Recovery without Hiring, World Inflation Waves, Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation, Peaking Valuation of Risk Financial Assets, World Financial Turbulence and Economic Slowdown with Global Recession Risk: III

 

Recovery without Hiring, World Inflation Waves, Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation, Peaking Valuation of Risk Financial Assets, World Financial Turbulence and Economic Slowdown with Global Recession Risk

Carlos M. Pelaez

© Carlos M. Pelaez, 2010, 2011, 2012, 2013

Executive Summary

I Recovery without Hiring

IA1 Hiring Collapse

IA2 Labor Underutilization

IA3 Ten Million Fewer Full-time Jobs

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 Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation

III World Financial Turbulence

IIIA Financial Risks

IIIE Appendix Euro Zone Survival Risk

IIIF Appendix on Sovereign Bond Valuation

IV Global Inflation

V World Economic Slowdown

VA United States

VB Japan

VC China

VD Euro Area

VE Germany

VF France

VG Italy

VH United Kingdom

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

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

VC China. China estimates an index of nonmanufacturing purchasing managers on the basis of a sample of 1200 nonmanufacturing enterprises across the country (http://www.stats.gov.cn/english/pressrelease/t20121009_402841094.htm). Table CIPMNM provides this index and components from Jan to No 2012. The index fell from 58.0 in Mar to 55.2 in May but climbed to 56.7 in Jun, which is lower than 58.0 in Mar and 57.3 in Feb but higher than in any other of the months in 2012. In Jul 2012 the index fell marginally to 55.6 and then to 56.3 in Aug and 53.7 in Sep but rebounded to 55.5 in Oct and 55.6 in Nov 2012.

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

2012	Total Index	New Orders	Interm. Input Prices	Subs Prices	Exp
Nov	55.6	53.2	52.5	48.4	64.6
Oct	55.5	51.6	58.1	50.5	63.4
Sep	53.7	51.8	57.5	51.3	60.9
Aug	56.3	52.7	57.6	51.2	63.2
Jul	55.6	53.2	49.7	48.7	63.9
Jun	56.7	53.7	52.1	48.6	65.5
May	55.2	52.5	53.6	48.5	65.4
Apr	56.1	52.7	57.9	50.3	66.1
Mar	58.0	53.5	60.2	52.0	66.6
Feb	57.3	52.7	59.0	51.2	63.8
Jan	55.7	52.2	58.2	51.1	65.3

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

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/

Chart CIPMNM provides China’s nonmanufacturing purchasing managers’ index from Nov 2011 to Nov 2012. There was slowing of the general index in Apr 2012 after the increase in Jan-Mar 2012 and further decline to 55.2 in May 2012 but increase to 56.7 in Jun 2012 with marginal decline to 55.6 in Jul 2012 and 56.3 in Aug 2012 and sharper drop to 53.7 in Sep 2012, rebounding to 55.5 in Oct 2012 and 55.6 in Nov 2012.

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

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/

Table CIPMMFG provides the index of purchasing managers of manufacturing seasonally adjusted of the National Bureau of Statistics of China. The general index (IPM) rose from 50.5 in Jan 2012 to 53.3 in Apr and declined to 50.1 in Jul and to the contraction zone at 49.2 in Aug and 49.8 in Sep, climbing above 50.0 to 50.2 in Oct and 50.6 in Nov. The index of new orders (NOI) fell from 54.5 in Apr 2012 to 49.0 in Jul and 48.7 in Aug, climbing above 50.0 to 51.2 in Nov 2012. The index of employment also fell from 51.0 in Apr to 49.1 in Aug and further down to 48.7 in Nov 2012.

Table CIPMMFG, China, Manufacturing Index of Purchasing Managers, %, Seasonally Adjusted

2012	IPM	PI	NOI	INV	EMP	SDEL
Nov	50.6	52.5	51.2	47.9	48.7	49.9
Oct	50.2	52.1	50.4	47.3	49.2	50.1
Sep	49.8	51.3	49.8	47.0	48.9	49.5
Aug	49.2	50.9	48.7	45.1	49.1	50.0
Jul	50.1	51.8	49.0	48.5	49.5	49.0
Jun	50.2	52.0	49.2	48.2	49.7	49.1
May	50.4	52.9	49.8	45.1	50.5	49.0
Apr	53.3	57.2	54.5	48.5	51.0	49.6
Mar	53.1	55.2	55.1	49.5	51.0	48.9
Feb	51.0	53.8	51.0	48.8	49.5	50.3
Jan	50.5	53.6	50.4	49.7	47.1	49.7

IPM: Index of Purchasing Managers; PI: Production Index; NOI: New Orders Index; EMP: Employed Person Index; SDEL: Supplier Delivery Time Index

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/

China estimates the manufacturing index of purchasing managers on the basis of a sample of 820 enterprises (http://www.stats.gov.cn/english/pressrelease/t20121009_402841094.htm). Chart CIPMMFG provides the manufacturing index of purchasing managers from Nov 2011 to Nov 2012. There is deceleration from 51.2 in Sep 2011 to marginal contraction at 49.0 in Nov 2011. Manufacturing activity recovered to 53.3 in Apr 2012 but then declined to 50.4 in May 2012 and 50.1 in Jun 2012, which is the lowest in a year with exception of contraction at 49.0 in Nov 2011. The index then fell to contraction at 49.2 in Aug 2012 and improved to 49.8 in Sep with movement to 50.2 in Oct 2012 and 50.6 in Nov 2012 above the neutral zone of 50.0.

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

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/

Cumulative growth of China’s GDP in the four quarters of 2012 relative to the same period in 2011 was 7.8 percent, as shown in Table VC-GDP. Secondary industry accounts for 45.3 percent of GDP of which industry alone for 40.1 percent in the first three quarters of 2012 and construction with the remaining 6.7 percent in the first three quarters of 2012. Tertiary industry accounts for 43.8 percent of GDP in the first three quarters of 2012 and primary industry for 9.4 percent in the first three quarters of 2012. China’s growth strategy consisted of rapid increases in productivity in industry to absorb population from agriculture where incomes are lower (Pelaez and Pelaez, The Global Recession Risk (2007), 56-80). The bottom block of Table VC-GDP provides quarter-on-quarter growth rates of GDP and their annual equivalent. China’s GDP growth decelerated significantly from annual equivalent 9.9 percent in IIIQ2011 to 7.0 percent in IVQ2011 and 6.1 percent in IQ2012, rebounding to 8.2 percent in IIQ2012, 9.1 percent in IIIQ2012 and 8.2 percent in IVQ2012.

Table VC-GDP, China, Cumulative and Quarterly Growth of GDP, Current CNY 100 Million and Inflation Adjusted ∆%

Cumulative GDP 2012	Value Current CNY Billion	2012 Year-on-Year ∆%
GDP	51,932.2	7.8
Primary Industry	5,237.7	4.5
Farming IIIQ	33,088.0	4.2
Secondary Industry	23,531.9	8.1
Industry IIIQ	141,641.5	7.9
Construction IIIQ	23,787.0	9.2
Tertiary Industry	23,162.6	8.1
Transport, Storage, Post IIIQ	18,941.0	6.7
Wholesale, Retail Trades IIIQ	31,651.2	11.8
Hotel & Catering Services IIIQ	7,015.6	7.6
Financial Intermediation IIIQ	22,465.2	9.5
Real Estate IIIQ	20,789.6	2.7
Other IIIQ	54,101.0	7.7
Growth in Quarter Relative to Prior Quarter	∆% on Prior Quarter	∆% Annual Equivalent
2012
IVQ2012	2.0	8.2
IIIQ2012	2.2	9.1
IIQ2012	2.0	8.2
IQ2012	1.5	6.1
2011
IVQ2011	1.7	7.0
IIIQ2011	2.4	9.9
IIQ2011	2.5	10.4
IQ2011	2.2	9.1

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Table VC-GDPb provides growth of GDP in China relative to a year earlier and relative to prior quarter. Growth of GDP relative to a year earlier decelerated from 12.1 percent in IQ2010 to 7.4 percent in IIIQ2012 and 7.9 percent in IVQ2012. Growth of secondary industry decelerated from 14.5 percent in IQ2010 to 7.4 percent in IIIQ2012 and 7.9 percent in IVQ2012.

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

	IQ 2011	IIQ 2011	IIIQ 2011	IVQ 2011	IQ     2012	IIQ 2012	IIIQ 2012	IVQ 2012
GDP	9.7	9.5	9.1	8.9	8.1	7.6	7.4	7.9
Primary Industry	3.5	3.2	3.8	4.5	3.8	4.3	4.2	4.5
Secondary Industry	11.1	11.0	10.8	10.6	9.1	8.3	8.1	8.1
Tertiary Industry	9.1	9.2	9.0	8.9	7.5	7.7	7.9	8.1
GDP ∆% Relative to a Prior Quarter	2.2	2.3	2.4	1.9	1.8	1.8	2.2	2.0
	IQ 2010	IIQ 2010	IIIQ 2010	IVQ 2010
GDP	12.1	11.2	10.7	12.1
Primary Industry	3.8	3.6	4.0	3.8
Secondary Industry	14.5	13.3	12.6	14.5
Tertiary Industry	10.5	9.9	9.7	10.5

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

The HSBC Flash China Manufacturing Purchasing Managers’ Index^™ (PMI^™) compiled by Markit ((http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10452) is improving. The overall Flash China Manufacturing PMI^™ increased marginally from 50.5 in Nov to 50.9 in Dec for a fourteen-month high while the Flash China Manufacturing Output Index decreased from 51.3 in Nov to 50.5 in Dec, both in expansion territory above 50.0. Hongbin Qu, Chief Economist, China and Co-Head of Asian Economic Research at HSBC, finds that the economy of China is improving because of internal demand while still requiring further easing policy (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10452).The HSBC China Services PMI^™, compiled by Markit, shows marginally improving business activity in China with the HSBC Composite Output, combining manufacturing and services, increasing from 51.6 in Nov to 51.8 in Dec for the fourth consecutive month of increasing output (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10556). Hongbin Qu, Chief Economist, China and Co-Head of Asian Economic Research at HSBC, finds that combined manufacturing and services data suggest growth of 8 percent in IVQ2012 GDP relative to a year earlier (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10556). The HSBC Business Activity index decreased from 52.1 in Nov to 51.7 in Dec with continuing growth in services at a slower rate (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10556). Hongbin Ku, Chief Economist, China & Co-Head of Asian Economic Research at HSBC, finds strength in services from new orders and growth of employment (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10556). The HSBC Purchasing Managers’ Index^™ (PMI^™), compiled by Markit, increased to 51.5 in Dec from 50.5 in Nov, indicating moderate activity, which is the highest reading since May 2011 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10489). Weak export orders were attributed to weakness in Europe, Japan and the US. Hongbin Qu, Chief Economist, China and Co-Head of Asian Economic Research at HSBC, finds gradual improvement of the economy of China with reduction of stocks and continuing government stimulus that is consistent with probable growth of GDP at 8.6 percent in 2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10489).

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

Table CNY, China, Economic Indicators

Price Indexes for Industry	Dec 12-month ∆%: minus 1.9 Dec month ∆%: minus 0.1 Blog 1/13/13
Consumer Price Index	Dec month ∆%: 0.8 Dec 12 months ∆%: 2.5 Blog 1/13/13
Value Added of Industry	Dec month ∆%: 0.87 Jan-Dec 2012/Jan-Dec 2011 ∆%: 10.0 Blog 1/20/13
GDP Growth Rate	Year IVQ2012 ∆%: 7.9 Quarter IIQ2012 ∆%: 2.0 Blog 1/20/13
Investment in Fixed Assets	Dec month ∆%: 1.24 Total Jan-Dec 2012 ∆%: 20.6 Real estate development: 16.2 Blog 1/20/13
Retail Sales	Dec month ∆%: 1.53 Dec 12 month ∆%: 15.2 Jan-Dec ∆%: 14.3 Blog 1/20/13
Trade Balance	Dec balance $31.67 billion Exports 12M ∆% 14.1 Imports 12M ∆% 6.0 Cumulative Dec: $231.1 billion Blog 1/13/13

Links to blog comments in Table CNY:

1/13/13 http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html

Cumulative growth of China’s GDP in the four quarters of 2012 relative to the same period in 2011 was 7.8 percent, as shown in Table VC-1. Secondary industry accounts for 45.3 percent of GDP of which industry alone for 40.1 percent in the first three quarters of 2012 and construction with the remaining 6.7 percent in the first three quarters of 2012. Tertiary industry accounts for 43.8 percent of GDP in the first three quarters of 2012 and primary industry for 9.4 percent in the first three quarters of 2012. China’s growth strategy consisted of rapid increases in productivity in industry to absorb population from agriculture where incomes are lower (Pelaez and Pelaez, The Global Recession Risk (2007), 56-80). The bottom block of Table VC-1 provides quarter-on-quarter growth rates of GDP and their annual equivalent. China’s GDP growth decelerated significantly from annual equivalent 9.9 percent in IIIQ2011 to 7.0 percent in IVQ2011 and 6.1 percent in IQ2012, rebounding to 8.2 percent in IIQ2012, 9.1 percent in IIIQ2012 and 82 percent in IVQ2012.

