Robert F. Wescott, Ph.D.

Global Economic Growth Prospects: 2007 and Beyond

• Keybridge Research LLC

• Washington, DC

4 Forces Shaping World Economy4 Forces Shaping World Economy in 2006-07 in 2006-07

1. Tighter monetary and fiscal policies: 1. Tighter monetary and fiscal policies:

2. Still high energy prices: 2. Still high energy prices:

3. Strong global productivity: 3. Strong global productivity:

4. Trade opening: 4. Trade opening:

Global Liquidity Now Slowing Global Liquidity Now Slowing U.S. monetary base plus world foreign exchange U.S. monetary base plus world foreign exchange

holdings (percent change, year on year)holdings (percent change, year on year)

0%

5%

10%

15%

20%

25%

30%

Sources: Federal Reserve, IMF COFER database

Oil: A Growing Burden on the Oil: A Growing Burden on the World EconomyWorld Economy

Source: EIA, IMF WEO

0%

1%

2%

3%

4%

5%

6%

7%

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

Global Slowdown Trigger Level?

2006-07 Economic Prospects2006-07 Economic Prospects Global growth downshifts from 5% to 3.5 or 4%Global growth downshifts from 5% to 3.5 or 4%

– – adjustment to higher interest rates, high adjustment to higher interest rates, high energy pricesenergy prices– – consensus view of 5% too high as real consensus view of 5% too high as real incomes slowincomes slow

Growth convergence: E.U. and Japan up to Growth convergence: E.U. and Japan up to 2.5%,2.5%, E.U.: profits spur investment, consumption E.U.: profits spur investment, consumption

recovers, pent up demandrecovers, pent up demand Japan: land prices rebound, credit increases, Japan: land prices rebound, credit increases,

provide liftprovide lift U.S. down—2.0% as housing slowsU.S. down—2.0% as housing slows China, India still strong, 7-8%China, India still strong, 7-8% Other Asia, Latin America, Eastern Europe—Other Asia, Latin America, Eastern Europe—

decent growth (4-5%)decent growth (4-5%)

2006-07 Financial Prospects2006-07 Financial Prospects Global interest rates: have already peaked at Global interest rates: have already peaked at

5.25% (U.S.)5.25% (U.S.) Global equities: have liked “Goldilocks” Global equities: have liked “Goldilocks”

worldview, but likely to suffer if U.S. really worldview, but likely to suffer if U.S. really slows to 2% GDP growthslows to 2% GDP growth

Currencies: $ depreciates. Euro, yen, and Currencies: $ depreciates. Euro, yen, and RMB appreciate.RMB appreciate.

U.S. equities: at risk, particularly housing, U.S. equities: at risk, particularly housing, lumber, autos, mortgage lenders (especially lumber, autos, mortgage lenders (especially sub-prime lenders)sub-prime lenders)

EU equities: profits should help sustain equity EU equities: profits should help sustain equity ralliesrallies

Eastern Europe equities: generally favorableEastern Europe equities: generally favorable

Housing Prices Rising WorldwideHousing Prices Rising Worldwide

-50% 0% 50% 100% 150% 200% 250%

Hong KongJapan

GermanySwitzerland

SwedenCanadaFrance

DenmarkBelgium

N. ZealandItalyU.S.

NetherlandsAustralia

BritainSpain

IrelandS. Africa

Percent Change, 1997-2005

Source: The Economist

5.3%

29.6%

20.6%

81.3%

Share of TotalEmployment, 2005

2004 2005 2001- 2005

Housing’s Disproportionate Housing’s Disproportionate Contribution to U.S. Job GrowthContribution to U.S. Job Growth

Source: BLS

Mortgage Equity Withdrawal Can Mortgage Equity Withdrawal Can Almost Entirely Explain the Decline in Almost Entirely Explain the Decline in

U.S. SavingU.S. Saving

Source: Federal Reserve, BEA, Office of Thrift Supervision, ISI

-2%

0%

2%

4%

6%

8%

10%

12%Household Savings RateMortgage Equity Withdrawal

Housing’s Contribution to U.S. Housing’s Contribution to U.S. GDP Growth, 2001-05GDP Growth, 2001-05

ChannelChannel Growth, Growth, ‘01-’05‘01-’05

Effect on Effect on GDPGDP

ContributioContribution to GDP n to GDP GrowthGrowth

Residential Residential InvestmentInvestment $343.4 billion$343.4 billion 100%100% $343.4 billion$343.4 billion

Housing Housing WealthWealth

$4,285.9 $4,285.9 billionbillion 7%7% $300.0 billion$300.0 billion

Cash Out Cash Out From From

RefinancingRefinancing

$1.219.0 $1.219.0 billionbillion 100%100% $1,219.0 $1,219.0

billionbillion

Total housing contribution to GDP Total housing contribution to GDP growth:growth:

$1,862.4 $1,862.4 billionbillion

Total U.S. GDP growth:Total U.S. GDP growth: $2,918.3 $2,918.3 billionbillion

Housing share of GDP growth (percent):Housing share of GDP growth (percent): 64%64%

U.S. Housing Downturns Tend to be U.S. Housing Downturns Tend to be DeepDeep

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%1973-75 1978-80 1981-82 1984 1986-91

Decline in Housing Starts, Last Five Housing Market Downturns

Source: Census Bureau

Average Decline: 51.2%

40

45

50

55

60

65

70

75

2002.02 2002.10 2003.06 2004.02 2004.10 2005.06 2006.02

U.S. Housing Slowdown Has Already U.S. Housing Slowdown Has Already StartedStarted

Source: National Association of Home Builders

NAHB/Wells Fargo Housing Market Index, 2002-2006

8 Observations About the 8 Observations About the Changing Global EconomyChanging Global Economy

1. Centers of activity will shift1. Centers of activity will shift 2. Consumer landscape will change2. Consumer landscape will change 3. Energy and environmental problems will grow3. Energy and environmental problems will grow 4. Emerging markets will have both inflationary 4. Emerging markets will have both inflationary

and deflationary effectsand deflationary effects 5. Battleground for talent will heat up5. Battleground for talent will heat up 6. Key secret of emerging markets: productivity 6. Key secret of emerging markets: productivity

and appreciating currenciesand appreciating currencies 7. But investors beware: diversification is falling7. But investors beware: diversification is falling 8. Risks to consider8. Risks to consider

1. Centers of economic 1. Centers of economic activity will shift profoundly activity will shift profoundly

– globally and regionally– globally and regionally Today Asia (excluding Japan) represents Today Asia (excluding Japan) represents

13% of world GDP; the E.U. represents 13% of world GDP; the E.U. represents 30%.30%.

In 2025 Asia and the E.U. will each be In 2025 Asia and the E.U. will each be 20%-22% of the world economy.20%-22% of the world economy.

The U.S. will remain the world’s largest The U.S. will remain the world’s largest economy.economy.

Regional shifts: toward regional capital Regional shifts: toward regional capital cities (Kansei, Kanto)cities (Kansei, Kanto)

China’s Trend Has Been China’s Trend Has Been Sharply UpwardSharply UpwardShare of World Economy, PPP Basis

0

5

10

15

20

25

30

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

pe

rce

nta

ge

Source: IMF

0

3

6

9

12

15

1980 1986 1992 1998 2004

Sources: Angus Maddison, The World Economy: A Millennial Perspective and International Monetary Fund

0

2

4

6

8

10

1820 1845 1870

0

5

10

15

20

25

1860 1882 1913

0

2

4

6

8

10

1950 1956 1962 1968 1974

China, 1980-2005

U.K., 1820-1870 U.S., 1860-1913

Japan, 1950-1974

GDP, % of World Total, PPP BasisGDP, % of World Total, PPP Basis

““Asian Tiger” Five Phase Asian Tiger” Five Phase Growth CycleGrowth Cycle

Pre-Pre-Takeoff Takeoff (5 yrs)(5 yrs)

TakeofTakeoff f (10 (10 yrs)yrs)

Maximum Maximum burst burst (10 (10

yrs)yrs)

ConsolidatConsolidation ion (10 (10

yrs)yrs)

Slow-Slow-down down (10 (10

yrs)yrs)

JapanJapan 1945-491945-49

2.0%2.0%1950-1950-

5959

6.5%6.5%

1960-691960-69

9.4%9.4%1970-791970-79

3.9%3.9%1980-891980-89

3.1%3.1%

TaiwanTaiwan 1955-59 1955-59

2.5%2.5%1960-1960-

69 69

6.4%6.4%

1970-79 1970-79

8.1%8.1%1980-891980-89

6.6%6.6%1990-991990-99

4.5%4.5%

KoreaKorea 1970-74 1970-74

6.3%6.3%1975-1975-

8484

5.8%5.8%

1985-941985-94

7.2%7.2%1995-2003 1995-2003

4.5%4.5%--------

ThailanThailandd

1970-74 1970-74

3.6%3.6%1975-1975-

8484

4.5%4.5%

1985-941985-94

7.4%7.4%1995-20031995-2003

1.7%1.7%--------

ChinaChina 1975-791975-79

4.1%4.1%1980-1980-

89 89

7.9%7.9%

1990-99 1990-99

8.6%8.6%2000-2000-

7.8%7.8%--------

Average Per Capita Income Growth %

China: Fitting the “Asian China: Fitting the “Asian Tiger” Growth ProfileTiger” Growth Profile

3.6

5.8

8

4.23.8

4.1

7.9

6.7

8.6

0

1

2

3

4

5

6

7

8

9

10

perc

enta

ge

Asian TigerAverage

China

Pre-Take-Off Take-Off Maximum Burst Consolidation Slowdown

5.0?

