowdown in China’s economy in IIQ2012, which requires further reduction of bank reserve requirements and the policy interest rate together with fiscal measures (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9721).

Wang Xiaotian, writing on China Daily, on “China cuts its reserve ratio again,” published by Xinhuanet on May 13, 2012 (http://news.xinhuanet.com/english/china/2012-05/13/c_131584252.htm), informs that the People’s Bank of China (PBC) (http://www.pbc.gov.cn/publish/english/963/index.html) reduced the reserve requirement imposed on Chinese lenders by 50 basis points with the objective of injecting liquidity to strengthen the economy. This is the second such reduction of reserve requirements in 2012. The reduction is estimated to release CNY 400 in China’s money market. The reserve requirement will be 20 percent for larger banks and 16.5 percent for smaller banks. The measures are intended to strengthen the economy. Xinhuanet, writing on “China announces surprise rate cuts amid economic downshift,” on Jun 5, 2012 (http://news.xinhuanet.com/english/china/2012-07/05/c_131697843.htm), informs that the central bank of China People’s Bank of China reduced the one year deposit rate by 25 basis points and the one year lending rate by 31 basis points effective Jun 6, 2012. The People’s Bank of China posts the new rates (http://www.pbc.gov.cn/publish/english/955/2012/20120608171005950734495/20120608171005950734495_.html). Table CNY provides the country data table for China.

Table CNY, China, Economic Indicators

Price Indexes for Industry	May 12-month ∆%: minus 1.4 May month ∆%: minus 0.4 Blog 6/17/12
Consumer Price Index	May month ∆%: -0.2 May 12 month ∆%: 3.0 Blog 6/17/12
Value Added of Industry	May month ∆%: 0.89 Jan-May 2012/Jan-May 2011 ∆%: 10.7 Blog 6/17/12
GDP Growth Rate	Year IQ2012 ∆%: 8.1 Quarter IQ2012 ∆%: 1.8 Blog 4/15/12
Investment in Fixed Assets	Total Jan-May 2012 ∆%: 20.1 Real estate development: 18.5 Blog 6/17/12
Retail Sales	May month ∆%: 0.84 May 12 month ∆%: 13.8 Jan-May ∆%: 14.5 Blog 6/17/12
Trade Balance	May balance $18.7 billion Exports ∆% 15.3 Imports ∆% 12.7 Cumulative May: $37.9 billion Blog 6/17/12

Links to blog comments in Table CNY:

6/17/12 http://cmpassocregulationblog.blogspot.com/2012/05/world-financial-turbulence-global_27.html

4/15/12 http://cmpassocregulationblog.blogspot.com/2012/04/fractured-labor-market-with-hiring_15.html

VD Euro Area. Table VD-EUR provides inflation, unemployment and real GDP growth in the euro area yearly from 1999 to 2011 together with growth forecasts of EUROSTAT for 2012 and 2013. Inflation in the euro zone remained subdued around 2 percent in the first five years of the euro zone from 1999 to 2004, as shown in Table VD-EUR. Inflation climbed above 2.0 percent after 2005, peaking at 3.3 percent in 2008 with the surge in commodity prices but falling to 0.3 percent in 2009 with the collapse of commodity prices. Inflation climbed back to 1.6 percent in 2010 and 2.7 percent in 2011. Under the regime of zero interest rates inflation returns worldwide during relaxation of risk aversion. The rate of unemployment increased in 2011 while the rate of GDP growth fell. EUROSTAT forecasts slightly negative growth of 0.3 percent in 2012 and growth of 1.0 percent in 2013.

Table VD-EUR, Euro Area, Yearly Percentage Change of Harmonized Index of Consumer Prices, Unemployment Rate and GDP, ∆%

Year	HICP ∆%	Unemployment %	GDP ∆%
1999	1.2	9.6	2.9
2000	2.2	8.7	3.8
2001	2.4	8.1	2.0
2002	2.3	8.5	0.9
2003	2.1	9.0	0.7
2004	2.2	9.3	2.2
2005	2.2	9.2	1.7
2006	2.2	8.5	3.3
2007	2.1	7.6	3.0
2008	3.3	7.6	0.4
2009	0.3	9.6	-4.4
2010	1.6	10.1	2.0
2011	2.7	10.2	1.5
2012*			-0.3
2013*			1.0

*EUROSTAT forecast

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

The Markit Eurozone PMI^® Composite Output Index, combining services and manufacturing activity with close association with GDP, increased from 46.0 in May to 46.4 in Jun, which is still in sharp contraction (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9769) in the deepest contraction in three years. Chris Williamson, Chief Economist at Markit, finds that the data are consistent with decline of GDP at a quarterly rate of 0.6 percent IIQ2012, which could result in the third consecutive quarterly contraction of euro area GDP (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9769). The Markit Eurozone Manufacturing PMI^® was unchanged at 45.1 in Jun, which indicates the sharpest deteriorating in activity in about three years (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9708). Chris Williamson, Chief Economist at Markit, finds that the index suggests manufacturing in the euro area declined at a quarterly rate of about 1 percent, exerting pressure on GDP in IIQ2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9708).

Table EUR provides the regional data table for the euro area.

Table EUR, Euro Area Economic Indicators

GDP	IQ2012 ∆% 0.0; IQ2012/IQ2011 ∆% -0.1 Blog 6/10/12
Unemployment	May 2012: 11.1% unemployment rate May 2012: 17.561 million unemployed Blog 7/8/12
HICP	May month ∆%: -0.1 12 months May ∆%: 2.4 Blog 6/17/12
Producer Prices	Euro Zone industrial producer prices May ∆%: -0.5 May 12-month ∆%: 2.3 Blog 7/8/12
Industrial Production	Apr month ∆%: -0.8; Apr 12 months ∆%: -2.3 Blog 6/17/12
Retail Sales	May month ∆%: 0.6 Apr 12 months ∆%: -1.7 Blog 7/8/12
Confidence and Economic Sentiment Indicator	Sentiment 89.9 Jun 2012 Confidence minus 19.8 Jun 2012 Blog 7/2/12
Trade	Jan-Apr 2012/Jan-Apr 2011 Exports ∆%: 7.9 Imports ∆%: 2.6 Apr 2012 12-month Exports ∆% 6.1 Imports ∆% -0.9 Blog 6/17/12

Links to blog comments in Table EUR:

7/2/12 http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states_03.html

6/17/12 http://cmpassocregulationblog.blogspot.com/2012/05/world-financial-turbulence-global_27.html

6/10/12 http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities_10.html

Eurostat estimates the rate of unemployment in the euro area as 11.1 percent in May 2012, as shown in Table VD-1. The number of unemployed in May 2012 was 17.561 million, which was 1.820 million higher than 15.741 million in May 2011. The rate of unemployment jumped from 10.0 percent in May 2011 to 11.1 percent in May 2012.

Table VD-1, Euro Area, Unemployment Rate and Number of Unemployed, % and Millions, SA 

	Unemployment Rate %	Number Unemployed Millions
May 2012	11.1	17.561
Apr	11.0	17.473
Mar	11.0	17.357
Feb	10.8	17.174
Jan	10.8	17.022
Dec 2011	10.7	16.862
Nov	10.6	16.773
Oct	10.5	16.537
Sep	10.3	16.342
Aug	10.2	16.099
Jul	10.1	15.994
Jun	10.0	15.821
May	10.0	15.741
Apr	9.9	15.602
Mar	9.9	15.600
Feb	9.9	15.604
Jan	10.0	15.660
Dec 2010	10.0	15.764

Source: EUROSTAT

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

Table VD-2 shows the disparity in rates of unemployment in the euro area with 11.1 percent for the region as a whole and 17.561 million unemployed but 5.6 percent in Germany and 2.341 million unemployed. At the other extreme is Spain with rate of unemployment of 24.6 percent and 5.701 million unemployed. The rate of unemployment of the European Union in May is 10.3 percent with 24.868 million unemployed.

Table VD-2, Unemployed and Unemployment Rate in Countries and Regions, Millions and %

May 2012	Unemployment Rate %	Unemployed Millions
Euro Zone	11.1	17.561
Germany	5.6	2.341
France	10.1	2.942
Netherlands	5.1	0.455
Finland	7.6	0.204
Portugal	15.2	0.822
Ireland	14.6	0.307
Italy	10.1	2.584
Greece	NA	NA
Spain	24.6	5.701
Belgium	7.2	0.355
European Union	10.3	24.868

Source: EUROSTAT

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

Chart VD-1 provides Eurosat estimates of unemployment rates in the European Union. There is significant diversity in the rates of unemployment in members of the euro zone and the European Union.

Chart VD-1, Unemployment Rate in Various Countries and Regions

Source: EUROSTAT

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

Advanced economies are experiencing weak demand. Table VD-3 provides month and 12-month percentage changes of the volume of retail sales in the euro zone from Jan 2011 to May 2012. Retail sales increased 0.6 percent in May 2012 but fell 1.7 percent in 12 months. The 12-month rates of growth have become negative since Mar 2011 with exception of 1.0 percent in Apr 2011 and stability in Aug 2011 and Mar 2012. The lower part of Table VD-3 provides annual percentage changes of inflation-adjusted retail sales in the euro zone since 1990. Retail sales fell 2.4 percent in 2009 after falling 0.8 percent in 2008 and fell again by 0.6 percent in 2011. The average yearly rate of increase of retail sales from 1999 to 2007 was 2.0 percent but growth has not recovered. The average yearly rate of increase for the entire period 1999 to 2011 is lower at 1.1 percent.

Table VD-3, Euro Zone, Volume of Retail Sales, Deflated ∆%

	Month ∆%	12-Month ∆%
May 2012	0.6	-1.7
Apr	-1.4	-3.4
Mar	0.4	0.0
Feb	-0.2	-2.0
Jan	1.2	-1.1
Dec 2011	-1.3	-1.7
Nov	-0.3	-1.4
Oct	-0.2	-0.7
Sep	-0.6	-1.1
Aug	-0.1	0.0
Jul	0.5	-0.4
Jun	0.8	-0.8
May	-1.6	-1.8
Apr	1.1	1.0
Mar	-1.2	-1.4
Feb	0.3	1.1
Jan	0.3	0.9
Annual ∆%
2011		-0.6
2010		0.9
2009		-2.4
2008		-0.8
2007		1.6
2006		2.2
2005		2.0
2004		1.5
2003		0.9
2002		1.2
2001		2.1
2000		2.5
1999		2.3
Average ∆% 1999-2007		2.0
Average ∆% 1999-2011		1.1

Source:

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

Growth rates of retail sales of the euro zone by major segments are in Table VD-4. Total sales in increased 0.6 percent in May 2012 and declined 1.7 percent in the 12 months ending in May 2012. All 12-month percentage changes are negative with improvement in all monthly rates.

Table VD-4, Euro Zone, Volume of Retail Sales by Products, ∆%

May 2012	Month ∆%	12-Month ∆%
Total	0.6	-1.7
Food, Drinks, Tobacco	0.2	-1.1
Nonfood Products ex Automotive Fuel	1.0	-1.5

Source:

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

Month and 12-month percentage rates of change of retail sales by member countries of the euro zone are shown in Table VD-5 for May 2012. Retail sales are weak throughout the euro zone. The 12-month percentage changes are negative for all members in Table VD-5 with the exception of 2.3 percent for Germany, 0.6 percent for Finland and 1.7 percent for Ireland. The 12-month percentage change for the UK, which is not a member of the euro zone, was 3.7 percent. The European Union’s 12-month percentage change was also negative by 0.3 percent.

Table VD-5, Euro Zone, Volume of Retail Sales by Member Countries, ∆%

May 2012	Month ∆%	12-Month ∆%
Euro Zone	0.6	-1.7
Germany	-0.3	2.3
France	1.2	-1.2
Netherlands	NA	NA
Finland	1.9	0.6
Belgium	0.2	-2.2
Portugal	2.9	-5.1
Ireland	1.7	1.7
Italy	NA	NA
Greece	NA	NA
Spain	1.2	-4.8
UK	1.3	3.7
European Union	0.6	-0.3

Source:

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

VE Germany. Table VE-DE provides yearly growth rates of the German economy from 1992 to 2011, price adjusted chain-linked and price and calendar-adjusted chain-linked. Germany’s GDP fell 5.1 percent in 2009 after growing below trend at 1.1 percent in 2008. Recovery has been robust in contrast with other advanced economy. The German economy grew at 3.7 percent in 2010 and at 3.0 percent in 2011. Growth slowed in 2011 from 1.3 percent in IQ2011, 0.3 percent in IIQ2011 and 0.6 percent in IIIQ2011 to decline of 0.2 percent in IVQ2011 and growth of 0.5 percent in IQ2012. The Federal Statistical Agency of Germany analyzes the fall and recovery of the German economy (http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/VolkswirtschaftlicheGesamtrechnungen/Inlandsprodukt/Aktuell,templateId=renderPrint.psml):

“The German economy again grew strongly in 2011. The price-adjusted gross domestic product (GDP) increased by 3.0% compared with the previous year. Accordingly, the catching-up process of the German economy continued during the second year after the economic crisis. In the course of 2011, the price-adjusted GDP again exceeded its pre-crisis level. The economic recovery occurred mainly in the first half of 2011. In 2009, Germany experienced the most serious post-war recession, when GDP suffered a historic decline of 5.1%. The year 2010 was characterised by a rapid economic recovery (+3.7%).”

Table VE-DE, Germany, GDP Year ∆%

	Price Adjusted Chain-Linked	Price- and Calendar-Adjusted Chain Linked
2011	3.0	3.1
2010	3.7	3.6
2009	-5.1	-5.1
2008	1.1	0.8
2007	3.3	3.4
2006	3.7	3.9
2005	0.7	0.8
2004	1.2	0.7
2003	-0.4	-0.4
2002	0.0	0.0
2001	1.5	1.6
2000	3.1	3.3
1999	1.9	1.8
1998	1.9	1.7
1997	1.7	1.8
1996	0.8	0.8
1995	1.7	1.8
1994	2.5	2.5
1993	-1.0	-1.0
1992	1.9	1.5

Source: Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/PressServices/Press/pr/2012/05/PE12_178_811.html

The Markit Germany Composite Output Index of the Markit Germany Services PMI^®, combining manufacturing and services with close association with Germany’s GDP, fell from 49.3 in May to 48.1 in Jun, indicating marginal deterioration in private sector output for the first time in six months and the deepest in three years (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9787). Tim Moore, Senior Economist at Markit and author of the report, finds that the index suggests flat GDP in Germany in IIQ2012 with possible deterioration in the future (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9787). The Markit/BME Germany Purchasing Managers’ Index^® (PMI^®), showing close association with Germany’s manufacturing output, fell from 45.2 in May to 45.0 in Jun, remaining below 50.0 during four consecutive months for the longest period since the global recession of 2008 and 2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9765). Tim Moore, Senior Economist at Markit and author of the report, finds that Germany’s manufacturing output is showing the sharpest drop in about three years with contracting orders from export markets (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9765).Table DE provides the country data table for Germany.