Table VC-1, China, Cumulative and Quarterly Growth of GDP, Current CNY 100 Million and Inflation Adjusted ∆%

Cumulative GDP 2012	Value Current CNY Billion	2012 Year-on-Year ∆%
GDP	51,932.2	7.8
Primary Industry	5,237.7	4.5
Farming IIIQ	33,088.0	4.2
Secondary Industry	23,531.9	8.1
Industry IIIQ	141,641.5	7.9
Construction IIIQ	23,787.0	9.2
Tertiary Industry	23,162.6	8.1
Transport, Storage, Post IIIQ	18,941.0	6.7
Wholesale, Retail Trades IIIQ	31,651.2	11.8
Hotel & Catering Services IIIQ	7,015.6	7.6
Financial Intermediation IIIQ	22,465.2	9.5
Real Estate IIIQ	20,789.6	2.7
Other IIIQ	54,101.0	7.7
Growth in Quarter Relative to Prior Quarter	∆% on Prior Quarter	∆% Annual Equivalent
2012
IVQ2012	2.0	8.2
IIIQ2012	2.2	9.1
IIQ2012	2.0	8.2
IQ2012	1.5	6.1
2011
IVQ2011	1.7	7.0
IIIQ2011	2.4	9.9
IIQ2011	2.5	10.4
IQ2011	2.2	9.1

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Table VC-2 provides growth of GDP in China relative to a year earlier and relative to prior quarter. Growth of GDP relative to a year earlier decelerated from 12.1 percent in IQ2010 to 7.4 percent in IIIQ2012 and 7.9 percent in IVQ2012. Growth of secondary industry decelerated from 14.5 percent in IQ2010 to 7.4 percent in IIIQ2012 and 7.9 percent in IVQ2012.

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

	IQ 2011	IIQ 2011	IIIQ 2011	IVQ 2011	IQ     2012	IIQ 2012	IIIQ 2012	IVQ 2012
GDP	9.7	9.5	9.1	8.9	8.1	7.6	7.4	7.9
Primary Industry	3.5	3.2	3.8	4.5	3.8	4.3	4.2	4.5
Secondary Industry	11.1	11.0	10.8	10.6	9.1	8.3	8.1	8.1
Tertiary Industry	9.1	9.2	9.0	8.9	7.5	7.7	7.9	8.1
GDP ∆% Relative to a Prior Quarter	2.2	2.3	2.4	1.9	1.8	1.8	2.2	2.0
	IQ 2010	IIQ 2010	IIIQ 2010	IVQ 2010
GDP	12.1	11.2	10.7	12.1
Primary Industry	3.8	3.6	4.0	3.8
Secondary Industry	14.5	13.3	12.6	14.5
Tertiary Industry	10.5	9.9	9.7	10.5

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Cumulative and 12-months rates of value added of industry in China are provided in Table VC-3. Value added in total industry in Jan-Dec 2012 increased 10.0 percent relative to a year earlier and 10.3 percent in the 12 months ending in Dec 2012. Heavy industry had been the driver of growth with a cumulative rate of 11.0 percent relative to a year earlier in Jan-Mar 2012 that declined to 10.5 percent in Jan-Apr 2012 relative to the same period a year earlier and further down to 10.1 percent in Jan-Jun 2012, 9.9 percent in Jan-Jul 2012, 9.8 percent in Jan-Aug 2012, 9.7 percent in Jan-Sep 2012, 9.7 percent in Jan-Oct 2012, 9.8 percent in Jan-Nov 2012 and 9.9 percent in Jan-Dec 2012. Light industry grew 10.1 percent in Jan-Dec 2012 relative to a year earlier and 9.6 percent in 12 months ending in Dec 2012. Growth of total industry decelerated from cumulative 14.4 percent in Jan-Mar 2011 to 10.0 percent in Jan-Dec 2012.

Table VC-3, China, Growth Rate of Value Added of Industry ∆%

	Industry	Light Industry	Heavy Industry	State Owned	Private
2012
Jan-Dec 2012	10.0	10.1	9.9	6.4	11.8
12 M Dec	10.3	9.6	10.6	8.0	12.1
Jan-Nov	10.0	10.2	9.8	6.3	11.8
12 M Nov	10.1	9.2	10.5	7.2	11.8
Jan-Oct	10.0	10.3	9.7	6.4	11.8
12 M Oct	9.6	9.1	9.7	7.0	11.7
Jan-Sep	10.0	10.4	9.7	6.3	11.8
12 M  Sep	9.2	9.0	9.3	6.3	11.0
Jan-Aug	10.1	10.5	9.8	6.3	15.4
12 M Aug	8.9	8.6	9.0	5.3	14.3
Jan-Jul	10.3	10.8	9.9	6.6	12.1
12 M Jul	9.2	10.1	8.8	4.8	10.9
Jan-Jun	10.5	11.1	10.1	7.0	12.4
12 M Jun	9.5	9.0	9.6	6.5	11.5
Jan-May	10.7	11.5	10.3	6.7	12.4
12 M May	9.6	9.1	9.8	6.6	11.0
Jan-Apr	11.0	12.3	10.5	6.6	12.9
12 M Apr	9.3	10.3	8.9	4.3	10.7
Jan-Mar	11.6	13.2	11.0	7.2	13.8
12 M Mar	11.9	13.9	11.2	8.0	13.7
Jan-Feb	11.4	12.7	10.9	7.3	13.9
2011
Jan-Dec	13.9	13.0	14.3	9.9	15.8
12 M Dec	12.8	12.6	13.0	9.2	14.7
Jan-Nov	14.0	13.0	14.4	9.9	16.0
12 M Nov	12.4	12.4	12.4	7.8	14.4
Jan-Oct	14.1	13.0	14.5	10.1	9.1
12 M Oct	13.2	12.1	13.7	8.9	15.1
Jan-Sep	14.2	13.1	14.6	10.4	16.1
12 M Sep	13.8	12.8	14.3	9.9	16.0
Jan-Aug	14.2	13.1	14.6	10.4	16.1
12 M Aug	13.5	13.4	13.5	9.4	15.5
Jan-Jul	14.3
12 M Jul	14.0	12.8	14.5	9.5
Jan-Jun	14.3	13.1	14.7	10.7	19.7
12 M Jun	15.1	13.9	15.6	10.7	20.8
Jan-May	14.0	12.9	14.4	10.7	19.3
12 M May	13.3	12.9	13.5	8.9	18.7
Jan-Apr	14.2	12.9	14.7	11.2	19.5
12 M Apr	13.4	11.9	14.0	10.4	18.0
Jan-Mar	14.4	13.1	14.9	11.4	19.8
12 M Mar	14.8	12.8	15.6	12.9	19.2
12 M Feb	14.9	13.1	15.6	10.5	21.7
Jan-Feb	14.1	13.3	14.4	10.6	20.3

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/

Chart VC-1 provides 12-month percentage changes of value added of industry in 2011 and from Jan to Dec 2012. Growth rates of value added of industry in the first five months of 2010 were higher than in 2011 as would be expected in an earlier phase of recovery from the global recession. Growth rates have converged in the second half of 2011 to lower percentages with further decline into 2012 to single digit percentage changes and 10.3 percent in Dec 2012.

Chart VC-1, China, Growth Rate of Total Value Added of Industry, 12-Month ∆%

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/

Yearly rates of growth for the past 12 months and cumulative relative to the earlier year of various segments of industrial production in China are provided in Table VC-4. Rates from Jan to Dec 2011 relative to the same period a year earlier fluctuated but remained mostly above 10 percent with the exception of motor vehicles and crude oil. There is deceleration in Jan-Dec 2012 of percentage change with no segment showing growth exceeding 10 percent with exception of 12-month growth of 13.5 percent for pig iron and 16.7 percent for nonferrous metals. Electricity fell from growth of 16.2 percent in the 12 months ending in Jun 2011 to 0.0 percent in the 12 months ending in Jun 2012, rebounding to 4.8 percent in Aug 2012 but declining to 1.5 percent in Sep 2012, increasing to 3.9 percent in Oct 2012, 7.9 percent in Nov 2012 and 7.6 percent in Dec 2012.

Table VC-4, China, Industrial Production Operation ∆%

	Elec- tricity	Pig Iron	Cement	Crude Oil	Non- ferrous Metals	Autos
2012
Jan-Dec	4.7	7.7	7.4	3.7	9.3	6.3
12 M Dec	7.6	13.5	5.4	8.4	16.7	5.3
Jan-Nov	4.4	7.2	7.5	3.2	8.4	6.5
12 M Nov	7.9	16.5	9.4	9.1	15.2	3.9
Jan-Oct	3.9	6.3	6.7	2.6	7.7	6.9
12 M Oct	6.4	11.7	11.5	6.7	14.0	3.8
Jan-Sep	3.6	5.7	6.7	2.2	7.1	7.3
12 M Sep	1.5	4.9	12.0	7.0	7.1	6.3
Jan-Aug	3.8	-0.5	8.7	2.5	13.8	10.4
12 M Aug	4.8	2.6	5.9	-0.4	13.8	9.7
Jan-Jul	3.8	6.1	5.3	1.6	6.7	7.4
12M Jul	2.1	6.5	6.1	1.1	4.1	12.3
Jan-Jun	3.7	6.1	5.5	1.7	6.7	6.7
12 M Jun	0.0	6.7	6.5	-0.6	5.8	13.8
Jan-May	4.7	6.3	5.0	2.2	5.1	6.2
12 M May	2.7	6.3	4.3	0.7	6.6	18.5
Jan-Apr	5.0	6.2	5.5	2.9	4.6	3.1
12 M Apr	0.7	7.9	4.9	-0.3	2.3	10.7
Jan-Mar	7.1	6.5	7.3	3.1	5.8	0.0
12 M Mar	7.2	10.2	7.9	2.0	3.3	5.1
Jan-Feb	7.1	4.6	4.8	4.0	8.4	-1.8
2011
Jan-Dec	12.0	8.4	16.1	4.9	10.6	3.0
12 M Dec	9.7	3.7	7.0	4.0	13.2	-6.5
Jan-Nov	12.0	13.1	17.2	5.3	10.2	3.9
12 M Nov	8.5	7.8	11.2	3.2	8.2	-1.3
Jan-Oct	12.3	13.7	18.0	5.4	10.4	5.2
12 M Oct	9.3	13.4	16.5	-0.9	3.7	1.3
Jan-Sep	12.7	13.9	18.1	6.0	11.2	5.5
12 M Sep	11.5	18.8	15.7	1.5	13.9	2.5
Jan-Aug	13.0	13.1	18.4	6.6		4.7
12 M Aug	10.0	12.9	12.8	4.5	15.6	9.5
Jan-Jul	13.3	13.0	19.2	6.9	9.9	4.0
12 M Jul	13.2	14.9	16.8	5.9	9.8	-1.3
12 M Jun	16.2	14.8	19.9	-0.7	9.8	3.6
12 M May	12.1	10.6	19.2	6.0	14.2	-1.9
12 M Apr	11.7	8.3	22.4	6.8	6.1	-1.6
12 M Mar	14.8	13.7	29.8	8.0	11.6	9.9
12 M Feb	11.7	14.5	9.1	10.9	14.4	10.3
12 M Jan	5.1	3.5	16.4	12.2	1.4	23.9
12 M Dec 2010	5.6	4.6	17.3	10.3	-1.9	27.6

M: month

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Monthly growth rates of industrial production in China are provided in Table VC-5. Monthly rates have fluctuated around 1 percent. Jan and Feb 2012 are somewhat weaker but there was improvement to 1.20 percent in Mar. The rate of 0.39 percent in Apr is the lowest in the monthly series from Feb 2011 to Dec 2012. Monthly sales growth remained below 1 percent in all the first eleven months of 2012 with the exception of Mar 2012.

Table VC-5, China, Industrial Production Operation, Month ∆%

2011	Month ∆%
Feb	0.93
Mar	0.99
Apr	1.32
May	0.79
Jun	1.30
Jul	0.82
Aug	0.85
Sep	0.95
Oct	0.71
Nov	0.68
Dec	0.94
Jan 2012	0.50
Feb	0.65
Mar	1.20
Apr	0.39
May	0.92
Jun	0.81
Jul	0.74
Aug	0.78
Sep	0.86
Oct	0.85
Nov	0.88
Dec	0.87

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/english/

Table VC-6 provides cumulative growth of investment in fixed assets in China in 2011 relative to 2010 and in Jan-Dec 2012 relative to a year earlier. Total fixed investment has grown at a high rate fluctuating around 25 percent and fixed investment in real estate development has grown at rates in excess of 30 percent. In Jan-Dec 2012 investment in fixed assets in China grew 20.6 percent relative to a year earlier and 16.2 percent in real estate development. There was slight deceleration in the final two months of 2011 that continued into Jan-Dec 2012.

Table VC-6, China, Investment in Fixed Assets ∆% Relative to a Year Earlier

	Total	State	Real Estate Development
Jan-Dec 2012	20.6	14.7	16.2
Jan-Nov	20.7	14.5	16.7
Jan-Oct	20.7	14.2	16.7
Jan-Sep	20.5	13.6	15.4
Jan-Aug	20.2	12.9	15.6
Jan-Jul	20.4	12.6	15.4
Jan-Jun	20.4	13.8	16.6
Jan-May	20.1	10.0	18.5
Jan-Apr	20.2	9.5	18.7
Jan-Mar	20.9	9.0	23.5
Jan-Feb	21.5	8.8	27.8
Jan-Dec 2011	23.8	11.1	27.9
Jan-Nov	24.5	11.7	29.9
Jan-Oct	24.9	12.4	31.1
Jan-Sep	24.9	12.7	32.0
Jan-Aug	25.0	12.1	33.2
Jan-Jul	25.4	13.6	33.6
Jan-Jun	25.6	14.6	32.9
Jan-May	25.8	14.9	34.6
Jan-Apr	25.4	16.6	34.3
Jan-Mar	25.0	17.0	34.1
Jan-Feb	24.9	15.6	35.2

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Chart VC-2 provides cumulative fixed asset investment in China relative to a year earlier in all months for 2011 and 2012. Growth rose to 25.8 percent in Jan-May 2011 and then fell back to 24.9 percent in Sep and Oct 2011, declining further to 24.5 percent in Nov and 23.8 percent in Dec 2011 with deeper drop in Jan-Feb 2012 to 21.5 percent, 20.9 percent in Jan-Mar, 20.2 percent in Jan-Apr 2012, 20.1 percent in Jan-Apr 2012, 20.4 percent in both Jan-Jun 2012 and Jan-Jul 2012, 20.2 percent in Jan-Aug 2012, 20.5 percent in Jan-Sep 2012, 20.7 percent in Jan-Oct 2012, 20.7 percent in Jan-Nov 2012 and 20.6 percent in Jan-Dec 2012. All rates in 2012 are lower than in 2011,

Chart VC-2, China, Investment in Fixed Assets, ∆% Cumulative over Year Earlier

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/

Monetary policy has been used in China in the form of increases in interest rates and required reserves of banks to moderate real estate investment. These policies have been reversed because of lower inflation and weakening economic growth. Chart VC-3 shows decline of fluctuating cumulative growth rates of investment in real estate development relative to a year earlier from 35.2 percent in Jan-Feb 2011 to 31.1 percent in Jan-Oct 2011, 29.9 percent in Jan-Nov 2011, 27.9 percent in Jan-Dec 2011, 27.8 percent in Jan-Feb 2012 and sharper decline to 23.5 percent in Jan-Mar 2012, 18.7 percent in Jan-Apr 2012 and 18.5 percent in Jan-May 2012. The trend of decline continued with 16.6 percent in Jan-Jun 2012, 15.4 percent in Jan-Jul 2012, 15.6 percent in Jan-Aug 2012, 15.4 percent in Jan-Sep 2012, 16.7 percent in Jan-Oct 2012, 16.7 percent in Jan-Nov 2012 and 16.2 percent in Jan-Dec 2012.

