The United States: Fiscal Facts and Fantasies. Presented by: Nigel Gault Chief U.S. Economist IHS Global Insight

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1 The United States: Fiscal Facts and Fantasies Presented by: Nigel Gault Chief U.S. Economist IHS Global Insight

2 Subdued Recovery: Tailwinds Battling Headwinds

3 The U.S. Recovery: Tailwinds More sectors contributing; not just an inventory-driven recovery Strong manufacturing growth Financial markets healing Large businesses are flush with cash Labor market is improving Stimulus from December s tax package 3

4 The U.S. Recovery: Headwinds Consumers and businesses remain cautious No housing recovery Rising commodity prices are squeezing real incomes The oil price rise could turn into a major shock Japan shock will temporarily disrupt the automotive sector State and local budget cuts continue Federal fiscal tightening is coming 4

5 Growth Indicators Showing Signs Of Weakening

6 Key Leading Indicators Show Growth, But Are Slipping (ISM Diffusion Indexes, 50 = breakeven) Manufacturing Index Nonmanufacturing Index NFIB Small-Business (RS, Optimism Index, 1986=100) 80 6

7 Cautionary Sign: Initial Unemployment Insurance Claims Have Turned Higher 525 (Initial unemployment insurance claims, thousands) Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 4-Week Moving Average Actual 7

8 2011 Growth Expected to Be Backloaded 4.0 (Annualized real rate of GDP growth, Q/Q, percent)

9 The Housing Cycle: Still at the Bottom

10 Mortgage Applications for House Purchase Sank After Tax Credit Expired 300 (Mortgage applications for purchase, index, Mar.16,1990 =100) Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 4-Week Moving Average Actual 10

11 Demand Shortfall: Household Formation Has Plunged (Millions of households) 357,000 households added in year to March 2010 a post-world War II low 0.00 Mar 01- Mar 02 Mar 02- Mar 03 Mar 03- Mar 04 Mar 04- Mar 05 Mar 05- Mar 06 Mar 06- Mar 07 Mar 07- Mar 08 Mar 08- Mar 09 Mar 09- Mar 10 Source: Census Bureau 11

12 Supply Excess: The Housing Overhang 3.0 (Proportion of homeowner inventory vacant and for sale, percent) Source: Census Bureau 12

13 Housing Starts Have Hit Bottom: Prices Not Quite There Yet Housing Starts (LS, millions of units) FHFA House Price Index (RS, purchase-only index, 1991Q1 = 100) 13

14 The Consumer : Signs of Life, But Now Threatened By Another Oil Spike

15 Employment Is Turning Private Payroll Employment* Unemployment Rate** Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan Length of Workweek*** Average Hourly Earnings Growth**** Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 *Thousands, monthly change, SA; **Percent; ***Hours, SA; ****Nominal, percent year-over-year 15

16 Energy and Food Prices Have Climbed Oil Price (LS, WTI, $/barrel) PPI Farm Products (RS, index, 1982=1.0) 16

17 ...Driving the CPI Higher And Hurting The Consumer s Purchasing Power (Percent change unless otherwise noted) CPI Components (rates of increase) Core Energy Food Components (contributions) Core (77.7%) Energy (8.6%) Food (13.7%) CPI weights as of Dec 2010 in parentheses Note: The 2011 payroll tax cut is worth 1.0% of disposable income, so it has been more than offset by higher inflation. 17

18 Consumer Spending Stabilizing, But Not a Strong Driver of Recovery 6 (Annualized rate of growth)

19 Business Investment: A Mixed Picture

20 Business Equipment Demand Recovering 70 (Non-defense capital goods orders ex-aircraft, 3-mo moving average, $ billions)

21 Nonresidential Construction: Architects Billings Just Above Neutral 65 (Diffusion Index) * Source: American Institute of Architects 21

22 Business Capital Spending Cycle: Construction Lags 45 (Percent change annualized rate, real spending) Software & Equipment Buildings 22

