Sunday, July 16, 2017

Rising Valuations of Risk Financial Assets and Dollar Devaluation, United States Current Account and International Investment Position, United States International Trade, World Cyclical Slow Growth and Global Recession Risk: Part I

Rising Valuations of Risk Financial Assets and Dollar Devaluation, United States Current Account and International Investment Position, United States International Trade, World Cyclical Slow Growth and Global Recession Risk

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017

I United States Industrial Production

II United States Current Account and International Investment Position

IIA United States International Trade

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

I United States Industrial Production. There is socio-economic stress in the combination of adverse events and cyclical performance:

Industrial production increased 0.4 percent in Jun 2017 and increased 0.1 percent in May 2017 after increasing 0.8 percent in Apr 2017, with all data seasonally adjusted, as shown in Table I-1. The Board of Governors of the Federal Reserve System conducted the annual revision of industrial production released on Mar 31, 2017 (https://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm):

“The Federal Reserve has revised its index of industrial production (IP) and the related measures of capacity and capacity utilization.[1] On net, the revisions were small, and the contour of total IP is little changed. Total IP is still reported to have moved up about 22 percent from the end of the recession in mid-2009 through late 2014, to have declined in 2015, and to have moved sideways in 2016. The most notable difference between the current and the previous estimates is that total IP is now reported to have decreased about 2 3/4 percent in 2015, whereas it previously showed a decline of about 1 3/4 percent.[2] The incorporation of detailed data for manufacturing from the U.S. Census Bureau's 2015 Annual Survey of Manufactures (ASM) accounts for the majority of the differences between the current and the previously published estimates.

Capacity for total industry is now reported to have expanded about 1 percent in 2015, a lower rate of increase than was reported earlier. Capacity was little changed in 2016 and is expected to increase 1 percent in 2017. Compared with prior reports, the rates of change in 2016 and 2017 are now a little smaller.

In the fourth quarter of 2016, capacity utilization for total industry stood at 75.8 percent, a rate 0.4 percentage point higher than previously published but still 4.1 percentage points below its long-run (1972–2016) average. Relative to earlier estimates, the utilization rates in recent years are now a little higher.”

The report of the Board of Governors of the Federal Reserve System states (https://www.federalreserve.gov/releases/g17/Current/default.htm):

“Industrial production rose 0.4 percent in June for its fifth consecutive monthly increase. Manufacturing output moved up 0.2 percent; although factory output has gone up and down in recent months, its level in June was little different from February. The index for mining posted a gain of 1.6 percent in June, just slightly below its pace in May. The index for utilities, however, remained unchanged. For the second quarter as a whole, industrial production advanced at an annual rate of 4.7 percent, primarily as a result of strong increases for mining and utilities. Manufacturing output rose at an annual rate of 1.4 percent, a slightly slower increase than in the first quarter. At 105.2 percent of its 2012 average, total industrial production in June was 2.0 percent above its year-earlier level. Capacity utilization for the industrial sector increased 0.2 percentage point in June to 76.6 percent, a rate that is 3.3 percentage points below its long-run (1972–2016) average.” In the six months ending in Jun 2017, United States national industrial production accumulated change of 1.3 percent at the annual equivalent rate of 2.6 percent, which is higher than growth of 2.0 percent in the 12 months ending in Jun 2017. Excluding growth of 0.8 percent in Apr 2016, growth in the remaining five months from Jan to Jun 2017 accumulated to 0.5 percent or 1.2 percent annual equivalent. Industrial production declined in one of the past six months, changed 0.1 percent in two months and increased 0.2 percent in one month, 0.4 percent in one month and 0.8 percent in one month. Industrial production grew at annual equivalent 5.3 percent in the most recent quarter from Apr 2017 to Jun and changed at 0.0 percent in the prior quarter Jan 2017 to Mar 2017. Business equipment accumulated change of 0.4 percent in the six months from Jan 2017 to Jun 2017, at the annual equivalent rate of 0.8 percent, which is higher than growth of 0.7 percent in the 12 months ending in Jun 2017. The Fed analyzes capacity utilization of total industry in its report (https://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for the industrial sector increased 0.2 percentage point in June to 76.6 percent, a rate that is 3.3 percentage points below its long-run (1972–2016) average.” United States industry apparently decelerated to a lower growth rate followed by possible acceleration and weakening growth in past months. There could renewed growth.

Table I-1, US, Industrial Production and Capacity Utilization, SA, ∆% 

Jun 

16

May 

17

Apr 

17

Mar 

17

Feb  

17

Jan 

17

Jun 17 

16/

Jun 16 

Total

0.4

0.1

0.8

0.1

0.2

-0.3

2.0

Market
Groups

Final Products

0.1

-0.1

1.5

0.2

-0.5

-0.7

0.8

Consumer Goods

0.0

0.1

1.5

0.3

-0.9

-1.1

0.2

Business Equipment

0.1

-0.9

1.5

-0.3

0.1

-0.1

0.7

Non
Industrial Supplies

0.1

-0.2

0.3

0.0

0.3

0.1

1.5

Construction

-0.1

-0.4

1.1

-1.1

1.6

1.4

3.9

Materials

0.7

0.3

0.5

0.1

0.9

0.0

3.1

Industry Groups

Manufacturing

0.2

-0.4

1.0

-0.8

0.3

0.4

1.2

Mining

1.6

1.9

0.7

-0.5

3.6

1.4

9.9

Utilities

0.0

0.8

0.1

8.2

-4.8

-7.2

-2.2

Capacity

76.6

76.4

76.4

75.8

75.8

75.7

1.0

Sources: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/default.htm

Manufacturing increased 0.2 percent in Jun 2017 and decreased 0.4 percent in May 2017 after increasing 1.0 percent in Apr 2017, seasonally adjusted, increasing 1.1 percent not seasonally adjusted in the 12 months ending in Jun 2017, as shown in Table I-2. Manufacturing increased cumulatively 0.7 percent in the six months ending in Jun 2017 or at the annual equivalent rate of 1.4 percent. Excluding the increase of 1.0 percent in Apr 2017, manufacturing decreased 0.3 percent from Jan 2017 to Jun 2017 or at the annual equivalent rate of 0.7 percent. Table I-2 provides a longer perspective of manufacturing in the US. There has been evident deceleration of manufacturing growth in the US from 2010 and the first three months of 2011 with recovery followed by renewed deterioration/improvement in more recent months as shown by 12 months’ rates of growth. Growth rates appeared to be increasing again closer to 5 percent in Apr-Jun 2012 but deteriorated. The rates of decline of manufacturing in 2009 are quite high with a drop of 18.5 percent in the 12 months ending in Apr 2009. Manufacturing recovered from this decline and led the recovery from the recession. Rates of growth appeared to be returning to the levels at 3 percent or higher in the annual rates before the recession but the pace of manufacturing fell steadily with some strength at the margin. There is renewed deterioration and improvement. The Board of Governors of the Federal Reserve System conducted the annual revision of industrial production released on Mar 31, 2017 (https://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm):

“The Federal Reserve has revised its index of industrial production (IP) and the related measures of capacity and capacity utilization.[1] On net, the revisions were small, and the contour of total IP is little changed. Total IP is still reported to have moved up about 22 percent from the end of the recession in mid-2009 through late 2014, to have declined in 2015, and to have moved sideways in 2016. The most notable difference between the current and the previous estimates is that total IP is now reported to have decreased about 2 3/4 percent in 2015, whereas it previously showed a decline of about 1 3/4 percent.[2] The incorporation of detailed data for manufacturing from the U.S. Census Bureau's 2015 Annual Survey of Manufactures (ASM) accounts for the majority of the differences between the current and the previously published estimates.

Capacity for total industry is now reported to have expanded about 1 percent in 2015, a lower rate of increase than was reported earlier. Capacity was little changed in 2016 and is expected to increase 1 percent in 2017. Compared with prior reports, the rates of change in 2016 and 2017 are now a little smaller. In the fourth quarter of 2016, capacity utilization for total industry stood at 75.8 percent, a rate 0.4 percentage point higher than previously published but still 4.1 percentage points below its long-run (1972–2016) average. Relative to earlier estimates, the utilization rates in recent years are now a little higher.”

The bottom part of Table I-2 shows decline of manufacturing by 22.3 from the peak in Jun 2007 to the trough in Apr 2009 and increase of 15.5 percent from the trough in Apr 2009 to Dec 2016. Manufacturing grew 20.8 percent from the trough in Apr 2009 to Jun 2017. Manufacturing in Jun 2017 is lower by 6.2 percent relative to the peak in Jun 2007. 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 IQ2017 would have accumulated to 31.4 percent. GDP in IQ2017 would be $19,699.2 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2826.4 billion than actual $16,872.8 billion. There are about two trillion dollars of GDP less than at trend, explaining the 21.9 million unemployed or underemployed equivalent to actual unemployment/underemployment of 13.0 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2017/07/rising-yields-twenty-two-million.html and earlier https://cmpassocregulationblog.blogspot.com/2017/06/twenty-two-million-unemployed-or.html). US GDP in IQ2017 is 14.3 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,872.8 billion in IQ2017 or 12.5 percent at the average annual equivalent rate of 1.3 percent. Professor John H. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. Cochrane (2016May02) measures GDP growth in the US at average 3.5 percent per year from 1950 to 2000 and only at 1.76 percent per year from 2000 to 2015 with only at 2.0 percent annual equivalent in the current expansion. Cochrane (2016May02) proposes drastic changes in regulation and legal obstacles to private economic activity. 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. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.1 percent per year from Jun 1919 to Jun 2017. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 144.6580 in Jun 2017. The actual index NSA in Jun 2017 is 105.6126, which is 27.0 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Jun 2017. Using trend growth of 2.1 percent per year, the index would increase to 131.8650 in Jun 2017. The output of manufacturing at 105.6126 in Jun 2017 is 19.9 percent below trend under this alternative calculation.

