Recovery without Hiring, Forecast Growth Mandate of Monetary Policy or QE∞, World Inflation Waves, United States International Trade, World Financial Turbulence and Economic Slowdown with Global Recession Risk: Part III

 

Recovery without Hiring, Forecast Growth Mandate of Monetary Policy or QE∞, World Inflation Waves, United States International Trade, World Financial Turbulence and Economic Slowdown with Global Recession Risk

Carlos M. Pelaez

© Carlos M. Pelaez, 2010, 2011, 2012

Executive Summary

I Recovery without Hiring

IA1 Hiring Collapse

IA2 Labor Underutilization

IA3 Ten Million Fewer Full-time Job

IA4 Youth and Middle-Aged Unemployment

II World Inflation Waves

IIA Appendix: Transmission of Unconventional Monetary Policy

IIA1 Theory

IIA2 Policy

IIA3 Evidence

IIA4 Unwinding Strategy

IIB United States Inflation

IIC Long-term US Inflation

IID Current US Inflation

IIE United States International Trade

IIE1 United States International Trade Deficit and Fiscal Imbalance

IIE2 Import Export Prices

III World Financial Turbulence

IIIA Financial Risks

IIIE Appendix Euro Zone Survival Risk

IIIF Appendix on Sovereign Bond Valuation

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

Appendixes

Appendix I The Great Inflation

IIIB Appendix on Safe Haven Currencies

IIIC Appendix on Fiscal Compact

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

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

VD Euro Area. Table VD-EUR provides yearly growth rates of the combined GDP of the members of the European Monetary Union (EMU) or euro area since 1996. Growth was very strong at 3.2 percent in 2006 and 3.0 percent in 2007. The global recession had strong impact with growth of only 0.4 percent in 2008 and decline of 4.4 percent in 2009. Recovery was at lower growth rates of 2.0 percent in 2010 and 1.4 percent in 2011. EUROSTAT forecasts growth of GDP of the euro area of minus 0.4 percent in 2012 and 0.1 percent in 2013 but 1.4 percent in 2014.

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

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	3.2
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	10.1	1.4
2012*			-0.4
2013*			0.1
2014*			1.4

*EUROSTAT forecast Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

The Flash Eurozone PMI Composite Output Index of the Markit Flash Eurozone PMI^®, combining activity in manufacturing and services, increased from 45.7 in Oct to 45.8 in Nov, for ten consecutive declines and fourteen drops in fifteen months, with Oct registering the lowest reading since IIQ2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10329). Chris Williamson, Chief Economist at Markit, finds that the Markit Flash Eurozone PMI index is consistent with significant worsening of economic activity with GDP declining even by 0.5 percent in IVQ2012 compared with contraction of 0.1 percent in IIIQ2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10329). The Markit Eurozone PMI^® Composite Output Index, combining services and manufacturing activity with close association with GDP, increased from 45.7 in Oct to 46.5 in Nov, which is the tenth consecutive contraction; contraction spread in manufacturing and services throughout the four largest economies of Germany, France, Italy and Spain with weak demand from internal and export markets affecting both manufacturing and services (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10404). Chris Williamson, Chief Economist at Markit, finds that the data are consistent with likely decline of GDP at a rate higher than 0.1 percent in IIIQ2012 but at a lower rate of contraction at the margin (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10404). The Markit Eurozone Services Business Activity Index increased from 46.0 in Oct, which was a low in 39 months since Jul 2009, to 46.7 in Nov but with contraction in 14 of the past 15 months (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10404). The Markit Eurozone Manufacturing PMI^® increased to 46.2 in Nov from 45.4 in Oct, which is the highest reading in eight months in sixteen consecutive months of deterioration of manufacturing business in the euro zone (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10365). New export orders declined in Nov for the seventeenth consecutive month with contracting demand within the euro area and deteriorating global markets. Chris Williamson, Chief Economist at Markit, finds that manufacturing output declined at the lowest rate in eight months, suggesting that recession in the euro area may have continued into a third consecutive quarter (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10365). Table EUR provides the regional data table for the euro area.

Table EUR, Euro Area Economic Indicators

GDP	IIIQ2012 ∆% -0.1; IIIQ2012/IIIQ2011 ∆% -0.6 Blog 12/9/12
Unemployment	Oct 2012: 11.7% unemployment rate Oct 2012: 18.703 million unemployed Blog 12/2/12
HICP	Nov month ∆%: -0.2 12 months Nov ∆%: 2.2 Blog 12/16/12
Producer Prices	Euro Zone industrial producer prices Oct ∆%: 0.1 Oct 12-month ∆%: 2.6 Blog 12/9/12
Industrial Production	Oct month ∆%: -1.4; Oct 12 months ∆%: -3.6 Blog 12/16/12
Retail Sales	Oct month ∆%: minus 1.2 Oct 12 months ∆%: minus 1.6 Blog 12/9/12
Confidence and Economic Sentiment Indicator	Sentiment 85.7 Nov 2012 Consumer minus 26.9 Nov 2012 Blog 12/2/12
Trade	Jan-Sep 2012/Jan-Sep 2011 Exports ∆%: 8.0 Imports ∆%: 1.8 Sep 2012 12-month Exports ∆% 1.4 Imports ∆% -4.1 Blog 11/18/12

Links to blog comments in Table EUR:

12/9/12 http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html

12/2/12 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html

11/18/12 http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html

Industrial production in the euro area decreased 1.4 percent in Oct 2012, declining in three of six months from May to Oct 2012 for cumulative growth of minus 1.8 percent that is equivalent to minus 3.6 percent in a year, as shown in Table VD-1 with revised estimates by EUROSTAT. All segments of industrial production fell sharply in Sep and Oct 2012 with exception of increase of nondurable goods by 1.2 percent in Oct 2012. Industrial production is highly volatile in the euro zone.

Table VD-1, Euro Zone, Industrial Production Month ∆%

	Total	INT	ENE	CG	DUR	NDUR
Oct 2012	-1.4	-1.2	-1.5	-3.0	-3.8	1.2
Sep	-2.3	-1.8	-0.2	-3.2	-3.5	-2.7
Aug	0.9	0.1	0.7	1.5	2.8	1.7
Jul	0.5	0.2	-0.7	2.1	-0.1	-0.4
Jun	-0.4	-0.5	1.2	-1.2	0.4	-0.7
May	0.9	0.4	-1.3	1.2	0.6	2.0

Notes: INT: Intermediate; ENE: Energy; CG: Capital Goods; DUR: Durable Consumer Goods; NDUR: Nondurable Consumer Goods

http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-12122012-AP/EN/4-12122012-AP-EN.PDF

Table VD-2 provides monthly and 12-month percentage changes of industrial production and major industrial categories in the euro zone. All percentage changes in Table VD-2 are sharply negative with exception of increase of 0.4 percent in output of energy in the 12 months ending in Oct 2012. Industrial production decreased 1.4 percent in the month of Oct 2012 and fell 3.6 percent in the 12 months ending in Oct 2012. Industrial production deteriorated at unusually high rates in Oct 2012.

Table VD-2, Euro Zone, Industrial Production 12-Month ∆%

2012	Oct Month ∆%	Oct 12-Month ∆%
Total	-1.4	-3.6
Intermediate Goods	-1.2	-4.6
Energy	-1.5	0.4
Capital Goods	-3.0	-4.3
Durable Consumer Goods	-3.8	-6.0
Nondurable Consumer Goods	1.2	-2.2

Source: Eurostat http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-12122012-AP/EN/4-12122012-AP-EN.PDF

There has been significant decline in percentage changes of industrial production and major categories in 12-month rates into 2012 as shown in Table VD-3. The 12-month rate of growth in Mar 2011 of minus 1.7 percent has fallen to minus 3.6 percent in Nov 2012. Trend is difficult to identify because of significant volatility but is evidently negative. Capital goods were growing at 2.4 percent in the 12 months ending in Mar 2011 and at minus 4.3 percent in the 12 months ending in Oct 2012.

Table VD-3, Euro Zone, Industrial Production 12-Month ∆%

	Total	INT	ENE	CG	DUR	NDUR
Oct 2012	-3.6	-4.6	0.4	-4.3	-6.0	-2.2
Sep	-2.8	-4.4	0.0	-1.3	-2.7	-3.0
Aug	-1.3	-3.6	0.2	0.2	-2.1	0.0
Jul	-2.7	-3.9	0.6	-1.6	-9.2	-2.6
Jun	-2.0	-3.6	1.4	-0.7	-2.3	-2.2
May	-2.6	-3.7	-0.6	-1.7	-6.3	-2.1

Notes: INT: Intermediate; ENE: Energy; CG: Capital Goods; DUR: Durable Consumer Goods; NDUR: Nondurable Consumer Goods http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-12122012-AP/EN/4-12122012-AP-EN.PDF

Table VD-7 provides industrial production of member countries of the euro zone, the UK and the European Union. Twelve-month percentage changes in Oct 2012 are negative for all countries in Table VD-7 with exception of 1.8 percent for Greece.

Table VD-7, Euro Zone, Industrial Production by Member Countries, ∆%

Oct 2012	Month ∆%	12-Month ∆%
Euro Zone	-1.4	-3.6
Germany	-2.4	-3.8
France	-0.6	-3.0
Netherlands	NA	-3.9
Finland	0.4	-0.6
Belgium	NA	NA
Portugal	4.8	-3.9
Ireland	2.7	-16.2
Italy	-1.1	-6.2
Greece	0.7	1.8
Spain	1.2	-3.3
UK	-0.8	-3.5
European Union	-1.0	-3.1

Source: EUROSTAT http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-12122012-AP/EN/4-12122012-AP-EN.PDF

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 Annual ∆%

	Price Adjusted Chain-Linked	Price- and Calendar-Adjusted Chain Linked
2011	3.0	3.1
2010	4.2	4.0
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: Statistisches Bundesamt Deutschland https://www.destatis.de/EN/PressServices/Press/pr/2012/08/PE12_287_811.html;jsessionid=A761BC574543A771416A9CF81034F7BA.cae1

The Flash Germany Composite Output Index of the Markit Flash Germany PMI^®, combining manufacturing and services, increased from 49.7 in Oct to 47.9 in Nov, which is the seventh consecutive reading below 50, indicating mild contraction (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10331). The pace of decline of new export orders for manufacturing was at the lowest in six months, with some respondents finding enhanced demand in China. Tim Moore, Senior Economist at Markit, finds that difficult short-term output for manufacturing and services firms because of decline at the sharpest rate in three years of stocks of purchases (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10331). The Markit Germany Composite Output Index of the Markit Germany Services PMI^®, combining manufacturing and services with close association with Germany’s GDP, increased from 47.7 in Oct to 49.2 in Nov, indicating a level below the neutral zone of 50.0 for seven consecutive months but improving at the margin (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10383). Tim Moore, Senior Economist at Markit and author of the report, finds that the composite index of manufacturing and services indicates four months of contraction (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10383). The Germany Services Business Activity Index increased from 48.4 in Oct to 49.7 in Sep, which is below the long-term average of 52.9 and also lower than readings in the first half of 2012 but indicating only marginal decline in general services business activity (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10383). The Markit/BME Germany Purchasing Managers’ Index^® (PMI^®), showing close association with Germany’s manufacturing conditions, increased from 46.0 in Oct to 46.8 in Nov for the ninth consecutive month in contraction territory below 50.0 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10384). New export orders fell for seventeen consecutive months but the rate of decline was the second slowest since Mar 2012. Tim Moore, Senior Economist at Markit and author of the report, finds continuing weakness in Germany’s manufacturing but some encouragement in the slower drop of new orders and output (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10384 ).Table DE provides the country data table for Germany.

Table DE, Germany, Economic Indicators

GDP	IIIQ2012 0.2 ∆%; III/Q2012/IIIQ2011 ∆% 0.4 2011/2010: 3.0% GDP ∆% 1992-2011 Blog 8/26/12 5/27/12 11/25/12
Consumer Price Index	Nov month NSA ∆%: -0.1 Nov 12-month NSA ∆%: 1.9 Blog 12/16/12
Producer Price Index	Oct month ∆%: 0.1 CSA, 0.0 NSA 12-month NSA ∆%: 1.5 Blog 11/25/12
Industrial Production	Mfg Oct month CSA ∆%: -2.4 12-month NSA: 2.7 Blog 12/9/12
Machine Orders	MFG Oct month ∆%: 3.9 Oct 12-month ∆%: 3.4 Blog 12/9/12
Retail Sales	Oct Month ∆% -0.8 12-Month ∆% -2.8 Blog 12/2/12
Employment Report	Unemployment Rate Sep 5.4% Blog 12/2/12
Trade Balance	Exports Oct 12-month NSA ∆%: 10.6 Imports Oct 12 months NSA ∆%: 6.0 Exports Oct month CSA ∆%: 0.3; Imports Oct month SA 2.5 Blog 12/16/12

Links to blog comments in Table DE:

12/9/12 http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html

12/2/12 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html

11/25/12 http://cmpassocregulationblog.blogspot.com/2012/11/contraction-of-united-states-real.html

8/26/12 http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with_26.html

Twelve-month rates of growth Germany’s exports and imports are shown in Table VE-1. There was sharp decline in the rates in Jun and Jul 2011 to single-digit levels especially for exports. In the 12 months ending in Aug 2011, exports rose 14.6 percent and imports 13.2 percent. In Sep 2011, exports grew 10.5 percent relative to a year earlier and imports grew 12.0 percent. Growth rates in 12 months ending in Oct 2011 fell significantly to 3.6 percent for exports and 9.2 percent for imports. Lower prices may explain part of the decline in nominal values. Exports fell 3.4 percent in 12 months ending in Sep 2012, rebounding to growth of 10.6 percent in Oct 2012, and imports decreased 3.6 percent in the 12 months ending in Sep 2012, rebounding to growth of 6.0 percent in Oct 2012. Growth was much stronger in the recovery during 2010 and 2011 from the fall from 2007 to 2009. Germany’s trade grew at high rates in 2006 and 2005.

