An Overview of the U.S. Economy - Casualty Actuarial Society

An Overview of the U.S. An Overview of the U.S. EconomyEconomyPresented by Daniel North, Euler Hermes ACI, June 9rd , 2010

2© Copyright Euler Hermes May 2010

The Overview, The Overview, June,June, 20102010

•• Good NewsGood News

•• Bad NewsBad News

•• News from the Future News from the Future


The Overview, The Overview, June,June, 20102010

•• Good NewsGood NewsThe Recession is OverThe Recession is Over

•• Bad NewsBad NewsInflation is on the WayInflation is on the Way

•• News from the FutureNews from the FutureChange Change


The Overview, The Overview, JuneJune 20102010Good News Good News -- The Recession is The Recession is OverOver

How we got in / out How we got in / out What the data saysWhat the data says

Bad News Bad News -- Inflation is on the WayInflation is on the WayMonetary and Fiscal policyMonetary and Fiscal policy

Consumer prices, interest rates, oil, Consumer prices, interest rates, oil, bubblesbubbles

Deficits and DebtDeficits and Debt

News from the FutureNews from the FutureChangeChange


Not around Not around here pal.here pal.


Source: NBER

The Business Cycle and RecessionsThe Business Cycle and Recessions

Source: NBER


Expansion, 57


Source: NBER


Expansion, 57 Recession10/20

Cycle, 67


Source: NBER



Cycle, 67

“recession over” is a direction - better


Source: NBER



Cycle, 67

averageaverage

goodgood

“recession over” is a direction - better

Business conditions Business conditions are a level:are a level:

badbad


•• ““The recession is over.The recession is over.”” = = ““Most measures of Most measures of economic activity are getting better.economic activity are getting better.””

•• But the But the unemployment rateunemployment rate is still is still highhigh –– it it lags lags -- and thatand that’’s why it feels like wes why it feels like we’’re still in re still in a recession.a recession.

•• Feel better: for the unemployment rate to Feel better: for the unemployment rate to improve, the recession must end. improve, the recession must end.

•• And it has.And it has.


•• Forces starting and ending the recession:Forces starting and ending the recession:•• OilOil•• HousingHousing•• Fed policiesFed policies•• FearFear

•• GDP: $14T, 3.3% ave. growthGDP: $14T, 3.3% ave. growth

The Overview, The Overview, JuneJune 20102010The Recession is OverThe Recession is Over


-200%

-100%

0%

100%

200%

300%

400%19

7119

7319

7519

7719

7919

8119

8319

8519

8719

8919

9119

9319

9519

9719

9920

0120

0320

0520

0720

09

-5%

0%

5%

10%Real Crude Prices (average of Brent,Dubai, WTI spot prices), Y/Y% growthReal GDP, Y/Y% growth

Source: Dept. of Commerce, Dept. of Labor, World Bank, EHACI

oil price shocks damage the economy… but it takes awhile

Oil Price Shocks and the Economy

290%

140%

56%38%21%

28% 36%41

-50%

13© Copyright Euler Hermes May 2010 house pricehouse price

-4%

-2%

0%

2%

4%

6%

Mar-19

74Mar-

1976

Mar-19

78Mar-

1980

Mar-19

82Mar-

1984

Mar-19

86Mar-

1988

Mar-19

90Mar-

1992

Mar-19

94Mar-

1996

Mar-19

98Mar-

2000

Mar-20

02Mar-

2004

Mar-20

06Mar-

2008

Mar-20

10

lowest in29 yrs

HIGHWAY MILES DRIVEN Rolling 12 mo. %Change

source: Federal Highway Administration


The Housing MarketThe Housing Market

More houseMore house

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

Mar-20

02

Mar-20

03

Mar-20

04

Mar-20

05

Mar-20

06

Mar-20

07

Mar-20

08

Mar-20

09

Mar-20

10

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

M / M Y / Y

Case - Shiller Home Price Index, % Change

S&P/Case-Shiller

16%? How about 6%

+4.4% anlzd ratesince April low


Existing 1 family home sales up Existing 1 family home sales up 21%21% y/yy/y

New 1 family home sales up New 1 family home sales up 48%48% y/yy/y

Months supply of existing homes down Months supply of existing homes down 25%25% to to 8.48.4 from 4/08 high of 11.2from 4/08 high of 11.2

Months supply of new homes down Months supply of new homes down 59%59% to to 5.05.0 from 1/09 high of from 1/09 high of 12.112.1

Starts up Starts up 41%41% y/y, permits up y/y, permits up 17%17%

The Housing Market: The Housing Market: More strong dataMore strong data

Intro ycIntro yc

16© Copyright Euler Hermes May 2010 fearfear

-4%

-2%

0%

2%

4%

6%

8%

10%1Q

74

1Q76

1Q78

1Q80

1Q82

1Q84

1Q86

1Q88

1Q90

1Q92

1Q94

1Q96

1Q98

1Q00

1Q02

1Q04

1Q06

1Q08

-200

-100

0

100

200

300

400

500

Steepness of Yield Curve:10yr-3 mo Treasuries (bps)

