CMP Associates Regulation Blog: September 2011

IMF View of World Economy and Finance, “Let’s Twist Again” Monetary Policy Worsening World Financial Turbulence and Global Growth Standstill

Carlos M. Pelaez

Executive Summary

I IMF View of World Economy and Finance

IA Outlook of World Economy and Finance

IB Global Rebalancing

II World Financial Turbulence

IIA Collapse of Valuations of Risk Financial Assets

IIA1 Euro Zone Survival Risk

IIB Markets Not Dancing Twist

III Global Inflation

IV World Economic Slowdown

IVA United States

IVB Japan

IVC China

IVD Euro Area

IVE Germany

IVF France

IVG Italy

IVH United Kingdom

V Valuation of Risk Financial Assets

VI Economic Indicators

VII Interest Rates

VIII Conclusion

References

Executive Summary

The term “operation twist” grew out of the dance “twist” popularized by successful musical performer Chubby Chekker (http://www.youtube.com/watch?v=aWaJ0s0-E1o). The crucial issue in “twisting time” monetary policy is if lowering the yields of long-term Treasury securities would have any impact on investment and consumption or aggregate demand. The decline of long-term yields of Treasury securities would have to cause decline of yields of asset-backed securities used to securitize loans for investment by firms and purchase of durable goods by consumers. The decline in costs of investment and consumption of durable goods would ultimately have to result in higher investment and consumption. It is possible that the decline in yields captured by event studies is ephemeral. The decline in yields just after “let’s twist again” monetary policy this week was caused by the flight out of risk financial assets into Treasury securities, which is the opposite of the desired effect of encouraging risk-taking in asset-backed securities and lending.

The “trend is your friend” motto of traders has been replaced with a “hit and realize profit” approach of managing positions to realize profits without sitting on positions. There is a trend of valuation of risk financial assets driven by the carry trade from zero interest rates with fluctuations provoked by events of risk aversion. Table 40, which is updated for every comment of this blog and is anticipated here from the text, shows the deep contraction of valuations of risk financial assets after the Apr 2010 sovereign risk issues in the fourth column “∆% to Trough.” There was sharp recovery after around Jul 2010 in the last column “∆% Trough to 09/23/11,” which has been recently stalling or reversing amidst profound risk aversion. “Let’s twist again” monetary policy during the week of Sep 23 caused deep worldwide risk aversion and selloff of risk financial assets. Monetary policy was designed to increase risk appetite but instead suffocated risk exposures. Recovering risk financial assets in column “∆% Trough to 09/23/11” are in the range from 0.8 percent for the Shanghai Composite and 15.4 percent for the DJ UBS Commodity Index. The carry trade from zero interest rates to leveraged positions in risk financial assets has proved strongest for commodity exposures. Before the current round of risk aversion, all assets in the column “∆% Trough to 09/23/11” had double digit gains relative to the trough around Jul 2, 2010. There are now several valuations lower than those at the trough around Jul 2: European stocks index STOXX 50 is now 5.8 percent below the trough on Jul 2, 2010; the NYSE Financial Index is 11.7 percent below the trough on Jul 2, 2010; Germany’s DAX index is 8.4 percent below; and Japan’s Nikkei Average is 2.9 below the trough on Aug 31, 2010 and 24.9 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 8560.25 on Fri Sep 23, which is 16.5 percent below 10,254.43 on Mar 11 on the date of the earthquake. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 13.3 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 09/23/2011” shows sharp losses for all risk financial assets in Table 40. The realization that there were no more remedies of monetary policy for the global economic slowdown caused flight away from exposures in risk financial assets. There are still high uncertainties on European sovereign risks, US and world growth recession and China’s growth and inflation tradeoff. 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 40 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 9/23/11” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Jul 29. Most financial risk assets had gained not only relative to the trough as shown in column “∆% Trough to 9/23/11” but also relative to the peak in column “∆% Peak to 9/23/11.” There are now no indexes above the peak, not even the DJ UBS Commodity Index that is 1.3 percent below the peak. There are several indexes well below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 29.7 percent, Nikkei Average by 24.9 percent, Shanghai Composite by 24.7 percent, STOXX 50 by 24.4 percent and Dow Global by 18.4 percent. S&P 500 is lower relative to the peak by 6.5 percent, DJ Asia Pacific is lower by 11.8 percent and the DJIA is lower by 6.4 percent. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr is more important than the performance relative to the trough around early Jul because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. The situation of risk financial assets has worsened.

Table 40, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 9/ 23/11	∆% Week 9/ 23/11	∆% Trough to 9/ 23/11
DJIA	4/26/ 10	7/2/10	-13.6	-3.9	-6.4	11.2
S&P 500	4/23/ 10	7/20/ 10	-16.0	-6.6	-6.5	11.1
NYSE Finance	4/15/ 10	7/2/10	-20.3	-29.7	-8.6	-11.7
Dow Global	4/15/ 10	7/2/10	-18.4	-18.5	-7.6	-0.2
Asia Pacific	4/15/ 10	7/2/10	-12.5	-11.8	-7.0	0.8
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-24.9	-3.4	-2.9
China Shang.	4/15/ 10	7/02 /10	-24.7	-23.1	-1.9	2.1
STOXX 50	4/15/10	7/2/10	-15.3	-24.4	-5.2	-10.7
DAX	4/26/ 10	5/25/ 10	-10.5	-17.9	-6.8	-8.4
Dollar Euro	11/25 2009	6/7 2010	21.2	10.8	2.1	-13.3
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-1.3	-9.1	15.4
10-Year Tre.	4/5/ 10	4/6/10	3.986	1.825

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

I IMF View of World Economy and Finance. The International Financial Institutions (IFI) consists of the International Monetary Fund, World Bank Group, Bank for International Settlements (BIS) and the multilateral development banks, which are the European Investment Bank, Inter-American Development Bank and the Asian Development Bank (Pelaez and Pelaez, International Financial Architecture (2005), The Global Recession Risk (2007), 8-19, 218-29, Globalization and the State, Vol. II (2008b), 114-48, Government Intervention in Globalization (2008c), 145-54). There are four types of contributions of the IFIs:

1. Safety Net. The IFIs contribute to crisis prevention and crisis resolution.

i. Crisis Prevention. An important form of contributing to crisis prevention is by surveillance of the world economy and finance by regions and individual countries. The IMF and World Bank conduct periodic regional and country evaluations and recommendations in consultations with member countries and also jointly with other international organizations. The IMF and the World Bank have been providing the Financial Sector Assessment Program (FSAP) by monitoring financial risks in member countries that can serve to mitigate them before they can become financial crises

ii. Crisis Resolution. The IMF jointly with other IFIs provides assistance to countries in resolution of those crises that do occur. Currently, the IMF is cooperating with the government of Greece, European Union and European Central Bank in resolving the debt difficulties of Greece as it has done in the past in numerous other circumstances

2. Surveillance. The IMF conducts surveillance of the world economy, finance and public finance with continuous research and analysis. Important documents of this effort are the World Economic Outlook of which the current one is IMF (2011WEOSep), Global Financial Stability Report of which the current one is IMF (2011GFSRSep) and Fiscal Monitor of which the current one is IMF (2011FMSep)

3. Infrastructure and Development. The IFIs also engage in infrastructure and development, in particular the World Bank Group and the multilateral development banks

4. Soft Law. Significant activity by IFIs has engaged in developing standards and codes under multiple forums. It is easier and faster to negotiate international agreements under soft law that are not binding but can be very effective. These norms and standards can solidify world economic and financial arrangements

The objective of this section is to analyze the current view of the IMF on the world economy (IMF 2011WEOSep), international finance (IMF2011GFSRSep) and global fiscal affairs (IMF2011FMSep). Subsection IA Outlook of World Economy and Finance probes the rich database of the IMF (WEO2011WEOSep http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx) and subsection IB Global Rebalancing considers the analysis of the world economy and finance by the IMF.

IA Outlook of World Economy and Finance. Table 1 is constructed with the database of the IMF (http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx) to show GDP in dollars in 2010 and the growth rate of real GDP of the world and selected regional countries from 2011 to 2014. The data illustrate the concept often repeated of “two-speed recovery” of the world economy from the recession of 2007 to 2009. The IMF has lowered its forecast of the world economy to 3.9 percent in 2011 and 3.9 percent in 2012 but accelerating to 4.5 percent in 2013 and 4.7 percent in 2014. Slow-speed recovery occurs in the “major advanced economies” of the G7 that account for $31,717 billion of world output of $62,911 billion but are projected to grow at much lower rates than world output, 1.9 percent on average from 2011 to 2014 in contrast with 4.3 percent for the world as a whole. While the world would cumulatively grow 18.1 percent in the four years from 2011 to 2014, the G7 as a whole would cumulatively grow 7.9 percent. The difference in dollars of 2010 is rather high: growing by 18.1 percent would add $11.4 trillion of output to the world economy, or roughly two times the output of the economy of Japan of $5,459 but growing by 7.9 percent would add $4.9 trillion of output to the world, or somewhat less than the output of Japan in 2010. The “two speed” concept is in reference to the growth of the 150 countries labeled as emerging and developing economies (EMDE) with joint output in 2010 of $21,536 billion, or 34.2 percent of world output. The EMDEs would grow cumulatively 28.2 percent or at the average yearly rate of 6.4 percent, contributing $6.0 trillion from 2011 to 2014 or the equivalent of almost the GDP of $5,878 billion of China in 2010. The final four countries in Table 1 (Brazil, Russia, India and China) are large, rapidly growing emerging economies. Their combined output adds to $11,808 billion, or 17.6 percent of world output, which is equivalent to 24.9 percent of the major advanced economies of the G7.

Table 1, IMF World Economic Outlook Database Projections of Real GDP Growth

	GDP USD 2010	Real GDP ∆% 2011	Real GDP ∆% 2012	Real GDP ∆% 2013	Real GDP ∆% 2014
World	62,911	3.9	3.9	4.5	4.7
G7	31,717	1.3	1.7	2.2	2.5
Canada	1,577	2.1	1.9	2.5	2.5
France	2,563	1.7	1.4	1.9	2.1
DE	3,286	2.7	1.3	1.5	1.5
Italy	2,055	0.6	0.3	0.5	0.8
Japan	5,459	-0.5	2.3	2.0	1.9
UK	2,250	1.1	1.6	2.3	2.6
US	14,527	1.5	1.8	2.5	3.1
Euro Area	12,168	1.6	1.1	1.5	1.7
DE	3,286	2.7	1.3	1.5	1.5
France	2,563	1.7	1.4	1.9	2.1
Italy	2,055	0.6	0.3	0.5	0.8
POT	229	-2.2	-1.8	1.2	2.5
Ireland	207	0.4	1.5	2.2	2.8
Greece	305	-5.0	-2.0	1.5	2.3
Spain	1,410	0.8	1.1	1.8	1.9
EMDE	21,536	6.4	6.1	6.5	6.6
Brazil	2,090	3.8	3.6	4.2	4.2
Russia	1,480	4.3	4.1	4.1	4.0
India	1,632	7.8	7.5	8.1	8.1
China	5,878	9.5	9.0	9.5	9.5

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx

Continuing high rates of unemployment in advanced economies constitute another characteristic of the database of the WEO (http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx). Table 2 is constructed with the WEO database to provide rates of unemployment from 2010 to 2014 for major countries and regions. In fact, unemployment rates in Table 2 are high for all countries: unusually high for countries with high rates most of the time and unusually high for countries with low rates most of the time. The rates of unemployment are particularly high for the countries with sovereign debt difficulties in Europe: 12.0 percent for Portugal (POT), 13.6 percent for Ireland, 12.5 percent for Greece, 20.1 percent for Spain and 8.4 percent for Italy, which is lower but still high. The G7 rate of unemployment is 8.2 percent. Unemployment rates are not likely to decrease substantially if slow growth persists in advanced economies.

Table 2, IMF World Economic Outlook Database Projections of Unemployment Rate as Percent of Labor Force

	% Labor Force 2010	% Labor Force 2011	% Labor Force 2012	% Labor Force 2013	% Labor Force 2014
World
G7	8.2	7.8	7.7	7.5	7.0
Canada	7.9	7.6	7.7	7.2	6.6
France	9.8	9.5	9.2	8.9	8.6
DE	7.1	6.0	6.2	6.4	6.3
Italy	8.4	8.2	8.5	8.6	8.3
Japan	5.1	4.9	4.8	4.6	4.4
UK	7.9	7.8	7.8	7.8	7.4
US	9.6	9.1	9.0	8.5	7.8
Euro Area	10.1	9.9	9.9	9.7	9.3
DE	7.1	6.0	6.2	6.4	6.3
France	9.8	9.5	9.2	8.9	8.6
Italy	8.4	8.2	8.5	8.6	8.3
POT	12.0	12.2	13.4	13.4	12.4
Ireland	13.6	14.3	13.9	13.2	12.4
Greece	12.5	16.5	18.5	18.9	18.5
Spain	20.1	20.7	19.7	18.5	17.5
EMDE
Brazil	6.7	6.7	7.5	7.0	7.0
Russia	7.5	7.3	7.1	7.0	7.0
India
China	4.1	4.0	4.0	4.0	4.0

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx

Newly released data by the US Census Bureau on income, poverty and health insurance (DeNavas-Walt, Proctor and Smith 2011) and the flow of funds report of the Federal Reserve System for IIQ2011 (http://www.federalreserve.gov/releases/z1/Current/z1.pdf) are summarized in Table 3. These reports depict 2010 household income of the US in constant 2010 dollars regressing to the level of 1996 and wealth of households and nonprofit organizations of the US in IIQ2011 falling $5.8 trillion below the level of 2007. The number of people in poverty in the US in 2010 is 46.180 million, equivalent to 15.1 percent of the population, which is the same as in 1993 and higher or equal than any percentage since 17.3 percent in 1965. The number of people without health insurance in 2010 is 49.904 million, which is 16.3 percent of the population. Although the economy recovered throughout 2010, income, wealth, poverty and lack of health insurance deteriorated. Increasing poverty and lack of health insurance suggest strengthening the social and health safety net. Evidence provided in prior blogs (http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html) shows that part of the explanation of the dramatically poor socio-economic indicators of the US could be explained by the sharp economic contraction from IV2007 to IIQ2009 but part originates in the worst recovery in a cyclical expansion during the postwar period.

Table 3, Summary of Social and Economic Indicators

People in Poverty	46.180 million 15.1% of population Among three highest since 1966
People without Health Insurance	49.985 million 16.1% of population
Median Household Income	$49,445 Worst since 1996
People in Job Stress	29.9 million unemployed or underemployed
Household Loss of Net Worth	-$5.8 trillion since 2007
Household Loss of Real Estate	-$5.1 trillion since 2007
Household Loss of Assets	-$6.3 trillion since 2007

Sources: DeNavas-Walt, Proctor and Smith (2011)

http://www.federalreserve.gov/releases/z1/Current/z1.pdf

Bureau of Labor Statistics

The database of the WEO (http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx) is used to construct the debt/GDP ratios of regions and countries in Table 4. The concept used is general government debt, which consists of central government debt, such as Treasury debt in the US, and all state and municipal debt. Net debt is provided for all countries except for gross debt for China, Russia and India. The net debt/GDP ratio of the G7 jumps from 76.5 in 2010 to 91.2 in 2014. G7 debt is pulled by the high debt of Japan that grows from 117.2 percent of GDP in 2010 to 152.8 percent of GDP in 2014. US general government debt grows from 68.3 percent of GDP in 2010 to 84.6 percent of GDP in 2014. Debt/GDP ratios of countries with sovereign debt difficulties in Europe are particularly worrisome. General government net debts of Italy, Ireland, Greece and Portugal exceed 100 percent of GDP or are expected to exceed 100 percent of GDP by 2014. The only country with relatively low debt/GDP ratio is Spain with 48.7 in 2010 but growing to 63.4 in 2014. Fiscal adjustment, voluntary or forced by defaults, may squeeze further economic growth and employment in many countries. Defaults could feed through exposures of banks and investors to financial institutions and economies in countries with sounder fiscal affairs.

Table 4, IMF World Economic Outlook Database Projections, General Government Net Debt as Percent of GDP

	% Debt/ GDP 2010	% Debt/ GDP 2011	% Debt/ GDP 2012	% Debt/ GDP 2013	% Debt/ GDP 2014
World	NA	NA	NA	NA	NA
G7	76.5	81.6	86.3	89.3	91.2
Canada	32.2	34.9	36.8	37.1	36.5
France	76.5	80.9	83.5	84.9	84.9
DE	57.6	57.2	56.9	56.6	55.3
Italy	99.4	100.4	100.7	99.6	98.4
Japan	117.2	130.6	138.9	146.4	152.8
UK	67.7	72.9	76.9	78.1	77.2
US	68.3	72.6	78.4	82.2	84.6
Euro Area	65.9	68.6	70.1	70.6	70.0
DE	57.6	57.2	56.9	56.6	55.3
France	76.5	80.9	83.5	84.9	84.2
Italy	99.4	100.4	100.7	99.6	98.4
POT	88.7	101.8	107.6	110.7	110.4
Ireland	78.0	98.8	104.6	107.4	105.7
Greece	142.8	153.1	175.4	173.6	163.6
Spain	48.7	56.0	58.7	61.3	63.4
EMDE	NA	NA	NA	NA	NA
Brazil	40.2	38.6	37.5	36.4	35.2
Russia*	11.7	11.7	12.1	12.6	14.5
India*	64.1	62.4	61.9	60.9	60.5
China*	33.8	26.9	22.2	18.5	15.5

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx

The primary balance consists of revenues less expenditures but excluding interest revenues and interest payments. It measures the capacity of a country to generate sufficient current revenue to meet current expenditures. Brazil is the only country in Table 5 with surplus of primary net lending/borrowing in 2010. Germany has a small primary net/lending deficit of 0.3 percent in 2010 but moves into surplus after 2011, which is also the case of Italy with deficit of 0.3 percent in 2010 but projected surpluses after 2011. Most countries in Table 5 face significant fiscal adjustment in the future.

