Can the World Survive the US Downturn? 1 Goldman Sachs Can the World Survive the US Downturn? Gavyn Davies Chief International Economist Enron Advisory Council Houston 11th April 2001

2 Main Topics Models to estimate the statistical probability of recession. The economic cycle and financial market risk premia - the importance of leading indicators. Goldman Sachs “main case” forecast for GDP. Downside risks - ICT spending; US domestic demand; oil. The downside case for economic activity. Interest rates for currencies.

Probability of Recession Model 3 Probability of Recession Model February Indicator Observation Coefficient T-Statistic Rank1 Univ. of Michigan Consumer Sentiment - 16.70 - 0.0610 - 2.79 2 Consumer Price Index - Energy 12.88 0.027 1.59 7 Inventory / Shipment Ratio - Mfg. 0.07 4.037 2.56 3 Ratio of Unsold to Sold Homes 0.34 8.266 5.46 6 10-Year / Fed Funds Spread - 0.39 - 0.869 - 5.65 1 Real M2 1.30 0.264 2.17 4 Corporate Yield Spread 0.77 0.83 2.13 5 1 Importance in recent rise in probability of recession. Source: Our Calculations.

US: Probability of Recession 4 US: Probability of Recession 0.0 0.2 0.4 0.6 0.8 1.0 1.2 Probability of recession* L:\shared\ventura7\wklyanal\graphs\cu0101.grf 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 Probability of recession starting within the following 12 months based upon a probit model using 7 real and financial indicators.

Probability of Recession: OECD ex. USA* 5 Probability of Recession: OECD ex. USA* 0.0 0.2 0.4 0.6 0.8 1.0 1.2 L:\shared\world\global\special\probrec.grf Line = yellow Bar chart = blue No animation 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 *Probability of a recession occurring within the following 12 months. Shaded regions indicate actual periods of recession.

Euroland GDP Growth Probabilities One Year Ahead 6 110 % 100 90 80 <2% 70 L:\shared\ppt\Dwalton\dw2001\nichart.grf 2% = yellow 0% = blue 60 50 40 30 <0% 20 10 92 93 94 95 96 97 98 99 00 01

Japan: Probability of Recession* 7 Japan: Probability of Recession* 10 20 30 40 50 60 70 80 90 100 % L\shared\world\japan\recess.grf 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 * Probability of the economy entering a recession over the next 12 months.

UK: Probability of Recession* 8 UK: Probability of Recession* 10 20 30 40 50 60 70 80 90 86 87 88 89 91 92 93 94 95 96 97 98 99 00 01 02 % Economy In Recession L:\shared\world\UK\ukspot\graphs\spt379\spt379a.grf Line = yellow bar = blue *Probability of negative annual GDP growth in one year's time.

9 Relative Performance of World Equities vs Bonds & OECD Leading Indicator -40 -30 -20 -10 10 20 30 40 -8 -6 -4 -2 2 4 6 8 12 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 % yoy OECD Leading Indicator World Equity Returns minus Bond Returns in US$ L:\shared\world\global\strategy\novoo.grf OECD Leading Indicator = Blue World Equity Returns - yellow no animation

OECD Leading Indicator and World Equity Risk Premium 10 OECD Leading Indicator and World Equity Risk Premium -6 -4 -2 2 4 6 8 10 0.5 1 1.5 2.5 3 3.5 90 91 92 93 94 95 96 97 98 99 00 01 02 OECD LI % yoy %, 3m Mov. Av World ERP (inverted) L/shared/ventura_1/global_2/gew0112/livs.graph OECD = blue World ERP = yellow

OECD Leading Indicator and US Corporate Bond Spread 11 OECD Leading Indicator and US Corporate Bond Spread -8 -6 -4 -2 2 4 6 8 10 12 0.5 1 1.5 2.5 3 3.5 4.5 5 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 OECD LI % yoy %, 3m Mov. Av. US Baa Corporate Bond Spread (inverted) L/shared/ventura_1/global_2/gew0112/livs.graph OECD = blue US Baa = yellow

