Contraction of United States GDP at 32.9
Percent SAAR in First Quarter 2020 in the Global Recession, with Output in
the US Reaching a High in Feb 2020 (https://www.nber.org/cycles.html), in the Lockdown
of Economic Activity in the COVID-19 Event, Mediocre Cyclical United States
Growth in the Lost Economic Cycle of the Global Recession with Economic Growth
Underperforming Below Trend Worldwide, Contraction of Real Private Fixed
Investment at 29.9 Percent SAAR, United States Terms of Trade, Beginning
Recovery in United States New House Sales, United States House Prices, World
Cyclical Slow Growth, and Government Intervention in Globalization: Part II Charts
Carlos M. Pelaez
© Carlos M. Pelaez, 2009,
2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019, 2020.
IA Mediocre
Cyclical United States Economic Growth
IID United States Terms of International Trade
IIA United States
Housing Collapse
IIA1 Sales of New Houses
IIA2
United States House Prices
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
IA1 Stagnating Real Private Fixed Investment.
Table IA1-1 provides quarterly seasonally adjusted annual rates (SAAR) of
growth of private fixed investment for the recessions of the 1980s and the
current economic cycle. In the cyclical expansion beginning in IQ1983 (https://www.nber.org/cycles.html), real
private fixed investment in the United States grew at the average annual rate
of 14.7 percent in the first eight quarters from IQ1983 to IVQ1984. Growth
rates fell to an average of 2.2 percent in the following eight quarters from
IQ1985 to IVQ1986 and to an average of 1.9 percent in the 12 quarters of 1985,
1986 and 1987. The average rate of growth in the four quarters of 1988 was 3.7
percent. There were only four quarters of contraction of private fixed
investment from IQ1983 to IVQ1987. The National Bureau of Economic Research
dates another cycle from Jul 1990 (IIIQ1981) to Mar 1991 (IQ1991) (https://www.nber.org/cycles.html), showing
in Table III-1 with contractions of fixed investment in the final three
quarters of 1990 and the first quarter of 1991. There is quite different
behavior of private fixed investment in the thirty-six quarters of cyclical
expansion from IIIQ2009 to IIQ2018. The average annual growth rate in the first
eight quarters of expansion from IIIQ2009 to IIQ2011 was 4.6 percent, which is
significantly lower than 14.7 percent in the first eight quarters of expansion
from IQ1983 to IVQ1984. There is only robust growth of private fixed investment
in the four quarters of expansion from IIQ2011 to IQ2012 at the average annual
rate of 12.8 percent. Growth has fallen from the SAAR of 17.9 percent in IIIQ2011
to 0.6 percent in IIIQ2012, recovering to 7.4 percent in IVQ2012 and increasing
to 7.0 percent in IQ2013. The SAAR of fixed investment fell to 7.1 percent in
IIIQ2013 and to 5.5 percent in IVQ2013. The SAAR of fixed investment decreased
to 4.1 percent in IQ2014. Fixed investment grew at the SAAR of 11.6 percent in
IIQ2014 and at 7.9 percent in IIIQ2014. Fixed investment grew at 4.7 percent in
IVQ2014, 1.1 percent in IQ2015 and 3.5 percent in IIQ2015. Fixed investment
grew at 3.4 percent in IIIQ2015 and fell at 1.1 percent in IVQ2015. Fixed
investment increased at 2.0 percent in IQ2016 and increased at 1.5 percent in
IIQ2016. Fixed investment increased at 3.2 percent in IIIQ2016 and increased at
2.7 percent in IVQ2016. Fixed investment increased at 7.1 percent in IQ2017 and
increased at 1.6 percent in IIQ2017. Fixed investment grew at 1.2 percent in
IIIQ2017. Fixed investment grew at 9.5 percent in IVQ2017 and increased at 8.5
percent in IQ2018. Fixed investment grew at 4.4 percent in IIQ2018. Fixed investment
increased at 0.8 percent in IIIQ2018 and increased at 2.6 percent in IVQ2018.
