CMP Associates Regulation Blog: 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 VI

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

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

VI Valuation of Risk Financial Assets. The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

Table VI-1 shows the phenomenal impulse to valuations of risk financial assets originating in the initial shock of near zero interest rates in 2003-2004 with the fed funds rate at 1 percent, in fear of deflation that never materialized, and quantitative easing in the form of suspension of the auction of 30-year Treasury bonds to lower mortgage rates. World financial markets were dominated by monetary and housing policies in the US. Between 2002 and 2008, the DJ UBS Commodity Index rose 165.5 percent largely because of unconventional monetary policy encouraging carry trades from low US interest rates to long leveraged positions in commodities, exchange rates and other risk financial assets. The charts of risk financial assets show sharp increase in valuations leading to the financial crisis and then profound drops that are captured in Table VI-1 by percentage changes of peaks and troughs. The first round of quantitative easing and near zero interest rates depreciated the dollar relative to the euro by 39.3 percent between 2003 and 2008, with revaluation of the dollar by 25.1 percent from 2008 to 2010 in the flight to dollar-denominated assets in fear of world financial risks. The dollar revalued 6.0 percent by Fri Aug 9, 2019. Dollar devaluation is a major vehicle of monetary policy in reducing the output gap that is implemented in the probably erroneous belief that devaluation will not accelerate inflation, misallocating resources toward less productive economic activities and disrupting financial markets. The last row of Table VI-1 shows CPI inflation in the US rising from 1.9 percent in 2003 to 4.1 percent in 2007 even as monetary policy increased the fed funds rate from 1 percent in Jun 2004 to 5.25 percent in Jun 2006.

Table VI-1, Volatility of Assets

DJIA	10/08/02-10/01/07	10/01/07-3/4/09	3/4/09- 4/6/10
∆%	87.8	-51.2	60.3
NYSE Financial	1/15/04- 6/13/07	6/13/07- 3/4/09	3/4/09- 4/16/07
∆%	42.3	-75.9	121.1
Shanghai Composite	6/10/05- 10/15/07	10/15/07- 10/30/08	10/30/08- 7/30/09
∆%	444.2	-70.8	85.3
STOXX EUROPE 50	3/10/03- 7/25/07	7/25/07- 3/9/09	3/9/09- 4/21/10
∆%	93.5	-57.9	64.3
UBS Com.	1/23/02- 7/1/08	7/1/08- 2/23/09	2/23/09- 1/6/10
∆%	165.5	-56.4	41.4
10-Year Treasury	6/10/03	6/12/07	12/31/08	4/5/10
%	3.112	5.297	2.247	3.986
USD/EUR	6/26/03	7/14/08	6/07/10	08/09/2019
Rate	1.1423	1.5914	1.192	1.1201
CNY/USD	01/03 2000	07/21 2005	7/15 2008	08/09/ 2019
Rate	8.2798	8.2765	6.8211	7.0624
New House	1963	1977	2005	2009
Sales 1000s	560	819	1283	375
New House	2000	2007	2009	2010
Median Price $1000	169	247	217	222
	2003	2005	2007	2010
CPI	2.3	3.4	2.8	1.6

Sources: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

http://www.census.gov/const/www/newressalesindex_excel.html

http://federalreserve.gov/releases/h10/Hist/dat00_eu.htm

Table VI-2 provides the Euro/Dollar (EUR/USD) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 25.1 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul 2010, shown in Table VI-4 below, the dollar has revalued to USD 1.1201/EUR on Aug 9, 2019 or by 6.0 percent {[(1.1201/1.192)-1]100 = -6.0%}. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. Risk aversion erodes devaluation of the dollar. China fixed the CNY to the dollar for an extended period at a highly undervalued level of around CNY 8.2765/USD subsequently revaluing to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent. After fixing again the CNY to the dollar, China devalued to CNY 7.0624/USD on Fri Aug 9, 2019, or by 3.5 percent, for cumulative revaluation of 14.7 percent. The final row of Table VI-2 shows: change of 0.0 percent in the week of Jul 19, 2019; change of 0.0 percent in the week of Jul 26, 2019; devaluation of 0.9 percent in the week of Aug 2, 2019; and devaluation of 1.8 percent in the week of Aug 9, 2019. There could be reversal of revaluation to devalue the Yuan but the outcome depends on ongoing negotiations.

Table VI-2, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate

USD/EUR	12/26/03	7/14/08	6/07/10	08/09/19
Rate	1.1423	1.5914	1.192	1.1201
CNY/USD	01/03 2000	07/21 2005	7/15 2008	08/02/19
Rate	8.2765	6.8211	6.8211	7.0624
Weekly Rates	07/19/2019	07/26/2019	08/02/2019	08/09/19
CNY/USD	6.8819	6.8792	6.9402	7.0624
∆% from Earlier Week*	0.0%	0.0%	-0.9%	-1.8

*Negative sign is depreciation; positive sign is appreciation

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

Bob Davis and Lingling Wei, writing on “China shifts course, lets Yuan drop,” on Jul 25, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444840104577548610131107868.html?mod=WSJPRO_hpp_LEFTTopStories), find that China is depreciating the CNY relative to the USD in an effort to diminish the impact of appreciation of the CNY relative to the EUR. Table VI-2A provides the CNY/USD rate from Oct 28, 2011 to Aug 9, 2019 in selected intervals on Fridays. The CNY/USD revalued by 0.9 percent from Oct 28, 2012 to Apr 27, 2012. The CNY was virtually unchanged relative to the USD by Aug 24, 2012 to CNY 6.3558/USD from the rate of CNY 6.3588/USD on Oct 28, 2011 and then revalued slightly by 1.1 percent to CNY 6.2858/USD on Sep 28, 2012. Devaluation of 0.6 percent from CNY 6.2858/USD on Sep 28, 2012 to CNY 6.3240/USD on Oct 5, 2012, reduced to 0.5 percent the cumulative revaluation from Oct 28, 2011 to Oct 5, 2012. Revaluation by 0.2 percent to CNY 6.2546/USD on Oct 12, 2012 and revalued the CNY by 1.6 percent relative to the dollar from CNY 6.3588/USD on Oct 29, 2011. By Aug 9, 2019, the CNY devalued 11.1 percent to CNY 7.0624/USD relative to CNY 6.3588/USD on Oct 29, 2011. There could be reversal of revaluation in favor of devaluation. Robin Harding and Josh Noble, writing on “US warns China after renminbi depreciation,” on Apr 8, 2014, published in the Financial Times (http://www.ft.com/intl/cms/s/0/3355dc74-bed7-11e3-a1bf-00144feabdc0.html?siteedition=intl#axzz2ynwr9l6s), quote concerns of a senior US Treasury official on possible change in China’s policy of revaluation. Meanwhile, the Senate of the US periodically considers a bill on China’s trade that could create a confrontation but may not be approved by the entire Congress. An important statement by the People’s Bank of China (PBC), China’s central bank, on Apr 14, 2012, announced the widening of the daily maximum band of fluctuation of the renminbi (RMB) yuan (http://www.pbc.gov.cn/publish/english/955/2012/20120414090756030448561/20120414090756030448561_.html):

“Along with the development of China’s foreign exchange market, the pricing and risk management capabilities of market participants are gradually strengthening. In order to meet market demands, promote price discovery, enhance the flexibility of RMB exchange rate in both directions, further improve the managed floating RMB exchange rate regime based on market supply and demand with reference to a basket of currencies, the People’s Bank of China has decided to enlarge the floating band of RMB’s trading prices against the US dollar and is hereby making a public announcement as follows:

Effective from April 16, 2012 onwards, the floating band of RMB’s trading prices against the US dollar in the inter-bank spot foreign exchange market is enlarged from 0.5 percent to 1 percent, i.e., on each business day, the trading prices of the RMB against the US dollar in the inter-bank spot foreign exchange market will fluctuate within a band of ±1 percent around the central parity released on the same day by the China Foreign Exchange Trade System. The spread between the RMB/USD selling and buying prices offered by the foreign exchange-designated banks to their customers shall not exceed 2 percent of the central parity, instead of 1 percent, while other provisions in the Circular of the PBC on Relevant Issues Managing the Trading Prices in the Inter-bank Foreign Exchange Market and Quoted Exchange Rates of Exchange-Designated Banks (PBC Document No.[2010]325) remain valid.”

Table VI-2A, Renminbi Yuan US Dollar Rate

	CNY/USD	∆% from CNY 6.3588/USD 0n 10/28/2011
08/09/19	7.0624	-11.1
08/02/19	6.9402	-9.1
07/26/19	6.8792	-8.2
07/19/19	6.8819	-8.2
07/12/19	6.8808	-8.2
07/05/19	6.8936	-8.4
06/28/19	6.8668	-8.0
06/21/19	6.8699	-8.0
06/14/19	6.9254	-8.9
06/07/19	6.9098	-8.7
05/31/19	6.9051	-8.6
05/24/19	6.9002	-8.5
05/17/19	6.9186	-8.8
05/10/19	6.8241	-7.3
05/03/19	6.7346	-5.9
04/26/19	6.7297	-5.8
04/19/19	6.7044	-5.4
04/12/19	6.7042	-5.4
04/05/19	6.7179	-5.6
03/29/19	6.7121	-5.6
03/22/19	6.7181	-5.7
03/15/19	6.7135	-5.6
03/08/19	6.7216	-5.7
03/01/19	6.7064	-5.5
02/22/19	6.7142	-5.6
02/15/19	6.7731	-6.5
02/08/19	6.7448	-6.1
02/01/19	6.7449	-6.1
01/25/19	6.7487	-6.1
01/18/19	6.7788	-6.6
01/11/19	6.7627	-6.4
01/04/19	6.8694	-8.0
12/28/18	6.8782	-8.2
12/21/18	6.9064	-8.6
12/14/18	6.9076	-8.6
12/07/18	6.8744	-8.1
11/30/18	6.9590	-9.4
11/23/18	6.9485	-9.3
11/16/18	6.9380	-9.1
11/09/18	6.9569	-9.4
11/02/18	6.8909	-8.4
10/26/18	6.9435	-9.2
10/19/18	6.9296	-9.0
10/12/18	6.9222	-8.9
10/05/18	6.8689	-8.0
09/28/18	6.8690	-8.0
09/21/18	6.8568	-7.8
09/14/18	6.8705	-8.0
09/07/18	6.8448	-7.6
08/31/18	6.8316	-7.4
08/24/18	6.8077	-7.1
08/17/18	6.8776	-8.2
08/10/18	6.8469	-7.7
08/03/18	6.8306	-7.4
07/27/18	6.8137	-7.2
07/20/18	6.7709	-6.5
07/13/18	6.6908	-5.2
07/06/18	6.6434	-4.5
06/29/18	6.6225	-4.1
06/22/18	6.5059	-2.3
06/15/18	6.4389	-1.3
06/08/18	6.4065	-0.8
06/01/18	6.4204	-1.0
05/25/18	6.3919	-0.5
05/18/18	6.3780	-0.3
05/11/18	6.3341	0.4
05/04/18	6.3627	-0.1
04/27/18	6.3336	0.4
04/20/18	6.2965	1.0
04/13/18	6.2788	1.3
04/06/18	6.3044	0.9
03/30/18	6.2911	1.1
03/23/18	6.3157	0.7
03/16/18	6.3346	0.4
03/09/18	6.3346	0.4
03/02/18	6.3485	0.2
02/23/18	6.3358	0.4
02/16/18	6.3458	0.2
02/09/18	6.2890	1.1
02/02/18	6.3033	0.9
01/26/18	6.3154	0.7
01/19/18	6.4058	-0.7
01/12/18	6.4518	-1.5
01/05/18	6.4891	-2.0
12/29/17	6.5030	-2.3
12/22/17	6.5744	-3.4
12/15/17	6.5989	-3.8
12/08/17	6.6179	-4.1
12/01/17	6.6134	-4.0
11/24/17	6.5983	-3.8
11/17/17	6.6287	-4.2
11/10/17	6.6415	-4.4
11/03/17	6.6387	-4.4
10/27/17	6.6507	-4.6
10/20/17	6.6221	-4.1
10/13/17	6.5901	-3.6
10/06/17	6.6534	-4.6
09/29/17	6.6366	-4.4
09/22/17	6.5935	-3.7
09/15/17	6.5537	-3.1
09/08/17	6.4817	-1.9
09/01/17	6.5591	-3.1
08/25/17	6.6482	-4.6
08/18/17	6.6719	-4.9
08/11/17	6.6647	-4.8
08/04/17	6.7305	-5.8
07/28/17	6.7374	-6.0
07/21/17	6.7670	-6.4
07/14/17	6.7840	-6.7
07/07/17	6.8128	-7.1
06/30/17	6.7787	-6.6
06/23/17	6.8359	-7.5
06/16/17	6.8103	-7.1
06/09/17	6.7987	-6.9
06/02/17	6.8105	-7.1
05/26/17	6.8556	-7.8
05/19/17	6.8839	-8.3
05/12/17	6.8998	-8.5
05/05/17	6.9031	-8.6
04/28/17	6.8940	-8.4
04/21/17	6.8848	-8.3
04/14/17	6.8854	-8.3
04/07/17	6.9044	-8.6
03/31/17	6.8866	-8.3
03/24/17	6.8772	-8.2
03/17/17	6.9093	-8.7
03/10/17	6.9071	-8.6
03/03/17	6.8955	-8.4
02/24/17	6.8668	-8.0
02/17/17	6.8650	-8.0
02/10/17	6.8776	-8.2
02/03/17	6.8661	-8.0
01/27/17	6.8811	-8.2
01/20/17	6.8765	-8.1
01/13/17	6.8998	-8.5
01/06/17	6.9185	-8.8
12/30/16	6.9448	-9.2
12/23/16	6.9463	-9.2
12/16/16	6.9593	-9.4
12/09/16	6.9077	-8.6
12/02/16	6.8865	-8.3
11/25/16	6.9236	-8.9
11/18/16	6.8883	-8.3
11/11/16	6.8151	-7.2
11/04/16	6.7540	-6.2
10/28/16	6.7983	-6.9
10/21/16	6.7624	-6.3
10/14/16	6.7296	-5.8
10/07/16	6.6728	-4.9
09/30/16	6.6711	-4.9
09/23/16	6.6724	-4.9
09/16/16	6.6701	-4.9
09/09/16	6.6876	-5.2
09/02/16	6.6822	-5.1
08/26/16	6.6685	-4.9
08/19/16	6.6523	-4.6
08/12/16	6.6408	-4.4
08/05/16	6.6438	-4.5
07/29/16	6.6550	-4.7
07/22/16	6.6819	-5.1
07/15/16	6.6924	-5.2
07/08/16	6.6881	-5.2
07/01/16	6.6564	-4.7
06/24/16	6.6128	-4.0
06/17/16	6.5836	-3.5
06/10/16	6.5720	-3.4
06/03/16	6.5518	-3.0
05/27/16	6.5630	-3.2
05/20/16	6.5464	-3.0
05/13/16	6.5319	-2.7
05/06/16	6.4965	-2.2
04/29/16	6.4741	-1.8
04/22/16	6.5068	-2.3
04/15/16	6.4781	-1.9
04/08/16	6.4673	-1.7
04/01/16	6.4787	-1.9
03/25/16	6.5204	-2.5
03/18/16	6.4716	-1.8
03/11/16	6.4961	-2.2
03/04/16	6.5027	-2.3
02/26/16	6.5433	-2.9
02/19/16	6.5225	-2.6
02/12/16	6.5733	-3.4
02/05/16	6.5736	-3.4
01/29/16	6.5761	-3.4
01/22/16	6.5789	-3.5
01/15/16	6.5836	-3.5
01/08/16	6.5934	-3.7
01/01/16	6.4931	-2.1
12/25/15	6.4801	-1.9
12/18/15	6.4827	-1.9
12/11/15	6.4558	-1.5
12/04/15	6.4006	-0.7
11/27/15	6.3964	-0.6
11/20/15	6.3885	-0.5
11/13/15	6.3738	-0.2
11/06/15	6.3515	0.1
10/30/15	6.3161	0.7
10/23/15	6.3542	0.1
10/16/15	6.3529	0.1
10/09/15	6.3447	0.2
10/02/15	6.3552	0.1
09/25/15	6.3754	-0.3
09/18/15	6.3639	-0.1
09/11/15	6.3734	-0.2
09/04/15	6.3701	-0.2
08/28/15	6.3872	-0.4
08/21/15	6.3870	-0.4
08/14/15	6.3907	-0.5
08/07/15	6.2097	2.3
07/31/15	6.2077	2.4
07/24/15	6.2085	2.4
07/17/15	6.2110	2.3
07/10/15	6.2115	2.3
07/03/15	6.2048	2.4
06/26/15	6.2090	2.4
06/19/15	6.2098	2.3
06/12/15	6.2068	2.4
06/05/15	6.2016	2.5
05/29/15	6.2004	2.5
05/22/15	6.1974	2.5
05/15/15	6.2054	2.4
05/08/15	6.2143	2.3
05/01/15	6.2134	2.3
04/24/15	6.1935	2.6
04/17/15	6.1953	2.6
04/10/15	6.2063	2.4
04/03/15	6.1466	3.3
03/27/15	6.2150	2.3
03/20/15	6.2046	2.4
03/13/15	6.2599	1.6
03/06/15	6.2644	1.5
02/27/1 5	6.2671	1.4
02/20/15	6.2546	1.6
02/13/2015	6.2446	1.8
02/06/2015	6.2445	1.8
01/30/2015	6.2543	1.6
01/23/2015	6.2309	2.0
01/16/2015	6.2063	2.4
01/09/2015	6.2045	2.4
01/02/2015	6.2063	2.4
12/26/2014	6.2276	2.1
12/19/2014	6.2226	2.1
12/12/2014	6.1852	2.7
12/05/2014	6.1502	3.3
11/28/2014	6.1431	3.4
11/21/2014	6.1228	3.7
11/14/2014	6.1313	3.6
11/07/2014	6.1238	3.7
10/31/2014	6.1133	3.9
10/24/2014	6.1181	3.8
10/17/2014	6.1246	3.7
10/10/2014	6.1299	3.6
0/03/2014	6.1363	3.5
9/26/2014	6.1272	3.6
9/19/2014	6.1412	3.4
9/12/2014	6.1334	3.5
9/05/2014	6.1406	3.4
8/29/2014	6.1457	3.4
8/22/2014	6.1522	3.2
8/15/2014	6.1463	3.3
8/8/2014	6.1548	3.2
8/1/2014	6.1781	2.8
7/25/2014	6.1923	2.6
7/18/2014	6.2074	2.4
7/11/2014	6.2040	2.4
7/4/2014	6.2036	2.4
6/27/2014	6.2189	2.2
6/20/14	6.2238	2.1
6/13/2014	6.2097	2.3
6/6/2014	6.2507	1.7
5/30/2014	6.2486	1.7
5/23/2014	6.2354	1.9
5/16/2014	6.2340	2.0
5/9/2014	6.2281	2.1
5/3/2014	6.2595	1.6
4/28/2014	6.2539	1.6
4/18/2014	6.2377	1.9
4/11/2014	6.2111	2.3
4/4/2014	6.2102	2.3
3/28/2014	6.2130	2.3
3/21/2014	6.2247	2.1
3/14/2014	6.1496	3.3
3/7/2014	6.1260	3.7
2/28/2014	6.1481	3.3
2/21/2014	6.0913	4.2
2/14/2014	6.0670	4.6
2/7/2014	6.0634	4.6
1/31/2014	6.0589	4.7
1/24/2014	6.0472	4.9
1/17/2014	6.0503	4.9
1/10/2014	6.0503	4.9
1/3/2014	6.0516	4.8
12/27/2013	6.0678	4.6
12/20/2013	6.0725	4.5
12/13/2013	6.0691	4.6
12/6/2013	6.0801	4.4
11/29/2013	6.0914	4.2
11/22/2013	6.0911	4.2
11/15/2013	6.0928	4.2
11/8/2013	6.0912	4.2
11/1/2013	6.0996	4.1
10/25/2013	6.0830	4.3
10/18/2013	6.0973	4.1
10/11/2013	6.1210	3.7
10/4/2013	6.1226	3.7
9/27/2013	6.1196	3.8
9/20/2013	6.1206	3.7
9/13/2013	6.1190	3.8
9/6/2013	6.1209	3.7
8/30/2013	6.1178	3.8
8/23/2013	6.1211	3.7
8/16/2013	6.1137	3.9
8/9/2013	6.1225	3.7
8/2/2013	6.1295	3.6
7/26/2013	6.1305	3.6
7/19/2013	6.1380	3.5
7/12/2013	6.1382	3.5
7/5/2013	6.1316	3.6
6/28/2013	6.1910	2.6
6/21/2013	6.1345	3.5
6/14/2013	6.1323	3.6
6/7/2013	6.1334	3.5
5/31/2013	6.1347	3.5
5/24/2013	6.1314	3.6
5/17/2013	6.1395	3.4
5/10/2013	6.1395	3.4
5/3/2013	6.1553	3.2
4/26/2013	6.1636	3.1
4/19/13	6.1788	2.8
4/12/2013	6.1947	2.6
4/5/2013	6.2051	2.4
3/29/2013	6.2119	2.3
3/22/2013	6.2112	2.3
3/15/2013	6.2131	2.3
3/8/2013	6.2142	2.3
3/1/2013	6.2221	2.1
2/22/2013	6.2350	1.9
2/15/2013	6.2328	2.0
2/8/2013	6.2323	2.0
2/1/2013	6.2316	2.0
1/25/2013	6.2228	2.1
1/18/2013	6.2182	2.2
1/11/2013	6.2168	2.2
1/4/2013	6.2316	2.0
12/28/2012	6.2358	1.9
12/21/2012	6.2352	1.9
12/14/2012	6.2460	1.8
12/7/2012	6.2254	2.1
11/30/2012	6.2310	2.0
11/23/2012	6.2328	2.0
11/16/2012	6.2404	1.9
11/9/2012	6.2452	1.8
11/2/2012	6.2458	1.8
10/26/2012	6.2628	1.5
10/19/2012	6.2546	1.6
10/12/2012	6.2670	1.4
10/5/2012	6.3240	0.5
9/28/2012	6.2858	1.1
9/21/2012	6.3078	0.8
9/14/2012	6.3168	0.7
9/7/2012	6.3438	0.2
8/31/2012	6.3498	0.1
8/24/2012	6.3558	0.0
8/17/2012	6.3589	0.0
8/10/2012	6.3604	0.0
8/3/2012	6.3726	-0.2
7/27/2012	6.3818	-0.4
7/20/2012	6.3750	-0.3
7/13/2012	6.3868	-0.4
7/6/2012	6.3658	-0.1
6/29/2012	6.3552	0.1
6/22/2012	6.3650	-0.1
6/15/2012	6.3678	-0.1
6/8/2012	6.3752	-0.3
6/1/2012	6.3708	-0.2
4/27/2012	6.3016	0.9
3/23/2012	6.3008	0.9
2/3/2012	6.3030	0.9
12/30/2011	6.2940	1.0
11/25/2011	6.3816	-0.4
10/28/2011	6.3588	-

Source:

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

http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm

Professor Edward P Lazear (2013Jan7), writing on “Chinese ‘currency manipulation’ is not the problem,” on Jan 7, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323320404578213203581231448.html), provides clear thought on the role of the yuan in trade between China and the United States and trade between China and Europe. There is conventional wisdom that Chinese exchange rate policy causes the loss of manufacturing jobs in the United States, which is shown by Lazear (2013Jan7) to be erroneous. The fact is that manipulation of the CNY/USD rate by China has only minor effects on US employment. Lazear (2013Jan7) shows that the movement of monthly exports of China to its major trading partners, United States and Europe, since 1995 cannot be explained by the fixing of the CNY/USD rate by China. The period is quite useful because it includes rapid growth before 2007, contraction until 2009 and weak subsequent expansion. Professor Charles W. Calomiris, at Columbia University, writing in the Wall Street Journal on Apr 17, 2017, provides perceptive analysis of China’s exchange rate. According to Calomiris (2017Apr), long-run exchange rate appreciation in China originates in productivity growth in accordance with Harrod (1939), Balassa (1964) and Samuelson (1964). In this view, reforms allowing increasing participation of private economic activity caused an increase in productivity measured by Calomiris (2017Apr) as only about 3 percent of US productivity around 1978 to current 13 percent of US productivity. Calomiris (2017Apr) attributes recent depreciation of the Yuan to rapidly increasing debt, slowing growth and inflation motivating capital flight. Chart VI-1 of the Board of Governors of the Federal Reserve System provides the CNY/SD exchange rate from Jan 3, 1995 to Aug 2, 2019 together with US recession dates in shaded areas. China fixed the CNY/USD rate for an extended period as shown in the horizontal segment from 1995 to 2005. There was systematic revaluation of 17.6 percent from CNY 8.2765 on Jul 21, 2005 to CNY 6.8211 on Jul 15, 2008. China fixed the CNY/USD rate until Jun 7, 2010, to avoid adverse effects on its economy from the global recession, which is shown as a horizontal segment from 2009 until mid-2010. China then continued the policy of appreciation of the CNY relative to the USD with oscillations until the beginning of 2012 when the rate began to move sideways followed by a final upward slope of devaluation that is measured in Table VI-2A but virtually disappeared in the rate of CNY 6.3589/USD on Aug 17, 2012 and was nearly unchanged at CNY 6.3558/USD on Aug 24, 2012. China then appreciated 0.2 percent in the week of Dec 21, 2012, to CNY 6.2352/USD for cumulative 1.9 percent revaluation from Oct 28, 2011 and left the rate virtually unchanged at CNY 6.2316/USD on Jan 11, 2013, moving to CNY 6.9387/USD on Aug 2, 2019, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD of 14.7 percent by Aug 9, 2019 has not reduced the trade surplus of China but reversal of the policy of revaluation could result in international confrontation. The interruption with upward slope in the final segment on the right of Chart VI-I is measured as virtually stability in Table VI-2A followed with decrease or revaluation and subsequent increase or devaluation. The final segment shows decline or revaluation with another upward move or devaluation. Linglin Wei, writing on “China intervenes to lower yuan,” on Feb 26, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304071004579406810684766716?KEYWORDS=china+yuan&mg=reno64-wsj), finds from informed sources that the central bank of China conducted the ongoing devaluation of the yuan with the objective of driving out arbitrageurs to widen the band of fluctuation. There is concern if the policy of revaluation is changing to devaluation.

