Global Economic and Financial Prospects and Risks: 2006
Robert F. Wescott, Ph.D.Rome5 December 2005
6 Forces Shaping World Economy in 2006
1. Reversal of policy stimulus: negative2. Still high energy prices: negative3. Faster global productivity: positive4. Tax/business policies: mixed5. Trade openness: neutral6. Demographics: mixed
Economic Policy Floodgates Closing
-5
-4
-3
-2
-1
0
1
2
-5 -4 -3 -2 -1 0 1 2
2000-2004
2004-2005
US
Canada
Germany
US
Italy
Euro AreaGermanyFrance
UK
Euro Area
FranceItaly
JapanUK
Japan
Canada
Tighter Fiscal PolicyEasier Fiscal Policy
% change in real six month LIBOR
Change in structural f iscal balance as a % of GDP
China
China
Tighter Monetary Policy
Easier Monetary Policy
Source: IMF WEO, Author’s calculations for China
Oil: A Growing Burden on the World Economy
World Oil Expenditure as Percent of World GDP
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%Global Recession
Trigger Level?
Source: EIA, IMF WEO
6 Forces Shaping World Economy in 2006
1. Reversal of policy stimulus: negative2. Still high energy prices: negative3. Faster global productivity: positive4. Tax/business policies: mixed5. Trade openness: neutral6. Demographics: mixed
Perceived Global Investment Risks
-80
-60
-40
-20
0
20
40
60
Canada UnitedStates
Japan WesternEurope
China EasternEurope
OtherAsia
LatinAmerica
Russia Africa MiddleEast
1998 2005
Source: UBS Index of Investor Optimism, August 2005
Percent rating the region “low risk”
minus percent rating it “high risk”
The dollar-euro in 2006
Shaped by long-run, medium-run, and short-run factorsLong run: competitiveness, productivity (good for $)Medium run: current account imbalances (very bad for $)Short run: interest rate differentials, growth differentials (shifting to euro)
Risks to PonderU.S. soft patch?
Energy prices lead to negative industry effects?Housing bubble bursts?
Wrong policies in Europe?Interest ratesLoss of jobs to China
Disequilibrium proves unsustainable?Hypothesis: U.S. consumes, China producesWeakened President Bush?
The Oil Price Pass-Through to Inflation is Falling
Percent change in CPI and core CPI divided by percent change in RAC of oil (during periods of 30%+ increases in oil prices)
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.1
1970s 2000s1990s1980s
CPI
Core CPI
CPICPI
CPI
Core CPI
Core CPI
Core CPI
Source: Bureau of Labor Statistics and Energy Information Agency
Why Isn’t the Dow at 12,800?(Because of Energy Prices)
Change in DJIA when Corporate Profits are up 30% or More (Y/Y)
21.9
-3.3
0.8
31.1
-15.1
6.1
27.7
36.036.0
-20
-10
0
10
20
30
40
2000s1950s-1990s
Average:-4.5%
Average: 21.5%
Source: Bureau of Economic Analysis, Yahoo! Finance
Housing Prices Rising Worldwide
-75 0 75 150 225 300
Hong KongJapan
GermanySwitzerland
SwedenCanadaFrance
DenmarkBelgium
N. ZealandItalyU.S.
NetherlandsAustralia
BritainSpain
IrelandS. Africa
Percent Change, 1997-2005
Source: The Economist
Are Rising Interest Rates Killing the U.S. Refinancing Boom?
10-Year U.S. Treasury Yield and Mortgage Refinancing Index
3
3.4
3.8
4.2
4.6
5
1/2/
2004
2/6/
2004
3/12
/200
4
4/16
/200
4
5/21
/200
4
6/25
/200
4
7/30
/200
4
9/3/
2004
10/8
/200
4
11/1
2/20
04
12/1
7/20
04
1/21
/200
5
2/25
/200
5
4/1/
2005
5/6/
2005
6/10
/200
5
7/15
/200
5
8/19
/200
5
9/23
/200
5
10/2
8/20
05
12/2
/200
5
10
-ye
ar
tre
as
ury
yie
ld
1000
2000
3000
4000
5000
6000 Mo
rtga
ge
Re
fina
nc
ing
Ind
ex
10-year treasury yield (left)
Mortgage Refinancing Index (right)
Sources: Federal Reserve, Mortgage Bankers Association
Greenspan’s Medicine Would Help Europe(Real short-term interest rates)
-2
-1
0
1
2
3
4
5
6
7
I 1
990
I 1
991
I 1
992
I 1
993
I 1
994
I 1
995
I 1
996
I 1
997
I 1
998
I 1
999
I 2
000
I 200
1
I 200
2
I 200
3
I 200
4
I 200
5
Fed funds / ECB policy rate deflated by “core” CPI inflation
US real interest rate
EU real interest rate
Sources: Federal Reserve, Bureau of Labor Statistics, European Central Bank, European Commission
China’s Trend Has Been Sharply 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 WEO
High Tech Manufactures: Asia Rising, Europe Declining
Source: National Science Foundation, “Science and Engineering Indicators 2004”
Share of World Production of High-Tech Goods
0%
5%
10%
15%
20%
25%
30%
35%
US Germany France U.K. Italy Japan China SouthKorea
India
1980 1990 2001
Percentage of 18-24 Year Olds in Science and Engineering Programs
0%
1%
2%
3%
4%
5%
6%
7%8%
9%
10%
U.K.
S. Kor
ea
France
Japa
n
German
yU.S
.Ita
lyChin
a
Source: National Science Foundation, Science and Engineering Indicators 2002
Can Disequilibrium Continue? (China produces, the U.S. consumes?)
Current Account Balance (percent of GDP)
-8
-6
-4
-2
0
2
4
6
8
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Source: IMF WEO
Historically, Rising Interest Rates Add Financial Pressures
Monthly Fed Funds Rate
0
2
4
6
8
10
12
14
16
18
20
???
Black Monday
Continental Illinois Bank
Franklin National Bank
S&L Crisis
Penn Central Railroad
Latin American Crisis
High Tech Bubble
Mexican Crisis
Source: Federal Reserve
Bush’s Falling Political CapitalPresident Bush's Job Approval Rating
30
40
50
60
70
80
90
100
11/2
8/20
05
5/23
-26/
05
3/18
-20/
05
1/3-
5/05
10/1
1-14
/04
7/30
- 8/
1/04
5/2-
4/04
2/6-
8/04
11/1
4-16
/03
8/25
-26/
03
5/30
- 6/
1/03
3/24
-25/
03
1/31
- 2/
2/03
12/9
-10/
02
10/3
-6/0
2
7/29
-31/
02
6/3-
6/02
3/22
-24/
02
1/7-
9/02
10/5
-6/0
1
7/19
-22/
01
4/20
-22/
01
September 11 Attacks
Invasion of Iraq Capture of
Saddam Hussein
Re-election and Inauguration
Source: Gallup
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