Economic Outlook: Cyclical Recovery, Structural Challenges

Economic Outlook: Cyclical Recovery, Structural Challenges Global Interdependence Center Conference John E. Silvia, Chief Economist December 3, 2012

What We Get Versus What We Expect: Limits to Finance

U.S. Real GDP Bars = CAGR

Line = Yr/Yr Percent Change

10%

10% GDP - CAGR: Q3 @ 2.0%

8%

GDP - Yr/Yr Percent Change: Q3 @ 2.3%

6%

6% Forecast

4%

Sustained recovery in 2012, but still below historical experience

4%

2%

2%

0%

0%

-2%

-2%

-4%

-4%

-6%

-6%

-8%

-8%

-10% 2000

-10% 2002

2004

2006

2008

Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

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8%

2

2010

2012

2014

Fiscal Policy: Difficult Choices/Chronic Imbalance

Federal Budget Balance Percentage of GDP

The nation has entered uncharted waters in fiscal policy

4.0%

4.0%

2.0%

2.0%

0.0%

0.0%

-2.0%

-2.0%

-4.0%

-4.0% Forecast

-6.0%

-6.0%

-8.0%

-8.0%

-10.0%

-10.0%

-12.0%

-12.0% Budget Balance: Q3 @ -7.0%

-14.0% 2000

-14.0% 2002

2004

2006

2008

2010

2012

2014

Source: U.S. Department of Commerce, U.S. Department of the Treasury and Wells Fargo Securities, LLC

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Fiscal Policy: Growth of Receipts and Spending

Federal Government Receipts & Outlay Growth Year-over-Year Percent Change, 12-Month Moving Average

Federal government receipts and outlays have changed course

20%

20%

15%

15%

10%

10%

5%

5%

0%

0%

-5%

-5%

-10%

-10%

-15%

-15%

-20%

-20%

Federal Government Receipts Growth: Sep @ 6.4% Federal Government Outlay Growth: Sep @ -1.7%

-25%

-25% 90

92

94

96

98

00

02

04

Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

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4

06

08

10

12

Long-term Growth: CBO Policy Assumptions

Polices Under Both CBO Long-Term Scenarios Baseline Scenario Expires

Alternative Fiscal Scenario Extended

Expires Expires

Extended Expires

Expires

Extended

Allowed to Go Into Effect Expires Allowed to Go into effect

Reversed Extended Extended

Allowed to Go Into Effect

Reversed

Alternative Minimum Tax relief Other provisions of the 2010 Tax Act which expanded tax credits and deductions and reduced tax rates 2 percentage-point cut in the payroll tax Partial expensing of investment property ("Bonus Depreciation") Increased tax rates on earnings and investment income for highincome tax payers Extended emergency unemployment benefits Reduction in Medicare's physician payment rate Automatic budget cuts as set forth in the Budget Control Act

Source: Congressional Budget Office and Wells Fargo Securities, LLC

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Economic Growth Projections

2013 CBO Economic Projections As of August 2012

Real GDP Growth (Q4/Q4 Percent C hange)

Economic growth looks very different under the two scenarios

Unemployment Rate (Q4)

PCE Price Index (Q4/Q4 Percent C hange)

10-Year Treasury Rate (Year-End)

Baseline Scenario

Alternative Scenario

-0.5

1.7

9.1

8

1.4

None

2

2.1

Source: C ongressional Budget Office and Wells Fargo Securities, LLC

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Federal Debt Held by the Public: Unsustainable

Under the CBO’s alternative fiscal scenario, federal debt held by the public would jump to nearly 90 percent of GDP by 2022, or just over $22 trillion dollars

Source: Congressional Budget Office

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U.S. Government Debt

U.S. Debt Held by the Public CBO Alt. Scenario vs. Baseline Projections, Percent of GDP 260% 240% 220%

Extending the analysis, government debt could jump to over 240 percent of GDP under the alternative scenario

260% Baseline Debt: 2042 @ 48.0% Alt. Scenario Debt: 2042 @ 247.0%

220%

200%

200%

180%

180%

160%

160%

140%

140%

120%

120%

100%

100%

80%

80%

60%

60%

40%

40%

20%

20% 2000 2004 2008 2012 2016 2020 2024 2028 2032 2036 2040

Source: Congressional Budget Office and Wells Fargo Securities, LLC

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240%

8

U.S. Government Debt: Who Holds Our Debt?

