Financial Volatility, Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend, Destruction of Household Nonfinancial Wealth with Stagnating Total Real Wealth, United States Commercial Banks, United States Housing Collapse, Household Income at 1995 Levels, World Cyclical Slow Growth and Global Recession Risk: Part II

 

Financial Volatility, Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend, Destruction of Household Nonfinancial Wealth with Stagnating Total Real Wealth, United States Commercial Banks, United States Housing Collapse, Household Income at 1995 Levels, World Cyclical Slow Growth and Global Recession Risk

Carlos M. Pelaez

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014

I Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars Below Trend

IA Mediocre Cyclical United States Economic Growth

IA1 Contracting Real Private Fixed Investment

IA2 Swelling Undistributed Corporate Profits

IB Destruction of Household Nonfinancial Wealth with Stagnating Total Real Wealth

IIA United States Commercial Banks Assets and Liabilities

IA Transmission of Monetary Policy

IB Functions of Banking

Appendix on Monetary Policy

IA1 Theory

IA2 Policy

IA3 Evidence

IA4 Unwinding Strategy

IC United States Commercial Banks Assets and Liabilities

ID Theory and Reality of Economic History, Cyclical Slow Growth not Secular Stagnation and Monetary Policy Based on Fear of Deflation

IIB United States Housing Collapse

IIC Household Income at 1995 Levels, 45 Million in Poverty and 41 Million without Health Insurance

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

IA Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend. The US is experiencing the first expansion from a recession after World War II with stressing socioeconomic conditions:

• Mediocre economic growth below potential and long-term trend, resulting in idle productive resources with GDP two trillion dollars below trend (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). US GDP grew at the average rate of 3.3 percent per year from 1929 to 2013 with similar performance in whole cycles of contractions and expansions but only at 0.9 percent per year on average from 2007 to 2013. GDP in IIQ2014 is 12.6 percent than what it would have been had it grown at trend of 3.0 percent.
• Private fixed investment stagnating at change of 0.3 percent in the entire cycle from IVQ2007 to IIQ2014 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html)

• Twenty seven million or 16.4 percent of the effective labor force unemployed or underemployed in involuntary part-time jobs with stagnating or declining real wages (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html)
• Stagnating real disposable income per person or income per person after inflation and taxes (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html)
• Depressed hiring that does not afford an opportunity for reducing unemployment/underemployment and moving to better-paid jobs (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.html)
• Productivity growth fell from 2.2 percent per year on average from 1947 to 2013 to 1.5 percent per year on average from 2007 to 2013 deteriorating future growth and prosperity (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html)
• Output of manufacturing in Aug at 17.6 percent below long-term trend since 1919 and at 13.8 percent below trend since 1986 (http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html)
• Unsustainable government deficit/debt and balance of payments deficit (http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html http://cmpassocregulationblog.blogspot.com/2014/06/valuation-risks-world-inflation-waves.html http://cmpassocregulationblog.blogspot.com/2014/02/theory-and-reality-of-cyclical-slow.html http://cmpassocregulationblog.blogspot.com/2014/03/interest-rate-risks-world-inflation.html http://cmpassocregulationblog.blogspot.com/2013/12/tapering-quantitative-easing-mediocre.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html)
• Worldwide waves of inflation (http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html)
• Deteriorating terms of trade and net revenue margins of production across countries in squeeze of economic activity by carry trades induced by zero interest rates (http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html)
• Financial repression of interest rates and credit affecting the most people without means and access to sophisticated financial investments with likely adverse effects on income distribution and wealth disparity (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html)
• 45 million in poverty and 41 million without health insurance with family income adjusted for inflation regressing to 1995 levels (Section II and earlier(http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html
• Net worth of households and nonprofits organizations increasing by 7.5 percent after adjusting for inflation in the entire cycle from IVQ2007 to IIQ2014 when it would have been over 22.0 percent at trend of 3.1 percent per year in real terms from 1945 to 2013 (Section IB and earlier http://cmpassocregulationblog.blogspot.com/2014/06/financial-indecision-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/03/global-financial-risks-recovery-without.html and earlier http://cmpassocregulationblog.blogspot.com/2013/12/collapse-of-united-states-dynamism-of.html). Financial assets increased $14.2 trillion while nonfinancial assets increased $224.1 billion with likely concentration of wealth in those with access to sophisticated financial investments. Real estate assets adjusted for inflation fell 13.5 percent from 2007 to IIQ2014.

Valuations of risk financial assets approach historical highs. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 20 quarters from IIIQ2009 to IIQ2014. 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). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the third estimate of GDP for IIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_3rd.pdf). The average of 7.7 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 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,294.6 billion than actual $16,010.4 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). US GDP in IIQ2014 is 12.5 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,010.4 billion in IIQ2014 or 6.8 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation. The economy of the US can be summarized in growth of economic activity or GDP as fluctuating from mediocre growth of 2.5 percent on an annual basis in 2010 to 1.6 percent in 2011, 2.3 percent in 2012 and 2.2 percent in 2013. The following calculations show that actual growth is around 2.1 to 2.6 percent per year. The rate of growth of 0.9 percent in the entire cycle from 2007 to 2013 is well below 3 percent per year in trend from 1870 to 2010, which the economy of the US always attained for entire cycles in expansions after events such as wars and recessions (Lucas 2011May). Revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) provide important information on long-term growth and cyclical behavior. Table Summary provides relevant data.

Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita

	GDP
Long-Term
1929-2013	3.3
1947-2013	3.2
Whole Cycles
1980-1989	3.5
2006-2013	1.0
2007-2013	0.9
Cyclical Contractions ∆%
IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982	-4.7
IVQ2007 to IIQ2009	-4.2
Cyclical Expansions Average Annual Equivalent ∆%
IQ1983 to IVQ1985 IQ1983-IQ1986 IQ1983-IIIQ1986 IQ1983-IVQ1986 IQ1983-IQ1987 IQ1983-IIQ1987 IQ1983-IIIQ1987 IQ1983 to IVQ1987	5.9 5.7 5.4 5.2 5.0 5.0 4.9 5.0
First Four Quarters IQ1983 to IVQ1983	7.8
IIIQ2009 to IIQ2014	2.2
First Four Quarters IIIQ2009 to IIQ2010	2.7
	Real Disposable Income	Real Disposable Income per Capita
Long-Term
1929-2013	3.2	2.0
1947-1999	3.7	2.3
Whole Cycles
1980-1989	3.5	2.6
2006-2013	1.3	0.5

Source: Bureau of Economic Analysis

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

The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace from 2.1 to 2.5 percent per year. Table Summary GDP provides the data.

1. Average Annual Growth in the Past Eight Quarters. GDP growth in the four quarters of 2012, the four quarters of 2013 and the first two quarters of 2014 accumulated to 5.4 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IIQ2014 of $16,010.4 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/10: {[($16,010.4/$15,190.3)^4/10 -1]100 = 2.1 percent.

2. Average Annual Growth in the Past Four Quarters. GDP growth in the four quarters of IIQ2013 to IIQ2014 accumulated to 2.6 percent that is equivalent to 2.6 percent in a year. This is obtained by dividing GDP in IIQ2014 of $16,010.4 billion by GDP in IIQ2013 of $15,606.6 billion and compounding by 4/4: {[($16,010.4/$15,606.6)^4/4 -1]100 = 2.6%}. The US economy grew 2.6 percent in IIQ2014 relative to the same quarter a year earlier in IIQ2013. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is in the borderline of contraction, and negative in IQ2014. US GDP fell 0.5 percent in IQ2014. The rate of growth of GDP in the revision of IIIQ2013 is 4.5 percent in seasonally adjusted annual rate (SAAR). Inventory accumulation contributed 1.49 percentage points to this rate of growth. The actual rate without this impulse of unsold inventories would have been 3.0 percent, or 0.74 percent in IIIQ2013, such that annual equivalent growth in 2013 is closer to 2.8 percent {[(1.007)(1.004)(1.0074)(1.009)^4/4-1]100 = 2.8%}, compounding the quarterly rates and converting into annual equivalent. Inventory divestment deducted 1.16 percentage points from GDP growth in IQ2014. Without this deduction of inventory divestment, GDP growth would have been minus 0.9 percent in IQ2014, such that the actual growth rates in the four quarters ending in IQ2014 is closer to 2.2 percent {[(1.004)(1.011)(1.009)(0.9977)]^4/4 -1]100 = 2.2%}.

Table Summary GDP, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%

	Real GDP, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	14,991.8	NA	NA	1.9
IVQ2011	15,190.3	1.3	1.1	1.7
IQ2012	15,275.0	1.9	0.6	2.6
IIQ2012	15,336.7	2.3	0.4	2.3
IIIQ2012	15,431.3	2.9	0.6	2.7
IVQ2012	15,433.7	2.9	0.0	1.6
IQ2013	15,538.4	3.6	0.7	1.7
IIQ2013	15,606.6	4.1	0.4	1.8
IIIQ2013	15,779.9	5.3	1.1	2.3
IVQ2013	15,916.2	6.2	0.9	3.1
IQ2014	15,831.7	5.6	-0.5	1.9
IIQ2014	16,010.4	6.8	1.1	2.6
Cumulative ∆% IQ2012 to IQ2014	5.4		5.4
Annual Equivalent ∆%	2.1		2.1

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

Historical parallels are instructive but have all the limitations of empirical research in economics. The more instructive comparisons are not with the Great Depression of the 1930s but rather with the recessions in the 1950s, 1970s and 1980s. The growth rates and job creation in the expansion of the economy away from recession are subpar in the current expansion compared to others in the past. Four recessions are initially considered, following the reference dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles/cyclesmain.html ): IIQ1953-IIQ1954, IIIQ1957-IIQ1958, IIIQ1973-IQ1975 and IQ1980-IIIQ1980. The data for the earlier contractions illustrate that the growth rate and job creation in the current expansion are inferior. The sharp contractions of the 1950s and 1970s are considered in Table I-1, showing the Bureau of Economic Analysis (BEA) quarter-to-quarter, seasonally adjusted (SA), yearly-equivalent growth rates of GDP. The recovery from the recession of 1953 consisted of four consecutive quarters of high percentage growth rates from IIIQ1954 to IIIQ1955: 4.6, 8.0, 11.9 and 6.7. The recession of 1957 was followed by four consecutive high percentage growth rates from IIIQ1958 to IIQ1959: 9.6, 9.7, 7.7 and 10.1. The recession of 1973-1975 was followed by high percentage growth rates from IIQ1975 to IQ1976: 3.1, 6.8, 5.5 and 9.3. The disaster of the Great Inflation and Unemployment of the 1970s, which made stagflation notorious, is even better in growth rates during the expansion phase in comparison with the current slow-growth recession.

Table I-1, US, Seasonally Adjusted Quarterly Percentage Growth Rates in Annual Equivalent of GDP in Cyclical Recessions and Following Four Quarter Expansions ∆%

	IQ	IIQ	IIIQ	IV
R IIQ1953-IIQ1954
1953			-2.2	-5.9
1954	-1.8
E IIIQ1954-IIQ1955
1954			4.6	8.0
1955	11.9	6.7
R IIIQ1957-IIQ1958
1957				-4.0
1958	-10.0
E IIIQ1958-IIQ1959
1958			9.6	9.7
1959	7.7	10.1
R IVQ1969-IV1970
1969				-1.7
1970	-0.7
E IIQ1970-IQ1971
1970		0.7	3.6	-4.0
1971	11.1
R IVQ1973-IQ1975
1973				3.8
1974	-3.3	1.1	-3.8	-1.6
1975	-4.7
E IIQ1975-IQ1976
1975		3.1	6.8	5.5
1976	9.3
R IQ1980-IIIQ1980
1980	1.3	-7.9	-0.6
R IQ1981-IVQ1982
1981	8.5	-2.9	4.7	-4.6
1982	-6.5	2.2	-1.4	0.4
E IQ1983-IVQ1983
1983	5.3	9.4	8.1	8.5
R IVQ2007-IIQ2009
2008	-2.7	2.0	-1.9	-8.2
2009	-5.4	-0.5
E IIIQ2009-IIQ2010
2009			1.3	3.9
2010	1.7	3.9

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

The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ1982 are combined, the impact of lost GDP of 4.7 percent is more comparable to the latest revised 4.2 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.4 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7 and revisions in http://bea.gov/iTable/index_nipa.cfm). Table I-2 provides the Bureau of Economic Analysis (BEA) quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981 to 1982 and 2007 to 2009, using the latest major revision published on July 31, 2013 and the second estimate for IIQ2014 GDP (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_2nd.pdf), which are available in the dataset of the US Bureau of Economic Analysis (http://www.bea.gov/iTable/index_nipa.cfm). There were four quarters of contraction in 1981-1982 ranging in rate from -1.4 percent to -6.5 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.5 percent to -8.2 percent. The striking difference is that in the first twenty quarters of expansion from IQ1983 to IIIQ1987, shown in Table I-2 in relief, GDP grew at the high quarterly percentage growth rates of 5.3, 9.4, 8.1, 8.5, 8.2, 7.2, 4.0, 3.2, 4.0, 3.7, 6.4, 3.0, 3.8, 1.9, 4.1, 2.1, 2.8, 4.6, 3.7 and 6.8. In contrast, the percentage growth rates in the first twenty quarters of expansion from IIIQ2009 to IIQ2014 shown in relief in Table I-2 were mediocre: 1.3, 3.9, 1.7, 3.9, 2.7, 2.5, -1.5, 2.9, 0.8, 4.6, 2.3, 1.6, 2.5, 0.1, 2.7, 1.8, 4.5, 3.5, minus 2.1 and 4.6. Inventory accumulation contributed 2.80 percentage points to the rate of growth of 4.6 percent in IVQ2011. Inventory divestment deducted 1.16 percentage points from GDP growth in IQ2014 and added 1.42 percentage points to the rate of growth in IIQ2014. Economic growth and employment creation continued at slow rhythm during 2012 and in 2013 while much stronger growth would be required in movement to full employment. The cycle is now long by historical standards and growth rates are typically weaker in the final periods of cyclical expansions.

Table I-2, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA

Q	1981	1982	1983	1984	2008	2009	2010
I	8.5	-6.5	5.3	8.2	-2.7	-5.4	1.7
II	-2.9	2.2	9.4	7.2	2.0	-0.5	3.9
III	4.7	-1.4	8.1	4.0	-1.9	1.3	2.7
IV	-4.6	0.4	8.5	3.2	-8.2	3.9	2.5
				1985			2011
I				4.0			-1.5
II				3.7			2.9
III				6.4			0.8
IV				3.0			4.6
				1986			2012
I				3.8			2.3
II				1.9			1.6
III				4.1			2.5
IV				2.1			0.1
				1987			2013
I				2.8			2.7
II				4.6			1.8
III				3.7			4.5
IV				6.8			3.5
				1988			2014
I				2.3			-2.1
II				5.4			4.6
III				2.3
IV				5.4

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

Chart I-1 of the Bureau of Economic Analysis (BEA) provides strong growth of real GDP in the US between 1929 and 1999 at the yearly average rate of 3.5 percent. There is an evident acceleration of the rate of GDP growth in the 1990s as shown by a much sharper slope of the growth curve. Cobet and Wilson (2002) define labor productivity as the value of manufacturing output produced per unit of labor input used (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). Between 1950 and 2000, labor productivity in the US grew less rapidly than in Germany and Japan. The major part of the increase in productivity in Germany and Japan occurred between 1950 and 1973 while the rate of productivity growth in the US was relatively subdued in several periods. While Germany and Japan reached their highest growth rates of productivity before 1973, the US accelerated its rate of productivity growth in the second half of the 1990s. Between 1950 and 2000, the rate of productivity growth in the US of 2.9 percent per year was much lower than 6.3 percent in Japan and 4.7 percent in Germany. Between 1995 and 2000, the rate of productivity growth of the US of 4.6 percent exceeded that of Japan of 3.9 percent and the rate of Germany of 2.6 percent.

Chart I-1, US, Real GDP 1929-1999

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

Chart I-1A provides real GDP annually from 1929 to 2013. Growth after the global recession from IVQ2007 to IIQ2009 has not been sufficiently high to compensate for the contraction as it had occurred in past economic cycles. GDP is about two trillion dollars lower than trend GDP, explaining 26.9 million unemployed or underemployed. There is dramatic decline of productivity growth in the whole cycle from 2.2 percent per year on average from 1947 to 2013 to 1.5 percent per year on average from 2007 to 2013 (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html). There is profound drop in the average rate of output growth from 3.2 percent on average from 1947 to 2013 to 1.0 percent from 2007 to 2013. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,294.6 billion than actual $16,010.4 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). US GDP in IIQ2014 is 12.5 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,010.4 billion in IIQ2014 or 6.8 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.

Chart I-1A, US, Real GDP 1929-2013

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

Chart I-2 provides the growth of real quarterly GDP in the US between 1947 and 2014. The drop of output in the recession from IVQ2007 to IIQ2009 has been followed by anemic recovery compared with return to trend at 3.0 percent from 1870 to 2010 after events such as wars and recessions (Lucas 2011May) and a standstill that can lead to growth recession, or low rates of economic growth. The expansion is relatively long compared to earlier expansion and there could be even another contraction or conventional recession in the future. The average rate of growth from 1947 to 2013 is 3.2 percent. The average growth rate from IV2007 to IVQ2013 is only 1.0 percent with 2.8 percent annual equivalent from the end of the recession in IVQ2001 to the end of the expansion in IVQ2007.

Chart I-2, US, Real GDP, Quarterly, 1947-2014

Source: US Bureau of Economic Analysis

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

Chart I-3 provides real GDP percentage change on the quarter a year earlier for 1983-1984. The objective is simply to compare expansion in two recoveries from sharp contractions as shown in Table I-2. Growth rates in the early phase of the recovery in 1983 and 1984 were very high, which is the opportunity to reduce unemployment that has characterized cyclical expansion in the postwar US economy.