Table 5, IMF World Economic Outlook Database Projections of Primary General Government Net Lending/Borrowing as Percent of GDP

	% GDP 2010	% GDP 2011	% GDP 2012	% GDP 2013	% GDP 2014
World
G7	-6.5	-5.9	-4.5	-3.1	-2.2
Canada	-4.9	-3.7	-2.5	-1.4	-0.5
France	-4.9	-3.4	-2.1	-1.4	-0.4
DE	-1.2	0.4	0.8	1.2	1.9
Italy	-0.3	0.5	2.6	4.1	4.5
Japan	-8.1	-8.9	-7.7	-6.2	-5.6
UK	-7.7	-5.6	-4.1	-2.2	-0.7
US	-8.4	-7.9	-6.3	-4.6	-3.4
Euro Area	-3.6	-1.5	-0.3	0.5	1.2
DE	-1.2	0.4	0.8	1.2	1.9
France	-4.9	-3.4	-2.1	-1.4	-0.4
Italy	-0.3	0.5	2.6	4.1	4.5
POT	-6.3	-1.9	0.1	1.9	2.6
Ireland	-28.9	-6.8	-4.4	-1.5	1.3
Greece	-4.9	-1.3	0.8	3.3	5.7
Spain	-7.8	-4.4	-3.1	-2.1	-1.4
EMDE
Brazil	2.4	3.2	3.0	2.9	2.9
Russia	-3.2	-0.6	-1.3	-1.4	-2.4
India*	-8.4	-7.7	-7.3	-7.2	-7.1
China*	-2.3	-1.6	-0.8	-0.1	0.0

*General Government Net Lending/Borrowing

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx

There were some hopes that the sharp contraction of output during the global recession would eliminate current account imbalances. Table 6 constructed with the database of the WEO (http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx) shows that external imbalances have been maintained in the form of current account deficits and surpluses. China’s current account surplus is 5.2 percent of GDP for 2010 and is projected to climb to 6.7 percent of GDP in 2014. At the same time the current account deficit of the US is 3.2 percent of GDP and is projected to decline to 1.8 percent of GDP in 2014. The current account surplus of Germany is 5.7 percent for 2010 and remains at a high 4.7 percent of GDP in 2014. Japan’s current account surplus is 3.6 percent of GDP in 2010 and declines slightly to 2.6 percent of GDP in 2014. These imbalances are analyzed in the following subsection.

Table 6, IMF World Economic Outlook Databank Projections, Current Account of Balance of Payments as Percent of GDP

	% CA/ GDP 2010	% CA/ GDP 2011	% CA/ GDP 2012	% CA/ GDP 2013	% CA/ GDP 2014
World	0.5	0.7	0.8	0.8	0.8
G7	-1.0	-1.2	-0.7	-0.5	-0.5
Canada	-3.1	-3.3	-3.8	-3.5	-3.2
France	-1.7	-2.7	-2.5	-2.5	-2.6
DE	5.7	5.0	4.9	4.8	4.7
Italy	-3.3	-3.5	-2.9	-2.5	-2.3
Japan	3.6	2.5	2.8	2.6	2.6
UK	-3.2	-2.7	-2.3	-1.7	-1.1
US	-3.2	-3.1	-2.1	-1.7	-1.8
Euro Area	0.3	0.1	0.4	0.5	0.5
DE	5.7	5.0	4.9	4.8	4.7
France	-1.7	-2.7	-2.5	-2.5	-2.6
Italy	-3.3	-3.5	-2.9	-2.5	-2.3
POT	-9.9	-8.6	-6.4	-5.3	-4.7
Ireland	0.5	1.8	1.9	1.4	1.5
Greece	-10.5	-8.4	-6.7	-6.0	-5.3
Spain	-4.6	-3.8	-3.1	-2.8	-2.5
EMDE	1.9	2.4	1.9	1.9	1.9
Brazil	-2.3	-2.3	-2.5	-2.9	-3.1
Russia	4.8	5.5	3.5	2.2	0.8
India	-2.6	-2.2	-2.2	-1.9	-2.0
China	5.2	5.2	5.6	6.2	6.7

Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)

Source: IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx

IB Global Rebalancing. 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 (http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx) is used to contract Table 7 with fiscal and current account imbalances projected for 2011 and 2015. 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.”

Table 7, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2011 Dollar GDP

	GDP $B 2011	FD %GDP 2011	CAD %GDP 2011	Debt %GDP 2011	FD%GDP 2015	CAD%GDP 2015	Debt %GDP 2015
US	15065	-7.9	-3.1	72.6	-3.1	-2.2	86.7
Japan	5855	-8.9	2.5	130.5	-8.4	2.4	160.0
UK	2481	-5.7	-2.7	72.9	0.4	-0.9	75.2
Euro	13355	-1.5	0.1	68.6	1.5	0.5	69.3
Ger	3629	0.4	5.0	56.9	2.1	4.7	55.3
France	2808	-3.4	-2.7	80.9	-2.5	0.6	83.9
Italy	2246	0.5	-3.5	100.4	4.5	-2.0	96.7
Can	1759	-3.7	-3.3	34.9	0.3	-2.6	35.1
China	6988	-1.6	5.2	22.2	0.1	7.0	12.9
Brazil	2518	3.2	-2.3	38.6	2.9	-3.2	34.1

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: http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx

The conventional approach of the doctrine of shared responsibility consisted of the following policies (Pelaez and Pelaez, The Global Recession Risk (2007), 220-1):

· Devaluation of the dollar relative to European and Asian currencies to eliminate the external imbalance of the US

· Fiscal consolidation in the US to reduce demand relative to output (which actually occurred through the global recession with the current account deficit falling from 6.1 percent of GDP in 2006 (Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 183) to 3.2 percent currently)

· Increase in demand relative to output in Germany and Japan to reduce their trade surpluses

· Revaluation of Asian currencies relative to the dollar, in particular the Chinese renminbi, to reduce the surplus in current account corresponding to reduction of the current account deficit of the US

There are four important lags in implementing this set of policies (Pelaez and Pelaez, The Global Recession Risk (2007), 220-1) similar to those in economic policy (Friedman 1952):

1. Recognition of the need for policy. That need was recognized in 2006 but it may prove even more difficult within the broader G20

2. Beginning of coordination agreement. Coordination never went beyond research and monitoring in the first attempt

3. Actual policy measures. After intense diplomatic efforts there is a lag of implementation of policies

4. Effects of policies. Assuming adequate and effectively implemented policies with full coordination of member countries, there is still the lag between actual policies and their effect

There are tough differences of interests among the members of the G20. As Olson (1965) analyzed, collective action by groups runs into problems of free riders. Members of a group do not assume their share of actions in the belief that their share of adjustment will be assumed by other members, thus free riding on the agreed policy. Agreements within international forums are similar to soft law in that they are not binding. There are additional technical hurdles in the form of models to determine the doses of policy required in attaining desired adjustment but simulation models may be inadequate because of the Lucas (1976) critique. An added problem is that widespread knowledge of the policy may trigger reversal actions by member countries, creating a temporal consistency problem (Kydland and Prescott 1977). One example in this case would be rush to protectionist policies and undervaluation of currencies.

Cooperation among countries is difficult during periods of prosperity. Joan Robinson (1947) analyzes how much tougher is cooperation during economic stress. The International Monetary and Financial Committee of the IMF reiterated the need for cooperation in ensuring global economic and financial recovery (IMFC 2011Sep24):

“The advanced economies are at the core of an effective resolution of current global stresses. The strategy is to restore sustainable public finances while ensuring continued economic recovery. Taking into account different national circumstances, advanced economies will adopt policies to build confidence and support growth, and implement clear, credible and specific measures to achieve fiscal consolidation. Euro-area countries will do whatever is necessary to resolve the euro-area sovereign debt crisis and ensure the financial stability of the euro area as a whole and its member states. This includes implementing the euro-area Leaders’ decision of July 21 to increase the flexibility of the European Financial Stability Facility, maximizing its impact, and improve euro-area crisis management and governance. Advanced economies will ensure that banks have strong capital positions and access to adequate funding; maintain accommodative monetary policies as long as this is consistent with price stability, bearing in mind international spillovers; revive weak housing markets and repair household balance sheets; and undertake structural reforms to boost jobs and the medium-term growth potential of their economies.

Emerging market and developing economies, which have displayed remarkable stability and growth, are also key to an effective global response. The strategy is to adjust macro-economic policies, where needed, to rebuild policy buffers, contain overheating and enhance our resilience in the face of volatile capital flows. Surplus economies will continue to implement structural reforms to strengthen domestic demand, supported by continued efforts that achieve greater exchange rate flexibility, thereby contributing to global demand and the rebalancing of growth. Fostering inclusive growth and creating jobs are priorities for all of us.”

The WEO finds need of another internal rebalancing of demand from fiscal policy to private demand (2011WEOSep, xvi):

“Policymakers in crisis-hit economies must resist the temptation to rely mainly on accommodative monetary policy to mend balance sheets and accelerate repair and reform of the financial sector. Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery. Fiscal adjustment has already started, and progress has been significant in many economies. Strengthening medium-term fiscal plans and implementing entitlement reforms are critical to ensuring credibility and fiscal sustainability and to creating policy room to support balance sheet repair, growth, and job creation.”

The Economic Counsellor of the IMF, Olivier Blanchard (2011WEOSep), proposes policies for adjustment of the current threat of combination of global growth slowdown and world financial turbulence. (1) There must be balance between need for continuing short-term fiscal impulses in some advanced countries and credible fiscal consolidation in the medium term. (2) Banks must be recapitalized to withstand the shocks of uncertainty in an environment of growth standstill. (3) Full recovery requires external rebalancing as discussed above.

II World Financial Turbulence. The Economic Counsellor of the IMF, Olivier Blanchard (2011WEOSep, xiii-xiv) identifies two critical risks to the world economy and international finance:

“Low underlying growth and fiscal and financial linkages may well feed back on each other, and this is where the risks are. Low growth makes it more difficult to achieve debt sustainability and leads markets to worry even more about fiscal stability. Low growth also leads to more nonperforming loans and weakens banks. Front-loaded fiscal consolidation in turn may lead to even lower growth. Weak banks and tight bank lending may have the same effect. Weak banks and the potential need for more capital lead to more worry about fiscal stability. Downside risks are very real.”

This blog has been considering systematically world financial turbulence and economic slowdown together with other risks to the international financial system and world economy. This section considers world financial turbulence and section IV World Economic Slowdown the almost nil rate of growth of the world economy. In addition, section III Global Inflation considers inflation that could pose risks of stagflation as during the Great Inflation and Unemployment of the 1970s. The first subsection IIA Collapse of Valuations of Risk Financial Assets considers the drop in valuations of key risk financial assets and subsection IIB Markets Not Dancing Twist “let’s twist again” monetary policy.

IIA Collapse of Valuations of Risk Financial Assets. The past three months have been characterized by financial turbulence, attaining unusual magnitude in the past month. Table 8, updated with every comment in this blog, provides beginning values on Sep 16 and daily values throughout the week ending on Fr Sep 23 of several financial assets. Section V Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Sep 16 and the percentage change in that prior week below the label of the financial risk asset. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing inflation. The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.3790/EUR in the first row, first column in the block for currencies in Table 8 for Fri Sep 16, appreciating to USD 1.3696/EUR on Mon Sep 9, or by 0.7 percent. Table 8 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention is required to maintain consistency in characterizing movements of the exchange rate in Table 8 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.3696/EUR on Sep 19; the second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Sep 16, to the last business day of the current week, in this case Fri Sep 23, such as appreciation of 2.1 percent for the dollar to USD 1.3505/EUR by Sep 23; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD appreciated (negative sign) by 2.1 percent from the rate of USD 1.3790/EUR on Fri Sep 16 to the rate of USD 1.3505 on Fri Sep 23 {[1.3505/1.3790 – 1]100 = 2.1%} and depreciated by 0.2 percent from the rate of USD 1.3473 on Thu Sep 22 to USD 1.3505/EUR on Fri Sep 23 {[1.3505/1.3473 -1]100 = -0.2%}. The dollar appreciated during the week because fewer dollars, $1.3505, were required to buy one euro on Fri Sep 23 than $1.3790 required to buy one euro on Fri Sep16. The appreciated of the dollar in the week was caused by risk aversion with risk financial investments being sold in exchange for dollar-denominated assets.

Table 8, Weekly Financial Risk Assets Sep 19 to Sep 23, 2011

Fr Sep 16

M 19

Tu 20

W 22

Th 22

Fr 23

USD/
EUR

1.3790

-0.9%

1.3696

0.7%

1.3682

0.8%

0.1%

1.3571

1.6%

0.8%

1.3473

2.3%

0.7%

1.3505

2.1%

-0.2%

JPY/
USD

76.76

1.1%

76.5473

0.3%

76.4020

0.5%

0.2%

76.7148

0.1%

-0.4%

76.2380

0.7%

0.6%

76.59

0.2%

-0.5%

CHF/
USD

0.875

0.9%

0.8814

-0.7%

0.8886

-1.6%

-0.8%

0.8993

-2.8%

-1.2%

0.9075

-3.7%

-0.9%

0.903

-3.2%

0.5%

CHF/EUR
1.2088

-0.1%

1.2072

0.1%

1.2158

-0.6%

-0.7%

1.2203

-0.9%

-0.4%

1.2227

-1.1%

-0.2

1.2229

-1.2%

0.0%

USD/
AUD

1.0360

0.9653

-1.1%

1.0223

0.9782

-1.3%

1.026

0.9747

0.9%

0.4%

1.004

0.996

-3.2%

-2.2%

0.9755

1.0251

-6.2%

-2.9%

0.978

1.0225

-5.9%

0.3%

10 Year
T Note

2.053

1.95

1.93

1.861

1.725

1.826

2 Year T Note
0.17

0.15

0.16

0.19

0.194

0.219

Year German Bond

2Y 0.51

10Y 1.86

2Y 0.46

10Y 1.80

2Y0.46

10Y 1.79

2Y 0.44

10Y 1.77

2Y 0.40

10Y 1.67

2Y 0.39

10Y 1.75

DJIA

11509.09

4.7%

-0.9%

0.1%

-3.3%

-2.5%

-6.7%

-3.5%

-6.4%

0.4%

DJ Global

1840.92

3.1%

-1.9%

-1.7%

0.3%

-3.7%

-2.0%

-8.1%

-4.7%

-7.6%

0.6%

DJ Asia Pacific

1241.18

-0.4%

-1.4%

-2.0%

-0.7%

-2.0%

0.0%

-5.9%

-3.9%

-7.0%

-1.2%

Nikkei
8864.16

1.4%

0.0%

-1.6%

-1.4%

0.2%

-3.4%

-2.1%

0.0%

Shanghai

2482.34

-0.6%

-1.8%

-1.4%

0.4%

1.2%

2.7%

-1.6%

-2.8%

-1.9%

-0.4%

DAX
5573.51

7.4%

-2.8%

0.0%

2.9%

-2.5%

-7.3

-4.9%

-6.8%

0.6%

DJ UBS Comm.

157.480

-1.9

-1.8%

-1.4%

0.3%

-2.2%

-0.8%

-6.5%

-4.4%

-9.1

-2.8%

WTI $ B
87.85

0.7%

85.890

-2.2%

86.370

-1.7%

0.6%

84.740

-3.5%

-1.9%

80.33-8.6%

-5.2%

80.22

-8.7%

-0.1%

Brent $/B

111.98

-0.6%

109.25

-2.4%

110.23

-1.6%

0.9%

109.19

-3.5%

-0.9%

105.12

-6.1%

-3.7%

103.96

-7.2%

-1.1%

Gold $/OZ

1812.1

-2.6%

1780.0

-1.8%

1807.30

-0.3%

1.5%

1783.70

-1.6%

-1.3%

1742.20

-3.9%

-2.3%

1625.6

-10.3%

-6.7

Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss

Franc; AUD: Australian dollar; Comm.: commodities; B: barrels; OZ: ounce

Sources:

http://www.bloomberg.com/markets/

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

There was flight from risk exposures to safe havens during the week of Sep 23. Risk aversion is present in the appreciation of the USD by 2.1 percent and the continuing strength of the Japanese yen. Exchange rate controls by the Swiss National Bank (SNB) fixing the rate at a minimum of CHF 1.20/EUR (http://www.snb.ch/en/mmr/reference/pre_20110906/source/pre_20110906.en.pdf) prevented flight of capital into the Swiss franc. The week was filled with rumors of further measures by the SNB. Another symptom of risk aversion is the depreciation of the Australian dollar by 5.9 percent in unwinding carry trades.

Risk aversion is also captured by the collapse of the yield of the 10-year Treasury note to 1.725 percent on Sep 22 and 1.826 percent on Sep 23. During the financial panic of Sep 2008, funds moved away from risk exposures to government securities. A similar risk aversion phenomenon occurred in Europe with the collapse of the yield of the 10-year government bond to 1.75 percent.

