1. What’s Wrong (And Right) With This Recovery HPVA Spring Convention May 25, 2010

2. I.What Kind of Recovery? Relatively weak GDP rebound A jobless recovery A lopsided upturn Only partly transformative Inorganic and not yet sustainable The recovery policy gave us II. More Headwinds than Tailwinds III. Questions for Discussion 1

3. Relatively Weak GDP Rebound Deep drop, weak rebound. Balance-sheet-led recession (not a business cycle recession). Growth at 2.2%, 5.6%, and 3.2%. 2

4. A Jobless Recovery The jobless recovery the worst yet. + 290,000 jobs in April. But, U-6 rose to 17.1%. Jobs deficit 12.8 million. 3

5. A Jobless Recovery: A Pattern of Missing Jobs Continues Technologically advanced industries disappoint. Projected 2.8 million new jobs (1998 to 2008). But 68,000 jobs lost. Health, ed, gov. 4

6. A Lopsided Recovery: Equity Rebound, Housing Slump Equity market recovery, housing price slump. Impact on middle-income households. More housing woes. 5

7. A Lopsided Recovery: Surging Profits, Stagnant Wages Corporate profit rebound, job and wage growth anemic. Corporate profits + 30.6% Nominal wage growth +1.6% 6

8. A Lopsided Recovery: The Return of Plutonomy? High end recovery. While stagnant wages and housing prices hurt moderate- and low-income. Return of Plutonomy 7

9. Partly Transformative (Positive): Rapid Productivity Growth Productivity growth increases growth potential. Also explains job loss. Productivity increased 6.3%. 8

10. Partly Transformative (Positive): CapEx and Industrial Production Capital spending on equipment +13.4% Industrial production + 5.2% 9

11. Partly Transformative (Negative): Too Dependent on Consumer Spending Consumer spending 71% of GDP. In Q1 2010, consumer spending was 2.6% of the 3.2% increase in GDP. Spending boosted by tax cuts, consumer rebates, and government transfer payments. 10

12. Partly Transformative (Negative): Too Dependent on Financial Profits Financial sector profits are soaring Account for 35.7% of all domestic corporate profits. Financial sector profits are driven by trading revenue. 11

13. Partly Transformative (Negative): Personal Savings Falling, Again Personal savings on decline (2.7% in March), enabling greater consumption. But slows household deleveraging and extends adjustment period. 12

14. Partly Transformative (Negative): Importing Our Way to Prosperity A recovery would benefit from rising net exports. Dollar strength and slow growth in export markets. Net exports subtracted 0.6% from GDP growth Q1 2010. 13

15. Inorganic and Not Yet Sustainable: One-Off Inventory Gains Inventory rebuild contributed over half of growth during the recovery. But, these are one off gains. Real final sales averaged only a 1.7% increase over the past three quarters, normally 3.5%. 14

16. Inorganic and Not Yet Sustainable: Consumer Spending is on Life Support Spending supported by transfer payments. Transfer payments now make up 1/5 th of personal income. Excluding transfer payments, personal income increased just 0.3% since the third quarter of 2009. 15

17. Policy Has Worked: The Recovery Reflects Washington’s Policy Priorities Gigantic monetary reflation and Wall Street bailout Recovery of financial assets and profits Tax cuts, “cash for clunkers,” and unemployment insurance (Temporary) support of consumer spending Modest infrastructure and public works spending Weak job creation and stagnant wages 16

18. II. More Headwinds Than Tailwinds The debt overhang The phasing out of fiscal and monetary stimulus State and local government fiscal crises Continued housing woes The euro crisis, the rising dollar, and a new Asian export push Renewed world deflationary pressures Uncertain tax and regulatory environment 17

19. The Debt Overhang Household deleveraging has just begun (cut just $310 billion of credit). High debt constrains spending. Household and financial sector debt decline, government debt rises. 18

20. Fed Wind-Down The Fed slashed interest rates and increased its balance sheet (to over $2.3 trillion dollars). The Fed recently ended asset purchases. And is preparing the market for future rate increases. 19

21. Government Support Will Fade Recovery Act half paid out. After the stimulus peak this summer, it will be a drag on growth. Government debt concerns will make more stimulus more difficult. 20

22. State and Local Government Fiscal Crises State and local governments face budget shortfalls. State and local governments subtracted 0.5% from GDP last quarter. States cut a net 5,000 employees from payrolls in April. 21

23. Continued Housing Woes Distorted by policy: Homebuyer tax credit FED MBS purchases Low interest rates, mods Case-Shiller shows declines. Experts predict renewed downward pressure with shadow inventory coming online. 22

24. The Euro Crisis, the Rising Dollar, and a New Asian Export Push EU accounts for: 21% of U.S. goods exports 20% of China’s goods exports EU slowdown, will reduce demand for US goods, hurting the manufacturing revival. Asian economies “double down” on exports (Japan and China). 23

25. Renewed World Deflationary Pressures Excess global overcapacity and deflation. Lack of demand (EU impaired, China and Japan resorting to exports). Difficult for US to export its way to recovery. US may be forced to absorb global capacity or face prolonged world recession. 24

26. Uncertainty Over Taxes and Regulation Biggest problems (Empire State Manufacturing Survey): Employee benefit costs Taxes Government regulation With uncertainty, outsourcing becomes a more attractive. 25

27. III. Mendonca’s Questions about the Economic Recovery To what degree is China’s stimulus going to create growth or will it create an asset bubble? Can the global banking system absorb losses that may be coming in consumer loans and commercial real estate? Is consumer deleveraging cyclical or structural? What is going to happen when the unprecedented levels of stimulus are wound down? One third of the $2 trillion in worldwide fiscal stimulus came from the United States. What happens in 2010 when federal stimulus is overcome by state budget cuts? Lenny Mendonca Presentation, Bernard L. Schwartz Symposium, The Jobs Deficit October 20, 2009 26

28. III. More Questions for Discussion If the economy slides back into recession, do we have room for a new fiscal recovery program? Can the European Central Bank and the Federal Reserve find ways to monetize the debt and reduce the debt overhang to avoid deflation without calling into question the fiat currency reserve system? Can public infrastructure investment help transform the economy by creating jobs, crowding in private investment, and enhancing America’s productive capacity? Can China and other high-savings, high-investment economies help rebalance the global economy by accelerating the improvement of their peoples’ living standards and by relying more on personal and social consumption? How can we revitalize our innovative capacity, especially in the critical areas of energy, life sciences, and biotechnology in an era of constrained government spending? 27