Chart I-3, Real GDP Percentage Change on Quarter a Year Earlier 1983-1987

Source: US Bureau of Economic Analysis

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

In contrast, growth rates in the comparable first nineteen quarters of expansion from 2009 to 2014 in Chart I-4 have been mediocre. As a result, growth has not provided the exit from unemployment and underemployment as in other cyclical expansions in the postwar period. Growth rates did not rise in V shape as in earlier expansions and then declined close to the standstill of growth recessions.

Chart I-4, US, Real GDP Percentage Change on Quarter a Year Earlier 2009-2014

Source: US Bureau of Economic Analysis

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

Table I-3 provides percentage change of real GDP in the United States in the 1930s, 1980s and 2000s. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.4 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7 and revisions in http://bea.gov/iTable/index_nipa.cfm). Data are available for the 1930s only on a yearly basis. US GDP fell 4.7 percent in the two recessions (1) from IQ1980 to IIIQ1980 and (2) from III1981 to IVQ1981 to IVQ1982 and 4.2 percent cumulatively in the recession from IVQ2007 to IIQ2009. It is instructive to compare the first three years of the expansions in the 1980s and the current expansion. GDP grew at 4.6 percent in 1983, 7.3 percent in 1984, 4.2 percent in 1985, 3.5 percent in 1986 and 3.5 percent in 1987. In contrast, GDP grew 2.5 percent in 2010, 1.6 percent in 2011, 2.3 percent in 2012 and 2.2 percent in 2013. Actual annual equivalent GDP growth in the four quarters of 2012, and six quarters from IQ2013 to IIQ2014 is 2.1 percent and 2.6 percent in the four quarters ending in IIQ2014. GDP grew at 4.2 percent in 1985, 3.5 percent in 1986 and 3.5 percent in 1987 while the forecasts of the central tendency of participants of the Federal Open Market Committee (FOMC) are in the range of 2.0 to 2.2 percent in 2014 (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf) with less reliable forecast of 2.6 to 3.0 percent in 2015 (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf ). Growth of GDP in the expansion from IIIQ2009 to IIQ2014 has been at average 2.2 percent in annual equivalent.

Table I-3, US, Percentage Change of GDP in the 1930s, 1980s and 2000s, ∆%

Year	GDP ∆%	Year	GDP ∆%	Year	GDP ∆%
1930	-8.5	1980	-0.2	2000	4.1
1931	-6.4	1981	2.6	2001	1.0
1932	-12.9	1982	-1.9	2002	1.8
1933	-1.3	1983	4.6	2003	2.8
1934	10.8	1984	7.3	2004	3.8
1935	8.9	1985	4.2	2005	3.3
1936	12.9	1986	3.5	2006	2.7
1937	5.1	1987	3.5	2007	1.8
1938	-3.3	1988	4.2	2008	-0.3
1930	8.0	1989	3.7	2009	-2.8
1940	8.8	1990	1.9	2010	2.5
1941	17.7	1991	-0.1	2011	1.6
1942	18.9	1992	3.6	2012	2.3
1943	17.0	1993	2.7	2013	2.2

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

Chart I-5 provides percentage change of GDP in the US during the 1930s. There is vast literature analyzing the Great Depression (Pelaez and Pelaez, Regulation of Banks and Finance (2009), 198-217). Cole and Ohanian (1999) find that US real per capita output was lower by 11 percent in 1939 than in 1929 while the typical expansion of real per capita output in the US during a decade is 31 percent. Private hours worked in the US were 25 percent lower in 1939 relative to 1929.

Chart I-5, US, Percentage Change of GDP in the 1930s

Source: US Bureau of Economic Analysis

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

In contrast, Chart I-6 shows rapid recovery from the recessions in the 1980s. High growth rates in the initial quarters of expansion eliminated the unemployment and underemployment created during the contraction. The economy then returned to grow at the trend of expansion, interrupted by another contraction in 1991.

Chart I-6, US, Percentage Change of GDP in the 1980s

Source: US Bureau of Economic Analysis

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

Chart I-7 provides the rates of growth during the 2000s. Growth rates in the initial eighteen quarters of expansion have been relatively lower than during recessions after World War II. As a result, unemployment and underemployment continue at the rate of 16.4 percent of the US labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html) with weak hiring (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.html).

Chart I-7, US, Percentage Change of GDP in the 2000s

Source: US Bureau of Economic Analysis

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

Characteristics of the four cyclical contractions are provided in Table I-4 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.7 percent, which is almost equal to the decline of 4.2 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.4 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7 and revisions in http://bea.gov/iTable/index_nipa.cfm). The comparison of the global recession after 2007 with the Great Depression is entirely misleading.

Table I-4, US, Number of Quarters, GDP Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions   

	Number of Quarters	Cumulative Percentage Contraction	Average Percentage Rate
IIQ1953 to IIQ1954	3	-2.4	-0.8
IIIQ1957 to IIQ1958	3	-3.0	-1.0
IVQ1973 to IQ1975	5	-3.1	-0.6
IQ1980 to IIIQ1980	2	-2.2	-1.1
IIIQ1981 to IVQ1982	4	-2.5	-0.64
IVQ2007 to IIQ2009	6	-4.2	-0.72

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

Table I-5 shows the mediocre average annual equivalent growth rate of 2.2 percent of the US economy in the twenty quarters of the current cyclical expansion from IIIQ2009 to IIQ2014. In sharp contrast, the average growth rate of GDP was:

• 5.7 percent in the first thirteen quarters of expansion from IQ1983 to IQ1986
• 5.4 percent in the first fifteen quarters of expansion from IQ1983 to IIIQ1986
• 5.2 percent in the first sixteen quarters of expansion from IQ1983 to IVQ1986
• 5.0 percent in the first seventeen quarters of expansion from IQ1983 to IQ1987
• 5.0 percent in the first eighteen quarters of expansion from IQ1983 to IIQ1987
• 4.9 percent in the first nineteen quarters of expansion from IQ1983 to IIIQ1987
• 5.0 percent in the first twenty quarters of expansion from IQ1983 to IVQ1987

The line “average first four quarters in four expansions” provides the average growth rate of 7.7 percent with 7.8 percent from IIIQ1954 to IIQ1955, 9.2 percent from IIIQ1958 to IIQ1959, 6.1 percent from IIIQ1975 to IIQ1976 and 7.8 percent from IQ1983 to IVQ1983. The United States missed this opportunity of high growth in the initial phase of recovery. BEA data show the US economy in standstill with annual growth of 2.5 percent in 2010 decelerating to 1.6 percent annual growth in 2011, 2.3 percent in 2012 and 2.2 percent in 2013 (http://www.bea.gov/iTable/index_nipa.cfm) The expansion from IQ1983 to IQ1986 was at the average annual growth rate of 5.7 percent, 5.2 percent from IQ1983 to IVQ1986, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983. GDP growth in the four quarters of 2012, the four quarters of 2013 and the first two quarters of 2014 accumulated to 5.4 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IIQ2014 of $16,010.4 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/10: {[($16,010.4/$15,190.3)^4/10 -1]100 = 2.1 percent. The rate of growth of GDP in the revision of the third estimate of IIIQ2013 is 4.5 percent in seasonally adjusted annual rate (SAAR). Inventory accumulation contributed 1.49 percentage points to this rate of growth. The actual rate without this impulse of unsold inventories would have been 3.0 percent, or 0.74 percent in IIIQ2013, such that annual equivalent growth in 2013 is closer to 2.8 percent {[(1.007)(1.004)(1.0074)(1.009)^4/4-1]100 = 2.8%}, compounding the quarterly rates and converting into annual equivalent. Inventory divestment deducted 1.16 percentage points from GDP growth in IQ2014. Without this deduction of inventory divestment, GDP growth would have been minus 0.9 percent in IQ2014, such that the actual growth rates in the four quarters ending in IQ2014 is closer to 2.2 percent {[(1.004)(1.011)(1.009)(0.9977)]^4/4 -1]100 = 2.2%}.

Table I-5, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions

	Number of Quarters	Cumulative Growth ∆%	Average Annual Equivalent Growth Rate
IIIQ 1954 to IQ1957	11	12.8	4.5
First Four Quarters IIIQ1954 to IIQ1955	4	7.8
IIQ1958 to IIQ1959	5	10.0	7.9
First Four Quarters IIIQ1958 to IIQ1959	4	9.2
IIQ1975 to IVQ1976	8	8.3	4.1
First Four Quarters IIIQ1975 to IIQ1976	4	6.1
IQ1983-IQ1986 IQ1983-IIIQ1986 IQ1983-IVQ1986 IQ1983-IQ1987 IQ1983-IIQ1987 IQ1983 to IIIQ1987 IQ1983 to IVQ1987	13 15 16 17 18 19 20	19.9 21.6 22.3 23.1 24.5 25.6 27.7	5.7 5.4 5.2 5.0 5.0 4.9 5.0
First Four Quarters IQ1983 to IVQ1983	4	7.8
Average First Four Quarters in Four Expansions*		7.7
IIIQ2009 to IIQ2014	20	11.5	2.2
First Four Quarters IIIQ2009 to IIQ2010		2.7

*First Four Quarters: 7.8% IIIQ1954-IIQ1955; 9.2% IIIQ1958-IIQ1959; 6.1% IIIQ1975-IQ1976; 7.8% IQ1983-IVQ1983

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

Chart I-8 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.

Chart I-8, US, Real GDP, 1980-1989

Source: US Bureau of Economic Analysis

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

Chart I-9 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2013. The economy has underperformed during the first twenty quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.

Chart I-9, US, Real GDP, 2007-2014

Source: US Bureau of Economic Analysis

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

As shown in Tables I-4 and I-5 above the loss of real GDP in the US during the contraction was 4.3 percent but the gain in the cyclical expansion has been only 11.4 percent (first to the last row in Table I-5), using all latest revisions. As a result, the level of real GDP in IIQ2014 with the first estimate and revisions is only higher by 6.8 percent than the level of real GDP in IVQ2007. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,294.6 billion than actual $16,010.4 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). US GDP in IIQ2014 is 12.5 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,010.4 billion in IIQ2014 or 6.8 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.

The contraction actually concentrated in two quarters: decline of 2.1 percent in IVQ2008 relative to the prior quarter and decline of 1.4 percent in IQ2009 relative to IVQ2008. The combined fall of GDP in IVQ2008 and IQ2009 was 3.5 percent {[(1-0.021) x (1-0.014) -1]100 = -3.5%}, or {[(IQ2009 $14,375.0)/(IIIQ2008 $14,891.6) – 1]100 = -3.5%} except for rounding. Those two quarters coincided with the worst effects of the financial crisis (Cochrane and Zingales 2009). GDP fell 0.1 percent in IIQ2009 but grew 0.3 percent in IIIQ2009, which is the beginning of recovery in the cyclical dates of the NBER. Most of the recovery occurred in five successive quarters from IVQ2009 to IVQ2010 of growth of 1.0 percent in IVQ2009, 0.4 percent in IQ2010, 1.0 percent in IIQ2010 and nearly equal growth at 0.7 percent in IIIQ2010 and 0.6 percent in IVQ2010 for cumulative growth in those five quarters of 3.8 percent, obtained by accumulating the quarterly rates {[(1.01 x 1.004 x 1.01 x 1.007 x 1.006) – 1]100 = 3.8%} or {[(IVQ2010 $14,939.0)/(IIIQ2009 $14,402.5) – 1]100 = 3.7%} with minor rounding difference. The economy then stalled during the first half of 2011 with decline of 0.4 percent in IQ2011 and growth of 0.7 percent in IIQ2011 for combined annual equivalent rate of 0.6 percent {(0.996 x 1.007)²}. The economy grew 0.2 percent in IIIQ2011 for annual equivalent growth of 0.7 percent in the first three quarters {[(0.996 x 1.007 x 1.002)^4/3 -1]100 = 0.7%}. Growth picked up in IVQ2011 with 1.1 percent relative to IIIQ2011. Growth in a quarter relative to a year earlier in Table I-6 slows from over 2.7 percent during three consecutive quarters from IIQ2010 to IVQ2010 to 1.9 percent in IQ2011, 1.7 percent in IIQ2011, 1.2 percent in IIIQ2011 and 1.7 percent in IVQ2011. As shown below, growth of 1.1 percent in IVQ2011 was partly driven by inventory accumulation. In IQ2012, GDP grew 0.6 percent relative to IVQ2011 and 2.6 percent relative to IQ2011, decelerating to 0.4 percent in IIQ2012 and 2.3 percent relative to IIQ2011 and 0.6 percent in IIIQ2012 and 2.7 percent relative to IIIQ2011 largely because of inventory accumulation and national defense expenditures. Growth was 0.0 percent in IVQ2012 with 1.6 percent relative to a year earlier but mostly because of deduction of 1.80 percentage points of inventory divestment and 1.12 percentage points of reduction of one-time national defense expenditures. Growth was 0.7 percent in IQ2013 and 1.7 percent relative to IQ2012 in large part because of burning savings to consume caused by financial repression of zero interest rates. There is similar growth of 0.4 percent in IIQ2013 and 1.8 percent relative to a year earlier. In IIIQ2013, GDP grew 1.1 percent relative to the prior quarter and 2.3 percent relative to the same quarter a year earlier with inventory accumulation contributing 1.49 percentage points to growth at 4.5 percent SAAR in IIIQ2013. GDP increased 0.9 percent in IVQ2013 and 3.1 percent relative to a year earlier. GDP fell 0.5 percent in IQ2014 and grew 1.9 percent relative to a year earlier. Inventory divestment deducted 1.16 percentage points from GDP growth in IQ2014. GDP grew 1.1 percent in IIQ2014, 2.6 percent relative to a year earlier and at 4.6 SAAR with inventory change contributing 1.42 percentage points. Rates of a quarter relative to the prior quarter capture better deceleration of the economy than rates on a quarter relative to the same quarter a year earlier. The critical question for which there is not yet definitive solution is whether what lies ahead is continuing growth recession with the economy crawling and unemployment/underemployment at extremely high levels or another contraction or conventional recession. Forecasts of various sources continued to maintain high growth in 2011 without taking into consideration the continuous slowing of the economy in late 2010 and the first half of 2011. The sovereign debt crisis in the euro area and growth in China are common sources of doubts on the rate and direction of economic growth in the US. There is weak internal demand in the US with almost no investment and spikes of consumption driven by burning saving because of financial repression forever in the form of zero interest rates.

Table I-6, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2009 Dollars and ∆%

	Real GDP, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	14,991.8	NA	0.4	1.9
IQ2008	14,889.5	-0.7	-0.7	1.1
IIQ2008	14,963.4	-0.2	0.5	0.8
IIIQ2008	14,891.6	-0.7	-0.5	-0.3
IVQ2008	14,577.0	-2.8	-2.1	-2.8
IQ2009	14,375.0	-4.1	-1.4	-3.5
IIQ2009	14,355.6	-4.2	-0.1	-4.1
IIIQ2009	14,402.5	-3.9	0.3	-3.3
IV2009	14,541.9	-3.0	1.0	-0.2
IQ2010	14,604.8	-2.6	0.4	1.6
IIQ2010	14,745.9	-1.6	1.0	2.7
IIIQ2010	14,845.5	-1.0	0.7	3.1
IVQ2010	14,939.0	-0.4	0.6	2.7
IQ2011	14,881.3	-0.7	-0.4	1.9
IIQ2011	14,989.6	0.0	0.7	1.7
IIIQ2011	15,021.1	0.2	0.2	1.2
IVQ2011	15,190.3	1.3	1.1	1.7
IQ2012	15,275.0	1.9	0.6	2.6
IIQ2012	15,336.7	2.3	0.4	2.3
IIIQ2012	15,431.3	2.9	0.6	2.7
IVQ2012	15,433.7	2.9	0.0	1.6
IQ2013	15,538.4	3.6	0.7	1.7
IIQ2013	15,606.6	4.1	0.4	1.8
IIIQ2013	15,779.9	5.3	1.1	2.3
IVQ2013	15,916.2	6.2	0.9	3.1
IQ2014	15,831.7	5.6	-0.5	1.9
IIQ2014	16,010.4	6.8	1.1	2.6

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

Chart I-10 provides the percentage change of real GDP from the same quarter a year earlier from 1980 to 1989. There were two contractions almost in succession in 1980 and from 1981 to 1983. The expansion was marked by initial high rates of growth as in other recession in the postwar US period during which employment lost in the contraction was recovered. Growth rates continued to be high after the initial phase of expansion.

Chart I-10, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 1980-1989

Source: US Bureau of Economic Analysis

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

The experience of recovery after 2009 is not as complete as during the 1980s. Chart I-11 shows the much lower rates of growth in the early phase of the current expansion and sharp decline from an early peak. The US missed the initial high growth rates in cyclical expansions that eliminate unemployment and underemployment.

Chart I-11, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 2007-2014

Source: US Bureau of Economic Analysis

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

Chart I-12 provides growth rates from a quarter relative to the prior quarter during the 1980s. There is the same strong initial growth followed by a long period of sustained growth.

Chart I-12, Percentage Change of Real Gross Domestic Product from Prior Quarter 1980-1989

Source: US Bureau of Economic Analysis

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

Chart I-13 provides growth rates in a quarter relative to the prior quarter from 2007 to 2014. Growth in the current expansion after IIIQ2009 has not been as strong as in other postwar cyclical expansions.