Table DE, Germany, Economic Indicators

GDP	IQ2012 0.5 ∆%; I/Q2012/IQ2011 ∆% 1.7 2011/2010: 3.0% GDP ∆% 1992-2011 Blog 5/27/12
Consumer Price Index	Jun month SA ∆%: -0.1 Jun 12-month NSA ∆%: 1.7 Blog 7/2/12
Producer Price Index	May month ∆%: -0.3 12-month NSA ∆%: 2.1 Blog 6/24/12
Industrial Production	Mfg May month SA ∆%: 1.9 12-month NSA: -7.0 Blog 7/8/12
Machine Orders	May month ∆%: 0.6 May 12-month ∆%: -10.6 Blog 7/8/12
Retail Sales	Apr Month ∆% 0.6 12-Month ∆% minus 3.8 Blog 6/3/12
Employment Report	Unemployment Rate May 5.5% Blog 7/2/12
Trade Balance	Exports Apr 12-month NSA ∆%: 3.4 Imports Apr 12 months NSA ∆%: -1.0 Exports Apr month SA ∆%: -1.7; Imports Apr month SA -4.8 Blog 6/10/12

Links to blog comments in Table DE:

7/2/12 http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states_03.html

6/24/12 http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of_24.html

6/10/12 http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities_10.html

6/3/12 http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs_04.html

5/27 http://cmpassocregulationblog.blogspot.com/2012_05_01_archive.html

The production industries index of Germany in Table VE-1 shows increase of 1.6 percent in May and decrease of 6.6 percent in the 12 months ending in May 2012. Germany’s production industries suffered decline of 7.3 percent in Dec 2008 relative to Dec 2007 and decline of 2.3 percent in 2009. Recovery was vigorous with 14.2 percent in the 12 months ending in Dec 2010. The first quarter of 2011 was quite strong when the German economy outperformed the other advanced economies. The performance of Germany’s production industries from 2003 to 2006 was vigorous with average rate of 4.4 percent. Data for the production industries index of Germany fluctuate sharply from month to month and also in 12-month rates.

Table VE-1, Germany, Production Industries, Month and 12-Month ∆%

	12-Month ∆% NSA	Month ∆% Calendar SA
May 2012	-6.6	1.6
Apr	-0.6	-2.1
Mar	-0.7	2.2
Feb	2.2	-0.4
Jan	4.6	0.8
Dec 2011	1.2	-2.0
Nov	4.6	0.1
Oct	0.4	0.5
Sep	5.5	-2.2
Aug	11.3	-0.3
Jul	6.5	3.0
Jun	0.0	-1.0
May	18.9	1.0
Apr	5.8	-0.3
Mar	10.3	0.9
Feb	16.4	1.2
Jan	16.0	0.7
Dec 2010	14.2
Dec 2009	-2.3
Dec 2008	-7.3
Dec 2007	-0.1
Dec 2006	2.5
Dec 2005	4.9
Dec 2004	5.3
Dec 2003	5.1
Dec 2002	2.0
Average ∆% 2003-2006	4.4

Source: Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Table VE-2 provides monthly percentage changes of the German production industries index by components from Oct 2011 to May 2012. There were three sharp declines in the monthly production industries of 2.2 percent in Sep 2011, 2.0 percent in Dec and 2.1 percent in Apr 2012 with much milder recoveries in the other months. The declines of investment or capital goods were quite sharp with 4.0 percent in Sep 2011 and 3.7 percent in Apr 2012 with recovery by 1.7 percent in May 2012. Durable goods and nondurable goods fell in five of the nine months from Sep 2011 to May 2012.

Table VE-2, Germany, Production Industries, Industry and Components, Month ∆%

	May	Apr	Mar	Feb	Jan	Dec	Nov	Oct
Production Industries	1.6	-2.1	2.2	-0.4	0.8	-2.0	0.1	0.5
Industry	1.8	-2.3	1.1	0.2	0.6	-1.5	-0.3	0.5
Mfg	1.9	-2.3	1.1	0.3	0.6	-1.4	-0.3	0.5
Intermediate Goods	1.0	-0.3	0.2	-0.1	0.9	-1.8	-0.3	-0.2
Investment Goods	1.7	-3.7	1.6	1.0	0.7	-1.4	-0.2	1.4
Durable Goods	2.7	-1.6	0.5	-1.5	1.2	-1.6	-2.0	1.4
Nondurable Goods	4.0	-3.8	2.6	-1.2	-0.6	-0.7	0.0	-0.2
Energy	-1.6	2.4	-2.0	6.7	1.1	-6.8	1.6	1.5

Seasonally Calendar Adjusted

Source: Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Table VE-3 provides 12-month unadjusted percentage changes of industry and components in Germany. Although there are sharp fluctuations in the data there is suggestion of deceleration that would be expected from much higher earlier rates. The deceleration is quite evident in single-digit percentage changes from Sep 2011 to May 2012 relative to high double-digit percentage changes in Jan-Mar 2011. There are multiple negative 12-month percentage changes across many segments. Growth rates in the recovery from the global recession from IVQ2007 to IIQ2009 were initially very vigorous in comparison with the growth rates before the contraction that are shown in the bottom part of Table VE-3.

Table VE-3, Germany, Industry and Components, 12-Month ∆% Unadjusted

	IND	MFG	INTG	INVG	DG	NDG	EN
2012
May	-7.2	-7.0	6.8	-7.3	-11.7	-7.7	3.5
Apr	-1.0	-0.8	-1.2	1.2	-6.5	-5.7	3.4
Mar	-0.2	-0.2	-2.0	2.9	-6.5	-3.2	-6.3
Feb	3.5	3.6	1.8	7.4	-0.7	-2.0	0.0
Jan	6.2	6.1	4.6	9.7	4.3	1.4	-12.0
2011
Dec	1.4	1.4	2.5	1.0	-0.4	0.2	-16.4
Nov	4.9	5.1	3.9	7.9	1.9	0.0	-4.0
Oct	1.1	1.2	0.4	3.6	-2.7	-2.8	-7.2
Sep	6.4	6.5	6.4	8.9	3.6	0.2	-6.3
Aug	12.8	12.6	10.8	20.2	4.5	1.2	-3.5
Jul	8.0	8.1	6.5	13.1	7.7	-0.5	-8.1
Jun	0.9	0.9	1.6	2.0	-10.5	-2.0	-7.4
May	21.4	21.4	17.7	28.3	21.7	13.4	-12.0
Apr	7.4	7.5	5.9	11.1	4.9	2.2	-8.2
Mar	10.7	10.9	10.0	14.9	8.5	2.1	1.2
Feb	16.8	17.0	16.1	22.4	11.0	6.1	-2.2
Jan	16.8	17.1	16.7	23.2	11.2	4.2	-1.8
2010
Dec	17.5	17.6	14.5	26.3	9.1	2.9	4.8
Nov	13.8	13.8	13.1	19.0	7.9	3.6	2.9
Oct	9.9	10.1	10.1	13.9	6.5	0.9	0.2
Sep	9.5	9.3	12.1	10.0	7.9	1.7	-2.4
Aug	17.2	17.2	19.0	20.3	19.5	6.9	-2.1
Jul	9.1	8.8	12.7	8.7	7.2	0.9	-0.2
Jun	16.2	16.1	20.5	16.0	20.5	5.3	-2.5
May	13.3	13.3	20.2	11.6	10.7	1.7	12.8
Apr	14.9	14.8	21.8	15.3	8.5	0.0	9.9
Mar	14.2	14.5	20.4	11.7	11.8	6.4	7.2
Feb	7.1	7.5	10.8	7.0	7.4	-1.2	5.4
Jan	0.6	0.9	6.7	-3.4	-0.4	-3.9	3.3
Dec 2010	17.5	17.6	14.5	26.3	9.1	2.9	4.8
Dec 2009	-3.3	-3.2	3.3	-9.9	-0.1	1.1	3.8
Dec 2008	-7.6	-7.4	-14.4	-5.5	-11.2	3.7	-9.0
Dec 2007	0.1	-0.3	-0.6	2.5	-10.0	-2.6	1.7
Dec 2006	3.1	3.1	5.2	2.3	8.7	-1.0	-5.4
Dec 2005	5.8	5.8	3.5	8.9	3.2	2.2	0.6
Dec 2004	5.2	5.6	7.6	3.4	0.9	5.7	9.6
Dec 2003	5.5	5.3	5.6	6.3	1.6	4.6	0.3
Dec 2002	3.7	3.4	5.3	3.4	-5.9	2.2	-2.6

Note: IND: Industry; MFG: Manufacturing; INTG: Intermediate Goods; INVG: Investment Goods; DG: Durable Goods; NDG: Nondurable Goods; EN: Energy

Source:  Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Broader perspective since 2002 is provided by Chart VE-1 of the Statistiche Bundesamt Deutschland, Federal Statistical Agency of Germany. The index rises by more than one third between 2003 and 2008 with sharp fluctuations and then collapses during the global recession in 2008. Recovery has been in a steep upward trajectory that has recovered at the more recent peaks the losses during the contraction. Recovery was reversed by the drop in Dec with strong rebound into 2012 and another sharp drop in Apr 2012 with recovery in May 2012.

Chart VE-1, Germany, Production Industries, Not Adjusted, 2005=100

Source: Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

More detail is provided by Chart VE-2 of the Statistiche Bundesamt Deutschland, or Federal Statistical Agency of Germany, with the unadjusted production industries index and trend from 2007 to 2012. There could be some flattening in recent months as depicted by trend.

Chart VE-2, Germany, Production Index, Production Industries, Not Adjusted Index and Trend, 2005=100

Source: Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Table VE-4 provides month and 12-month rates of growth of manufacturing in Germany in 2011 from Jan 2011 to May 2012. There are fluctuations in both monthly rates and in the past 12 months. Recovery is strong in Jan-Mar 2012 with cumulative growth of 2.1 percent at the high annual equivalent rate of 8.7 percent but the drop in Apr 2012 of 2.3 percent results in decline of 0.2 percent in the first four months of 2012 that pulls down the 12-month rate of Apr 2012 to minus 0.8 percent. Growth of 1.9 percent in May 2012 is insufficient to prevent decline of 7.0 percent in 12 months because production was quite strong in the first part of 2011.

Table VE-4, Germany, Manufacturing Month and 12-Month ∆%

	12-Month ∆% NSA	Month ∆% SA and Calendar Adjusted
May 2012	-7.0	1.9
Apr	-0.8	-2.3
Mar	-0.2	1.1
Feb	3.6	0.3
Jan	6.1	0.7
Dec 2011	1.4	-1.4
Nov	5.1	-0.3
Oct	1.2	0.5
Sep	6.5	-2.3
Aug	12.6	-0.3
Jul	8.1	3.2
Jun	0.9	-1.1
May	21.4	1.4
Apr	7.5	0.4
Mar	10.9	0.7
Feb	17.0	1.4
Jan	17.1	-0.6
Dec	17.6	1.9

Source: Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Chart VE-3 of the Statistiche Bundesamt Deutschland, or Federal Statistical Office of Germany, provides the manufacturing index of Germany from 2007 to 2012. Manufacturing was already flattening in 2007 and fell sharply in 2008 to the beginning of 2010. Manufacturing grew sharply in the initial phase of recovery but has flattened in recent months as revealed by the trend.

Chart VE-3, Germany, Manufacturing Index, Not Adjusted Index and Trend, 2005=100

Source: Statistiche Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Several tables and charts facilitate analysis of machinery orders in Germany. Table VE-5 reveals strong fluctuations in an evident deceleration of total orders for industry of Germany. The same behavior is observed for total, foreign and domestic orders with decline in 12-month rates from two-digit levels to single digits and some negative changes. An important aspect of Germany is that the bulk of orders is domestic or from other European countries while foreign orders have been growing rapidly. Total orders increased 0.6 percent in May 2012 with decrease of 1.3 percent in domestic orders and sharp compensatory increase of 2.3 percent of foreign orders. In contrast, there was weakness in Apr 2012 with decreases of total orders by 1.4 percent and foreign orders by 3.1 percent while domestic orders increased 1.3 percent. As in other countries, data on orders for manufacturing are highly volatile. All 12-month percentage changes from Jan 2012 to May 2012 in Table VE-5 are negative largely because of the unusual strength of the Germany economy in the beginning of 2011.