Table VE-1, Germany, Exports and Imports NSA Euro Billions and 12-Month ∆%

	Exports EURO Billions	12- Month ∆%	Imports EURO Billions	12-Month ∆%
Oct 2012	98.5	10.6	82.7	6.0
Sep	91.7	-3.4	74.8	-3.6
Aug	90.2	5.7	73.9	0.5
Jul	93.5	9.2	76.6	2.1
Jun	94.7	7.5	76.8	2.1
May	92.7	0.4	77.2	-0.5
Apr	87.2	3.1	72.7	-1.3
Mar	98.8	0.1	81.4	2.0
Feb	91.2	7.9	76.5	5.4
Jan	86.0	8.4	72.8	4.9
Dec 2011	84.8	4.7	72.3	5.6
Nov	94.1	7.4	78.0	5.8
Oct	89.1	3.6	78.1	9.2
Sep	95.0	10.5	77.7	11.7
Aug	85.3	14.6	73.5	13.2
Jul	85.6	5.2	75.0	9.7
Jun	88.1	3.3	75.2	5.6
May	92.4	21.2	77.5	17.4
Apr	84.5	12.4	73.7	18.5
Mar	98.7	15.3	79.8	15.1
Feb	84.5	20.8	72.4	27.6
Jan	79.3	25.2	69.4	26.0
Dec 2010	81.0	20.0	68.4	24.4
Nov	87.6	21.2	73.7	30.9
Oct	86.0	18.7	71.5	19.2
Sep	86.0	21.2	69.5	17.0
Aug	74.4	23.8	64.9	27.1
Jul	81.4	15.3	68.4	24.4
Jun	85.3	27.5	71.2	33.9
May	76.2	25.6	66.1	31.3
Apr	75.2	16.8	62.2	14.4
Mar	85.6	22.0	69.3	18.0
Feb	70.0	9.7	56.8	3.2
Jan	63.4	-0.3	55.1	-1.9
Dec 2009	67.5	1.2	55.0	-7.3
Dec 2008	66.7	-8.6	59.4	-5.0
Dec 2007	73.0	-0.6	62.5	-0.1
Dec 2006	73.4	10.2	62.6	8.5
Dec 2005	66.6	11.5	57.7	18.1
Dec 2004	59.7	9.2	48.9	10.8
Dec 2003	54.7	7.6	44.1	3.9
Dec 2002	50.8	5.5	42.5	6.4
Dec 2001	48.2	-3.7	39.9	-17.5
Dec 2000	50.0		48.4

Source: Statistisches Bundesamt Deutschland https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

Chart VE-1 of the Statistisches Bundesamt Deutschland shows exports and trend of German exports. Growth has been with fluctuations around a strong upward trend that is milder than earlier in the recovery but does not appear to be flattening.

Chart VE-1, Germany, Exports Original Value and Trend 2008-2012

Source: Statistisches Bundesamt Deutschland

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

Chart VE-2 of the Statistisches Bundesamt Deutschland provides German imports and trend. Imports also fell sharply and have been recovering with fluctuations around a strong upward trend that could be flattening.

Chart VE-2, Germany, Imports Original Value and Trend 2008-2012

Source: Statistisches Bundesamt Deutschland

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

Chart VE-3 of the Statistisches Bundesamt Deutschland shows the trade balance of Germany since 2008. There was sharp decline during the global recession and fluctuations around a mild upward trend during the recovery with stabilization followed by stronger trend in recent months.

Chart VE-3, Germany, Trade Balance Original and Trend 2008-2012

Source: Statistisches Bundesamt Deutschland

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

Table VE-2 provides monthly rates of growth of exports and imports of Germany. Exports decreased 2.5 percent in Sep 2012 after increasing 2.5 percent in Aug 2012, growing again 0.3 percent in Nov 2012. Imports decreased 1.4 percent in Sep 2012 after increasing 0.4 percent in Aug 2012, growing 2.5 percent in Oct 2012. Export growth and import growth were vigorous in Jan-Mar 2011 when Germany’s economy outperformed most advanced economies but less dynamic and consistently in following months as world trade weakens.

Table VE-2, Germany, Exports and Imports Month ∆% Calendar and Seasonally Adjusted 

	Exports	Imports
Oct 2012	0.3	2.5
Sep	-2.4	-1.4
Aug	2.5	0.4
Jul	-0.2	0.4
Jun	-0.4	-2.2
May	3.8	5.2
Apr	-1.7	-4.1
Mar	0.8	0.7
Feb	1.6	2.7
Jan	2.4	1.8
Dec 2011	-2.8	-1.9
Nov	1.7	-1.0
Oct	-3.4	-0.8
Sep	1.5	-0.3
Aug	3.2	0.2
Jul	-1.5	0.5
Jun	-0.1	-0.2
May	2.0	1.4
Apr	-3.6	-0.4
Mar	5.6	2.3
Feb	1.4	1.6
Jan	0.8	4.6
Dec 2010	0.0	-2.0

Source: Statistisches Bundesamt Deutschland https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html

There is extremely important information in Table VE-3 for the current sovereign risk crisis in the euro zone. Table VE-3 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Oct 2012. German exports to other European Union (EU) members are 57.3 percent of total exports in Oct 2012 and 57.2 percent in Jan-Oct 2012. Exports to the euro area are 37.6 percent in Oct and 37.6 percent in Jan-Oct. Exports to third countries are 42.7 percent of the total in Oct and 42.8 percent in Jan-Oct. There is similar distribution for imports. Exports to non-euro countries are decreasing 2.7 percent in Oct 2012 and increasing 4.4 percent in Jan-Oct 2012 while exports to the euro area are increasing 7.0 percent in Oct and decreasing 1.2 percent in Jan-Oct 2012. Exports to third countries, accounting for 42.7 percent of the total in Oct 2012, are increasing 1.8 percent, and 10.9 percent in Jan-Oct, accounting for 42.8 percent of the cumulative total in Jan-Oct 2012. Price competitiveness through devaluation could improve export performance and growth. Economic performance in Germany is closely related to its high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of high share in its exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.

Table VE-3, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	Oct 2012  € Billions	Oct 12-Month ∆%	Jan–Oct 2012 € Billions	Jan-Oct 2012/ Jan-Oct 2011 ∆%
Total Exports	98.5	10.6	924.4	4.8
A. EU Members	56.4 % 57.3	7.8	528.6 % 57.2	0.6
Euro Area	37.0 % 37.6	7.0	347.8 % 37.6	-1.2
Non-euro Area	19.3 % 19.7	-2.7	180.7 % 19.6	4.4
B. Third Countries	42.1 % 42.7	1.8	395.8 % 42.8	10.9
Total Imports	82.7	6.0	765.1	1.7
C. EU Members	51.9 % 62.8	5.4	484.4 % 63.3	1.7
Euro Area	35.5 % 42.9	-5.7	339.4 % 44.4	1.4
Non-euro Area	16.4 % 19.8	-2.8	145.0 % 18.9	2.5
D. Third Countries	30.8 % 37.2	6.9	280.7 % 36.7	1.7

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

Source:

Statistisches Bundesamt Deutschland https://www.destatis.de/EN/PressServices/Press/pr/2012/12/PE12_432_51.html;jsessionid=5B7D9B7A67D38989763779A0A5711A66.cae4

VF France. Table VF-FR provides growth rates of GDP of France with the estimates of Institut National de la Statistique et des Études Économiques (INSEE). The long-term rate of GDP growth of France from IIQ1949 to IIQ2012 is quite high at 3.3 percent. France’s growth rates were quite high in the four decades of the 1950s, 1960, 1970s and 1980s with an average growth rate of 4.1 percent compounding the average rates in the decades and discounting to one decade. The growth impulse diminished with 1.8 percent in the 1990s and 1.7 percent from 2000 to 2007. The average growth rate from 2000 to 2012, using second quarter data, is 1.1 percent because of the sharp impact of the global recession from IVQ2007 to IIQ2009. Cobet and Wilson (2002) provide estimates of output per hour and unit labor costs in national currency and US dollars for the US, Japan and Germany from 1950 to 2000 (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). The average yearly rate of productivity change from 1950 to 2000 was 2.9 percent in the US, 6.3 percent for Japan and 4.7 percent for Germany while unit labor costs in USD increased at 2.6 percent in the US, 4.7 percent in Japan and 4.3 percent in Germany. From 1995 to 2000, output per hour increased at the average yearly rate of 4.6 percent in the US, 3.9 percent in Japan and 2.6 percent in Germany while unit labor costs in US fell at minus 0.7 percent in the US, 4.3 percent in Japan and 7.5 percent in Germany. There was increase in productivity growth in the G7 in Japan and France in the second half of the 1990s but significantly lower than the acceleration of 1.3 percentage points per year in the US. Lucas (2011May) compares growth of the G7 economies (US, UK, Japan, Germany, France, Italy and Canada) and Spain, finding that catch-up growth with earlier rates for the US and UK stalled in the 1970s.

Table VF-FR, France, Average Growth Rates of GDP Fourth Quarter, 1949-2012

Period	Average ∆%
1949-2012*	3.3
2000-2012*	1.1
2000-2011	1.1
2000-2007	1.7
1990-1999	1.9
1980-1989	2.6
1970-1979	3.8
1960-1969	5.7
1950-1959	4.2

*Second Quarter on Second Quarter

Source: Institut National de la Statistique et des Études Économiques http://www.insee.fr/en/themes/info-rapide.asp?id=28

The Markit Flash France Composite Output Index increased marginally from 43.5 in Oct to 44.6 in Nov for the ninth consecutive contraction, indicating fast rate of decline (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10328). Jack Kennedy, Senior Economist at Markit and author of the report, finds weakness in the index suggesting that GDP growth of 0.2 percent in IIIQ2012 may not be sustained in IVQ2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10328).

The Markit France Composite Output Index, combining services and manufacturing with close association with French GDP, increased marginally from 43.5 in Oct to 44.3 in Nov, indicating significant contraction of private sector activity for a ninth consecutive month at slower rate (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10367). Jack Kennedy, Senior Economist at Markit and author of the France Services PMI^®, finds that new business declining at the fastest rate since the beginning of 2009 indicates weak conditions of France’s services sector at the end of 2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10367). The Markit France Services Activity index increased from 44.6 in Oct to 45.8 in Nov (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10301). The Markit France Manufacturing Purchasing Managers’ Index^® increased to 44.5 in Nov from 43.7 in Sep, remaining deeply below the neutral level of 50.0 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10347). Jack Kennedy, Senior Economist at Markit and author of the France Manufacturing PMI^®, finds continuing weakness in manufacturing with new orders falling at fast pace mostly because of restrained internal demand (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10347). Table FR provides the country data table for France.

Table FR, France, Economic Indicators

CPI	Nov month ∆% -0.2 12 months ∆%: 1.4 12/16/12
PPI	Sep month ∆%: 0.3 Sep 12 months ∆%: 2.9 Blog 11/4/12
GDP Growth	IIIQ2012/IIQ2012 ∆%: 0.2 IIIQ2012/IIIQ2011 ∆%: 0.2 Blog 11/18/12
Industrial Production	Oct ∆%: Manufacturing minus 0.9 12-Month ∆%: Manufacturing minus 4.0 Blog 12/16/12
Consumer Spending	Sep Manufactured Goods ∆%: 0.2 Aug 12-Month Manufactured Goods ∆%: -0.5 Blog 11/4/12
Employment	IIIQ2012 Unemployed 2.826 million Unemployment Rate: 9.9% Employment Rate: 63.9% Blog 12/16/12
Trade Balance	Sep Exports ∆%: month -1.5, 12 months 5.2 Sep Imports ∆%: month -1.9, 12 months 0.0 Blog 11/11/12
Confidence Indicators	Historical averages 100 Nov Mfg Business Climate 88 Blog 11/25/12

Links to blog comments in Table FR:

11/25/12 http://cmpassocregulationblog.blogspot.com/2012/11/contraction-of-united-states-real_25.html

11/18/12 http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html

11/11/12 http://cmpassocregulationblog.blogspot.com/2012/11/recovery-without-hiring-united-states.html

11/4/12 http://cmpassocregulationblog.blogspot.com/2012/11/twenty-eight-million-unemployed-or.html

The number of unemployed in France rose from 2.099 million in IV2007, for a rate of unemployment of 7.5 percent, to 2.826 million in IIIQ2012, for a rate of unemployment of 9.9 percent, as shown in Table VF-1. At the same time, the rate of employment fell from 64.6 percent in IV2007 to 63.9 percent in IIIQ2012.

Table VF-1, France, Metropolitan France, Employment Rate, Unemployed and Unemployment Rate, Millions and %

	Unemployed Millions	Unemployed Percent	Employment Rate
IIIQ2012	2.826	9.9	63.9
IIQ2012	2.797	9.8	63.9
IQ2012	2.732	9.6	63.8
IVQ2011	2.675	9.4	63.9
IIIQ2011	2.608	9.2	63.8
IIQ2011	2.571	9.1	63.9
IQ2011	2.593	9.1	63.9
IVQ2010	2.628	9.3	63.8
IIIQ2010	2.626	9.3	63.9
IIQ2010	2.632	9.3	63.9
IQ2010	2.671	9.4	63.9
IVQ2009	2.712	9.6	63.7
IIIQ2009	2.584	9.2	63.9
IIQ2009	2.593	9.2	64.1
IQ2009	2.414	8.6	64.4
IVQ2008	2.183	7.8	64.8
IIIQ2008	2.061	7.4	64.8
IIQ2008	2.028	7.3	64.8
IQ2008	1.984	7.1	64.9
IV2007	2.099	7.5	64.6
IIIQ2007	2.214	8.0	64.3
IIQ2007	2.250	8.1	64.1
IQ2007	2.338	8.4	63.9
IVQ2006	2.326	8.4	63.9
IVQ2005	2.494	9.1	63.5
IVQ2004	2.433	8.9	63.7
IVQ2003	2.373	8.8	63.8
IVQ2002	2.143	8.0
IVQ2001	2.067	7.8
IVQ2000	2.115	8.0
IVQ1999	2.476	9.5
IVQ1995	2.546	10.0
IVQ1990	1.958	7.9
IVQ1985	2.173	8.9
IVQ1980	1.331	5.6
IVQ1975	0.847	3.7

Source: Institut National de la Statistique et des Études Économiques http://www.insee.fr/en/themes/info-rapide.asp?id=14&date=20121206

Chart VF-1 of the Institut National de la Statistique et des Études Économiques provides an excellent view of the unemployment rate in France. The rate of unemployment rose from 2003 to 2006 and then fell sharply in 2007. The global recession caused sharp increase in the French rate of unemployment that has declined from the peak, stabilized at a high level and is climbing again.

Chart VF-1, France, Unemployment Rate International Labor Organization Criterion, Seasonally Adjusted Average over Quarter, Percent

Source: Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=14&date=20121206

Table VF-2 provides longer historical perspective of manufacturing in France. There had been steady improvement in manufacturing output in France with three consecutive months of increases Jun-Aug 2012 with 0.2 percent in Jun 2012, 0.8 percent in Jul 2012 and 2.1 percent in Aug 2012 for cumulative quarterly increase of 3.1 percent at annual equivalent 13.1 percent. Improvement was interrupted by declines of manufacturing of 3.4 in Sep 2012 and 0.9 percent in Oct 2012 such that the cumulative from Jun 2012 to Oct 2012 is minus 1.3 percent and minus 4.0 percent in 12 months. Decline of manufacturing in four of the six months from Dec 2011 to May 2012 with cumulative decline of 3.7 percent from Dec 2011 to May 2012, or 7.2 percent annual equivalent, pulled down the 12-month percentage change to minus 4.8 percent in May 2012. In contrast, the cumulative increase of 3.1 percent in Jun-Aug 2012 pulled up the 12-month rate to only minus 0.4 percent in Aug 2012. In the quarter Dec 2011 to Feb 2012, manufacturing fell 2.9 at the annual equivalent rate of minus 11.0 percent. There is strength earlier in the recovery in 2010 and early 2011 with less strong performance in the latter part of 2011. Manufacturing fell 12.9 percent in 2008 during the global contraction and an additional 2.9 percent in 2009.

