Saturday, August 10, 2019

Competitive Exchange Rate Policies, Weakening Flows of International Trade, Contraction of Valuations of Risk Financial Assets, Inverted Yield Curve, Recovery Without Hiring in the Lost Economic Cycle of the Global Recession with Economic Growth Underperforming Below Trend Worldwide, Ten Million Fewer Full-Time Jobs, Youth and Middle-Age Unemployment, United States International Trade, Annual Revision of US National Accounts PCE Prices, World Cyclical Slow Growth, Government Intervention in Globalization, and Global Recession Risk: Part II


Competitive Exchange Rate Policies, Weakening Flows of International Trade, Contraction of Valuations of Risk Financial Assets, Inverted Yield Curve, Recovery Without Hiring in the Lost Economic Cycle of the Global Recession with Economic Growth Underperforming Below Trend Worldwide, Ten Million Fewer Full-Time Jobs, Youth and Middle-Age Unemployment, United States International Trade, Annual Revision of US National Accounts PCE Prices, World Cyclical Slow Growth, Government Intervention in Globalization, and Global Recession Risk

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019

I Recovery without Hiring

IA1 Hiring Collapse

IA2 Labor Underutilization

ICA3 Ten Million Fewer Full-time Jobs

IA4 Theory and Reality of Cyclical Slow Growth Not Secular Stagnation: Youth and Middle-Age Unemployment

IID United States International Trade

III World Financial Turbulence

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

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 (https://www.census.gov/foreign-trade/index.html). 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/2019/07/global-manufacturing-stress-world.html and earlier https://cmpassocregulationblog.blogspot.com/2019/06/fomc-outlook-uncertainty-central-bank.html and earlier https://cmpassocregulationblog.blogspot.com/2019/05/contraction-of-risk-financial-assets.html). The Census Bureau revised data for 2019, 2018, 2017, 2016, 2015, 2014 and 2013. Exports decreased 2.1 percent in Jun 2019 while imports decreased 1.7 percent. The trade deficit decreased from $55,344 million in May 2019 to $55,154 million in Jun 2019. The trade deficit deteriorated to $45,224 million in Feb 2016, improving to $38,454 million in Mar 2016. The trade deficit deteriorated to $38,922 million in Apr 2016, deteriorating to $40,372 million in May 2016 and $43,856 million in Jun 2016. The trade deficit improved to $41,360 million in Jul 2016, moving to $41,681 million in Aug 2016. The trade deficit improved to $39,049 million in Sep 2016, deteriorating to $42,002 million in Oct 2016. The trade deficit deteriorated to $46,631 million in Nov 2016, improving to $43,475 million in Dec 2016. The trade deficit deteriorated to $46,417 million in Jan 2017, improving to $43,103 million in Feb 2017. The trade deficit deteriorated to $44,531 million in Mar 2017 and $47,384 million in Apr 2017, improving to $46,684 million in May 2017. The trade deficit improved to $45,609 million in Jun 2017 and to $44,162 million in Jul 2017. The trade deficit improved to $43,689 million in Aug 2017, improving to $43,571 million in Sep 2017. The trade deficit deteriorated to $45,478 million in Oct 2017, deteriorating to $49,120 million in Nov 2017. The trade deficit deteriorated to 50,376 million in Dec 2017, deteriorating to $52,113 million in Jan 2018. The trade deficit deteriorated to $53,818 million in Feb 2018, improving to $47,177 million in Mar 2018. The trade deficit worsened to $48,218 million in Apr 2018, improving to $44,352 million in May 2018. The trade deficit deteriorated to $47,431 million in Jun 2018, deteriorating to $52,442 million in Jul 2018. The trade deficit deteriorated to $54,889 million in Aug 2018 and deteriorated to $56,094 million in Sep 2018. The trade deficit deteriorated to $56,692 million in Oct 2018 and improved to $53,647 million in Nov 2018. The trade deficit deteriorated to $60,807 million in Dec 2018, improving to $52,700 million in Jan 2019. The trade deficit improved to $50,003 million in Feb 2019, deteriorating to $51,906 million in Mar 2019. The trade deficit improved to $51,224 million in Apr 2019, deteriorating to $55,344 million in May 2019. The trade deficit improved to $55,154 million in Jun 2019.

