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by Victor A. Canto
Economic Disturbances and Equilibrium in an Integrated Global Economy
Cover
Title page
Table of Contents
Copyright
Preface
Introduction: Asset Allocation: Indexing, Smart Beta, and ValueTiming
Section I: Arbitrage and Mobility
Chapter 1: Arbitrage, Mobility, and Equilibrium Prices
Abstract
A 2X2X2X2 World
Equilibrium Under Autarky
Global and National Equilibrium
Global Equilibrium and the Trade Accounts
The Terms of Trade or Real Exchange Rate
Interest Rate Parity
What Happens When the Terms of Trade Change in Predictable Directions?
Adding the Final X2
Mobility, Trade, and the Equalization of Price and Factor Returns Across Borders
Transportation Costs and Overall Equilibrium
Mobility and the Incidence of Taxes and Other Economic Shocks
The Speed of Adjustment to a New Equilibrium
Chapter 2: Practical Applications: The Investment and Policy Insights and Implications Derived From Arbitrage and Mobility
Abstract
Is the Law of One Price a Useful Concept?
Convergence: The Implementation of the Euro
The Convergence and Postconvergence Euro Environments
Divergence: The Dismantling of Bretton Woods
The Local Inflation Results
Does the Law of One Price Still Hold?
Are the Terms of Trade Constant?
Chapter 3: Are Commodity Price Increases Equivalent to Tax Increases?
Abstract
Are Commodity Price Increases a Harbinger of Future Inflation?
Solving the Signal Extraction Problem
Searching for the Equivalence between Price and Tax Increases
Does the Price/Tax Equivalence Always Hold?
Considering the Different Possibilities
Interpreting Relative Price Swings
Is a Commodity Relative Price Increase Bullish or Bearish?
Chapter 4: The Terms of Trade
Abstract
A Broader Estimate
Policy Links
The Adjustment Process: Investment Implications
Does Our Theory Hold Water?
Does the Relationship Hold for Other Countries?
Chapter 5: Yields, Risk Premium, and Terms of Trade
Abstract
The Different States of the World
Identifying the Different Environments
Summary
Chapter 6: The Competitive Economic Environment: Lessons From the States
Abstract
The States’ Competitive Environment
The States’ Income Tax Rates as a Proxy for Their Competitive Environment
The Evidence: The Changing Competitive Environment
The Interaction Among States’ Migration, State Income Tax Rates, and Right to Work
Brain Drain?
Summary
Chapter 7: Economic Policy and Performance: The Small-Cap and Country Effect
Abstract
A Framework for Regional Economic Performance
The Ranking of the States
Application: The States’ GDP Relative Performance
Application: The States’ Relative Stock Return Performance and the Size Effect
Investment Implications
Chapter 8: Migration: A Political Problem, an Economic Problem, or Both?
Abstract
Migration: Europe and the Middle East
Where Will the Migrants Go and What Will Be Their Economic Impact on These Economies?
Politics or Economics?
Is Europe Unique or Are These Effects Universal?
The Recent US Experience
Immigration as an Economic Problem
Who Should be Coming Into the Country?
How Would We Modify Immigration: What to Look for and How to Take Into Account the Policy Interactions?
The Economic Determinants of Migration
The Anchor Babies
The Politics of Immigration
The Burden of Adjustment
Section II: The Trade Balance
Chapter 9: Global Investing: The Macro Prospective Building Blocks
Abstract
The Framework
The Monetary System
The Exchange Rate and the Organization of the Monetary System
The Trade Balance and Capital Flows
What Happens When the Terms of Trade Change in Predictable Directions?
Chapter 10: Diversity and Harmonization
Abstract
Autarkic Equilibrium
Free Trade Equilibrium
Some Generalizations
The Link Between Consumption Harmonization and Production Divergence
The Politics of Job Protection Policies
Diversity and Harmonization
Chapter 11: The State Competitive Environment: Integration and Convergence
Abstract
A Framework for Regional Economic Performance
The Degree of Economic Integration
Some Evidence
States’ Fiscal Policies Could Potentially Impact the Degree of Integration
The Measurement of the Differences in Policies Across the States
The States’ Relative Marginal Tax Rates
Investment Strategy
Limitations of the State Competitive Environment as an Investment Strategy
Competitiveness, Integration, and Convergence
Chapter 12: The Degree of Global Integration and National Economies’ Policy Options and Limitations
Abstract
The Integrated Economy
The Price and Output Adjustment to a New Equilibrium
The Demand and Supply Response
Transportation Costs and the Degree of Integration
China and the Commodity Supercycle in the Context of an Integrated Global Economy
The Commodity Supercycle
Policy Differences and the Degree of Integration in an Economy Output Level
China’s Impact on the Global Economy’s Equilibrium Output
Implications and Insights
Chapter 13: A Unified Theory: Terms of Trade, Real GDP Growth Rate Differentials, the Trade Balance, Capital Flows, and the Relative Stock Market Performance
Abstract
The Two Possibilities
The Terms of Trade
The Global Economy’s Adjustments to Economic Disturbances and the Correlation Among the Key Economic Variables
What Does the Global Data Tell Us?
