Presentation to: The 2005 Global Economic Outlook Conference
Translating Trendsinto Actions
John Silvia – Chief Economist March 8, 2005
Economic Transition •
Traditional Business Cycle •
Not the Sky is Falling
SUSTAINED GROWTH: ABOVE TREND BIAS Real GDP
8%
8%
4th Quarter 2004 @ 3.8%
6%
6%
4%
4%
2%
2%
0%
0%
-2% 1999
2000
2001
2002
2003
-2% 2004
Quarter/Quarter Percent Change, Seasonally Adusted Annual Rate
Mid-Cycle Economics: Real GDP 3.35% 3.30% 3.25% 3.20% 3.15% 3.10% 3.05% 3.00% 2.95% 2.90% Phase 1
Phase 2
INVESTMENT RECOVERY MODERATES 15%
FINAL DOMESTIC DEMAND COMPONENTS
15%
Green Line = Business Fixed Investment (Year-on-Year Growth)
10%
10%
5%
5%
0%
0%
-5%
-5%
-10%
Red Line = Government Spending Blue Line = Consumer Spending
97
98
99
00
01
02
03
04
-10%
d-Cycle Economics: Housing Sta
Phase 1
Phase
Where are we going? •
Outlook – Growth: But Slower • Not Your Father’ s Economic Recovery.
FEWER CLAIMS SIGNAL RECOVERY 500
Initial Jobless Claims, In Thousands
Blue Line = 4-Week Moving Average @ 307.00 Green Line = Weekly Figure @ 310.00
450
February 26
500 450
400
400
350
350
300
300
250
250
2002
2003
2004
2005
MANUFACTURING RECOVERY 65 60
ISM COMPOSITE INDEX
Diffusion Index
February @ 55.3
65 60
55
55
50
50
45
45
40
40
35 97 98 99 00 01 02 03 04 05 35
DURABLES VS NONDURABLE GOODS MANUFACTURING 140
Industrial Production, Index
140
Blue Line = Durable Goods @ 137.0
130
130
120
120
January
110
110
100
100 Green Line = Nondurable Goods @ 101.7
90 97 98 99 00 01 02 03 04 05 90
SERVICE SECTOR GAINS CONTINUE 70 65
ISM NON-MANUFACTURING INDEX BUSINESS ACTIVITY INDEX
February @ 59.8
70 65
60
60
55
55
50
50
45
45
40
40
Seasonally Adjusted
35 97 98 99 00 01 02 03 04 05 35
A Hybrid World Clues for Change
CONSUMER PRICE INDEX Year-over-Year Percent Change
4.0%
4.0%
Blue Line = CPI Green Line = Core CPI
3.5%
3.5%
3.0%
3.0%
2.5%
2.5%
2.0%
2.0%
1.5%
1.5%
1.0%
1.0%
0.5%
0.5%
01
02
03
04
G8 Real GDP Growth Rates Year-on-Year %Change
8% 7%
8%
2Q 2004 3Q 2004
7%
6%
6%
5%
5%
4%
4%
3%
3%
2%
2%
1% U.S. Japan Eurozone U.K. Russia Canada 1%
WHAT DOLLAR IS IN YOUR WALLET? 105
Green Line = OITP Index
105
100
100
95
95
90
90
85
85
80
80
Blue Line = Major Currency Index 75 75 2003 2004 2005
ACCOMODATIVE FED POLICY CONTINUES 12% 10%
REAL FEDERAL FUNDS RATE VS. M2 MONEY GROWTH
Blue Line = M2 Growth, Yr/Yr % Change, January @ 5.6% Green Line = Real Fed Funds Rate*, January @ 0.0%
12% 10%
8%
8%
6%
6%
4%
4%
2%
2%
0%
0% * Fed Funds Rate minus "Core" Consumer Price Index
-2% 92
94
96
98
00
02
04
-2%
FEDERAL BUDGET IMBALANCE 23% 22% 21%
Spending & Revenue As Percent of GDP
January '05 SPENDING (Blue Line) 19.3%
20%
Latest 12 months: Revenue $1,943 Trillion 19% Spending $2,333 Trillion
18% 17% 16%
23% 22% 21% 20% 19% 18%
REVENUE (Green Line) 16.1%
17% 16%
15% 87 89 91 93 95 97 99 01 03 05 15%
FEDERAL BUDGET SURPLUS OR DEFICIT $30
12 month moving average
$30
$20
$20
$10
$10
$0
$0
$-10
$-10
$-20
$-20
$-30
$-30
$-40
January 2005 @ -$32.6 Billion
$-40
$-50 1998 1999 2000 2001 2002 2003 2004 2005 $-50
0
Social Security, Medicare, and Medicaid Spending as a Percent of GDP Percent of GDP
Medicare
Medicaid Social Security
2020
2030
2040
2050
2060
Note: Social Security and Medicare projections based on the intermediate assumptions of the 2004 Trustees’ Reports. Medicaid projections based on CBO’s January 2004 short-term Medicaid estimates and CBO’s December 2003 long-term Medicaid projections under mid-range assumptions. Source: GAO analysis based on data from the Office of the Chief Actuary, Social Security Administration, Office of the Actuary, Centers for Medicare and Medicaid Services, and the Congressional Budget Office.
