THE ECONOMIC OUTLOOK:

HALF-SPEED AHEADHALF-SPEED AHEAD

David Wyss

Brown University

April 24, 2012

The Pace Of The Recovery Has Slowed

• A recovery is underway, but is likely to remain weak.

• Housing now appears to be stabilizing, although prices are still falling.

• Overseas partners are recovering, helping exports. The financial

problems add to risks and probably mean a recession in Europe.

• The fiscal stimulus helped boost the economy, but is being reversed.

The Washington gridlock makes any help from Washington unlikely, and

the government could cause a recession.

2.

the government could cause a recession.

• Private nonresidential construction remains weak, but equipment

spending has begun to recover

• Consumers aren’t bouncing back as quickly as usual, but are showing a

few more signs of life as they start replacement purchases.

• Another dip into recession is possible if the financial markets lock up

again or oil prices jump farther on Middle East turmoil.

The Housing Bubble

• Housing was too affordable, thanks to low mortgage rates

• Ratio of home price to income hit a record high in 2007.

• We built too many houses at too high prices

• Starts and sales dropped sharply

• Defaults have soared, cutting back on willingness to lend

• Prices fell one-third from their peak, with the price/income ratio below

3.

• Prices fell one-third from their peak, with the price/income ratio below

its historical average

• Starts and sales are recovering

• But prices are likely to drop back through spring.

Home Prices Were Too High

(Ratio of average home price to average household disposable income)

3.5

4

4.5

4.

Source: Bureau of Economic Analysis and Census Bureau

2

2.5

3

1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015

Existing New Quality-adjusted

Bubbles Were Almost Everywhere

SwedenItaly

IrelandBritain

NetherlandsSwitzerland

GermanyCanada

US

(Percent increase in home prices, 1997-2005)

5.

-100 -50 0 50 100 150 200 250

Hong KongNewZealand

ChinaAustralia

JapanSpain

FranceSweden

Source: Mortgage Bankers’ Association and Standard & Poor’s

Those Who Bubbled Highest Burst Loudest

(Percent increase in S&P/Case-Shiller home price index, July 2011)

PortlandSeattle

New YorkSan Francisco

PhoenixLas Vegas

TampaSan Diego

WashingtonLos Angeles

Miami

6.

Source: Standard & Poor’s

-100 -50 0 50 100 150 200

ClevelandDallasDetroitAtlanta

CharlotteDenver

ChicagoMinneapolis

BostonPortland

peak-present 2000-peak

(Percent)

The Fed Didn’t Stop At Nothing

6

8

10

7.

Source: Federal Reserve

0

2

4

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Federal Funds Rate 10-Yr Bond Yield Mortgage rate

Synchronized Sinking

• Industrial countries went into recession in 2008, and into a plunge in the

fourth quarter of 2008

• Real GDP fell in the U.S., Japan, and Europe

• Developing countries looked like they might escape

• Until commodity prices plunged in Q4 2008

• World GDP is recovering, up 4.2% in 2010 from -2.1% in 2009

8.

• The most synchronized world recession in history is being followed by a

slow, less synchronized recovery

• Problems in Europe and Japan will further cut developed country

growth, with Japan back in recession.

• But Asia continues to grow strongly

Synchronized Sinking

-2

0

2

4

6

8

10

(Real GDP, % change)

9.

-8

-6

-4

-2

2007 2008 2009 2010 2011 2012 2013

Source: Global Insight and Standard & Poor’s

(Index)

Trade Gap And Reserve Diversification Will Send Dollar Lower

(Percent of GDP)

-4%

-3%

-2%

-1%

0%

1

1.1

1.2

1.3

1.4

10.

Source: Bureau of Economic Analysis and Federal Reserve, S&P projections

-7%

-6%

-5%

-4%

0.7

0.8

0.9

1

2000 2002 2004 2006 2008 2010 2012 2014

Net exports (right) Dollar index (major trading partners)

Timeo Danaos Et Debitum Ferentes

(Central government debt as percent of GDP, 2010)

11.

Source: Standard & Poor’s from national sources

Budget Deficits Depend On Economy

0 2 4 6 8 10 12

Australia

Canada

China

France

Germany

Greece

(Budget gap as percent of GDP, 2010)

12.