Chart VI-1, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 3, 1995-Aug 2, 2019

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-1A provides the daily CNY/USD rate from Jan 5, 1981 to Aug 2, 2019. The exchange rate was CNY 1.5418/USD on Jan 5, 1981. There is sharp cumulative depreciation of 107.8 percent to CNY 3.2031 by Jul 2, 1986, continuing to CNY 5.8145/USD on Dec 29, 1993 for cumulative 277.1 percent since Jan 5, 1981. China then devalued sharply to CNY 8.7117/USD on Jan 7, 1994 for 49.8 percent relative to Dec 29, 1993 and cumulative 465.0 percent relative to Jan 5, 1981. China then fixed the rate at CNY 8.2765/USD until Jul 21, 2005 and revalued as analyzed in Chart VI-1. The final data point in Chart VI-1A is CNY 6.9387/USD on Aug 2, 2019. To be sure, China fixed the exchange rate after substantial prior devaluation. It is unlikely that the devaluation could have been effective after many years of fixing the exchange rate with high inflation and multiple changes in the world economy. The argument of Lazear (2013Jan7) is still valid in view of the lack of association between monthly exports of China to the US and Europe since 1995 and the exchange rate of China.

Chart VI-1A, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 5, 1981-Aug 2, 2019

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-1B provides finer details with the rate of Chinese Yuan (CNY) to the US Dollar (USD) from Oct 28, 2011 to Aug 2, 2019. There have been alternations of revaluation and devaluation. The initial data point is CNY 6.5370 on Nov 3, 2011. There is an episode of devaluation from CNY 6.2790 on Apr 30, 2012 to CNY 6.3879 on Jul 25, 2012, or devaluation of 1.4 percent. Another devaluation is from CNY 6.0402/USD on Jan 21, 2014 to CNY 6.9387/USD on Aug 2, 2019, or devaluation of 14.9 percent. Calomiris (2017Apr) attributes recent depreciation of the Yuan to rapidly increasing debt, slowing growth and inflation motivating capital flight. China is the largest holder of US Treasury securities 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.”

Chart VI-1B, Chinese Yuan (CNY) per US Dollar (US), Business Days, Oct 28, 2011-Aug 2, 2019

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart VI-1B for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart VI-1B cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s. The loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy. This interpretation is consistent with the case of the 24 emerging market economies analyzed by Reinhart and Rogoff (2010GTD, 4), concluding that “higher debt levels are associated with significantly higher levels of inflation in emerging markets. Median inflation more than doubles (from less than seven percent to 16 percent) as debt rises from the low (0 to 30 percent) range to above 90 percent. Fiscal dominance is a plausible interpretation of this pattern.”

The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:

“So, inflation is caused by ‘tightness’ and deflation by ‘slack’ in the economy. This is not just a cause and forecasting variable, it is the cause, because given ‘slack’ we apparently do not have to worry about inflation from other sources, notwithstanding the weak correlation of [Phillips circuits]. These statements [by the Fed] do mention ‘stable inflation expectations. How does the Fed know expectations are ‘stable’ and would not come unglued once people look at deficit numbers? As I read Fed statements, almost all confidence in ‘stable’ or ‘anchored’ expectations comes from the fact that we have experienced a long period of low inflation (adaptive expectations). All these analyses ignore the stagflation experience in the 1970s, in which inflation was high even with ‘slack’ markets and little ‘demand, and ‘expectations’ moved quickly. They ignore the experience of hyperinflations and currency collapses, which happen in economies well below potential.”

Yellen (2014Aug22) states that “Historically, slack has accounted for only a small portion of the fluctuations in inflation. Indeed, unusual aspects of the current recovery may have shifted the lead-lag relationship between a tightening labor market and rising inflation pressures in either direction.”

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

Chart VI1-B, Brazil, Phillips Circuit, 1963-1987

Source:

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

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

Cost of Domestic Loan ≥ Cost of Foreign Loan

This ordering was attained in practice by setting the domestic interest rate of the overnight interest rate plus spread higher than indexing of government securities with lower spread than loans in turn higher than devaluation plus spread of foreign loans. Interest parity required equality of inflation, devaluation and indexing. Brazil devalued the cruzeiro by 30 percent in 1983 because the depreciation of the German mark DM relative to the USD had eroded the competitiveness of Brazil’s products in Germany and in competition with German goods worldwide. The database of the Board of Governors of the Federal Reserve System quotes DM 1.7829/USD on Mar 3 1980 and DM 2.4425/USD on Mar 15, 1983 (http://www.federalreserve.gov/releases/h10/hist/dat89_ge.htm) for devaluation of 37.0 percent. Parity of costs and rates of domestic and foreign loans and assets required ensuring that there would not be appreciation of the exchange rate, inducing capital flight in expectation of future devaluation that would have reversed stabilization. Table VI-2C provides inflation, devaluation, overnight interest rate and indexing. One of the main problems of adjustment of members of the euro area with high debts is that they cannot adjust the exchange rate because of the common euro currency. This is not an argument in favor of breaking the euro area because there would be also major problems of adjustment such as exiting the euro in favor of a new Drachma in the case of Greece. Another hurdle of adjustment in the euro area is that Brazil could have moved swiftly to adjust its economy in 1983 but the euro area has major sovereignty and distribution of taxation hurdles in moving rapidly.

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

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

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

The G7 meeting in Washington on Apr 21, 2006 of finance ministers and heads of central bank governors of the G7 established the “doctrine of shared responsibility” (G7 2006Apr):

“We, Ministers and Governors, reviewed a strategy for addressing global imbalances. We recognized that global imbalances are the product of a wide array of macroeconomic and microeconomic forces throughout the world economy that affect public and private sector saving and investment decisions. We reaffirmed our view that the adjustment of global imbalances:

Is shared responsibility and requires participation by all regions in this global process;
Will importantly entail the medium-term evolution of private saving and investment across countries as well as counterpart shifts in global capital flows; and
Is best accomplished in a way that maximizes sustained growth, which requires strengthening policies and removing distortions to the adjustment process.

In this light, we reaffirmed our commitment to take vigorous action to address imbalances. We agreed that progress has been, and is being, made. The policies listed below not only would be helpful in addressing imbalances, but are more generally important to foster economic growth.

In the United States, further action is needed to boost national saving by continuing fiscal consolidation, addressing entitlement spending, and raising private saving.
In Europe, further action is needed to implement structural reforms for labor market, product, and services market flexibility, and to encourage domestic demand led growth.
In Japan, further action is needed to ensure the recovery with fiscal soundness and long-term growth through structural reforms.

Others will play a critical role as part of the multilateral adjustment process.

In emerging Asia, particularly China, greater flexibility in exchange rates is critical to allow necessary appreciations, as is strengthening domestic demand, lessening reliance on export-led growth strategies, and actions to strengthen financial sectors.

In oil-producing countries, accelerated investment in capacity, increased economic diversification, enhanced exchange rate flexibility in some cases.

Other current account surplus countries should encourage domestic consumption and investment, increase micro-economic flexibility and improve investment climates.

We recognized the important contribution that the IMF can make to multilateral surveillance.”

The concern at that time was that fiscal and current account global imbalances could result in disorderly correction with sharp devaluation of the dollar after an increase in premiums on yields of US Treasury debt (see Pelaez and Pelaez, The Global Recession Risk (2007)). The IMF was entrusted with monitoring and coordinating action to resolve global imbalances. The G7 was eventually broadened to the formal G20 in the effort to coordinate policies of countries with external surpluses and deficits.

The database of the WEO (https://www.imf.org/external/pubs/ft/weo/2019/01/weodata/index.aspx) is used to construct Table VI-3 with fiscal and current account imbalances projected for 2017 and 2019. The WEO finds the need to rebalance external and domestic demand (IMF 2011WEOSep xvii):

“Progress on this front has become even more important to sustain global growth. Some emerging market economies are contributing more domestic demand than is desirable (for example, several economies in Latin America); others are not contributing enough (for example, key economies in emerging Asia). The first set needs to restrain strong domestic demand by considerably reducing structural fiscal deficits and, in some cases, by further removing monetary accommodation. The second set of economies needs significant currency appreciation alongside structural reforms to reduce high surpluses of savings over investment. Such policies would help improve their resilience to shocks originating in the advanced economies as well as their medium-term growth potential.”

The IMF (2012WEOApr, XVII) explains decreasing importance of the issue of global imbalances as follows:

“The latest developments suggest that global current account imbalances are no longer expected to widen again, following their sharp reduction during the Great Recession. This is largely because the excessive consumption growth that characterized economies that ran large external deficits prior to the crisis has been wrung out and has not been offset by stronger consumption in .surplus economies. Accordingly, the global economy has experienced a loss of demand and growth in all regions relative to the boom years just before the crisis. Rebalancing activity in key surplus economies toward higher consumption, supported by more market-determined exchange rates, would help strengthen their prospects as well as those of the rest of the world.”

The IMF (http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/c4.pdf) analyzes global imbalances as:

Global current account imbalances have narrowed by more than a third from

their peak in 2006. Key imbalances—the large deficit of the United States and

the large surpluses of China and Japan—have more than halved.

The narrowing in imbalances has largely been driven by demand contraction

(“expenditure reduction”) in deficit economies.

Exchange rate adjustment has facilitated rebalancing in China and the United

States, but in general the contribution of exchange rate changes (“expenditure

switching”) to current account adjustment has been relatively modest.

The narrowing of imbalances is expected to be durable, as domestic demand in

deficit economies is projected to remain well below pre-crisis trends.

Since flow imbalances have narrowed but not reversed, net creditor and debtor

positions have widened further. Weak growth has also contributed to still high

ratios of net external liabilities to GDP in some debtor economies.

Risks of a disruptive adjustment in global current account balances have

decreased, but global demand rebalancing remains a policy priority. Stronger

external demand will be instrumental for reviving growth in debtor countries and

reducing their net external liabilities.”

Table VI-3, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2018 Dollar GDP

	GDP $B 2018	FD %GDP 2017	CAD %GDP 2017	Debt %GDP 2017	FD%GDP 2019	CAD%GDP 2019	Debt %GDP 2019
US	20494	-2.2	-2.3	80.7	-2.9	-2.4	83.4
Japan	4972	-2.7	4.0	151.1	-2.7	3.5	153.6
UK	2829	-0.1	-3.3	77.5	0.1	-4.2	76.2
Euro	12652	0.8	3.2	70.9	0.6	2.9	67.9
Ger	4000	1.9	8.0	44.5	1.8	7.1	38.6
France	2775	-1.0	-0.6	87.5	-1.7	-0.4	88.2
Italy	2072	1.2	2.8	119.0	0.9	2.9	121.5
Can	1711	0.0	-2.8	27.6	-0.2	-3.1	26.6
China	13407	-3.0	1.4	46.8	-4.9	0.4	55.4
Brazil	1868	-1.8	-0.4	51.6	-1.8	-1.7	56.2

Note: GER = Germany; Can = Canada; FD = fiscal deficit; CAD = current account deficit

FD is primary except total for China; Debt is net except gross for China

Source: IMF World Economic Outlook databank

https://www.imf.org/external/pubs/ft/weo/2019/01/weodata/index.aspx

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

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?"”

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):

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:

(M_t + B_t)/P_t = E_t∫(1/R_t_{, t+τ})s_t_+τdτ (4)

Equation (4) expresses the monetary, M_t, and debt, B_t, liabilities of the government, divided by the price level, P_t, in terms of the expected value discounted by the ex-post rate on government debt, R_t_{, t+τ}, of the future primary surpluses s_t_+τ, which are equal to T_t_+τ – G_t_+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post R_t_{, t+τ}. The second equation of Cochrane (2011Jan, 5) is:

M_tV(i_t, ·) = P_tY_t (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.

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

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.

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.

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

The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task for both theory and measurement. The IMF (2013WEOOct) provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/ns/cs.aspx?id=29); of the world financial system with its Global Financial Stability Report (GFSR) (IMF 2013GFSROct) (http://www.imf.org/external/pubs/ft/gfsr/index.htm); and of fiscal affairs with the Fiscal Monitor (IMF 2013FMOct) (http://www.imf.org/external/ns/cs.aspx?id=262). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider global economic and financial risks, which are analyzed in the comments of this blog.

Economic risks include the following:

First. China’s Economic Growth. China lowered the GDP growth forecast to “around 6.5 percent” in 2017 (http://news.xinhuanet.com/english/2017-03/05/c_136104699.htm). The National People’s Congress of China in Mar 2016 is reducing the GDP growth target to the range of 6.5 percent to 7.0 percent in guiding stable market expectations (http://news.xinhuanet.com/english/photo/2016-03/05/c_135157171.htm). President Xi Jinping announced on Nov 3, 2015 that “For China to double 2010 GDP and the per capita income of both urban and rural residents by 2010, annual growth for the 2016-2020 period must be at least 6.5 percent,” as quoted by Xinhuanet (http://news.xinhuanet.com/english/2015-11/03/c_134780377.htm). China lowered the growth target to approximately 7.0 percent in 2015, as analyzed by Xiang Bo, writing on “China lowers 2015 economic growth target to around 7 percent,” published on Xinhuanet on Mar 5, 2015 (http://news.xinhuanet.com/english/2015-03/05/c_134039341.htm). China had lowered its growth target to 7.5 percent per year. Lu Hui, writing on “China lowers GDP target to achieve quality economic growth, on Mar 12, 2012, published in Beijing by Xinhuanet (http://news.xinhuanet.com/english/china/2012-03/12/c_131461668.htm), informs that Premier Jiabao wrote in a government work report that the GDP growth target will be lowered to 7.5 percent to enhance the quality and level of development of China over the long term. The Third Plenary Session of the 18^th Central Committee of the Communist Party of China adopted unanimously on Nov 15, 2013, a new round of reforms with 300 measures (Xinhuanet, “China details reform decision-making process,” Nov 19, 2013 http://news.xinhuanet.com/english/china/2013-11/19/c_125722517.htm). There was decennial change in leadership in China (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). Xi Jinping initiated a second term of leadership in Oct 2017 (http://news.xinhuanet.com/english/2017-10/25/c_136705344.htm). There was decennial change in leadership in China (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). Xi Jinping initiated a second term of leadership in Oct 2017 (http://news.xinhuanet.com/english/2017-10/25/c_136705344.htm). There was decennial change in leadership in China (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). China’s GDP grew 1.9 percent in IQ2012, annualizing to 7.8 percent, and 8.1 percent relative to a year earlier. The GDP of China grew at 2.1 percent in IIQ2012, which annualizes to 8.7 percent, and 7.6 percent relative to a year earlier. China grew at 1.8 percent in IIIQ2012, which annualizes at 7.4 percent, and 7.5 percent relative to a year earlier. In IVQ2012, China grew at 2.0 percent, which annualizes at 8.2 percent, and 8.1 percent in IVQ2012 relative to IVQ2011. In IQ2013, China grew at 1.9 percent, which annualizes at 7.8 percent, and 7.9 percent relative to a year earlier. In IIQ2013, China grew at 1.8 percent, which annualizes at 7.4 percent, and 7.6 percent relative to a year earlier. China grew at 2.1 percent in IIIQ2013, which annualizes at 8.7 percent, and increased 7.9 percent relative to a year earlier. China grew at 1.6 percent in IVQ2013, which annualized to 6.6 percent, and 7.7 percent relative to a year earlier. China’s GDP grew 1.8 percent in IQ2014, which annualizes to 7.4 percent, and 7.4 percent relative to a year earlier. China’s GDP grew 1.8 percent in IIQ2014, which annualizes at 7.4 percent, and 7.5 percent relative to a year earlier. China’s GDP grew 1.8 percent in IIIQ2014, which is equivalent to 7.4 percent in a year, and 7.1 percent relative to a year earlier. The GDP of China grew 1.7 percent in IVQ2014, which annualizes at 7.0 percent, and 7.2 percent relative to a year earlier. The GDP of China grew at 1.8 percent in IQ2015, which annualizes at 7.4 percent, and 7.0 percent relative to a year earlier. The GDP of China grew 1.8 percent in IIQ2015, which annualizes at 7.4 percent, and increased 7.0 percent relative to a year earlier. In IIIQ2015, China’s GDP grew at 1.7 percent, which annualizes at 7.0 percent, and increased 6.9 percent relative to a year earlier. The GDP of China grew at 1.5 percent in IVQ2015, which annualizes at 6.1 percent, and increased 6.8 percent relative to a year earlier. The GDP of China grew 1.4 percent in IQ2016, which annualizes at 5.7 percent, and increased 6.7 percent relative to a year earlier. In IIQ2016, the GDP of China increased 1.9 percent, which annualizes to 7.8 percent, and increased 6.7 percent relative to a year earlier. The GDP of China increased at 1.7 percent in IIIQ2016, which annualizes at 7.0 percent, and increased 6.7 percent relative to a year earlier. The GDP of China increased at 1.6 percent in IVQ2016, which annualizes at 6.6 percent, and increased 6.8 percent relative to a year earlier. The GDP of China increased at 1.5 percent in IQ2017, which annualizes at 6.1 percent and increased 6.8 percent relative to a year earlier. China’s GDP increased at 1.8 percent in IIQ2017, which annualizes at 7.4 percent, and increased 6.8 percent relative to a year earlier. The GDP of China increased 1.7 percent in IIIQ2017, which annualizes at 7.0 percent, and increased 6.7 percent relative to a year earlier. China’s GDP increased at 1.5 percent in IVQ2017, which annualizes at 6.1 percent, and increased 6.7 percent relative to a year earlier. The GDP of China grew at 1.5 percent in IQ2018, which annualizes to 6.1 percent, and increased 6.8 percent relative to a year earlier. China’s GDP increased at 1.7 percent in IIQ2018, which annualizes at 7.0 percent, and increased 6.7 percent relative to a year earlier. The GDP of China grew at 1.6 percent in IIIQ2018, which annualizes to 6.6 percent, and increased 6.5 percent relative to a year earlier. China’s GDP increased 1.5 percent in IVQ2018, which annualized at 6.1 percent, and increased 6.4 percent relative to a year earlier. The GDP of China grew at 1.4 percent in IQ2019, which annualizes at 5.7 percent and increased 6.4 percent relative to a year earlier. China’s GDP increased 1.6 percent in IIQ2019, which annualized at 6.6 percent, and increased 6.2 percent relative to a year earlier. There was decennial change in leadership in China (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). Xi Jinping initiated a second term of leadership in Oct 2017 (http://news.xinhuanet.com/english/2017-10/25/c_136705344.htm). Growth rates of GDP of China in a quarter relative to the same quarter a year earlier have been declining from 2011 to 2019. Growth rates of GDP of China in a quarter relative to the same quarter a year earlier have been declining from 2011 to 2019. (https://cmpassocregulationblog.blogspot.com/2019/07/dollar-appreciation-in-anticipations-of.html and earlier https://cmpassocregulationblog.blogspot.com/2019/04/high-levels-of-valuations-of-risk.html and earlier https://cmpassocregulationblog.blogspot.com/2019/02/dollar-revaluation-with-increases-in.html and earlier https://cmpassocregulationblog.blogspot.com/2018/11/weaker-world-economic-growth-with.html and earlier https://cmpassocregulationblog.blogspot.com/2018/07/revision-of-united-states-national.html and earlier https://cmpassocregulationblog.blogspot.com/2018/04/dollar-appreciation-mediocre-cyclical.html and earlier https://cmpassocregulationblog.blogspot.com/2018/01/continuing-dollar-devaluation-mediocre.html and earlier

2. United States Economic Growth, Labor Markets and Budget/Debt Quagmire. (i) The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.3 percent on average in the cyclical expansion in the 40 quarters from IIIQ2009 to IIQ2019. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the first estimate of GDP for IIQ2019 (https://www.bea.gov/system/files/2019-07/gdp2q19_adv.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.8 percent obtained by dividing GDP of $15,557.3 billion in IIQ2010 by GDP of $15,134.1 billion in IIQ2009 {[($15,557.3/$15,134.1) -1]100 = 2.8%], or accumulating the quarter on quarter growth rates (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). The expansion from IQ1983 to IQ1986 was at the average annual growth rate of 5.7 percent, 5.3 percent from IQ1983 to IIIQ1986, 5.1 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987, 4.9 percent from IQ1983 to IIQ1988, 4.8 percent from IQ1983 to IIIQ1988, 4.8 percent from IQ1983 to IVQ1988, 4.8 percent from IQ1983 to IQ1989, 4.7 percent from IQ1983 to IIQ1989, 4.6 percent from IQ1983 to IIIQ1989, 4.5 percent from IQ1983 to IVQ1989. 4.5 percent from IQ1983 to IQ1990, 4.4 percent from IQ1983 to IIQ1990, 4.3 percent from IQ1983 to IIIQ1990, 4.0 percent from IQ1983 to IVQ1990, 3.8 percent from IQ1983 to IQ1991, 3.8 percent from IQ1983 to IIQ1991, 3.8 percent from IQ1983 to IIIQ1991, 3.7 percent from IQ1983 to IVQ1991, 3.7 percent from IQ1983 to IQ1992, 3.7 percent from IQ1983 to IIQ1992, 3.7 percent from IQ1983 to IIIQ2019, 3.8 percent from IQ1983 to IVQ1992 and at 7.9 percent from IQ1983 to IVQ1983 (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). The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (https://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (https://apps.bea.gov/iTable/index_nipa.cfm). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2019 would have accumulated to 40.5 percent. GDP in IIQ2019 would be $22,145.6 billion (in constant dollars of 2012) if the US had grown at trend, which is higher by $3121.8 billion than actual $19,023.8 billion. There are more than three trillion dollars of GDP less than at trend, explaining the 18.8 million unemployed or underemployed equivalent to actual unemployment/underemployment of 11.0 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2019/08/dollar-appreciation-contraction-of.html and earlier https://cmpassocregulationblog.blogspot.com/2019/07/twenty-million-unemployed-or.html). US GDP in IIQ2019 is 14.1 percent lower than at trend. US GDP grew from $15,762.0 billion in IVQ2007 in constant dollars to $19,023.8 billion in IIQ2019 or 20.7 percent at the average annual equivalent rate of 1.6 percent. Professor John H. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. Cochrane (2016May02) measures GDP growth in the US at average 3.5 percent per year from 1950 to 2000 and only at 1.76 percent per year from 2000 to 2015 with only at 2.0 percent annual equivalent in the current expansion. Cochrane (2016May02) proposes drastic changes in regulation and legal obstacles to private economic activity. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth of manufacturing at average 3.1 percent per year from Jun 1919 to Jun 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.

The GDP of Germany increased 0.3 percent in IQ2012 and increased 1.6 percent relative to a year earlier. In IIQ2012, Germany’s GDP increased 0.1 percent and increased 0.4 percent relative to a year earlier but 0.9 percent relative to a year earlier when adjusted for calendar effects (CA). In IIIQ2012, Germany’s GDP increased 0.3 percent and 0.2 percent relative to a year earlier. Germany’s GDP contracted 0.5 percent in IVQ2012 and decreased 0.1 percent relative to a year earlier. In IQ2013, Germany’s GDP decreased 0.3 percent and fell 1.5 percent relative to a year earlier. In IIQ2013, Germany’s GDP increased 0.9 percent and grew 0.9 percent relative to a year earlier. The GDP of Germany increased 0.6 percent in IIIQ2013 and grew 1.2 percent relative to a year earlier. In IVQ2013, Germany’s GDP increased 0.4 percent and increased 1.4 percent relative to a year earlier. The GDP of Germany increased 1.0 percent in IQ2014 and grew 3.2 percent relative to a year earlier. In IIQ2014, Germany’s GDP decreased 0.1 percent and increased 1.5 percent relative to a year earlier. The GDP of Germany increased 0.3 percent in IIIQ2014 and increased 1.7 percent relative to a year earlier. Germany’s GDP increased 1.0 percent in IVQ2014 and increased 2.4 percent relative to a year earlier. The GDP of Germany decreased 0.1 percent in IQ2015 and increased 1.3 percent relative to a year earlier. Germany’s GDP increased 0.6 percent in IIQ2015 and grew 1.8 percent relative to a year earlier. The GDP of Germany increased 0.3 percent in IIIQ2015 and grew 1.8 percent relative to a year earlier. Germany’s GDP increased 0.5 percent in IVQ2015 and grew 2.1 percent relative to a year earlier. In IQ2016, the GDP of Germany increased 0.9 percent and grew 2.0 percent relative to a year earlier. Germany’s GDP increased 0.4 percent in IIQ2016 and increased 3.7 percent relative to a year earlier. In IIIQ2016, the GDP of Germany increased 0.2 percent and grew 1.9 percent relative to a year earlier. Germany’s GDP increased 0.4 percent in IVQ2016 and grew 1.4 percent relative to a year earlier. In IQ2017, the GDP of Germany increased 1.1 percent and grew 3.4 percent relative to a year earlier. Germany’s GDP increased 0.5 percent in IIQ2017 and grew 0.9 percent relative to a year earlier and 2.2 percent relative to a year earlier adjusting for calendar effects (CA). In IIIQ2017, the GDP of Germany increased 0.6 percent and increased 2.2 percent relative to a year earlier and 2.6 percent relative to a year earlier (CA). Germany’s GDP increased 0.5 percent in IVQ2017, 2.2 percent relative to a year earlier and 2.8 percent relative to a year earlier (CA). The GDP of Germany increased 0.4 percent in IQ2018 and grew 1.4 percent relative to a year earlier and 2.1 percent relative to a year earlier (CA). Germany’s GDP increased 0.5 percent in IIQ2018, 2.3 percent relative to a year earlier and 2.0 relative to a year earlier (CA). The GDP of Germany decreased 0.2 percent in IIIQ2018, increasing 1.1 percent relative to a year earlier and 1.1 percent relative to a year earlier (CA). Germany’s GDP changed 0.0 percent in IVQ2018, increasing 0.9 percent relative to a year earlier and 0.6 relative to a year earlier (CA). The GDP of Germany increased 0.4 percent in IQ2019, increasing 0.6 percent relative to a year earlier and increasing 0.7 percent relative to a year earlier (CA).

