Slow Growth, Inflation, Unemployment and 17 Million less Hiring Per Year
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011
This comment analyzes the current slow growth of the US economy with the third estimate of IVQ2010 (fourth quarter 2010) GDP in relation to expansions following similar contractions. The Great Inflation and Unemployment of the 1970s has been linked to Federal Reserve policies that focused exclusively on monetary accommodation to reduce the gap between potential and actual output with the objective of promoting employment at the expense of the other mandate of maintaining price stability (http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). Just before the beginning of the Great Inflation in the mid 1960s, consumer price inflation was 0.7 percent in 1961. Misleading comparisons of the current US economy with deflation in the 1930s erroneously support the current symmetric price target of the Fed of inflation in an infinitesimal neighborhood of 2 percent that is used to maintain the fed funds rate at zero percent and large-scale purchases of long-term securities in a bloated $2.6 trillion Fed balance sheet. Theory, empirical verification, forecasts, policy modeling and current economic information continue to be as deficient as during the Great Inflation such that the precise inflation target of the Fed is likely to be overshot. In the last deflationist fear, CPI inflation rose from 1.9 percent in 2003 to 4.1 percent in 2007. The combined Fed policy of zero fed funds rate and $2.3 trillion holdings of long-term securities is devaluing the dollar and inflating commodity prices with the objective of raising “core” inflation to the neighborhood of 2 percent. Between 2003 and 2008, the dollar devalued by 39.3 percent relative to the euro and the dollar has devalued by 18.1 percent since the decline of risk aversion with calmer sovereign risks in Europe in Jun 2010 to Fri Mar 25. The DJ-UBS commodity index rose 165.5 percent between 2002 and 2008, largely because of similar policies by the Fed, and has risen 32.9 percent since Jul 2, 2010, when sovereign risks in Europe moderated, to Fri Mar 25. Inflation is moving throughout the production and distribution chain of the US and is everywhere in the world economy. Inflation will not stay out of the US economy because of appeal to economic history research on the Great Depression, which, admired by most economists, has little if any relevance to current policy issues. Inflation is coexisting again, as in the 1970s inflation instead of as in 1930s deflation, with persistent unemployment in advanced economies. There is 17 million less hiring per year in the US than in 2006 or 2007. The Fed is likely to raise inflation without improving job markets as it happened before during the Great Inflation. The issue is not whether the US should have a central bank, with most economists agreeing on the need of central banking, or rules such as the gold standard and fixed exchange rates, which caused past economic disasters, but the need for a change to less exotic, experimental monetary policy by the Fed of zero interest rates and large-scale purchases of long-term securities in a misleading fear of deflation while inflation is evident and no longer lurking. The contents of this comment are as follows:
I Slow Growth
II Inflation and Unemployment
III 17 Million less Hiring per Year
III Valuation of Risk Financial Assets
IV Economic Indicators
V Interest Rates
VI Conclusion
References
I Slow Growth. Chairman Bernanke is quoted by the FCIC (2011R, 382) stating that:
“As a scholar of the Great Depression, I honestly believe that September and October 2008 was the worst financial crisis in global history, including the Great Depression. If you look at the firms that came under pressure in that period…only one…was not at serious risk of failure…So out of maybe the 13, 13 of the most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two.”
Comparisons of the credit/dollar crisis and global recession with the Great Depression are typically misleading and not rare. For example, Modigliani (1988, 399) states that in a speech President Reagan “began by suggesting that ‘we are in the worst economic mess since the Great Depression,’ a statement that an objective review of the situation would find highly exaggerated.” Much the same occurs currently in comparisons with the 1930s that provide some of the widest fluctuations of events and data required for economic research. US GDP in constant dollars fell 8.6 percent in 1930, 6.4 percent in 1931, 13.0 percent in 1932 and 1.3 percent in 1934 for a cumulative contraction of 26.5 percent and GDP in current dollars contracted by 48.9 percent (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-1; Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 205-7; for review of the academic literature on the Great Depression see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 198-217). About 40 percent of commercial banks in the US in 1929-1933, or 9440, were suspended, 79 percent of which were state banks and 21 percent national banks (Mitchener 2005, 156).
The main theme of the G20 meeting of finance ministers and governors of central banks in Paris on Feb 18-19 was the issue of global imbalances (http://www.g20.utoronto.ca/2011/2011-finance-110219-fr.html). This theme has recurred over a decade (Pelaez and Pelaez, International Financial Architecture (2005), 1-62, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b) 180-213, Government Intervention in Globalization (2008c), 167-84). In a key analysis of the global imbalances, Obstfeld and Rogoff (2005, 6) find:
“The end of the 1980s witnessed a 40 percent decline in the trade weighted dollar as the Reagan-era current account deficit closed up. Yet, the change was arguably relatively benign (though some would say that Japan’s macroeconomic response to the sharp appreciation of the yen in the late 1980s helped plant the seeds of the prolonged slump that began in the next decade). However, it may ultimately turn out that the early-1970s dollar collapse following the breakdown of the Bretton Woods system is a closer parallel. Then, as now, the United States was facing open-ended security costs, rising energy prices, a rise in retirement program costs, and the need to rebalance monetary policy.”
Historical parallels are instructive but have all the limitations of empirical research in economics. The more instructive comparisons are not with the Great Depression of the 1930s but rather with the recessions in the 1950s, 1970s and 1980s.
The growth rate and job creation in the expansion of the economy away from recession are subpar in the current expansion compared to others in the past. Four recessions are initially considered, following the reference dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles/cyclesmain.html ): IIQ1953-IIQ1954, IIIQ1957-IIQ1958, IIIQ1973-IQ1975 and IQ1980-IIIQ1980. The data for the earlier contractions illustrate that the growth rate and job creation in the current expansion are inferior. The sharp contractions of the 1950s and 1970s are considered in Table 1, showing the Bureau of Economic Analysis (BEA) quarter-to-quarter, seasonally adjusted (SA), yearly-equivalent growth rates of GDP. The recovery from the recession of 1953 consisted of four consecutive quarters of high percentage growth rates from IIIQ1954 to IIIQ1955: 4.6, 8.3, 12.0, 6.8 and 5.4. The recession of 1957 was followed by four consecutive high percentage growth rates from IIIQ1958 to IIQ1959: 9.7, 9.7, 8.3 and 10.5. The recession of 1973-1975 was followed by high percentage growth rates from IIQ1975 to IIQ1976: 6.9, 5.3, 9.4 and 3.0.
Table 1, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| IQ | IIQ | IIIQ | IVQ | |
| 1953 | 7.7 | 3.1 | -2.4 | -6.2 |
| 1954 | -1.9 | 0.5 | 4.6 | 8.3 |
| 1955 | 12.0 | 6.8 | 5.4 | 2.3 |
| 1957 | 2.5 | -1.0 | 3.9 | -4.1 |
| 1958 | -10.4 | 2.5 | 9.7 | 9.7 |
| 1959 | 8.3 | 10.5 | -0.5 | 1.4 |
| 1973 | 10.6 | 4.7 | -2.1 | 3.9 |
| 1974 | 3.5 | 1.0 | -3.9 | 6.9 |
| 1975 | -4.8 | 3.1 | 6.9 | 5.3 |
| 1976 | 9.4 | 3.0 | 2.0 | 2.9 |
| 1979 | 0.7 | 0.4 | 2.9 | 1.1 |
| 1980 | 1.3 | -7.9 | -0.7 | 7.6 |
The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ 1982 are combined, the impact on lost GDP is comparable to the revised 4.1 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. Table 2 provides the BEA quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981-1982 and 2007 to 2009. There were four quarters of contraction in 1981-1982 ranging in rate from -1.5 percent to -6.4 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.7 percent to -6.8 percent. The striking difference is that in the first six quarters of expansion from IQ1983 to IIQ1984 GDP grew at the high quarterly percentage growth rate of 5.1, 9.3, 8.1, 8.5, 7.1 and 3.9 while the percentage growth rate in the first six quarters from IIIQ2009 to IVQ2010 was mediocre: 1.6, 5.0, 3.7, 1.7, 2.6 and 3.1. The data in this and the following tables incorporate the third estimate of IVQ2010 by the BEA, increasing the rate of growth of GDP from 2.8 to 3.1 percent. Inventory change contributed to initial growth but was rapidly replaced by growth in investment and demand in 1983. The key difference may be found in the negative incentive to business and household investment and business hiring from the structural shock to business models resulting from legislative restructurings and regulation with alleged benefits in the long-term but adverse short-term growth and jobs effects.