Fixed investment increased at 2.9 percent in IQ2019 and decreased at 0.4
percent in IIQ2019. Fixed investment decreased at 2.4 percent in IIIQ2019.
Fixed investment increased at 1.0 percent in IVQ2019. Fixed investment
decreased at 1.4 percent in IQ2020 and decreased at 29.9 percent in IIQ2020 in
the global recession, with output in the US reaching a high in Feb 2020 (https://www.nber.org/cycles.html), in the
lockdown of economic activity in the COVID-19 event. Sudeep Reddy and Scott
Thurm, writing on “Investment falls off a cliff,” on Nov 18, 2012, published in
the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324595904578123593211825394.html?mod=WSJPRO_hpp_LEFTTopStories) analyze
the decline of private investment in the US and inform that a review by the Wall Street Journal of filing and
conference calls finds that 40 of the largest publicly traded corporations in
the US have announced intentions to reduce capital expenditures in 2012.
Table IA1-1,
US, Quarterly Growth Rates of Real Private Fixed Investment, % Annual
Equivalent SA
|
Q
|
1981
|
1982
|
1983
|
1984
|
2008
|
2009
|
2010
|
|
I
|
3.8
|
-10.6
|
9.3
|
13.2
|
-6.1
|
-28.2
|
-0.2
|
|
II
|
3.2
|
-12.0
|
15.9
|
16.6
|
-3.2
|
-13.7
|
15.4
|
|
III
|
0.2
|
-9.2
|
24.4
|
8.2
|
-9.7
|
1.5
|
2.2
|
|
IV
|
-1.3
|
0.2
|
24.3
|
7.4
|
-23.9
|
2.0
|
7.8
|
|
|
|
|
|
1985
|
|
|
2011
|
|
I
|
|
|
|
3.7
|
|
|
-0.7
|
|
II
|
|
|
|
5.2
|
|
|
9.7
|
|
III
|
|
|
|
-1.6
|
|
|
17.9
|
|
IV
|
|
|
|
7.8
|
|
|
10.6
|
|
|
|
|
|
1986
|
|
|
2012
|
|
I
|
|
|
|
1.1
|
|
|
13.1
|
|
II
|
|
|
|
0.1
|
|
|
8.3
|
|
III
|
|
|
|
-1.8
|
|
|
0.6
|
|
IV
|
|
|
|
3.1
|
|
|
7.4
|
|
|
|
|
|
1987
|
|
|
2013
|
|
I
|
|
|
|
-6.7
|
|
|
7.0
|
|
II
|
|
|
|
6.3
|
|
|
3.3
|
|
III
|
|
|
|
7.1
|
|
|
7.1
|
|
IV
|
|
|
|
-0.2
|
|
|
5.5
|
|
|
|
|
|
1988
|
|
|
2014
|
|
I
|
|
|
|
0.2
|
|
|
4.1
|
|
II
|
|
|
|
8.1
|
|
|
11.6
|
|
III
|
|
|
|
1.9
|
|
|
7.9
|
|
IV
|
|
|
|
4.8
|
|
|
4.7
|
|
|
|
|
|
1989
|
|
|
2015
|
|
IQ
|
|
|
|
3.6
|
|
|
1.1
|
|
IIQ
|
|
|
|
0.5
|
|
|
3.5
|
|
IIIQ
|
|
|
|
7.2
|
|
|
3.4
|
|
IVQ
|
|
|
|
-5.1
|
|
|
-1.1
|
|
|
|
|
|
1990
|
|
|
2016
|
|
IQ
|
|
|
|
4.8
|
|
|
2.0
|
|
IIQ
|
|
|
|
-7.7
|
|
|
1.5
|
|
IIIQ
|
|
|
|
-3.2
|
|
|
3.2
|
|
IVQ
|
|
|
|
-9.9
|
|
|
2.7
|
|
|
|
|
|
1991
|
|
|
2017
|
|
I
|
|
|
|
-10.6
|
|
|
7.1
|
|
II
|
|
|
|
1.2
|
|
|
1.6
|
|
III
|
|
|
|
0.5
|
|
|
1.2
|
|
IV
|
|
|
|
1.7
|
|
|
9.5
|
|
|
|
|
|
1992
|
|
|
2018
|
|
I
|
|
|
|
4.5
|
|
|
8.5
|
|
II
|
|
|
|
13.8
|
|
|
4.4
|
|
III
|
|
|
|
4.7
|
|
|
0.8
|
|
IV
|
|
|
|
12.2
|
|
|
2.6
|
|
1993
|
|
|
|
|
|
|
2019
|
|
I
|
|
|
|
3.0
|
|
|
2.9
|
|
II
|
|
|
|
7.4
|
|
|
-0.4
|
|
III
|
|
|
|
6.4
|
|
|
2.4
|
|
IV
|
|