In IQ2012, UK GDP increased 0.6 percent and increased 1.2 percent relative to a year earlier. In IIQ2012, GDP fell 0.1 percent relative to IQ2012 and increased 1.0 percent relative to a year earlier. In IIIQ2012, GDP increased 1.2 percent and increased 2.0 percent relative to the same quarter a year earlier. In IVQ2012, GDP fell 0.2 percent and increased 1.6 percent relative to a year earlier. Fiscal consolidation in an environment of weakening economic growth is much more challenging. GDP increased 1.6 percent in IQ2013 relative to a year earlier and 0.6 percent in IQ2013 relative to IVQ2012. In IIQ2013, GDP increased 0.5 percent and 2.2 percent relative to a year earlier. GDP increased 0.9 percent in IIIQ2013 and 1.9 percent relative to a year earlier. GDP increased 0.5 percent in IVQ2013 and 2.6 percent relative to a year earlier. In IQ2014, GDP increased 0.8 percent and 2.8 percent relative to a year earlier. GDP increased 0.8 percent in IIQ2014 and 3.1 percent relative to a year earlier. GDP increased 0.7 percent in IIIQ2014 and 2.9 percent relative to a year earlier. In IVQ2014, GDP increased 0.7 percent and 3.1 percent relative to a year earlier. GDP increased 0.4 percent in IQ2015 and increased 2.7 percent relative to a year earlier. GDP increased 0.6 percent in IIQ2015 and increased 2.4 percent relative to a year earlier. UK GDP increased 0.4 percent in IIIQ2015 and increased 2.1 percent relative to a year earlier. GDP increased 0.7 percent in IVQ2015 and increased 2.2 percent relative to a year earlier. GDP increased 0.3 percent in IQ2016 and increased 2.1 percent relative to a year earlier. GDP increased 0.2 percent in IIQ2016 and grew 1.7 percent relative to a year earlier. UK GDP increased 0.5 percent in IIIQ2016 and increased 1.7 percent relative to a year earlier. GDP increased 0.7 percent in IVQ2016 and increased 1.7 percent relative to a year earlier. UK GDP increased 0.4 percent in IQ2017 and increased 1.8 percent relative to a year earlier. GDP increased 0.3 percent in IIQ2017 and increased 1.9 percent relative to a year earlier. In IIIQ2017, GDP increased 0.5 percent and increased 2.0 percent relative to a year earlier. GDP increased 0.4 percent in IVQ2017 and increased 1.6 percent relative to a year earlier. In IQ2018, GDP increased 0.1 percent and increased 1.2 percent relative to a year earlier. GDP increased 0.4 percent in IIQ2018 and increased 1.4 percent relative to a year earlier. In IIIQ2018, GDP increased 0.7 percent and increased 1.6 percent relative to a year earlier. GDP increased 0.2 percent in IVQ2018 and increased 1.4 percent relative to a year earlier. In IQ2019, GDP increased 0.5 percent and increased 1.8 percent relative to a year earlier.

A list of financial uncertainties includes:

1. Euro Area Survival Risk. The resilience of the euro to fiscal and financial doubts on larger member countries is still an unknown risk. Adjustment programs consist of immediate adoption of economic reforms that would increase future growth permitting fiscal consolidation, which would reduce risk spreads on sovereign debt. Fiscal consolidation is challenging in an environment of weak economic growth as analyzed by Blanchard (2011WEOSep) and consolidation can restrict growth as analyzed by Blanchard (2012WEOApr). Adjustment of countries such as Italy requires depreciation of the currency to parity, as proposed by Caballero and Giavazzi (2012Jan15), but it is not workable within the common currency and zero interest rates in the US. Stronger members at the risk of impairing their own sovereign debt credibility cannot permanently provide bailouts of member countries of the euro area with temporary liquidity challenges. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times).

2. Foreign Exchange Wars. Exchange rate struggles continue as zero interest rates in advanced economies induce devaluation of their currencies. After deep global recession, regulation, trade and devaluation wars were to be expected (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 181): “There are significant grounds for concern on the basis of this experience. International economic cooperation and the international financial framework can collapse during extreme events. It is unlikely that there will be a repetition of the disaster of the Great Depression. However, a milder contraction can trigger regulatory, trade and exchange wars”

3. Valuation of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with weak volumes. For example, the DJIA has increased 171.4 percent since the trough of the sovereign debt crisis in Europe on Jul 9, 2010 to

A competing event is the high level of valuations of risk financial assets (https://cmpassocregulationblog.blogspot.com/2018/01/twenty-three-million-unemployed-or.html and earlier https://cmpassocregulationblog.blogspot.com/2017/12/twenty-one-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/unconventional-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2016/01/unconventional-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2015/01/peaking-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2014/01/theory-and-reality-of-secular.html). Matt Jarzemsky, writing on “Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 26,287.44 on Aug 9, 2019, which is higher by 85.6 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 85.1 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial assets have been approaching or exceeding historical highs. Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):

So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly” (emphasis added).

The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:

(M_t + B_t)/P_t = E_t∫(1/R_t_{, t+τ})s_t_+τdτ (1)

Equation (1) expresses the monetary, M_t, and debt, B_t, liabilities of the government, divided by the price level, P_t, in terms of the expected value discounted by the ex-post rate on government debt, R_t_{, t+τ}, of the future primary surpluses s_t_+τ, which are equal to T_t_+τ – G_t_+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post R_t_{, t+τ}. The present value of the firm can also be expressed as the discounted future value of net cash flows. Equities can inflate beyond sound values if cash flows that depend on economic activity prove to be illusory in continuing mediocre growth

4. Duration Trap of the Zero Bound. The yield of the US 10-year Treasury rose from 2.031 percent on Mar 9, 2012, to 2.294 percent on Mar 16, 2012. Considering a 10-year Treasury with coupon of 2.625 percent and maturity in exactly 10 years, the price would fall from 105.3512 corresponding to yield of 2.031 percent to 102.9428 corresponding to yield of 2.294 percent, for loss in a week of 2.3 percent but far more in a position with leverage of 10:1. Min Zeng, writing on “Treasurys fall, ending brutal quarter,” published on Mar 30, 2012, in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303816504577313400029412564.html?mod=WSJ_hps_sections_markets), informs that Treasury bonds maturing in more than 20 years lost 5.52 percent in the first quarter of 2012. Professor Ronald I. McKinnon (2013Oct27), writing on “Tapering without tears—how to end QE3,” on Oct 27, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304799404579153693500945608?KEYWORDS=Ronald+I+McKinnon), finds that the major central banks of the world have fallen into a “near-zero-interest-rate trap.” World economic conditions are weak such that exist from the zero interest rate trap could have adverse effects on production, investment and employment. The maintenance of interest rates near zero creates long-term near stagnation. The proposal of Professor McKinnon is credible, coordinated increase of policy interest rates toward 2 percent. Professor John B. Taylor at Stanford University, writing on “Economic failures cause political polarization,” on Oct 28, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303442004579121010753999086?KEYWORDS=John+B+Taylor), analyzes that excessive risks induced by near zero interest rates in 2003-2004 caused the financial crash. Monetary policy continued in similar paths during and after the global recession with resulting political polarization worldwide.

5. Credibility and Commitment of Central Bank Policy. There is a credibility issue of the commitment of monetary policy. The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):

“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

The FOMC changed the policy guidance in the statement of Mar 19, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140319a.htm):

“With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee's guidance does not indicate any change in the Committee's policy intentions as set forth in its recent statements.”

At its meeting on Jan 25, 2012, the FOMC began to provide to the public the specific forecasts of interest rates and other economic variables by FOMC members. These forecasts are analyzed in Section IV Global Inflation. Thomas J. Sargent and William L. Silber, writing on “The challenges of the Fed’s bid for transparency,” on Mar 20, published in the Financial Times (http://www.ft.com/intl/cms/s/0/778eb1ce-7288-11e1-9c23-00144feab49a.html#axzz1pexRlsiQ), analyze the costs and benefits of transparency by the Fed. In the analysis of Sargent and Silber (2012Mar20), benefits of transparency by the Fed will exceed costs if the Fed is successful in conveying to the public what policies would be implemented and how forcibly in the presence of unforeseen economic events. History has been unkind to policy commitments. The risk in this case is if the Fed would postpone adjustment because of political pressures as has occurred in the past or because of errors of evaluation and forecasting of economic and financial conditions. Both political pressures and errors abounded in the unhappy stagflation of the 1970s also known as the US Great Inflation (see http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB http://www.johnbtaylor.com/ http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html and earlier http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). The challenge of the Fed, in the view of Sargent and Silber (2012Mar20), is to convey to the public the need to deviate from the commitment to interest rates of zero to ¼ percent because conditions have changed instead of unwarranted inaction or policy changes. Errors have abounded such as a critical cause of the global recession pointed by Sargent and Silber (2012Mar20): “While no president is known to have explicitly pressurized Mr. Bernanke’s predecessor, Alan Greenspan, he found it easy to maintain low interest rates for too long, fueling the credit boom and housing bubble that led to the financial crisis in 2008.” Sargent and Silber (2012Mar20) also find need of commitment of fiscal authorities to consolidation required to attain sustainable path of debt.

The analysis by Kydland and Prescott (1977, 447-80, equation 5) uses the “expectation augmented” Phillips curve with the natural rate of unemployment of Friedman (1968) and Phelps (1968), which in the notation of Barro and Gordon (1983, 592, equation 1) is:

U_t = Uⁿ_t – α(π_t – π^e) α > 0 (1)

Where U_t is the rate of unemployment at current time t, Uⁿ_t is the natural rate of unemployment, π_t is the current rate of inflation and π^e is the expected rate of inflation by economic agents based on current information. Equation (1) expresses unemployment net of the natural rate of unemployment as a decreasing function of the gap between actual and expected rates of inflation. The system is completed by a social objective function, W, depending on inflation, π, and unemployment, U:

W = W(π_t, U_t) (2)

The policymaker maximizes the preferences of the public, (2), subject to the constraint of the tradeoff of inflation and unemployment, (1). The total differential of W set equal to zero provides an indifference map in the Cartesian plane with ordered pairs (π_t, U_t- Uⁿ) such that the consistent equilibrium is found at the tangency of an indifference curve and the Phillips curve in (1). The indifference curves are concave to the origin. The consistent policy is not optimal. Policymakers without discretionary powers following a rule of price stability would attain equilibrium with unemployment not higher than with the consistent policy. The optimal outcome is obtained by the rule of price stability, or zero inflation, and no more unemployment than under the consistent policy with nonzero inflation and the same unemployment. Taylor (1998LB) attributes the sustained boom of the US economy after the stagflation of the 1970s to following a monetary policy rule instead of discretion (see Taylor 1993, 1999).

6. Carry Trades. Commodity prices driven by zero interest rates could resume their increasing path. Some analytical aspects of the carry trade are instructive (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 101-5, Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 202-4), Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 70-4). Consider the following symbols: R_t is the exchange rate of a country receiving carry trade denoted in units of domestic currency per dollars at time t of initiation of the carry trade; R_t_+τ is the exchange of the country receiving carry trade denoted in units of domestic currency per dollars at time t+τ when the carry trade is unwound; i_f is the domestic interest rate of the high-yielding country where investment will be made; i_usd is the interest rate on short-term dollar debt assumed to be 0.5 percent per year; i_f >i_usd, which expresses the fact that the interest rate on the foreign country is much higher than that in short-term USD (US dollars); S_t is the dollar value of the investment principal; and π is the dollar profit from the carry trade. The investment of the principal S_t in the local currency debt of the foreign country provides a profit of:

π = (1 + i_f)(R_tS_t)(1/R_t_+τ) – (1 + i_usd)S_t (3)

The profit from the carry trade, π, is nonnegative when:

(1 + i_f)/ (1 + i_usd) ≥ R_t_+τ/R_t (4)

In words, the difference in interest rate differentials, left-hand side of inequality (4), must exceed the percentage devaluation of the currency of the host country of the carry trade, right hand side of inequality (4). The carry trade must earn enough in the host-country interest rate to compensate for depreciation of the host-country at the time of return to USD. A simple example explains the vulnerability of the carry trade in fixed-income. Let i_f be 0.10 (10 percent), i_usd 0.005 (0.5 percent), S_t USD100 and R_t CUR 1.00/USD. Adopt the fixed-income rule of months of 30 days and years of 360 days. Consider a strategy of investing USD 100 at 10 percent for 30 days with borrowing of USD 100 at 0.5 percent for 30 days. At time t, the USD 100 are converted into CUR 100 and invested at [(30/360)10] equal to 0.833 percent for thirty days. At the end of the 30 days, assume that the rate R_t₊₃₀ is still CUR 1/USD such that the return amount from the carry trade is USD 0.833. There is still a loan to be paid [(0.005)(30/360)USD100] equal to USD 0.042. The investor receives the net amount of USD 0.833 minus USD 0.042 or US 0.791. The rate of return on the investment of the USD 100 is 0.791 percent, which is equivalent to the annual rate of return of 9.49 percent {(0.791)(360/30)}. This is incomparably better than earning 0.5 percent. There are alternatives of hedging by buying forward the exchange for conversion back into USD.

Research by the Federal Reserve Bank of St. Louis finds that the dollar declined on average by 6.56 percent in the events of quantitative easing, ranging from depreciation of 10.8 percent relative to the Japanese yen to 3.6 percent relative to the pound sterling (http://research.stlouisfed.org/wp/2010/2010-018.pdf). A critical assumption of Rudiger Dornbusch (1976) in his celebrated analysis of overshooting (Rogoff 2002MF http://www.imf.org/external/np/speeches/2001/kr/112901.pdf) is “that exchange rates and asset markets adjust fast relative to goods markets” (Rudiger Dornbusch 1976, 1162). The market response of a monetary expansion is “to induce an immediate depreciation in the exchange rate and accounts therefore for fluctuations in the exchange rate and the terms of trade. During the adjustment process, rising prices may be accompanied by an appreciating exchange rate so that the trend behavior of exchange rates stands potentially in strong contrast with the cyclical behavior of exchange rates and prices” (Dornbusch 1976, 1162). The volatility of the exchange rate “is needed to temporarily equilibrate the system in response to monetary shocks, because underlying national prices adjust so slowly” (Rogoff 2002MF http://www.imf.org/external/np/speeches/2001/kr/112901.pdf 3). The exchange rate “is identified as a critical channel for the transmission of monetary policy to aggregate demand for domestic output” (Dornbusch 1976, 1162).

In a world of exchange wars, depreciation of the host-country currency can move even faster such that the profits from the carry trade may become major losses. Depreciation is the percentage change in instants against which the interest rate of a day is in the example [(10)(1/360)] or 0.03 percent. Exchange rates move much faster in the real world as in the overshooting model of Dornbusch (1976). Profits in carry trades have greater risks but equally greater returns when the short position in zero interest rates, or borrowing, and on the dollar, are matched with truly agile financial risk assets such as commodities and equities. A simplified analysis could consider the portfolio balance equations A_ij = f(r, x) where A_ij is the demand for i = 1,2,∙∙∙n assets from j = 1,2, ∙∙∙m sectors, r the 1xn vector of rates of return, r_i, of n assets and x a vector of other relevant variables. Tobin (1969) and Brunner and Meltzer (1973) assume imperfect substitution among capital assets such that the own first derivatives of A_ij are positive, demand for an asset increases if its rate of return (interest plus capital gains) is higher, and cross first derivatives are negative, demand for an asset decreases if the rate of return of alternative assets increases. Theoretical purity would require the estimation of the complete model with all rates of return. In practice, it may be impossible to observe all rates of return such as in the critique of Roll (1976). Policy proposals and measures by the Fed have been focused on the likely impact of withdrawals of stocks of securities in specific segments, that is, of effects of one or several specific rates of return among the n possible rates. In fact, the central bank cannot influence investors and arbitrageurs to allocate funds to assets of desired categories such as asset-backed securities that would lower the costs of borrowing for mortgages and consumer loans. Floods of cheap money may simply induce carry trades in arbitrage of opportunities in fast moving assets such as currencies, commodities and equities instead of much lower returns in fixed income securities (see http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html).

The major reason and channel of transmission of unconventional monetary policy is through expectations of inflation. Fisher (1930) provided theoretical and historical relation of interest rates and inflation. Let i_n be the nominal interest rate, i_r the real or inflation-adjusted interest rate and π^e the expectation of inflation in the time term of the interest rate, which are all expressed as proportions. The following expression provides the relation of real and nominal interest rates and the expectation of inflation:

(1 + i_r) = (1 + i_n)/(1 + π^e) (1)

That is, the real interest rate equals the nominal interest rate discounted by the expectation of inflation in time term of the interest rate. Fisher (1933) analyzed the devastating effect of deflation on debts. Nominal debt contracts remained at original principal interest but net worth and income of debtors contracted during deflation. Real interest rates increase during declining inflation. For example, if the interest rate is 3 percent and prices decline 0.2 percent, equation (1) calculates the real interest rate as:

(1 +0.03)/(1 – 0.02) = 1.03/(0.998) = 1.032

That is, the real rate of interest is (1.032 – 1)100 or 3.2 percent. If inflation were 2 percent, the real rate of interest would be 0.98 percent, or about 1.0 percent {[(1.03/1.02) -1]100 = 0.98%}.

The yield of the one-year Treasury security was quoted in the Wall Street Journal at 0.114 percent on Fri May 17, 2013 (http://online.wsj.com/mdc/page/marketsdata.html?mod=WSJ_topnav_marketdata_main) The expected rate of inflation π^e in the next twelve months is not observed. Assume that it would be equal to the rate of inflation in the past twelve months estimated by the Bureau of Economic Analysis (BLS) at 1.1 percent (http://www.bls.gov/cpi/). The real rate of interest would be obtained as follows:

(1 + 0.00114)/(1 + 0.011) = (1 + r_r) = 0.9902

That is, i_r is equal to 1 – 0.9902 or minus 0.98 percent. Investing in a one-year Treasury security results in a loss of 0.98 percent relative to inflation. The objective of unconventional monetary policy of zero interest rates is to induce consumption and investment because of the loss to inflation of riskless financial assets. Policy would be truly irresponsible if it intended to increase inflationary expectations or π^e. The result could be the same rate of unemployment with higher inflation (Kydland and Prescott 1977).

Focus is shifting from tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 1½ to 1¾ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Markets overreacted to the so-called “paring” of outright purchases to $15 billion of securities per month for the balance sheet of the Fed.

In the Semiannual Monetary Policy Report to Congress on Feb 24, 2015, Chair Yellen analyzes the timing of interest rate increases (http://www.federalreserve.gov/newsevents/testimony/yellen20150224a.htm):

“The FOMC's assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee's judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting. Provided that labor market conditions continue to improve and further improvement is expected, the Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when, on the basis of incoming data, the Committee is reasonably confident that inflation will move back over the medium term toward our 2 percent objective.”

What is truly important is the fixing of the overnight fed funds at 2 to 2¼ percent with all measures depending on “a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190731a.htm): “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments” (emphasis added). The “outlook is uncertain”: “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. This action supports the Committee's view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190731a.htm) In the Opening Remarks to the Press Conference on Jan 30, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190130.pdf): “Today, the FOMC decided that the cumulative effects of those developments over the last several months warrant a patient, wait-and-see approach regarding future policy changes. In particular, our statement today says, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near … 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook. In addition, the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to push headline inflation lower still in coming months. Further, as we noted in our post-meeting statement, while survey-based measures of inflation expectations have been stable, financial market measures of inflation compensation have moved lower. Similarly, the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms. In this environment, we believe we can best support the economy by being patient in evaluating the outlook before making any future adjustment to policy.” The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm) with significant changes (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf). In the opening remarks to the Mar 20, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf): “In discussing the Committee’s projections, it is useful to note what those projections are, as well as what they are not. The SEP includes participants’ individual projections of the most likely economic scenario along with their views of the appropriate path of the federal funds rate in that scenario. Views about the most likely scenario form one input into our policy discussions. We also discuss other plausible scenarios, including the risk of more worrisome outcomes. These and other scenarios and many other considerations go into policy, but are not reflected in projections of the most likely case. Thus, we always emphasize that the interest rate projections in the SEP are not a Committee decision. They are not a Committee plan. As Chair Yellen noted some years ago, the FOMC statement, rather than the dot plot, is the device that the Committee uses to express its opinions about the likely path of rates.” In the Introductory Statement on Jul 25, 2019, in Frankfurt am Main, the President of the European Central Bank, Mario Draghi, stated (https://www.ecb.europa.eu/press/pressconf/2019/html/ecb.is190725~547f29c369.en.html): “Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. We expect them to remain at their present or lower levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to our aim over the medium term.

We intend to continue reinvesting, in full, the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.”

At the press conference following the meeting on Mar 19, 2014, Chair Yellen answered a question of Jon Hilsenrath of the Wall Street Journal explaining “In particular, the Committee has endorsed the view that it anticipates that will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates. And of course on our present path, well, that's not utterly preset. We would be looking at next, next fall. So, I think that's important guidance” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140319.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”

At the press conference following the meeting on Dec 17, 2014, Chair Yellen answered a question by Jon Hilseranth of the Wall Street Journal explaining “patience” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20141217.pdf):

“So I did say that this statement that the committee can be patient should be interpreted as meaning that it is unlikely to begin the normalization process, for at least the next couple of meetings. Now that doesn't point to any preset or predetermined time at which normalization is -- will begin. There are a range of views on the committee, and it will be dependent on how incoming data bears on the progress, the economy is making. First of all, I want to emphasize that no meeting is completely off the table in the sense that if we do see faster progress toward our objectives than we currently expect, then it is possible that the process of normalization would occur sooner than we now anticipated. And of course the converse is also true. So at this point, we think it unlikely that it will be appropriate, that we will see conditions for at least the next couple of meetings that will make it appropriate for us to decide to begin normalization. A number of committee participants have indicated that in their view, conditions could be appropriate by the middle of next year. But there is no preset time.”

At a speech on Mar 31, 2014, Chair Yellen analyzed labor market conditions as follows (http://www.federalreserve.gov/newsevents/speech/yellen20140331a.htm):

“And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress. The first of those goals is maximum sustainable employment, the highest level of employment that can be sustained while maintaining a stable inflation rate. Most of my colleagues on the Federal Open Market Committee and I estimate that the unemployment rate consistent with maximum sustainable employment is now between 5.2 percent and 5.6 percent, well below the 6.7 percent rate in February.

Let me explain what I mean by that word "slack" and why it is so important.

Slack means that there are significantly more people willing and capable of filling a job than there are jobs for them to fill. During a period of little or no slack, there still may be vacant jobs and people who want to work, but a large share of those willing to work lack the skills or are otherwise not well suited for the jobs that are available. With 6.7 percent unemployment, it might seem that there must be a lot of slack in the U.S. economy, but there are reasons why that may not be true.”

Yellen (2014Aug22) provides comprehensive review of the theory and measurement of labor markets. Monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”

Yellen (2014Aug22) finds that the unemployment rate is not sufficient in determining slack:

“One convenient way to summarize the information contained in a large number of indicators is through the use of so-called factor models. Following this methodology, Federal Reserve Board staff developed a labor market conditions index from 19 labor market indicators, including four I just discussed. This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.”

Yellen (2014Aug22) restates that the FOMC determines monetary policy on newly available information and interpretation of labor markets and inflation and does not follow a preset path:

“But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter. Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate. As I have noted many times, monetary policy is not on a preset path. The Committee will be closely monitoring incoming information on the labor market and inflation in determining the appropriate stance of monetary policy.”

The minutes of the meeting of the Federal Open Market Committee (FOMC) on Sep 16-17, 2014, reveal concern with global economic conditions (http://www.federalreserve.gov/monetarypolicy/fomcminutes20140917.htm):

“Most viewed the risks to the outlook for economic activity and the labor market as broadly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.”

There is similar concern in the minutes of the meeting of the FOMC on Dec 16-17, 2014 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20141217.htm):

“In their discussion of the foreign economic outlook, participants noted that the implications of the drop in crude oil prices would differ across regions, especially if the price declines affected inflation expectations and financial markets; a few participants said that the effect on overseas employment and output as a whole was likely to be positive. While some participants had lowered their assessments of the prospects for global economic growth, several noted that the likelihood of further responses by policymakers abroad had increased. Several participants indicated that they expected slower economic growth abroad to negatively affect the U.S. economy, principally through lower net exports, but the net effect of lower oil prices on U.S. economic activity was anticipated to be positive.”

Chair Yellen analyzes the view of inflation (http://www.federalreserve.gov/newsevents/speech/yellen20140416a.htm):

“Inflation, as measured by the price index for personal consumption expenditures, has slowed from an annual rate of about 2-1/2 percent in early 2012 to less than 1 percent in February of this year. This rate is well below the Committee's 2 percent longer-run objective. Many advanced economies are observing a similar softness in inflation.

To some extent, the low rate of inflation seems due to influences that are likely to be temporary, including a deceleration in consumer energy prices and outright declines in core import prices in recent quarters. Longer-run inflation expectations have remained remarkably steady, however. We anticipate that, as the effects of transitory factors subside and as labor market gains continue, inflation will gradually move back toward 2 percent.”

There is a critical phrase in the statement of Sep 19, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm): “but mortgage rates have risen further.” Did the increase of mortgage rates influence the decision of the FOMC not to taper? Is FOMC “communication” and “guidance” successful? Will the FOMC increase purchases of mortgage-backed securities if mortgage rates increase?

At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states needs and intentions of policy:

“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time.

For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”

The President of the ECB Mario Draghi stated in a speech at the conference “The ECB and its Watchers XX,” in Frankfurt am Main, on Mar 27, 2019 (https://www.ecb.europa.eu/press/key/date/2019/html/ecb.sp190327~2b454e4326.en.html): “We will continue monitoring how banks can maintain healthy earning conditions while net interest margins are compressed. And, if necessary, we need to reflect on possible measures that can preserve the favourable implications of negative rates for the economy, while mitigating the side effects, if any. That said, low bank profitability is not an inevitable consequence of negative rates. ECB analysis finds that the best-performing banks in the euro area in terms of return on equity between 2009 and 2017 share three key features: they have been able to significantly reduce their cost-to-income ratios; they have embarked on large-scale investments in information technology; and they have been able to diversify their revenue sources in a low interest rate environment.” Tom Fairless and Brian Blackstone, “ECB’s Draghi hints at drawbacks of negative rates,” Wall Street Journal, Mar 27, 2019, argue that while negative interest rates may encourage spending and investing they create adverse effects such as banks paying for reserves and holders of government bonds paying to hold them such as the current negative yields of ten-year bonds of Germany. Extremely low interest rates also encouraged artificial booms in real estate, which was one of the causes of the financial crisis and global recession (Taylor 2018Nov20, 3-4). Unconventional monetary policy of extremely low interest rates and bloated central bank balance sheet is almost impossible to reverse without causing financial crisis and recession.

In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):

“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differ from each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”

Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and r^e the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+r^e). Thus, g = [(r/r^e) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dr^e>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (10

Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.