Table VF-2, France, Manufacturing, Month and 12-Month ∆%

	Month ∆%	12-Month ∆%
Oct 2012	-0.9	-4.0
Sep	-3.4	-2.6
Aug	2.1	-0.4
Jul	0.8	-2.8
Jun	0.2	-2.7
May	-1.2	-4.8
Apr	-0.7	-2.2
Mar	1.1	-1.4
Feb	-1.4	-4.1
Jan	0.2	-2.1
Dec 2011	-1.7	-0.3
Nov	1.0	1.5
Oct	0.4	2.1
Sep	-1.2	1.0
Aug	-0.3	3.6
Jul	0.9	2.9
Jun	-1.9	2.6
May	1.5	3.2
Apr	0.1	2.6
Mar	-1.6	3.4
Feb	0.6	6.8
Jan	2.0	6.1
Dec 2010	0.1	5.0
Dec 2009		-2.9
Dec 2008		-12.9
Dec 2007		-0.2
Dec 2006		2.4
Dec 2005		0.0
Dec 2004		1.4
Dec 2003		0.4
Dec 2002		-0.6
Dec 2001		-4.9
Dec 2000		5.2
Annual
Average ∆% 1990-2000		1.6
Average ∆% 2003-2007		0.9

Source:

Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=10&date=20121210

Chart VF-2 of France’s Institut National de la Statistique et des Études Économiques shows indices of manufacturing in France from 2008 to 2012. Manufacturing, which is CZ in Chart VF-1, fell deeply in 2008 and part of 2009. All curves of industrial indices tend to flatten recently with oscillations and declines and marginal improvement followed by renewed decline in the final segment.

Chart VF-2, France, Industrial Production Indices 2007-2011

Legend : CZ : Manufacturing - (C1) : Manufacture of food products and beverages - (C3) : Electrical and electronic equipment; machine equipment - (C4) : Manufacture of transport equipment - (C5) : Other manufacturing

Source: Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=10&date=20121210

VG Italy. Table VG-IT provides percentage changes in a quarter relative to the same quarter of Italy’s expenditure components in chained volume measures. GDP has been declining at sharper rates from minus 0.5 percent in IQ2012 to minus 2.4 percent in IIIQ2012. The aggregate demand components of consumption and gross fixed capital formation (GFCF) have been declining at faster rates.

Table VG-IT, Italy, GDP and Expenditure Components, Chained Volume Measures, Quarter ∆% on Same Quarter Year Earlier

	GDP	Imports	Consumption	GFCF	Exports
2012
IIIQ	-2.4	-7.8	-3.7	-9.8	1.6
IIQ	-2.3	-7.6	-3.5	-9.6	2.5
IQ	-1.3	-9.0	-2.8	-7.9	1.9
2011
IVQ	-0.5	-6.8	-1.6	-3.7	3.3
IIIQ	0.4	0.3	-0.5	-2.2	5.9
IIQ	1.0	3.4	0.6	-0.2	7.1
IQ	1.3	8.9	0.9	0.7	10.9
2010
IVQ	2.2	15.4	0.8	2.3	13.3
IIIQ	1.9	13.0	1.0	4.3	12.2
IIQ	1.9	13.2	0.5	2.3	12.0
IQ	1.1	7.3	0.5	-0.8	7.3
2009
IVQ	-3.5	-6.4	-0.1	-7.5	-9.3
IIIQ	-5.0	-12.1	-0.9	-12.6	-16.3
IIQ	-6.6	-17.8	-1.3	-13.7	-21.4
IQ	-6.9	-17.2	-1.6	-12.7	-22.9
2008
IVQ	-3.0	-8.2	-0.9	-8.3	-10.3
IIIQ	-1.9	-5.0	-0.8	-4.5	-3.9
IIQ	-0.2	-0.1	-0.3	-1.5	0.4
IQ	0.5	1.7	0.1	-1.0	2.9

GFCF: Gross Fixed Capital Formation

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/77009

The Markit/ADACI Business Activity Index decreased from 44.6 in Oct to 44.6 in Nov, indicating significant contraction of output of Italy’s services at a marginally higher rate for contraction during a year and a half (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10428). Phil Smith, economist at Markit and author of the Italy Services PMI^®, finds that the data suggest contraction of business services activity at an accelerating rate, breaking improvement in recent months (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10428). The Markit/ADACI Purchasing Managers’ Index^® (PMI^®), decreased from 45.5 in Oct to 45.1 in Nov for 16 consecutive months of contraction of Italy’s manufacturing (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10388 ). New foreign orders continued contracting especially from France and Germany. Phil Smith, economist at Markit and author of the Italian Manufacturing PMI^®, finds that decline of foreign orders was partly because of weakness in the economies of France and Germany but also to high selling prices that reversed prior gains in competitiveness (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10388). Table IT provides the country data table for Italy.

Table IT, Italy, Economic Indicators

Consumer Price Index	Nov month ∆%: -0.2 Nov 12-month ∆%: 2.5 Blog 12/16/12
Producer Price Index	Oct month ∆%: -0.3 Oct 12-month ∆%: 2.6 Blog 12/2/12
GDP Growth	IIIQ2012/IIQ2012 SA ∆%: minus 0.2 IIIQ2012/IIIQ2011 NSA ∆%: minus 2.4 Blog 12/16/12
Labor Report	Oct 2012 Participation rate 64.0% Employment ratio 56.9% Unemployment rate 11.1% Blog 12/2/12
Industrial Production	Oct month ∆%: minus 1.1 12 months ∆%: minus 6.2 Blog 12/16/12
Retail Sales	Sep month ∆%: 0.0 Sep 12-month ∆%: -1.7 Blog 11/25/12
Business Confidence	Mfg Nov 88.5, Jul 87.3 Construction Oct 79.7, Jul 83.5 Blog 12/2/12
Trade Balance	Balance Sep SA €1556 million versus Aug €968 Exports Sep month SA ∆%: minus 2.0; Imports Sep month minus ∆%: 4.2 Exports 12 months Sep NSA ∆%: minus 4.2 Imports 12 months NSA ∆%: minus 10.6 Blog 11/18/12

Links to blog comments in Table IT:

12/2/12 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html

11/25/12 http://cmpassocregulationblog.blogspot.com/2012/11/contraction-of-united-states-real.html

11/18/12 http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html

Table VG-1 provides percentage changes in a quarter relative to the same quarter of Italy’s expenditure components in chained volume measures. GDP has been declining at sharper rates from minus 0.5 percent in IQ2012 to minus 2.4 percent in IIIQ2012. The aggregate demand components of consumption and gross fixed capital formation (GFCF) have been declining at faster rates.

Table VG-1, Italy, GDP and Expenditure Components, Chained Volume Measures, Quarter ∆% on Same Quarter Year Earlier

	GDP	Imports	Consumption	GFCF	Exports
2012
IIIQ	-2.4	-7.8	-3.7	-9.8	1.6
IIQ	-2.3	-7.6	-3.5	-9.6	2.5
IQ	-1.3	-9.0	-2.8	-7.9	1.9
2011
IVQ	-0.5	-6.8	-1.6	-3.7	3.3
IIIQ	0.4	0.3	-0.5	-2.2	5.9
IIQ	1.0	3.4	0.6	-0.2	7.1
IQ	1.3	8.9	0.9	0.7	10.9
2010
IVQ	2.2	15.4	0.8	2.3	13.3
IIIQ	1.9	13.0	1.0	4.3	12.2
IIQ	1.9	13.2	0.5	2.3	12.0
IQ	1.1	7.3	0.5	-0.8	7.3
2009
IVQ	-3.5	-6.4	-0.1	-7.5	-9.3
IIIQ	-5.0	-12.1	-0.9	-12.6	-16.3
IIQ	-6.6	-17.8	-1.3	-13.7	-21.4
IQ	-6.9	-17.2	-1.6	-12.7	-22.9
2008
IVQ	-3.0	-8.2	-0.9	-8.3	-10.3
IIIQ	-1.9	-5.0	-0.8	-4.5	-3.9
IIQ	-0.2	-0.1	-0.3	-1.5	0.4
IQ	0.5	1.7	0.1	-1.0	2.9

GFCF: Gross Fixed Capital Formation

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/77009

Table VG-2 provides revised percentage changes of GDP in Italy of quarter on prior quarter and quarter on same quarter a year earlier. Italy’s GDP fell 0.2 percent in IIIQ2012 and declined 2.4 percent relative to IIIQ2011. GDP had been growing during six consecutive quarters but at very low rates from IQ2010 to IIQ2011 and has fallen in five consecutive quarters from IIIQ2011 to IIIQ2012 at increasingly higher rates of contraction from 0.1 percent in IIIQ2011 to 0.7 percent in IVQ2011, 0.8 percent in IQ2012 and 0.7 percent in IIQ2012 but at lower 0.2 percent in IIIQ2012. GDP contracted cumulatively 2.5 percent in five consecutive quarterly contractions from IIIQ2011 to IIIQ2012 at the annual equivalent rate of 2.0 percent. The yearly rate has fallen from 2.2 percent in IVQ2010 to minus 2.4 percent in IIIQ2012. The fiscal adjustment of Italy is significantly more difficult with the economy not growing especially on the prospects of increasing government revenue. The strategy is for reforms to improve productivity so as to facilitate future fiscal consolidation.

Table VG-2, Italy, GDP ∆%

	Quarter ∆% Relative to Preceding Quarter	Quarter ∆% Relative to Same Quarter Year Earlier
IIIQ2012	-0.2	-2.4
IIQ2012	-0.7	-2.3
IQ2012	-0.8	-1.3
IVQ2011	-0.7	-0.5
IIIQ2011	-0.1	0.4
IIQ2011	0.3	1.0
IQ2011	0.1	1.3
IVQ2010	0.2	2.2
IIIQ2010	0.4	1.9
IIQ2010	0.6	1.9
IQ2010	1.0	1.1
IVQ2009	-0.1	-3.5
IIIQ2009	0.4	-5.0
IIQ2009	-0.2	-6.6
IQ2009	-3.6	-6.9
IVQ2008	-1.6	-3.0
IIIQ2008	-1.3	-1.9
IIQ2008	-0.5	-0.2
IQ2008	0.5	0.5
IV2007	-0.4	0.1
IIIQ2007	0.3	1.7
IIQ2007	0.2	2.0
IQ2007	0.0	2.4

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/77009

Table VG-3 provides percentage changes in a quarter relative to the same quarter a year earlier for GDP and value added components. Percentage declines of industry have been sharper from IVQ2011 to IIIQ2012 than for services.

Table VG-3, Italy, GDP and Valued Added of Components, Chained Volume Measures, Quarter ∆% on Same Quarter Year Earlier

	Agriculture	Industry	Services	VAT and Net Taxes	GDP Market Prices
2012
% Value Added	2.1	24.1	73.8
IIIQ	-5.1	-4.6	-1.3	-4.3	-2.4
IIQ	1.1	-5.6	-0.8	-5.6	-2.3
IQ	1.0	-3.5	-0.2	-4.2	-1.3
2011
IVQ	-1.6	-1.9	0.5	-3.5	-0.5
IIIQ	0.0	0.2	0.7	-0.9	0.4
IIQ	-0.5	2.1	0.7	0.1	1.0
IQ	0.5	2.6	1.0	0.7	1.3
2010
IVQ	0.1	4.6	1.8	-0.4	2.2
IIIQ	-1.0	5.0	1.4	-1.1	1.9
IIQ	-0.2	5.0	1.2	-0.4	1.9
IQ	0.1	2.3	1.1	-1.6	1.1
2009
IVQ	-3.6	-7.3	-2.2	-2.9	-3.5
IIIQ	-1.0	-12.9	-2.3	-4.3	-5.0
IIQ	-4.0	-16.6	-3.0	-5.2	-6.6
IQ	-1.4	-16.7	-3.4	-6.1	-6.9
2008
IVQ	2.2	-8.2	-1.3	-2.1	-3.0
IIIQ	1.0	-3.9	-1.2	-1.7	-1.9
IIQ	2.3	-0.6	0.0	-1.4	-0.2
IQ	0.1	1.0	0.4	-0.1	0.5

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/77009

Chart VG-1 of the Italian National Institute of Statistics (ISTAT) provides growth of GDP of Italy at market prices. The year on year rate of growth pulled strongly out of the contraction. There is evident trend of deceleration with increasingly sharper contraction

Chart VG-1, Italy, GDP at Market Prices, ∆% on Same Quarter Year Earlier

Source: Istituto Nazionale di Statistica

http://www.istat.it/en/

Italy’s industrial production fell 1.1 percent in Oct 2012, pulling down the 12-month rate of growth to minus 6.2 percent and fell 1.3 percent in Sep with 12-month decline of 5.0 percent, as shown in Table VG-4. Industrial production recovered with growth of 0.7 percent in May 2012 but growth in the 12 months ending in May 2012 was minus 6.7 percent. Industrial production fell 7.9 percent in the 12 months ending in Jun 2012. There have been negative changes with oscillations in monthly industrial production. Industrial production fell 18.8 percent in 2009 after falling 3.2 percent in 2008.

Table VG-4, Italy, Industrial Production ∆% 

	Month ∆% SA	12-Month ∆% Calendar Adjusted
Oct 2012	-1.1	-6.2
Sep	-1.3	-5.0
Aug	1.2	-5.2
Jul	-0.2	-7.1
Jun	-1.1	-7.9
May	0.7	-6.7
Apr	-1.9	-9.3
Mar	0.5	-5.5
Feb	-1.1	-7.0
Jan	-2.1	-4.6
Dec 2011	0.8	-1.8
Nov	-0.5	-4.1
Oct	-0.3	-3.8
Sep	-3.0	-2.6
Aug	1.4	4.8
Jul	-1.0	-1.2
Jun	-0.2	0.4
May	-1.4	2.1
Apr	1.4	3.9
Mar	-0.3	3.2
Feb	1.3	2.5
Jan	-0.8	0.2
Dec 2010	-0.4	6.8
Nov	0.6	5.5
Oct	-0.1	4.1
Sep	0.9	5.8
Aug	-0.8	11.4
Jul	0.6	7.5
Jun	1.0	9.9
May	0.9	8.9
Apr	0.9	9.5
Mar	-0.2	8.5
Feb	-0.3	4.5
Jan	4.0	0.6
Dec 2009	-1.3	-6.6
Year		Not CA
2011		-0.7
2010		7.0
2009		-18.8
2008		-3.2

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/76987

Chart VG-2 of Italy’s Istituto Nazionale di Statistica provides 12-month percentage changes of Italy’s industrial production. There is worsening trend after Aug 2011, sharply deteriorating after Dec 2011 into 2012 with marginal recovery in May 2012 and further drops in Jun-Jul 2012 followed by marginal improvement in Aug and decline in Sep-Oct 2012 but still in negative territory.