Table VE-5, Germany, Volume of Orders Received in Manufacturing, Total, Domestic and Foreign, ∆%  

	Total 12 M	Total M	Foreign 12 M	Foreign M	Home 12 M	Home M
2012
May	-10.6	0.6	-3.3	2.3	-18.3	-1.3
Apr	-3.4	-1.4	-4.0	-3.1	-2.5	0.6
Mar	-2.0	3.0	-0.9	4.4	-3.3	1.3
Feb	-4.5	0.6	-4.9	1.7	-3.9	-0.8
Jan	-3.1	-1.4	-5.7	-3.8	0.1	1.7
2011
Dec	-0.2	0.7	-0.8	3.7	0.6	-2.8
Nov	-4.2	-2.8	-7.6	-4.4	0.0	-0.7
Oct	0.6	2.7	2.2	4.7	-1.3	0.5
Sep	2.4	-4.6	1.2	-6.2	3.8	-2.7
Aug	6.8	-0.4	4.3	0.3	10.1	-1.3
Jul	5.6	-3.2	5.7	-7.5	5.6	2.6
Jun	3.8	0.8	8.0	10.8	-1.6	-10.0
May	22.7	2.8	16.2	-3.3	30.2	10.2
Apr	6.9	1.8	9.9	1.7	3.4	1.8
Mar	9.1	-2.8	11.9	-2.3	5.8	-3.2
Feb	21.5	0.7	24.8	-0.3	17.8	1.9
Jan	22.4	4.2	26.5	3.4	17.6	5.5
2010
Dec	22.2	-3.3	27.3	-3.5	15.8	-3.2
Nov	21.5	5.6	26.8	8.8	15.6	1.8
Oct	14.1	1.3	17.7	0.9	10.4	1.8
Sep	13.9	-2.8	16.0	-5.3	11.6	0.4
Aug	23.5	3.5	31.9	6.1	14.4	0.3
Jul	14.2	-2.2	21.7	-3.2	6.3	-1.2
Jun	28.5	3.9	32.0	6.3	24.3	1.2
May	24.4	0.1	28.9	0.3	19.9	-0.1
Apr	29.3	2.2	33.0	2.1	25.2	2.2
Mar	29.4	6.0	32.3	6.9	26.4	5.0
Feb	23.4	-0.3	27.6	-0.2	18.6	-0.4
Jan	16.7	4.5	23.6	4.2	9.7	4.8
Dec 2009	9.2	-2.4	10.6	-2.7	7.4	-1.9
Dec 2008	-28.2	-7.1	-31.5	-9.7	-23.7	-4.1
Dec 2007	7.1	-1.8	9.1	-2.9	4.5	-0.6
Dec 2006	2.9	0.4	3.4	0.3	2.2	0.5
Dec 2005	4.9	-0.5	10.5	-0.8	-1.5	0.1
Dec 2004	12.7	6.6	12.9	8.4	12.7	4.9
Dec 2003	10.7	2.4	16.4	5.4	5.1	-0.8
Dec 2002	-0.2	-3.4	-0.8	-6.6	0.2	-0.3
Average ∆% 2003-2007	7.6		10.4		4.5
Average ∆% 2003-2011	3.6		5.1		1.9

Notes: AE: Annual Equivalent; M: Month; M: Calendar and seasonally-adjusted; 12 M: Non-adjusted

Source: Statistisches Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Orders for investment goods of Germany are shown in Table VE-6. Total investment goods orders increased 0.2 percent in May 2012 with foreign orders increasing 1.6 percent and domestic orders decreasing 2.0 percent. There has been evident deceleration from 2010 and early 2011 with growth rates falling from two digit levels to single digits and multiple negative changes. An important aspect of Germany’s economy shown in Tables VE-5 and VE-6 is the success in increasing the competitiveness of its economic activities as shown by rapid growth of orders for industry after the recession of 2001 in the period before the global recession beginning in late 2007. Germany adopted fiscal and labor market reforms to increase productivity.

Table VE-6, Germany, Volume of Orders Received of Capital Goods Industries, Total, Foreign and Domestic, ∆%

	Total 12 M	Total M	Foreign 12 M	Foreign M	Domestic 12 M	Domestic M
2012
May	-11.0	0.2	-1.9	1.6	-22.9	-2.0
Apr	-2.3	-2.9	-3.7	-5.2	0.0	1.1
Mar	1.9	5.8	3.8	9.8	-1.1	-0.2
Feb	-5.9	1.3	-7.4	1.0	-3.6	1.8
Jan	-3.6	-4.4	-6.0	-5.2	0.6	-3.2
2011
Dec	1.6	2.8	0.5	4.0	3.5	1.0
Nov	-5.9	-3.6	-9.4	-6.2	-0.1	0.6
Oct	3.6	5.0	7.5	7.9	-2.3	0.6
Sep	2.9	-5.5	1.8	-6.9	4.9	-3.3
Aug	6.3	0.6	3.5	1.8	11.1	-1.2
Jul	7.7	-8.1	6.9	-13.7	8.9	2.0
Jun	8.9	3.4	13.6	17.5	1.0	-15.1
May	26.8	4.4	18.0	-4.6	40.3	19.1
Apr	11.3	3.1	14.7	3.8	6.2	1.8
Mar	11.0	-5.0	13.7	-4.1	7.0	-6.4
Feb	29.4	2.5	33.1	1.2	23.9	4.8
Jan	26.4	3.2	32.4	3.2	17.5	2.9
2010
Dec	27.3	-4.9	31.0	-6.2	21.3	-2.7
Nov	30.1	9.4	35.9	14.3	21.5	2.2
Oct	20.6	1.2	23.9	-0.6	16.0	4.1
Sep	18.1	-4.6	20.4	-7.2	14.6	-0.1
Aug	29.3	6.8	42.8	9.7	12.0	2.3
Jul	14.1	-4.7	28.4	-6.3	-2.3	-2.1
Jun	33.5	6.4	41.3	10.3	22.2	0.4
May	25.9	1.3	35.6	0.6	13.6	2.6
Apr	30.1	1.3	40.1	1.7	17.4	0.6
Mar	26.2	8.4	33.8	10.2	16.1	5.6
Feb	20.3	-1.3	30.3	-0.3	8.1	-2.5
Jan	16.9	4.3	29.5	2.2	2.5	7.2
Dec 2009	8.1	-1.4	13.6	-1.6	0.5	-1.2
Dec 2008	-32.2	-7.2	-36.7	-9.9	-24.4	-3.5
Dec 2007	9.6	-1.2	11.6	-3.3	6.3	2.2
Dec 2006	3.6	2.2	3.8	2.7	3.1	1.4
Dec 2005	1.9	-1.9	9.8	-2.1	-8.5	-1.6
Dec 2004	19.4	11.2	18.6	12.2	20.5	9.8
Dec 2003	11.7	2.1	17.2	5.0	5.4	-1.6
Dec 2002	-2.8	-4.3	-3.7	-8.1	-1.8	0.2
Average ∆% 2003-2007	9.1		12.1		4.9
Average ∆% 2003-2011	3.4		4.4		2.1

Notes: AE: Annual Equivalent; M: Month; M: Calendar and seasonally-adjusted; 12 M: Non-adjusted

Source: Statistisches Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Chart VE-4 of the German Statistisches Bundesamt Deutschland shows the sharp upward trend of total orders in manufacturing before the global recession. There is also an obvious upward trend in the recovery from the recession with Germany’s economy being among the most dynamic in the advanced economies until the slowdown beginning in the final months of 2011 and what could be stationary series from late 2011 into 2012.

Chart VE-4, Germany, Volume of Total Orders in Manufacturing, Non-Adjusted, 2005=100

Source:  Statistisches Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Chart VE-5 of the German Statistisches Bundesamt Deutschland provides unadjusted volume of total orders in manufacturing and a trend curve. The final segment on the right could be the beginning of flattening or even decline of the trend curve but it is early to reach conclusions.

Chart VE-5, Germany, Volume of Total Orders in Manufacturing and Trend, Non-Adjusted, 2005=100

Source: Statistisches Bundesamt Deutschland

https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

VF France. The Markit France Composite Output Index, combining services and manufacturing with close association with French GDP, increased from 44.6 in May to 47.3 in Jun, indicating contraction of private sector activity at a more moderate rate (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9783). Jack Kennedy, Senior Economist at Markit and author of the France Services PMI^®, finds that weak services and manufacturing survey data suggest contraction of GDP in IIQ2012 after no growth in IQ2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9783).The Markit France Manufacturing Purchasing Managers’ Index^® increased to 45.2 in Jun from 44.7 in May, which was the sharpest decline of the manufacturing economy in three years (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9727). Jack Kennedy, Senior Economist at Markit and author of the France Manufacturing PMI^®, finds continuing deterioration in manufacturing with IIQ2012 being the weakest quarter for French manufacturing in three years (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9727). Table FR provides the country data table for France.

Table FR, France, Economic Indicators

CPI	May month ∆% -0.1 12 months ∆%: 2.0 6/17/12
PPI	May month ∆%: -1.1 May 12 months ∆%: 2.2 Blog 7/2/12
GDP Growth	IQ2012/IVQ2011 ∆%: 0.0 IQ2012/IQ2011 ∆%: 0.3 Blog 7/2/12
Industrial Production	Apr SA ∆%: Industrial Production 1.5; Manufacturing -0.7 YOY NSA ∆%: Industrial Production -0.6; Manufacturing -1.8 Blog 6/17/12
Consumer Spending	May Manufactured Goods ∆%: 1.4 May 12-Month Manufactured Goods ∆%: 0.2 Blog 7/2/12
Employment	IQ2012 Unemployed 2.746 million Unemployment Rate: 9.6% Employment Rate: 63.8% Blog 6/10/12
Trade Balance	May Exports ∆%: month 1.3, 12 months 7.8 Apr Imports ∆%: month 0.1, 12 months 3.2 Blog 7/8/12
Confidence Indicators	Historical averages 100 Jun Mfg Business Climate 92 Blog 6/24/12

Links to blog comments in Table FR:

7/2/12 http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states_03.html

6/24/12 http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of_24.html

6/17/12 http://cmpassocregulationblog.blogspot.com/2012/05/world-financial-turbulence-global_27.html

6/10/12 http://cmpassocregulationblog.blogspot.com/2012/06/rules versus-discretionary-authorities_10.html

France has been running a trade deficit fluctuating around €6,000 million, as shown in Table VF-1. Exports increased 1.3 percent in Apr while imports increased 0.1 percent, resulting in decrease of the trade deficit from revised €5768 million in Apr to €5325 million in May.

Table VF-1, France, Exports, Imports and Trade Balance, € Millions 

	Exports	Imports	Trade Balance
May 2012	37,440	42,765	-5,325
Apr	36,969	42,737	-5,768
Mar	36,316	41,876	-5,560
Feb	36,945	43,355	-6,410
Jan	36,728	43,127	-5,399
Dec 2011	36,143	41,428	-5,285
Nov	37,122	41,504	-4,382
Oct	35,813	41,711	-5,898
Sep	35,677	42,091	-6,414
Aug	37,576	42,158	-4,582
Jul	34,938	41,436	-6,498
Jun	34,746	40,065	-5,319
May	34,732	41,458	-6,726
Apr	34,558	41,445	-6,887
Mar	35,233	41,394	-6,161
Feb	34,716	41,086	-6,370
Jan	34,320	40,879	-6,559
Dec 2010	33,975	39,496	-5,521

Source: http://lekiosque.finances.gouv.fr/AppChiffre/Portail_default.asp

Monthly and 12-month rates of growth of exports and imports of France are provided in Table VF-2. Exports increased 1.3 percent in Apr and 7.8 percent in the 12 months ending in May. Imports increased 0.1 percent in May and 3.2 percent in12 months. Growth of exports and imports has fluctuated in 2011 as a result of price surges of commodities and raw materials.

Table VF-2, France, Exports and Imports, Month and 12-Month ∆%

	Exports Month ∆%	Exports 12-Month ∆%	Imports Month ∆%	Imports 12-Month ∆%
May 2012	1.3	7.8	0.1	3.2
Apr	1.8	7.0	2.1	3.1
Mar	-1.7	3.1	-3.4	1.2
Feb	0.6	6.4	2.9	5.5
Jan	1.6	7.0	1.7	3.1
Dec 2011	-2.6	6.4	-0.2	4.9
Nov	3.7	7.4	-0.5	4.6
Oct	0.4	8.6	-0.9	14.3
Sep	-5.1	7.6	-0.2	10.8
Aug	7.6	10.8	1.7	8.6
Jul	0.6	1.7	3.4	8.8
Jun	0.0	3.5	-3.4	8.2
May	0.5	15.5	0.0	16.4
Apr	-1.9	7.7	0.1	14.4
Mar	1.5	11.6	0.7	15.0
Feb	1.2	13.9	0.5	21.8
Jan	1.0	13.8	3.5	20.4
Dec 2011		6.4		4.9
Dec 2010		14.4		15.0
Dec 2009		-9.8		-1.8
Dec 2008		-7.3		-11.3
Dec 2007		6.1		8.3
Dec 2006		7.2		6.8
Dec 2005		11.3		15.1
Dec 2004		-3.5		6.0
Dec 2003		7.1		1.6

Source: http://lekiosque.finances.gouv.fr/AppChiffre/Portail_default.asp

Annual data for France’s exports, imports and trade balance are provided in Table VF-3. France’s trade balance deteriorated sharply from 2007 to 2011 with the deficit increasing from €42,494 million in 2007 to €70,799 million in 2011. Annual growth rates of exports have not been sufficiently high to compensate for growth of imports driven in part by commodity price increases.

Table VF-3, France, Exports, Imports and Balance Year € Millions and ∆%

	Exports € Millions	∆%	Imports € Millions	∆%	Balance € Millions
May 2012 12 Months	432,118		499,677		-67,559
Year
2011	427,061	8.3	497,860	11.5	-70,799
2010	394,269	13.8	446,536	14.0	-52,267
2009	346,340	-17.1	391,667	-17.3	-45,327
2008	417,634	2.7	473,853	5.5	-56,219
2007	406,487	3.0	448,981	5.8	-42,494
2006	394,621	9.5	424,549	10.4	-29,928
2005	360,376	4.4	384,588	9.6	-24,212
2004	345,256	5.4	350,996	7.0	-5,740
2003	327,653		327,884		-231

Source: http://lekiosque.finances.gouv.fr/AppChiffre/Portail_default.asp

VG Italy. The Markit/ADACI Business Activity Index increased from 42.8 in May to 43.1 in Jun, indicating sharp contraction of output of Italy’s services sector in 13 consecutive months of contraction (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9785). Phil Smith, economist at Markit and author of the Italy Services PMI^®, finds that the combined manufacturing and services indexes suggest continuing recession in IIQ2012 at the sharpest rate since IIQ2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9785). The Markit/ADACI Purchasing Managers’ Index^® (PMI^®), fell slightly from 44.8 in May to 44.6 in Jun for nine consecutive months of contraction of Italy’s manufacturing quite sharp relative to the history of the index (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9744). Phil Smith, economist at Markit and author of the Italian Manufacturing PMI^®, finds continuing sharp contraction of new orders of manufacturing in Italy and manufacturing output lower than in the first quarter when it fell at a quarterly rate of 2 percent (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9744). Table IT provides the country data table for Italy.