Note: Asian Tigers = Average of Japan, Taiwan, Korea and Thailand. Data adjusted for differences in cost of living and exchange rates.

Average Annual Growth in Per Capita Income

2. The consumer landscape 2. The consumer landscape will expand significantlywill expand significantly

$5,000 in income is a threshold above $5,000 in income is a threshold above which spending can go to discretionary which spending can go to discretionary items (like Italian silk scarves)items (like Italian silk scarves)

Spending power in emerging markets will Spending power in emerging markets will jump from $4 trillion today to $10 trillion in jump from $4 trillion today to $10 trillion in 2025.2025.

Already Poland has more people with a Already Poland has more people with a Danish income level than Denmark.Danish income level than Denmark.

Soon China will have more people with a Soon China will have more people with a German income level than Germany.German income level than Germany.

Vehicles Registered per Vehicles Registered per CapitaCapitaVehicle Vehicle

RegistratRegistrationion

Country/YearCountry/Year Per Capita Per Capita IncomeIncome

0.010.01

(1 in 100)(1 in 100)China, 1997China, 1997 $3,695$3,695

Korea, 1973Korea, 1973 $3,465$3,465

0.050.05

(1 in 20)(1 in 20)Korea, 1988Korea, 1988 $8,934$8,934

Taiwan, 1981Taiwan, 1981 $6,628$6,628

Mexico, 1974Mexico, 1974 $7,639$7,639

0.10.1

(1 in 10)(1 in 10)Korea, 1991Korea, 1991 $10,973$10,973

Taiwan, 1987Taiwan, 1987 $9,992$9,992

Mexico, 1981Mexico, 1981 $10,030$10,030

0.20.2

(1 in 5)(1 in 5)Japan, 1971Japan, 1971 $11,400$11,400

Korea, 1995Korea, 1995 $13,864$13,864

Taiwan, 1992Taiwan, 1992 $13,458$13,458

The “Sweet Spot” for Car Ownership The “Sweet Spot” for Car Ownership is between $4,000 & $9,000 Per is between $4,000 & $9,000 Per

Capita IncomeCapita Income

0

$3,000

$6,000

$9,000

$12,000

$15,000

$18,000

$21,000

1

Vehicle Registration per Capita

Per Capita Income-US$ PPP Basis

China (1997)Korea (1973)India(2002)

China(2002)Korea(1981)

Korea(1991)

Taiwan(1987)

Thailand(1996)

Korea(1991)

Taiwan(1987)

Thailand(1996)

Mexico(2000)Korea(1995)Japan(1971)

Korea(2002)

Taiwan(2001)Japan(1976)

0.01 0.02 0.05 0.1 0.2 0.3

$3,400

$4,900

$6,700

$9,100

$12,400

$19,200

Average of Japan, Taiwan, Korea, Thailand, China, and Mexico

3. Demand for natural 3. Demand for natural resources will grow; put resources will grow; put

strain on the environmentstrain on the environment Oil demand projected to grow 50% Oil demand projected to grow 50%

in the next 20 yearsin the next 20 years But China cannot use oil as U.S. But China cannot use oil as U.S.

and Europe doand Europe do Growing demands for steel, Growing demands for steel,

aluminum, copper, minerals, wateraluminum, copper, minerals, water Pressing need for alternate fuels, Pressing need for alternate fuels,

new transportation technologynew transportation technology

0

50

100

150

200

250

300

350

1980 1986 1992 1998 2004

Sources: International Iron and Steel Institute, Japan Iron and Steel Federation, Barraclough: Steelmaking, Hogan: The Economic History of the Iron and Steel Industry in the U.S, Hudson & Sadler: The International Steel Industry

05

10152025303540

1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910

0

20

40

60

80

100

120

140

1950 1956 1962 1968 1974

China, 1980-2005

U.S., 1860-1913 Japan, 1950-1974

Steel Production, Millions of tonsSteel Production, Millions of tons

<10% of world (1843)

36% of world (1900)

<5% of world (1950)

19% of world (1974)

<4% of world (1980)

29% of world (2005)

World COWorld CO22 Emissions Are Emissions Are Rising and Asia is the Biggest Rising and Asia is the Biggest