Table 2, Quarterly Growth Rates of GDP, % Annual Equivalent SA
| Q | 1981 | 1982 | 1983 | 1984 | 2008 | 2009 | 2010 |
| I | 8.6 | -6.4 | 5.1 | 7.1 | -0.7 | -4.9 | 3.7 |
| II | -3.2 | 2.2 | 9.3 | 3.9 | 0.6 | -0.7 | 1.7 |
| III | 4.9 | -1.5 | 8.1 | 3.3 | -4.0 | 1.6 | 2.6 |
| IV | -4.9 | 0.3 | 8.5 | 5.4 | -6.8 | 5.0 | 3.1 |
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_3rd.pdf
The contributions to the rate of growth of GDP in percentage points (PP) are provided in Table 3. Aggregate demand, personal consumption expenditures (PCE) and gross private domestic investment (GDI) were much stronger during the expansion phase in IQ1983 to IIQ1984 than in IIIQ2009 to IVQ2010.
Table 3, Contributions to the Rate of Growth of GDP in Percentage Points
| GDP | PCE | GDI | ∆ PI | Trade | GOV | |
| 2010 | ||||||
| I | 3.7 | 1.33 | 3.04 | 2.64 | -0.31 | -0.32 |
| II | 1.7 | 1.54 | 2.88 | 0.82 | -3.50 | 0.80 |
| III | 2.6 | 1.67 | 1.80 | 1.61 | -1.70 | 0.79 |
| IV | 3.1 | 2.79 | -2.61 | -3.42 | 3.27 | -0.34 |
| 2009 | ||||||
| I | -4.9 | -0.34 | -6.80 | -1.09 | 2.88 | -0.61 |
| II | -0.7 | -1.12 | -2.30 | -1.03 | 1.47 | 1.24 |
| III | 1.6 | 1.41 | 1.22 | 1.10 | -1.37 | 0.33 |
| IV | 5.0 | 0.69 | 2.70 | 2.83 | 1.90 | -0.28 |
| 1982 | ||||||
| I | -6.4 | 1.62 | -7.50 | -5.47 | -0.49 | -0.03 |
| II | -2.2 | 0.90 | -0.05 | 2.35 | 0.84 | 0.50 |
| III | -1.5 | 1.92 | -0.72 | 1.15 | -3.31 | 0.57 |
| IV | 0.3 | 4.64 | -5.66 | -5.48 | -0.10 | 1.44 |
| 1983 |
|
|
|
|
|
|
| I | 5.1 | 2.54 | 2.20 | 0.94 | -0.30 | 0.63 |
| II | 9.3 | 5.22 | 5.87 | 3.51 | -2.54 | 0.75 |
| III | 8.1 | 4.66 | 4.30 | 0.60 | -2.32 | 1.48 |
| IV | 8.5 | 4.20 | 6.84 | 3.09 | -1.17 | -1.35 |
| 1984 | ||||||
| I | 8.0 | 2.35 | 7.15 | 5.07 | -2.37 | 0.86 |
| II | 7.1 | 3.75 | 2.44 | -0.30 | -0.89 | 1.79 |
| III | 3.9 | 2.02 | -0.89 | 0.21 | -0.36 | 0.62 |
| IV | 3.3 | 3.38 | 1.79 | -2.50 | -0.58 | 1.75 |
Note: PCE: personal consumption expenditures; GDI: gross private domestic investment; ∆ PI: change in private inventories; Trade: net exports of goods and services; GOV: government consumption expenditures and gross investment; – is negative and no sign positive
GDP: percent change at annual rate; percentage points at annual rates
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_3rd.pdf
Table 4 provides more detailed information on the causes of the acceleration of GDP growth from 2.6 percent in IIIQ10 to 3.1 percent in IVQ10. The Bureau of Economic Analysis (BEA) finds three source of contribution to the acceleration: (1) sharp deceleration of import growth from 16.8 percent in IIIQ10 to negative 12.6 percent in IVQ10; (2) acceleration in PCE growth from 2.4 percent to 4.0 percent; and (3) acceleration in residential fixed investment (RFI) growth from negative 27.3 percent to 3.3 percent. There are three sources constraining growth: (1) deceleration of nonresidential fixed investment (NRFI) from 10.0 percent to 7.7 percent; (2) negative percentage point contribution of change in private inventories (∆% PI) of 3.42 from 1.61; and (3) deceleration of government consumption and expenditures (GOV) from 3.9 percent to negative 1.7 percent with federal government consumption and expenditures decelerating from 8.8 percent to negative 0.3 percent and state/local from 0.7 percent to negative 2.6 percent.
Table 4, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase
| IIIQ2010 | IVQ2010 | |
| GDP | 2.6 | 3.1 |
| PCE | 2.4 | 4.0 |
| Durable Goods | 7.6 | 21.1 |
| NRFI | 10.0 | 7.7 |
| RFI | -27.3 | 3.3 |
| Exports | 6.8 | 8.6 |
| Imports | 16.8 | -12.6 |
| GOV | 3.9 | -1.7 |
| Federal GOV | 8.8 | -0.3 |
| State/Local GOV | 0.7 | -2.6 |
| ∆ PI (PP) | 1.61 | -3.42 |
| GDP-∆ PI | 0.99 | -0.91 |
| Gross Domestic Purchases | 4.2 | -0.2 |
| Prices Gross Domestic Purchases | 0.7 | 2.1 |
| Real Disposable Personal Income | 1.0 | 1.9 |
| Personal Savings Rate | 6.0 | 5.6 |
Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in
private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income
Source:
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_3rd.pdf
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_adv.pdf
Table 5 shows the percentage point (PP) contributions to the annual levels in the earlier recessions 1958-1959, 1975-1976, 1982-1983 and 2009 and 2010. The most striking contrast is in the rates of growth of annual GDP in the expansion phases of 7.2 percent in 1959, 5.4 percent in 1983 followed by 7.2 percent in 1984 and 4.1 percent in 1985 but only 2.9 percent in 2010 after six consecutive quarters of growth. The annual levels also show much stronger growth of PCEs in the expansions after the earlier contractions. PCEs contributed 1.26 PPs to GDP growth in 2010 of which 0.99 PP in goods and 0.27 PP in services. GDI deducted 3.24 PPs of GDP growth in 2009 of which -2.69 PPs by fixed investment and -0.55 PP of ∆PI and added 1.87 PPs to GDI in 2010 of which 0.48 PPs of fixed investment and 1.40 of ∆PI. Trade, or exports of goods and services net of imports, contributed 1.13 PPs in 2009 of which exports deducted 1.18 PPs and imports added 2.32 PPs. In 2010, trade deducted 0.49 PP with exports contributing 1.34 PPs and imports deducting 1.83 PPs. In 2009, Government added 0.32 PP of which 0.43 PP by the federal government and -0.11 PP by state and local government; in 2010, government added 0.21 PP of which 0.39 PP by the federal government with state and local government deducting 0.18 PP.
