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Copyright © 2008 Global Insight, Inc. The Outlook for the U.S. and World Economies: It Will Get Much Worse Before It Gets Better Nariman Behravesh Chief Economist Houston November 14, 2008
Copyright © 2008 Global Insight, Inc. Crisis Update
Copyright © 2008 Global Insight, Inc.3 09/2008 Big, Bad, and Broad-based By some measures the biggest global housing and credit bubble in history Not just Made in U.S.A. Credit growth was strong everywhere Bank loan/deposit ratios were much higher in Europe Subprime crisis was the first symptom Bubbles in commodity, equity, foreign exchange and real estate markets are bursting in many parts of the world No region will be unscathed—the only question is how badly will they be hurt
Copyright © 2008 Global Insight, Inc.4 09/2008 A Key Sign of Extreme Risk Aversion (3-month LIBOR less 3-month Treasury bill rate, % points)
Copyright © 2008 Global Insight, Inc.5 09/2008 How Did We Get Here? Classic hangover after a binge Driving forces: deregulation, financial innovation, and the globalization of capital Major culprit: loose monetary policies everywhere… …Although the savings “glut” may have only played a secondary role, interest rates have been falling for decades Another major culprit: government incentives to take on debt— e.g., not everyone should own a home Modern finance has done a lot of good, but it has not reduced volatility, speculation or leverage
Copyright © 2008 Global Insight, Inc.6 09/2008 Money Supply Growth (Percent change in U.S. dollar value) * Through August 2008; ** Percent change calculated in local currency units
Copyright © 2008 Global Insight, Inc.7 09/2008 (Percent) Policy Interest Rates: Mostly Moving Down
Copyright © 2008 Global Insight, Inc.8 09/2008 Long-term Interest Rates (10-year government bond yields, percent)
Copyright © 2008 Global Insight, Inc.9 09/2008 Lessons from Past Crises We’ve been here before—many times Finance is speculation—but it has played a hugely beneficial role throughout history Wall Street R.I.P? Don’t bet on it The worst financial crises in recent decades have occurred in heavily regulated and bank-dominated financial systems (e.g., Japan and South Korea) Lesson: deflation is a bigger threat than inflation (Fed versus ECB) Lesson: beggar-thy-neighbor policies are a disaster Lesson: bold swift action is needed (Japan versus Sweden)
Copyright © 2008 Global Insight, Inc.10 09/2008 Fiscal Costs of Post-War Banking Crises U.S. Subprime Crisis 2007-Present U.S. S&L Crisis 1984-91 Sweden 1991 Norway 1987-93 Finland 1991-94 Spain 1977-85 Japan 1991-2003 (Percent of nominal GDP) Source: OECD, IMF, Global Insight South Korea 1997-2002 The Big Financial Crises Since 1970
Copyright © 2008 Global Insight, Inc.11 09/2008 Lessons from Past Crises II Lesson: there are limits to crisis management—sooner rather than later systemic solutions are needed Lesson: dealing with illiquidity without dealing with insolvency is ineffective Lesson: key ingredients of a successful “fix” include: lots of liquidity, capital infusions, debt guarantees, deposit insurance, and fiscal stimulus – plus help for homeowners Good news: after bumbling around for a while, the G7 got their act together in a matter of months not years Bad news: the average downturn after a big banking crisis has lasted four years – although it may not be as bad this time around
Copyright © 2008 Global Insight, Inc. World Recession Alert
Copyright © 2008 Global Insight, Inc.13 09/2008 Commodities: What Goes Up Must Come Down Commodities were very much a part of the bubble Stimulative monetary polices were a key factor in demand growth Over the past couple of years a weak dollar and investment flows (speculation?) also contributed—but their role should not be exaggerated The worsening credit crunch and expectations of a global recession have triggered 40% to 50% drops in a matter of a few weeks Worst case scenario: commodity prices could fall another 20% to 30% from current levels
Copyright © 2008 Global Insight, Inc.14 09/2008 (Global Insight Indexes, 2002:1=1.0) Industrial Materials Prices Plunge from Peaks
Copyright © 2008 Global Insight, Inc.15 09/2008 (West Texas Intermediate price, dollars per barrel) Relief from High Crude Oil Prices