Chart I-13, Percentage Change of Real Gross Domestic Product from Prior Quarter 2007-2014

Source: US Bureau of Economic Analysis

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

The revised estimates and earlier estimates from IQ2008 to IQ2014 in seasonally adjusted annual equivalent rates are shown in Table I-7. The strongest revision is for IVQ2008 for which the contraction of GDP is revised from minus 6.8 percent to minus 8.9 percent and minus 8.2 percent. IQ2009 is also revised from contraction of minus 4.9 percent to minus 6.7 percent but then lowered to contraction of 5.3 percent and 5.4 percent. There is only minor revision in IIIQ2008 of the contraction of minus 4.0 percent to minus 3.7 percent and much lower to minus 1.9 percent. Growth of 5.0 percent in IV2009 is revised to 3.8 percent and then increased to 4.0 percent but lowered to 3.9 percent. Growth in IQ2010 is lowered from 3.9 percent to 2.3 percent and 1.7 percent. Growth in IIQ2010 is upwardly revised to 3.8 percent but then lowered to 2.2 percent. The final revision increased growth in IIQ2010 to 3.9 percent. Revisions lowered growth of 1.9 percent in IQ2011 to minus 1.5 percent. The revisions increased growth of 1.8 percent in IQ2013 to 2.7 percent and increased growth of 2.0 percent in IQ2012 to 2.3 percent. The revisions do not alter the conclusion that the current expansion is much weaker than historical sharp contractions since the 1950s and is now changing into slow growth recession with higher risks of contraction and continuing underperformance.

Table I-7, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA, Revised and Earlier Estimates

Quarters	Rev Jul 30, 2014	Rev Jul 31, 2013	Rev Jul 27, 2012	Rev Jul 29, 2011	Earlier Estimate
2008
I	-2.7	-2.7		-1.8	-0.7
II	2.0	2.0		1.3	0.6
III	-1.9	-2.0		-3.7	-4.0
IV	-8.2	-8.3		-8.9	-6.8
2009
I	-5.4	-5.4	-5.3	-6.7	-4.9
II	-0.5	-0.4	-0.3	-0.7	-0.7
III	1.3	1.3	1.4	1.7	1.6
IV	3.9	3.9	4.0	3.8	5.0
2010
I	1.7	1.6	2.3	3.9	3.7
II	3.9	3.9	2.2	3.8	1.7
III	2.7	2.8	2.6	2.5	2.6
IV	2.5	2.8	2.4	2.3	3.1
2011
I	-1.5	-1.3	0.1	0.4	1.9
II	2.9	3.2	2.5
III	0.8	1.4	1.3
IV	4.6	4.9	4.1
2012
I	2.3	3.7	2.0
II	1.6	1.2	1.3
III	2.5	2.8	3.1
IV	0.1	0.1	0.4
2013
I	2.7	1.1	1.8
II	1.8	2.5
III	4.5	4.1
IV	3.5	2.6
2014
I	-2.1	-2.9

Note: Rev: Revision

Source: US Bureau of Economic Analysis

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

Aggregate demand, personal consumption expenditures (PCE) and gross private domestic investment (GDI) were much stronger during the expansion phase from IQ1983 to IQ1987 than from IIIQ2009 to IIQ2014, as shown in Table I-8. GDI provided the impulse of growth in 1983 and 1984, which has not been the case from 2009 to 2014. The investment decision in the US economy has been frustrated in the current cyclical expansion. Growth of GDP in IIIQ2013 at seasonally adjusted annual rate of 4.5 percent consisted of positive contribution of 1.39 percentage points of personal consumption expenditures (PCE) plus positive contribution of 2.50 percentage points of gross private domestic investment (GDI) of which 1.49 percentage points of inventory investment (∆PI), contribution of net exports (trade or exports less imports) of 0.59 percentage points and 0.04 percentage points of government consumption expenditures and gross investment (GOV) partly because of one-time contribution of national defense expenditures of 0.03 percentage points. Growth at 3.5 percent in IVQ2013 had strongest contributions of 2.51 percentage points of PCE and 1.08 percentage points of trade. Growth of GDP at minus 2.1 percent in IQ2014 is mostly contribution of 0.83 percentage points by PCE with deductions of 1.13 percentage points by GDI, inventory divestment of 1.16 percentage points and trade deducting 1.66 percentage points. Growth at 4.6 percent in IIQ2014 consists of contributions of 1.75 percentage points by PCE and 2.87 percentage points by GDI with 1.42 percentage points by inventory change. Trade deducted 0.34 percentage points and government added 0.31 percentage points mostly because of contribution of 0.38 percentage points of expenditures by state and local government. The economy of the United States has lost the dynamic growth impulse of earlier cyclical expansions with mediocre growth resulting from consumption forced by one-time effects of financial repression, national defense expenditures and inventory accumulation.

Table I-8, US, Contributions to the Rate of Growth of GDP in Percentage Points

	GDP	PCE	GDI	∆ PI	Trade	GOV
2014
I	-2.1	0.83	-1.13	-1.16	-1.66	-0.15
II	4.6	1.75	2.87	1.42	-0.34	0.31
2013
I	2.7	2.45	1.12	0.70	-0.08	-0.75
II	1.8	1.23	1.03	0.30	-0.54	0.04
III	4.5	1.39	2.50	1.49	0.59	0.04
IV	3.5	2.51	0.62	-0.34	1.08	-0.71
2012
I	2.3	1.87	1.04	-0.20	-0.11	-0.56
II	1.6	0.86	0.88	0.27	-0.04	-0.08
III	2.5	1.32	0.26	-0.19	0.39	0.52
IV	0.1	1.32	-0.84	-1.80	0.79	-1.20
2011
I	-1.5	1.38	-1.07	-0.96	-0.24	-1.60
II	2.9	0.57	2.14	1.04	0.31	-0.08
III	0.8	1.20	0.15	-2.10	0.01	-0.52
IV	4.6	0.94	4.16	2.80	-0.21	-0.31
2010
I	1.7	1.46	1.77	1.66	-0.85	-0.63
II	3.9	2.23	2.86	1.09	-1.77	0.61
III	2.7	1.77	1.86	1.90	-0.83	-0.07
IV	2.5	2.79	-0.51	-1.63	1.12	-0.87
2009
I	-5.4	-0.86	-7.02	-2.26	2.30	0.15
II	-0.5	-1.19	-3.25	-1.12	2.34	1.56
III	1.3	1.68	-0.40	-0.38	-0.45	0.48
IV	3.9	-0.01	4.05	4.40	0.06	-0.17
1982
I	-6.5	1.61	-7.59	-5.33	-0.49	-0.05
II	2.2	0.89	-0.06	2.26	0.81	0.56
III	-1.4	1.88	-0.62	1.11	-3.22	0.53
IV	0.4	4.51	-5.37	-5.33	-0.10	1.35
1983
I	5.3	2.45	2.36	0.92	-0.29	0.82
II	9.4	5.06	5.96	3.43	-2.46	0.89
III	8.1	4.50	4.40	0.57	-2.25	1.42
IV	8.5	4.06	6.94	3.01	-1.14	-1.36
1984
I	8.2	2.26	7.23	4.94	-2.31	1.01
II	7.2	3.64	2.57	-0.29	-0.87	1.87
III	4.0	1.95	1.69	0.21	-0.36	0.70
IV	3.2	3.29	-1.08	-2.44	-0.56	1.58
1985
I	4.0	4.23	-2.14	-2.86	0.94	1.01
II	3.7	2.35	1.34	0.35	-1.90	1.93
III	6.4	4.82	-0.43	-0.15	-0.01	1.98
IV	3.0	0.62	2.80	1.40	-0.66	0.27
1986
I	3.8	2.10	0.04	-0.17	0.92	0.70
II	1.9	2.77	-1.30	-1.30	-1.33	1.70
III	4.1	4.55	-1.97	-1.62	-0.45	1.95
IV	2.1	1.62	0.24	-0.29	0.71	-0.48
1987
I	2.8	0.05	1.98	3.28	0.23	0.57
II	4.6	3.54	0.08	-0.99	0.14	0.81
III	3.7	2.97	0.03	-1.19	0.45	0.23
IV	6.8	0.57	4.94	4.95	0.18	1.08

Note: PCE: personal consumption expenditures; GDI: gross private domestic investment; ∆ PI: change in private inventories; Trade: net exports of goods and services; GOV: government consumption expenditures and gross investment; – is negative and no sign positive

GDP: percent change at annual rate; percentage points at annual rates

Source: US Bureau of Economic Analysis

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

The Bureau of Economic Analysis (BEA) (pages 1) conducted the annual revision of GDP (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_adv.pdf):

“The estimates released today reflect the results of the annual revision of the national income and product accounts (NIPAs) in conjunction with the "advance" estimate of GDP for the second quarter of 2014. In addition to the regular revision of estimates for the most recent 3 years and the first quarter of 2014, GDP and select components were revised back to the first quarter of 1999 (see the Technical Note). More information is available in "Preview of Upcoming NIPA Revision" in the May Survey of Current Business and on BEA's Web site. The August Survey will contain an article describing the annual revision in detail. “

The Bureau of Economic Analysis (BEA) (pages 1-2 http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_3rd.pdf) explains growth of GDP in IIQ2014 as follows:

“Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 4.6 percent in the second quarter of 2014, according to the "third" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 2.1 percent.

The GDP estimate released today is based on more complete source data than were available for the "second" estimate issued last month. In the second estimate, the increase in real GDP was 4.2 percent. With the third estimate for the second quarter, the general picture of economic growth remains the same; increases in nonresidential fixed investment and in exports were larger than previously estimated (for more information, see "Revisions" on page 3).

The increase in real GDP in the second quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, private inventory investment, nonresidential fixed investment, state and local government spending, and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased.

Real GDP increased 4.6 percent in the second quarter, after decreasing 2.1 percent in the first.

This upturn in the percent change in real GDP primarily reflected upturns in exports and in private inventory investment, accelerations in nonresidential fixed investment and in PCE, and upturns in state and local government spending and in residential fixed investment that were partly offset by an acceleration in imports. “

There are positive contributions to growth in IIQ2014 shown in Table I-9:

• Personal consumption expenditures (PCE) growing at 2.5 percent
• Consumption of durable goods growing at 14.1 percent
• Nonresidential fixed investment growing at 9.7 percent
• Residential fixed investment growing at 8.8 percent
• Government expenditures growing at 1.7 percent
• Exports growing at 11.1 percent
• National defense expenditures growing at 11.3 percent
• Private inventory investment contributing 1.42 percentage points

There were negative contributions in IIQ2014:

• Imports growing at 11.3 percent, which is deduction from growth
• Federal government expenditures contracting at 0.9 percent

The BEA explains acceleration in real GDP growth in IIQ2014 by:

• Increase in the growth rate of PCE from 1.2 percent in IQ2014 to 2.5 percent in IIQ2014
• Acceleration of inventory investment contributing 1.42 percentage points in IIQ2014 after deducting 1.16 percentage points in IQ2014
• Growth of state and local government expenditures at 3.4 percent in IIQ2014 compared with contraction at 1.3 percent in IQ2014
• Growth of nonresidential fixed investment at 9.7 percent in IIQ2014 compared with growth at 1.6 percent in IQ2014
• Growth of residential fixed investment at 8.8 percent compared with contraction at 5.3 percent in IQ2014
• Growth of consumption of durable goods at 14.1 percent in IIQ2014 compared with 3.2 percent in IQ2014
• Growth of exports at 11.1 percent compared with contraction at 9.2 percent in IQ2014
• Acceleration of national defense expenditures at 0.9 percent in IIQ2014 compared with contraction at 4.0 percent in IQ2014

The BEA finds offsetting decelerating factors:

· Acceleration of growth of imports at 11.3 percent in IIQ2014 after growth at 2.2 percent in IQ2014

An important aspect of growth in the US is the decline in growth of real disposable personal income, or what is left after taxes and inflation, which increased at the rate of 0.9 percent in IIIQ2013 compared with a year earlier. Contraction of real disposable income of 1.9 percent in IVQ2013 relative to a year earlier is largely due to comparison with an artificially higher level in anticipations of income in Nov and Dec 2012 to avoid increases in taxes in 2013, an episode known as “fiscal cliff.” Real disposable personal income increased 2.4 percent in IQ2014 relative to a year earlier and 2.5 percent in IIQ2014 relative to a year earlier. The effects of financial repression, or zero interest, are vividly shown in the decline of the savings rate, or personal saving as percent of disposable income from 8.6 percent in IVQ2012 to 5.2 percent in IIIQ2013 and 4.4 percent in IVQ2013. The savings rate eased to 4.9 percent in IQ2014, increasing to 5.4 percent in IIQ2014. Anticipation of income in IVQ2012 to avoid higher taxes in 2013 caused increases in income and savings while higher payroll taxes in 2013 restricted income growth and savings in IQ2013. Zero interest rates induce risky investments with high leverage and can contract balance sheets of families, business and financial institutions when interest rates inevitably increase in the future. There is a tradeoff of weaker economy in the future when interest rates increase by meager growth in the present with forced consumption by zero interest rates. Microeconomics consists of the analysis of allocation of scarce resources to alternative and competing ends. Zero interest rates cloud he calculus of risk and returns in consumption and investment, disrupting decisions that maintain the economy in its long-term growth path.

Table I-9, US, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase, %

	IIQ 2013	IIIQ 2012	IVQ     2013	IQ  2014	IIQ  2014
GDP	1.8	4.5	3.5	-2.1	4.6
PCE	1.8	2.0	3.7	1.2	2.5
Durable Goods	4.5	4.9	5.7	3.2	14.1
NRFI	1.6	5.5	10.4	1.6	9.7
RFI	19.0	11.2	-8.5	-5.3	8.8
Exports	6.3	5.1	10.0	-9.2	11.1
Imports	8.5	0.6	1.3	2.2	11.3
GOV	0.2	0.2	-3.8	-0.8	1.7
Federal GOV	-3.5	-1.2	-10.4	-0.1	-0.9
National Defense	-2.1	0.4	-11.4	-4.0	0.9
Cont to GDP Growth % Points	-0.09	0.03	-0.55	-0.18	0.04
State/Local GOV	2.7	1.1	0.6	-1.3	3.4
∆ PI (PP)	0.30	1.49	-0.34	-1.16	1.42
Final Sales of Domestic Product	1.5	3.0	3.9	-1.0	3.2
Gross Domestic Purchases	2.2	3.8	2.3	-0.4	4.8
Prices Gross Domestic Purchases	0.8	1.7	1.4	1.4	2.0
Prices of GDP	1.2	1.7	1.5	1.3	2.1
Prices of GDP Excluding Food and Energy	1.3	1.9	1.8	1.2	1.8
Prices of PCE	0.5	1.7	1.0	1.4	2.3
Prices of PCE Excluding Food and Energy	1.0	1.4	1.3	1.2	2.0
Prices of Market Based PCE	0.1	1.7	0.7	1.2	2.2
Prices of Market Based PCE Excluding Food and Energy	0.7	1.4	1.0	1.0	1.8
Real Disposable Personal Income*	0.3	0.9	-1.9	2.4	2.5
Personal Saving As % Disposable Income	5.2	5.2	4.4	4.9	5.4

Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in

private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income

*Percent change from quarter one year ago

Source: Bureau of Economic Analysis

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

Percentage shares of GDP are shown in Table I-10. PCE (personal consumption expenditures) is equivalent to 68.5 percent of GDP and is under pressure with stagnant real disposable income, high levels of unemployment and underemployment and higher savings rates than before the global recession, temporarily interrupted by financial repression in the form of zero interest rates. Gross private domestic investment is also growing slowly even with about two trillion dollars in cash holdings by companies. In a slowing world economy, it may prove more difficult to grow exports faster than imports to generate higher growth. Bouts of risk aversion revalue the dollar relative to most currencies in the world as investors increase their holdings of dollar-denominated assets.

Table I-10, US, Percentage Shares of GDP, %

	IIQ2014
GDP	100.0
PCE	68.5
Goods	22.9
Durable	7.5
Nondurable	15.4
Services	45.6
Gross Private Domestic Investment	16.4
Fixed Investment	15.8
NRFI	12.6
Structures	2.9
Equipment & Software	5.8
Intellectual Property	3.9
RFI	3.2
Change in Private       Inventories	0.6
Net Exports of Goods and Services	-3.2
Exports	13.5
Goods	9.4
Services	4.2
Imports	16.7
Goods	13.9
Services	2.8
Government	18.3
Federal	7.0
National Defense	4.4
Nondefense	2.6
State and Local	11.3

PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment

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

Table I-11 shows percentage point (PP) contributions to the annual levels of GDP growth in the earlier recessions 1958-1959, 1975-1976, 1982-1983 and 2009, 2010, 2011, 2012 and 2013. The data incorporate the new revisions released by the BEA on Jul 31, 2013. The most striking contrast is in the rates of growth of annual GDP in the expansion phases of 6.9 percent in 1959, 5.4 percent in 1976, and 4.6 percent in 1983 followed by 7.3 percent in 1984 and 4.2 percent in 1985. In contrast, GDP grew 2.5 percent in 2010 after six consecutive quarters of growth, 1.6 percent in 2011 after ten consecutive quarters of expansion, 2.3 percent in 2012 after 14 quarters of expansion and 2.2 percent in 2013 after 18 consecutive quarters of expansion. Annual levels also show much stronger growth of PCEs in the expansions after the earlier contractions than in the expansion after the global recession of 2007. Gross domestic investment was much stronger in the earlier expansions than in 2010, 2011, 2012 and 2013.