Chart VG-2, Italy, Industrial Production, 12-Month Percentage Changes

Source: Istituto Nazionale di Statistica

http://www.istat.it/en

VH United Kingdom. Annual data in Table VH-UK show the strong impact of the global recession in the UK with decline of GDP of 4.0 percent in 2009 after dropping 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 0.9 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	0.9
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/second-estimate-of-gdp/q3-2012/stb-second-estimate-of-gdp--q3-2012.html

The Business Activity Index of the Markit/CIPS UK Services PMI^® decreased from 50.6 in Oct to 50.2 in Nov with growth during 23 consecutive months, decreasing at the margin (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10433). Chris Williamson, Chief Economist at Markit, finds that the lowest level of the index registered in 23 months suggests together with weak survey data for manufacturing and construction suggests that the UK economy could fall back to contraction after growth in IIIQ2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10433). The Markit/CIPS UK Manufacturing Purchasing Managers’ Index^® (PMI^®) increased from 47.3 in Oct to 49.1 in Nov for seven months in contraction territory (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10398). The PMI registered average 47.8 in IIIQ2012, which is the lowest reading since IIQ2009 but the average to date for IVQ2012 at 48.2 is higher than 47.8 in IIIQ2012. New export orders continued to fall with declining new business from Europe and the US. Rob Dobson, Senior Economist at Markit and author of the Markit/CIPS Manufacturing PMI^®, finds that recession in the Europe and weak world growth continue to affect exports (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10398). Table UK provides the economic indicators for the United Kingdom.

Table UK, UK Economic Indicators

CPI	Oct month ∆%: 0.5 Oct 12-month ∆%: 2.7 Blog 11/18/12
Output/Input Prices	Output Prices: Oct 12-month NSA ∆%: 2.5; excluding food, petroleum ∆%: 1.4 Input Prices: Oct 12-month NSA ∆%: 0.1 Excluding ∆%: -0.3 Blog 11/18/12
GDP Growth	IIIQ2012 prior quarter ∆% minus 1.0; year earlier same quarter ∆%: -0.1 Blog 12/2/12
Industrial Production	Oct 2012/Oct 2011 ∆%: Production Industries minus 3.0; Manufacturing minus 2.1 Blog 12/9/12
Retail Sales	Oct month ∆%: 0.0 Oct 12-month ∆%: 0.6 Blog 11/18/12
Labor Market	Jul-Sep Unemployment Rate: 7.8%; Claimant Count 4.8%; Earnings Growth 1.8% Blog 11/18/12
Trade Balance	Balance Oct minus ₤3644 million Exports Oct ∆%: -0.8; Aug-Oct ∆%: -2.7 Imports Oct ∆%: 1.9 Aug-Oct ∆%: -0.1 Blog 12/9/12

Links to blog comments in Table UK:

12/9/12 http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html

12/2/12 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html

11/18/12 http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.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 10.4 percent by Fri Dec 14, 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	12/14/2012
Rate	1.1423	1.5914	1.192	1.3162
CNY/USD	01/03 2000	07/21 2005	7/15 2008	12/14/ 2012
Rate	8.2798	8.2765	6.8211	6.2460
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 1.3162/EUR on Dec 14, 2012 or by 10.4 percent {[(1.3162/1.192)-1]100 = 10.4%}. 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 6.2460/USD on Fri Dec 14, 2012, or by an additional 8.4 percent, for cumulative revaluation of 24.5 percent. The final row of Table VI-2 shows revaluation of the CNY in two of the past four weeks by 0.1 percent in the weeks of Nov 23 and Dec 7; and depreciation by 0.3 percent in the week of Dec 14, 2012.

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	12/14/ /2012
Rate	1.1423	1.5914	1.192	1.3162
CNY/USD	01/03 2000	07/21 2005	7/15 2008	12/14/ 2012
Rate	8.2798	8.2765	6.8211	6.2460
Weekly Rates	11/23/2012	11/30/2012	12/7/2012	12/14/ 2012
CNY/USD	6.2328	6.2310	6.2254	6.2460
∆% from Earlier Week*	0.1	0.0	0.1	-0.3

*Negative sign is depreciation, positive sign is appreciation

Source:

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

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

The Dow Jones Newswires informs on Oct 15 that the premier of China Wen Jiabao announced that the Chinese yuan will not be further appreciated to prevent adverse effects on exports (http://professional.wsj.com/article/SB10001424052970203914304576632790881396896.html?mod=WSJ_hp_LEFTWhatsNewsCollection). Bob Davis and Lingling Wei, writing on “China shifts course, lets Yuan drop,” on Jul 25, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444840104577548610131107868.html?mod=WSJPRO_hpp_LEFTTopStories), find that China is depreciating the CNY relative to the USD in an effort to diminish the impact of appreciation of the CNY relative to the EUR. Table VI-2A provides the CNY/USD rate from Oct 28, 2011 to Nov 9, 2012 in selected intervals on Fridays. The CNY/USD revalued by 0.9 percent from Oct 28, 2012 to Apr 27, 2012. The CNY was virtually unchanged relative to the USD by Aug 24, 2012 to CNY 6.3558/USD from the rate of CNY 6.3588/USD on Oct 28, 2011 and then revalued slightly by 1.1 percent to CNY 6.2858/USD on Sep 28, 2012. Devaluation of 0.6 percent from CNY 6.2858/USD on Sep 28, 2012 to CNY 6.3240/USD on Oct 5, 2012, reduced to 0.5 percent the cumulative revaluation from Oct 28, 2011 to Oct 5, 2012. Revaluation by 0.2 percent to CNY 6.2546/USD on Oct 12, 2012, revalued the CNY by 1.6 percent relative to the dollar from CNY 6.3588/USD on Oct 29, 2011. By Dec 14, 2012, the CNY revalued 1.8 percent to CNY 6.2460/USD relative to CNY 6.3588/USD on Oct 29, 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
12/14/12	6.2460	1.8
12/7/12	6.2254	2.1
11/30/12	6.2310	2.0
11/23/12	6.2328	2.0
11/16/12	6.2404	1.9
11/9/12	6.2452	1.8
11/2/12	6.2458	1.8
10/26/12	6.2628	1.5
10/19/12	6.2546	1.6
10/12/12	6.2670	1.4
10/5/12	6.3240	0.5
9/28/12	6.2858	1.1
9/21/12	6.3078	0.8
9/14/12	6.3168	0.7
9/7/12	6.3438	0.2
8/31/12	6.3498	0.1
8/24/12	6.3558	0.0
8/17/12	6.3589	0.0
8/10/12	6.3604	0.0
8/3/12	6.3726	-0.2
7/27/12	6.3818	-0.4
7/20/12	6.3750	-0.3
7/13/12	6.3868	-0.4
7/6/12	6.3658	-0.1
6/29/12	6.3552	0.1
6/22/12	6.3650	-0.1
6/15/12	6.3678	-0.1
6/8/2012	6.3752	-0.3
6/1/2012	6.3708	-0.2
4/27/2012	6.3016	0.9
3/23/2012	6.3008	0.9
2/3/2012	6.3030	0.9
12/30/2011	6.2940	1.0
11/25/2011	6.3816	-0.4
10/28/2011	6.3588	-

Source:

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

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

Chart VI-1 of the Board of Governors of the Federal Reserve System provides the CNY/USD exchange rate from Jan 3, 2000 to Dec 7, 2012 together with US recession dates in shaded areas. China fixed the CNY/USD rate for a long period as shown in the horizontal segment from 1995 to 2005. There was systematic revaluation of 17.6 percent from CNY 8.2765 on Jul 21, 2005 to CNY 6.8211 on Jul 15, 2008. China fixed the CNY/USD rate until Jun 7, 2010, to avoid adverse effects on its economy from the global recession, which is shown as a horizontal segment from 2009 until mid 2010. China then continued the policy of appreciation of the CNY relative to the USD with oscillations until the beginning of 2012 when the rate began to move sideways followed by a final upward slope of devaluation that is measured in Table VI-2A but virtually disappeared in the rate of CNY 6.3589/USD on Aug 17, 2012 and was nearly unchanged at CNY 6.3558/USD on Aug 24, 2012. China then depreciated 0.3 percent in the week of Dec 14, 2012, to CNY 6.2460/USD for cumulative 1.8 percent revaluation from Oct 28, 2011. Revaluation of the CNY relative to the USD by 24.5 percent by Dec 14, 2012 has not reduced the trade surplus of China but reversal of the policy of revaluation could result in international confrontation. The upward slope in the final segment on the right of Chart VI-I is measured as virtually stability in Table VI-2A with slight decrease or revaluation in the final segment.

Chart VI-1, Chinese Yuan (CNY) per US Dollar (US), Jan 3, 1995-Dec 7, 2012

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

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

The G7 meeting in Washington on Apr 21 2006 of finance ministers and heads of central bank governors of the G7 established the “doctrine of shared responsibility” (G7 2006Apr):

“We, Ministers and Governors, reviewed a strategy for addressing global imbalances. We recognized that global imbalances are the product of a wide array of macroeconomic and microeconomic forces throughout the world economy that affect public and private sector saving and investment decisions. We reaffirmed our view that the adjustment of global imbalances:

• Is shared responsibility and requires participation by all regions in this global process;
• Will importantly entail the medium-term evolution of private saving and investment across countries as well as counterpart shifts in global capital flows; and
• Is best accomplished in a way that maximizes sustained growth, which requires strengthening policies and removing distortions to the adjustment process.

In this light, we reaffirmed our commitment to take vigorous action to address imbalances. We agreed that progress has been, and is being, made. The policies listed below not only would be helpful in addressing imbalances, but are more generally important to foster economic growth.

• In the United States, further action is needed to boost national saving by continuing fiscal consolidation, addressing entitlement spending, and raising private saving.
• In Europe, further action is needed to implement structural reforms for labor market, product, and services market flexibility, and to encourage domestic demand led growth.
• In Japan, further action is needed to ensure the recovery with fiscal soundness and long-term growth through structural reforms.

Others will play a critical role as part of the multilateral adjustment process.

• In emerging Asia, particularly China, greater flexibility in exchange rates is critical to allow necessary appreciations, as is strengthening domestic demand, lessening reliance on export-led growth strategies, and actions to strengthen financial sectors.

• In oil-producing countries, accelerated investment in capacity, increased economic diversification, enhanced exchange rate flexibility in some cases.

• Other current account surplus countries should encourage domestic consumption and investment, increase micro-economic flexibility and improve investment climates.

We recognized the important contribution that the IMF can make to multilateral surveillance.”

The concern at that time was that fiscal and current account global imbalances could result in disorderly correction with sharp devaluation of the dollar after an increase in premiums on yields of US Treasury debt (see Pelaez and Pelaez, The Global Recession Risk (2007)). The IMF was entrusted with monitoring and coordinating action to resolve global imbalances. The G7 was eventually broadened to the formal G20 in the effort to coordinate policies of countries with external surpluses and deficits.

The database of the WEO (http://www.imf.org/external/datamapper/index.php?db=WEO) is used to contract Table VI-3 with fiscal and current account imbalances projected for 2012 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 2012	FD %GDP 2011	CAD %GDP 2011	Debt %GDP 2011	FD%GDP 2015	CAD%GDP 2015	Debt %GDP 2015
US	15653	-7.8	-3.1	80.3	-2.2	-3.2	89.5
Japan	5984	-8.9	2.0	126.4	-4.6	2.4	152.4
UK	2434	-5.7	-1.9	76.6	-1.5	-1.5	91.5
Euro	15653	-1.5	0.4	68.0	1.2	1.5	74.4
Ger	3366	0.9	5.7	55.3	1.2	4.4	56.2
France	2580	-2.7	-1.9	78.8	0.4	-1.2	86.1
Italy	1980	0.8	-3.2	99.6	4.2	-1.2	102.4
Can	1770	-3.9	-2.8	33.1	-1.3	-3.5	37.8
China	8250	-1.2	2.8	25.8	-0.1	3.2	14.9
Brazil	2425	3.1	-2.1	34.4	3.1	-3.3	28.7

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: IMF World Economic Outlook databank http://www.imf.org/external/datamapper/index.php?db=WEO

The current account of the US balance of payments is provided in Table VI-3A for IIQ2011 and IIQ2012. 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 decreased from $124.5 billion in IIQ2011, or 3.2 percent of GDP, to $123.2 billion in IIQ2012, or 3.0 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

	IIQ2011	IIQ2012	Difference
Goods Balance	-190,477	-189,344	1,133
X Goods	375,554	396,218	5.5 ∆%
M Goods	-566,031	-585,562	3.5 ∆%
Services Balance	39,949	40,690	741
X Services	148,999	154,291	3.6 ∆%
M Services	-109,050	-113,601	4.2 ∆%
Balance Goods and Services	-150,528	-148,654	1,874
Balance Income	58,335	57,504	-831
Unilateral Transfers	-32,291	-32,049	-242
Current Account Balance	-124,484	-123,199	-1,285
% GDP	IIQ2011	IVQ2011	IIQ2012
	3.2	3.1	3.0

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 alternative fiscal scenario of the CBO (2012NovCDR) resembles an economic world in which eventually the placement of debt reaches a limit of what is proportionately desired of US debt in investment portfolios. This unpleasant environment is occurring in various European countries.