The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). There is currently population growth in the ages of 16 to 24 years but not enough job creation and discouragement of job searches for all ages (Section I and earlier https://cmpassocregulationblog.blogspot.com/2019/07/fomc-uncertain-outlook-frank-h-knights.html). This is merely another case of theory without reality with dubious policy proposals. The current reality is cyclical slow growth.

Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σ_y and prices σ_p. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html and earlier http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). If there were an infallible science of central banking, models and forecasts would provide accurate information to policymakers on the future course of the economy in advance. Such forewarning is essential to central bank science because of the long lag between the actual impulse of monetary policy and the actual full effects on income and prices many months and even years ahead (Romer and Romer 2004, Friedman 1961, 1953, Culbertson 1960, 1961, Batini and Nelson 2002). The transcripts of the Fed meetings in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm) analyzed by Jon Hilsenrath demonstrate that Fed policymakers frequently did not understand the current state of the US economy in 2008 and much less the direction of income and prices. The conclusion of Friedman (1953) is that monetary impulses increase financial and economic instability because of lags in anticipating needs of policy, taking policy decisions and effects of decisions. This is a fortiori true when untested unconventional monetary policy in gargantuan doses shocks the economy and financial markets. What is truly important is the fixing of the overnight fed funds at 2 to 2¼ percent with all measures depending on “a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190731a.htm): “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments” (emphasis added). The “outlook is uncertain”: “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. This action supports the Committee's view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190731a.htm) In the Opening Remarks to the Press Conference on Jan 30, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190130.pdf): “Today, the FOMC decided that the cumulative effects of those developments over the last several months warrant a patient, wait-and-see approach regarding future policy changes. In particular, our statement today says, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near … 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook. In addition, the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to push headline inflation lower still in coming months. Further, as we noted in our post-meeting statement, while survey-based measures of inflation expectations have been stable, financial market measures of inflation compensation have moved lower. Similarly, the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms. In this environment, we believe we can best support the economy by being patient in evaluating the outlook before making any future adjustment to policy.” The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm) with significant changes (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf). In the opening remarks to the Mar 20, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf): “In discussing the Committee’s projections, it is useful to note what those projections are, as well as what they are not. The SEP includes participants’ individual projections of the most likely economic scenario along with their views of the appropriate path of the federal funds rate in that scenario. Views about the most likely scenario form one input into our policy discussions. We also discuss other plausible scenarios, including the risk of more worrisome outcomes. These and other scenarios and many other considerations go into policy, but are not reflected in projections of the most likely case. Thus, we always emphasize that the interest rate projections in the SEP are not a Committee decision. They are not a Committee plan. As Chair Yellen noted some years ago, the FOMC statement, rather than the dot plot, is the device that the Committee uses to express its opinions about the likely path of rates.” In the Introductory Statement on Jul 25, 2019, in Frankfurt am Main, the President of the European Central Bank, Mario Draghi, stated (https://www.ecb.europa.eu/press/pressconf/2019/html/ecb.is190725~547f29c369.en.html): “Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. We expect them to remain at their present or lower levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to our aim over the medium term.

Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):

In a speech at the IMF on Jul 2, 2014, Chair Yellen analyzed the link between monetary policy and financial risks (http://www.federalreserve.gov/newsevents/speech/yellen20140702a.htm):

“Monetary policy has powerful effects on risk taking. Indeed, the accommodative policy stance of recent years has supported the recovery, in part, by providing increased incentives for households and businesses to take on the risk of potentially productive investments. But such risk-taking can go too far, thereby contributing to fragility in the financial system. This possibility does not obviate the need for monetary policy to focus primarily on price stability and full employment--the costs to society in terms of deviations from price stability and full employment that would arise would likely be significant. In the private sector, key vulnerabilities included high levels of leverage, excessive dependence on unstable short-term funding, weak underwriting of loans, deficiencies in risk measurement and risk management, and the use of exotic financial instruments that redistributed risk in nontransparent ways.”

Yellen (2014Jul14) warned again at the Committee on Banking, Housing and Urban Affairs on Jul 15, 2014:

“The Committee recognizes that low interest rates may provide incentives for some investors to “reach for yield,” and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance. More broadly, the financial sector has continued to become more resilient, as banks have continued to boost their capital and liquidity positions, and growth in wholesale short-term funding in financial markets has been modest” (emphasis added).

Greenspan (1996) made similar warnings:

“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy” (emphasis added).

Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. What is the success in evaluating deviations of valuations of risk financial assets from “historical norms”? What are the consequences on economic activity and employment of deviations of valuations of risk financial assets from those “historical norms”? What are the policy tools and their effectiveness in returning valuations of risk financial assets to their “historical norms”?

The key policy is maintaining fed funds rate between 2¼ and 2½ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.

The Communiqué of the Istanbul meeting of G20 Finance Ministers and Central Bank Governors on February 10, 2015, sanctions the need of unconventional monetary policy with warning on collateral effects (http://www.g20.utoronto.ca/2015/150210-finance.html):

“We agree that consistent with central banks' mandates, current economic conditions require accommodative monetary policies in some economies. In this regard, we welcome that central banks take appropriate monetary policy action. The recent policy decision by the ECB aims at fulfilling its price stability mandate, and will further support the recovery in the euro area. We also note that some advanced economies with stronger growth prospects are moving closer to conditions that would allow for policy normalization. In an environment of diverging monetary policy settings and rising financial market volatility, policy settings should be carefully calibrated and clearly communicated to minimize negative spillovers.”

Professor Raguram G Rajan, former governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation. Rajan (2005) anticipated the risks of the world financial crisis. Professor John B. Taylor (2014Jul15, 2014Jun26) building on advanced research (Taylor 2007, 2008Nov, 2009, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB, 2015, 2012 Oct 25; 2013Oct28, 2014 Jan01, 2014Jan3, 2014Jun26, 2014Jul15, 2015, 2016Dec7, 2016Dec20 http://www.johnbtaylor.com/) finds that a monetary policy rule would function best in promoting an environment of low inflation and strong economic growth with stability of financial markets. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html and earlier http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html).

Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.

Dan Strumpf and Pedro Nicolaci da Costa, writing on “Fed’s Yellen: Stock Valuations ‘Generally are Quite High,’” on May 6, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/feds-yellen-cites-progress-on-bank-regulation-1430918155?tesla=y ), quote Chair Yellen at open conversation with Christine Lagarde, Managing Director of the IMF, finding “equity-market valuations” as “quite high” with “potential dangers” in bond valuations. The DJIA fell 0.5 percent on May 6, 2015, after the comments and then increased 0.5 percent on May 7, 2015 and 1.5 percent on May 8, 2015.

Fri May 1

Mon 4

Tue 5

Wed 6

Thu 7

Fri 8

DJIA

18024.06

-0.3%

1.0%

18070.40

0.3%

17928.20

-0.5%

-0.8%

17841.98

-1.0%

-0.5%

17924.06

-0.6%

0.5%

18191.11

0.9%

1.5%

There are two approaches in theory considered by Bordo (2012Nov20) and Bordo and Lane (2013). The first approach is in the classical works of Milton Friedman and Anna Jacobson Schwartz (1963a, 1987) and Karl Brunner and Allan H. Meltzer (1973). There is a similar approach in Tobin (1969). Friedman and Schwartz (1963a, 66) trace the effects of expansionary monetary policy into increasing initially financial asset prices: “It seems plausible that both nonbank and bank holders of redundant balances will turn first to securities comparable to those they have sold, say, fixed-interest coupon, low-risk obligations. But as they seek to purchase these they will tend to bid up the prices of those issues. Hence they, and also other holders not involved in the initial central bank open-market transactions, will look farther afield: the banks, to their loans; the nonbank holders, to other categories of securities-higher risk fixed-coupon obligations, equities, real property, and so forth.”

The second approach is by the Austrian School arguing that increases in asset prices can become bubbles if monetary policy allows their financing with bank credit. Professor Michael D. Bordo provides clear thought and empirical evidence on the role of “expansionary monetary policy” in inflating asset prices (Bordo2012Nov20, Bordo and Lane 2013). Bordo and Lane (2013) provide revealing narrative of historical episodes of expansionary monetary policy. Bordo and Lane (2013) conclude that policies of depressing interest rates below the target rate or growth of money above the target influences higher asset prices, using a panel of 18 OECD countries from 1920 to 2011. Bordo (2012Nov20) concludes: “that expansionary money is a significant trigger” and “central banks should follow stable monetary policies…based on well understood and credible monetary rules.” Taylor (2007, 2009) explains the housing boom and financial crisis in terms of expansionary monetary policy. Professor Martin Feldstein (2016), at Harvard University, writing on “A Federal Reserve oblivious to its effects on financial markets,” on Jan 13, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/a-federal-reserve-oblivious-to-its-effect-on-financial-markets-1452729166), analyzes how unconventional monetary policy drove values of risk financial assets to high levels. Quantitative easing and zero interest rates distorted calculation of risks with resulting vulnerabilities in financial markets.

Another hurdle of exit from zero interest rates is “competitive easing” that Professor Raghuram Rajan, governor of the Reserve Bank of India, characterizes as disguised “competitive devaluation” (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). The fed has been considering increasing interest rates. The European Central Bank (ECB) announced, on Mar 5, 2015, the beginning on Mar 9, 2015 of its quantitative easing program denominated as Public Sector Purchase Program (PSPP), consisting of “combined monthly purchases of EUR 60 bn [billion] in public and private sector securities” (http://www.ecb.europa.eu/mopo/liq/html/pspp.en.html). Expectation of increasing interest rates in the US together with euro rates close to zero or negative cause revaluation of the dollar (or devaluation of the euro and of most currencies worldwide). US corporations suffer currency translation losses of their foreign transactions and investments (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318) while the US becomes less competitive in world trade (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), Government Intervention in Globalization (2008c)). The DJIA fell 1.5 percent on Mar 6, 2015 and the dollar revalued 2.2 percent from Mar 5 to Mar 6, 2015. The euro has devalued 42.0 percent relative to the dollar from the high on Jul 15, 2008 to Aug 9, 2019.

Fri 27 Feb

Mon 3/2

Tue 3/3

Wed 3/4

Thu 3/5

Fri 3/6

USD/ EUR

1.1197

1.6%

0.0%

1.1185

0.1%

1.1176

0.2%

0.1%

1.1081

1.0%

0.9%

1.1030

1.5%

0.5%

1.0843

3.2%

1.7%

Chair Yellen explained the removal of the word “patience” from the advanced guidance at the press conference following the FOMC meeting on Mar 18, 2015 (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20150318.pdf):

“In other words, just because we removed the word “patient” from the statement doesn’t mean we are going to be impatient. Moreover, even after the initial increase in the target funds rate, our policy is likely to remain highly accommodative to support continued progress toward our objectives of maximum employment and 2 percent inflation.”

Exchange rate volatility is increasing in response of “impatience” in financial markets with monetary policy guidance and measures:

Fri Mar 6

Mon 9

Tue 10

Wed 11

Thu 12

Fri 13

USD/ EUR

1.0843

3.2%

1.7%

1.0853

-0.1%

1.0700

1.3%

1.4%

1.0548

2.7%

1.4%

1.0637

1.9%

-0.8%

1.0497

3.2%

1.3%

Fri Mar 13

Mon 16

Tue 17

Wed 18

Thu 19

Fri 20

USD/ EUR

1.0497

3.2%

1.3%

1.0570

-0.7%

1.0598

-1.0%

-0.3%

1.0864

-3.5%

-2.5%

1.0661

-1.6%

1.9%

1.0821

-3.1%

-1.5%

Fri Apr 24

Mon 27

Tue 28

Wed 29

Thu 30

May Fri 1

USD/ EUR

1.0874

-0.6%

-0.4%

1.0891

-0.2%

1.0983

-1.0%

-0.8%

1.1130

-2.4%

-1.3%

1.1223

-3.2%

-0.8%

1.1199

-3.0%

0.2%

In a speech at Brown University on May 22, 2015, Chair Yellen stated (http://www.federalreserve.gov/newsevents/speech/yellen20150522a.htm):

“For this reason, if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalizing monetary policy. To support taking this step, however, I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium term. After we begin raising the federal funds rate, I anticipate that the pace of normalization is likely to be gradual. The various headwinds that are still restraining the economy, as I said, will likely take some time to fully abate, and the pace of that improvement is highly uncertain.”

The US dollar appreciated 3.8 percent relative to the euro in the week of May 22, 2015:

Fri May 15

Mon 18

Tue 19

Wed 20

Thu 21

Fri 22

USD/ EUR

1.1449

-2.2%

-0.3%

1.1317

1.2%

1.1150

2.6%

1.5%

1.1096

3.1%

0.5%

1.1113

2.9%

-0.2%

1.1015

3.8%

0.9%

The Managing Director of the International Monetary Fund (IMF), Christine Lagarde, warned on Jun 4, 2015, that: (http://blog-imfdirect.imf.org/2015/06/04/u-s-economy-returning-to-growth-but-pockets-of-vulnerability/):

“The Fed’s first rate increase in almost 9 years is being carefully prepared and telegraphed. Nevertheless, regardless of the timing, higher US policy rates could still result in significant market volatility with financial stability consequences that go well beyond US borders. I weighing these risks, we think there is a case for waiting to raise rates until there are more tangible signs of wage or price inflation than are currently evident. Even after the first rate increase, a gradual rise in the federal fund rates will likely be appropriate.”

The President of the European Central Bank (ECB), Mario Draghi, warned on Jun 3, 2015 that (http://www.ecb.europa.eu/press/pressconf/2015/html/is150603.en.html):

“But certainly one lesson is that we should get used to periods of higher volatility. At very low levels of interest rates, asset prices tend to show higher volatility…the Governing Council was unanimous in its assessment that we should look through these developments and maintain a steady monetary policy stance.”

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).

At the press conference after the meeting of the FOMC on Sep 17, 2015, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20150917.pdf 4):

“The outlook abroad appears to have become more uncertain of late, and heightened concerns about growth in China and other emerging market economies have led to notable volatility in financial markets. Developments since our July meeting, including the drop in equity prices, the further appreciation of the dollar, and a widening in risk spreads, have tightened overall financial conditions to some extent. These developments may restrain U.S. economic activity somewhat and are likely to put further downward pressure on inflation in the near term. Given the significant economic and financial interconnections between the United States and the rest of the world, the situation abroad bears close watching.”

Some equity markets fell on Fri Sep 18, 2015:

Fri Sep 11

Mon 14

Tue 15

Wed 16

Thu 17

Fri 18

DJIA

16433.09

2.1%

0.6%

16370.96

-0.4%

16599.85

1.0%

1.4%

16739.95

1.9%

0.8%

16674.74

1.5%

-0.4%

16384.58

-0.3%

-1.7%

Nikkei 225

18264.22

2.7%

-0.2%

17965.70

-1.6%

18026.48

-1.3%

0.3%

18171.60

-0.5%

0.8%

18432.27

0.9%

1.4%

18070.21

-1.1%

-2.0%

DAX

10123.56

0.9%

-0.9%

10131.74

0.1%

10188.13

0.6%

10227.21

1.0%

0.4%

10229.58

1.0%

0.0%

9916.16

-2.0%

-3.1%

Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. Chair Yellen, in a lecture on “Inflation dynamics and monetary policy,” on Sep 24, 2015 (http://www.federalreserve.gov/newsevents/speech/yellen20150924a.htm), states that (emphasis added):

· “The economic outlook, of course, is highly uncertain”

· “Considerable uncertainties also surround the outlook for economic activity”

· “Given the highly uncertain nature of the outlook…”

Is there a “science” or even “art” of central banking under this extreme uncertainty in which policy does not generate higher volatility of money, income, prices and values of financial assets?

Lingling Wei, writing on Oct 23, 2015, on China’s central bank moves to spur economic growth,” published in the Wall Street Journal (http://www.wsj.com/articles/chinas-central-bank-cuts-rates-1445601495), analyzes the reduction by the People’s Bank of China (http://www.pbc.gov.cn/ http://www.pbc.gov.cn/english/130437/index.html) of borrowing and lending rates of banks by 50 basis points and reserve requirements of banks by 50 basis points. Paul Vigna, writing on Oct 23, 2015, on “Stocks rally out of correction territory on latest central bank boost,” published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2015/10/23/stocks-rally-out-of-correction-territory-on-latest-central-bank-boost/), analyzes the rally in financial markets following the statement on Oct 22, 2015, by the President of the European Central Bank (ECB) Mario Draghi of consideration of new quantitative measures in Dec 2015 (https://www.youtube.com/watch?v=0814riKW25k&rel=0) and the reduction of bank lending/deposit rates and reserve requirements of banks by the People’s Bank of China on Oct 23, 2015. The dollar revalued 2.8 percent from Oct 21 to Oct 23, 2015, following the intended easing of the European Central Bank. The DJIA rose 2.8 percent from Oct 21 to Oct 23 and the DAX index of German equities rose 5.4 percent from Oct 21 to Oct 23, 2015.

Fri Oct 16

Mon 19

Tue 20

Wed 21

Thu 22

Fri 23

USD/ EUR

1.1350

0.1%

0.3%

1.1327

0.2%

1.1348

0.0%

-0.2%

1.1340

0.1%

1.1110

2.1%

2.0%

1.1018

2.9%

0.8%

DJIA

17215.97

0.8%

0.4%

17230.54

0.1%

17217.11

0.0%

-0.1%

17168.61

-0.3%

17489.16

1.6%

1.9%

17646.70

2.5%

0.9%

Dow Global

2421.58

0.3%

0.6%

2414.33

-0.3%

2411.03

-0.4%

-0.1%

2411.27

-0.4%

0.0%

2434.79

0.5%

1.0%

2458.13

1.5%

1.0%

DJ Asia Pacific

1402.31

1.1%

0.3%

1398.80

-0.3%

1395.06

-0.5%

-0.3%

1402.68

0.0%

0.5%

1396.03

-0.4%

-0.5%

1415.50

0.9%

1.4%

Nikkei 225

18291.80

-0.8%

1.1%

18131.23

-0.9%

18207.15

-0.5%

0.4%

18554.28

1.4%

1.9%

18435.87

0.8%

-0.6%

18825.30

2.9%

2.1%

Shanghai

3391.35

6.5%

1.6%

3386.70

-0.1%

3425.33

1.0%

1.1%

3320.68

-2.1%

-3.1%

3368.74

-0.7%

1.4%

3412.43

0.6%

1.3%

DAX

10104.43

0.1%

0.4%

10164.31

0.6%

10147.68

0.4%

-0.2%

10238.10

1.3%

0.9%

10491.97

3.8%

2.5%

10794.54

6.8%

2.9%

Ben Leubsdorf, writing on “Fed’s Yellen: December is “Live Possibility” for First Rate Increase,” on Nov 4, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/feds-yellen-december-is-live-possibility-for-first-rate-increase-1446654282) quotes Chair Yellen that a rate increase in “December would be a live possibility.” The remark of Chair Yellen was during a hearing on supervision and regulation before the Committee on Financial Services, US House of Representatives (http://www.federalreserve.gov/newsevents/testimony/yellen20151104a.htm) and a day before the release of the employment situation report for Oct 2015 (Section I). The dollar revalued 2.4 percent during the week. The euro has devalued 42.0 percent relative to the dollar from the high on Jul 15, 2008 to Aug 9, 2019.

Fri Oct 30

Mon 2

Tue 3

Wed 4

Thu 5

Fri 6

USD/ EUR

1.1007

0.1%

-0.3%

1.1016

-0.1%

1.0965

0.4%

0.5%

1.0867

1.3%

0.9%

1.0884

1.1%

-0.2%

1.0742

2.4%

1.3%

The release on Nov 18, 2015 of the minutes of the FOMC (Federal Open Market Committee) meeting held on Oct 28, 2015 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20151028.htm) states:

“Most participants anticipated that, based on their assessment of the current economic situation and their outlook for economic activity, the labor market, and inflation, these conditions [for interest rate increase] could well be met by the time of the next meeting. Nonetheless, they emphasized that the actual decision would depend on the implications for the medium-term economic outlook of the data received over the upcoming intermeeting period… It was noted that beginning the normalization process relatively soon would make it more likely that the policy trajectory after liftoff could be shallow.”

Markets could have interpreted a symbolic increase in the fed funds rate at the meeting of the FOMC on Dec 15-16, 2015 (http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm) followed by “shallow” increases, explaining the sharp increase in stock market values and appreciation of the dollar after the release of the minutes on Nov 18, 2015:

Fri Nov 13

Mon 16

Tue 17

Wed 18

Thu 19

Fri 20

USD/ EUR

1.0774

-0.3%

0.4%

1.0686

0.8%

1.0644

1.2%

0.4%

1.0660

1.1%

-0.2%

1.0735

0.4%

-0.7%

1.0647

1.2%

0.8%

DJIA

17245.24

-3.7%

-1.2%

17483.01

1.4%

17489.50

1.4%

0.0%

17737.16

2.9%

1.4%

17732.75

2.8%

0.0%

17823.81

3.4%

0.5%

DAX

10708.40

-2.5%

-0.7%

10713.23

0.0%

10971.04

2.5%

2.4%

10959.95

2.3%

-0.1%

11085.44

3.5%

1.1%

11119.83

3.8%

0.3%

In testimony before The Joint Economic Committee of Congress on Dec 3, 2015 (http://www.federalreserve.gov/newsevents/testimony/yellen20151203a.htm), Chair Yellen reiterated that the FOMC (Federal Open Market Committee) “anticipates that even after employment and inflation are near mandate-consistent levels, economic condition may, for some time, warrant keeping the target federal funds rate below the Committee views as normal in the longer run.” Todd Buell and Katy Burne, writing on “Draghi says ECB could step up stimulus efforts if necessary,” on Dec 4, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/draghi-says-ecb-could-step-up-stimulus-efforts-if-necessary-1449252934), analyze that the President of the European Central Bank (ECB), Mario Draghi, reassured financial markets that the ECB will increase stimulus if required to raise inflation the euro area to targets. The USD depreciated 3.1 percent on Thu Dec 3, 2015 after weaker than expected measures by the European Central Bank. DJIA fell 1.4 percent on Dec 3 and increased 2.1 percent on Dec 4. DAX fell 3.6 percent on Dec 3.

Fri Nov 27

Mon 30

Tue 1

Wed 2

Thu 3

Fri 4

USD/ EUR

1.0594

0.5%

0.2%

1.0565

0.3%

1.0634

-0.4%

-0.7%

1.0616

-0.2%

0.2%

1.0941

-3.3%

-3.1%

1.0885

-2.7%

0.5%

DJIA

17798.49

-0.1%

17719.92

-0.4%

17888.35

0.5%

1.0%

17729.68

-0.4%

-0.9%

17477.67

-1.8%

-1.4%

17847.63

0.3%

2.1%

DAX

11293.76

1.6%

-0.2%

11382.23

0.8%

11261.24

-0.3%

-1.1%

11190.02

-0.9%

-0.6%

10789.24

-4.5%

-3.6%

10752.10

-4.8%

-0.3%

At the press conference following the meeting of the FOMC on Dec 16, 2015, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20151216.pdf page 8):

“And we recognize that monetary policy operates with lags. We would like to be able to move in a prudent, and as we've emphasized, gradual manner. It's been a long time since the Federal Reserve has raised interest rates, and I think it's prudent to be able to watch what the impact is on financial conditions and spending in the economy and moving in a timely fashion enables us to do this.”

The implication of this statement is that the state of the art is not accurate in analyzing the effects of monetary policy on financial markets and economic activity. The US dollar appreciated and equities fluctuated:

Fri Dec 11

Mon 14

Tue 15

Wed 16

Thu 17

Fri 18

USD/ EUR

1.0991

-1.0%

-0.4%

1.0993

0.0%

1.0932

0.5%

0.6%

1.0913

0.7%

0.2%

1.0827

1.5%

0.8%

1.0868

1.1%

-0.4%

DJIA

17265.21

-3.3%

-1.8%

17368.50

0.6%

17524.91

1.5%

0.9%

17749.09

2.8%

1.3%

17495.84

1.3%

-1.4%

17128.55

-0.8%

-2.1%

DAX

10340.06

-3.8%

-2.4%

10139.34

-1.9%

10450.38

-1.1%

3.1%

10469.26

1.2%

0.2%

10738.12

3.8%

2.6%

10608.19

2.6%

-1.2%

On January 29, 2016, the Policy Board of the Bank of Japan introduced a new policy to attain the “price stability target of 2 percent at the earliest possible time” (https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf). The new framework consists of three dimensions: quantity, quality and interest rate. The interest rate dimension consists of rates paid to current accounts that financial institutions hold at the Bank of Japan of three tiers zero, positive and minus 0.1 percent. The quantitative dimension consists of increasing the monetary base at the annual rate of 80 trillion yen. The qualitative dimension consists of purchases by the Bank of Japan of Japanese government bonds (JGBs), exchange traded funds (ETFs) and Japan real estate investment trusts (J-REITS). The yen devalued sharply relative to the dollar and world equity markets soared after the new policy announced on Jan 29, 2016:

Fri 22

Mon 25

Tue 26

Wed 27

Thu 28

Fri 29

JPY/ USD

118.77

-1.5%

-0.9%

118.30

0.4%

118.42

0.3%

-0.1%

118.68

0.1%

-0.2%

118.82

0.0%

-0.1%

121.13

-2.0%

-1.9%

DJIA

16093.51

0.7%

1.3%

15885.22

-1.3%

16167.23

0.5%

1.8%

15944.46

-0.9%

-1.4%

16069.64

-0.1%

0.8%

16466.30

2.3%

2.5%

Nikkei

16958.53

-1.1%

5.9%

17110.91

0.9%

16708.90

-1.5%

-2.3%

17163.92

1.2%

2.7%

17041.45

0.5%

-0.7%

17518.30

3.3%

2.8%

Shanghai

2916.56

0.5%

1.3

2938.51

0.8%

2749.79

-5.7%

-6.4%

2735.56

-6.2%

-0.5%

2655.66

-8.9%

-2.9%

2737.60

-6.1%

3.1%

DAX

9764.88

2.3%

2.0%

9736.15

-0.3%

9822.75

0.6%

0.9%

9880.82

1.2%

0.6%

9639.59

-1.3%

-2.4%

9798.11

0.3%

1.6%

In testimony on the Semiannual Monetary Policy Report to the Congress on Feb 10-11, 2016, Chair Yellen (http://www.federalreserve.gov/newsevents/testimony/yellen20160210a.htm) states: “U.S. real gross domestic product is estimated to have increased about 1-3/4 percent in 2015. Over the course of the year, subdued foreign growth and the appreciation of the dollar restrained net exports. In the fourth quarter of last year, growth in the gross domestic product is reported to have slowed more sharply, to an annual rate of just 3/4 percent; again, growth was held back by weak net exports as well as by a negative contribution from inventory investment.”