Equity indexes collapsed during the week. There were heavy losses in the week in major indexes: minus 6.4 percent for DJIA, minus 7.6 percent for DJ Global, minus 7.0 percent for DJ Asia Pacific and minus 6.8 percent for DAX.

Commodities also suffered heavy losses. The DJ UBS Commodity Index lost 9.1 percent in the week. WTI lost 8.7 percent and Brent dropped 7.2 percent. Not even the alleged hedge property of gold survived, declining by 10.3 percent.

There are three factors dominating valuations of risk financial assets that are systematically discussed in this blog.

1. Euro zone survival risk. The fundamental issue of sovereign risks in the euro zone is whether the group of countries with euro as common currency and unified monetary policy through the European Central Bank will (i) continue to exist; (ii) downsize to a limited number of countries with the same currency; or (iii) revert to the prior system of individual national currencies. This issue is discussed in the following subsection IIA1 Euro Zone Survival Risk.

2. United States Growth, Employment and Fiscal Soundness. Recent posts of this blog analyze the mediocre rate of growth of the US in contrast with V-shaped recovery in all expansions following recessions since World War II, deterioration of social and economic indicators, unemployment and underemployment of 30 million, decline of yearly hiring by 17 million, falling real wages and unsustainable central government or Treasury debt (http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html).

3. World Economic Slowdown. Careful, detailed analysis of the slowdown of the world economy is provided in Section IV World Economic Slowdown. Data and analysis are provided for regions and countries that jointly account for about three quarters of world output.

There were three interrelated risk waves affecting valuations of risk financial assets: doubts on banks, Greece’s likelihood of default and the European sovereign debt resolution mechanism, currently European Financial Stability Facility (EFSF) (http://www.efsf.europa.eu/about/index.htm) changing to European Stability Mechanism (ESM) in 2013.

First, banks. Moody’s Investors Service (2011Sep23) downgraded by two notches the long-term deposit and senior debt ratings of eight Greek banks. On Sep 21, Moody’s downgraded the long-term and short-term debt of two of the largest US banks (Moody’s 2011Sep21BAC, 2011Sep21WFC) and downgraded the short-term debt of another of the largest banks in the US (Moody’s 2011Sep21C). The rationale for the downgrades is that in there is decreasing probability that banks would be supported by the US government if needed. Brooke Masters, Peggy Hollinger and Alex Barker, writing on Sep 22 on “EU set to speed recapitalization of 16 banks,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/49d6240e-e527-11e0-bdb8-00144feabdc0.html#axzz1YQzd3mPK), analyze the move by the European Union to recapitalize 16 banks that came close to failing the stress test conducted during the summer of 2011. Nine banks that failed the test were required to increase capital before the end of the year. The minimum score for passing was 5 percent core tier one capital ratios. The 16 banks scored between 5 and 6 and need to increase their core capital. The IMF (2011GRSRSep, 16) summarizes the banking problems of the euro area:

“The high-spread euro area bank credit default swaps have widened by around 400 basis points since January 2010, in line with the increase in sovereign credit default swap spreads. At the same time, the equity market capitalization of EU banks has declined by more than 40 percent. These market pressures have intensified in recent weeks.”

The change in market capitalization of euro area banks since Jan 2010 is about €400 billion or a loss of 42 percent. The IMF (2011GFSRSep, 21) estimates spillovers of European bank exposures to Greek sovereign debt close to €60 billion. Adding exposures to Ireland and Portugal increases the spillover to €80 billion. The addition of credit risks resulting from Belgium, Italy and Spain raises the total to €200 billion. Declines in asset prices of banks raises total spillover to €300 billion. Precise measurements are quite difficult but the IMF finds the risks to be quite real. There are also exposures of European banks and financial institutions to banks and financial institutions in other areas.

Second, Greece. The week was filled with doubts and reassurances about the program of rescue of Greece. The yield of the 2-year sovereign bond of Greece traded above 50 percent during the week. Default by Greece is viewed by some as extending to other sovereigns in Europe.

Third, European sovereign debt resolution. On Sep 19, Standard & Poor’s lowered the long- and short-term sovereign rating of Italy from A+/Negative/A-1+ to A/Negative/A-1 (S&P 2011Sep19). There are four factors used by S&P for this downgrade: (1) real and nominal slow growth perspective; (2) political obstacles to approving and implementing reforms to promote economic growth; (3) high levels of gross and net government debt; and (4) fiscal program with low commitment to reducing expenditures. In the view of S&P, the greatest weight in the downgrade is given to (2), political obstacles to required reforms, and (3), high debt levels. Bloomberg revealed access to internal working documents showing more drastic measures to contain the sovereign debt crisis. Rebecca Christie and James G. Neuger, writing on Sep 23 on “EU plans Greek buyback program open to all debt,” published by Bloomberg (http://www.bloomberg.com/news/print/2011-09-23/eu-plans-greek-buyback-program-open-to-all-debt-all-investors-for-bailout.html), provide information in a European Union internal document that the second bailout of Greek debt could cover all debt and would be implemented together with the bond swap with private creditors. The EFSF would provide the funds for the buyback. James G. Neuger, writing on Sep 23 on “Europe may speed permanent fund enactment,” published by Bloomberg (http://www.bloomberg.com/news/2011-09-23/europe-weighs-speedier-enactment-of-permanent-rescue-fund-to-stem-crisis.html), informs that an internal working paper of the European Union explores acceleration of the creation of the permanent rescue fund of sovereign debts, European Stability Mechanism (ESM). The resources of the fund would amount to €500 billion or around USD 677 billion that could be sufficient to assist larger countries such as Italy.

IIA1 Euro Zone Survival Risk. The Wriston “doctrine” on sovereign lending was predicated on the argument that countries do not bankrupt (Wriston 1982). Another Wriston idea was that the old Citibank should be more valuable dead than alive: if Citibank followed the model of the old Merrill Lynch and sold the individual components or franchises the value would be higher than that of the unbroken Citibank. There was a rise in leveraged buy outs (LBO) in the 1980s that has been extensively analyzed in academic literature (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 159-66). The debt crisis of the 1980s and many other episodes in history actually proved that a country can bankrupt and that many countries can bankrupt simultaneously.

Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:

“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”

If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.

The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by a few of the other members. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Sep 23, the yield of the 2-year bond of the government of Greece was quoted at over 56 percent and the 10-year bond yield traded at over 22 percent. In contrast, the 2-year US Treasury note traded at 0.219 percent and the 10-year at 1.826 percent while the comparable 2-year government bond of Germany traded at 0.39 percent and the 10-year government bond of Germany traded at 1.75 percent (see Table 8). There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound.

Much of the analysis and concern over the euro zone centers on the default risk of the debt of a few countries while there is little if any risk of default of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be survival of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with nil default probability. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will (or should) survive without major changes.

The prospects of survival of the euro zone are dire. Table 9 is constructed with IMF World Economic Outlook database released during the week for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2010.

Table 9, World and Selected Regional and Country GDP and Fiscal Situation

	GDP 2010 USD Billions	Primary Net Lending Borrowing % GDP 2010	General Government Net Debt % GDP 2010
World	62,911.2
Euro Zone	12,167.8	-3.6	65.9
Portugal	229.2	-6.3	88.7
Ireland	206.9	-28.9	78.0
Greece	305.4	-4.9	142.8
Spain	1,409.9	-7.8	48.8
Major Advanced Economies G7	31,716.9	-6.5	76.5
United States	14,526.6	-8.4	68.3
UK	2,250.2	-7.7	67.7
Germany	3,286.5	-1.2	57.6
France	2,562.7	-4.9	76.5
Japan	5,458.8	-8.1	117.2
Canada	1,577.0	-4.9	32.2
Italy	2,055.1	-0.3	99.4
China	5,878.3	-2.3	33.8*
Cyprus	23.2	-5.3	61.6

*Gross Debt

Source: http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx

The data in Table 9 are used for some very simple calculations in Table 10. The column “Net Debt USD Billions” in Table 10 is generated by applying the percentage in Table 9 column “General Government Net Debt % GDP 2010” to the column “GDP USD Billions.” The total debt of France and Germany in 2010 is $3853.5 billion, as shown in row “B+C” in column “Net Debt USD Billions” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $3531.6 billion. There is some simple “unpleasant bond arithmetic” in the two final columns of Table 10. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $7385.1 billion, which would be equivalent to 126.3 percent of their combined GDP in 2010. Under this arrangement the entire debt of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 224 percent if including debt of France and 165 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is a limit also to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks.

Table 10, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %

	Net Debt USD Billions	Debt as % of Germany Plus France GDP	Debt as % of Germany GDP
A Euro Area	8,018.6
B Germany	1,893.0		$7385.1 as % of $3286.5 =224.7% $5424.6 as % of $3286.5 =165.1%
C France	1,960.5
B+C	3,853.5	GDP $5849.2 Total Debt $7385.1 Debt/GDP: 126.3%
D Italy	2,042.8
E Spain	688.0
F Portugal	203.3
G Greece	436.1
H Ireland	161.4
Subtotal D+E+F+G+H	3,531.6

Source: calculation with IMF data http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx

IIB Markets Not Dancing Twist. The term “operation twist” grew out of the dance “twist” popularized by successful musical performer Chubby Chekker (http://www.youtube.com/watch?v=aWaJ0s0-E1o). Meulendyke (1998, 39) describes the coordination of policy by Treasury and the FOMC in the beginning of the Kennedy administration in 1961:

“In 1961, several developments led the FOMC to abandon its “bills only” restrictions. The new Kennedy administration was concerned about gold outflows and balance of payments deficits and, at the same time, it wanted to encourage a rapid recovery from the recent recession. Higher rates seemed desirable to limit the gold outflows and help the balance of payments, while lower rates were wanted to speed up economic growth.

To deal with these problems simultaneously, the Treasury and the FOMC attempted to encourage lower long-term rates without pushing down short-term rates. The policy was referred to in internal Federal Reserve documents as “operation nudge” and elsewhere as “operation twist.” For a few months, the Treasury engaged in maturity exchanges with trust accounts and concentrated its cash offerings in shorter maturities.

The Federal Reserve participated with some reluctance and skepticism, but it did not see any great danger in experimenting with the new procedure.

It attempted to flatten the yield curve by purchasing Treasury notes and bonds while selling short-term Treasury securities. The domestic portfolio grew by $1.7 billion over the course of 1961. Note and bond holdings increased by a substantial $8.8 billion, while certificate of indebtedness holdings fell by almost $7.4 billion (Table 2). The extent to which these actions changed the yield curve or modified investment decisions is a source of dispute, although the predominant view is that the impact on yields was minimal. The Federal Reserve continued to buy coupon issues thereafter, but its efforts were not very aggressive. Reference to the efforts disappeared once short-term rates rose in 1963. The Treasury did not press for continued Fed purchases of long-term debt. Indeed, in the second half of the decade, the Treasury faced an unwanted shortening of its portfolio. Bonds could not carry a coupon with a rate above 4 1/4 percent, and market rates persistently exceeded that level. Notes—which were not subject to interest rate restrictions—had a maximum maturity of five years; it was extended to seven years in 1967.”

As widely anticipated by markets, perhaps intentionally, the Federal Open Market Committee (FOMC) decided at its meeting on Sep 21 that it was again “twisting time:”

“Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.

The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate.”

The worldwide selloff of risk financial assets that followed this statement was loosely attributed by some as reaction to the phrase “there are significant downside risks to the economic outlook,” with emphasis added here. To be sure, there are differences on the extent of the downside risks. Market participants have been keenly aware since the end of 2010 and beginning of 2011 that the world economy was slowing down. The standstill in the US was more than evident after the release of the first and second estimates of IIQ2011. Real GDP grew at the seasonally-adjusted annual equivalent rate of 0.4 percent in the first quarter of 2011, IQ2011, and at 1.0 percent in IIQ2011. Discounting 0.4 percent to one quarter is 0.1 percent and discounting 1.0 percent is 0.25 percent. Real GDP growth in the first half of the 2011 accumulated to 0.35 percent (1.001 x 1.0025), which is equal to 0.7 percent (compounding 1.0035 for two successive half years). The US economy is close to a standstill. This blog has been tracing stagnation of real disposable income since the beginning of 2011. A host of other high-frequency information confirms that growth in the US and worldwide is at standstill. Smart money did not flee from exposures in risk financial assets because of the change in outlook of the FOMC, which is at the frontier of knowledge but about equal to that of market participants. Foresight at the FOMC and at smart money managers is equally cloudy. The global selloff is more likely the consequence of realization that unconventional monetary policy of zero interest rates and various versions of quantitative easing is not effective in recovering the economy.

There are two main issues with “let’s twist again” monetary policy and quantitative easing in general.

First, impact on Treasury yields. The limited size of operation twist is related to the findings of Modigliani and Sutch (1966, 196) that:

“1. The expectation model can account remarkably well for the relation between short- and long-term rates in the United States. Furthermore, the prevailing expectations of long-term rates involve a blending of extrapolation of very recent changes and regression toward a long term normal level.

2. There is no evidence that the maturity structure of the federal debt, or changes in this structure, exert a significant, lasting or transient, influence on the relation between the two rates.

3. The spread between long and short rates in the government market since the inception of Operation Twist was on the average some twelve base points below what one might infer from the pre-Operation Twist relation. This discrepancy seems to be largely attributable to the successive increase in the ceiling rate under Regulation Q which enabled the newly invented CD's to exercise their maximum influence.

4. Any effects, direct or indirect, of Operation Twist in narrowing the spread which further study might establish, are most unlikely to exceed some ten to twenty base points a reduction that can be considered moderate at best.”

Swanson (2011Mar, 31-2) finds with modern state of the art estimation methods operation twist reduced yields of long-term US treasury securities by 15 basis points:

“The present paper has reexamined Operation Twist using a modern high-frequency event-study approach, which avoids the problems with lower-frequency methods discussed above. In contrast to Modigliani and Sutch, we find that Operation Twist had a highly statistically significant impact on longer-term Treasury yields. However, consistent with those authors, we find that the size of the effect was moderate, amounting to about 15 basis points. This estimate is also consistent with the lower end of the range of estimates of Treasury supply effects in the literature.”

The effects of quantitative easing or operation twist of 15 basis points are comparable to those of tightening of the fed funds rate by 100 basis points, as measured by Gürkaynak, Sack and Swanson (2005, 84):

“In particular, we estimate that a 1 percentage point surprise tightening in the federal funds rate leads, on average, to a 4.3 percent decline in the S&P 500 and increases of 49, 28, and 13 bp in two-, five-, and ten-year Treasury yields, respectively.”

There is another operational factors of the “let’s twist again” monetary policy. Swanson (2011Mar) also reminds that lowering long-term yields in a new twist of the yield curve does not require increasing short-term rates as in the part of operation twist policy designed to prevent net capital outflows of the US. The desk of the Federal Reserve Bank of New York can continue to implement the target of fed funds rate of 0 to ¼ percent. This is exactly what the FOMC decided.

Second, impact on other yields, risk aversion and the economy. The crucial issue here is if lowering the yields of long-term Treasury securities would have any impact on investment and consumption or aggregate demand. The decline of long-term yields of Treasury securities would have to cause decline of yields of asset-backed securities used to securitize loans for investment by firms and purchase of durable goods by consumers. The decline in costs of investment and consumption of durable goods would ultimately have to result in higher investment and consumption. It is possible that the decline in yields captured by event studies is ephemeral. The decline in yields just after “let’s twist again” monetary policy this week was caused by the flight out of risk financial assets into Treasury securities, which is the opposite of the desired effect of encouraging risk-taking in asset-backed securities and lending.

Unconventional monetary policy of near zero interest rates and quantitative easing has been successful mainly in promoting the carry trade from near zero interest rates to leveraged positions in risk financial assets, in particular commodity futures. Chart 1 of the Food and Agriculture Organization shows the Food Price Index that trended down during the recession of 2001. An upward trend was promoted by unconventional monetary policy of 1 percent fed funds rate together with the suspension of the auction of the 30-year Treasury bond to lower mortgage rates, encouraging refinancing that was more important in cash infusion of households than tax rebates. Food prices trended upward and with sharp reductions of monetary policy rates peaked in a big jump to more than $140/barrel in 2008 during a global recession. The flight out of risk financial assets after the announcement of the Troubled Asset Relief Program (TARP) (see Cochrane and Zingales 2009) is shown in Chart 1 in a collapse of the Food Price Index of FAO. With zero interest rates after the FOMC meeting on Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm) and realization in early 2009 that bank assets were not as worrisome as argued for approval of TARP, food prices jumped again to even higher levels.

Chart 1, Food and Agriculture Organization Food Price Index 1990-2011

Source: http://www.fao.org/worldfoodsituation/wfs-home/foodpricesindex/en/

Chart 2 of the US Energy Information Administration shows exactly the same behavior of the price of crude oil. There is the same decline after the 2001 recession that was confused as global deflation. Oil prices trend upward with the near zero interest rates and suspension of the auction of the 30-year Treasury, which was quantitative easing by reduction of supply in a desired segment of the yield curve. There is the same jump of oil prices in 2008 in the midst of sharp global contraction and vertical drop in the flight to safety away from risk financial assets. A new upward trend was promoted by the carry trade from zero interest rates after Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm) and the return of risk appetite in early 2009. Prices have dropped recently because of risk aversion resulting from the European sovereign risk crisis and the US and world growth slowdown. The success of unconventional monetary policy of zero interest rates and quantitative easing is in promoting carry trades from zero interest rates into risk financial assets such as equities, emerging markets, currencies and commodities’ futures.