|
|
17.1
|
|
|
1.0
|
|
1994
|
|
|
|
|
|
|
2020
|
|
I
|
|
|
|
4.8
|
|
|
-1.4
|
|
II
|
|
|
|
8.3
|
|
|
-29.9
|
|
III
|
|
|
|
3.3
|
|
|
|
|
IV
|
|
|
|
10.0
|
|
|
|
Chart IA1-1 of the US
Bureau of Economic Analysis (BEA) provides seasonally adjusted annual rates of
growth of real private fixed investment from 1980 to 1993. Growth rates
recovered sharply during the first eight quarters, which was essential in
returning the economy to trend growth and eliminating unemployment and most
underemployment accumulated during the contractions. 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).
Chart IA1-1, US, Real Private Fixed Investment, Seasonally
Adjusted Annual Rates Percent Change from Prior Quarter, 1980-1993
Source: US Bureau of Economic Analysis
Weak behavior
of real private fixed investment from 2007 to 2020 is in Chart IA1-2. Growth
rates of real private fixed investment were much lower during the initial phase
of the current economic cycle, entered sharp trend of decline and recovered
recently, with another decline followed by increase and renewed decline. Fixed
investment contracted sharply, at 1.4 percent in IQ2020 and at 29.9 percent in
IIQ2020. There is a downward effect in the global recession, with output in the
US reaching a high in Feb 2020 (https://www.nber.org/cycles.html), in the
lockdown of economic activity in the COVID-19 event.
Chart IA1-2, US, Real Private Fixed Investment, Seasonally
Adjusted Annual Rates Percent Change from Prior Quarter, 2007-2020
Source: US Bureau of Economic Analysis
Table IA1-2 provides real private fixed
investment at seasonally adjusted annual rates from IVQ2007 to IIQ2020 or for
the complete economic cycle. The first column provides the quarter, the second
column percentage change relative to IVQ2007, the third column the quarter
percentage change in the quarter relative to the prior quarter and the final
column percentage change in a quarter relative to the same quarter a year
earlier. In IQ1980, real gross private domestic
investment in the US was $933.1 billion of chained 2012 dollars, growing to
$1,372.1 billion in IVQ1993 or 47.0 percent. 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). Real gross private domestic investment
in the US increased 6.2 percent from $2,653.1 billion in IVQ2007 to $2,817.7
billion in IIQ2020. Real private fixed investment increased 17.4 percent from
$2,630.0 billion of chained 2012 dollars in IVQ2007 to $3,088.6 billion in
IQ2020. Real gross private domestic investment fell at SAAR 49.0 percent in IIQ2020,
and private fixed investment fell at SAAR 29.9 percent in the