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

Exports

Month ∆%

Imports

Month ∆%

Jan-2016

-41,957

179,030

-2.2

220,986

-1.5

Feb-2016

-45,224

180,488

0.8

225,712

2.1

Mar-2016

-38,454

179,884

-0.3

218,338

-3.3

Apr-2016

-38,922

182,164

1.3

221,086

1.3

May-2016

-40,372

183,392

0.7

223,764

1.2

Jun-2016

-43,856

184,470

0.6

228,325

2.0

Jul-2016

-41,360

185,977

0.8

227,337

-0.4

Aug-2016

-41,681

188,034

1.1

229,714

1.0

Sep-2016

-39,049

188,707

0.4

227,757

-0.9

Oct-2016

-42,002

187,115

-0.8

229,117

0.6

Nov-2016

-46,631

185,489

-0.9

232,121

1.3

Dec-2016

-43,475

191,089

3.0

234,564

1.1

Jan-2017

-46,417

192,190

0.6

238,607

1.7

Feb-2017

-43,103

192,602

0.2

235,704

-1.2

Mar-2017

-44,531

192,314

-0.1

236,844

0.5

Apr-2017

-47,384

191,562

-0.4

238,946

0.9

May-2017

-46,684

192,223

0.3

238,908

0.0

Jun-2017

-45,609

194,260

1.1

239,868

0.4

Jul-2017

-44,162

194,747

0.3

238,908

-0.4

Aug-2017

-43,689

195,565

0.4

239,254

0.1

Sep-2017

-43,571

198,166

1.3

241,737

1.0

Oct-2017

-45,478

199,315

0.6

244,792

1.3

Nov-2017

-49,120

202,904

1.8

252,024

3.0

Dec-2017

-50,376

206,700

1.9

257,076

2.0

Jan-2018

-52,113

202,575

-2.0

254,689

-0.9

Feb-2018

-53,818

205,607

1.5

259,425

1.9

Mar-2018

-47,177

209,937

2.1

257,114

-0.9

Apr-2018

-48,218

208,883

-0.5

257,102

0.0

May-2018

-44,352

213,341

2.1

257,692

0.2

Jun-2018

-47,431

210,967

-1.1

258,398

0.3

Jul-2018

-52,442

208,734

-1.1

261,175

1.1

Aug-2018

-54,889

207,758

-0.5

262,647

0.6

Sep-2018

-56,094

209,747

1.0

265,840

1.2

Oct-2018

-56,692

210,124

0.2

266,816

0.4

Nov-2018

-53,647

207,976

-1.0

261,623

-1.9

Dec-2018

-60,807

205,661

-1.1

266,468

1.9

Jan-2019

-52,700

207,382

0.8

260,082

-2.4

Feb-2019

-50,003

209,652

1.1

259,655

-0.2

Mar-2019

-51,906

211,411

0.8

263,317

1.4

Apr-2019

-51,224

206,411

-2.4

257,635

-2.2

May-2019

-55,344

210,689

2.1

266,033

3.3

Jun-2019

-55,154

206,300

-2.1

261,454

-1.7

Source: US Census Bureau

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

-468,262

13.7

693,104

-4.9

1,161,366

1.8

2003

-532,350

13.7

724,771

4.6

1,257,121

8.2

2004

-654,829

23.0

814,875

12.4

1,469,703

16.9

2005

-772,374

18.0

901,082

10.6

1,673,456

13.9

2006

-827,970

7.2

1,025,969

13.9

1,853,939

10.8

2007

-808,765

-2.3

1,148,197

11.9

1,956,962

5.6

2008

-816,200

0.9

1,287,441

12.1

2,103,641

7.5

2009

-503,583

-38.3

1,056,042

-18.0

1,559,625

-25.9

2010

-635,365

26.2

1,278,493

21.1

1,913,858

22.7

2011

-725,447

14.2

1,482,507

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

-745,483

1.5

1,503,328

-7.3

2,248,811

-4.6

2016

-735,326

-1.4

1,451,460

-3.5

2,186,786

-2.8

2017

-793,411

7.9

1,546,473

6.5

2,339,884

7.0

2018

-874,814

10.3

1,665,992

7.7

2,540,806

8.6

Source: US Census Bureau

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

There is recent sharp deterioration of the US trade balance and the three-month moving average in Chart IIA-1 of the US Census Bureau with further improvement in Jan-Feb 2019. There is marginal improvement in Jun 2019.

clip_image002

Chart IIA-1A, US, International Trade Balance, Exports and Imports of Goods and Services and Three-Month Moving Average, USD Billions

Source: US Census Bureau

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

Chart IIA-1A 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 2.3 percent during the expansion beginning since IIIQ2009 does not deteriorate further the trade balance. Higher rates of growth may cause sharper deterioration.

clip_image004

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 1960 to 2018. 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 seasonally adjusted at 2.3 percent in IQ2018 decreases to 2.1 percent in IIQ2018. The current account deficit increases to 2.4 percent in IIIQ2018. The current account deficit increases to 2.8 percent in IVQ2018. The current account deficit decreases to 2.5 percent in IQ2019. The absolute value of the net international investment position increases from minus $7.8 trillion in IQ2018 to minus $8.9 trillion in IIQ2018. The absolute value of the net international investment position increases to $9.7 trillion in IIIQ2018. The absolute value of the net international investment position stabilizes at $9.6 trillion in IVQ2018. The absolute value of the net international investment position deteriorates to $9.9 trillion in IQ2019. 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. The final rows of Table IIA-2B show marginal improvement of the trade deficit from $549,699 million in 2011 to lower $537,408 million in 2012 with exports growing 4.3 percent and imports 3.0 percent. The trade balance improved further to deficit of $461,135 million in 2013 with growth of exports of 3.4 percent while imports virtually stagnated. The trade deficit deteriorated in 2014 to $489,584 million with growth of exports of 3.6 percent and of imports of 4.0 percent. The trade deficit deteriorated in 2015 to $498,525 million with decrease of exports of 4.6 percent and decrease of imports of 3.5 percent. The trade deficit deteriorated in 2016 to $502,982 million with decrease of exports of 2.2 percent and decrease of imports of 1.7 percent. The trade deficit deteriorated in 2017 to $550,123 million with growth of exports of 6.2 percent and of imports of 6.8 percent. The trade deficit deteriorated in 2018 to $627,679 million with growth of exports of 6.3 percent and of imports of 7.8 percent. Growth and commodity shocks under alternating inflation waves (https://cmpassocregulationblog.blogspot.com/2019/07/global-manufacturing-stress-world.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

22,432

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

-495,225

1,853,038

17.1

2,348,263

19.4

2011

-549,699

2,125,947

14.7

2,675,646

13.9

2012

-537,408

2,218,354

4.3

2,755,762

3.0

2013

-461,135

2,294,199

3.4

2,755,334

0.0

2014

-489,584

2,376,657

3.6

2,866,241

4.0

2015

-498,525

2,266,691

-4.6

2,765,216

-3.5

2016

-502,982

2,215,839

-2.2

2,718,821

-1.7

2017

-550,123

2,352,546

6.2

2,902,669

6.8

2018

-627,679

2,501,310

6.3

3,128,989

7.8

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 Jun 2019. 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.