Table 5, Percentage Point Contributions to the Annual Growth Rate of GDP
| GDP | PCE | GDI | ∆ PI | Trade | GOV | |
| 1958 | -0.9 | 0.54 | -1.25 | -0.18 | -0.89 | 0.70 |
| 1959 | 7.2 | 3.61 | 2.80 | 0.86 | 0.00 | 0.76 |
| 1975 | -0.2 | 1.40 | -2.98 | -1.27 | 0.89 | 0.48 |
| 1976 | 5.4 | 3.51 | 2.84 | 1.41 | -1.08 | 0.10 |
| 1982 | -1.9 | 0.86 | -2.55 | -1.34 | -0.60 | 0.35 |
| 1983 | 4.5 | 3.65 | -1.45 | 0.29 | -1.35 | 0.76 |
| 1984 | 7.2 | 3.43 | 4.63 | 1.95 | -1.58 | 0.70 |
| 1985 | 4.1 | 3.32 | -0.17 | -1.06 | -0.42 | 1.41 |
| 2009 | -2.6 | -0.84 | -3.24 | -0.55 | 1.13 | 0.32 |
| 2010 | 2.9 | 1.26 | 1.87 | 1.40 | -0.49 | 0.21 |
http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_3rd.pdf
II Inflation and Unemployment. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table 6, updated with every post, provides the latest yearly data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly-indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of the sovereign risk issues (http://www.ft.com/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1G67TzFqs). Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration. The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. There are six key interrelated vulnerabilities in the world economy that have been causing global financial turbulence: (1) sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings; (2) the tradeoff of growth and inflation in China; (3) slow growth (see http://cmpassocregulationblog.blogspot.com/2011/02/mediocre-growth-raw-materials-shock-and.html) and continuing job stress of 25 to 30 million people in the US (see http://cmpassocregulationblog.blogspot.com/2011/03/unemployment-and-undermployment.html); (4) the timing, dose, impact and instruments of normalizing monetary and fiscal policies (see http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies; (5) the earthquake and tsunami affecting Japan that is having repercussions throughout the world economy because of Japan’s share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) the geopolitical events in the Middle East.
Table 6, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 2.7 | 2.1 | 5.6 | 8.9 |
| Japan | 2.5 | 0.0 | 1.7 | 4.9 |
| China | 9.8 | 4.9 | 7.2 | |
| UK | 1.5 | 4.4* | 5.3* output 14.6* input 8.5** | 7.9 |
| Euro Zone | 2.0 | 2.4 | 6.1 | 9.9 |
| Germany | 4.0 | 2.2 | 5.5 | 6.5 |
| France | 1.5 | 1.8 | 5.5 | 9.6 |
| Nether-lands | 2.4 | 2.0 | 10.3 | 4.3 |
| Finland | 5.0 | 3.5 | 8.1 | 8.0 |
| Belgium | 1.8 | 3.5 | 9.0 | 8.0 |
| Portugal | 1.2 | 3.5 | 5.7 | 11.2 |
| Ireland | -1.0 | 2.1 | 4.0 | 13.5 |
| Italy | 1.5 | 2.1 | 4.6 | 8.6 |
| Greece | -6.6 | 4.2 | 6.7 | 12.4 |
| Spain | 0.6 | 3.4 | 6.8 | 20.4 |
Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier
*Feb Office for National Statistics
http://www.statistics.gov.uk/statbase/Product.asp?vlnk=790
http://www.statistics.gov.uk/statbase/Product.asp?vlnk=868
** Jan EUROSTAT http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-02032011-AP/EN/4-02032011-AP-EN.PDF
Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html
Wall Street Journal Professional Factiva
The dramatic event known as the Great Inflation is shown in Table 7. In celebrated political economy analysis of this episode, DeLong (1997, 256-7) finds, somewhat irreverently, that:
“It may be that for every conceivable policy there is an economist who can wear a suit and pronounce the policy sound and optimal, and that to a large degree presidents and senators get the economic advice that they ask for. It may be that a less optimistic group of advisers drawn from the academic economics community would have had no more effect on macroeconomic policy in the 1960s than advisers from the academic economics community had on fiscal policy at the beginning of the 1980s, when they pointed out that revenue projections seemed, as Martin Feldstein (1994) politely put it, ‘inconsistent with the Federal Reserve’s very tight monetary policy.”
DeLong (1997, 247-8) shows that the 1970s were the only peacetime period of inflation in the US without parallel in the prior century. The price level in the US drifted upward since 1896 with jumps resulting from the two world wars: “on this scale, the inflation of the 1970s was as large an increase in the price level relative to drift as either of this century’s major wars” (DeLong, 1997, 248). Monetary policy focused almost on accommodating higher inflation with emphasis solely on the mandate of promoting employment has been blamed as deliberate or because of model error or imperfect measurement for creating the Great Inflation (http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). As DeLong (1997) shows, the Great Inflation began in the mid 1960s, well before the oil shocks of the 1970s (see also the comment to DeLong 1997 by Taylor 1997, 276-7). A counterfactual of the 1970s immediately rises out of Table 7. What would have been the Great Inflation if the Federal Reserve would have lowered interest rates to zero in 1961, in fear of deflation because of 0.7 percent CPI inflation, and purchased the equivalent of 30 percent of the Treasury debt in long-term securities, subsequently engaging in quantitative easing II in 1964 after CPI inflation of 1.0 percent? The counterfactual would not be complete without including the equivalent of $5.4 trillion fiscal deficits, as between 2009 and 2012, with the government debt/GDP ratio rising from 40.8 percent to 75.1 percent from 2008 to 2012, as in the current budget (http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html).
Table 7, US Annual Rate of Growth of GDP and CPI and Unemployment Rate 1960-1982
| ∆% GDP | ∆% CPI | UNE | |
| 1960 | 2.5 | 1.4 | 6.6 |
| 1961 | 2.3 | 0.7 | 6.0 |
| 1962 | 6.1 | 1.3 | 5.5 |
| 1963 | 4.4 | 1.6 | 5.5 |
| 1964 | 5.8 | 1.0 | 5.0 |
| 1965 | 6.4 | 1.9 | 4.0 |
| 1966 | 6.5 | 3.5 | 3.8 |
| 1967 | 2.5 | 3.0 | 3.8 |
| 1968 | 4.8 | 4.7 | 3.4 |
| 1969 | 3.1 | 6.2 | 3.5 |
| 1970 | 0.2 | 5.6 | 6.1 |
| 1971 | 3.4 | 3.3 | 6.0 |
| 1972 | 5.3 | 3.4 | 5.2 |
| 1973 | 5.8 | 8.7 | 4.9 |
| 1974 | -0.6 | 12.3 | 7.2 |
| 1975 | -0.2 | 6.9 | 8.2 |
| 1976 | 5.4 | 4.9 | 7.8 |
| 1977 | 4.6 | 6.7 | 6.4 |
| 1978 | 5.6 | 9.0 | 6.0 |
| 1979 | 3.1 | 13.3 | 6.0 |
| 1980 | -0.3 | 12.5 | 7.2 |
| 1981 | 2.5 | 8.9 | 8.5 |
| 1982 | -1.9 | 3.8 | 10.8 |
| 1983 | 4,5 | 3.8 | 8.3 |
| 1984 | 7.2 | 3.9 | 7.3 |
| 1985 | 4.1 | 3.8 | 7.0 |
| 1986 | 3.5 | 1.1 | 6.6 |
| 1987 | 3.2 | 4.4 | 5.7 |
| 1988 | 4.1 | 4.4 | 5,3 |
| 1989 | 3.6 | 4.6 | 5.4 |
| 1990 | 1.9 | 6.1 | 6.3 |
Note: GDP: Gross Domestic Product; CPI: consumer price index; UNE: rate of unemployment; CPI and UNE are at year end instead of average to obtain a complete series
Source: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
http://www.bls.gov/web/empsit/cpseea01.htm
http://data.bls.gov/pdq/SurveyOutputServlet
The baseline monetary policy rule considered by Clarida, GalĂ and Gertler (CGG) in the analysis of the Great Inflation is a simple linear equation:
r*t = r* + β(inflation gap) + γ(output gap) (1)
Where r*t is the Fed’s target rate for the fed funds rate in period t, r* is the desired nominal rate corresponding to both inflation and output being at their target levels (CGG 2000, 150), (inflation gap) is the deviation of actual inflation from target inflation and (output gap) is the percentage difference between actual GDP and its target. The rule is forward looking because the two gaps are relative to future desired levels. The Federal Reserve of the Great Inflation virtually ignored the inflation gap with generous accommodation to tighten the output gap. The result was major increases of both the inflation gap and output gap, manifested in high inflation rates and equally high unemployment rates.
