Mediocre United States Economic Growth, Stagnating Real Disposable Income, Financial Repression, Swelling Undistributed Corporate Profits, Peaking Valuations of Risk Financial Assets, World Economic Slowdown and Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011, 2012, 2013
Executive Summary
I Mediocre and Decelerating United States Economic Growth
IA Mediocre and Decelerating United States Economic Growth
IA1 Contracting Real Private Fixed Investment
IA2 Swelling Undistributed Corporate Profits
II Stagnating Real Disposable Income and Consumption Expenditures
IIA1 Stagnating Real Disposable Income and Consumption Expenditures
IIA2 Financial Repression
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
VE Germany. Table VE-DE provides yearly growth rates of the German economy from 1992 to 2012, 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 economies. The German economy grew at 4.2 percent in 2010, 3.0 percent in 2011 and 0.7 percent in 2012.
The Federal Statistical Agency of Germany analyzes the fall and recovery of the German economy (http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/VolkswirtschaftlicheGesamtrechnungen/Inlandsprodukt/Aktuell,templateId=renderPrint.psml):
“The German economy again grew strongly in 2011. The price-adjusted gross domestic product (GDP) increased by 3.0% compared with the previous year. Accordingly, the catching-up process of the German economy continued during the second year after the economic crisis. In the course of 2011, the price-adjusted GDP again exceeded its pre-crisis level. The economic recovery occurred mainly in the first half of 2011. In 2009, Germany experienced the most serious post-war recession, when GDP suffered a historic decline of 5.1%. The year 2010 was characterised by a rapid economic recovery (+3.7%).”
Table VE-DE, Germany, GDP Year ∆%
| Price Adjusted Chain-Linked | Price- and Calendar-Adjusted Chain Linked | |
| 2012 | 0.7 | 0.9 |
| 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 (Destatis) https://www.destatis.de/EN/PressServices/Press/pr/2013/02/PE13_066_811.html;jsessionid=59DE7E440F9F7393B12C16FDA63BEB66.cae1
The Flash Germany Composite Output Index of the Markit Flash Germany PMI®, combining manufacturing and services, decreased from 50.6 in Mar to 48.8 in Apr, which indicates moderate contraction (http://www.markiteconomics.com/Survey/PressRelease.mvc/403f548dda24421facaee99f64821d5b). New export orders for manufacturing decreased at the fastest rate in 2013. Tim Moore, Senior Economist at Markit and author of the report, finds weakening in Germany’s private sector with accelerated decline in new orders for both manufacturing and services (http://www.markiteconomics.com/Survey/PressRelease.mvc/403f548dda24421facaee99f64821d5b). The Markit Germany Composite Output Index of the Markit Germany Services PMI®, combining manufacturing and services with close association with Germany’s GDP, decreased from 50.6 in Mar to 49.2 in Apr (http://www.markiteconomics.com/Survey/PressRelease.mvc/87059b95df854202afbb0fc45ee9900e). Tim Moore, Senior Economist at Markit and author of the report, finds risks of standstill in the economy of Germany (http://www.markiteconomics.com/Survey/PressRelease.mvc/87059b95df854202afbb0fc45ee9900e). The Germany Services Business Activity Index decreased from 50.9 in Mar to 49.6 in Apr (http://www.markiteconomics.com/Survey/PressRelease.mvc/87059b95df854202afbb0fc45ee9900e). The Markit/BME Germany Purchasing Managers’ Index® (PMI®), showing close association with Germany’s manufacturing conditions, decreased from 49.0 in Mar to 48.1 in Apr, in contraction territory below 50.0 (http://www.markiteconomics.com/Survey/PressRelease.mvc/40e3836803c0428d83b2f6aa8da5c5ee). New export orders decreased moderately in Apr with declining business within the euro zone offsetting demand from emerging countries. Tim Moore, Senior Economist at Markit and author of the report, finds moderately deteriorating conditions in German manufacturing with lower volumes of new orders and job reductions (http://www.markiteconomics.com/Survey/PressRelease.mvc/40e3836803c0428d83b2f6aa8da5c5ee).Table DE provides the country data table for Germany.
Table DE, Germany, Economic Indicators
| GDP | IQ2013 0.1 ∆%; I/Q2013/IQ2012 ∆% -1.4 2012/2011: 0.7% GDP ∆% 1992-2012 Blog 8/26/12 5/27/12 11/25/12 2/24/13 5/19/13 5/26/13 |
| Consumer Price Index | Apr month NSA ∆%: -0.5 |
| Producer Price Index | Apr month ∆%: -0.2 CSA, -0.2 NSA |
| Industrial Production | MFG Mar month CSA ∆%: 1.4 |
| Machine Orders | MFG Mar month ∆%: 2.2 |
| Retail Sales | Apr Month ∆% -0.4 12-Month ∆% 1.8 Blog 6/2/13 |
| Employment Report | Unemployment Rate SA Mar 5.4% |
| Trade Balance | Exports Mar 12-month NSA ∆%: -4.2 Blog 5/12/13 |
Links to blog comments in Table DE:
5/26/13 http://cmpassocregulationblog.blogspot.com/2013/05/united-states-commercial-banks-assets.html
5/19/13 http://cmpassocregulationblog.blogspot.com/2013/05/word-inflation-waves-squeeze-of.html
5/12/13 http://cmpassocregulationblog.blogspot.com/2013/05/recovery-without-hiring-collapse-of.html
2/24/13 http://cmpassocregulationblog.blogspot.com/2013/02/world-inflation-waves-united-states.html
11/25/12 http://cmpassocregulationblog.blogspotcom/2012/11/contraction-of-united-states-real.html
Germany’s labor market continues to show strength not found in most of the advanced economies, as shown in Table VE-1. The number unemployed, not seasonally adjusted, increased from 2.22 million in Apr 2012 to 2.26 million in Apr 2013, or 1.8 percent, while the unemployment rate increased from 5.3 percent in Apr 2012 to 5.4 percent in Apr 2013. The number of persons in employment, not seasonally adjusted, increased from 39.61 million in Apr 2012 to 39.92 million in Mar 2013, or 0.7 percent, while the employment rate increased from 63.0 percent in Apr 2012 to 63.3 percent in Apr 2013. The number unemployed, seasonally adjusted, was unchanged from 2.29 million in Mar 2013 to 2.29 million in Apr 2013, while the unemployment rate was unchanged from 5.4 percent in Mar 2013 to 5.4 percent in Apr 2013. The number of persons in employment, seasonally adjusted, increased from 40.19 million in Mar 2013 to 40.22 million in Apr 2013, or 0.1 percent.
Table VE-1, Germany, Unemployment Labor Force Survey
| Apr 2013 | Mar 2013 | Apr 2012 | |
| NSA | |||
| Number | 2.26 ∆% Apr 2013 /Mar 2013: -4.6 ∆% Apr 2013/Apr 2012:1.8 | 2.37 | 2.22 |
| % Rate Unemployed | 5.4 | 5.6 | 5.3 |
| Persons in Employment Millions | 39.92 ∆% Apr 2013/Mar 2013: -0.2 ∆% Apr 2013/Apr 2012: 0.8 | 39.99 | 39.61 |
| Employment Rate | 63.3 | 63.5 | 63.0 |
| SA | |||
| Number | 2.29 ∆% Apr 2013/Mar 2013: 0.0 ∆% Apr 2013/Apr 2012: –1.3 | 2.29 | 2.32 |
| % Rate Unemployed | 5.4 | 5.4 | 5.5 |
| Persons in Employment Millions | 40.22 ∆% Apr 2013/Mar 2013: 0.1 ∆%Apr 2013/Apr 2012: 1.0 | 40.19 | 39.87 |
NSA: not seasonally adjusted; SA: seasonally adjusted
Source: Statistisches Bundesamt https://www.destatis.de/EN/PressServices/Press/pr/2013/05/PE13_180_132.html;jsessionid=02AC7469864C4315BB5469B2D1FEBB1C.cae1
https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
The unemployment rate in Germany as percent of the labor force in Table VE-2 stood at 6.5 percent in Sep, Oct and Nov 2012, increasing to 6.7 percent in Dec 2012, 7.4 percent in Jan 2013, 7.3 in Feb 2013 and 7.1 percent in Apr 2013. The unemployment rate fell to 6.8 percent in May 2013. The rate is much lower than 11.1 percent in 2005 and 9.6 percent in 2006.
Table VE-2, Germany, Unemployment Rate in Percent of Labor Force
| Percent of Labor Force | |
| May 2013 | 6.8 |
| Apr | 7.1 |
| Feb | 7.3 |
| Jan | 7.4 |
| Dec 2012 | 6.7 |
| Nov | 6.5 |
| Oct | 6.5 |
| Sep | 6.5 |
| Aug | 6.8 |
| Jul | 6.8 |
| Jun | 6.6 |
| May | 6.7 |
| Apr | 7.0 |
| Mar | 7.2 |
| Feb | 7.4 |
| Jan | 7.3 |
| Dec 2011 | 6.6 |
| Nov | 6.4 |
| Oct | 6.5 |
| Sep | 6.6 |
| Aug | 7.0 |
| Jul | 7.0 |
| Jun | 6.9 |
| May | 7.0 |
| Apr | 7.3 |
| Mar | 7.6 |
| Feb | 7.9 |
| Jan | 7.9 |
| Dec 2010 | 7.1 |
| Dec 2009 | 7.8 |
| Dec 2008 | 7.4 |
| Dec 2007 | 8.1 |
| Dec 2006 | 9.6 |
| Dec 2005 | 11.1 |
Source: Statistisches Bundesamt Deutschland https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
Chart VE-1 of Statistisches Bundesamt Deutschland, or Federal Statistical Office of Germany, shows the long-term decline of the rate of unemployment in Germany from more than 12 percent in early 2005 to 6.6 percent in Dec 2011, 6.6 percent in Jun 2012, 6.8 percent in Jul and Aug 2012 and 6.5 percent from Sep to Nov 2012, increasing to 6.7 percent in Dec 2012 and 6.8 percent in Apr 2013.
Chart VE-1, Germany, Unemployment Rate, Unadjusted, Percent
Source: Statistisches Bundesamt Deutschland
https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
Retail sales in Germany adjusted for inflation are provided in Table VE-3. There have been sharp fluctuations in monthly and 12 months percentage changes. Retail sales decreased 0.4 percent in Apr 2013 and increased 1.8 percent in 12 months. Retail sales rebounded in Jan 2013 with monthly increase of 3.1 percent and 2.7 percent in 12 months.
Table VE-3, Retail Sales in Germany Adjusted for Inflation
| 12-Month ∆% NSA | Month ∆% SA and Calendar Adjusted | |
| Apr 2013 | 1.8 | -0.4 |
| Mar | -2.5 | -0.1 |
| Feb | -2.8 | -0.8 |
| Jan | 2.7 | 3.1 |
| Dec 2012 | -3.3 | -2.1 |
| Nov | 0.5 | 1.0 |
| Oct | 1.6 | -0.7 |
| Sep | -3.4 | 0.0 |
| Aug | -0.4 | 0.2 |
| Jul | -1.1 | -1.2 |
| Jun | 4.6 | 0.1 |
| May | -0.7 | 0.5 |
| Apr | -4.7 | -0.2 |
| Mar | 4.2 | 1.3 |
| Feb | 2.5 | 0.2 |
| Jan | 1.9 | -1.8 |
| Dec 2011 | 0.8 | 0.9 |
| Nov | 0.9 | -0.6 |
| Oct | -0.4 | 0.2 |
| Sep | 1.2 | 0.2 |
| Aug | 3.4 | -0.5 |
| Jul | -2.4 | 0.4 |
| Jun | -2.0 | 2.0 |
| May | 4.5 | -1.5 |
| Apr | 4.8 | 1.1 |
| Mar | -2.9 | -2.2 |
| Feb | 3.0 | 0.6 |
| Jan | 3.3 | 0.9 |
| Dec 2010 | -0.2 | 0.3 |
| Dec 2009 | -2.2 | |
| Dec 2008 | 3.4 | |
| Dec 2007 | -6.2 | |
| Dec 2006 | 1.3 |
Source: Statistisches Bundesamt Deutschland (Destatis) https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
Chart VE-2 of the Statistisches Bundesamt Deutschland, Federal Statistical Office of Germany, shows retail sales at constant prices from 2009 to 2013. There appear to be fluctuations without trend.
Chart VE-2, Germany, Turnover in Retail Trade at Constant Prices 2005=100
Source: Statistisches Bundesamt Deutschland (Destatis), Federal Statistical Office of Germany
https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
Chart VE-3 of the Statistisches Bundesamt Deutschland, Federal Statistical Office of Germany, shows retail sales at current prices from 2005 to 2013. There are also sharp fluctuations but without trend.
Chart VE-3, Germany, Turnover in Retail Sales at Current Prices, Original Values, 2005=100
Source: Statistisches Bundesamt Deutschland (Destatis), Federal Statistical Office of Germany
https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.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 IVQ1949 to IVQ2012 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 fourth quarter data, is 1.0 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 | 1.0 |
| 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 |
Source: Institut National de la Statistique et des Études Économiques http://www.insee.fr/en/themes/info-rapide.asp?id=28&date=20130327
The Markit Flash France Composite Output Index increased from 41.9 in Mar, which was the lowest reading in four years, to 44.2 in Apr (http://www.markiteconomics.com/Survey/PressRelease.mvc/6dafcd8352ea42db99a917747050e63b). Jack Kennedy, Senior Economist at Markit and author of the report, finds that the data suggest the index in Apr improved the sharpest decline of overall output in about four years since IQ2009 conditions of the private sector in France continue struggling (http://www.markiteconomics.com/Survey/PressRelease.mvc/6dafcd8352ea42db99a917747050e63b).