Copyright © 2008 Global Insight, Inc.16 09/2008 Why Is the Dollar So Strong? “Best looking horse in the glue factory” Even though the U.S. is one of the hardest hit economies, the safe-haven/principal-reserve-currency status of the dollar has trumped other fears So far, many currencies have born the brunt of this attempt to seek safety – including the euro Real effective exchange rates tell a very different story than bilateral nominal exchange rates: the euro is not that strong and the dollar is not that weak, but the yen is still quite weak and the renminbi is quite strong Ten-year anniversary of the euro: a mixed record
Copyright © 2008 Global Insight, Inc.17 09/2008 Canadian DollarEuro Japanese Yen Chinese Renminbi (Canadian dollars per U.S. dollar, quarterly averages)(Euro per U.S. dollar, quarterly averages) (Yen per U.S. dollar, quarterly averages) (Yuan per U.S. dollar, quarterly averages) U.S. Dollar Exchange Rates
Copyright © 2008 Global Insight, Inc.18 09/2008 Who Is Most Vulnerable? Already we have seen emerging markets equity prices fall around 60% since fall of 2007 At the same time, emerging markets risk spreads have surged to around 800bp… …And many currencies have seen large drops It’s clear that capital flows into even the strongest emerging markets (e.g., China) have fallen Because of its export dependence, Asia is particularly vulnerable to a downside scenario Countries with large current account deficits are at risk Unexpected winner? Japan
Copyright © 2008 Global Insight, Inc.19 09/2008 Current Account Deficits, 2008 Percent of GDP
Copyright © 2008 Global Insight, Inc.20 09/2008 Bottom Line: World Recession in 2009 … The U.S., Europe, and Japan will suffer through recessions that, in retrospect will probably be “more than mild” No regions will be immune from a significant deceleration— some will be particularly hard hit (e.g., Emerging Europe) Large reserves will help Asia and the Middle East—but for how long? A repeat of either the Great Depression or a Japan-style lost decade seems like a remote possibility Forecast of our forecast: there will most likely be further downward revisions
Copyright © 2008 Global Insight, Inc.21 09/2008 … But Also a Relatively Strong Rebound The collapse of commodity prices will help consumers and businesses The financial rescue packages will help – they already are Existing and expected monetary stimulus will make the adjustments easier More fiscal stimulus in the pipeline in many countries Comparisons with Sweden are misleading Bottom line: deep recession in 2009, modest recovery in 2010, and a sharper rebound in 2011
Copyright © 2008 Global Insight, Inc.22 09/2008 The World Economy: No Recovery Until 2010 (Percent change)
Copyright © 2008 Global Insight, Inc. U.S. Outlook
Copyright © 2008 Global Insight, Inc.24 09/2008 North America: Deeper Recession The only debate now is how deep will the recession be The rescue efforts seem to be bearing fruit, although it is too early to tell More fiscal stimulus is in the cards – the incoming Obama administration will probably push for a package of $200 billion in tax cuts and spending increases The Fed will cut at least another 50bp Worsening prospects in the rest of the world will hurt U.S. exports Canada and Mexico will not be able to avoid being badly hurt
Copyright © 2008 Global Insight, Inc.25 09/2008 (Annual percent change, 2000 dollars)(Percent) As U.S. Economic Growth Falls Below Potential, the Unemployment Rate Rises
Copyright © 2008 Global Insight, Inc.26 09/2008 The Downturn Was Dampened by Foreign Trade (Annualized rate of growth)
Copyright © 2008 Global Insight, Inc.27 09/2008 (Percent of all home mortgage loans entering foreclosure) Foreclosure Rate Has Hit New Highs Source: Mortgage Bankers Association
Copyright © 2008 Global Insight, Inc.28 09/2008 OFHEO House Prices: Purchase Only, 2008Q2 Q/Q Annualized Percent Change Computed by Global Insight Source: National City
Copyright © 2008 Global Insight, Inc.29 09/2008 House Prices: Overvaluations Becoming Less Extreme Source: National City Q2 2008 Valuations
Copyright © 2008 Global Insight, Inc.30 09/2008 Affordability Varies Across Regions Source: National Association of Realtors A higher index means homes are more affordable.