Top Holders of U.S. Treasuries Billions of Dollars $1,400

$1,400

Sep-10 Sep-11

$1,200

Aug-12

$1,000

Japan and China hold an unprecedented amount of U.S. debt

$1,000

$800

$800

$600

$600

$400

$400

$200

$200

$0

$0 Japan

China

U.K.

OPEC

Source: U.S. Department of the Treasury and Wells Fargo Securities, LLC

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$1,200

9

Taiwan

Caribbean

Fiscal Deficit: Outside the Historical Experience

Federal Budget Surplus or Deficit 12-Month Moving Sum in Billions of Dollars $400

$400

$200

$200

$0

The federal government has incurred a deficit of over $1 trillion for the past three years

$0

-$200

-$200

-$400

-$400

-$600

-$600

-$800

-$800

-$1,000

-$1,000

-$1,200

-$1,200

-$1,400

-$1,400

Surplus or Deficit: Sep @ -$1,089 Billion

-$1,600

-$1,600 67

71

75

79

83

87

91

95

Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

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10

99

03

07

11

U.S. Budget Gap

Under the alternative scenario non-interest spending balloons while revenues remain muted with the extension of certain tax cuts

Baseline Scenario

Alternative Scenario

U.S. Budget Gap

U.S. Budget Gap

CBO Baseline Scenario Projections, Percent of GDP

CBO Alternative Scenario Projections, Percent of GDP

26%

26%

24%

24%

22%

22%

20%

20%

18%

28%

28%

26%

26%

24%

24%

22%

22%

20%

20%

18%

18%

18%

16%

16%

16%

Non-Interest Spending: 2042 @ 23.1% Extended Baseline Revenues: 2042 @ 24.6% 14%

16%

Alt. Scenario Revenues: 2042 @ 18.5% 14%

14%

Source: Congressional Budget Office and Wells Fargo Securities, LLC

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Non-Interest Spending: 2042 @ 26.8%

11

14%

U.S. Government Debt

U.S. Central Government Debt Percent of GDP

110%

Government Debt: Q3 @ 101.5%

100%

Current tax and spending policy is unsustainable

110%

100%

90%

90%

80%

80%

70%

70%

60%

60%

50%

50%

40%

40%

30%

30%

20%

20%

10%

10% 54

59

64

69

74

79

84

89

Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

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94

99

04

09

U.S. Government Debt

Total Outlays as Percent of Nominal GDP 12-Month Moving Average 26%

26% Total Outlays as a Percent of GDP: Sep @ 22.7%

The spending-to-GDP ratio skyrocketed during the most recent recession, and while trending down, it still remains at unprecedented levels

25%

25%

24%

24%

23%

23%

22%

22%

21%

21%

20%

20%

19%

19%

18%

18%

17%

17% 69

72

75

78

81

84

87

90

93

96

Source: U.S. Department of the Treasury and Wells Fargo Securities, LLC

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13

99

02

05

08

11

Government Spending

A combination of spending increases and a revenue cap causes primary deficits to swell under the alternative scenario