Important analysis of monetary policy is provided by Reinhart (2011Mar17) and Meltzer (2011Feb5) (Tom Keene interviewed them simultaneously in Bloomberg Surveillance Midday http://noir.bloomberg.com/apps/news?pid=20601087&sid=a9kDlLyyuMrU&pos=4). Reinhart (2011Mar17) find reasons for moderation in monetary policy similar to those that would have been pragmatic in slowing speed to permit the identification of unexpected harms that could help to soften potential damage, such as unexpected collision with an iceberg when navigating treacherous waters that sunk the Titanic 100 years ago. In the view of Reinhart (2011Mar17), Fed policy in the past three years has been concerned with the downside risk of economic activity and unemployment while inflation is at low levels courting deflation or preventing policy from further accommodation. As of Mar 23, the line “Reserve Bank credit” in the Fed balance sheet was $2585 billion, or $2.6 trillion, with portfolio of long-term securities of $2356 billion, or $2.4 trillion, composed of $1223 billion of nominal long-term notes and bonds, $57 billion of inflation indexed long-term notes and bonds, $132 billion of federal agency debt securities and $944 billion of mortgage-backed securities; the line “reserve balances with Federal Reserve Banks” was $1408 billion or $1.4 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The purchase of $2.4 trillion long-term securities, in the view of Reinhart (2011Mar17), was designed to support financial markets through three channels: (1) securities were purchased by the issue of Fed money or $1.4 trillion of electronic deposit of reserves of banks at the Fed that could be used for lending that would increase investment and consumption or aggregate demand, thus raising GDP growth and employment; (2) additional purchases in the second round of quantitative easing would raise equity valuations that Bernanke (2010WP) argued would support consumer wealth and raise aggregate demand via consumption; and (3) what Reinhart (2011Mar17) finds a perhaps flagrant flirt with “central-bank disaster,” increase inflationary expectations; the real rate of interest, nominal rate of zero for fed funds less inflationary expectations (Fisher 1930), would decline supporting spending, devaluing the dollar and increasing commodity prices. Reinhart (2011Mar17) finds that the Fed has been successful in generating inflation as input prices infiltrate headline inflation with the CPI change in the last three month annualized at 3.875 percent. There are no precise measurements of the factors of recent growth and their relation to monetary stimulus and of whether CPI inflation is eliminating the risk of disinflation or accelerating the rate of inflation. Without more precise knowledge, Reinhart (2011Mar17) proposes prudent reduction of monthly purchases of long-term securities to $25 billion per month, allowing sufficient time until the end of the year in which purchases can be accelerated if needed or reduced further if inflation accelerates (see other contributions by Reinhart 2004, Bernanke and Reinhart 2004, Bernanke, Reinhart and Sack 2004).
Meltzer (2011Feb5) finds that economic policy currently should focus on reduction of government expenditures, lowering corporate tax rates and a moratorium of three years on new regulation but the most important policy should be by the Fed in preventing another Great Inflation as in the 1970s. In this view, there is still time to stop accelerating inflation. The interpretation by Meltzer (2011Feb5) of the Great Inflation is that policymakers of the time decided to reduce unemployment by lowering interest rates based on a reading of the Phillips curve that suggested dealing with inflation in the future. The increase in inflation and unemployment during the 1970s confused and surprise policymakers. The Great Inflation and underemployment episode ended when Paul Volcker implemented a policy by which the best way to promote employment in the future was to reduce inflation now. The Fed has repeated the same policy mistakes often with two being more crucial currently: (1) the Fed focuses on short-term events that it cannot control, neglecting the consequences of current policies in the long term; and (2) the Fed interprets the dual mandate as using all its resources in reducing unemployment without a credible long-term policy to attain the dual mandate of reducing unemployment and stabilizing prices (for the definitive history of the Federal Reserve see Meltzer 2004, 2010). The current Fed view on the dual mandate failed in the 1970s when it increased inflation and also unemployment and, in Meltzer’s opinion, will fail again now. Meltzer (2011Feb5) finds that there is inflation in countries everywhere. The dollar devalues against the euro, which is a currency weakened by sovereign risk issues. Prices of commodities and various raw materials have increased sharply in the past year. Eventually, business will increase prices by the pressure of rising costs. Money in circulation is increasing with higher loan demand. There is no value in the belief that the US will not experience inflation that is accelerating worldwide. An important comment by Professor Meltzer in the Bloomberg Surveillance Midday interview is that housing has a weight of about 40 percent of the US CPI (http://www.bls.gov/cpi/cpiri2010.pdf). Recovery of housing prices with current monetary policy accommodation devaluing the dollar and increasing commodity prices could result in sudden jumps of headline inflation. Meltzer (2011Feb5) proposes three changes in Fed policy: (1) the fed funds policy should increase to 1 percent from the current 0 to ¼ percent as explicit intention of acting strongly and timely to control inflation; (2) the Fed should announce specific measures of reducing the about $1 trillion of excess reserves of banks; and (3) the Fed should terminate the second round of quantitative easing.
Friedman (1948, 255) argues that:
“There is a strong presumption that these discretionary actions will in general be subject to longer lags than the automatic reactions and hence will be destabilizing even more frequently. The basis for this presumption can best be seen by subdividing into three parts the total lag involved in any action to offset a disturbance: (1) the lag between the need for action and the recognition of this need; (2) the lag between recognition of the need for action and the taking of action; and (3) the lag between the action and its effects.”
Lucas (1976) warns about the use in policy of econometric relations estimated from a structure before policy implementation because the parameters are likely to change as the public anticipates the policy change. An example from Lucas (1976) is discussed by Chari (1998). A tax credit on investment may be designed to stimulate the economy away from recession or low employment but the anticipation of the credit results in postponement of decisions until the completion of the political process of approval and the legislation being in force.
DeLong (1997, 262) argues that:
“I think that the power, formal correctness, and elegance of the Lucas critique has put into shadow the limits of macroeconomic knowledge even assuming that the policy and institutional regime is unchanged. There is a sense in which Milton Friedman (1968) gave the wrong presidential address to the American Economic Association: he should have repeated his message of 1953, “The Effects of Full-Employment Policy on Economic Stability,” and argued that uncertainty about parameters makes “fine-tuning”-and its cousin, “gradualism”-next to impossible.”
Theoretical knowledge, empirical verification, forecasting and policy simulation are not very successful in identifying policy needs and designing appropriate doses such as the quest to fix inflation in the infinitesimal neighborhood around 2 percent and the nonaccelerating-inflation rate of unemployment (NAIRU) in a neighborhood of 5.5 percent, assuming that its drift over time can be measured. Policy experiments with zero interest rates and trillion-dollar Fed balance sheets are likely to overshoot inflation and NAIRU as it happened during the Great Inflation and Unemployment episode of the 1970s.