Table I-2, US, Monthly and 12-Month Rates of Growth of Manufacturing ∆%

Month SA ∆%

12-Month NSA ∆%

Jun 2017

0.2

1.1

May

-0.4

1.2

Apr

1.0

-0.3

Mar

-0.8

1.0

Feb

0.3

0.9

Jan

0.4

0.4

Dec 2016

0.2

0.6

Nov

0.2

0.1

Oct

0.2

0.0

Sep

0.2

0.3

Aug

-0.4

-0.8

Jul

0.1

-0.5

Jun

0.2

0.2

May

-0.2

-0.3

Apr

0.0

0.5

Mar

-0.2

-0.7

Feb

-0.2

0.4

Jan

0.6

0.2

Dec 2015

-0.3

-0.9

Nov

-0.1

-0.7

Oct

0.2

0.2

Sep

-0.3

-0.8

Aug

-0.1

0.1

Jul

0.6

0.3

Jun

-0.3

-0.6

May

-0.1

0.2

Apr

0.1

0.3

Mar

0.3

0.3

Feb

-0.5

0.7

Jan

-0.4

2.1

Dec 2014

-0.4

1.7

Nov

0.9

1.9

Oct

0.0

1.1

Sep

0.0

1.2

Aug

-0.4

1.4

Jul

0.2

2.0

Jun

0.3

1.5

May

0.2

1.3

Apr

0.0

0.9

Mar

0.8

1.5

Feb

1.1

0.2

Jan

-1.0

-0.7

Dec 2013

0.0

0.0

Nov

0.0

1.0

Oct

0.1

1.7

Sep

0.1

1.1

Aug

1.0

1.3

Jul

-1.1

0.2

Jun

0.2

0.7

May

0.2

0.9

Apr

-0.4

1.1

Mar

-0.2

0.7

Feb

0.5

0.9

Jan

-0.3

1.0

Dec 2012

0.7

2.0

Nov

0.8

2.0

Oct

-0.2

0.9

Sep

0.0

1.7

Aug

-0.2

2.2

Jul

-0.1

2.5

Jun

0.2

3.3

May

-0.4

3.2

Apr

0.6

3.6

Mar

-0.5

2.5

Feb

0.4

3.8

Jan

0.9

3.2

Dec 2011

0.6

2.8

Nov

-0.4

2.3

Oct

0.6

2.5

Sep

0.3

2.3

Aug

0.4

1.9

Jul

0.5

2.2

Jun

0.1

1.8

May

0.1

1.6

Apr

-0.6

2.9

Mar

0.6

4.5

Feb

0.1

5.1

Jan

0.2

5.2

Dec 2010

0.4

5.8

Nov

0.0

4.9

Oct

0.1

6.1

Sep

0.1

6.4

Aug

0.2

7.0

Jul

0.6

7.5

Jun

-0.1

9.2

May

1.4

8.7

Apr

0.9

6.9

Mar

1.2

4.6

Feb

-0.1

1.2

Jan

1.1

1.1

Dec 2009

-0.2

-3.4

Nov

1.0

-6.3

Oct

0.2

-9.3

Sep

0.8

-10.7

Aug

1.2

-13.7

Jul

1.4

-15.4

Jun

-0.4

-18.0

May

-1.1

-17.8

Apr

-0.8

-18.5

Mar

-1.9

-17.4

Feb

-0.2

-16.3

Jan

-3.0

-16.6

Dec 2008

-3.5

-14.1

Nov

-2.3

-11.4

Oct

-0.6

-8.9

Sep

-3.4

-8.7

Aug

-1.1

-5.2

Jul

-1.2

-3.7

Jun

-0.6

-3.3

May

-0.5

-2.6

Apr

-1.1

-1.3

Mar

-0.3

-0.8

Feb

-0.6

0.8

Jan

-0.4

2.1

Dec 2007

0.1

1.8

Nov

0.5

3.3

Oct

-0.4

2.7

Sep

0.4

2.9

Aug

-0.3

2.7

Jul

0.1

3.6

Jun

0.3

3.1

May

-0.1

3.2

Apr

0.7

3.7

Mar

0.8

2.6

Feb

0.4

1.6

Jan

-0.5

1.3

Dec 2006

2.7

Dec 2005

3.5

Dec 2004

4.0

Dec 2003

2.2

Dec 2002

2.4

Dec 2001

-5.4

Dec 2000

0.8

Dec 1999

5.2

Average ∆% Dec 1986-Dec 2016

2.0

Average ∆% Dec 1986-Dec 2015

2.0

Average ∆% Dec 1986-Dec 2014

2.1

Average ∆% Dec 1986-Dec 2013

2.2

Average ∆% Dec 1986-Dec 1999

4.3

Average ∆% Dec 1999-Dec 2006

1.4

Average ∆% Dec 1999-Dec 2016

0.3

∆% Peak 112.5742 in 06/2007 to 100.9324 in 12/2016

-10.3

∆% Peak 112.5742 in 06/2007 to Trough 87.4229 in 4/2009

-22.3

∆% Trough 87.4229 in 04/2009 to 100.9324 in 12/2016

15.5

∆% Trough 87.4229 in 04/2009 to 105.6126 in 6/2017

20.8

∆% Peak 112.5742 on 06/2007 to 105.6126 in 6/2017

-6.2

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/default.htm

Chart I-1 of the Board of Governors of the Federal Reserve System provides industrial production, manufacturing and capacity since the 1970s. There was acceleration of growth of industrial production, manufacturing and capacity in the 1990s because of rapid growth of productivity in the US (Cobet and Wilson (2002); see Pelaez and Pelaez, The Global Recession Risk (2007), 135-44). The slopes of the curves flatten in the 2000s. Production and capacity have not recovered sufficiently above levels before the global recession, remaining like GDP below historical trend. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.1 percent per year from Jun 1919 to Jun 2017. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 144.6580 in Jun 2017. The actual index NSA in Jun 2017 is 105.6126, which is 27.0 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Jun 2017. Using trend growth of 2.1 percent per year, the index would increase to 131.8650 in Jun 2017. The output of manufacturing at 105.6126 in Jun 2017 is 19.9 percent below trend under this alternative calculation.

clip_image001

Chart I-1, US, Industrial Production, Capacity and Utilization

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/ipg1.gif

The modern industrial revolution of Jensen (1993) is captured in Chart I-2 of the Board of Governors of the Federal Reserve System (for the literature on M&A and corporate control see Pelaez and Pelaez, Regulation of Banks and Finance (2009a), 143-56, Globalization and the State, Vol. I (2008a), 49-59, Government Intervention in Globalization (2008c), 46-49). The slope of the curve of total industrial production accelerates in the 1990s to a much higher rate of growth than the curve excluding high-technology industries. Growth rates decelerate into the 2000s and output and capacity utilization have not recovered fully from the strong impact of the global recession. Growth in the current cyclical expansion has been more subdued than in the prior comparably deep contractions in the 1970s and 1980s. Chart I-2 shows that the past recessions after World War II are the relevant ones for comparison with the recession after 2007 instead of common comparisons with the Great Depression (https://cmpassocregulationblog.blogspot.com/2017/07/dollar-devaluation-and-rising-yields.html and earlier https://cmpassocregulationblog.blogspot.com/2017/05/mediocre-cyclical-united-states.html). The bottom left-hand part of Chart II-2 shows the strong growth of output of communication equipment, computers and semiconductor that continued from the 1990s into the 2000s. Output of semiconductors has already surpassed the level before the global recession.

clip_image002

Chart I-2, US, Industrial Production, Capacity and Utilization of High Technology Industries

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/ipg3.gif

Additional detail on industrial production and capacity utilization is in Chart I-3 of the Board of Governors of the Federal Reserve System. Production of consumer durable goods fell sharply during the global recession by more than 30 percent and is oscillating above the level before the contraction. Output of nondurable consumer goods fell around 10 percent and is some 5 percent below the level before the contraction. Output of business equipment fell sharply during the contraction of 2001 but began rapid growth again after 2004. An important characteristic is rapid growth of output of business equipment in the cyclical expansion after sharp contraction in the global recession, stalling in the final segment. Output of defense and space only suffered reduction in the rate of growth during the global recession and surged ahead of the level before the contraction, declining in the final segment. Output of construction supplies collapsed during the global recession and is well below the level before the contraction. Output of energy materials was stagnant before the contraction but recovered sharply above the level before the contraction with recent decline.

clip_image003

Chart I-3, US, Industrial Production and Capacity Utilization

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/ipg2.gif

United States manufacturing output from 1919 to 2017 on a monthly basis is in Chart I-4 of the Board of Governors of the Federal Reserve System. The second industrial revolution of Jensen (1993) is quite evident in the acceleration of the rate of growth of output given by the sharper slope in the 1980s and 1990s. Growth was robust after the shallow recession of 2001 but dropped sharply during the global recession after IVQ2007. Manufacturing output recovered sharply but has not reached earlier levels and is losing momentum at the margin. Current output is well below extrapolation of trend. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.2 percent per year from May 1919 to May 2017. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 145.6138 in May 2017. The actual index NSA in May 2017 is 103.6037, which is 28.9 percent below trend. Manufacturing output grew at average 2.0 percent between Dec 1986 and May 2017. Using trend growth of 2.0 percent per year, the index would increase to 130.4278 in May 2017. The output of manufacturing at 103.6037 in May 2017 is 20.6 percent below trend under this alternative calculation. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.1 percent per year from Jun 1919 to Jun 2017. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 144.6580 in Jun 2017. The actual index NSA in Jun 2017 is 105.6126, which is 27.0 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Jun 2017. Using trend growth of 2.1 percent per year, the index would increase to 131.8650 in Jun 2017. The output of manufacturing at 105.6126 in Jun 2017 is 19.9 percent below trend under this alternative calculation.

clip_image004

Chart I-4, US, Manufacturing Output, 1919-2017

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/default.htm

Manufacturing jobs not seasonally adjusted increased 46,000 from Jun 2016 to
Jun 2017 or at the average monthly rate of 3833.   Industrial production increased 0.4 percent in Jun 2017 and increased 0.1 percent in May 2017 after increasing 0.8 percent in Apr 2017, with all data seasonally adjusted. The Board of Governors of the Federal Reserve System conducted the annual revision of industrial production released on Mar 31, 2017 (https://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm):

“The Federal Reserve has revised its index of industrial production (IP) and the related measures of capacity and capacity utilization.[1] On net, the revisions were small, and the contour of total IP is little changed. Total IP is still reported to have moved up about 22 percent from the end of the recession in mid-2009 through late 2014, to have declined in 2015, and to have moved sideways in 2016. The most notable difference between the current and the previous estimates is that total IP is now reported to have decreased about 2 3/4 percent in 2015, whereas it previously showed a decline of about 1 3/4 percent.[2] The incorporation of detailed data for manufacturing from the U.S. Census Bureau's 2015 Annual Survey of Manufactures (ASM) accounts for the majority of the differences between the current and the previously published estimates.

Capacity for total industry is now reported to have expanded about 1 percent in 2015, a lower rate of increase than was reported earlier. Capacity was little changed in 2016 and is expected to increase 1 percent in 2017. Compared with prior reports, the rates of change in 2016 and 2017 are now a little smaller. In the fourth quarter of 2016, capacity utilization for total industry stood at 75.8 percent, a rate 0.4 percentage point higher than previously published but still 4.1 percentage points below its long-run (1972–2016) average. Relative to earlier estimates, the utilization rates in recent years are now a little higher.” Manufacturing fell 22.3 from the peak in Jun 2007 to the trough in Apr 2009 and increased 15.5 percent from the trough in Apr 2009 to Dec 2016. Manufacturing grew 20.8 percent from the trough in Apr 2009 to Jun 2017. Manufacturing in Jun 2017 is lower by 6.2 percent relative to the peak in Jun 2007. 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 IQ2017 would have accumulated to 31.4 percent. GDP in IQ2017 would be $19,699.2 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2826.4 billion than actual $16,872.8 billion. There are about two trillion dollars of GDP less than at trend, explaining the 21.9 million unemployed or underemployed equivalent to actual unemployment/underemployment of 13.0 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2017/07/rising-yields-twenty-two-million.html and earlier https://cmpassocregulationblog.blogspot.com/2017/06/twenty-two-million-unemployed-or.html). US GDP in IQ2017 is 14.3 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,872.8 billion in IQ2017 or 12.5 percent at the average annual equivalent rate of 1.3 percent. Professor John H. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. Cochrane (2016May02) measures GDP growth in the US at average 3.5 percent per year from 1950 to 2000 and only at 1.76 percent per year from 2000 to 2015 with only at 2.0 percent annual equivalent in the current expansion. Cochrane (2016May02) proposes drastic changes in regulation and legal obstacles to private economic activity. 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. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.1 percent per year from Jun 1919 to Jun 2017. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 144.6580 in Jun 2017. The actual index NSA in Jun 2017 is 105.6126, which is 27.0 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Jun 2017. Using trend growth of 2.1 percent per year, the index would increase to 131.8650 in Jun 2017. The output of manufacturing at 105.6126 in Jun 2017 is 19.9 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 86.9 percent in IQ2017. Most of US national income is in the form of services. In Jun 2017, there were 147.388 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 125.152 million NSA in Jun 2017 accounted for 84.9 percent of total nonfarm jobs of 147.388 million, of which 12.480 million, or 10.0 percent of total private jobs and 8.5 percent of total nonfarm jobs, were in manufacturing. Private service-providing jobs were 104.852 million NSA in Jun 2017, or 71.1 percent of total nonfarm jobs and 83.8 percent of total private-sector jobs. Manufacturing has share of 10.1 percent in US national income in IQ2017 and durable goods 5.9 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
IVQ2016

% Total

SAAR IQ2017

% Total

National Income WCCA

16,222.0

100.0

16,316.5

100.0

Domestic Industries

15,978.9

98.5

16,088.1

98.6

Private Industries

14,093.8

86.9

14,181.9

86.9

Agriculture

112.6

0.7

108.3

0.7

Mining

188.3

1.2

194.5

1.2

Utilities

173.8

1.1

175.2

1.1

Construction

781.6

4.8

794.9

4.9

Manufacturing

1650.8

10.2

1649.9

10.1

Durable Goods

971.8

6.0

964.5

5.9

Nondurable Goods

679.0

4.2

685.4

4.2

Wholesale Trade

941.9

5.8

927.0

5.7

Retail Trade

1133.5

7.0

1137.9

7.0

Transportation & WH

497.5

3.1

505.7

3.1

Information

588.8

3.6

588.6

3.6

Finance, Insurance, RE

2912.4

18.0

2937.0

18.0

Professional & Business Services

2285.2

14.1

2306.1

14.1

Education, Health Care

1647.6

10.2

1662.9

10.2

Arts, Entertainment

701.1

4.3

710.3

4.4

Other Services

478.6

3.0

483.6

3.0

Government

1885.1

11.6

1906.2

11.7

Rest of the World

243.0

1.5

228.4

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

Motor vehicle sales and production in the US have been in long-term structural change. Table VA-1A provides the data on new motor vehicle sales and domestic car production in the US from 1990 to 2010. New motor vehicle sales grew from 14,137 thousand in 1990 to the peak of 17,806 thousand in 2000 or 29.5 percent. In that same period, domestic car production fell from 6,231 thousand in 1990 to 5,542 thousand in 2000 or -11.1 percent. New motor vehicle sales fell from 17,445 thousand in 2005 to 11,772 in 2010 or 32.5 percent while domestic car production fell from 4,321 thousand in 2005 to 2,840 thousand in 2010 or 34.3 percent. In Jun 2017, light vehicle sales accumulated to 8,452,134 million, which is lower by 2.1 percent relative to 8,636,946 a year earlier (http://motorintelligence.com/m_frameset.html). The seasonally adjusted annual rate of light vehicle sales in the US reached 16.50 million in Jun 2017, lower than 16.66 million in May 2017 and lower than 16.80 million in Jun 2016. (http://motorintelligence.com/m_frameset.html).