Real GDP Growth,Y/Y % Change

Source: Census Bureau, Federal Reserve

The Treasury Yield Curve vs. GDP

17© Copyright Euler Hermes May 2010 fearfear

-4%

-2%

0%

2%

4%

6%

8%

10%1Q

74

1Q76

1Q78

1Q80

1Q82

1Q84

1Q86

1Q88

1Q90

1Q92

1Q94

1Q96

1Q98

1Q00

1Q02

1Q04

1Q06

1Q08

1Q10

-200

-100

0

100

200

300

400

500

Steepness of Yield Curve:10yr-3 mo Treasuries (bps)

Real GDP Growth,Y/Y % Change

Source: Census Bureau, Federal Reserve

The Treasury Yield Curve vs. GDP


How we got here How we got here -- fearfear

0%

1%

2%

3%

4%

5%

01-Ju

l-200

814

-Jul-2

008

25-Ju

l-200

8

07-A

ug-20

08

20-A

ug-20

08

02-S

ep-20

08

15-S

ep-20

08

26-S

ep-20

0809

-Oct-

2008

22-O

ct-20

08

04-N

ov-20

08

17-N

ov-20

08

28-N

ov-20

08

11-D

ec-20

08

24-D

ec-20

08

06-Ja

n-2009

19-Ja

n-2009

30-Ja

n-2009

12-Feb

-2009

25-Feb

-2009

10-M

ar-20

09

23-M

ar-20

09

03-A

pr-20

09

16-A

pr-20

09

29-A

pr-20

09

12-M

ay-20

09

25-M

ay-20

09RISK MEASURES IN THE CREDIT MARKETS

1 mo. LIBOR: rate banks charge each other

TED spread: banks'lending - borrowing rates

Sept. 15th;AIG, Merrill,

Lehman

source: Financial Times,Merrill Lynch,Federal Reserve

Commercial Paper - Treasuries: default risk

Spreads returning to "normal"

Fed Fed


How we got here How we got here -- fearfear

-80

-60

-40

-20

0

20

40

60

80

100

2Q93

2Q94

2Q95

2Q96

2Q97

2Q98

2Q99

2Q00

2Q01

2Q02

2Q03

2Q04

2Q05

2Q06

2Q07

2Q08

2Q09

2Q10

Tightening conditions, large firmsWidening spreads, large firms

source: Federal Reserve

Net % of Banks...

6 Q's up (bad)

6 Q's down

(good)

credit just got easier!


OK, fine, 4 forces working for usOK, fine, 4 forces working for us……

..but what are the results?..but what are the results?


-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Q1-197

9Q1-1

981

Q1-198

3Q1-1

985

Q1-198

7Q1-1

989

Q1-199

1Q1-1

993

Q1-199

5Q1-1

997

Q1-199

9Q1-2

001

Q1-200

3Q1-2

005

Q1-200

7Q1-2

009

Real Gross Domestic Product (GDP)annualized quarterly growth rate

source: BEA

Consensus forecasts generally 3%- 4% in 2010

3 consecutive quarters up !


ConsumerConsumer

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Q1-197

9Q1-1

981

Q1-198

3Q1-1

985

Q1-198

7Q1-1

989

Q1-199

1Q1-1

993

Q1-199

5Q1-1

997

Q1-199

9Q1-2

001

Q1-200

3Q1-2

005

Q1-200

7Q1-2

009

Consumption Component (C) of Real GDPannualized quarterly growth rate

source: BEA

Even without Cash for Clunkers, 3Q consumer = +1.1%

3 consecutive quarters up !

Consensus forecasts generally 2%-4% in 2010


ConsumerConsumer

-4%

-2%

0%

2%

4%

6%

8%

10%A

pr-1

970

Apr

-197

2

Apr

-197

4

Apr

-197

6

Apr

-197

8

Apr

-198

0

Apr

-198

2

Apr

-198

4

Apr

-198

6

Apr

-198

8

Apr

-199

0

Apr

-199

2

Apr

-199

4

Apr

-199

6

Apr

-199

8

Apr

-200

0

Apr

-200

2

Apr

-200

4

Apr

-200

6

Apr

-200

8

Apr

-201

0

source: BEA

Real Personal Consumption Expenditures, y/y% Growth Rate

pent-up demand


ConsumerConsumer

-4%

-2%

0%

2%

4%

6%

8%

10%A

pr-1

970

Apr

-197

2

Apr

-197

4

Apr

-197

6

Apr

-197

8

Apr

-198

0

Apr

-198

2

Apr

-198

4

Apr

-198

6

Apr

-198

8

Apr

-199

0

Apr

-199

2

Apr

-199

4

Apr

-199

6

Apr

-199

8

Apr

-200

0

Apr

-200

2

Apr

-200

4

Apr

-200

6

Apr

-200

8

Apr

-201

0

source: BEA

Real Personal Consumption Expenditures, y/y% Growth Rate

pent-up demand

pent-updemand

25© Copyright Euler Hermes May 2010 Fed Fed

30

35

40

45

50

55

60

65

5/00

5/01

5/02

5/03

5/04

5/05

5/06

5/07

5/08

5/09

5/10

Institute of Supply Management (ISM) Indices(>50 Expansion, <50 Contraction)