The Markit France Composite Output Index, combining services and manufacturing with close association with French GDP, increased from 41.9 in Mar to 44.3 in Apr, indicating of private sector activity at the slowest rate of deterioration in 2013 (http://www.markiteconomics.com/Survey/PressRelease.mvc/e36516ccd4cb42b980b63e9370857958). Jack Kennedy, Senior Economist at Markit and author of the France Services PMI®, finds that composite data for manufacturing and services indicate weak expectations of business activity (http://www.markiteconomics.com/Survey/PressRelease.mvc/e36516ccd4cb42b980b63e9370857958). The Markit France Services Activity index increased from 41.3 in Mar to 44.3 in Apr (http://www.markiteconomics.com/Survey/PressRelease.mvc/e36516ccd4cb42b980b63e9370857958). The Markit France Manufacturing Purchasing Managers’ Index® increased marginally to 44.4 in Apr from 44.0 in Mar, for the highest reading since Dec 2012 but remaining deeply below the neutral level of 50.0 (http://www.markiteconomics.com/Survey/PressRelease.mvc/6991f050ab1b42e497b80087c06ada32). Jack Kennedy, Senior Economist at Markit and author of the France Manufacturing PMI®, finds continuing weakness in manufacturing with favorable decline in input costs (http://www.markiteconomics.com/Survey/PressRelease.mvc/6991f050ab1b42e497b80087c06ada32). Table FR provides the country data table for France.
Table FR, France, Economic Indicators
| CPI | Apr month ∆% -0.1 |
| PPI | Apr month ∆%: -0.9 Blog 6/2/13 |
| GDP Growth | IQ2013/IQ2012 ∆%: -0.2 |
| Industrial Production | Mar ∆%: |
| Consumer Spending | Manufactured Goods |
| Employment | IVQ2012 Unemployed 2.944 million |
| Trade Balance | Mar Exports ∆%: month 1.4, 12 months -0.4 Mar Imports ∆%: month -1.1, 12 months -3.1 Blog 5/12/13 |
| Confidence Indicators | Historical averages 100 Apr Mfg Business Climate 92 Blog 5/26/13 |
Links to blog comments in Table FR:
5/26/13 http://cmpassocregulationblog.blogspot.com/2013/05/united-states-commercial-banks-assets.html
5/19/13 http://cmpassocregulationblog.blogspot.com/2013/05/word-inflation-waves-squeeze-of.html
5/12/13 http://cmpassocregulationblog.blogspot.com/2013/05/recovery-without-hiring-collapse-of.html
3/10/13 http://cmpassocregulationblog.blogspot.com/2013/03/thirty-one-million-unemployed-or.html
The monthly report of household expenditures in consumption goods for France is in Table VF-1. Total consumption decreased 0.3 percent in Apr 2013 after increasing 1.3 percent in Mar 2013. Consumption of manufactured products decreased 0.4 percent in Apr 2013 after increasing 1.3 percent in Mar 2013. Total consumption increased 0.2 percent in Apr 2013 relative to Apr 2012 and consumption of manufactured goods increased 0.2 percent in Apr 2013 relative to Apr 2012. Internal demand is weak throughout most advanced economies.
Table VF-1, France, Household Expenditures in Consumption Goods, Month ∆% Chained Billion Euros Trading-Days SA
| Total | Food | Eng. Goods | Energy | Mfg | |
| Apr 2013 | -0.3 | -3.3 | 1.0 | 2.8 | -0.4 |
| Apr 2013/Apr 2012 | 0.2 | -1.3 | 0.1 | 2.9 | 0.2 |
| Mar | 1.3 | 2.7 | -0.6 | 3.2 | 1.3 |
| Feb | -0.3 | -0.8 | -0.8 | 1.6 | -0.8 |
| Jan | -0.5 | 0.7 | -2.2 | 1.5 | -1.1 |
| Dec 2012 | 0.0 | 0.2 | 1.5 | -3.9 | 0.5 |
| Nov | 0.1 | -0.5 | -0.3 | 2.2 | -0.2 |
| Oct | 0.0 | -0.6 | 0.3 | 0.3 | 0.1 |
| Sep | 0.1 | -0.3 | 0.2 | 0.5 | 0.0 |
| Aug | -0.8 | 0.1 | -0.8 | -2.4 | -0.9 |
| Jul | 0.2 | -0.1 | 0.5 | -0.1 | 0.3 |
| Jun | 0.6 | 1.0 | 0.0 | 1.0 | 0.5 |
| May | -0.2 | -0.3 | 1.5 | -3.8 | 0.9 |
| Apr | 0.7 | 0.0 | -2.7 | 11.0 | -1.3 |
| Mar | -3.1 | -2.0 | 0.9 | -14.0 | -0.9 |
| Feb | 2.7 | 1.8 | -0.3 | 12.3 | 1.1 |
| Jan | -0.2 | 0.9 | -1.6 | 1.4 | -0.5 |
| Dec 2011 | -0.2 | -0.8 | 0.4 | -0.7 | -0.3 |
| Nov | -0.3 | 0.2 | 0.0 | -2.0 | -0.2 |
| Oct | -0.1 | -0.7 | 0.5 | -0.6 | -0.1 |
| Sep | -0.3 | 0.4 | 0.0 | -2.9 | -0.3 |
| Aug | 0.8 | 0.5 | 0.5 | 2.4 | 0.9 |
| Jul | -0.1 | 0.0 | -0.4 | 0.5 | -0.1 |
| Jun | 0.2 | -0.6 | 0.4 | 1.4 | 0.3 |
| May | 0.2 | -0.5 | -0.4 | 3.6 | -0.6 |
| Apr | -1.9 | 0.5 | -2.5 | -5.3 | -1.4 |
| Mar | -0.7 | -0.4 | -0.9 | -1.2 | -0.9 |
| Feb | 0.8 | 0.9 | 1.8 | -2.0 | 1.3 |
| Jan | -1.3 | -0.8 | -0.2 | -5.1 | -0.5 |
| Dec 2010 | 0.9 | 0.4 | 0.4 | 3.5 | 0.5 |
Eng. Goods: Engineered Goods
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=19&date=20130531
Chart VF-1 of the Institut National de la Statistique et des Études Économiques of France provides consumption of manufactured goods in France in volumes of chained 2005 billion euro from Jan 1980 to Apr 2013. Consumption of manufactured goods increased above the level before the global recession but shows declining trend in recent months.
Char VF-1, France, Consumption of Manufactured Goods, Volume Chained 2005 Billion Euro and Converted Euro, Jan 1980 to Apr 2013
Adjusted and Quarterly ∆%
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=19&date=20130531
Chart VF-1 of Institut National de la Statistique et des Études Économiques of France provides growth of total consumption in France. Internal demand is not supporting overall economic growth. There is downward trend of monthly consumption with fluctuations and stability in the final segment followed by another drop in Jan-Feb 2013 and increase in Mar 2013 but renewed decrease in Apr 2013.
Chart VF-2, France, Total Consumption of Goods, Billions of Euros Trading and Seasonally Adjusted and Quarterly ∆%
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=19&date=20130531
VG Italy. Table VG-IT provides percentage changes in a quarter relative to the same quarter a year earlier of Italy’s expenditure components in chained volume measures. GDP has been declining at sharper rates from minus 0.5 percent in IVQ2011 to minus 2.8 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 | |||||
| IVQ | -2.8 | -6.6 | -3.9 | -7.6 | 1.9 |
| IIIQ | -2.6 | -8.0 | -4.3 | -8.5 | 2.5 |
| IIQ | -2.6 | -7.5 | -4.1 | -8.6 | 2.5 |
| IQ | -2.6 | -9.0 | -3.4 | -7.2 | 1.9 |
| 2011 | |||||
| IVQ | -0.5 | -6.8 | -1.9 | -3.2 | 3.2 |
| IIIQ | 0.4 | 0.1 | -0.6 | -2.2 | 5.7 |
| IIQ | 0.9 | 3.1 | 0.6 | -0.3 | 7.0 |
| IQ | 1.2 | 8.8 | 1.0 | 0.3 | 10.8 |
| 2010 | |||||
| IVQ | 1.9 | 15.4 | 1.0 | 0.9 | 13.3 |
| IIIQ | 1.7 | 13.2 | 1.2 | 2.7 | 12.1 |
| IIQ | 1.9 | 13.5 | 0.9 | 0.8 | 12.0 |
| IQ | 1.2 | 7.1 | 0.9 | -2.1 | 7.1 |
| 2009 | |||||
| IVQ | -3.4 | -6.4 | 0.2 | -7.8 | -9.3 |
| IIIQ | -4.9 | -12.2 | -0.8 | -12.6 | -16.4 |
| IIQ | -6.6 | -17.9 | -1.5 | -13.6 | -21.4 |
| IQ | -7.0 | -17.2 | -1.7 | -12.6 | -22.8 |
| 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/84408
The Markit/ADACI Business Activity Index increased from 45.5 in Mar to 47.0 in Apr, indicating contraction of output of Italy’s services sector for 23 consecutive months of decline since Jun 2011 but at a high in 20 months and above the average for the period of contraction (http://www.markiteconomics.com/Survey/PressRelease.mvc/48355ce5432a42259bbb65b5397deb81). Phil Smith, economist at Markit and author of the Italy Services PMI®, finds that the index suggests a bottom for the contraction in Italy (http://www.markiteconomics.com/Survey/PressRelease.mvc/48355ce5432a42259bbb65b5397deb81). The Markit/ADACI Purchasing Managers’ Index® (PMI®), increased from 44.5 in Mar to 45.5 in Apr for 21 consecutive months of contraction of Italy’s manufacturing below 50.0 with the Apr reading marginally below the average in
IQ2013 (http://www.markiteconomics.com/Survey/PressRelease.mvc/51837a55ad9c42eeb4bed079157e67bd). Phil Smith, economist at Markit and author of the Italian Manufacturing PMI®, finds renewed deterioration with continuing decline in new orders and the contraction extending in a longer period than during the global recession in 2008 to 2009 (http://www.markiteconomics.com/Survey/PressRelease.mvc/51837a55ad9c42eeb4bed079157e67bd). Table IT provides the country data table for Italy.
Table IT, Italy, Economic Indicators
| Consumer Price Index | May month ∆%: 0.1 |
| Producer Price Index | Apr month ∆%: -0.5 Blog 6/2/13 |
| GDP Growth | IQ2013/IVQ2012 SA ∆%: minus 0.5 |
| Labor Report | Apr 2013 Participation rate 63.8% Employment ratio 56.0% Unemployment rate 12.0% Blog 6/2/13 |
| Industrial Production | Mar month ∆%: -0.8 |
| Retail Sales | Mar month ∆%: -0.3 Mar 12-month ∆%: -3.0 Blog 5/26/13 |
| Business Confidence | Mfg May 88.5, Jan 88.3 Construction May 81.8, Jan 80.4 Blog 6/2/13 |
| Trade Balance | Balance Mar SA €2384 million versus Feb €2067 |
Links to blog comments in Table IT:
5/26/13 http://cmpassocregulationblog.blogspot.com/2013/05/united-states-commercial-banks-assets.html
5/19/13 http://cmpassocregulationblog.blogspot.com/2013/05/word-inflation-waves-squeeze-of.html
5/12/13 http://cmpassocregulationblog.blogspot.com/2013/05/recovery-without-hiring-collapse-of.html
3/17/13 http://cmpassocregulationblog.blogspot.com/2013/03/recovery-without-hiring-ten-million.html
Data on Italy’s labor market since 2004 are provided in Table VG-1. The unemployment rate has risen from 6.2 percent in Dec 2006 to 12.0 percent in Apr 2013. As in other advanced economies, unemployment has reached high levels.