Table VA-1A, US, New Motor Vehicle Sales and Car Production, Thousand Units 7

New Motor Vehicle Sales

New Car Sales and Leases

New Truck Sales and Leases

Domestic Car Production

1990

14,137

9,300

4,837

6,231

1991

12,725

8,589

4,136

5,454

1992

13,093

8,215

4,878

5,979

1993

14,172

8,518

5,654

5,979

1994

15,397

8,990

6,407

6,614

1995

15,106

8,536

6,470

6,340

1996

15,449

8,527

6,922

6,081

1997

15,490

8,273

7,218

5,934

1998

15,958

8,142

7,816

5,554

1999

17,401

8,697

8,704

5,638

2000

17,806

8,852

8,954

5,542

2001

17,468

8,422

9,046

4,878

2002

17,144

8,109

9,036

5,019

2003

16,968

7,611

9,357

4,510

2004

17,298

7,545

9,753

4,230

2005

17,445

7,720

9,725

4,321

2006

17,049

7,821

9,228

4,367

2007

16,460

7,618

8,683

3,924

2008

13,494

6,814

6.680

3,777

2009

10,601

5,456

5,154

2,247

2010

11,772

5,729

6,044

2,840

Source: US Census Bureau

http://www.census.gov/compendia/statab/cats/wholesale_retail_trade/motor_vehicle_sales.html

Chart I-5 of the Board of Governors of the Federal Reserve provides output of motor vehicles and parts in the United States from 1972 to 2017. Output virtually stagnated since the late 1990s with recent increase.

Chart I-5 of the Board of Governors of the Federal Reserve provides output of motor vehicles and parts in the United States from 1972 to 2017. Output virtually stagnated since the late 1990s with recent increase.

clip_image005

Chart 1-5, US, Motor Vehicles and Parts Output, 1972-2017

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/default.htm

Chart I-6 of the Board of Governors of the Federal Reserve System provides output of computers and electronic products in the United States from 1972 to 2017. Output accelerated sharply in the 1990s and 2000s and surpassed the level before the global recession beginning in IVQ2007.

clip_image006

Chart I-6, US, Output of Computers and Electronic Products, 1972-2017

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/default.htm

Chart I-7 of the Board of Governors of the Federal Reserve System shows that output of durable manufacturing accelerated in the 1980s and 1990s with slower growth in the 2000s perhaps because processes matured. Growth was robust after the major drop during the global recession but appears to vacillate in the final segment.

clip_image007

Chart I-7, US, Output of Durable Manufacturing, 1972-2017

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/default.htm

Chart I-8 of the Board of Governors of the Federal Reserve System provides output of aerospace and miscellaneous transportation equipment from 1972 to 2017. There is long-term upward trend with oscillations around the trend and cycles of large amplitude.

clip_image008

Chart I-8, US, Output of Aerospace and Miscellaneous Transportation Equipment, 1972-2017

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/g17/Current/default.htm

II United States Current Account and International Investment Position. The current account of the US balance of payments is in Table VI-3A for IQ2016 and IQ2017. The Bureau of Economic Analysis analyzes as follows (https://www.bea.gov/newsreleases/international/transactions/2017/pdf/trans117.pdf):

“The U.S. current-account deficit increased to $116.8 billion (preliminary) in the first quarter of 2017 from $114.0 billion (revised) in the fourth quarter of 2016, according to statistics released by the Bureau of Economic Analysis (BEA). The deficit increased to 2.5 percent of current-dollar gross domestic product (GDP) from 2.4 percent in the fourth quarter. The $2.8 billion increase in the current-account deficit reflected a $5.3 billion increase in the deficit on goods and a $3.6 billion decrease in the surplus on primary income that were partly offset by a $5.8 billion decrease in the deficit on secondary income and a $0.3 billion increase in the surplus on services.”

The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US not seasonally adjusted decreased from $98.9 billion in IQ2016 to $93.4 billion in IQ2017. The current account deficit seasonally adjusted at annual rate decreased from 2.6 percent of GDP in IQ2016 to 2.4 percent of GDP in IVQ2016, increasing to 2.5 percent of GDP in IQ2017. The ratio of the current account deficit to GDP has stabilized below 3 percent of GDP compared with much higher percentages before the recession but is combined now with much higher imbalance in the Treasury budget (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71). There is still a major challenge in the combined deficits in current account and in federal budgets.

Table VI-3A, US, Balance of Payments, Millions of Dollars NSA

IQ2016

IQ2017

Difference

Goods Balance

-169,590

-180,079

-14,489

X Goods

347,778

374,594

7.7 ∆%

M Goods

-517,368

-554,673

7.2 ∆%

Services Balance

65,503

66,668

1,165

X Services

183,648

190,025

3.5 ∆%

M Services

-118,145

-123,357

4.4 ∆%

Balance Goods and Services

-104,086

-113,411

-9,325

Exports of Goods and Services and Income Receipts

752,767

814,939

Imports of Goods and Services and Income Payments

-851,660

-908,385

Current Account Balance

-98,893

-93,446

-5,447

% GDP

IQ2016

IQ2017

IVQ2016

2.6

2.5

2.4

X: exports; M: imports

Balance on Current Account = Exports of Goods and Services – Imports of Goods and Services and Income Payments

Source: Bureau of Economic Analysis

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

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

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

The alternative fiscal scenario of the CBO (2012NovCDR, 2013Sep17) resembles an economic world in which eventually the placement of debt reaches a limit of what is proportionately desired of US debt in investment portfolios. This unpleasant environment is occurring in various European countries.

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

First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:

D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)

Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,

{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:

N(t+1) = (1+n)N(t), n>-1 (2)

The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:

B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)

On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.

Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:

(Mt + Bt)/Pt = Et∫(1/Rt, t+Ï„)st+Ï„dÏ„ (4)

Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+Ï„, of the future primary surpluses st+Ï„, which are equal to Tt+Ï„ – Gt+Ï„ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+Ï„. The second equation of Cochrane (2011Jan, 5) is:

MtV(it, ·) = PtYt (5)

Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):

“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”

An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.

There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:

(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress

(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality

(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.

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

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

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

The United States could be moving toward a situation typical of heavily indebted countries, requiring fiscal adjustment and increases in productivity to become more competitive internationally. The CAD and NIIP of the United States are not observed in full deterioration because the economy is well below trend. There are two complications in the current environment relative to the concern with disorderly correction in the first half of the past decade. In the release of Jun 14, 2013, the Bureau of Economic Analysis (http://www.bea.gov/newsreleases/international/transactions/2013/pdf/trans113.pdf) informs of revisions of US data on US international transactions since 1999:

“The statistics of the U.S. international transactions accounts released today have been revised for the first quarter of 1999 to the fourth quarter of 2012 to incorporate newly available and revised source data, updated seasonal adjustments, changes in definitions and classifications, and improved estimating methodologies.”

The BEA introduced new concepts and methods (http://www.bea.gov/international/concepts_methods.htm) in comprehensive restructuring on Jun 18, 2014 (http://www.bea.gov/international/modern.htm):

“BEA introduced a new presentation of the International Transactions Accounts on June 18, 2014 and will introduce a new presentation of the International Investment Position on June 30, 2014. These new presentations reflect a comprehensive restructuring of the international accounts that enhances the quality and usefulness of the accounts for customers and bring the accounts into closer alignment with international guidelines.”

Table VI-3B provides data on the US fiscal and balance of payments imbalances incorporating all revisions and methods. In 2007, the federal deficit of the US was $161 billion corresponding to 1.1 percent of GDP while the Congressional Budget Office estimates the federal deficit in 2012 at $1087 billion or 6.8 percent of GDP. The estimate of the deficit for 2013 is $680 billion or 4.1 percent of GDP. The combined record federal deficits of the US from 2009 to 2012 are $5094 billion or 31.6 percent of the estimate of GDP for fiscal year 2012 implicit in the CBO (CBO 2013Sep11) estimate of debt/GDP. The deficits from 2009 to 2012 exceed one trillion dollars per year, adding to $5.094 trillion in four years, using the fiscal year deficit of $1087 billion for fiscal year 2012, which is the worst fiscal performance since World War II. Federal debt in 2007 was $5035 billion, slightly less than the combined deficits from 2009 to 2012 of $5094 billion. Federal debt in 2012 was 70.4 percent of GDP (CBO 2015Jan26) and 72.6 percent of GDP in 2013 (http://www.cbo.gov/). This situation may worsen in the future (CBO 2013Sep17):

“Between 2009 and 2012, the federal government recorded the largest budget deficits relative to the size of the economy since 1946, causing federal debt to soar. Federal debt held by the public is now about 73 percent of the economy’s annual output, or gross domestic product (GDP). That percentage is higher than at any point in U.S. history except a brief period around World War II, and it is twice the percentage at the end of 2007. If current laws generally remained in place, federal debt held by the public would decline slightly relative to GDP over the next several years, CBO projects. After that, however, growing deficits would ultimately push debt back above its current high level. CBO projects that federal debt held by the public would reach 100 percent of GDP in 2038, 25 years from now, even without accounting for the harmful effects that growing debt would have on the economy. Moreover, debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely.

The gap between federal spending and revenues would widen steadily after 2015 under the assumptions of the extended baseline, CBO projects. By 2038, the deficit would be 6½ percent of GDP, larger than in any year between 1947 and 2008, and federal debt held by the public would reach 100 percent of GDP, more than in any year except 1945 and 1946. With such large deficits, federal debt would be growing faster than GDP, a path that would ultimately be unsustainable.

Incorporating the economic effects of the federal policies that underlie the extended baseline worsens the long-term budget outlook. The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues and higher interest payments. With those effects included, debt under the extended baseline would rise to 108 percent of GDP in 2038.”

The most recent CBO long-term budget on Mar 27, 2017, projects US federal debt at 150.0 percent of GDP in 2047 (Congressional Budget Office, The 2017 Long-term Budget Outlook. Washington, DC, Mar 30, 2017 https://www.cbo.gov/publication/52480).

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

2007

2008

2009

2010

2011

Goods &
Services

-705

-709

-384

-495

-549

Primary Income

85

130

115

168

211

Secondary Income

-91

-102

-104

-104

-107

Current Account

-711

-681

-373

-431

-445

NGDP

14478

14719

14419

14964

15518

Current Account % GDP

-4.9

-4.6

-2.6

-2.9

-2.9

NIIP

-1279

-3995

-2628

-2512

-4455

US Owned Assets Abroad

20705

19423

19426

21767

22209

Foreign Owned Assets in US

21984

23418

22054

24279

26664

NIIP % GDP

-8.8

-27.1

-18.2

-16.8

-28.7

Exports
Goods,
Services and
Income

2559

2742

2283

2625

2983

NIIP %
Exports
Goods,
Services and
Income

-50

-145

-115

-95

-149

DIA MV

5858

3707

4945

5486

5215

DIUS MV

4134

3091

3619

4099

4199

Fiscal Balance

-161

-459

-1413

-1294

-1300

Fiscal Balance % GDP

-1.1

-3.1

-9.8

-8.7

-8.5

Federal   Debt

5035

5803

7545

9019

10128

Federal Debt % GDP

35.2

39.3

52.3

60.9

65.9

Federal Outlays

2729

2983

3518

3457

3603

∆%

2.8

9.3

17.9

-1.7

4.2

% GDP

19.1

20.2

24.4

23.4

23.4

Federal Revenue

2568

2524

2105

2163

2303

∆%

6.7

-1.7

-16.6

2.7

6.5

% GDP

17.9

17.1

14.6

14.6

15.0

2012

2013

2014

2015

2016

Goods &
Services

-537

-462

-490

-500

-505

Primary Income

207

206

210

181

173

Secondary Income

-97

-94

-94

-115

-120

Current Account

-426

-350

-374

-434

-452

NGDP

16155

16692

17393

18037

18569

Current Account % GDP

-2.6

-2.1

-2.2

-2.4

-2.4

NIIP

-4518

-5373

-6980

-7493

-8318

US Owned Assets Abroad

22562

24145

24832

23352

23849

Foreign Owned Assets in US

27080

29517

31813

30846

32168

NIIP % GDP

-28.0

-32.2

-40.1

-41.5

-44.8

Exports
Goods,
Services and
Income

3096

3212

3333

3173

3157

NIIP %
Exports
Goods,
Services and
Income

-146

-167

-209

-236

-263

DIA MV

5969

7121

7189

6999

7375

DIUS MV

4662

5815

6370

6701

7569

Fiscal Balance

-1087

-680

-485

-439

-587

Fiscal Balance % GDP

-6.8

-4.1

-2.8

-2.4

-3.2

Federal   Debt

11281

11983

12780

13117

14168

Federal Debt % GDP

70.4

72.6

74.2

73.3

77.0

Federal Outlays

3537

3455

3506

3688

3853

∆%

-1.8

-2.3

1.5

5.2

4.5

% GDP

22.1

20.9

20.4

20.6

20.9

Federal Revenue

2450

2775

3022

3250

3268

∆%

6.4

13.3

8.9

7.6

0.5

% GDP

15.3

16.8

17.5

18.2

17.8

Sources:

Notes: NGDP: nominal GDP or in current dollars; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. There are minor discrepancies in the decimal point of percentages of GDP between the balance of payments data and federal debt, outlays, revenue and deficits in which the original number of the CBO source is maintained. See Bureau of Economic Analysis, US International Economic Accounts: Concepts and Methods. 2014. Washington, DC: BEA, Department of Commerce, Jun 2014 http://www.bea.gov/international/concepts_methods.htm These discrepancies do not alter conclusions. Budget http://www.cbo.gov/

https://www.cbo.gov/about/products/budget-economic-data#6

https://www.cbo.gov/about/products/budget_economic_data#3

https://www.cbo.gov/about/products/budget-economic-data#2

https://www.cbo.gov/about/products/budget_economic_data#2 Balance of Payments and NIIP http://www.bea.gov/international/index.htm#bop Gross Domestic Product, Bureau of Economic Analysis (BEA) http://www.bea.gov/iTable/index_nipa.cfm

Table VI-3C provides quarterly estimates NSA of the external imbalance of the United States. The current account deficit seasonally adjusted decreases from 2.6 percent of GDP in IQ2016 to 2.3 percent in IIQ2016. The current account deficit increases to 2.4 percent of GDP in IIIQ2016. The deficit does not change to 2.4 percent in IVQ2016 and increases to 2.5 percent in IQ2017. The absolute value of the net international investment position increases from minus $7.8 trillion in IQ2016 to minus $8.3 trillion in IIQ2016, decreasing at minus $8.0 trillion in IIIQ2016. The absolute value of the net international investment position increases to minus $8.3 trillion in IVQ2016 and decreases to minus $8.2 trillion in IQ2017. The BEA explains as follows (https://www.bea.gov/newsreleases/international/intinv/2017/pdf/intinv117.pdf):

“The U.S. net international investment position increased to −$8,141.2 billion (preliminary) at the end of the first quarter of 2017 from −$8,318.4 billion (revised) at the end of the fourth quarter of 2016, according to statistics released today by the Bureau of Economic Analysis (BEA). The $177.2 billion increase reflected a $983.8 billion increase in U.S. assets and an $806.6 billion increase in U.S. liabilities.”

The BEA explains further (https://www.bea.gov/newsreleases/international/intinv/2017/pdf/intinv117.pdf): “The net investment position increased 2.1 percent in the first quarter, compared with a decrease of 3.5 percent in the fourth quarter and an average quarterly decrease of 5.7 percent from the first quarter of 2011 through the third quarter of 2016. U.S. assets increased $983.8 billion to $24,833.2 billion at the end of the first quarter. Assets excluding financial derivatives increased $1,246.1 billion to $22,886.5 billion, mostly reflecting increases in portfolio investment and direct investment assets. The $1,246.1 billion increase resulted from other changes in position of $951.9 billion and financial transactions of $294.1 billion (table A). Other changes in position mostly reflected price increases on portfolio investment and direct investment equity assets and the appreciation of major foreign currencies against the U.S. dollar that raised the value of assets in dollar terms. Financial derivatives decreased $262.3 billion to $1,946.7 billion, reflecting decreases in single currency interest rate contracts and foreign exchange contracts. U.S. liabilities increased $806.6 billion to $32,974.5 billion at the end of the first quarter. Liabilities excluding financial derivatives increased $1,049.2 billion to $31,069.4 billion, mostly reflecting increases in portfolio investment and direct investment liabilities. The $1,049.2 billion increase resulted from other changes in position of $656.1 billion and financial transactions of $393.2 billion (table A). Other changes in position were driven by price increases on portfolio investment and direct investment equity liabilities. Financial derivatives decreased $242.6 billion to $1,905.1 billion, reflecting decreases in single currency interest rate contracts and foreign exchange contracts.”

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

IQ2016

IIQ2016

IIIQ2016

IVQ2016

IQ2017

Goods &
Services

-104

-132

-136

-132

-113

Primary

Income

37

43

43

51

46

Secondary Income

-32

-26

-32

-31

-26

Current Account

-99

-115

-126

-112

-93

Current Account % GDP

-2.6

-2.3

-2.4

-2.4

-2.5

NIIP

-7833

-8292

-8036

-8318

-8217

US Owned Assets Abroad

24090

24558

24839

23849

24833

Foreign Owned Assets in US

-31924

-32851

-32875

-32168

-33051

DIA MV

7036

7002

7392

7375

7844

DIA MV Equity

5819

5780

6147

6172

6604

DIUS MV

6862

7123

7424

7569

7952

DIUS MV Equity

5182

5377

5607

5784

6149

Notes: NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. See Bureau of Economic Analysis, US International Economic Accounts: Concepts and Methods. 2014. Washington, DC: BEA, Department of Commerce, Jun 2014 http://www.bea.gov/international/concepts_methods.htm

Chart VI-3C of the US Bureau of Economic Analysis provides the quarterly and annual US net international investment position (NIIP) NSA in billion dollars. The NIIP deteriorated in 2008, improving in 2009-2011 followed by deterioration after 2012.

clip_image010

Chart VI-3C, US Net International Investment Position, NSA, Billion US Dollars

Source: Bureau of Economic Analysis

http://www.bea.gov/newsreleases/international/intinv/intinvnewsrelease.htm

IIA United States International Trade. Table IIA-1 provides the trade balance of the US and monthly growth of exports and imports seasonally adjusted with the latest release and revisions (http://www.census.gov/foreign-trade/). Because of heavy dependence on imported oil, fluctuations in the US trade account originate largely in fluctuations of commodity futures prices caused by carry trades from zero interest rates into commodity futures exposures in a process similar to world inflation waves (https://cmpassocregulationblog.blogspot.com/2017/06/fomc-interest-rate-increase-planned.html). The Census Bureau revised data for 2017, 2016, 2015, 2014 and 2013. Exports increased 0.5 percent in May 2017 while imports decreased 0.1 percent. The trade deficit decreased from $47,585 million in Apr 2017 to $46,507 million in May 2017. The trade deficit deteriorated to $45,290 million in Feb 2016, improving to $37,380 million in Mar 2016. The trade deficit deteriorated to $38,422 million in Apr 2016, deteriorating to $41,520 million in May 2016 and $43,385 million in Jun 2016. The trade deficit improved to $41,294 million in Jul 2016, moving to $41,130 million in Aug 2016. The trade deficit improved to $38,466 million in Sep 2016, deteriorating to $43,069 million in Oct 2016. The trade deficit deteriorated to $46,373 million in Nov 2016, improving to $44,607 million in Dec 2016. The trade deficit deteriorated to $48,786 million in Jan 2017, improving to $44,910 million in Feb 2017. The trade deficit deteriorated to $45,283 million in Mar 2017 and $47,585 million in Apr 2017, improving to $46,507 million in May 2017.

Table IIA-1, US, Trade Balance of Goods and Services Seasonally Adjusted Millions of Dollars and ∆%  

Trade Balance

Exports

Month ∆%

Imports

Month ∆%

May

-46,507

192,098

0.5

238,535

-0.1

Apr

-47,585

191,173

-0.1

238,758

0.9

Mar

-45,283

191,458

-0.1

236,741

0.1

Feb

-44,910

191,679

0.1

236,589

-1.5

Jan

-48,786

191,497

1.1

240,282

2.6

Dec 2016

-44,607

189,507

2.5

234,114

1.3

Nov

-46,373

184,848

-0.4

231,221

1.1

Oct

-43,069

185,599

-1.3

228,668

0.9

Sep

-38,466

188,123

0.4

226,588

-0.8

Aug

-41,130

187,385

1.1

228,514

0.8

Jul

-41,294

185,330

0.8

226,624

-0.4

Jun

-43,385

183,770

0.9

227,605

1.8

May

-41,520

182,166

0.1

223,686

1.5

Apr

-38,422

181,895

1.1

220,317

1.4

Mar

-37,380

179,887

-0.6

217,277

-3.9

Feb

-45,290

180,892

1.2

226,182

1.9

Jan

-43,409

178,660

-2.3

222,070

-0.9

Dec 2015

-41,125

182,919

-0.5

224,044

-0.3

Jan-Dec 2016

-504,793

2,208,072

-2.5

2,712,866

-1.9

Note: Trade Balance of Goods = Exports of Goods less Imports of Goods. Trade balance may not add exactly because of errors of rounding and seasonality. Source: US Census Bureau, Foreign Trade Division

http://www.census.gov/foreign-trade/

Table IIA-1B provides US exports, imports and the trade balance of goods. The US has not shown a trade surplus in trade of goods since 1976. The deficit of trade in goods deteriorated sharply during the boom years from 2000 to 2007. The deficit improved during the contraction in 2009 but deteriorated in the expansion after 2009. The deficit could deteriorate sharply with growth at full employment.

Table IIA-1B, US, International Trade Balance of Goods, Exports and Imports of Goods, Millions of Dollars, Census Basis

Balance

∆%

Exports

∆%

Imports

∆%

1960

4,608

(X)

19,626

(X)

15,018

(X)

1961

5,476

18.8

20,190

2.9

14,714

-2.0

1962

4,583

-16.3

20,973

3.9

16,390

11.4

1963

5,289

15.4

22,427

6.9

17,138

4.6

1964

7,006

32.5

25,690

14.5

18,684

9.0

1965

5,333

-23.9

26,699

3.9

21,366

14.4

1966

3,837

-28.1

29,379

10.0

25,542

19.5

1967

4,122

7.4

30,934

5.3

26,812

5.0

1968

837

-79.7

34,063

10.1

33,226

23.9

1969

1,289

54.0

37,332

9.6

36,043

8.5

1970

3,224

150.1

43,176

15.7

39,952

10.8

1971

-1,476

-145.8

44,087

2.1

45,563

14.0

1972

-5,729

288.1

49,854

13.1

55,583

22.0

1973

2,389

-141.7

71,865

44.2

69,476

25.0

1974

-3,884

-262.6

99,437

38.4

103,321

48.7

1975

9,551

-345.9

108,856

9.5

99,305

-3.9

1976

-7,820

-181.9

116,794

7.3

124,614

25.5

1977

-28,352

262.6

123,182

5.5

151,534

21.6

1978

-30,205

6.5

145,847

18.4

176,052

16.2

1979

-23,922

-20.8

186,363

27.8

210,285

19.4

1980

-19,696

-17.7

225,566

21.0

245,262

16.6

1981

-22,267

13.1

238,715

5.8

260,982

6.4

1982

-27,510

23.5

216,442

-9.3

243,952

-6.5

1983

-52,409

90.5

205,639

-5.0

258,048

5.8

1984

-106,702

103.6

223,976

8.9

330,678

28.1

1985

-117,711

10.3

218,815

-2.3

336,526

1.8

1986

-138,279

17.5

227,159

3.8

365,438

8.6

1987

-152,119

10.0

254,122

11.9

406,241

11.2

1988

-118,526

-22.1

322,426

26.9

440,952

8.5

1989

-109,399

-7.7

363,812

12.8

473,211

7.3

1990

-101,719

-7.0

393,592

8.2

495,311

4.7

1991

-66,723

-34.4

421,730

7.1

488,453

-1.4

1992

-84,501

26.6

448,164

6.3

532,665

9.1

1993

-115,568

36.8

465,091

3.8

580,659

9.0

1994

-150,630

30.3

512,626

10.2

663,256

14.2

1995

-158,801

5.4

584,742

14.1

743,543

12.1

1996

-170,214

7.2

625,075

6.9

795,289

7.0

1997

-180,522

6.1

689,182

10.3

869,704

9.4

1998

-229,758

27.3

682,138

-1.0

911,896

4.9

1999

-328,821

43.1

695,797

2.0

1,024,618

12.4

2000

-436,104

32.6

781,918

12.4

1,218,022

18.9

2001

-411,899

-5.6

729,100

-6.8

1,140,999

-6.3

2002

-468,263

13.7

693,103

-4.9

1,161,366

1.8

2003

-532,350

13.7

724,771

4.6

1,257,121

8.2

2004

-654,830

23.0

814,875

12.4

1,469,704

16.9

2005

-772,373

18.0

901,082

10.6

1,673,455

13.9

2006

-827,971

7.2

1,025,967

13.9

1,853,938

10.8

2007

-808,763

-2.3

1,148,199

11.9

1,956,962

5.6

2008

-816,199

0.9

1,287,442

12.1

2,103,641

7.5

2009

-503,582

-38.3

1,056,043

-18.0

1,559,625

-25.9

2010

-635,362

26.2

1,278,495

21.1

1,913,857

22.7

2011

-725,447

14.2

1,482,508

16.0

2,207,954

15.4

2012

-730,446

0.7

1,545,821

4.3

2,276,267

3.1

2013

-689,470

-5.6

1,578,517

2.1

2,267,987

-0.4

2014

-734,482

6.5

1,621,874

2.7

2,356,356

3.9

2015

-745,082

1.4

1,503,101

-7.3

2,248,183

-4.6

2016

-736,794

-1.1

1,451,011

-3.5

2,187,805

-2.7

Source: US Census Bureau, Foreign Trade Division

http://www.census.gov/foreign-trade/

Chart IIA-1 of the US Census Bureau of the Department of Commerce shows that the trade deficit (gap between exports and imports) fell during the economic contraction after 2007 but has grown again during the expansion. The low average rate of growth of GDP of 2.1 percent during the expansion beginning since IIIQ2009 does not deteriorate further the trade balance. Higher rates of growth may cause sharper deterioration.