Table I-11, US, Percentage Point Contributions to the Annual Growth Rate of GDP

	GDP	PCE	GDI	∆ PI	Trade	GOV
1958	-0.7	0.52	-1.16	-0.17	-0.87	0.77
1959	6.9	3.49	2.82	0.83	0.00	0.59
1975	-0.2	1.36	-2.90	-1.23	0.86	0.49
1976	5.4	3.41	2.91	1.37	-1.05	0.12
1982	-1.9	0.86	-2.55	-1.30	-0.59	0.38
1983	4.6	3.54	1.60	0.28	-1.32	0.81
1984	7.3	3.32	4.73	1.90	-1.54	0.76
1985	4.2	3.25	-0.01	-1.03	-0.39	1.38
1986	3.5	2.63	0.03	-0.31	-0.29	1.14
1987	3.5	2.14	0.53	0.41	0.17	0.63
2009	-2.8	-1.08	-3.52	-0.76	1.19	0.64
2010	2.5	1.32	1.66	1.45	-0.46	0.02
2011	1.6	1.55	0.73	-0.14	-0.02	-0.65
2012	2.3	1.25	1.33	0.15	0.04	-0.30
2013	2.2	1.64	0.76	0.06	0.22	-0.39

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

Table I-12 provides more detail of the contributions to growth of GDP from 2009 to 2013 using annual-level data. PCEs contributed 1.32 PPs to GDP growth in 2010 of which 0.77 percentage points (PP) in goods and 0.55 PP in services. Gross private domestic investment (GPDI) deducted 3.52 PPs of GDP growth in 2009 of which -2.77 PPs by fixed investment and -0.76 PPs of inventory change (∆PI) and added 1.66 PPs of GPDI in 2010 of which 0.21 PPs of fixed investment and 1.45 PPs of inventory accumulation (∆PI). Trade, or exports of goods and services net of imports, contributed 1.19 PPs in 2009 of which exports deducted 1.07 PPs and imports added 2.26 PPs. In 2010, trade deducted 0.46 PPs with exports contributing 1.33 PPs and imports deducting 1.79 PPs likely benefitting from dollar revaluation. In 2009, government added 0.64 PP of which 0.44 PPs by the federal government and 0.20 PPs by state and local government; in 2010, government added 0.02 PPs of which 0.37 PPs by the federal government with state and local government deducting 0.35 PPs. Table I-12 provides the estimates for 2011, 2012 and 2013. PCE contributed 1.55 PPs in 2011 after 1.32 PPs in 2010. The contribution of PCE fell to 1.25 points in 2012 and increased to 1.64 PPs in 2013. The breakdown into goods and services is similar but with contributions in 2012 of 0.64 PPs of goods and 0.61 PPs of services. In 2013, goods contributed 0.78 PPs and services 0.86 PPs. Gross private domestic investment contributed 1.66 PPs in 2010 with 1.45 PPs of change of private inventories but the contribution of gross private domestic investment was only 0.73 PPs in 2011. The contribution of GDI in 2012 increased to 1.33 PPs with fixed investment increasing its contribution to 1.17 PPs and residential investment contributing 0.33 PPs for the first time since 2009. GDI contributed 1.33 PPs in 2012 with 1.17 PPs from fixed investment and 0.15 PPs from inventory change. Net exports of goods and services deducted marginally in 2011 with 0.02 PPs and added 0.04 PPs in 2012. Net trade contributed 0.22 PPs in 2013. The contribution of exports fell from 1.33 PPs in 2010 and 0.87 PPs in 2011 to only 0.44 PPs in 2012 and 0.41 PPs in 2013. Government deducted 0.65 PPs in 2011, 0.30 PPs in 2012 and 0.39 PPs in 2013. Demand weakened in 2013 with higher contribution of personal consumption expenditures of 1.64 PPs and of gross domestic investment of 0.76 PPs. Net trade contributed only 0.22 PPs. The expansion since IIIQ2009 has been characterized by weak contributions of aggregate demand, which is the sum of personal consumption expenditures plus gross private domestic investment. The US did not recover strongly from the global recessions as typical in past cyclical expansions. Recoveries tend to be more sluggish as expansions mature. At the margin in IVQ2011, the acceleration of expansion was driven by inventory accumulation instead of aggregate demand of consumption and investment. Growth of PCE was partly the result of burning savings because of financial repression, which may not be sustainable in the future while creating multiple distortions of resource allocation and growth restraint.

Table I-12, US, Contributions to Growth of Gross Domestic Product in Percentage Points

	2009	2010	2011	2012	2013
GDP Growth ∆%	-2.8	2.5	1.6	2.3	2.2
Personal Consumption Expenditures (PCE)	-1.08	1.32	1.55	1.25	1.64
Goods	-0.68	0.77	0.71	0.64	0.78
Durable	-0.41	0.43	0.43	0.52	0.49
Nondurable	-0.27	0.34	0.28	0.12	0.29
Services	-0.40	0.55	0.84	0.61	0.86
Gross Private Domestic Investment (GPDI)	-3.52	1.66	0.73	1.33	0.76
Fixed Investment	-2.77	0.21	0.86	1.17	0.70
Nonresidential	-2.04	0.28	0.85	0.84	0.37
Structures	-0.70	-0.49	0.06	0.32	-0.01
Equipment, software	-1.29	0.70	0.66	0.37	0.26
Intellectual Property	-0.05	0.07	0.13	0.15	0.13
Residential	-0.73	-0.07	0.01	0.33	0.33
Change Private Inventories	-0.76	1.45	-0.14	0.15	0.06
Net Exports of Goods and Services	1.19	-0.46	-0.02	0.04	0.22
Exports	-1.07	1.33	0.87	0.44	0.41
Goods	-1.03	1.08	0.57	0.34	0.26
Services	-0.04	0.25	0.29	0.10	0.15
Imports	2.26	-1.79	-0.89	-0.40	-0.19
Goods	2.15	-1.69	-0.78	-0.30	-0.13
Services	0.10	-0.10	-0.11	-0.10	-0.06
Government Consumption Expenditures and Gross Investment	0.64	0.02	-0.65	-0.30	-0.39
Federal	0.44	0.37	-0.24	-0.15	-0.45
National Defense	0.27	0.18	-0.13	-0.18	-0.33
Nondefense	0.17	0.19	-0.11	0.03	-0.12
State and Local	0.20	-0.35	-0.41	-0.15	0.06

Source: US Bureau of Economic Analysis

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

Manufacturing jobs not seasonally adjusted increased 166,000 from Aug 2013 to
Aug 2014 or at the average monthly rate of 13,833. There are effects of the weaker economy and international trade together with the yearly adjustment of labor statistics. Industrial production decreased 0.1 percent in Aug 2014 after increasing 0.2 percent in Jul 2014 and increasing 0.3 percent in Jun 2014, with all data seasonally adjusted. The Federal Reserve completed its annual revision of industrial production and capacity utilization on Mar 28, 2014 (http://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm). The report of the Board of Governors of the Federal Reserve System states (http://www.federalreserve.gov/releases/g17/Current/default.htm):

“The index of industrial production edged down 0.1 percent in August, and the index for manufacturing output decreased 0.4 percent; the declines were the first for each since January. The gains in July for both indexes were revised down. The declines in total industrial production and in manufacturing output in August reflected a decrease of 7.6 percent in the production of motor vehicles and parts, which had jumped more than 9 percent in July. Excluding motor vehicles and parts, factory output rose 0.1 percent in both July and August. The production at mines moved up 0.5 percent in August, and the output of utilities rose 1.0 percent. At 104.1 percent of its 2007 average, total industrial production in August was 4.1 percent above its year-earlier level. Capacity utilization for total industry decreased 0.3 percentage point in August to 78.8 percent, a rate 1.0 percentage point above its level of a year earlier and 1.3 percentage points below its long-run (1972–2013) average.”

In the six months ending in Jul 2014, United States national industrial production accumulated increase of 1.8 percent at the annual equivalent rate of 3.7 percent, which is lower than growth of 4.1 percent in the 12 months ending in Aug 2014. Excluding growth of 0.8 percent in Mar 2014, growth in the remaining five months from Apr to Aug 2014 accumulated to 1.0 percent or 2.4 percent annual equivalent. Industrial production declined in one of the past six months. Industrial production expanded at annual equivalent 1.6 percent in the most recent quarter from Jun to Aug 2014 and at 5.7 percent in the prior quarter Mar-May 2014. Business equipment accumulated growth of 3.0 percent in the six months from Mar to Aug 2014 at the annual equivalent rate of 6.2 percent, which is higher than growth of 5.7 percent in the 12 months ending in Aug 2014. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for total industry decreased 0.3 percentage point in August to 78.8 percent, a rate 1.0 percentage point above its level of a year earlier and 1.3 percentage points below its long-run (1972–2013) average.” United States industry apparently decelerated to a lower growth rate with possible acceleration in past months.

Manufacturing fell 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increased by 19.9 percent from the trough in Apr 2009 to Dec 2013. Manufacturing grew 26.2 percent from the trough in Apr 2009 to Aug 2014. Manufacturing output in Aug 2014 is 1.5 percent below the peak in Jun 2007. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,310.7 billion than actual $15,994.3 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-valuations-twenty-seven.html). US GDP in IIQ2014 is 12.6 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $15,994.3 billion in IIQ2014 or 6.7 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.

Table I-13 provides national income by industry without capital consumption adjustment (WCCA). “Private industries” or economic activities have share of 87.3 percent in IIQ2014. Most of US national income is in the form of services. In Aug 2014, there were 138,989 million nonfarm jobs NSA in the US, according to estimates of the establishment survey of the Bureau of Labor Statistics (BLS) (http://www.bls.gov/news.release/empsit.nr0.htm Table B-1). Total private jobs of 118.179 million NSA in Aug 2014 accounted for 85.0 percent of total nonfarm jobs of 138.989 million, of which 12.254 million, or 10.4 percent of total private jobs and 8.8 percent of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 98.637 million NSA in Aug 2014, or 71.0 percent of total nonfarm jobs and 83.5 percent of total private-sector jobs. Manufacturing has share of 11.3 percent in US national income in IIQ2014 and durable goods 6.4 percent, as shown in Table I-13. Most income in the US originates in services. Subsidies and similar measures designed to increase manufacturing jobs will not increase economic growth and employment and may actually reduce growth by diverting resources away from currently employment-creating activities because of the drain of taxation.

Table I-13, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total

	SAAR IQ2014	% Total	SAAR IIQ2014	% Total
National Income WCCA	14,982.0	100.0	15,276.2	100.0
Domestic Industries	14,771.0	98.6	15,062.8	98.6
Private Industries	13,055.8	87.1	13,342.0	87.3
Agriculture	161.0	1.1	178.6	1.2
Mining	273.1	1.8	260.5	1.7
Utilities	209.1	1.4	215.7	1.4
Construction	660.3	4.4	666.8	4.4
Manufacturing	1642.5	11.0	1721.4	11.3
Durable Goods	950.2	6.3	982.0	6.4
Nondurable Goods	692.3	4.6	739.3	4.8
Wholesale Trade	908.7	6.1	925.1	6.1
Retail Trade	1029.8	6.9	1051.9	6.9
Transportation & WH	465.6	3.1	478.0	3.1
Information	560.5	3.7	578.0	3.8
Finance, Insurance, RE	2638.0	17.6	2661.9	17.4
Professional & Business Services	2026.8	13.5	2086.1	13.7
Education, Health Care	1461.8	9.8	1487.5	9.7
Arts, Entertainment	593.9	4.0	605.2	4.0
Other Services	424.7	2.8	425.4	2.8
Government	1715.1	11.4	1720.8	11.3
Rest of the World	211.0	1.4	213.5	1.4

Notes: SSAR: Seasonally-Adjusted Annual Rate; WCCA: Without Capital Consumption Adjustment by Industry; WH: Warehousing; RE, includes rental and leasing: Real Estate; Art, Entertainment includes recreation, accommodation and food services; BS: business services

Source: US Bureau of Economic Analysis

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

IA1. Contracting Real Private Fixed Investment. The United States economy has grown at the average yearly rate of 3 percent per year and 2 percent per year in per capita terms from 1870 to 2010, as measured by Lucas (2011May). An important characteristic of the economic cycle in the US has been rapid growth in the initial phase of expansion after recessions. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 20 quarters from IIIQ2009 to IIQ2014. 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). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the third estimate of GDP for IIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_3rd.pdf). The average of 7.7 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 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,294.6 billion than actual $16,010.4 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). US GDP in IIQ2014 is 12.5 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,010.4 billion in IIQ2014 or 6.8 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.

Inferior performance of the US economy and labor markets is the critical current issue of analysis and policy design. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. Table IA1-1 provides quarterly seasonally adjusted annual rates (SAAR) of growth of private fixed investment for the recessions of the 1980s and the current economic cycle. In the cyclical expansion beginning in IQ1983 (http://www.nber.org/cycles.html), real private fixed investment in the United States grew at the average annual rate of 14.7 percent in the first eight quarters from IQ1983 to IVQ1984. Growth rates fell to an average of 2.2 percent in the following eight quarters from IQ1985 to IVQ1986 and to an average of 1.9 percent in the 12 quarters of 1985, 1986 and 1987. There were only four quarters of contraction of private fixed investment from IQ1983 to IVQ1987. There is quite different behavior of private fixed investment in the twenty quarters of cyclical expansion from IIIQ2009 to IIQ2014. The average annual growth rate in the first eight quarters of expansion from IIIQ2009 to IIQ2011 was 3.2 percent, which is significantly lower than 14.7 percent in the first eight quarters of expansion from IQ1983 to IVQ1984. There is only strong growth of private fixed investment in the four quarters of expansion from IIQ2011 to IQ2012 at the average annual rate of 11.1 percent. Growth has fallen from the SAAR of 17.3 percent in IIIQ2011 to 3.1 percent in IIIQ2012, recovering to 6.6 percent in IVQ2012 and falling to 2.7 percent in IQ2013. The SAAR of fixed investment rose to 6.6 percent in IIIQ2013 and fell to 6.3 percent in IVQ2013. The SAAR of fixed investment fell to 0.2 percent in IQ2014. Fixed investment grew at the SAAR of 9.5 percent in IIQ2014. Sudeep Reddy and Scott Thurm, writing on “Investment falls off a cliff,” on Nov 18, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324595904578123593211825394.html?mod=WSJPRO_hpp_LEFTTopStories) analyze the decline of private investment in the US and inform that a review by the Wall Street Journal of filing and conference calls finds that 40 of the largest publicly traded corporations in the US have announced intentions to reduce capital expenditures in 2012.

Table IA1-1, US, Quarterly Growth Rates of Real Private Fixed Investment, % Annual Equivalent SA

Q	1981	1982	1983	1984	2008	2009	2010
I	3.8	-12.2	9.4	13.1	-7.1	-27.4	0.8
II	3.2	-12.1	16.0	16.6	-5.5	-14.2	13.6
III	0.1	-9.3	24.4	8.2	-12.1	-0.5	-0.4
IV	-1.5	0.2	24.3	7.3	-23.9	-2.8	8.5
				1985			2011
I				3.7			-0.9
II				5.2			8.2
III				-1.6			17.3
IV				7.8			9.9
				1986			2012
I				1.1			9.1
II				0.1			4.4
III				-1.8			3.1
IV				3.1			6.6
				1987			2013
I				-6.7			2.7
II				6.3			4.9
III				7.1			6.6
IV				-0.2			6.3
				1988		2014
I				0.2			0.2
II				8.1			9.5
III				1.9
IV				4.8

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

Chart IA1-1 of the US Bureau of Economic Analysis (BEA) provides seasonally adjusted annual rates of growth of real private fixed investment from 1981 to 1987. Growth rates recovered sharply during the first eight quarters, which was essential in returning the economy to trend growth and eliminating unemployment and most underemployment accumulated during the contractions.

Chart IA1-1, US, Real Private Fixed Investment, Seasonally-Adjusted Annual Rates Percent Change from Prior Quarter, 1981-1987

Source: US Bureau of Economic Analysis

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

Weak behavior of real private fixed investment from 2007 to 2014 is shown in Chart IA1-2. Growth rates of real private fixed investment were much lower during the initial phase of expansion in the current economic cycle and have entered sharp trend of decline.

Chart IA1-2, US, Real Private Fixed Investment, Seasonally-Adjusted Annual Rates Percent Change from Prior Quarter, 2007-2013

Source: US Bureau of Economic Analysis

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

Table IA1-2 provides real private fixed investment at seasonally adjusted annual rates from IVQ2007 to IIQ2014 or for the complete economic cycle. The first column provides the quarter, the second column percentage change relative to IVQ2007, the third column the quarter percentage change in the quarter relative to the prior quarter and the final column percentage change in a quarter relative to the same quarter a year earlier. In IQ1980, real gross private domestic investment in the US was $951.6 billion of chained 2009 dollars, growing to $1,254.6 billion in IVQ1987 or 31.8 percent. Real gross private domestic investment in the US increased 3.8 percent from $2,605.2 billion of chained 2009 dollars in IVQ2007 to $2,703.7 billion in IIQ2014, which is stagnation in comparison with growth of 31.8 percent in the comparable first twenty quarters of expansion from IQ1983 to IVQ1987. As shown in Table IAI-2, real private fixed investment increased 0.3 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,594.5 billion in IIQ2014. Private fixed investment fell relative to IVQ2007 in all quarters preceding IIQ2014. Growth of real private investment in Table IA1-2 is mediocre for all but four quarters from IIQ2011 to IQ2012.

Table IA1-2, US, Real Private Fixed Investment and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions of Chained 2009 Dollars and ∆%

	Real PFI, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	2586.3	NA	-0.9	-1.4
IQ2008	2539.1	-1.8	-1.8	-3.0
IIQ2008	2503.4	-3.2	-1.4	-4.6
IIIQ2008	2424.1	-6.3	-3.2	-7.1
IV2008	2263.8	-12.5	-6.6	-12.5
IQ2009	2089.3	-19.2	-7.7	-17.7
IIQ2009	2011.0	-22.2	-3.7	-19.7
IIIQ2009	2008.4	-22.3	-0.1	-17.1
IVQ2009	1994.1	-22.9	-0.7	-11.9
IQ2010	1997.9	-22.8	0.2	-4.4
IIQ2010	2062.8	-20.2	3.2	2.6
IIIQ2010	2060.8	-20.3	-0.1	2.6
IVQ2010	2103.1	-18.7	2.1	5.5
IQ2011	2098.4	-18.9	-0.2	5.0
IIQ2011	2140.2	-17.2	2.0	3.8
IIIQ2011	2227.5	-13.9	4.1	8.1
IVQ2011	2280.6	-11.8	2.4	8.4
IQ2012	2330.7	-9.9	2.2	11.1
IIQ2012	2355.6	-8.9	1.1	10.1
IIIQ2012	2373.7	-8.2	0.8	6.6
IVQ2012	2412.0	-6.7	1.6	5.8
IQ2013	2428.0	-6.1	0.7	4.2
IIQ2013	2457.0	-5.0	1.2	4.3
IIIQ2013	2496.8	-3.5	1.6	5.2
IVQ2013	2535.0	-2.0	1.5	5.1
IQ2014	2536.1	-1.9	0.0	4.5
IIQ2014	2594.5	0.3	2.3	5.6

PFI: Private Fixed Investment

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

Chart IA1-3 provides real private fixed investment in billions of chained 2009 dollars from IQ2007 to IIQ2014. Real private fixed investment has not recovered, stabilizing at a level in IIQ2014 that is equal to that in IVQ2007.