Chart 2, Crude Oil Cushing, OK, Contract 1

Source: http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RCLC1&f=D

III Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table 11 updated with every post, provides the latest annual 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). Newly available data on inflation is considered below in this section. The data in Table 11 for the euro zone and its members is updated from information provided by Eurostat but individual country information is provided in this section as soon as available, following Table 11. Data for other countries in Table 11 is also updated with reports from their statistical agencies. Economic data for major regions and countries is considered in Section IV World Economic Slowdown following individual country and regional data tables.

Table 11, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates

	GDP	CPI	PPI	UNE
US	2.9	3.8	6.5	9.1
Japan	-1.1	0.2	2.6	4.6
China	9.6	6.2	7.3
UK	1.8	4.5* RPI 5.2	6.1* output 16.2* input 13.0**	7.7
Euro Zone	1.6	2.5	6.1	10.0
Germany	2.8	2.5	5.7	6.1
France	1.6	2.4	6.1	9.9
Nether-lands	1.5	2.8	8.2	4.3
Finland	2.7	3.5	7.3	7.9
Belgium	2.5	3.4	8.4	7.5
Portugal	-0.9	2.8	5.7	12.3
Ireland	-1.0	1.0	5.0	14.5
Italy	0.8	2.3	4.9	8.0
Greece	-4.8	1.4	8.7	15.1
Spain	0.7	2.7	7.4	21.2

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

*Office for National Statistics

PPI http://www.ons.gov.uk/ons/dcp171778_230822.pdf

CPI http://www.statistics.gov.uk/pdfdir/cpi0611.pdf

** Excluding food, beverage, tobacco and petroleum

Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html

Table 12 provides the forecasts of the Federal Reserve Board Members and Federal Reserve Bank Presidents for the FOMC meeting in Jun. There are lags in effect of monetary policy (Batini and Nelson 2002, Culbertson 1960, 1961, Friedman 1961, Romer and Romer 2004). Central banks forecast inflation in the effort to program monetary policy to attain effects at the correct timing of need by taking into account lags in effects of policy (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-116). Inflation by the price index of personal consumption expenditures (PCE) was forecast for 2011 in the Apr meeting of the FOMC between 2.1 to 2.8 percent. Table 12 shows that the interval has narrowed to PCE (personal consumption expenditures) headline inflation of between 2.3 and 2.5 percent. The FOMC focuses on core PCE inflation, which excludes food and energy. The Apr forecast of core PCE inflation was an interval between 1.3 and 1.6 percent. Table 12 shows the revision of this forecast in Jun to a higher interval between 1.5 and 1.8 percent. A new forecast with significant changes will be provided in Nov.

Table 12, Forecasts of PCE Inflation and Core PCE Inflation by the FOMC, %

	PCE Inflation	Core PCE Inflation
2011	2.3 to 2.5	1.5 to 1.8
2012	1.5 to 2.0	1.4 to 2.0
2013	1.5 to 2.0	1.4 to 2.0
Longer Run	1.7 to 2.0

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20110622.pdf

The producer price index (PPI) of Germany in Table 13 shows significant deceleration from the first quarter of 2011 with annual equivalent inflation of 9.6 percent falling to 1.5 percent annual equivalent in the four months from May to Aug, which is also much lower than 5.8 percent annual equivalent for the entire first eight months of 2011. The 12 months rate of inflation fell from 6.4 percent in Jan to 5.5 percent in Aug. Risk aversion and the global economic slowdown have caused decline of commodity prices that had driven PPI inflation. The lower part of Table 13 shows the acceleration of PPI inflation during the carry trade from low interest rates to positions in risk financial assets such as commodity futures that characterized the decade. Risk aversion and clouded outlook of economic growth cause unwinding of carry trades that in turn moderate increases in commodity prices and PPI inflation.

Table 13, Germany, Producer Price Index ∆%

	Month SA ∆%	12 Months NSA ∆%
Aug	-0.3	5.5
Jul	0.7	5.8
Jun	0.1	5.6
May	± 0.0	6.1
Apr	1.0	6.4
Mar	0.4	6.2
Feb	0.7	6.4
Jan	1.2	5.7
AE ∆% Jan-Aug	5.8
Dec 2010	0.7	5.3
Nov	0.2	4.4
Oct	0.4	4.3
Sep	0.3	3.9
Aug	0.0	3.2
Jul	0.5	3.7
		Year over Year ∆%
2010/2009		1.6
2009/2008		-4.2
2008/2007		5.5
2007/2006		1.3
2006/2005		5.4
2005/2004		4.4

AE: annual equivalent

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/DE/Presse/pm/2011/09/PD11__342__61241,templateId=renderPrint.psml

IV World Economic Slowdown. The JP Morgan Global Manufacturing & Services PMI^™ produced by JP Morgan and Markit jointly with ISM and IFPSM finds slowing global growth with contraction of manufacturing (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8544). The JP Morgan all-industry PMI seasonally adjusted diffusion index is closely associated with the seasonally-adjusted annual equivalent rate of global GDP. The headline index of 52.0 with available information for IIIQ2011 is lower than 52.3 in IIQ2011 and much lower than 57.3 in IQ2011. The slowdown is widespread with the index for the euro zone at the slowest pace in two years, the UK at the slowest since May 2009, India at a 27-month low, China flat from Jul and Brazil with the first decline in more than two years (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8544). The Director of Global Economics Coordination at JP Morgan, David Hensley, finds that world output has fallen to the slowest pace in the recovery from the global recession. Slowing world output was mainly caused by manufacturing but the services sector was only marginally better. Flash indexes for the euro zone and China are considered below in the sections for the euro zone and China.

This section considers seven countries and the euro zone in separate subsections, each of which is preceded by a regional or country data table. The subsections update economic indicators released during the week ending on Sep 23. The earliest released indicators are the diffusion indexes of purchasing managers provided by Markit in association with multiple institutions. The subsections follow on the purchasing managers’ indexes with high-frequency data and analysis.

IVA United States. The nonmanufacturing PMI of the Institute for Supply Management rose 0.6 percentage points from 52.7 in Jul to 53.3 in Aug, indicating faster growth, while the manufacturing purchasing managers’ index fell 0.3 percentage points from 50.9 in Jul to 50.6 in Aug, indicating slower growth (http://www.ism.ws/ISMReport/NonMfgROB.cfm). Business activity fell 0.5 percentage points for the nonmanufacturing index from 56.1 in Jul to 55.6, indicating slower growth, but fell 3.7 percentage points in manufacturing, from 52.3 in Jul to 48.6 in Aug, now indicating contraction. New orders rose 1.1 percentage points for the nonmanufacturing survey from 51.7 in Jul to 52.8 in Aug, indicating faster growth, and increased 0.4 points from 49.2 in Jul to 49.6 in Aug, which remains in contraction territory.

Table USA provides the summary indicators of the US economy and where to locate them in the blog. Indicators released in the week of Sep 23 are discussed after Table USA.

Table USA, US Economic Indicators

Consumer Price Index	Aug 12 months NSA ∆%: 3.8; ex food and energy ∆%: 2.0 Aug month ∆%: 0.4; ex food and energy ∆%: 0.2 Blog 09/18/11
Producer Price Index	Jun 12 months NSA ∆%: 6.5; ex food and energy ∆% 2.4 Aug month SA ∆% 0.2; ex food and energy∆%: 0.1 Blog 09/18/11
PCE Inflation	Jul 12 months NSA ∆%: headline 2.8; ex food and energy ∆% 1.6 Blog 09/04/11
Employment Situation	Household Survey: Aug Unemployment Rate SA 9.1% Blog calculation People in Job Stress Aug: 29.9 million NSA Establishment Survey: Aug Nonfarm Jobs 0 (zero jobs created); Private +17,000 job created Jul 12 months Average Hourly Earnings Inflation Adjusted ∆%: minus 1.3% Blog 09/04/11
Nonfarm Hiring	Nonfarm Hiring fell from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million Private-Sector Hiring Jul 2011 3.985 million lower by 1.393 million than 5.378 million during contraction in Jul 2001 Blog 09/11/11
GDP Growth	BEA Revised National Income Accounts back to 2003 IQ2011 SAAR ∆%: 0.4 IIQ2011 SAAR ∆%: 1.0 First semester 2011 AE ∆% 0.7 Blog 08/28/11
Personal Income and Consumption	Jul month ∆% SA Real Disposable Personal Income (RDPI) -0.1 Jul month SA ∆% Real Personal Consumption Expenditures (RPCE): 0.5 12 months NSA ∆%: RDPI: 1.2; RPCE ∆%: 1.6 Blog 09/04/11
Quarterly Services Report	IIQ11/IQII SA ∆%: Information 2.0 Professional 1.6 Administrative 2.1 Hospitals 1.8 Blog 09/11/11
Employment Cost Index	IIQ2011 SA ∆%: 0.7 Jun 12 months ∆%: 3.4 Blog 08/07/11
Industrial Production	Aug month SA ∆%: 0.2 Aug 12 months NSA ∆%: 3.4 Capacity Utilization: 77.4 Blog 09/18/11
Productivity and Costs	Nonfarm Business Productivity IIQ2011∆% SAAE -0.7; IIQ2011/IIQ2010 ∆% minus 0.7; Unit Labor Costs IIQ2011 ∆% 3.3; IIQ2011/IIQ2010 ∆%: 1.9 Blog 09/04/11
New York Fed Manufacturing Index	General Business Conditions From -7.72 Aug to Sep: –8.82 New Orders: From -7.82 Aug to –8.0 Blog 09/18/11
Philadelphia Fed Business Outlook Index	General Index from -30.7 Aug to -17.5 Sep New Orders from Aug -26.8 to -11.3 Sep Blog 09/18/11
Manufacturing Shipments and Orders	Jul/Jun New Orders SA ∆%: 2.4; ex transport ∆%: 0.9 12 months Jun NSA ∆%: 12.6; ex transport ∆% 12.9 Blog 09/04/11
Durable Goods	Jul New Orders SA ∆%: 4.0; ex transport ∆%: 0.7 Jul 12 months NSA New Orders ∆%: 9.4; ex transport ∆% : 9.2 Blog 08/28/11
Sales of Merchant Wholesalers	Jan-Jul 2011/2010 ∆%: Total 14.5; Durable Goods: 11.4; Nondurable Goods 17.2 Blog 09/11/11
Sales and Inventories of Manufacturers, Retailers and Merchant Wholesalers	Jul 11/Jul 10 NSA ∆%: Total Business 9.8; Manufacturers 11.8 Retailers 6.5; Merchant Wholesalers 10.8 Blog 09/18/11
Sales for Retail and Food Services	Aug 12 months ∆%: Retail and Food Services: 7.9; Retail ∆% 8.3 Blog 09/18/11
Value of Construction Put in Place	Jun SAAR month SA ∆%: -1.3 Jun 12 months NSA: –0.5 Blog 09/04/11
Case-Shiller Home Prices	Jun 2011/Jun 2010 ∆% NSA: 10 Cities –3.8; 20 Cities: –4.5 ∆% Jun SA: 10 Cities 0.04; 20 Cities: –0.1 Blog 09/04/11
FHFA House Price Index Purchases Only	Jul SA ∆% 0.8; 12 month ∆%: minus 3.2 Blog 09/25/11
New House Sales	Jul month SAAR ∆%: -0.7 Jan/Jul 2011/2010 NSA ∆%: minus 10.6 Blog 08/28/11
Housing Starts and Permits	Aug Starts month SA ∆%: -5.0; Permits ∆%: 3.2 Jan/Jul 2011/2010 NSA ∆% Starts -3.8; Permits ∆% –2.8 Blog 09/25/11
Trade Balance	Balance Jul SA -$44,808 million versus Jun -$51,570 million Exports Jul SA ∆%: 3.6 Imports Jul SA ∆%: -0.2 Exports Jan-Jul 2011/2010 NSA ∆%: 18.1 Imports Jan-Jul 2011/2010 NSA ∆%: 17.5 Blog 09/11/11
Export and Import Prices	Aug 12 months NSA ∆%: Imports 13.0; Exports 9.6 Blog 09/18/11
Consumer Credit	Jul ∆% annual rate: 5.9% Blog 09/12/11
Net Foreign Purchases of Long-term Treasury Securities	Jul Net Foreign Purchases of Long-term Treasury Securities: $9.5 billion Jul versus Jun $3.4 billion Major Holders of Treasury Securities: China $1173 billion; Japan $915 billion Blog 09/11/11
Treasury Budget	Fiscal Year to Aug 2011/2010 ∆%: Receipts 7.6; Outlays 3.8; Deficit -2.0; Individual Income Taxes 23.5 Deficit Fiscal Year to Aug 2011 $1,234,052 million Blog 09/18/11
Flow of Funds	IIQ2011 ∆ since 2007 Assets -$6311B Real estate -$5111B Financial -$1490 Net Worth -$5802 Blog 09/18/11
Current Account Balance of Payments	IIQ2011 -121B %GDP 3.2 Blog 09/18/11

Links to blog comments in Table USA:

09/18/11 http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html

09/11/11 http://cmpassocregulationblog.blogspot.com/2011/09/financial-turbulence-wriston-doctrine.html

09/05/11 http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html

08/28/11 http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html

08/21/11 http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

Housing starts and permits of privately-owned houses in seasonally-adjusted annual rates are provided in Table 14 for May-Aug 2011. Between May and Aug, housing starts rose 3.3 percent and housing permits 1.8 percent. The best month of housing starts was Jun at the annual seasonally-adjusted rate of 615, 000 for an increase of 11.2 percent relative to May. Housing starts fell by 2.3 percent in Jul and then fell another 5 percent in Aug for cumulative increase of 3.3 percent from May to Aug. Housing permits rose 3.2 percent in Aug and 1.3 percent in Jun but fell 2.6 percent in Jul for a net increase of 1.8 from May to Aug.

Table 14, US, Housing Starts and Permits Seasonally Adjusted Annual Equivalent Rates, Thousands of Units, %

	Housing Starts	Housing Permits
Aug 2011	571	620
Jul 2011	601	601
∆% Aug/Jul 2011	-5.0	3.2
Jun 2011	615	617
∆% Jul/Jun 2011	-2.3	-2.6
May 2011	553	609
∆% May/Jun 2011	11.2	1.3
∆% Aug/May 2011	3.3	1.8

Source: http://www.census.gov/const/newresconst.pdf

Chart 3 of the US Bureau of the Census shows the sharp increase in construction of new houses from 2000 to 2006. Housing construction fell sharply through the recession, recovering from the trough around IIQ209. The left-hand side of Chart shows a mild downward trend from mid 2010 to the present.

Chart 3, US, New Housing Units Started 2000-2011

Source: http://www.census.gov/briefrm/esbr/www/esbr020.html

Cumulative housing starts and permits from Jan to Aug not-seasonally adjusted are provided in Table 15. Housing starts fell 3.8 percent in the cumulative of Jan-Aug 2011 relative to the same period in 2010 and in the same period new permits fell 2.8 percent. Construction of new houses in the US remains at very depressed levels. Housing starts fell 69.2 percent in Jan-Aug 2011 relative to Jan-Aug 2006 and 71.6 relative to Jan-Aug 2005. Housing permits fell 69.8 percent from Jan-Aug 2006 to Jan-Aug 2011 and 72.4 percent from Jan-Aug 2005.

Table 15, US, Housing Starts and New Permits, Thousands of Units, NSA, and %

	Housing Starts	New Permits
Jan-Aug 2011	398.3	406.9
Jan-Aug 2010	414.1	418.6
∆% Jan-Aug 2011/Jan-Aug 2010	-3.8	-2.8
Jan-Aug 2006	1292.5	1346.3
∆%/Jan-Aug 2011	-69.2	-69.8
Jan-Aug 2005	1403.2	1471.9
∆%/ Jan-Aug 2011	-71.6	-72.4

Source: http://www.census.gov/const/newresconst.pdf

http://www.census.gov/const/newresconst_200708.pdf

http://www.census.gov/const/newresconst_200608.pdf

A longer perspective on residential construction in the US is provided by Table 16 with annual data from 1960 to 2010. Housing starts fell 71.6 percent from 2005 to 2010, 62.6 percent from 2000 to 2010 and 53.1 percent relative to 1960. Housing permits fell 71.9 percent from 2005 to 2010, 62.0 percent from 2000 to 2010 and 39.4 percent from 1960 to 2010. Housing starts rose 31.8 from 2000 to 2005 while housing permits grew 35.4 percent. From 1990 to 2000 housing starts increased 31.5 percent while permits increased 43.3 percent.

