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Prof. Jacob A. Frenkel Chairman, Merrill Lynch International Former Governor of the Bank of Israel The Global Economy Challenges to Recovery 9 th Dubrovnik.

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Presentation on theme: "Prof. Jacob A. Frenkel Chairman, Merrill Lynch International Former Governor of the Bank of Israel The Global Economy Challenges to Recovery 9 th Dubrovnik."— Presentation transcript:


2 Prof. Jacob A. Frenkel Chairman, Merrill Lynch International Former Governor of the Bank of Israel The Global Economy Challenges to Recovery 9 th Dubrovnik Economic Conference Dubrovnik June 26 – 28, 2003

3 June 18, 2003 Table of Contents The US economy: Background and Challenges A more sustainable growth outlook Private sector reacts to challenges A timely policy response The path to economic recovery Downside risks Asset market vulnerability Unwinding the current account deficit Geo-political instability and oil shocks Euroland economic outlook Japan economic outlook Emerging Asia and Latin America Global Recessionary Deflation?

4 June 18, 2003 US Economy Enjoys High Productivity Source: Bureau of Labour Statistics % year-on-year Non-farm Productivity, last data point: Q1 03 1998-2002 average = 2.7%

5 June 18, 2003 Background and Challenges Non-sustainable rapid growth in the 1990s led to a series of real and financial imbalances Bubbles burst in tech sectors and telecoms with fallouts in financial and real markets Profit crunch required cost reduction Manufacturing sector declined, employment weakened Terrorism (9/11) damaged economic confidence Corporate governance crisis damaged financial integrity Confidence crisis and recession required policy response Iraq crisis: before and after

6 June 18, 2003 Actual Numbers Source: Bureau of Economic Analysis, last data point: Q1 03 ML Forecast Quarterly Real GDP (4 Quarter percentage change) Boom, Gloom and Modest US Recovery Actual Numbers Average 1996-2000: 4.0% Average 2001-2002: 1.4% Average 2003-2004: 2.8%

7 June 18, 2003 A More Sustainable US Growth Outlook A flexible, competitive and deregulated economy enables: A smooth response by corporates and households A timely policy response Real GDP growth forecast: 2.2% in 2003, 3.4% in 2004 Capital spending starts to recover; limited overhang Consumer spending less buoyant but still robust High and rising productivity yields a jobless recovery Housing market remains a solid pillar

8 June 18, 2003 Quick Reaction of Economic Agents and Policies A flexible and adaptable economy, with low inflation and moderate public debt has facilitated: An effective private sector response: A significant reduction in labor costs A rapid adjustment of inventories Mitigating the profit crunch An effective policy response: A decisive and timely monetary policy response A series of fiscal stimulus packages

9 June 18, 2003 Profit Crunch Requires Adjustment Source: Bureau of Economic Analysis, last data point: Q1 03 1992-2002 average = 10.1% Profits as Share of Non-Financial Corporate GDP US Recession %

10 June 18, 2003 Companies Lay Off Workers to Cut Costs Source: Bureau of Labour Statistics, last data point: May 03 SA Unemployment Rate, as % of Total Civilian Labour Force US Job Loss Jan 01-Dec 02 > 1.9m

11 June 18, 2003 Unit Labour Cost Pressures Have Declined Source: Bureau of Labour Statistics; Unit Labour Costs, Non-farm Business Sector, last data point: Q1 03 % change US Recession

12 June 18, 2003 US Inventory Reflects Flexibility Source: Census Bureau, last data point: Apr 03 % change Inventories cut by $250bn in one year Manufacturing & Wholesale Inventories, 3 Month % Change, Annualised

13 June 18, 2003 Decisive US Fed Rate Cuts Source: Federal Reserve Bank of New York Federal Funds Target

14 June 18, 2003 In a Low Inflation Environment Source: Bureau of Labour Statistics, Merrill Lynch forecast % year-on-year 10 year average = 2.5%

15 June 18, 2003 Reinforced by Ample Fiscal Stimulus US Budget Balance as % of GDP US Gross Public Debt as % of GDP Source: IMF World Economic Outlook, April 2003

16 June 18, 2003 Capital Spending Leads the Recovery Source: Census Bureau, last data point: Apr 03 New Orders of Non-Defense Capital Goods, % change year-on-year % change

17 June 18, 2003 US Tech Spending Recovers Source: Bureau of Economic Analysis, last data point: Q1 03 Real Capital Spending on Tech Equipment & Software, % change quarterly YoY % change

18 June 18, 2003 Mortgage Refinancing Supports Consumption Source: Mortgage Bankers Association, last data point: 3rd June 03 US Recession Mortgage Application Index for Refinancing 4 Week Moving Average Households “cash out” $150-200bn in 2002

19 June 18, 2003 US Retail Sales Rebound and Stabilise Source: Census Bureau, Retail Sales ex-autos, last data point: May 03 % year-on-year

20 June 18, 2003 Robust US Housing Starts Source: Census Bureau; Single-Family Housing Starts, 000s, SAAR, last data point: May 03 10 year average US Recession

21 June 18, 2003 The Recovery Remains Jobless Source: BEA, BLS, last data point: Employment May 03, GDP Mar 03 % YoY growth

22 June 18, 2003 Global Growth Outlook Merrill Lynch Forecasts, June 2003 (*) IMF forecasts

23 June 18, 2003 Downside Risks Vulnerable Asset Markets Could further Affect Confidence The investment rebound could be short-lived Household spending could retrench Disorderly Unwinding of US Current Account Deficit if: Foreign investors reduce holdings of US assets US Dollar weakens and forex markets remain volatile US savings recover too rapidly US investment recovers too slowly Geo-political Instability and Oil Shocks Global recessionary deflation?