Monthly survey asks if conditions are same, better, or worse for: new orders, production, employment, supplier deliveries, inventories, customer inventories, prices, backlogs, new export orders, imports.

record low

26© Copyright Euler Hermes May 2010 D G OD G O

10

20

30

40

50

60

70

80

90

100

May-20

00May

-2001

May-20

02May

-2003

May-20

04May

-2005

May-20

06May

-2007

May-20

08May

-2009

May-20

10

TotalNew OrdersEmploymentPrices

Institute of Supply Management (ISM) Indices(>50 Expansion, <50 Contraction)

Monthly survey asks if conditions are same, better, or worse for: new orders, production, employment, supplier deliveries, inventories, customer inventories, prices, backlogs, new export orders, imports.

whoa!

27© Copyright Euler Hermes May 2010 Trck tonTrck ton

-40%

-30%

-20%

-10%

0%

10%

20%

30%

Apr-20

08Ju

n-2008

Aug-20

08Oct-

2008

Dec-20

08Feb

-2009

Apr-20

09Ju

n-2009

Aug-20

09Oct-

2009

Dec-20

09Feb

-2010

Apr-20

10

Manufacturers' NewOrders: Durable Goods

Manufacturers' NewOrders: NondefenseCapital Goods ex Aircraft

NDCGXA up 21% since 4/08 low

DGO up 21% since 3/08 low

Durable Goods Orders, y/y % Growth(note: Manufacturers' New Orders for Nondefense Capital Goods ex Aircraft, is a

carefully watched indicator of future business spending.

source: Census Bureau


EmploymentEmployment

300

400

500

600

700

May-08

Sep-08

Jan-0

9

May-09

Sep-09

Jan-1

0

May-10

Weekly Jobless Claims, 000's, 4 wk rolling ave.

source: Labor Dept.

-30% sincepeak



-1,000

-800

-600

-400

-200

0

200

400

600

May-00

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

3%

4%

5%

6%

7%

8%

9%

10%

11%

Non-Farm Payroll Jobs Created (000's) (left scale)

Jobs Created and The Unemployment Rate

source: Labor Department

UnemploymentRate (right scale)

positive past 6/7 months !



-1,000

-800

-600

-400

-200

0

200

400

600

May-00

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

May-10

3%

4%

5%

6%

7%

8%

9%

10%

11%


Jobs Created and The Unemployment Rate


UnemploymentRate (right scale)

positive past 6/7 months !



bruptbrupt

-1,000

-800

-600

-400

-200

0

200

400

600

800

1,000

Mar

-70

Mar

-72

Mar

-74

Mar

-76

Mar

-78

Mar

-80

Mar

-82

Mar

-84

Mar

-86

Mar

-88

Mar

-90

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

Mar

-10


Jobs Created


Always back & forth at change



We are right on the cusp We are right on the cusp of steadyof steady job growthjob growth

•• The pattern, and the trend, are right The pattern, and the trend, are right •• Weekly jobless claims approaching 450kWeekly jobless claims approaching 450k

level which would indicate job growthlevel which would indicate job growth•• ISM employment index now >50ISM employment index now >50•• Unemployment peaked at 10.1% in Oct,Unemployment peaked at 10.1% in Oct,

now now 9.7%9.7%--temp. gets worse as unemployed temp. gets worse as unemployed job seekers rejob seekers re--enter job forceenter job force

•• 6/76/7 mos. had positive job mos. had positive job growthgrowth•• FedFed signalingsignaling

bruptbrupt


Bankruptcies also lagBankruptcies also lag

recaprecap

0

5,000

10,000

15,000

20,000

25,000

30,000Q

4-19

82

Q4-

1984

Q4-

1986

Q4-

1988

Q4-

1990

Q4-

1992

Q4-

1994

Q4-

1996

Q4-

1998

Q4-

2000

Q4-

2002

Q4-

2004

Q4-

2006

Q4-

2008

Q4-

2010

U.S. Business Bankruptcy Filings, quarterly

`

40-50% annual growth rate from

2008 - 2009...

2010 f'cast = -5%,but still near

highs of 1990s

...now down 2 consec Q's,first since 2004


RecapRecap

•• 4 forces caused recession, now helping 4 forces caused recession, now helping recoveryrecovery

•• Consumer, manufacturing sectors Consumer, manufacturing sectors positive and improvingpositive and improving

•• Employment lagging but getting betterEmployment lagging but getting better•• Bankruptcies lagging but getting betterBankruptcies lagging but getting better•• On to Inflation, the future, conclusionOn to Inflation, the future, conclusion


INFLATIONINFLATION


InflationInflationSimple exampleSimple example

Today:Today:Lend $1 @10%. Loaf of Bread costs $1Lend $1 @10%. Loaf of Bread costs $1

Inflation goes to 20%Inflation goes to 20%

A Year later:A Year later:Creditor gets $1.10 back.Creditor gets $1.10 back.But now loaf of bread costs $1.20.But now loaf of bread costs $1.20.