Jon Hilsenrath, writing on “Yellen Says Fed Should Be Prepared to Use Negative Rates if Needed,” on Feb 11, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/yellen-reiterates-concerns-about-risks-to-economy-in-senate-testimony-1455203865), analyzes the statement of Chair Yellen in Congress that the FOMC (Federal Open Market Committee) is considering negative interest rates on bank reserves. The Wall Street Journal provides yields of two and ten-year sovereign bonds with negative interest rates on shorter maturities where central banks pay negative interest rates on excess bank reserves:

Sovereign Yields 2/12/16	Japan	Germany	USA
2 Year	-0.168	-0.498	0.694
10 Year	0.076	0.262	1.744

On Mar 10, 2016, the European Central Bank (ECB) announced (1) reduction of the refinancing rate by 5 basis points to 0.00 percent; decrease the marginal lending rate to 0.25 percent; reduction of the deposit facility rate to 0,40 percent; increase of the monthly purchase of assets to €80 billion; include nonbank corporate bonds in assets eligible for purchases; and new long-term refinancing operations (https://www.ecb.europa.eu/press/pr/date/2016/html/pr160310.en.html). The President of the ECB, Mario Draghi, stated in the press conference (https://www.ecb.europa.eu/press/pressconf/2016/html/is160310.en.html): “How low can we go? Let me say that rates will stay low, very low, for a long period of time, and well past the horizon of our purchases…We don’t anticipate that it will be necessary to reduce rates further. Of course, new facts can change the situation and the outlook.”

The dollar devalued relative to the euro and open stock markets traded lower after the announcement on Mar 10, 2016, but stocks rebounded on Mar 11:

Fri 4

Mon 7

Tue 8

Wed 9

Thu10

Fri 11

USD/ EUR

1.1006

-0.7%

-0.4%

1.1012

-0.1%

1.1013

-0.1%

0.0%

1.0999

0.1%

1.1182

-1.6%

-1.7%

1.1151

-1.3%

0.3%

DJIA

17006.77

2.2%

0.4%

17073.95

0.4%

16964.10

-0.3%

-0.6%

17000.36

0.0%

0.2%

16995.13

-0.1%

0.0%

17213.31

1.2%

1.3%

DAX

9824.17

3.3%

0.7%

9778.93

-0.5%

0.5%

9692.82

-1.3%

-0.9%

9723.09

-1.0%

0.3%

9498.15

-3.3%

-2.3%

9831.13

0.1%

3.5%

In presenting the Semiannual Monetary Policy Report to Congress on Jul 17, 2018, the Chairman of the Board of Governors of the Federal Reserve System, Jerome H. Powell, stated (https://www.federalreserve.gov/newsevents/testimony/powell20180717a.htm): “With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that--for now--the best way forward is to keep gradually raising the federal funds rate. We are aware that, on the one hand, raising interest rates too slowly may lead to high inflation or financial market excesses. On the other hand, if we raise rates too rapidly, the economy could weaken and inflation could run persistently below our objective. The Committee will continue to weigh a wide range of relevant information when deciding what monetary policy will be appropriate. As always, our actions will depend on the economic outlook, which may change as we receive new data.”

The decisions of the FOMC (Federal Open Market Committee) depend on incoming data. There are unexpected swings in valuations of risk financial assets by “carry trades” from interest rates below inflation to exposures in stocks, commodities and their derivatives. Another issue is the unexpected “data surprises” such as the sharp decline in 12 months rates of increase of real disposable income, or what is left after taxes and inflation, and the price indicator of the FOMC, prices of personal consumption expenditures (PCE) excluding food and energy. There is no science or art of monetary policy that can deal with this uncertainty.

Real Disposable Personal Income	Real Personal Consumption Expenditures	Prices of Personal Consumption Expenditures	PCE Prices Excluding Food and Energy
∆%12M	∆%12M	∆%12M	∆%12M
6/2017	6/2017	6/2017	6/2017
1.2	2.4	1.4	1.5

At an address to The Clearing House and The Bank Policy Institute Annual Conference (https://www.federalreserve.gov/newsevents/speech/clarida20181127a.htm), in New York City, on Nov 27, 2018, the Vice Chairman of the Fed, Richard H. Clarida, analyzes the data dependence of monetary policy. An important hurdle is critical unobserved parameters of monetary policy (https://www.federalreserve.gov/newsevents/speech/clarida20181127a.htm): “But what if key parameters that describe the long-run destination of the economy are unknown? This is indeed the relevant case that the FOMC and other monetary policymakers face in practice. The two most important unknown parameters needed to conduct‑‑and communicate‑‑monetary policy are the rate of unemployment consistent with maximum employment, u*, and the riskless real rate of interest consistent with price stability, r*. As a result, in the real world, monetary policy should, I believe, be data dependent in a second sense: that incoming data can reveal at each FOMC meeting signals that will enable it to update its estimates of r* and u* in order to obtain its best estimate of where the economy is heading.” Current robust economic growth, employment creation and inflation close to the Fed’s 2 percent objective suggest continuing “gradual policy normalization.” Incoming data can be used to update u^* and r^* in designing monetary policy that attains price stability and maximum employment. Clarida also finds that the current expansion will be the longest in history if it continues into 2019. In an address at The Economic Club of New York, New York City, Nov 28, 2018 (https://www.federalreserve.gov/newsevents/speech/powell20181128a.htm), the Chairman of the Fed, Jerome H. Powell, stated (https://www.federalreserve.gov/newsevents/speech/powell20181128a.htm): “For seven years during the crisis and its painful aftermath, the Federal Open Market Committee (FOMC) kept our policy interest rate unprecedentedly low--in fact, near zero--to support the economy as it struggled to recover. The health of the economy gradually but steadily improved, and about three years ago the FOMC judged that the interests of households and businesses, of savers and borrowers, were no longer best served by such extraordinarily low rates. We therefore began to raise our policy rate gradually toward levels that are more normal in a healthy economy. Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth. My FOMC colleagues and I, as well as many private-sector economists, are forecasting continued solid growth, low unemployment, and inflation near 2 percent.” The market focused on policy rates “just below the broad range of estimates of the level that would be neutral for the economy—that is, neither speeding up nor slowing down growth.” There was a relief rally in the stock market of the United States:

Fri 23

Mon 26

Tue 27

Wed 28

Thu 29

Fri 30

USD/EUR

1.1339

0.7%

0.6%

1.1328

0.1%

1.1293

0.4%

0.3%

1.1368

-0.3%

-0.7%

1.1394

-0.5%

-0.2%

1.1320

0.2%

0.6%

DJIA

24285.95

-4.4%

-0.7%

24640.24

1.5%

24748.73

1.9%

0.4%

25366.43

4.4%

2.5%

25338.84

4.3%

-0.1%

25538.46

5.2%

0.8%

At a meeting of the American Economic Association in Atlanta on Friday, January 4, 2019, the Chairman of the Fed, Jerome H. Powell, stated that the Fed would be “patient” with interest rate increases, adjusting policy “quickly and flexibly” if required (https://www.aeaweb.org/webcasts/2019/us-federal-reserve-joint-interview). Treasury yields declined and stocks jumped.

Fri 28	Mon 31	Tue 1	Wed 2	Thu 3	Fri 4
10Y Note 2.736	2.683	2.683	2.663	2.560	2.658
2Y Note 2.528	2.500	2.500	2.488	2.387	2.480
DJIA 23062.40 2.7% -0.3%	23327.46 1.1% 1.1%	23327.46 1.1% 0.0%	23346.24 1.2% 0.1%	22686.22 -1.6% -2.8%	23433.16 1.6% 3.3%
Dow Global 2718.19 1.3% 0.8%	2734.40 0.6% 0.6%	2734.40 0.6% 0.0%	2729.74 0.4% -0.2%	2707.29 -0.4% -0.8%	2773.12 2.0% 2.4%

In the Opening Remarks to the Press Conference on Jan 30, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190130.pdf): “Today, the FOMC decided that the cumulative effects of those developments over the last several months warrant a patient, wait-and-see approach regarding future policy changes. In particular, our statement today says, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near … 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook. In addition, the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to Page 3 of 5 push headline inflation lower still in coming months. Further, as we noted in our post-meeting statement, while survey-based measures of inflation expectations have been stable, financial market measures of inflation compensation have moved lower. Similarly, the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms. In this environment, we believe we can best support the economy by being patient in evaluating the outlook before making any future adjustment to policy.” The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm).

Fri 25

Mon 28

Tue 29

Wed 30

Thu 31

Fri 1

DJIA

24737.20

0.1%

0.7%

24528.22

-0.8%

24579.96

-0.6%

0.2%

25014.86

1.1%

1.8%

24999.67

1.1%

-0.1%

25063.89

1.3%

0.3%

Dow Global

2917.27

0.5%

1.0%

2899.74

-0.6%

2905.29

-0.4%

0.2%

2927.10

0.3%

0.8%

2945.73

1.0%

0.6%

2947.87

1.0%

0.1%

DJ Asia Pacific

Nikkei

20773.56

0.5%

1.0%

20649.00

-0.6%

20664.64

-0.5%

0.1%

20556.54

-1.0%

-0.5%

20773.49

0.0%

1.1%

20788.39

0.1%

Shanghai

2601.72

0.2%

0.4%

2596.98

-0.2%

2594.25

-0.3%

-0.1%

2575.58

-1.0%

-0.7%

2584.57

-0.7%

0.3%

2618.23

0.6%

1.3%

DAX

11281.79

0.7%

1.4%

11210.31

-0.6%

11218.83

-0.6%

0.1%

11181.66

-0.9%

-0.3%

11173.10

-1.0%

-0.1%

11180.66

-0.9%

0.1%

BOVESPA

97677.19

1.6%

0.0%

95443.88

-2.3%

95639.33

-2.1%

0.2%

96996.21

-0.7%

1.4%

97393.75

-0.3%

0.4%

97861.27

0.2%

0.5%

Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. The FOMC statement on Jun 19, 2019 analyzes uncertainty in the outlook (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190619a.htm): “The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes, but uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.” In the Semiannual Monetary Policy Report to the Congress, on Jul 10, 2019, Chair Jerome H. Powell states (https://www.federalreserve.gov/newsevents/testimony/powell20190710a.htm): “Since our May meeting, however, these crosscurrents have reemerged, creating greater uncertainty. Apparent progress on trade turned to greater uncertainty, and our contacts in business and agriculture report heightened concerns over trade developments. Growth indicators from around the world have disappointed on net, raising concerns that weakness in the global economy will continue to affect the U.S. economy. These concerns may have contributed to the drop in business confidence in some recent surveys and may have started to show through to incoming data.

”(emphasis added). European Central Bank President, Mario Draghi, stated at a meeting on “Twenty Years of the ECB’s Monetary Policy,” in Sintra, Portugal, on Jun 18, 2019, that (https://www.ecb.europa.eu/press/key/date/2019/html/ecb.sp190618~ec4cd2443b.en.html): “In this environment, what matters is that monetary policy remains committed to its objective and does not resign itself to too-low inflation. And, as I emphasised at our last monetary policy meeting, we are committed, and are not resigned to having a low rate of inflation forever or even for now. In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required. In our recent deliberations, the members of the Governing Council expressed their conviction in pursuing our aim of inflation close to 2% in a symmetric fashion. Just as our policy framework has evolved in the past to counter new challenges, so it can again. In the coming weeks, the Governing Council will deliberate how our instruments can be adapted commensurate to the severity of the risk to price stability.” The harmonized index of consumer prices of the euro zone increased 1.2 percent in the 12 months ending in May 2019 and the PCE inflation excluding food and energy increased 1.6 percent in the 12 months ending in Apr 2019. Inflation below 2 percent with symmetric targets in both the United States and the euro zone together with apparently weakening economic activity could lead to interest rate cuts. Stock markets jumped worldwide in renewed risk appetite during the week of Jun 19, 2019 in part because of anticipation of major central bank rate cuts and also because of domestic factors:

Fri 14

Mon 17

Tue 18

Wed 19

Thu 20

Fri 21

DJIA

26089.61

0.4%

-0.1%

26112.53

0.1%

26465.54

1.4%

26504.00

1.6%

0.1%

26753.17

2.5%

0.9%

26719.13

2.4%

-0.1%

Dow Global

2998.79

0.2%

-0.4%

2999.93

0.0%

3034.59

1.2%

3050.80

1.7%

0.5%

3077.81

2.6%

0.9%

3081.62

2.8%

0.1%

DJ Asia Pacific

Nikkei

21116.89

1.1%

0.4%

21124.00

0.0%

20972.71

-0.7%

21333.87

1.0%

1.7%

21462.86

1.6%

0.6%

21258.64

0.7%

-1.0%

Shanghai

2881.97

1.9%

-1.0%

2887.62

0.2%

2890.16

0.3%

0.1%

2917.80

1.2%

1.0%

2987.12

3.6%

2.4%

3001.98

4.2%

0.5%

DAX

12096.40

0.4%

-0.6%

12085.82

-0.1%

12331.75

1.9%

2.0%

12308.53

1.8%

-0.2%

12355.39

2.1%

0.4%

12339.92

2.0%

-0.1%

BOVESPA

98040.06

0.2%

-0.7%

97623.25

-0.4%

99404.39

1.4%

1.8%

100303.41

2.3%

0.9%

100303.41

2.3%

0.0%

102012.64

4.1%

1.7%

The carry trade from zero interest rates to leveraged positions in risk financial assets had proved strongest for commodity exposures but US equities have regained leadership. The DJIA has increased 171.4 percent since the trough of the sovereign debt crisis in Europe on Jul 16, 2010 to Aug 9, 2019; S&P 500 has gained 185.4 percent and DAX 106.2 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 08/09/19” in Table VI-4 had double digit gains relative to the trough around Jul 2, 2010 followed by negative performance but now some valuations of equity indexes show varying behavior. China’s Shanghai Composite is 16.4 percent above the trough. Japan’s Nikkei Average is 134.4 percent above the trough. Dow Global is 74.3 percent above the trough. STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 33.3 percent above the trough. NYSE Financial Index is 85.9 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 106.2 percent above the trough. Japan’s Nikkei Average is 134.4 percent above the trough on Aug 31, 2010 and 81.6 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 20,684.82 on Aug 9, 2019 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 101.7 percent higher than 10,254.43 on Mar 11, 2011, on the date of the Tōhoku or Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar appreciated 6.0 percent relative to the euro. The dollar devalued before the new bout of sovereign risk issues in Europe. The column “∆% week to 08/09/19” in Table VI-4 shows

decrease of 3.2 percent for China’s Shanghai Composite. The Nikkei decreased 1.9 percent. NYSE Financial decreased 0.9 percent in the week. Dow Global decreased 1.2 percent in the week of Aug 9, 2019. The DJIA decreased 0.7 percent and S&P 500 decreased 0.5 percent. DAX of Germany decreased 1.5 percent. STOXX 50 decreased 1.7 percent. The USD depreciated 0.8 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table VI-4 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 08/09/19” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Aug 9, 2019. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 08/09/19” but also relative to the peak in column “∆% Peak to 08/09/19.” There are now several equity indexes above the peak in Table VI-4: DJIA 134.6 percent, S&P 500 139.8 percent, DAX 84.7 percent, Dow Global 42.2 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.stml) 48.1 percent, Nikkei Average 81.6 percent and STOXX 50 12.9 percent. Shanghai Composite is 12.3 percent below the peak. The Shanghai Composite increased 40.5 percent from March 12, 2014, to Aug 9, 2019. The US dollar strengthened 26.0 percent relative to the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul 2010 because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010.

Sharp and continuing strengthening of the dollar, with recent oscillation of dollar devaluation, is affecting balance sheets of US corporations with foreign operations (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318). Recently, the dollar is depreciating. The Federal Open Market Committee (FOMC) is following “financial and international developments” as part of the process of framing interest rate policy (http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm). Kate Linebaugh, writing on “Corporate profits set to shrink for fourth consecutive quarter,” on Jul 17, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/corporate-profits-set-to-shrink-for-fourth-consecutive-quarter-1468799278), quotes forecasts of Thomson Reuters of 4.7 decline of adjusted earnings per share in the S&P 500 index in IIQ2016 relative to a year earlier. That would be the fourth consecutive quarterly decline. Theo Francis and Kate Linebaugh, writing on “US corporate profits on pace for third straight decline,” on Apr 28, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/u-s-corporate-profits-on-pace-for-third-straight-decline-1461872242), analyze three consecutive quarters of decline of corporate earnings and revenue in companies in S&P 500. They quote Thomson Reuters on expected decline of earnings of 6.1 percent in IQ2016 based on 55 percent of reporting companies. Weakness of economic activity shows in decline of revenues in IQ2016 of 1.4 percent, increasing 1.7 percent excluding energy, and contraction of profits of 0.5 percent. Justin Lahart, writing on “S&P 500 Earnings: far worse than advertised,” on Feb 24, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/s-p-500-earnings-far-worse-than-advertised-1456344483), analyzes S&P 500 earnings in 2015. Under data provided by companies, earnings increased 0.4 percent in 2015 relative to 2014 but under GAAP (Generally Accepted Accounting Principles), earnings fell 12.7 percent, which is the worst decrease since 2008. Theo Francis e Kate Linebaugh, writing on Oct 25, 2015, on “US Companies Warn of Slowing Economy, published in the Wall Street Journal (http://www.wsj.com/articles/u-s-companies-warn-of-slowing-economy-1445818298) analyze the first contraction of earnings and revenue of big US companies. Production, sales and employment are slowing in a large variety of companies with some contracting. Corporate profits also suffer from revaluation of the dollar that constrains translation of foreign profits into dollar balance sheets. Francis and Linebaugh quote Thomson Reuters that analysts expect decline of earnings per share of 2.8 percent in IIIQ2015 relative to IIIQ2014 based on reports by one third of companies in the S&P 500. Sales would decline 4.0% in a third quarter for the first joint decline of earnings per share and revenue in the same quarter since IIIQ2009. Dollar revaluation also constrains corporate results.

Inyoung Hwang, writing on “Fed optimism spurs record bets against stock volatility,” on Aug 21, 2014, published in Bloomberg.com (http://www.bloomberg.com/news/2014-08-21/fed-optimism-spurs-record-bets-against-stock-voalitlity.html), informs that the S&P 500 is trading at 16.6 times estimated earnings, which is higher than the five-year average of 14.3 Tom Lauricella, writing on Mar 31, 2014, on “Stock investors see hints of a stronger quarter,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304157204579473513864900656?mod=WSJ_smq0314_LeadStory&mg=reno64-wsj), finds views of stronger earnings among many money managers with positive factors for equity markets in continuing low interest rates and US economic growth. There is important information in the Quarterly Markets review of the Wall Street Journal (http://online.wsj.com/public/page/quarterly-markets-review-03312014.html) for IQ2014. Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. In IQ1980, real gross private domestic investment in the US was $933.1 billion of chained 2012 dollars, growing to $1,274.9 billion in IVQ1992 or 36.6 percent. The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). Real gross private domestic investment in the US increased 29.4 percent from $2653.1 billion in IVQ2007 to $3,432.4 billion in IIQ2019. Real private fixed investment increased 27.1 percent from $2,630.0 billion of chained 2012 dollars in IVQ2007 to $3,342.7 billion in IIQ2019. Private fixed investment fell relative to IVQ2007 in all quarters preceding IVQ2012 and increased 0.9 percent in IIIQ2016, increasing 0.7 percent in IIQ2016 and increasing 0.6 percent in IQ2016. Private fixed investment increased 0.5 percent in IVQ2016. Private fixed investment increased 1.9 percent in IQ2017 and increased 0.7 percent in IIQ2017. Private fixed investment increased 0.4 percent in IIIQ2017 and increased 2.1 percent in IVQ2017. Private fixed investment increased 1.3 percent in IQ2018, increasing 1.3 percent in IIQ2018. Private fixed investment increased 0.2 percent in IIIQ2018, increasing 0.7 percent in IVQ2018. Private fixed investment increased 0.8 percent in IQ2019, decreasing 0.2 percent in IIQ2019. Growth of real private investment is mediocre for all but four quarters from IIQ2011 to IQ2012. There is recent robust growth. The investment decision of United States corporations is fractured in the current economic cycle in preference of cash.

There are three aspects. First, there is fluctuation in corporate profits. Corporate profits increased at $65.0 billion in IIQ2018. Corporate profits increased at $78.2 billion in IIIQ2018. Corporate profits decreased at $9.7 billion in IVQ2018. Corporate profits decreased at $59.3 billion in IQ2019. Profits after tax with IVA and CCA increased at $42.2 billion in IIQ2018. Profits after tax with IVA and CCA increased at $69.3 billion in IIIQ2018. Profits after tax with IVA and CCA decreased at $0.6 billion in IVQ2018. Profits after tax with IVA and CCA decreased at $63.9 billion in IQ2019. Net dividends increased at $9.8 billion in IIQ2018. Net dividends increased at $27.6 billion in IIIQ2018. Net dividends increased at $28.9 billion in IVQ2018. Net dividends decreased at $40.0 billion in IQ2019. Undistributed corporate profits increased at $32.4 billion in IIQ2018. Undistributed corporate profits increased at 41.7 billion in IIIQ2018. Undistributed corporate profits decreased at $29.5 billion in IVQ2018. Undistributed corporate profits decreased at $23.8 billion in IQ2019. Undistributed corporate profits swelled 231.7 percent from $138.0 billion in IQ2007 to $457.8 billion in IQ2019 and changed signs from minus $4.3 billion in current dollars in IVQ2007. The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Second, sharp and continuing strengthening of the dollar, with recent depreciation at the margin, is affecting balance sheets of US corporations with foreign operations (https://www.fasb.org/summary/stsum52.shtml) and the overall US economy. The bottom part of Table IA1-9 provides the breakdown of corporate profits with IVA and CCA in domestic industries and the rest of the world. Corporate profits with IVA and CCA increased at $65.0 billion in IIQ2018. Profits from domestic industries increased at $69.5 billion and profits from nonfinancial business increased at $53.0 billion. Profits from the rest of the world decreased at $4.5 billion. Corporate profits with IVA and CCA increased at $78.2 billion in IIIQ2018. Profits from domestic industries increased at $76.9 billion and profits from nonfinancial business increased at $83.0 billion. Profits from the rest of the world increased at $1.3 billion. Corporate profits with IVA and CCA decreased at $9.7 billion in IVQ2018. Profits from domestic industries decreased at $11.6 billion and profits from nonfinancial business increased at $13.6 billion. Profits from the rest of the world increased at $1.9 billion. Corporate profits with IVA and CCA decreased at $59.3 billion in IQ2019. Profits from domestic industries decreased at $66.7 billion and profits from nonfinancial business decreased at $68.1 billion. Profits from the rest of the world increased at $7.4 billion. Total corporate profits with IVA and CCA were $2251.5 billion in IQ2019 of which $1758.9 billion from domestic industries, or 78.1 percent of the total, and $492.7 billion, or 21.9 percent, from the rest of the world. Nonfinancial corporate profits of $1331.0 billion account for 59.1 percent of the total. Third, there is reduction in the use of corporate cash for investment. Vipal Monga, David Benoit and Theo Francis, writing on “Companies send more cash back to shareholders,” published on May 26, 2015 in the Wall Street Journal (http://www.wsj.com/articles/companies-send-more-cash-back-to-shareholders-1432693805?tesla=y), use data of a study by Capital IQ conducted for the Wall Street Journal. This study shows that companies in the S&P 500 reduced investment in plant and equipment to median 29 percent of operating cash flow in 2013 from 33 percent in 2003 while increasing dividends and buybacks to median 36 percent in 2013 from 18 percent in 2003.

The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:

Where R_τ is expected revenue in the time horizon from τ =1 to T; C_τ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that interest rates increase without bound, then V → 0, or

declines. Equally, decline in expected revenue from the stock or project, R_τ, causes decline in valuation. Paul A. Samuelson (http://www.nobelprize.org/nobel_prizes/economics/laureates/1970/samuelson-bio.html) popularized the view of the elusive relation between stock markets and economic activity in an often-quoted phrase “the stock market has predicted nine of the last five recessions.” In the presence of zero interest rates forever, valuations of risk financial assets are likely to differ from the performance of the overall economy. The interrelations of financial and economic variables prove difficult to analyze and measure.

Table VI-4, Stock Indexes, Commodities, Dollar and Ten-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 08/09/ /19	∆% Week 08/09/19	∆% Trough to 08/09/ 19
DJIA	4/26/ 10	7/2/10	-13.6	134.6	-0.7	171.4
S&P 500	4/23/ 10	7/20/ 10	-16.0	139.8	-0.5	185.4
NYSE Finance	4/15/ 10	7/2/10	-20.3	48.1	-0.9	85.9
Dow Global	4/15/ 10	7/2/10	-18.4	42.2	-1.2	74.3
Asia Pacific	4/15/ 10	7/2/10	-12.5	NA	NA	NA
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	81.6	-1.9	134.4
China Shang.	4/15/ 10	7/02 /10	-24.7	-12.3	-3.2	16.4
STOXX 50	4/15/10	7/2/10	-15.3	12.9	-1.7	33.3
DAX	4/26/ 10	5/25/ 10	-10.5	84.7	-1.5	106.2
Dollar Euro	11/25 2009	6/7 2010	21.2	26.0	-0.8	6.0
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	NA	NA	NA
10-Year T Note	4/5/ 10	4/6/10	3.986	2.784	2.658	1.736

T: trough; Dollar: positive sign appreciation relative to euro (less dollars paid per euro), negative sign depreciation relative to euro (more dollars paid per euro)

Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. Table VI-5 shows a gain by Apr 29, 2011 in the DJIA of 14.3 percent and of the S&P 500 of 12.5 percent since Apr 26, 2010, around the time when sovereign risk issues in Europe began to be acknowledged in financial risk asset valuations. The last row of Table VI-5 for Aug 9, 2019 shows that the S&P 500 is now 140.8 percent above the Apr 26, 2010 level and the DJIA is 134.6 percent above the level on Apr 26, 2010. Multiple rounds of risk aversion eroded earlier gains, showing that risk aversion can destroy market value even with zero interest rates. Relaxed risk aversion has contributed to recovery of valuations. Much the same as zero interest rates and quantitative easing have not had any effects in recovering economic activity while distorting financial markets and resource allocation.