Copyright © 2008 Global Insight, Inc.31 09/2008 (Millions of units) Home Sales Probably Not at Bottom Yet (Millions of units)
Copyright © 2008 Global Insight, Inc.32 09/2008 (Months’ supply at current selling rate, single-family homes) Inventory Overhang Peaking
Copyright © 2008 Global Insight, Inc.33 09/2008 (Million units) Housing Starts Dip Further, Prices to Fall Sharply in 2008 (Year/year percent change)
Copyright © 2008 Global Insight, Inc.34 09/2008 Bad News Everywhere For Consumer Finances Positive Forces Gasoline is below its peak Negative Forces Falling Employment Falling Real Wages Declining Housing Wealth Declining Stock Market Tightening Credit Conditions Mounting Debt Burdens Low Saving Rate
Copyright © 2008 Global Insight, Inc.35 09/2008 Household Net Worth Has Plunged End-Q3 2007 to end-Q3 2008: down $4.3 trillion* End-Q3 2008 to October 10, 2008: down $2.8 trillion* Total loss: $7.1 trillion* (down 12%) If wealth effect on consumption is 5 cents on the dollar, that means a $350 billion hit to consumer spending That’s 3.5% off consumer spending * Wealth figures are Global Insight estimates
Copyright © 2008 Global Insight, Inc.36 09/2008 (Percent change, annual rate) A Downturn in Payroll Employment
Copyright © 2008 Global Insight, Inc.37 09/2008 Consumption Growth Fading (Percent growth, real)
Copyright © 2008 Global Insight, Inc.38 09/2008 Light Vehicle Sales (Millions of units)
Copyright © 2008 Global Insight, Inc.39 09/2008 Corporate Cash Flow Hit Record Levels; But Is Now Weakening (Net corporate cash flow, percent of GDP)
Copyright © 2008 Global Insight, Inc.40 09/2008 (Percent change from a year earlier, real spending) The Business Capital Spending Cycle: Construction Is Peaking
Copyright © 2008 Global Insight, Inc.41 09/2008 Current Account Deficit: Peaking at Last (Billions of dollars)(Percent of GDP)
Copyright © 2008 Global Insight, Inc.42 09/2008 (Percent change from a year earlier, volumes) Export Growth Expected to Ease
Copyright © 2008 Global Insight, Inc.43 09/2008 (Year-over-year percent change) Food and Energy Prices Caused a Spike in Consumer Price Inflation
Copyright © 2008 Global Insight, Inc.44 09/2008 Productivity Growth (Percent change)
Copyright © 2008 Global Insight, Inc.45 09/2008 Labor Cost Pressures Have Eased (Percent change, year-on-year, unit labor cost proxy)
Copyright © 2008 Global Insight, Inc.46 09/2008 (Billions of dollars, fiscal years)(Percent of GDP) The Federal Budget Deficit Widens Again
Copyright © 2008 Global Insight, Inc.47 09/2008 (Percent of GDP, fiscal years, unified budget) Closing the Federal Budget Gap Will Require Spending Restraint and/or Higher Taxes
Copyright © 2008 Global Insight, Inc.48 09/2008 Elements of an Obama Fiscal Package More rebates – but will they be effective? Infrastructure spending Revenue sharing with state and local governments (e.g. some of it focused on Medicaid) More unemployment benefits Some relief for homeowners Bailout for Detroit?