Table IT, Italy, Economic Indicators

Consumer Price Index	Jun month ∆%: 0.3 Jun 12-month ∆%: 3.3 Blog 7/2/12
Producer Price Index	May month ∆%: -0.3 May 12-month ∆%: 2.3 Blog 7/2/12
GDP Growth	IQ2012/IVQ2011 SA ∆%: minus 0.8 IQ2012/IQ2011 NSA ∆%: minus 1.4 Blog 6/17/12
Labor Report	Apr 2012 Participation rate 63.4% Employment ratio 57.0% Unemployment rate 10.2% Blog 6/3/12
Industrial Production	Apr month ∆%: -1.9 12 months ∆%: minus 9.2 Blog 6/10/12
Retail Sales	Apr month ∆%: -1.6 Apr 12-month ∆%: -6.9 Blog 7/2/12
Business Confidence	Mfg Jun 88.9, Feb 90.9 Construction Jun 85.6, Feb 84.6 Blog 7/2/12
Consumer Confidence	Consumer Confidence May 86.5, Apr 88.8 Economy May 64.4, Apr 71.6 Blog 5/27/12
Trade Balance	Balance Apr SA -€36 million versus Mar +€714 Exports Apr month SA ∆%: 0.2; Imports Apr month ∆%: 2.5 Exports 12 months NSA ∆%: -1.7 Imports 12 months NSA ∆%: minus 9.3 Blog 6/17/12

Links to blog comments in Table IT:

7/2/12 http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states_03.html

6/17/12 http://cmpassocregulationblog.blogspot.com/2012/05/world-financial-turbulence-global_27.html

6/10/12 http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities_10.html

6/3/12 http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs_04.html

5/27/12 http://cmpassocregulationblog.blogspot.com/2012/05/world-financial-turbulence-global_27.html

VH United Kingdom. Revised annual data in Table VH-UK show the strong impact of the global recession in the UK with decline of GDP of revised 4.0 percent in 2009 after dropping revised 1.0 percent in 2008. Recovery of 1.8 percent in 2010 is relatively low compared to annual growth rates in 2007 and earlier years. Growth was only 0.8 percent in 2011. The bottom part of Table VH-UK provides average growth rates of UK GDP since 1948. The UK economy grew at 2.7 percent on average between 1948 and 2011, which is relatively high for an advanced economy. The growth rate of GDP between 2000 and 2007 is higher at 3.0 percent. Growth in the current cyclical expansion has been only at 1.3 percent as advanced economies struggle with weak internal demand and world trade.

Table VH-UK, UK, Gross Domestic Product, ∆%

	∆% on Prior Year
1998	3.5
1999	3.2
2000	4.2
2001	2.9
2002	2.4
2003	3.8
2004	2.9
2005	2.8
2006	2.6
2007	3.6
2008	-1.0
2009	-4.0
2010	1.8
2011	0.8
Average ∆% per Year
1948-2011	2.7
1948-1959	2.9
1960-1969	3.3
1970-1979	2.5
1980-1989	3.2
1990-1999	2.6
2000-2011	1.7
2000-2007	3.0
2009-2011	1.3

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/naa2/quarterly-national-accounts/q1-2012/index.html

http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of_24.html

The Business Activity Index of the Markit/CIPS UK Services PMI^® fell from 53.3 in May to 51.3 in Jun with growth during 18 months but at the weakest level since Oct 2011 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9784). Chris Williamson, Chief Economist at Markit, finds that services grew only around 0.2 percent in IIQ2012, stagnating at the margin in Jun (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9784). The Markit/CIPS UK Manufacturing Purchasing Managers’ Index^® (PMI^®) increased from the three-year low of 45.9 in May to 48.6 in Jun with the average quarterly reading of 48.2 being the lowest since IIQ2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9748). The decline of 4.3 points in May is the second sharpest decline in the history of 20 years of the index. Rob Dobson, Senior Economist at Markit and author of the Markit/CIPS Manufacturing PMI^®, finds significant volatility from factors such as the jubilee holidays with production increase in Jun raising more favorable views but manufacturing output probably falling by around 0.5 percent in IIQ2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9748).

Table UK, UK Economic Indicators

CPI	May month ∆%: -0.1 May 12-month ∆%: 2.8 Blog 6/24/12
Output/Input Prices	Output Prices: Jun 12-month NSA ∆%: 2.3; excluding food, petroleum ∆%: 2.0 Input Prices: Jun 12-month NSA ∆%: -2.3 Excluding ∆%: -0.1 Blog 7/8/12
GDP Growth	IQ2012 prior quarter ∆% minus 0.3; year earlier same quarter ∆%: minus 0.2 Blog 7/2/12
Industrial Production	Apr 2012/Apr 2011 NSA ∆%: Production Industries minus 1.0; Manufacturing minus 0.3 Blog 6/17/12
Retail Sales	May month SA ∆%: +1.4 May 12-month NSA ∆%: +2.4 Blog 6/24/12
Labor Market	Feb-Apr Unemployment Rate: 8.2%; Claimant Count 4.9%; Earnings Growth 1.4% Blog 6/24/12
Trade Balance	Balance Apr minus ₤4421 million Exports Apr ∆%: -5.1 Mar-Apr ∆%: 0.6 Imports Apr ∆%: -1.4 Mar-Apr ∆%: 5.2 Blog 6/17/12

Links to blog comments in Table UK:

7/2/12 http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states_03.html

6/24/12 http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of_24.html

6/17/12 http://cmpassocregulationblog.blogspot.com/2012/05/world-financial-turbulence-global_27.html

VI Valuation of Risk Financial Assets. The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html 

Table VI-1 shows the phenomenal impulse to valuations of risk financial assets originating in the initial shock of near zero interest rates in 2003-2004 with the fed funds rate at 1 percent, in fear of deflation that never materialized, and quantitative easing in the form of suspension of the auction of 30-year Treasury bonds to lower mortgage rates. World financial markets were dominated by monetary and housing policies in the US. Between 2002 and 2008, the DJ UBS Commodity Index rose 165.5 percent largely because of unconventional monetary policy encouraging carry trades from low US interest rates to long leveraged positions in commodities, exchange rates and other risk financial assets. The charts of risk financial assets show sharp increase in valuations leading to the financial crisis and then profound drops that are captured in Table VI-1 by percentage changes of peaks and troughs. The first round of quantitative easing and near zero interest rates depreciated the dollar relative to the euro by 39.3 percent between 2003 and 2008, with revaluation of the dollar by 25.1 percent from 2008 to 2010 in the flight to dollar-denominated assets in fear of world financial risks and then devaluation of the dollar of 3.1 percent by Fri Jul 6, 2012. Dollar devaluation is a major vehicle of monetary policy in reducing the output gap that is implemented in the probably erroneous belief that devaluation will not accelerate inflation, misallocating resources toward less productive economic activities and disrupting financial markets. The last row of Table VI-1 shows CPI inflation in the US rising from 1.9 percent in 2003 to 4.1 percent in 2007 even as monetary policy increased the fed funds rate from 1 percent in Jun 2004 to 5.25 percent in Jun 2006.

Table VI-1, Volatility of Assets

DJIA	10/08/02-10/01/07	10/01/07-3/4/09	3/4/09- 4/6/10
∆%	87.8	-51.2	60.3
NYSE Financial	1/15/04- 6/13/07	6/13/07- 3/4/09	3/4/09- 4/16/07
∆%	42.3	-75.9	121.1
Shanghai Composite	6/10/05- 10/15/07	10/15/07- 10/30/08	10/30/08- 7/30/09
∆%	444.2	-70.8	85.3
STOXX EUROPE 50	3/10/03- 7/25/07	7/25/07- 3/9/09	3/9/09- 4/21/10
∆%	93.5	-57.9	64.3
UBS Com.	1/23/02- 7/1/08	7/1/08- 2/23/09	2/23/09- 1/6/10
∆%	165.5	-56.4	41.4
10-Year Treasury	6/10/03	6/12/07	12/31/08	4/5/10
%	3.112	5.297	2.247	3.986
USD/EUR	6/26/03	7/14/08	6/07/10	7/6/2012
Rate	1.1423	1.5914	1.192	1.2288
CNY/USD	01/03 2000	07/21 2005	7/15 2008	7/6/ 2012
Rate	8.2798	8.2765	6.8211	6.3658
New House	1963	1977	2005	2009
Sales 1000s	560	819	1283	375
New House	2000	2007	2009	2010
Median Price $1000	169	247	217	203
	2003	2005	2007	2010
CPI	1.9	3.4	4.1	1.5

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

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

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

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

Table VI-2 extracts four rows of Table VI-I with the Dollar/Euro (USD/EUR) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 25.1 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul, 2010, shown in Table VI-4 below, the dollar has devalued again to USD 1.2288/EUR on Jul 6, 2012 or by 3.1 percent {[(1.2288/1.192)-1]100 = 3.1%}. 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 6.3658/USD on Fri Jul 6, 2012, or by an additional 6.7 percent, for cumulative revaluation of 23.1 percent.

Table VI-2, 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	7/6/ /2012
Rate	1.1423	1.5914	1.192	1.2288
CNY/USD	01/03 2000	07/21 2005	7/15 2008	7/6/ 2012
Rate	8.2798	8.2765	6.8211	6.3658
Weekly Rates	6/15/2012	6/22/2012	6/29/2012	7/6/ 2012
CNY/USD	6.3678	6.3650	6.3552	6.3658
∆% from Earlier Week*	0.1	0.0	0.2	-0.2

*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 VI-2A provides the CNY/USD rate from Oct 28, 2011 to Jun 29, 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 VI-2), the CNY has appreciated 0.1 percent relative to Oct 28, 2011, as shown in Table VI-2A. The CNY devalued by 0.2 percent relative to the USD in the week of Jul 6, 2012 such that, as shown in Table VI-2A, there is marginal devaluation of 0.1 percent on Jul 6, 2012 relative to Oct 28, 2011. 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. An important statement by the People’s Bank of China (PBC), China’s central bank, on Apr 14, 2012, announced the widening of the daily maximum band of fluctuation of the renminbi (RMB) yuan (http://www.pbc.gov.cn/publish/english/955/2012/20120414090756030448561/20120414090756030448561_.html):

“Along with the development of China’s foreign exchange market, the pricing and risk management capabilities of market participants are gradually strengthening. In order to meet market demands, promote price discovery, enhance the flexibility of RMB exchange rate in both directions, further improve the managed floating RMB exchange rate regime based on market supply and demand with reference to a basket of currencies, the People’s Bank of China has decided to enlarge the floating band of RMB’s trading prices against the US dollar and is hereby making a public announcement as follows:

Effective from April 16, 2012 onwards, the floating band of RMB’s trading prices against the US dollar in the inter-bank spot foreign exchange market is enlarged from 0.5 percent to 1 percent, i.e., on each business day, the trading prices of the RMB against the US dollar in the inter-bank spot foreign exchange market will fluctuate within a band of ±1 percent around the central parity released on the same day by the China Foreign Exchange Trade System. The spread between the RMB/USD selling and buying prices offered by the foreign exchange-designated banks to their customers shall not exceed 2 percent of the central parity, instead of 1 percent, while other provisions in the Circular of the PBC on Relevant Issues Managing the Trading Prices in the Inter-bank Foreign Exchange Market and Quoted Exchange Rates of Exchange-Designated Banks(PBC Document No.[2010]325) remain valid.

In view of the domestic and international economic and financial conditions, the People’s Bank of China will continue to fulfill its mandates in relation to the RMB exchange rate, keeping RMB exchange rate basically stable at an adaptive and equilibrium level based on market supply and demand with reference to a basket of currencies to preserve stability of the Chinese economy and financial markets.”

Table VI-2A, Renminbi Yuan US Dollar Rate

	CNY/USD	∆% from 10/28/2011
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

The database of the World Economic Outlook (WEO) of the IMF (http://www.imf.org/external/pubs/ft/weo/2012/01/weodata/index.aspx) is used to contract Table VI-3 with fiscal and current account imbalances projected for 2011 and 2015. The WEO finds the need to rebalance external and domestic demand (IMF 2011WEOSep xvii):

“Progress on this front has become even more important to sustain global growth. Some emerging market economies are contributing more domestic demand than is desirable (for example, several economies in Latin America); others are not contributing enough (for example, key economies in emerging Asia). The first set needs to restrain strong domestic demand by considerably reducing structural fiscal deficits and, in some cases, by further removing monetary accommodation. The second set of economies needs significant currency appreciation alongside structural reforms to reduce high surpluses of savings over investment. Such policies would help improve their resilience to shocks originating in the advanced economies as well as their medium-term growth potential.”

The IMF (2012WEOApr, XVII) explains decreasing importance of the issue of global imbalances as follows:

“The latest developments suggest that global current account imbalances are no longer expected to widen again, following their sharp reduction during the Great Recession. This is largely because the excessive consumption growth that characterized economies that ran large external deficits prior to the crisis has been wrung out and has not been offset by stronger consumption in surplus economies. Accordingly, the global economy has experienced a loss of demand and growth in all regions relative to the boom years just before the crisis. Rebalancing activity in key surplus economies toward higher consumption, supported by more market-determined exchange rates, would help strengthen their prospects as well as those of the rest of the world.”

Table VI-3, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2011 Dollar GDP

	GDP $B 2011	FD %GDP 2011	CAD %GDP 2011	Debt %GDP 2011	FD%GDP 2015	CAD%GDP 2015	Debt %GDP 2015
US	15094	-7.3	-3.1	80.3	-2.3	-3.2	88.3
Japan	5869	-9.1	2.0	126.6	-5.8	2.4	155.0
UK	2418	-5.8	-1.9	78.3	-0.8	-0.4	88.1
Euro	13115	-1.6	0.3	68.4	1.1	1.2	71.3
Ger	3577	0.7	5.7	56.1	1.4	4.3	52.4
France	2776	-2.9	-2.2	80.4	0.3	-0.8	83.8
Italy	2199	0.8	-3.2	99.6	4.4	-1.6	101.5
Can	1737	-4.1	-2.8	33.3	-1.1	-2.5	37.4
China	7298	-1.2	2.7	25.8	-0.1	3.4	14.8
Brazil	2493	3.1	-2.1	36.4	3.1	-3.4	31.9

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

FD is primary except total for China; Debt is net except gross for China

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

The current account of the US balance of payments is provided in Table VI-A for IQ2011 and IQ2012. 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. 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 VI-3A, US Balance of Payments, Millions of Dollars NSA

	IQ2011	IQ2012	Difference
Goods Balance	-181,358	-194,462	-13,104
X Goods	360,917	388,501	11.0 ∆%
M Goods	-542,276	-582.963	12.9 ∆%
Services Balance	44,133	43,465	-668
X Services	147,894	154,420	9.1 ∆%
M Services	-103,761	-110,955	8.0 ∆%
Balance Goods and Services	-137,225	-150,997	-13,772
Balance Income	52,451	47,571	-4,880
Unilateral Transfers	-35,223	-33,887	1,336
Current Account Balance	-119,997	-137,313	-17,316
% GDP	IQ2011	IVQ2011	IQ2012
	3.2	3.1	3.6

X: exports; M: imports

Balance on Current Account = Balance on Goods and Services + Balance on Income + Unilateral Transfers

Source: Bureau of Economic Analysis

http://www.bea.gov/international/index.htm#bop

In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):

“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”

The current real value of government debt plus monetary liabilities depends on the expected discounted values of future primary surpluses or difference between tax revenue and government expenditure excluding interest payments (Cochrane 2011Jan, 27, equation (16)). There is a point when adverse expectations about the capacity of the government to generate primary surpluses to honor its obligations can result in increases in interest rates on government debt.