Greece

India

Italy

Japan

Korea

Spain

UK

US

Source: Standard & Poor’s CRISIL

Deficits Are Mostly Cyclical

-4

-2

0

2

4

(Government deficit as % of GDP, fiscal years)

13.

-12

-10

-8

-6

2000 2003 2006 2009 2012

stimulus ex stimulus

Source: Standard & Poor’s

The Future Looks Bleak

308

415

753

431404 400

400

500

600

700

800

(Government debt as % of GDP)

14.

69106

72 79 75

180

308

192 184155

0

100

200

300

US Japan UK France Germany

2010 2030 2050

Source: Standard & Poor’s, 2010

Aging Populations Will Boost Government Spending

40

50

60

70

80

(Retirees as percentage of labor force)

15.

0

10

20

30

US Canada France Germany Italy UK Japan Australia China OECD

2010 2030

Source: Organization for Economic Cooperation and Development

(4-quarter percent change)

Weaker Employment Is Hurting Construction

-2%

-1%

0%

1%

2%

3%

4%

-10%

0%

10%

20%

16.

Source: Bureau of Labor Statistics, Bureau of Economic Analysis, S&P projections

-6%

-5%

-4%

-3%

-2%

-40%

-30%

-20%

2005 2007 2009 2011 2013 2015

Nonresidential construction Nonfarm employment

140

160

180

200

220

240

Commercial Real Estate Price Declines Are Bottoming

17.

60

80

100

120

140

Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08

Source: M.I.T. Center for Real Estate.

(4-quarter percent change, and production as % of capacity)

Equipment Spending Follows Capacity Needs

(Percent)

75

80

85

0%

10%

20%

18.

Source: Federal Reserve, Bureau of Economic Analysis

60

65

70

-30%

-20%

-10%

2000 2002 2004 2006 2008 2010 2012 2014

Business equipment (real, left scale) Capacity Utilization, mfg (Right)

Can the Consumer Keep Spending?

• Consumer spending led recent expansions

• But wealth is down because home prices have dropped and

• Stocks are still below their 2007 peak

• Borrowing is more difficult, and home equity loans much

less available

• Confidence has dropped and unemployment risen

19.

• Consumers are likely to continue to save more and

borrow less

• High oil prices hurt purchasing power and confidence

• Stimulus package provided some income boost

Debt Is Dropping From Record Highs

(Percent of after-tax income)

1.1

1.2

1.3

1.4

1.5

3

4

5

6

7

20.

Source: Bureau of Economic Analysis and Federal Reserve

0.7

0.8

0.9

1.0

0

1

2

3

2000 2002 2004 2006 2008 2010 2012 2014

Saving rate Debt/income (right scale)

Wealth Slides With Home and Stock Prices

(Percent of after-tax income)

400%

500%

600%

700%

21.

Source: Federal Reserve

0%

100%

200%

300%

1990 1993 1996 1999 2002 2005 2008 2011 2014

Net worth Financial assets

4

5

6

7

8

9

(Percent)

Default Rates Begin To Drop

22.

0

1

2

3

4

2005 2005 2006 2007 2007 2008 2009 2009 2010 2011

Auto BankCard First Mtg Second Mtg

Auto BankCard First Mtg Second Mtg

Source: S&P/Experian

Bigger Than The Average Bear

• A great run from 1982 to 2000

• But the secular bear began in 2000

• Two largest bear markets since the depression

• Earnings were negative in 2008 Q4 for first time in history

• We think the rally will continue

• But the long-term cycle probably has another bear in it.

23.

• World stock markets have generally become synchronized

• As money flows between markets in search of yield

Bottom Line: The Economy Will Recover Slowly

• The recession is the longest and deepest since the 1930s

• Fiscal stimulus has supported the recovery

• But recovery is likely to be slow because of financial markets and

switch to higher savings

• If financial markets lock up again

• Fiscal stimulus ends abruptly

24.

• Home prices continue to fall

• And oil prices continue to rise

• The recession could be longer and deeper

• With the risk of a “lost decade” similar to Japan in the 1990s

Oil Prices Remain Down From Peak

($/barrel, WTI and deflated by CPI; household energy purchases as percent of disposable income)

6%

7%

8%

9%

80

100

120

140

25.

Source: Bureau of Economic Analysis

3%

4%

5%

0

20

40

60

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Oil Price (WTI) 2005 Dollars % of disp. income