24 June 18, 2003 Risk Aversion in US Markets Source: Merrill Lynch, last data point: 17 June 03 Risk Aversion Index, 30 days moving average Index composed of Equity Implied Volatility, Swap Spreads & Spread Ratio between BBB & BB Corps Russia/LTCM collapse September 11 Accounting scandals Fall of Baghdad

25 June 18, 2003 High US Corporate Debt Ratio Source: Census Bureau, last data point: Q4 02 10 year average = 75% Long-Term Debt/Income, all Manufacturing Industries

26 June 18, 2003 US Corporate Debt Servicing Manageable Source: Bureau of Economic Analysis, last data point: Q1 03 % 10 year average = 12.8% Current = 14.3% US Recession Interest Expense/EBITDA

27 June 18, 2003 Insert Footnote Text Corporate Bond Defaults Rise Globally No. of issuers US$ bn Source: Standard & Poor’s Amount defaulted No. of issuers

28 June 18, 2003 US Corporate Credit Ratings Worsen Source: Standard & Poor’s US$ bn US rating actions by value

29 June 18, 2003 Are Residential Prices Sustainable? Source: Bank for International Settlements Residential Price Indices, 1992 =100, logarithmic scale France USA Italy Germany Japan UK

30 June 18, 2003 A Rising Current Account Deficit Source: Bureau of Economic Analysis, Merrill Lynch Current Account balance as % of GDP

31 June 18, 2003 Risks to External Financing of Deficits US current account deficit projected to remain above 4% of GDP, worsening net foreign liability position A potentially disorderly unwinding of US current account deficit is possible if: Loss of confidence or a shift in portfolio preferences reduces foreign investors appetite for US assets US Savings recover too quickly US Investments recover too slowly Possible disruption of exchange rates and interest rates

32 June 18, 2003 Foreign Investors Withdraw from US Markets US$ bn, 12 months moving average Foreign Purchases of US Stocks Foreign Purchases of US Corporate Bonds Source: Federal Reserve, last data point: Mar 03

33 June 18, 2003 US Dollar Weakens Source: Bloomberg US$/Euro

34 June 18, 2003 Oil Price (WTI) Source: Bloomberg $/bbl 08/01/90 - Iraq invades Kuwait 01/17/91 - Operation Desert Storm begins 02/28/91 - Cessation of war

35 June 18, 2003 Fiscal Consolidation and Convergence Source: IMF, April 2003 Budget Balance as % of GDP France Germany Italy Spain

36 June 18, 2003 Euroland Economic Outlook Euro strength & US weakness dampen growth prospects Unemployment is rising again Business & consumer confidence are falling Controversies concerning the “stability and growth” pact The German engine is lagging Structural measures are essential for future growth European Recovery Lags Behind US

37 June 18, 2003 Euroland Recovery Lags Behind US % Real GDP Growth Source: Merrill Lynch forecasts

38 June 18, 2003 Long Term Recession in Japan Real GDP %, YoY OECD 10-year Avg = 2.4% Japan 10-year Avg = 0.5% Source: ESRI, Merrill Lynch forecasts

39 June 18, 2003 Fiscal Laxity has Created Public Debt Problem Japan Budget Balance as % of GDP Japan Gross Public Debt as % of GDP Source: IMF World Economic Outlook, April 2003

40 June 18, 2003 Slow Progress on Japanese Bank Restructuring A few major banks start to deal with bad loans and strengthen their capital base But… Under-provisioning for bad loans persists Weak capital base and low profitability of banks limit speed of bad loan disposal Market confidence in financial sector is low

41 June 18, 2003 Asian Economic Outlook Growth remains strong across Asian region: China and India insulated by strong local markets Tech-dependent Asia pulled by policy easing Countries with strong policy frameworks experience stronger growth High level of foreign reserves and current account surpluses have reduced vulnerability Incomplete corporate and bank restructuring Solid Recovery Continues In 2003

42 June 18, 2003 Latin America Economic Outlook Smaller fiscal deficits and lower inflation are key Corporate governance and political stability remain critical factors Region dependent on capital inflows Argentina: needs to be reborn Brazil: on the road to recovery Mexico and Chile: bright spots Venezuela, Ecuador and Peru: in trouble Outlook Reflects Domestic Policies and US Growth

43 June 18, 2003 If US and Europe Stay the Course, Global Recessionary Deflation Will Be Avoided Global Recessionary Deflation? US: Very unlikely Flexible and competitive economy High productivity growth Decisive policy response Euroland: Unlikely but watch for Germany Benefits from single currency and convergence Structural rigidities Political and institutional challenges Japan: In the midst of deflation Rigid policy framework Needs financial restructuring

44 END

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