image

Chart IIA-1, US, International Trade Balance, Exports and Imports of Goods and Services USD Billions

Source: US Census Bureau

https://www.census.gov/foreign-trade/data/ustrade.jpg

Table IIA-2B provides the US international trade balance, exports and imports of goods and services on an annual basis from 1992 to 2016. The trade balance deteriorated sharply over the long term. The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US not seasonally adjusted decreased from $98.9 billion in IQ2016 to $93,446 billion in IVQ2016 (http://www.bea.gov/international/index.htm). The current account deficit seasonally adjusted at annual rate decreased from 2.6 percent of GDP in IQ2016 to 2.4 percent of GDP in IVQ2016, increasing to 2.5 percent of GDP in IQ2017 (http://www.bea.gov/international/index.htm http://www.bea.gov/iTable/index_nipa.cfm). The ratio of the current account deficit to GDP has stabilized around 3 percent of GDP compared with much higher percentages before the recession (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71). The final rows of Table IIA-2B show marginal improvement of the trade deficit from $548,625 million in 2011 to lower $536,773 million in 2012 with exports growing 4.3 percent and imports 3.0 percent. The trade balance improved further to deficit of $461,876 million in 2013 with growth of exports of 3.4 percent while imports virtually stagnated. The trade deficit deteriorated in 2014 to $490,336 million with growth of exports of 3.6 percent and of imports of 4.0 percent. The trade deficit deteriorated in 2015 to $500,445 million with decrease of exports of 4.7 percent and decrease of imports of 3.6 percent. The trade deficit deteriorated in 2016 to $504,793 million with decrease of exports of 2.5 percent and decrease of imports of 1.9 percent. Growth and commodity shocks under alternating inflation waves (https://cmpassocregulationblog.blogspot.com/2017/06/fomc-interest-rate-increase-planned.html) have deteriorated the trade deficit from the low of $383,774 million in 2009.

Table IIA-2B, US, International Trade Balance of Goods and Services, Exports and Imports of Goods and Services, SA, Millions of Dollars, Balance of Payments Basis

Balance

Exports

∆%

Imports

∆%

1960

3,508

25,940

NA

22,432

NA

1961

4,195

26,403

1.8

22,208

-1.0

1962

3,370

27,722

5.0

24,352

9.7

1963

4,210

29,620

6.8

25,410

4.3

1964

6,022

33,341

12.6

27,319

7.5

1965

4,664

35,285

5.8

30,621

12.1

1966

2,939

38,926

10.3

35,987

17.5

1967

2,604

41,333

6.2

38,729

7.6

1968

250

45,543

10.2

45,293

16.9

1969

91

49,220

8.1

49,129

8.5

1970

2,254

56,640

15.1

54,386

10.7

1971

-1,302

59,677

5.4

60,979

12.1

1972

-5,443

67,222

12.6

72,665

19.2

1973

1,900

91,242

35.7

89,342

23.0

1974

-4,293

120,897

32.5

125,190

40.1

1975

12,404

132,585

9.7

120,181

-4.0

1976

-6,082

142,716

7.6

148,798

23.8

1977

-27,246

152,301

6.7

179,547

20.7

1978

-29,763

178,428

17.2

208,191

16.0

1979

-24,565

224,131

25.6

248,696

19.5

1980

-19,407

271,834

21.3

291,241

17.1

1981

-16,172

294,398

8.3

310,570

6.6

1982

-24,156

275,236

-6.5

299,391

-3.6

1983

-57,767

266,106

-3.3

323,874

8.2

1984

-109,072

291,094

9.4

400,166

23.6

1985

-121,880

289,070

-0.7

410,950

2.7

1986

-138,538

310,033

7.3

448,572

9.2

1987

-151,684

348,869

12.5

500,552

11.6

1988

-114,566

431,149

23.6

545,715

9.0

1989

-93,141

487,003

13.0

580,144

6.3

1990

-80,864

535,233

9.9

616,097

6.2

1991

-31,135

578,344

8.1

609,479

-1.1

1992

-39,212

616,882

6.7

656,094

7.6

1993

-70,311

642,863

4.2

713,174

8.7

1994

-98,493

703,254

9.4

801,747

12.4

1995

-96,384

794,387

13.0

890,771

11.1

1996

-104,065

851,602

7.2

955,667

7.3

1997

-108,273

934,453

9.7

1,042,726

9.1

1998

-166,140

933,174

-0.1

1,099,314

5.4

1999

-258,617

969,867

3.9

1,228,485

11.8

2000

-372,517

1,075,321

10.9

1,447,837

17.9

2001

-361,511

1,005,654

-6.5

1,367,165

-5.6

2002

-418,955

978,706

-2.7

1,397,660

2.2

2003

-493,890

1,020,418

4.3

1,514,308

8.3

2004

-609,883

1,161,549

13.8

1,771,433

17.0

2005

-714,245

1,286,022

10.7

2,000,267

12.9

2006

-761,716

1,457,642

13.3

2,219,358

11.0

2007

-705,375

1,653,548

13.4

2,358,922

6.3

2008

-708,726

1,841,612

11.4

2,550,339

8.1

2009

-383,774

1,583,053

-14.0

1,966,827

-22.9

2010

-494,658

1,853,606

17.1

2,348,263

19.4

2011

-548,625

2,127,021

14.8

2,675,646

13.9

2012

-536,773

2,218,989

4.3

2,755,762

3.0

2013

-461,876

2,293,457

3.4

2,755,334

0.0

2014

-490,336

2,375,905

3.6

2,866,241

4.0

2015

-500,445

2,263,907

-4.7

2,764,352

-3.6

2016

-504,793

2,208,072

-2.5

2,712,866

-1.9

Source: US Census Bureau

http://www.census.gov/foreign-trade/

Chart IIA-2 of the US Census Bureau provides the US trade account in goods and services SA from Jan 1992 to May 2017. There is long-term trend of deterioration of the US trade deficit shown vividly by Chart IIA-2. The global recession from IVQ2007 to IIQ2009 reversed the trend of deterioration. Deterioration resumed together with incomplete recovery and was influenced significantly by the carry trade from zero interest rates to commodity futures exposures (these arguments are elaborated in Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4 http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html). Earlier research focused on the long-term external imbalance of the US in the form of trade and current account deficits (Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State Vol. II (2008b) 183-94, Government Intervention in Globalization (2008c), 167-71). US external imbalances have not been fully resolved and tend to widen together with improving world economic activity and commodity price shocks. There are additional effects for revaluation of the dollar with the Fed orienting interest rate increases while the European Central Bank and the Bank of Japan determine negative nominal interest rates.

clip_image015

Chart IIA-2, US, Balance of Trade SA, Monthly, Millions of Dollars, Jan 1992-May 2017

Source: US Census Bureau

http://www.census.gov/foreign-trade/

Chart IIA-3 of the US Census Bureau provides US exports SA from Jan 1992 to May 2017. There was sharp acceleration from 2003 to 2007 during worldwide economic boom and increasing inflation. Exports fell sharply during the financial crisis and global recession from IVQ2007 to IIQ2009. Growth picked up again together with world trade and inflation but stalled in the final segment with less rapid global growth and inflation.

clip_image016

Chart IIA-3, US, Exports SA, Monthly, Millions of Dollars Jan 1992-May 2017

Source: US Census Bureau

http://www.census.gov/foreign-trade/

Chart IIA-4 of the US Census Bureau provides US imports SA from Jan 1992 to May 2017. Growth was stronger between 2003 and 2007 with worldwide economic boom and inflation. There was sharp drop during the financial crisis and global recession. There is stalling import levels in the final segment resulting from weaker world economic growth and diminishing inflation because of risk aversion and portfolio reallocations from commodity exposures to equities.

clip_image017

Chart IIA-4, US, Imports SA, Monthly, Millions of Dollars Jan 1992-May 2017

Source: US Census Bureau

http://www.census.gov/foreign-trade/

There is deterioration of the US trade balance in goods in Table IIA-3 from deficit of $62,347 million in May 2016 to deficit of $67,492 million in May 2017. The nonpetroleum deficit increased $2368 million while the petroleum deficit increased $3163 million. Total exports of goods increased 6.2 percent in May 2017 relative to a year earlier while total imports increased 6.9 percent. Nonpetroleum exports increased 5.3 percent from May 2016 to May 2017 while nonpetroleum imports increased 4.9 percent. Petroleum imports increased 40.6 percent.

Table IIA-3, US, International Trade in Goods Balance, Exports and Imports $ Millions and ∆% SA

May 2017

May 2016

∆%

Total Balance

-67,492

-62,347

Petroleum

-6,189

-3,026

Non Petroleum

-60,137

-57,769

Total Exports

127,205

119,760

6.2

Petroleum

9,623

8,216

17.1

Non Petroleum

117,160

111,251

5.3

Total Imports

194,697

182,106

6.9

Petroleum

15,811

11,243

40.6

Non Petroleum

177,297

169,020

4.9

Details may not add because of rounding and seasonal adjustment

Source: US Census Bureau

http://www.census.gov/foreign-trade/

US exports and imports of goods not seasonally adjusted in Jan-May 2017 and Jan-May 2016 are in Table IIA-4. The rate of growth of exports was 6.8 percent and 7.7 percent for imports. The US has partial hedge of commodity price increases in exports of agricultural commodities that increased 14.0 percent and of mineral fuels that increased 49.9 percent both because prices of raw materials and commodities increase and fall recurrently because of shocks of risk aversion and portfolio reallocations. The US exports an insignificant but growing amount of crude oil, increasing 36.1 percent in cumulative Jan-May 2017 relative to a year earlier. US exports and imports consist mostly of manufactured products, with less rapidly increasing prices. US manufactured exports increased 3.7 percent while manufactured imports increased 5.1 percent. Significant part of the US trade imbalance originates in imports of mineral fuels increasing 53.8 percent and petroleum increasing 54.5 percent with wide oscillations in oil prices. The limited hedge in exports of agricultural commodities and mineral fuels compared with substantial imports of mineral fuels and crude oil results in waves of deterioration of the terms of trade of the US, or export prices relative to import prices, originating in commodity price increases caused by carry trades from zero interest rates. These waves are similar to those in worldwide inflation.

Table IIA-4, US, Exports and Imports of Goods, Not Seasonally Adjusted Millions of Dollars and %, Census Basis

Jan-May 2017 $ Millions

Jan-May 2016 $ Millions

∆%

Exports

624,695

585,026

6.8

Manufactured

445,736

429,974

3.7

Agricultural
Commodities

57,518

50,456

14.0

Mineral Fuels

52,422

34,972

49.9

Petroleum

38,996

28,656

36.1

Imports

936,936

870,132

7.7

Manufactured

801,962

763,032

5.1

Agricultural
Commodities

51,344

49,178

4.4

Mineral Fuels

82,379

53,551

53.8

Petroleum

76,430

49,457

54.5

Source: US Census Bureau

http://www.census.gov/foreign-trade/

The current account of the US balance of payments is in Table VI-3A for IQ2016 and IQ2017. The Bureau of Economic Analysis analyzes as follows (https://www.bea.gov/newsreleases/international/transactions/2017/pdf/trans117.pdf):

“The U.S. current-account deficit increased to $116.8 billion (preliminary) in the first quarter of 2017 from $114.0 billion (revised) in the fourth quarter of 2016, according to statistics released by the Bureau of Economic Analysis (BEA). The deficit increased to 2.5 percent of current-dollar gross domestic product (GDP) from 2.4 percent in the fourth quarter. The $2.8 billion increase in the current-account deficit reflected a $5.3 billion increase in the deficit on goods and a $3.6 billion decrease in the surplus on primary income that were partly offset by a $5.8 billion decrease in the deficit on secondary income and a $0.3 billion increase in the surplus on services.”

