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Bridging
 
the
 
output
 
gap:
 
How
 
the
 
nature
 
of 
 
risks
 
shift
 
in
 
a
 
zero
 
interest
 
rate
 
regime
 
By:
 
Procyon
 
Mukherjee
 
13
th
 
November,
 
2009
 
The
 
intertwining
 
of 
 
a
 
myriad
 
of 
 
linkages
 
starting
 
with
 
macro
‐
economic
 
imbalances
 
to
 
high
 
savings
 
rate
 
in
 
the
 
world’s
 
developing
 
economies,
 
specially
 
China,
 
impacting
 
prime
 
lending
 
rates
 
which
 
also
 
stems
 
from
 
the
 
large
 
scale
 
flow
 
of 
 
funds
 
into
 
U.S.
 
Treasury
 
and
 
then
 
the
 
impending
 
rush
 
of 
 
a
 
plethora
 
of 
 
products
 
to
 
meet
 
the
 
challenges
 
of 
 
such
 
a
 
regime
 
has
 
been
 
seen
 
by
 
the
 
world.
 
The
 
roller
 
coaster
 
ride
 
of 
 
these
 
products
 
to
 
make
 
the
 
engine
 
of 
 
economic
 
activity
 
to
 
move
 
in
 
a
 
direction
 
that
 
is
 
true
 
North,
 
saw
 
some
 
issues
 
when
 
these
 
products
 
failed
 
to
 
stymie
 
systemic
 
risks,
 
in
 
the
 
likes
 
of 
 
housing
 
market
 
products
 
or
 
derivatives
 
of 
 
them
 
as
 
well;
 
the
 
more
 
alluding
 
example
 
was
 
the
 
failure
 
of 
 
certain
 
investment
 
banks
 
to
 
understand
 
the
 
implications
 
of 
 
excessive
 
leveraging.
 
The
 
world
 
has
 
seen
 
sense
 
in
 
a
 
collapse
 
than
 
in
 
a
 
continuum
 
of 
 
an
 
illusory
 
boom,
 
where
 
all
 
participants
 
in
 
the
 
market
 
could
 
simultaneously
 
prosper,
 
while
 
the
 
underlying
 
prospects
 
remained
 
a
 
puzzle
 
for
 
long.
 
It
 
is
 
in
 
this
 
underlying,
 
core
 
process
 
of 
 
economic
 
reconstruction
 
that
 
the
 
focus
 
then
 
shifted
 
and
 
in
 
the
 
very
 
core
 
economic
 
activities
 
that
 
lead
 
to
 
wealth
 
creation.
 
But
 
it
 
could
 
not
 
until
 
the
 
banks
 
could
 
be
 
bailed
 
out
 
and
 
they
 
could
 
be
 
put
 
back
 
into
 
their
 
original
 
groove.
 
This
 
process
 
meant
 
deleveraging
 
and
 
recapitalization
 
and
 
it
 
could
 
not
 
be
 
done
 
without
 
tax
‐
payer
 
money
 
being
 
channelized
 
to
 
these
 
means.
 
The
 
Fed
 
and
 
the
 
European
 
Central
 
bank
 
had
 
slightly
 
different
 
approach
 
(and
 
so
 
are
 
governments
 
like
 
U.S.
 
and
 
Germany,
 
so
 
different
 
in
 
approach
 
as
 
shown
 
by
 
Krugman
 
in
 
today’s
 
New
 
York
 
times),
 
but
 
disregarding
 
the
 
slightly
 
different
 
anointment
 
of 
 
these
 
maneuvers,
 
the
 
fact
 
of 
 
the
 
matter
 
was
 
that
 
money
 
that
 
could
 
be
 
otherwise
 
used
 
for
 
a
 
direct
 
investment
 
in
 
assets
 
of 
 
higher
 
economic
 
return
 
for
 
the
 
struggling
 
economies,
 
it
 
was
 
alternatively
 
used
 
to
 
cover
 
up
 
past
 
losses
 
some
 
of 
 
which
 
weren’t
 
even
 
visible
 
in
 
the
 
balance
 
sheet
 
of 
 
some
 
banks.
 