Table VG-1, Italy, Labor Report
| Participation Rate % | Employment Ratio % | Unemployment Rate % | |
| Apr 2013 | 63.8 | 56.0 | 12.0 |
| Mar | 63.8 | 56.1 | 11.9 |
| Feb | 64.0 | 56.3 | 11.9 |
| Jan | 63.9 | 56.1 | 11.9 |
| Dec 2012 | 63.7 | 56.3 | 11.4 |
| Nov | 63.8 | 56.4 | 11.3 |
| Oct | 63.9 | 56.6 | 11.3 |
| Sep | 63.6 | 56.6 | 11.0 |
| Aug | 63.6 | 56.7 | 10.7 |
| Jul | 63.7 | 56.8 | 10.7 |
| Jun | 63.7 | 56.8 | 10.7 |
| May | 63.6 | 56.9 | 10.4 |
| Apr | 63.7 | 56.9 | 10.6 |
| Mar | 63.5 | 56.9 | 10.3 |
| Feb | 63.4 | 56.9 | 10.0 |
| Jan | 63.2 | 57.1 | 9.6 |
| Dec 2011 | 63.0 | 57.0 | 9.5 |
| Nov | 62.7 | 56.7 | 9.3 |
| Oct | 62.6 | 57.0 | 8.8 |
| Sep | 62.4 | 56.8 | 8.9 |
| Aug | 62.5 | 57.1 | 8.4 |
| Jul | 62.2 | 56.9 | 8.3 |
| Jun | 62.0 | 57.0 | 8.0 |
| May | 62.0 | 57.0 | 8.1 |
| Apr | 61.7 | 56.9 | 7.7 |
| Mar | 62.1 | 57.2 | 7.9 |
| Feb | 61.8 | 56.9 | 7.9 |
| Jan | 61.9 | 56.9 | 8.1 |
| Dec 2010 | 62.1 | 57.0 | 8.2 |
| Dec 2009 | 62.3 | 57.1 | 8.3 |
| Dec 2008 | 62.4 | 58.1 | 6.8 |
| Dec 2007 | 63.1 | 58.9 | 6.5 |
| Dec 2006 | 62.5 | 58.6 | 6.2 |
| Dec 2005 | 62.6 | 57.8 | 7.5 |
| Dec 2004 | 62.5 | 57.5 | 7.9 |
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/91565
Table VG-2 provides more detail on the labor report for Italy in Apr 2012. The level of employment decreased 18,000 from Mar to Apr 2013 and fell 373,000 Apr 2012 to Apr 2013. Unemployment increased 23,000 in Apr 2013 and increased 373,000 from a year earlier. A dramatic aspect found in most advanced economies is the high rate of unemployment of youth at 36.2 percent in Apr 2013 for ages 15 to 24 years.
Table VG-2, Italy, Labor Report
| Apr 2013 | 1000s | Change from Prior Month 1000s | ∆% from Prior Month | Change from Prior Year 1000s | ∆% from Prior Year |
| EMP | 22.596 | -18 | -0.1 | -373 | -1.6 |
| UNE | 3.083 | 23 | 0.7 | 373 | 13.8 |
| INA 15-64 | 14.334 | 25 | 0.2 | -44 | -0.3 |
| EMP % | 56.0 | -0.1 | -0.9 | ||
| UNE % | 12.0 | 0.1 | 1.5 | ||
| Youth UNE % 15-24 | 40.5 | 0.2 | 5.9 | ||
| INA % 15-64 | 36.2 | 0.1 | -0.1 |
Notes: EMP: Employed; UNE: Unemployed; INA 15-64: Inactive aged 15 to 64; EMP %: Employment Rate; UNE %: Unemployment Rate; Youth UNE % 15-24: Youth Unemployment Rate aged 15 to 24; INA % 15-64: Inactive Rate aged 15 to 64.
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/91565
Chart VG-1 of the Istituto Nazionale di Statistica provides the rate of unemployment in Italy. The rate increase from 10.6 percent in Apr 2012 to 12.0 percent in Apr 2013.
Chart VG-1, Italy, Rate of Unemployment, %
Source: Istituto Nazionale di Statistica
Chart VG-2 of the Istituto Nazionale di Statistica provides the total number of employed persons in Italy. The level of employment dropped from slightly below 23 million in Apr 2012 to 22.596 million in Apr 2013.
Chart VG-2, Italy, Total Number of Employed Persons, Millions, SA
Source: Istituto Nazionale di Statistica
Italy’s index of business confidence in manufacturing and construction is provided in Table VG-3. There has been stabilization of manufacturing confidence below the historical average of 100 from 88.3 in Jan 2013 to 88.5 in May 2013. Order books deteriorated to minus 44 in May 2013. There is oscillation in construction with the index moving from 80.4 in Jan 2013 to 81.8 in May 2013.
Table VG-3, Italy, Index of Business Confidence in Manufacturing and Construction 2005=100
| May 2013 | Apr 2013 | Mar 2013 | Feb 2013 | Jan 2013 | |
| Mfg Confidence | 88.5 | 87.9 | 88.9 | 88.5 | 88.3 |
| Order Books | -44 | -45 | -43 | -42 | -43 |
| Stocks Finished Products | 1 | -1 | 0 | 1 | 0 |
| Production | -2 | -4 | -3 | -4 | -4 |
| Construction Confidence | 81.8 | 78.4 | 80.0 | 81.5 | 80.4 |
| Order Books | -49 | -52 | -53 | -51 | -50 |
| Employment | -13 | -17 | -13 | -13 | -15 |
Mfg: manufacturing
Source: Istituto Nazionale di Statistica
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 1.0 percent in 2011 and 0.3 percent in 2012. The bottom part of Table VH-UK provides average growth rates of UK GDP since 1948. The UK economy grew at 2.6 percent on average between 1948 and 2012, 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 1.0 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 | 1.0 |
| 2012 | 0.3 |
| Average ∆% per Year | |
| 1948-2012 | 2.6 |
| 1948-1959 | 2.9 |
| 1960-1969 | 3.3 |
| 1970-1979 | 2.5 |
| 1980-1989 | 3.2 |
| 1990-1999 | 2.6 |
| 2000-2012 | 1.6 |
| 2000-2007 | 3.0 |
| 2009-2012 | 1.0 |
Source: UK Office for National Statistics Statistics http://www.ons.gov.uk/ons/rel/naa2/second-estimate-of-gdp/q1-2013/index.html
The Business Activity Index of the Markit/CIPS UK Services PMI® increased from 52.4 in Mar to 52.9 in Apr, indicating increase in activity in every month since the beginning of 2013 (http://www.markiteconomics.com/Survey/PressRelease.mvc/adb4686ad34742cf80b3a54f1334b1cb). Chris Williamson, Chief Economist at Markit, finds continuing improvement in the UK’s economy (http://www.markiteconomics.com/Survey/PressRelease.mvc/adb4686ad34742cf80b3a54f1334b1cb). The Markit/CIPS UK Manufacturing Purchasing Managers’ Index® (PMI®) increased from 48.6 in Mar to 49.8 in Apr (http://www.markiteconomics.com/Survey/PressRelease.mvc/c442cfc78c0a4267a9b3d10be64598a8). Rob Dobson, Senior Economist at Markit that compiles the Markit/CIPS Manufacturing PMI®, finds manufacturing may not restrain overall growth (http://www.markiteconomics.com/Survey/PressRelease.mvc/c442cfc78c0a4267a9b3d10be64598a8). Table UK provides the economic indicators for the United Kingdom.
Table UK, UK Economic Indicators
| CPI | Apr month ∆%: 0.2 |
| Output/Input Prices | Output Prices: Apr 12-month NSA ∆%: 1.1; excluding food, petroleum ∆%: 0.8 |
| GDP Growth | IQ2013 prior quarter ∆% 0.3; year earlier same quarter ∆%: 0.6 |
| Industrial Production | Mar 2013/Mar 2012 ∆%: Production Industries minus 1.4; Manufacturing minus 1.4 |
| Retail Sales | Mar month ∆%: -0.7 |
| Labor Market | Jan-Mar Unemployment Rate: 7.8%; Claimant Count 4.5%; Earnings Growth 0.4% |
| Trade Balance | Balance Mar minus ₤3130 million |
Links to blog comments in Table UK:
5/26/13 http://cmpassocregulationblog.blogspot.com/2013/05/united-states-commercial-banks-assets.html
5/19/13 http://cmpassocregulationblog.blogspot.com/2013/05/word-inflation-waves-squeeze-of.html
5/12/13 http://cmpassocregulationblog.blogspot.com/2013/05/recovery-without-hiring-collapse-of.html
4/28/13 http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.html
03/31/13 http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states.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 9.0 percent by Fri May 31, 2013. 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 | 5/31/2013 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.2996 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 5/31/ 2013 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.1347 |
| 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 1.2996/EUR on May 31, 2013 or by 9.0 percent {[(1.2996/1.192)-1]100 = 9.0%}. 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 6.1347/USD on Fri May 31, 2013, or by an additional 10.1 percent, for cumulative revaluation of 25.9 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 May 10, 0.3 percent in the week of May 17 and 0.1 percent in the week of May 24. The CNY devaluated by 0.1 percent in the week of May 31, 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 | 5/31/ |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.2996 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 5/31/ 2013 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.1347 |
| Weekly Rates | 5/10/2013 | 5/17/2013 | 5/24/2013 | 5/31/ 2013 |
| CNY/USD | 6.1395 | 6.1395 | 6.1314 | 6.1347 |
| ∆% from Earlier Week* | 0.3 | 0.3 | 0.1 | -0.1 |
*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 Apr 5, 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 and revalued the CNY by 1.6 percent relative to the dollar from CNY 6.3588/USD on Oct 29, 2011. By May 31, 2013, the CNY revalued 3.5 percent to CNY 6.1347/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 | |
| 5/31/13 | 6.1347 | 3.5 |
| 5/24/13 | 6.1314 | 3.6 |
| 5/17/13 | 6.1395 | 3.4 |
| 5/10/13 | 6.1395 | 3.4 |
| 5/3/13 | 6.1553 | 3.2 |
| 4/26/13 | 6.1636 | 3.1 |
| 4/19/13 | 6.1788 | 2.8 |
| 4/12/13 | 6.1947 | 2.6 |
| 4/5/13 | 6.2051 | 2.4 |
| 3/29/13 | 6.2119 | 2.3 |
| 3/22/13 | 6.2112 | 2.3 |
| 3/15/13 | 6.2131 | 2.3 |
| 3/8/13 | 6.2142 | 2.3 |
| 3/1/13 | 6.2221 | 2.1 |
| 2/22/15 | 6.2350 | 1.9 |
| 2/15/13 | 6.2328 | 2.0 |
| 2/8/13 | 6.2323 | 2.0 |
| 2/1/13 | 6.2316 | 2.0 |
| 1/25/13 | 6.2228 | 2.1 |
| 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, 1995 to May 24, 2013 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, 2013, appreciating to CNY 6.1311/USD on May 24, 2013, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD by 25.9 percent by May 31, 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 decrease or revaluation in the final segment.
Chart VI-1, Chinese Yuan (CNY) per US Dollar (US), Jan 3, 1995-May 24, 2013
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
Chart VI-1A provides the daily CNY/USD rate from Jan 5, 1981 to May 24, 2013. The exchange rate was CNY 1.5418/USD on Jan 5, 1981. There is sharp cumulative depreciation 107.8 percent to CNY 3.2031 by Jul 2, 1986, continuing to CNY 5.8145/USD on Dec 29, 1993 for cumulative 277.1 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 465.0 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 6.1311/USD on May 24, 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-May24, 2013
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
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.
Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart VI-1B for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart VI-1B cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s. The loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy. This interpretation is consistent with the case of the 24 emerging market economies analyzed by Reinhart and Rogoff (2010GTD, 4), concluding that “higher debt levels are associated with significantly higher levels of inflation in emerging markets. Median inflation more than doubles (from less than seven percent to 16 percent) as debt rises from the low (0 to 30 percent) range to above 90 percent. Fiscal dominance is a plausible interpretation of this pattern.”
The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:
“So, inflation is caused by ‘tightness’ and deflation by ‘slack’ in the economy. This is not just a cause and forecasting variable, it is the cause, because given ‘slack’ we apparently do not have to worry about inflation from other sources, notwithstanding the weak correlation of [Phillips circuits]. These statements [by the Fed] do mention ‘stable inflation expectations. How does the Fed know expectations are ‘stable’ and would not come unglued once people look at deficit numbers? As I read Fed statements, almost all confidence in ‘stable’ or ‘anchored’ expectations comes from the fact that we have experienced a long period of low inflation (adaptive expectations). All these analyses ignore the stagflation experience in the 1970s, in which inflation was high even with ‘slack’ markets and little ‘demand, and ‘expectations’ moved quickly. They ignore the experience of hyperinflations and currency collapses, which happen in economies well below potential.”
Chart 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.