The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US not seasonally adjusted decreased from $98.9 billion in IQ2016 to $93.4 billion in IQ2017. The current account deficit seasonally adjusted at annual rate decreased from 2.6 percent of GDP in IQ2016 to 2.4 percent of GDP in IVQ2016, increasing to 2.5 percent of GDP in IQ2017. The ratio of the current account deficit to GDP has stabilized below 3 percent of GDP compared with much higher percentages before the recession but is combined now with much higher imbalance in the Treasury budget (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71). There is still a major challenge in the combined deficits in current account and in federal budgets.

Table VI-3A, US, Balance of Payments, Millions of Dollars NSA

IQ2016

IQ2017

Difference

Goods Balance

-169,590

-180,079

-14,489

X Goods

347,778

374,594

7.7 ∆%

M Goods

-517,368

-554,673

7.2 ∆%

Services Balance

65,503

66,668

1,165

X Services

183,648

190,025

3.5 ∆%

M Services

-118,145

-123,357

4.4 ∆%

Balance Goods and Services

-104,086

-113,411

-9,325

Exports of Goods and Services and Income Receipts

752,767

814,939

Imports of Goods and Services and Income Payments

-851,660

-908,385

Current Account Balance

-98,893

-93,446

-5,447

% GDP

IQ2016

IQ2017

IVQ2016

2.6

2.5

2.4

X: exports; M: imports

Balance on Current Account = Exports of Goods and Services – Imports of Goods and Services and Income Payments

Source: Bureau of Economic Analysis

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

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

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

The alternative fiscal scenario of the CBO (2012NovCDR, 2013Sep17) resembles an economic world in which eventually the placement of debt reaches a limit of what is proportionately desired of US debt in investment portfolios. This unpleasant environment is occurring in various European countries.

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

First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:

D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)

Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,

{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:

N(t+1) = (1+n)N(t), n>-1 (2)

The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:

B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)

On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.

Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:

(Mt + Bt)/Pt = Et∫(1/Rt, t+Ï„)st+Ï„dÏ„ (4)

Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+Ï„, of the future primary surpluses st+Ï„, which are equal to Tt+Ï„ – Gt+Ï„ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+Ï„. The second equation of Cochrane (2011Jan, 5) is:

MtV(it, ·) = PtYt (5)

Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):

“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”

An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.

There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:

(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress

(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality

(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.

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

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

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

The United States could be moving toward a situation typical of heavily indebted countries, requiring fiscal adjustment and increases in productivity to become more competitive internationally. The CAD and NIIP of the United States are not observed in full deterioration because the economy is well below trend. There are two complications in the current environment relative to the concern with disorderly correction in the first half of the past decade. In the release of Jun 14, 2013, the Bureau of Economic Analysis (http://www.bea.gov/newsreleases/international/transactions/2013/pdf/trans113.pdf) informs of revisions of US data on US international transactions since 1999:

“The statistics of the U.S. international transactions accounts released today have been revised for the first quarter of 1999 to the fourth quarter of 2012 to incorporate newly available and revised source data, updated seasonal adjustments, changes in definitions and classifications, and improved estimating methodologies.”

The BEA introduced new concepts and methods (http://www.bea.gov/international/concepts_methods.htm) in comprehensive restructuring on Jun 18, 2014 (http://www.bea.gov/international/modern.htm):

“BEA introduced a new presentation of the International Transactions Accounts on June 18, 2014 and will introduce a new presentation of the International Investment Position on June 30, 2014. These new presentations reflect a comprehensive restructuring of the international accounts that enhances the quality and usefulness of the accounts for customers and bring the accounts into closer alignment with international guidelines.”

Table VI-3B provides data on the US fiscal and balance of payments imbalances incorporating all revisions and methods. In 2007, the federal deficit of the US was $161 billion corresponding to 1.1 percent of GDP while the Congressional Budget Office estimates the federal deficit in 2012 at $1087 billion or 6.8 percent of GDP. The estimate of the deficit for 2013 is $680 billion or 4.1 percent of GDP. The combined record federal deficits of the US from 2009 to 2012 are $5094 billion or 31.6 percent of the estimate of GDP for fiscal year 2012 implicit in the CBO (CBO 2013Sep11) estimate of debt/GDP. The deficits from 2009 to 2012 exceed one trillion dollars per year, adding to $5.094 trillion in four years, using the fiscal year deficit of $1087 billion for fiscal year 2012, which is the worst fiscal performance since World War II. Federal debt in 2007 was $5035 billion, slightly less than the combined deficits from 2009 to 2012 of $5094 billion. Federal debt in 2012 was 70.4 percent of GDP (CBO 2015Jan26) and 72.6 percent of GDP in 2013 (http://www.cbo.gov/). This situation may worsen in the future (CBO 2013Sep17):

“Between 2009 and 2012, the federal government recorded the largest budget deficits relative to the size of the economy since 1946, causing federal debt to soar. Federal debt held by the public is now about 73 percent of the economy’s annual output, or gross domestic product (GDP). That percentage is higher than at any point in U.S. history except a brief period around World War II, and it is twice the percentage at the end of 2007. If current laws generally remained in place, federal debt held by the public would decline slightly relative to GDP over the next several years, CBO projects. After that, however, growing deficits would ultimately push debt back above its current high level. CBO projects that federal debt held by the public would reach 100 percent of GDP in 2038, 25 years from now, even without accounting for the harmful effects that growing debt would have on the economy. Moreover, debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely.

The gap between federal spending and revenues would widen steadily after 2015 under the assumptions of the extended baseline, CBO projects. By 2038, the deficit would be 6½ percent of GDP, larger than in any year between 1947 and 2008, and federal debt held by the public would reach 100 percent of GDP, more than in any year except 1945 and 1946. With such large deficits, federal debt would be growing faster than GDP, a path that would ultimately be unsustainable.

Incorporating the economic effects of the federal policies that underlie the extended baseline worsens the long-term budget outlook. The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues and higher interest payments. With those effects included, debt under the extended baseline would rise to 108 percent of GDP in 2038.”

The most recent CBO long-term budget on Mar 27, 2017, projects US federal debt at 150.0 percent of GDP in 2047 (Congressional Budget Office, The 2017 Long-term Budget Outlook. Washington, DC, Mar 30, 2017 https://www.cbo.gov/publication/52480).

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

2007

2008

2009

2010

2011

Goods &
Services

-705

-709

-384

-495

-549

Primary Income

85

130

115

168

211

Secondary Income

-91

-102

-104

-104

-107

Current Account

-711

-681

-373

-431

-445

NGDP

14478

14719

14419

14964

15518

Current Account % GDP

-4.9

-4.6

-2.6

-2.9

-2.9

NIIP

-1279

-3995

-2628

-2512

-4455

US Owned Assets Abroad

20705

19423

19426

21767

22209

Foreign Owned Assets in US

21984

23418

22054

24279

26664

NIIP % GDP

-8.8

-27.1

-18.2

-16.8

-28.7

Exports
Goods,
Services and
Income

2559

2742

2283

2625

2983

NIIP %
Exports
Goods,
Services and
Income

-50

-145

-115

-95

-149

DIA MV

5858

3707

4945

5486

5215

DIUS MV

4134

3091

3619

4099

4199

Fiscal Balance

-161

-459

-1413

-1294

-1300

Fiscal Balance % GDP

-1.1

-3.1

-9.8

-8.7

-8.5

Federal   Debt

5035

5803

7545

9019

10128

Federal Debt % GDP

35.2

39.3

52.3

60.9

65.9

Federal Outlays

2729

2983

3518

3457

3603

∆%

2.8

9.3

17.9

-1.7

4.2

% GDP

19.1

20.2

24.4

23.4

23.4

Federal Revenue

2568

2524

2105

2163

2303

∆%

6.7

-1.7

-16.6

2.7

6.5

% GDP

17.9

17.1

14.6

14.6

15.0

2012

2013

2014

2015

2016

Goods &
Services

-537

-462

-490

-500

-505

Primary Income

207

206

210

181

173

Secondary Income

-97

-94

-94

-115

-120

Current Account

-426

-350

-374

-434

-452

NGDP

16155

16692

17393

18037

18569

Current Account % GDP

-2.6

-2.1

-2.2

-2.4

-2.4

NIIP

-4518

-5373

-6980

-7493

-8318

US Owned Assets Abroad

22562

24145

24832

23352

23849

Foreign Owned Assets in US

27080

29517

31813

30846

32168

NIIP % GDP

-28.0

-32.2

-40.1

-41.5

-44.8

Exports
Goods,
Services and
Income

3096

3212

3333

3173

3157

NIIP %
Exports
Goods,
Services and
Income

-146

-167

-209

-236

-263

DIA MV

5969

7121

7189

6999

7375

DIUS MV

4662

5815

6370

6701

7569

Fiscal Balance

-1087

-680

-485

-439

-587

Fiscal Balance % GDP

-6.8

-4.1

-2.8

-2.4

-3.2

Federal   Debt

11281

11983

12780

13117

14168

Federal Debt % GDP

70.4

72.6

74.2

73.3

77.0

Federal Outlays

3537

3455

3506

3688

3853

∆%

-1.8

-2.3

1.5

5.2

4.5

% GDP

22.1

20.9

20.4

20.6

20.9

Federal Revenue

2450

2775

3022

3250

3268

∆%

6.4

13.3

8.9

7.6

0.5

% GDP

15.3

16.8

17.5

18.2

17.8

Sources:

Notes: NGDP: nominal GDP or in current dollars; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. There are minor discrepancies in the decimal point of percentages of GDP between the balance of payments data and federal debt, outlays, revenue and deficits in which the original number of the CBO source is maintained. See Bureau of Economic Analysis, US International Economic Accounts: Concepts and Methods. 2014. Washington, DC: BEA, Department of Commerce, Jun 2014 http://www.bea.gov/international/concepts_methods.htm These discrepancies do not alter conclusions. Budget http://www.cbo.gov/

https://www.cbo.gov/about/products/budget-economic-data#6

https://www.cbo.gov/about/products/budget_economic_data#3

https://www.cbo.gov/about/products/budget-economic-data#2

https://www.cbo.gov/about/products/budget_economic_data#2 Balance of Payments and NIIP http://www.bea.gov/international/index.htm#bop Gross Domestic Product, Bureau of Economic Analysis (BEA) http://www.bea.gov/iTable/index_nipa.cfm

Table VI-3C provides quarterly estimates NSA of the external imbalance of the United States. The current account deficit seasonally adjusted decreases from 2.6 percent of GDP in IQ2016 to 2.3 percent in IIQ2016. The current account deficit increases to 2.4 percent of GDP in IIIQ2016. The deficit does not change to 2.4 percent in IVQ2016 and increases to 2.5 percent in IQ2017. The absolute value of the net international investment position increases from minus $7.8 trillion in IQ2016 to minus $8.3 trillion in IIQ2016, decreasing at minus $8.0 trillion in IIIQ2016. The absolute value of the net international investment position increases to minus $8.3 trillion in IVQ2016 and decreases to minus $8.2 trillion in IQ2017. The BEA explains as follows (https://www.bea.gov/newsreleases/international/intinv/2017/pdf/intinv117.pdf):

“The U.S. net international investment position increased to −$8,141.2 billion (preliminary) at the end of the first quarter of 2017 from −$8,318.4 billion (revised) at the end of the fourth quarter of 2016, according to statistics released today by the Bureau of Economic Analysis (BEA). The $177.2 billion increase reflected a $983.8 billion increase in U.S. assets and an $806.6 billion increase in U.S. liabilities.”

The BEA explains further (https://www.bea.gov/newsreleases/international/intinv/2017/pdf/intinv117.pdf): “The net investment position increased 2.1 percent in the first quarter, compared with a decrease of 3.5 percent in the fourth quarter and an average quarterly decrease of 5.7 percent from the first quarter of 2011 through the third quarter of 2016. U.S. assets increased $983.8 billion to $24,833.2 billion at the end of the first quarter. Assets excluding financial derivatives increased $1,246.1 billion to $22,886.5 billion, mostly reflecting increases in portfolio investment and direct investment assets. The $1,246.1 billion increase resulted from other changes in position of $951.9 billion and financial transactions of $294.1 billion (table A). Other changes in position mostly reflected price increases on portfolio investment and direct investment equity assets and the appreciation of major foreign currencies against the U.S. dollar that raised the value of assets in dollar terms. Financial derivatives decreased $262.3 billion to $1,946.7 billion, reflecting decreases in single currency interest rate contracts and foreign exchange contracts. U.S. liabilities increased $806.6 billion to $32,974.5 billion at the end of the first quarter. Liabilities excluding financial derivatives increased $1,049.2 billion to $31,069.4 billion, mostly reflecting increases in portfolio investment and direct investment liabilities. The $1,049.2 billion increase resulted from other changes in position of $656.1 billion and financial transactions of $393.2 billion (table A). Other changes in position were driven by price increases on portfolio investment and direct investment equity liabilities. Financial derivatives decreased $242.6 billion to $1,905.1 billion, reflecting decreases in single currency interest rate contracts and foreign exchange contracts.”

