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Leadership Institute for Directors Farm Credit “ An Economy Full of Conundrums ”

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  1. 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

  2. “All News is Economic— • and All Economic News is Bad”

  3. Measures of Our Economy’s Performance • Unemployment Rate • Inflation Rate • Growth Rate • Balance of Payments

  4. Unemployment Rate Good News • Today 5.1% • Two Years Ago 6.3% • Hurricanes Can (eventually) Be Good for Employment

  5. Unemployment Good News • Manufacturing Employment has Stabilized Bad News • Manufacturing Employment Still Down –

  6. 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

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

  8. 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%

  9. 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

  10. Trade Balance Good News • Exports are Increasing – Helping Manufacturing Bad News • Imports Have Been Increasing Faster than Exports – Hurting Manufacturing and Agriculture

  11. 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! !

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

  13. 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

  14. Oil Conundrum Why hadn’t oil derailed the economy prior to the hurricanes?

  15. 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!

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

  17. Aggregate Demand • Consumer Spending • Investment Spending • Government Spending • Net Exports = (Exports-Imports)

  18. 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

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

  20. 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!

  21. 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

  22. Government Spending Conundrum Why haven’t large government deficits pushed up interest rates?

  23. Government Spending How Much of Today’s 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!

  24. 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

  25. 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

  26. Dollar 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

  27. 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%

  28. 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. Asia’s Desire to Keep Exporting 6. Stability of European Union

  29. 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

  30. 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

  31. 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

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

  33. 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

  34. 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

  35. 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!

  36. 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!

  37. 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?

  38. 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

  39. 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

  40. Monetary PolicyQUESTION OF THE DAY • Forget About the Judges! Who Will Replace Alan Greenspan? One of the Most Important Appointments of Bush’s Presidency

  41. Conclusion Beware of the Sleeping Dragon! Think China When You Think About Our Country’s Future

  42. 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

  43. 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

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

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

  46. CONCLUSION We Must be Proactive In Correcting Our Imbalances! We Must Continue to Work to Regain Our Fiscal Sanity!

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

  48. CONCLUSION What Can You do? Just Don’t Stop Shopping!