The 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. Table VI-2C provides inflation, devaluation, overnight interest rate and indexing. 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/pubs/ft/weo/2013/01/weodata/index.aspx) is used to contract Table VI-3 with fiscal and current account imbalances projected for 2013 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 2012 | FD | CAD | Debt | FD%GDP | CAD%GDP | Debt | |
| US | 15685 | -7.3 | -3.1 | 80.3 | -2.3 | -3.2 | 88.3 |
| Japan | 5964 | -9.1 | 2.0 | 126.6 | -5.8 | 2.4 | 155.0 |
| UK | 2441 | -5.8 | -1.9 | 78.3 | -0.8 | -0.4 | 88.1 |
| Euro | 12198 | -1.6 | 0.3 | 68.4 | 1.1 | 1.2 | 71.3 |
| Ger | 3401 | 0.7 | 5.7 | 56.1 | 1.4 | 4.3 | 52.4 |
| France | 2609 | -2.9 | -2.2 | 80.4 | 0.3 | -0.8 | 83.8 |
| Italy | 2014 | 0.8 | -3.2 | 99.6 | 4.4 | -1.6 | 101.5 |
| Can | 1819 | -4.1 | -2.8 | 33.3 | -1.1 | -2.5 | 37.4 |
| China | 8227 | -1.2 | 2.7 | 25.8 | -0.1 | 3.4 | 14.8 |
| Brazil | 2396 | 3.3 | -2.4 | 33.6 | 3.1 | -3.3 | 30.8 |
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/pubs/ft/weo/2013/01/weodata/index.aspx
The current account of the US balance of payments is provided in Table VI-3A for IVQ2011 and IVQ2012. The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US decreased from $117.9 billion in IVQ2011, or 3.1 percent of GDP, to $111.2 billion in IIIQ2012, or 2.8 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
| IVQ2011 | IVQ2012 | Difference | |
| Goods Balance | -186,332 | -176,774 | 9,558 |
| X Goods | 387,237 | 399,304 | 3.1 ∆% |
| M Goods | -573,569 | -576,078 | 0.4 ∆% |
| Services Balance | 44,252 | 52,148 | 3,647 |
| X Services | 151,164 | 158,749 | 5.0 ∆% |
| M Services | -106,912 | -106,601 | -0.3 ∆% |
| Balance Goods and Services | -142,080 | -124,626 | 17,454 |
| Balance Income | 56,263 | 48,293 | -7,970 |
| Unilateral Transfers | -32,135 | -34,827 | -2,692 |
| Current Account Balance | -117,952 | -111,159 | 6,793 |
| % GDP | IVQ2011 | IVQ2012 | IIIQ2012 |
| 3.1 | 2.8 | 2.8 |
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 http://www.bea.gov/iTable/index_nipa.cfm
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 7.0 percent of GDP (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.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 $15,549 billion for fiscal year 2012 by the CBO (http://www.cbo.gov/publication/43905 CBO (2013BEOFeb5)). 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 67.8 percent of GDP and is estimated to reach 72.5 percent of GDP in 2012 (CBO2012AugBEO, CBO2012NovCDR, CBO2013BEOFeb5). 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 %
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |
| Goods & | -696 | -698 | -379 | -495 | -560 | -539 |
| Income | 101 | 147 | 119 | 184 | 227 | 198 |
| UT | -115 | -126 | -122 | -131 | -133 | -134 |
| Current Account | -710 | -677 | -382 | -442 | -466 | -475 |
| NGDP | 14028 | 14291 | 13974 | 14499 | 15076 | 15681 |
| Current Account % GDP | -5.1 | -4.7 | -2.7 | -3.1 | -3.1 | -3.0 |
| NIIP | -1796 | -3260 | -2321 | -2474 | -4030 | NA |
| US Owned Assets Abroad | 18399 | 19464 | 18512 | 20298 | 21132 | NA |
| Foreign Owned Assets in US | 20195 | 22724 | 20833 | 22772 | 25162 | NA |
| NIIP % GDP | -12.8 | -22.8 | -16.6 | -17.1 | -26.7 | NA |
| Exports | 2488 | 2657 | 2181 | 2519 | 2848 | 2937 |
| NIIP % | -72 | -123 | -106 | -98 | -142 | NA |
| DIA MV | 5274 | 3102 | 4287 | 4767 | 4499 | NA |
| DIUS MV | 3551 | 2486 | 2995 | 3397 | 3509 | NA |
| Fiscal Balance | -161 | -459 | -1413 | -1294 | -1296 | -1089 |
| Fiscal Balance % GDP | -1.2 | -3.2 | -10.1 | -9.0 | -8.7 | -7.0 |
| Federal Debt | 5035 | 5803 | 7545 | 9019 | 10128 | 11280 |
| Federal Debt % GDP | 36.3 | 40.5 | 54.1 | 62.9 | 67.8 | 72.5 |
| Federal Outlays | 2729 | 2983 | 3518 | 3456 | 3598 | 3538 |
| ∆% | 2.8 | 9.3 | 17.9 | -1.8 | 4.1 | -1.7 |
| % GDP | 19.7 | 20.8 | 25.2 | 24.1 | 24.1 | 22.8 |
| Federal Revenue | 2568 | 2524 | 2105 | 2162 | 2302 | 2449 |
| ∆% | 6.7 | -1.7 | -16.6 | 2.7 | 6.5 | 6.4 |
| % GDP | 18.5 | 17.6 | 15.1 | 15.1 | 15.4 | 15.8 |
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: http://www.bea.gov/international/index.htm#bop Balance of Payments and NIIP, Bureau of Economic Analysis (BEA)
Gross Domestic Product, Bureau of Economic Analysis (BEA) http://www.bea.gov/iTable/index_nipa.cfm
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 GDP relative to a year earlier decelerated from 12.1 percent in IQ2010 to 7.4 percent in IIIQ2012, 7.9 percent in IVQ2012 and 7.7 percent in IQ2013. Growth of secondary industry decelerated from 14.5 percent in IQ2010 to 8.1 percent in IIIQ2012, 8.1 percent in IVQ2012 and 7.8 percent in IQ2013. China’s GDP growth decelerated significantly from annual equivalent 9.9 percent in IIQ2011 to 7.4 percent in IVQ2011 and 6.6 percent in IQ2012, rebounding to 7.8 percent in IIQ2012, 8.7 percent in IIIQ2012 and 8.2 percent in IVQ2012. Annual equivalent growth in IQ2013 fell to 6.6 percent. (See Subsection VC and earlier at http://cmpassocregulationblog.blogspot.com/2013/01/recovery-without-hiring-world-inflation.html 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 2010, 1.8 percent in 2011 and 2.2 percent in 2012 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.html). Growth is not only mediocre but sharply decelerating to a rhythm that is not consistent with reduction of unemployment and underemployment of 28.6 million people. (ii) The labor market continues fractured with 28.6 million unemployed or underemployed (http://cmpassocregulationblog.blogspot.com/2013/05/twenty-nine-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2013/04/thirty-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/2013/02/united-states-unsustainable-fiscal.html 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 (Section I http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html and earlier 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 72.5 percent in 2012. The CBO (2012AugBEO, CBO2012NovCDR, 2013BEOFeb5) 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 (Section I at http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html).
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, 1.3 percent in IQ2012 relative to IVQ2011; fell 0.2 percent in IIQ2012 relative to IQ2012, increasing 4.0 percent relative to a year earlier; contracted 0.9 percent in IIIQ2012, increasing 0.3 percent relative to a year earlier; increased 0.3 percent in IVQ2012, growing 0.5 percent relative to a year earlier and grew 0.9 percent in IQ2013 and 0.2 percent relative to a year earlier (http://cmpassocregulationblog.blogspot.com/2013/05/word-inflation-waves-squeeze-of.html
http://cmpassocregulationblog.blogspot.com/2013/03/thirty-one-million-unemployed-or.html). The euro zone’s GDP fell 0.1 in IQ2012 and 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 0.7 percent relative to a year earlier; fell 0.6 percent in IVQ2012, declining 0.9 percent relative to a year earlier; and fell 0.2 percent in IQ2013, decreasing 1.0 percent relative to a year earlier. Germany’s GDP grew 0.6 percent in IQ2012 and 1.8 percent relative to IQ2011; increasing 0.2 percent in IIQ2012 and 0.5 percent relative to IIQ2011; growing 0.2 percent in IIIQ2012 with growth of 0.4 percent relative to a year earlier; falling 0.7 percent in IVQ2012, growing 0.0 percent relative to a year earlier; and increased 0.1 percent in IQ2013 but fell 1.0 percent relative to a year earlier. The UK’s GDP fell 0.1 percent in IVQ2011, 0.1 percent in IQ2012 and 0.4 percent in IIQ2012 for cumulative decline of 0.6 percent in three consecutive quarters at annual equivalent rate of minus 0.8 percent and changed 0.0 percent in IIQ2012 relative to IIQ2011. In IIIQ2012, the UK grew 0.9 percent relative to IIQ2012 and increased 0.4 percent relative to IIIQ2011. UK GDP contracted 0.3 percent in IVQ2012 and increased 0.2 relative to a year earlier. In IQ2013, UK’s GDP increased 0.3 percent and 0.6 percent relative to a year earlier. There is still high unemployment in advanced economies
4. World Inflation Waves. Inflation continues in repetitive waves globally (http://cmpassocregulationblog.blogspot.com/2013/05/word-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.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 56.0 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to May 31, 2013, S&P 500 has gained 59.5 percent and DAX 47.2 percent. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). 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). Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.
Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans.
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). 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). Matt Jarzemsky, writing on Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 15,115.57
on Fri May 31, 2013, which is higher by 6.7 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 6.5 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs.
The week of May 24 was dominated by the testimony of Chairman Bernanke to the Joint Economic Committee of the US Congress on May 22, 2013 (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm), followed by questions and answers and the release on May 22, 2013 of the minutes of the meeting of the Federal Open Market Committee (FOMC) from Apr 30 to May 1, 2013 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm). Monetary policy emphasizes communication of policy intentions to avoid that expectations reverse outcomes in reality (Kydland and Prescott 1977). Jon Hilsenrath, writing on “In bid for clarity, Fed delivers opacity,” on May 23, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath), analyzes discrepancies in communication by the Fed. The annotated chart of values of the Dow Jones Industrial Average (DJIA) during trading on May 23,2013 provided by Hinselrath, links the prepared testimony of Chairman Bernanke at 10:AM, following questions and answers and the release of the minutes of the FOMC at 2PM. Financial markets strengthened between 10 and 10:30AM on May 23, 2013, perhaps because of the statement by Chairman Bernanke in prepared testimony (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm):
“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.”
In that testimony, Chairman Bernanke (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm) also analyzes current weakness of labor markets:
“Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down. Moreover, nearly 8 million people are working part time even though they would prefer full-time work. High rates of unemployment and underemployment are extraordinarily costly: Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers' skills and--particularly relevant during this commencement season--by preventing many young people from gaining workplace skills and experience in the first place. The loss of output and earnings associated with high unemployment also reduces government revenues and increases spending on income-support programs, thereby leading to larger budget deficits and higher levels of public debt than would otherwise occur.”
Hilsenrath (op. cit. http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath) analyzes the subsequent decline of the market from 10:30AM to 10:40AM as Chairman Bernanke responded questions with the statement that withdrawal of stimulus would be determined by data but that it could begin in one of the “next few meetings.” The DJIA recovered part of the losses between 10:40AM and 2PM. The minutes of the FOMC released at 2PM on May 23, 2013, contained a phrase that troubled market participants (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm): “A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.” The DJIA closed at 15,387.58 on May 21, 2013 and fell to 15,307.17 at the close on May 22, 2013, with the loss of 0.5 percent occurring after release of the minutes of the FOMC at 2PM when the DJIA stood at around 15,400. The concern about exist of the Fed from stimulus affected markets worldwide as shown in declines of equity indexes in Table III-1 with delays because of differences in trading hours. This behavior shows the trap of unconventional monetary policy with no exit from zero interest rates without risking financial crash and likely adverse repercussions on economic activity.
Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
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:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (1)
Equation (1) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+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 Rt, 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:
Ut = Unt – α(πt – πe) α > 0 (1)
Where Ut is the rate of unemployment at current time t, Unt is the natural rate of unemployment, πt is the current rate of inflation and πe 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(πt, Ut) (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 (πt, Ut - 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: Rt 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; Rt+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; if is the domestic interest rate of the high-yielding country where investment will be made; iusd is the interest rate on short-term dollar debt assumed to be 0.5 percent per year; if >iusd, which expresses the fact that the interest rate on the foreign country is much higher than that in short-term USD (US dollars); St is the dollar value of the investment principal; and π is the dollar profit from the carry trade. The investment of the principal St in the local currency debt of the foreign country provides a profit of:
π = (1 + if)(RtSt)(1/Rt+τ) – (1 + iusd)St (3)
The profit from the carry trade, π, is nonnegative when:
(1 + if)/ (1 + iusd) ≥ Rt+τ/Rt (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 if be 0.10 (10 percent), iusd 0.005 (0.5 percent), St USD100 and Rt 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 Rt+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 Aij = f(r, x) where Aij is the demand for i = 1,2,∙∙∙n assets from j = 1,2, ∙∙∙m sectors, r the 1xn vector of rates of return, ri, 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 Aij 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 4/24/13,” 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 5/10/13” of Table VI-4 are by US equities indexes: DJIA 56.1 percent and S&P 500 59.8 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 46.0 percent above the trough. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.
Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans.
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). Matt Jarzemsky, writing on Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 15,115.57
on Fri May 31, 2013, which is higher by 6.7 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 6.5 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs.
Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
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. The DJIA has increased 56.0 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to May 31, 2013, S&P 500 has gained 59.5 percent and DAX 47.2 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 5/31/13” 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 3.5 percent below the trough; Japan’s Nikkei Average is 56.1 percent above the trough; DJ Asia Pacific TSM is 20.9 percent above the trough; Dow Global is 28.3 percent above the trough; STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 19.4 percent above the trough; and NYSE Financial Index is 36.1 percent above the trough. DJ UBS Commodities is 5.4 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 47.2 percent above the trough. Japan’s Nikkei Average is 56.1 percent above the trough on Aug 31, 2010 and 20.9 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 13,774.54
on Fri May 31, 2013 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 34.3 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 9.0 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 5/31/13” in Table VI-4 shows increase of 0.5 percent for China’s Shanghai Composite in the week. DJ Asia Pacific decreased 2.3 percent. NYSE Financial decreased 0.5 percent in the week. DJ UBS Commodities decreased 0.9 percent. Dow Global decreased 1.0 percent in the week of May 31, 2013. The DJIA decreased 1.2 percent and S&P 500 decreased 1.1 percent. DAX of Germany increased 0.5 percent. STOXX 50 decreased 1.3 percent. The USD depreciated 0.5 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table VI-4 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 5/31/13” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to May 31, 2013. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 5/31/13” but also relative to the peak in column “∆% Peak to 5/31/13.” There are now several equity indexes above the peak in Table VI-4: DJIA 34.9 percent, S&P 500 34.0 percent, DAX 31.8 percent, Dow Global 4.7 percent, DJ Asia Pacific 5.8 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 8.4 percent, Nikkei Average 20.9 percent and STOXX 50 1.1 percent. There is only one equity index below the peak: Shanghai Composite by 27.3 percent. DJ UBS Commodities Index is now 9.9 percent below the peak. The US dollar strengthened 14.1 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. Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. 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 Rτ is expected revenue in the time horizon from τ =1 to T; Cτ 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
![clip_image012[1]](https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhfI4MxPjh5x7xCBTe3vM3zVztm9sKjyjwr2QK4UJivKDuPVnx-UT8xVW6AFvSQofwBdWqNuaTTsAfpGtII_fnVl8FJelnsKcK4cicAFF_Pu9ao5NgDwk6rpu8BfIwL90s82j3KfMvdaoY/s1600-h/clip_image012%25255B1%25255D%25255B2%25255D.gif "clip_image012[1]"){kind=small}
declines. Equally, decline in expected revenue from the stock or project, Rτ, 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 5/31/ /13 | ∆% Week 5/31/13 | ∆% Trough to 5/31/ 13 | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 34.9 | -1.2 | 56.0 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 34.0 | -1.1 | 59.5 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | 8.4 | -0.5 | 36.1 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | 4.7 | -1.0 | 28.3 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | 5.8 | -2.3 | 20.9 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | 20.9 | -5.7 | 56.1 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -27.3 | 0.5 | -3.5 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | 1.1 | -1.3 | 19.4 |
| DAX | 4/26/ | 5/25/ | -10.5 | 31.8 | 0.5 | 47.2 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 14.1 | -0.5 | -9.0 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | -9.9 | -0.9 | 5.4 |
| 10-Year T Note | 4/5/ | 4/6/10 | 3.986 | 2.132 |
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 May 31, 2013, shows that the S&P 500 is now 34.5 percent above the Apr 26, 2010 level and the DJIA is 34.9 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
| ∆% DJIA from prior date | ∆% DJIA from | ∆% S&P 500 from prior date | ∆% S&P 500 from | |
| Apr 26 2010 | ||||
| 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 2011 | 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 |
| Jan 25 | 1.8 | 24.0 | 1.1 | 24.0 |
| Feb 1 | 0.8 | 25.0 | 0.7 | 24.8 |
| Feb 8 | -0.1 | 24.9 | 0.3 | 25.2 |
| Feb 15 | -0.1 | 24.8 | 0.1 | 25.4 |
| Feb 22 | 0.1 | 24.9 | -0.3 | 25.0 |
| Mar 1 | 0.6 | 25.7 | 0.2 | 25.3 |
| Mar 8 | 2.2 | 28.5 | 2.2 | 28.0 |
| Mar 15 | 0.8 | 29.5 | 0.6 | 28.8 |
| Mar 22 | 0.0 | 29.5 | -0.2 | 28.5 |
| Mar 29 | 0.5 | 30.1 | 0.8 | 29.5 |
| Apr 5 | -0.1 | 30.0 | -1.0 | 28.2 |
| Apr 12 | 2.1 | 32.7 | 2.3 | 31.1 |
| Apr 19 | -2.1 | 29.8 | -2.1 | 28.3 |
| Aug 26 | 1.1 | 31.3 | 1.7 | 30.5 |
| May 3 | 1.8 | 33.6 | 2.0 | 33.2 |
| May 10 | 1.0 | 34.9 | 1.2 | 34.8 |
| May 17 | 1.6 | 37.0 | 2.1 | 37.6 |
| May 24 | -0.3 | 36.6 | -1.1 | 36.1 |
| May 31 | -1.2 | 34.9 | -1.1 | 34.5 |
Source: http://professional.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3014
The Communiqué of Meeting of G20 Finance Ministers and Central Bank Governors in Moscow on February 16, 2013, available at the University of Toronto G20 Information Center (http://www.g8.utoronto.ca/g20/2013/2013-0216-finance.html), appears to rule out currency wars:
“Global Economy and G20 Framework for Strong, Sustainable and Balanced Growth
2. Thanks to the important policy actions in Europe, the US, Japan, and the resilience of the Chinese economy, tail risks to the global economy have receded and financial market conditions have improved. However, we recognize that important risks remain and global growth is still too weak, with unemployment remaining unacceptably high in many countries. We agree that the weak global performance derives from policy uncertainty, private deleveraging, fiscal drag, and impaired credit intermediation, as well as incomplete rebalancing of global demand. Under these circumstances, a sustained effort is required to continue building a stronger economic and monetary union in the euro area and to resolve uncertainties related to the fiscal situation in the United States and Japan, as well as to boost domestic sources of growth in surplus economies, taking into account special circumstances of large commodity producers.
3. To address the weakness of the global economy, ambitious reforms and coordinated policies are key to achieving strong, sustainable and balanced growth and restoring confidence. We will continue to implement our previous commitments, including on the financial reform agenda to build a more resilient financial system and on ambitious structural reforms to lift growth. We are committed to ensuring sustainable public finances. Advanced economies will develop credible medium-term fiscal strategies in line with the commitments made by our Leaders in Los Cabos by the St Petersburg Summit. Credible medium-term fiscal consolidation plans will be put in place, and implemented taking into account near-term economic conditions and fiscal space where available. We support action to improve the flow of credit to the economy, where necessary. Monetary policy should be directed toward domestic price stability and continuing to support economic recovery according to the respective mandates. We commit to monitor and minimize the negative spillovers on other countries of policies implemented for domestic purposes. We look forward to the results of the ongoing work on spillovers in the Framework Working Group.
4. We have adopted an assessment process on the implementation of our structural reform commitments, which will inform the direction of our future structural policies.
5. We reaffirm our commitment to cooperate for achieving a lasting reduction in global imbalances, and pursue structural reforms affecting domestic savings and improving productivity. We reiterate our commitments to move more rapidly toward more market-determined exchange rate systems and exchange rate flexibility to reflect underlying fundamentals, and avoid persistent exchange rate misalignments and in this regard, work more closely with one another so we can grow together. We reiterate that excess volatility of financial flows and disorderly movements in exchange rates have adverse implications for economic and financial stability. We will refrain from competitive devaluation. We will not target our exchange rates for competitive purposes, will resist all forms of protectionism and keep our markets open.”
The final phrases rule out “competitive devaluation” and the use of “exchange rates for competitive purposes.” What is seriously absent in this statement of intentions is monetary policy, which is precisely the mechanism by which competitive devaluations are currently implemented.
In the restatement of the liquidity trap and large-scale policies of monetary/fiscal stimulus, Krugman (1998, 162) finds:
“In the traditional open economy IS-LM model developed by Robert Mundell [1963] and Marcus Fleming [1962], and also in large-scale econometric models, monetary expansion unambiguously leads to currency depreciation. But there are two offsetting effects on the current account balance. On one side, the currency depreciation tends to increase net exports; on the other side, the expansion of the domestic economy tends to increase imports. For what it is worth, policy experiments on such models seem to suggest that these effects very nearly cancel each other out.
Krugman (1998) uses a different dynamic model with expectations that leads to similar conclusions.
The central bank could also be pursuing competitive devaluation of the national currency in the belief that it could increase inflation to a higher level and promote domestic growth and employment at the expense of growth and unemployment in the rest of the world. An essay by Chairman Bernanke in 1999 on Japanese monetary policy received attention in the press, stating that (Bernanke 2000, 165):
“Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and experiment—in short, to do whatever it took to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done”
Quantitative easing has never been proposed by Chairman Bernanke or other economists as certain science without adverse effects. What has not been mentioned in the press is another suggestion to the Bank of Japan (BOJ) by Chairman Bernanke in the same essay that is very relevant to current events and the contentious issue of ongoing devaluation wars (Bernanke 2000, 161):
“The BOJ could probably undertake yen depreciation unilaterally; because the BOJ has a legal mandate to pursue price stability, it certainly could make a good argument that, with interest rates at zero, depreciation of the yen is the best available tool for achieving its mandated objective. Defenders of inaction on the yen claim that a large yen depreciation would therefore create serious international tensions. Whatever validity this political argument may have had at various times, it is of no relevance at the moment, for Japan has recently been urged by its most powerful allies and trading partners to weaken the yen—and refused! Moreover, the economic validity of the beggar-thy-neighbor thesis is doubtful, as depreciation creates trade—by raising home-country income—as well as diverting it. Perhaps not all those who cite the beggar-thy-neighbor thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery. A yen trading at 100 to the dollar or less is in no one’s interest.”
Chairman Bernanke is referring to the argument by Joan Robinson based on the experience of the Great Depression that: “in times of general unemployment a game of beggar-my-neighbour is played between the nations, each one endeavouring to throw a larger share of the burden upon the others” (Robinson 1947, 156). Devaluation is one of the tools used in these policies (Robinson 1947, 157). Banking crises dominated the experience of the United States, but countries that recovered were those devaluing early such that competitive devaluations rescued many countries from a recession as strong as that in the US (see references to Ehsan Choudhri, Levis Kochin and Barry Eichengreen in Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 205-9; for the case of Brazil that devalued early in the Great Depression recovering with an increasing trade balance see Pelaez, 1968, 1968b, 1972; Brazil devalued and abandoned the gold standard during crises in the historical period as shown by Pelaez 1976, Pelaez and Suzigan 1981). Beggar-my-neighbor policies did work for individual countries but the criticism of Joan Robinson was that it was not optimal for the world as a whole.
Is depreciation of the dollar the best available tool currently for achieving the dual mandate of higher inflation and lower unemployment? Bernanke (2002) finds dollar devaluation against gold to have been important in preventing further deflation in the 1930s (http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm):
“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”
Should the US devalue following Roosevelt? Alternatively, has monetary policy intended devaluation? Fed policy is seeking, deliberately or as a side effect, what Irving Fisher proposed “that great depressions are curable and preventable through reflation and stabilization” (Fisher, 1933, 350). The Fed has created not only high volatility of assets but also what many countries are regarding as a competitive devaluation similar to those criticized by Nurkse (1944). 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. There is increasing unrest within the G20 and worldwide about the appreciation of exchange rates of most countries while the dollar devalues. Global coordination of policies with free riders in an institution of diverse interests such as the G20 is unlikely. Distortions of financial markets in the US and worldwide depend only on more sober evaluation of risks of unconventional policies at a body without free riders, such as the Federal Open Market Committee (FOMC).
Chairman Bernanke (2013Mar 25) reinterprets devaluation and recovery from the Great Depression:
“The uncoordinated abandonment of the gold standard in the early 1930s gave rise to the idea of "beggar-thy-neighbor" policies. According to this analysis, as put forth by important contemporary economists like Joan Robinson, exchange rate depreciations helped the economy whose currency had weakened by making the country more competitive internationally. Indeed, the decline in the value of the pound after 1931 was associated with a relatively early recovery from the Depression by the United Kingdom, in part because of some rebound in exports. However, according to this view, the gains to the depreciating country were equaled or exceeded by the losses to its trading partners, which became less internationally competitive--hence, ‘beggar thy neighbor.’ Economists still agree that Smoot-Hawley and the ensuing tariff wars were highly counterproductive and contributed to the depth and length of the global Depression. However, modern research on the Depression, beginning with the seminal 1985 paper by Barry Eichengreen and Jeffrey Sachs, has changed our view of the effects of the abandonment of the gold standard. Although it is true that leaving the gold standard and the resulting currency depreciation conferred a temporary competitive advantage in some cases, modern research shows that the primary benefit of leaving gold was that it freed countries to use appropriately expansionary monetary policies. By 1935 or 1936, when essentially all major countries had left the gold standard and exchange rates were market-determined, the net trade effects of the changes in currency values were certainly small. Yet the global economy as a whole was much stronger than it had been in 1931. The reason was that, in shedding the strait jacket of the gold standard, each country became free to use monetary policy in a way that was more commensurate with achieving full employment at home.”
Nurkse (1944) raised concern on the contraction of trade by competitive devaluations during the 1930s. Haberler (1937) dwelled on the issue of flexible exchange rates. Bordo and James (2001) provide perceptive exegesis of the views of Haberler (1937) and Nurkse (1944) together with the evolution of thought by Haberler. Policy coordination among sovereigns may be quite difficult in practice even if there were sufficient knowledge and sound forecasts. Friedman (1953) provided strong case in favor of a system of flexible exchange rates.
Eichengreen and Sachs (1985) argue theoretically with measurements using a two-sector model that it is possible for series of devaluations to improve the welfare of all countries. There were adverse effects of depreciation on other countries but depreciation by many countries could be beneficial for all. The important counterfactual is if depreciations by many countries would have promoted faster recovery from the Great Depression. Depreciation in the model of Eichengreen and Sachs (1985) affected domestic and foreign economies through real wages, profitability, international competitiveness and world interest rates. Depreciation causes increase in the money supply that lowers world interest rates, promoting growth of world output. Lower world interest rates could compensate contraction of output from the shift of demand away from home goods originating in neighbor’s exchange depreciation. Eichengreen and Sachs (1985, 946) conclude:
“This much, however, is clear. We do not present a blanket endorsement of the competitive devaluations of the 1930s. Though it is indisputable that currency depreciation conferred macroeconomic benefits on the initiating country, because of accompanying policies the depreciations of the 1930s had beggar-thy-neighbor effects. Though it is likely that currency depreciation (had it been even more widely adopted) would have worked to the benefit of the world as a whole, the sporadic and uncoordinated approach taken to exchange-rate policy in the 1930s tended, other things being equal, to reduce the magnitude of the benefits.”