What
 
could
 
have
 
been
 
their
 
alternate
 
use
 
is
 
better
 
explained
 
by
 
the
 
famous
 
helicopter
 
example,
 
or
 
may
 
be
 
the
 
more
 
mundane
 
Chinese
 
example
 
where
 
governments
 
stepped
 
in
 
to
 
buy
 
‘outputs’
 
when
 
the
 
output
 
gap
 
widened,
 
the
 
most
 
burning
 
example
 
being
 
in
 
the
 
field
 
of 
 
Aluminum.
 
There
 
are
 
other
 
examples,
 
the
 
more
 
soft
 
ones,
 
like
 
providing
 
incentives
 
to
 
purchase
 
of 
 
cars
 
to
 
save
 
the
 
car
 
industry,
 
or
 
providing
 
more
 
unemployment
 
assistance,
 
where
 
the
 
need
 
arose.
 
The
 
fiscal
 
gap
 
kept
 
on
 
widening
 
for
 
governments
 
and
 
the
 
governments
 
therefore
 
resorted
 
to
 
a
 
more
 
moderate
 
stance
 
of 
 
keeping
 
the
 
lending
 
rate
 
near
 
zero,
 
to
 
take
 
on
 
the
 
more
 
indirect
 
approach
 
of 
 
making
 
the
 
banks
 
take
 
up
 
the
 
responsibility
 
of 
 
lending
 
less
 
modestly
 
to
 
make
 
the
 
output
 
gap
 
contract.
 
The
 
output
 
gap,
 
which
 
is
 
the
 
fundamental
 
problem
 
of 
 
the
 
U.S.
 
economy
 
and
 
most
 
leading
 
economies
 
of 
 
the
 
EU,
 
(Output
 
gap
 
is
 
defined
 
as
 
the
 
gap
 
between
 
the
 
potential
 
GDP
 
and
 
the
 
actual
 
GDP,
 
or
 
by
 
the
 
gap
 
between
 
the
 
under
‐
utilized
 
capacity
 
at
 
full
 
employment),
 
could
 
better
 
be
 
understood
 
taking
 
a
 
more
 
mundane
 
example
 
in
 
the
 
context
 
of 
 
a
 
firm.
 
If 
 
the
 
underlying
 
demand
 
of 
 
its
 
products
 
shrinks,
 
the
 
firm
 
has
 
looming
 
output
 
gap
 
problem,
 
which
 
is
 
fundamentally
 
a
 
problem
 
of 
 
increasing
 
operating
 
leverage.
 
The
 
firm
 
responds
 
to
 
this
 
by
 
cutting
 
back
 
on
 
production
 
capacity
 
by
 
taking
 
out
 
these
 
capacities
 
and
 
its
 
costs
 
as
 
well.
 
If 
 
the
 
costs
 
match
 
the
 
firm
 
is
 
able
 
to
 
balance
 
its
 
output
 
to
 
the
 
current
 
demand.
 
If 
 
all
 
the
 
firms
 
do
 
 
the
 
same,
 
there
 
is
 
a
 
looming
 
problem
 
in
 
the
 
economy
 
as
 
the
 
reduced
 
output
 
clearly
 
affects
 
income
 
of 
 
people
 
who
 
get
 
eventually
 
displaced.
 
Okun’s
 
Law
 
very
 
simply
 
brings
 
this
 
connection
 
between
 
unemployment
 
and
 
output
 
through
 
his
 
famous
 
equation:
 
Output
 
Gap
 
is
 
equal
 
to
 
beta
 
times
 
cyclical
 
unemployment
 
percentage,
 
where
 
beta
 
is
 
derived
 
from
 
the
 
regression
 
between
 
natural
 
output
 
and
 
natural
 
unemployment.
 
Firms
 
also
 
face
 
the
 
same
 
brunt
 
of 
 
output
 
gap
 
as
 
an
 
economy
 
does,
 
but
 
some
 
who
 
are
 
free
‐
riders,
 
who
 
wait
 
for
 
the
 
demand
 
to
 
return,
 
could
 
be
 
less
 
lucky
 
in
 
the
 
interim
 
period.
 
The
 
more
 
bold
 
ones
 
who
 
take
 
out
 
existing
 
assets
 
and
 
restructure
 
to
 
place
 
these
 
assets
 
in
 
better
 
orientation
 
to
 
the
 
demand
 
for
 
the
 
future,
 
get
 
the
 
double
 
benefit
 
when
 
the
 
demand
 
returns,
 
as
 
they
 
have
 
better
 
cost
 
advantages
 
and
 
productivity
 
as
 
well,
 
to
 
back
 
them.
 