This analysis suggests that there may be a point of saturation of demand for United States financial liabilities without an increase in interest rates on Treasury securities. A risk premium may develop on US debt. Such premium is not apparent currently because of distressed conditions in the world economy and international financial system. Risk premiums are observed in the spread of bonds of highly indebted countries in Europe relative to bonds of the government of Germany.

The issue of global imbalances centered on the possibility of a disorderly correction (Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State Vol. II (2008b) 183-94, Government Intervention in Globalization (2008c), 167-71). Such a correction has not occurred historically but there is no argument proving that it could not occur. The need for a correction would originate in unsustainable large and growing United States current account deficits (CAD) and net international investment position (NIIP) or excess of financial liabilities of the US held by foreigners net of financial liabilities of foreigners held by US residents. The IMF estimated that the US could maintain a CAD of two to three percent of GDP without major problems (Rajan 2004). The threat of disorderly correction is summarized by Pelaez and Pelaez, The Global Recession Risk (2007), 15):

“It is possible that foreigners may be unwilling to increase their positions in US financial assets at prevailing interest rates. An exit out of the dollar could cause major devaluation of the dollar. The depreciation of the dollar would cause inflation in the US, leading to increases in American interest rates. There would be an increase in mortgage rates followed by deterioration of real estate values. The IMF has simulated that such an adjustment would cause a decline in the rate of growth of US GDP to 0.5 percent over several years. The decline of demand in the US by four percentage points over several years would result in a world recession because the weakness in Europe and Japan could not compensate for the collapse of American demand. The probability of occurrence of an abrupt adjustment is unknown. However, the adverse effects are quite high, at least hypothetically, to warrant concern.”

The United States could be moving toward a situation typical of heavily indebted countries, requiring fiscal adjustment and increases in productivity to become more competitive internationally. The CAD and NIIP of the United States are not observed in full deterioration because the economy is well below potential. There are two complications in the current environment relative to the concern with disorderly correction in the first half of the past decade. Table VI-3B provides data on US fiscal and balance of payments imbalances. In 2007, the federal deficit of the US was $161 billion corresponding to 1.2 percent of GDP while the Congressional Budget Office (CBO 2012MarBEO, 2) estimates the federal deficit in 2012 at $1171 billion or 7.6 percent of GDP. The combined record federal deficits of the US from 2009 to 2012 are $5178 billion or 33 percent of the estimate of GDP of $15,508 billion for 2012 by the CBO (2012MarBEO, 2). Federal debt in 2007 was $5035 billion, less than the combined deficits from 2009 to 2012 of $5178 billion, and corresponded to 36.3 percent of GDP. Federal debt in 2011 was 67.7 percent of GDP and is estimated to reach 73.2 percent of GDP in 2012 (CBO2012MarBEO, 2). This situation may worsen in the future (CBO 2012LTBO):

“The budget outlook is much bleaker under the extended alternative fiscal scenario, which maintains what some analysts might consider “current policies,” as opposed to current laws. Federal debt would grow rapidly from its already high level, exceeding 90 percent of GDP in 2022. After that, the growing imbalance between revenues and spending, combined with spiraling interest payments, would swiftly push debt to higher and higher levels. Debt as a share of GDP would exceed its historical peak of 109 percent by 2026, and it would approach 200 percent in 2037.

The changes under this scenario would result in much lower revenues than would occur under the extended baseline scenario because almost all expiring tax provisions are assumed to be extended through 2022 (with the exception of the current reduction in the payroll tax rate for Social Security). After 2022, revenues under this scenario are assumed to remain at their 2022 level of 18.5 percent of GDP, just above the average of the past 40 years.

Outlays would be much higher than under the other scenario. This scenario incorporates assumptions that through 2022, lawmakers will act to prevent Medicare’s payment rates for physicians from declining; that after 2022, lawmakers will not allow various restraints on the growth of Medicare costs and health insurance subsidies to exert their full effect; and that the automatic reductions in spending required by the Budget Control Act of 2011 will not occur (although the original caps on discretionary appropriations in that law are assumed to remain in place). Finally, under this scenario, federal spending as a percentage of GDP for activities other than Social Security, the major health care programs, and interest payments is assumed to return to its average level during the past two decades, rather than fall significantly below that level, as it does under the extended baseline scenario.”

Table VI-3B, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and %

	2000	2007	2008	2009	2010	2011
Goods & Services	-377	-697	-698	-379	-495	-559
Income	19	101	147	119	184	227
UT	-58	-115	-126	-122	-131	-133
Current Account	-416	-710	-677	-382	-442	-466
NGDP	9951	14028	14291	13939	14526	15094
Current Account % GDP	-3.8	-5.0	-4.9	-2.7	-3.4	-3.7
NIIP	-1337	-1796	-3260	-2396	-2471	NA
NIIP % GDP	-13.4	-12.8	-22.8	-17.2	-17.0	NA
Exports Goods Services Income	1425	2488	2657	2181	2519	2848
NIIP % Exports Goods Services Income	-94	-72	-123	-110	-98	NA
DIA MV	2694	5274	3102	4331	4843	NA
DIUS MV	2783	3551	2486	3027	3451	NA
Fiscal Balance	+236	-161	-459	-1413	-1294	-1300
Fiscal Balance % GDP	+2.4	-1.2	-3.2	-9.9	-8.9	-8.7
Federal   Debt	3410	5035	5803	7545	9019	10128
Federal Debt % GDP	34.7	36.3	40.5	54.1	62.8	67.7
Federal Outlays	1789	2729	2983	3518	3456	3598
∆%	5.1	2.8	9.3	17.9	-1.8	4.1
% GDP	18.2	19.7	20.8	25.2	24.1	24.1
Federal Revenue	2052	2568	2524	2105	2162	2303
∆%	10.8	6.7	-1.7	-16.6	2.7	6.5
% GDP	20.6	18.5	17.6	15.1	15.1	15.4

Sources: 

Notes: UT: unilateral transfers; NGDP: nominal GDP or in current dollars; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. There are minor discrepancies in the decimal point of percentages of GDP between the balance of payments data and federal debt, outlays, revenue and deficits in which they original number of the CBO source is maintained. These discrepancies do not alter conclusions.

Sources: Balance of Payments and NIIP, Bureau of Economic Analysis (BEA) http://www.bea.gov/international/index.htm#bop

Gross Domestic Product, Bureau of Economic Analysis (BEA) http://www.bea.gov/national/index.htm#gdp

Federal Outlays, Revenues and Debt, Congressional Budget Office (CBO) http://www.cbo.gov/publication/42911

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 (2012WEOApr) provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2012/01/pdf/text.pdf), of the world financial system with its Global Financial Stability Report (GFSR) (IMF 2012GFSRApr) (http://www.imf.org/external/pubs/ft/gfsr/2012/01/pdf/text.pdf) and of fiscal affairs with the Fiscal Monitor (IMF 2012FMApr) (http://www.imf.org/external/pubs/ft/fm/2012/01/pdf/fm1201.pdf). 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 global economic and financial risks, which are analyzed in the comments of this blog.

Economic risks include the following:

1. China’s Economic Growth. China is lowering its growth target to 7.5 percent per year. Lu Hui, writing on “China lowers GDP target to achieve quality economic growth, on Mar 12, 2012, published in Beijing by Xinhuanet (http://news.xinhuanet.com/english/china/2012-03/12/c_131461668.htm), informs that Premier Jiabao wrote in a government work report that the GDP growth target will be lowered to 7.5 percent to enhance the quality and level of development of China over the long term. The quarterly growth rate of GDP in IQ2012 of 1.8 percent is equivalent to 7.4 percent per year (see subsection VC at http://cmpassocregulationblog.blogspot.com/2012/04/fractured-labor-market-with-hiring_15.html). There is also ongoing political development in China during a decennial political reorganization. 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).

2. United States Economic Growth, Labor Markets and Budget/Debt Quagmire. (i) The US economy grew at 1.7 percent in 2011 (Section I), 1.7 percent in annual equivalent in the five quarters from IQ2011 to IQ2012 and 2.0 percent in IQ2012 relative to IQ2011 (http://cmpassocregulationblog.blogspot.com/2012/07/mediocre-economic-growth-united-states.html). (ii) The labor market continues fractured with 28.4 million unemployed or underemployed (see Section I and earlier http://cmpassocregulationblog.blogspot.com/2012/06/mediocre-recovery-without-jobs.html). There are over 10 million fewer full-time jobs and hiring has collapsed (http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of.html). (iii) There is a difficult climb from the record federal deficit of 9.9 percent of GDP in 2009 and cumulative deficit of $5178 in four consecutive years of deficits exceeding one trillion dollars from 2009 to 2012 (see Section VA http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars_17.html). There is no subsequent jump of debt in US peacetime history as the one from 40.5 percent of GDP in 2008 to 67.7 percent of GDP in 2011 and projected by the Congressional Budget Office (CBO 2012MarBEO, 2) at 73.2 percent in 2012. The CBO (2012MarBEO) must use current law without any changes in the baseline scenario but also calculates another alternative scenario with different assumptions. In the alternative scenario, the debt/GDP ratio rises to 94.2 percent by 2022. The US is facing an unsustainable debt/GDP path. Feldstein (2012Mar19) finds that the most troubling uncertainty in the US is the programmed tax increases projected by the CBO (2012JanBEO) under current law with federal government revenue increasing from $2.4 trillion in fiscal year 2012 to $2.9 trillion in fiscal year 2013. The increase of $512 billion of federal revenue would be about 2.9 percent of GDP, raising the share of federal revenue in GDP from 15.8 percent in fiscal year 2012 to 18.7 percent of GDP in fiscal year 2013. In the analysis of Feldstein (2012Mar19), increasing revenue would originate in higher personal tax rates, payroll tax contributions and taxes on dividends, capital gains and corporate income tax. The share of federal revenue in GDP would increase to 19.8 percent in 2014, remaining above 20 percent during the rest of the decade. Feldstein (2012Mar19) finds that such a shock of sustained tax increases would risk another recession in 2013, requiring preventive legislation to smooth tax increases

3. Economic Growth and Labor Markets in Advanced Economies. Advanced economies are growing slowly. Japan’s GDP fell 0.6 percent in IVQ2011 relative to a year earlier but grew 2.8 percent in IQ2012 relative to a year earlier and 1.2 percent in IQ2012 relative to IVQ2011. The euro zone’s GDP fell 0.3 percent in IVQ2011 and was flat in IQ2012, falling 0.1 percent relative to a year earlier in IQ2011; Germany’s GDP fell 0.2 percent in IVQ2011 but grew 0.5 percent in IQ2012; and the UK’s GDP fell 0.3 percent in IVQ2011 and 0.3 percent in IQ2012. There is still high unemployment in advanced economies

4. World Inflation Waves. Inflation continues in repetitive waves globally (see Section I Inflation Waves http://cmpassocregulationblog.blogspot.com/2012/06/destruction-of-three-trillion-dollars.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/05/world-inflation-waves-monetary-policy.html http://cmpassocregulationblog.blogspot.com/2012/04/fractured-labor-market-with-hiring.html and http://cmpassocregulationblog.blogspot.com/2012/03/global-financial-and-economic-risk.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. Adjustment programs consist of immediate adoption of economic reforms that would increase future growth permitting fiscal consolidation, which would reduce risk spreads on sovereign debt. Fiscal consolidation is challenging in an environment of weak economic growth as analyzed by Blanchard (2011WEOSep) and consolidation can restrict growth as analyzed by Blanchard (2012WEOApr). Adjustment of countries such as Italy requires depreciation of the currency to parity, as proposed by Caballero and Giavazzi (2012Jan15), but it is not workable within the common currency and zero interest rates in the US. Bailouts of euro area member countries with temporary liquidity challenges cannot be permanently provided by stronger members at the risk of impairing their own sovereign debt credibility

2. Foreign Exchange Wars. Exchange rate struggles continue as zero interest rates in advanced economies induce devaluation. After deep global recession, regulation, trade and devaluation wars were to be expected (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 181): “There are significant grounds for concern on the basis of this experience. International economic cooperation and the international financial framework can collapse during extreme events. It is unlikely that there will be a repetition of the disaster of the Great Depression. However, a milder contraction can trigger regulatory, trade and exchange wars”

3. Valuation of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with lower volumes. For example, the DJIA has increased 31.9 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010, and the S&P 500 has gained 32.5 percent. It is challenging in theory and practice to assess when variables have peaked but sustained valuations to very high levels could be followed by contractions of valuations. Jonathan Cheng, writing on “Stocks add 66 points, post first-quarter record,” published on Mar 30, 2012, in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303816504577313123753822852.html?mod=WSJ_Markets_LEFTTopStories&mg=reno64-sec-wsj), finds that the DJIA rose 8.1 percent in IQ2012, which is the highest since 1998, while the S&P 500 gained 12 percent. Paul A. Samuelson remarked that “the stock market has predicted nine of the last five recessions.” Another version of this phrase would be that “the stock market has predicted nine of the last five economic booms.” 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 (1)

Equation (1) 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 present value of the firm can also be expressed as the discounted future value of net cash flows. Equities can inflate beyond sound values if cash flows that depend on economic activity prove to be illusory in continuing mediocre growth

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. The Federal Open Market Committee (FOMC) advised on its Jun 20, 2012 statement that: “To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its 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.” (http://www.federalreserve.gov/newsevents/press/monetary/20120620a.htm). At its meeting on Jan 25, the FOMC began to provide to the public the specific forecasts of interest rates and other economic variables by FOMC members. These forecasts are analyzed in Section IV Global Inflation. 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 and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). 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.