Chart IA1-3, US, Real Private Fixed Investment, Billions of Chained 2009 Dollars, IQ2007 to IIQ2014

Source: US Bureau of Economic Analysis

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

Chart IA1-4 provides real gross private domestic investment in chained dollars of 2009 from 1980 to 1987. Real gross private domestic investment climbed 31.8 percent to $1254.6 billion of 2009 dollars in IVQ1987 above the level of $951.6 billion in IQ1980.

Chart IA1-4, US, Real Gross Private Domestic Investment, Billions of Chained 2009 Dollars at Seasonally Adjusted Annual Rate, 1980-1987

Source: US Bureau of Economic Analysis

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

Chart IA1-5 provides real gross private domestic investment in the United States in billions of chained dollars of 2009 from 2006 to 2014. Real gross private domestic investment reached a level of $2703.7 in IIQ2014, which was only 3.8 percent higher than the level of $2605.2 billion in IVQ2007 (http://www.bea.gov/iTable/index_nipa.cfm).

Chart IA1-5, US, Real Gross Private Domestic Investment, Billions of Chained 2009 Dollars at Seasonally Adjusted Annual Rate, 2007-2014

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

Table IA1-3 provides percentage shares in GDP of gross private domestic investment and its components in IIQ2014, IIQ2006 and IIQ2000. The share of gross private domestic investment in GDP has fallen from 20.2 percent in IIQ2000 and 19.5 percent in IIQ2006 to 16.4 percent in IIQ2014. There are declines in percentage shares in GDP of all components with sharp reduction of residential investment from 4.7 percent in IIQ2000 and 6.2 percent in IIQ2006 to 3.2 percent in IIQ2014. The share of fixed investment in GDP fell from 19.3 percent in IIQ2000 and 19.0 percent in IIQ2006 to 15.8 percent in IIQ2014.

Table IA1-3, Percentage Shares of Gross Private Domestic Investment and Components in Gross Domestic Product, % of GDP, IQ2013

	IIQ2014	IIQ2006	IIQ2000
Gross Private Domestic Investment	16.4	19.5	20.2
Fixed Investment	15.8	19.0	19.3
Nonresidential	12.6	12.8	14.5
Structures	2.9	3.0	3.0
Equipment           and Software	5.8	6.2	7.5
Intellectual            Property	3.9	3.6	4.0
Residential	3.2	6.2	4.7
Change in Private Inventories	0.6	0.6	0.9

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

Broader perspective is provided in Chart IA1-6 with the percentage share of gross private domestic investment in GDP in annual data from 1929 to 2013. There was sharp drop during the current economic cycle with almost no recovery in contrast with sharp recovery after the recessions of the 1980s.

Chart IA1-6, US, Percentage Share of Gross Private Domestic Investment in Gross Domestic Product, Annual, 1929-2013

Source: US Bureau of Economic Analysis

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

Chart IA1-7 provides percentage shares of private fixed investment in GDP with annual data from 1929 to 2013. The sharp contraction after the recessions of the 1980s was followed by sustained recovery while the sharp drop in the current economic cycle has not been recovered.

Chart IA1-7, US, Percentage Share of Private Fixed Investment in Gross Domestic Product, Annual, 1929-2013

Source: US Bureau of Economic Analysis

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

Chart IA1-8 provides percentage shares in GDP of nonresidential investment from 1929 to 2013. There is again recovery from sharp contraction in the 1980s but inadequate recovery in the current economic cycle.

Chart IA1-8, US, Percentage Share of Nonresidential Investment in Gross Domestic Product, Annual, 1929-2013

Source: US Bureau of Economic Analysis

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

Chart IA1-9 provides percentage shares of business equipment and software in GDP with annual data from 1929 to 2013. There is again inadequate recovery in the current economic cycle.

Chart IA1-9, US, Percentage Share of Business Equipment and Software in Gross Domestic Product, Annual, 1929-2013

Source: US Bureau of Economic Analysis

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

Chart IA1-10 provides percentage shares of residential investment in GDP with annual data from 1929 to 2013. The salient characteristic of Chart IA1-10 is the vertical increase of the share of residential investment in GDP up to 2006 and subsequent collapse.

Chart IA1-10, US, Percentage Share of Residential Investment in Gross Domestic Product, Annual, 1929-2013

Source: US Bureau of Economic Analysis

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

Finer detail is provided by the quarterly share of residential investment in GDP from 1979 to 2014 in Chart IA1-11. There was protracted growth of that share, accelerating sharply into 2006 followed with nearly vertical drop. The explanation of the sharp contraction of United States housing can probably be found in the origins of the financial crisis and global recession. Let V(T) represent the value of the firm’s equity at time T and B stand for the promised debt of the firm to bondholders and assume that corporate management, elected by equity owners, is acting on the interests of equity owners. Robert C. Merton (1974, 453) states:

“On the maturity date T, the firm must either pay the promised payment of B to the debtholders or else the current equity will be valueless. Clearly, if at time T, V(T) > B, the firm should pay the bondholders because the value of equity will be V(T) – B > 0 whereas if they do not, the value of equity would be zero. If V(T) ≤ B, then the firm will not make the payment and default the firm to the bondholders because otherwise the equity holders would have to pay in additional money and the (formal) value of equity prior to such payments would be (V(T)- B) < 0.”

Pelaez and Pelaez (The Global Recession Risk (2007), 208-9) apply this analysis to the US housing market in 2005-2006 concluding:

“The house market [in 2006] is probably operating with low historical levels of individual equity. There is an application of structural models [Duffie and Singleton 2003] to the individual decisions on whether or not to continue paying a mortgage. The costs of sale would include realtor and legal fees. There could be a point where the expected net sale value of the real estate may be just lower than the value of the mortgage. At that point, there would be an incentive to default. The default vulnerability of securitization is unknown.”

There are multiple important determinants of the interest rate: “aggregate wealth, the distribution of wealth among investors, expected rate of return on physical investment, taxes, government policy and inflation” (Ingersoll 1987, 405). Aggregate wealth is a major driver of interest rates (Ingersoll 1987, 406). Unconventional monetary policy, with zero fed funds rates and flattening of long-term yields by quantitative easing, causes uncontrollable effects on risk taking that can have profound undesirable effects on financial stability. Excessively aggressive and exotic monetary policy is the main culprit and not the inadequacy of financial management and risk controls.

The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent restatement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption decisions is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (1)

Equation (1) shows that as r goes to zero, r →0, W grows without bound, W→∞.

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 close to zero interest rates, 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 to purchase 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).

Chart IA1-11, US, Percentage Share of Residential Investment in Gross Domestic Product, Quarterly, 1979-2014

Source: US Bureau of Economic Analysis

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

Chart IA1-12 provides the share of intellectual property products investment in GDP with annual data from 1929 to 2013. This is an important addition in the revision and enhancement of GDP provided by the Bureau of Economic Analysis. The share rose sharply over time but stabilized at a lower level in the past decade.

Chart IA1-12, US, Percentage Share of Intellectual Property Products Investment in Gross Domestic Product, Annual, 1929-2013

Source: US Bureau of Economic Analysis

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

Chart IA1-13 provides the percentage share of intellectual property investment in GDP on a quarterly basis from 1979 to 2013. The share stabilized in the 2000s.

Chart IA1-13, US, Percentage Share of Intellectual Property Investment in Gross Domestic Product, Quarterly, 1979-2014

Source: US Bureau of Economic Analysis

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

Table IA1-4 provides the seasonally adjusted annual rate of real GDP percentage change and contributions in percentage points in annual equivalent rate of gross domestic investment (GDI), real private fixed investment (PFI), nonresidential investment (NRES), business equipment and software (BES), residential investment (RES), intellectual property products (IPP) and change in inventories (∆INV) for the cyclical expansions from IQ1983 to IVQ1985 and from IIIQ2009 to IIQ2014. GDI added 2.87 percentage points to GDP growth in IIQ2014: 1.45 for PFI, 1.18 for NRES, 0.35 for BES, 0.21 for IPP, 0.27 for RES and 1.42 for inventory change. GDI deducted 1.13 percentage points from GDP growth in IQ2014: 0.03 for PFI, 0.20 for NRES, 0.08 for BES and minus 0.17 for RES. IPP added 0.18 percentage points in IQ2014 and inventory change deducted 1.16 percentage points. GDI provided strong percentage points contributions to GDP growth in the critical first year of expansion in 1983 and also in several quarters in 1984 and 1985 while it has been muted in the cyclical expansion since IIIQ2009 with contributions largely only from IQ2010 to IVQ2011. Gross domestic investment added 0.62 percentage points to GDP growth in IVQ2013. Nonresidential investment added 1.23 percentage points while residential investment subtracted 0.28 percentage points. Inventory investment deducted 0.34 percentage points. Gross domestic investment added 2.50 percentage points to GDP growth of 4.5 percent in IIIQ2013 partly because of change of inventories of 1.49 percentage points with PFI adding 1.01 percentage points. Nonresidential investment added 0.67 percentage points and residential investment added 0.34 percentage points to GDP growth of 4.5 percent in IIIQ2013. GDI added 1.03 percentage points to GDP growth of 1.8 percent in IIQ2013 with 0.30 percentage points from inventory change while nonresidential investment added 0.21 percentage points and residential investment 0.53 percentage points. GDI added 1.12 percentage points in IQ2013 mostly because of 0.70 percentage points of inventory investment while private fixed investment added 0.42 percentage points. Nonresidential investment added 0.20 percentage points in IQ2013. Business equipment and software deducted 0.33 percentage points and residential investment added 0.22 percentage points. Intellectual property products (IPP) added 0.24 percentage points in IQ2013, deducted 0.08 percentage points in IIQ2013 and added 0.11 percentage points in IIIQ2013. Intellectual property products added 0.14 percentage points in IVQ2013, 0.18 percentage points in IQ2014 and 0.21 percentage points in IIQ2014. Much of the strong performance of GDI in the cyclical expansion after IQ1983 originated in contributions by real private fixed investment (PFI). Nonresidential investment also contributed strongly to growth in the expansion of the 1980s but has been muted in the current expansion. The contribution of business equipment and software collapsed to minus 0.04 percentage points in IIIQ2012 and minus 0.19 percentage points in IVQ2012 as business scales down investment. BES rebounded with 0.34 percentage points in IVQ2013, 0.29 percentage points in IIQ2013 and 0.19 percentage points in IIQ2013. Business equipment added 0.08 percentage points in IQ2014 and 0.35 percentage points in IIQ2014. Residential investment (RES) was relatively strong in 1983 but was muted in following quarters. Residential investment only contributed significantly to growth of GDP in the four quarters of 2012, IQ2013, IIQ2013 and IIIQ2013. Residential investment deducted 0.28 percentage points in IVQ2013 and 0.17 percentage points in IQ2014, raising concerns on the sustainability of housing recovery. Residential investment added 0.27 percentage points in IIQ2014.

Table IA1-4, US, Contributions to the Rate of Growth of Real GDP in Percentage Points

	GDP	GDI	PFI	NRES	BES	IPP	RES	∆INV
2014
I	-2.1	-1.13	0.03	0.20	0.08	0.18	-0.17	-1.16
II	4.6	2.87	1.45	1.18	0.35	0.21	0.27	1.42
2013
I	2.7	1.12	0.42	0.20	-0.33	0.24	0.22	0.70
II	1.8	1.03	0.74	0.21	0.19	-0.08	0.53	0.30
III	4.5	2.50	1.01	0.67	0.29	0.11	0.34	1.49
IV	3.5	0.62	0.95	1.23	0.34	0.14	-0.28	-0.34
2012
I	2.3	1.04	1.24	0.66	0.46	0.03	0.59	-0.20
II	1.6	0.88	0.61	0.50	0.27	0.19	0.11	0.27
III	2.5	0.26	0.45	0.09	-0.04	0.10	0.36	-0.19
IV	0.1	-0.84	0.96	0.44	-0.19	0.19	0.52	-1.80
2011
I	-1.5	-1.07	-0.11	-0.09	-0.73	0.05	-0.02	-0.96
II	2.9	2.14	1.10	0.97	0.63	0.12	0.13	1.04
III	0.8	0.15	2.25	2.06	0.56	0.19	0.19	-2.10
IV	4.6	4.16	1.36	1.08	0.34	0.26	0.28	2.80
2010
I	1.7	1.77	0.11	0.46	1.25	-0.07	-0.35	1.66
II	3.9	2.86	1.76	1.21	1.02	-0.08	0.56	1.09
III	2.7	1.86	-0.04	0.90	0.83	0.22	-0.94	1.90
IV	2.5	-0.51	1.13	0.94	0.57	0.19	0.19	-1.63
2009
I	-5.4	-7.02	-4.75	-3.58	-2.25	-0.23	-1.17	-2.26
II	-0.5	-3.25	-2.13	-1.46	-0.60	0.16	-0.66	-1.12
III	1.3	-0.40	-0.02	-0.54	0.25	0.04	0.52	-0.38
IV	3.9	4.05	-0.36	-0.37	0.36	0.25	0.01	4.40
1982
I	-6.5	-7.59	-2.26	-1.45	-0.83	0.14	-0.81	-5.33
II	2.2	-0.06	-2.32	-1.89	-1.20	0.08	-0.44	2.26
III	-1.4	-0.62	-1.73	-1.72	-0.55	0.06	-0.02	1.11
IV	0.4	-5.37	-0.03	-1.05	-0.57	0.00	1.01	-5.33
1983
I	5.3	2.36	1.44	-0.92	-0.27	0.16	2.36	0.92
II	9.4	5.96	2.53	0.67	1.24	0.29	1.86	3.43
III	8.1	4.40	3.82	2.13	1.43	0.31	1.70	0.57
IV	8.5	6.94	3.93	3.14	2.32	0.35	0.79	3.01
1984
I	8.2	7.23	2.29	1.71	0.46	0.30	0.58	4.94
II	7.2	2.57	2.86	2.52	1.36	0.29	0.34	-0.29
III	4.0	1.69	1.48	1.70	0.88	0.25	-0.22	0.21
IV	3.2	-1.08	1.36	1.34	0.86	0.29	0.02	-2.44
1985
I	4.0	-2.14	0.72	0.67	-0.23	0.14	0.05	-2.86
II	3.7	1.34	0.99	0.83	0.64	0.20	0.16	0.35
III	6.4	-0.43	-0.28	-0.62	-0.38	0.13	0.34	-0.15
IV	3.0	2.80	1.40	1.00	0.53	0.26	0.40	1.40
1986
I	3.8	0.04	0.21	-0.55	-0.28	0.17	0.76	-0.17
II	1.9	-1.30	0.00	-1.12	0.34	0.15	1.12	-1.30
III	4.1	-1.97	-0.34	-0.63	-0.17	0.10	0.28	-1.62
IV	2.1	0.24	0.53	0.48	0.30	0.10	0.05	-0.29
1987
I	2.8	1.98	-1.30	-1.26	-0.97	0.07	-0.04	3.28
II	4.6	0.08	1.07	1.00	0.76	0.08	0.07	-0.99
III	3.7	0.03	1.22	1.39	0.70	0.11	-0.17	-1.19
IV	6.8	4.94	-0.01	-0.05	-0.48	0.16	0.04	4.95

GDP: Gross Domestic Product; GDI: Gross Domestic Investment; PFI: Private Fixed Investment; NRES: Nonresidential; BES: Business Equipment and Software; IPP: Intellectual Property Products; RES: Residential; ∆INV: Change in Private Inventories.

GDI = PFI + ∆INV, may not add exactly because of errors of rounding.

GDP: Seasonally adjusted annual equivalent rate of growth in a quarter; components: percentage points at annual rate.

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

IA2 Swelling Undistributed Corporate Profits. Table IA1-5 provides value added of corporate business, dividends and corporate profits in billions of current dollars at seasonally adjusted annual rates (SAAR) in IVQ2007 and IIQ2014 together with percentage changes. The last three rows of Table IA1-5 provide gross value added of nonfinancial corporate business, consumption of fixed capital and net value added in billions of chained 2009 dollars at SAARs. Deductions from gross value added of corporate profits down the rows of Table IA1-5 end with undistributed corporate profits. Profits after taxes with inventory valuation adjustment (IVA) and capital consumption adjustment (CCA) increased by 74.4 percent in nominal terms from IVQ2007 to IIQ2014 while net dividends increased 3.6 percent and undistributed corporate profits swelled 262.2 percent from $107.7 billion in IQ2007 to $390.1 billion in IIQ2014 and changed signs from minus $55.9 billion in current dollars in IVQ2007. The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Gross value added of nonfinancial corporate business adjusted for inflation increased 8.5 percent from IVQ2007 to IIQ2014, which is much lower than nominal increase of 21.0 percent in the same period for gross value added of total corporate business.