Table 16, US, Annual New Privately Owned Housing Units Authorized by Building Permits in Permit-Issuing Places and New Privately Owned Housing Units Started, Thousands

	Starts	Permits
2010	586.9	604.6
∆% 2010/2005	-71.6	-71.9
∆% 2010/2000	-62.6	-62.0
∆% 2010/1960	-53.1	-39.4
2009	554,0	583.0
2008	905.5	905.4
2007	1,355,0	1,398.4
2006	1,800.9	1,838.9
2005	2,068.3	2,155.3
∆% 2005/2000	31.8	35.4
2004	1,955.8	2,070.1
2003	1,847.7	1,889,2
2002	1,704.9	1,747.2
2001	1,602.7	1,1637.7
2000	1,568.7	1,592.3
∆% 2000/1990	31.5	43.3
1990	1,192,7	1,110.8
1980	1,292.7	1,190.6
1970	1,433.6	1,351.5
1960	1,252.2	997.6

Source: http://www.census.gov/const/www/newresconstindex.html

The Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac, calculates the FHFA House Price Index (HPI) that “is calculated using home sales price information from Fannie Mae- and Freddie Mac-acquired mortgages” (http://www.fhfa.gov/webfiles/22558/2q2011HPI.pdf). Table 17 provides the FHFA HPI for purchases only, which shows behavior similar to that of the Case-Shiller index. House prices catapulted from 2000 to 2003, 2005 and 2006. The index for the US as a whole rose 59.5 percent between IIQ2000 and IIQ2006, NSA, and by more than 70 percent for New England, Middle Atlantic, South Atlantic but only by 31.6 percent for East South Central. Prices fell relative to 2011 from all years since 2005. From IIQ2000 to IIQ2011, prices rose for the US and the four regions in Table 17.

Table 17, US, FHFA House Price Index Purchases Only NSA ∆%

	United States	New England	Middle Atlantic	South Atlantic	East South Central
2Q2000 to 2Q2003	22.9	40.9	34.1	24.3	9.9
2Q2000 to 2Q2005	48.5	72.0	66.5	56.9	21.9
2Q2000 to 2Q2006	59.5	75.4	79.5	73.3	31.6
2Q2005 t0 2Q2011	-12.4	-11.9	-1.1	-17.2	1.6
2Q2006 to 2Q2011	-18.4	-13.6	-8.3	-25.1	-5.9
2Q2007 to 2Q2011	-19.4	-12.3	-9.9	-26.6	-10.2
2Q2009 to 2Q2011	-7.5	-4.8	-3.8	-10.9	-6.6
2Q2010 to 2Q2011	-5.8	-2.4	-3.2	-7.8	-4.6
2Q2000 to 2Q2011	30.0	51.5	64.6	29.8	23.8

Source:http://www.fhfa.gov/webfiles/22558/2q2011HPI.pdf

Data of the FHFA HPI for the remaining US regions are provided in Table 18. Behavior is not very different than in Table 17 with the exception of East North Central. House prices in the Pacific region doubled between 2000 and 2006. Although prices of houses declined sharply from 2005 to 2011, there was still appreciation relative to 2000.

Table 18, US, FHFA House Price Index Purchases Only NSA ∆%

	West South Central	West North Central	East North Central	Moun-tain	Pacific
2Q2000 to 2Q2003	12.3	18.2	14.7	17.5	40.6
2Q2000 to 2Q2005	22.5	31.9	25.3	50.5	103.3
2Q2000 to 2Q2006	31.3	37.3	28.0	69.7	123.7
2Q2005 t0 2Q2011	12.2	-5.7	-15.2	-20.8	-32.7
2Q2006 to 2Q2011	4.7	-9.3	-17.0	-29.7	-38.8
2Q2007 to 2Q2011	-0.6	-10.9	-16.4	-31.9	-36.9
2Q2009 to 2Q2011	-1.2	-6.3	-7.8	-14.6	-8.7
2Q2010 to 2Q2011	-1.9	-5.7	-5.1	-9.7	-9.1
2Q2000 to 2Q2011	37.5	24.4	6.2	19.2	36.8

Source: http://www.fhfa.gov/webfiles/22558/2q2011HPI.pdf

Monthly changes of the house price index of FHFA in Table 19 show improvement from Apr to Jul. The annual equivalent rate of price appreciation from Apr to Jul is 6.8 percent. As a result, the 12 months rates of price decrease have fallen from as high as 6.2 percent in Apr to 3.2 percent in Jul. Table 19 also provides the year-end rate of price change from 2000 to 2010. The year-end rates from 2000 to 2005 oscillated from around 7 percent to 10 percent. Prices nearly double compounding 10 percent during seven years and compounding 7 percent during ten years.

Table 19, US, FHFA House Price Index Purchases Only SA. Month and NSA 12 Months ∆%

2011	Month ∆% SA	12 Month ∆% NSA
Jul	0.8	-3.2
Jun	0.7	-4.5
May	0.3	-6.1
Apr	0.4	-6.2
Mar	-0.4	-6.1
Feb	-1.6	-5.6
Jan	-1.1	-4.8
Dec 2010		-3.8
Dec 2009		-1.8
Dec 2008		-9.4
Dec 2007		-3.1
Dec 2006		2.5
Dec 2005		9.9
Dec 2004		10.1
Dec 2003		7.9
Dec 2002		7.8
Dec 2001		6.8
Dec 2000		7.1

Source:

http://www.fhfa.gov/Default.aspx?Page=87

Chart 4 of the Federal Housing Finance Agency shows the Housing Price Index four-quarter price change from IIQ1998 to IIQ2011. House prices appreciated sharply from 1998 to 2005 and then fell rapidly. Recovery began already in IIQ2008 but there was another decline after IIQ2010. The data do not show yet the appreciation from Apr to Jul.

Chart 4, Federal Housing Finance Agency House Price Index Four Quarter Price Change

Source: http://www.fhfa.gov/default.aspx?Page=14

The monthly archive of the NSA house price index of FHFA is used to construct Table 20. The fastest period of price appreciation was from Dec 2000 to Dec 2005 at the extremely high average yearly compound rate of 8.5 percent. Stimulus of housing had already begun in the second half of the 1990s with cumulative appreciation of 27.9 percent and average yearly rate of 5.1 percent. Appreciation of house prices since 1991, the FHFA index begins, to 2011, accumulated 85.9 percent for yearly average rate of 3.2 percent.

Table 20, US, FHFA House Price Index NSA ∆% and Average Yearly Growth Rate

	∆%	Yearly Average Growth Rate
Dec 1991 to Dec 2000	42.4	4.0
Dec 1991-Dec 1995	11.3	2.7
Dec 1995-Dec 2000	27.9	5.1
Dec 2000 to Dec 2005	50.3	8.5
Dec 2000 to Dec 2006	54.0	7.5
Jul 2000 to Jul 2011	31.7	2.5
Jul 1991-Jul 2011	85.9	3.2

Source: http://www.fhfa.gov/Default.aspx?Page=87

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 (Ibid, 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).

IVB Japan. The Markit Japan Services PMI^™ report with composite PMI data shows the sharpest rate of decline of activity in the sector service which combined with the slowest pace of growth of manufacturing in three months results in combined manufacturing/services output index of 46.7 in Aug that is the lowest in three months (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8455). A worrisome aspect of the report is growth driven by domestic demand as new export business declined in a tough environment of world economic activity.

The indices of all industry activity of Japan, which is an approximation of GDP or economic activity, fell to levels close to the worst point of the recession, showing the brutal impact of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Japan jumped almost vertically from the setback to the economy caused by the natural disaster. The V-shaped recovery is even more remarkable because Japan depends on foreign demand that stalled in the first half of 2011. There is now another major challenge for Japan in the unfavorable world growth environment. Table JPY provides the country data table for Japan followed with indicators released in the week of Sep 23.

Table JPY, Japan, Economic Indicators

Historical GDP and CPI	1981-2010 Real GDP Growth and CPI Inflation 1981-2010 Blog 07/31/11
Corporate Goods Prices	Aug ∆% -0.2 12 months ∆% 2.6 Blog 09/18/11
Consumer Price Index	Jul SA ∆% 0.0 Jul 12 months NSA ∆% 0.2 Blog 08/28/11
Real GDP Growth	IIQ2011 ∆%: –0.5 on IQ2011; ∆% from quarter a year earlier: –1.1% Blog 09/11/11
Employment Report	Jul Unemployed 2.92 million Change in unemployed since last year: minus 360 thousand Unemployment rate: 4.7% Blog 09/04/11
All Industry Index	Jul month SA ∆% 0.4 12 months NSA ∆% minus 0.8 Blog 09/25/11
Industrial Production	Jul SA month ∆%: 0.6 12 months NSA ∆% –2.8 Blog 09/04/11
Machine Orders	Total Jul ∆% –11.3 Private Jul ∆%: -15.9 Jul ∆% Excluding Volatile Orders -8.2 Blog 09/11/2011
Tertiary Index	Jul month SA ∆% -0.1 Jul 12 months NSA ∆% -0.2 Blog 09/18/2011
Wholesale and Retail Sales	Jul 12 months: Total ∆%: 2.3 Wholesale ∆%: 3.0 Retail ∆%: 0. Blog 09/18/11
Family Income and Expenditure Survey	Jul 12 months ∆% total nominal consumption minus 1.8, real minus 2.1 Blog 09/04/11
Trade Balance	Exports Aug 12 months ∆%: 2.8 Imports Aug 12 months ∆% 19.2 Blog 09/25/11

Links to blog comments in Table JPY:

09/25/11 http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html

09/11/11 http://cmpassocregulationblog.blogspot.com/2011/09/financial-turbulence-wriston-doctrine.html

09/04/11 http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html

08/28/11 http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

The indices of all industry activity of Japan, which is an approximation of GDP or economic activity, fell to levels close to the worst point of the recession, showing the brutal impact of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Table 21 shows the quarterly index which permits comparison with the movement of real GDP. The first row provides weights of the various components of the index: AG (agriculture), CON (construction), IND (industrial production), TERT (services), IND (industrial production) and GOVT (government). GDP fell 0.5 percent in the second quarter. Another important fact is the decline of GDP in IVQ2010 by 0.6 percent. All components of the indices of all industry activity fell with the exception of government and services. Japan had already experienced a very weak quarter when it was unexpectedly hit on Mar 11 by the Great East Earthquake and Tsunami of Mar 11, 2011. The worst impact of the natural disaster was on construction with drop of 7.1 percent in IIQ2011 relative to IQ2011. Industrial production fell 4.0 percent from IQ2011 into IIQ2011. Many accounts had already been closed when the earthquake occurred, but there is visible decline of the indices of all industry by 1.9 percent in IQ2011 caused by decline of industrial production by 2.0 percent and services by 1.4 percent.

Table 21, Japan, Indices of All Industry Activity Percentage Change from Prior Quarter SA ∆%

	CON	IND	TERT	GOVT	ALL IND	REAL GDP
Weight %	5.7	18.3	63.2	11.4	100.0
2011
IIQ	-7.1	-4.0	0.0	0.7	-0.4	-0.5
IQ	2.7	-2.0	-1.4	0.2	-1.9	0.9
2010
IV Q	-1.8	-0.1	0.3	-0.3	-0.2	-0.6
III Q	1.9	-1.0	0.6	0.0	0.7	1.0
IIQ	-0.9	0.7	0.4	-0.2	0.8	-0.1
IQ	0.7	7.4	0.7	-0.4	1.3	2.3

AG: indices of agriculture, forestry and fisheries has weight of 1.4% and is not included in official report or in this table; CON: indices of construction industry activity; IND: indices of industrial production; TERT: indices of tertiary industry activity; GOVT: indices of government services, etc.; ALL IND: indices of all industry activity

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201106j.pdf

http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201107j.pdf

There are more details in Table 22. Jul was saved by industrial production that grew 0.4 percent after growing 3.8 percent in Jun, 6.2 percent in May and 1.6 percent in Apr, following a brutal collapse of 15.5 percent in Mar. All other components of the indices of all industry activity fell in Jul. The highest risk to Japan is if weakening world growth would affect Japanese exports.

Table 22, Japan, Indices of All Industry Activity Percentage Change from Prior Month SA ∆%

	CON	IND	TERT	GOVT	ALL IND
Jul 2011	-0.5	0.4	-0.1	-0.6	0.4
Jun	0.3	3.8	1.8	0.3	2.2
May	3.7	6.2	0.9	1.0	2.0
Apr	-5.7	1.6	2.7	-0.1	1.7
Mar	-8.6	-15.5	-5.9	-0.1	-6.4
Feb	6.3	1.8	0.8	0.2	0.9
Jan	2.3	0.0	-0.1	0.0	-0.5
Dec 2010	-0.5	2.4	-0.2	0.3	0.1
Nov	-1.4	1.6	0.6	-0.4	0.3
Oct	0.1	-1.4	0.2	-0.1	0.0
Sep	-1.9	-0.8	-0.4	-0.1	-0.4
Aug	1.6	-0.1	0.1	0.1	-0.5
Jul	0.8	0.3	0.7	0.1	1.1
Jun	-2.1	-1.5	0.1	-0.1	0.2
May	6.3	-0.1	-0.3	0.0	0.0
Apr	-3.1	0.6	1.6	-0.2	0.9

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201106j.pdf

Rates of change from a year earlier in calendar years and relative to the same quarter a year earlier are provided in Table 23. The first row shows that services contribute 63.2 percent of the total index and industry contributes 18.3 percent for joint contribution of 81.5 percent. The fall of industrial production in 2009 was by a catastrophic 21.9 percent. Japan emerged from the crisis with industrial growth of 16.4 percent in 2010. Quarterly data show that industry is the most dynamic sector of the Japanese economy.

Table 23, Japan, Indices of All Industry Activity Percentage Change from Earlier Calendar Year and Same Quarter Year Earlier NSA ∆%

	CON	IND	TERT	GOVT	ALL IND	REAL GDP
Weight %	5.7	18.3	63.2	11.4	100.0
Calendar Year
2010	-7.0	16.4	1.3	-0.7	3.1	4.0
2009	-5.6	-21.9	-5.2	0.1	-7.7	-6.3
2008	-7.6	-3.4	-1.0	-1.4	-1.9	-1.2
2011
IIQ	-4.6	-6.8	-0.6	0.3	-1.7	-1.0
IQ	1.6	-2.5	-0.1	-0.4	-0.5	-1.0
2010
IV Q	-0.6	5.9	1.6	-0.8	2.1	2.1
III Q	-3.2	14.0	1.8	-0.6	3.2	5.0
IIQ	-11.3	21.3	1.4	-0.7	3.5	3.1
IQ	-12.4	28.0	0.8	-0.5	3.9	5.6

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201106j.pdf

Rates of change of a month relative to the same month a year earlier for the indices of all industry activity of Japan are shown in Table 24. Jul shows weakness in all components relative to a year earlier. The economy does not appear to have recovered to the level of activity before the earthquake/tsunami.

Table 24, Japan, Indices of All Industry Activity Percentage Change from Same Month Year Earlier NSA ∆%

	CON	IND	TERT	GOVT	ALL IND
Jul 2011	-5.2	-3.0	-0.2	1.2	-0.8
Jun	-4.0	-1.7	0.8	1.1	0.2
May	-6.0	-5.5	-0.2	0.1	-1.3
Apr	-3.8	-13.6	-2.3	0.4	-4.0
Mar	-1.1	-13.1	-3.1	-0.3	-4.5
Feb	4.4	2.9	2.0	-0.3	2.0
Jan	1.3	4.6	1.1	-0.5	1.4
Dec 2010	-0.5	5.9	1.8	-0.7	2.1
Nov	-0.5	7.0	2.5	-1.9	2.7
Oct	-1.1	5.0	0.5	0.3	1.3
Sep	-2.8	12.1	1.3	-0.6	2.7
Aug	-1.7	15.5	2.3	-1.1	3.8
Jul	-5.3	14.6	1.6	-0.1	3.3
Jun	-8.3	16.6	1.0	-0.7	3.0
May	-8.1	20.7	1.2	-0.9	3.4
Apr	-17.0	27.0	1.9	-0.4	-

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201106j.pdf

Finally, Table 25 shows the indices of all industry activity divided in components of final demand as in the identity of the national accounts:

Y = C + I + (X-M) (2)

Where Y is income, C consumption, I investment, X exports and M imports. Final demand of consumption, investment and next exports had risen sharply since Mar but Jul 2011 was relatively weak with growth of only 0.7 percent relative to Jul 2010.

Table 25, Japan, Final Demand Components of Index of All Industries Activity, ∆% from Year Earlier

	Final Demand	C	I	X	M
Jul 2011	0.7	0.7	-1.9	-0.7	-5.7
Jun	4.1	3.2	3.9	9.6	1.5
May	3.9	2.5	7.8	1.2	1.4
Apr	-0.1	1.7	-0.7	-9.6	3.9
Mar	-8.4	5.9	-9.7	-11.8	-1.6
Feb	1.1	-0.2	-0.1	9.2	-3.0
Jan	-1.1	0.1	-0.2	-4.1	4.1
Dec 2010	-0.2	-1.2	-0.6	4.9	-3.6
Nov	0.4	1.1	0.8	2.4	1.6
Oct	-0.1	-0.6	-0.1	-0.2	-0.1
Sep	0.4	-0.1	0.4	1.7	0.1
Aug	-0.1	0.3	0.6	-3.3	2.6
Jul	0.6	0.8	0.2	1.1	1.9

Notes: C: Consumption; I: Investment; X: Exports; M: Imports

Source: http://www.meti.go.jp/statistics/tyo/zenkatu/result-2/pdf/hv37913_201107j.pdf

Japan’s trade balance is in Table 26. Japan experienced another deficit in trade balance in Aug, which is the first since May. The adversity caused by the Great East Earthquake/tsunami is manifested in drops of exports in 12 months ending in Mar through Jul with the first 12-month increase of 2.8 percent in Aug. At the same time, imports rose rapidly because of the need to reconstruct the country in recovering internal production. The combination of risk aversion in international finance with unconventional monetary policy of zero interest rates and quantitative easing has caused an adverse appreciation of the Japanese yen relative to the dollar. Yen appreciation undermines the competitiveness of Japanese products in world markets.