The analysis by Kydland and Prescott (1977, 447-80, equation 5) uses the “expectation augmented” Phillips curve with the natural rate of unemployment of Friedman (1968) and Phelps (1968), which in the notation of Barro and Gordon (1983, 592, equation 1) is:

U_t = Uⁿ_t – α(π_t – π^e) α > 0 (1)

Where U_t is the rate of unemployment at current time t, Uⁿ_t is the natural rate of unemployment, π_t is the current rate of inflation and π^e is the expected rate of inflation by economic agents based on current information. Equation (1) expresses unemployment net of the natural rate of unemployment as a decreasing function of the gap between actual and expected rates of inflation. The system is completed by a social objective function, W, depending on inflation, π, and unemployment, U:

W = W(π_t, U_t) (2)

The policymaker maximizes the preferences of the public, (2), subject to the constraint of the tradeoff of inflation and unemployment, (1). The total differential of W set equal to zero provides an indifference map in the Cartesian plane with ordered pairs (π_t, U_t - Uⁿ) such that the consistent equilibrium is found at the tangency of an indifference curve and the Phillips curve in (1). The indifference curves are concave to the origin. The consistent policy is not optimal. Policymakers without discretionary powers following a rule of price stability would attain equilibrium with unemployment not higher than with the consistent policy. The optimal outcome is obtained by the rule of price stability, or zero inflation, and no more unemployment than under the consistent policy with nonzero inflation and the same unemployment. Taylor (1998LB) attributes the sustained boom of the US economy after the stagflation of the 1970s to following a monetary policy rule instead of discretion (see Taylor 1993, 1999).

6. Carry Trades. Commodity prices driven by zero interest rates have resumed their increasing path. Some analytical aspects of the carry trade are instructive (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 101-5, Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 202-4), Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 70-4). Consider the following symbols: R_t is the exchange rate of a country receiving carry trade denoted in units of domestic currency per dollars at time t of initiation of the carry trade; R_t+τ is the exchange of the country receiving carry trade denoted in units of domestic currency per dollars at time t+τ when the carry trade is unwound; i_f is the domestic interest rate of the high-yielding country where investment will be made; i_usd is the interest rate on short-term dollar debt assumed to be 0.5 percent per year; i_f >i_usd, which expresses the fact that the interest rate on the foreign country is much higher than that in short-term USD (US dollars); S_t is the dollar value of the investment principal; and π is the dollar profit from the carry trade. The investment of the principal S_t in the local currency debt of the foreign country provides a profit of:

π = (1 + i_f)(R_tS_t)(1/R_t+τ) – (1 + i_usd)S_t (3)

The profit from the carry trade, π, is nonnegative when:

(1 + i_f)/ (1 + i_usd) ≥ R_t+τ/R_t (4)

In words, the difference in interest rate differentials, left-hand side of inequality (4), must exceed the percentage devaluation of the currency of the host country of the carry trade, right hand side of inequality (4). The carry trade must earn enough in the host-country interest rate to compensate for depreciation of the host-country at the time of return to USD. A simple example explains the vulnerability of the carry trade in fixed-income. Let i_f be 0.10 (10 percent), i_usd 0.005 (0.5 percent), S_t USD100 and R_t CUR 1.00/USD. Adopt the fixed-income rule of months of 30 days and years of 360 days. Consider a strategy of investing USD 100 at 10 percent for 30 days with borrowing of USD 100 at 0.5 percent for 30 days. At time t, the USD 100 are converted into CUR 100 and invested at [(30/360)10] equal to 0.833 percent for thirty days. At the end of the 30 days, assume that the rate R_t+30 is still CUR 1/USD such that the return amount from the carry trade is USD 0.833. There is still a loan to be paid [(0.005)(30/360)USD100] equal to USD 0.042. The investor receives the net amount of USD 0.833 minus USD 0.042 or US 0.791. The rate of return on the investment of the USD 100 is 0.791 percent, which is equivalent to the annual rate of return of 9.49 percent {(0.791)(360/30)}. This is incomparably better than earning 0.5 percent. There are alternatives of hedging by buying forward the exchange for conversion back into USD.

Research by the Federal Reserve Bank of St. Louis finds that the dollar declined on average by 6.56 percent in the events of quantitative easing, ranging from depreciation of 10.8 percent relative to the Japanese yen to 3.6 percent relative to the pound sterling (http://research.stlouisfed.org/wp/2010/2010-018.pdf). A critical assumption of Rudiger Dornbusch (1976) in his celebrated analysis of overshooting (Rogoff 2002MF http://www.imf.org/external/np/speeches/2001/kr/112901.pdf) is “that exchange rates and asset markets adjust fast relative to goods markets” (Rudiger Dornbusch 1976, 1162). The market response of a monetary expansion is “to induce an immediate depreciation in the exchange rate and accounts therefore for fluctuations in the exchange rate and the terms of trade. During the adjustment process, rising prices may be accompanied by an appreciating exchange rate so that the trend behavior of exchange rates stands potentially in strong contrast with the cyclical behavior of exchange rates and prices” (Dornbusch 1976, 1162). The volatility of the exchange rate “is needed to temporarily equilibrate the system in response to monetary shocks, because underlying national prices adjust so slowly” (Rogoff 2002MF http://www.imf.org/external/np/speeches/2001/kr/112901.pdf 3). The exchange rate “is identified as a critical channel for the transmission of monetary policy to aggregate demand for domestic output” (Dornbusch 1976, 1162).

In a world of exchange wars, depreciation of the host-country currency can move even faster such that the profits from the carry trade may become major losses. Depreciation is the percentage change in instants against which the interest rate of a day is in the example [(10)(1/360)] or 0.03 percent. Exchange rates move much faster in the real world as in the overshooting model of Dornbusch (1976). Profits in carry trades have greater risks but equally greater returns when the short position in zero interest rates, or borrowing, and on the dollar, are matched with truly agile financial risk assets such as commodities and equities. A simplified analysis could consider the portfolio balance equations A_ij = f(r, x) where A_ij is the demand for i = 1,2,∙∙∙n assets from j = 1,2, ∙∙∙m sectors, r the 1xn vector of rates of return, r_i, of n assets and x a vector of other relevant variables. Tobin (1969) and Brunner and Meltzer (1973) assume imperfect substitution among capital assets such that the own first derivatives of A_ij are positive, demand for an asset increases if its rate of return (interest plus capital gains) is higher, and cross first derivatives are negative, demand for an asset decreases if the rate of return of alternative assets increases. Theoretical purity would require the estimation of the complete model with all rates of return. In practice, it may be impossible to observe all rates of return such as in the critique of Roll (1976). Policy proposals and measures by the Fed have been focused on the likely impact of withdrawals of stocks of securities in specific segments, that is, of effects of one or several specific rates of return among the n possible rates. In fact, the central bank cannot influence investors and arbitrageurs to allocate funds to assets of desired categories such as asset-backed securities that would lower the costs of borrowing for mortgages and consumer loans. Floods of cheap money may simply induce carry trades in arbitrage of opportunities in fast moving assets such as currencies, commodities and equities instead of much lower returns in fixed income securities (see http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html).

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 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 VI-4, 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 7/6/12,” 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, 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]. 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 by the European Council on bank resolutions. 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. The highest valuations in column “∆% Trough to 7/6/12” are by US equities indexes: DJIA 31.9 percent and S&P 500 32.5 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 7/6/12” 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 6.7 percent below the trough; STOXX 50 of Europe is 5.5 percent above the trough; Japan’s Nikkei Average is 2.2 percent above the trough; DJ Asia Pacific TSM is 5.8 percent above the trough; Dow Global is 6.5 percent above the trough; and NYSE Financial is 4.0 percent above the trough. DJ UBS Commodities is 10.4 percent above the trough. DAX is 13.0 percent above the trough. Japan’s Nikkei Average is 2.2 percent above the trough on Aug 31, 2010 and 20.8 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 9020.75 on Fri Jul 6, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 12.0 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 3.1 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 7/6/12” in Table VI-4 shows that there were increases of valuations of risk financial assets in the week of Jul 7, 2012 such as 1.2 percent for DJ Asia Pacific, 0.2 percent for Nikkei Average and 1.8 percent for STOXX 50. DJ UBS Commodities increased 1.1 percent. Other valuations decreased such as 0.8 percent for NYSE Financial, 0.9 percent for Dow Global and 0.1 percent for DAX. The DJIA fell 0.8 percent and S&P 500 decreased 0.5 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 VI-4 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 7/6/12” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Jul 6, 2012. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 7/6/12” but also relative to the peak in column “∆% Peak to 7/6/12.” There are now only three equity indexes above the peak in Table VI-4: DJIA 14.0 percent, S&P 500 11.3 percent and DAX 1.2 percent. There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 17.2 percent, Nikkei Average by 20.8 percent, Shanghai Composite by 29.7 percent, DJ Asia Pacific by 7.3 percent, STOXX 50 by 10.6 percent and Dow Global by 13.1 percent. DJ UBS Commodities Index is now 5.6 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 VI-4, Stock Indexes, Commodities, Dollar and 10-Year Treasury  

	Peak	Trough	∆% to Trough	∆% Peak to 7/6 /12	∆% Week 7/6/12	∆% Trough to 7/6 12
DJIA	4/26/ 10	7/2/10	-13.6	14.0	-0.8	31.9
S&P 500	4/23/ 10	7/20/ 10	-16.0	11.3	-0.5	32.5
NYSE Finance	4/15/ 10	7/2/10	-20.3	-17.2	-0.8	4.0
Dow Global	4/15/ 10	7/2/10	-18.4	-13.1	-0.9	6.5
Asia Pacific	4/15/ 10	7/2/10	-12.5	-7.3	1.2	5.8
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-20.8	0.2	2.2
China Shang.	4/15/ 10	7/02 /10	-24.7	-29.7	-0.1	-6.7
STOXX 50	4/15/10	7/2/10	-15.3	-10.6	1.8	5.5
DAX	4/26/ 10	5/25/ 10	-10.5	1.2	-0.1	13.0
Dollar Euro	11/25 2009	6/7 2010	21.2	18.8	2.9	-3.1
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-5.6	1.1	10.4
10-Year T Note	4/5/ 10	4/6/10	3.986	1.548

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

Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. Table VI-5 shows a gain by Apr 29, 2011 in the DJIA of 14.3 percent and of the S&P 500 of 12.5 percent since Apr 26, 2010, around the time when sovereign risk issues in Europe began to be acknowledged in financial risk asset valuations. The last row of Table VI-5 for Jul 6, 2012, shows that the S&P 500 is now 11.8 percent above the Apr 26, 2010 level and the DJIA is 14.0 percent above the level on Apr 26, 2010. Multiple rounds of risk aversion eroded earlier gains, showing that risk aversion can destroy market value even with zero interest rates. Relaxed risk aversion has contributed to recovery of valuations. Much the same as zero interest rates and quantitative easing have not had any effects in recovering economic activity while distorting financial markets and resource allocation.

Table VI-5, Percentage Changes of DJIA and S&P 500 in Selected Dates

2010	∆% DJIA from  prior date	∆% DJIA from Apr 26	∆% S&P 500 from prior date	∆% S&P 500 from Apr 26
Apr 26
May 6	-6.1	-6.1	-6.9	-6.9
May 26	-5.2	-10.9	-5.4	-11.9
Jun 8	-1.2	-11.3	2.1	-12.4
Jul 2	-2.6	-13.6	-3.8	-15.7
Aug 9	10.5	-4.3	10.3	-7.0
Aug 31	-6.4	-10.6	-6.9	-13.4
Nov 5	14.2	2.1	16.8	1.0
Nov 30	-3.8	-3.8	-3.7	-2.6
Dec 17	4.4	2.5	5.3	2.6
Dec 23	0.7	3.3	1.0	3.7
Dec 31	0.03	3.3	0.07	3.8
Jan 7	0.8	4.2	1.1	4.9
Jan 14	0.9	5.2	1.7	6.7
Jan 21	0.7	5.9	-0.8	5.9
Jan 28	-0.4	5.5	-0.5	5.3
Feb 4	2.3	7.9	2.7	8.1
Feb 11	1.5	9.5	1.4	9.7
Feb 18	0.9	10.6	1.0	10.8
Feb 25	-2.1	8.3	-1.7	8.9
Mar 4	0.3	8.6	0.1	9.0
Mar 11	-1.0	7.5	-1.3	7.6
Mar 18	-1.5	5.8	-1.9	5.5
Mar 25	3.1	9.1	2.7	8.4
Apr 1	1.3	10.5	1.4	9.9
Apr 8	0.03	10.5	-0.3	9.6
Apr 15	-0.3	10.1	-0.6	8.9
Apr 22	1.3	11.6	1.3	10.3
Apr 29	2.4	14.3	1.9	12.5
May 6	-1.3	12.8	-1.7	10.6
May 13	-0.3	12.4	-0.2	10.4
May 20	-0.7	11.7	-0.3	10.0
May 27	-0.6	11.0	-0.2	9.8
Jun 3	-2.3	8.4	-2.3	7.3
Jun 10	-1.6	6.7	-2.2	4.9
Jun 17	0.4	7.1	0.04	4.9
Jun 24	-0.6	6.5	-0.2	4.6
Jul 1	5.4	12.3	5.6	10.5
Jul 8	0.6	12.9	0.3	10.9
Jul 15	-1.4	11.4	-2.1	8.6
Jul 22	1.6	13.2	2.2	10.9
Jul 29	-4.2	8.4	-3.9	6.6
Aug 05	-5.8	2.1	-7.2	-1.0
Aug 12	-1.5	0.6	-1.7	-2.7
Aug 19	-4.0	-3.5	-4.7	-7.3
Aug 26	4.3	0.7	4.7	-2.9
Sep 02	-0.4	0.3	-0.2	-3.1
Sep 09	-2.2	-1.9	-1.7	-4.8
Sep 16	4.7	2.7	5.4	0.3
Sep 23	-6.4	-3.9	-6.5	-6.2
Sep 30	1.3	-2.6	-0.4	-6.7
Oct 7	1.7	-0.9	2.1	-4.7
Oct 14	4.9	3.9	5.9	1.0
Oct 21	1.4	5.4	1.1	2.2
Oct 28	3.6	9.2	3.8	6.0
Nov 04	-2.0	6.9	-2.5	3.4
Nov 11	1.4	8.5	0.8	4.3
Nov 18	-2.9	5.3	-3.8	0.3
Nov 25	-4.8	0.2	-4.7	-4.4
Dec 02	7.0	7.3	7.4	2.7
Dec 09	1.4	8.7	0.9	3.6
Dec 16	-2.6	5.9	-2.8	0.6
Dec 23	3.6	9.7	3.7	4.4
Dec 30	-0.6	9.0	-0.6	3.8
Jan 6 2012	1.2	10.3	1.6	5.4
Jan 13	0.5	10.9	0.9	6.4
Jan 20	2.4	13.5	2.0	8.5
Jan 27	-0.5	13.0	0.1	8.6
Feb 3	1.6	14.8	2.2	11.0
Feb 10	-0.5	14.2	-0.2	10.8
Feb 17	1.2	15.6	1.4	12.3
Feb 24	0.3	15.9	0.3	12.7
Mar 2	0.0	15.8	0.3	13.0
Mar 9	-0.4	15.3	0.1	13.1
Mar 16	2.4	18.1	2.4	15.9
Mar 23	-1.1	16.7	-0.5	15.3
Mar 30	1.0	17.9	0.8	16.2
Apr 6	-1.1	16.6	-0.7	15.3
Apr 13	-1.6	14.7	-2.0	13.1
Apr 20	1.4	16.3	0.6	13.7
Apr 27	1.5	18.1	1.8	15.8
May 4	-1.4	16.4	-2.3	12.9
May 11	-1.7	14.4	-1.1	11.7
May 18	-3.5	10.4	-4.3	6.4
May 25	0.7	11.2	1.7	8.7
Jun 1	-2.7	8.2	-3.0	5.4
Jun 8	3.6	12.0	3.7	9.4
Jun 15	1.7	13.9	1.3	10.8
Jun 22	-1.0	12.8	-0.6	10.1
Jun 29	1.9	14.9	2.0	12.4
Jul 6	-0.8	14.0	-0.5	11.8