Ten ex-chairs of the President’s Council of Economic Advisers (2011Mar24) published a joint statement, arguing that “repeated battles over the 2011 budget are taking attention from a more dire problem—the long-run budget deficit.” There could be a dreaded risk premium on yields of US Treasury securities: “at some point, bond markets are likely to turn on the United States—leading to a crisis that could dwarf 2008” (Ibid).
Table 8, updated with every blog, provides in the second column the yield at the close of market of the 10-year Treasury note on the date in the first column. The price in the third column is calculated with the coupon of 2.625 percent of the 10-year note current at the time of the second round of quantitative easing after Nov 3, 2010 and the final column “∆% 11/04/10” calculates the percentage change of the price on the date relative to that of 101.2573 at the close of market on Nov 4, 2010, one day after the decision on quantitative easing by the Fed on Nov 3, 2010. Prices with the new coupon of 3.63 percent in recent auctions (http://www.treasurydirect.gov/instit/annceresult/press/preanre/2011/2011.htm) are not comparable to prices in Table 8. The highest yield in the decade was 5.510 percent on May 1, 2001 that would result in a loss of principal of 22.9 percent relative to the price on Nov 4. The Fed has created a “duration trap” of bond prices. Duration is the percentage change in bond price resulting from a percentage change in yield or what economists call the yield elasticity of bond price. Duration is higher the lower the bond coupon and yield, all other things constant. This means that the price loss in a yield rise from low coupons and yields is much higher than with high coupons and yields. Intuitively, the higher coupon payments offset part of the price loss. Prices/yields of Treasury securities were affected by the combination of Fed purchases for its program of quantitative easing and also by the flight to dollar-denominated assets because of geopolitical risks in the Middle East and subsequently by the tragic earthquake and tsunami in Japan. The yield of 3.435 percent at the close of market on Mar 25 would be equivalent to price of 93.1935 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price loss of 7.9 percent relative to the price on Nov 4, 2010, one day after the decision on the second program of quantitative easing. If inflation accelerates, yields of Treasury securities may rise sharply. Yields are not observed without special yield-lowering effects such as the flight into dollars caused by the events in the Middle East, continuing purchases of Treasury securities by the Fed, the tragic earthquake and tsunami affecting Japan and recurring fears on European sovereign issues. Important causes of the rise in yields shown in Table 8 are expectations of rising inflation and US government debt estimated to reach 75 percent in 2012 (http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html). There is no simple exit of this trap with the highest monetary policy accommodation in US history.
Table 8, Yield, Price and Percentage Change to November 4, 2010 of Ten-Year Treasury Note
| Date | Yield | Price | ∆% 11/04/10 |
| 05/01/01 | 5.510 | 78.0582 | -22.9 |
| 06/10/03 | 3.112 | 95.8452 | -5.3 |
| 06/12/07 | 5.297 | 79.4747 | -21.5 |
| 12/19/08 | 2.213 | 104.4981 | 3.2 |
| 12/31/08 | 2.240 | 103.4295 | 2.1 |
| 03/19/09 | 2.605 | 100.1748 | -1.1 |
| 06/09/09 | 3.862 | 89.8257 | -11.3 |
| 10/07/09 | 3.182 | 95.2643 | -5.9 |
| 11/27/09 | 3.197 | 95.1403 | -6.0 |
| 12/31/09 | 3.835 | 90.0347 | -11.1 |
| 02/09/10 | 3.646 | 91.5239 | -9.6 |
| 03/04/10 | 3.605 | 91.8384 | -9.3 |
| 04/05/10 | 3.986 | 88.8726 | -12.2 |
| 08/31/10 | 2.473 | 101.3338 | 0.08 |
| 10/07/10 | 2.385 | 102.1224 | 0.8 |
| 10/28/10 | 2.658 | 99.7119 | -1.5 |
| 11/04/10 | 2.481 | 101.2573 | - |
| 11/15/10 | 2.964 | 97.0867 | -4.1 |
| 11/26/10 | 2.869 | 97.8932 | -3.3 |
| 12/03/10 | 3.007 | 96.7241 | -4.5 |
| 12/10/10 | 3.324 | 94.0982 | -7.1 |
| 12/15/10 | 3.517 | 92.5427 | -8.6 |
| 12/17/10 | 3.338 | 93.9842 | -7.2 |
| 12/23/10 | 3.397 | 93.5051 | -7.7 |
| 12/31/10 | 3.228 | 94.3923 | -6.7 |
| 01/07/11 | 3.322 | 94.1146 | -7.1 |
| 01/14/11 | 3.323 | 94.1064 | -7.1 |
| 01/21/11 | 3.414 | 93.4687 | -7.7 |
| 01/28/11 | 3.323 | 94.1064 | -7.1 |
| 02/04/11 | 3.640 | 91.750 | -9.4 |
| 02/11/11 | 3.643 | 91.5319 | -9.6 |
| 02/18/11 | 3.582 | 92.0157 | -9.1 |
| 02/25/11 | 3.414 | 93.3676 | -7.8 |
| 03/04/11 | 3.494 | 92.7235 | -8.4 |
| 03/11/11 | 3.401 | 93.4727 | -7.7 |
| 03/18/11 | 3.273 | 94.5115 | -6.7 |
| 03/25/11 | 3.435 | 93.1935 | -7.9 |
Note: price is calculated for an artificial 10-year note paying semi-annual coupon and maturing in ten years using the actual yields traded on the dates and the coupon of 2.625% on 11/04/10
Source:
http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3020
Equation (1) gives the false impression that the Fed has the “science,” measurements and forecasting to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table 9 when the Fed pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table 9 shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without Fed tightening because of the long lag in effect of monetary policy on inflation. The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery and creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether exotic policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability. A glance at Table 7 shows CPI inflation of 0.7 percent in 1961, creating a counterfactual of what would have been the Great Inflation if the Fed had set the policy rate at zero and purchased a third of the outstanding Treasury debt. The symmetric inflation target of “a little less than 2 percent,” or an infinitesimal neighborhood of 2, is an extremely dangerous misplaced analogy with the Great Depression that may bring the economy closer to the relevant historical event of the Great Inflation of the 1970s and the Great Bond Crash of 1994.
Table 9, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994
| 1994 | FF | 30Y | 30P | 10Y | 10P | MOR | CPI |
| Jan | 3.00 | 6.29 | 100 | 5.75 | 100 | 7.06 | 2.52 |
| Feb | 3.25 | 6.49 | 97.37 | 5.97 | 98.36 | 7.15 | 2.51 |
| Mar | 3.50 | 6.91 | 92.19 | 6.48 | 94.69 | 7.68 | 2.51 |
| Apr | 3.75 | 7.27 | 88.10 | 6.97 | 91.32 | 8.32 | 2.36 |
| May | 4.25 | 7.41 | 86.59 | 7.18 | 88.93 | 8.60 | 2.29 |
| Jun | 4.25 | 7.40 | 86.69 | 7.10 | 90.45 | 8.40 | 2.49 |
| Jul | 4.25 | 7.58 | 84.81 | 7.30 | 89.14 | 8.61 | 2.77 |
| Aug | 4.75 | 7.49 | 85.74 | 7.24 | 89.53 | 8.51 | 2.69 |
| Sep | 4.75 | 7.71 | 83.49 | 7.46 | 88.10 | 8.64 | 2.96 |
| Oct | 4.75 | 7.94 | 81.23 | 7.74 | 86.33 | 8.93 | 2.61 |
| Nov | 5.50 | 8.08 | 79.90 | 7.96 | 84.96 | 9.17 | 2.67 |
| Dec | 6.00 | 7.87 | 81.91 | 7.81 | 85.89 | 9.20 | 2.67 |
Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months
Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
III 17 Million less Hiring per Year. An appropriate measure of job stress is considered by Blanchard and Katz (1997, 53):
“The right measure of the state of the labor market is the exit rate from unemployment, defined as the number of hires divided by the number unemployed, rather than the unemployment rate itself. What matters to the unemployed is not how many of them there are, but how many of them there are in relation to the number of hires by firms.”