Chart VC-3, China, Investment in Real Estate Development, ∆% Cumulative over Year Earlier

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/

Table VC-7 provides monthly growth rates of investment in fixed assets in China from Feb 2011 to Dec 2012. Growth rates moderated from Nov 2011 to May 2012. The rate of 1.20 percent in Feb 2012 is the lowest for any month after Mar 2011 but rates rebounded to 1.72 percent in May 2012, 1.47 percent in Jun, 1.37 percent in Jul 2012, 1.74 percent in Aug 2012, 1.86 percent in Sep 2012, 1.26 percent in Oct 2012, 1.53 percent in Nov 2012 and 1.24 in Dec 2012.

Table VC-7, China, Investment in Fixed Assets, Month ∆%

	Month ∆%
Feb 2011	-0.23
Mar	2.45
Apr	2.22
May	1.68
Jun	1.48
Jul	1.58
Aug	1.62
Sep	1.88
Oct	1.42
Nov	1.43
Dec	1.52
Jan 2012	1.24
Feb	1.20
Mar	1.22
Apr	1.77
May	1.72
Jun	1.47
Jul	1.37
Aug	1.74
Sep	1.86
Oct	1.26
Nov	1.53
Dec	1.24

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Growth rates of retail sales in China monthly, 12 months and cumulative relative to a year earlier are in Table VC-8. There is decline of growth rates to cumulative 14.7 percent in Feb 2012, 14.8 percent in Mar, 14.7 percent in Apr, 14.5 percent in May, 14.4 percent in Jun, 14.2 percent in Jul, 14.1 percent in Aug to Oct 2012, 14.2 percent in Nov 2012 and 14.3 percent in Dec 2012. Percentage growth rates have declined in Jan-Dec 2012 relative to earlier months in 2011.

Table VC-8, China, Total Retail Sales of Consumer Goods ∆%

	Month ∆%	12-Month ∆%	Cumulative ∆%/ Cumulative Year Earlier
2012
Dec	1.53	15.2	14.3
Nov	1.52	14.9	14.2
Oct	1.38	14.5	14.1
Sep	1.68	14.2	14.1
Aug	1.38	13.2	14.1
Jul	1.28	13.1	14.2
Jun	1.49	13.7	14.4
May	1.36	13.8	14.5
Apr	1.17	14.1	14.7
Mar	1.56	15.2	14.8
Feb	1.22	14.7	14.7
Jan	0.19
2011
Dec	1.41	18.1	17.1
Nov	1.26	17.3	17.0
Oct	1.36	17.2	17.0
Sep	1.33	17.7	17.0
Aug	1.50	17.0	16.9
Jul	1.57	17.2	16.8
Jun	1.49	17.7	16.8
May	1.39	16.9	16.6
Apr	1.30	17.1	16.5
Mar	1.26	17.4	17.4
Feb	1.35	11.6	15.8
Jan		19.9	19.9

Note: there are slight revisions of month relative to earlier month data but not of the month on the same month year earlier or cumulative relative to cumulative year earlier in the databank

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Chart VC-4 of the National Bureau of Statistics of China provides 12-month rates of growth of retail sales in 2011 and 2012. There is again a drop into 2012 with the lowest percentages in Chart VC-4 followed by increases.

Chart VC-4, China, Total Retail Sales of Consumer Goods 12-Month ∆%

Source: National Bureau of Statistics of China

http://www.stats.gov.cn/enGliSH/

Table VC-9 provides monthly percentage changes of retail sales in China. Although the rate of 0.19 percent in Jan 2012 is the lowest in Table VC-9, the rate of 1.65 percent in Sep is relatively high and 1.53 percent in Dec 2012 is closer to rates in 2011.

Table VC-9, China, Retail Sales, Month ∆%

2011	Month ∆%
Feb	1.35
Mar	1.26
Apr	1.30
May	1.39
Jun	1.49
Jul	1.57
Aug	1.50
Sep	1.33
Oct	1.36
Nov	1.26
Dec	1.41
2012
Jan	0.19
Feb	1.22
Mar	1.56
Apr	1.17
May	1.36
Jun	1.49
Jul	1.28
Aug	1.38
Sep	1.68
Oct	1.38
Nov	1.52
Dec	1.53

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

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, Unemployment and GDP ∆%

Year	HICP ∆%	Unemployment %	GDP ∆%
1999	1.2	9.6	2.9
2000	2.2	8.7	3.8
2001	2.4	8.1	2.0
2002	2.3	8.5	0.9
2003	2.1	9.0	0.7
2004	2.2	9.3	2.2
2005	2.2	9.2	1.7
2006	2.2	8.5	3.2
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	10.2	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 46.5 in Nov to 47.3 in Dec, for eleven consecutive declines and fifteen drops in sixteen months, with Oct registering the lowest reading since IIQ2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10458). Chris Williamson, Chief Economist at Markit, finds that the Markit Flash Eurozone PMI index is consistent with GDP declining even by more than contraction of 0.1 percent in IIIQ2012 but improving outlook for return to growth next year (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10458). The Markit Eurozone PMI^® Composite Output Index, combining services and manufacturing activity with close association with GDP, increased from 46.5 in Nov to 47.2 in Dec, which is the eleventh consecutive contraction; contraction spread in manufacturing and services throughout France, Italy and Spain but with growth in Germany (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10527). Chris Williamson, Chief Economist at Markit, finds that the data are consistent with sharper contraction in IVQ2012 but easing in all four of the largest economies (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10527). The Markit Eurozone Services Business Activity Index increased from 46.7 in Nov to 47.8 in Dec (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10527). The Markit Eurozone Manufacturing PMI^® decreased marginally to 46.1 in Dec from 46.2 in Nov, which indicates contraction in seventeen consecutive months of deterioration of manufacturing business in the euro zone (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10479). New export orders declined in Dec for the eighteenth consecutive month with contracting demand within the euro area and deteriorating global markets. Chris Williamson, Chief Economist at Markit, finds that the survey data are consistent with decline of output at a quarterly rate of 1 percent in IVQ2012 but milder than in the autumn (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10479). Table EUR provides the regional data table for the euro area.

Table EUR, Euro Area Economic Indicators

GDP	IIIQ2012 ∆% 0.1; IIIQ2012/IIIQ2011 ∆% 0.0 Blog 12/30/12
Unemployment	Nov 2012: 11.8% unemployment rate Nov 2012: 18.820 million unemployed Blog 1/13/13
HICP	Dec month ∆%: 0.4 12 months Dec ∆%: 2.2 Blog 1/20/13
Producer Prices	Euro Zone industrial producer prices Nov ∆%: -0.2 Nov 12-month ∆%: 2.1 Blog 1/13/13
Industrial Production	Nov month ∆%: -0.3; Nov 12 months ∆%: -3.7 Blog 1/20/13
Retail Sales	Nov month ∆%: 0.1 Nov 12 months ∆%: minus 2.6 Blog 1/13/13
Confidence and Economic Sentiment Indicator	Sentiment 87.0 Dec 2012 Consumer minus 26.5 Dec 2012 Blog 1/13/13
Trade	Jan-Nov 2012/Jan-Nov 2011 Exports ∆%: 8.3 Imports ∆%: 2.0 Nov 2012 12-month Exports ∆% 5.4 Imports ∆% -0.3 Blog 1/20/13

Links to blog comments in Table EUR:

1/13/13 http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html

12/30/12 http://cmpassocregulationblog.blogspot.com/2012/12/united-states-commercial-banks-assets.html

12/23-24/12 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html

Industrial production in the euro area decreased 0.3 percent in Nov 2012, declining in four of six months from Jun to Nov 2012 for cumulative growth of minus 2.7 percent that is equivalent to minus 5.3 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
Nov 2012	-0.3	-0.3	-1.6	0.7	-1.1	-1.2
Oct	-1.0	-0.6	-0.3	-2.9	-3.8	1.2
Sep	-2.3	-2.0	-0.2	-3.0	-3.5	-2.8
Aug	0.8	0.2	0.7	1.3	2.7	1.6
Jul	0.5	0.1	-1.4	2.2	-0.2	-0.5
Jun	-0.4	-0.5	1.9	-1.2	0.4	-0.7

Notes: INT: Intermediate; ENE: Energy; CG: Capital Goods; DUR: Durable Consumer Goods; NDUR: Nondurable Consumer Goods Source: Eurostat http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

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 0.5 percent in output of energy in the 12 months ending in Nov 2012 and 0.7 percent for capital goods in Nov 2012. Industrial production decreased 0.3 percent in the month of Nov 2012 and fell 3.7 percent in the 12 months ending in Nov 2012. Industrial production deteriorated at unusually high rates in the earlier months of Oct and Sep 2012.

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

2012	Nov Month ∆%	Nov 12-Month ∆%
Total	-0.3	-3.7
Intermediate Goods	-0.3	-4.8
Energy	-1.6	0.5
Capital Goods	0.7	-4.4
Durable Consumer Goods	-1.1	-7.7
Nondurable Consumer Goods	-1.2	-3.0

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

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 3.7 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 4.4 percent in the 12 months ending in Nov 2012.

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

	Total	INT	ENE	CG	DUR	NDUR
Nov 2012	-3.7	-4.8	0.5	-4.4	-7.7	-3.0
Oct	-3.3	-4.3	1.5	-4.2	-6.4	-2.3
Sep	-2.7	-4.5	0.2	-1.1	-3.0	-3.0
Aug	-1.2	-3.6	0.3	0.3	-2.3	0.0
Jul	-2.6	-3.9	0.6	-1.3	-9.3	-2.6
Jun	-1.9	-3.6	2.1	-0.6	-2.3	-2.2

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

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

Table VD-4 provides industrial production of member countries of the euro zone, the UK and the European Union. Twelve-month percentage changes in Nov 2012 are negative for all countries in Table VD-4 with exception of 1.1 percent for the Netherlands and 1.8 percent for Greece.

Table VD-4, Euro Zone, Industrial Production by Member Countries, ∆%

Nov 2012	Month ∆%	12-Month ∆%
Euro Zone	-0.3	-3.7
Germany	0.1	-3.0
France	0.5	-3.2
Netherlands	1.0	1.1
Finland	-0.7	-2.2
Belgium	NA	NA
Portugal	-3.4	-4.0
Ireland	-1.1	-6.6
Italy	-1.0	-7.6
Greece	-1.5	1.8
Spain	-2.5	-3.1
UK	0.3	-2.1
European Union	-0.3	-3.3

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

Euro zone trade growth continues to be relatively strong as shown in Table VD-5. Exports grew at 8.3 percent and imports at 2.0 percent in Jan-Nov 2012 relative to Jan-Nov 2011. The 12-month rate of growth of exports was 5.4 percent in Nov 2012 while imports decreased 0.3 percent. In Oct 2012, exports increased 14.1 percent in 12 months and imports increased 7.4 percent. At the margin, rates of growth of trade are declining in part because of moderation of commodity prices.

Table VD-5, Euro Zone, Exports, Imports and Trade Balance, Billions of Euros and Percent, NSA

	Exports	Imports
Jan-Nov 2012	1,724.1	1,648.6
Jan-Nov 2011	1,592.6	1,616.3
∆%	8.3	2.0
Nov 2012	164.2	150.5
Nov 2011	155.8	150.9
∆%	5.4	-0.3
Oct 2012	169.1	159.9
Oct 2011	148.2	148.9
∆%	14.1	7.4
Trade Balance	Jan-Nov 2012	Jan-Nov 2011
€ Billions	75.5	-23.7

Source: EUROSTAT http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/6-15012013-AP/EN/6-15012013-AP-EN.PDF

The structure of trade of the euro zone in Jan-Oct 2012 is provided in Table VD-6. Data are still not available for trade structure for Nov 2012. Manufactured exports increased 7.7 percent in Jan-Oct 2012 relative to Jan-Oct 2011 while imports fell 1.0 percent. The trade surplus in manufactured products was marginally higher than the trade deficit in primary products in Jan-Oct 2012 but lower in Jan-Oct 2011 largely because of the commodity shock caused by carry trades.