Copyright © 2008 Global Insight, Inc. Rest of World Roundup
Copyright © 2008 Global Insight, Inc.50 09/2008 Western Europe: No Avoiding Recession No de-coupling here After some hesitation, Europe has shown leadership on the resolution of the financial crisis… …Nevertheless, high leverage, exposure to the subprime mess, a strong euro, and a world recession will drag down the key economies Housing crashes will also inflict a lot of damage A weaker euro and lower oil prices are the only positive developments Many countries are in or on the brink of recession (Italy, Spain, and the U.K.—Germany is not far behind)
Copyright © 2008 Global Insight, Inc.51 09/2008 Source: The Economist, September 13, 2008 House Prices Soared in Many Countries (Cumulative percent change)
Copyright © 2008 Global Insight, Inc.52 09/2008 (Percent change) Real GDP Growth Rates Vary Across Europe
Copyright © 2008 Global Insight, Inc.53 09/2008 Emerging Europe: Very Vulnerable Because of large current account deficits many countries in this region are particularly vulnerable to the credit crunch and rising risk premia The countries at the periphery of Europe (Iceland, the Baltics, Bulgaria, etc.) are in deep trouble Russia’s recent financial turmoil suggests that the boom is not only over, but there is more downside to growth Lower oil prices and recessions in the U.S. and the EU will inflict even more pain on the Russian economy
Copyright © 2008 Global Insight, Inc.54 09/2008 (Percent change) Real GDP Growth in Emerging Europe
Copyright © 2008 Global Insight, Inc.55 09/2008 Asia: Better Off than Most? While the exposure to the subprime crisis is limited and finances are strong, export dependence is a big vulnerability Can domestic demand compensate for the worsening external environment? Only up to a point Capital inflows are diminishing, hurting investment prospects Australia and South Korea are particularly vulnerable – as are Pakistan, Thailand and Vietnam China has suffered (the collapse in the stock market), but may be able to weather the crisis better than most
Copyright © 2008 Global Insight, Inc.56 09/2008 (Percent change, real GDP) Japan’s Economy Has Limited Growth Potential
Copyright © 2008 Global Insight, Inc.57 09/2008 Real GDP Growth in Asia/Pacific Economies (Percent change)
Copyright © 2008 Global Insight, Inc.58 09/2008 Latin America: Mostly Bad News Collapsing commodity prices, a slump in world trade and recessions in key markets will pull down growth across the region Mexico will be dragged down by a U.S. recession Argentina: a mini banking crisis earlier this year, still high financing needs, a mismanaged economy, and a bleaker commodity outlook have limited options for growth Brazil: strong growth will likely be cut with the credit squeeze, falling stock prices and huge downward pressure on the real Venezuela: collapsing oil prices will hurt the government’s ability to fund its social programs ahead of the elections, and a falling currency will exacerbate inflationary pressures—caused by terrible policies
Copyright © 2008 Global Insight, Inc.59 09/2008 (Percent change) Real GDP Growth in Latin America
Copyright © 2008 Global Insight, Inc.60 09/2008 Middle East and Africa: The Party’s Over Volatility in the price of oil and other commodities is nothing but bad news Large current account surpluses in oil exporting countries will help to cushion the blow… …But the global liquidity squeeze is hurting investment projects throughout the region Keep an eye on South Africa—there may be trouble ahead If the price of oil stays at $60 or goes lower, it will cut growth by a lot
Copyright © 2008 Global Insight, Inc.61 09/2008 (Percent change) Real GDP Growth in the Middle East and Africa
Copyright © 2008 Global Insight, Inc.62 09/2008 Bottom Line A world recession is inevitable—the only debate is about how deep and how long If the financial crisis dissipates, then a modest rebound in 2010 is possible, if not… De-leveraging in the worst-hit countries could take many years Falling commodity prices will “re-balance” growth and change the terms of trade Don’t get too carried away with the doom and gloom—the rebound (when it starts) is likely to be strong U.S. economic resilience and Asian dynamism will likely reassert themselves once the crisis has blown over
Copyright © 2008 Global Insight, Inc.63 09/2008 Thank You! Visit our Web site at www.globalinsight.com
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