A Unified Theory
Appendix
Section III: Exchange Rate and the Terms of Trade
Chapter 14: Protectionism, Devaluation, and the Terms of Trade
Abstract
The Nominal Exchange Rate
Floating Exchange Rates, Purchasing Power Parity, and the Terms of Trade
Currency Manipulation
Terms of Trade Changes, the Wealth Effect, and the Transfer Problem
A Signal Extraction Problem
Chapter 15: Exchange Rates, Devaluations, and the Terms of Trade
Abstract
The Equivalence Between Currency Manipulation and Countervailing Duties
Why Tariffs May Fail
The Protectionist Case for Exchange Rate Management
The Case Against Devaluation or Revaluation
More on the Case Against the Nominal Exchange Rate
Expanding the View
The Big Mac Standard
The Real Exchange Rate or Terms of Trade as an Indicator
The Better and Broader Measure
Chapter 16: The Nominal Exchange Rate, the Terms of Trade, and the Economy
Abstract
Expanding the Framework to Include Transportation Costs
What Drives the Nominal Exchange Rate?
Devaluation and Terms of Trade Effects
A Signal Extraction or a Conceptual Problem?
What Moves the Exchange Rates and Terms of Trade?
The Economic Performance During the Cycles
The Events
Mexico and the Tequila Effect
The Thai Blood Baht and the Asian Flu
The Russian Crisis
The Commodity Super Cycle
China
Chapter 17: The US Experience: An Interpretation
Abstract
Trade Balance: Value or Growth Signal?
The Trade Balance and the Economy’s Price Earnings Ratio
Trade, Employment, and Growth
Do Exports Create Jobs? What About Imports?
Economic Growth, the Trade Balance, and the Stock Market Performance
The Exchange Rate and Terms of Trade
Chapter 18: Relative Price Changes, Income Redistribution, and the Politics of Envy
Abstract
Necessary Conditions
Agricultural Commodities, the New Oil?
Impact of Agricultural Price Support Programs
Unintended Consequences: Economic Dependency
Economic Growth and Price Support Programs
Unintended Consequences: Oil and Agricultural Products
A Warning
More Unintended Consequences: Starvation
More Unintended Consequences: Trade Restrictions
A Generalization
Mercantilism Does Not Make For Good Economics
Protectionists Versus Free Trade Arguments
The Facts
Chapter 19: Self-Sufficiency, Nationalism, and Protectionism: The Common Elements
Abstract
Self-Sufficiency Policies: Potential Pitfalls
The Narrow View
Budget Constraints and Self-Sufficiency Policies
Self-Sufficiency or Trade Restriction Policy Equivalences
Winners and Losers and the Politics of Special Interest Groups
Intertemporal Considerations
Is Self-Sufficiency and Protectionism the Answer?
Chapter 20: Immigration and Protectionism
Abstract
Illegal Immigration
Security
Crime
Legal Immigration: Economic Issues
The Case for a Skills-Based Immigration System
The Unintended Consequences of an Immigration System
The Effect of Alternative Immigration Schemes
Chapter 21: Trade Policy, Protectionism, and Currency Manipulation
Abstract
Global Implications of an Anticurrency Manipulation Policy
Will Currency Manipulation Deliver the Goods?