FEDERAL GOVERNMENT SPENDING, Ex. INTEREST PAYMENTS Year to Year Percent Change, 12 Month Moving Average
20%
Blue Line = Gov't Spending ex. Interest Payments @ 5.8%
20%
Red Line = Nominal GDP, Yr/Yr @ 5.6%
15%
15%
10%
10%
5%
5%
0%
0%
-5%
-5%
78
83
88
93
98
03
9%
10-YEAR TREASURY VS. BAA CORPORATE BOND YIELD
9%
February 8%
8%
7%
7%
6%
6%
5%
5%
4%
4%
3%
Green Line = BAA Yield Blue Line = 10-Yr Treasury
97 98 99 00 01 02 03 04 05
3%
Traditional Model • Fed Raises Rates • Inflation Up • Sustained Economic Growth • Persistent Fiscal Deficits • Declining Dollar • Yet Treasury Rates
NOMINAL GDP VS. 10-YR TREASURY 8% 7%
Blue Line = Nominal GDP, Yr/Yr % Change Green Line = 10-Yr Treasury Yield
8% 7%
6%
6%
5%
5%
4%
4%
3%
3%
2%
2%
96 97 98 99 00 01 02 03 04
AA and BAA Corporate Bond Yield Spreads (Over 10-Year Treasury)
2.00%
2.00% Enron - Oct 2001 World Com - March 2002 Sarbannes-Oxley - July 2002
1.80%
Red Line = Baa Spread
1.60%
1.40%
1.80%
1.60%
1.40% Blue Line = Aa Spread
1.20%
2002
2003
2004
2005
1.20%
35% 30%
CORPORATE INTEREST EXPENSE AS A PERCENT OF CASH FLOW Nonfinancial Corporate Business
3Q 2004 @ 13.5%
35% 30%
25%
25%
20%
20%
15%
15%
10% 80 82 84 86 88 90 92 94 96 98 00 02 04 10%
Traditional Model Managed Exchanged Rates China, Japan Profit Motive Central Bank Directed Capital Flows Preferred Habitat
Managed Exchange Rates • Domestic, Foreign Bonds not Perfect Substitutes. • Buy UST to Manage Exchange Rate Even if Adjusted for Exchange Rate Risk and if Below Other Sovereign Debt Expected Rates of Return.
FED CUSTODY HOLDINGS OF U.S. TREASURY SECURITIES FOR FOREIGN CENTRAL BANKS
$1100
In Billions of Dollars
$1100
$1000
$1000
$900
$900
$800
$800
$700
$700
$600
$600
$500 96 97 98 99 00 01 02 03 04 05 $500
Total Net Foreign Purchases of U.S. Treasurys by World Region 200,000
150,000
Net Foreign Purchases of U.S. Treasurys ($ Millions)
100,000
50,000
0
-50,000
200 4
Europe
200 3
Japan
200 2
200 1
0
199 9
8 199
200
Source: Dept. of U.S. Treasury
199 7
6 199
199 5
-100,000
Latin America & Caribbean
China
Total Net Foreign Purchases of U.S. Corporate and Agency Bonds by World Region 250,000
200,000
Net Foreign Purchases of U.S. Corporate and Agency Bonds ($ Millions)
150,000
100,000
50,000
0
200 4
3
Europe
200
200 1
Japan
200 2
200 0
199 9
199 8
6 199
Source: US Dept. of Treasury
199 7
5 199
-50,000
Latin America & Caribbean
China
Why Euro so Strong if U.S. Growth Stronger Than Euro Community? • Only Trade the Euro.