Creditors lose.Creditors lose.Debtors like the U.S. government, win.Debtors like the U.S. government, win.


InflationInflationSeveral types of inflation:Several types of inflation:

•• Consumer price inflation Consumer price inflation -- breadbread•• Money price inflation Money price inflation -- interest ratesinterest rates•• Commodity price inflation Commodity price inflation -- oiloil•• Asset price inflation Asset price inflation -- stocks, housesstocks, houses


Monetary policy Monetary policy (Takes 3(Takes 3--5 Q5 Q’’s to work!)s to work!)•• Bernanke is student of the Great Depression Bernanke is student of the Great Depression --

move big and move fastmove big and move fast•• Slashed FF rate to 0%Slashed FF rate to 0%•• Invented many schemes to create liquidityInvented many schemes to create liquidity

Fiscal PolicyFiscal Policy•• $150B stimulus in 2008: tax rebates$150B stimulus in 2008: tax rebates•• $787B stimulus: lower taxes, increase $787B stimulus: lower taxes, increase

spending spending –– can work. can work. •• But itBut it’’s a terrible sham s a terrible sham -- 75% will be spent 75% will be spent afterafter

the recession! Inflation, deficit, debt.the recession! Inflation, deficit, debt.

No inflation now, but tremendous No inflation now, but tremendous inflationary pressures in pipelineinflationary pressures in pipeline


-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%Q

4-22

Q4-

25Q

4-28

Q4-

31Q

4-34

Q4-

37Q

4-40

Q4-

43Q

4-46

Q4-

49Q

4-52

Q4-

55Q

4-58

Q4-

61Q

4-64

Q4-

67Q

4-70

Q4-

73Q

4-76

Q4-

79Q

4-82

Q4-

85Q

4-88

Q4-

91Q

4-94

Q4-

97Q

4-00

Q4-

03Q

4-06

Q4-

09

-30%

-20%

-10%

0%

10%

20%

30%

CPI 4qs % Δ

Monetary Base4qs % Δ

Source of Inflation: Too Much Money

source: Federal Reserve Bank of St Louis, BLS


-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%Q

4-22

Q4-

25Q

4-28

Q4-

31Q

4-34

Q4-

37Q

4-40

Q4-

43Q

4-46

Q4-

49Q

4-52

Q4-

55Q

4-58

Q4-

61Q

4-64

Q4-

67Q

4-70

Q4-

73Q

4-76

Q4-

79Q

4-82

Q4-

85Q

4-88

Q4-

91Q

4-94

Q4-

97Q

4-00

Q4-

03Q

4-06

Q4-

09

-30%

-10%

10%

30%

50%

70%

90%

CPI 4qs % Δ





-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%Q

4-22

Q4-

25Q

4-28

Q4-

31Q

4-34

Q4-

37Q

4-40

Q4-

43Q

4-46

Q4-

49Q

4-52

Q4-

55Q

4-58

Q4-

61Q

4-64

Q4-

67Q

4-70

Q4-

73Q

4-76

Q4-

79Q

4-82

Q4-

85Q

4-88

Q4-

91Q

4-94

Q4-

97Q

4-00

Q4-

03Q

4-06

Q4-

09

-30%

-10%

10%

30%

50%

70%

90%

CPI 4qs % Δ





0

500

1,000

1,500

2,000

2,500

1-08

3-08

5-08

7-08

9-08

10-08

12-08 2-0

9

4-09

6-09

8-09

9-09

11-09 1-1

0Federal Reserve Balance Sheet, $B

Total

Treas.

Agency

MBS

signalssignals


Subtle SignalsSubtle SignalsAugust FOMC meeting: August FOMC meeting: “…“…important to continue important to continue communicating that the Fedcommunicating that the Fed…… has the tools and has the tools and willingness to begin withdrawing monetary policy willingness to begin withdrawing monetary policy accommodationaccommodation…”…”

••Late September: mention reverse Late September: mention reverse reposrepos••Late October: Late October: ””ItIt’’s only a test..s only a test..””••November FOMC: reducing agency debt purchasesNovember FOMC: reducing agency debt purchases••December: Time DepositsDecember: Time Deposits••February: Interest on Deposits, Discount window, February: Interest on Deposits, Discount window, Treasury programTreasury program

So the tightening will happen becauseSo the tightening will happen because……


HereHere’’s what happens if you s what happens if you print a bit too much print a bit too much money:money:


Wholesale Price IndexWholesale Price Index

July 1914 July 1914 1.01.0

Jan 1919 Jan 1919 2.62.6

July 1919July 1919 3.43.4

German HyperinflationGerman Hyperinflation



July 1914 July 1914 1.01.0

Jan 1919 Jan 1919 2.62.6

July 1919July 1919 3.43.4

Jan 1920 Jan 1920 12.612.6

Jan 1921 Jan 1921 14.414.4

July 1921July 1921 14.314.3




July 1914 July 1914 1.01.0

Jan 1919 Jan 1919 2.62.6

July 1919July 1919 3.43.4

Jan 1920 Jan 1920 12.612.6

Jan 1921 Jan 1921 14.414.4

July 1921July 1921 14.314.3

Jan 1922 Jan 1922 36.736.7

July 1922July 1922 100.6100.6




July 1914 July 1914 1.01.0

Jan 1919 Jan 1919 2.62.6

July 1919July 1919 3.43.4

Jan 1920 Jan 1920 12.612.6

Jan 1921 Jan 1921 14.414.4

July 1921July 1921 14.314.3

Jan 1922 Jan 1922 36.736.7

July 1922July 1922 100.6100.6

Jan 1923 Jan 1923 2,7852,785

July 1923 July 1923 194,000194,000

Nov 1923 Nov 1923 726,000,000,000726,000,000,000



Zimbabwean HyperinflationZimbabwean Hyperinflation

231 000 000% (official, July 08)89.7 × 1021% (HHIZ, 14 Nov 08)6.5 × 10108% (Forbes Asia, 22 Dec 08)

$250,000,000$250,000,000


The Fed is unlikely to let that happen.The Fed is unlikely to let that happen.

So change in balance sheet and public statements are So change in balance sheet and public statements are starting to signal gently that it WILL have to comestarting to signal gently that it WILL have to come

““But thereBut there’’s no sign of inflation and unemployments no sign of inflation and unemployment’’s s high!high!””

Of course there isnOf course there isn’’t! Thatt! That’’s not the point!s not the point!

The point is that inflation gets out of hand easily, and it The point is that inflation gets out of hand easily, and it takes a really long time for changes in monetary policy to takes a really long time for changes in monetary policy to have full effect; 3have full effect; 3--5 Qs.5 Qs.

First note that unemployment peaks around 1First note that unemployment peaks around 1--2 Qs after 2 Qs after recession endsrecession ends…… about about rightright


2%

4%

6%

8%

10%

12%

Feb-19

56Feb

-1959

Feb-19

62Feb

-1965

Feb-19

68Feb

-1971

Feb-19

74Feb

-1977

Feb-19

80Feb

-1983

Feb-19

86Feb

-1989

Feb-19

92Feb

-1995

Feb-19

98Feb

-2001

Feb-20

04Feb

-2007

Feb-20

10

0%

5%

10%

15%

20%

25%Unemployment rate (left axis)

Fed Funds (right axis)

Source: Federal Reserve, BLS

Federal Funds Rate vs Unemployment


2%

4%

6%

8%

10%

12%

Feb-19

56Feb

-1959

Feb-19

62Feb

-1965

Feb-19

68Feb

-1971

Feb-19

74Feb

-1977

Feb-19

80Feb

-1983

Feb-19

86Feb

-1989

Feb-19

92Feb

-1995

Feb-19

98Feb

-2001

Feb-20

04Feb

-2007

Feb-20

10

0%

5%

10%

15%

20%

25%Unemployment rate (left axis)

Fed Funds (right axis)


Federal Funds Rate vs Unemployment

The Fed is usually too late: ave. 10 mos from peak unemployment to tightening.


-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Feb-19

56Feb

-1959

Feb-19

62Feb

-1965

Feb-19

68Feb

-1971

Feb-19

74Feb

-1977

Feb-19

80Feb

-1983

Feb-19

86Feb

-1989

Feb-19

92Feb

-1995

Feb-19

98Feb

-2001

Feb-20

04Feb

-2007

Feb-20

10

0%

5%

10%

15%

20%

25%CPI (left axis)Fed Funds (right axis)


Federal Funds Rate vs Inflation

A technical rebound in CPI, or the start of the chase?


-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Feb-19

56Feb

-1959

Feb-19

62Feb

-1965

Feb-19

68Feb

-1971

Feb-19

74Feb

-1977

Feb-19

80Feb

-1983

Feb-19

86Feb

-1989

Feb-19

92Feb

-1995

Feb-19

98Feb

-2001

Feb-20

04Feb

-2007

Feb-20

10

0%

5%

10%

15%

20%

25%CPI (left axis)Fed Funds (right axis)


Federal Funds Rate vs Inflation

The Fed is almost always too late: ave. 31 mos from tightening until peak CPI

A technical rebound in CPI, or the start of the chase?


Fiscal PolicyFiscal Policy


The Federal Reserve Bank at The Federal Reserve Bank at least has a plan to reduce least has a plan to reduce spending and mop up liquidity.spending and mop up liquidity.

The Federal GovernmentThe Federal Government’’s plan is s plan is to spend to spend moremore, to effectively , to effectively increaseincrease liquidity, and to liquidity, and to increaseincreasethe debt burden.the debt burden.


