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Economic Disturbances and Equilibrium in an Integrated Global Economy

Book Description

Economic Disturbances and Equilibrium in an Integrated Global Economy: Investment Insights and Policy Analysis helps readers develop a framework for analyzing economic events and make better, more consistent decisions. Victor Canto presents the theoretical building blocks that make up the overall framework, then expands the framework to tackle more complex problems, applying additional considerations to actual policy or investment issues. Drawing upon the most recent trends in monetary policy and international economics, the book offers sustained direct engagement with the main research question and makes innovative use of the simple concepts of supply and demand to illuminate modern finance literature.

The book succeeds by highlighting the often-forgotten interconnectedness of different economic processes. How do we respond to a change in policy or an economic shock? Are all the expected changes to the general equilibrium consistent with each other?

  • Helps readers build an intellectual framework that enables them to interpret articles in the financial press and policy decisions in a logical and consistent manner
  • Differs from other books by eschewing partial equilibria analyses and instead providing a general equilibrium perspective useful for investors and policy makers
  • Provides supporting data on a freely-accessible website so readers can test and replicate results

Table of Contents

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