Table VD-6, Euro Zone, Structure of Exports, Imports and Trade Balance, € Billions, NSA, ∆%

	Primary	Manufactured	Other	Total
Exports
Jan-Oct 2012 € B	245.0	1,271.0	43.9	1,559.9
Jan-Oct 2011 € B	217.1	1,179.7	40.0	1,436.8
∆%	12.9	7.7	9.8	8.6
Imports
Jan-Oct 2012 € B	553.1	918.0	27.1	1,498.1
Jan-Oct 2011  € B	513.5	927.7	24.2	1,465.4
∆%	7.7	-1.0	12.0	2.2
Trade Balance € B
Jan-Oct 2012	-308.1	353.0	16.9	61.8
Jan-Oct 2011	-296.4	252.0	15.8	-28.6

Source: EUROSTAT http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/6-15012013-AP/EN/6-15012013-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 49.2 in Nov to 50.5 in Dec, which is the highest reading in eight months (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10456). The pace of decline of new export orders for manufacturing was at the lowest in nine months, with some respondents finding enhanced demand in Asia and the US but continuing weakness in Europe. Tim Moore, Senior Economist at Markit and author of the report, finds growth in services compensating decline in manufacturing (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10560). 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 49.2 in Nov to 50.3 in Dec, indicating a level above the neutral zone of 50.0 after seven consecutive months below 50 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10560). 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 49.7 in Nov to 52.0 in Dec (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10560). The Markit/BME Germany Purchasing Managers’ Index^® (PMI^®), showing close association with Germany’s manufacturing conditions, decreased from 46.8 in Nov to 46.0 in Dec for the tenth consecutive month in contraction territory below 50.0 and lower than the average of 46.7 for 2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10538). New export orders fell for eighteen consecutive months with weak demand from internal and external clients. Tim Moore, Senior Economist at Markit and author of the report, finds continuing weakness in Germany’s manufacturing that cannot maintain strong performance in the beginning of the cyclical expansion (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10538).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	Dec month NSA ∆%: 0.9 Dec 12-month NSA ∆%: 2.1 Blog 1/20/12
Producer Price Index	Nov month ∆%: 0.1 CSA, -0.1 NSA 12-month NSA ∆%: 1.4 Blog 12/23-24/12
Industrial Production	Mfg Oct month CSA ∆%: 0.4 12-month NSA: minus 3.2 Blog 1/13/13
Machine Orders	MFG Nov month ∆%: -1.8 Nov 12-month ∆%: -1.0 Blog 1/13/13
Retail Sales	Nov Month ∆% 1.2 12-Month ∆% -1.0 Blog 1/6/13
Employment Report	Unemployment Rate Nov 5.3% Blog 1/6/13
Trade Balance	Exports Nov 12-month NSA ∆%: 0.0 Imports Nov 12 months NSA ∆%: -1.2 Exports Nov month CSA ∆%: -3.4; Imports Nov month SA -3.7 Blog 1/13/13

Links to blog comments in Table DE:

1/13/13 http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html

1/6/13 http://cmpassocregulationblog.blogspot.com/2013/01/thirty-million-unemployed-or.html

12/23-24/12 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.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

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 IIIQ1949 to IIIQ2012 is quite high at 3.2 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 1.9 percent in the 1990s and 1.7 percent from 2000 to 2007. The average growth rate from 2000 to 2012, using third 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*	3.2
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

*Third Quarter on Third Quarter

Source: Institut National de la Statistique et des Études Économiques http://www.insee.fr/en/themes/info-rapide.asp?id=28&date=20121228

The Markit Flash France Composite Output Index increased marginally from 44.3 in Nov to 45.0 in Dec for the highest reading in four months (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10453). Jack Kennedy, Senior Economist at Markit and author of the report, finds that the data suggest the weakest quarter in output in four years (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10453).

The Markit France Composite Output Index, combining services and manufacturing with close association with French GDP, increased marginally from 44.3 in Nov to 44.6 in Dec, indicating significant contraction of private sector activity for a tenth consecutive month at slower rate (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10552). Jack Kennedy, Senior Economist at Markit and author of the France Services PMI^®, finds that the economy performed in IVQ2012 at the slowest pace since IQ2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10552). The Markit France Services Activity index decreased from 45.8 in Nov to 45.2 in Dec (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10552). The Markit France Manufacturing Purchasing Managers’ Index^® increased marginally to 44.6 in Dec from 44.5 in Nov, remaining deeply below the neutral level of 50.0 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10535). Jack Kennedy, Senior Economist at Markit and author of the France Manufacturing PMI^®, finds continuing weakness in manufacturing with new orders because of weakness in both foreign and domestic demand (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10535). Table FR provides the country data table for France.

Table FR, France, Economic Indicators

CPI	Dec month ∆% 0.3 12 months ∆%: 1.3 1/13/13
PPI	Nov month ∆%: -0.5 Nov 12 months ∆%: 1.9 Blog 12/30/12
GDP Growth	IIIQ2012/IIQ2012 ∆%: 0.1 IIIQ2012/IIIQ2011 ∆%: 0.0 Blog 12/30/12
Industrial Production	Nov ∆%: Manufacturing 0.2 12-Month ∆%: Manufacturing minus 4.6 Blog 1/13/13
Consumer Spending	Nov Manufactured Goods ∆%: -0.2 Nov 12-Month Manufactured Goods ∆%: -1.0 Blog 12/30/12
Employment	IIIQ2012 Unemployed 2.826 million Unemployment Rate: 9.9% Employment Rate: 63.9% Blog 12/16/12
Trade Balance	Nov Exports ∆%: month -2.8, 12 months -3.4 Nov Imports ∆%: month -2.5, 12 months -3.4 Blog 1/13/13
Confidence Indicators	Historical averages 100 Dec Mfg Business Climate 89 Blog 12/30/12

Links to blog comments in Table FR:

1/13/13 http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html

12/30/12 http://cmpassocregulationblog.blogspot.com/2012/12/united-states-commercial-banks-assets.html

12/16/12 http://cmpassocregulationblog.blogspot.com/2012/12/recovery-without-hiring-forecast-growth.html

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 increased from 44.6 in Nov to 45.6 in Dec, indicating significant contraction of output of Italy’s services at a marginally lower rate for contraction during a year and a half (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10555). Phil Smith, economist at Markit and author of the Italy Services PMI^®, finds that new business fell at a faster rate (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10555). The Markit/ADACI Purchasing Managers’ Index^® (PMI^®), increased from 45.1 in Nov to 46.7 in Dec for 17 consecutive months of contraction of Italy’s manufacturing but the highest reading in nine months (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10494). Weak internal demand contributed more to contraction than foreign demand that declined only marginally. Phil Smith, economist at Markit and author of the Italian Manufacturing PMI^®, finds a more encouraging reading with softer declines in output and new orders (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10494). Table IT provides the country data table for Italy.

Table IT, Italy, Economic Indicators

Consumer Price Index	Dec month ∆%: 0.2 Dec 12-month ∆%: 2.3 Blog 1/20/13
Producer Price Index	Nov month ∆%: -0.1 Nov 12-month ∆%: 2.2 Blog 12/30/12
GDP Growth	IIIQ2012/IIQ2012 SA ∆%: minus 0.2 IIIQ2012/IIIQ2011 NSA ∆%: minus 2.4 Blog 12/16/12
Labor Report	Nov 2012 Participation rate 63.9% Employment ratio 56.8% Unemployment rate 11.1% Blog 1/13/13
Industrial Production	Nov month ∆%: minus 1.0 12 months ∆%: minus 7.6 Blog 1/20/13
Retail Sales	Oct month ∆%: -1.0 Sep 12-month ∆%: -3.8 Blog 12/23-24/12
Business Confidence	Mfg Dec 88.9, Aug 87.5 Construction Dec 79.5, Jul 81.6 Blog 12/30/12
Trade Balance	Balance Nov SA €2261 million versus Oct €1442 Exports Nov month SA ∆%: 0.4; Imports Nov month ∆%: minus 2.2 Exports 12 months Nov NSA ∆%: 3.6 Imports 12 months NSA ∆%: -8.2 Blog 1/20/13

Links to blog comments in Table IT:

1/13/13 http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html

12/30/12 http://cmpassocregulationblog.blogspot.com/2012/12/united-states-commercial-banks-assets.html

12/23-24/12 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html

12/16/12 http://cmpassocregulationblog.blogspot.com/2012/12/recovery-without-hiring-forecast-growth.html

Italy’s industrial production fell 1.0 percent in Nov 2012, pulling down the 12-month rate of growth to minus 7.6 percent and fell 1.3 percent in Sep with 12-month decline of 6.1 percent, as shown in Table VG-1. In the quarter Sep-Nov 2012, industrial production fell cumulative 3.4 percent, at the annual equivalent rate of 12.8 percent. 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-1, Italy, Industrial Production ∆% 

	Month ∆% SA	12-Month ∆% Calendar Adjusted
Nov 2012	-1.0	-7.6
Oct	-1.1	-6.1
Sep	-1.3	-5.0
Aug	1.2	-5.2
Jul	-0.4	-7.1
Jun	-1.1	-7.9
May	0.6	-6.7
Apr	-1.9	-9.3
Mar	0.4	-5.5
Feb	-1.1	-7.0
Jan	-2.1	-4.6
Dec 2011	0.5	-1.7
Nov	0.1	-4.1
Oct	-0.3	-3.8
Sep	-3.0	-2.6
Aug	1.2	4.8
Jul	-0.9	-1.2
Jun	-0.2	0.4
May	-1.5	2.1
Apr	1.4	3.9
Mar	-0.4	3.2
Feb	1.5	2.5
Jan	-0.9	0.2
Dec 2010	-0.4	6.7
Nov	0.8	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/79552

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-Nov 2012 deeper in negative territory.

Chart VG-1, Italy, Industrial Production, 12-Month Percentage Changes

Source: Istituto Nazionale di Statistica

http://www.istat.it/en

Exports and imports of Italy and monthly growth rates SA are provided in Table VG-2. There have been significant fluctuations. Seasonally-adjusted exports increased 0.4 percent in Nov 2012 while imports decreased 2.2 percent. The SA trade balance improved from surplus of €1442 million in Oct 2012 to surplus of €2261 million in Nov 2012.

Table VG-2, Italy, Exports, Imports and Trade Balance SA Million Euros and Month SA ∆%

	Exports	∆%	Imports	∆%	Balance
2010
Dec	29,676	1.5	33,596	3.1	-3,920
2011
Jan	31,091	4.8	33,829	0.7	-2,738
Feb	30,516	-1.8	33,162	-2.0	-2,646
Mar	31,115	2.0	35,116	5.9	-4,001
Apr	31,487	1.2	34,300	-2.3	-2,813
May	32,193	2.2	34,766	1.4	-2,573
Jun	31,413	-2.4	33,299	-4.2	-1,886
Jul	31,621	0.7	33,918	1.9	-2,297
Aug	31,674	0.2	34,223	0.9	-2,549
Sep	31,909	0.7	33,280	-2.8	-1,371
Oct	31,099	-2.5	32,632	-1.9	-1,533
Nov	31,593	1.6	32,989	1.1	-1,396
Dec	32,697	3.5	32,098	-2.7	599
2012
Jan	31,950	-2.3	32,430	1.0	-480
Feb	31,888	-0.2	32,425	0.0	-537
Mar	32,369	1.5	31,739	-2.1	630
Apr	32,360	0.0	32,334	1.9	26
May	32,801	1.4	32,536	0.6	265
Jun	32,350	-1.4	30,606	-5.9	1,744
Jul	32,642	0.9	31,677	3.5	965
Aug	33,501	2.6	32,637	3.0	864
Sep	32,779	-2.2	31,159	-4.5	1,620
Oct	32,750	-0.1	31,308	0.5	1,442
Nov	32,876	0.4	30,615	-2.2	2,261

Source: Istituto Nazionale di Statistica

http://www.istat.it/it/archivio/79713

Italy’s trade account not seasonally adjusted is provided in Table VG-3. Values are different because the data are original and not adjusted. Exports increased 3.6 percent in the 12 months ending in Nov 2012 while imports decreased 8.2 percent. Twelve-month rates of growth picked up again in Aug 2011 with 15.2 percent for exports and 12.6 percent for imports. In Sep 2011, exports grew 10.2 percent relative to a year earlier while imports grew only 3.6 percent. In Oct 2011, exports grew 4.5 percent while imports fell 0.2 percent. In Nov 2011, exports grew 6.5 percent in 12 months while imports grew 0.5 percent. Exports continued to growth of 7.2 percent in the 12 months ending in Aug 2012 while imports fell 2.7 percent. The actual or not seasonally adjusted trade balance deficit fell from €2948 million in Aug 2011 to surplus of €1407 million in Dec 2011 but turned into deficit of €4574 million in Jan 2012, improving to lower deficit of €1195 million in Feb 2012 and surplus of €1792 million in Mar 2012, returning to deficit of €250 million in Apr and surplus of €867 million in May. In Jun 2012, the actual surplus was €2780 million and then €4733 million in Jul 2012 which was the highest in 2012 but deteriorated to actual deficit of €483 million in Aug 2012. Exports fell 20.9 percent and imports 22.1 percent during the global recession in 2009. Growth of exports of minus 12.0 percent in the 12 months ending in Oct 2012 while imports increased 0.9 percent increased the trade surplus to €2420 million. The trade surplus was €2363 million in Nov 2012 with growth of exports of 3.6 percent in 12 months in Nov while imports fell 8.2 percent.