Table 26, Japan, Exports, Imports and Trade Balance, NSA JPY Billions and ∆%

	Exports JPY Billions	12 months ∆%	Imports JPY Billions	12 months ∆%	Balance YPY Billions
Aug 2011	5,357.5	2.8	6,132.8	19.2	-775.3
Jul	5,781.0	-3.3	5,709.4	9.9	71.6
Jun	5,775.6	-1.6	5,706.9	9.8	68.6
May	4,760.0	-10.3	5,617.3	12.4	-857.3
Apr	5,156.6	-12.4	5.624.3	9.0	-467.7
Mar	5,861.2	-2.3	5,674.9	12.0	186.3
Feb	5.589.0	9.0	4,938.7	10.0	650.3
Jan	4,970.3	1.4	5,449.7	12.2	-479.4
Dec 2010	6,112.0	12.9	5,392.4	10.7	32.6
Nov	5,439.8	9.1	5,282.2	14.3	157.6
Oct	5,722.5	7.8	4,909.9	8.9	812.6
Sep	5,839.6	14.3	5,065.3	10.3	774.3
Aug	5,209.8	15.5	5,146.0	18.4	63.8
Jul	5,981.9	23.5	5,197.3	16.1	784.6
Jan-Mar 2011	16,420.5	2.4	16,063.3	11.4	357.3
Apr-Jun 2011	15,692.2	-8.0	16,948.5	10.4	-1,256.3

Source: http://www.customs.go.jp/toukei/info/index_e.htm

The structure of exports and imports of Japan is in Table 27. Japan imports all types of raw materials and fuels at rapidly increasing prices caused by the carry trade from zero interest rates to commodities. Weakness of world demand depresses prices of industrial goods. The result is pressure on Japan’s terms of trade.

Table 27, Japan, Structure and Growth of Exports and Imports % and ∆%

Aug 2011	Value JPY Billions	% of Total	∆%
Exports	5,357.5	100.0	2.8
Foodstuffs	26.2	0.5	-9.7
Raw Materials	82.6	1.5	11.9
Mineral Fuels	140.9	2.6	9.2
Chemicals	726.0	13.6	2.2
Manufactures	757.6	13.1	-1.2
Machinery	1,084.7	20.2	2.5
Electrical Machinery	962.5	18.0	-4.9
Transport Equipment	1,086.9	20.3	7.7
Other	699.8	13.1	8.9
Imports	6,132.8	100.0	19.2
Foodstuffs	510.2	8.3	11.7
Raw Materials	494.7	8.1	12.3
Mineral Fuels	2,060.4	33.6	41.9
Chemicals	530.6	8.8	19.4
Manufactures	540.4	8.8	8.7
Machinery	415.9	6.8	10.4
Electrical Machinery	669.6	10.9	-2.4
Transport Equipment	161.5	2.6	15.6
Other	749.5	12.2	8.9

Source: http://www.customs.go.jp/toukei/shinbun/trade-st_e/2011/2011074e.pdf

IVC China. The HSBC China Services PMI^™ with composite PMI data compiled by Markit shows that the composite output index registered 50.4 in Aug, flat relative to the low of 28 months registered in Jul (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8453). The Business Activity segment registered 50.6, suggesting muted growth of services. New orders for the private sector in China have stagnated. The HSBC Flash China Manufacturing PMI^™ compiled by Markit (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8567) registered 49.4 in Sep, which is slightly lower than 49.9 in Aug, for a two month low. The flash China manufacturing output index fell to 49.2 in Sep from 50.2 in Aug. A level of 50.0 indicates no change from the prior month seasonally adjusted. The PMI is contracting at a faster rate while output changed direction and is now contracting. New orders are contracting but at an unchanged rate while new export orders are contracting at a faster rate. Both output and input prices are indicating faster rates of inflation. Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC finds that internal demand is strong enough in supporting GDP growth of between 8.5 and 9 percent in future quarters. The flash estimate normally uses around 85 to 90 percent of replies to the PMI survey released a week later at the turn of the month. Table CNY provides the country data table for China.

Table CNY, China, Economic Indicators

Price Indexes for Industry	Aug 12 months ∆%: 7.3 Jan-Aug ∆%: 7.1 Aug month ∆%: 0.1 Blog 09/11/11
Consumer Price Index	Aug month ∆%: 0.3 Aug 12 month ∆%: 6.2 Jan-Aug ∆%: 5.6 Blog 09/11/11
Value Added of Industry	Aug 12 month ∆%: 13.5 Jan-Aug 2011/Jan-Aug 2010 ∆%: 14.2 Blog 09/11/11
GDP Growth Rate	Year IIQ2011 ∆%: 9.6 Quarter IIQ2011 ∆%: 2.2 Blog 08/14/11
Investment in Fixed Assets	Total Jan-Aug ∆%: 25.0 Jan-Aug ∆% real estate development: 33.2 Blog 09/11/11
Retail Sales	Aug month ∆%: 1.4 Aug 12 month ∆%: 17.0 Jan-Aug ∆%: 16.9 Blog 09/11/11
Trade Balance	Aug balance $17.9 billion Exports ∆% 24.5 Imports ∆% 30.2 Jan-Aug balance $76.2 billion Exports ∆% 23.6 Import ∆% 27.5 Blog 09/11/11

Links to blog comments in Table CNY:

09/11/11 http://cmpassocregulationblog.blogspot.com/2011/09/financial-turbulence-wriston-doctrine.html

09/04/11 http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

IVD Euro Area. The Markit Eurozone Composite output PMI^® registered 50.7 in Aug, lower than 51.1 in Jul, which is the second weakest rate since Aug 2009 when recovery began (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8486). Chris Williamson, Chief Economist at Markit, finds that growth is the slowest in two years with recovery almost dropping to standstill. New business fell for the first in two years when recovery began. Weakness is across all member states. The Markit Flash Eurozone Composite Output PMI^®, showing high association with euro zone GDP since 1999, registered 49.2 in Sep, in contraction territory, compared with 50.7 in Aug, being the lowest level since Jul 2009 (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8568). There is significant difference between core and periphery in the euro zone. Growth of output was nearly stagnant in both Germany and France for the lowest expansion rates since the beginning of recovery more than two years ago. There was a fourth monthly consecutive contraction in the rest of the euro zone with acceleration of decline at the highest rate since Jul 2009. The Chief Economist at Markit, Chris Williamson, finds possible stagnation of the euro zone in the third quarter with the first contraction in Sep in more than two years (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8568). There could be more contraction in future months as suggested by acceleration of the rate of decline of new business and confidence in the next year in services. There has been decline from higher growth rates for Germany and France to near stagnation while the rest of the euro zone contracts. The only good news in the report is the moderation of prices. Table EUR provides the data table for the euro zone.

Table EUR, Euro Area Economic Indicators

GDP	IIQ2011 ∆% 0.2; IIQ2011/IIQ2010 ∆% 1.6 Blog 09/11/11
Unemployment	Jul 2011: 10.0% unemployment rate Jul 2011: 15.757 million unemployed Blog 09/04/11
HICP	Aug month ∆%: 0.2 12 months Aug ∆%: 2.5 Blog 09/18/11
Producer Prices	Euro Zone industrial producer prices Jul 12 months ∆%: 6.1 Blog 09/04/11
Industrial Production	Jul month ∆%: 1.0 Jul 12 months ∆%: 4.2 Blog 09/18/11
Industrial New Orders	Jul month ∆%: minus 2.1 Jul 12 months ∆%: 8.5 Blog 09/25/11
Construction Output	Jul month ∆%: 1.4 Jul 12 months ∆%: 1.2 Blog 09/25/11
Retail Sales	Jul month ∆%: 0.2 Jul 12 months ∆%: –0.2 Blog 09/11/11
Confidence and Economic Sentiment Indicator	Sentiment 98.3 Aug 2011 down from 107 in Dec 2010 Confidence minus 16.5 Aug 2011 down from 11 in Dec 2010 Blog 09/04/11
Trade	Jan-Jul 2011/2010 Exports ∆%: 15.0 Imports ∆%: 16.0 Blog 09/18/11
HICP, Rate of Unemployment and GDP	Historical from 1999 to 2011 Blog 09/04/11

Links to blog comments in Table EUR:

09/18/11 http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html

09/11/11 http://cmpassocregulationblog.blogspot.com/2011/09/financial-turbulence-wriston-doctrine.html

09/04/11 http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html

08/21/11 http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

07/31/11: http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html

07/24/11: http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html

There is significant volatility in industrial new orders and the euro zone is not an exception. Table 28 shows percentage changes of euro zone industrial new orders. Both monthly changes and 12 months changes are highly volatile. Monthly changes have been negative in the past two months with declines of 1.2 percent in Jun and 2.1 in Jul. The 12 months rates of change have declined from 21.0 percent in Feb to 8.4 percent in Jul. The data consist of values such that moderation of producer prices may influence rates of change.

Table 28, Euro Zone, Industrial New Orders ∆%

	Month	12 Months
Jul 2011	-2.1	8.4
Jun	-1.2	10.6
May	3.7	13.9
Apr	-0.4	11.7
Mar	0.5	14.5
Feb	1.5	21.0
Jan	1.9	21.2
Dec 2010	1.1	18.3

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-22092011-AP/EN/4-22092011-AP-EN.PDF

Table 29 provides the monthly rates of change of new orders by components. There is high volatility even when excluding heavy transport and equipment, increasing 1.4 percent in Jul after falling 3.3 percent in Jun. Capital goods have been somewhat stronger and nondurable goods more moderate. The month of Jun was particularly weak with all segments showing declines with the exception of capital goods.

Table 29, Euro Zone, Industrial New Orders Month ∆%

2011	Jul	Jun	May	Apr	Mar	Feb
Total	-2.1	-1.2	3.7	-0.4	0.5	1.5
Interm.	2.3	-5.3	2.8	-2.1	1.4	0.9
Capital Goods	-2.5	2.6	2.0	2.2	-1.1	0.5
Durable	5.1	-3.4	0.7	1.8	-4.8	2.3
Non- durable	-0.1	-3.1	4.5	1.0	-1.6	1.1
Total Ex Heavy T&E	1.4	-3.3	2.9	-0.5	-0.4	1.3

Note: Interm: Intermediate; T&E: Transport & Equipment

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-22092011-AP/EN/4-22092011-AP-EN.PDF

Rates of change of euro zone industrial orders for a month relative to the same month a year earlier are shown in Table 30 for total manufacturing and components. Growth rates relative to a year earlier have been lower in magnitude with significant oscillations. Data consist of values such that there are influences of prices and quantity changes. Capital goods have performed above the total manufacturing orders. Total growth rates excluding heavy transport and equipment have also been volatile and declining in magnitude.

Table 30, Euro Zone, Industrial New Orders 12 Months ∆%

2011	Jul	Jun	May	Apr	Mar	Feb
Total	8.4	10.6	13.9	11.7	14.5	21.0
Interm.	8.0	5.5	14.8	11.5	19.1	22.3
Capital Goods	11.1	18.1	15.2	16.1	14.6	24.4
Durable	3.8	-5.9	-2.2	0.8	-0.9	8.3
Non- durable	1.8	2.9	9.2	3.5	-0.4	7.9
Total Ex Heavy T&E	8.2	7.7	12.9	10.7	15.2	20.5

Note: Interm: Intermediate; T&E: Transport & Equipment

Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-22092011-AP/EN/4-22092011-AP-EN.PDF

Construction is weak throughout most advanced economies. Growth of euro zone construction output in Table 31 has fluctuated with alternation of negative change. Jul was a better month with growth of 1.4 percent in the month and 1.2 percent in 12 months. With the exception of 3.3 percent in Feb and 1.2 percent in Jul, euro zone 12 months rates of growth have been negative.

Table 31, Euro Zone, Construction Output ∆%

	Month	12 Months
Jul 2011	1.4	1.2
Jun	-1.3	-11.5
May	0.1	-0.8
Apr	0.8	-2.4
Mar	-0.2	-5.3
Feb	-0.5	3.3
Jan	4.0	-4.0
Dec 2010	-2.6	-13.8

Source: http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home

IVE Germany. The Markit Germany Services PMI^® with Composite PMI^® data for manufacturing and services exhibits high association with German GDP since 1997. The composite output index registered 51.3 in Aug, lower than 52.5 in Jul, indicating the slowest expansion of Germany’s private sector out in the 25 months of recovery (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8460). The information shows weakness in both manufacturing and services. The favorable events are reduced pressure in inflation of inputs. The Markit Flash Germany PMI^®, with high association with German GDP since 1997, fell to a 26-month low in Sep of 50.8, at the border of contraction, relative to 51.3 in Aug (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8568). The flash Germany services and manufacturing indexes were at 26 and 24 months lows and the manufacturing output index was the highest in two months. The headline Markit Composite PMI^® has declined for eight consecutive months, the second longest such period of decline after the period May 2008 to Feb 2009. Tim Moore, Senior Economist at Markit, finds the economy close to standstill with growth of both manufacturing and services approximating stagnation. Third-quarter output growth was the weakest in the more than two years of recovery. The outlook is deteriorating with weaker growth trend for new orders than for output. Table DE provides the data table for Germany.

Table DE, Germany, Economic Indicators

GDP	IIQ2011 0.1 ∆%; II/Q2011/IIQ2010 ∆% 2.7 Blog 09/11/11
Consumer Price Index	Aug month SA ∆%: 0.0 Aug 12 months ∆%: 2.4 Blog 09/04/11
Wholesale Price Index	Aug month ∆%: 0.1 12 months NSA ∆%: 6.5 Blog 09/11/11
Industrial Production	Jul month SA ∆%: 4.0 12 months NSA: 6.3 Blog 09/11/11
Machine Orders	Jul month ∆%: -2.8 Jul 12 months ∆%: 5.5 Blog 09/11/11
Retail Sales	Jul Month ∆% 0.0 12 Months ∆% minus 1.6 Blog 09/04/11
Employment Report	Employment Accounts: Jul Employed 12 months NSA ∆%: 1.4 Labor Force Survey: Jul Unemployment Rate: 6.1% Blog 09/04/11
Trade Balance	Exports Jul 12 month NSA ∆%: 4.4 (versus ∆% 3.1 Jun and 19.9 May) Imports Jul 12 months NSA ∆%: 9.9 (versus ∆% 6.0 Jun and 15.7 May) Exports Jul month SA ∆%: minus 1.8 percent, versus Jun minus 1.2; Imports Jul month SA minus 0.3∆% versus Jun 0.3 Blog 09/11/11

Links to blog comments in Table DE:

09/18/11 http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html

09/11/11 http://cmpassocregulationblog.blogspot.com/2011/09/financial-turbulence-wriston-doctrine.html

09/04/11 http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html

IVF France. The Markit France Services PMI^® with Composite PMI^® finds dynamism in services that compensated for the first decline of manufacturing output in 26 month. The result is a composite output index of 53.7 that is slightly higher than 53.2 in Jul (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8533). The Markit Flash France PMI^® registered weakness in all components: composite output falling to 50.7 for a marginal rate of expansion that is the weakest in 26 months; services activity falling to 52.5 in Sep from 56.8 in Aug for the lowest reading in 25 months; manufacturing falling to faster contraction at 47.3 for the lowest reading in 27 months; and manufacturing output falling to faster contraction at 46.6 in Sep, which is the lowest in 28 months (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8565). Jack Kennedy, Senior Economist at Markit, finds commentary that indicates decline in confidence because of the crisis in the eurozone with adverse effects throughout the economy in weaker demand and economic activity. Table FR provides the data table for France.

Table FR, France, Economic Indicators

CPI	Aug month ∆% 0.5 12 months ∆%: 2.2 09/18/11
PPI	Jun month ∆%: –0.1 Jun 12 months ∆%: 6.1
GDP Growth	IIQ2011/IQ2011 ∆%: 0.0 IIQ2011/IIQ2010 ∆%: 1.6 Blog 08/14/11
Industrial Production	Jul/Jun SA ∆%: Industrial Production 1.5; Manufacturing 1.4 Jun 12 months NSA ∆%: Industrial Production 2.8; Manufacturing 4.2 Blog 09/11/11
Consumer Spending	Jun Manufactured Goods ∆%: 1.1 Jun Manufactured Goods ∆%: 2.2 Blog 08/07/11
Employment	IIQ2011 Unemployed 2.580 million Unemployment Rate: 9.1% Employment Rate: 63.9% Blog 09/04/11
Trade Balance	Jul Exports ∆%: month 0.3, 12 months 2.4 Jul Imports ∆%: month 2.9, 12 months 8.6 Blog 09/11/11
Confidence Indicators	Historical averages 100 Mfg Business Climate 99 Household Confidence 80 Wholesale Trade 99 Blog 9/25/11

Links to blog comments in Table FR: 09/18/11 http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html

09/11/11 http://cmpassocregulationblog.blogspot.com/2011/09/financial-turbulence-wriston-doctrine.html

09/04/11 http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

The business climate survey of the Institut National de la Statistique et des Études Économiques (INSEE) of France finds deteriorating conditions in Sep. Table 32 shows the INSEE business climate indicator. The headline synthetic index has fallen to 99, which is below the average since 1976. The final row shows the general production expectations falling to -29, well below the average of -8 since 1976.