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Chart IIA-2, US, Balance of Trade SA, Monthly, Millions of Dollars, Jan 1992-Jun 2019

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 2019. 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.

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Chart IIA-3, US, Exports SA, Monthly, Millions of Dollars Jan 1992-Jun 2019

Source: US Census Bureau

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

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 in Chart IIIA-4 resulting from weaker world economic growth and diminishing inflation because of risk aversion and portfolio reallocations from commodity exposures to equities.

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Chart IIA-4, US, Imports SA, Monthly, Millions of Dollars Jan 1992-Jun 2019

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 $69,434 million in Jun 2018 to deficit of $75,121 million in Jun 2019. The nonpetroleum deficit increased $8,048 million while the petroleum deficit decreased $2,349 million. Total exports of goods decreased 3.5 percent in Jun 2019 relative to a year earlier while total imports increased 0.3 percent. Nonpetroleum exports decreased 3.6 percent from Jun 2018 to Jun 2019 while nonpetroleum imports increased 1.8 percent. Petroleum imports decreased 14.6 percent.

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

Jun 2019

Jun 2018

∆%

Total Balance

-75,121

-69,434

Petroleum

-1,355

-3,704

Non-Petroleum

-72,806

-64,758

Total Exports

137,135

142,172

-3.5

Petroleum

15,293

15,786

-3.1

Non-Petroleum

121,159

125,716

-3.6

Total Imports

212,255

211,606

0.3

Petroleum

16,649

19,490

-14.6

Non-Petroleum

193,964

190,474

1.8

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-Jun 2019 and Jan-Jun 2018 are in Table IIA-4. The rate of growth of exports was minus 0.9 percent and 0.3 percent for imports. The US has partial hedge of commodity price increases in exports of agricultural commodities that decreased 5.4 percent and of mineral fuels that increased 7.6 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 a growing amount of crude oil, increasing 7.4 percent in cumulative Jan-Jun 2019 relative to a year earlier. US exports and imports consist mostly of manufactured products, with less rapidly increasing prices. US manufactured exports decreased 2.8 percent while manufactured imports increased 0.7 percent. Significant part of the US trade imbalance originates in imports of mineral fuels decreasing 9.5 percent and petroleum decreasing 10.3 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-Jun 2019 $ Millions

Jan-Jun 2018 $ Millions

∆%

Exports

824,098

831,886

-0.9

Manufactured

565,232

581,430

-2.8

Agricultural
Commodities

67,722

71,617

-5.4

Mineral Fuels

96,590

89,781

7.6

Petroleum

75,848

70,611

7.4

Imports

1,235,753

1,232,372

0.3

Manufactured

1,065,095

1,057,194

0.7

Agricultural
Commodities

67,769

66,455

2.0

Mineral Fuels

103,238

114,054

-9.5

Petroleum

96,530

107,631

-10.3

Source: US Census Bureau

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

Table IIA-4A provides the United States balance of trade in goods, exports of goods and imports of goods NSA in millions of US dollars and percent share in Jan-Jun 2019. North America, consisting of Mexico and Canada, have joint share of 33.7 percent of exports and 27.3 of imports. The combined share of North America and Europe is 57.2 percent of exports and 51.4 percent of imports. The share of the Pacific Rim in exports is 23.4 percent and 33.6 percent of imports.

Table IIA-4A United States, Balance of Trade in Goods, Exports in Goods and Imports of Goods, NSA, Millions of US Dollars

Jan-Jun 2019

Region/Country

Balance

Exports

%

Imports

%

Total Census Basis

-411,654

824,098

1,235,753

North America*

-59,927

277,828

33.7

337,755

27.3

Europe

-103,738

193,516

23.5

297,254

24.1

Euro Area

-75,090

125,592

15.2

200,682

16.2

Pacific Rim

-221,957

193,140

23.4

415,097

33.6

China

-167,044

52,000

6.3

219,044

17.7

Japan

-36,042

36,844

4.5

72,886

5.9

Brazil

5,273

20,792

2.5

15,519

1.3

*Canada and Mexico

Source: US Census Bureau

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

The US Bureau of Labor Statistics (BLS) provides measurements of US international terms of trade. The measurement by the BLS is as follows (https://www.bls.gov/mxp/terms-of-trade.htm):

“BLS terms of trade indexes measure the change in the U.S. terms of trade with a specific country, region, or grouping over time. BLS terms of trade indexes cover the goods sector only.

To calculate the U.S. terms of trade index, take the U.S. all-export price index for a country, region, or grouping, divide by the corresponding all-import price index and then multiply the quotient by 100. Both locality indexes are based in U.S. dollars and are rounded to the tenth decimal place for calculation. The locality indexes are normalized to 100.0 at the same starting point.
TTt=(LODt/LOOt)*100,
where
TTt=Terms of Trade Index at time t
LODt=Locality of Destination Price Index at time t
LOOt=Locality of Origin Price Index at time t
The terms of trade index measures whether the U.S. terms of trade are improving or deteriorating over time compared to the country whose price indexes are the basis of the comparison. When the index rises, the terms of trade are said to improve; when the index falls, the terms of trade are said to deteriorate. The level of the index at any point in time provides a long-term comparison; when the index is above 100, the terms of trade have improved compared to the base period, and when the index is below 100, the terms of trade have deteriorated compared to the base period.”