Spending, Deficits and DebtSpending, Deficits and Debt

GovGov’’t spendst spends $120$120

GovGov’’t gets tax revenuet gets tax revenue $100$100

DeficitDeficit $20$20

•• Treas. gets loan, issues $20 notes/bondsTreas. gets loan, issues $20 notes/bonds

•• Not a Ponzi scheme, no intent to deceive, Not a Ponzi scheme, no intent to deceive, return is fixed, debt retired, revolving return is fixed, debt retired, revolving creditcredit




1960 - '07Ave. Max

U.S. -2.1% -6.0%UK -2.2% -7.9%France -1.7% -6.0%Italy -6.0% -12.4%Japan -3.7% -10.2%Canada -1.8% -6.0%EU targ. 3.0%-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

2020

Federal Budget Deficit as a % of GDP

Sources: The Federal Reserve. Congressional Budget Off ice


A New Era of A New Era of Responsibility!Responsibility!

1960 - '07Ave. Max

U.S. -2.1% -6.0%UK -2.2% -7.9%France -1.7% -6.0%Italy -6.0% -12.4%Japan -3.7% -10.2%Canada -1.8% -6.0%EU targ. 3.0%-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

2020

Federal Budget Deficit as a % of GDP



1991-2007U.S. 63%Italy 110%Germ. 58%UK 42%

20%

30%

40%

50%

60%

70%

80%

90%

100%19

6219

6419

6619

6819

7019

7219

7419

7619

7819

8019

8219

8419

8619

8819

9019

9219

9419

9619

9820

0020

0220

0420

0620

0820

1020

1220

1420

1620

1820

20

Federal Debt as a % of GDP (CBO)


1991-2007U.S. 63%Italy 110%Germ. 58%UK 42%


20%

30%

40%

50%

60%

70%

80%

90%

100%19

6219

6419

6619

6819

7019

7219

7419

7619

7819

8019

8219

8419

8619

8819

9019

9219

9419

9619

9820

0020

0220

0420

0620

0820

1020

1220

1420

1620

1820

20



1991-2007U.S. 63%Italy 110%Germ. 58%UK 42%


20%

30%

40%

50%

60%

70%

80%

90%

100%19

6219

6419

6619

6819

7019

7219

7419

7619

7819

8019

8219

8419

8619

8819

9019

9219

9419

9619

9820

0020

0220

0420

0620

0820

1020

1220

1420

1620

1820

20


debt held by public


12%

14%

16%

18%

20%

22%

24%

26%19

5019

5219

5419

5619

5819

6019

6219

6419

6619

6819

7019

7219

7419

7619

7819

8019

8219

8419

8619

8819

9019

9219

9419

9619

9820

0020

0220

0420

0620

0820

1020

1220

1420

1620

1820

20

Revenue and Spending as a % of GDP (OMB)

Revenue

Spending


The Fiscal StimulusThe Fiscal Stimulus•• $787B stimulus spending: several more $787B stimulus spending: several more years, only $333 (42%) has been years, only $333 (42%) has been ““obligatedobligated””, only 35% has been , only 35% has been ““spentspent””

•• $150B $150B ““Jobs BillJobs Bill””

•• $25B to state govts to prevent layoffs$25B to state govts to prevent layoffs

•• Health Care!Health Care!

•• Note to CongressNote to Congress……


•• Deficit will contribute to Inflation Deficit will contribute to Inflation of Consumer Pricesof Consumer Prices

•• And will really contribute to And will really contribute to Inflation of Money Prices; Inflation of Money Prices; Interest RatesInterest Rates


-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

2020

0%

2%

4%

6%

8%

10%

12%

14%

as the deficit gets larger...

…interest rates climb

"Crowding Out:" The Budget Deficit vs. Interest Rates


yield on 10 yr. Treasuries (rhs)

Deficit as a % of

GDP (lhs)


-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

2020

0%

2%

4%

6%

8%

10%

12%

14%

as the deficit gets larger...

…interest rates climb

"Crowding Out:" The Budget Deficit vs. Interest Rates


yield on 10 yr. Treasuries (rhs)

Deficit as a % of

GDP (lhs)


DeficitsDeficits

•• Do usually cause money price inflation Do usually cause money price inflation (interest rates) as just shown(interest rates) as just shown

•• In this case, massive deficits also likely In this case, massive deficits also likely to cause FX$ inflation to cause FX$ inflation –– ““weakweak”” $...$...

•• Which will lead to commodity, Which will lead to commodity, particularly OIL price inflationparticularly OIL price inflation


-10%

-5%

0%

5%

10%

15%

Mar-19

99Mar-

2000

Mar-20

01Mar-

2002

Mar-20

03Mar-

2004

Mar-20

05Mar-

2006

Mar-20

07Mar-

2008

Mar-20

09Mar-

2010

-150%

-100%

-50%

0%

50%

100%

FX$ (inverted)Oil

FX$ vs. Oil, 12mo %change

Sources: Nominal Broad Trade-Weighted Exchange Value of the US$, Fed. Average Spot Price: Crude Oil: Average of Brent, Dubai & WTI (US$/Barrel); World Bank

FX$ weaker...