Table VI-5, Percentage Changes of DJIA and S&P 500 in Selected Dates

	∆% DJIA from prior date	∆% DJIA from Apr 26 2010	∆% S&P 500 from prior date	∆% S&P 500 from Apr 26 2010
Apr 26, 2010
May 06/10	-6.1	-6.1	-6.9	-6.9
May 26/10	-5.2	-10.9	-5.4	-11.9
Jun 08/10	-1.2	-11.3	2.1	-12.4
Jul 02/10	-2.6	-13.6	-3.8	-15.7
Aug 09/10	10.5	-4.3	10.3	-7.0
Aug 31/10	-6.4	-10.6	-6.9	-13.4
Nov 5/10	14.2	2.1	16.8	1.0
Nov 30/10	-3.8	-3.8	-3.7	-2.6
Dec 17/10	4.4	2.5	5.3	2.6
Dec 23/10	0.7	3.3	1.0	3.7
Dec 31/10	0.03	3.3	0.0	3.8
Jan 7, 2011	0.8	4.2	1.1	4.9
Jan 14/11	0.9	5.2	1.7	6.7
Jan 21/11	0.7	5.9	-0.8	5.9
Jan 28/11	-0.4	5.5	-0.5	5.3
Feb 04/11	2.3	7.9	2.7	8.1
Feb 11/11	1.5	9.5	1.4	9.7
Feb 18/11	0.9	10.6	1.0	10.8
Feb 25/11	-2.1	8.3	-1.7	8.9
Mar 4/11	0.3	8.6	0.1	9.0
Mar 11/11	-1.0	7.5	-1.3	7.6
Mar 18/11	-1.5	5.8	-1.9	5.5
Mar 25/11	3.1	9.1	2.7	8.4
Apr 01/11	1.3	10.5	1.4	9.9
Apr 08/11	0.03	10.5	-0.3	9.6
Apr 15/11	-0.3	10.1	-0.6	8.9
Apr 22/11	1.3	11.6	1.3	10.3
Apr 29/11	2.4	14.3	1.9	12.5
May 06/11	-1.3	12.8	-1.7	10.6
May 13/11	-0.3	12.4	-0.2	10.4
May 20/11	-0.7	11.7	-0.3	10.0
May 27/11	-0.6	11.0	-0.2	9.8
Jun 03/11	-2.3	8.4	-2.3	7.3
Jun 10/11	-1.6	6.7	-2.2	4.9
Jun 17/11	0.4	7.1	0.04	4.9
Jun 24/11	-0.6	6.5	-0.2	4.6
Jul 01/11	5.4	12.3	5.6	10.5
Jul 08/11	0.6	12.9	0.3	10.9
Jul 15/11	-1.4	11.4	-2.1	8.6
Jul 22/11	1.6	13.2	2.2	10.9
Jul 29/11	-4.2	8.4	-3.9	6.6
Aug 05/11	-5.8	2.1	-7.2	-1.0
Aug 12/11	-1.5	0.6	-1.7	-2.7
Aug 19/11	-4.0	-3.5	-4.7	-7.3
Aug 26/11	4.3	0.7	4.7	-2.9
Sep 02/11	-0.4	0.3	-0.2	-3.1
Sep 09/11	-2.2	-1.9	-1.7	-4.8
Sep 16/11	4.7	2.7	5.4	0.3
Sep 23/11	-6.4	-3.9	-6.5	-6.2
Sep 30/11	1.3	-2.6	-0.4	-6.7
Oct 7/11	1.7	-0.9	2.1	-4.7
Oct 14/11	4.9	3.9	5.9	1.0
Oct 21/11	1.4	5.4	1.1	2.2
Oct 28/11	3.6	9.2	3.8	6.0
Nov 04/11	-2.0	6.9	-2.5	3.4
Nov 11/11	1.4	8.5	0.8	4.3
Nov 18/11	-2.9	5.3	-3.8	0.3
Nov 25/11	-4.8	0.2	-4.7	-4.4
Dec 02/11	7.0	7.3	7.4	2.7
Dec 09/11	1.4	8.7	0.9	3.6
Dec 16/11	-2.6	5.9	-2.8	0.6
Dec 23/11	3.6	9.7	3.7	4.4
Dec 30/11	-0.6	9.0	-0.6	3.8
Jan 06 2012	1.2	10.3	1.6	5.4
Jan 13/12	0.5	10.9	0.9	6.4
Jan 20/12	2.4	13.5	2.0	8.5
Jan 27/12	-0.5	13.0	0.1	8.6
Feb 3/12	1.6	14.8	2.2	11.0
Feb 10/12	-0.5	14.2	-0.2	10.8
Feb 17/12	1.2	15.6	1.4	12.3
Feb 24/12	0.3	15.9	0.3	12.7
Mar 2/12	0.0	15.8	0.3	13.0
Mar 9/12	-0.4	15.3	0.1	13.1
Mar 16/12	2.4	18.1	2.4	15.9
Mar 23/12	-1.1	16.7	-0.5	15.3
Mar 30/12	1.0	17.9	0.8	16.2
Apr 6/12	-1.1	16.6	-0.7	15.3
Apr 13/12	-1.6	14.7	-2.0	13.1
Apr 20/12	1.4	16.3	0.6	13.7
Apr 27/12	1.5	18.1	1.8	15.8
May 4/12	-1.4	16.4	-2.3	12.9
May 11/12	-1.7	14.4	-1.1	11.7
May 18/12	-3.5	10.4	-4.3	6.4
May 25/12	0.7	11.2	1.7	8.7
Jun 01/12	-2.7	8.2	-3.0	5.4
Jun 08/12	3.6	12.0	3.7	9.4
Jun 15/12	1.7	13.9	1.3	10.8
Jun 22/12	-1.0	12.8	-0.6	10.1
Jun 29/12	1.9	14.9	2.0	12.4
Jul 06/12	-0.8	14.0	-0.5	11.8
Jul 13/12	0.0	14.0	0.2	11.9
Jul 20/12	0.4	14.4	0.4	12.4
Jul 27/12	2.0	16.7	1.7	14.3
Aug 03/12	0.2	16.9	0.4	14.8
Aug 10/12	0.9	17.9	1.1	16.0
Aug 17/12	0.5	18.5	0.9	17.0
Aug 24/12	-0.9	17.4	-0.5	16.4
Aug 31/12	-0.5	16.8	-0.3	16.0
Sep 07/12	1.6	18.8	2.2	18.6
Sep 14/12	2.2	21.3	1.90	20.9
Sep 21/12	-0.1	21.2	-0.4	20.5
Sep 28/12	-1.0	19.9	-1.3	18.9
Oct 05/12	1.3	21.5	1.4	20.5
Oct 12/12	-2.1	18.9	-2.2	17.9
Oct 19/12	0.1	19.1	0.3	18.3
Oct 26/12	-1.8	17.0	-1.5	16.5
Nov 02/12	-0.1	16.9	0.2	16.7
Nov 09/12	-2.1	14.4	-2.4	13.8
Nov 16/12	-1.8	12.3	-1.4	12.2
Nov 23/12	3.3	16.1	3.6	16.3
Nov 30/12	0.1	16.2	0.5	16.8
Dec 07/12	1.0	17.4	0.1	17.0
Dec 14/12	-0.2	17.2	-0.3	16.6
Dec 21/12	0.4	17.7	1.2	18.0
Dec 28/12	-1.9	15.5	-1.9	15.7
Jan 04, 2013	3.8	19.9	4.6	21.0
Jan 11/13	0.4	20.4	0.4	21.5
Jan 18/13	1.2	21.8	0.9	22.6
Jan 25/13	1.8	24.0	1.1	24.0
Feb 01/13	0.8	25.0	0.7	24.8
Feb 08/13	-0.1	24.9	0.3	25.2
Feb 15/13	-0.1	24.8	0.1	25.4
Feb 22/13	0.1	24.9	-0.3	25.0
Mar 1/13	0.6	25.7	0.2	25.3
Mar 8/13	2.2	28.5	2.2	28.0
Mar 15/13	0.8	29.5	0.6	28.8
Mar 22/13	0.0	29.5	-0.2	28.5
Mar 29/13	0.5	30.1	0.8	29.5
Apr 05/13	-0.1	30.0	-1.0	28.2
Apr 12/13	2.1	32.7	2.3	31.1
Apr 19/13	-2.1	29.8	-2.1	28.3
Aug 26/13	1.1	31.3	1.7	30.5
May 03/13	1.8	33.6	2.0	33.2
May 10/13	1.0	34.9	1.2	34.8
May 17/13	1.6	37.0	2.1	37.6
May 24/13	-0.3	36.6	-1.1	36.1
May 31/13	-1.2	34.9	-1.1	34.5
Jun 07/13	0.9	36.1	0.8	35.6
Jun 14/13	-1.2	34.5	-0.9	34.4
Jun 21/13	-1.8	32.1	-2.2	31.4
Jun 28/13	0.7	33.1	0.9	32.5
Jul 05/13	1.5	35.1	1.6	34.6
Jul 12/13	2.2	38.0	3.0	38.6
Jul 19/13	0.5	38.7	0.7	39.6
Jul 26/13	0.1	38.9	0.0	39.6
Aug 02/13	0.6	39.7	1.1	41.1
Aug 09/13	-1.5	37.7	-1.1	39.6
Aug 16/13	-2.2	34.6	-2.1	36.6
Aug 23/13	-0.5	34.0	0.5	37.2
Aug 30/13	-1.3	32.2	-1.8	34.7
Sep 06/13	0.8	33.2	1.4	36.6
Sep 13/13	3.0	37.2	2.0	39.3
Sep 20/13	0.5	37.9	1.3	41.1
Sep 27/13	-1.2	36.2	-1.1	39.6
Oct 04/13	-1.2	34.5	-0.1	39.5
Oct 11/13	1.1	36.0	0.8	40.5
Oct 18/13	1.1	37.4	2.4	43.9
Oct 25/13	1.1	39.0	0.9	45.2
Nov 01/13	0.3	39.4	0.1	45.3
Nov 08/13	0.9	40.7	0.5	46.1
Nov 15/13	1.3	42.5	1.6	48.4
Nov 22/13	0.6	43.4	0.4	48.9
Nov 29/13	0.1	43.6	0.1	49.0
Dec 06/13	-0.4	43.0	0.0	48.9
Dec 13/13	-1.7	40.6	-1.6	46.5
Dec 20/13	3.0	44.8	2.4	50.0
Dec 27/13	1.6	47.1	1.3	51.9
Jan 03, 2014	-0.1	47.0	-0.5	79.1
Jan 10/14	-0.2	46.7	0.6	52.0
Jan 17/14	0.1	46.9	-0.2	51.7
Jan 24/14	-3.5	41.7	-2.6	47.7
Jan 31/14	-1.1	40.1	-0.4	47.1
Feb 7/14	0.6	41.0	0.8	48.3
Feb 14/14	2.3	44.2	2.3	51.7
Feb 21/14	-0.3	43.7	-0.1	51.5
Feb 28/14	1.4	45.7	1.3	53.4
Mar 7/14	0.8	46.8	1.0	54.9
Mar 14/14	-2.4	43.4	-2.0	51.9
Mar 21/14	1.5	45.5	1.4	54.0
Mar 28/14	0.1	45.7	-0.5	53.3
Apr 04/14	0.5	46.5	0.4	53.9
Apr 11/14	-2.4	43.0	-2.6	49.8
Apr 17/14	2.4	46.4	2.7	53.9
Apr 25/14	-0.3	46.0	-0.1	53.7
May 02/14	0.9	47.4	1.0	55.2
May 09/14	0.4	48.0	-0.1	55.0
May 16, 14	-0.6	47.2	0.0	54.9
May 23, 14	0.7	48.2	1.2	56.8
May 30, 14	0.7	49.2	1.2	58.7
Jun 06, 14	1.2	51.0	1.3	60.8
Jun 13, 14	-0.9	49.7	-0.7	59.7
Jun 20, 14	1.0	51.2	1.4	61.9
Jun 27, 14	-0.6	50.4	-0.1	61.8
Jul 04, 14	1.3	52.3	1.2	63.8
Jul 11, 14	-0.7	51.2	-0.9	62.3
Jul 18, 14	0.9	52.6	0.5	63.2
Jul 25, 14	-0.8	51.4	0.0	63.2
Aug 1, 14	-2.8	47.2	-2.7	58.8
Aug 8, 14	0.4	47.7	0.3	59.4
Aug 15, 14	0.7	48.7	1.2	61.3
Aug 22, 14	2.0	51.7	1.7	64.1
Aug 29, 14	0.6	52.6	0.8	65.3
Sep 5, 14	0.2	52.9	0.2	65.6
Sep 12, 14	-0.9	51.6	-1.1	63.8
Sep 19, 14	1.7	54.2	1.3	65.9
Sep 26,14	-1.0	52.7	-1.4	63.6
Oct 3, 14	-0.6	51.8	-0.8	62.4
Oct 10, 14	-2.7	47.6	-3.1	57.3
Oct 17, 14	-1.0	46.2	-1.0	55.7
Oct 24, 14	2.6	50.0	4.1	62.1
Oct 31, 14	3.5	55.2	2.7	66.5
Nov 7, 14	1.1	56.8	0.7	67.6
Nov 14, 14	0.3	57.4	0.4	68.3
Nov 21,14	1.0	58.9	1.2	70.2
Nov 28, 14	0.1	59.1	0.2	70.6
Dec 5, 14	0.7	60.3	0.4	71.2
Dec 12, 14	-3.8	54.2	-3.5	65.2
Dec 19, 14	3.0	58.9	3.4	70.8
Dec 26, 14	1.4	61.1	0.9	72.3
Jan 02, 2015	-1.2	59.2	-1.5	69.8
Jan 09, 15	-0.5	58.3	-0.7	68.7
Jan 16, 15	-1.3	56.3	-1.2	66.6
Jan 23, 15	0.9	57.7	1.6	69.3
Jan 30, 15	-2.9	53.2	-2.8	64.6
Feb 06, 15	3.8	59.1	3.0	69.6
Feb 13, 15	1.1	60.8	2.0	73.0
Feb 20, 15	0.7	61.9	0.6	74.1
Feb 27, 15	0.0	61.8	-0.3	73.6
Feb 6, 15	-1.5	59.4	-1.6	70.9
Feb 13 15	-0.6	58.4	-0.9	69.4
Feb 20, 15	2.1	61.8	2.7	73.9
Feb 27, 15	-2.3	58.1	-2.2	70.0
Apr 03, 15	0.3	58.5	0.3	70.5
Apr 10, 15	1.7	61.2	1.7	73.4
Apr 17, 15	-1.3	59.1	-1.0	71.7
Apr 24, 2015	1.4	61.4	1.8	74.7
May 1, 2015	-0.3	60.9	-0.4	73.9
May 8, 2015	0.9	62.3	0.4	74.6
May 15, 2015	0.4	63.1	0.3	75.1
May 22, 2015	-0.2	62.7	0.2	75.4
May 29, 2015	-1.2	60.7	-0.9	73.9
Jun 5, 2015	-0.9	59.3	-0.7	72.7
Jun 12, 2015	0.3	59.7	0.1	72.8
Jun 19, 2015	0.7	60.8	0.8	74.1
Jun 26, 2015	-0.4	60.2	-0.4	73.4
Jul 3, 2015	-1.2	58.2	-1.2	71.3
Jul 10, 2015	0.2	58.5	0.0	71.3
Jul 17, 2015	1.8	61.4	2.4	75.5
Jul 24, 2015	-2.9	56.8	-2.2	71.6
Jul 31, 2015	0.7	57.9	1.2	73.6
Aug 7, 2015	-1.8	55.0	-1.2	71.4
Aug 14, 2015	0.6	56.0	0.7	72.6
Aug 21, 2015	-5.8	46.9	-5.8	62.6
Aug 28, 2015	1.1	48.5	0.9	64.1
Sep 4, 2015	-3.2	43.7	-3.4	58.5
Sep 11, 2015	2.1	46.7	2.1	61.8
Sep 18, 2015	-0.3	46.2	-0.2	61.5
Sep 25, 2015	-0.4	45.6	-1.4	59.3
Oct 2, 2015	1.0	47.0	1.0	70.1
Oct 9, 2015	3.7	52.5	3.3	66.2
Oct 16, 2015	0.8	53.6	0.9	67.7
Oct 23, 2015	2.5	57.5	2.1	71.2
Oct 30, 2015	0.1	57.6	0.2	71.6
Nov 6, 2015	0.4	59.8	1.0	73.2
Nov 13, 2015	-3.7	53.9	-3.6	66.9
Nov 20, 2015	3.4	59.1	3.3	72.4
Nov 27, 2015	-0.1	58.8	0.0	72.4
Dec 4, 2015	0.3	59.3	0.1	72.6
Dec 11, 2015	-3.3	54.1	-3.8	66.0
Dec 18, 2015	-0.8	52.9	-0.3	65.5
Dec 23, 2015	2.5	56.6	2.8	70.0
Dec 31, 2015	-0.7	55.5	-0.8	68.6
Jan 08, 2016	-6.2	45.9	-6.0	58.6
Jan 15, 2016	-2.2	42.7	-2.2	55.1
Jan 22, 2016	0.7	43.6	1.4	57.3
Jan 29, 2016	2.3	47.0	1.7	60.1
Feb 05, 2016	-1.6	44.6	-3.1	55.1
Feb 12, 2016	-1.4	42.6	-0.8	53.9
Feb 19, 2016	2.6	46.3	2.8	58.2
Feb 26, 2016	1.5	48.5	1.6	60.7
Mar 04, 2016	2.2	51.8	2.7	65.0
Mar 11, 2016	1.2	53.6	1.1	66.8
Mar 18, 2016	2.3	57.1	1.4	69.1
Mar 25, 2016	-0.5	56.3	-0.7	68.0
Apr 01, 2016	1.6	58.8	1.8	71.0
Apr 08, 2016	-1.2	56.9	-1.2	68.9
Apr 15, 2016	1.8	59.7	1.6	71.7
Apr 22, 2016	0.6	60.7	0.5	72.6
Apr 29, 2016	-1.3	58.6	-1.3	70.4
May 6, 2016	-0.2	58.3	-0.4	69.7
May 13, 2016	-1.2	56.5	-0.5	68.9
May 20, 2016	-0.2	56.2	0.3	69.3
May 27, 2016	2.1	59.5	2.3	73.2
Jun 03, 2016	-0.4	58.9	0.0	73.2
Jun 10, 2016	0.3	59.4	-0.1	72.9
Jun 17, 2016	-1.1	57.7	-1.2	70.9
Jun 24, 2016	-1.6	55.3	-1.6	68.1
Jul 01, 2016	3.2	60.2	3.2	73.5
Jul 08, 2016	1.1	62.0	1.3	75.7
Jul 15, 2016	2.0	65.3	1.5	78.4
Jul 22, 2016	0.3	65.7	0.6	79.5
Jul 29, 2016	-0.7	64.5	-0.1	79.3
Aug 05, 2016	0.6	65.5	0.4	80.1
Aug 12, 2016	0.2	65.8	0.1	80.2
Aug 19, 2016	-0.1	65.6	0.0	80.2
Aug 26, 2016	-0.8	64.2	-0.7	79.0
Sep 02, 2016	0.5	65.0	0.5	79.9
Sep 09, 2016	-2.2	61.4	-2.4	75.6
Sep 16, 2016	0.2	61.7	0.5	76.5
Sep 23, 2016	0.8	63.0	1.2	78.6
Sep 30, 2016	0.3	63.4	0.2	78.9
Oct 07, 2016	-0.4	62.8	-0.7	77.7
Oct 14, 2016	-0.6	61.9	-1.0	76.0
Oct 21, 2016	0.0	61.9	0.4	87.3
Oct 28, 2016	0.1	62.1	-0.7	75.4
Nov 04, 2016	-1.5	59.6	-1.9	72.0
Nov 11, 2016	5.4	68.2	3.8	78.6
Nov 18, 2016	0.1	68.4	0.8	94.8
Nov 25, 2016	1.5	70.9	1.4	82.6
Dec 02, 2016	0.1	71.1	-1.0	80.8
Dec 09, 2016	3.1	76.3	3.1	86.4
Dec 16, 2016	0.4	77.1	-0.1	86.3
Dec 23, 2016	0.5	77.9	0.3	86.8
Dec 30, 2016	-0.9	76.4	-1.1	84.7
Jan 06, 2017	1.0	78.2	1.7	87.9
Jan 13, 2017	-0.4	77.5	-0.1	87.7
Jan 20, 2017	-0.3	76.9	-0.1	122.1
Jan 27, 2017	1.3	79.3	1.0	89.3
Feb 03, 2017	-0.1	79.1	0.1	89.5
Feb 10, 2017	1.0	80.9	0.8	91.1
Feb 17, 2017	1.7	84.1	1.5	94.0
Feb 24, 2017	1.0	85.8	0.7	95.3
Mar 03, 2017	0.9	87.5	0.7	96.6
Mar 10, 2017	-0.5	86.5	-0.4	95.8
Mar 17, 2017	0.1	86.7	0.2	96.2
Mar 24, 2017	-1.5	83.8	-1.4	93.4
Mar 31, 2017	0.3	84.4	0.8	94.9
Apr 07, 2017	0.0	84.3	-0.3	94.3
Apr 14, 2017	-1.0	82.5	-1.1	92.1
Apr 21, 2017	0.5	83.4	0.8	93.8
Apr 28, 2017	1.9	86.9	1.5	96.7
May 05, 2017	0.3	87.5	0.6	98.0
May 12, 2017	-0.5	86.5	-0.3	97.3
Mar 19, 2017	-0.4	85.7	-0.4	96.5
Mar 26, 2017	1.3	88.1	1.4	99.3
Jun 02, 2017	0.6	89.3	1.0	101.2
Jun 09, 2017	0.3	89.8	-0.3	100.6
Jun 16, 2017	0.5	90.8	0.1	100.7
Jun 23, 2017	0.0	90.9	0.2	101.2
Jun 30, 2017	-0.2	90.5	-0.6	99.9
Jul 07, 2017	0.3	91.1	0.1	100.1
Jul 14, 2017	1.0	93.1	1.4	102.9
Jul 21, 2017	-0.3	92.6	0.5	104.0
Jul 28, 2017	1.2	94.8	0.0	104.0
Aug 04, 2017	1.2	97.2	0.2	104.4
Aug 11. 2017	-1.1	95.1	-1.4	101.4
Aug 18, 2017	-0.8	93.4	-0.6	100.1
Aug 25, 2017	0.6	94.7	0.7	101.6
Sep 01, 2017	0.8	96.2	1.4	104.3
Sep 08, 2017	-0.9	94.5	-0.6	103.1
Sep 15, 2017	2.2	98.7	1.6	106.3
Sep 22, 2017	0.4	99.5	0.1	106.4
Sep 29, 2017	0.2	100.0	0.7	107.9
Oct 06, 2017	1.6	103.2	1.2	110.3
Oct 13, 2017	0.4	104.1	0.2	110.6
Oct 20, 2017	2.0	108.2	0.9	112.5
Oct 27, 2017	0.5	109.1	0.2	113.0
Nov 03, 2017	0.4	110.1	0.3	113.5
Nov 10, 2017	-0.5	109.0	-0.2	113.1
Nov 17, 2017	-0.3	108.5	-0.1	112.8
Nov 24, 2017	0.9	110.2	0.9	114.7
Dec 01, 2017	2.9	116.3	1.5	118.0
Dec 08, 2017	0.4	117.1	0.4	118.8
Dec 15, 2017	1.3	120.0	0.9	120.8
Dec 22, 2017	0.4	120.9	0.3	121.4
Dec 29, 2017	-0.1	120.6	-0.4	120.6
Jan 05, 2018	2.3	125.8	2.6	126.3
Jan 12, 2018	2.0	130.3	1.6	129.9
Jan 19, 2018	1.0	132.7	0.9	131.9
Jan 26, 2018	2.1	137.5	2.2	137.0
Feb 02, 2018	-4.1	127.8	-3.9	127.9
Feb 09, 2018	-5.2	115.9	-5.2	116.1
Feb 16, 2018	4.3	125.1	4.3	125.4
Feb 23, 2018	0.4	125.9	0.6	126.7
Mar 02, 2018	-3.0	119.0	-2.0	122.0
Mar 09, 2018	3.3	126.1	3.5	129.9
Mar 16, 2018	-1.5	122.6	-1.2	127.1
Mar 23, 2018	-5.7	110.0	-6.0	113.5
Mar 30, 2018	2.4	115.1	2.0	117.9
Apr 06, 2018	-0.7	113.6	-1.4	114.9
Apr 13, 2018	1.8	117.4	2.0	119.2
Apr 20, 2018	0.4	118.3	0.5	120.3
Apr 27, 2018	-0.6	117.0	0.0	120.3
May 04, 2018	-0.2	116.5	-0.2	119.7
May 11, 2018	2.3	121.6	2.4	125.1
May 18, 2018	-0.5	120.6	-0.5	123.8
May 25, 2018	0.2	120.9	0.3	124.5
Jun 01, 2018	-0.5	119.9	0.5	125.6
Jun 08, 2018	2.8	125.9	2.4	130.9
Jun 15, 2018	-0.9	123.9	-0.7	129.3
Jun 22, 2018	-2.0	119.4	-0.9	127.3
Jun 29, 2018	-1.3	116.6	-1.3	124.3
Jul 06, 2018	0.8	118.3	1.5	127.7
Jul 13, 2018	2.3	123.3	1.5	131.1
Jul 20, 2018	0.2	123.6	0.0	131.2
Jul 27, 2018	1.6	127.1	0.6	132.6
Aug 03, 2018	0.0	127.2	0.8	134.3
Aug 10, 2018	-0.6	125.9	-0.2	133.8
Aug 17, 2018	1.4	129.1	0.6	135.1
Aug 24, 2018	0.5	130.2	0.9	137.2
Aug 31, 2018	0.7	131.7	0.9	139.4
Sep 07, 2018	-0.2	131.3	-1.0	136.9
Sep 14, 2018	0.9	133.4	1.2	139.7
Sep 21, 2018	2.3	138.7	0.8	141.7
Sep 28, 2018	-1.1	136.1	-0.5	140.4
Oct 05, 2018	0.0	136.0	-1.0	138.1
Oct 12, 2018	-4.2	126.1	-4.1	128.3
Oct 19, 2018	0.4	127.1	0.0	128.4
Oct 26, 2018	-3.0	120.3	-3.9	119.4
Nov 02, 2018	2.4	125.5	2.4	124.7
Nov 09, 2018	2.8	131.9	2.1	129.4
Nov 16, 2018	-2.2	126.8	-1.6	125.8
Nov 23, 2018	-4.4	116.7	-3.8	117.2
Nov 30, 2018	5.2	127.9	4.8	127.7
Dec 07, 2018	-4.5	117.7	-4.6	117.2
Dec 14, 2018	-1.2	115.1	-1.3	114.5
Dec 21, 2018	-6.9	100.3	-7.1	99.4
Dec 28, 2018	2.7	105.8	2.9	105.1
Jan 04, 2019	1.6	109.1	1.9	108.9
Jan 11, 2019	2.4	114.2	2.5	114.2
Jan 18, 2019	3.0	120.5	2.9	120.3
Jan 25, 2019	0.1	120.8	-0.2	119.9
Feb 01, 2019	1.3	123.7	1.6	123.3
Feb 08, 2019	0.2	124.1	0.0	123.4
Feb 15, 2019	3.1	131.0	2.5	129.0
Feb 22, 2019	0.6	132.3	0.6	130.4
Mar 01, 2019	0.0	132.3	0.4	131.3
Mar 08, 2019	-2.2	127.1	-2.2	126.3
Mar 15, 2019	1.6	130.7	2.9	132.9
Mar 22, 2019	-1.3	127.6	-0.8	131.1
Mar 29, 2019	1.7	131.4	1.2	133.9
Apr 05, 2019	1.9	135.8	2.1	138.7
Apr 12, 2019	0.0	135.7	0.5	139.9
Apr 19, 2019	0.6	137.0	-0.1	139.7
Apr 26, 2019	-0.1	136.9	1.2	142.6
May 03, 2019	-0.1	136.5	0.2	143.0
May 10, 2019	-2.1	131.5	-2.2	137.7
May 17, 2019	-0.7	129.9	-0.8	135.9
May 24, 2019	-0.7	128.3	-1.2	133.2
May 31, 2019	-3.0	121.5	-2.6	127.1
Jun 07, 2019	4.7	131.9	4.4	137.1
Jun 14, 2019	0.4	132.8	0.5	138.2
Jun 21, 2019	2.4	138.5	2.2	143.4
Jun 28, 2019	-0.4	137.4	-0.3	142.7
Jul 05, 2019	1.2	140.3	1.7	146.7
Jul 12, 2019	1.5	143.9	0.8	148.7
Jul 19, 2019	-0.7	142.3	-1.2	145.6
Jul 26, 2019	0.1	142.7	1.7	149.6
Aug 02, 2019	-2.6	136.4	-3.1	141.9
Aug 09, 2019	-0.7	134.6	-0.5	140.8