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

IQ2016

IIQ2016

IIIQ2016

IVQ2016

IQ2017

Goods &
Services

-104

-132

-136

-132

-113

Primary

Income

37

43

43

51

46

Secondary Income

-32

-26

-32

-31

-26

Current Account

-99

-115

-126

-112

-93

Current Account % GDP

-2.6

-2.3

-2.4

-2.4

-2.5

NIIP

-7833

-8292

-8036

-8318

-8217

US Owned Assets Abroad

24090

24558

24839

23849

24833

Foreign Owned Assets in US

-31924

-32851

-32875

-32168

-33051

DIA MV

7036

7002

7392

7375

7844

DIA MV Equity

5819

5780

6147

6172

6604

DIUS MV

6862

7123

7424

7569

7952

DIUS MV Equity

5182

5377

5607

5784

6149

Notes: NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. See Bureau of Economic Analysis, US International Economic Accounts: Concepts and Methods. 2014. Washington, DC: BEA, Department of Commerce, Jun 2014 http://www.bea.gov/international/concepts_methods.htm

Chart VI-3C of the US Bureau of Economic Analysis provides the quarterly and annual US net international investment position (NIIP) NSA in billion dollars. The NIIP deteriorated in 2008, improving in 2009-2011 followed by deterioration after 2012.

clip_image018

Chart VI-3C, US Net International Investment Position, NSA, Billion US Dollars

Source: Bureau of Economic Analysis

http://www.bea.gov/newsreleases/international/intinv/intinvnewsrelease.htm

Chart VI-10 of the Board of Governors of the Federal Reserve System provides the overnight Fed funds rate on business days from Jul 1, 1954 at 1.13 percent through Jan 10, 1979, at 9.91 percent per year, to Jul 13, 2017, at 1.16 percent per year. US recessions are in shaded areas according to the reference dates of the NBER (http://www.nber.org/cycles.html). In the Fed effort to control the “Great Inflation” of the 1970s (http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html), the fed funds rate increased from 8.34 percent on Jan 3, 1979 to a high in Chart VI-10 of 22.36 percent per year on Jul 22, 1981 with collateral adverse effects in the form of impaired savings and loans associations in the United States, emerging market debt and money-center banks (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7; Pelaez 1986, 1987). Another episode in Chart VI-10 is the increase in the fed funds rate from 3.15 percent on Jan 3, 1994, to 6.56 percent on Dec 21, 1994, which also had collateral effects in impairing emerging market debt in Mexico and Argentina and bank balance sheets in a world bust of fixed income markets during pursuit by central banks of non-existing inflation (Pelaez and Pelaez, International Financial Architecture (2005), 113-5). Another interesting policy impulse is the reduction of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of equally non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85), followed by increments of 25 basis points from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006 in Chart VI-10. Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).

The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever-increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). A final episode in Chart VI-10 is the reduction of the fed funds rate from 5.41 percent on Aug 9, 2007, to 2.97 percent on October 7, 2008, to 0.12 percent on Dec 5, 2008 and close to zero throughout a long period with the final point at 1.16 percent on Jul 13, 2017. Evidently, this behavior of policy would not have occurred had there been theory, measurements and forecasts to avoid these violent oscillations that are clearly detrimental to economic growth and prosperity without inflation. The Chair of the Board of Governors of the Federal Reserve System, Janet L. Yellen, stated on Jul 10, 2015 that (http://www.federalreserve.gov/newsevents/speech/yellen20150710a.htm):

“Based on my outlook, I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy. But I want to emphasize that the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step. I currently anticipate that the appropriate pace of normalization will be gradual, and that monetary policy will need to be highly supportive of economic activity for quite some time. The projections of most of my FOMC colleagues indicate that they have similar expectations for the likely path of the federal funds rate. But, again, both the course of the economy and inflation are uncertain. If progress toward our employment and inflation goals is more rapid than expected, it may be appropriate to remove monetary policy accommodation more quickly. However, if progress toward our goals is slower than anticipated, then the Committee may move more slowly in normalizing policy.”

There is essentially the same view in the Testimony of Chair Yellen in delivering the Semiannual Monetary Policy Report to the Congress on Jul 15, 2015 (http://www.federalreserve.gov/newsevents/testimony/yellen20150715a.htm). The FOMC (Federal Open Market Committee) raised the fed funds rate to ¼ to ½ percent at its meeting on Dec 16, 2015 (http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm).

It is a forecast mandate because of the lags in effect of monetary policy impulses on income and prices (Romer and Romer 2004). The intention is to reduce unemployment close to the “natural rate” (Friedman 1968, Phelps 1968) of around 5 percent and inflation at or below 2.0 percent. If forecasts were reasonably accurate, there would not be policy errors. A commonly analyzed risk of zero interest rates is the occurrence of unintended inflation that could precipitate an increase in interest rates similar to the Himalayan rise of the fed funds rate from 9.91 percent on Jan 10, 1979, at the beginning in Chart VI-10, to 22.36 percent on Jul 22, 1981. There is a less commonly analyzed risk of the development of a risk premium on Treasury securities because of the unsustainable Treasury deficit/debt of the United States (https://cmpassocregulationblog.blogspot.com/2017/04/mediocre-cyclical-economic-growth-with.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/twenty-four-million-unemployed-or.html and earlier and earlier http://cmpassocregulationblog.blogspot.com/2016/12/rising-yields-and-dollar-revaluation.html http://cmpassocregulationblog.blogspot.com/2016/07/unresolved-us-balance-of-payments.html and earlier http://cmpassocregulationblog.blogspot.com/2016/04/proceeding-cautiously-in-reducing.html and earlier http://cmpassocregulationblog.blogspot.com/2016/01/weakening-equities-and-dollar.html and earlier http://cmpassocregulationblog.blogspot.com/2015/09/monetary-policy-designed-on-measurable.html and earlier http://cmpassocregulationblog.blogspot.com/2015/06/fluctuating-financial-asset-valuations.html and earlier (http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/12/patience-on-interest-rate-increases.html

and earlier http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/02/theory-and-reality-of-cyclical-slow.html and earlier (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). There is not a fiscal cliff or debt limit issue ahead but rather free fall into a fiscal abyss. The combination of the fiscal abyss with zero interest rates could trigger the risk premium on Treasury debt or Himalayan hike in interest rates.

clip_image019

Chart VI-10, US, Fed Funds Rate, Business Days, Jul 1, 1954 to Jul 13, 2017, Percent per Year

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table VI-7G when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table VI-7G shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.

Table VI-7G, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994

1994

FF

30Y

30P

10Y

10P

MOR

CPI

Jan

3.00

6.29

100

5.75

100

7.06

2.52

Feb

3.25

6.49

97.37

5.97

98.36

7.15

2.51

Mar

3.50

6.91

92.19

6.48

94.69

7.68

2.51

Apr

3.75

7.27

88.10

6.97

91.32

8.32

2.36

May

4.25

7.41

86.59

7.18

88.93

8.60

2.29

Jun

4.25

7.40

86.69

7.10

90.45

8.40

2.49

Jul

4.25

7.58

84.81

7.30

89.14

8.61

2.77

Aug

4.75

7.49

85.74

7.24

89.53

8.51

2.69

Sep

4.75

7.71

83.49

7.46

88.10

8.64

2.96

Oct

4.75

7.94

81.23

7.74

86.33

8.93

2.61

Nov

5.50

8.08

79.90

7.96

84.96

9.17

2.67

Dec

6.00

7.87

81.91

7.81

85.89

9.20

2.67

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

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

Chart VI-14 provides the overnight fed funds rate, the yield of the 10-year Treasury constant maturity bond, the yield of the 30-year constant maturity bond and the conventional mortgage rate from Jan 1991 to Dec 1996. In Jan 1991, the fed funds rate was 6.91 percent, the 10-year Treasury yield 8.09 percent, the 30-year Treasury yield 8.27 percent and the conventional mortgage rate 9.64 percent. Before monetary policy tightening in Oct 1993, the rates and yields were 2.99 percent for the fed funds, 5.33 percent for the 10-year Treasury, 5.94 for the 30-year Treasury and 6.83 percent for the conventional mortgage rate. After tightening in Nov 1994, the rates and yields were 5.29 percent for the fed funds rate, 7.96 percent for the 10-year Treasury, 8.08 percent for the 30-year Treasury and 9.17 percent for the conventional mortgage rate.

clip_image021

Chart VI-14, US, Overnight Fed Funds Rate, 10-Year Treasury Constant Maturity, 30-Year Treasury Constant Maturity and Conventional Mortgage Rate, Monthly, Jan 1991 to Dec 1996

Source: Board of Governors of the Federal Reserve System

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

Chart VI-15 of the Bureau of Labor Statistics provides the all items consumer price index from Jan 1991 to Dec 1996. There does not appear acceleration of consumer prices requiring aggressive tightening.

clip_image022

Chart VI-15, US, Consumer Price Index All Items, Jan 1991 to Dec 1996

Source: Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

Chart IV-16 of the Bureau of Labor Statistics provides 12-month percentage changes of the all items consumer price index from Jan 1991 to Dec 1996. Inflation collapsed during the recession from Jul 1990 (III) and Mar 1991 (I) and the end of the Kuwait War on Feb 25, 1991 that stabilized world oil markets. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). Policy tightening had adverse collateral effects in the form of emerging market crises in Mexico and Argentina and fixed income markets worldwide.

clip_image023

Chart VI-16, US, Consumer Price Index All Items, Twelve-Month Percentage Change, Jan 1991 to Dec 1996

Source: Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

  The Congressional Budget Office (CBO 2017Jun29, CBO 2017Jan24) estimates potential GDP, potential labor force and potential labor productivity provided in Table IB-3. The CBO estimates average rate of growth of potential GDP from 1950 to 2016 at 3.2 percent per year. The projected path is significantly lower at 1.8 percent per year from 2017 to 2027. The legacy of the economic cycle expansion from IIIQ2009 to IQ2017 at 2.1 percent on average is in contrast with 4.3 percent on average in the expansion from IQ1983 to IIIQ1990 (https://cmpassocregulationblog.blogspot.com/2017/07/dollar-devaluation-and-rising-yields.html and earlier https://cmpassocregulationblog.blogspot.com/2017/05/mediocre-cyclical-united-states.html). Subpar economic growth may perpetuate unemployment and underemployment estimated at 21.9 million or 13.0 percent of the effective labor force in Jun 2017 (https://cmpassocregulationblog.blogspot.com/2017/07/rising-yields-twenty-two-million.html and earlier https://cmpassocregulationblog.blogspot.com/2017/06/twenty-two-million-unemployed-or.html) with much lower hiring than in the period before the current cycle (https://cmpassocregulationblog.blogspot.com/2017/06/flattening-us-treasury-yield-curve.html).

Table IB-3, US, Congressional Budget Office History and Projections of Potential GDP of US Overall Economy, ∆%

Potential GDP

Potential Labor Force

Potential Labor Productivity*

Average Annual ∆%

1950-1973

4.0

1.6

2.4

1974-1981

3.2

2.5

0.6

1982-1990

3.4

1.7

1.7

1991-2001

3.3

1.2

2.0

2002-2007

2.4

1.0

1.4

2008-2016

1.4

0.5

0.9

Total 1950-2016

3.2

1.4

1.7

Projected Average Annual ∆%

2017-2020

1.7

0.5

1.2

2021-2027

1.9

0.5

1.4

2017-2027

1.8

0.5

1.3

*Ratio of potential GDP to potential labor force

Source: https://www.cbo.gov/about/products/budget-economic-data#6 CBO, An update to the budget and economic outlook: 2017 to 2027. Washington, DC, Jun 29, 2017 https://www.cbo.gov/publication/52801 CBO, The budget and economic outlook: 2017-2027. Washington, DC, Jan 24, 2017 https://www.cbo.gov/publication/52370 CBO (2014BEOFeb4), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014. CBO, The budget and economic outlook: 2015 to 2025. Washington, DC, Congressional Budget Office, Jan 26, 2015. Aug 2016.