global recession, with output in the US reaching a high in Feb 2020 (https://www.nber.org/cycles.html), in the
lockdown of economic activity in the COVID-19 event. Private fixed investment fell relative
to IVQ2007 in all quarters preceding IVQ2012 and increased 0.8 percent in
IIIQ2016, increasing 0.4 percent in IIQ2016 and increasing 0.5 percent in
IQ2016. Private fixed investment increased 0.7 percent in IVQ2016. Private
fixed investment increased 1.7 percent in IQ2017 and increased 0.4 percent in
IIQ2017. Private fixed investment increased 0.3 percent in IIIQ2017 and
increased 2.3 percent in IVQ2017. Private fixed investment increased 2.1 percent
in IQ2018, increasing 1.1 percent in IIQ2018. Private fixed investment
increased 0.2 percent in IIIQ2018, increasing 0.7 percent in IVQ2018. Private
fixed investment increased 0.7 percent in IQ2019, decreasing 0.1 percent in
IIQ2019. Private fixed investment increased 0.6 percent in IIIQ2019. Private
fixed investment increased 0.2 percent in IVQ2019. Private fixed investment
decreased 0.3 percent in IQ2020. Private fixed investment decreased 8.5 percent
in IIQ2020. Growth of real private investment in Table IA1-2 is mediocre for
all but four quarters from IIQ2011 to IQ2012. There is recent robust growth
followed by sharp contraction in the global recession, with output in the
US reaching a high in Feb 2020 (https://www.nber.org/cycles.html), in the
lockdown of economic activity in the COVID-19 event. The investment decision of United
States corporations is fractured in the current economic cycle in preference of
cash.
Table IA1-2,
US, Real Private Fixed Investment and Percentage Change Relative to IVQ2007 and
Prior Quarter, Billions of Chained 2012 Dollars and ∆%
|
|
Real PFI,
Billions Chained 2012
Dollars
|
∆% Relative
to IVQ2007
|
∆% Relative
to Prior Quarter
|
∆%
over Year Earlier |
|
IVQ2007
|
2630.0
|
NA
|
-1.0
|
-1.1
|
|
IQ2008
|
2589.1
|
-1.6
|
-1.6
|
-2.6
|
|
IIQ2008
|
2567.9
|
-2.4
|
-0.8
|
-3.8
|
|
IIIQ2008
|
2503.0
|
-4.8
|
-2.5
|
-5.7
|
|
IV2008
|
2337.8
|
-11.1
|
-6.6
|
-11.1
|
|
IQ2009
|
2151.9
|
-18.2
|
-8.0
|
-16.9
|
|
IIQ2009
|
2073.9
|
-21.1
|
-3.6
|
-19.2
|
|
IIIQ2009
|
2081.6
|
-20.9
|
0.4
|
-16.8
|
|
IVQ2009
|
2092.0
|
-20.5
|
0.5
|
-10.5
|
|
IQ2010
|
2091.0
|
-20.5
|
0.0
|
-2.8
|
|
IIQ2010
|
2167.1
|
-17.6
|
3.6
|
4.5
|
|
IIIQ2010
|
2178.7
|
-17.2
|
0.5
|
4.7
|
|
IVQ2010
|
2220.0
|
-15.6
|
1.9
|
6.1
|
|
IQ2011
|
2216.2
|
-15.7
|
-0.2
|
6.0
|
|
IIQ2011
|
2268.0
|
-13.8
|
2.3
|
4.7
|
|
IIIQ2011
|
2363.3
|
-10.1
|
4.2
|
8.5
|
|
IVQ2011
|
2423.7
|
-7.8
|
2.6
|
9.2
|
|
IQ2012
|
2499.4
|
-5.0
|
3.1
|
12.8
|
|
IIQ2012
|
2549.8
|
-3.0
|
2.0
|
12.4
|
|
IIIQ2012