Let
 
us
 
see
 
whether
 
an
 
economy
 
could
 
do
 
this.
 
It
 
would
 
mean
 
that
 
a
 
large
 
pool
 
of 
 
people
 
engaged
 
in
 
production
 
of 
 
certain
 
outputs
 
are
 
cut
 
back
 
and
 
are
 
re
‐
employed
 
in
 
a
 
more
 
productive
 
orientation,
 
where
 
demand
 
could
 
be
 
spurred
 
through
 
certain
 
starting
 
incentives.
 
I
 
think
 
some
 
European
 
economies
 
have
 
done
 
it
 
and
 
succeeded
 
to
 
stymie
 
the
 
slide
 
of 
 
output.
 
The
 
bulk
 
of 
 
the
 
American
 
economy
 
however
 
did
 
not,
 
thus
 
the
 
banks
 
flushed
 
with
 
funds
 
at
 
very
 
low
 
lending
 
rates
 
did
 
not
 
have
 
options
 
to
 
invest
 
in
 
output
 
enhancing
 
assets
 
in
 
the
 
same
 
economy.
 
They
 
did
 
some
 
quick
 
re
‐
 jigging
 
of 
 
their
 
portfolio,
 
moved
 
to
 
economies
 
that
 
had
 
higher
 
chances
 
of 
 
output
 
gaps
 
being
 
reduced,
 
but
 
there
 
was
 
already
 
quite
 
a
 
crowd
 
out
 
there.
 
With
 
current
 
output
 
growth
 
projected
 
at
 
very
 
low
 
levels
 
and
 
unemployment
 
rate
 
at
 
high
 
levels,
 
this
 
created
 
a
 
certain
 
uneasiness
 
which
 
lasted
 
for
 
a
 
couple
 
of 
 
quarters.
 
The
 
solution
 
to
 
this
 
conundrum
 
was
 
provided
 
by
 
commodities,
 
which
 
was
 
again
 
an
 
example
 
of 
 
changing
 
risk
 
portfolio
 
of 
 
the
 
banks.
 
It
 
started
 
with
 
oil,
 
then
 
it
 
moved
 
to
 
Aluminum
 
and
 
Gold
 
remained
 
the
 
altogether
 
safest
 
haven,
 
ever.
 
The
 
crowding
 
of 
 
the
 
oil
 
tankers
 
around
 
Singapore
 
did
 
catch
 
attention
 
of 
 
people,
 
large
 
tankers
 
being
 
berthed
 
for
 
good
 
for
 
long.
 
The
 
hardening
 
of 
 
the
 
tanker
 
rates
 
followed;
 
as
 
a
 
follow
 
through
 
one
 
also
 
noticed
 
the
 
hardening
 
of 
 
the
 
general
 
freight
 
rates
 
in
 
non
‐
oil
 
sector
 
as
 
well.
 
The
 
very
 
fact
 
that
 
in
 
a
 
severe
 
downturn
 
the
 
shipping
 
industry
 
did
 
not
 
go
 
through
 
a
 
complete
 
collapse
 
this
 
time
 
was
 
a
 
surprise.
 
The
 
Oil
 
contango
 
clearly
 
showed
 
the
 
opportunity,
 
at
 
$5
 
per
 
barrel
 
on
 
a
 
$50
 
per
 
barrel,
 
it
 
was
 
a
 
high
 
potential
 
for
 
selling
 
forward
 
in
 
cash
 
and
 
carry
 
trades.
 
The
 
suffering
 
shipping
 
industry
 
from
 
production
 
cuts
 
saw
 
some
 
glimmer
 
of 
 
hope
 
and
 
offered
 
to
 
support
 
this
 
through
 
lucrative
 
offers
 
for
 
these
 
trades
 
in
 
terms
 
of 
 
oil
 
carrying
 
costs,
 
as
 
large
 
warehousing
 
in
 
oil
 
as
 
an
 
alternate
 
solution
 
did
 
not
 
exist.
 