Eurozone vs U.S. Policy Rates 7%
ECB Rate Fed Funds Rate $ per Euro
5%
$1.40 $1.30 $1.20
4% $1.10 3% $1.00
2% 1%
$0.90
0%
$0.80
2000 2001 2002 2003 2004 2005
$ p e r Eu r o
C e n tr a l B a n k P o lic y R a te s
6%
versus Euro/Dollar Echange Rate
versus Euro/Dollar Echange Rate
10%
$1.30
Eurozone GDP U.S. GDP $ per Euro
8%
$1.20
6% $1.10 4% $1.00 2% $0.90
0% -2%
2000
2001
2002
2003
Real Growth at a Quarterly Annualized Change
2004
$0.80
$ p e r Eu r o
G D P G r o w th R a te s
Eurozone GDP vs U.S. GDP Growth
Profit Motive Central Banks of Japan, China not mark to market not quarterly report to shareholders Therefore Buy Treasuries Even if Expected Rate of Return Lower and Exchange Risk Higher.
Directed Capital Flows • Preferred Habitat • Global Demand is the Marginal Buyer • Imperfect Capital Mobility
Net Foreign Purchases of U.S. Debt Products 60%
50%
Foreigners Purchases as a Percentage of U.S. Debt Financial Assets
40%
30%
20%
10% 1998
1999
2000
2001
2002
2003
2004
Source: Flow of Funds and U.S. Dept. of Treasury Note: Total debt created represents the sum of government, household and non financial corporate sector net borrow ing.
Tax Reform Fundamentals
100%
Top 20% of Taxpayers Pay More in Taxes Than Their Share of Income 81%
80%
58%
60% 40% 20% 0%
3% 0%
7%
12% 2%
5%
20% 12%
Bottom 20% Second 20% Middle 20% Fourth 20%
Top 20%
Percentage of Total Income (AGI) Percentage of Income Taxes Paid
Source: Tax Foundation Individual Tax Model, does not include refundable portion of EITC or Child Tax Credit
Tale of Two Americas Payers -Rising Number of Dual-Income Working Professional Couples in Urban Areas - Growing Class of Entrepreneurs & Business Owners (Sole Proprietors, Partnerships, S-Corporations) Non-Payers - Growing Class of Tax Filers Who Have No Tax Liability
The Number of Non-Paying Filers Has Exploded Since 2000 50 45 40 35 30 25 20 15 10 5 0
44.2
26.7
1995
29.2
29.9
1998
2000
2004 Est.
Millions of Tax Returns Source: Tax Foundation Individual Tax Model based on IRS and Census Data
Who are the NonPayers? Low-Income: 97% Earn Less Than $40,000 •
• Young: 36% below Age 25, 56% below 35 • Women and Unmarried: 54% are single Women or Female-Headed Households • Part-Time Workers: 42% Work Part-Time, 20% Work Full-Time but less than 50 weeks • Benefit from Credits: 34% Claim
Who are the Payers? They are married, dual-income professionals; •
• They are entrepreneurs and business owners; • They tend to live in high-cost areas; • They are educated; • They are older; and • They pay the lion’ s share of income taxes
Married? Then You Are Most Likely "Rich" 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
86%
84% 71%
69% 57% 43% 31%
29% 16%
Poorest 20% 2nd 20% 0$ -- $14,415
14%
Middle 20% $25,500 -$41,640
4th 20%
Richest 20% $68,296+
Singles Married Source: Tax Foundation Calculations based on IRS Data
College Educated? You Are Most Likely "Rich" 100% 90%
90%
80% 70% 60%
63%
56%
55% 44%
50% 40%
25%
30% 20% 10%
37% 33%
14%
20%
0% Bottom 20% Second 20% Middle 20% Fourth 20%
Top 20%
High School or Less Bachelor or Above Source: Tax Foundation Individual Tax Model based on IRS and Census data
What Does This Mean For Tax Reform? • Tax reform must recognize changing demographics of American taxpayers – Today’ s “ middle-class” is not our father’ s middle-class. • Traditional distributional tables are of little value to good tax policy – no two tax returns are the same. • Broadening the base could put people back on the tax rolls – difficult politically. • Cutting rates will be perceived as “ tax cuts for the rich” – difficult politically. • Adhering to a progressive rate structure will continue to put tax burden on urban professional families, educated Americans, older workers, and business owners.
Economic Forecast *(Qtr/Qtr% Change, Annual Rate)
2002 2003 2004
2005
Real GDP* 1.9% 3.0% 4.4% 3.7% Personal 3.1% 3.3% 3.8% 3.3% Consumptio n* Equipment & Software*
- 6.4% 5.5%
13.6 %
11.9 %
CPI (YoY)
1.5% 2.3% 2.7% 2.8%
Corporate Profits (YoY)
14.0 16.8 % %
14.5 %
10.4 %
10-Yr TNote
4.30 3.89 % %
4.21 %
4.54 %
www.wachovia.com/economics