...oil rises


The Trouble With Oil isThe Trouble With Oil is……•• It may soar on deficits and $FX, but it is probably more likely It may soar on deficits and $FX, but it is probably more likely

to soar based on fundamentalsto soar based on fundamentals

•• Its Its daily supplydaily supply is fixed but is fixed but its demandits demand is everis ever--growinggrowing

•• ItIt’’s denominated in US$s denominated in US$

•• Its use is pervasiveIts use is pervasive•• $1B/day in US, or around 3% of GDP$1B/day in US, or around 3% of GDP

•• 85 million bbls produced / consumed daily worldwide. You used 2 85 million bbls produced / consumed daily worldwide. You used 2 gallons of oil today gallons of oil today –– 1.3 gallons came from foreigners1.3 gallons came from foreigners

•• In 1973 we relied on foreigners for only 19% of our oil, but OPEIn 1973 we relied on foreigners for only 19% of our oil, but OPEC C embargoed us, and drove us into recession. Today, we rely on embargoed us, and drove us into recession. Today, we rely on foreigners to provide 66% of our foreigners to provide 66% of our oil. Theoil. The outside world could easily outside world could easily crush crush us.us.

•• Drilling would be great, but itDrilling would be great, but it’’s a bit out of fashion at the moment.s a bit out of fashion at the moment.


•• SoSo wewe’’ve seen consumer, interest rate, ve seen consumer, interest rate, and commodity inflation.and commodity inflation.

•• FinalFinal Form of Inflation: BubblesForm of Inflation: Bubbles

•• HowHow did that mess just did that mess just happen?happen?

•• HowHow did that bubble form?did that bubble form?

•• HowHow about the one before that?about the one before that?••(and (and ChinaChina now, and now, and AustraliaAustralia now)now)


100%

120%

140%

160%

180%

200%

220%

240%

260%

Q459

Q461

Q463

Q465

Q467

Q469

Q471

Q473

Q475

Q477

Q479

Q481

Q483

Q485

Q487

Q489

Q491

Q493

Q495

Q497

Q499

Q401

Q403

Q405

Q407

Q409

2%

4%

6%

8%

10%

12%

14%

16%Outstanding creditmarket debt/GDP10 yr. Yield

The Big Picture; the Evolution of Easy Money

inflation whipped, interest rates fell


private label MBS

stock index options

interest rate options

interest rate swaps

secrtzation of mortgs

sec. auto, cred cards


100%

120%

140%

160%

180%

200%

220%

240%

260%

Q459

Q461

Q463

Q465

Q467

Q469

Q471

Q473

Q475

Q477

Q479

Q481

Q483

Q485

Q487

Q489

Q491

Q493

Q495

Q497

Q499

Q401

Q403

Q405

Q407

Q409

2%

4%

6%

8%

10%

12%

14%

16%Outstanding creditmarket debt/GDP10 yr. Yield

The Big Picture; the Evolution of Easy Money

inflation whipped, interest rates fell


private label MBS

stock index options

interest rate options

interest rate swaps

secrtzation of mortgs

sec. auto, cred cards

…"easy money"


But really, whoBut really, who’’s to blame for s to blame for the financial crisis?the financial crisis?

•• Community Reinvestment Act for promoting Community Reinvestment Act for promoting risky loansrisky loans•• Mortgage bankers and brokers for making Mortgage bankers and brokers for making those loansthose loans•• People for taking those loans when they People for taking those loans when they shouldnshouldn’’t have t have •• Fannie / Freddie for providing a market for Fannie / Freddie for providing a market for those loansthose loans•• Rating Agencies for being lulledRating Agencies for being lulled•• Regulators for not paying attentionRegulators for not paying attention•• Foreigners for lending us too much moneyForeigners for lending us too much money•• Investors for creating too much Investors for creating too much ““specspec”” housinghousing•• Investors for seeking too much risk in MBSInvestors for seeking too much risk in MBS



•• Investors for panicking and paralyzing banksInvestors for panicking and paralyzing banks•• Alan Greenspan for inflating the housing Alan Greenspan for inflating the housing bubblebubble•• Ben Bernanke for bursting the housing bubbleBen Bernanke for bursting the housing bubble•• Paulson, Geithner, Bernanke, etc. for bailing Paulson, Geithner, Bernanke, etc. for bailing out all those banksout all those banks•• Paulson, Geithner, Bernanke, etc. for Paulson, Geithner, Bernanke, etc. for notnotbailing out that one bankbailing out that one bank•• Congress for not passing TARPCongress for not passing TARP•• Congress for passing TARPCongress for passing TARP

•• And most importantlyAnd most importantly……



••……the Human Condition.the Human Condition.

•• Humans will always strive to improve their Humans will always strive to improve their status, and will always take risks to do it.status, and will always take risks to do it.

•• That will never change, and no amount of That will never change, and no amount of regulation canregulation can’’t stop the need to take risks.t stop the need to take risks.

•• So this is So this is notnot the last financial crisis you will the last financial crisis you will ever see. ever see. (Sorry).(Sorry).