The
 
economics
 
was
 
simple,
 
if 
 
there
 
was
 
a
 
contango
 
that
 
was
 
large
 
enough
 
to
 
support
 
the
 
gap
 
of 
 
carrying
 
costs
 
in
 
a
 
relatively
 
low
 
interest
 
rate
 
regime,
 
there
 
was
 
a
 
way
 
to
 
reduce
 
the
 
output
 
gap
 
of 
 
oil.
 
The
 
Aluminum
 
industry
 
saw
 
the
 
opportunity
 
early
 
enough,
 
which
 
was
 
a
 
mix
 
of 
 
factors
 
related
 
with
 
the
 
most
 
commoditized
 
player
 
in
 
the
 
industry,
 
United
 
Rusal.
 
The
 
consortium
 
of 
 
banks
 
lending
 
to
 
Rusal
 
were
 
also
 
steeped
 
in
 
this
 
puzzle
 
of 
 
getting
 
Rusal
 
out
 
of 
 
the
 
muddle
 
as
 
their
 
fortunes
 
were
 
linked.
 
So
 
when
 
LME
 
of 
 
Alumium
 
touched
 
$1500/T
‐
$1600/T,
 
and
 
virtually
 
it
 
meant
 
taking
 
out
 
capacities
 
and
 
idling
 
them,
 
the
 
banks
 
stepped
 
in
 
to
 
fill
 
up
 
the
 
output
 
gap
 
puzzle
 
with
 
the
 
following
 
solution.
 
 
If 
 
the
 
contango
 
in
 
Aluminum
 
was
 
above
 
$35
 
per
 
ton
 
cash
 
to
 
three
 
months,
 
there
 
was
 
sense
 
in
 
locking
 
metal
 
in
 
financing
 
deals
 
as
 
the
 
cost
 
of 
 
warehousing
 
also
 
crashed
 
and
 
there
 
were
 
more
 
people
 
available
 
to
 
offer
 
warehouses
 
in
 
a
 
dropping
 
market,
 
and
 
when
 
the
 
rates
 
touched
 
$1/ton/month
 
in
 
the
 
private
 
warehouses,
 
it
 
made
 
perfect
 
sense
 
to
 
make
 
money
 
in
 
these
 
deals.
 
The
 
banks
 
used
 
Aluminum
 
as
 
collateral
 
and
 
Rusal
 
sold
 
forward
 
almost
 
their
 
entire
 
production
 
and
 
got
 
cash
 
in
 
return
 
as
 
Glencore
 
the
 
buyer
 
was
 
also
 
an
 
investor
 
in
 
Rusal.
 
When
 
the
 
quantities
 
touched
 
almost
 
a
 
million
 
tones,
 
the
 
contango
 
still
 
remained
 
and
 
the
 
act
 
lasted
 
more
 
than
 
originally
 
thought
 
it
 
would.
 
When
 
one
 
looks
 
at
 
the
 
implication
 
of 
 
this
 
on
 
a
 
grand
 
scale
 
in
 
the
 
market
 
of 
 
Aluminum
 
it
 
means
 
that
 
currently
 
there
 
is
 
7.5
 
Million
 
tonnes
 
of 
 
Aluminum
 
locked
 
in
 
various
 
warehouses
 
in
 
these
 
kinds
 
of 
 
financing
 
deals.
 
It
 
is
 
relatively
 
risk
 
free
 
as
 
long
 
as
 
the
 
contango
 
lasts
 
as
 
the
 
banks
 
have
 
the
 
stocks
 
as
 
collateral.
 
It
 
is
 
like
 
saying
 
that
 
‘financing’
 
is
 
a
 
consumer
 
of 
 
last
 
resort
 
holding
 
20%
 
of 
 
the
 
pie
 
of 
 
the
 
world’s
 
aluminum
 
production.
 
But
 
like
 
all
 
paradoxes,
 
there
 
is
 
an
 
underlying
 
paradox
 
that
 
one
 
cannot
 
lose
 
sight
 
of.
 