23 Foreign Trade: A Key Driver of Growth

24 Export Growth By Destination 30 (Percent growth in 12-month-moving average, merchandise exports, Feb 2011) Total (100%) Latin America (23%) Pac Rim (25%) Canada (19%) Other (10%) Europe (22%) Export shares are in parentheses. Latin America includes Mexico. 24

25 The U.S. Dollar: Secular Weakness Against Emerging Market Currencies 1.6 (2005=1.0, inflation-adjusted) Major Currency Index Other Important Trading Partners Index 25

26 Exports Expected to Outpace Imports 40 (Percent change annualized rate, volumes) Real U.S. Exports Real U.S. Imports 26

27 Inflation and Interest Rates

28 Core Inflation Is Bottoming Out: Oil and Food Driving Headline Inflation Higher (Percent change from a year earlier) All-Urban CPI Core PCE Price Index 28

29 Federal Funds Rate to Stay Near Zero Until 2012: Long Rates Rise But Only Gradually at First 7 (Percent) Federal Funds 10-Year Treasury Yield 29

30 Fiscal Facts and Fantasies

31 Will The U.S. Ever Stabilize the Public Debt? You can always count on Americans to do the right thing - after they've tried everything else. Winston S. Churchill 31

32 Fiscal Facts The federal fiscal trajectory is wholly unsustainable Spending is high, revenues are low S&P has issued a downgrade warning, but markets have not panicked 10-year Treasury yields are not far above 3% Politicians are now getting more serious; they know something must be done There is a huge philosophical divide over how to cut the deficit There are elections in 2012 (isn t that the place to argue things out?) There is a looming flashpoint before 2012: The debt ceiling must be raised. Drop-dead date currently August 2. 32

33 Fiscal Fantasies The deficit can be stabilized just by cutting spending Tax cuts can pay for themselves Only the rich need pay more taxes Spending can be cut just by getting rid of waste and inefficiency Medicare can continue as is Defense can t be touched Austerity in current conditions is expansionary Everybody must give a little ground on their fantasies to allow a comprehensive deficit-reduction plan. Unlikely before the elections. 33

34 The Federal Budget Gap 26 (Percent of GDP) Revenues Expenditures 34

35 Federal Debt Projections 80 (Percent of GDP) IHSGI (May) Ryan (Apr) Obama (Feb) Bowles-Simpson (Dec) 35

36 Federal Deficit Projections 12 (Percent of GDP) IHSGI (May) Ryan (Apr) Obama (Feb) Bowles-Simpson (Dec) 36

37 Federal Spending Projections 26 (Percent of GDP) IHSGI (May) Ryan (Apr) Obama (Feb) Bowles-Simpson (Dec) 37

38 Federal Revenue Projections 21 (Percent of GDP) IHSGI (May) Ryan (Apr) Obama (Feb) Bowles-Simpson (Dec) 38

39 Entitlements and Interest Make It Hard to Cut Federal Spending 25 (IHSGI May Baseline, percent of GDP) Defense Social Security Nondefense Goods & Services Medicare/Medicaid Interest Other 39

40 Summary Tables and Implications

41 U.S. Economic Growth by Sector (Percent change unless otherwise noted) Real GDP Final Sales Consumption Light Vehicle Sales (Millions) Residential Investment Housing Starts (Millions) Business Fixed Investment Federal Government State and Local Government Exports Imports

42 Other Key Indicators (Percent unless otherwise noted) Industrial Production (% growth) Employment (% growth) Unemployment Rate CPI Inflation Oil Prices (WTI, $/bbl) Core PCE Price Inflation Federal Funds Rate year Government Bond Yield Dollar (Major Currencies, 2005=1)

43 Implications Recovery muted by historical standards; growth stays just below 3% Higher oil and food prices are offsetting the payroll tax cut stimulus Core inflation has bottomed but won t rise rapidly Fed will stay the course on QE II; no QE III Fiscal tightening on the way, but the big issues (entitlements, taxes) probably won t be tackled soon Key Risks: Middle East turmoil / renewed commodity price spike Housing Federal Deficit is it ok to wait till after 2012 for the big fix? 43

44 Thank You for Your Participation! Presented by: Nigel Gault Chief U.S. Economist IHS Global Insight

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