Chart IID-3 provides the BLS terms of trade of the US with Canada. The index increases from 100.0 in Dec 2017 to 117.8 in Dec 2018 and decreases to 96.1 in Jun 2019.

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Chart IID-3, US Terms of Trade, Monthly, All Goods, Canada, NSA, Dec 2017=100

Source: Bureau of Labor Statistics https://www.bls.gov/mxp/data.htm

Chart IID-4 provides the BLS terms of trade of the US with the European Union. There is improvement from 100.0 in Dec 2017 to 102.5 in Jun 2019.

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Chart IID-4, US Terms of Trade, Monthly, All Goods, European Union, NSA, Dec 2017=100

Source: Bureau of Labor Statistics https://www.bls.gov/mxp/data.htm

Chart IID-4 provides the BLS terms of trade of the US with the European Union. There is improvement from 100.0 in Dec 2017 to 101.4 in Jun 2019.

clip_image010[1]

Chart IID-4, US Terms of Trade, Monthly, All Goods, European Union, NSA, Dec 2017=100

Source: Bureau of Labor Statistics https://www.bls.gov/mxp/data.htm

Chart IID-4 provides the BLS terms of trade of the US with Mexico. There is improvement from 100.0 in Dec 2017 to 101.4 in Jun 2019.

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Chart IID-5, US Terms of Trade, Monthly, All Goods, Mexico, NSA, Dec 2017=100

Source: Bureau of Labor Statistics https://www.bls.gov/mxp/data.htm

Chart IID-4 provides the BLS terms of trade of the US with China. There is deterioration from 100.0 in Dec 2017 to 98.0 in Sep 2018, improvement to 100.6 in Apr 2019 with deterioration to 98.8 in Jun 2019.

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Chart IID-6, US Terms of Trade, Monthly, All Goods, China, NSA, Dec 2017=100

Source: Bureau of Labor Statistics https://www.bls.gov/mxp/data.htm

Chart IID-4 provides the BLS terms of trade of the US with Japan. There is deterioration from 100.0 in Dec 2017 to 97.8 in Jan 2019 and improvement to 98.2 in Jun 2019.

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Chart IID-7, US Terms of Trade, Monthly, All Goods, Japan, NSA, Dec 2017=100

Source: Bureau of Labor Statistics https://www.bls.gov/mxp/data.htm

Manufacturing is underperforming in the lost cycle of the global recession. Manufacturing (SIC) in Jun 2019 is lower by 4.4 percent relative to the peak in Jun 2007, as shown in Chart V-3A. Manufacturing (NAICS) in Jun 2019 at 108.3755 is lower by 1.8 percent relative to the peak at 110.3108 in Sep 2007. 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 2019. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2987 in Dec 2007 to 153.8501 in Jun 2019. The actual index NSA in Jun 2019 is 107.3417, which is 30.2 percent below trend. Manufacturing grew at the average annual rate of 3.3 percent between Dec 1986 and Dec 2006. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 108.2987 in Dec 2007 to 157.3175 in Jun 2019. The actual index NSA in Jun 2019 is 107.3417, which is 31.8 percent below trend. Manufacturing output grew at average 2.0 percent between Dec 1986 and Jun 2019. Using trend growth of 2.0 percent per year, the index would increase to 135.9957 in Jun 2019. The output of manufacturing at 107.3417 in Jun 2019 is 21.1 percent below trend under this alternative calculation.

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Chart V-3A, United States Manufacturing (NAICS) NSA, Jun 2007 to Jun 2019

Board of Governors of the Federal Reserve System

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

Chart V-3B provides the civilian noninstitutional population of the United States, or those available for work. The civilian noninstitutional population increased from 231.713 million in Jun 2007 to 259.037 million in Jun 2019 or 27.324 million.

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Chart V-3B, United States, Civilian Noninstitutional Population, Million, NSA, Jan 2007 to Jun 2019

Source: US Bureau of Labor Statistics

https://www.bls.gov/

Chart V-3C provides nonfarm payroll manufacturing jobs in the United States from Jan 2007 to Jun 2019. Nonfarm payroll jobs fell from 13.987 million in Jun 2007 to 12.932 million in Jun 2019, or 1.055 million.

clip_image016

Chart V-3C, United States, Payroll Manufacturing Jobs, NSA, Jun 2007 to Jun 2019, Thousands

Source: US Bureau of Labor Statistics

https://www.bls.gov

Chart V-3D provides the index of US manufacturing (NAICS) from Jan 1972 to Jun 2019. The index continued increasing during the decline of manufacturing jobs after the early 1980s. There are likely effects of changes in the composition of manufacturing with also changes in productivity and trade.

clip_image017

Chart V-3D, United States Manufacturing (NAICS) NSA, Jan 1972 to Jun 2019

Board of Governors of the Federal Reserve System

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

Chart V3E provides the US noninstitutional civilian population, or those in condition of working, from Jan 1948, when first available, to Jun 2019. The noninstitutional civilian population increased from 170.042 million in Jun 1981 to 259.037 million in Jun 2019, or 88.995 million.

clip_image018

Chart V-3E, United States, Civilian Noninstitutional Population, Million, NSA, Jan 1948 to Jun 2019