|
2553.6
|
-2.9
|
0.1
|
8.1
|
|
IVQ2012
|
2599.4
|
-1.2
|
1.8
|
7.2
|
|
IQ2013
|
2643.9
|
0.5
|
1.7
|
5.8
|
|
IIQ2013
|
2665.3
|
1.3
|
0.8
|
4.5
|
|
IIIQ2013
|
2711.3
|
3.1
|
1.7
|
6.2
|
|
IVQ2013
|
2748.0
|
4.5
|
1.4
|
5.7
|
|
IQ2014
|
2775.6
|
5.5
|
1.0
|
5.0
|
|
IIQ2014
|
2852.8
|
8.5
|
2.8
|
7.0
|
|
IIIQ2014
|
2907.3
|
10.5
|
1.9
|
7.2
|
|
IVQ2014
|
2941.2
|
11.8
|
1.2
|
7.0
|
|
IQ2015
|
2949.5
|
12.1
|
0.3
|
6.3
|
|
IIQ2015
|
2974.9
|
13.1
|
0.9
|
4.3
|
|
IIIQ2015
|
2999.8
|
14.1
|
0.8
|
3.2
|
|
IVQ2015
|
2991.8
|
13.8
|
-0.3
|
1.7
|
|
IQ2016
|
3006.8
|
14.8
|
0.5
|
1.9
|
|
IIQ2016
|
3018.0
|
14.8
|
0.4
|
1.4
|
|
IIIQ2016
|
3041.8
|
15.7
|
0.8
|
1.4
|
|
IVQ2016
|
3062.2
|
16.4
|
0.7
|
2.4
|
|
IQ2017
|
3115.5
|
18.5
|
1.7
|
3.6
|
|
IIQ2017
|
3127.7
|
18.9
|
0.4
|
3.6
|
|
IIIQ2017
|
3137.1
|
19.3
|
0.3
|
3.1
|
|
IVQ2017
|
3209.2
|
22.0
|
2.3
|
4.8
|
|
IQ2018
|
3275.2
|
24.5
|
2.1
|
5.1
|
|
IIQ2018
|
3310.6
|
25.9
|
1.1
|
5.8
|
|
IIIQ2018
|
3317.0
|
26.1
|
0.2
|
5.7
|
|
IVQ2018
|
3338.7
|
26.9
|
0.7
|
4.0
|
|
IQ2019
|
3362.3
|
27.8
|
0.7
|
2.7
|
|
IIQ2019
|
3358.6
|
27.7
|
-0.1
|
1.4
|
|
IIIQ2019
|
3378.9
|
28.5
|
0.6
|
1.9
|
|
IVQ2019
|
3387.2
|
28.8
|
0.2
|
1.5
|
|
IQ2020
|
3375.4
|
28.3
|
-0.3
|
0.4
|
|
IIQ2020
|
3088.6
|
17.4
|
-8.5
|
-8.0
|
PFI: Private
Fixed Investment
Chart IA1-3
provides real private fixed investment in chained dollars of 2009 from 2007 to
2020. Real private fixed investment increased 17.4 percent from $2,630.0
billion of chained 2012 dollars in IVQ2007 to $3,088.6 billion in IIQ2020. Real
private fixed investment decreased at SAAR 29.9 percent in IIQ2020 after
decreasing at SAAR 1.4 percent in IQ2020.
Chart IA1-3, US, Real Private Fixed Investment, Billions of
Chained 2009 Dollars, 2007 to 2020
Source: US Bureau of Economic Analysis
Chart IA1-4 provides real gross private domestic investment
in chained dollars of 2012 from 1980 to 1993. Real gross private domestic
investment climbed 47.0 percent to $1,372.1 billion of 2012 dollars in IIIQ1993
above the level of $933.1 billion in IQ1980. 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).
Chart IA1-4, US, Real Gross Private Domestic Investment,
Billions of Chained 2009 Dollars at Seasonally Adjusted Annual Rate, 1980-1993
Source: US Bureau of Economic Analysis
Chart IA1-5 provides real gross private
domestic investment in the United States in billions of chained dollars of 2012
from 2007 to 2020. Real gross private domestic investment reached a level of $2,817.7
billion in IIQ2020, which was 6.2 percent higher than the level of $2,653.1
billion in IVQ2007 (https://apps.bea.gov/iTable/index_nipa.cfm).