Source: http://professional.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3014

Table VI-6, updated with every blog comment, shows that exchange rate valuations affect a large variety of countries, in fact, almost the entire world, in magnitudes that cause major problems for domestic monetary policy and trade flows. Dollar devaluation is expected to continue because of zero fed funds rate, expectations of rising inflation, large budget deficit of the federal government (http://professional.wsj.com/article/SB10001424052748703907004576279321350926848.html?mod=WSJ_hp_LEFTWhatsNewsCollection) and now zero interest rates indefinitely but with interruptions caused by risk aversion events. Such an event actually occurred in the week of Sep 23 reversing the devaluation of the dollar in the form of sharp appreciation of the dollar relative to other currencies from all over the world including the offshore Chinese yuan market. Column “Peak” in Table VI-6 shows exchange rates during the crisis year of 2008. There was a flight to safety in dollar-denominated government assets as a result of the arguments in favor of TARP (Cochrane and Zingales 2009). This is evident in various exchange rates that depreciated sharply against the dollar such as the South African rand (ZAR) at the peak of depreciation of ZAR 11.578/USD on Oct 22, 2008, subsequently appreciating to the trough of ZAR 7.238/USD by Aug 15, 2010 but now depreciating by 13.9 percent to ZAR 8.2483/USD on Jul 6, 2012, which is still 28.8 percent stronger than on Oct 22, 2008. An example from Asia is the Singapore Dollar (SGD) highly depreciated at the peak of SGD 1.553/USD on Mar 3, 2009 but subsequently appreciating by 13.2 percent to the trough of SGD 1.348/USD on Aug 9, 2010 but is now only 5.6 percent stronger at SGD 1.2719/USD on Jul 6, 2012 relative to the trough of depreciation but still stronger by 18.1 percent relative to the peak of depreciation on Mar 3, 2009. Another example is the Brazilian real (BRL) that depreciated at the peak to BRL 2.43/USD on Dec 5, 2008 but appreciated 28.5 percent to the trough at BRL 1.737/USD on Apr 30, 2010, showing depreciation of 16.8 percent relative to the trough to BRL 2.0281/USD on Jul 6, 2012 but still stronger by 16.5 percent relative to the peak on Dec 5, 2008. At one point in 2011 the Brazilian real traded at BRL 1.55/USD and in the week of Sep 23 surpassed BRL 1.90/USD in intraday trading for depreciation of more than 20 percent. The Banco Central do Brasil, Brazil’s central bank, lowered its policy rate SELIC by 50 basis points for the sixth consecutive meeting of its monetary policy committee, COPOM (http://www.bcb.gov.br/textonoticia.asp?codigo=3554&IDPAI=NEWS):

“Copom reduces the Selic rate to 8.5 percent

30/05/2012 8:04:00 PM

Brasília - Continuing the adjustment process of monetary conditions, the Copom unanimously decided to reduce the Selic rate to 8.50 percent.”

Jeffrey T. Lewis, writing on “Brazil steps up battle to curb real’s rise,” on Mar 1, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203986604577255793224099580.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes new measures by Brazil to prevent further appreciation of its currency, including the extension of the tax on foreign capital for three years terms, subsequently broadened to five years, and intervention in the foreign exchange market by the central bank. Unconventional monetary policy of zero interest rates and quantitative easing creates trends such as the depreciation of the dollar followed by Table VI-6 but with abrupt reversals during risk aversion. The main effects of unconventional monetary policy are on valuations of risk financial assets and not necessarily on consumption and investment or aggregate demand.

Table VI-6, Exchange Rates

	Peak	Trough	∆% P/T	Jul 6, 2012	∆% T Jul 6, 2012	∆% P Jul 6, 2012
EUR USD	7/15 2008	6/7 2010		7/6 2012
Rate	1.59	1.192		1.2288
∆%			-33.4		3.0	-29.4
JPY USD	8/18 2008	9/15 2010		7/6 2012
Rate	110.19	83.07		79.66
∆%			24.6		4.1	27.7
CHF USD	11/21 2008	12/8 2009		7/6 2012
Rate	1.225	1.025		0.9774
∆%			16.3		4.6	20.2
USD GBP	7/15 2008	1/2/ 2009		7/6 2012
Rate	2.006	1.388		1.5489
∆%			-44.5		10.4	-29.5
USD AUD	7/15 2008	10/27 2008		7/6 2012
Rate	1.0215	1.6639		1.0211
∆%			-62.9		41.1	4.1
ZAR USD	10/22 2008	8/15 2010		6/29 2012
Rate	11.578	7.238		8.2483
∆%			37.5		-13.9	28.8
SGD USD	3/3 2009	8/9 2010		7/6 2012
Rate	1.553	1.348		1.2719
∆%			13.2		5.6	18.1
HKD USD	8/15 2008	12/14 2009		7/6 2012
Rate	7.813	7.752		7.7542
∆%			0.8		0.0	0.8
BRL USD	12/5 2008	4/30 2010		7/6 2012
Rate	2.43	1.737		2.0281
∆%			28.5		-16.8	16.5
CZK USD	2/13 2009	8/6 2010		7/6 2012
Rate	22.19	18.693		20.92
∆%			15.7		-11.9	5.7
SEK USD	3/4 2009	8/9 2010		7/6 2012
Rate	9.313	7.108		7.0204
∆%			23.7		1.2	24.6
CNY USD	7/20 2005	7/15 2008		7/6 2012
Rate	8.2765	6.8211		6.3658
∆%			17.6		6.7	23.1

Symbols: USD: US dollar; EUR: euro; JPY: Japanese yen; CHF: Swiss franc; GBP: UK pound; AUD: Australian dollar; ZAR: South African rand; SGD: Singapore dollar; HKD: Hong Kong dollar; BRL: Brazil real; CZK: Czech koruna; SEK: Swedish krona; CNY: Chinese yuan; P: peak; T: trough

Note: percentages calculated with currencies expressed in units of domestic currency per dollar; negative sign means devaluation and no sign appreciation

Source:

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

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

Chart VI-1 of the Board of Governors of the Federal Reserve System provides indexes of the dollar from 2010 to 2012. The dollar depreciates during episodes of risk appetite but appreciate during risk aversion as funds seek dollar-denominated assets in avoiding financial risk.

Chart VI-1, US Dollar Currency Indexes

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/DataDownload/Chart.aspx?rel=H10&series=122e3bcb627e8e53f1bf72a1a09cfb81&lastObs=260&from=&to=&filetype=csv&label=include&layout=seriescolumn&pp=Download&names=%7bH10/H10/JRXWTFB_N.B,H10/H10/JRXWTFN_N.B,H10/H10/JRXWTFO_N.B%7d

Chart VI-2 of the Board of Governors of the Federal Reserve System provides the exchange rate of the US relative to the euro, or USD/EUR. During maintenance of the policy of zero fed funds rates the dollar appreciates during periods of significant risk aversion such as the flight into US government obligations in late 2008 and early 2009 and during the various fears generated by the European sovereign debt crisis.

Chart VI-2, US Dollars per Euro, 2009-2012

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/DataDownload/Chart.aspx?rel=H10&series=e85cfb140ce469e13bec458013262fa1&lastObs=780&from=&to=&filetype=csv&label=include&layout=seriescolumn&pp=Download&names=%7bH10/H10/RXI$US_N.B.EU%7d

Table VI-7, updated with every blog comment, provides in the second column the yield at the close of market of the 10-year Treasury note on the date in the first column. The price in the third column is calculated with the coupon of 2.625 percent of the 10-year note current at the time of the second round of quantitative easing after Nov 3, 2010 and the final column “∆% 11/04/10” calculates the percentage change of the price on the date relative to that of 101.2573 at the close of market on Nov 4, 2010, one day after the decision on quantitative easing by the Fed on Nov 3, 2010. Prices with new coupons such as 2.0 percent in recent auctions (http://www.treasurydirect.gov/RI/OFAuctions?form=extended&cusip=912828RR3) are not comparable to prices in Table VI-7. The highest yield in the decade was 5.510 percent on May 1, 2001 that would result in a loss of principal of 22.9 percent relative to the price on Nov 4. Monetary policy has created a “duration trap” of bond prices. Duration is the percentage change in bond price resulting from a percentage change in yield or what economists call the yield elasticity of bond price. Duration is higher the lower the bond coupon and yield, all other things constant. This means that the price loss in a yield rise from low coupons and yields is much higher than with high coupons and yields. Intuitively, the higher coupon payments offset part of the price loss. Prices/yields of Treasury securities were affected by the combination of Fed purchases for its program of quantitative easing and also by the flight to dollar-denominated assets because of geopolitical risks in the Middle East, subsequently by the tragic Great East Japan Earthquake and Tsunami and now again by the sovereign risk doubts in Europe and the growth recession in the US and the world. The yield of 1.548 percent at the close of market on Fri Jul 6, 2012 would be equivalent to price of 109.9423 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price gain of 8.6 percent relative to the price on Nov 4, 2010, one day after the decision on the second program of quantitative easing, as shown in the first to the last row of Table VI-7. The price loss between Jun 1, 2012 and Jun 8, 2012 would have been 1.6 percent, in just a week, and much higher with leverage of 10:1 as typical in Treasury positions. The price loss between Mar 9, 2012 and Mar 16, 2012 is 2.3 percent but much higher when using common leverage of 10:1. These losses defy annualizing. If inflation accelerates, yields of Treasury securities may rise sharply. Yields are not observed without special yield-lowering effects such as the flight into dollars caused by the events in the Middle East, continuing purchases of Treasury securities by the Fed, the tragic Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 affecting Japan, recurring fears on European sovereign credit issues and worldwide risk aversion in the week of Sep 30 caused by “let’s twist again” monetary policy. The realization of a growth standstill recession is also influencing yields. Important causes of the earlier rise in yields shown in Table VI-7 are expectations of rising inflation and US government debt estimated to be around 70 percent of GDP in 2012 (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/2011/02/policy-inflation-growth-unemployment.html http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html), rising from 40.5 percent of GDP in 2008, 54.1 percent in 2009 (Table IV-1 at http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html and Table 2 in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html) and 67.7 percent in 2011. On Jul 4, 2012, the line “Reserve Bank credit” in the Fed balance sheet stood at $2848 billion, or $2.8 trillion, with portfolio of long-term securities of $2584 billion, or $2.6 trillion, consisting of $1570 billion Treasury nominal notes and bonds, $68 billion of notes and bonds inflation-indexed, $91 billion Federal agency debt securities and $855 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $1506 billion or $1.5 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). There is no simple exit of this trap created by the highest monetary policy accommodation in US history together with the highest deficits and debt in percent of GDP since World War II. Risk aversion from various sources, discussed in section III World Financial Turbulence, has been affecting financial markets for several months. The risk is that in a reversal of risk aversion that has been typical in this cyclical expansion of the economy yields of Treasury securities may back up sharply.