Other cntryOther cntry


A final word on inflationA final word on inflation

WeWe’’ve seen ve seen pressurespressures on consumer, interest on consumer, interest rate, and commodity inflation, butrate, and commodity inflation, but……

……other countries are already other countries are already feelingfeeling it, it, preparing for it:preparing for it:

•• Canada Canada –– raised onceraised once•• AustraliaAustralia –– raised six times, 1.5%raised six times, 1.5%•• India India –– raised twice for 50bps, fraised twice for 50bps, f’’cast 5.5% cast 5.5% inflation inflation •• China China –– put restrictions on lending to prevent put restrictions on lending to prevent bubblebubble

futurefuture


News From the FutureNews From the Future


India, 2%

China 8%

Japan 9%

EU 28%

U.S. 25%ROTW 27%

20092009

The World is Going to Change:The World is Going to Change:World GDPWorld GDP

Source: IMF, Prof. Jeremy Siegel


U.S. 10%

Japan2%

EU7%

China20%

India20%

ROTW41%

20502050




U.S. 10%

Japan2%

EU7%

China20%

India20%

ROTW41%

India, 2%

China 8%

Japan 9%

EU 28%

U.S. 25%ROTW 27%

20092009 20502050



Not misNot mis--managementmanagement


USUS45%45%

WEWE30%30%

CH <1%CH <1%

IN <1%IN <1%

USUS17%17%

WEWE9%9%

CH 20%CH 20%IN 14%IN 14%


The World is Going to ChangeThe World is Going to Change

Implications:Implications:

•• Protectionism will no longer be an optionProtectionism will no longer be an option•• Teach our children Chinese and Hindi, Teach our children Chinese and Hindi, not Spanish and Frenchnot Spanish and French•• It is 8x as many people, growing with 2nd It is 8x as many people, growing with 2nd mover advantage (phones, airports).mover advantage (phones, airports).•• It is It is notnot doomsday. It does doomsday. It does notnot mean the mean the end of U.S. prosperity, freedom or global end of U.S. prosperity, freedom or global importance, but it puts us more at riskimportance, but it puts us more at risk……


China says to the U.S.,China says to the U.S.,

““Get your house in order.Get your house in order.””


China says to the U.S.,China says to the U.S.,

““Get your house in order.Get your house in order.””

MoodyMoody’’s: s: …… doubtdoubt


•• 4 Forces4 Forces•• RecoveryRecovery•• InflationInflation•• Debt, deficitsDebt, deficits•• FutureFuture•• Risks Risks •• ConclusionsConclusions

RecapRecap


RisksRisks•• PIIGS damage the euroPIIGS damage the euro--zonezone•• DoubleDouble Dip Dip –– weak consumer + something else weak consumer + something else bad sends us back into bad sends us back into recessionrecession•• Housing market collapses / foreclosuresHousing market collapses / foreclosures•• Commercial real estateCommercial real estate•• State budgets brokenState budgets broken•• More wasteMore waste•• Oil prices spikeOil prices spike•• Increasingly divisive politics, populism / Increasingly divisive politics, populism / protectionismprotectionism•• Global growth Global growth stagnatesstagnates


ConclusionsConclusions•• Recession over thanks to oil, housing, interest rates, and lackRecession over thanks to oil, housing, interest rates, and lackof fear. Expect GDP growth of fear. Expect GDP growth of aroundof around 3% 3% overover next next few yearsfew years•• On brink of creating jobs, unemployment rate is near the On brink of creating jobs, unemployment rate is near the peak but will take years to come back down, hurting those in peak but will take years to come back down, hurting those in office. office. •• Inflation likely on the way, 2011 and beyondInflation likely on the way, 2011 and beyond•• Interest rates up soon, and then continuing next 2Interest rates up soon, and then continuing next 2--3 years3 years•• Monetary policy was great and is getting mopped up, but it Monetary policy was great and is getting mopped up, but it was too much to avoid consumer inflationwas too much to avoid consumer inflation•• Fiscal policy of huge deficits will cause money inflation Fiscal policy of huge deficits will cause money inflation (interest rates)(interest rates)•• Will also likely cause FX$ inflation, and oil price inflationWill also likely cause FX$ inflation, and oil price inflation•• Oil prices are problematic in several waysOil prices are problematic in several ways•• Bubbles are caused by Bubbles are caused by ““easy moneyeasy money”” which will come which will come around again some day as the credit cycle easesaround again some day as the credit cycle eases……


Finally, please, remember, this is a Finally, please, remember, this is a mostly mostly positivepositive presentation!presentation!

•• The economic news is The economic news is very goodvery good right right now.now.

•• We know about inflation ahead of time so itWe know about inflation ahead of time so it’’s s less of a less of a problem.problem.

•• Our fiscal situation is scary but it does Our fiscal situation is scary but it does notnot have to be have to be doomsday doomsday –– it can it can change.change.

•• We know about 8x as many people ahead of time so itWe know about 8x as many people ahead of time so it’’s s less of a problemless of a problem

•• The economic news is The economic news is very goodvery good right now.right now.


Thank you for your attention.www.eulerhermes.com


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An Overview of the U.S. Economy - Casualty Actuarial Society