Source: US Bureau of Labor Statistics

https://www.bls.gov/

Chart V-3F provides manufacturing jobs in the United States from Jan 1939 to May 2019. Nonfarm payroll manufacturing jobs decreased from a peak of 18.890 million in Jun 1981 to 12.932 million in Jun 2019.

clip_image019

Chart V-3C, United States, Payroll Manufacturing Jobs, NSA, Jan 1939 to Jun 2019, Thousands

Source: US Bureau of Labor Statistics

https://www.bls.gov/

Table I-13A provides national income without capital consumption by industry with estimates based on the Standard Industrial Classification (SIC). The share of agriculture declines from 8.7 percent in 1948 to 1.7 percent in 1987 while the share of manufacturing declines from 30.2 percent in 1948 to 19.4 percent in 1987. Colin Clark (1957) pioneered the analysis of these trends over long periods.

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

1948

% Total

1987

% Total

National Income WCCA

249.1

100.0

4,029.9

100.0

Domestic Industries

247.7

99.4

4,012.4

99.6

Private Industries

225.3

90.4

3,478.8

86.3

Agriculture

21.7

8.7

66.5

1.7

Mining

5.8

2.3

42.5

1.1

Construction

11.1

4.5

201.0

5.0

Manufacturing

75.2

30.2

780.2

19.4

Durable Goods

37.5

15.1

458.4

11.4

Nondurable Goods

37.7

15.1

321.8

8.0

Transportation PUT

21.3

8.5

317.7

7.9

Transportation

13.8

5.5

127.2

3.2

Communications

3.8

1.5

96.7

2.4

Electric, Gas, SAN

3.7

1.5

93.8

2.3

Wholesale Trade

17.1

6.9

283.1

7.0

Retail Trade

28.8

11.6

400.4

9.9

Finance, INS, RE

22.9

9.2

651.7

16.2

Services

21.4

8.6

735.7

18.3

Government

22.4

9.0

533.6

13.2

Rest of World

1.5

0.6

17.5

0.4

2003.9

11.6

2016.3

11.5

252.6

1.5

257.9

1.5

Notes: Using 1972 Standard Industrial Classification (SIC). Percentages Calculates from Unrounded Data; WCCA: Without Capital Consumption Adjustment by Industry; RE: Real Estate; PUT: Public Utilities; SAN: Sanitation

Source: US Bureau of Economic Analysis

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

Table I-13B provides national income without capital consumption estimated based on the 2012 North American Industry Classification (NAICS). The share of manufacturing fell from 14.9 percent in 1998 to 9.5 percent in 2018.

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

1998

% Total

2018

% Total

National Income WCCA

7,744.4

100.0

17,136.5

100.0

Domestic Industries

7,727.0

99.8

16,868.6

98.4

Private Industries

6,793.3

87.7

14,889.6

86.9

Agriculture

72.7

0.9

119.7

0.7

Mining

74.2

1.0

202.7

1.2

Utilities

134.4

1.7

157.7

0.9

Construction

379.2

4.9

902.5

5.3

Manufacturing

1156.4

14.9

1635.3

9.5

Durable Goods

714.9

9.2

964.9

5.6

Nondurable Goods

441.5

5.7

670.4

3.9

Wholesale Trade

512.8

6.6

958.2

5.6

Retail Trade

610.0

7.9

1124.1

6.6

Transportation & WH

246.1

3.2

554.4

3.2

Information

294.3

3.8

629.7

3.7

Finance, Insurance, RE

1280.9

16.5

3058.8

17.8

Professional & Business Services

889.8

11.5

2522.6

14.7

Education, Health Care

607.1

7.8

1764.8

10.3

Arts, Entertainment

290.5

3.8

756.6

4.4

Other Services

244.9

3.3

502.5

2.9

Government

933.7

12.1

1979.0

11.5

Rest of the World

17.4

0.2

267.9

1.6

Notes: Estimates based on 2012 North American Industry Classification System (NAICS). Percentages Calculates from Unrounded Data; 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

The current account of the US balance of payments is in Table VI-3A for IQ2018 and IQ2019. The Bureau of Economic Analysis analyzes as follows (https://www.bea.gov/system/files/2019-06/trans119.pdf):

“The U.S. current-account deficit decreased to $130.4 billion (preliminary) in the first quarter of 2019 from $143.9 billion (revised) in the fourth quarter of 2018, according to statistics released by the Bureau of Economic Analysis (BEA). The deficit was 2.5 percent of current-dollar gross domestic product in the first quarter, down from 2.8 percent in the fourth quarter.”

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 increased from $116.2 billion in IVQ2017 to $138.4 billion in IVQ2018. The current account deficit seasonally adjusted at annual rate increased from 2.3 percent of GDP in IVQ2017 to 2.5 percent of GDP in IIIQ2018, increasing to 2.6 percent of GDP in IVQ2018. 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

IQ2018

IQ2019

Difference

Goods Balance

-198,523

-193,115

5,408

X Goods

404,940

410,423

1.4 ∆%

M Goods

-603,462

-603,538

0.0 ∆%

Services Balance

74,700

68,579

-6,121

X Services

207,237

208,132

0.4 ∆%

M Services

-132,537

-139,553

5.3 ∆%

Balance Goods and Services

-123,823

-124,536

713

Exports of Goods and Services and Income Receipts

907,296

932,875

25,579

Imports of Goods and Services and Income Payments

-991,133

-1,032,792

-41,659

Current Account Balance

-83,837

-99,917

-16,080

% GDP

IQ2018

IQ2019

IVQ2018

2.3

2.5

2.8

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

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Chart VI-3B1, US, Current Account and Components Balances, Quarterly SA