Table VI-7, Yield, Price and Percentage Change to November 4, 2010 of Ten-Year Treasury Note

Date	Yield	Price	∆% 11/04/10
05/01/01	5.510	78.0582	-22.9
06/10/03	3.112	95.8452	-5.3
06/12/07	5.297	79.4747	-21.5
12/19/08	2.213	104.4981	3.2
12/31/08	2.240	103.4295	2.1
03/19/09	2.605	100.1748	-1.1
06/09/09	3.862	89.8257	-11.3
10/07/09	3.182	95.2643	-5.9
11/27/09	3.197	95.1403	-6.0
12/31/09	3.835	90.0347	-11.1
02/09/10	3.646	91.5239	-9.6
03/04/10	3.605	91.8384	-9.3
04/05/10	3.986	88.8726	-12.2
08/31/10	2.473	101.3338	0.08
10/07/10	2.385	102.1224	0.8
10/28/10	2.658	99.7119	-1.5
11/04/10	2.481	101.2573	-
11/15/10	2.964	97.0867	-4.1
11/26/10	2.869	97.8932	-3.3
12/03/10	3.007	96.7241	-4.5
12/10/10	3.324	94.0982	-7.1
12/15/10	3.517	92.5427	-8.6
12/17/10	3.338	93.9842	-7.2
12/23/10	3.397	93.5051	-7.7
12/31/10	3.228	94.3923	-6.7
01/07/11	3.322	94.1146	-7.1
01/14/11	3.323	94.1064	-7.1
01/21/11	3.414	93.4687	-7.7
01/28/11	3.323	94.1064	-7.1
02/04/11	3.640	91.750	-9.4
02/11/11	3.643	91.5319	-9.6
02/18/11	3.582	92.0157	-9.1
02/25/11	3.414	93.3676	-7.8
03/04/11	3.494	92.7235	-8.4
03/11/11	3.401	93.4727	-7.7
03/18/11	3.273	94.5115	-6.7
03/25/11	3.435	93.1935	-7.9
04/01/11	3.445	93.1129	-8.0
04/08/11	3.576	92.0635	-9.1
04/15/11	3.411	93.3874	-7.8
04/22/11	3.402	93.4646	-7.7
04/29/11	3.290	94.3759	-6.8
05/06/11	3.147	95.5542	-5.6
05/13/11	3.173	95.3387	-5.8
05/20/11	3.146	95.5625	-5.6
05/27/11	3.068	96.2089	-4.9
06/03/11	2.990	96.8672	-4.3
06/10/11	2.973	97.0106	-4.2
06/17/11	2.937	97.3134	-3.9
06/24/11	2.872	97.8662	-3.3
07/01/11	3.186	95.2281	-5.9
07/08/11	3.022	96.5957	-4.6
07/15/11	2.905	97.5851	-3.6
07/22/11	2.964	97.0847	-4.1
07/29/11	2.795	98.5258	-2.7
08/05/11	2.566	100.5175	-0.7
08/12/11	2.249	103.3504	2.1
08/19/11	2.066	105.270	3.7
08/26/11	2.202	103.7781	2.5
09/02/11	1.992	105.7137	4.4
09/09/11	1.918	106.4055	5.1
09/16/11	2.053	101.5434	0.3
09/23/11	1.826	107.2727	5.9
09/30/11	1.912	106.4602	5.1
10/07/11	2.078	104.9161	3.6
10/14/11	2.251	103.3323	2.0
10/21/11	2.220	103.6141	2.3
10/28/11	2.326	102.6540	1.4
11/04/11	2.066	105.0270	3.7
11/11/11	2.057	105.1103	3.8
11/18/11	2.003	105.6113	4.3
11/25/11	1.964	105.9749	4.7
12/02/11	2.042	105.2492	3.9
12/09/11	2.065	105.0363	3.7
12/16/11	1.847	107.0741	5.7
12/23/11	2.027	105.3883	4.1
12/30/11	1.871	106.8476	5.5
01/06/12	1.957	106.0403	4.7
01/13/12	1.869	106.8664	5.5
01/20/12	2.026	105.3976	4.1
01/27/12	1.893	106.6404	5.3
02/03/12	1.923	106.3586	5.0
02/10/12	1.974	105.8815	4.6
02/17/12	2.000	105.6392	4.3
02/24/12	1.977	105.8535	4.5
03/02/12	1.977	105.8535	4.5
03/09/12	2.031	105.3512	4.0
03/16/12	2.294	102.9428	1.7
03/23/12	2.234	103.4867	2.2
03/30/12	2.214	103.6687	2.4
04/06/12	2.058	105.1010	3.8
04/13/12	1.987	105.7603	4.4
04/20/12	1.959	106.0216	4.7
04/27/12	1.931	106.2836	5.0
05/04/12	1.876	106.8004	5.5
05/11/12	1.845	107.0930	5.8
05/18/12	1.714	108.3393	7.0
05/25/12	1.738	108.1098	6.8
06/01/12	1.454	110.8618	9.5
06/08/12	1.635	109.0989	7.7
06/15/12	1.584	109.5924	8.2
06/22/12	1.676	108.7039	7.4
06/29/12	1.648	108.9734	7.6
07/06/12	1.548	109.9423	8.6

Note: price is calculated for an artificial 10-year note paying semi-annual coupon and maturing in ten years using the actual yields traded on the dates and the coupon of 2.625% on 11/04/10

Source:

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

VII Economic Indicators. Crude oil input in refineries increased 0.3 percent to 15,626 thousand barrels per day on average in the four weeks ending on Jun 29, 2012 from 15,585 thousand barrels per day in the four weeks ending on Jun 22, 2012, as shown in Table VII-1. The rate of capacity utilization in refineries continues at a relatively high level of 92.1 percent on Jun 29, 2012, which is higher than 88.0 percent on Jul 1, 2011 and higher than 91.9 percent on Jun 22, 2012. Imports of crude oil decreased 0.5 percent from 9,120 thousand barrels per day on average in the four weeks ending on Jun 22 to 9,075 thousand barrels per day in the week of Jun 29. The Energy Information Administration (EIA) informs that “US crude oil imports averaged 8.8 million barrels per day last week, down by 344 thousand barrels per day from the previous week [Jun 22]” (http://www.eia.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/pdf/highlights.pdf). Increasing utilization in refineries with decreasing imports at the margin in the prior week resulted in decrease of commercial crude oil stocks by 4.3 million barrels from 387.2 million barrels on Jun 22 to 382.9 million barrels on Jun 29. Motor gasoline production increased 0.9 percent to 9,310 thousand barrels per day in the week of Jun 29 from 9,227 thousand barrels per day on average in the week of Jun 22. Gasoline stocks increased 0.2 million barrels and stocks of fuel oil decreased 1.1 million barrels. Supply of gasoline decreased from 9,315 thousand barrels per day on Jul 1, 2011, to 8,918 thousand barrels per day on Jun 29, 2012, or by 4.3 percent, while fuel oil supply increased 3.8 percent. Part of the fall in consumption of gasoline is due to high prices and part to the growth recession. WTI crude oil price traded at $85.04/barrel on Jun 29, 2012, decreasing 10.3 percent relative to $94.81/barrel on Jul 1, 2011. Gasoline prices fell 6.2 percent from Jul 4, 2011 to Jul 2, 2012. Increases in prices of crude oil and gasoline relative to a year earlier are moderating because year earlier prices are already reflecting the commodity price surge and commodity prices have been declining recently during worldwide risk aversion. Gasoline prices had been increasing to the highest levels at this time of the year.

Table VII-1, US, Energy Information Administration Weekly Petroleum Status Report

Four Weeks Ending Thousand Barrels/Day	6/29/12	6/22/12	7/1/11
Crude Oil Refineries Input	15,626 Week       ∆%: 0.3	15,585	15,177
Refinery Capacity Utilization %	92.1	91.9	88.0
Motor Gasoline Production	9,310 Week      ∆%: 0.9	9,227	9,409
Distillate Fuel Oil Production	4,668 Week     ∆%: 0.3	4,654	4,362
Crude Oil Imports	9,075 Week        ∆%: -0.5	9,120	9,095
Motor Gasoline Supplied	8,918 ∆% 2012/2011= -4.3%	8,829	9,315
Distillate Fuel Oil Supplied	3,717 ∆% 2012/2011 = 3.8%	3,599	3,580
	6/29/12	6/22/12	7/1/11
Crude Oil Stocks Million B	382.9     ∆=   -4.3 MB	387.2	358.6
Motor Gasoline Million B	205.0  ∆= +0.2 MB	204.8	212.5
Distillate Fuel Oil Million B	117.8 ∆= -1.1 MB	118.9	142.1
WTI Crude Oil Price $/B	85.04 ∆% 2012/2011 -10.3	79.33	94.81
	7/2/12	6/25/12	7/4/11
Regular Motor Gasoline $/G	3.356 ∆% 2012/2011 -6.2	3.437	3.579

B: barrels; G: gallon

Source: US Energy Information Administration

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

Chart VII-1 of the US Energy Information Administration shows commercial stocks of crude oil of the US. There have been fluctuations around an upward trend since 2005. Crude oil stocks trended downwardly during a few weeks but with fluctuations followed by several sharp weekly increases.

Chart VII-1, US, Weekly Crude Oil Ending Stocks

Source: US Energy Information Administration

http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCESTUS1&f=W

Chart VII-2 provides the evolution of distillate fuel oil stocks in the US since 2007. There have been oscillations around a downward trend.

Chart VII-2, US, Total Distillate Fuel Oil Stocks

Source: US Energy Information Administration

http://www.eia.gov/petroleum/

Chart VII-3 of the US Energy Information Administration shows the price of WTI crude oil since the 1980s. Chart VII-3 captures commodity price shocks during the past decade. The costly mirage of deflation was caused by the decline in oil prices during the recession of 2001. The upward trend after 2003 was promoted by the carry trade from near zero interest rates. The jump above $140/barrel during the global recession in 2008 can only be explained by the carry trade promoted by monetary policy of zero fed funds rate. After moderation of risk aversion, the carry trade returned with resulting sharp upward trend of crude prices. Risk aversion resulted in another drop in recent weeks.

Chart VII-3, US, Crude Oil Futures Contract

Source: US Energy Information Administration

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

There is typically significant difference between initial claims for unemployment insurance adjusted and not adjusted for seasonality provided in Table VII-2. Seasonally adjusted claims decreased 14,000 from 388,000 on Jun 23, 2012, to 374,000 on Jun 30. Claims not adjusted for seasonality decreased 3,129 from 370,460 on Jun 23, 2012 to 367,331 on Jun 30. Strong seasonality is preventing clear analysis of labor markets.

Table VII-2, US, Initial Claims for Unemployment Insurance

	SA	NSA	4-week MA SA
June 30, 12	374,000	367,331	385,750
June 23, 12	388,000	370,460	387,250
Change	-14,000	-3,129	-1,500
Jun 16, 12	392,000	364,548	387,500
Prior Year	422,000	425,640	422,250

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

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

Table VII-3 provides seasonally and not seasonally adjusted claims in the comparable week for the years from 2001 to 2012. Seasonally adjusted claims typically are lower than claims not adjusted for seasonality. Claims not seasonally adjusted have declined from 563,387 on Jun 27, 2009 to 406,633 on Jun 25, 2011, and 367,331 on Jun 30, 2012. There is strong indication of significant decline in the level of layoffs in the US but some doubts at the margin after the high increase in unadjusted claims in the week of Jun 9, 2012. Hiring has not recovered (see http://cmpassocregulationblog.blogspot.com/2012/06/recovery-without-hiring-continuance-of.html).

Table VII-3, US, Unemployment Insurance Weekly Claims

	Not Seasonally Adjusted Claims	Seasonally Adjusted Claims
Jun 30, 2001	375,885	394,000
Jun 29, 2002	358,658	386,00
Jun 28, 2003	394,214	429,000
Jun 26, 2004	318,746	348,000
Jun 25, 2005	286,681	311,000
Jun 24, 2006	287,503	309,000
Jun 30, 2007	300,348	317,000
Jun 28, 2008	368,544	392,000
Jun 27, 2009	563,387	595,000
Jun 26, 2010	444,712	466,000
Jun 25, 2011	406,633	425,000
Jun 30, 2012	367,331	374,000

Source: http://workforcesecurity.doleta.gov/unemploy/claims.asp

VIII Interest Rates. It is quite difficult to measure inflationary expectations because they tend to break abruptly from past inflation. There could still be an influence of past and current inflation in the calculation of future inflation by economic agents. Table VIII-1 provides inflation of the CPI. In the four months Jan to May 2012, CPI inflation for all items seasonally adjusted was 1.4 percent in annual equivalent, that is, compounding inflation in Jan-May 2012 and assuming it would be repeated for a full year. In the 12 months ending in May, CPI inflation of all items not seasonally adjusted was 1.7 percent. Inflation in May 2012 not seasonally adjusted was minus 0.1 percent relative to Apr 2012 and minus 0.3 percent seasonally adjusted (http://www.bls.gov/cpi/). The second row provides the same measurements for the CPI of all items excluding food and energy: 2.3 percent in 12 months and 2.2 percent in annual equivalent Jan-May 2012. Bloomberg provides the yield curve of US Treasury securities (http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/). The lowest yield is 0.07 percent for three months, 0.14 percent for six months, 0.18 percent for 12 months, 0.27 percent for two years, 0.36 percent for three years, 0.64 percent for five years, 1.01 percent for seven years, 1.55 percent for ten years and 2.66 percent for 30 years. The Irving Fisher definition of real interest rates is approximately the difference between nominal interest rates, which are those estimated by Bloomberg, and the rate of inflation expected in the term of the security, which could behave as in Table VIII-1. May inflation is low because of the unwinding of carry trades from zero interest rates to commodity futures prices but could ignite again with subdued risk aversion. Real interest rates in the US have been negative during substantial periods in the past decade while monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

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

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

Table VIII-1, US, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%

	∆% 12 Months May 2012/May 2011 NSA	∆% Annual Equivalent Jan-May 2012 SA
CPI All Items	1.7	1.4
CPI ex Food and Energy	2.3	2.2

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/

IX Conclusion. Table IX-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 IX-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

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Appendix I. The Great Inflation

Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart I1 for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart I1 cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s; the loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy.  This interpretation is consistent with the case of the 24 emerging market economies analyzed by Reinhart and Rogoff (2010GTD, 4), concluding that “higher debt levels are associated with significantly higher levels of inflation in emerging markets. Median inflation more than doubles (from less than seven percent to 16 percent) as debt rises from the low (0 to 30 percent) range to above 90 percent. Fiscal dominance is a plausible interpretation of this pattern.”

The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:

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

Chart I1, Brazil, Phillips Circuit 1963-1987

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

DeLong (1997, 247-8) shows that the 1970s were the only peacetime period of inflation in the US without parallel in the prior century. The price level in the US drifted upward since 1896 with jumps resulting from the two world wars: “on this scale, the inflation of the 1970s was as large an increase in the price level relative to drift as either of this century’s major wars” (DeLong, 1997, 248). Monetary policy focused on accommodating higher inflation, with emphasis solely on the mandate of promoting employment, has been blamed as deliberate or because of model error or imperfect measurement for creating the Great Inflation (http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). As DeLong (1997) shows, the Great Inflation began in the mid 1960s, well before the oil shocks of the 1970s (see also the comment to DeLong 1997 by Taylor 1997, 276-7). TableI1 provides the change in GDP, CPI and the rate of unemployment from 1960 to 1990. There are three waves of inflation (1) in the second half of the 1960s; (2) from 1973 to 1975; and (3) from 1978 to 1981. In one of his multiple important contributions to understanding the Great Inflation, Meltzer (2005) distinguishes between one-time price jumps, such as by oil shocks, and a “maintained” inflation rate. Meltzer (2005) uses a dummy variable to extract the one-time oil price changes, resulting in a maintained inflation rate that was never higher than 8 to 10 percent in the 1970s. There is revealing analysis of the Great Inflation and its reversal by Meltzer (2005, 2010a, 2010b).

Table I1, US Annual Rate of Growth of GDP and CPI and Unemployment Rate 1960-1982

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

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

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

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

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

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

There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table I2 when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table I2 shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.

Table I2, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994

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

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

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

© Carlos M. Pelaez, 2010, 2011, 2012