Baseline Scenario

Alternative Scenario

U.S. Federal Government Outlays

U.S. Federal Government Outlays

Percent of GDP, CBO Baseline Projections 40%

Percent of GDP, CBO Alt. Scenario Projections 40%

40%

Net Interest: 2042 @ 0.4% 35%

Other: 2042 @ 6.8%

35%

35%

Healthcare Programs: 2042 @ 10.3% 30%

Social Security: 2042 @ 3.5%

40% Net Interest: 2042 @ 11.8% Other: 2042 @ 9.5%

35%

Healthcare Programs: 2042 @ 11.2%

30%

30%

25%

25%

25%

25%

20%

20%

20%

20%

15%

15%

15%

15%

10%

10%

10%

10%

Social Security: 2042 @ 6.1%

30%

5%

5%

5%

5%

0%

0%

0%

0%

Source: Congressional Budget Office and Wells Fargo Securities, LLC

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U.S. Government Revenues

Federal Receipts as Percent of Nominal GDP 12-Month Moving Average

Revenues have settled in to below-trend growth

22%

22%

21%

21%

20%

20%

19%

19%

18%

18%

17%

17%

16%

16%

15%

15%

14%

14%

13%

13%

Revenue: Sep @ 15.4%

12%

12% 90

92

94

96

98

00

02

04

Source: U.S. Department of the Treasury and Wells Fargo Securities, LLC

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15

06

08

10

12

U.S. Government Revenue Projections

Federal Government Revenues CBO Alt. Scenario vs. Baseline Projections, Percent of GDP

The future path of revenues depends on the tax policy decisions that will be made in the coming months

40%

40%

35%

35%

30%

30%

25%

25%

20%

20%

15%

15%

10%

10%

5%

Extended Baseline Revenues: 2042 @ 24.6%

5%

Alt. Scenario Revenues: 2042 @ 18.5%

0%

0% 2000 2004 2008 2012 2016 2020 2024 2028 2032 2036 2040

Source: U.S. Department of the Treasury and Wells Fargo Securities, LLC

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U.S. Government Revenues by Source

FY 2011 Revenue By Category Other 9%

Social Insurance Taxes 36% Individual Income Taxes 47%

Individual income taxes account for the largest source of government revenues

Corporate Income Taxes 8%

Source: Congressional Budget Office and Wells Fargo Securities, LLC

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Tax Rate: Capital Gains

Average Effective Tax Rate: Capital Gains Returns with Positive Net Capital Gains, Percent

30%

30%

Average Effective Tax Rate: 2008 @ 13.8%

The maximum tax rate on capital gains has declined off of earlier highs

25%

25%

20%

20%

15%

15%

10%

10%

5%

5%

%

% 1970

1975

1980

1985

Source: Tax Policy Center and Wells Fargo Securities, LLC

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1990

1995

2000

2005

Tax Reform

Income and Individual Tax Rates - 2010 Percent

70%

70%

Percent of Total Adj. Income Earned 60%

Tax reform is likely the single biggest challenge facing policymakers due to the imbalance in who pays taxes

Percent of Total Income Taxes Paid

60%

50%

50%

40%

40%

30%

30%

20%

20%

10%

10%

0%

0% $0-$49,999

$50,000-$199,999

Source: U.S. Department of the Treasury and Wells Fargo Securities, LLC

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$200,000 +

Fiscal Cliff: Decisions Are Needed

Tax Policy

 Let tax cuts expire as scheduled and not index the AMT for inflation

 Limit the extent to What decisions need to be made regarding the Fiscal Cliff?

which taxes can be reduced through itemized deductions

 Eliminate the income tax deduction for state and local taxes

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Government Spending

 Change age targets for social security or payment amounts

 Reduce the other activities of the federal government

 Repeal provisions of the Affordable Care Act that expands medical coverage

U.S. Forecast

Wells Fargo U.S. Economic Outlook Actual

Forecast 2012

Real Gross Domestic Product Personal Consumption Inflation Indicators PCE Deflator

1

2012

Forecast 2013 2014

1Q

2Q

3Q

4Q

1Q

2Q

3Q

4Q

2.0

1.3

2.0

1.4

1.0

2.1

2.2

2.2

2.4

1.8

2.1

1.6

2.2

2.4

1.5

2.0

2.4

0.6

1.2

1.4

1.3

1.8

2.5

1.9

1.4

1.3

2.4

1.6

1.5

1.8

1.5

1.7

1.6

1.5

1.9

2.4

1.8

1.6

1.9

2.8

1.9

1.7

2.3

2.2

2.7

2.7

2.3

1.6

3.1

2.2

2.5

2.2

2

Consumer Price Index Industrial Production

1

Corporate Profits Before Taxes Trade Weighted Dollar Index Unemployment Rate Housing Starts