Source: https://www.bea.gov/news/2019/us-international-transactions-first-quarter-2019-and-annual-update

The Bureau of Economic Analysis (BEA) provides analytical insight and data on the 2017 Tax Cuts and Job Act:

“In the international transactions accounts, income on equity, or earnings, of foreign affiliates of U.S. multinational enterprises consists of a portion that is repatriated to the parent company in the United States in the form of dividends and a portion that is reinvested in foreign affiliates. In response to the 2017 Tax Cuts and Jobs Act, which generally eliminated taxes on repatriated earnings, some U.S. multinational enterprises repatriated accumulated prior earnings of their foreign affiliates. In the first, second, and fourth quarters of 2018, the repatriation of dividends exceeded current-period earnings, resulting in negative values being recorded for reinvested earnings. In the first quarter of 2019, dividends were $100.2 billion while reinvested earnings were $40.2 billion (see table below). The reinvested earnings are also reflected in the net acquisition of direct investment assets in the financial account (table 6). For more information, see "How does the 2017 Tax Cuts and Jobs Act affect BEA’s business income statistics?" and "How are the international transactions accounts affected by an increase in direct investment dividend receipts?"”

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Chart VI-3B, US, Direct Investment Earnings Receipts and Components

Source: https://www.bea.gov/news/2019/us-international-transactions-first-quarter-2019-and-annual-update

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 IIA2-3 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 Jun 26, 2018 projects US federal debt at 152.0 percent of GDP in 2048 (Congressional Budget Office, The 2018 long-term budget outlook. Washington, DC, Jun 26 https://www.cbo.gov/publication/53919).

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

14452

14713

14449

14992

15543

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

16197

16785

17522

18219

18707

Current Account % GDP

-2.6

-2.1

-2.1

-2.4

-2.4

NIIP

-4518

-5369

-6945

-7462

-8182

US Owned Assets Abroad

22562

24145

24883

23431

24061

Foreign Owned Assets in US

27080

29513

31828

30892

32242

NIIP % GDP

-27.9

-32.0

-39.6

-41.0

-43.7

Exports
Goods,
Services and
Income

3096

3212

3333

3173

3157

NIIP %
Exports
Goods,
Services and
Income

-146

-167

-208

-235

-259

DIA MV

5969

7121

72421

7057

7422

DIUS MV

4662

5815

6370

6729

7596

Fiscal Balance

-1087

-680

-485

-439

-585

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

74.1

72.9

76.7

Federal Outlays

3537

3455

3506

3688

3853

∆%

-1.8

-2.3

1.5

5.2

4.5

% GDP

22.1

20.9

20.3

20.5

20.9

Federal Revenue

2450

2775

3022

3250

3268

∆%

6.4

13.3

8.9

7.6

0.6

% GDP

15.3

16.8

17.5

18.1

17.7

2017

Goods &
Services

-568

Primary Income

217

Secondary Income

-115

Current Account

-466

NGDP

19485

Current Account % GDP

2.4

NIIP

-7725

US Owned Assets Abroad

27799

Foreign Owned Assets in US

35524

NIIP % GDP

-39.6

Exports
Goods,
Services and
Income

3408

NIIP %
Exports
Goods,
Services and
Income

-227

DIA MV

8910

DIUS MV

8925

Fiscal Balance

-665

Fiscal Balance % GDP

-3.5

Federal   Debt

14666

Federal Debt % GDP

76.5

Federal Outlays

3982

∆%

3.3

% GDP

20.8

Federal Revenue

3316

∆%

1.5

% GDP

17.3

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 at 2.3 percent in IQ2018 decreases to 2.1 percent in IIQ2018. The current account deficit increases to 2.4 percent in IIIQ2018. The current account deficit increases to 2.8 percent in IVQ2018. The current account deficit decreases to 2.5 percent in IQ2019. The absolute value of the net international investment position increases from minus $7.8 trillion in IQ2018 to minus $8.9 trillion in IIQ2018. The absolute value of the net international investment position increases to $9.7 trillion in IIIQ2018. The absolute value of the net international investment position stabilizes at $9.6 trillion in IVQ2018. The absolute value of the net international investment position deteriorates to $9.9 trillion in IQ2019. The BEA explains as follows (https://www.bea.gov/system/files/2019-06/intinv119.pdf):

“The U.S. net international investment position decreased to −$9.93 trillion (preliminary) at the end of the first quarter of 2019 from −$9.55 trillion (revised) at the end of the fourth quarter of 2018, according to statistics released by the Bureau of Economic Analysis (BEA). The $374.4 billion decrease reflected a $1.90 trillion increase in U.S. assets and a $2.27 trillion increase in U.S. liabilities (table 1).”

The BEA explains further (https://www.bea.gov/system/files/2019-06/intinv119.pdf):

U.S. assets increased $1.90 trillion to $27.14 trillion at the end of the first quarter, reflecting increases in all major categories of assets, particularly in portfolio investment and direct investment assets.

  • Assets excluding financial derivatives increased $1.83 trillion to $25.58 trillion. The increase resulted from financial transactions of $157.4 billion and other changes in position of $1.68 trillion (table A).
    • Financial transactions reflected net U.S. acquisitions of other investment loan assets, direct investment equity assets, and foreign debt securities that were partly offset by net U.S. sales of foreign stocks.
    • Other changes in position were driven by foreign stock price increases that raised the equity value of portfolio investment and direct investment assets.
  • Financial derivatives increased $62.7 billion to $1.55 trillion, reflecting an increase in single-currency interest rate contracts that was partly offset by a decrease in foreign exchange contracts.”