If 
 
this
 
form
 
of 
 
output
 
gap
 
solution
 
was
 
possible,
 
in
 
a
 
number
 
of 
 
commodities
 
that
 
have
 
matured
 
trading
 
markets,
 
then
 
one
 
could
 
have
 
avoided
 
all
 
recessions
 
and
 
this
 
would
 
have
 
provided
 
perfect
 
opportunity
 
for
 
more
 
stability
 
in
 
prices,
 
which
 
then
 
would
 
bring
 
the
 
contango
 
down,
 
thus
 
endangering
 
the
 
very
 
basis
 
on
 
which
 
the
 
whole
 
premise
 
of 
 
doing
 
business
 
lie.
 
There
 
is
 
a
 
premium
 
component
 
that
 
we
 
cannot
 
lose
 
sight
 
of.
 
The
 
premium
 
is
 
a
 
reflection
 
of 
 
the
 
physical
 
side
 
of 
 
the
 
transactions
 
in
 
the
 
market.
 
If 
 
the
 
premium
 
of 
 
Aluminum
 
rises
 
there
 
could
 
be
 
many
 
traders
 
who
 
would
 
be
 
interested
 
to
 
do
 
physical
 
trades
 
and
 
get
 
the
 
short
 
term
 
benefit
 
of 
 
making
 
money
 
from
 
the
 
higher
 
premium,
 
which
 
he
 
would
 
lose
 
if 
 
he
 
did
 
not
 
take
 
the
 
opportunity.
 
In
 
fact
 
as
 
the
 
premium
 
rises,
 
it
 
rises
 
because
 
the
 
physical
 
demand
 
needs
 
to
 
be
 
balanced
 
by
 
the
 
availability
 
of 
 
supply
 
at
 
a
 
price
 
that
 
makes
 
economic
 
sense.
 
In
 
sum,
 
premium
 
rise
 
would
 
make
 
more
 
metal
 
available
 
for
 
sale
 
for
 
the
 
traders,
 
thus
 
taking
 
metal
 
off 
 
the
 
warehousing
 
deals
 
and
 
the
 
contango
 
loses
 
the
 
shine
 
as
 
more
 
supply
 
is
 
made
 
available.
 
If 
 
the
 
underlying
 
demand
 
becomes
 
stronger
 
the
 
tension
 
between
 
these
 
alternate
 
proposals
 
of 
 
business
 
becomes
 
even
 
tenser.
 
Very
 
low
 
interest
 
rates,
 
actually
 
is
 
another
 
part
 
of 
 
the
 
puzzle.
 
Had
 
the
 
interest
 
rates
 
been
 
higher
 
the
 
whole
 
economics
 
would
 
have
 
shifted.
 
The
 
real
 
reason
 
why
 
this
 
game
 
is
 
still
 
lasting
 
is
 
because
 
at
 
such
 
low
 
interest
 
rates
 
the
 
banks
 
seeking
 
investment
 
avenues
 
have
 
a
 
much
 
larger
 
pool
 
of 
 
money
 
and
 
a
 
much
 
lower
 
pool
 
of 
 
safe
 
havens.
 
The
 
commodities
 
market
 
like
 
oil,
 
Aluminum
 
and
 
gold
 
provide
 
them
 
 just
 
the
 
perfect
 
haven
 
where
 
inventories
 
could
 
be
 
collaterized
 
and
 
money
 
could
 
be
 
made
 
from
 
the
 
contango.
 
The
 
depreciation
 
of 
 
the
 
dollar
 
provides
 
the
 
perfect
 
icing
 
on
 
the
 
cake.
 
There
 
is
 
additional
 
money
 
to
 
be
 
made
 
if 
 
carry
 
trades
 
could
 
be
 
done
 
with
 
the
 
dollar,
 
as
 
instead
 
of 
 
zero
 
interest
 
rates,
 
the
 
interest
 
rates
 
would
 
be
 
actually
 
negative
 
if 
 
money
 
was
 
borrowed
 
in
 
dollars.
 
The
 
dollar
 
therefore
 
completes
 
the
 
tango
 
for
 
the
 
sequence
 
to
 
last
 
longer
 
than
 
we
 
thought.
 
When
 
the
 
end
‐
consumer
 
sees
 
this
 
tango,
 
he
 
cannot
 
help
 
gasping
 
for
 
breath
 
to
 
have
 
better
 
credit
 
conditions
 
sorted
 
out
 
for
 
himself 
 
or
 
his
 
related
 
business.
 
But
 
he
 
has
 
a
 
collateral
 
problem
 
to
 
deal
 
with,
 
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