Leadership Institute for Directors Farm Credit An Economy Full of Conundrums

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Leadership Institute for DirectorsFarm
CreditAn Economy Full of Conundrums

• November 13, 2005
• Hyatt Regency
• Savannah, Georgia
• Gerald J. Swanson, Ph.D.
• Professor of Economics
• Thomas R. Brown Chair in Economics Education
• Eller College of Management
• University of Arizona

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• All News is Economic
• and
• All Economic News is Bad

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Measures of Our Economys Performance

• Unemployment Rate
• Inflation Rate
• Growth Rate
• Balance of Payments

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Unemployment Rate

• Good News
• Today 5.1
• Two Years Ago 6.3
• Hurricanes Can (eventually) Be Good for
  Employment

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Unemployment

• Good News
• Manufacturing Employment has Stabilized
• Bad News
• Manufacturing Employment Still Down

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Inflation Rate

• Good News
• Inflation 3.3 for 2004
• Core Inflation at 2
• Bad News
• CPI for September Up 1.2 14.4 Annually
• Prices are on the Rise in Most Sectors of the
  Economy

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Inflation

• Inflationary Expectations are Building
• Prices of Imports Up 2.5 for August
• Projected Growth in Federal Budget Deficit
• Unit Labor Cost Rising

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Economic GrowthGDP

• Around 3.5 This Year
• 2004 4.4 Strongest Growth in 5 Years
• 2003 3 Growth
• There are Signs that Growth is Slowing!
• 2005
• 1st Quarter 3.8
• 2nd Quarter 3.3
• 3rd Quarter 3.0

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Productivity

• First half 2005 Productivity Gains 1.8
• 2003 2004 Productivity Average 5
• GOOD NEWS
• Productivity is Slowing
• Firms must now hire to increase output
• Still Positive
• Contrast - 1973-1995 Average Gain 1.4
• BAD NEWS
• Productivity is Slowing
• Harder to Fight Rising Costs

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Trade Balance

• Good News
• Exports are Increasing Helping Manufacturing
• Bad News
• Imports Have Been Increasing Faster than Exports
  Hurting Manufacturing and Agriculture

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Trade BalanceExports - Imports

• TRADE DEFICIT Continues to set RECORDS
• Record -530 billion deficit
• Record -666 billion deficit
• First Three Months 2005 Record 174 billon
  deficit
• February Record deficit for one month -61
  billion
• First half 2005 - 346billion
• 2005 Estimate over -700 billion deficit A
  Record!
• This is a Major Imbalance
  
• It is Not Sustainable!
• !

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Trade Deficit

• Who Should We Blame?
• China? Japan? European Union?
• Ourselves?
• Oil?
• Multinationals Cross Border Trade?
• All of the Above

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OILDown But Not Out!

• Good News
• Oil Prices Today Above 60/barrel
• 70/barrel Record Price Nominal Terms
• Bad News
• Oil Prices Up 106 from December 2003
• December- 2003 Oil 31 per barrel
• Oil Prices Up 255 from November 2001
• November 2001 OIL 18/barrel

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Oil

• Conundrum
• Why hadnt oil derailed the economy prior to the
  hurricanes?

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OIL

• Oil Has Been the Key Trigger for Every Serious
  Bout of Inflation Since WW II
• This is Not Just an Oil-Shock
• Price is Being Driven by Demand
• At 9 Growth China Doubles Its Use of Resources
  Every 8 Years Including Oil
• China is Currently the Second Largest Consumer of
  Oil in the World!

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Oil

• Basic Fact of Life
• The Equilibrium Price of World Oil Has Increased!

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Aggregate Demand

• Consumer Spending
• Investment Spending
• Government Spending
• Net Exports (Exports-Imports)

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Consumer Spending

• The Main Variable
• Good News
• Worried, But They Still Keep Shopping
• Spending Home Equity
• Bad News
• Record Consumer Debt Levels
• Consumer Confidence is Down
• Real Wages Declining
• Higher Gasoline and Heating Oil Prices
  Cutting into Budgets

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Investment Spending

• Good News
• Business Spending Showing Signs of Life
• Bad News
• Inventories are Starting to Increase
• Business Confidence is Weakening

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Fiscal Policy

• Good News
• Tax Revenues are Up 14 over last year
• Bad News
• Pre Katrina and Rita Spending
• Spending Increases are Slowing - but up 7 over
  last year
• Medicare spending up 9.6
• Guns and Butter Squeeze Yet to Come!

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Government Spending

• Good News
• Projected Deficit for 2005 Now Below 2004
• Deficit Projection 333billion Fiscal 2005
• BAD NEWS
• Record Deficit 2004 - 413 billion
• Projection - Fiscal 2006 A Record Deficit

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Government Spending

• Conundrum
• Why havent large government deficits pushed up
  interest rates?

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Government Spending

• How Much of Todays Federal Government Budget
• is Really Discretionary?
• Social Security?
• Medicare?
• Interest on the Debt?
• National Defense?
• Percent of Budget 82
• Virtually Running All Other Functions of Our
  Federal Government on Borrowed Money!

