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The Global Economy Challenges to Recovery

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

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The Global Economy Challenges to Recovery

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

  2. 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?

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

  4. 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

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

  6. 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

  7. Quick Reaction of Economic Agentsand 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

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

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

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

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

  12. Decisive US Fed Rate Cuts Federal Funds Target Source: Federal Reserve Bank of New York

  13. In a Low Inflation Environment % year-on-year 10 year average = 2.5% Source: Bureau of Labour Statistics, Merrill Lynch forecast

  14. Reinforced by Ample Fiscal Stimulus US Budget Balance as% of GDP US Gross Public Debtas % of GDP Source: IMF World Economic Outlook, April 2003

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

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

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

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

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

  20. The Recovery Remains Jobless % YoY growth Source: BEA, BLS, last data point: Employment May 03, GDP Mar 03

  21. Global Growth Outlook Merrill Lynch Forecasts, June 2003 (*) IMF forecasts

  22. 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?

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

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

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

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

  27. US Corporate Credit Ratings Worsen US$ bn US rating actions by value Source: Standard & Poor’s

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

  29. A Rising Current Account Deficit Current Account balance as % of GDP Source: Bureau of Economic Analysis, Merrill Lynch

  30. 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

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

  32. US Dollar Weakens US$/Euro Source: Bloomberg

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

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

  35. European Recovery Lags Behind US 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

  36. Euroland Recovery Lags Behind US % Real GDP Growth Source: Merrill Lynch forecasts

  37. 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

  38. Fiscal Laxity has Created Public Debt Problem Japan Budget Balanceas % of GDP Japan Gross Public Debtas % of GDP Source: IMF World Economic Outlook, April 2003

  39. 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

  40. Solid Recovery Continues In 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

  41. Outlook Reflects Domestic Policies and US Growth 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

  42. 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

  43. END

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