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Leadership Institute for Directors Farm Credit “ An 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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leadership institute for directors farm credit an economy full of conundrums

Leadership Institute for DirectorsFarm Credit“An 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

“All News is Economic—
  • and

All Economic News is Bad”

measures of our economy s performance
Measures of Our Economy’s Performance
  • Unemployment Rate
  • Inflation Rate
  • Growth Rate
  • Balance of Payments
unemployment rate
Unemployment Rate

Good News

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

Good News

  • Manufacturing Employment has Stabilized

Bad News

  • Manufacturing Employment Still Down –
inflation rate
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
  • Inflationary Expectations are Building
  • Prices of Imports Up 2.5% for August
  • Projected Growth in Federal Budget Deficit
  • Unit Labor Cost Rising
economic growth gdp
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!


1st Quarter 3.8%

2nd Quarter 3.3%

3rd Quarter 3.0%


First half 2005 Productivity Gains 1.8%

2003 – 2004 Productivity Average 5%


  • Productivity is Slowing
  • Firms must now hire to increase output
  • Still Positive
  • Contrast - 1973-1995 Average Gain = 1.4%


  • Productivity is Slowing
  • Harder to Fight Rising Costs
trade balance
Trade Balance

Good News

  • Exports are Increasing – Helping Manufacturing

Bad News

  • Imports Have Been Increasing Faster than Exports – Hurting Manufacturing and Agriculture
trade balance exports imports
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!


trade deficit
Trade Deficit

Who Should We Blame?

  • China? Japan? European Union?
  • Ourselves?
  • Oil?
  • Multinationals – Cross Border Trade?
  • All of the Above
oil down but not out
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



Why hadn’t oil derailed the economy prior to the hurricanes?


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!

  • Basic Fact of Life
  • The Equilibrium Price of World Oil Has Increased!
aggregate demand
Aggregate Demand
  • Consumer Spending
  • Investment Spending
  • Government Spending
  • Net Exports = (Exports-Imports)
consumer spending
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

investment spending
Investment Spending

Good News

Business Spending Showing Signs of Life

Bad News

Inventories are Starting to Increase

Business Confidence is Weakening

fiscal policy
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!

government spending
Government Spending

Good News

Projected Deficit for 2005 Now Below 2004

Deficit Projection $333billion Fiscal 2005


Record Deficit 2004 - $413 billion

Projection - Fiscal 2006 – A Record Deficit

government spending22
Government Spending


Why haven’t large government deficits pushed up interest rates?

government spending23
Government Spending

How Much of Today’s Federal Government Budget

is Really Discretionary?

Social Security?


Interest on the Debt?

National Defense?

Percent of Budget = 82%

Virtually Running All Other Functions of Our Federal Government on Borrowed Money!

federal budget key dates for trust funds
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


exports imports dollar
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


Flooding World with Dollars

  • Japan and China Using Dollars to Buy Our Government Bonds

Accepting Our IOU’s to Buy Their Goods

  • Positive – Keeps Interest Rates Down
  • Negative – We Have Become Dependent on the Generosity of Foreigners to Finance Our Excesses
  • 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%

factors affecting the value of the dollar
Factors Affecting the Value of the Dollar

1. Interest Rate Differentials Among


2. Widening Trade Deficit

3. Foreign Central Banks Diversifying

Foreign Currency Reserves

4.Currency Speculation

5. Asia’s Desire to Keep Exporting

6. Stability of European Union

value of the dollar
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

monetary policy
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

housing bubble
Housing Bubble
  • Remember “Irrational Exuberance”?

Alan Greenspan Re Stock Market Bubble

Alan’s 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

housing bubble32
Housing Bubble

What is Fueling the Bubble?


Low Interest Rates


  • Adjustable Rate Mortgages
  • Interest Only Mortgages
  • 100% Financing


housing bubble33
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
housing bubble34
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

housing bubble35
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!

monetary policy36
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


monetary policy37
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?

future is in plastic no interest rates
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

interest rates
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
monetary policy question of the day
  • Forget About the Judges!

Who Will Replace Alan Greenspan?

One of the Most Important Appointments of Bush’s Presidency


Beware of the Sleeping Dragon!

Think China When You Think About Our Country’s Future


China and India are the Future of the Global


Combined Population Over 2 Billion!


United States, as Well as Germany and Japan, Remain A Very Big Part of the Present

  • 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

  • So Called “Twin Deficits”
  • Budget Deficits
  • Trade Deficits
  • And of course,
  • Consumer Debt
  • There are Some Major Imbalances

The Risks Out There are Real!

We are Nervous Because of the Large Amount of Uncertainty

So Many events Beyond Our Control


We Must be Proactive In Correcting Our Imbalances!

We Must Continue to Work to Regain Our Fiscal Sanity!


Good News For Now

Our Economy is Moving Forward Despite Major Natural Disasters.


What Can You do?

Just Don’t Stop Shopping!