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Federal BudgetKey Dates for Trust Funds

• First Year Outgo Exceeds Income for
• Social Security - 2017
• Disability Insurance - 2008
• MEDICARE it Happened in the Summer of 2004
• UNFUNDED LIABILITIES YET TO BE ADDRESSED

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Exports - ImportsDollar

• This is the Big Topic of the Day
• Dollar has Gained Some Strength
• A Conundrum
• Good News
• Weaker Dollar has Helped Exports
• Bad News
• Weaker Dollar Increases Costs of Imports
• Increases Risk of Inflation

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Dollar

• Flooding World with Dollars
• Japan and China Using Dollars to Buy Our
  Government Bonds
• Accepting Our IOUs to Buy Their Goods
• Positive Keeps Interest Rates Down
• Negative We Have Become Dependent on the
  Generosity of Foreigners to Finance Our Excesses

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Dollar

• United States is absorbing 80 of world savings
• Our savings rate is negative as a percentage of
  disposable income
• Savings Rate
• 1982 12
• 1990 7.4
• 2005 -0.7

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Factors Affecting the Value of the Dollar

• 1. Interest Rate Differentials Among
• Countries
• 2. Widening Trade Deficit
• 3. Foreign Central Banks Diversifying
• Foreign Currency Reserves
• 4.Currency Speculation
• 5. Asias Desire to Keep Exporting
• 6. Stability of European Union

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Value of the Dollar

• Currency Trading is Up 25 From Last Year
• Currency Markets Daily Trading Value
• 1.9 trillion
• By Far Larger Than Any Other Financial Market

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Monetary Policy

• Current Federal Funds Rate Target 3.75
• Up 275 form June 2003
• Eleven Quarter Percent Increases Since June 2004
• Still Very Accommodative
• Alan Greenspan is Creating His Own Rational
  Expectations
• Measured Increases
• Alan Wants to Make Rates Neutral
• 4 to 4.5
• Prior to June 2003 We Went Four Years Without an
  Interest Rate Increase

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Housing Bubble

• Remember Irrational Exuberance?
• Alan Greenspan Re Stock Market Bubble
• Alans Recent comments
• Housing Market is a Little Too Exuberant for Its
  Own Good.
• There are Lots of Local bubbles
• Low interest rates lead to upward adjustments in
  asset prices--housing

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Housing Bubble

• What is Fueling the Bubble?
• Demographics
• Low Interest Rates
• ALTERNATIVE MORTAGES
• Adjustable Rate Mortgages
• Interest Only Mortgages
• 100 Financing
• SPECULATION!

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Housing Bubble

• Alternative Mortgages 2/3 of Mortgage
  Originations in Second Half of 2004
• Strange Because 30 Year Fixed Mortgages are
  Still Below 6 -
• Low by Historical Standards
• Speculation Boom
• Affordability Index Reaching Record Levels in Hot
  Markets LA,, Boston, Miami

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Housing Bubble

• What Do All These Exotic Loans Have in Common?
• They Allow Homeowners to Buy a More Expensive
  Home Than They Could Have Qualified for With a
  Traditional Loan

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Housing Bubble

• What Happens if Interest Rates Increase?
• The Bubble Bust!
• Housing Prices Fall
• Borrowers With Interest Only Loans
• Could End Up Owing More Than the Value of
  
• Their Home!

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Monetary Policy

• Questions of the Day
• Is Monetary Policy Too Tight?
• Short Term Interest Rates Up
• Is Monetary Policy Too Loose?
• Long Term Interest Rates Remain Low
• A CONUNDRUM!

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Monetary Policy

• Higher Oil Prices Pose a Quandary for the
  Federal Reserve
• Higher Oil Prices Act as a Tax on Consumer
  Spending Slows the Economy
• Higher Oil Prices Boost Other Prices
• Causes Inflation
• Which Should Alan Fight?

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Future is in Plastic!No Interest Rates

• Higher Interest Rates
• Could Hurt Home Sales
• Could Hurt Car sales
• Could Hurt Retail Sales
• Could Really Hurt Federal Budget
• Could Hurt Bond Market
• Could Hurt Financial Institutions

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Interest Rates

• What Would Happen to Interest Payments on the
  National Debt if Short-Term Interest Rates
  Continue to Increase?
• 275 Increase in Short-term Interest Rates Since
  June 2003

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Monetary PolicyQUESTION OF THE DAY

• Forget About the Judges!
• Who Will Replace Alan Greenspan?
• One of the Most Important Appointments of
  Bushs Presidency

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Conclusion

• Beware of the Sleeping Dragon!
• Think China When You Think About Our Countrys
  Future

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Conclusion

• China and India are the Future of the Global
• Economy
• Combined Population Over 2 Billion!
• However--
• United States, as Well as Germany and Japan,
  Remain A Very Big Part of the Present

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CONCLUSION

• Our Economy Appears to be Cooling Off a Little
• Hitting a Bit of a SOFT PATCH
• Still Moving in a Positive Direction
• SO FAR We are Weathering the Storm

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Conclusion
So Called Twin Deficits Budget Deficits Trade
Deficits And of course, Consumer Debt

• There are Some Major Imbalances

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Conclusion

• The Risks Out There are Real!
• We are Nervous Because of the Large Amount of
  Uncertainty
• So Many events Beyond Our Control

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CONCLUSION

• We Must be Proactive In Correcting Our
  Imbalances!
• We Must Continue to Work to Regain Our Fiscal
  Sanity!

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Conclusion

• Good News For Now
• Our Economy is Moving Forward Despite Major
  Natural Disasters.

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CONCLUSION

• What Can You do?
• Just Dont Stop Shopping!