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 the 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 2012NovCDR) estimates the federal deficit in 2012 at $1089 billion or 7.7 percent of GDP (http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html). The combined record federal deficits of the US from 2009 to 2012 are $5092 billion or 33 percent of the estimate of GDP of $15,538 billion for fiscal year 2012 by the CBO (http://www.cbo.gov/publication/43542 2012AugBEO). The deficits from 2009 to 2012 exceed one trillion dollars per year, adding to $5092 trillion in four years, using the fiscal year deficit of $1089.4 billion for fiscal year 2012 (http://www.fms.treas.gov/mts/mts0912.txt), which is the worst fiscal performance since World War II. Federal debt in 2007 was $5035 billion, less than the combined deficits from 2009 to 2012 of $5092 billion. Federal debt in 2011 was 67.7 percent of GDP and is estimated to reach 72.6 percent of GDP in 2012 (CBO2012AugBEO, CBO2012NovCDR). 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	13974	14499	15076
Current Account % GDP	-3.8	-5.1	-4.7	-2.7	-3.1	-3.1
NIIP	-1337	-1796	-3260	-2321	-2474	-4030
US Owned Assets Abroad	6239	18399	19464	18512	20298	21132
Foreign Owned Assets in US	7576	20195	22724	20833	22772	25162
NIIP % GDP	-13.4	-12.8	-22.8	-16.6	-17.1	26.7
Exports Goods Services Income	1425	2488	2657	2181	2519	2848
NIIP % Exports Goods Services Income	-94	-72	-123	-106	-98	-142
DIA MV	2694	5274	3102	4287	4767	4450
DIUS MV	2783	3551	2486	2995	3397	3509
Fiscal Balance	+236	-161	-459	-1413	-1294	-1297
Fiscal Balance % GDP	+2.4	-1.2	-3.2	-10.1	-9.0	-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	3603
∆%	5.1	2.8	9.3	17.9	-1.8	4.3
% GDP	18.2	19.7	20.8	25.2	24.1	24.1
Federal Revenue	2052	2568	2524	2105	2162	2302
∆%	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 the 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

Budget, Congressional Budget Office http://www.cbo.gov/

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 (2012WEOOct) provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2012/02/pdf/text.pdf), of the world financial system with its Global Financial Stability Report (GFSR) (IMF 2012GFSROct) (http://www.imf.org/external/pubs/ft/gfsr/2012/02/pdf/text.pdf) and of fiscal affairs with the Fiscal Monitor (IMF 2012FMOct) (http://www.imf.org/external/pubs/ft/fm/2012/02/fmindex.htm). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider 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 IIQ2012 of 1.8 percent is equivalent to 7.4 percent per year and growth in IIQ2012 relative to IIQ2011 is estimated at 7.6 percent, which is the lowest since the global recession. GDP in China increased 2.2 percent in IIIQ2012 relative to IIQ2012, or annual equivalent of 9.1 percent, and 7.4 percent relative to IIQ2011 (See Subsection VC at http://cmpassocregulationblog.blogspot.com/2012/10/world-inflation-waves-stagnating-united_21.html). There is also ongoing political development in China during a decennial political reorganization with new leadership (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). 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 is experiencing the first expansion from a recession after World War II without growth and without jobs. The economy of the US can be summarized in growth of economic activity or GDP as decelerating from mediocre growth of 2.4 percent on an annual basis in 2011 to cumulative growth of 1.5 percent in the first three quarters of 2012, which is equivalent to 2.0 percent per year (Mediocre and Decelerating United States Economic Growth at http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/10/mediocre-and-decelerating-united-states.html). Growth is not only mediocre but sharply decelerating to a rhythm that is not consistent with reduction of unemployment and underemployment of 28.6 million people. (ii) The labor market continues fractured with 28.6 million unemployed or underemployed (Section I at http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html

and earlier http://cmpassocregulationblog.blogspot.com/2012/11/twenty-eight-million-unemployed-or.html). (iii) There is a difficult climb from the record federal deficit of 9.9 percent of GDP in 2009 and cumulative deficit of $5092 billion in four consecutive years of deficits exceeding one trillion dollars from 2009 to 2012, which is the worst fiscal performance since World War II (Section I at http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html and earlier Section IB at http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.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 (Table IB-3 at http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html and CBO 2012AugBEO http://www.cbo.gov/sites/default/files/cbofiles/attachments/08-22-2012-Update_to_Outlook.pdf iv) at 72.6 percent in 2012. The CBO (2012AugBEO, CBO2012NovCDR) 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 89.7 percent by 2022 (Table IB-6 at http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html). 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 grew 3.4 percent in IQ2012 relative to a year earlier, 1.4 percent in IQ2012 relative to IVQ2011, 0.0 percent in IIQ2012 relative to IQ2011 and contracted 0.9 percent in IIIQ2012, increasing 0.5 percent relative to a year earlier (see Section VB and earlier at http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal_18.html). The euro zone’s GDP was flat in IQ2012 and fell 0.1 percent relative to a year earlier in IQ2011 but fell 0.2 percent in IIQ2012 and declined 0.5 percent relative to IIQ2011, falling 0.1 percent in IIIQ2012 and declining 0.6 percent relative to a year earlier; Germany’s GDP grew 0.5 percent in IQ2012 and 1.7 percent relative to IQ2011, increasing 0.3 percent in IIQ2012 and 0.5 percent relative to IIQ2011 and growing 0.2 percent in IIIQ2012 with growth of 0.4 percent relative to a year earlier; and the UK’s GDP fell 0.4 percent in IVQ2011, 0.3 percent in IQ2012 and 0.4 percent in IIQ2012 for cumulative decline of 1.1 percent in three consecutive quarters at annual equivalent rate of minus 1.5 percent and declined 0.5 percent in IIQ2012 relative to IIQ2011. In IIIQ2012, the UK grew 1.0 percent relative to IIQ2012 and fell 0.1 percent relative to IIIQ2011. There is still high unemployment in advanced economies

4. World Inflation Waves. Inflation continues in repetitive waves globally (see Section II and earlier at http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html and earlier http://cmpassocregulationblog.blogspot.com/2012/10/world-inflation-waves-stagnating-united.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 of their currencies. 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 35.6 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to Dec 14, 2012, and the S&P 500 has gained 38.2 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) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):

“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

At its meeting on Jan 25, 2012, 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 12/14/12,” which has been recently stalling or reversing amidst bouts of risk aversion. “Let’s twist again” monetary policy during the week of Sep 23 caused deep worldwide risk aversion and selloff of risk financial assets (http://cmpassocregulationblog.blogspot.com/2011/09/imf-view-of-world-economy-and-finance.html http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html). Monetary policy was designed to increase risk appetite but instead suffocated risk exposures. There has been rollercoaster fluctuation in risk aversion and financial risk asset valuations: surge in the week of Dec 2, 2011, mixed performance of markets in the week of Dec 9, renewed risk aversion in the week of Dec 16, end-of-the-year relaxed risk aversion in thin markets in the weeks of Dec 23 and Dec 30, mixed sentiment in the weeks of Jan 6 and Jan 13 2012 and strength in the weeks of Jan 20, Jan 27 and Feb 3 followed by weakness in the week of Feb 10 but strength in the weeks of Feb 17 and 24 followed by uncertainty on financial counterparty risk in the weeks of Mar 2 and Mar 9. All financial values have fluctuated with events such as the surge in the week of Mar 16 on favorable news of Greece’s bailout even with new risk issues arising in the week of Mar 23 but renewed risk appetite in the week of Mar 30 because of the end of the quarter and the increase in the firewall of support of sovereign debts in the euro area. New risks developed in the week of Apr 6 with increase of yields of sovereign bonds of Spain and Italy, doubts on Fed policy and weak employment report. Asia and financial entities are experiencing their own risk environments. Financial markets were under stress in the week of Apr 13 because of the large exposure of Spanish banks to lending by the European Central Bank and the annual equivalent growth rate of China’s GDP of 7.4 percent in IQ2012 [(1.018)⁴], which was repeated in IIQ2012. There was strength again in the week of Apr 20 because of the enhanced IMF firewall and Spain placement of debt, continuing into the week of Apr 27. Risk aversion returned in the week of May 4 because of the expectation of elections in Europe and the new trend of deterioration of job creation in the US. Europe’s sovereign debt crisis and the fractured US job market continued to influence risk aversion in the week of May 11. Politics in Greece and banking issues in Spain were important factors of sharper risk aversion in the week of May 18. Risk aversion continued during the week of May 25 and exploded in the week of Jun 1. Expectations of stimulus by central banks caused valuation of risk financial assets in the week of Jun 8 and in the week of Jun 15. Expectations of major stimulus were frustrated by minor continuance of maturity extension policy in the week of Jun 22 together with doubts on the silent bank run in highly indebted euro area member countries. There was a major rally of valuations of risk financial assets in the week of Jun 29 with the announcement of new measures on bank resolutions by the European Council. New doubts surfaced in the week of Jul 6, 2012 on the implementation of the bank resolution mechanism and on the outlook for the world economy because of interest rate reductions by the European Central, Bank of England and People’s Bank of China. Risk appetite returned in the week of July 13 in relief that economic data suggests continuing high growth in China but fiscal and banking uncertainties in Spain spread to Italy in the selloff of July 20, 2012. Mario Draghi (2012Jul26), president of the European Central Bank, stated: “But there is another message I want to tell you.

Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” This statement caused return of risk appetite, driving upward valuations of risk financial assets worldwide. Buiter (2011Oct31) analyzes that the European Financial Stability Fund (EFSF) would need a “bigger bazooka” to bail out euro members in difficulties that could possibly be provided by the ECB. The dimensions of the problem may require more firepower than a bazooka perhaps that of the largest conventional bomb of all times of 44,000 pounds experimentally detonated only once by the US in 1948 (http://www.airpower.au.af.mil/airchronicles/aureview/1967/mar-apr/coker.html). Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. Risk appetite continued in the week of Aug 3, 2012, in expectation of purchases of sovereign bonds by the ECB. Growth of China’s exports by 1.0 percent in the 12 months ending in Jul 2012 released in the week of Aug 10, 2012, together with doubts on the purchases of bonds by the ECB injected a mild dose of risk aversion. There was optimism on the resolution of the European debt crisis on Aug 17, 2012. The week of Aug 24, 2012 had alternating shocks of risk aversion and risk appetite from the uncertainties of success of the Greek adjustment program, the coming decision of the Federal Constitutional Court of Germany on the European Stability Mechanism, disagreements between the Deutsche Bundesbank and the European Central Bank on purchase of sovereign bonds of highly indebted euro area member countries and the exchange of letters between Darrell E. Issa (2012Aug1), Chairman of the House Committee on Oversight and Government Reform, and Chairman Bernanke (2012Aug22) on monetary policy. Bernanke (2012JHAug31) and Draghi (2012Aug29) generated risk enthusiasm in the week of Aug 31, 2012. Risk appetite returned in the week of Sep 7, 2012, with the announcement of the bond-buying program of OMT (Outright Monetary Transactions) on Sep 6, 2012, by the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). Valuations of risk financial assets increased sharply after the statement of the FOMC on Sep 13, 2012 with open-ended quantitative easing and self-imposed single-mandate of jobs that would maintain easing monetary policy well after the economy returns to full potential. Risk aversion returned in the week of Sep 21, 2012 on doubts about the success of quantitative easing and weakness in flash purchasing managers’ indices. Risk aversion returned in the week of Sep 28, 2012, because of uncertainty on the consequences of a bailout of Spain and weakness of central banks in controlling financial turbulence but was followed by risk appetite in the week of Oct 5, aversion in the week of Oct 12 and mixed views in the week of Oct 19. Revenue declines for reporting companies caused decline of stocks in the week of Oct 26. Continuing risk aversion originates in the week of Nov 9 from the unresolved European debt crisis, world economic slowdown and low growth with fiscal challenges in the United States. Risk aversion continued in the week of Nov 16 with the unresolved European debt crisis, world economic slowdown and the unsustainable deficit/debt of the US threatening prosperity. Risk appetite returned in the Thanksgiving week with expectations of a deal for avoiding expenditure reductions and tax increases in the US in 2013. Risks doubts returned in some markets in the week of Nov 30 with impasse in fiscal negotiations in the US and sovereign debt doubts in Europe. Increase in China’s purchasing managers’ indexes stimulated markets that did not react adversely to downgrades of growth by the Deutsche Bundesbank and the European Central Bank in the week of Dec 7, 2012. The flash HSBC manufacturing PMI index showing the highest reading in 14 months also supported Chinese stocks. The highest valuations in column “∆% Trough to 12/14/12” are by US equities indexes: DJIA 35.6 percent and S&P 500 38.2 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 13,661.87 on Oct 5, 2012, 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 12/14/12” had double digit gains relative to the trough around Jul 2, 2010 but now some valuations of equity indexes show varying behavior: China’s Shanghai Composite is 9.7 percent below the trough; Japan’s Nikkei Average is 10.4 percent above the trough; DJ Asia Pacific TSM is 13.0 percent above the trough; Dow Global is 15.9 percent above the trough; STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 12.7 percent above the trough; and NYSE Financial is 16.7 percent above the trough. DJ UBS Commodities is 13.4 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 34.0 percent above the trough. Japan’s Nikkei Average is 10.4 percent above the trough on Aug 31, 2010 and 14.5 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 9737.56 on Fri Dec 14, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 5.0 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 10.4 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 12/14/12” in Table VI-4 shows that there were increases of valuations of risk financial assets in the week of Dec 14, 2012 such as 0.9 percent for Dow Global, 0.2 percent for NYSE Financial, 0.2 percent for STOXX 50, 1.0 percent for DAX and 0.9 percent for DJ Asia Pacific TSM. Nikkei Average increased 2.2 percent in the week. DJ UBS Commodities decreased 0.7 percent. China’s Shanghai Composite increased 4.3 percent in the week of Dec 14, 2012. The DJIA decreased 0.2 percent and S&P 500 decreased 0.3 percent. The USD depreciated 1.8 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 12/14/12” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Dec 14, 2012. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 12/14/12” but also relative to the peak in column “∆% Peak to 12/14/12.” There are now only three equity indexes above the peak in Table VI-4: DJIA 17.2 percent, S&P 500 16.1 percent and DAX 20.0 percent. There are several indexes below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 7.1 percent, Nikkei Average by 14.5 percent, Shanghai Composite by 32.0 percent, DJ Asia Pacific by 1.1 percent, STOXX 50 by 4.6 percent and Dow Global by 5.4 percent. DJ UBS Commodities Index is now 3.1 percent below the peak. The US dollar strengthened 13.0 percent relative to 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. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. It may be quite painful to exit QE∞ or use of the balance sheet of the central together with zero interest rates forever. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:

Where R_τ is expected revenue in the time horizon from τ =1 to T; C_τ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that interest rates increase without bound, then V → 0, or

declines. Equally, decline in expected revenue from the stock or project, R_τ, causes decline in valuation. 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 12/14/ /12	∆% Week 12/14/12	∆% Trough to 12/14/ 12
DJIA	4/26/ 10	7/2/10	-13.6	17.2	-0.2	35.6
S&P 500	4/23/ 10	7/20/ 10	-16.0	16.1	-0.3	38.2
NYSE Finance	4/15/ 10	7/2/10	-20.3	-7.1	0.2	16.7
Dow Global	4/15/ 10	7/2/10	-18.4	-5.4	0.9	15.9
Asia Pacific	4/15/ 10	7/2/10	-12.5	-1.1	0.9	13.0
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-14.5	2.2	10.4
China Shang.	4/15/ 10	7/02 /10	-24.7	-32.0	4.3	-9.7
STOXX 50	4/15/10	7/2/10	-15.3	-4.6	0.2	12.7
DAX	4/26/ 10	5/25/ 10	-10.5	20.0	1.0	34.0
Dollar Euro	11/25 2009	6/7 2010	21.2	13.0	-1.8	-10.4
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-3.1	-0.7	13.4
10-Year T Note	4/5/ 10	4/6/10	3.986	1.704

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 Nov 30, 2012, shows that the S&P 500 is now 16.6 percent above the Apr 26, 2010 level and the DJIA is 17.2 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
Jul 13	0.0	14.0	0.2	11.9
Jul 20	0.4	14.4	0.4	12.4
Jul 27	2.0	16.7	1.7	14.3
Aug 3	0.2	16.9	0.4	14.8
Aug 10	0.9	17.9	1.1	16.0
Aug 17	0.5	18.5	0.9	17.0
Aug 24	-0.9	17.4	-0.5	16.4
Aug 31	-0.5	16.8	-0.3	16.0
Sep 7	1.6	18.8	2.2	18.6
Sep 14	2.2	21.3	1.90	20.9
Sep 21	-0.1	21.2	-0.4	20.5
Sep 28	-1.0	19.9	-1.3	18.9
Oct 5	1.3	21.5	1.4	20.5
Oct 12	-2.1	18.9	-2.2	17.9
Oct 19	0.1	19.1	0.3	18.3
Oct 26	-1.8	17.0	-1.5	16.5
Nov 2	-0.1	16.9	0.2	16.7
Nov 9	-2.1	14.4	-2.4	13.8
Nov 16	-1.8	12.3	-1.4	12.2
Nov 23	3.3	16.1	3.6	16.3
Nov 30	0.1	16.2	0.5	16.8
Dec 7	1.0	17.4	0.1	17.0
Dec 14	-0.2	17.2	-0.3	16.6

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, 2011 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 19.1 percent to ZAR 8.6171/USD on Dec 14, 2012, which is still 25.6 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 9.5 percent stronger at SGD 1.2193/USD on Dec 14, 2012 relative to the trough of depreciation but still stronger by 21.5 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 20.1 percent relative to the trough to BRL 2.0867/USD on Dec 14, 2012 but still stronger by 14.1 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 for nine consecutive meeting (http://www.bcb.gov.br/?INTEREST) of its monetary policy committee, COPOM, but made no changes in its most recent meeting (http://www.bcb.gov.br/textonoticia.asp?codigo=3694&IDPAI=NEWS):

“Copom maintains the Selic rate at 7.25 percent

28/11/2012 8:07:00 PM

Brasília - The Copom unanimously decided to maintain the Selic rate to 7.25 percent.”