Source:

http://professional.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3014

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

Table VI-6, updated with every blog comment, shows that exchange rate valuations affect a large variety of countries, in fact, almost the entire world, in magnitudes that cause major problems for domestic monetary policy and trade flows. Dollar devaluation/fluctuation is expected to continue because of zero fed funds rate, expectations of rising inflation, large budget deficit of the federal government (http://professional.wsj.com/article/SB10001424052748703907004576279321350926848.html?mod=WSJ_hp_LEFTWhatsNewsCollection) and now near zero interest rates indefinitely but with interruptions caused by risk aversion events. The euro has devalued 42.0 percent relative to the US dollar from the high on Jul 15, 2008 to Aug 9, 2019. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). The British pound (GBP) devalued 15.4 percent from the trough of USD/₤1.388 on Jan 2, 2009 to USD/₤1.2028 on Aug 9, 2019 and devalued 66.8 percent from the high of USD/₤2.006 on Jul 15, 2008, exchange rate changes measuring ₤/USD. Such similar event occurred in the week of Sep 23, 2011 reversing the devaluation of the dollar in the form of sharp appreciation of the dollar relative to other currencies from all over the world including the offshore Chinese yuan market. The Bank of England reduced the Bank Rate to 0.25 percent on Aug 4, 2016, and announced new measures of quantitative easing

(http://www.bankofengland.co.uk/publications/Pages/news/2016/008.aspx). The Bank of England increased the policy interest rate by 0.25 percentage points to 0.75 percent at the meeting of its Monetary Policy Committee on Aug 1, 2018 (https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2018/august-2018). Column “Peak” in Table VI-6 shows exchange rates during the crisis year of 2008. There was a flight to safety in dollar-denominated government assets because of the arguments in favor of TARP (Cochrane and Zingales 2009). This is evident in various exchange rates that depreciated sharply against the dollar such as the South African rand (ZAR) at the peak of depreciation of ZAR 11.578/USD on Oct 22, 2008. Subsequently, the ZAR appreciated to the trough of ZAR 7.238/USD by Aug 15, 2010 but now depreciating 110.7 percent to ZAR 15.2540/USD on Aug 9, 2019, which is depreciation of 31.7 percent relative to Oct 22, 2008. An example from Asia is the Singapore Dollar (SGD) that depreciated at the peak of SGD 1.553/USD on Mar 3, 2009. The SGD depreciated by 13.2 percent to the trough of SGD 1.348/USD on Aug 9, 2010 but is now depreciating 2.8 percent at SGD 1.3855/USD on Aug 9, 2019 relative to the trough of depreciation but still stronger by 10.8 percent relative to the peak of depreciation on Mar 3, 2009. Another example is the Brazilian real (BRL) that depreciated at the peak to BRL 2.43/USD on Dec 5, 2008. The BRL appreciated 28.5 percent to the trough at BRL 1.737/USD on Apr 30, 2010, showing depreciation of 127.0 percent relative to the trough to BRL 3.8886/USD on Aug 9, 2019 but depreciating by 62.2 percent relative to the peak on Dec 5, 2008. At one point in 2011, the Brazilian real traded at BRL 1.55/USD and in the week of Sep 23 surpassed BRL 1.90/USD in intraday trading for depreciation of more than 20 percent. The Banco Central do Brasil (BCB), Brazil’s central bank, decreased its policy rate SELIC for ten consecutive meetings (http://www.bcb.gov.br/?INTEREST) of its monetary policy committee, COPOM. Brazil’s central bank did not change the SELIC rate at its most recent meeting (https://www.bcb.gov.br/en/pressdetail/2278/nota):

“224^th Meeting of the Monetary Policy Committee (COPOM) of the Central Bank of Brazil Press Release

07/31/2019

The COPOM unanimously decided to lower the Selic rate to 6.00 percent per year” (https://www.bcb.gov.br/en/pressdetail/2278/nota). The Banco Central do Brasil also engaged in FX auctions (http://www.bcb.gov.br/en/#!/c/news/1828):

“BC announces FX auctions program 22/08/2013 6:44:00 PM

With the aim of providing FX ‘hedge” (protection) to the economic agents and liquidity to the FX market, the Banco Central do Brasil informs that a program of FX swap auctions and US dollar sale auctions with repurchase program will begin, as of Friday, August 23. This program will last, at least, until December 31, 2013. The swap auctions will occur every Monday, Tuesday, Wednesday and Thursday, when US$500 million will be offered per day. On Fridays, a credit line of US$1 billion will be offered to the market, through sale auctions with repurchase agreement. If it is considered appropriate, the Banco Central do Brasil will carry out additional operations.”

Jeffrey T. Lewis, writing on “Brazil steps up battle to curb real’s rise,” on Mar 1, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203986604577255793224099580.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes new measures by Brazil to prevent further appreciation of its currency, including the extension of the tax on foreign capital for three years terms, subsequently broadened to five years, and intervention in the foreign exchange market by the central bank. Jeff Fick, writing on “Brazil shifts tack to woo wary investors,” on Jun 5, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324299104578527000680111188.html), analyzes the lifting in the week of Jun 7, 2013, of the tax on foreign transactions designed in Oct 2010 to contain the flood of foreign capital into Brazil that overvalued its currency. Jeffrey T. Lewis, writing on “Brazil’s real closes weaker,” on Jun 14, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323734304578545680335302180.html), analyzes measures to contain accelerated depreciation such as currency swaps and the lifting of the 1 percent tax on exchange derivatives on Jun 12, 2013. Unconventional monetary policy of zero interest rates and quantitative easing creates trends such as the depreciation of the dollar followed by Table VI-6 but with abrupt reversals during risk aversion. The main effects of unconventional monetary policy are on valuations of risk financial assets and not necessarily on consumption and investment or aggregate demand.

Table VI-6, Exchange Rates

	Peak	Trough	∆% P/T	Aug 09, 2019	∆% T Aug 09, 2019	∆% P Aug 09, 2019
EUR USD	7/15 2008	6/7 2010		08/09/2019
Rate	1.59	1.192		1.1201
∆%			-33.4		-6.4	-42.0
JPY USD	8/18 2008	9/15 2010		08/09/2019
Rate	110.19	83.07		105.67
∆%			24.6		-27.2	4.1
CHF USD	11/21 2008	12/8 2009		08/09/2019
Rate	1.225	1.025		0.9725
∆%			16.3		5.1	20.6
USD GBP	7/15 2008	1/2/ 2009		08/09/2019
Rate	2.006	1.388		1.2028
∆%			-44.5		-15.4	-66.8
USD AUD	7/15 2008	10/27 2008		08/09/2019
Rate	1.0215	1.6639		0.6786
∆%			-62.9		11.4	-44.3
ZAR USD	10/22 2008	8/15 2010		08/09/2019
Rate	11.578	7.238		15.2540
∆%			37.5		-110.7	-31.7
SGD USD	3/3 2009	8/9 2010		08/09/2019
Rate	1.553	1.348		1.3855
∆%			13.2		-2.8	10.8
HKD USD	8/15 2008	12/14 2009		08/09/2019
Rate	7.813	7.752		7.8418
∆%			0.8		-1.2	-0.4
BRL USD	12/5 2008	4/30 2010		08/09/2019
Rate	2.43	1.737		3.9425
∆%			28.5		-127.0	-62.2
CZK USD	2/13 2009	8/6 2010		08/09/2019
Rate	22.19	18.693		23.081
∆%			15.7		-23.5	-4.0
SEK USD	3/4 2009	8/9 2010		08/09/2019
Rate	9.313	7.108		9.5443
∆%			23.7		-34.3	-2.5
CNY USD	7/20 2005	7/15 2008		08/09/2019
Rate	8.2765	6.8211		7.0624	-3.5	14.7
∆%			17.6

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

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

Source:

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

https://markets.ft.com/data/currencies

There are major ongoing and unresolved realignments of exchange rates in the international financial system as countries and regions seek parities that can optimize their productive structures. Seeking exchange rate parity or exchange rate optimizing internal economic activities is complex in a world of unconventional monetary policy of zero interest rates and even negative nominal interest rates of government obligations such as negative yields for the two-year government bond of Germany. Regulation, trade and devaluation conflicts should have been expected from a global recession (Pelaez and Pelaez (2007), The Global Recession Risk, Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008a)): “There are significant grounds for concern on the basis of this experience. International economic cooperation and the international financial framework can collapse during extreme events. It is unlikely that there will be a repetition of the disaster of the Great Depression. However, a milder contraction can trigger regulatory, trade and exchange wars” (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 181). Chart VI-2 of the Board of Governors of the Federal Reserve System provides the key exchange rate of US dollars (USD) per euro (EUR) from Jan 4, 1999 to Aug 2, 2019. US recession dates are in shaded areas. The rate on Jan 4, 1999 was USD 1.1812/EUR, declining to USD 0.8279/EUR on Oct 25, 2000, or appreciation of the USD by 29.9 percent. The rate depreciated 21.9 percent to USD 1.0098/EUR on Jul 22, 2002. There was sharp devaluation of the USD of 34.9 percent to USD 1.3625/EUR on Dec 27, 2004 largely because of the 1 percent interest rate between Jun 2003 and Jun 2004 together with a form of quantitative easing by suspension of auctions of the 30-year Treasury, which was equivalent to withdrawing supply from markets. Another depreciation of 17.5 percent took the rate to USD 1.6010/EUR on Apr 22, 2008, already inside the shaded area of the global recession. The flight to the USD and obligations of the US Treasury appreciated the dollar by 22.3 percent to USD 1.2446/EUR on Oct 27, 2008. In the return of the carry trade after stress tests showed sound US bank balance sheets, the rate depreciated 21.2 percent to USD 1.5085/EUR on Nov 25, 2009. The sovereign debt crisis of Europe in the spring of 2010 caused sharp appreciation of 20.7 percent to USD 1.1959/EUR on Jun 6, 2010. Renewed risk appetite depreciated the rate 24.4 percent to USD 1.4875/EUR on May 3, 2011. The rate appreciated 7.1 percent to USD 1.1112/EUR on Aug 2, 2019, which is the last point in Chart VI-2. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-2, US Dollars (USD) per Euro (EUR), Jan 4, 1999 to Aug 2, 2019

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI 3 provides three currency indexes of the dollar from Jan 4, 1995 to Aug 2, 2019. Chart VI-3A provides the overnight fed funds rate and yields of the three-month constant maturity Treasury bill, the ten-year constant maturity Treasury note and Moody’s Baa bond from Jan 4, 1995 to Jul 7, 2016. Chart VI-3B provides the overnight fed funds rate and yields of the three-month constant maturity Treasury bill and the ten-year constant maturity Treasury from Jan 5, 2001 to Aug 8, 2019. The first phase from 1995 to 2001 shows sharp trend of appreciation of the USD while interest rates remained at relatively high levels. The dollar revalued partly because of the emerging market crises that provoked inflows of financial investment into the US and partly because of a deliberate strong dollar policy. DeLong and Eichengreen (2001, 4-5) argue:

“That context was an economic and political strategy that emphasized private investment as the engine for U.S. economic growth. Both components of this term, "private" and "investment," had implications for the administration’s international economic strategy. From the point of view of investment, it was important that international events not pressure on the Federal Reserve to raise interest rates, since this would have curtailed capital formation and vitiated the effects of the administration’s signature achievement: deficit reduction. A strong dollar -- or rather a dollar that was not expected to weaken -- was a key component of a policy which aimed at keeping the Fed comfortable with low interest rates. In addition, it was important to create a demand for the goods and services generated by this additional productive capacity. To the extent that this demand resided abroad, administration officials saw it as important that the process of increasing international integration, of both trade and finance, move forward for the interest of economic development in emerging markets and therefore in support of U.S. economic growth.”

The process of integration consisted of restructuring “international financial architecture” (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Debtors and Creditors (2005)). Policy concerns subsequently shifted to the external imbalances, or current account deficits, and internal imbalances, or government deficits (Pelaez and Pelaez, The Global Recession Risk: Dollar Devaluation and the World Economy (2007)). Fed policy consisted of lowering the policy rate or fed funds rate, which is close to the marginal cost of funding of banks, toward zero during the past decade. Near zero interest rates induce carry trades of selling dollar debt (borrowing), shorting the USD and investing in risk financial assets. Without risk aversion, near zero interest rates cause devaluation of the dollar. Chart VI-3 shows the weakening USD between the recession of 2001 and the contraction after IVQ2007. There was a flight to dollar assets and especially obligations of the US government after Sep 2008. Cochrane and Zingales (2009) show that flight was coincident with proposals of TARP (Troubled Asset Relief Program) to withdraw “toxic assets” in US banks (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a) and Regulation of Banks and Finance (2009b)). There are shocks to globalization in the form of regulation, trade and devaluation wars and breakdown of international cooperation (Pelaez and Pelaez, Globalization and the State: Vol. I (2008a), Globalization and the State: Vol. II (2008b) and Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c)). As evident in Chart VI-3A, there is no exit from near zero interest rates without a financial crisis and economic contraction, verified by the increase of interest rates from 1 percent in Jun 2004 to 5.25 percent in Jun 2006. The Federal Open Market Committee (FOMC) lowered the target of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85). The FOMC implemented increments of 25 basis points of the fed funds target from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006, as shown in Chart VI-3A. The gradual exit from the first round of unconventional monetary policy from 1.00 percent in Jun 2004 (http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040630/default.htm) to 5.25 percent in Jun 2006 (http://www.federalreserve.gov/newsevents/press/monetary/20060629a.htm) caused the financial crisis and global recession. There are conflicts on exchange rate movements among central banks. There is concern of declining inflation in the euro area and appreciation of the euro. On Jun 5, 2014, the European Central Bank introduced cuts in interest rates and a negative rate paid on deposits of banks (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605.en.html):

“5 June 2014 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.15%, starting from the operation to be settled on 11 June 2014.
The interest rate on the marginal lending facility will be decreased by 35 basis points to 0.40%, with effect from 11 June 2014.
The interest rate on the deposit facility will be decreased by 10 basis points to -0.10%, with effect from 11 June 2014. A separate press release to be published at 3.30 p.m. CET today will provide details on the implementation of the negative deposit facility rate.”

The ECB also introduced new measures of monetary policy on Jun 5, 2014 (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605_2.en.html):

“5 June 2014 - ECB announces monetary policy measures to enhance the functioning of the monetary policy transmission mechanism

In pursuing its price stability mandate, the Governing Council of the ECB has today announced measures to enhance the functioning of the monetary policy transmission mechanism by supporting lending to the real economy. In particular, the Governing Council has decided:

To conduct a series of targeted longer-term refinancing operations (TLTROs) aimed at improving bank lending to the euro area non-financial private sector ^[¹^], excluding loans to households for house purchase, over a window of two years.
To intensify preparatory work related to outright purchases of asset-backed securities (ABS).”

The President of the European Central Bank (ECB) Mario Draghi analyzed the measures at a press conference (http://www.ecb.europa.eu/press/pressconf/2014/html/is140605.en.html). At the press conference following the meeting of the ECB on Jul 3, 2014, Mario Draghi stated (http://www.ecb.europa.eu/press/pressconf/2014/html/is140703.en.html): “In fact, as I said, interest rates will stay low for an extended period of time, and the Governing Council is unanimous in its commitment to use also nonstandard, unconventional measures to cope with the risk of a too-prolonged period of time of low inflation.”

The President of the ECB Mario Draghi analyzed unemployment in the euro area and the policy response policy in a speech at the Jackson Hole meeting of central bankers on Aug 22, 2014 (http://www.ecb.europa.eu/press/key/date/2014/html/sp140822.en.html):

“We have already seen exchange rate movements that should support both aggregate demand and inflation, which we expect to be sustained by the diverging expected paths of policy in the US and the euro area (Figure 7). We will launch our first Targeted Long-Term Refinancing Operation in September, which has so far garnered significant interest from banks. And our preparation for outright purchases in asset-backed security (ABS) markets is fast moving forward and we expect that it should contribute to further credit easing. Indeed, such outright purchases would meaningfully contribute to diversifying the channels for us to generate liquidity.”

On Sep 4, 2014, the European Central Bank lowered policy rates (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140904.en.html):

“4 September 2014 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.05%, starting from the operation to be settled on 10 September 2014.
The interest rate on the marginal lending facility will be decreased by 10 basis points to 0.30%, with effect from 10 September 2014.
The interest rate on the deposit facility will be decreased by 10 basis points to -0.20%, with effect from 10 September 2014.”

The President of the European Central Bank announced on Sep 4, 2014, the decision to expand the balance sheet by purchases of asset-backed securities (ABS) in a new ABS Purchase Program (ABSPP) and covered bonds (http://www.ecb.europa.eu/press/pressconf/2014/html/is140904.en.html):

“Based on our regular economic and monetary analyses, the Governing Council decided today to lower the interest rate on the main refinancing operations of the Eurosystem by 10 basis points to 0.05% and the rate on the marginal lending facility by 10 basis points to 0.30%. The rate on the deposit facility was lowered by 10 basis points to -0.20%. In addition, the Governing Council decided to start purchasing non-financial private sector assets. The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP). This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter, as decided by the Governing Council in June. In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs domiciled in the euro area under a new covered bond purchase programme (CBPP3). Interventions under these programmes will start in October 2014. The detailed modalities of these programmes will be announced after the Governing Council meeting of 2 October 2014. The newly decided measures, together with the targeted longer-term refinancing operations which will be conducted in two weeks, will have a sizeable impact on our balance sheet.”

At the Thirtieth Meeting of the International Monetary and Financial Committee of the IMF (IMFC), the President of the European Central Bank (ECB), Mario Draghi stated (http://www.ecb.europa.eu/press/key/date/2014/html/sp141010.en.html):

“Our monetary policy continues to aim at firmly anchoring medium to long-term inflation expectations, in line with our objective of maintaining inflation rates below, but close to, 2% over the medium term. In this context, we have taken both conventional and unconventional measures that will contribute to a return of inflation rates to levels closer to our aim. Our unconventional measures, more specifically our TLTROs (Targeted Longer-Term Refinancing Operations) and our new purchase programmes for ABSs and covered bonds, will further enhance the functioning of our monetary policy transmission mechanism and facilitate credit provision to the real economy. Should it become necessary to further address risks of too prolonged a period of low inflation, the ECB’s Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate.”

In a speech on “Monetary Policy in the Euro Area,” on Nov 21, 2014, the President of the European Central Bank, Mario Draghi, advised of the determination to bring inflation back to normal levels by aggressive holding of securities in the balance sheet (http://www.ecb.europa.eu/press/key/date/2014/html/sp141121.en.html):

“In short, there is a combination of policies that will work to bring growth and inflation back on a sound path, and we all have to meet our responsibilities in achieving that. For our part, we will continue to meet our responsibility – we will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us.

If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialise, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases.”

In the Introductory Statement to the press conference on Dec 4, 2014, the President of the European Central Bank Mario Draghi advised that (http://www.ecb.europa.eu/press/pressconf/2014/html/is141204.en.html):

“In this context, early next year the Governing Council will reassess the monetary stimulus achieved, the expansion of the balance sheet and the outlook for price developments. We will also evaluate the broader impact of recent oil price developments on medium-term inflation trends in the euro area. Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council remains unanimous in its commitment to using additional unconventional instruments within its mandate. This would imply altering early next year the size, pace and composition of our measures.”

The Swiss National Bank (SNB) announced on Jan 15, 2015, the termination of its peg of the exchange rate of the Swiss franc to the euro (http://www.snb.ch/en/mmr/speeches/id/ref_20150115_tjn/source/ref_20150115_tjn.en.pdf):

“The Swiss National Bank (SNB) has decided to discontinue the minimum exchange rate of

CHF 1.20 per euro with immediate effect and to cease foreign currency purchases associated with enforcing it.”

The SNB also lowered interest rates to nominal negative percentages (http://www.snb.ch/en/mmr/speeches/id/ref_20150115_tjn/source/ref_20150115_tjn.en.pdf):

“At the same time as discontinuing the minimum exchange rate, the SNB will be lowering the interest rate for balances held on sight deposit accounts to –0.75% from 22 January. The exemption thresholds remain unchanged. Further lowering the interest rate makes Swiss-franc investments considerably less attractive and will mitigate the effects of the decision to discontinue the minimum exchange rate. The target range for the three-month Libor is being lowered by 0.5 percentage points to between –1.25% and –0.25%.”

The Swiss franc rate relative to the euro (CHF/EUR) appreciated 18.7 percent on Jan 15, 2015. The Swiss franc rate relative to the dollar (CHF/USD) appreciated 17.7 percent. Central banks are taking measures in anticipation of the quantitative easing by the European Central Bank.

On Jan 22, 2015, the European Central Bank (ECB) decided to implement an “expanded asset purchase program” with combined asset purchases of €60 billion per month “until at least Sep 2016 (http://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html). The objective of the program is that (http://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html):

“Asset purchases provide monetary stimulus to the economy in a context where key ECB interest rates are at their lower bound. They further ease monetary and financial conditions, making access to finance cheaper for firms and households. This tends to support investment and consumption, and ultimately contributes to a return of inflation rates towards 2%.”

The President of the ECB, Mario Draghi, explains the coordination of asset purchases with NCBs (National Central Banks) of the euro area and risk sharing (http://www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html):

“In March 2015 the Eurosystem will start to purchase euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary market. The purchases of securities issued by euro area governments and agencies will be based on the Eurosystem NCBs’ shares in the ECB’s capital key. Some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme. As regards the additional asset purchases, the Governing Council retains control over all the design features of the programme and the ECB will coordinate the purchases, thereby safeguarding the singleness of the Eurosystem’s monetary policy. The Eurosystem will make use of decentralised implementation to mobilise its resources. With regard to the sharing of hypothetical losses, the Governing Council decided that purchases of securities of European institutions (which will be 12% of the additional asset purchases, and which will be purchased by NCBs) will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will not be subject to loss sharing. The ECB will hold 8% of the additional asset purchases. This implies that 20% of the additional asset purchases will be subject to a regime of risk sharing.”

The President of the ECB, Mario Draghi, rejected the possibility of seigniorage in the new asset purchase program, or central bank financing of fiscal expansion (http://www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html):

“As I just said, it would be a big mistake if countries were to consider that the presence of this programme might be an incentive to fiscal expansion. They would undermine the confidence, so it’s not directed to monetary financing at all. Actually, it’s been designed as to avoid any monetary financing.”

The President of the ECB, Mario Draghi, does not find effects of monetary policy in inflating asset prices (http://www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html):

“On the first question, we monitor closely any potential instance of risk to financial stability. So we're very alert to that risk. So far we don't see bubbles. There may be some local episodes of certain specific markets where prices are going up fast. But to have a bubble, besides having that, one should also identify, detect an increase, dramatic increase in leverage or in bank credit, and we don't see that now. However, we, as I said, we are alert. If bubbles are of a local nature, they should be addressed by local instruments, namely macro-prudential instruments rather than by monetary policy.”

Fri May 1

Mon 4

Tue 5

Wed 6

Thu 7

Fri 8

DJIA

18024.06

-0.3%

1.0%

18070.40

0.3%

17928.20

-0.5%

-0.8%

17841.98

-1.0%

-0.5%

17924.06

-0.6%

0.5%

18191.11

0.9%

1.5%

Another hurdle of exit from zero interest rates is “competitive easing” that Professor Raghuram Rajan, former governor of the Reserve Bank of India, characterizes as disguised “competitive devaluation” (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). The fed has been considering increasing interest rates. The European Central Bank (ECB) announced, on Mar 5, 2015, the beginning on Mar 9, 2015 of its quantitative easing program denominated as Public Sector Purchase Program (PSPP), consisting of “combined monthly purchases of EUR 60 bn [billion] in public and private sector securities” (http://www.ecb.europa.eu/mopo/liq/html/pspp.en.html). Expectation of increasing interest rates in the US together with euro rates close to zero or negative cause revaluation of the dollar (or devaluation of the euro and of most currencies worldwide). US corporations suffer currency translation losses of their foreign transactions and investments (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318) while the US becomes less competitive in world trade (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), Government Intervention in Globalization (2008c)). The DJIA fell 1.5 percent on Mar 6, 2015 and the dollar revalued 2.2 percent from Mar 5 to Mar 6, 2015. The euro has devalued 42.0 percent relative to the dollar from the high on Jul 15, 2008 to Aug 9, 2019.