The natural rate of unemployment and the similar NAIRU are quite difficult to estimate in practice (Ibid; see Ball and Mankiw 2002).
The Bureau of Labor Statistics (BLS) created the Job Openings and Labor Turnover Survey (JOLTS) with the purpose that (http://www.bls.gov/jlt/jltover.htm#purpose):
“These data serve as demand-side indicators of labor shortages at the national level. Prior to JOLTS, there was no economic indicator of the unmet demand for labor with which to assess the presence or extent of labor shortages in the United States. The availability of unfilled jobs—the jobs opening rate—is an important measure of tightness of job markets, parallel to existing measures of unemployment.”
The BLS collects data from about 16,000 US business establishments in nonagricultural industries through the 50 states and DC. The data are released monthly and constitute an important complement to other data provided by the BLS.
The data in Table 10 provide evidence of the strong impact of the recession on the US job market. Hiring in the nonfarm sector (HNF) has declined from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million while hiring in the private sector (HP) has declined from 60.4 million in 2006 to 43.3 million in 2010 or by 17.1 million. The ratio of nonfarm hiring to unemployment (RHNF) has fallen from 9.3 in 2006 to 3.2 in 2010 and in the private sector (RHP) from 8.6 in 2006 to 2.9 in 2010. The last two columns provide employment (EMP) and the ratio of employment to population (REMP) or the number of people employed and their share in the population. Employment fell from 144.4 million in 2006 to 139.1 million in 2010 and the employment population ratio fell from 62.7 in 2006 to 58.5 in 2010. The job market is under significant stress with only some marginal improvement.
Table 10, Nonfarm Hiring, Private Hiring, Employed, and Ratios to Unemployed and Population Millions and Ratios, Not Seasonally Adjusted
| HNF | UNE | RHNF | HP | RHP | EMP | REMP | |
| 2001 | 63.7 | 6.8 | 9.4 | 59.3 | 8.7 | 136.9 | 64.4 |
| 2002 | 59.8 | 8.4 | 7.1 | 55.7 | 6.6 | 136.5 | 62.6 |
| 2003 | 57.8 | 8.8 | 6.6 | 54.1 | 6.1 | 137.7 | 62.3 |
| 2004 | 61.6 | 8.1 | 7.6 | 57.5 | 7.1 | 139.3 | 62.3 |
| 2005 | 64.5 | 7.6 | 8.5 | 60.4 | 7.9 | 141.7 | 62.7 |
| 2006 | 64.9 | 7.0 | 9.3 | 60.4 | 8.6 | 144.4 | 62.7 |
| 2007 | 63.3 | 7.1 | 8.9 | 58.8 | 8.3 | 146.0 | 63.0 |
| 2008 | 53.9 | 8.9 | 6.1 | 50.3 | 5.7 | 145.4 | 62.2 |
| 2009 | 45.4 | 14.3 | 3.2 | 41.9 | 2.9 | 139.9 | 59.3 |
| 2010 | 47.2 | 14.8 | 3.2 | 43.3 | 2.9 | 139.1 | 58.5 |
Notes: HNF: total hiring nonfarm millions; UNE: unemployed millions; RHNF= HNF/UNE; HP: hiring private millions; RHP = HP/UNE; EMP: employed millions; REMP: EMP as % population
Sources: http://www.bls.gov/web/empsit/cpseea01.htm
http://www.bls.gov/jlt/data.htm
Table 11 provides other important data of JOLTS. The first two columns are the ratios of nonfarm hiring to employment (RHNF*), declining from 47.7 in 2006 to 36.4 in 2010, and private hiring to employment (RHP*), declining from 52.9 in 2006 to 40.2 in 2010. Private job opening (PJO) and the ratio of private job openings to (employment plus private job openings) are provided on a monthly level at the end of Dec, also declining as a result of the recession. Separations (SEP) and the ratio of separations to employment have also declined.
Table 11, Rate of Hiring Nonfarm and Private to Employment and Private Job Openings and Separations Millions and Ratios Not Seasonally Adjusted
| RHNF* | RHP* | PJO’ | RPJO’ | SEP | RSEP | |
| 2001 | 48.4 | 53.6 | 2.7 | 2.4 | 65.6 | 49.8 |
| 2002 | 45.9 | 51.1 | 2.4 | 2.1 | 60.4 | 46.3 |
| 2003 | 44.5 | 49.9 | 2.6 | 2.3 | 57.8 | 44.5 |
| 2004 | 46.9 | 52.4 | 3.1 | 2.7 | 59.7 | 45.4 |
| 2005 | 48.2 | 54.0 | 3.5 | 3.0 | 62.1 | 46.4 |
| 2006 | 47.7 | 52.9 | 3.7 | 3.1 | 62.7 | 46.1 |
| 2007 | 46.0 | 50.9 | 3.5 | 2.9 | 62.2 | 45.2 |
| 2008 | 39.5 | 44.0 | 2.3 | 2.0 | 57.5 | 42.1 |
| 2009 | 34.7 | 38.8 | 1.8 | 1.6 | 50.5 | 38.6 |
| 2010 | 36.4 | 40.3 | 2.2 | 2.0 | 46.3 | 35.7 |
Notes: RHNF*= HNF/EMP; RHP* = HP/EMP; PJO’: private job openings Dec millions; RPJO’: PJO’/(EMP + PJO); SEP: separations millions; RSEP = SEP/EMP
Sources: http://www.bls.gov/jlt/data.htm
IV 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/2011/01/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 12 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 Fed and housing policy in the US. Between 2002 and 2008, the DJ UBS Commodity Index rose 165.5 percent largely because of the unconventional monetary policy of the Fed encouraging carry trade 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 12 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 and then devaluation of the dollar by 18.1 percent by Fri Mar 25, 2011. Dollar devaluation is a major vehicle of the Fed in reducing the output gap that is implemented in the erroneous belief that devaluation will not accelerate inflation.
Table 12, 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 | 03/25 /11 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.408 |
| CNY/USD | 01/03 2000 | 07/21 2005 | 7/15 2008 | 03/25 2011 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.5565 |
| New House | 1963 | 1977 | 2005 | 2009 |
| Sales 1000s | 560 | 819 | 1283 | 375 |
| New House | 2000 | 2007 | 2009 | 2010 |
| Median Price $1000 | 169 | 247 | 217 | 203 |
| 2003 | 2005 | 2007 | 2010 | |
| CPI | 1.9 | 3.4 | 4.1 | 1.5 |
Sources: http://online.wsj.com/mdc/page/marketsdata.html
http://www.census.gov/const/www/newressalesindex_excel.html
http://federalreserve.gov/releases/h10/Hist/dat00_eu.htm
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm
http://markets.ft.com/ft/markets/currencies.asp
The trends of valuations of global risk financial assets are dominated by the carry trade from near zero interest rates in the US to take long positions in risk financial assets. Investors and financial professionals learned from losses or how to avoid them. The carry trade is now more opportunistic in quickly realizing profits to avoid losses during periods of risk aversion resulting from events such as the European risk issues, fears of the tradeoff of growth and inflation in Asia, geopolitical events such as the ongoing Middle East oil price shock and slow growth with high unemployment and underemployment in the US together with expectations of increases in taxes and interest rates. When risk aversion is subdued, the combination of near zero interest rates of fed funds and quantitative easing creates again the dream of traders of “the trend is your friend” without as strong a belief in the Bernanke-put, or floor on risk financial asset valuations set by Fed monetary policy, as in earlier periods. Table 13 captures in the fourth column “∆% to Trough” the decline of risk financial assets resulting from the European sovereign risk issues after Apr and the sharp recovery in the last column “∆% Trough to 3/ 25/11” that was not interrupted by the second round of Ireland in late Nov. The final column “∆% Trough to 3/ 25/11” shows that after Jun there is repetition of the trend of high valuations of risk financial assets with the exception of the dollar that devalued by 18.1 percent. A major risk of world capital markets is in sustained increases in oil prices that could cause another downturn of risk financial assets similar to the one that occurred in the European sovereign risk event after Apr 2010. That risk could be significant as shown by the decline of valuations of risk financial assets in column “∆% to Trough” with high double-digit losses. The column “∆% Week 3/25/11” shows major gains in the week of Mar 25 after losses in the week of Mar 18 following similar losses in the prior week ending on Mar 11. Risk financial assets are experiencing significant turbulence because of the joint incidence of geopolitical events in the Middle East, the Japan earthquake and sovereign risk issues in Europe.