Table 32, France, Business Climate Indicator of Manufacturing of INSEE

Mfg	Average since 1976	Jul 2011	Sep 2011
Synthetic Index	100	105	99
Recent Changes in Output	5	15	6
Finished- Goods Inventory Level	13	1	11
Demand and Total Order Levels	-17	-10	-17
Demand and Export Order Levels	-12	-5	-11
Personal Production Expectations	5	6	4
General Production Expectations	-8	3	-29

Source: http://www.insee.fr/en/themes/info-rapide.asp?id=11&date=20110923

Chart 5 of the Institut National de la Statistique et des Études Économiques (INSEE) provides the history of the business climate synthetic index of INSEEsince 1992. The index falls during the contractions of 1991, 2001 and 2008. After rapid recovery beginning in 2009 the synthetic index shows declining trend in 2011.

Chart 5, France, INSEE Business Climate Synthetic Indicators

Source: http://www.insee.fr/en/themes/info-rapide.asp?id=11&date=20110923

Chart 6 of the Institut National de la Statistique et des Études Économiques (INSEE) shows strong drops of the turning point indicator in the recessions of 1991, 2001 and 2008. There have been other drops of this index. The turning point indicator has fallen to levels registered in the past contractions.

Chart 6, INSEE Business Climate Turning Point Indicator

Source: http://www.insee.fr/en/themes/info-rapide.asp?id=11&date=20110923

Chart 7 of the Institut National de la Statistique et des Études Économiques (INSEE) of France shows the indexes of general production expectations, personal production expectations and recent changes in output. All three indexes fell during the past three contractions after 1991, 2001 and 2008. The indexes are showing downward trend in 2011.

Chart 7, INSEE Business Climate General Production, Personal Production and Recent Changes in Output

Source: http://www.insee.fr/en/themes/info-rapide.asp?id=11&date=20110923

Table 34 provides three confidence indicators of the Institut National de la Statistique et des Études Économiques (INSEE) of France for manufacturing climate, household confidence and wholesale trade. All three indexes are below their historical averages since 1976. Household confidence registered 80 in Sep, which is well below the 100 historical average.

Table 34, France, Confidence Indicators

	Average	Jul 2011	Sep 2011
Business Climate Mfg	100 since 1976	105	99
Household Confidence	100 between Jan 1987 and Dec 2010	82	80
Wholesale trade Business Climate	100 since 1979	105	99

Source: http://www.insee.fr/en/default.asp

IVG Italy. The Markit/ADACI Italy Services PMI^® finds contraction of business activity in services in Italy at moderate pace (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8528). The index fell to 48.4 in Aug from 48.6 in Jul, indicating moderate contraction as in manufacturing.

Table IT provides the country data table for Italy.

Table IT, Italy, Economic Indicators

Consumer Price Index	Aug month ∆%: 0.3 Aug 12 months ∆%: 2.8 Blog 09/018/11
Producer Price Index	Jul month ∆%: 0.3 Aug 12 months ∆%: 4.9 Blog 09/04/11
GDP Growth	IIQ2011/IIQ2010 SA ∆%: 0.8 IIQ2011/IQ2011 NSA ∆%: 0.3 Blog 09/11/11
Labor Report	Jul 2011 Participation rate 62% Employment ratio 56.9% Unemployment rate 8.0% Blog 09/04/11
Industrial Production	Jul month ∆%: –0.7 12 months ∆%: -1.6 Blog 09/18/11
Retail Sales	Jul month ∆%: -0.1 Jul 12 months ∆%: -2.4 Blog 09/25/11
Business Confidence	Mfg Aug 99.9, Apr 102.6 Construction Jul 75.8, Apr 73.1 Blog 09/04/11
Consumer Confidence	Consumer Confidence Aug 100.3, Apr 103.7 Economy Aug 70.0, Apr 72.8 Blog 09/04/11
Trade Balance	Balance Jul SA -€ 2196 million versus Jul -€ 1985 Exports Jul month SA ∆%: 1.0 Imports Jul month SA ∆%: 1.6 Exports 12 months NSA ∆%: 5.4 Imports 12 months NSA ∆%: 6.1 Blog 09/18/11

Links to blog comments in Table IT: 09/18/22 http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html

09/11/11 http://cmpassocregulationblog.blogspot.com/2011/09/financial-turbulence-wriston-doctrine.html

09/04/11 http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html

08/14/11 (08/9): http://cmpassocregulationblog.blogspot.com/2011/08/turbulence-in-world-financial-markets.html

08/07/11: http://cmpassocregulationblog.blogspot.com/2011/08/global-growth-recession-25-to-30.html

An important part of the analysis of Blanchard (2011WEOSep) is the much more difficult adjustment of economies with need of fiscal consolidation in the presence of weak economic growth. Demand has significantly weakened throughout the advanced economies. There are many sound fundamentals in Italy such as high income and companies. The restraints consist of low economic growth with high debt/GDP ratio. Table 35 provides retail sales growth for Italy. Besides a zero there are only negative signs. Retail sales fell 0.1 percent in Jul relative to Jun and declined 2.4 percent in the 12 months ending in Jul.

Table 35, Italy, Retail Sales ∆%

	Jul 2011/ Jun 2011 SA	May-Jul 11/ Feb-Apr 11 SA	Jul 2011/ Jul 2010 NSA	Jan-Jul 2011/ Jan-Jul 2010
Total	-0.1	-0.4	-2.4	-0.7
Food	-0.3	0.0	-2.0	-0.2
Non-food	-0.1	-0.5	-2.6	-1.0

Source: http://www.istat.it/it/archivio/39774

A longer perspective of retail sales in Italy is provided by 12 month rates in 2011 and yearly rates from 2008 to 2010 in Table 36. Retail sales did not decline very sharply during the global recession but rose only 0.2 percent in 2010. There is an evident declining trend in 2011.

Table 36, Italy, Retail Sales 12 Months ∆%

	12 Months ∆%
July 2011	-2.4
Jun	-1.1
May	-0.4
Apr	2.2
Mar	-2.1
Feb	0.0
Jan	-1.1
Dec 2010	0.6
2010	0.2
2009	-1.7
2008	-0.3

Source: http://www.istat.it/it/archivio/36712

Chart 8 of the Istituto Nazionale di Statistica (ISTAT) of Italy shows an evident trend of decline of retail sales in Italy. The trend appears to have accelerated in the past four months.

Chart 8, Italy, Retail Trade Index

Source: http://www.istat.it/en/

IVH United Kingdom. The Markit/CIPS UK Services PMI^® finds activity in the UK service sector at its slowest rate in 2011. The Business Activity Index fell 4.3 points in Aug to 51.1, which is the second steepest decline in the history of the index excluding the market crash following Lehman Brothers (http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=8536). The UK private sector is experiencing weakness in manufacturing, services and construction. Table UK provides the country data table for the United Kingdom.

Table UK, UK Economic Indicators


CPI	Aug month ∆%: 0.6 Aug 12 months ∆%: 4.5 Blog 09/18/11
Output/Input Prices	Output Prices: Aug 12 months NSA ∆%: 6.1; excluding food, petroleum ∆%: 3.6 Input Prices: Aug 12 months NSA ∆%: 16.2 Excluding ∆%: 13.0 Blog 09/011/11
GDP Growth	IIQ2011 prior quarter ∆% 02; year earlier same quarter ∆%: 0.7 Blog 08/28/11
Industrial Production	Jul 2011/Jul 2010 NSA ∆%: Industrial Production -0.7; Manufacturing 1.9 Jul/Jun 2011 ∆%: Industrial Production -0.2 Manufacturing 0.1 Blog 09/11/11
Retail Sales	Aug month SA ∆%: 0.0 Jul 12 months ∆%: 4.7 Blog 09/18/11
Labor Market	May-Jul Unemployment Rate: 7.9% Blog 09/18/11
Trade Balance	Balance Jul -₤4,450 billion Exports Jul ∆%: 3/2 May/Jul ∆%: 8.1 Imports Jun ∆%: 2.9 May/Jul ∆%: 8.1 Blog 09/18/11

Links to blog comments in Table UK: 09/25/11 http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html

09/11/11 http://cmpassocregulationblog.blogspot.com/2011/09/financial-turbulence-wriston-doctrine.html

09/04/11 http://cmpassocregulationblog.blogspot.com/2011/09/global-growth-standstill-recession.html

08/28/11 http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html

V 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/2011/07/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 37 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 the unconventional monetary policy 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 37 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 13.3 percent by Fri Sep 23, 2011. 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 and cause misallocation of resources toward less productive economic activities. The last row of Table 37 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 37, 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	09/23 /2011
Rate	1.1423	1.5914	1.192	1.35
CNY/USD	01/03 2000	07/21 2005	7/15 2008	09/23 2011
Rate	8.2798	8.2765	6.8211	6.388
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://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

ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

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

Table 38 extracts four rows of Table 27 with the Dollar/Euro (USD/EUR) 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 30 below, the dollar has devalued again to USD 1.35/EUR or by 15.7 percent. 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. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD until it revalued to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent and after fixing it again to the dollar, revalued to CNY 6.388/USD on Fri Sep 23, 2011, or by an additional 6.3 percent, for cumulative revaluation of 22.8 percent.

Table 38, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate

USD/EUR	6/26/03	7/14/08	6/07/10	09/23 /2011
Rate	1.1423	1.5914	1.192	1.35
CNY/USD	01/03 2000	07/21 2005	7/15 2008	09/23 2011
Rate	8.2798	8.2765	6.8211	6.388

Source: Table 37.

Dollar devaluation did not eliminate the US current account deficit, which is projected by the International Monetary Fund (IMF) with the new database of Sep 2011 at 3.1 percent of GDP in 2011 and at 2.2 percent of GDP in 2015, as shown in Table 39. Revaluation of the CNY has not reduced the current account surplus of China, which is projected by the IMF to increase from 5.2 percent of GDP in 2011 to 7.0 percent of GDP in 2015.

Table 39, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2011 Dollar GDP

	GDP $B 2011	FD %GDP 2011	CAD %GDP 2011	Debt %GDP 2011	FD%GDP 2015	CAD%GDP 2015	Debt %GDP 2015
US	15065	-7.9	-3.1	72.6	-3.1	-2.2	86.7
Japan	5855	-8.9	2.5	130.5	-8.4	2.4	160.0
UK	2481	-5.7	-2.7	72.9	0.4	-0.9	75.2
Euro	13355	-1.5	0.1	68.6	1.5	0.5	69.3
Ger	3629	0.4	5.0	56.9	2.1	4.7	55.3
France	2808	-3.4	-2.7	80.9	-2.5	0.6	83.9
Italy	2246	0.5	-3.5	100.4	4.5	-2.0	96.7
Can	1759	-3.7	-3.3	34.9	0.3	-2.6	35.1
China	6988	-1.6	5.2	22.2	0.1	7.0	12.9
Brazil	2518	3.2	-2.3	38.6	2.9	-3.2	34.1

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: http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/index.aspx

There is a new carry trade that learned from the losses after the crisis of 2007 or learned from the crisis how to avoid losses. The sharp rise in valuations of risk financial assets shown in Table 37 above after the first policy round of near zero fed funds and quantitative easing by the equivalent of withdrawing supply with the suspension of the 30-year Treasury auction was on a smooth trend with relatively subdued fluctuations. The credit crisis and global recession have been followed by significant fluctuations originating in sovereign risk issues in Europe, doubts of continuing high growth and accelerating inflation in China, events such as in the Middle East and Japan and legislative restructuring, regulation, insufficient growth, falling real wages, depressed hiring and high job stress of unemployment and underemployment in the US now with realization of growth standstill recession. The “trend is your friend” motto of traders has been replaced with a “hit and realize profit” approach of managing positions to realize profits without sitting on positions. There is a trend of valuation of risk financial assets driven by the carry trade from zero interest rates with fluctuations provoked by events of risk aversion. Table 40, which is updated for every comment of this blog, shows the deep contraction of valuations of risk financial assets after the Apr 2010 sovereign risk issues in the fourth column “∆% to Trough.” There was sharp recovery after around Jul 2010 in the last column “∆% Trough to 09/23/11,” which has been recently stalling or reversing amidst profound risk aversion. “Let’s twist again” monetary policy during the week of Sep 23 caused deep worldwide risk aversion and selloff of risk financial assets. Monetary policy was designed to increase risk appetite but instead suffocated risk exposures. Recovering risk financial assets in column “∆% Trough to 09/23/11” are in the range from 0.8 percent for the Shanghai Composite and 15.4 percent for the DJ UBS Commodity Index. The carry trade from zero interest rates to leveraged positions in risk financial assets has proved strongest for commodity exposures. Before the current round of risk aversion, all assets in the column “∆% Trough to 09/23/11” had double digit gains relative to the trough around Jul 2, 2010. There are now several valuations lower than those at the trough around Jul 2: European stocks index STOXX 50 is now 5.8 percent below the trough on Jul 2, 2010; the NYSE Financial Index is 11.7 percent below the trough on Jul 2, 2010; Germany’s DAX index is 8.4 percent below; and Japan’s Nikkei Average is 2.9 below the trough on Aug 31, 2010 and 24.9 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 8560.25 on Fri Sep 23, which is 16.5 percent below 10,254.43 on Mar 11 on the date of the earthquake. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 13.3 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 09/23/2011” shows sharp losses for all risk financial assets in Table 40. The realization that there were no more remedies of monetary policy for the global economic slowdown caused flight away from exposures in risk financial assets. There are still high uncertainties on European sovereign risks, US and world growth recession and China’s growth and inflation tradeoff. 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 40 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 9/23/11” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Jul 29. Most financial risk assets had gained not only relative to the trough as shown in column “∆% Trough to 9/23/11” but also relative to the peak in column “∆% Peak to 9/23/11.” There are now no indexes above the peak, not even the DJ UBS Commodity Index that is 1.3 percent below the peak. There are several indexes well below the peak: NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) by 29.7 percent, Nikkei Average by 24.9 percent, Shanghai Composite by 24.7 percent, STOXX 50 by 24.4 percent and Dow Global by 18.4 percent. S&P 500 is lower relative to the peak by 6.5 percent, DJ Asia Pacific is lower by 11.8 percent and the DJIA is lower by 6.4 percent. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr is more important than the performance relative to the trough around early Jul because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. The situation of risk financial assets has worsened.

Table 40, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 9/ 23/11	∆% Week 9/ 23/11	∆% Trough to 9/ 23/11
DJIA	4/26/ 10	7/2/10	-13.6	-3.9	-6.4	11.2
S&P 500	4/23/ 10	7/20/ 10	-16.0	-6.6	-6.5	11.1
NYSE Finance	4/15/ 10	7/2/10	-20.3	-29.7	-8.6	-11.7
Dow Global	4/15/ 10	7/2/10	-18.4	-18.5	-7.6	-0.2
Asia Pacific	4/15/ 10	7/2/10	-12.5	-11.8	-7.0	0.8
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-24.9	-3.4	-2.9
China Shang.	4/15/ 10	7/02 /10	-24.7	-23.1	-1.9	2.1
STOXX 50	4/15/10	7/2/10	-15.3	-24.4	-5.2	-10.7
DAX	4/26/ 10	5/25/ 10	-10.5	-17.9	-6.8	-8.4
Dollar Euro	11/25 2009	6/7 2010	21.2	10.8	2.1	-13.3
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-1.3	-9.1	15.4
10-Year Tre.	4/5/ 10	4/6/10	3.986	2.053

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 41 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 31 for Sep 23 shows that the S&P 500 is now 6.2 percent below the Apr 26, 2010 level and the DJIA is 3.9 percent below the level on Apr 26, 2010. Multiple rounds of risk aversion eroded the earlier gains, showing that risk aversion can destroy market value even with zero interest rates. 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 41, Percentage Changes of DJIA and S&P 500 in Selected Dates

2010	∆% DJIA from prior date	∆% DJIA from Apr 26	∆% S&P 500 from prior 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
Apr 1	1.3	10.5	1.4	9.9
Apr 8	0.03	10.5	-0.3	9.6
Apr 15	-0.3	10.1	-0.6	8.9
Apr 22	1.3	11.6	1.3	10.3
Apr 29	2.4	14.3	1.9	12.5
May 6	-1.3	12.8	-1.7	10.6
May 13	-0.3	12.4	-0.2	10.4
May 20	-0.7	11.7	-0.3	10.0
May 27	-0.6	11.0	-0.2	9.8
Jun 3	-2.3	8.4	-2.3	7.3
Jun 10	-1.6	6.7	-2.2	4.9
Jun 17	0.4	7.1	0.04	4.9
Jun 24	-0.6	6.5	-0.2	4.6
Jul 1	5.4	12.3	5.6	10.5
Jul 8	0.6	12.9	0.3	10.9
Jul 15	-1.4	11.4	-2.1	8.6
Jul 22	1.6	13.2	2.2	10.9
Jul 29	-4.2	8.4	-3.9	6.6
Aug 05	-5.8	2.1	-7.2	-1.0
Aug 12	-1.5	0.6	-1.7	-2.7
Aug 19	-4.0	-3.5	-4.7	-7.3
Aug 26	4.3	0.7	4.7	-2.9
Sep 02	-0.4	0.3	-0.2	-3.1
Sep 09	-2.2	-1.9	-1.7	-4.8
Sep 16	4.7	2.7	5.4	0.3
Sep 23	-6.4	-3.9	-6.5	-6.2