Actual 2010 2011

2013

3

4

Quarter-End Interest Rates 5 Federal Funds Target Rate

2

5.9

2.6

-0.4

0.5

0.7

3.5

4.1

4.1

5.4

4.1

3.6

1.8

3.8

10.3

6.7

5.7

5.3

4.8

5.2

5.7

6.3

26.8

7.3

6.9

5.5

7.0

72.7

74.5

72.7

73.0

74.0

75.0

76.0

77.0

75.4

70.9

73.2

75.5

74.5

8.3

8.2

8.1

7.8

7.7

7.8

7.9

7.9

9.6

9.0

8.1

7.8

7.7

0.71

0.74

0.79

0.84

0.90

0.96

1.02

1.08

0.59

0.61

0.77

0.99

1.17

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

Conventional Mortgage Rate

3.95

3.68

3.50

3.40

3.40

3.40

3.45

3.50

4.69

4.46

3.63

3.44

3.80

10 Year Note

2.23

1.67

1.65

1.70

1.70

1.80

1.85

1.90

3.22

2.78

1.81

1.81

2.15

Forecast as of: November 8, 2012 1 C ompound Annual Growth Rate Quarter-over-Quarter 2 Year-over-Year Percentage C hange 3 Federal Reserve Major C urrency Index, 1973=100 - Quarter End 4 Millions of Units 5

Annual Numbers Represent Averages

Source: U.S. Department of Commerce, U.S. Department of Labor, Federal Reserve Board, Freddie Mac and Wells Fargo Securities, LLC

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Appendix

Wells Fargo Economics Group Publications

Recent Special Commentary Date November-01

To join any of our research distribution lists please visit our website: http://www.wellsfargo.com/ economics

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Title

Authors

North Carolina Economic Outlook

Vitner, Brown & Watt

October-29 October-24 October-18 October-18 October-12 October-08 October-02

Housing Data Wrap-Up: October 2012 2012 Holiday Sales Outlook U.S. Fiscal Primer III: Federal Revenues Retirement in America: Extending the Finish Line The Great Unemplyoment Rate Debate The Unemployment Rate: Seasonality and Sampling Housing Chartbook: September 2012

Vitner & Khan Aleman, Iqubal & Brown Silvia, Bryson & Brown Bryson, Iqbal & Watt Silvia, Watt & Swankoski Silvia, Iqbal & Watt Vitner, Khan & Silverman

September-25 September-17 September-10 September-06 September-05

Local Budgets Under Pressure: A Fiscal Outlook Global Chartbook: September 2012 U.S. Fiscal Primer II: Federal Government Spending Commercial Real Estate Chartbook: Quarter 2 Brazilian Economy Slows Down; Better Times Ahead

Silvia & Brown Bryson, Aleman & Quinlan Silvia, Bryson & Brown Vitner & Khan Aleman

Mexico: Thanks to Auto Demand California's Economy: Gaining Momentum Real GDP in Eurozone Slumped in Q2 Rocky Mountain Summit: July 2012 Orders and Production: No Time for Complacency U.S. Fiscal Primer I: The Deficit and Debt

Aleman Vitner & Watt Bryson Silvia Silvia, Quinlan & Watt Silvia, Bryson & Brown

July-19 July-13 July-11 July-10 July-09 July-05 July-02

U.S. States Grapple with Europe's Woes The Lowdown on Consumer Spending Employment: Beyond the Sound Bites—Reading the Signals IX Employment: Beyond the Sound Bites—Reading the Signals VIII Employment: Beyond the Sound Bites—Reading the Signals VII Housing Data Wrap-Up: June 2012 Do Too Many Dollars Make Us an Inflation Nation?