Chart IA1-5, US, Real Gross Private Domestic Investment,
Billions of Chained 2009 Dollars at Seasonally Adjusted Annual Rate, 2007-2020
Source: US Bureau of Economic Analysis https://apps.bea.gov/iTable/index_nipa.cfm
Table IA1-3 shows that
the share of gross private domestic investment in GDP has decreased from 20.3
percent in IIQ2000 and 19.7 percent in IIQ2006 to 16.0 percent in IIQ2020.
There are declines in percentage shares in GDP of all components with sharp
reduction of residential investment from 4.7 percent in IIQ2000 and 6.2 percent
in IIQ2006 to 4.0 percent in IIQ2020. The share of fixed investment in GDP fell
from 19.4 percent in IIQ2000 and 19.2 percent in IIQ2006 to 17.6 percent in IIQ2020.
Table IA1-3,
Percentage Shares of Gross Private Domestic Investment and Components in
Gross Domestic Product, % of GDP
|
|
IIQ2020
|
IIQ2006
|
IIQ2000
|
|
Gross Private
Domestic Investment
|
16.0
|
19.7
|
20.3
|
|
Fixed
Investment
|
17.6
|
19.2
|
19.4
|
|
Nonresidential
|
13.6
|
12.9
|
14.6
|
|
Structures
|
3.0
|
3.1
|
3.1
|
|
Equipment
and Software
|
5.4
|
6.2
|
7.6
|
|
Intellectual
Property |
5.2
|
3.6
|
4.0
|
|
Residential
|
4.0
|
6.2
|
4.7
|
|
Change in Private Inventories
|
-1.7
|
0.5
|
0.9
|
Finer detail is provided by the quarterly share of
residential investment in GDP from 1979 to 2020 in Chart IA1-11. There was
protracted growth of that share, accelerating sharply into 2006 followed with
nearly vertical drop. The explanation
of the sharp contraction of United States housing can probably be found in the
origins of the financial crisis and global recession. Let V(T)
represent the value of the firm’s equity at time T and B stand
for the promised debt of the firm to bondholders and assume that corporate management,
elected by equity owners, is acting on the
interests of equity owners. Robert C. Merton (1974, 453) states:
“On the maturity date T, the firm must either pay the
promised payment of B to the debtholders or else the current equity will
be valueless. Clearly, if at time T, V(T) > B,
the firm should pay the bondholders because the value of equity will be V(T)
– B > 0 whereas if they do not, the value of equity would be zero. If
V(T) ≤ B, then the firm will not make the payment and
default the firm to the bondholders because otherwise the equity holders would
have to pay in additional money and the (formal) value of equity prior to such
payments would be (V(T)- B) < 0.”
Pelaez and Pelaez (The Global Recession Risk (2007),
208-9) apply this analysis to the US housing market in 2005-2006 concluding:
“The house market [in 2006] is probably operating with low
historical levels of individual equity. There is an application of structural
models [Duffie and Singleton 2003] to the individual decisions on whether or
not to continue paying a mortgage. The costs of sale would include realtor and
legal fees. There could be a point where the expected net sale value of the
real estate may be just lower than the value of the mortgage. At that point,
there would be an incentive to default. The default vulnerability of
securitization is unknown.”
There are multiple important determinants of the interest rate:
“aggregate wealth, the distribution of wealth among investors, expected rate of
return on physical investment, taxes, government policy and inflation”
(Ingersoll 1987, 405). Aggregate wealth is a major driver of interest rates
(Ingersoll 1987, 406). Unconventional monetary policy, with zero fed funds
rates and flattening of long-term yields by quantitative easing, causes
uncontrollable effects on risk taking that can have profound undesirable
effects on financial stability. Excessively aggressive and exotic monetary
policy is the main culprit and not the inadequacy of financial management and
risk controls.