There could major difference in the current world economy. The initiating impulse for depreciation originates in zero interest rates on the fed funds rate. The dollar is the world’s reserve currency. Risk aversion intermittently channels capital flight to the safe haven of the dollar and US Treasury securities. In the absence of risk aversion, zero interest rates induce carry trades of short positions in dollars and US debt (borrowing) together with long leveraged exposures in risk financial assets such as stocks, emerging stocks, commodities and high-yield bonds. Without risk aversion, the dollar depreciates against every currency in the world. The dollar depreciated against the euro by 39.3 percent from USD 1.1423/EUR con Jun 26, 2003 to USD 1.5914/EUR on Jun 14, 2008 during unconventional monetary policy before the global recession (Table VI-1). Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can increases net exports of the US that increase aggregate economic activity (Yellen 2011AS). The country issuing the world’s reserve currency appropriates the advantage from initiating devaluation that in policy intends to generate net exports that increase domestic output.
Pelaez and Pelaez (Regulation of Banks and Finance (2009b), 208-209) summarize the experience of Brazil as follows:
“During 1927–9, Brazil accumulated ￡30 million of foreign exchange of which ￡20 million were deposited at its stabilization fund (Pelaez 1968, 43–4). After the decline in coffee prices and the first impact of the Great Depression in Brazil a hot money movement wiped out foreign exchange reserves. In addition, capital inflows stopped entirely. The deterioration of the terms of trade further complicated matters, as the value of exports in foreign currency declined abruptly. Because of this exchange crisis, the service of the foreign debt of Brazil became impossible. In August 1931, the federal government was forced to cancel the payment of principal on certain foreign loans. The balance of trade in 1931 was expected to yield ￡20 million whereas the service of the foreign debt alone amounted to ￡22.6 million. Part of the solution given to these problems was typical of the 1930s. In September 1931, the government of Brazil required that all foreign transactions were to be conducted through the Bank of Brazil. This monopoly of foreign exchange was exercised by the Bank of Brazil for the following three years. Export permits were granted only after the exchange derived from sales abroad was officially sold to the Bank, which in turn allocated it in accordance with the needs of the economy. An active black market in foreign exchange developed. Brazil was in the first group of countries that abandoned early the gold standard, in 1931, and suffered comparatively less from the Great Depression. The Brazilian federal government, advised by the BOE, increased taxes and reduced expenditures in 1931 to compensate a decline in custom receipts (Pelaez 1968, 40). Expenditures caused by a revolution in 1932 in the state of Sao Paulo and a drought in the northeast explain the deficit. During 1932–6, the federal government engaged in strong efforts to stabilize the budget. Apart from the deliberate efforts to balance the budget during the 1930s, the recovery in economic activity itself may have induced a large part of the reduction of the deficit (Ibid, 41). Brazil’s experience is similar to that of the United States in that fiscal policy did not promote recovery from the Great Depression.”
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 37.5 percent to ZAR 10.0881/USD on May 31, 2013, which is still 12.9 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 6.2 percent stronger at SGD 1.2642/USD on May 31, 2013 relative to the trough of depreciation but still stronger by 18.6 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 23.2 percent relative to the trough to BRL 2.1395/USD on May 31, 2013 but still stronger by 11.9 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 (BCB), 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. Brazil central bank raised the SELIC rate at its most recent meeting (http://www.bcb.gov.br/textonoticia.asp?codigo=3737&IDPAI=NEWS):
“Copom raises the Selic rate to 8.00 percent
29/05/2013 8:33:00 PM
Brasília – Continuing the adjustment process of the basic interest rate, the Copom unanimously decided to increase the Selic rate to 8.00 percent without bias. The Committee evaluations that this decision will contribute to set inflation into decline and ensure that this trend persists in the upcoming year” (http://www.bcb.gov.br/textonoticia.asp?codigo=3737&IDPAI=NEWS). 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 | May 31, 2013 | ∆% T May 31, 2013 | ∆% P May 31, 2013 | |
| EUR USD | 7/15 | 6/7 2010 | 5/31/ 2013 | |||
| Rate | 1.59 | 1.192 | 1.2996 | |||
| ∆% | -33.4 | 8.3 | -22.4 | |||
| JPY USD | 8/18 | 9/15 | 5/31/ 2013 | |||
| Rate | 110.19 | 83.07 | 100.48 | |||
| ∆% | 24.6 | -21.0 | 8.8 | |||
| CHF USD | 11/21 2008 | 12/8 2009 | 5/31/ 2013 | |||
| Rate | 1.225 | 1.025 | 0.9554 | |||
| ∆% | 16.3 | 6.8 | 22.0 | |||
| USD GBP | 7/15 | 1/2/ 2009 | 5/31/ 2013 | |||
| Rate | 2.006 | 1.388 | 1.5200 | |||
| ∆% | -44.5 | 8.7 | -32.0 | |||
| USD AUD | 7/15 2008 | 10/27 2008 | 5/31/ | |||
| Rate | 1.0215 | 1.6639 | 0.9572 | |||
| ∆% | -62.9 | 37.2 | -2.3 | |||
| ZAR USD | 10/22 2008 | 8/15 | 5/31/ 2013 | |||
| Rate | 11.578 | 7.238 | 10.0881 | |||
| ∆% | 37.5 | -39.4 | 12.9 | |||
| SGD USD | 3/3 | 8/9 | 5/31/ | |||
| Rate | 1.553 | 1.348 | 1.2642 | |||
| ∆% | 13.2 | 6.2 | 18.6 | |||
| HKD USD | 8/15 2008 | 12/14 2009 | 5/31/ | |||
| Rate | 7.813 | 7.752 | 7.7628 | |||
| ∆% | 0.8 | -0.1 | 0.6 | |||
| BRL USD | 12/5 2008 | 4/30 2010 | 5/31/ 2013 | |||
| Rate | 2.43 | 1.737 | 2.1395 | |||
| ∆% | 28.5 | -23.2 | 11.9 | |||
| CZK USD | 2/13 2009 | 8/6 2010 | 5/31/ | |||
| Rate | 22.19 | 18.693 | 19.797 | |||
| ∆% | 15.7 | -5.9 | 10.8 | |||
| SEK USD | 3/4 2009 | 8/9 2010 | 5/31/ 2013 | |||
| Rate | 9.313 | 7.108 | 6.6214 | |||
| ∆% | 23.7 | 6.8 | 28.9 | |||
| CNY USD | 7/20 2005 | 7/15 | 5/31/ | |||
| Rate | 8.2765 | 6.8211 | 6.1347 | |||
| ∆% | 17.6 | 10.1 | 25.9 |
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 May 23, 2013. US recession dates are in shaded areas. The rate on Jan 4, 1999 was USD 1.1812/EUR, declining to USD 0.8279/EUR on Oct 25, 2000, or appreciation of the USD by 29.9 percent. The rate depreciated 21.9 percent to USD 1.0098/EUR on Jul 22, 2002. There was sharp devaluation of the USD of 34.9 percent to USD 1.3625/EUR on Dec 27, 2004 largely because of the 1 percent interest rate between Jun 2003 and Jun 2004 together with a form of quantitative easing by suspension of auctions of the 30-year Treasury, which was equivalent to withdrawing supply from markets. Another depreciation of 17.5 percent took the rate to USD 1.6010/EUR on Apr 22, 2008, already inside the shaded area of the global recession. The flight to the USD and obligations of the US Treasury appreciated the dollar by 22.3 percent to USD 1.2446/EUR on Oct 27, 2008. In the return of the carry trade after stress tests showed sound US bank balance sheets, the rate depreciated 21.2 percent to USD 1.5085/EUR on Nov 25, 2009. The sovereign debt crisis of Europe in the spring of 2010 caused sharp appreciation of 20.7 percent to USD 1.1959/EUR on Jun 6, 2010. Renewed risk appetite depreciated the rate 24.4 percent to USD 1.4875/EUR on May 3, 2011. The rate appreciated 13.0 percent to USD 1.2944/EUR on May 23, 2013, 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 May 23, 2013
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
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
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
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 May 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 100.8522/USD in May 2013 for appreciation of 18.7 percent relative to JPY 124.0900/USD on Jun 22, 2007 before the global recession and expansion characterized by recurring bouts of risk aversion. 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-May 2013
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
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 2.0225/USD on May 24, 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 2.0225/USD on May 24, 2013 for depreciation of 31.5 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 May 24, 2013
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
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 May 24, 2013
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
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 2.132 percent at the close of market on Fri May 31, 2013 would be equivalent to price of 104.5015 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price gain of 3.2 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 72.5 percent of GDP in 2012 (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html 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 May 29, 2013, the line “Reserve Bank credit” in the Fed balance sheet stood at $3342 billion, or $3.3 trillion, with portfolio of long-term securities (“securities held outright”) of $3107 billion, or $3.1 trillion, consisting of $1789 billion Treasury nominal notes and bonds, $82 billion of notes and bonds inflation-indexed, $71 billion Federal agency debt securities and $1165 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $2023 billion or $2.0 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 |
| 1/25/13 | 1.947 | 106.1338 | 4.8 |
| 2/1/13 | 2.024 | 105.4161 | 4.1 |
| 2/8/13 | 1.949 | 106.1151 | 4.8 |
| 2/15/13 | 2.007 | 105.5741 | 4.3 |
| 2/22/13 | 1.967 | 105.9469 | 4.6 |
| 3/1/13 | 1.842 | 107.1213 | 5.8 |
| 3/8/13 | 2.056 | 105.1195 | 3.8 |
| 3/15/13 | 1.992 | 105.7137 | 4.4 |
| 03/22/13 | 1.931 | 106.2836 | 5.0 |
| 03/29/13 | 1.847 | 107.0741 | 5.7 |
| 04/05/13 | 1.706 | 108.4160 | 7.1 |
| 04/12/13 | 1.719 | 108.2914 | 6.9 |
| 04/19/13 | 1.702 | 108.4543 | 7.1 |
| 04/26/13 | 1.663 | 108.8290 | 7.5 |
| 05/3/13 | 1.742 | 108.2436 | 6.9 |
| 05/10/13 | 1.896 | 106.6122 | 5.3 |
| 05/17/13 | 1.952 | 106.0870 | 4.8 |
| 05/24/13 | 2.009 | 105.5555 | 4.2 |
| 05/31/13 | 2.132 | 104.5015 | 3.2 |
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 Dec | 16,457,613 | 4,846,174 | 11,611,439 |
| 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 | 4,355,292 | 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. 2013Mar. Treasury Bulletin. Washington, DC, Mar 2013.
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 Dec 2012. Total debt held by investors increased from $3635 billion in 2007 to $9040 billion in fiscal year 2012 or by 148.7 percent and to $9374 billion in Dec 2012 or increase by 157.9 percent. There are two concerns with the maturity distribution of US debt. (1) Growth of debt is moving total debt to the point of saturation in investors’ portfolio. In a new environment of risk appetite and nonzero fed funds rates with economic growth at historical trend of around 3 percent, yields on risk financial assets are likely to increase. Placement of new debt may require increasing interest rates in an environment of continuing placement of debt by the US Treasury without strong fiscal constraints. (2) Refinancing of maturing debt is likely to occur in an environment of higher interest rates, exerting pressure on future fiscal budgets. In Dec 2012, $2932 billion or 31.3 percent of outstanding debt held by investors matures in less than a year and $4124 billion or 44.0 percent of total debt matures in one to five years. Debt maturing in five years or less adds to $7056 billion or 75.3 percent of total outstanding debt held by investors of $9374 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 | Dec 2012 |
| Total* | 3635 | 4745 | 6229 | 7676 | 7951 | 9040 | 9374 |
| <1 Year | 1176 | 2042 | 2605 | 2480 | 2504 | 2897 | 2932 |
| 1-5 Years | 1310 | 1468 | 2075 | 2956 | 3085 | 3852 | 4124 |
| 5-10 Years | 678 | 719 | 995 | 1529 | 1544 | 1488 | 1517 |
| 10-20 Years | 292 | 352 | 351 | 341 | 309 | 271 | 262 |
| >20 Years | 178 | 163 | 204 | 371 | 510 | 533 | 538 |
| Average | 58 | 49 | 49 | 57 | 60 | 55 | 54 |
*Amount Outstanding Privately Held
Source: United States Treasury. 2013Mar. Treasury Bulletin. Washington, DC, Mar 2013.