Table VI-3C, US, Current Account, Net International Investment Position and Direct Investment, Dollar Billions, NSA

IQ2018

IIQ2018

IIIQ2018

IVQ2018

IQ2019

Goods &
Services

-124

-152

-174

-178

-124

Primary

Income

68

62

63

60

62

Secondary Income

-28

-28

-28

-33

-38

Current Account

-84

-118

-139

-151

-100

Current Account % GDP SA

-2.3

-2.1

-2.4

-2.8

-2.5

NIIP

-7832

-8906

-9701

-9555

-9929

US Owned Assets Abroad

27619

26962

27062

25241

27138

Foreign Owned Assets in US

-35451

-35868

-36763

-34796

-37067

DIA MV

8594

8422

8489

7504

8209

DIA MV Equity

7254

7111

7176

6184

6877

DIUS MV

8830

9004

9606

8583

9441

DIUS MV Equity

7064

7272

7854

6797

7724

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-3CA 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. There is improvement in 2017 and deterioration in 2018.

clip_image025

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

Source: Bureau of Economic Analysis

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

clip_image027

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-3C1 provides the quarterly NSA NIIP.

clip_image029

Chart VI-3C1, 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-3C2 updates annual and quarterly estimates of the US Net International Investment Position. There is continuing deterioration.

clip_image031

Chart VI-3C2, 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 Aug 8, 2019, at 2.12 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 2.12 percent on Aug 8, 2019. 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/2018/10/global-contraction-of-valuations-of.html and earlier 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_image032

Chart VI-10, US, Fed Funds Rate, Business Days, Jul 1, 1954 to Aug 8, 2019, 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_image033

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_image034

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_image035

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 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 2017 at 3.2 percent per year. The projected path is significantly lower at 1.4 percent per year from 2018 to 2028. The legacy of the economic cycle expansion from IIIQ2009 to IIQ2019 at 2.3 percent on average is in contrast with 3.8 percent on average in the expansion from IQ1983 to IVQ1992 (https://cmpassocregulationblog.blogspot.com/2019/07/dollar-appreciation-in-anticipations-of.html and earlier https://cmpassocregulationblog.blogspot.com/2019/06/mediocre-cyclical-united-states.html). Subpar economic growth may perpetuate unemployment and underemployment estimated at 18.8 million or 11.0 percent of the effective labor force in Jun 2019 (https://cmpassocregulationblog.blogspot.com/2019/08/dollar-appreciation-contraction-of.html and earlier https://cmpassocregulationblog.blogspot.com/2019/07/twenty-million-unemployed-or.html) with much lower hiring than in the period before the current cycle (Section I and earlier https://cmpassocregulationblog.blogspot.com/2019/07/fomc-uncertain-outlook-frank-h-knights.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

0.7

1982-1990

3.4

1.7

1.7

1991-2001

3.2

1.2

2.0

2002-2007

2.5

1.0

1.5

2008-2017

1.5

0.5

0.9

Total 1950-2017

3.2

1.4

1.7

Projected Average Annual ∆%

2018-2022

2.0

0.6

1.4

2023-2028

1.8

0.4

1.4

2018-2028

1.9

0.5

1.4

*Ratio of potential GDP to potential labor force

Source: CBO, The budget and economic outlook: 2018-2028. Washington, DC, Apr 9, 2018 https://www.cbo.gov/publication/53651 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-BEO2818 of the Congressional Budget Office provides historical and projected annual growth of United States potential GDP. The projection is of faster growth of real potential GDP.

clip_image036

Chart IB1-BEO2818, CBO Economic Forecast

Source: CBO, The budget and economic outlook: 2018-2028. Washington, DC, Apr 9, 2018 https://www.cbo.gov/publication/53651 CBO (2014BEOFeb4).

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_image038

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_image039

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 Congressional Budget Office 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 2017 at 3.2 percent per year. The projected path is significantly lower at 1.4 percent per year from 2018 to 2028. The legacy of the economic cycle expansion from IIIQ2009 to IIQ2019 at 2.3 percent on average is in contrast with 3.8 percent on average in the expansion from IQ1983 to IVQ1992 (https://cmpassocregulationblog.blogspot.com/2019/07/dollar-appreciation-in-anticipations-of.html and earlier https://cmpassocregulationblog.blogspot.com/2019/06/mediocre-cyclical-united-states.html). Subpar economic growth may perpetuate unemployment and underemployment estimated at 18.8 million or 11.0 percent of the effective labor force in Jun 2019 (https://cmpassocregulationblog.blogspot.com/2019/08/dollar-appreciation-contraction-of.html and earlier https://cmpassocregulationblog.blogspot.com/2019/07/twenty-million-unemployed-or.html) with much lower hiring than in the period before the current cycle (Section I and earlier https://cmpassocregulationblog.blogspot.com/2019/07/fomc-uncertain-outlook-frank-h-knights.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_image041

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_image043

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_image045

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_image046

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_image047

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_image048

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 2018. 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_image050

Chart IIA2-6, US, Real GDP, 1960-2018, 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 2011. 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_image051

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) deteriorated from $40.8 billion in Apr 2019 to minus $14.6 billion in May

2019. Foreign residents’ purchases minus sales of US long-term securities (row A in Table VA-4) in Apr 2019 of $36.4 billion deteriorated to minus $5.7 billion in May 2019. Net US (residents) purchases of long-term foreign securities (row B in Table VA-4) deteriorated from $10.5 billion in Apr 2019 to $9.2 billion in May 2019. Other transactions (row C2 in Table VA-4) changed from minus $6.2 billion in Apr 2019 to minus $18.2 billion in May 2019. In May 2019,

C = A + B + C2 = -$5.7 billion + $9.2 billion - $18.2 billion = -$14.6 billion.