Table 13, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 3/ 25/11 | ∆% Week 3/ 25/11 | ∆% Trough to 3/ 25/11 | |
| DJIA | 4/26/ 10 | 7/2/10 | -13.6 | 9.1 | 3.1 | 26.2 |
| S&P 500 | 4/23/ 10 | 7/20/ 10 | -16.0 | 7.9 | 2.7 | 28.5 |
| NYSE Finance | 4/15/ 10 | 7/2/10 | -20.3 | -3.6 | 1.3 | 20.9 |
| Dow Global | 4/15/ 10 | 7/2/10 | -18.4 | 3.8 | 3.5 | 27.2 |
| Asia Pacific | 4/15/ 10 | 7/2/10 | -12.5 | 4.9 | 4.1 | 19.8 |
| Japan Nikkei Aver. | 4/05/ 10 | 8/31/ 10 | -22.5 | -16.3 | 3.6 | 8.1 |
| China Shang. | 4/15/ 10 | 7/02 /10 | -24.7 | -5.9 | 2.4 | 24.9 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -4.3 | 3.5 | 13.1 |
| DAX | 4/26/ 10 | 5/25/ 10 | -10.5 | 9.7 | 4.2 | 22.5 |
| Dollar Euro | 11/25 2009 | 6/7 2010 | 21.2 | 6.9 | 0.7 | -18.1 |
| DJ UBS Comm. | 1/6/ 10 | 7/2/10 | -14.5 | 16.3 | 2.4 | 36.1 |
| 10-Year Tre. | 4/5/ 10 | 4/6/10 | 3.986 | 3.435 |
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://online.wsj.com/mdc/page/marketsdata.html.
Table 14, updated with every post, provides the percentage changes of the DJIA and the S&P 500 since Apr 26, around the European sovereign risk issues, from current to previous selected dates and relative to Apr 26. Chairman Bernanke (2010WP) first argued on Nov 4, 2010 that quantitative easing was also designed to increase the valuations of stocks with the objective of creating a wealth effect that would motivate consumption. The problem is that the Fed does not control effects over multiple asset classes including riskier financial assets such as commodities and exchange rates. The decline of major US stock indexes in the week of Feb 25 without full recovery in the week of Mar 4 and renewed weakness in the weeks ending on Mar 11 and Mar 18 reduced the valuations of the DJIA and S&P 500 to single digit increases since the effects of the European sovereign risk event beginning around Apr 26. There were major gains in the week of Mar 25 of 3.1 percent for the DJIA and 2.7 percent for the S&P 500 that raised valuations since Apr to 9.1 percent and 8.4 percent, respectively.
Table 14, Percentage Changes of DJIA and S&P 500 in Selected Dates
| 2010 | ∆% DJIA from earlier date | ∆% DJIA from Apr 26 | ∆% S&P 500 from earlier date | ∆% S&P 500 from Apr 26 |
| Apr 26 | ||||
| May 6 | -6.1 | -6.1 | -6.9 | -6.9 |
| May 26 | -5.2 | -10.9 | -5.4 | -11.9 |
| Jun 8 | -1.2 | -11.3 | 2.1 | -12.4 |
| Jul 2 | -2.6 | -13.6 | -3.8 | -15.7 |
| Aug 9 | 10.5 | -4.3 | 10.3 | -7.0 |
| Aug 31 | -6.4 | -10.6 | -6.9 | -13.4 |
| Nov 5 | 14.2 | 2.1 | 16.8 | 1.0 |
| Nov 30 | -3.8 | -3.8 | -3.7 | -2.6 |
| Dec 17 | 4.4 | 2.5 | 5.3 | 2.6 |
| Dec 23 | 0.7 | 3.3 | 1.0 | 3.7 |
| Dec 31 | 0.03 | 3.3 | 0.07 | 3.8 |
| Jan 7 | 0.8 | 4.2 | 1.1 | 4.9 |
| Jan 14 | 0.9 | 5.2 | 1.7 | 6.7 |
| Jan 21 | 0.7 | 5.9 | -0.8 | 5.9 |
| Jan 28 | -0.4 | 5.5 | -0.5 | 5.3 |
| Feb 4 | 2.3 | 7.9 | 2.7 | 8.1 |
| Feb 11 | 1.5 | 9.5 | 1.4 | 9.7 |
| Feb 18 | 0.9 | 10.6 | 1.0 | 10.8 |
| Feb 25 | -2.1 | 8.3 | -1.7 | 8.9 |
| Mar 4 | 0.3 | 8.6 | 0.1 | 9.0 |
| Mar 11 | -1.0 | 7.5 | -1.3 | 7.6 |
| Mar 18 | -1.5 | 5.8 | -1.9 | 5.5 |
| Mar 25 | 3.1 | 9.1 | 2.7 | 8.4 |
Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3004
Table 15, which is updated with every post, shows in the last three rows the Chinese yuan (CNY) to US dollar (USD) exchange rate or number of CNY required to buy one USD. China fixed the rate at around 8.2765 CNY/USD for a long period until Aug 2005. That rate afforded a competitive edge to Chinese products in world markets and in competition of internally-produced goods with foreign-produced imports. China then strengthened the yuan by 17.6 percent until Jul 2008 when it fixed it to the dollar in an effort to prevent the erosion of its competitiveness in world markets and at home to protect the economy from the global recession. China resumed the revaluation of the yuan in 2010, with revaluation by 3.9 percent by Mar 25, 2011. Table 15 shows the sharp appreciation relative to the dollar of most currencies in the world, which is far higher than the Fed’s objective of attaining by quantitative easing “a moderate change in the foreign exchange value of the dollar that provides support to net exports,” as revealed for the first time by Yellen (2011AS, 6). Bernanke (2002FD) states:
“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”
Many countries have complained that Fed “nonconventional policy” of near zero interest rates and quantitative easing is designed to cause, or at least results in, competitive devaluation of the dollar that would export US unemployment to other countries. A widening differential between interest rates in the euro area and the US could further devalue the dollar, inducing carry trade from near zero interest rates in the US to risk financial assets.