The Selic rate has been lowered from 12.50 percent on Jul 20, 2011 to 7.25 percent on Oct 11, 2012 (http://www.bcb.gov.br/?INTEREST). 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	Dec 14, 2012	∆% T Dec 14, 2012	∆% P Dec 14, 2012
EUR USD	7/15 2008	6/7 2010		12/14/ 2012
Rate	1.59	1.192		1.3162
∆%			-33.4		9.4	-20.8
JPY USD	8/18 2008	9/15 2010		12/14/ 2012
Rate	110.19	83.07		83.51
∆%			24.6		-0.5	24.2
CHF USD	11/21 2008	12/8 2009		12/14/ 2012
Rate	1.225	1.025		0.9179
∆%			16.3		10.4	25.1
USD GBP	7/15 2008	1/2/ 2009		12/14/ 2012
Rate	2.006	1.388		1.6171
∆%			-44.5		14.2	-24.1
USD AUD	7/15 2008	10/27 2008		12/14/ 2012
Rate	1.0215	1.6639		1.0565
∆%			-62.9		43.1	7.3
ZAR USD	10/22 2008	8/15 2010		12/14/ 2012
Rate	11.578	7.238		8.6171
∆%			37.5		-19.1	25.6
SGD USD	3/3 2009	8/9 2010		12/14/ 2012
Rate	1.553	1.348		1.2193
∆%			13.2		9.5	21.5
HKD USD	8/15 2008	12/14 2009		12/14/ 2012
Rate	7.813	7.752		7.7502
∆%			0.8		0.0	0.8
BRL USD	12/5 2008	4/30 2010		12/14/ 2012
Rate	2.43	1.737		2.0867
∆%			28.5		-20.1	14.1
CZK USD	2/13 2009	8/6 2010		12/14/ 2012
Rate	22.19	18.693		19.167
∆%			15.7		-2.5	13.6
SEK USD	3/4 2009	8/9 2010		12/14/ 2012
Rate	9.313	7.108		6.6774
∆%			23.7		6.1	27.2
CNY USD	7/20 2005	7/15 2008		12/14/ 2012
Rate	8.2765	6.8211		6.2460
∆%			17.6		8.4	24.5

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

There are major ongoing and unresolved realignments of exchange rates in the international financial system as countries and regions seek parities that can optimize their productive structures. Seeking exchange rate parity or exchange rate optimizing internal economic activities is complex in a world of unconventional monetary policy of zero interest rates and even negative nominal interest rates of government obligations such as yield of 0.01 percent for the two-year government bond of Germany. Regulation, trade and devaluation conflicts should have been expected from a global recession (Pelaez and Pelaez (2007), The Global Recession Risk, Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008a)): “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” (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 181). Chart VI-2 of the Board of Governors of the Federal Reserve System provides the key exchange rate of US dollars (USD) per euro (EUR) from Jan 4, 1999 to Dec 7, 2012. US recession dates are in shaded areas. The rate on Jan 4, 1999 was USD 1.1812/EUR, declining to USD 0.8279/EUR on Oct 25, 2000, or appreciation of the USD by 29.9 percent. The rate depreciated 21.9 percent to USD 1.0098/EUR on Jul 22, 2002. There was sharp devaluation of the USD of 34.9 percent to USD 1.3625/EUR on Dec 27, 2004 largely because of the 1 percent interest rate between Jun 2003 and Jun 2004 together with a form of quantitative easing by suspension of auctions of the 30-year Treasury, which was equivalent to withdrawing supply from markets. Another depreciation of 17.5 percent took the rate to USD 1.6010/EUR on Apr 22, 2008, already inside the shaded area of the global recession. The flight to the USD and obligations of the US Treasury appreciated the dollar by 22.3 percent to USD 1.2446/EUR on Oct 27, 2008. In the return of the carry trade after stress tests showed sound US bank balance sheets, the rate depreciated 21.2 percent to USD 1.5085/EUR on Nov 25, 2009. The sovereign debt crisis of Europe in the spring of 2010 caused sharp appreciation of 20.7 percent to USD 1.1959/EUR on Jun 6, 2010. Renewed risk appetite depreciated the rate 24.4 percent to USD 1.4875/EUR on May 3, 2011. The rate appreciated 13.0 percent to USD 1.2942/EUR on Dec 7, 2012, which is the last point in Chart VI-2. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-2, US Dollars (USD) per Euro (EUR), Jan 4, 1999 to Dec 7, 2012

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

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

Chart VI-3 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-3, 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-4 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-4, 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

Chart VI-5 of the Board of Governors of the Federal Reserve System provides the rate of Japanese yen (JPY) per US dollar (USD) from Jan 1971 to Dec 2012. The first data point on the extreme left is JPY 358.0200/USD for Jan 1971. The JPY has appreciated over the long term relative to the USD with fluctuations along an evident long-term appreciation. Before the global recession, the JPY stood at JPY 124.0900/USD on Jun 22, 2007. The use of the JPY as safe haven is evident by sharp appreciation during the global recession to JPY 110.48/USD on Aug 15, 2008, and to JPY 87.8000/USD on Jan 21, 2009. The final data point in Chart VI-5 is JPY 82.2320/USD in Dec 2012 for appreciation of 33.7 percent relative to JPY 124.0900/USD on Jun 22, 2007 before the global recession and expansion characterized by recurring bouts of risk aversion. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-5, Japanese Yen JPY per US Dollars USD, Monthly, Jan 1971-Dec 2012

Note: US Recessions in Shaded Areas 

Source: Board of Governors of the Federal Reserve System

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

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 

Zero interest rates in the United States forever tend to depreciate the dollar against every other currency if there is no risk aversion preventing portfolio rebalancing toward risk financial assets, which include the capital markets and exchange rates of emerging-market economies. The objective of unconventional monetary policy as argued by Yellen 2011AS) is to devalue the dollar to increase net exports that increase US economic growth. Increasing net exports and internal economic activity in the US is equivalent to decreasing net exports and internal economic activity in other countries.

Continental territory, rich endowment of natural resources, investment in human capital, teaching and research universities, motivated labor force and entrepreneurial initiative provide Brazil with comparative advantages in multiple economic opportunities. Exchange rate parity is critical in achieving Brazil’s potential but is difficult in a world of zero interest rates. Chart IV-6 of the Board of Governors of the Federal Reserve System provides the rate of Brazilian real (BRL) per US dollar (USD) from BRL 1.2074/USD on Jan 4, 1999 to BRL 2.0800/USD on Dec 7, 2012. The rate reached BRL 3.9450/USD on Oct 10, 2002 appreciating 60.5 percent to BRL 1.5580/USD on Aug 1, 2008. The rate depreciated 68.1 percent to BRL 2.6187/USD on Dec 5, 2008 during worldwide flight from risk. The rate appreciated again by 41.3 percent to BRL 1.5375/USD on Jul 26, 2011. The final data point in Chart VI-6 is BRL 2.0800/USD on Dec 7, 2012 for depreciation of 35.3 percent. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-6, Brazilian Real (BRL) per US Dollar (USD) Jan 4, 1999 to Dec 7, 2012

Note: US Recessions in Shaded Areas 

Source: Board of Governors of the Federal Reserve System

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

Chart VI-7 of the Board of Governors of the Federal Reserve System provides the history of the BRL beginning with the first data point of BRL 0.8440/USD on Jan 2, 1995. The rate jumped to BRL 2.0700/USD on Jan 29, 1999 after changes in exchange rate policy and then to BRL 2.2000/USD on Mar 3, 1999. The rate depreciated 26.7 percent to BRL 2.7880/USD on Sep 21, 2001 relative to Mar 3, 1999.

Chart VI-7, Brazilian Real (BRL) per US Dollar (USD), Jan 2, 1995 to Dec 7, 2012

Note: US Recessions in Shaded Areas 

Source: Board of Governors of the Federal Reserve System

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

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 1.704 percent at the close of market on Fri Dec 14, 2012 would be equivalent to price of 108.4351 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price gain of 7.1 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 last row of Table VI-7. The price loss between Sep 7, 2012 and Sep 14, 2012 would have been 1.7 percent in just five trading days. 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 72.6 percent of GDP in 2012 (Section I 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 (see Table IB-2 http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html). On Dec 12, 2012, the line “Reserve Bank credit” in the Fed balance sheet stood at $2899 billion, or $2.9 trillion, with portfolio of long-term securities of $2658 billion, or $2.6 trillion, consisting of $1575 billion Treasury nominal notes and bonds, $75 billion of notes and bonds inflation-indexed, $79 billion Federal agency debt securities and $929 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $1548 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
07/13/12	1.49	110.5086	9.1
07/20/12	1.459	110.8127	9.4
07/27/12	1.544	109.9812	8.6
08/03/12	1.569	109.7380	8.4
08/10/12	1.658	108.8771	7.5
08/17/12	1.814	107.3864	6.1
08/24/12	1.684	108.6270	7.3
08/31/12	1.543	109.9910	8.6
9/7/12	1.668	108.7808	7.4
9/14/12	1.863	106.9230	5.6
9/21/12	1.753	107.9666	6.6
9/28/12	1.631	109.1375	7.8
10/05/12	1.737	108.1193	6.8
10/12/12	1.663	108.8290	7.5
10/19/12	1.766	107.8426	6.5
10/26/12	1.748	108.0143	6.7
11/02/12	1.715	108.3297	7.0
11/09/12	1.614	109.3018	7.9
11/16/12	1.584	109.5924	8.2
11/23/12	1.691	108.5598	7.2
11/30/12	1.612	109.3211	7.9
12/7/12	1.625	109.1954	7.8
12/14/12	1.704	108.4351	7.1

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

Table VI-7A provides the maturity distribution and average length in months of marketable interest-bearing debt held by private investors from 2007 to Jun 2012. Total debt increased from $3635 billion in 2007 to $8793 billion in Jun 2012 or increase by 141.9 percent. There are two concerns with the maturity distribution of US debt. (1) Growth of debt is moving total debt to the point of saturation in investors’ portfolio. In a new environment of risk appetite and nonzero fed funds rates with economic growth at historical trend of around 3 percent, yields on risk financial assets are likely to increase. Placement of new debt may require increasing interest rates in an environment of continuing placement of debt by the US Treasury without strong fiscal constraints. (2) Refinancing of maturing debt is likely to occur in an environment of higher interest rates, exerting pressure on future fiscal budgets. In Jun 2012, $2808 billion or 31.9 percent of outstanding debt held by investors matures in less than a year and $3668 billion or 41.7 percent of total debt matures in one to five years. Debt maturing in five years or less adds to $6476 billion or 73.7 percent of total outstanding debt held by investors of $8793 billion. This historical episode may be remembered as one in which the US managed its government debt with short-dated instruments during record low long-dated yields and on the verge of fiscal pressures on all interest rates, which kind of maximizes over time interest payments on government debt by taxpayers that is precisely the opposite of the objective of sound debt management and taxpayer welfare.

Table VI-7A, Maturity Distribution and Average Length in Months of Marketable Interest-Bearing Public Debt Held by Private Investors, Billions of Dollars

End of Fiscal Year or Month	2007	2008	2009	2010	2011	Jun 2012
Total*	3635	4745	6229	7676	7951	8793
<1 Year	1176	2042	2605	2480	2504	2808
1-5 Years	1310	1468	2075	2956	3085	3668
5-10 Years	678	719	995	1529	1544	1502
10-20 Years	292	352	351	341	309	285
>20 Years	178	163	204	371	510	529
Average Months	58	49	49	57	60	56

*Amount Outstanding Privately Held

Source: United States Treasury. 2012Sep. Treasury Bulletin. Washington, DC, Sep 2012.

https://www.fms.treas.gov/bulletin/index.html

Chart VI-8 of the Board of Governors of the Federal Reserve System provides the yield of the ten-year constant maturity Treasury from Jan 3, 1977 to Dec 13, 2012. The yield stood at 7.67 percent on Feb 16, 1977. A peak was reached at 15.21 percent on Oct 26, 1981 during the inflation control effort by the Fed. There is a second local peak in Chart VI-8 on May 3, 1984 at 13.94 percent followed by another local peak at 8.14 percent on Nov 21, 1994 during another inflation control effort (see Appendix I The Great Inflation). There was sharp reduction of the yields from 5.44 percent on Apr 1, 2002 until they reached a low point of 3.13 percent on Jun 13, 2003. Yields rose again to 4.89 percent on Jun 14, 2004 and 5.23 percent on Jul 5, 2006. Yields declined sharply during the financial crisis, reaching 2.08 percent on Dec 18, 2008, lowered by higher prices originating in sharply increasing demand in the flight to the US dollar and obligations of the US government. Yields rose again to 4.01 percent on Apr 5, 2010 but collapsed to 2.41 percent on Oct 8, 2010 because of higher demand originating in the flight from the European sovereign risk event. During higher risk appetite, yields rose to 3.75 percent on Feb 8, 2011 and collapsed to 1.74 percent on Dec 13, 2012, which is the last data point in Chart VI-8. There has been a trend of decline of yields with oscillations. During periods of risk aversion investors seek protection in obligations of the US government, causing decline in their yields. In an eventual resolution of international financial risks with higher economic growth there could be the trauma of rising yields with significant capital losses in portfolios of government securities. The data in Table VI-7 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-8, US, Ten-Year Treasury Constant Maturity Yield, Jan 3, 1977 to Dec 13, 2012

Note: US Recessions in Shaded Areas 

Source: Board of Governors of the Federal Reserve System

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

Chart VI-9 of the Board of Governors of the Federal Reserve System provides securities held outright by Federal Reserve banks from 2002 to 2012. The first data point in Chart VI-9 is the level for Dec 18, 2002 of $629,407 million and the final data point in Chart VI-9 is level of $2,668,891 million on Dec 12, 2012.