Table VG-3, Italy, Exports, Imports and Trade Balance NSA Million Euros and 12 Month ∆%

	Exports	12-M ∆%	Imports	12-M ∆%	Balance
Annual
2009	291,733	-20.9	297,609	-22.1	-5,876
2010	337,346	15.6	367,390	23.4	-30,044
2011	375,904	11.4	401,428	9.3	-25,524
Monthly
2010
Dec	29,714	20.2	32,732	31.7	-3,018
2011
Jan	26,163	24.7	32,552	28.8	-6,389
Feb	29,625	17.8	32,682	16.4	-3,057
Mar	34,340	13.8	38,527	20.9	-4,187
Apr	31,079	12.6	33,969	18.4	-2,890
May	33,545	19.9	35,853	18.8	-2,308
Jun	32,649	8.1	34,481	2.1	-1,832
Jul	35,327	6.0	34,058	7.1	1,269
Aug	24,245	15.2	27,193	12.6	-2,948
Sep	32,996	10.2	34,886	3.6	-1,890
Oct	32,131	4.5	33,245	-0.2	-1,114
Nov	32,440	6.5	34,025	0.5	-1,585
Dec	31,364	5.6	29,957	-8.5	1,407
2012
Jan	27,429	4.8	32,003	-1.7	-4,574
Feb	31,787	7.3	32,982	0.9	-1,195
Mar	36,070	5.0	34,278	-11.0	1,792
Apr	30,510	-1.8	30,760	-9.4	-250
May	35,132	4.7	34,265	-4.4	867
Jun	34,358	5.2	31,578	-8.4	2,780
Jul	37,019	4.8	32,286	-5.2	4,733
Aug	25,979	7.2	26,462	-2.7	-483
Sep	31,602	-4.2	31,193	-10.6	409
Oct	35,997	12.0	33,577	1.0	2,420
Nov	33,593	3.6	31,229	-8.2	2,363

Source: Istituto Nazionale di Statistica

http://www.istat.it/it/archivio/79713

Growth rates of Italy’s trade and major products are provided in Table VG-4 for the period Jan-Nov 2012 relative to Jan-Nov 2011. Growth rates in 12 months of imports are negative with the exception of 7.9 percent for energy. The higher rate of growth of exports of 4.3 percent in Jan-Nov 2012/Jan-Nov 2011 relative to imports of minus 5.6 percent may reflect weak demand in Italy with GDP declining during five consecutive quarters from IIIQ2011 through IIIQ2012.

Table VG-4, Italy, Exports and Imports % Share of Products in Total and ∆%

	Exports Share %	Exports ∆% Jan-Nov 2012/ Jan-Nov 2011	Imports Share %	Imports ∆% Jan-Nov 2012/ Jan-Nov 2011
Consumer Goods	28.9	5.4	25.0	-3.0
Durable	5.9	3.2	3.0	-6.7
Non Durable	23.0	6.0	22.0	-2.5
Capital Goods	32.3	2.3	21.1	-12.9
Inter- mediate Goods	34.2	2.9	34.3	-10.7
Energy	4.7	21.7	19.6	7.9
Total ex Energy	95.3	3.5	80.4	-8.9
Total	100.0	4.3	100.0	-5.6

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/79713

Table VG-5 provides Italy’s trade balance by product categories in Nov 2012 and cumulative Jan-Nov 2012. Italy’s trade balance excluding energy generated surplus of €7027 million in Nov 2012 and €67,201 million in Jan-Nov 2012 but the energy trade balance created deficit of €4664 million in Nov 2012 and €58,341 million in Jan-Nov 2012. The overall surplus in Nov 2012 was €2363 million with surplus of €8860 million in Jan-Nov 2012. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.

Table VG-5, Italy, Trade Balance by Product Categories, € Millions

	Nov 2012	Cumulative Jan-Nov 2012
Consumer Goods	2,105	15,515
Durable	1,227	10,598
Nondurable	877	4,917
Capital Goods	4,270	44,859
Intermediate Goods	652	6,827
Energy	-4,664	-58,341
Total ex Energy	7,027	67,201
Total	2,363	8,860

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/79713

Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. That success would be assured with growth of the Italian economy. A critical problem is that the common euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surplus that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Newly available data in Table VG-6 providing Italy’s trade with regions and countries supports the argument of Caballero and Giavazzi (2012Jan15). Italy’s exports to the European Monetary Union (EMU), or euro area, are only 42.6 percent of the total. Exports to the non-European Union area with share of 44.0 percent in Italy’s total exports are growing at 9.6 percent in Jan-Nov 2012 relative to Jan-Nov 2011 while those to EMU are falling at 1.0 percent.

Table VG-6, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%

Nov 2012	Exports % Share	∆% Jan-Nov 2012/ Jan-Nov 2011	Imports % Share	Imports ∆% Jan-Nov 2012/ Jan-Nov 2011
EU	56.0	-0.1	53.7	-7.3
EMU 17	42.6	-1.0	43.4	-7.2
France	11.6	0.1	8.4	-6.4
Germany	13.1	-0.3	15.5	-11.1
Spain	5.3	-8.0	4.5	-8.0
UK	4.7	9.6	2.7	-13.4
Non EU	44.0	10.0	46.3	-3.7
Europe non EU	13.3	9.6	10.8	-1.4
USA	6.1	18.5	3.2	-1.2
China	2.7	-10.0	7.4	-16.7
OPEC	4.7	25.6	8.5	21.2
Total	100.0	4.3	100.0	-5.6

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

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/79713

Table VG-7 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €559 million with the 17 countries of the euro zone (EMU 17) in Nov 2012 and deficit of €2194 million in Jan-Nov 2012. Depreciation to parity could permit greater competitiveness in improving the trade surpluses of €10,857 million in Jan-Nov 2012 with Europe non European Union and of €12,716 million with the US and in reducing the deficit with non European Union of €1251 million in Jan-Nov 2012. There is significant rigidity in the trade deficits in Jan-Nov of €15,005 million with China and €18,209 million with members of the Organization of Petroleum Exporting Countries (OPEC). Higher exports could drive economic growth in the economy of Italy that would permit less onerous adjustment of the country’s fiscal imbalances, raising the country’s credit rating.

Table VG-7, Italy, Trade Balance by Regions and Countries, Millions of Euro 

Regions and Countries	Trade Balance Nov 2012 Millions of Euro	Trade Balance Cumulative Jan-Nov 2012 Millions of Euro
EU	508	10,111
EMU 17	-559	-2,194
France	1,074	11,262
Germany	-632	-5,472
Spain	193	1,514
UK	842	8,841
Non EU	1,855	-1,251
Europe non EU	1,320	10,857
USA	1,325	12,716
China	-838	-15,005
OPEC	-1,355	-18,209
Total	2,363	8,860

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

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/79713

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/quarterly-national-accounts/q3-2012/index.html

The Business Activity Index of the Markit/CIPS UK Services PMI^® decreased from 50.2 in Nov to 48.9 in Dec with interruption of growth by marginal contraction for the first time since Dec 2010 during inclement snow weather (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10559). Chris Williamson, Chief Economist at Markit, finds that combined services, manufacturing and construction survey data suggests possible contraction of UK GDP of 0.2 percent in IVQ2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10559). The Markit/CIPS UK Manufacturing Purchasing Managers’ Index^® (PMI^®) increased from 49.1 in Nov to 51.4 in Dec with the first reading above 50 after seven consecutive months of contraction (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10539). The PMI registered average 49.5 in IVQ2012, which is higher than 48.1 in IIIQ2012 and higher than the average of 49.2 for 2012. New export orders continued to fall as in all months in 2012 with weakness in the euro area that is the United Kingdom’s major export destination. Rob Dobson, Senior Economist at Markit and author of the Markit/CIPS Manufacturing PMI^®, finds that conditions improved in Dec but contraction in IVQ2012 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=10539). Table UK provides the economic indicators for the United Kingdom.

Table UK, UK Economic Indicators

CPI	Dec month ∆%: 0.5 Dec 12-month ∆%: 2.7 Blog 1/20/13
Output/Input Prices	Output Prices: Dec 12-month NSA ∆%: 2.2; excluding food, petroleum ∆%: 1.5 Input Prices: Dec 12-month NSA ∆%: 0.3 Excluding ∆%: 0.0 Blog 1/20/13
GDP Growth	IIIQ2012 prior quarter ∆% 0.9; year earlier same quarter ∆%: 0.0 Blog 12/30/12
Industrial Production	Nov 2012/Nov 2011 ∆%: Production Industries minus 2.4; Manufacturing minus 2.1 Blog 1/13/13
Retail Sales	Dec month ∆%: -0.1 Nov 12-month ∆%: 0.3 Blog 1/20/13
Labor Market	Aug-Oct Unemployment Rate: 7.8%; Claimant Count 4.8%; Earnings Growth 1.8% Blog 12/23-24/12
Trade Balance	Balance Oct minus ₤3466 million Exports Nov ∆%: 1.7; Sep-Nov ∆%: -1.0 Imports Nov ∆%: 1.0 Sep-Nov ∆%: -0.9 Blog 1/13/13

Links to blog comments in Table UK:

1/13/13 http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html

12/30/12 http://cmpassocregulationblog.blogspot.com/2012/12/united-states-commercial-banks-assets.html

12/23-24/12 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html

The volume of retail sales in the UK decreased 0.1 percent in Dec 2012 and increased 0.3 percent in the 12 months ending in Dec 2012, as shown in Table VH-1. Retail sales percentage changes in 12 months had been positive in several months since Sep 2011 with exception of decline of 2.3 percent in Apr 2012. The decline of 0.8 percent in Oct 2012 brought down the 12-month increase to 0.6 percent.

Table VH-1, UK, Volume of Retail Sales ∆%

	Month ∆%	12-Month ∆%
Dec 2012	-0.1	0.3
Nov	0.0	0.9
Oct	-0.8	0.6
Sep	0.5	2.3
Aug	-0.1	2.5
Jul	0.2	2.2
Jun	0.4	2.2
May	1.4	1.8
Apr	-2.3	-1.7
Mar	2.0	2.8
Feb	-0.6	0.6
Jan	-0.1	0.5
Dec 2011	0.5	2.5
Nov	-0.3	0.2
Oct	0.8	0.6
Sep	0.6	0.3
Aug	-0.5	-1.2
Jul	0.2	-0.9
Jun	0.0	-0.7
May	-2.1	-0.8
Apr	2.2	2.1
Mar	-0.3	0.0
Feb	-0.6	0.1
Jan	1.9	3.5
Dec 2010	-1.8	-2.2

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/rsi/retail-sales/december-2012/index.html

Retail sales in the UK struggle with relatively high inflation. Table VH-2 provides 12-month percentage changes of the implied deflator of UK retail sales. The implied deflator of all retail sales increased 0.6 percent in the 12 months ending in Dec 2012 while that of sales excluding auto fuel increased 0.8 percent. The 12-month increase of the implied deflator of auto fuel sales rose to 16.9 percent in Sep 2011, which is the highest 12-month increase in 2011, but then declined to 0.3 percent in Dec 2012. The percentage change of the implied deflator of sales of food stores at 0.8 percent in Dec 2012 that is higher than for total retail sales. Increases in fuel prices at the retail level have occurred throughout most years since 2005 with exception of the decline of 9.5 percent in 2008 when commodity carry trades were reversed in the panic of the financial crisis, as shown in Table VH-2. UK inflation is particularly sensitive to changes in commodity prices.

Table VH-2, UK, Implied Deflator of Retail Sales, 12-Month Percentage Changes, ∆%

	All Retail	Ex Auto Fuel	Food Stores	Non- Food	Auto Fuel
Dec 2012	0.6	0.8	3.0	-0.5	0.3
Nov	0.4	0.5	3.0	-1.3	1.4
Oct	0.9	0.8	2.7	-0.7	2.7
Sep	0.7	0.5	2.0	-0.6	2.9
Aug	0.3	0.4	2.0	-1.0	0.4
Jul	0.2	0.5	1.9	-0.6	-1.3
Jun	0.3	0.7	2.2	-0.5	-1.1
May	1.2	1.3	3.1	-0.1	1.2
Apr	2.0	1.7	3.7	0.0	5.2
Mar	2.9	2.5	4.5	0.9	4.9
Feb	2.7	2.3	4.0	0.6	5.3
Jan	2.5	2.1	3.5	0.9	5.3
Dec 2011	2.8	2.0	4.3	0.6	9.1
Nov	3.8	2.7	4.6	1.4	12.6
Oct	4.6	3.4	5.0	2.1	14.7
Sep	5.1	3.6	6.1	1.5	16.9
Aug	5.4	4.0	6.0	2.3	16.2
Jul	5.1	3.8	5.9	2.1	14.4
Jun	4.6	3.3	6.1	1.0	14.5
May	4.6	3.4	5.5	1.7	13.1
Apr	4.2	3.2	4.8	1.9	12.2
Mar	4.3	2.9	4.3	1.7	14.8
Feb	4.9	3.6	5.5	2.0	15.0
Jan	4.2	3.0	5.3	1.1	14.4
Dec 2010	3.4	3.0	5.2	1.1	12.4
Dec 2009	3.6	2.4	2.1	1.7	16.8
Dec 2008	-0.3	0.4	7.1	-4.1	-9.5
Dec 2007	1.8	0.6	3.9	-1.7	15.3
Dec 2006	1.1	0.9	3.3	-1.0	1.1
Dec 2005	-0.4	-1.0	1.3	-2.6	6.6

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/rsi/retail-sales/december-2012/index.html

UK monthly retail volume of sales is quite volatile, as shown in Table VH-3. Total volume of sales decreased 0.1 percent in Dec 2012. There was decrease of 0.3 percent in retail sales excluding auto fuels and declines of 0.3 percent in food stores and 0.7 percent in nonfood stores but increase of 1.8 percent in auto fuel stores. Multiple positive and negative variations and changes in magnitudes confirm high volatility.