Table 15, Exchange Rates
| Peak | Trough | ∆% P/T | Mar 25 2011 | ∆% T Mar 25 2011 | ∆% P Mar 25 2011 | |
| EUR USD | 7/15 2008 | 6/7 2010 | 3/25/ 2011 | |||
| Rate | 1.59 | 1.192 | 1.408 | |||
| ∆% | -33.4 | 15.3 | -12.9 | |||
| JPY USD | 8/18 2008 | 9/15 2010 | 3/25 2011 | |||
| Rate | 110.19 | 83.07 | 81.32 | |||
| ∆% | 24.6 | 2.1 | 26.2 | |||
| CHF USD | 11/21 2008 | 12/8 2009 | 3/25 2011 | |||
| Rate | 1.225 | 1.025 | 0.914 | |||
| ∆% | 16.3 | 10.8 | 25.4 | |||
| USD GBP | 7/15 2008 | 1/2/ 2009 | 3/25 2011 | |||
| Rate | 2.006 | 1.388 | 1.604 | |||
| ∆% | -44.5 | 13.5 | -25.1 | |||
| USD AUD | 7/15 2008 | 10/27 2008 | 3/25 2011 | |||
| Rate | 1.0215 | 1.6639 | 1.026 | |||
| ∆% | -62.9 | 41.4 | 4.6 | |||
| ZAR USD | 10/22 2008 | 8/15 2010 | 3/25 2011 | |||
| Rate | 11.578 | 7.238 | 6.84 | |||
| ∆% | 37.5 | 5.5 | 40.9 | |||
| SGD USD | 3/3 2009 | 8/9 2010 | 3/25 2011 | |||
| Rate | 1.553 | 1.348 | 1.261 | |||
| ∆% | 13.2 | 6.5 | 18.8 | |||
| HKD USD | 8/15 2008 | 12/14 2009 | 3/25 2011 | |||
| Rate | 7.813 | 7.752 | 7.795 | |||
| ∆% | 0.8 | -0.6 | 0.2 | |||
| BRL USD | 12/5 2008 | 4/30 2010 | 3/25 2011 | |||
| Rate | 2.43 | 1.737 | 1.656 | |||
| ∆% | 28.5 | 4.7 | 31.9 | |||
| CZK USD | 2/13 2009 | 8/6 2010 | 3/18/ 2011 | |||
| Rate | 22.19 | 18.693 | 17.361 | |||
| ∆% | 15.7 | 7.1 | 21.8 | |||
| SEK USD | 3/4 2009 | 8/9 2010 | 3/25 2011 | |||
| Rate | 9.313 | 7.108 | 6.375 | |||
| ∆% | 23.7 | 10.3 | 31.5 | |||
| CNY USD | 7/20 2005 | 7/15 2008 | 3/25/ 2011 | |||
| Rate | 8.2765 | 6.8211 | 6.5565 | |||
| ∆% | 17.6 | 3.9 | 20.8 |
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://online.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000
http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm
http://markets.ft.com/ft/markets/currencies.asp
V Economic Indicators. Sales of new houses with seasonal adjustment in annual equivalent rate were 250,000 in Feb, which is 16.9 percent lower than 301,000 in Jan and 28.9 percent lower than 347,000 in Feb 2010. The stock of unsold houses in Feb was 186,000 that is equivalent to 8.9 months of sales at current sales rates. Table 16 provides data without seasonal adjustment in the first two months of the year that are equivalent to declines of 72.8 percent to 80.1 percent in 2010 and 2011 in relation to 2005 and 2006. Existing home sales estimated by the National Association of Realtors fell 9.6 percent in Feb relative to Jan and dropped 2.8 percent relative to Feb 2010 (http://www.realtor.org/press_room/news_releases/2011/03/feb_decline). The Federal Housing Finance Agency House Price Index fell 0.3 percent seasonally adjusted from Dec to Jan; the decline in Dec was revised downward to 1.0 percent; and the index fell 3.9 percent in the 12 months ending in Jan and is 16.5 percent below its peak in Apr 2007 (http://www.fhfa.gov/webfiles/20529/JanHPI32211FF.pdf). Manufacturers’ new orders not seasonally adjusted were higher by 7.6 percent in the first two months of 2011 relative to 2010 and shipments were higher by 7.6 percent; excluding transportation new orders were higher in the first two months by 10.7 percent and shipments were higher by 9.0 percent relative to a year ago; and excluding defense new orders in the first two months were higher by 9.4 percent and shipments by 9.0 percent than a year ago (http://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf). Data are not adjusted for inflation such that there are price effects in these nominal values. Corporate profits before tax (without inventory valuation and capital consumption adjustment) rose 16.1 percent in the fourth quarter of 2010 relative to the fourth quarter of 2009 and 18.3 percent with inventory valuation and capital consumption adjustment; and profits after tax without inventory valuation and capital consumption adjustment rose 11.4 percent in the fourth quarter of 2010 relative to the fourth quarter of 2009 and 13.7 percent with adjustments (http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp4q10_3rd.pdf). Initial claims for unemployment insurance seasonally adjusted fell 5000 to 382,000 in the week ending on Mar 19 from 387,000 in the week of Mar 12; initial claims not seasonally adjusted fell 23,487 to 351,204 in the week of Mar 19 from 374,691 in the week of Mar 12; and the four-week moving average seasonally adjusted fell 1500 to 385,250 in the week of Mar 19 from 386,750 in the week of Mar 12 (http://www.dol.gov/opa/media/press/eta/ui/current.htm).
Table 16, Sales of New Houses in Jan-Feb Not Seasonally Adjusted
| Sales thousands | ∆% 2005 | ∆% 2006 | ∆% 2010 | |
| 2005 | 201 | |||
| 2006 | 184 | |||
| 2010 | 50 | -75.1 | -72.8 | |
| 2011 | 40 | -80.1 | -78.3 | -20.0 |
Source:
http://www.census.gov/const/newressales.pdf
http://www.census.gov/const/newressales_200602.pdf
http://www.census.gov/const/newressales_0502.pdf
VI Interest Rates. Treasury yields are backing up again with the reduction of risk aversion. The 10-year Treasury note was traded on Mar 25 at yield of 3.44 percent, which was higher than 3.27 percent a week earlier and about the same as 3.43 percent a month earlier. The 30-year Treasury bond was traded at yield of 4.50 percent on Mar 25, which was higher than 4.42 percent a week earlier and about the same as 4.51 percent a month earlier. The 10-year government bond of Germany was traded at 3.29 percent for negative spread of 15 basis points relative to the comparable Treasury security (http://markets.ft.com/markets/bonds.asp). The Treasury note with coupon of 3.63 percent and maturity on 02/21 was traded on Mar 25 at price of 101.50 or equivalent to yield of 3.44 percent (http://markets.ft.com/ft/markets/reports/FTReport.asp?dockey=GOV-250311). This price is not comparable to the price in Table 8, which is based on coupon of 2.625 percent and maturity in exactly ten years for purposes of comparison with the price on Nov 4, one day after the Fed’s decision on quantitative easing.
VII Conclusion. The meeting of European leaders ended with a promise to increase the lending capacity of the rescue fund to the full €440 billion instead of the current effective €250 billion because of the need to deposit part of the proceeds from issuing bonds in order to maintain AAA-rating (http://www.ft.com/cms/s/0/4d75d4cc-5677-11e0-84e9-00144feab49a.html#axzz1HnQryIWX). The rescue of Portugal alone could absorb €70 billion (http://noir.bloomberg.com/apps/news?pid=20601087&sid=azSq1fxz1SpM&pos=4). Financial turbulence will continue because of the uncertainties not only of sovereign risk issues in Europe but also because of other factors: the impact of the earthquake in the Japanese economy and the rest of the world; the tough tradeoff of inflation and growth in China; and geopolitical events such as in the Middle East. Perhaps the US may prove to be the most influential event in world capital markets with: slow growth; inadequate job creation; fiscal deficit over $1 trillion in four years 2009 to 2012; debt rising to 75 percent of GDP in 2012; and expectations of increasing taxes and interest rates. While inflation is showing everywhere in the world economy, the Fed continues the policy of near zero fed funds rate and balance sheet of $2.6 trillion that devalues the dollar and increases commodity prices by subsidizing the carry trade with low interest rates. The overshooting of the inflation rate, which the Fed cannot control as during the Great Inflation of the 1970s, raises the fear of another Great Bond Crash as that of 1994. (Go to http://cmpassocregulationblog.blogspot.com/ http://sites.google.com/site/economicregulation/carlos-m-pelaez)
http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10 )
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