Table IA1-5, US, Value Added of Corporate Business, Corporate Profits and Dividends, IVQ2007-IQ2013

	IVQ2007	IIQ2014	∆%
Current Billions of Dollars Seasonally Adjusted Annual Rates (SAAR)
Gross Value Added of Corporate Business	8,165.9	9,884.3	21.0
Consumption of Fixed Capital	1,216.5	1,450.3	19.2
Net Value Added	6,949.4	8,433.9	21.4
Compensation of Employees	4,945.8	5,631.3	13.9
Taxes on Production and Imports Less Subsidies	688.5	796.0	15.6
Net Operating Surplus	1,315.1	2,006.6	52.6
Net Interest and Misc	204.2	188.5	-7.7
Business Current Transfer Payment Net	68.9	105.8	53.6
Corporate Profits with IVA and CCA Adjustments	1,042.0	1,712.2	64.3
Taxes on Corporate Income	408.8	608.0	48.7
Profits after Tax with IVA and CCA Adjustment	633.2	1,104.3	74.4
Net Dividends	689.1	714.2	3.6
Undistributed Profits with IVA and CCA Adjustment	-55.9	390.1	NA ∆% 262.2 relative to 107.7 in IQ2007
Billions of Chained USD 2009 SAAR
Gross Value Added of Nonfinancial Corporate Business	7,519.3	8,160.6	8.5
Consumption of Fixed Capital	1,066.0	1,203.5	12.9
Net Value Added	6,453.4	6,957.1	7.8

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Table IA1-6 provides comparable United States value added of corporate business, corporate profits and dividends from IQ1980 to IVQ1987. There is significant difference both in nominal and inflation-adjusted data. Between IQ1980 and IVQ1987, profits after tax with IVA and CCA increased 101.5 percent with dividends growing 150.4 percent and undistributed profits increasing 67.8 percent. There was much higher inflation in the 1980s than in the current cycle. For example, the consumer price index increased 44.1 from Mar 1980 to Dec 1987 but only 13.5 percent between Dec 2007 and Jun 2014 (http://www.bls.gov/cpi/data.htm). The comparison is still valid in terms of inflation-adjusted data: gross value added of nonfinancial corporate business adjusted for inflation increased 33.6 percent between IQ1980 and IVQ1987 but only 8.5 percent between IVQ2007 and IIQ2014 while net value added adjusted for inflation increased 32.7 percent between IQ1980 and IVQ1987 but only 7.8 percent between IVQ2007 and IIQ2014.

Table IA1-6, US, Value Added of Corporate Business, Corporate Profits and Dividends, IQ1980-IIIQ1987

	IQ1980	IVQ1987	∆%
Current Billions of Dollars Seasonally Adjusted Annual Rates (SAAR)
Gross Value Added of Corporate Business	1,654.1	2,996.1	81.1
Consumption of Fixed Capital	200.5	380.9	90.0
Net Value Added	1,453.6	2,615.2	79.9
Compensation of Employees	1,072.9	1,909.1	77.9
Taxes on Production and Imports Less Subsidies	121.5	239.6	97.2
Net Operating Surplus	259.2	466.5	80.0
Net Interest and Misc.	50.4	108.0	114.3
Business Current Transfer Payment Net	11.5	24.2	110.4
Corporate Profits with IVA and CCA Adjustments	197.2	334.3	69.5
Taxes on Corporate Income	97.0	132.4	36.5
Profits after Tax with IVA and CCA Adjustment	100.2	201.9	101.5
Net Dividends	40.9	102.4	150.4
Undistributed Profits with IVA and CCA Adjustment	59.3	99.5	67.8
Billions of Chained USD 2009 SAAR
Gross Value Added of Nonfinancial Corporate Business	2,952.3	3,943.0	33.6
Consumption of Fixed Capital	315.6	444.8	40.9
Net Value Added	2,636.7	3,498.3	32.7

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Chart IA1-14 of the US Bureau of Economic Analysis provides quarterly corporate profits after tax and undistributed profits with IVA and CCA from 1979 to 2014. There is tightness between the series of quarterly corporate profits and undistributed profits in the 1980s with significant gap developing from 1988 and to the present with the closest approximation peaking in IVQ2005 and surrounding quarters. These gaps widened during all recessions including in 1991 and 2001 and recovered in expansions with exceptionally weak performance in the current expansion.

Chart IA1-14, US, Corporate Profits after Tax and Undistributed Profits with Inventory Valuation Adjustment and Capital Consumption Adjustment, Quarterly, 1979-2013

Source: US Bureau of Economic Analysis

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

Table IA1-7 provides price, costs and profit per unit of gross value added of nonfinancial domestic corporate income for IVQ2007 and IIQ2014 in the upper block and for IQ1980 and IVQ1987 in the lower block. Compensation of employees or labor costs per unit of gross value added of nonfinancial domestic corporate income hardly changed from 0.577 in IVQ2007 to 0.609 in IIQ2014 in a fractured labor market but increased from 0.340 in IQ1980 to 0.441 in IVQ1987 in a more vibrant labor market. Unit nonlabor costs increased mildly from 0.270 per unit of gross value added in IVQ2007 to 0.289 in IIQ2014 but increased from 0.124 in IQ1980 to 0.182 in IVQ1987 in an economy closer to full employment of resources. Profits after tax with IVA and CCA per unit of gross value added of nonfinancial domestic corporate income increased from 0.076 in IVQ2007 to 0.106 in IIQ2014 and from 0.029 in IQ1980 to 0.045 in IVQ1987.

Table IA1-7, US, Price, Costs and Profit per Unit of Gross Value Added of Nonfinancial Domestic Corporate Income

	IVQ2007	IIQ2014
Price per Unit of Real Gross Value Added of Nonfinancial Corporate Business	0.961	1.053
Compensation of Employees (Unit Labor Cost)	0.577	0.609
Unit Nonlabor Cost	0.270	0.289
Consumption of Fixed Capital	0.140	0.156
Taxes on Production and Imports less Subsidies plus Business Current Transfer Payments (net)	0.093	0.100
Net Interest and Misc. Payments	0.037	0.033
Corporate Profits with IVA and CCA Adjustment (Unit Profits from Current Production)	0.114	0.154
Taxes on Corporate Income	0.038	0.048
Profits after Tax with IVA and CCA Adjustment	0.076	0.106
	IQ1980	IVQ1987
Price per Unit of Real Gross Value Added of Nonfinancial Corporate Business	0.518	0.692
Compensation of Employees (Unit Labor Cost)	0.340	0.441
Unit Nonlabor Cost	0.124	0.182
Consumption of Fixed Capital	0.064	0.087
Taxes on Production and Imports less Subsidies plus Business Current Transfer Payments (net)	0.042	0.064
Net Interest and Misc. Payments	0.018	0.031
Corporate Profits with IVA and CCA Adjustment (Unit Profits from Current Production)	0.055	0.069
Taxes on Corporate Income	0.026	0.024
Profits after Tax with IVA and CCA Adjustment	0.029	0.045

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Chart IA1-15 provides quarterly profits after tax with IVA and CCA per unit of gross value added of nonfinancial domestic corporate income from 1980 to 2014. In an environment of idle labor and other productive resources nonfinancial corporate income increased after tax profits with IVA and CCA per unit of gross value added at a faster pace in the weak economy from IVQ2007 to IIQ2014 than in the vibrant expansion following the cyclical contractions of the 1980s. Part of the profits was distributed as dividends and significant part was retained as undistributed profits in the current economic cycle with frustrated investment decision.

Chart IA1-15, US, Profits after Tax with Inventory Valuation Adjustment and Capital Consumption Adjustment per Unit of Gross Value Added of Nonfinancial Domestic Corporate Income, 1980-2013

Source: US Bureau of Economic Analysis

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

Table IA1-8 provides percentage changes of corporate profits in 2012 and 2013 and seasonally adjusted annual rates of change of corporate profits from IIIQ2013 to IIQ2014. US Corporate profits with IVA and CCA rebounded at 1.8 percent in IIIQ2013 and at 1.8 percent after taxes. Corporate profits with IVA and CCA increased at 0.1 percent in IVQ2013 and fell at 1.5 percent after taxes. Corporate profits with IVA and CCA decreased at 9.4 percent in IQ2014 and fell at 16.3 percent after taxes. Corporate profits with IVA and CCA increased at 8.4 percent in IIQ2014 and at 8.6 percent after taxes. Corporate profits with IVA and CCA increased 0.1 percent in IIQ2014 relative to IIQ2013 and profits after tax with IVA and CCA fell 8.9 percent in IIQ2014 relative to IIQ2013. Net dividends fell at 17.0 percent in IIIQ2013 and increased at 8.8 percent in IVQ2013. Net dividends fell at 9.0 percent in IQ2014 and decreased at 0.1 percent in IIQ2014. Undistributed profits increased at 39.5 percent in IIIQ2013 and decreased at 13.8 percent in IVQ2013. Undistributed profits fell at 27.3 percent in IQ2014 and increased at 24.9 percent in IIQ2014. Undistributed profits increased 9.2 percent in IIQ2014 relative to IIQ2013.

Table IA1-8, Quarterly Seasonally Adjusted Annual Equivalent Percentage Rates of Change of Corporate Profits, ∆%

	2012	2013	IIIQ 2013	IVQ 2013	IQ 2014	IIQ   2014	IIQ13/ IIQ13
Corporate Profits with IVA and CCA	11.3	4.2	1.8	0.1	-9.4	8.4	0.1
Corporate Income Taxes	20.0	4.3	1.8	6.0	13.5	8.1	32.4
After Tax Profits with IVA and CCA	9.1	4.1	1.7	-1.5	-16.3	8.6	-8.9
Net Dividends	21.8	12.0	-17.0	8.8	-9.0	-0.1	-17.9
Und Profits with IVA and CCA	-3.1	-5.3	39.5	-13.8	-27.3	24.9	9.2

Source: Bureau of Economic Analysis

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

Table IA1-9 provides change from prior quarter of the level of seasonally adjusted annual rates of US corporate profits. Corporate profits with IVA and CCA rebounded with $37.1 billion in IIIQ2013 and $3.1 billion in IVQ2013. Corporate profits with IVA and CCA fell $201.7 billion in IIQ2014 and increased $164.1 billion in IIQ2014. In IIIQ2013, profits after tax with IVA and CCA increased $28.7 billion and decreased $24.7 billion in IVQ2013. In IQ2014, profits after tax with IVA and CCA decreased $268.6 billion. Profits after tax with IVA and CCA increased at $118.4 billion in IIQ2014. Net dividends fell at $187.0 billion in IIIQ2013 and increased at $80.6 billion in IVQ2013. Net dividends fell at $89.5 billion in IIQ2014 and fell at $0.5 billion in IIQ2014. Undistributed profits with IVA and CCA rose at $215.8 billion in IIIQ2013 and fell at $105.5 billion in IVQ2013. Undistributed profits with IVA and CCA fell $178.9 percent in IQ2014 and increased at $118.8 billion in IIQ2014. Undistributed corporate profits swelled 262.2 percent from $107.7 billion in IQ2007 to $390.1 billion in IIQ2014 and changed signs from minus $55.9 billion in current dollars in IVQ2007. Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment.

Table IA1-9, Change from Prior Quarter of Level of Seasonally Adjusted Annual Equivalent Rates of Corporate Profits, Billions of Dollars

	2012	2013	IIIQ 2013	IVQ 2013	IQ 2014	IIQ       2014
Corporate Profits with IVA and CCA	206.2	84.1	37.1	3.1	-201.7	164.1
Corporate Income Taxes	75.7	19.5	8.3	27.9	66.9	45.7
After Tax Profits with IVA and CCA	130.5	64.6	28.7	-24.7	-268.6	118.4
Net Dividends	153.4	102.5	-187.0	80.6	-89.5	-0.5
Und Profits with IVA and CCA	-23.0	-37.9	215.8	-105.5	-178.9	118.8

Source: Bureau of Economic Analysis

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

IIA Destruction of Household Nonfinancial Wealth with Stagnating Total Real Wealth. The valuable report on Financial Accounts of the United States formerly Flow of Funds Accounts of the United States provided by the Board of Governors of the Federal Reserve System (http://www.federalreserve.gov/releases/z1/Current/ http://www.federalreserve.gov/apps/fof/) is rich in important information and analysis. Table IIA-1, updated in this blog for every new quarterly release, shows the balance sheet of US households combined with nonprofit organizations in 2007, 2011, 2013 and IIQ2014. The data show the strong shock to US wealth during the contraction. Assets fell from $81.2 trillion in 2007 to $77.3 trillion in 2011 even after nine consecutive quarters of growth beginning in IIIQ2009 (Section I and earlier (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html), for decline of $3.9 trillion or 4.8 percent. Assets stood at $92.7 trillion in 2013 for gain of $11.5 trillion relative to $81.2 trillion in 2007 or increase by 14.1 percent. Assets increased to $95.4 trillion in IIQ2014 by $14.2 trillion relative to 2007 or 17.5 percent. Liabilities declined from $14.4 trillion in 2007 to $13.6 trillion in 2011 or by $820.3 billion equivalent to decline by 5.7 percent. Liabilities declined $593.1 billion or 4.1 percent from 2007 to 2013 and increased 1.7 percent from 2011 to 2013. Liabilities fell from $14.4 trillion in 2007 to $13.9 trillion in IQ2014, by $445.9 billion or decline of 3.1 percent. Net worth shrank from $66.8 trillion in 2007 to $63.7 trillion in 2011, that is, $3.1 trillion equivalent to decline of 4.6 percent. Net worth increased from $66,802.7 billion in 2007 to $81,492.8 billion in IIQ2014 by $14,690.1 billion or 22.0 percent. The US consumer price index for all items increased from 210.036 in Dec 2007 to 238.343 in Jun 2014 (http://www.bls.gov/cpi/data.htm) or 13.5 percent. Net worth adjusted by CPI inflation increased 7.5 percent from 2007 to IQ2014. Nonfinancial assets increased $224.1 billion from $28,167.5 billion in 2007 to $28,391.6 billion in IIQ2014 or 0.8 percent. There was decrease from 2007 to IIQ2013 of $0.420 trillion in real estate assets or by 1.8 percent. Real estate assets adjusted for CPI inflation fell 13.5 percent between 2007 and IIQ2014. The National Association of Realtors estimated that the gains in net worth in homes by Americans were about $4 trillion between 2000 and 2005 (quoted in Pelaez and Pelaez, The Global Recession Risk (2007), 224-5).

Table IIA-1, US, Balance Sheet of Households and Nonprofit Organizations, Billions of Dollars Outstanding End of Period, NSA

	2007	2011	2013	IIQ2014
Assets	81,197.0	77,272.1	92,669.2	95,441.2
Nonfinancial	28,167.5	23,347.2	27,669.2	28,391.6
Real Estate	23,358.0	18,221.5	22,295.9	22,938.4
Durable Goods	4,476.0	4,723.3	4,942.2	5,013.2
Financial	53,029.5	53,925.0	65,000.1	67,049.6
Deposits	7,560.6	8,746.6	9,630.5	9,861.0
Credit   Market	3,987.7	4,374.0	3,848.8	3,535.9
Mutual Fund Shares	4,597.4	4,661.8	7,152.4	7,688.3
Equities Corporate	9,911.7	8,475.6	12,451.3	13,306.7
Equity Noncorporate	9,003.8	7,418.3	9,057.7	9,188.4
Pension	15,262.2	17,444.7	19,886.1	20,406.1
Liabilities	14,394.3	13,574.0	13,801.2	13,948.4
Home Mortgages	10,611.7	9,698.5	9,415.9	9,374.6
Consumer Credit	2,615.7	2,755.9	3,097.9	3,169.6
Net Worth	66,802.7	63,698.1	78,868.0	81,492.8

Net Worth = Assets – Liabilities

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

The explanation of the sharp contraction of household wealth can probably be found in the origins of the financial crisis and global recession. Let V(T) represent the value of the firm’s equity at time T and B stand for the promised debt of the firm to bondholders and assume that corporate management, elected by equity owners, is acting on the interests of equity owners. Robert C. Merton (1974, 453) states:

“On the maturity date T, the firm must either pay the promised payment of B to the debtholders or else the current equity will be valueless. Clearly, if at time T, V(T) > B, the firm should pay the bondholders because the value of equity will be V(T) – B > 0 whereas if they do not, the value of equity would be zero. If V(T) ≤ B, then the firm will not make the payment and default the firm to the bondholders because otherwise the equity holders would have to pay in additional money and the (formal) value of equity prior to such payments would be (V(T)- B) < 0.”

Pelaez and Pelaez (The Global Recession Risk (2007), 208-9) apply this analysis to the US housing market in 2005-2006 concluding:

“The house market [in 2006] is probably operating with low historical levels of individual equity. There is an application of structural models [Duffie and Singleton 2003] to the individual decisions on whether or not to continue paying a mortgage. The costs of sale would include realtor and legal fees. There could be a point where the expected net sale value of the real estate may be just lower than the value of the mortgage. At that point, there would be an incentive to default. The default vulnerability of securitization is unknown.”

There are multiple important determinants of the interest rate: “aggregate wealth, the distribution of wealth among investors, expected rate of return on physical investment, taxes, government policy and inflation” (Ingersoll 1987, 405). Aggregate wealth is a major driver of interest rates (Ibid, 406). Unconventional monetary policy, with zero fed funds rates and flattening of long-term yields by quantitative easing, causes uncontrollable effects on risk taking that can have profound undesirable effects on financial stability. Excessively aggressive and exotic monetary policy is the main culprit and not the inadequacy of financial management and risk controls.

The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent restatement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption decisions is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (1)

Equation (1) shows that as r goes to zero, r →0, W grows without bound, W→∞.

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 close to zero interest rates, 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 to purchase 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).

There are significant elements of the theory of bank financial fragility of Diamond and Dybvig (1983) and Diamond and Rajan (2000, 2001a, 2001b) that help to explain the financial fragility of banks during the credit/dollar crisis (see also Diamond 2007). The theory of Diamond and Dybvig (1983) as exposed by Diamond (2007) is that banks funding with demand deposits have a mismatch of liquidity (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 58-66). A run occurs when too many depositors attempt to withdraw cash at the same time. All that is needed is an expectation of failure of the bank. Three important functions of banks are providing evaluation, monitoring and liquidity transformation. Banks invest in human capital to evaluate projects of borrowers in deciding if they merit credit. The evaluation function reduces adverse selection or financing projects with low present value. Banks also provide important monitoring services of following the implementation of projects, avoiding moral hazard that funds be used for, say, real estate speculation instead of the original project of factory construction. The transformation function of banks involves both assets and liabilities of bank balance sheets. Banks convert an illiquid asset or loan for a project with cash flows in the distant future into a liquid liability in the form of demand deposits that can be withdrawn immediately.