VH-3, UK, Growth of Retail Sales Volume by Component Groups Month SA ∆%

		All Retail	Ex Auto Fuel	Food Stores	Non-Food	Auto Fuel
	Dec	-1.8	-1.1	-2.0	-0.7	-8.4
2011	Jan	1.9	1.2	0.3	1.8	9.7
	Feb	-0.6	-0.7	-0.4	-1.1	0.2
	Mar	-0.3	-0.2	1.0	-1.0	-0.9
	Apr	2.2	2.2	3.5	0.9	1.8
	May	-2.1	-2.3	-4.2	-0.9	0.1
	Jun	0.0	0.0	-0.4	-0.3	0.2
	Jul	0.2	0.3	1.0	0.0	-0.2
	Aug	-0.5	-0.4	-0.1	-1.2	-0.6
	Sep	0.6	0.7	0.1	1.4	0.2
	Oct	0.8	0.8	0.8	1.1	1.1
	Nov	-0.3	-0.6	-0.6	-1.5	2.8
	Dec	0.5	0.6	0.1	1.6	-0.7
2012	Jan	-0.1	0.0	-0.2	0.0	-0.9
	Feb	-0.6	-0.4	-0.1	-0.9	-1.8
	Mar	2.0	1.6	0.1	2.9	5.6
	Apr	-2.3	-1.2	-0.3	-2.2	-12.6
	May	1.4	1.0	0.5	1.3	5.8
	Jun	0.4	0.7	0.0	1.4	-2.5
	Jul	0.2	-0.1	0.4	-1.0	2.5
	Aug	-0.1	-0.2	0.1	0.4	0.5
	Sep	0.5	0.5	-0.1	0.6	0.7
	Oct	-0.8	-0.6	-1.0	-0.6	-3.0
	Nov	0.0	0.2	0.0	0.3	-1.6
	Dec	-0.1	-0.3	-0.3	-0.7	1.8

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/rsi/retail-sales/december-2012/index.html

Percentage growth in 12 months of retail sales volume by component groups in the UK is provided in Table VH-4. Total retail sales increased 0.3 percent in the 12 months ending in Dec 2012 with increase of 1.1 percent in sales excluding auto fuel. The increase of auto fuel stores of 1.8 percent in Dec 2012 reduced the 12-month decline from 8.9 percent in Nov 2012 to 6.6 percent in Dec 2012 in another round of carry trades. Significant improvement since Aug 2011 was interrupted with sharp declines in Apr 2012 but recovery from May to Nov 2012.

Table VH-4, UK, Growth of Retail Sales Volume by Component Groups 12-Month ∆%

		All Retail	Ex Auto	Food Stores	Non-Food	Auto Fuel
	Dec	-2.2	-1.6	-4.1	-0.3	-8.4
2011	Jan	3.5	3.1	-2.5	7.2	7.4
	Feb	0.1	-0.4	-2.4	-0.1	4.8
	Mar	0.0	-0.4	-1.2	-0.7	3.6
	Apr	2.1	1.9	2.3	0.4	3.9
	May	-0.8	-1.1	-3.3	-0.8	2.3
	Jun	-0.7	-1.2	-4.0	-0.8	3.3
	Jul	-0.9	-1.2	-1.1	-2.7	2.2
	Aug	-1.2	-1.5	-0.6	-3.8	2.0
	Sep	0.3	0.0	-0.2	-1.3	3.4
	Oct	0.6	0.4	0.5	-0.8	2.6
	Nov	0.2	-0.3	-1.1	-1.6	5.2
	Dec	2.5	1.4	1.1	0.7	14.0
2012	Jan	0.5	0.2	0.5	-1.1	2.9
	Feb	0.6	0.5	0.9	-0.8	1.0
	Mar	2.8	2.3	0.0	3.1	7.6
	Apr	-1.7	-1.1	-3.8	-0.2	-7.6
	May	1.8	2.2	1.0	2.0	-2.3
	Jun	2.2	2.9	1.4	3.8	-4.9
	Jul	2.1	2.6	0.8	2.7	-2.3
	Aug	2.5	2.9	0.9	4.4	-1.3
	Sep	2.3	2.6	0.6	3.6	-0.8
	Oct	0.6	1.2	-1.1	1.9	-4.8
	Nov	0.9	2.0	-0.6	3.9	-8.9
	Dec	0.3	1.1	-1.0	1.6	-6.6

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/rsi/retail-sales/december-2012/index.html

Table VH-5 provides the analysis of the UK Office for National Statistics of contributions to 12-month percentage changes of value and volume of retail sales in the UK. The volume of retail sales seasonally adjusted increased 0.3 percent in the 12 months ending in Dec 2012. Sales of predominantly food stores with weight of 41.3 percent decreased 1.0 percent in the 12 months ending in Dec 2012, deducting 0.4 percentage points. Mostly nonfood stores with weight of 41.6 percent increased 1.6 percent with contribution of 0.7 percentage points. Positive contribution to 12-month percentage changes of volume was made by non-store retailing with weight of 5.3 percent, growth of 11.8 percent and positive contribution of 0.7 percentage points but automotive fuel with weight of 11.8 percent and growth of minus 6.6 percent deducted 0.7 percentage points. The value of retail sales increased 0.7 percent in the 12 months ending in Dec 2012. There were positive contributions: 0.7 percentage points for predominantly food stores, 0.2 percentage points for predominantly nonfood stores and 0.6 percentage points for non-store retailing. Automotive fuel stores deducted 0.8 percentage points.

Table VH-5, UK, Value of Retail Sales 12-month ∆% and Percentage Points Contributions by Sectors

Dec 2012	Weight % of All Retailing	Volume SA 12- Month ∆%	PP Cont. % points	Value SA 12- Month ∆%	PP Cont. % points
All Retailing	100.0	0.3		0.7
Mostly Food Stores	41.3	-1.0	-0.4	1.7	0.7
Mostly Nonfood Stores
Total	41.6	1.6	0.7	0.6	0.2
Non- specialized	7.8	7.3	0.6	5.6	0.4
Textile, Clothing & Footwear	12.3	-3.5	-0.4	-2.8	-0.3
Household Goods Stores	8.8	2.1	0.2	0.5	0.0
Other	12.7	2.7	0.3	1.0	0.1
Non-store Retailing	5.3	11.8	0.7	10.4	0.6
Automotive Fuel	11.8	-6.6	-0.7	-6.7	-0.8

Cont.: Contribution

Sources: UK Office for National Statistics http://www.ons.gov.uk/ons/rel/rsi/retail-sales/december-2012/index.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 11.8 percent by Fri Jan 18, 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	1/18/2013
Rate	1.1423	1.5914	1.192	1.3321
CNY/USD	01/03 2000	07/21 2005	7/15 2008	1/18/ 2013
Rate	8.2798	8.2765	6.8211	6.2182
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 1.3321/EUR on Jan 18, 2013 or by 11.8 percent {[(1.3321/1.192)-1]100 = 11.8%}. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. Risk aversion erodes devaluation of the dollar. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD subsequently revaluing to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent and after fixing it again to the dollar, revalued to CNY 6.2182/USD on Fri Jan 18, 2013, or by an additional 8.8 percent, for cumulative revaluation of 24.9 percent. The final row of Table VI-2 shows revaluation of the CNY in three of the past four weeks by 0.1 percent in the week of Jan 4 and 0.2 percent in the week of Jan 11; and no change in the week of Jan 18, 2013.

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	1/18/ /2013
Rate	1.1423	1.5914	1.192	1.3321
CNY/USD	01/03 2000	07/21 2005	7/15 2008	1/18/ 2013
Rate	8.2798	8.2765	6.8211	6.2182
Weekly Rates	12/28/2012	1/4/2013	1/11/2013	1/18/ 2013
CNY/USD	6.2358	6.2316	6.2168	6.2182
∆% from Earlier Week*	0.0	0.1	0.2	0.0

*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, 2011, 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 Jan 18, 2013 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 Jan 18, 2013, the CNY revalued 2.2 percent to CNY 6.2182/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
1/18/13	6.2182	2.2
1/11/13	6.2168	2.2
1/4/13	6.2316	2.0
12/28/12	6.2358	1.9
12/21/12	6.2352	1.9
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

Professor Edward P Lazear (2013Jan7), writing on “Chinese ‘currency manipulation’ is not the problem,” on Jan 7, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323320404578213203581231448.html), provides clear thought on the role of the yuan in trade between China and the United States and trade between China and Europe. There is conventional wisdom that Chinese exchange rate policy causes the loss of manufacturing jobs in the United States, which is shown by Lazear (2013Jan7) to be erroneous. The fact is that manipulation of the CNY/USD rate by China has only minor effects on US employment. Lazear (2013Jan7) shows that the movement of monthly exports of China to its major trading partners, United States and Europe, since 1995 cannot be explained by the fixing of the CNY/USD rate by China. The period is quite useful because it includes rapid growth before 2007, contraction until 2009 and weak subsequent expansion. Chart VI-1 of the Board of Governors of the Federal Reserve System provides the CNY/USD exchange rate from Jan 3, 2000 to Jan 11, 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 appreciated 0.2 percent in the week of Dec 21, 2012, to CNY 6.2352/USD for cumulative 1.9 percent revaluation from Oct 28, 2011 and left the rate virtually unchanged at CNY 6.2316/USD on Jan 4, 2012, appreciating to CNY 6.2156/USD on Jan 11, 2013, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD by 24.9 percent by Jan 18, 2013 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-Jan 11, 2013

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-1A provides the daily CNY/USD rate from Jan 5, 1981 to Jan 11, 2013. The first data point in Chart VI-1A is CNY 1.5418/USD on Jan 5, 1981. There is sharp cumulative depreciation 106.4 percent to CNY 3.2031 by Jul 2, 1986, continuing to CNY 5.8145/USD on Dec 29, 1993 for cumulative 274.7 percent since Jan 5, 1981. China then devalued sharply to CNY 8.7117/USD on Jan 7, 1994 for 49.8 percent relative to Dec 29, 1993 and cumulative 461.4 percent relative to Jan 5, 1981. China then fixed the rate at CNY 8.2765/USD until Jul 21, 2005 and revalued as analyzed in Chart VI-1. The final data point in Chart VI-1A is CNY 6.2156/USD on Jan 11, 2013. To be sure, China fixed the exchange rate after substantial prior devaluation. It is unlikely that the devaluation could have been effective after many years of fixing the exchange rate with high inflation and multiple changes in the world economy. The argument of Lazear (2013Jan7) is still valid in view of the lack of association between monthly exports of China to the US and Europe since 1995 and the exchange rate of China.

Chart VI-1A, Chinese Yuan (CNY) per US Dollar (US), Business Days, Jan 5, 1981-Jan 11, 2013

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

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

Economic policy during the debt crisis of 1983 may be useful in analyzing the options of the euro area. Brazil successfully combined fiscal consolidation, structural reforms to eliminate subsidies and devaluation to parity. Brazil’s terms of trade, or export prices relative to import prices, deteriorated by 47 percent from 1977 to 1983 (Pelaez 1986, 46). Table VI-2B provides selected economic indicators of the economy of Brazil from 1970 to 1985. In 1983, Brazil’s inflation was 164.9 percent, GDP fell 3.2 percent, idle capacity in manufacturing reached 24.0 percent and Brazil had an unsustainable foreign debt. US money center banks would have had negative capital if loans to emerging countries could have been marked according to loss given default and probability of default (for credit risk models see Pelaez and Pelaez (2005), International Financial Architecture, 134-54). Brazil’s current account of the balance of payments shrank from $16,310 million in 1982 to $6,837 million in 1983 because of the abrupt cessation of foreign capital inflows with resulting contraction of Brazil’s GDP by 3.2 percent. An important part of adjustment consisted of agile coordination of domestic production to cushion the impact of drastic reduction in imports. In 1984, Brazil had a surplus of $45 million in current account, the economy grew at 4.5 percent and inflation was stabilized at 232.9 percent.

Table VI-2B, Brazil, Selected Economic Indicators 1970-1985

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

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

Chart VI-1B provides the tortuous Phillips Circuit of Brazil from 1963 to 1987. There were no reliable consumer price index and unemployment data in Brazil for that period. Chart VI-1B used the more reliable indicator of inflation, the wholesale price index, and idle capacity of manufacturing as a proxy of unemployment in large urban centers.

Chart VI-1B, Brazil, Phillips Circuit 1963-1987

Source:

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

A key to success in stabilizing an economy with significant risk aversion is finding parity of internal and external interest rates. Brazil implemented fiscal consolidation and reforms that are advisable in explosive foreign debt environments. In addition, Brazil had the capacity to find parity in external and internal interest rates to prevent capital flight and disruption of balance sheets (for analysis of balance sheets, interest rates, indexing, devaluation, financial instruments and asset/liability management in that period see Pelaez and Pelaez (2007), The Global Recession Risk: Dollar Devaluation and the World Economy, 178-87). Table VI-2C provides monthly percentage changes of inflation, devaluation and indexing and the monthly percent overnight interest rate. Parity was attained by means of a simple inequality:

Cost of Domestic Loan ≥ Cost of Foreign Loan

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

Table VI-2C, Brazil, Inflation, Devaluation, Overnight Interest Rate and Indexing, Percent per Month, 1984

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

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

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 IIB-1 for IIIQ2011 and IIIQ2012. The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US increased from $128.2 billion in IIIQ2011, or 3.4 percent of GDP, to $128.3 billion in IIIQ2012, or 3.3 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 but is combined now with much higher imbalance in the Treasury budget (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

	IIIQ2011	IIIQ2012	Difference
Goods Balance	-202,153	-196,249	5,904
X Goods	378,454	382,877	1.2 ∆%
M Goods	-580,607	-579,126	-0.3 ∆%
Services Balance	48,571	52,218	3,647
X Services	161,319	165,492	2.6 ∆%
M Services	-112,747	-113,273	0.5 ∆%
Balance Goods and Services	-153,581	-144,031	9,550
Balance Income	57,934	50,271	-7,663
Unilateral Transfers	-32,525	-34,510	-1,985
Current Account Balance	-128,172	-128,270	-98
% GDP	IIIQ2011	IVQ2011	IIIQ2012
	3.4	3.1	3.3