There are minor rounding errors. There is weakening demand in Table VA-4 in May 2019 in A1 private purchases by residents overseas of US long-term securities of $10.1 billion of which weakening in A11 Treasury securities of $11.8 billion, weakening in A12 of $12.3 billion in agency securities, strengthening of $13.7 billion of corporate bonds and weakening of minus $4.0 billion in equities. Worldwide risk aversion causes flight into US Treasury obligations with significant oscillations. Official purchases of securities in row A2 decreased $15.7 billion with decrease of Treasury securities of $22.0 billion in May 2019. Official purchases of agency securities increased $2.8 billion in May 2019. Row D shows increase in May 2019 of 0.1 billion in purchases of short-term dollar denominated obligations. Foreign holdings of US Treasury bills decreased $7.3 billion (row D1) with foreign official holdings decreasing $9.6 billion while the category “other” decreased $7.4 billion. Foreign private holdings of US Treasury bills increased $2.3 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

May 2018 12 Months

May 2019 12 Months

Apr 2019

May 2019

A Foreign Purchases less Sales of
US LT Securities

399.1

-4.3

36.4

-5.7

A1 Private

415.5

171.0

53.4

10.1

A11 Treasury

143.7

154.1

44.4

-11.8

A12 Agency

108.8

146.6

14.7

12.3

A13 Corporate Bonds

107.7

54.6

-5.1

13.7

A14 Equities

55.3

-184.3

-0.6

-4.0

A2 Official

-16.4

-175.3

-17.0

-15.7

A21 Treasury

-82.7

-242.5

-27.5

-22.0

A22 Agency

70.0

79.5

10.5

2.8

A23 Corporate Bonds

-0.9

-7.6

0.3

0.8

A24 Equities

-2.8

-4.7

-0.4

2.6

B Net US Purchases of LT Foreign Securities

209.1

281.8

10.5

9.2

B1 Foreign Bonds

240.1

267.9

10.7

10.9

B2 Foreign Equities

-31.0

13.8

-0.2

-1.7

C1 Net Transactions

608.2

277.5

46.9

3.5

C2 Other

-99.0

-168.0

-6.2

-18.2

C Net Foreign Purchases of US LT Securities

509.2

109.5

40.8

-14.6

D Increase in Foreign Holdings of Dollar Denominated Short-term 

US Securities & Other Liab

242.5

343.7

-30.7

0.1

D1 US Treasury Bills

57.5

-14.5

-29.5

-7.3

D11 Private

40.6

39.1

-18.4

2.3

D12 Official

16.9

-53.6

-11.1

-9.6

D2 Other

185.1

358.1

-1.2

7.4

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 largest holder with $1110.2 billion in May 2019, decreasing 0.3 percent from $1113.0 billion in Apr 2019 while decreasing $72.9 billion from May 2018 or 6.2 percent. The United States Treasury estimates US government debt held by private investors at $13,682 billion in Mar 2019 (Fiscal Year 2018). China’s holding of US Treasury securities represents 8.1 percent of US government marketable interest-bearing debt held by private investors (https://www.fiscal.treasury.gov/reports-statements/treasury-bulletin/). 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 $1048.9 billion in May 2018 to $1101.0 billion in May 2019 or 5.0 percent. The combined holdings of China and Japan in May 2019 add to $2211.2 billion, which is equivalent to 16.2 percent of US government marketable interest-bearing securities held by investors of $13,682 billion in Mar 2019 (Fiscal Year 2018) (https://www.fiscal.treasury.gov/reports-statements/treasury-bulletin/). Total foreign holdings of Treasury securities increased from $6215.1 billion in May 2018 to $6539.1 billion in May 2019, or 5.2 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)). Professor Martin Feldstein, at Harvard University, writing on “The Debt Crisis Is Coming Soon,” published in the Wall Street Journal on Mar 20, 2019 (https://www.wsj.com/articles/the-debt-crisis-is-coming-soon-11553122139?mod=hp_opin_pos3), foresees a US debt crisis with deficits moving above $1 trillion and debt above 100 percent of GDP. 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

May 2019

Apr 2019

May 2018

Total

6539.1

6433.6

6215.1

China

1110.2

1113.0

1183.1

Japan

1101.0

1064.0

1048.9

United Kingdom

323.1

300.8

265.0

Brazil

305.7

306.7

299.2

Ireland

270.7

269.7

301.0

Switzerland

231.4

226.9

243.4

Luxembourg

229.6

223.7

208.9

Cayman Islands

216.1

217.2

186.2

Hong Kong

204.0

205.9

191.9

Belgium

190.5

179.8

150.5

Saudi Arabia

179.0

176.6

162.2

Taiwan

172.0

171.1

164.8

India

156.9

155.3

148.9

Singapore

150.4

139.3

118.9

Foreign Official Holdings

4103.9

4062.5

3990.9

A. Treasury Bills

292.7

302.3

346.3

B. Treasury Bonds and Notes

3811.3

3760.2

3644.6

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, 2018, 2019.

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