The net worth of the economy depends on interest rates. In
theory, “income is generally defined as the amount a consumer unit could
consume (or believe that it could) while maintaining its wealth intact”
(Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a
rate of return, r, to a stock of wealth, W, or Y = rW
(Ibid). According to a subsequent restatement: “The basic idea is simply that
individuals live for many years and that therefore the appropriate constraint
for consumption decisions is the long-run expected yield from wealth r*W.
This yield was named permanent income: Y* = r*W” (Darby 1974,
229), where * denotes permanent. The simplified relation of income and wealth
can be restated as:
W = Y/r (1)
Equation (1) shows that as r goes to zero, r →0, W
grows without bound, W→∞.
Lowering the interest rate near the zero bound in 2003-2004
caused the illusion of permanent increases in wealth or net worth in the
balance sheets of borrowers and also of lending institutions, securitized
banking and every financial institution and investor in the world. The
discipline of calculating risks and returns was seriously impaired. The
objective of monetary policy was to encourage borrowing, consumption and
investment but the exaggerated stimulus resulted in a financial crisis of major
proportions as the securitization that had worked for a long period was shocked
with policy-induced excessive risk, imprudent credit, high leverage and low
liquidity by the incentive to finance everything overnight at close to zero
interest rates, from adjustable rate mortgages (ARMS) to asset-backed
commercial paper of structured investment vehicles (SIV).
The consequences of inflating liquidity and net worth of
borrowers were a global hunt for yields to protect own investments and money
under management from the zero interest rates and unattractive long-term yields
of Treasuries and other securities. Monetary policy distorted the calculations
of risks and returns by households, business and government by providing
central bank cheap money. Short-term zero interest rates encourage financing of
everything with short-dated funds, explaining the SIVs created off-balance
sheet to issue short-term commercial paper to purchase default-prone mortgages
that were financed in overnight or short-dated sale and repurchase agreements
(Pelaez and Pelaez, Financial Regulation after the Global Recession,
50-1, Regulation of Banks and Finance, 59-60, Globalization and the
State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government
Intervention in Globalization, 62-3, International Financial
Architecture, 144-9). ARMS were created to lower monthly mortgage payments
by benefitting from lower short-dated reference rates. Financial institutions
economized in liquidity that was penalized with near zero interest rates. There
was no perception of risk because the monetary authority guaranteed a minimum
or floor price of all assets by maintaining low interest rates forever or
equivalent to writing an illusory put option on wealth. Subprime mortgages were
part of the put on wealth by an illusory put on house prices. The housing
subsidy of $221 billion per year created the impression of ever increasing
house prices. The suspension of auctions of 30-year Treasuries was designed to
increase demand for mortgage-backed securities, lowering their yield, which was
equivalent to lowering the costs of housing finance and refinancing. Fannie and
Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked
with leverage of 75:1 under Congress-provided charters and lax oversight. The
combination of these policies resulted in high risks because of the put option
on wealth by near zero interest rates, excessive leverage because of cheap
rates, low liquidity because of the penalty in the form of low interest rates
and unsound credit decisions because the put option on wealth by monetary
policy created the illusion that nothing could ever go wrong, causing the
credit/dollar crisis and global recession (Pelaez and Pelaez, Financial
Regulation after the Global Recession, 157-66, Regulation of Banks, and
Finance, 217-27, International Financial Architecture, 15-18, The
Global Recession Risk, 221-5, Globalization and the State Vol. II,
197-213, Government Intervention in Globalization, 182-4).
Chart IA1-11, US, Percentage Share of Residential Investment
in Gross Domestic Product, Quarterly, 1979-2020
Source: US Bureau of Economic Analysis
Chart IA1-13 provides the percentage share of intellectual property
investment in GDP on a quarterly basis from 1979 to 2019.
Chart IA1-13, US, Percentage Share of Intellectual Property
Investment in Gross Domestic Product, Quarterly, 1979-2020
Source: US Bureau of Economic Analysis
©
Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018,
2019, 2020.
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