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/index.htm), of the world financial system with its Global Financial Stability Report (GFSR) (IMF 2012GFSROct) (http://www.imf.org/external/pubs/ft/gfsr/2012/02/index.htm) 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. Growth of China’s GDP relative to a year earlier decelerated from 12.1 percent in IQ2010 to 7.4 percent in IIIQ2012 and 7.9 percent in IVQ2012. Growth of secondary industry decelerated from 14.5 percent in IQ2010 to 7.4 percent in IIIQ2012 and 7.9 percent in IVQ2012. China’s GDP growth decelerated significantly from annual equivalent 9.9 percent in IIIQ2011 to 7.0 percent in IVQ2011 and 6.1 percent in IQ2012, rebounding to 8.2 percent in IIQ2012, 9.1 percent in IIIQ2012 and 8.2 percent in IVQ2012. (See Subsection VC and earlier 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 1.59 percent in the first three quarters of 2012, which is equivalent to 2.1 percent per year (Mediocre and Decelerating United States Economic Growth at http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/12/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 29.5 million people. (ii) The labor market continues fractured with 29.5 million unemployed or underemployed (http://cmpassocregulationblog.blogspot.com/2013/01/thirty-million-unemployed-or.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/12/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 at http://cmpassocregulationblog.blogspot.com/2012/12/recovery-without-hiring-forecast-growth.html 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 1.0 percent in three consecutive quarters at annual equivalent rate of minus 1.3 percent and declined 0.3 percent in IIQ2012 relative to IIQ2011. In IIIQ2012, the UK grew 0.9 percent relative to IIQ2012 and was unchanged 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 http://cmpassocregulationblog.blogspot.com/2012/12/recovery-without-hiring-forecast-growth.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 40.9 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to Jan 18, 2013, S&P 500 has gained 45.3 percent and DAX 35.8 percent. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States. A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html). Rita Nazareth and Sarah Pringle, writing on “Dow Average rises to 5-year high amid debt-ceiling talks,” on Jan 18, 2012, published in Bloomberg (http://www.bloomberg.com/news/2013-01-18/u-s-stock-futures-little-changed-before-earnings-data.html), find that the DJIA reached on Jan 18, 2012, the highest level in five years at 13,649.70 with volume of 6.6 billion shares in US exchanges, which is higher by 6.9 percent than the average in three months. Vito J. Bacanelli, writing on “GOP proposal lifts Dow to five-year high,” on Jan 19, 2013, published by Barron’s (http://online.barrons.com/article/SB50001424052748703596604578235762819811322.html?mod=BOL_hpp_mag#articleTabs_article%3D1), finds that the closing level of 13,649.70 on Jan 18, 2013, is the highest close since Dec 10, 2007, only 4 percent lower than the all-time high and the best start for a year since 1997. The Wall Street Journal finds a 52-week high of 13661.87 on Oct 5, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). The S&P 500 at 1485.98 is 5 percent below its all time high of 1565 in 2007. 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 1/18/13,” 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. Unsustainable deficit/debt in the United States is dominating financial/economic risk perceptions in the weeks of Dec 21 and 28, 2012. Equity markets soared in the week of Jan 4, 2013 with H.R. 8 American Taxpayer Relief Act of 2012 (http://www.gpo.gov/fdsys/pkg/BILLS-112hr8eas/pdf/BILLS-112hr8eas.pdf). Market rallied in the week of Jan 18, 2012, on the expectation of a deal to circumvent the debt limit of the United States, which hides the unresolved unsustainable Federal deficit/debt. The highest valuations in column “∆% Trough to 1/18/13” of Table VI-4 are by US equities indexes: DJIA 40.9 percent and S&P 500 45.3 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. DAX of Germany is now 35.8 percent above the trough. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States. A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html). Rita Nazareth and Sarah Pringle, writing on “Dow Average rises to 5-year high amid debt-ceiling talks,” on Jan 18, 2012, published in Bloomberg (http://www.bloomberg.com/news/2013-01-18/u-s-stock-futures-little-changed-before-earnings-data.html), find that the DJIA reached on Jan 18, 2012, the highest level in five years at 13,649.70 with volume of 6.6 billion shares in US exchanges, which is higher by 6.9 percent than the average in three months. Vito J. Bacanelli, writing on “GOP proposal lifts Dow to five-year high,” on Jan 19, 2013, published by Barron’s (http://online.barrons.com/article/SB50001424052748703596604578235762819811322.html?mod=BOL_hpp_mag#articleTabs_article%3D1), finds that the closing level of 13,649.70 on Jan 18, 2013, is the highest close since Dec 10, 2007, only 4 percent lower than the all-time high and the best start for a year since 1997. 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) and closed at 13649.70 on Jan 11, 2013, which is only 0.089 percent below the recent 52-week high. 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 1/18/13” had double digit gains relative to the trough around Jul 2, 2010 followed by negative performance but now some valuations of equity indexes show varying behavior: China’s Shanghai Composite is 2.8 percent below the trough; Japan’s Nikkei Average is 23.7 percent above the trough; DJ Asia Pacific TSM is 18.0 percent above the trough; Dow Global is 22.6 percent above the trough; STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 14.7 percent above the trough; and NYSE Financial Index is 25.7 percent above the trough. DJ UBS Commodities is 14.1 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 35.8 percent above the trough. Japan’s Nikkei Average is 23.7 percent above the trough on Aug 31, 2010 and 4.2 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 10913.30 on Fri Jan 18, 2013 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 6.4 percent higher 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 11.8 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 1/18/13” in Table VI-4 shows that there were increases of valuations of risk financial assets in the week of Jan 18, 2013 such as 0.6 percent for DJ Asia Pacific TSM. Nikkei Average increased 1.0 percent in the week. DJ UBS Commodities increased 2.1 percent. China’s Shanghai Composite increased 3.3 percent in the week of Jan 18, 2013. The DJIA increased 1.2 percent and S&P 500 increased 0.9 percent. There were increases in several indexes: 0.3 percent for NYSE Financial Index and 0.6 percent for Dow Global. STOXX 50 fell 0.5 percent and DAX of Germany fell 0.2 percent. The USD appreciated 0.2 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table 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 1/18/13” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Jan 18, 2013. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 1/18/13” but also relative to the peak in column “∆% Peak to 1/18/13.” There are now several equity indexes above the peak in Table VI-4: DJIA 21.8 percent, S&P 500 22.1 percent, DAX 21.6 percent, DJ Asia Pacific 3.3 percent and NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 0.1 percent with Dow Global unchanged. There are several indexes below the peak: Nikkei Average by 4.2 percent, Shanghai Composite by 26.8 percent and STOXX 50 by 2.9 percent. DJ UBS Commodities Index is now 2.4 percent below the peak. The US dollar strengthened 11.9 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 1/18/ /13	∆% Week 1/18/13	∆% Trough to 1/18/ 13
DJIA	4/26/ 10	7/2/10	-13.6	21.8	1.2	40.9
S&P 500	4/23/ 10	7/20/ 10	-16.0	22.1	0.9	45.3
NYSE Finance	4/15/ 10	7/2/10	-20.3	0.1	0.3	25.7
Dow Global	4/15/ 10	7/2/10	-18.4	0.0	0.6	22.6
Asia Pacific	4/15/ 10	7/2/10	-12.5	3.3	0.6	18.0
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-4.2	1.0	23.7
China Shang.	4/15/ 10	7/02 /10	-24.7	-26.8	3.3	-2.8
STOXX 50	4/15/10	7/2/10	-15.3	-2.9	-0.5	14.7
DAX	4/26/ 10	5/25/ 10	-10.5	21.6	-0.2	35.8
Dollar Euro	11/25 2009	6/7 2010	21.2	11.9	0.2	-11.8
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-2.4	2.1	14.1
10-Year T Note	4/5/ 10	4/6/10	3.986	1.840

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 Jan 11, 2013, shows that the S&P 500 is now 22.6 percent above the Apr 26, 2010 level and the DJIA is 21.8 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
Dec 21	0.4	17.7	1.2	18.0
Dec 28	-1.9	15.5	-1.9	15.7
Jan 4 2013	3.8	19.9	4.6	21.0
Jan 11	0.4	20.4	0.4	21.5
Jan 18	1.2	21.8	0.9	22.6

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 22.7 percent to ZAR 8.8810/USD on Jan 18, 2013, which is still 23.3 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 8,9 percent stronger at SGD 1.2277/USD on Jan 18, 2013 relative to the trough of depreciation but still stronger by 20.9 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 17.5 percent relative to the trough to BRL 2.0412/USD on Jan 18, 2013 but still stronger by 16.0 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=3705&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 at 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	Jan 18, 2013	∆% T Jan 18, 2013	∆% P Jan 18, 2013
EUR USD	7/15 2008	6/7 2010		1/18/ 2013
Rate	1.59	1.192		1.3321
∆%			-33.4		10.5	-19.4
JPY USD	8/18 2008	9/15 2010		1/18/ 2013
Rate	110.19	83.07		90.09
∆%			24.6		-8.5	18.2
CHF USD	11/21 2008	12/8 2009		1/18/ 2013
Rate	1.225	1.025		0.9343
∆%			16.3		8.8	23.7
USD GBP	7/15 2008	1/2/ 2009		1/18/ 2013
Rate	2.006	1.388		1.5864
∆%			-44.5		12.5	-26.5
USD AUD	7/15 2008	10/27 2008		1/18/ 2013
Rate	1.0215	1.6639		1.0509
∆%			-62.9		42.8	6.8
ZAR USD	10/22 2008	8/15 2010		1/18/ 2013
Rate	11.578	7.238		8.8810
∆%			37.5		-22.7	23.3
SGD USD	3/3 2009	8/9 2010		1/18/ 2013
Rate	1.553	1.348		1.2277
∆%			13.2		8.9	20.9
HKD USD	8/15 2008	12/14 2009		1/18/ 2013
Rate	7.813	7.752		7.7526
∆%			0.8		0.0	0.8
BRL USD	12/5 2008	4/30 2010		1/18/ 2013
Rate	2.43	1.737		2.0412
∆%			28.5		-17.5	16.0
CZK USD	2/13 2009	8/6 2010		1/18/ 2013
Rate	22.19	18.693		19.239
∆%			15.7		-2.9	13.3
SEK USD	3/4 2009	8/9 2010		1/18/ 2013
Rate	9.313	7.108		6.5143
∆%			23.7		8.4	30.1
CNY USD	7/20 2005	7/15 2008		1/18/ 2013
Rate	8.2765	6.8211		6.2182
∆%			17.6		8.8	24.9

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

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

Source:

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

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 negative yields 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 Jan 11, 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 10.2 percent to USD 1.3353/EUR on Jan 11, 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 Jan 11, 2013

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, 2010-2013

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 Jan 2013. 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 87.8038/USD in Jan 2013 for appreciation of 29.2 percent relative to JPY 124.0900/USD on Jun 22, 2007 before the global recession and expansion characterized by recurring bouts of risk aversion. Takashi Nakamichi and Eleanor Warnock, writing on “Japan lashes out over dollar, euro,” on Dec 29, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323530404578207440474874604.html?mod=WSJ_markets_liveupdate&mg=reno64-wsj), analyze the “war of words” launched by Japan’s new Prime Minister Shinzo Abe and his finance minister Taro Aso, arguing of deliberate devaluations of the USD and EUR relative to the JPY, which are hurting Japan’s economic activity. 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-Jan 2013

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 2.0375/USD on Jan 11, 2013. 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 2.0375/USD on Jan 11, 2013 for depreciation of 32.5 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 Jan 11, 2013

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 Jan 11, 2013

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 1.840 percent at the close of market on Fri Jan 18, 2013 would be equivalent to price of 107.1403 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price gain of 5.8 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. The price loss between Dec 28, 2012 and Jan 4, 2013 would have been 1.7 percent. 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 Jan 16, 2013, the line “Reserve Bank credit” in the Fed balance sheet stood at $2946 billion, or $2.9 trillion, with portfolio of long-term securities of $2701 billion, or $2.7 trillion, consisting of $1603 billion Treasury nominal notes and bonds, $75 billion of notes and bonds inflation-indexed, $75 billion Federal agency debt securities and $948 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $1604 billion or $1.6 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). There is no simple exit of this trap created by the highest monetary policy accommodation in US history together with the highest deficits and debt in percent of GDP since World War II. Risk aversion from various sources, discussed in section 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
12/21/12	1.770	107.8045	6.5
12/28/12	1.699	108.4831	7.1
1/4/13	1.898	106.5934	5.3
1/11/13	1.862	106.9324	5.6
1/18/13	1.840	107.1403	5.8

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 federal debt outstanding, held by government accounts and held by the public in millions of dollars for fiscal years from 2007 to 2012. Federal debt outstanding has increased 78.2 percent from fiscal year 2007 to fiscal year 2012 while federal debt held by the public has increased 122.8 percent and federal debt held by government accounts has increased 21.1 percent.