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 2.1 percent on average in the cyclical expansion from IIIQ2009 to IQ2013 (http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.html). Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). The average of 7.8 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 3.2 percent obtained by diving GDP of $13,103.5 billion in IIIQ2010 by GDP of $12,701.0 billion in IIQ2009 {[$13.103.5/$12,701.0 -1]100 = 3.2%}, or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.html). Weakness of growth and employment creation is analyzed in the following Conclusion Collapse of United States Dynamism of Income Growth and Employment Creation. There are 29.6 million people without jobs or underemployed that is equivalent to 17.6 percent of the US effective labor force (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/03/thirty-one-million-unemployed-or.html) and hiring is significantly below the earlier cyclical expansion before 2007 (http://cmpassocregulationblog.blogspot.com/2013/03/recovery-without-hiring-ten-million.html and earlier http://cmpassocregulationblog.blogspot.com/2013/02/recovery-without-hiring-united-states.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 94.4 percent. Debt held by the public as percent of GDP or economic activity jumped from 40.5 percent in 2008 to 72.5 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. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5.
The major hurdle in adjusting the fiscal situation of the US is shown in Table VI-7D 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 and increasing toward 80-100 percent of GDP. On the side of revenues, taxes provide 90.6 percent of revenue in 2012 and are projected to provide 92.9 percent in the total revenues from 2014 to 2023 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 46.2 percent of federal government revenues in 2012 to 49.1 percent in total revenues projected by the CBO from 2014 to 2023. There are equally difficult conflicts in what the government gives away in a rigid structure of expenditures. Mandatory expenditures account for 57.4 percent of federal government outlays in 2012 and are projected to increase to 61.3 percent of the total projected by the CBO for the years 2014 to 2023. The total of Social Security plus Medicare and Medicaid accounts for 44.4 percent of federal government outlays in 2012 and is projected to increase to 50.0 percent in the total for 2014 to 2023. The inflexibility of what to cut is more evident in the first to the last row of Table VI-7D with the aggregate of defense plus Social Security plus Medicare plus Medicaid accounting for 63.2 percent of expenditures in 2012, rising to 63.9 percent of the total outlays projected by the CBO from 2014 to 2023. The cuts are in discretionary spending that declines from 36.3 percent of the total in 2012 to 27.2 percent of total outlays in the CBO projection for 2014 to 2023.
Table VI-7D, Structure of Federal Government Revenues and Outlays, $ Billions and Percent
| 2012 | % Total | Total 2014-2023 | % Total | |
| Revenues | 2,449 | 100.00 | 40,241 | 100.00 |
| Individual Income Taxes | 1,132 | 46.2 | 19,747 | 49.1 |
| Social Insurance Taxes | 845 | 34.5 | 12,852 | 31.9 |
| Corporate Income Taxes | 242 | 9.9 | 4,805 | 11.9 |
| Other | 229 | 9.4 | 2,837 | 7.1 |
| Outlays | 3,538 | 100.00 | 47,199 | 100.0 |
| Mandatory | 2,031 | 57.4 | 28,938 | 61.3 |
| Social Security | 768 | 20.1 | 11,149 | 38.5 |
| Medicare | 551 | 15.5 | 8,070 | 17.1 |
| Medicaid | 251 | 7.6 | 4,360 | 9.2 |
| SS + Medicare + Medicaid | 1,570 | 44.4 | 23,579 | 50.0 |
| Discre- | 1,285 | 36.3 | 12,852 | 27.2 |
| Defense | 668* | 18.9 | 6,566 | 13.9 |
| Non- | 617* | 17.4 | 5,960 | 12.6 |
| Net Interest | 223 | 6.3 | 5,410 | 11.5 |
| Defense +SS + Medicare + Medicaid | 2,238 | 63.2 | 30,145 | 63.9 |
| MEMO: GDP | 15,549 | 213,326 |
*Same proportions of total discretionary spending as in 2011
Source: CBO (2012JanBEO), CBO (2012AugBeo). CBO (2013BEOFeb5).
The CBO (2012NovCDR) focuses on adjustment by fiscal-year 2020. Major segments of the base projections of CBO (2013BEOFeb5) to 2020 and the earlier alternative fiscal scenario (CBO12NovCDR) are shown in Table VI-7E. The base scenario has moved closer to the tougher earlier alternative scenario. The base projection has revenues as percent of GDP of 18.7 percent, higher than 18 percent historically on average from 1970 to 2010 compared with 18.5 percent in the fiscal scenario. The base scenario requires return of growth to trend or whereabouts together with the capacity to increase revenues above the 18.5 percent threshold. Most revenue components are similar under both scenarios with exception of individual income taxes that reach 9.4 percent of GDP in 2020 under the base projection while they reach only 9.0 percent under the alternative fiscal scenario. There is also significant difference in total outlays, reaching 22.2 percent of GDP under the base projection but increasing to 23.3 percent of GDP under the earlier alternative fiscal scenario. Discretionary spending reaches 6.2 percent under the alternative fiscal scenario with increases in the share in GDP of both defense and nondefense components while net interest payments by the federal government are higher by 3.1 percent under the alternative fiscal scenario with much higher debt than 2.9 percent in the base projection. In mandatory spending, the difference is 3.8 percent in the base projection in Medicare with 3.5 percent in the alternative fiscal scenario. Under the base projection, the deficit would decline to $798 billion in 2020 or 3.5 percent of GDP while it would reach $1102 billion, or $1.1 trillion, in the alternative fiscal scenario for 4.8 percent of GDP. Debt held by the public at the end of the year, in the final row, would be $16,957 billion, or $13.9 trillion, in the base projection, for 74.2 percent of GDP, and $19,477 billion, or $19.5 trillion for 85.7 percent of GDP, under the alternative fiscal scenario.
The CBO (2012NovEEP) provides analysis of what would happen in two alternatives: (1) there is no extension of tax reductions and mandatory cuts; and (2) there is extension of some or all of the tax reductions and mandatory cuts. The CBO (2012NovEEP) actually identifies what will be a continuing tradeoff of short-term and long-term measures for the unsustainable fiscal situation of the United States.
The CBO (2012NovEEP) estimates that fiscal tightening from failure to extend tax rates and mandatory spending would cause: decline of inflation-adjusted or real GDP by 0.5 percent from IVQ2012 to IVQ2013 and increase of the rate of unemployment to 9.1 percent by IVQ2013. Growth would increase after 2013 with return to potential output and unemployment rate of 5.5 percent in 2018.
The CBO (2012NovEEP) estimates that growth will continue to be weak and unemployment high even if there were removal of all or a large part of fiscal tightening by not extending some or all tax rates and preventing mandatory cuts in spending. The future would be troubled according to the CBO (2012NovEEP, 1):
“Moreover, if the fiscal tightening was removed and the policies that are currently in effect were kept in place indefinitely, a continued surge in federal debt during the rest of this decade and beyond would raise the risk of a fiscal crisis (in which the government would lose the ability to borrow money at affordable interest rates) and would eventually reduce the nation’s output and income below what would occur if the fiscal tightening was allowed to take place as currently set by law.”
The CBO (2012NovEEP, 7) estimates that the non-extension of lower tax rates on income above certain thresholds would result in revenue effect of $38 billion in 2014, which hardly has an effect on budget deficits of trillion dollars. Elimination of deductions is the same as tax increases. There are no easy fixes for the fiscal situation of the United States and tough tradeoffs between the present and the future in a multitude of combinations of alternative policies with effects on growth and employment that are quite difficult to calculate.
Table VI-7E, CBO Budget Projections for 2020 Baseline and Alternative Fiscal Scenario, Billions of Dollars and % of GDP
| $ B Base 2020 | % GDP Base 2020 | $B Alt 2020 | % GDP Alt 2020 | |
| Revenues | 4,279 | 18.7 | 4,196 | 18.5 |
| Individual Income Taxes | 2,158 | 9.4 | 2,055 | 9.0 |
| Social Insurance Taxes | 1,372 | 6.0 | 1,412 | 6.2 |
| Corporate Income Taxes | 492 | 2.2 | 424 | 1.9 |
| Other | 258 | 1.1 | 305 | 1.3 |
| Total Outlays | 5,078 | 22.2 | 5,298 | 23.3 |
| Mandatory Spending | 3,087 | 13.5 | 3,190 | 14.0 |
| Social Security | 1,199 | 5.3 | 1,202 | 5.3 |
| Medicare | 867 | 3.8 | 793 | 3.5 |
| Medicaid | 476 | 2.1 | 514 | 2.3 |
| Other Major Health Care Programs | 165 | 0.1 | 117 | 0.5 |
| Other Mandatory Spending | 380 | 1.7 | 566 | 2.5 |
| Discretionary Spending | 1,324 | 5.8 | 1,403 | 6.2 |
| Defense | 679 | 3.0 | 750 | 3.3 |
| Nondefense | 616 | 2.7 | 653 | 2.9 |
| Net Interest | 667 | 2.9 | 704 | 3.1 |
| Deficit | -798 | -3.5 | -1,102 | -4.8 |
| Debt Held by the Public at the End of the Year | 16,957 | 74.2 | 19,477 | 85.7 |
Source: CBO (2012NovCDR). CBO (2013BEOFeb5).
Chart VI-8 of the Board of Governors of the Federal Reserve System provides the yield of the ten-year constant maturity Treasury and the overnight fed funds rate from Jan 3, 1977 to May 30, 2013. The yield of the ten-year constant maturity Treasury 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. The fed funds rate was 1.18 percent on Jun 23, 2003 and the ten-year yield 3.36 percent. Yields rose again to 4.89 percent on Jun 14, 2004 with the fed funds rate at 1.02 percent and the ten-year yield stood at 5.23 percent on Jul 5, 2006. At the onset of the financial crisis on Sep 17, 2007, the fed funds rate was 5.33 percent and the ten-year yield 4.48 percent. On Dec 26, 2008, the fed funds rate was 0.09 percent and the ten-year yield 2.16 percent. 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 2.13 percent on May 30, 2013 with the fed funds rate at 0.08 percent, 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, Overnight Federal Funds Rate and Ten-Year Treasury Constant Maturity Yield, Jan 2, 1962 to May 30, 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 $3,119,382 million on May 29, 2013.
Chart VI-9, US, Securities Held Outright by Federal Reserve Banks, Wednesday Level, Dec 18, 2002 to May 29, 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 10, 1979, at 9.91 percent per year, to May 30, 2013, at 0.08 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 0.12 percent on May 9, 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 9.91 percent on Jan 10, 1979, at the beginning 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/2013/02/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 May 30, 2013, Percent per Year
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
Chart VI-11 of the Board of Governors of the Federal Reserve System provides the fed funds rate and the prime bank loan rate in business days from Jan 10, 1970 to May 30, 2013. The fed funds overnight rate is the rate charged by a depository institution with idle reserves deposited at a federal reserve bank to exchange its deposits overnight to another depository institution in need of reserves. In a sense, it is the marginal cost of funding for a bank in the United States, or the cost of a unit of additional funding. The fed funds rate is the rate charged by a bank to another bank in an uncollateralized overnight loan. The fed funds rate is the traditional policy rate or rate used to implement policy directives of the Federal Open Market Committee (FOMC). Thus, there should be an association between the fed funds rate or cost of funding of a bank and its prime lending rate. Such an association is verified in Chart VI-11 with the rates moving quite closely over time. On January 10, 1979, the fed funds rate was set at 9.91 percent and banks set their prime lending rate at 11.75 percent. On Dec 16, 2008, the policy determining committee of the Fed decided (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm): “The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.” The final segment of Chart VI-11 shows similar movement of the fed funds rate and the prime bank loan rate following the fixing of the fed funds rate to approximately zero. In the final data point of Chart VI-11, the fed funds rate is 0.08 percent and the prime rate 3.25 percent.
Chart VI-11, US, Fed Funds Rate and Prime Bank Loan Rate, Business Days, Jan 10, 1979 to May 30, 2013, Percent per Year
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
Lending has become more complex over time. The critical fact of current world financial markets is the combination of “unconventional” monetary policy with intermittent shocks of financial risk aversion. There are two interrelated unconventional monetary policies. First, unconventional monetary policy consists of (1) reducing short-term policy interest rates toward the “zero bound” such as fixing the fed funds rate at 0 to ¼ percent by decision of the Federal Open Market Committee (FOMC) since Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). Second, unconventional monetary policy also includes a battery of measures to also reduce long-term interest rates of government securities and asset-backed securities such as mortgage-backed securities. When inflation is low, the central bank lowers interest rates to stimulate aggregate demand in the economy, which consists of consumption and investment. When inflation is subdued and unemployment high, monetary policy would lower interest rates to stimulate aggregate demand, reducing unemployment. When interest rates decline to zero, unconventional monetary policy would consist of policies such as large-scale purchases of long-term securities to lower their yields. A major portion of credit in the economy is financed with long-term asset-backed securities. Loans for purchasing houses, automobiles and other consumer products are bundled in securities that in turn are sold to investors. Corporations borrow funds for investment by issuing corporate bonds. Loans to small businesses are also financed by bundling them in long-term bonds. Securities markets bridge the needs of higher returns by investors obtaining funds from savers that are channeled to consumers and business for consumption and investment. Lowering the yields of these long-term bonds could lower costs of financing purchases of consumer durables and investment by business. The essential mechanism of transmission from lower interest rates to increases in aggregate demand is portfolio rebalancing. Withdrawal of bonds in a specific maturity segment or directly in a bond category such as currently mortgage-backed securities causes reductions in yield that are equivalent to increases in the prices of the bonds. There can be secondary increases in purchases of those bonds in private portfolios in pursuit of their increasing prices. Lower yields translate into lower costs of buying homes and consumer durables such as automobiles and also lower costs of investment for business.