In the theory of banking of Diamond and Rajan (2000, 2001a, 2001b), the bank creates liquidity by tying human assets to capital. The collection skills of the relationship banker convert an illiquid project of an entrepreneur into liquid demand deposits that are immediately available for withdrawal. The deposit/capital structure is fragile because of the threat of bank runs. In these days of online banking, the run on Washington Mutual was through withdrawals online. A bank run can be triggered by the decline of the value of bank assets below the value of demand deposits.

Pelaez and Pelaez (Regulation of Banks and Finance 2009b, 60, 64-5) find immediate application of the theories of banking of Diamond, Dybvig and Rajan to the credit/dollar crisis after 2007. It is a credit crisis because the main issue was the deterioration of the credit portfolios of securitized banks as a result of default of subprime mortgages. It is a dollar crisis because of the weakening dollar resulting from relatively low interest rate policies of the US. It caused systemic effects that converted into a global recession not only because of the huge weight of the US economy in the world economy but also because the credit crisis transferred to the UK and Europe. Management skills or human capital of banks are illustrated by the financial engineering of complex products. The increasing importance of human relative to inanimate capital (Rajan and Zingales 2000) is revolutionizing the theory of the firm (Zingales 2000) and corporate governance (Rajan and Zingales 2001). Finance is one of the most important examples of this transformation. Profits were derived from the charter in the original banking institution. Pricing and structuring financial instruments was revolutionized with option pricing formulas developed by Black and Scholes (1973) and Merton (1973, 1974, 1998) that permitted the development of complex products with fair pricing. The successful financial company must attract and retain finance professionals who have invested in human capital, which is a sunk cost to them and not of the institution where they work.

The complex financial products created for securitized banking with high investments in human capital are based on houses, which are as illiquid as the projects of entrepreneurs in the theory of banking. The liquidity fragility of the securitized bank is equivalent to that of the commercial bank in the theory of banking (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 65). Banks created off-balance sheet structured investment vehicles (SIV) that issued commercial paper receiving AAA rating because of letters of liquidity guarantee by the banks. The commercial paper was converted into liquidity by its use as collateral in SRPs at the lowest rates and minimal haircuts because of the AAA rating of the guarantor bank. In the theory of banking, default can be triggered when the value of assets is perceived as lower than the value of the deposits. Commercial paper issued by SIVs, securitized mortgages and derivatives all obtained SRP liquidity on the basis of illiquid home mortgage loans at the bottom of the pyramid. The run on the securitized bank had a clear origin (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 65):

“The increasing default of mortgages resulted in an increase in counterparty risk. Banks were hit by the liquidity demands of their counterparties. The liquidity shock extended to many segments of the financial markets—interbank loans, asset-backed commercial paper (ABCP), high-yield bonds and many others—when counterparties preferred lower returns of highly liquid safe havens, such as Treasury securities, than the risk of having to sell the collateral in SRPs at deep discounts or holding an illiquid asset. The price of an illiquid asset is near zero.”

Gorton and Metrick (2010H, 507) provide a revealing quote to the work in 1908 of Edwin R. A. Seligman, professor of political economy at Columbia University, founding member of the American Economic Association and one of its presidents and successful advocate of progressive income taxation. The intention of the quote is to bring forth the important argument that financial crises are explained in terms of “confidence” but as Professor Seligman states in reference to historical banking crises in the US the important task is to explain what caused the lack of confidence. It is instructive to repeat the more extended quote of Seligman (1908, xi) on the explanations of banking crises:

“The current explanations may be divided into two categories. Of these the first includes what might be termed the superficial theories. Thus it is commonly stated that the outbreak of a crisis is due to lack of confidence,--as if the lack of confidence was not in itself the very thing which needs to be explained. Of still slighter value is the attempt to associate a crisis with some particular governmental policy, or with some action of a country’s executive. Such puerile interpretations have commonly been confined to countries like the United States, where the political passions of democracy have had the fullest way. Thus the crisis of 1893 was ascribed by the Republicans to the impending Democratic tariff of 1894; and the crisis of 1907 has by some been termed the ‘[Theodore] Roosevelt panic,” utterly oblivious of the fact that from the time of President Jackson, who was held responsible for the troubles of 1837, every successive crisis had had its presidential scapegoat, and has been followed by a political revulsion. Opposed to these popular, but wholly unfounded interpretations, is the second class of explanations, which seek to burrow beneath the surface and to discover the more occult and fundamental causes of the periodicity of crises.”

Scholars ignore superficial explanations in the effort to seek good and truth. The problem of economic analysis of the credit/dollar crisis is the lack of a structural model with which to attempt empirical determination of causes (Gorton and Metrick 2010SB). There would still be doubts even with a well-specified structural model because samples of economic events do not typically permit separating causes and effects. There is also confusion is separating the why of the crisis and how it started and propagated, all of which are extremely important.

In true heritage of the principles of Seligman (1908), Gorton (2009EFM) discovers a prime causal driver of the credit/dollar crisis. The objective of subprime and Alt-A mortgages was to facilitate loans to populations with modest means so that they could acquire a home. These borrowers would not receive credit because of (1) lack of funds for down payments; (2) low credit rating and information; (3) lack of information on income; and (4) errors or lack of other information. Subprime mortgage “engineering” was based on the belief that both lender and borrower could benefit from increases in house prices over the short run. The initial mortgage would be refinanced in two or three years depending on the increase of the price of the house. According to Gorton (2009EFM, 13, 16):

“The outstanding amounts of Subprime and Alt-A [mortgages] combined amounted to about one quarter of the $6 trillion mortgage market in 2004-2007Q1. Over the period 2000-2007, the outstanding amount of agency mortgages doubled, but subprime grew 800%! Issuance in 2005 and 2006 of Subprime and Alt-A mortgages was almost 30% of the mortgage market. Since 2000 the Subprime and Alt-A segments of the market grew at the expense of the Agency (i.e., the government sponsored entities of Fannie Mae and Freddie Mac) share, which fell from almost 80% (by outstanding or issuance) to about half by issuance and 67% by outstanding amount. The lender’s option to rollover the mortgage after an initial period is implicit in the subprime mortgage. The key design features of a subprime mortgage are: (1) it is short term, making refinancing important; (2) there is a step-up mortgage rate that applies at the end of the first period, creating a strong incentive to refinance; and (3) there is a prepayment penalty, creating an incentive not to refinance early.”

The prime objective of successive administrations in the US during the past 20 years and actually since the times of Roosevelt in the 1930s has been to provide “affordable” financing for the “American dream” of home ownership. The US housing finance system is mixed with public, public/private and purely private entities. The Federal Home Loan Bank (FHLB) system was established by Congress in 1932 that also created the Federal Housing Administration in 1934 with the objective of insuring homes against default. In 1938, the government created the Federal National Mortgage Association, or Fannie Mae, to foster a market for FHA-insured mortgages. Government-insured mortgages were transferred from Fannie Mae to the Government National Mortgage Association, or Ginnie Mae, to permit Fannie Mae to become a publicly-owned company. Securitization of mortgages began in 1970 with the government charter to the Federal Home Loan Mortgage Corporation, or Freddie Mac, with the objective of bundling mortgages created by thrift institutions that would be marketed as bonds with guarantees by Freddie Mac (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 42-8). In the third quarter of 2008, total mortgages in the US were $12,057 billion of which 43.5 percent, or $5423 billion, were retained or guaranteed by Fannie Mae and Freddie Mac (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 45). In 1990, Fannie Mae and Freddie Mac had a share of only 25.4 percent of total mortgages in the US. Mortgages in the US increased from $6922 billion in 2002 to $12,088 billion in 2007, or by 74.6 percent, while the retained or guaranteed portfolio of Fannie and Freddie rose from $3180 billion in 2002 to $4934 billion in 2007, or by 55.2 percent.

According to Pinto (2008) in testimony to Congress:

“There are approximately 25 million subprime and Alt-A loans outstanding, with an unpaid principal amount of over $4.5 trillion, about half of them held or guaranteed by Fannie and Freddie. Their high risk activities were allowed to operate at 75:1 leverage ratio. While they may deny it, there can be no doubt that Fannie and Freddie now own or guarantee $1.6 trillion in subprime, Alt-A and other default prone loans and securities. This comprises over 1/3 of their risk portfolios and amounts to 34% of all the subprime loans and 60% of all Alt-A loans outstanding. These 10.5 million unsustainable, nonprime loans are experiencing a default rate 8 times the level of the GSEs’ 20 million traditional quality loans. The GSEs will be responsible for a large percentage of an estimated 8.8 million foreclosures expected over the next 4 years, accounting for the failure of about 1 in 6 home mortgages. Fannie and Freddie have subprimed America.”

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

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

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

Table IIA-2 shows the euphoria of prices during the housing boom and the subsequent decline. House prices rose 93.7 percent in the 10-city composite of the Case-Shiller home price index and 78.1 percent in the 20-city composite between Jun 2000 and Jun 2005. Prices rose around 100 percent from Jun 2000 to Jun 2006, increasing 109.9 percent for the 10-city composite and 93.3 percent for the 20-city composite. House prices rose 38.8 percent between Jun 2003 and Jun 2005 for the 10-city composite and 32.4 percent for the 20-city composite propelled by low fed funds rates of 1.0 percent between Jun 2003 and Jun 2004. Fed funds rates increased by 0.25 basis points at every meeting of the Federal Open Market Committee (FOMC) from Jun 2004 until Jun 2006, reaching 5.25 percent. Simultaneously, the suspension of auctions of the 30-year Treasury bond caused decline of yields of mortgage-backed securities with intended decrease in mortgage rates. Similarly, between Jun 2003 and Jun 2006, the 10-city index gained 51.2 percent and the 20-city index increased 46.0 percent. House prices have fallen from Jun 2006 to Jun 2014 by 17.3 percent for the 10-city composite and 16.5 percent for the 20-city composite. Measuring house prices is quite difficult because of the lack of homogeneity that is typical of standardized commodities. In the 12 months ending in Jun 2014, house prices increased 8.1 percent in the 10-city composite and also increased 8.1 percent in the 20-city composite. Table IIA-2 also shows that house prices increased 73.6 percent between Jun 2000 and Jun 2014 for the 10-city composite and increased 61.4 percent for the 20-city composite. House prices are close to the lowest level since peaks during the boom before the financial crisis and global recession. The 10-city composite fell 17.3 percent from the peak in Jun 2006 to Jun 2014 and the 20-city composite fell 17.4 percent from the peak in Jul 2006 to Jun 2014. The final part of Table I-4 provides average annual percentage rates of growth of the house price indexes of Standard & Poor’s Case-Shiller. The average annual growth rate between Dec 1987 and Dec 2013 for the 10-city composite was 3.7 percent. Data for the 20-city composite are available only beginning in Jan 2000. House prices accelerated in the 1990s with the average rate of the 10-city composite of 5.0 percent between Dec 1992 and Dec 2000 while the average rate for the period Dec 1987 to Dec 2000 was 3.8 percent. Although the global recession affecting the US between IVQ2007 (Dec) and IIQ2009 (Jun) caused decline of house prices of slightly above 30 percent, the average annual growth rate of the 10-city composite between Dec 2000 and Dec 2013 was 3.6 percent while the rate of the 20-city composite was 3.1 percent.

Table IIA-2, US, Percentage Changes of Standard & Poor’s Case-Shiller Home Price Indices, Not Seasonally Adjusted, ∆%

	10-City Composite	20-City Composite
∆% Jun 2000 to Jun 2003	38.8	32.4
∆% Jun 2000 to Jun 2005	93.7	78.1
∆% Jun 2003 to Jun 2005	39.5	34.5
∆% Jun 2000 to Jun 2006	109.9	93.3
∆% Jun 2003 to Jun 2006	51.2	46.0
∆% Jun 2005 to Jun 2014	-10.4	-9.3
∆% Jun 2006 to Jun 2014	-17.3	-16.5
∆% Jun 2009 to Jun 2014	22.1	21.4
∆% Jun 2010 to Jun 2014	16.2	16.4
∆% Jun 2011 to Jun 2014	20.9	21.8
∆% Jun 2012 to Jun 2014	20.8	21.1
∆% Jun 2013 to Jun 2014	8.1	8.1
∆% Jun 2000 to Jun 2014	73.6	61.4
∆% Peak Jun 2006 Jun 2014	-17.3
∆% Peak Jul 2006 Jun 2014		-16.6
Average ∆% Dec 1987-Dec 2013	3.7	NA
Average ∆% Dec 1987-Dec 2000	3.8	NA
Average ∆% Dec 1992-Dec 2000	5.0	NA
Average ∆% Dec 2000-Dec 2013	3.6	3.1

Source: http://us.spindices.com/index-family/real-estate/sp-case-shiller

The S&P Dow Jones Case-Shiller Home Price Indices register significant slowing of price increases for both the 10-City and 20-City composites (http://www.housingviews.com/wp-content/uploads/2014/08/CSHomePrice_Release_June2014-results.pdf). Monthly house prices increased sharply from Feb 2013 to Jan 2014 for both the 10- and 20-city composites. In Jan 2013, the seasonally adjusted 10-city composite increased 0.9 percent and the 20-city increased 1.0 percent while the 10-city not seasonally adjusted changed 0.0 percent and the 20-city changed 0.0 percent. House prices increased at high monthly percentage rates from Feb to Nov 2013. With the exception of Feb through Apr 2012, house prices seasonally adjusted declined in every month for both the 10-city and 20-city Case-Shiller composites from Dec 2010 to Jan 2012, as shown in Table IIA-3. The most important seasonal factor in house prices is school changes for wealthier homeowners with more expensive houses. Without seasonal adjustment, house prices fell from Dec 2010 throughout Mar 2011 and then increased in every month from Apr to Aug 2011 but fell in every month from Sep 2011 to Feb 2012. The not seasonally adjusted index registers decline in Mar 2012 of 0.1 percent for the 10-city composite and is flat for the 20-city composite. Not seasonally adjusted house prices increased 1.4 percent in Apr 2012 and at high monthly percentage rates until Sep 2012. House prices not seasonally adjusted stalled from Oct 2012 to Jan 2013 and surged from Feb to Sep 2013, decelerating in Oct 2013-Feb 2014. House prices grew at fast rates in Jun 2014. The 10-city NSA index increased 1.0 percent in Jun 2014 and the 20-city 1.0 percent while the 10-city SA fell 0.1 percent and the 20-city SA fell 0.2 percent. Declining house prices cause multiple adverse effects of which two are quite evident. (1) There is a disincentive to buy houses in continuing price declines. (2) More mortgages could be losing fair market value relative to mortgage debt. Another possibility is a wealth effect that consumers restrain purchases because of the decline of their net worth in houses.

Table IIA-3, US, Monthly Percentage Change of S&P Case-Shiller Home Price Indices, Seasonally +Adjusted and Not Seasonally Adjusted, ∆%

	10-City Composite SA	10-City Composite NSA	20-City Composite SA	20-City Composite NSA
Jun 2014	-0.1	1.0	-0.2	1.0
May	-0.2	1.1	-0.3	1.2
Apr	-0.1	1.1	0.1	1.2
Mar	1.1	0.8	1.1	0.9
Feb	1.0	0.0	0.9	0.0
Jan	0.8	-0.1	0.8	-0.1
Dec 2013	0.8	-0.1	0.8	-0.1
Nov	0.9	0.0	0.9	-0.1
Oct	1.1	0.2	1.1	0.2
Sep	1.0	0.7	1.0	0.7
Aug	1.0	1.3	1.0	1.3
Jul	0.7	1.9	0.6	1.8
Jun	1.0	2.2	1.0	2.2
May	1.1	2.5	1.1	2.5
Apr	1.5	2.6	1.5	2.6
Mar	1.6	1.3	1.6	1.3
Feb	1.3	0.3	1.2	0.2
Jan	0.9	0.0	1.0	0.0
Dec 2012	1.0	0.2	1.0	0.2
Nov	0.7	-0.3	0.8	-0.2
Oct	0.7	-0.2	0.8	-0.1
Sep	0.5	0.3	0.6	0.3
Aug	0.5	0.8	0.5	0.9
Jul	0.3	1.5	0.4	1.6
Jun	0.9	2.1	1.0	2.3
May	0.9	2.2	0.9	2.4
Apr	0.4	1.4	0.5	1.4
Mar	0.3	-0.1	0.3	0.0
Feb	0.0	-0.9	0.1	-0.8
Jan	-0.2	-1.1	-0.1	-1.0
Dec 2011	-0.4	-1.2	-0.3	-1.1
Nov	-0.5	-1.4	-0.5	-1.3
Oct	-0.5	-1.3	-0.5	-1.4
Sep	-0.4	-0.6	-0.4	-0.7
Aug	-0.3	0.1	-0.3	0.1
Jul	-0.2	0.9	-0.2	1.0
Jun	-0.1	1.0	-0.1	1.2
May	-0.3	1.0	-0.3	1.0
Apr	-0.3	0.6	-0.2	0.6
Mar	-0.4	-1.0	-0.6	-1.0
Feb	-0.4	-1.3	-0.3	-1.2
Jan	-0.2	-1.1	-0.2	-1.1
Dec 2010	-0.2	-0.9	-0.2	-1.0

Source: http://us.spindices.com/index-family/real-estate/sp-case-shiller

Table IIA-4 summarizes the brutal drops in assets and net worth of US households and nonprofit organizations from 2007 to 2008 and 2009. Total assets fell $10.4 trillion or 12.8 percent from 2007 to 2008 and $8.9 trillion or 10.9 percent to 2009. Net worth fell $10.3 trillion from 2007 to 2008 or 15.4 percent and $8.8 trillion to 2009 or 12.8 percent. Subsidies to housing prolonged over decades together with interest rates at 1.0 percent from Jun 2003 to Jun 2004 inflated valuations of real estate and risk financial assets such as equities. The increase of fed funds rates by 25 basis points until 5.25 percent in Jun 2006 reversed carry trades through exotic vehicles such as subprime adjustable rate mortgages (ARM) and world financial markets. 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 to purchase 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).