Table VI-7A, US, Federal Debt Outstanding, Held by Government Accounts and Held by the Public, Millions of Dollars

	Outstanding	Held by Government Accounts	Held by the Public
2012 Sep	16,090,640	4,791,850	11,298,790
Fiscal Years
2012	16,090,640	4,791,850	11,298,790
2011	14,815,328	4,658,307	10,157,021
2010	13,585,596	4,534,014	9,051,582
2009	11,933,031	4,355,291	7,577,739
2008	10,047,828	4,210,491	5,837,337
2007	9,030,612	3,958,417	5,072,195
∆% 2007-2012	78.2	21.1	122.8

Source: United States Treasury. 2012Dec. Treasury Bulletin. Washington, DC, Dec 2012. https://www.fms.treas.gov/bulletin/index.html

Table VI-7B provides the maturity distribution and average length in months of marketable interest-bearing debt held by private investors from 2007 to Sep 2012. Total debt held by investors increased from $3635 billion in 2007 to $9040 billion in Sep 2012 or increase by 148.7 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 Sep 2012, $2897 billion or 32.1 percent of outstanding debt held by investors matures in less than a year and $3852 billion or 42.6 percent of total debt matures in one to five years. Debt maturing in five years or less adds to $6749 billion or 74.7 percent of total outstanding debt held by investors of $9040 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-7B, 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	2012	Sep     2012
Total*	3635	4745	6229	7676	7951	9040	9040
<1 Year	1176	2042	2605	2480	2504	2897	2897
1-5 Years	1310	1468	2075	2956	3085	3852	3852
5-10 Years	678	719	995	1529	1544	1488	1488
10-20 Years	292	352	351	341	309	271	271
>20 Years	178	163	204	371	510	533	533
Average Months	58	49	49	57	60	55	55

*Amount Outstanding Privately Held

Source: United States Treasury. 2012Dec. Treasury Bulletin. Washington, DC, Dec 2012. https://www.fms.treas.gov/bulletin/index.html

Table VI-7C provides additional information required for understanding the deficit/debt situation of the United States. The table is divided into three parts: federal fiscal data for the years from 2009 to 2012; federal fiscal data for the years from 2005 to 2008; and Treasury debt held by the public from 2005 to 2012. Total revenues of the US from 2009 to 2012 accumulate to $9019 billion, or $9.0 trillion, while expenditures or outlays accumulate to $14,111 billion, or $14.1 trillion, with the deficit accumulating to $5092 billion, or $5.1 trillion. Revenues decreased 6.6 percent from $9653 billion in the four years from 2005 to 2008 to $9019 billion in the years from 2009 to 2012. Decreasing revenues were caused by the global recession from IVQ2007 (Dec) to IIQ2009 (Jun) and also by growth of only 2.2 percent on average in the cyclical expansion from IIIQ2009 to IIIQ2012, which is much lower than 6.2 percent on average in cyclical expansions since the 1950s (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). Weakness of growth and employment creation is analyzed in IB Collapse of United States Dynamism of Income Growth and Employment Creation. There are 29.5 million people without jobs or underemployed that is equivalent to 18.2 percent of the US effective labor force (Section I and earlier http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html) and hiring is significantly below the earlier cyclical expansion before 2007 (http://cmpassocregulationblog.blogspot.com/2012/12/recovery-without-hiring-forecast-growth.html). In contrast with the decline of revenue, outlays or expenditures increased 30.2 percent from $10,839 billion, or $10.8 trillion, in the four years from 2005 to 2008, to $14,111 billion, or $14.1 trillion, in the four years from 2009 to 2012. Increase in expenditures by 30.2 percent while revenue declined by 6.6 percent caused the increase in the federal deficit from $1186 billion in 2005-2008 to $5092 billion in 2009-2012. Federal revenue was 15.4 percent of GDP on average in the years from 2009 to 2012, which is well below 18.0 percent of GDP on average from 1970 to 2010. Federal outlays were 24.1 percent of GDP on average from 2009 to 2012, which is well above 21.9 percent of GDP on average from 1970 to 2010. The lower part of Table VI-7C shows that debt held by the public swelled from $5803 billion in 2008 to $11,280 billion in 2012, by $5477 billion or 94.3 percent. Debt held by the public as percent of GDP or economic activity jumped from 40.5 percent in 2008 to 72.6 percent in 2012, which is well above the average of 37.0 percent from 1970 to 2010. The United States faces tough adjustment because growth is unlikely to recover, creating limits on what can be obtained by increasing revenues, while continuing stress of social programs restricts what can be obtained by reducing expenditures.

Table VI-7C, US, Treasury Budget and Debt Held by the Public, Billions of Dollars and Percent of GDP 

	Receipts	Outlays	Deficit (-), Surplus (+)
$ Billions
2012	2,449	3,538	-1,089
Fiscal Year 2011	2,302	3,599	-1,297
Fiscal Year 2010	2,163	3,456	-1,293
Fiscal Year 2009	2,105	3,518	-1,413
Total 2009-2012	9,019	14,111	-5,092
Average % GDP 2009-2012	15.4	24.1	-8.7
Fiscal Year 2008	2,524	2,983	-459
Fiscal Year 2007	2,568	2,729	-161
Fiscal Year 2006	2,407	2,655	-248
Fiscal Year 2005	2,154	2,472	-318
Total 2005-2008	9,653	10,839	-1,186
Average % GDP 2005-2008	17.9	20.1	-2.2
Debt Held by the Public	Billions of Dollars	Percent of GDP
2005	4,592	36.9
2006	4,829	36.6
2007	5,035	36.3
2008	5,803	40.5
2009	7,545	54.1
2010	9,019	62.8
2011	10,128	67.7
2012	11,280	72.6

Source: http://www.fms.treas.gov/mts/index.html CBO (2012NovMBR). CBO (2011AugBEO); Office of Management and Budget. 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB; CBO. 2011JanBEO. Budget and Economic Outlook. Washington, DC, Jan. CBO. 2012AugBEO. Budget and Economic Outlook. Washington, DC, Aug 22. CBO. 2012Jan31. Historical budget data. Washington, DC, Jan 31. CBO. 2012NovCDR. Choices for deficit reduction. Washington, DC. Nov.

The CBO (2012NovCDR, 4) uses different assumptions to calculate what would happen with the US budget and debt under an alternative fiscal scenario of no measures of fiscal tightening:

“The alternative fiscal scenario incorporates the assumptions that all expiring tax provisions (other than the payroll tax reduction), including those that expired at the end of December 2011, are instead extended; that the alternative minimum tax is indexed for inflation after 2011 (starting at the 2011 exemption amount); that Medicare’s payment rates for physicians’ services are held constant at their current level; and that the automatic enforcement procedures specified by the Budget Control Act of 2011 do not take effect. Outlays under that scenario also include the incremental interest costs associated with projected additional borrowing.”

Table VI-7D provides the projections of the alternative fiscal scenario of the CBO under those assumptions. Debt as percent of GDP increases from 72.6 percent in 2012 to 89.7 percent in 2022.

Table VI-7D, US, Alternative Scenario CBO Projections of Federal Government Revenues, Outlays, Deficit and Debt as Percent of GDP

	Revenues % GDP	Outlays % GDP	Deficit % GDP	Debt GDP
2011	15.4	24.1	-8.7	67.7
2012	15.8	22.8	-7.0	72.6
2013	16.3	22.8	-6.5	78.6
2014	17.2	22.9	-5.6	82.3
2015	17.8	22.5	-4.6	82.5
2016	18.1	22.6	-4.5	82.5
2017	18.3	22.5	-4.2	82.5
2018	18.3	22.5	-4.2	82.9
2019	18.4	23.0	-4.6	84.1
2020	18.5	23.3	-4.8	85.7
2021	18.5	23.6	-5.1	87.5
2022	18.6	24.1	-5.5	89.7
Total 2013-2017	17.6	22.6	-5.0	NA
Total 2013-2022	18.1	23.0	-4.9	NA
Average 1971-2010	18.0	21.9	NA	37.0

Source: CBO (2012AugBEO). CBO (2012NovCDR).

There is highly unpleasant fiscal arithmetic in the United States. DeNavas-Walt, Proctor and Smith (2012Sep) provide the report on income, poverty and health insurance coverage in the United States for 2011, which consist of the latest available data. There are 121,084 households in the United States in 2011 with mean income of $69,677 or total income of $8437 billion. The highest quintile earns mean income of $178,020 that is equivalent to 51.1 percent of total household income or $4311 billion. A tax of 100 percent on 11 million households in the highest quintile would bring slightly more than outlays of the Treasury of $3603 billion in fiscal year 2011. There are numerous professional households in that 11 million that would default their students loans and be thrown into poverty. After the tax on 100 percent of income of the 11 million in the upper quintile the US Treasury would default because of calamitous disappearance of income that could be taxed to generate revenue. Economic growth at 2.2 percent on average in the 13 quarters of expansion from IIIQ2009 to IIIQ2012 compared with 6.2 percent in earlier expansions of the economic cycle (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html) has been insufficient to restore government revenue to its long-term average of 18.0 percent from 1970 to 2010 while outlays as percent of GDP have jumped to 24.1 percent in 2011 compared with 21.9 percent on average from 1970 to 2010. Even smaller deficits by restraining outlays to 21.9 percent of GDP will not be sufficient because Treasury debt has jumped from 40.5 percent in 2008 to 72.6 percent in 2012, which is well above the average of 37.0 percent from 1970 to 2010. United States fiscal affairs resemble those of countries in sovereign debt crises. Attempts to tax current levels of expenditures and debt are unsuccessful with the threat of disorderly adjustment in a future debt crisis in generalized expectation that the government is incapable of generating future primary budget surpluses. Financing budget surpluses with issue of money or seigniorage and various forms of financial repression to lower interest rates on government debt also creates unpleasant outcomes.

The major hurdle in adjusting the fiscal situation of the US is shown in Table VI-7E in terms of the rigid structure of revenues that can be increased and outlays that can be reduced. There is no painless adjustment of a debt exceeding 70 percent of GDP. On the side of revenues, taxes provide 90.9 percent of revenue in 2011 and are projected to provide 92.2 percent in the total revenues from 2013 to 2022 in the CBO projections. Thus, revenue measures are a misleading term for what are actually tax increases. The choices are especially difficult because of the risks of balancing inequity and disincentives to economic activity. Individual income taxes are projected to increase from 47.4 percent of federal government revenues in 2011 to 51.4 percent in total revenues projected by the CBO from 2013 to 2022. There are equally difficult conflicts in what the government gives away in a rigid structure of expenditures. Mandatory expenditures account for 56.3 percent of federal government outlays in 2011 and are projected to increase to 62.4 percent of the total projected by the CBO for the years 2013 to 2022. The total of Social Security plus Medicare and Medicaid accounts for 43.4 percent of federal government outlays in 2011 and is projected to increase to 51.5 percent in the total for 2013 to 2022. The inflexibility of what to cut is more evident in the first to the last row of Table VI-7E with the aggregate of defense plus Social Security plus Medicare plus Medicaid accounting for 62.7 percent of expenditures in 2011, rising to 66.6 percent of the total outlays projected by the CBO from 2013 to 2022. The cuts are in discretionary spending that declines from 37.4 percent of the total in 2011 to 28.9 percent of total outlays in the CBO projection for 2013 to 2022.

Table VI-7E, Structure of Federal Government Revenues and Outlays, $ Billions and Percent

	2011 $ Billions	% Total	Total 2013-2022 $ Billions	% Total
Revenues	2,303	100.00	41,565	100.00
Individual Income Taxes	1,091	47.4	21,379	51.4
Social Insurance Taxes	819	35.6	12,476	30.0
Corporate Income Taxes	181	7.9	4,477	10.8
Other	212	9.2	3,232	7.8
Outlays	3,603	100.00	43,823	100.0
Mandatory	2,027	56.3	27,324	62.4
Social Security	725	20.1	10,545	24.1
Medicare	560	15.5	7,722	17.6
Medicaid	275	7.6	4,291	9.8
SS + Medicare + Medicaid	1,560	43.3	22,558	51.5
Discre- tionary	1,346	37.4	12,664	28.9
Defense	700	19.4	6,726	15.4
Non- defense	646	17.9	5,370	12.3
Net Interest	230	6.4	3,835	8.8
Defense + SS + Medicare + Medicaid	2,260	62.7	29,284	66.8
MEMO: GDP	15,076		217,200

Source: CBO (2012JanBEO), CBO (2012AugBeo).

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 Jan 17, 2013. 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 1.89 percent on Jan 17, 2013, 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 in the text 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 Jan 17, 2013

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 2013. 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 $2,711,605 million on Jan 16, 2013.

Chart VI-9, US, Securities Held Outright by Federal Reserve Banks, Wednesday Level, Dec 18, 2002 to Jan 16, 2013, USD Millions

Source: Board of Governors of the Federal Reserve System

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

Chart VI-10 of the Board of Governors of the Federal Reserve System provides the overnight Fed funds rate on business days from Jan 3, 1979, at 8.34 percent per year, to Jan 17, 2013, at 0.14 percent per year. US recessions are in shaded areas according to the reference dates of the NBER (http://www.nber.org/cycles.html). In the Fed effort to control the “Great Inflation” of the 1930s (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 fed funds rate increased from 8.34 percent on Jan 3, 1979 to a high in Chart VI-10 of 22.36 percent per year on Jul 22, 1981 with collateral adverse effects in the form of impaired savings and loans associations in the United States, emerging market debt and money-center banks (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7; Pelaez 1986, 1987). Another episode in Chart VI-10 is the increase in the fed funds rate from 3.15 percent on Jan 3, 1994, to 6.56 percent on Dec 21, 1994, which also had collateral effects in impairing emerging market debt in Mexico and Argentina and bank balance sheets in a world bust of fixed income markets during pursuit by central banks of non-existing inflation (Pelaez and Pelaez, International Financial Architecture (2005), 113-5). Another interesting policy impulse is the reduction of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of equally non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85), followed by increments of 25 basis points from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006 in Chart VI-10. Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).

The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). A final episode in Chart VI-10 is the reduction of the fed funds rate from 5.41 percent on Aug 9, 2007, to 2.97 percent on October 7, 2008, to 0.12 percent on Dec 5, 2008 and close to zero throughout a long period with the final point at 0.14 percent on Jan 10, 2013. Evidently, this behavior of policy would not have occurred had there been theory, measurements and forecasts to avoid these violent oscillations that are clearly detrimental to economic growth and prosperity without inflation. Current policy consists of forecast mandate of maintaining policy accommodation until the forecast of the rate of unemployment reaches 6.5 percent and the rate of personal consumption expenditures excluding food and energy reaches 2.5 percent (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm). It is a forecast mandate because of the lags in effect of monetary policy impulses on income and prices (Romer and Romer 2004). The intention is to reduce unemployment close to the “natural rate” (Friedman 1968, Phelps 1968) of around 5 percent and inflation at or below 2.0 percent. If forecasts were reasonably accurate, there would not be policy errors. A commonly analyzed risk of zero interest rates is the occurrence of unintended inflation that could precipitate an increase in interest rates similar to the Himalayan rise of the fed funds rate from 8.34 percent on Jan 3, 1979, at the beginning point in Chart VI-10, to 22.36 percent on Jul 22, 1981. There is a less commonly analyzed risk of the development of a risk premium on Treasury securities because of the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html). There is not a fiscal cliff or debt limit issue ahead but rather free fall into a fiscal abyss. The combination of the fiscal abyss with zero interest rates could trigger the risk premium on Treasury debt or Himalayan hike in interest rates.

Chart VI-10, US, Fed Funds Rate, Business Days, Jan 10, 1979 to Jan 17, 2013, Percent per Year

Source: Board of Governors of the Federal Reserve System http://www.federalreserve.gov/releases/h15/

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 VI-7E 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 VI-7E 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 VI-7E, 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, 2013