China
Chapter 22: Protectionism and Trade Policy
Abstract
The Trade Balance and Real GDP Growth
The Trade Balance and the Capital Account
The Conquest by Purchase
Section IV: The Balance of Payments
Chapter 23: Global Investing: The Balance of Payments
Abstract
The Monetary System
Extending the Framework to Account for Multiple Economies and Currencies
The Global and Individual Countries’ Monetary Equilibrium Under a Floating Exchange Rate
Variations on a Theme: Alternative Assumption Regarding the Money Demand Functions
Scenario 1: The Textbook Scenario Where Each Country Exclusively Uses Its Own Currency in All Domestic Transactions
Scenario 2: Each Country Uses Both Currencies in Domestic Transactions
Implications and Insights
Scenario 3: One Country’s Currency Circulates Both at Home and Abroad, but the Second Country’s Currency Only Circulates at Home
Extending the Framework: Accounting for Alternative Operating Procedures by the Monetary Authorities
Scenario 1: Each Country’s Central bank Is Committed to not Allowing Its Currency to Appreciate and Thereby Lose What They Perceive to Be a Comparative Advantage Due to an Exchange Rate Appreciation
Scenario 2: Each Country Central Bank Is Committed to Not Allowing the Other Country’s Currency to Depreciate and Thereby Prevent the Other Country From Gaining What They Perceive to Be a Comparative
Scenario 3: One of the Country’s Central Bank Decides to Fix Its Exchange Rate to the Currency of Another Country
The Mechanics of Operation of a Strict Fixed Exchange Rate Mechanism and Its Impact on the Domestic Monetary Base
The Nonreserve Currency Country Equilibrium Relationships
Reining in the Reserve Currency Country
That Relative Price Thing
What if the Central Bank Chooses to Hold a 100% Inventory of the Commodity Used as Reserve? How Safe Is It Against a Speculative Attack?
Chapter 24: Monetary Views: Part I
Abstract
Is There an Inflation/Output Trade-off?
The Phillips Curve and the Dual Mandate
Rules Versus Discretion
Chapter 25: Monetary Views: Part II
Abstract
The Monetarist Views
Can the Fed Control the Quantity of Money?
Exploring the Left Side of the Equation
The Case for a Quantity Rule
The Case for a Price Rule
The Financial Crisis
Chapter 26: The Greenspan Monetary Rule
Abstract
Chapter 27: Transparency and Rule-Based Monetary Policy
Abstract
Deconstructing Monetary Policy
Anticipating Monetary Responses
A Concern: Can the Fed Replicate Its Precrisis Success?
Chapter 28: A Single or Dual Mandate
Abstract
The Interaction between the Mandates and the Organization of the Monetary System
Evaluating the Post-Crisis Monetary Policy
Chapter 29: The Demise of the Global Price Rule
Abstract
The Elements of the Global Price Rule
What Could Go Wrong?
Nonreserve Currency Issues
Chapter 30: The US Inflation Rate
Abstract
The Different Specifications
The Results
A Final Thought
Chapter 31: The Exchange Rate and the Rest of the World Inflation
Abstract
The Perfect Substitutability or Fixed Exchange Rate
The Textbook Flexible Exchange Rate
The Partial Substitutability Case
Empirical Relationships: The Exchange Rate Changes
Empirical Relationships: The Inflation Rate
Section V: The Financial Crisis—A Case Study
Chapter 32: The Financial Crisis: Inflection Point or Black Swan?
Abstract
Did We Find a Black Swan?
An Inflection Point?
Hindsight or Foresight?
The Parallels
Chapter 33: The Financial Crisis: Could We Have Avoided It or At Least Minimize Its Impact?
Abstract
The Credit and Leverage Economy (October 21, 2004)
The Anatomy of a Crisis
Japan Is a Perfect Example
A Generalization of the Crisis Preconditions
How to Deal with a Potential Crisis
How Resilient Is the US Financial System?
Appendix A: Credit Creation Constraints
Chapter 34: The Roadmap to a Backcast
Abstract
A Primer on the S&L Crisis
The Impact of the Regulatory Changes on the S&Ls
Spillover Effects
The Fannie and Freddie Crisis
A Primer on the Financial Crisis
Spillover Effects
Were the RTC Lessons Useful?
Chapter 35: Credit, the Carry Trade, Tax Rates, and the Residential Real Estate Market: A Retrospective
Abstract
The Democratization of Credit and Income Smoothing
The Role of Real Estate in the Credit Equation
The Advantages of Owner-occupied Residential Real Estate
Financial Innovations and the Loss of Transparency
The Credit Explosion
Excessive Credit Creation and the Economy
The Fed’s Role and the Carry Trade
Did the Carry Trade Fuel the Market?