Table IIA-4, Difference of Balance Sheet of Households and Nonprofit Organizations, Billions of Dollars from 2007 to 2008 and 2009

	2007	2008	Change to 2008	2009	Change to 2009
A	81,197.0	70,804.9	-10,392.1	72,330.9	-8,866.1
Non FIN	28,167.5	24,756.9	-3,410.6	23,677.1	-4,490.4
RE	23,358.0	19,822.7	-3,535.3	18,720.7	-4,637.3
FIN	53,029.5	46,047.9	-6,981.6	48,653.8	-4,375.7
LIAB	14,394.3	14,278.6	-115.7	14,062.1	-332.2
NW	66,802.7	56,526.2	-10,276.5	58,268.8	-8,833.9

A: Assets; Non FIN: Nonfinancial Assets; RE: Real Estate; FIN: Financial Assets; LIAB: Liabilities; NW: Net Worth

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

The apparent improvement in Table IIA-4A is mostly because of increases in valuations of risk financial assets by the carry trade from zero interest rates to leveraged exposures in risk financial assets such as stocks, high-yield bonds, emerging markets, commodities and so on. Zero interest rates also act to increase net worth by reducing debt or liabilities. The net worth of households has become an instrument of unconventional monetary policy by zero interest rates in the theory that increases in net worth increase consumption that accounts for 68.5 percent of GDP in IIQ2014 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html), generating demand to increase aggregate economic activity and employment. There are neglected and counterproductive risks in unconventional monetary policy. Between 2007 and IIQ2014, real estate fell in value by $419.6 billion and financial assets increased $14,020.1 billion for net gain of real estate and financial assets of $13,600.5 billion, explaining most of the increase in net worth of $14,690.1 billion obtained by adding the decrease in liabilities of $445.9 billion to the increase of assets of $14,244.2 billion. Net worth increased from $66,802.7 billion in 2007 to $81,492.8 billion in IIQ2014 by $14,690.1 billion or 22.0 percent. The US consumer price index for all items increased from 210.036 in Dec 2007 to 238.343 in Jun 2014 (http://www.bls.gov/cpi/data.htm) or 13.5 percent. Net worth adjusted by CPI inflation increased 7.5 percent from 2007 to IIQ2014. Real estate assets adjusted for CPI inflation fell 13.5 percent from 2007 to IQ2014. There are multiple complaints that unconventional monetary policy concentrates income on wealthier individuals because of their holdings of financial assets while the middle class has gained less because of fewer holdings of financial assets and higher share of real estate in family wealth. There is nothing new in these arguments. Interest rate ceilings on deposits and loans have been commonly used. The Banking Act of 1933 imposed prohibition of payment of interest on demand deposits and ceilings on interest rates on time deposits. These measures were justified by arguments that the banking panic of the 1930s was caused by competitive rates on bank deposits that led banks to engage in high-risk loans (Friedman, 1970, 18; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 74-5). The objective of policy was to prevent unsound loans in banks. Savings and loan institutions complained of unfair competition from commercial banks that led to continuing controls with the objective of directing savings toward residential construction. Friedman (1970, 15) argues that controls were passive during periods when rates implied on demand deposit were zero or lower and when Regulation Q ceilings on time deposits were above market rates on time deposits. The Great Inflation or stagflation of the 1960s and 1970s changed the relevance of Regulation Q. Friedman (1970, 26-7) predicted the future:

“The banks have been forced into costly structural readjustments, the European banking system has been given an unnecessary competitive advantage, and London has been artificially strengthened as a financial center at the expense of New York.”

In short, Depression regulation exported the US financial system to London and offshore centers. What is vividly relevant currently from this experience is the argument by Friedman (1970, 27) that the controls affected the most people with lower incomes and wealth who were forced into accepting controlled-rates on their savings that were lower than those that would be obtained under freer markets. As Friedman (1970, 27) argues:

“These are the people who have the fewest alternative ways to invest their limited assets and are least sophisticated about the alternatives.” US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 20 quarters from IIIQ2009 to IIQ2014. 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). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the third estimate of GDP for IIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_3rd.pdf). The average of 7.7 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 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,294.6 billion than actual $16,010.4 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). US GDP in IIQ2014 is 12.5 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,010.4 billion in IIQ2014 or 6.8 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.

Table IIA-4A, US, Difference of Balance Sheet of Households and Nonprofit Organizations Billions of Dollars from 2007 to 2011 and IQ2014

	Value 2007	Change to 2011	Change to 2013	Change to IIQ2014
Assets	81,197.0	-3,924.9	11,472.2	14,244.2
Nonfinancial	28,167.5	-4,820.3	-498.3	224.1
Real Estate	23,358.0	-5,136.5	-1,062.1	-419.6
Financial	53,029.5	895.5	11,970.6	14,020.1
Liabilities	14,394.3	-820.3	-593.1	-445.9
Net Worth	66,802.7	-3,104.6	12,065.3	14,690.1

Net Worth = Assets – Liabilities

Source: Net Worth = Assets – Liabilities

Source: Board of Governors of the Federal Reserve System.

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

The comparison of net worth of households and nonprofit organizations in the entire economic cycle from IQ1980 (and from IVQ1979) to IVQ1987 and from IVQ2007 to IIQ2014 is provided in Table IIA-5. The data reveal the following facts for the cycles in the 1980s:

• IVQ1979 to IVQ1987. Net worth increased 99.2 percent from IVQ1979 to IVQ1987, the all items CPI index increased 50.5 percent from 76.7 in Dec 1979 to 115.4 in Dec 1987 and real net worth increased 32.4 percent.
• IQ1980 to IVQ1985. Net worth increased 65.4 percent, the all items CPI index increased 36.5 percent from 80.1 in Mar 1980 to 109.3 in Dec 1985 and real net worth increased 21.2 percent.
• IVQ1979 to IVQ1985. Net worth increased 68.8 percent, the all items CPI index increased 42.5 percent from 76.7 in Dec 1979 to 109.3 in Dec 1985 and real net worth increased 18.5 percent.
• IQ1980 to IVQ1987. Net worth increased 95.1 percent, the all items CPI index increased 44.1 percent from 80.1 in Mar 1980 to 115.4 in Dec 1987 and real net worth increased 35.4 percent.

There is disastrous performance in the current economic cycle:

• IVQ2007 to IQ2014. Net worth increased 22.0 percent, the all items CPI increased 13.5 percent from 210.036 in Dec 2007 to 238.343 in Jun 2014 and real or inflation adjusted net worth increased 7.5 percent. Real estate assets adjusted for inflation fell 13.5 percent.

The explanation is partly in the sharp decline of wealth of households and nonprofit organizations and partly in the mediocre growth rates of the cyclical expansion beginning in IIIQ2009. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 20 quarters from IIIQ2009 to IIQ2014. 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). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the third estimate of GDP for IIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_3rd.pdf). The average of 7.7 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 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,294.6 billion than actual $16,010.4 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). US GDP in IIQ2014 is 12.5 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,010.4 billion in IIQ2014 or 6.8 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.

Table IIA-5, Net Worth of Households and Nonprofit Organizations in Billions of Dollars, IVQ1979 to IVQ1985 and IVQ2007 to IVQ2012

Period IQ1980 to IVQ1985
Net Worth of Households and Nonprofit Organizations USD Millions
IVQ1979 IQ1980	9,049.0 9,239.9
IVQ1985 IIIQ1986 IVQ1986 IQ1987 IIQ1987 IIIQ1987 IVQ1987	15,279.1 16,292.8 16,842.4 17,496.7 17,786.1 18,197.5 18,024.1
∆ USD Billions IVQ1985 IVQ1987 IQ1980-IVQ1985 IQ1980-IIIQ1986 IQ1980-IVQ1986 IQ1980-IQ1987 IQ1980-IIQ1987 IQ1980-IIIQ1987 IQ1980-IVQ1987	+6,230.1  ∆%68.8 R∆%18.5 +8,975.1  ∆%99.2 R∆%32.4 +6,039.2 ∆%65.4 R∆%21.2 +7,052.9 ∆%76.3 R∆%28.2 +7,602.5 ∆%82.3 R∆%32.1 +8,256.8 ∆%89.4 R∆%35.3 +8,546.2 ∆%92.5 R∆%35.8 +8,957.6 ∆%96.9 R∆%37.2 +8784.2 ∆%95.1 R∆%35.4
Period IVQ2007 to IIQ2013
Net Worth of Households and Nonprofit Organizations USD Millions
IVQ2007	66,802.7
IIQ2014	81,492.8
∆ USD Billions	+14,690.1 ∆%22.0 R∆%7.5

Net Worth = Assets – Liabilities. R∆% real percentage change or adjusted for CPI percentage change.

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

Chart IIA-1 of the Board of Governors of the Federal Reserve System provides US wealth of households and nonprofit organizations from IVQ2007 to IQ2014. There is remarkable stop and go behavior in this series with two sharp declines and two standstills in the 19 quarters of expansion of the economy beginning in IIIQ2009. The increase in net worth of households and nonprofit organizations is the result of increases in valuations of risk financial assets and compressed liabilities resulting from zero interest rates. Wealth of households and nonprofits organization increased 7.5 percent from IVQ2007 to IIQ2014 when adjusting for consumer price inflation.

Chart IIA-1, Net Worth of Households and Nonprofit Organizations in Millions of Dollars, IVQ2007 to IIQ2014

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

Chart IIA-2 of the Board of Governors of the Federal Reserve System provides US wealth of households and nonprofit organizations from IVQ1979 to IIIQ1987. There are changes in the rates of growth of wealth suggested by the changing slopes but there is smooth upward trend. There was significant financial turmoil during the 1980s. Benston and Kaufman (1997, 139) find that there was failure of 1150 US commercial and savings banks between 1983 and 1990, or about 8 percent of the industry in 1980, which is nearly twice more than between the establishment of the Federal Deposit Insurance Corporation in 1934 through 1983. More than 900 savings and loans associations, representing 25 percent of the industry, were closed, merged or placed in conservatorships (see Pelaez and Pelaez, Regulation of Banks and Finance (2008b), 74-7). The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) created the Resolution Trust Corporation (RTC) and the Savings Association Insurance Fund (SAIF) that received $150 billion of taxpayer funds to resolve insolvent savings and loans. The GDP of the US in 1989 was $5657.7 billion (http://www.bea.gov/iTable/index_nipa.cfm), such that the partial cost to taxpayers of that bailout was around 2.65 percent of GDP in a year. US GDP in 2013 is estimated at $16,768.1 billion, such that the bailout would be equivalent to cost to taxpayers of about $444.4 billion in current GDP terms. A major difference with the Troubled Asset Relief Program (TARP) for private-sector banks is that most of the costs were recovered with interest gains whereas in the case of savings and loans there was no recovery. Money center banks were under extraordinary pressure from the default of sovereign debt by various emerging nations that represented a large share of their net worth (see Pelaez 1986). Net worth of households and nonprofit organizations increased 99.2 percent from IVQ1979 to IVQ1987 and 32.4 percent when adjusting for consumer price inflation. Net worth of households and nonprofit organizations increased 95.1 percent from IQ1980 to IVQ1987 and 35.4 percent when adjusting for consumer price inflation.

Chart IIA-2, Net Worth of Households and Nonprofit Organizations in Millions of Dollars, IVQ1979 to IVQ1987

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

Chart IIA-3 of the Board of Governors of the Federal Reserve System provides US wealth of households and nonprofit organizations from IVQ1945 at $767.3 billion to IVQ2013 at $78,867.9 billion or increase of 10,178.6 percent. The consumer price index not seasonally adjusted was 18.2 in Dec 1945 jumping to 233.049 in Dec 2013 or increase of 1,180.5 percent. There was a gigantic increase of US net worth of households and nonprofit organizations over 68 years with inflation-adjusted increase from $42.159 in dollars of 1945 to $338.418 in IVQ2013 or 702.7 percent. In a simple formula: {[($78,867.9/$767.3)/(233.049/18.2)-1]100 = 702.7%}. Wealth of households and nonprofit organizations increased from $767.3 billion at year-end 1945 to $78,867.9 billion at the end of 2013 or 10,178.6 percent. The consumer price index increased from 18.2 in Dec 1945 to 233.049 in Dec 2013 or 1180.5 percent. Net wealth of households and nonprofit organizations in dollars of 1945 increased from $42.159 in 1945 to $338.418 in 2013 or 702.7 percent at the average yearly rate of 3.1 percent. US real GDP grew at the average rate of 2.9 percent from 1945 to 2013 (http://www.bea.gov/iTable/index_nipa.cfm). The combination of collapse of values of real estate and financial assets during the global recession of IVQ2007 to IIQ2009 caused sharp contraction of net worth of US households and nonprofit organizations. Recovery has been in stop-and-go fashion during the worst cyclical expansion in the 68 years when US GDP grew at 2.2 percent on average in the twenty quarters between IIIQ2009 and IIQ2014 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). US GDP was $228.2 billion in 1945 and net worth of households and nonprofit organizations $767.3 billion for ratio of wealth to GDP of 3.36. The ratio of net worth of households and nonprofits of $66,802.7 billion in 2007 to GDP of $14,477.6 billion was 4.61. The ratio of net worth of households and nonprofits of $78,867.9 billion in 2013 to GDP of 16,768.1 billion was 4.70. The final data point in Chart IIA-3 is net worth of household and nonprofit institutions at $81,492.8 billion in IIQ2014 for increase of 10,520.7 percent relative to $767.3 billion in IVQ1945. CPI adjusted net worth of household and nonprofit institutions increased from $42.159 in IVQ1945 to $341.914 in IIQ2014 or 711.0 percent at the annual equivalent rate of 3.1 percent.

Chart IIA-3, Net Worth of Households and Nonprofit Organizations in Millions of Dollars, IVQ1945 to IIQ2014

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

Table IIA-6 provides percentage changes of nonfinancial domestic sector debt. Households increased debt by 10.2 percent in 2006 but reduced debt from 2009 to 2011. Households have increased debt moderately since 2012. Financial repression by zero fed funds rates or negative interest rates intends to increase debt and reduce savings. Business had not been as exuberant in acquiring debt and has been increasing debt benefitting from historically low costs while increasing cash holdings to around $2 trillion by swelling undistributed profits because of the uncertainty of capital budgeting. The key to growth and hiring consists in creating the incentives for business to invest and hire. States and local government were forced into increasing debt by the decline in revenues but began to contract in IQ2011, decreasing again from IQ2011 to IVQ2011, increasing at 2.1 percent in IIQ2012 and decreasing at 0.2 percent in IIIQ2012 and 2.6 percent in IVQ2012. State and local government increased debt at 1.9 percent in IQ2013 and decreased at 0.2 percent in IIQ2013. State and local government decreased debt at 3.7 percent in IIIQ2013 and at 3.3 percent in IVQ2013. State and local government reduced debt at 1.3 percent in IQ2014 and increased at 1.2 percent in IIQ2014. Opposite behavior is found for the federal government that has been rapidly accumulating debt but without success in the self-assigned goal of promoting economic growth. Financial repression constitutes seigniorage of government debt (http://cmpassocregulationblog.blogspot.com/2011/05/global-inflation-seigniorage-financial.html http://cmpassocregulationblog.blogspot.com/2011/05/global-inflation-seigniorage-monetary.html).

Table IIA-6, US, Percentage Change of Nonfinancial Domestic Sector Debt

	Total	Households	Business	State & Local Govern-ment	Federal
IIQ2014	3.8	3.6	6.3	1.2	2.5
IQ2014	4.3	2.2	6.2	-1.3	6.0
IVQ2013	4.4	0.7	4.5	-3.3	10.5
IIIQ2013	3.5	3.1	7.0	-3.7	2.6
IIQ2013	3.0	1.6	4.9	-0.2	3.5
IQ2013	4.1	0.8	3.5	1.9	9.1
IVQ2012	5.2	1.9	7.0	-2.6	9.3
IIIQ2012	3.8	0.6	4.2	-0.2	8.4
IIQ2012	5.5	2.7	3.7	2.1	11.6
IQ2012	5.1	1.1	4.0	0.0	12.6
2013	3.8	1.6	5.1	-1.3	6.5
2012	5.0	1.6	4.8	-0.2	10.9
2011	3.6	-0.2	3.0	-1.7	11.4
2010	4.1	-1.1	-0.9	2.3	20.2
2009	3.3	0.0	-4.3	4.0	22.7
2008	6.2	1.1	5.8	0.6	24.2
2007	8.2	7.0	12.4	5.5	4.9
2006	8.4	10.2	9.8	3.9	3.9
2005	9.0	11.2	8.1	5.8	7.0

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

Table IIA-7 provides wealth of US households and nonprofit organizations since 2005 in billions of current dollars at the end of period, NSA. Wealth fell from $66,803 billion in 2007 to $58,269 billion in 2009 or 12.8 percent and to $63,698 billion in 2011 or 4.6 percent. Wealth increased 22.0 percent from 2007 to IIQ2014, increasing 7.5 percent after adjustment for inflation, primarily because of bloating financial assets while nonfinancial assets declined in real terms.

Table IIA-7, US, Net Worth of Households and Nonprofit Organizations, Billions of Dollars, Amounts Outstanding at End of Period, NSA

Quarter	Net Worth
IIQ2014	81,493
IQ2014	80,102
IVQ2013	78,668
IIIQ2013	76,160
IIQ2013	73,814
IQ2013	72,290
IVQ2012	69,523
IIIQ2012	68,241
IIQ2012	66,046
IQ2012	65,860
2013	78,868
2012	69,523
2011	63,698
2010	62,484
2009	58,269
2008	56,526
2007	66,803
2006	66,393
2005	61,886

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: second quarter 2014. Washington, DC, Federal Reserve System, Jun 5. http://www.federalreserve.gov/releases/z1/

Reserve System, Sep 18.

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014.