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

Table 42, updated with every post, 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 is expected to continue because of zero fed funds rate, expectations of rising inflation, the large budget deficit of the federal government (http://professional.wsj.com/article/SB10001424052748703907004576279321350926848.html?mod=WSJ_hp_LEFTWhatsNewsCollection) and now zero interest rates indefinitely but with interruptions caused by risk aversion events. Such an event actually occurred in the week of Sep 23 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. Column “Peak” in Table 42 shows exchange rates during the crisis year of 2008. There was a flight to safety in dollar-denominated government assets as a result 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 appreciating to the trough of ZAR 7.238/USD by Aug 15, 2010 but now depreciating by 11.9 percent to ZAR 8.105/USD on Apr 23, which is still 29.9 percent stronger than on Oct 22, 2008. An example from Asia is the Singapore Dollar (SGD) highly depreciated at the peak of SGD 1.553/USD on Mar 3, 2009 but subsequently appreciating by 13.2 percent to the trough of SGD 1.348/USD on Aug 9, 2010 but is now only 3.8 percent stronger at SGD 1.297/USD on Sep 23 relative to the trough of depreciation but still stronger by 16.5 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 on Dec 5, 2008 but appreciated to the trough at BRL 1.737/USD on Apr 30, 2010, showing the first depreciation relative to the trough to BRL 1.832/USD on Sep 23 but still stronger by 24.6 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. Unconventional monetary policy of zero interest rates and quantitative easing creates trends such as the depreciation of the dollar followed by Table 42 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 42, Exchange Rates

	Peak	Trough	∆% P/T	Sep 23, 2011	∆T Sep 23 2011	∆P Sep 23 2011
EUR USD	7/15 2008	6/7 2010		9/23 2011
Rate	1.59	1.192		1.35
∆%			-33.4		11.7	-17.8
JPY USD	8/18 2008	9/15 2010		9/23 2011
Rate	110.19	83.07		76.59
∆%			24.6		7.8	30.5
CHF USD	11/21 2008	12/8 2009		9/23 2011
Rate	1.225	1.025		0.903
∆%			16.3		11.9	26.3
USD GBP	7/15 2008	1/2/ 2009		9/23 2011
Rate	2.006	1.388		1.545
∆%			-44.5		10.2	-29.8
USD AUD	7/15 2008	10/27 2008		9/23 2011
Rate	1.0215	1.6639		0.978
∆%			-62.9		38.5	-0.1
ZAR USD	10/22 2008	8/15 2010		9/23 2011
Rate	11.578	7.238		8.105
∆%			37.5		-11.9	29.9
SGD USD	3/3 2009	8/9 2010		9/23 2011
Rate	1.553	1.348		1.297
∆%			13.2		3.8	16.5
HKD USD	8/15 2008	12/14 2009		9/23 2011
Rate	7.813	7.752		7.804
∆%			0.8		-0.7	0.1
BRL USD	12/5 2008	4/30 2010		9/23 2011
Rate	2.43	1.737		1.832
∆%			28.5		-5.5	24.6
CZK USD	2/13 2009	8/6 2010		9/23 2011
Rate	22.19	18.693		18.251
∆%			15.7		2.4	17.8
SEK USD	3/4 2009	8/9 2010		9/23 2011
Rate	9.313	7.108		6.93
∆%			23.7		2.5	25.6
CNY USD	7/20 2005	7/15 2008		9/23 2011
Rate	8.2765	6.8211		6.388
∆%			17.6		6.3	22.8

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

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

Table 43, updated with every blog comment, 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 new coupons such as 3.63 percent in recent auctions (http://www.treasurydirect.gov/instit/annceresult/press/preanre/2011/2011.htm) are not comparable to prices in Table 43. 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, subsequently by the tragic earthquake and tsunami in Japan and now again by the sovereign risk doubts in Europe and the growth recession in the US and the world. The yield of 1.825 percent at the close of market on Fr Sep 23, 2011 would be equivalent to price of 107.2727 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price gain of 5.9 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, recurring fears on European sovereign credit issues and worldwide risk aversion in the week of Sep 23 caused by “let’s twist again” monetary policy. The realization of a growth standstill recession is also influencing yields. Important causes of the earlier rise in yields shown in Table 43 are expectations of rising inflation and US government debt estimated to exceed 70 percent of GDP in 2012 (http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html), rising from 40.8 percent of GDP in 2008, 53.5 percent in 2009 (Table 2 in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html) and 69 percent in 2011. On Sep 14, 2011, the line “Reserve Bank credit” in the Fed balance sheet stood at $2841 billion, or $2.8 trillion, with portfolio of long-term securities of $2622 billion, or $2.6 trillion, consisting of $1568 billion Treasury nominal notes and bonds, $67 billion of notes and bonds inflation-indexed, $108 billion Federal agency debt securities and $879 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $1546 billion or $1.5 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). There is no simple exit of this trap created by the highest monetary policy accommodation in US history together with the highest deficits and debt in percent of GDP since World War II. Risk aversion from various sources, discussed in section III World Financial Turbulence, has been affecting financial markets for several weeks. The risk is that in a reversal of risk aversion that has been typical in this cyclical expansion of the economy yields of Treasury securities may back up sharply.

Table 43, 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
04/01/11	3.445	93.1129	-8.0
04/08/11	3.576	92.0635	-9.1
04/15/11	3.411	93.3874	-7.8
04/22/11	3.402	93.4646	-7.7
04/29/11	3.290	94.3759	-6.8
05/06/11	3.147	95.5542	-5.6
05/13/11	3.173	95.3387	-5.8
05/20/11	3.146	95.5625	-5.6
05/27/11	3.068	96.2089	-4.9
06/03/11	2.990	96.8672	-4.3
06/10/11	2.973	97.0106	-4.2
06/17/11	2.937	97.3134	-3.9
06/24/11	2.872	97.8662	-3.3
07/01/11	3.186	95.2281	-5.9
07/08/11	3.022	96.5957	-4.6
07/15/11	2.905	97.5851	-3.6
07/22/11	2.964	97.0847	-4.1
07/29/11	2.795	98.5258	-2.7
08/05/11	2.566	100.5175	-0.7
08/12/11	2.249	103.3504	2.1
08/19/11	2.066	105.270	3.7
08/26/11	2.202	103.7781	2.5
09/02/11	1.992	105.7137	4.4
09/09/11	1.918	106.4055	5.1
09/16/11	2.053	101.5434	0.3
09/23/11	1.826	107.2727	5.9

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

VI Economic Indicators. Crude oil input in refineries fell to 15,306 thousand barrels per day on average in the four weeks ending on Sep 16 from 15,395 thousand barrels per day in the four weeks ending on Sep 9, as shown in Table 44. The rate of capacity utilization in refineries continues at a high level close of 89.3 percent. Imports of crude oil fell from 8,846 thousand barrels per day on average to 8,731 thousand barrels per day. Decreasing utilization with decreasing imports resulted in decrease of commercial crude oil stocks by 7.4 million barrels from 346.4 million barrels on Sep 9 to 339.0 million on Sep 16. Gasoline stocks rose 3.3 million barrels and stocks of fuel oil declined by 1.7 million barrels. Supply of gasoline fell from 9,196 thousand barrels per day on Sep 10, 2010, to 9,011 thousand barrels per day on Sep 17, 2011, or by 1.7 percent, while fuel oil supply rose 0.5 percent. Part of the fall in consumption of gasoline is due to higher prices and part to the growth recession. Table 34 also shows increase in WTI price by 21.4 percent from Sep 17, 2010 to Sep 16, 2011. Gasoline prices rose by 32.2 percent from Sep 20, 2010 to Sep 19, 2011. Increases in prices of crude oil and gasoline relative to a year earlier are moderating because year earlier prices are already reflecting the commodity price surge and commodity prices have been declining recent during worldwide risk aversion.

Table 44, US, Energy Information Administration Weekly Petroleum Status Report

Four Weeks Ending Thousand Barrels/Day	09/16/11	09/09/11	09/17/10
Crude Oil Refineries Input	15,306	15,395	14,947
Refinery Capacity Utilization %	88.3	88.9	87.7
Motor Gasoline Production	9,295	9,361	9,249
Distillate Fuel Oil Production	4,555	4,607	4,319
Crude Oil Imports	8,731	8,846	9,196
Motor Gasoline Supplied	8,973 ∆% 2011/2010= –1.7%	9,011	9,129
Distillate Fuel Oil Supplied	3,868 ∆% 2011/2010 = 0.5%	3,862	3,848
	09/16/11	09/09/11	09/17/10
Crude Oil Stocks Million B	339.0 ∆= –7.4MB	346.4	358.3
Motor Gasoline Million B	214.1 ∆= 3.3 MB	210.8	226.1
Distillate Fuel Oil Million B	157.6 ∆= –0.9 MB	158.5	174.9
WTI Crude Oil Price $/B	89.40 ∆% 2011/2010 21.4	89.05	73.63
	09/19/11	09/12/11	09/20/10
Regular Motor Gasoline $/G	3.601 ∆% 2011/2010 32.2	3.661	2.723

B: barrels; G: gallon

Source: http://www.eia.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/pdf/highlights.pdf

Chart 9 of the US Energy Information Administration shows the commercial stocks of crude oil of the US. There have been fluctuations around an upward trend since 2005. Stocks have declined in the past few weeks.

Chart 9, US, Weekly Crude Oil Ending Stocks

Source: http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCESTUS1&f=W

Chart 10 of the US Energy Information Administration shows the price of WTI crude oil since the 1980s. Chart 10 captures the commodity shocks during the past decade. The illusion of deflation was caused by the decline in oil prices resulting from the recession of 2001. The upward trend after 2003 was promoted by the carry trade from near zero interest rates. The jump above $140/barrel during the global recession in 2008 can only be explained by the carry trade promoted by monetary policy collapsing to zero. After moderation of risk aversion, the carry trade returned with resulting sharp upward trend of crude prices.

Chart 10, Crude Oil Cushing, OK, Contract 1

Source: http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RCLC1&f=D

Chart 11 of the US Energy Information Administration reveals the sharp rise of gasoline prices in 2010-2011 relative to more subdued prices in 2009-2010. Carry trade benefitting from more moderate risk aversion explains the difference. Risk aversion has ended the surge in commodity prices.

Chart 11, US, Regular Gasoline Prices

Source: http://www.eia.gov/oog/info/gdu/gasdiesel.asp

Chart 12 of the US Energy Information Administration provides the price of a gallon of gasoline at the retail pump in terms of costs. Crude oil represents 68 percent of costs, refining 15 percent and taxes 11 percent for joint 94 percent.

Chart 12, Gasoline Retail Price Costs

Source: http://www.eia.gov/oog/info/gdu/gasdiesel.asp

Initial claims for unemployment insurance are shown in Table 45. Seasonally adjusted claims fell 9000 from 432,000 in the week of Sep 10 to 423,000 on Sep 17. Not seasonally adjusted claims rose 21,308 from 328,868 in the week of Sep 10 to 350,176 in the week of Sep 17.

Table 45, US, Initial Claims for Unemployment Insurance

2011	SA	NSA	4-week MA SA
Sep 17	423,000	350,176	421,000
Sep 10	432,000	328,868	420,500
Change	-9,000	+21,308	+500
Sep 3	417,000	348,582	415,500
Prior Year	463,000	382,341	459,000

Note: SA: seasonally adjusted; NSA: not seasonally adjusted; MA: moving average

Source: http://www.dol.gov/opa/media/press/eta/ui/current.htm

Table 46 uses the database of the Bureau of Labor Statistics (BLS) of the Department of Labor to obtain seasonally adjusted and not seasonally adjusted claims during the comparable week in Sep from 2000 to 2011. Seasonally-adjusted claims always exceed not seasonally adjusted claims. Both seasonally and not seasonally adjusted claims have declined from the levels of recession in 2008 and 2009. The difference in the current labor market is the decline of hiring by 17 million per year that makes adjustment to layoffs quite difficult

Table 46, US, Unemployment Insurance Weekly Claims

	Not Seasonally Adjusted Claims	Seasonally Adjusted Claims
Sep 16, 2000	245,991	311,000
Sep 15, 2001	317,245	395,000
Sep 14, 2002	337,577	412,000
Sep 20, 2003	301,217	379,000
Sep 18, 2004	275,846	341,000
Sep 17, 2005	346,204	424,000
Sep 16, 2006	267,036	324,000
Sep 15, 2007	261,971	315,000
Sep 20, 2008	397,600	484,000
Sep 19, 2009	441,311	537,000
Sep 18, 2010	382,341	463,000
Sep 17, 2011	350,176	423,000

Source: http://workforcesecurity.doleta.gov/unemploy/finance.asp

VII Interest Rates. It is quite difficult to measure inflationary expectations because they tend to break abruptly from past inflation. There could still be an influence of past and current inflation in the calculation of future inflation by economic agents. Table 47 provides inflation of the CPI. In Jan-Aug 2011, CPI inflation for all items seasonally adjusted was 4.1 percent in annual equivalent, that is, compounding inflation in the first eight months and assuming it would be repeated during the remainder of 2011. In the 12 months ending in Aug, CPI inflation of all items not seasonally adjusted was 3.8 percent. The second row provides the same measurements for the CPI of all items excluding food and energy: 2.6 percent annual equivalent in Jan-Aug and 2.0 percent in 12 months. Bloomberg provides the yield curve of US Treasury securities (http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/). The lowest yield is 0.00 percent for three months or zero, 0.01 percent for six months, 0.09 percent for 12 months, 0.21 percent for two years, 0.36 percent for three years, 0.86 percent for five years, 1.33 percent for seven years, 1.81 percent for ten years and 2.86 percent for 30 years. The Irving Fisher definition of real interest rates is approximately the difference between nominal interest rates, which are those estimated by Bloomberg, and the rate of inflation expected in the term of the security, which could behave as in Table 47. Real interest rates in the US have been negative during substantial periods in the past decade while 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”

Negative real rates of interest distort calculations of risk and returns from capital budgeting by firms, through lending by financial intermediaries to decisions on savings, housing and purchases of households. Inflation on near zero interest rates misallocates resources away from their most productive uses and creates uncertainty of the future path of adjustment to higher interest rates that inhibit sound decisions.

Table 47, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%

	∆% 12 Months Aug 2011/Aug 2010 NSA	∆% Annual Equivalent Jan-Aug 2011 SA
CPI All Items	3.8	4.1
CPI ex Food and Energy	2.0	2.6

Source: http://www.bls.gov/news.release/pdf/cpi.pdf

VIII Conclusion.

The crucial issue of “let’s twist again “ monetary policy is if lowering the yields of long-term Treasury securities would have any impact on investment and consumption or aggregate demand. The decline of long-term yields of Treasury securities would have to cause decline of yields of asset-backed securities used to securitize loans for investment by firms and purchase of durable goods by consumers. The decline in costs of investment and consumption of durable goods would ultimately have to result in higher investment and consumption. It is possible that the decline in yields captured by event studies is ephemeral. The decline in yields just after “let’s twist again” monetary policy this week was caused by the flight out of risk financial assets into Treasury securities, which is the opposite of the desired effect of encouraging risk-taking in asset-backed securities and lending.

(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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Appendix I. The Great Inflation

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 I1 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 I1 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.”

Chart I1, Brazil, Phillips Circuit 1963-1987

©Carlos Manuel Pelaez, O cruzado e o austral. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.

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 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/2011/05/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). 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). TableI1 provides the change in GDP, CPI and the rate of unemployment from 1960 to 1990. There are three waves of inflation (1) in the second half of the 1960s; (2) from 1973 to 1975; and (3) from 1978 to 1981. In one of his multiple important contributions to understanding the Great Inflation, Meltzer (2005) distinguishes between one-time price jumps, such as by oil shocks, and a “maintained” inflation rate. Meltzer (2005) uses a dummy variable to extract the one-time oil price changes, resulting in a maintained inflation rate that was never higher than 8 to 10 percent in the 1970s. There is revealing analysis of the Great Inflation and its reversal by Meltzer (2005, 2010a, 2010b).

Table I1, 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.bea.gov/national/nipaweb/TableView.asp?SelectedTable=2&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=2009&LastYear=2010&3Place=N&Update=Update&JavaBox=no

http://www.bls.gov/web/empsit/cpseea01.htm

http://data.bls.gov/pdq/SurveyOutputServlet

There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table I2 when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table I2 shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.

Table I2, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994

1994	FF	30Y	30P	10Y	10P	MOR	CPI
Jan	3.00	6.29	100	5.75	100	7.06	2.52
Feb	3.25	6.49	97.37	5.97	98.36	7.15	2.51
Mar	3.50	6.91	92.19	6.48	94.69	7.68	2.51
Apr	3.75	7.27	88.10	6.97	91.32	8.32	2.36
May	4.25	7.41	86.59	7.18	88.93	8.60	2.29
Jun	4.25	7.40	86.69	7.10	90.45	8.40	2.49
Jul	4.25	7.58	84.81	7.30	89.14	8.61	2.77
Aug	4.75	7.49	85.74	7.24	89.53	8.51	2.69
Sep	4.75	7.71	83.49	7.46	88.10	8.64	2.96
Oct	4.75	7.94	81.23	7.74	86.33	8.93	2.61
Nov	5.50	8.08	79.90	7.96	84.96	9.17	2.67
Dec	6.00	7.87	81.91	7.81	85.89	9.20	2.67

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

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

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Sunday, September 25, 2011

IMF View of World Economy and Finance, “Let’s Twist Again” Monetary Policy Worsening World Financial Turbulence and Global Growth Standstill