PolluterPolluterWorld Carbon Dioxide Emissions by Region

0

5,000

10,000

15,000

20,000

25,000

30,000

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

mill

ion

met

ric

ton

s

North America

Western Europe

CIS/E. Europe

Africa

Middle East

Asia

Latin America

Source: Energy Information Agency, U.S. Department of Energy

4. For Goods that China 4. For Goods that China BuysBuys……

0.6

0.7

0.8

0.9

1

1.1

1.2

1.3

1.4

1.5

1.6

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Copper Iron Aluminium

China’s Share of World Imports of Metal Ores & ConcentratesChina’s Share of World Imports of Metal Ores & Concentrates

Source: UN ComTradeSource: UN ComTrade

……Prices Go Prices Go UpUp

95

105

115

125

135

145

155

1991 1993 1995 1997 1999 2001 2003 2005

Source: United States Geological SurveySource: United States Geological Survey

Average US Market Spot Prices, Indexed to 1996 PricesAverage US Market Spot Prices, Indexed to 1996 Prices

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

1990 1992 1994 1996 1998 2000 2002 2004 2006

Bil

lio

n Y

uan

But for Goods that China But for Goods that China SellsSells……

China’s exports have increased 3X in 5 years

……Prices Are Held Prices Are Held DownDown

0

5

10

15

20

25

30

35

40

45

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

U.S. Import Non-energy Import Price Index 1990 = 100

U.S. Core CPI, Index 1990 = 100

5. Battleground for talent will 5. Battleground for talent will shiftshift

Shift from production to knowledge-Shift from production to knowledge-intensive industries (science, technology, intensive industries (science, technology, culture, arts, entertainment)culture, arts, entertainment)

In U.S., 5% of jobs were in these In U.S., 5% of jobs were in these industries in 1900, but 40% today are.industries in 1900, but 40% today are.

In Italy, 13% are today, but this will In Italy, 13% are today, but this will increase.increase.

33 million university-educated young 33 million university-educated young professionals in developing countries professionals in developing countries today (more than twice the number in today (more than twice the number in advanced countries)advanced countries)

TalentTalent

0%

5%

10%

15%

20%

25%

30%

Denm

ark

Austri

a

Portu

gal

Italy

Franc

e

Irela

nd

Greec

e

Belgi

um

Sweden

Finlan

d

Germ

any

Spain

U.K.

Nethe

rlands U.S

.

Percent of population ages 25-64 with a B.A. degree or above

Source: Florida and Tinagli, “Europe in the Creative Age,” Feb. 2004

6. Key Attractions of Emerging 6. Key Attractions of Emerging Markets:Markets:

Rapid Productivity Growth & Appreciating Rapid Productivity Growth & Appreciating CurrenciesCurrencies

-0.3

-0.1

0.1

0.3

0.5

0.7

0.9

1989 1991 1993 1995 1997 1999 2001 2003 2005Source: IMFSource: IMF

While Poland’s productivity has

increased 4.2% a year, the Zloty has

appreciated by roughly 3% per year against the

currencies of all its trading partners.

Polish Zloty, real effective exchange rate, 1995 = 0

Average Correlation Between US & Emerging Market Equity Average Correlation Between US & Emerging Market Equity Indices Indices

-0.3

-0.1

0.1

0.3

0.5

0.7

0.9

1989 1991 1993 1995 1997 1999 2001 2003 2005

7. Together We Rise, Together We 7. Together We Rise, Together We Fall!Fall!

Tighter Linkages Between Equity MarketsTighter Linkages Between Equity Markets

Source: Global Financial Data. Equity market indices for Argentina, Brazil, China, India, Mexico, South Africa, South Source: Global Financial Data. Equity market indices for Argentina, Brazil, China, India, Mexico, South Africa, South Korea, Taiwan, Turkey, Venezuela, and the United States. Korea, Taiwan, Turkey, Venezuela, and the United States.

8. Risk: Can Disequilibrium 8. Risk: Can Disequilibrium Continue?Continue?

Source: IMF WEO

-8

-6

-4

-2

0

2

4

6

8

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

Current Account Balance as a Percent of GDP

China Produces

The US Consumes

Problems from China’s over Problems from China’s over savingsaving Inefficient use of capital (zero returns)Inefficient use of capital (zero returns)

Stirs protectionist backlash from trading Stirs protectionist backlash from trading partnerspartners

Impediments to Shift to Domestic Impediments to Shift to Domestic DemandDemand

Confucian work ethic (Japan and Korea, etc. Confucian work ethic (Japan and Korea, etc. maintained 30% saving rates for 30-40 years)maintained 30% saving rates for 30-40 years)

One child policy (“1-2-4” problem, dependency One child policy (“1-2-4” problem, dependency ratio up starting in 2010)ratio up starting in 2010)

Weak Social Security systemWeak Social Security system Banking system weak, may not be able to Banking system weak, may not be able to

support consumerismsupport consumerism