Chart IB1-A1 of the Congressional Budget Office provides historical and projected annual growth of United States potential GDP. There is sharp decline of growth of United States potential GDP.

clip_image025

Chart IB-1A1, Congressional Budget Office, Projections of Annual Growth of United States Potential GDP

Source: CBO, The budget and economic outlook: 2017-2027. Washington, DC, Jan 24, 2017 https://www.cbo.gov/publication/52370

https://www.cbo.gov/about/products/budget-economic-data#6

Chart IB-1A of the Congressional Budget Office provides historical and projected potential and actual US GDP. The gap between actual and potential output closes by 2017. Potential output expands at a lower rate than historically. Growth is even weaker relative to trend.

clip_image026

Chart IB-1A, Congressional Budget Office, Estimate of Potential GDP and Gap

Source: Congressional Budget Office

https://www.cbo.gov/publication/49890

Chart IB-1 of the Congressional Budget Office (CBO 2013BEOFeb5) provides actual and potential GDP of the United States from 2000 to 2011 and projected to 2024. Lucas (2011May) estimates trend of United States real GDP of 3.0 percent from 1870 to 2010 and 2.2 percent for per capita GDP. The United States successfully returned to trend growth of GDP by higher rates of growth during cyclical expansion as analyzed by Bordo (2012Sep27, 2012Oct21) and Bordo and Haubrich (2012DR). Growth in expansions following deeper contractions and financial crises was much higher in agreement with the plucking model of Friedman (1964, 1988). The unusual weakness of growth at 2.1 percent on average from IIIQ2009 to IQ2017 during the current economic expansion in contrast with 4.3 percent on average in the cyclical expansion from IQ1983 to IIIQ1990 (https://cmpassocregulationblog.blogspot.com/2017/07/dollar-devaluation-and-rising-yields.html and earlier https://cmpassocregulationblog.blogspot.com/2017/05/mediocre-cyclical-united-states.html) cannot be explained by the contraction of 4.2 percent of GDP from IVQ2007 to IIQ2009 and the financial crisis. Weakness of growth in the expansion is perpetuating unemployment and underemployment of 21.9 million or 13.0 percent of the labor force as estimated for Jun 2017 (https://cmpassocregulationblog.blogspot.com/2017/07/rising-yields-twenty-two-million.html and earlier https://cmpassocregulationblog.blogspot.com/2017/06/twenty-two-million-unemployed-or.html). There is no exit from unemployment/underemployment and stagnating real wages because of the collapse of hiring (https://cmpassocregulationblog.blogspot.com/2017/06/flattening-us-treasury-yield-curve.html). The US economy and labor markets collapsed without recovery. Abrupt collapse of economic conditions can be explained only with cyclic factors (Lazear and Spletzer 2012Jul22) and not by secular stagnation (Hansen 1938, 1939, 1941 with early dissent by Simons 1942).

clip_image028

Chart IB-1, US, Congressional Budget Office, Actual and Projections of Potential GDP, 2000-2024, Trillions of Dollars

Source: Congressional Budget Office, CBO (2013BEOFeb5). The last year in common in both projections is 2017. The revision lowers potential output in 2017 by 7.3 percent relative to the projection in 2007.

Chart IB-2 provides differences in the projections of potential output by the CBO in 2007 and more recently on Feb 4, 2014, which the CBO explains in CBO (2014Feb28).

clip_image030

Chart IB-2, Congressional Budget Office, Revisions of Potential GDP

Source: Congressional Budget Office, 2014Feb 28. Revisions to CBO’s Projection of Potential Output since 2007. Washington, DC, CBO, Feb 28, 2014.

Chart IB-3 provides actual and projected potential GDP from 2000 to 2024. The gap between actual and potential GDP disappears at the end of 2017 (CBO2014Feb4). GDP increases in the projection at 2.5 percent per year.

clip_image032

Chart IB-3, Congressional Budget Office, GDP and Potential GDP

Source: CBO (2013BEOFeb5), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014.

Chart IIA2-3 of the Bureau of Economic Analysis of the Department of Commerce shows on the lower negative panel the sharp increase in the deficit in goods and the deficits in goods and services from 1960 to 2012. The upper panel shows the increase in the surplus in services that was insufficient to contain the increase of the deficit in goods and services. The adjustment during the global recession has been in the form of contraction of economic activity that reduced demand for goods.

clip_image033

Chart IIA2-3, US, Balance of Goods, Balance on Services and Balance on Goods and Services, 1960-2013, Millions of Dollars

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

Chart IIA2-4 of the Bureau of Economic Analysis shows exports and imports of goods and services from 1960 to 2012. Exports of goods and services in the upper positive panel have been quite dynamic but have not compensated for the sharp increase in imports of goods. The US economy apparently has become less competitive in goods than in services.

clip_image034

Chart IIA2-4, US, Exports and Imports of Goods and Services, 1960-2013, Millions of Dollars

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

Chart IIA2-5 of the Bureau of Economic Analysis shows the US balance on current account from 1960 to 2012. The sharp devaluation of the dollar resulting from unconventional monetary policy of zero interest rates and elimination of auctions of 30-year Treasury bonds did not adjust the US balance of payments. Adjustment only occurred after the contraction of economic activity during the global recession.

clip_image035

Chart IIA2-5, US, Balance on Current Account, 1960-2013, Millions of Dollars

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

Chart IIA2-6 of the Bureau of Economic Analysis provides real GDP in the US from 1960 to 2016. The contraction of economic activity during the global recession was a major factor in the reduction of the current account deficit as percent of GDP.

clip_image036

Chart IIA2-6, US, Real GDP, 1960-2016, Billions of Chained 2009 Dollars

Source: Bureau of Economic Analysis

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

Chart IIA-7 provides the US current account deficit on a quarterly basis from 1980 to IQ1983. The deficit is at a lower level because of growth below potential not only in the US but worldwide. The combination of high government debt and deficit with external imbalance restricts potential prosperity in the US.

clip_image037

Chart IIA-7, US, Balance on Current Account, Quarterly, 1980-2013

Source: Bureau of Economic Analysis

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

Risk aversion channels funds toward US long-term and short-term securities that finance the US balance of payments and fiscal deficits benefitting from risk flight to US dollar denominated assets. There are now temporary interruptions because of fear of rising interest rates that erode prices of US government securities because of mixed signals on monetary policy and exit from the Fed balance sheet of four trillion dollars of securities held outright. Net foreign purchases of US long-term securities (row C in Table VA-4) weakened from $46.2 billion in Mar 2017 to $11.2 billion in Apr 2017. Foreign residents’ purchases minus sales of US long-term securities (row A in Table VA-4) in Mar 2017 of $30.8 billion weakened to minus $0.8 billion in Apr 2017. Net US (residents) purchases of long-term foreign securities (row B in Table VA-4) weakened from minus $28.9 billion in Mar 2017 to $2.7 billion in Apr 2017. Other transactions (row C2 in Table VA-4) changed from minus $13.5 billion in Mar 2017 to minus $13.0 billion in Apr 2017. In Apr 2017,

C = A + B + C2 = -$0.8 billion + $2.7 billion -$13.0 billion = -$11.2 billion

There are minor rounding errors. There is weakening demand in Table VA-4 in Apr 2017 in A1 private purchases by residents overseas of US long-term securities of $1.4 billion of which strengthening in A11 Treasury securities of minus $16.0 billion, strengthening in A12 of $2.5 billion in agency securities, strengthening of

$6.8 billion of corporate bonds and strengthening of $8.0 billion in equities. Worldwide risk aversion causes flight into US Treasury obligations with significant oscillations. Official purchases of securities in row A2 decreased $2.2 billion with decrease of Treasury securities of $6.6 billion in Apr 2017. Official purchases of agency securities increased $1.7 billion in Apr 2017. Row D shows increase in Apr 2017 of $26.0 billion in purchases of short-term dollar denominated obligations. Foreign private holdings of US Treasury bills decreased $1.6 billion (row D11) with foreign official holdings increasing $8.8 billion while the category “other” increased $18.8 billion. Foreign private holdings of US Treasury bills decreased $8.8 billion in what could be arbitrage of duration exposures and international risks. Risk aversion of default losses in foreign securities dominates decisions to accept zero interest rates in Treasury securities with no perception of principal losses. In the case of long-term securities, investors prefer to sacrifice inflation and possible duration risk to avoid principal losses with significant oscillations in risk perceptions.

Table VA-4, Net Cross-Borders Flows of US Long-Term Securities, Billion Dollars, NSA

Mar 2016 12 Months

Mar 2017 12 Months

Mar 2017

Apr 2017

A Foreign Purchases less Sales of
US LT Securities

122.7

119.7

30.8

-0.8

A1 Private

400.9

352.4

41.5

1.4

A11 Treasury

229.2

12.1

33.5

-16.0

A12 Agency

142.3

180.6

0.7

2.5

A13 Corporate Bonds

152.9

110.5

6.0

6.8

A14 Equities

-123.5

49.2

1.2

8.0

A2 Official

-278.2

-232.7

-10.7

-2.2

A21 Treasury

-290.3

-269.4

-9.1

-6.6

A22 Agency

31.4

31.3

-1.8

1.7

A23 Corporate Bonds

-6.3

-4.1

0.6

-0.1

A24 Equities

-12.9

9.4

-0.3

2.8

B Net US Purchases of LT Foreign Securities

197.3

165.2

28.9

2.7

B1 Foreign Bonds

293.9

250.6

35.2

28.2

B2 Foreign Equities

-96.7

-85.4

-6.3

-25.5

C1 Net Transactions

320.0

284.9

59.7

1.8

C2 Other

-193.2

-261.1

-13.5

-13.0

C Net Foreign Purchases of US LT Securities

126.8

23.8

46.2

-11.2

D Increase in Foreign Holdings of Dollar Denominated Short-term 

US Securities & Other Liab

23.2

57.3

2.8

26.0

D1 US Treasury Bills

10.9

-20.2

12.6

7.2

D11 Private

93.7

-61.8

-2.8

-1.6

D12 Official

-82.7

41.7

15.3

8.8

D2 Other

12.3

77.5

-9.8

18.8

C1 = A + B; C = C1+C2

A = A1 + A2

A1 = A11 + A12 + A13 + A14

A2 = A21 + A22 + A23 + A24

B = B1 + B2

D = D1 + D2

Sources: United States Treasury

https://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticpress.aspx

http://www.treasury.gov/press-center/press-releases/Pages/jl2609.aspx

Table VA-5 provides major foreign holders of US Treasury securities. China is the second largest holder with $1092.2 billion in Apr 2017, increasing 0.4 percent from $1087.6 billion in Mar 2017 while decreasing $150.6 billion from Apr 2016 or 12.1 percent. The United States Treasury estimates US government debt held by private investors at $11,489 billion in Mar 2017. China’s holding of US Treasury securities represents 9.5 percent of US government marketable interest-bearing debt held by private investors (http://www.fms.treas.gov/bulletin/index.html). Min Zeng, writing on “China plays a big role as US Treasury yields fall,” on Jul 16, 2014, published in the Wall Street Journal (http://online.wsj.com/articles/china-plays-a-big-role-as-u-s-treasury-yields-fall-1405545034?tesla=y&mg=reno64-wsj), finds that acceleration in purchases of US Treasury securities by China has been an important factor in the decline of Treasury yields in 2014. Japan increased its holdings from $1142.8 billion in Apr 2016 to $1106.9 billion in Apr 2017 or 3.1 percent. The combined holdings of China and Japan in Apr 2017 add to $2199.1 billion, which is equivalent to 19.1 percent of US government marketable interest-bearing securities held by investors of $11,489 billion in Mar 2017 (http://www.fms.treas.gov/bulletin/index.html). Total foreign holdings of Treasury securities decreased from $6238.9 billion in Apr 2016 to $6073.7 billion in Apr 2017, or 2.6 percent. The US continues to finance its fiscal and balance of payments deficits with foreign savings (see Pelaez and Pelaez, The Global Recession Risk (2007)). A point of saturation of holdings of US Treasury debt may be reached as foreign holders evaluate the threat of reduction of principal by dollar devaluation and reduction of prices by increases in yield, including possibly risk premium. Shultz et al (2012) find that the Fed financed three-quarters of the US deficit in fiscal year 2011, with foreign governments financing significant part of the remainder of the US deficit while the Fed owns one in six dollars of US national debt. Concentrations of debt in few holders are perilous because of sudden exodus in fear of devaluation and yield increases and the limit of refinancing old debt and placing new debt. In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):

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

Table VA-5, US, Major Foreign Holders of Treasury Securities $ Billions at End of Period

Apr 2017

Mar 2017

Apr 2016

Total

6073.7

6102.3

6238.9

Japan

1106.9

1119.3

1142.8

China

1092.2

1087.6

1242.8

Ireland

299.9

315.8

257.4

Brazil

267.7

259.5

249.1

Cayman Islands

256.8

250.8

259.4

Switzerland

234.1

235.4

230.0

United Kingdom

231.5

230.8

216.4

Luxembourg

212.1

219.3

221.7

Hong Kong

196.6

202.2

194.5

Taiwan

185.6

185.2

185.2

Saudi Arabia

126.8

124.5

113.0

India

124.1

117.1

121.6

Foreign Official Holdings

3911.6

3881.2

4046.0

A. Treasury Bills

326.5

317.8

284.9

B. Treasury Bonds and Notes

3585.1

3563.5

3761.2

Source: United States Treasury

http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticpress.aspx

http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/index.aspx

http://ticdata.treasury.gov/Publish/mfh.txt

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017.

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