Vitner & Brown Vitner & Quinlan Silvia & Watt Silvia & Watt Silvia & Watt Vitner & Khan Bullard & Quinlan

June-29 June-22 June-20 June-20 June-20 June-19 June-15 June-07 June-07

2012 State Budget Outlook Student Loans: The Best of Intentions FOMC: Keep On Twisting Until Europe's Fever Breaks The Fiscal Cliff: Likelihood and Economic Impact Credit Quality Monitor: June 2012 The Fed: Same Goal, Different Method Economic Growth Appears to Be Lost in a Fog of Uncertainty What Happens if Span or Italy Leaves EMU? Housing Chartbook: May 2012

Silvia & Brown Silvia, Seydl & Watt Vitner Silvia, Brown & Watt Anderson & Kashmarkek Silvia & Khan Vitner Bryson, Quinlan & Swankoski Vitner, Khan & Seydl

May-29 May-24 May-22 May-16 May-16 May-15 May-07

Implications of a Euro Exit to Greece Puerto Rico: Failure of the State Commercial Real Estate Snapshot: South Carolina Expected Inflation Continues to Fall, Challenging the FOMC Work or Retirement? The Employment Outlook for Seniors The Not So Great Migration North Carolina: A Better Year Ahead?

Bryson, Quinlan & Swankoski Aleman Vitner & Watt Bullard & Seydl Bryson & Watt Silvia, Brown & Seydl Silvia, Brown & Watt

April-24 April-19 April-18 April-10 April-09

Lessons from British Fiscal Consolidation Credit: Changing Patterns in How We Finance Growth Business, Banking & the 2008 Financial Crisis: Where Are we Now? Fiscal Consolidation in a Flow-of-Funds Framework Budget and Election Year Uncertainty Restrain the Capital Region

Bryson & Seydl Silvia & Iqbal Silvia Bryson & Seydl Vitner & Watt

August-22 August-15 August-14 August-09 August-06 August-01

23

Wells Fargo Securities, LLC Economics Group Global Head of Research and Economics

Economists Azhar Iqbal, Econometrician………………………………azhar.iqbal@wellsfargo.com

Diane Schumaker-Krieg ………………… ….diane.schumaker@wellsfargo.com Global Head of Research & Economics ……

Tim Quinlan, Economist …………………………………..tim.quinlan@wellsfargo.com

Chief Economist John Silvia

…

Michael A. Brown, Economist ………………… michael.a.brown@wellsfargo.com

...................... …

Economic Analysts

john.silvia@wellsfargo.com

.

Sarah Watt, Economic Analyst …………………………… .sarah.watt@wellsfargo.com Senior Economists Mark Vitner, Senior Economist……………....………. .

Jay Bryson, Global Economist

Anika Khan, Senior Economist

.

mark.vitner@wellsfargo.com

Zachary Griffiths, Economic Analyst

…………………....……….jay.bryson@wellsfargo.com

Eugenio Aleman, Senior Economist Sam Bullard, Senior Economist

Kaylyn Swankoski, Economic Analyst

Sara Silverman, Economic Analyst

…………….eugenio.j.aleman@wellsfargo.com

zachary.griffiths@wellsfargo.com sara.silverman@wellsfargo.com

Administrative Assistants Peg Gavin, Executive Assistant.

………………………….sam.bullard@wellsfargo.com .…

kaylyn.swankoski@wellsfargo.com

Cyndi Flowe, Administrative Assistant

. anika.khan@wellsfargo.com

peg.gavin@wellsfargo.com cyndi.h.flowe@wellsfargo.com

Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A, Wells Fargo Advisors, LLC, and Wells Fargo Securities International Limited. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company.

SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited (“WFSIL”). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Services Authority. The content of this report has been approved by WFSIL a regulated person under the Act. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive 2007. The FSA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, not will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the “Materials”) are provided for general informational purposes only.

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