Chart VI-9, US, Securities Held Outright by Federal Reserve Banks, Wednesday Level, Dec 18, 2002 to Dec 12, 2012, USD Millions

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/monetarypolicy/bst_fedsbalancesheet.htm

VII Economic Indicators. Crude oil input in refineries increased 1.3 percent to 15,215 thousand barrels per day on average in the four weeks ending on Dec 7, 2012 from 15,026 thousand barrels per day in the four weeks ending on Nov 30, 2012, as shown in Table VII-1. The rate of capacity utilization in refineries continues at a relatively high level of 89.2 percent on Dec 7, 2012, which is higher than 85.7 percent on Dec 9, 2011 and marginally higher than 88.2 percent on Nov 30, 2012. Imports of crude oil increased 2.0 percent from 7,955 thousand barrels per day on average in the four weeks ending on Nov 30 to 8,112 thousand barrels per day in the week of Dec 7. The Energy Information Administration (EIA) informs that “US crude oil imports averaged 8.5 million barrels per day last week, up by 269 thousand barrels per day from the previous week [Nov 30]” (http://www.eia.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/pdf/highlights.pdf). Marginally higher utilization in refineries with increasing imports at the margin in the prior week resulted in increase of commercial crude oil stocks by 0.8 million barrels from 371.8 million barrels on Nov 30 to 372.6 million barrels on Dec 7. Motor gasoline production decreased 0.5 percent to 9,006 thousand barrels per day in the week of Dec 7 from 9,005 thousand barrels per day on average in the week of Nov 30. Gasoline stocks increased 5.0 million barrels and stocks of fuel oil increased 3.0 million barrels. Supply of gasoline decreased from 8,650 thousand barrels per day on Dec 9, 2011, to 8,542 thousand barrels per day on Dec, 7, 2012, or by 1.2 percent, while fuel oil supply decreased 0.7 percent. Part of the fall in consumption of gasoline has been due to high prices and part to the growth recession. WTI crude oil price traded at $85.45/barrel on Dec 7, 2012, decreasing 14.0 percent relative to $99.40/barrel on Dec 9, 2011. Gasoline prices increased 1.9 percent from Dec 12, 2011 to Dec 10, 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	12/7/12	11/30/12	12/9/11
Crude Oil Refineries Input	15,215 Week       ∆%: +1.3	15,026	14,816
Refinery Capacity Utilization %	89.2	88.2	85.7
Motor Gasoline Production	9,006 Week      ∆%: -0.5	9,055	9,332
Distillate Fuel Oil Production	4,710 Week     ∆%: +1.0%	4,662	4,902
Crude Oil Imports	8,112 Week       ∆%: +2.0	7,955	8,749
Motor Gasoline Supplied	8,542 ∆% 2012/2011= -1.2%	8,647	8,650
Distillate Fuel Oil Supplied	3,771 ∆% 2012/2011 = -0.7%	3,922	3,796
	12/7/12	11/30/12	12/9/11
Crude Oil Stocks Million B	372.6  ∆=   +0.8 MB	371.8	334.2
Motor Gasoline Million B	217.1 ∆= +5.0 MB	212.1	218.8
Distillate Fuel Oil Million B	118.1 ∆= +3.0 MB	115.1	141.5
WTI Crude Oil Price $/B	85.45 ∆% 2012/2011 -14.0	88.54	99.40
	12/10/12	12/3/12	12/12/11
Regular Motor Gasoline $/G	3.349 ∆% 2012/2011 1.9	3.394	3.286

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 alternating with declines.

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 of the US Energy Information Administration (EIA) provides distillate fuel oil stocks from 2011 to 2012. There was sharp downward trend from 2011 into 2012 followed by fluctuating upward trend.

Chart VII-2, US, 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 at $145.29/barrel on Jul 3, 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 followed by some recovery.

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 29,000 from 372,000 on Dec 1, 2012, to 343,000 on Dec 8. Claims not adjusted for seasonality decreased 72,117 from 500,931 on Dec 1, 2012 to 428,814 on Dec 8, 2012. Strong seasonality is preventing clear analysis of labor markets and data incorporate effects of hurricane Sandy.

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

	SA	NSA	4-week MA SA
Dec 8, 2012	343,000	428,814	381,500
Dec 1, 2012	372,000	500,931	408,500
Change	-29,000	-72,117	-27,000
Nov 24, 2012	395,000	358,869	405,750
Prior Year	371,000	435,863	386,000

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

Source: http://www.dol.gov/opa/media/press/eta/ui/current.htm#.UM0ibuRZWwZ

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 673,097 on Dec 5, 2009 to 528,793 on Dec 3, 2011, and 428,814 on Dec 8, 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 weeks of Jun 9, 2012 and Jul 7, 2012. Hiring has not recovered (Section I and earlier http://cmpassocregulationblog.blogspot.com/2012/11/recovery-without-hiring-united-states.html) and there is continuing unemployment and underemployment of 28.6 million or 17.7 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html).

Table VII-3, US, Unemployment Insurance Weekly Claims

	Not Seasonally Adjusted Claims	Seasonally Adjusted Claims
Dec 8, 2001	491,836	393,000
Dec 7, 2002	547,430	425,000
Dec 6, 2003	486,202	367,000
Dec 4, 2004	473,570	343,000
Dec 3, 2005	444,600	321,000
Dec 9, 2006	384,123	311,000
Dec 8, 2007	423,130	332,000
Dec 6, 2008	760,481	567,000
Dec 5, 2009	673,097	494,000
Dec 4, 2010	585,711	427,000
Dec 3, 2011	528,793	383,000
Dec 8, 2012	428,814	343,000

Source: http://www.ows.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 three months Sep-Nov 2012, CPI inflation for all items seasonally adjusted was 1.6 percent in annual equivalent, obtained by compounding inflation in Sep-Nov 2012 and assuming it would be repeated for a full year. In the 12 months ending in Nov, CPI inflation of all items not seasonally adjusted was 1.8 percent. Inflation in Nov 2012 seasonally adjusted was minus 0.3 percent relative to Oct 2012, or minus 3.5 percent annual equivalent (http://www.bls.gov/cpi/). The second row provides the same measurements for the CPI of all items excluding food and energy: 1.9 percent in 12 months and 1.6 percent in annual equivalent Sep-Nov 2012. The Wall Street Journal provides the yield curve of US Treasury securities (http://professional.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3000). The lowest yield is 0.030 percent for three months, 0.096 percent for six months, 0.132 percent for 12 months, 0.250 percent for two years, 0.342 percent for three years, 0.691 percent for five years, 1.132 percent for seven years, 1.708 percent for ten years and 2.866 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 the Wall Street Journal, and the rate of inflation expected in the term of the security, which could behave as in Table VIII-1. Oct inflation is low in 12 months 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 Nov 2012/Nov 2011 NSA	∆% Annual Equivalent Sep-Nov 2012 SA
CPI All Items	1.8	1.6
CPI ex Food and Energy	1.9	1.6

Source: http://www.bls.gov/cpi/

IX Conclusion. Lucas (2011May) estimates US economic growth in the long-term at 3 percent per year and about 2 percent per year in per capita terms. There are displacements from this trend caused by events such as wars and recessions but the economy then returns to trend. Historical US GDP data exhibit remarkable growth: Lucas (2011May) estimates an increase of US real income per person by a factor of 12 in the period from 1870 to 2010. The explanation by Lucas (2011May) of this remarkable growth experience is that government provided stability and education while elements of “free-market capitalism” were an important driver of long-term growth and prosperity. The analysis is sharpened by comparison with the long-term growth experience of G7 countries (US, UK, France, Germany, Canada, Italy and Japan) and Spain from 1870 to 2010. Countries benefitted from “common civilization” and “technology” to “catch up” with the early growth leaders of the US and UK, eventually growing at a faster rate. Significant part of this catch up occurred after World War II. Lucas (2011May) finds that the catch up stalled in the 1970s. The analysis of Lucas (2011May) is that the 20-40 percent gap that developed originated in differences in relative taxation and regulation that discouraged savings and work incentives in comparison with the US. A larger welfare and regulatory state, according to Lucas (2011May), could be the cause of the 20-40 percent gap. Cobet and Wilson (2002) provide estimates of output per hour and unit labor costs in national currency and US dollars for the US, Japan and Germany from 1950 to 2000 (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). The average yearly rate of productivity change from 1950 to 2000 was 2.9 percent in the US, 6.3 percent for Japan and 4.7 percent for Germany while unit labor costs in USD increased at 2.6 percent in the US, 4.7 percent in Japan and 4.3 percent in Germany. From 1995 to 2000, output per hour increased at the average yearly rate of 4.6 percent in the US, 3.9 percent in Japan and 2.6 percent in Germany while unit labor costs in USD fell at minus 0.7 percent in the US, 4.3 percent in Japan and 7.5 percent in Germany. There was increase in productivity growth in Japan and France within the G7 in the second half of the 1990s but significantly lower than the acceleration of 1.3 percentage points per year in the US. Long-term economic growth and prosperity are measured by the key indicators of growth of real income per capita, or what is earned per person after inflation. A refined concept would include real disposable income per capita, or what is earned per person after inflation and taxes.

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 13 quarters of the current cyclical expansion from IIIQ2009 to IIIQ2012, GDP increased 7.4 percent at the annual equivalent rate of 2.2 percent. In the 12 quarters of cyclical expansion real disposable personal income (RDPI) increased 5.4 percent at the annual equivalent rate of 1.6 percent; RDPI per capita increased 3.0 percent at the annual equivalent rate of 1.0 percent; and population increased 2.3 percent at the annual equivalent rate of 0.7 percent. Third, since the beginning of the recession in IVQ2007 to IIIQ2012, GDP increased 2.2 percent, or barely above the level before the recession. Since the beginning of the recession in IVQ2007 to IIIQ2012, real disposable personal income increased 3.4 percent at the annual equivalent rate of 0.7 percent; population increased 3.9 percent at the annual equivalent rate of 0.8 percent; and real disposable personal income per capita is 0.5 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. Bordo (2012 Sep27) and Bordo and Haubrich (2012DR) provide strong evidence that recoveries have been faster after deeper recessions and recessions with financial crises, casting serious doubts on the conventional explanation of weak growth during the current expansion allegedly because of the depth of the contraction from IVQ2007 to IIQ2009 of 4.7 percent and the financial crisis.

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 IIIQ2012	13
GDP		7.4	2.2
RDPI		5.4	1.6
RDPI per Capita		3.0	0.9
Population		2.3	0.7
IVQ2007 to IIIQ2012	20
GDP		2.2	0.4
RDPI		3.4	0.7
RDPI per Capita		-0.5
Population		3.9	0.8

RDPI: Real Disposable Personal Income

Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm

There are seven basic facts illustrating the current economic disaster of the United States: (1) GDP maintained trend growth in the entire business cycle from IQ1980 to IV1985, including contractions and expansions, but is well below trend in the entire business cycle from IVQ2007 to IIQ2012, including contractions and expansions; (2) per capita real disposable income exceeded trend growth in the 1980s but is substantially below trend in IIQ2012; (3) the number of employed persons increased in the 1980s but declined into IIQ2012; (4) the number of full-time employed persons increased in the 1980s but declined into IIIQ2012; (5) the number unemployed, unemployment rate and number employed part-time for economic reasons fell in the recovery from the recessions of the 1980s but not substantially in the recovery after IIQ2009; (6) wealth of households and nonprofit organizations soared in the 1980s but declined into IIQ2012; and (7) gross private domestic investment increased sharply from IQ1980 to IVQ1985 but gross private domestic investment and private fixed investment have fallen sharply from IVQ2007 to IIIQ2007. There is a critical issue of whether the United States economy will be able in the future to attain again the level of activity and prosperity of projected trend growth. Growth at trend during the entire business cycles built the largest economy in the world but there may be an adverse, permanent weakness in United States economic performance and prosperity. Table IX-2 provides data for analysis of these five basic facts. The six blocks of Table IX-2 are separated initially after individual discussion of each one followed by the full Table IX-2.

1. Trend Growth.

i. As shown in Table IX-2, actual GDP grew cumulatively 17.7 percent from IQ1980 to IVQ1985, which is relatively close to what trend growth would have been at 18.5 percent. Rapid growth at 5.7 percent annual rate on average per quarter during the expansion from IQ1983 to IVQ1985 erased the loss of GDP of 4.8 percent during the contraction and maintained trend growth at 3 percent over the entire cycle.

ii. In contrast, cumulative growth from IVQ2007 to IIIQ2012 was 2.3 percent while trend growth would have been 15.1 percent. GDP in IIIQ2012 at seasonally adjusted annual rate is estimated at $13,638.1 by the Bureau of Economic Analysis (BEA) (http://www.bea.gov/iTable/index_nipa.cfm) and would have been $15,338.2 billion, or $1,700.1 billion higher, had the economy grown at trend over the entire business cycle as it happened during the 1980s and throughout most of US history. There is $1.7 trillion of foregone GDP that would have been created as it occurred during past cyclical expansions, which explains why employment has not rebounded to even higher than before. There would not be recovery of full employment even with growth of 3 percent per year beginning immediately because the opportunity was lost to grow faster during the expansion from IIIQ2009 to IIIQ2012 after the recession from IVQ2007 to IIQ2009. The United States has acquired a heavy social burden of unemployment and underemployment of 28.1 million people or 17.4 percent of the effective labor force (Section I, Table I-4 http://cmpassocregulationblog.blogspot.com/2012/11/twenty-eight-million-unemployed-or.html) that will not be significantly diminished even with return to growth of GDP of 3 percent per year because of growth of the labor force by new entrants. The US labor force grew from 142.583 million in 2000 to 153.124 million in 2007 or by 7.4 percent at the average yearly rate of 1.0 percent per year. The civilian noninstitutional population increased from 212.577 million in 2000 to 231.867 million in 2007 or 9.1 percent at the average yearly rate of 1.3 percent per year (data from http://www.bls.gov/data/). Data for the past five years cloud accuracy because of the number of people discouraged from seeking employment. The noninstitutional population of the United States increased from 231.867 million in 2007 to 239.618 million in 2011 or by 3.3 percent while the labor force increased from 153.124 million in 2007 to 153.617 million in 2011 or by 0.3 percent (data from http://www.bls.gov/data/). People ceased to seek jobs because they do not believe that there is a job available for them (http://cmpassocregulationblog.blogspot.com/2012/11/twenty-eight-million-unemployed-or.html ).