Fri 27 Feb

Mon 3/2

Tue 3/3

Wed 3/4

Thu 3/5

Fri 3/6

USD/ EUR

1.1197

1.6%

0.0%

1.1185

0.1%

1.1176

0.2%

0.1%

1.1081

1.0%

0.9%

1.1030

1.5%

0.5%

1.0843

3.2%

1.7%

Exchange rate volatility is increasing in response of “impatience” in financial markets with monetary policy guidance and measures:

Fri Mar 6

Mon 9

Tue 10

Wed 11

Thu 12

Fri 13

USD/ EUR

1.0843

3.2%

1.7%

1.0853

-0.1%

1.0700

1.3%

1.4%

1.0548

2.7%

1.4%

1.0637

1.9%

-0.8%

1.0497

3.2%

1.3%

Fri Mar 13

Mon 16

Tue 17

Wed 18

Thu 19

Fri 20

USD/ EUR

1.0497

3.2%

1.3%

1.0570

-0.7%

1.0598

-1.0%

-0.3%

1.0864

-3.5%

-2.5%

1.0661

-1.6%

1.9%

1.0821

-3.1%

-1.5%

Fri Apr 24

Mon 27

Tue 28

Wed 29

Thu 30

May Fri 1

USD/ EUR

1.0874

-0.6%

-0.4%

1.0891

-0.2%

1.0983

-1.0%

-0.8%

1.1130

-2.4%

-1.3%

1.1223

-3.2%

-0.8%

1.1199

-3.0%

0.2%

In a speech at Brown University on May 22, 2015, Chair Yellen stated (http://www.federalreserve.gov/newsevents/speech/yellen20150522a.htm):

The US dollar appreciated 3.8 percent relative to the euro in the week of May 22, 2015:

Fri May 15

Mon 18

Tue 19

Wed 20

Thu 21

Fri 22

USD/ EUR

1.1449

-2.2%

-0.3%

1.1317

1.2%

1.1150

2.6%

1.5%

1.1096

3.1%

0.5%

1.1113

2.9%

-0.2%

1.1015

3.8%

0.9%

The President of the European Central Bank (ECB), Mario Draghi, warned on Jun 3, 2015 that (http://www.ecb.europa.eu/press/pressconf/2015/html/is150603.en.html):

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):

At the press conference after the meeting of the FOMC on Sep 17, 2015, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20150917.pdf 4):

Some equity markets fell on Fri Sep 18, 2015:

Fri Sep 11

Mon 14

Tue 15

Wed 16

Thu 17

Fri 18

DJIA

16433.09

2.1%

0.6%

16370.96

-0.4%

16599.85

1.0%

1.4%

16739.95

1.9%

0.8%

16674.74

1.5%

-0.4%

16384.58

-0.3%

-1.7%

Nikkei 225

18264.22

2.7%

-0.2%

17965.70

-1.6%

18026.48

-1.3%

0.3%

18171.60

-0.5%

0.8%

18432.27

0.9%

1.4%

18070.21

-1.1%

-2.0%

DAX

10123.56

0.9%

-0.9%

10131.74

0.1%

10188.13

0.6%

10227.21

1.0%

0.4%

10229.58

1.0%

0.0%

9916.16

-2.0%

-3.1%

· “The economic outlook, of course, is highly uncertain”

· “Considerable uncertainties also surround the outlook for economic activity”

· “Given the highly uncertain nature of the outlook…”

Fri Oct 16

Mon 19

Tue 20

Wed 21

Thu 22

Fri 23

USD/ EUR

1.1350

0.1%

0.3%

1.1327

0.2%

1.1348

0.0%

-0.2%

1.1340

0.1%

1.1110

2.1%

2.0%

1.1018

2.9%

0.8%

DJIA

17215.97

0.8%

0.4%

17230.54

0.1%

17217.11

0.0%

-0.1%

17168.61

-0.3%

17489.16

1.6%

1.9%

17646.70

2.5%

0.9%

Dow Global

2421.58

0.3%

0.6%

2414.33

-0.3%

2411.03

-0.4%

-0.1%

2411.27

-0.4%

0.0%

2434.79

0.5%

1.0%

2458.13

1.5%

1.0%

DJ Asia Pacific

1402.31

1.1%

0.3%

1398.80

-0.3%

1395.06

-0.5%

-0.3%

1402.68

0.0%

0.5%

1396.03

-0.4%

-0.5%

1415.50

0.9%

1.4%

Nikkei 225

18291.80

-0.8%

1.1%

18131.23

-0.9%

18207.15

-0.5%

0.4%

18554.28

1.4%

1.9%

18435.87

0.8%

-0.6%

18825.30

2.9%

2.1%

Shanghai

3391.35

6.5%

1.6%

3386.70

-0.1%

3425.33

1.0%

1.1%

3320.68

-2.1%

-3.1%

3368.74

-0.7%

1.4%

3412.43

0.6%

1.3%

DAX

10104.43

0.1%

0.4%

10164.31

0.6%

10147.68

0.4%

-0.2%

10238.10

1.3%

0.9%

10491.97

3.8%

2.5%

10794.54

6.8%

2.9%

Fri Oct 30

Mon 2

Tue 3

Wed 4

Thu 5

Fri 6

USD/ EUR

1.1007

0.1%

-0.3%

1.1016

-0.1%

1.0965

0.4%

0.5%

1.0867

1.3%

0.9%

1.0884

1.1%

-0.2%

1.0742

2.4%

1.3%

The release on Nov 18, 2015 of the minutes of the FOMC (Federal Open Market Committee) meeting held on Oct 28, 2015 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20151028.htm) states:

Fri Nov 13

Mon 16

Tue 17

Wed 18

Thu 19

Fri 20

USD/ EUR

1.0774

-0.3%

0.4%

1.0686

0.8%

1.0644

1.2%

0.4%

1.0660

1.1%

-0.2%

1.0735

0.4%

-0.7%

1.0647

1.2%

0.8%

DJIA

17245.24

-3.7%

-1.2%

17483.01

1.4%

17489.50

1.4%

0.0%

17737.16

2.9%

1.4%

17732.75

2.8%

0.0%

17823.81

3.4%

0.5%

DAX

10708.40

-2.5%

-0.7%

10713.23

0.0%

10971.04

2.5%

2.4%

10959.95

2.3%

-0.1%

11085.44

3.5%

1.1%

11119.83

3.8%

0.3%

Fri Nov 27

Mon 30

Tue 1

Wed 2

Thu 3

Fri 4

USD/ EUR

1.0594

0.5%

0.2%

1.0565

0.3%

1.0634

-0.4%

-0.7%

1.0616

-0.2%

0.2%

1.0941

-3.3%

-3.1%

1.0885

-2.7%

0.5%

DJIA

17798.49

-0.1%

17719.92

-0.4%

17888.35

0.5%

1.0%

17729.68

-0.4%

-0.9%

17477.67

-1.8%

-1.4%

17847.63

0.3%

2.1%

DAX

11293.76

1.6%

-0.2%

11382.23

0.8%

11261.24

-0.3%

-1.1%

11190.02

-0.9%

-0.6%

10789.24

-4.5%

-3.6%

10752.10

-4.8%

-0.3%

At the press conference following the meeting of the FOMC on Dec 16, 2015, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20151216.pdf page 8):

Fri Dec 11

Mon 14

Tue 15

Wed 16

Thu 17

Fri 18

USD/ EUR

1.0991

-1.0%

-0.4%

1.0993

0.0%

1.0932

0.5%

0.6%

1.0913

0.7%

0.2%

1.0827

1.5%

0.8%

1.0868

1.1%

-0.4%

DJIA

17265.21

-3.3%

-1.8%

17368.50

0.6%

17524.91

1.5%

0.9%

17749.09

2.8%

1.3%

17495.84

1.3%

-1.4%

17128.55

-0.8%

-2.1%

DAX

10340.06

-3.8%

-2.4%

10139.34

-1.9%

10450.38

-1.1%

3.1%

10469.26

1.2%

0.2%

10738.12

3.8%

2.6%

10608.19

2.6%

-1.2%

Fri 22

Mon 25

Tue 26

Wed 27

Thu 28

Fri 29

JPY/ USD

118.77

-1.5%

-0.9%

118.30

0.4%

118.42

0.3%

-0.1%

118.68

0.1%

-0.2%

118.82

0.0%

-0.1%

121.13

-2.0%

-1.9%

DJIA

16093.51

0.7%

1.3%

15885.22

-1.3%

16167.23

0.5%

1.8%

15944.46

-0.9%

-1.4%

16069.64

-0.1%

0.8%

16466.30

2.3%

2.5%

Nikkei

16958.53

-1.1%

5.9%

17110.91

0.9%

16708.90

-1.5%

-2.3%

17163.92

1.2%

2.7%

17041.45

0.5%

-0.7%

17518.30

3.3%

2.8%

Shanghai

2916.56

0.5%

1.3

2938.51

0.8%

2749.79

-5.7%

-6.4%

2735.56

-6.2%

-0.5%

2655.66

-8.9%

-2.9%

2737.60

-6.1%

3.1%

DAX

9764.88

2.3%

2.0%

9736.15

-0.3%

9822.75

0.6%

0.9%

9880.82

1.2%

0.6%

9639.59

-1.3%

-2.4%

9798.11

0.3%

1.6%

Sovereign Yields 2/12/16	Japan	Germany	USA
2 Year	-0.168	-0.498	0.694
10 Year	0.076	0.262	1.744

The dollar devalued relative to the euro and open stock markets traded lower after the announcement on Mar 10, 2016, but stocks rebounded on Mar 11:

Fri 4

Mon 7

Tue 8

Wed 9

Thu10

Fri 11

USD/ EUR

1.1006

-0.7%

-0.4%

1.1012

-0.1%

1.1013

-0.1%

0.0%

1.0999

0.1%

1.1182

-1.6%

-1.7%

1.1151

-1.3%

0.3%

DJIA

17006.77

2.2%

0.4%

17073.95

0.4%

16964.10

-0.3%

-0.6%

17000.36

0.0%

0.2%

16995.13

-0.1%

0.0%

17213.31

1.2%

1.3%

DAX

9824.17

3.3%

0.7%

9778.93

-0.5%

0.5%

9692.82

-1.3%

-0.9%

9723.09

-1.0%

0.3%

9498.15

-3.3%

-2.3%

9831.13

0.1%

3.5%

At the press conference after the FOMC meeting on Sep 21, 2016, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20160921.pdf ): “However, the economic outlook is inherently uncertain.” In the address to the Jackson Hole symposium on Aug 26, 2016, Chair Yellen states: “I believe the case for an increase in in federal funds rate has strengthened in recent months…And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course” (http://www.federalreserve.gov/newsevents/speech/yellen20160826a.htm). In a speech at the World Affairs Council of Philadelphia, on Jun 6, 2016 (http://www.federalreserve.gov/newsevents/speech/yellen20160606a.htm), Chair Yellen finds that “there is considerable uncertainty about the economic outlook.” There are fifteen references to this uncertainty in the text of 18 pages double-spaced. In the Semiannual Monetary Policy Report to the Congress on Jun 21, 2016, Chair Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20160621a.htm), “Of course, considerable uncertainty about the economic outlook remains.” Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. Is there a “science” or even “art” of central banking under this extreme uncertainty in which policy does not generate higher volatility of money, income, prices and values of financial assets? What is truly important is the fixing of the overnight fed funds at 2 to 2¼ percent with all measures depending on “a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190731a.htm): “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments” (emphasis added). The “outlook is uncertain”: “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. This action supports the Committee's view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190731a.htm) In the Opening Remarks to the Press Conference on Jan 30, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190130.pdf): “Today, the FOMC decided that the cumulative effects of those developments over the last several months warrant a patient, wait-and-see approach regarding future policy changes. In particular, our statement today says, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near … 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook. In addition, the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to push headline inflation lower still in coming months. Further, as we noted in our post-meeting statement, while survey-based measures of inflation expectations have been stable, financial market measures of inflation compensation have moved lower. Similarly, the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms. In this environment, we believe we can best support the economy by being patient in evaluating the outlook before making any future adjustment to policy.” The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm) with significant changes (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf). In the opening remarks to the Mar 20, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf): “In discussing the Committee’s projections, it is useful to note what those projections are, as well as what they are not. The SEP includes participants’ individual projections of the most likely economic scenario along with their views of the appropriate path of the federal funds rate in that scenario. Views about the most likely scenario form one input into our policy discussions. We also discuss other plausible scenarios, including the risk of more worrisome outcomes. These and other scenarios and many other considerations go into policy, but are not reflected in projections of the most likely case. Thus, we always emphasize that the interest rate projections in the SEP are not a Committee decision. They are not a Committee plan. As Chair Yellen noted some years ago, the FOMC statement, rather than the dot plot, is the device that the Committee uses to express its opinions about the likely path of rates.” In the Introductory Statement on Jul 25, 2019, in Frankfurt am Main, the President of the European Central Bank, Mario Draghi, stated (https://www.ecb.europa.eu/press/pressconf/2019/html/ecb.is190725~547f29c369.en.html): “Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. We expect them to remain at their present or lower levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to our aim over the medium term.

Real Disposable Personal Income	Real Personal Consumption Expenditures	Prices of Personal Consumption Expenditures	PCE Prices Excluding Food and Energy
∆%12M	∆%12M	∆%12M	∆%12M
6/2017	6/2017	6/2017	6/2017
1.2	2.4	1.4	1.5

Fri 23

Mon 26

Tue 27

Wed 28

Thu 29

Fri 30

USD/EUR

1.1339

0.7%

0.6%

1.1328

0.1%

1.1293

0.4%

0.3%

1.1368

-0.3%

-0.7%

1.1394

-0.5%

-0.2%

1.1320

0.2%

0.6%

DJIA

24285.95

-4.4%

-0.7%

24640.24

1.5%

24748.73

1.9%

0.4%

25366.43

4.4%

2.5%

25338.84

4.3%

-0.1%

25538.46

5.2%

0.8%

Fri 28	Mon 31	Tue 1	Wed 2	Thu 3	Fri 4
10Y Note 2.736	2.683	2.683	2.663	2.560	2.658
2Y Note 2.528	2.500	2.500	2.488	2.387	2.480
DJIA 23062.40 2.7% -0.3%	23327.46 1.1% 1.1%	23327.46 1.1% 0.0%	23346.24 1.2% 0.1%	22686.22 -1.6% -2.8%	23433.16 1.6% 3.3%
Dow Global 2718.19 1.3% 0.8%	2734.40 0.6% 0.6%	2734.40 0.6% 0.0%	2729.74 0.4% -0.2%	2707.29 -0.4% -0.8%	2773.12 2.0% 2.4%

Fri 25

Mon 28

Tue 29

Wed 30

Thu 31

Fri 1

DJIA

24737.20

0.1%

0.7%

24528.22

-0.8%

24579.96

-0.6%

0.2%

25014.86

1.1%

1.8%

24999.67

1.1%

-0.1%

25063.89

1.3%

0.3%

Dow Global

2917.27

0.5%

1.0%

2899.74

-0.6%

2905.29

-0.4%

0.2%

2927.10

0.3%

0.8%

2945.73

1.0%

0.6%

2947.87

1.0%

0.1%

DJ Asia Pacific

Nikkei

20773.56

0.5%

1.0%

20649.00

-0.6%

20664.64

-0.5%

0.1%

20556.54

-1.0%

-0.5%

20773.49

0.0%

1.1%

20788.39

0.1%

Shanghai

2601.72

0.2%

0.4%

2596.98

-0.2%

2594.25

-0.3%

-0.1%

2575.58

-1.0%

-0.7%

2584.57

-0.7%

0.3%

2618.23

0.6%

1.3%

DAX

11281.79

0.7%

1.4%

11210.31

-0.6%

11218.83

-0.6%

0.1%

11181.66

-0.9%

-0.3%

11173.10

-1.0%

-0.1%

11180.66

-0.9%

0.1%

BOVESPA

97677.19

1.6%

0.0%

95443.88

-2.3%

95639.33

-2.1%

0.2%

96996.21

-0.7%

1.4%

97393.75

-0.3%

0.4%

97861.27

0.2%

0.5%

Fri 14

Mon 17

Tue 18

Wed 19

Thu 20

Fri 21

DJIA

26089.61

0.4%

-0.1%

26112.53

0.1%

26465.54

1.4%

26504.00

1.6%

0.1%

26753.17

2.5%

0.9%

26719.13

2.4%

-0.1%

Dow Global

2998.79

0.2%

-0.4%

2999.93

0.0%

3034.59

1.2%

3050.80

1.7%

0.5%

3077.81

2.6%

0.9%

3081.62

2.8%

0.1%

DJ Asia Pacific

Nikkei

21116.89

1.1%

0.4%

21124.00

0.0%

20972.71

-0.7%

21333.87

1.0%

1.7%

21462.86

1.6%

0.6%

21258.64

0.7%

-1.0%

Shanghai

2881.97

1.9%

-1.0%

2887.62

0.2%

2890.16

0.3%

0.1%

2917.80

1.2%

1.0%

2987.12

3.6%

2.4%

3001.98

4.2%

0.5%

DAX

12096.40

0.4%

-0.6%

12085.82

-0.1%

12331.75

1.9%

2.0%

12308.53

1.8%

-0.2%

12355.39

2.1%

0.4%

12339.92

2.0%

-0.1%

BOVESPA

98040.06

0.2%

-0.7%

97623.25

-0.4%

99404.39

1.4%

1.8%

100303.41

2.3%

0.9%

100303.41

2.3%

0.0%

102012.64

4.1%

1.7%

Chart VI-3, US Dollar Currency Indexes, Jan 4, 1995-Aug 2, 2019

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-3A, US, Overnight Fed Funds Rate, Yield of Three-Month Treasury Constant Maturity, Yield of Ten-Year Treasury Constant Maturity and Yield of Moody’s Baa Bond, Jan 4, 1995 to Jul 25, 2016

Source: Board of Governors of the Federal Reserve System

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

Chart VI-3B, US, Overnight Fed Funds Rate, Yield of Three-Month Treasury Constant Maturity and Yield of Ten-Year Treasury Constant Maturity, Jan 4, 1995 to Aug 8, 2019

Source: Board of Governors of the Federal Reserve System

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

Chart VI-4 of the Board of Governors of the Federal Reserve System provides the exchange rate of the US relative to the euro, or USD/EUR. During maintenance of the policy of zero fed funds rates the dollar appreciates in periods of significant risk aversion such as flight into US government obligations in late 2008 and early 2009 and in the various risks concerns generated by the European sovereign debt crisis. There was depreciation of the dollar followed by recent appreciation.

Chart VI-4, US Dollars per Euro, 2015-2019

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/DataDownload/Chart.aspx?rel=H10&series=e85cfb140ce469e13bec458013262fa1&lastObs=780&from=&to=&filetype=csv&label=include&layout=seriescolumn&pp=Download&names=%7bH10/H10/RXI$US_N.B.EU%7d

Carry trades induced by zero interest rates increase capital flows into emerging markets that appreciate exchange rates. Portfolio reallocations away from emerging markets depreciate their exchange rates in reversals of capital flows. Chart VI-4A provides the exchange rate of the Mexican peso (MXN) per US dollar from Nov 8, 1993 to Aug 2, 2019. The first data point in Chart VI-4A is MXN 3.1520 on Nov 8, 1993. The rate devalued to 11.9760 on Nov 14, 1995 during emerging market crises in the 1990s and the increase of interest rates in the US in 1994 that stressed world financial markets (Pelaez and Pelaez, International Financial Architecture 2005, The Global Recession Risk 2007, 147-77). The MXN depreciated sharply to MXN 15.4060/USD on Mar 2, 2009, during the global recession. The rate moved to MXN 11.5050/USD on May 2, 2011, during the sovereign debt crisis in the euro area. The rate depreciated to 11.9760 on May 9, 2013. The final data point is MXN 19.3115/USD on Aug 2, 2019.

Chart VI-4A, Mexican Peso (MXN) per US Dollar (USD), Nov 8, 1993 to Aug 2, 2019

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the former Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Professor Rajan, in an interview with Kartik Goyal of Bloomberg (http://www.bloomberg.com/news/2014-01-30/rajan-warns-of-global-policy-breakdown-as-emerging-markets-slide.html), warns of breakdown of global policy coordination. Professor Willem Buiter (2014Feb4), a distinguished economist currently Global Chief Economist at Citigroup (http://www.willembuiter.com/resume.pdf), writing on “The Fed’s bad manners risk offending foreigners,” on Feb 4, 2014, published in the Financial Times (http://www.ft.com/intl/cms/s/0/fbb09572-8d8d-11e3-9dbb-00144feab7de.html#axzz2suwrwkFs), concurs with Raghuram Rajan. Buiter (2014Feb4) argues that international policy cooperation in monetary policy is both in the interest of the world and the United States. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows. In a speech at the Brookings Institution on Apr 10, 2014, Raghuram G. Rajan (2014Apr10, 1, 10) argues:

“As the world seems to be struggling back to its feet after the great financial crisis, I want to draw attention to an area we need to be concerned about: the conduct of monetary policy in this integrated world. A good way to describe the current environment is one of extreme monetary easing through unconventional policies. In a world where debt overhangs and the need for structural change constrain domestic demand, a sizeable portion of the effects of such policies spillover across borders, sometimes through a weaker exchange rate. More worryingly, it prompts a reaction. Such competitive easing occurs both simultaneously and sequentially, as I will argue, and both advanced economies and emerging economies engage in it. Aggregate world demand may be weaker and more distorted than it should be, and financial risks higher. To ensure stable and sustainable growth, the international rules of the game need to be revisited. Both advanced economies and emerging economies need to adapt, else I fear we are about to embark on the next leg of a wearisome cycle. A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have.”

Chart VI-4B provides the rate of the Indian rupee (INR) per US dollar (USD) from Jan 2, 1973 to Aug 2, 2019. The first data point is INR 8.0200 on Jan 2, 1973. The rate depreciated sharply to INR 51.9600 on Mar 3, 2009, during the global recession. The rate appreciated to INR 44.0300/USD on Jul 28, 2011 in the midst of the sovereign debt event in the euro area. The rate overshot to INR 68.8000 on Aug 28, 2013. The final data point is INR 69.5600/USD on Aug 2, 2019.

Chart VI-4B, Indian Rupee (INR) per US Dollar (USD), Jan 2, 1973 to Aug 2, 2019

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-5 provides the exchange rate of JPY (Japan yen) per USD (US dollars). The first data point on the extreme left is JPY 357.7300/USD for Jan 14, 1971. The JPY has appreciated over the long term relative to the USD with fluctuations along an evident long-term appreciation. Before the global recession, the JPY stood at JPY 124.0900/USD on Jun 22, 2007. The use of the JPY as safe haven is evident by sharp appreciation during the global recession to JPY 110.4800/USD on Aug 15, 2008, and to JPY 87.8000/USD on Jan 21, 2009. The final data point in Chart VI-5 is JPY 106.6400/USD on Aug 2, 2019 for appreciation of 14.1 percent relative to JPY 124.0900/USD on Jun 29, 2007 before the global recession and expansion characterized by recurring bouts of risk aversion. Takashi Nakamichi and Eleanor Warnock, writing on “Japan lashes out over dollar, euro,” on Dec 29, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323530404578207440474874604.html?mod=WSJ_markets_liveupdate&mg=reno64-wsj), analyze the “war of words” launched by Japan’s new Prime Minister Shinzo Abe and his finance minister Taro Aso, arguing of deliberate devaluations of the USD and EUR relative to the JPY, which are hurting Japan’s economic activity. Gerard Baker and Jacob M. Shlesinger, writing on “Bank of Japan’s Kuroda signals impatience with Abe government,” on May 23, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303480304579579311491068756?KEYWORDS=bank+of+japan+kuroda&mg=reno64-wsj), analyze concerns of the Governor of the Bank of Japan Haruhiko Kuroda that the JPY has strengthened relative to the USD, partly eroding earlier depreciation. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-5, Japanese Yen JPY per US Dollars USD, Monthly, Jan 4, 1971-Aug 2, 2019

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

The causes of the financial crisis and global recession were interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

Zero interest rates in the United States forever tend to depreciate the dollar against every other currency if there is no risk aversion preventing portfolio rebalancing toward risk financial assets, which include the capital markets and exchange rates of emerging-market economies. The objective of unconventional monetary policy as argued by Yellen 2011AS) is to devalue the dollar to increase net exports that increase US economic growth. Increasing net exports and internal economic activity in the US is equivalent to decreasing net exports and internal economic activity in other countries.

Continental territory, rich endowment of natural resources, investment in human capital, teaching and research universities, motivated labor force and entrepreneurial initiative provide Brazil with comparative advantages in multiple economic opportunities. Exchange rate parity is critical in achieving Brazil’s potential but is difficult in a world of zero interest rates. Chart IV-6 of the Board of Governors of the Federal Reserve System provides the rate of Brazilian real (BRL) per US dollar (USD) from BRL 1.2074/USD on Jan 4, 1999 to BRL 3.8789/USD on Aug 2, 2019. The rate reached BRL 3.9450/USD on Oct 10, 2002 appreciating 60.5 percent to BRL 1.5580/USD on Aug 1, 2008. The rate depreciated 68.1 percent to BRL 2.6187/USD on Dec 5, 2008 during worldwide flight from risk. The rate appreciated again by 41.3 percent to BRL 1.5375/USD on Jul 26, 2011. The final data point in Chart VI-6 is BRL 3.8789/USD on Aug 2, 2019 for depreciation of 152.3 percent. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-6, Brazilian Real (BRL) per US Dollar (USD) Jan 4, 1999 to Aug 2, 2019

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-7 of the Board of Governors of the Federal Reserve System provides the history of the BRL beginning with the first data point of BRL 0.8400/USD on Jan 2, 1995. The rate jumped to BRL 2.0700/USD on Jan 29, 1999 after changes in exchange rate policy and then to BRL 2.2000/USD on Mar 3, 1999. The rate depreciated 26.7 percent to BRL 2.7880 on Sep 21, 2001 relative to Mar 3, 1999.

Chart VI-7, Brazilian Real (BRL) per US Dollar (USD), Jan 2, 1995 to Aug 2, 2019

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

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