The Making of a Storm
The Anatomy of a Crisis
Chapter 36: The Fed’s Crisis Response
Abstract
The Greenspan Fed’s Preemptive Strike
Two Wrongs Do Not Make a Right
Some Money and Banking Mechanics
Helicopter Ben’s Crisis Response
Chapter 37: Monetary Policy and the Interaction Between the Money and Credit Markets
Abstract
Money Market Disturbances, Uncertainty, and the Demand for Cash
The Interaction Between Price Stability and the Credit Markets
Money Demand and Supply Shocks
Chapter 38: Is Central Banking an Art?
Abstract
Low-Interest Rates and Keynesian Monetarism
Yield: Documenting the Effects Induced by Low-Interest Rates
What Does the Data Tell Us?
Keynesian Monetarism’s Track Record
Monetary Policy’s Burden
Chapter 39: After the Deluge?
Abstract
A Brief Description of the Problem and Economic Conditions as We Saw It
The Monetary Base, Bank Credit, Money of Zero Maturity, and the Financial Crisis
The Fed’s Crisis Response
The Monetary Aggregates After the Crisis
Inflation Rate, Interest Rates, the Slope of the Yield Curve, and the Credit Spread
How Distorted Is the Fixed Income Market?
Chapter 40: The Panic of 2008: Cause and Consequences
Abstract
Bad Luck or Bad Policies
Lack of Regulation
Searching for Causes and Cures: The Carry Trade
Searching for Causes and Cures: The Government-Sponsored Enterprises
Searching for Causes and Cures: The Homeowners
Searching for Causes and Cures: The Financing Mechanisms
Searching for Causes and Cures: Wealth Versus Income
Searching for Causes and Cures: Capital Adequacy Ratios
Searching for Causes and Cures: The Fed and Other Government Agencies
Some Conclusions
Chapter 41: Realignment?
Abstract
A Government That Works?
Failure or Success, What Does the Data Say?
Policy-Induced Moral Hazard and Substitution Effects
Multiplier Effects?
The Politics of Special Interest Groups
Class Warfare, the Politics of Redistribution, and the Slow Growth Trap
A Lasting Legacy?
Summary and Implications
Chapter 42: Obamanomics: An Evaluation
Abstract
Was President Obama Dealt a Bad Hand?
The Misery Index
The Ranking of the Economic Performance
Improvement Over the Initial Economic Conditions
Transformational Change or Trickle up Economics
Section VI: China—A Case Study
Chapter 43: China in a Global Economy: An Interpretation
Abstract
Weeding Out the Wrong Theories
The Possibilities Under a Floating Exchange Rate System
The Fixed Exchange Rate Scenarios
Where Is China Today?
Chapter 44: China’s Wealth, Income, and the Savings Rate: The Complete Markets Case
Abstract
Wealth, Income, and the Savings Rate: The Incomplete Markets Case
Implications
Appendix to Chapter 2: Consumption, Savings, and Net Wealth
Chapter 45: Examining China: Purchasing Power Parity, Terms of Trade, and Real Exchange Rates
Abstract
A Purchasing Power Parity World
Nontraded Goods: A Violation of PPP?
Rates of Returns and Relative Price Differentials Across National Economies
Purchasing Power Parity Versus the Terms of Trade
Was China’s Currency Overvalued?
Chapter 46: Examining China: Economic Growth, Exchange Rates, and Relative Stock Performance
Abstract
A Tale of Two Countries
Are There More Than Two Tales?
Which Tale is the Relevant One?
Can Currency Manipulation Affect the Trade Balance?
What Do We Know
Chapter 47: Examining China: Monetary Policy, Inflation Potential, and the Organization of the Monetary System Under a Floating Exchange Rate System
Abstract
China’s Monetary Policy and the Floating Exchange Rate Experience
The Central Bank Reaction to the Floating Exchange Rate Experience
Chapter 48: Examining China: Monetary Policy, Inflation Potential, and the Organization of the Monetary System Under a Fixed Exchange Rate System
Abstract
The RCC and NRCC Countries
China’s Monetary Policy and the Fixed-Rate Experience
Chapter 49: Examining China: China as a Nonreserve Currency Country
Abstract
The Fixed Exchange Rate Mechanism Link to the Domestic Money Supply
The Limits to the Central Bank’s Money Creation Ability
Domestic Credit Creation: Too Loose or Too Tight
The Balance of Payments
Domestic Credit Creation and Hot Capital Flows
Grading China’s Performance as a NRCC
Index
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