Monetary policy can lower short-term interest rates quite effectively. Lowering long-term yields is somewhat more difficult. The critical issue is that monetary policy cannot ensure that increasing credit at low interest cost increases consumption and investment. There is a large variety of possible allocation of funds at low interest rates from consumption and investment to multiple risk financial assets. Monetary policy does not control how investors will allocate asset categories. A critical financial practice is to borrow at low short-term interest rates to invest in high-risk, leveraged financial assets. Investors may increase in their portfolios asset categories such as equities, emerging market equities, high-yield bonds, currencies, commodity futures and options and multiple other risk financial assets including structured products. If there is risk appetite, the carry trade from zero interest rates to risk financial assets will consist of short positions at short-term interest rates (or borrowing) and short dollar assets with simultaneous long positions in high-risk, leveraged financial assets such as equities, commodities and high-yield bonds. Low interest rates may induce increases in valuations of risk financial assets that may fluctuate in accordance with perceptions of risk aversion by investors and the public. During periods of muted risk aversion, carry trades from zero interest rates to exposures in risk financial assets cause temporary waves of inflation that may foster instead of preventing financial instability (http://cmpassocregulationblog.blogspot.com/2013/05/word-inflation-waves-squeeze-of.html). During periods of risk aversion such as fears of disruption of world financial markets and the global economy resulting from collapse of the European Monetary Union, carry trades are unwound with sharp deterioration of valuations of risk financial assets. More technical discussion is in IA Appendix: Transmission of Unconventional Monetary Policy at http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html.
Chart VI-12 of the Board of Governors of the Federal Reserve System provides the fed funds rate, prime bank loan rate and the yield of a corporate bond rated Baa by Moody’s. On Jan 10, 1979, the fed funds rate was fixed at 9.91 percent and banks fixed the prime loan rate at 11.75 percent. Reflecting differences in risk, the fed funds rate was 8.76 percent on Jan 2, 1986, the prime rate 9.50 percent and the Baa Corporate bond yield 11.38 percent. The yield of the Baa corporate bond collapsed toward the bank prime loan rate after the end of extreme risk aversion in the beginning of 2009. The final data point in Chart VI-12 is for May 30, 2013, with the fed funds rate at 0.08 percent, the bank prime rate at 3.25 percent and the yield of the Baa corporate bond at 4.90 percent. Empirical tests of the transmission of unconventional monetary policy to actual increases in consumption and investment or aggregate demand find major hurdles (see IA Appendix: Transmission of Unconventional Monetary Policy at http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html).
Chart VI-12, US, Fed Funds Rate, Prime Bank Loan Rate and Yield of Moody’s Baa Corporate Bond, Business Days, Jan 10, 1979 to May 30, 2013, Percent per Year
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
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-7F 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-7F 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-7F, 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
VII Economic Indicators. Crude oil input in refineries increased 0.5 percent to 15,178 thousand barrels per day on average in the four weeks ending on May 24, 2013 from 15,098 thousand barrels per day in the four weeks ending on May 17, 2013, as shown in Table VII-1. The rate of capacity utilization in refineries continues at a relatively high level of 87.2 percent on May 24, 2013, which is lower than 88.0 percent on May 25, 2012 and higher than 86.7 percent on May 17, 2013. Imports of crude oil decreased 1.1 percent from 7,834 thousand barrels per day on average in the four weeks ending on May 17 to 7,747 thousand barrels per day in the week of May 24. The Energy Information Administration (EIA) informs that “US crude oil imports averaged over 7.8 million barrels per day last week, down by 313 thousand barrels per day from the previous week [May 24]. Over the last four weeks, crude oil imports have averaged just 7.8 million barrels per day, 1.1 million barrels per day below the same four-week period last year” (http://www.eia.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/pdf/highlights.pdf). Marginally higher utilization in refineries with decreasing imports at the margin in the prior week resulted in increase of commercial crude oil stocks by 3.0 million barrels from 394.6 million barrels on May 17 to 397.6 million barrels on May 24. Motor gasoline production increased 0.6 percent to 8,956 thousand barrels per day in the week of May 24 from 8,901 thousand barrels per day on average in the week of May 17. Gasoline stocks decreased 1.5 million barrels and stocks of fuel oil increased 1.9 million barrels. Supply of gasoline decreased from 8,850 thousand barrels per day on May 25, 2012, to 8,633 thousand barrels per day on May 24, 2013, or by 2.5 percent, while fuel oil supply increased 1.4 percent. Part of the prior fall in consumption of gasoline had been due to high prices and part to the growth recession. WTI crude oil price traded at $93.84/barrel on May 24, 2013, increasing 3.5 percent relative to $90.64/barrel on May 25, 2012. Gasoline prices decreased 0.7 percent from May 28, 2012 to May 27, 2013. Increases in prices of crude oil and gasoline relative to a year earlier are moderating because year earlier prices are already reflecting the commodity price surge and commodity prices have been declining recently during worldwide risk aversion. Gasoline prices had been increasing to the highest levels at this time of the year.
Table VII-1, US, Energy Information Administration Weekly Petroleum Status Report
| Four Weeks Ending Thousand Barrels/Day | 5/24/13 | 5/17/13 | 5/25/12 |
| Crude Oil Refineries Input | 15,178 Week ∆%: 0.5 | 15,098 | 14,986 |
| Refinery Capacity Utilization % | 87.2 | 86.7 | 88.0 |
| Motor Gasoline Production | 8,956 Week ∆%: 0.6 | 8,901 | 9,071 |
| Distillate Fuel Oil Production | 4,681 Week ∆%: 2.5 | 4,565 | 4,502 |
| Crude Oil Imports | 7,747 Week ∆%: -1.1% | 7,834 | 8,833 |
| Motor Gasoline Supplied | 8,633 ∆% 2013/2012= -2.5% | 8,498 | 8,850 |
| Distillate Fuel Oil Supplied | 3,819 ∆% 2013/2012 = 1.4% | 3,782 | 3,768 |
| 5/24/13 | 5/17/13 | 5/25/12 | |
| Crude Oil Stocks | 397.6 ∆= 3.0 MB | 394.6 | 384.7 |
| Motor Gasoline Million B | 219.2 ∆= -1.5 MB | 220.7 | 200.2 |
| Distillate Fuel Oil Million B | 120.7 | 118.8 | 117.8 |
| WTI Crude Oil Price $/B | 93.84 ∆% 2013/2012 3.5 | 95.72 | 90.64 |
| 5/27/13 | 5/20/13 | 5/28/12 | |
| Regular Motor Gasoline $/G | 3.645 ∆% 2013/2012 | 3.673 | 3.670 |
B: barrels; G: gallon
Source: US Energy Information Administration
http://www.eia.gov/petroleum/supply/weekly/
Chart VII-1 of the US Energy Information Administration shows commercial stocks of crude oil of the US. There have been fluctuations around an upward trend since 2005. Crude oil stocks trended downwardly during a few weeks but with fluctuations followed by several sharp weekly increases alternating with declines.
Chart VII-1, US, Weekly Crude Oil Ending Stocks
Source: US Energy Information Administration
http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCESTUS1&f=W
Chart VII-2 of the US Energy Information Administration (EIA) provides crude oil stocks from 2011 to 2013. There was sharp downward trend from 2011 into 2012 followed by fluctuating upward trend with recent decrease followed by increase in 2013.
Chart VII-2, US, Crude Oil Stocks
Source: US Energy Information Administration
Chart VII-3 of the US Energy Information Administration shows the price of WTI crude oil since the 1980s. Chart VII-3 captures commodity price shocks during the past decade. The costly mirage of deflation was caused by the decline in oil prices during the recession of 2001. The upward trend after 2003 was promoted by the carry trade from near zero interest rates. The jump above $140/barrel during the global recession in 2008 at $145.29/barrel on Jul 3, 2008, can only be explained by the carry trade promoted by monetary policy of zero fed funds rate. After moderation of risk aversion, the carry trade returned with resulting sharp upward trend of crude prices. Risk aversion resulted in another drop in recent weeks followed by some recovery.
Chart VII-3, US, Crude Oil Futures Contract
Source: US Energy Information Administration
http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RCLC1&f=D
There is typically significant difference between initial claims for unemployment insurance adjusted and not adjusted for seasonality provided in Table VII-2. Seasonally adjusted claims increased 10,000 from 344,000 on May 18, 2013, to 354,000 on May 25, 2013. Claims not adjusted for seasonality increased 13,653 from 304,079 on May 18, 2013 to 317,732 on May 25, 2013. Strong seasonality is preventing clear analysis of labor markets.
Table VII-2, US, Initial Claims for Unemployment Insurance
| SA | NSA | 4-week MA SA | |
| May 25, 2013 | 354,000 | 317,732 | 347,250 |
| May 18, 2013 | 344,000 | 304,079 | 340,500 |
| Change | +10,000 | +13,653 | +6,750 |
| May 11, 2012 | 363,000 | 320,873 | 340,000 |
| Prior Year | 382,000 | 346,260 | 373,000 |
Note: SA: seasonally adjusted; NSA: not seasonally adjusted; MA: moving average
Source: http://www.dol.gov/opa/media/press/eta/ui/current.htm#.UO83JeRZWwb
Table VII-3 provides seasonally and not seasonally adjusted claims in the comparable week for the years from 2001 to 2013. Seasonally adjusted claims typically are lower than claims not adjusted for seasonality. Claims not seasonally adjusted have declined from 538,311 on May 23, 2009 to 376,632 on May 21, 2011, 346,260 on May 26, 2012 and 317,732 on May 25, 2013. There is strong indication of significant decline in the level of layoffs in the US. Hiring has not recovered (http://cmpassocregulationblog.blogspot.com/2013/05/recovery-without-hiring-collapse-of.html and earlier
http://cmpassocregulationblog.blogspot.com/2013/04/recovery-without-hiring-ten-million.html) and there is continuing unemployment and underemployment of 28.6 million or 17.6 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2013/05/twenty-nine-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2013/04/thirty-million-unemployed-or.html).
Table VII-3, US, Unemployment Insurance Weekly Claims
| Not Seasonally Adjusted Claims | Seasonally Adjusted Claims | |
| May 26, 2001 | 346,231 | 405,000 |
| May 25, 2002 | 346,439 | 403,000 |
| May 24, 2003 | 359,500 | 419,000 |
| May 29, 2004 | 304,067 | 337,000 |
| May 28, 2005 | 304,306 | 340,000 |
| May 27, 2006 | 292,714 | 330,000 |
| May 26, 2007 | 273,397 | 310,000 |
| May 24, 2008 | 326,627 | 369,000 |
| May 23, 2009 | 538,311 | 607,000 |
| May 22, 2010 | 410,778 | 462,000 |
| May 21, 2011 | 376,632 | 423,000 |
| May 26, 2012 | 346,260 | 382,000 |
| May 25, 2013 | 317,732 | 354,000 |
Source: http://www.ows.doleta.gov/unemploy/claims.asp
VIII Interest Rates. It is quite difficult to measure inflationary expectations because they tend to break abruptly from past inflation. There could still be an influence of past and current inflation in the calculation of future inflation by economic agents. Table VIII-1 provides inflation of the CPI. In the three months Feb-Apr 2013, CPI inflation for all items seasonally adjusted was 0.4 percent in annual equivalent, obtained by compounding inflation from Feb 2013 to Apr 2013 and assuming it would be repeated for a full year. In the 12 months ending in Apr 2013, CPI inflation of all items not seasonally adjusted was 1.1 percent. Inflation in Apr 2013 seasonally adjusted was minus 0.4 percent relative to Mar 2013, or minus 4.7 percent annual equivalent (http://www.bls.gov/cpi/). The second row provides the same measurements for the CPI of all items excluding food and energy: 1.7 percent in 12 months and 1.6 percent in annual equivalent Jan to Mar 2013. The Wall Street Journal provides the yield curve of US Treasury securities (http://professional.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3000). The lowest yield is 0.036 percent for three months, 0.069 percent for six months, 0.142 percent for one year, 0.305 percent for two years, 0.493 percent for three years, 1.024 percent for five years, 1.534 percent for seven years, 2.134 percent for ten years and 3.285 percent for 30 years. The Irving Fisher (1930) definition of real interest rates is approximately the difference between nominal interest rates, which are those estimated by the Wall Street Journal, and the rate of inflation expected in the term of the security, which could behave as in Table VIII-1. Mar inflation is low in 12 months because of the unwinding of carry trades from zero interest rates to commodity futures prices but could ignite again with subdued risk aversion. Real interest rates in the US have been negative during substantial periods in the past decade while monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):
“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”
Negative real rates of interest distort calculations of risk and returns from capital budgeting by firms, through lending by financial intermediaries to decisions on savings, housing and purchases of households. Inflation on near zero interest rates misallocates resources away from their most productive uses and creates uncertainty of the future path of adjustment to higher interest rates that inhibit sound decisions.
Table VIII-1, US, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%
| ∆% 12 Months Apr 2013/Apr | ∆% Annual Equivalent Feb 2013 to Apr 2013 SA | |
| CPI All Items | 1.1 | 0.4 |
| CPI ex Food and Energy | 1.7 | 1.6 |
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
© Carlos M. Pelaez, 2010, 2011, 2012, 2013
No comments:
Post a Comment