Period IQ1980 to IVQ1985
GDP SAAR USD Billions
IQ1980	5,903.4
IVQ1985	6,950.0
∆% IQ1980 to IVQ1985	17.7
∆% Trend Growth IQ1980 to IVQ1985	18.5

Period IVQ2007 to IIIQ2012
GDP SAAR USD Billions
IVQ2007	13,326.0
IIIQ2012	13,638.1
∆% IVQ2007 to IIIQ2012 Actual	2.3
∆% IVQ2007 to IIIQ2012 Trend	15.1

2. Decline of Per Capita Real Disposable Income

i. In the entire business cycle from IQ1980 to IVQ1985, as shown in Table IX-2 trend growth of per capita real disposable income, or what is left per person after inflation and taxes, grew cumulatively 14.5 percent, which is close to what would have been trend growth of 12.1 percent.

ii. In contrast, in the entire business cycle from IVQ2007 to IIIQ2012, per capita real disposable income fell 0.5 percent while trend growth would have been 10.4 percent. Income available after inflation and taxes is lower than before the contraction after 13 consecutive quarters of GDP growth at mediocre rates relative to those prevailing during historical cyclical expansions.

Period IQ1980 to IVQ1985

Real Disposable Personal Income per Capita IQ1980 Chained 2005 USD	18,938
Real Disposable Personal Income per Capita IVQ1985 Chained 2005 USD	21,687
∆% IQ1980 to IVQ1985	14.5
∆% Trend Growth	12.1

Period IVQ2007 to IIIQ2012

Real Disposable Personal Income per Capita IVQ2007 Chained 2005USD	32,837
Real Disposable Personal Income per Capita IIIQ2012 Chained 2005 USD	32,686
∆% IVQ2007 to IIIQ2012	-0.5
∆% Trend Growth	10.4

3. Number of Employed Persons

i. As shown in Table IX-2, the number of employed persons increased over the entire business cycle from 98.527 million not seasonally adjusted (NSA) in IQ1980 to 107.819 million NSA in IVQ1985 or by 9.4 percent.

ii. In contrast, during the entire business cycle the number employed fell from 146.334 million in IVQ2007 to 143.202 million in IIIQ2012 or by 2.1 percent. There are 28.1 million persons unemployed or underemployed, which is 17.4 percent of the effective labor force (Section I, Table I-4 http://cmpassocregulationblog.blogspot.com/2012/11/twenty-eight-million-unemployed-or.html).

Period IQ1980 to IVQ1985

Employed Millions IQ1980 NSA End of Quarter	98.527
Employed Millions IV1985 NSA End of Quarter	107.819
∆% Employed IQ1980 to IV1985	9.4

Period IVQ2007 to IIIQ2012

Employed Millions IVQ2007 NSA End of Quarter	146.334
Employed Millions IIIQ2012 NSA End of Quarter	143.333
∆% Employed IVQ2007 to IIIQ2012	-2.1

4. Number of Full-Time Employed Persons

i. As shown in Table IX-2, during the entire business cycle in the 1980s, including contractions and expansion, the number of employed full-time rose from 81.280 million NSA in IQ1980 to 88.757 million NSA in IVQ1985 or 9.2 percent.

ii. In contrast, during the entire current business cycle, including contraction and expansion, the number of persons employed full-time fell from 121.042 million in IVQ2007 to 115.678 million in IIIQ2012 or by minus 4.4 percent.

Period IQ1980 to IVQ1985

Employed Full-time Millions IQ1980 NSA End of Quarter	81.280
Employed Full-time Millions IV1985 NSA End of Quarter	88.757
∆% Full-time Employed IQ1980 to IV1985	9.2

Period IVQ2007 to IIIQ2012

Employed Full-time Millions IVQ2007 NSA End of Quarter	121.042
Employed Full-time Millions IIIQ2012 NSA End of Quarter	115.678
∆% Full-time Employed IVQ2007 to IIIQ2012	-4.4

5. Unemployed, Unemployment Rate and Employed Part-time for Economic Reasons.

i. As shown in Table IX-2 and in the following block, in the cycle from IQ1980 to IVQ1985: (a) the rate of unemployment was virtually the same at 6.7 percent in IQ1985 relative to 6.6 percent in IQ1980; (b) the number unemployed increased from 6.983 million in IQ1980 to 7.717 million in IVQ1985 or 10.5 percent; and (c) the number employed part-time for economic reasons increased 49.1 percent from 3.624 million in IQ1980 to 5.402 million in IVQ1985.

ii. In contrast, in the economic cycle from IVQ2007 to IIIQ2012: (a) the rate of unemployment increased from 4.8 percent in IVQ2007 to 7.6 percent in IIIQ2012; (b) the number unemployed increased 59.3 percent from 7.371 million in IVQ2007 to 11.742 million in IIIQ2012; (c) the number employed part-time for economic reasons increased 70.7 percent from 4.750 million in IVQ2007 to 8.110 million in IIIQ2012; and (d) U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA increased from 8.7 percent in IVQ2007 to 14.2 percent in IIIQ2012.

Period IQ1980 to IVQ1985

Unemployment Rate IQ1980 NSA End of Quarter	6.6
Unemployment Rate  IV1985 NSA End of Quarter	6.7
Unemployed IQ1980 Millions End of Quarter	6.983
Unemployed IV 1985 Millions End of Quarter	7.717
Employed Part-time Economic Reasons Millions IQ1980 End of Quarter	3.624
Employed Part-time Economic Reasons Millions IVQ1985 End of Quarter	5.402
∆%	49.1

Period IVQ2007 to IIIQ2012

Unemployment Rate IVQ2007 NSA End of Quarter	4.8
Unemployment Rate IIIQ2012 NSA End of Quarter	7.6
Unemployed IVQ2007 Millions End of Quarter	7.371
Unemployed IIIQ2009 Millions End of Quarter	11.742
∆%	59.3
Employed Part-time Economic Reasons IVQ2007 Millions End of Quarter	4.750
Employed Part-time Economic Reasons Millions IIIQ2009 End of Quarter	8.110
∆%	70.7
U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA
IVQ2007	8.7
IIIQ2012	14.2

6. Wealth of Households and Nonprofit Organizations.

i. The comparison of net worth of households and nonprofit organizations in the entire economic cycle from IQ1980 (and also from IVQ1979) to IVQ1985 and from IVQ2007 to IIQ2012 is provided in the following block and in Table IX-2. Net worth of households and nonprofit organizations increased from $8,326.4 billion in IVQ1979 to $14,395.2 billion in IVQ1985 or 72.9 percent or 69.3 percent from $8,502.9 billion in IQ1980. The starting quarter does not bias the results. The US consumer price index not seasonally adjusted increased from 76.7 in Dec 1979 to 109.3 in Dec 1985 or 42.5 percent or 36.5 percent from 80.1 in Mar 1980 (using consumer price index data from the US Bureau of Labor Statistics at http://www.bls.gov/cpi/data.htm). In terms of purchasing power measured by the consumer price index, real wealth of households and nonprofit organizations increased 21.3 percent in constant purchasing power from IVQ1979 to IVQ1985 or 24.0 percent from IQ1980.

ii. In contrast, as shown in Table IX-2, net worth of households and nonprofit organizations fell from $66,000.6 billion in IVQ2007 to $64,768.8 billion in IIIQ2012 by $1,231.8 billion or 1.9 percent. The US consumer price index was 210.036 in Dec 2007 and 231.407 in Sep 2012 for increase of 10.2 percent. In purchasing power of Dec 2007, wealth of households and nonprofit organizations is lower by 10.9 percent in Sep 2012 after 13 consecutive quarters of expansion from IIIQ2009 to IIIQ2012 relative to IVQ2007 when the recession began. The explanation is partly in the sharp decline of wealth of households and nonprofit organizations and partly in the mediocre growth rates of the cyclical expansion beginning in IIIQ2009. The average growth rate from IIIQ2009 to IIQ2012 has been 2.2 percent, which is substantially lower than the average of 6.2 percent in cyclical expansions after World War II and 5.7 percent in the expansion from IQ1983 to IVQ1985. The US missed the opportunity of high growth rates that has been available in past cyclical expansions. US wealth of households and nonprofit organizations grew from IVQ1945 at $710,125.9 million to IIIQ2009 at $64,768,835.3 million or increase of 9,020.8 percent. The consumer price index not seasonally adjusted was 18.2 in Dec 1945 jumping to 231.407 in Sep 2012 or 1,171.5 percent. There was a gigantic increase of US net worth of households and nonprofit organizations over 67 years with inflation adjusted increase of 617.3 percent. The combination of collapse of values of real estate and financial assets during the global recession of IVQ2007 to IIQ2009 caused sharp contraction of US household and nonprofit net worth. Recovery has been in stop-and-go fashion during the worst cyclical expansion in the 67 years when US GDP grew at 2.2 percent on average in 13 quarters between IIIQ2009 and IIIQ2012 in contrast with average 5.7 percent from IQ1983 to IVQ1985 and average 6.2 percent during cyclical expansions in those 67 years (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html).

Period IQ1980 to IVQ1985
Net Worth of Households and Nonprofit Organizations USD Billions
IVQ1979	8,326.4
IVQ1985	14,395.2
∆ USD Billions	+6,068.8
Period IVQ2007 to IIQ2012
Net Worth of Households and Nonprofit Organizations USD Billions
IVQ2007	66,000.6
IIQ2012	64,768.8
∆ USD Billions	-1,231.8

7. Gross Private Domestic Investment.

i. The comparison of gross private domestic investment in the entire economic cycles from IQ1980 to IV1985 and from IVQ2007 to IIQ2012 is provides in the following block and in Table IX-2. Gross private domestic investment increased from $778.3 billion in IQ1980 to $965.9 billion in IVQ1985 or by 24.1 percent.

ii In the current cycle, gross private domestic investment decreased from $2,123.6 billion in IVQ2007 to $1,929.3 billion in IIIQ2012, or decline by 9.1 percent. Private fixed investment fell from $2,111.5 billion in IVQ2007 to $1843.9 billion in IIIQ2012, or decline by 12.7 percent.

Period IQ1980 to IVQ1985
Gross Private Domestic Investment USD 2005 Billions
IQ1980	778.3
IVQ1985	965.9
∆%	24.1
Period IVQ2007 to IIIQ2012
Gross Private Domestic Investment USD Billions
IVQ2007	2,123.6
IIIQ2012	1,929.3
∆%	-9.1
Private Fixed Investment USD 2005 Billions
IVQ2007	2,111.5
IIIQ2012	1,843.9
∆%	-12.7

Table IX-2, US, GDP and Real Disposable Personal Income per Capita Actual and Trend Growth and Employment, 1980-1985 and 2007-2012, SAAR USD Billions, Millions of Persons and ∆%

Period IQ1980 to IVQ1985
GDP SAAR USD Billions
IQ1980	5,903.4
IVQ1985	6,950.0
∆% IQ1980 to IVQ1985	17.7
∆% Trend Growth IQ1980 to IVQ1985	18.5
Real Disposable Personal Income per Capita IQ1980 Chained 2005 USD	18,938
Real Disposable Personal Income per Capita IVQ1985 Chained 2005 USD	21,687
∆% IQ1980 to IVQ1985	14.5
∆% Trend Growth	12.1
Employed Millions IQ1980 NSA End of Quarter	98.527
Employed Millions IV1985 NSA End of Quarter	107.819
∆% Employed IQ1980 to IV1985	9.4
Employed Full-time Millions IQ1980 NSA End of Quarter	81.280
Employed Full-time Millions IV1985 NSA End of Quarter	88.757
∆% Full-time Employed IQ1980 to IV1985	9.2
Unemployment Rate IQ1980 NSA End of Quarter	6.6
Unemployment Rate  IV1985 NSA End of Quarter	6.7
Unemployed IQ1980 Millions NSA End of Quarter	6.983
Unemployed IV 1985 Millions NSA End of Quarter	7.717
∆%	11.9
Employed Part-time Economic Reasons IVQ2007 Millions NSA End of Quarter	4.750
Employed Part-time Economic Reasons Millions IIQ2009 NSA End of Quarter	8.394
∆%	76.7
Net Worth of Households and Nonprofit Organizations USD Billions
IVQ1979	8,326.4
IVQ1985	14,395.2
∆ USD Billions	+6,068.8
Gross Private Domestic Investment USD 2005 Billions
IQ1980	778.3
IVQ1985	965.9
∆%	24.1
Period IVQ2007 to IIIQ2012
GDP SAAR USD Billions
IVQ2007	13,326.0
IIIQ2012	13,638.1
∆% IVQ2007 to IIIQ2012	2.3
∆% IVQ2007 to IIIQ2012 Trend Growth	15.1
Real Disposable Personal Income per Capita IVQ2007 Chained 2005USD	32,837
Real Disposable Personal Income per Capita IIIQ2012 Chained 2005 USD	32,686
∆% IVQ2007 to IIIQ2012	-0.5
∆% Trend Growth	10.4
Employed Millions IVQ2007 NSA End of Quarter	146.334
Employed Millions IIIQ2012 NSA End of Quarter	143.333
∆% Employed IVQ2007 to IIIQ2012	-2.1
Employed Full-time Millions IVQ2007 NSA End of Quarter	121.042
Employed Full-time Millions IIIQ2012 NSA End of Quarter	115.678
∆% Full-time Employed IVQ2007 to IIIQ2012	-4.4
Unemployment Rate IVQ2007 NSA End of Quarter	4.8
Unemployment Rate IIIQ2012 NSA End of Quarter	7.6
Unemployed IVQ2007 Millions NSA End of Quarter	7.371
Unemployed IIIQ2009 Millions NSA End of Quarter	11.742
∆%	59.3
Employed Part-time Economic Reasons IVQ2007 Millions NSA End of Quarter	4.750
Employed Part-time Economic Reasons Millions IIIQ2012 NSA End of Quarter	8.110
∆%	70.7
U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA
IVQ2007	8.7
IIIQ2012	14.2
Net Worth of Households and Nonprofit Organizations USD Billions
IVQ2007	66,000.6
IIQ2012	64,768.8
∆ USD Billions	-1,231.8
Gross Private Domestic Investment USD Billions
IVQ2007	2,123.6
IIIQ2012	1,929.3
∆%	-9.1
Private Fixed Investment USD 2005 Billions
IVQ2007	2,111.5
IIIQ2012	1,843.9
∆%	-12.7

Note: GDP trend growth used is 3.0 percent per year and GDP per capita is 2.0 percent per year as estimated by Lucas (2011May) on data from 1870 to 2010.

Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm US Bureau of Labor Statistics http://www.bls.gov/data/. Board of Governors of the Federal Reserve System. 2012Sep20. Flow of funds accounts of the United States. Washington, DC, Federal Reserve System.

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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