12 Relative Performance of Emerging Market vs World Equities & OECD Leading Indicator -80 -60 -40 -20 20 40 60 80 -8 -6 -4 -2 2 4 6 8 10 12 86 88 90 92 94 96 98 00 02 % yoy Emerging Market minus World Equity Returns in US$ OECD Leading Indicator L:\shared\world\global\strategy\novoo.grf OECD Leading Indicators = Blue Emerging Markets = yellow no animation

Lead/lag of OECD Leading Indicators at Turning Points 13 Lead/lag of OECD Leading Indicators at Turning Points Turning Point in OECD LI Peak Lead in months over... OECD 4 Ind. Prodn Bond Sprd. Emg. Mkt. 8 Spread 1 US Corp. World Equity Risk Premium Average 4.4 - 2.7 0.3 0.2 - 4 Sep-97 Jan-00 Trough 6 - 2 Oct-98 9 2 Oct-92 - 14 - 5 - 7 Jun-96 7 - 12 - 3 Jan-95 3 — Jan-89 TYPE Date

Correlation between OECD Leading Indicators & Other Variables 14 Correlation between OECD Leading Indicators & Other Variables Variable Correlation with Leading Indicators x months ahead* Months -6 -4 -2 0.854 -7 0.50 0.21 0.15 0.12 — 0.893 -1 0.854 -6 0.47 0.24 0.26 0.17 0.809 0.891 +2 +4 +6 +2 0.811 -3 0.05 -0.05 0.10 0.16 0.749 0.855 US Corp. Spread 0.45 0.48 0.35 0.20 Emg. Mkt. Bond Spread -0.09 0.04 0.25 0.17 World Equity Risk Premium 0.04 0.13 0.19 0.07 US Equity Risk Premium -0.03 0.04 0.18 0.16 Months -9 -8 -5 -4 OECD Ind. Prod. 0.838 0.847 0.849 0.835 OECD GDP 0.726 — — — Months -4 -3 +1 GS LI 0.888 0.891 0.887 0.873 * Month of highest correlation in bold.

Turning Points in “OECD” Longer Leading Indicator and Other Indicators 15 Turning Points in “OECD” Longer Leading Indicator and Other Indicators Turning Point Trough Lead of “OECD” LLI in months over... 7 Average 6.4 May-98 Dec-00 Peak 5 Jun-99 Oct-94 6 Feb-97 3 Dec-95 17 Oct-92 OECD LI 11 10.9 9 4 10 20 OECD IP TYPE “OECD” LLI Aug-87 .

Leading Indicators of OECD Economic Activity 16 Leading Indicators of OECD Economic Activity 0.90 0.95 1.00 1.05 1.10 1.15 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 Ratio to trend f'cst values OECD's Leading Indicator *Constructed from the components of the OECD's indicator that have historically had a long lead on economic activity at turning points. "Longer" Leading Indicator ("OECD" LLI)* L:/users/wahhaz/lendind/lichart.grf Longer Leading = blue OECD Leading = yellow

Leading Indicators of OECD Economic Activity 17 Leading Indicators of OECD Economic Activity 0.90 0.95 1.00 1.05 1.10 1.15 Ratio to trend OECD's Leading Indicator GS Leading L:/users/wahhaz/lendind/lichart.grf GS Leading = blue OECD Leading = yellow Indicator (GS LI)* f'cst *Based on an econometric model to predict values changes in the OECD's indicator. 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02

Main Six Economies 18 12 16 11 10 12 9 Leading Indicator 8 8 7 6 5 4 4 % yoy 11 % yoy 10 12 9 Leading Indicator 8 8 7 6 5 4 L:\shared world\leadin\gdplead 4 3 2 1 -4 -1 -8 -2 Industrial Production -3 -4 -12 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01

Global GDP Forecasts 19 % Change on Year Earlier 1999 2000 2001 2002 USA 4.2 5.0 1.4 2.5 Euroland 2.5 3.4 2.4 2.7 Japan 0.8 1.7 1.5 1.4 OECD Total 3.0 3.7 1.8 2.5 Non Japan Asia 6.5 7.2 5.1 5.8 Latin America 0.0 4.2 3.4 4.3 Emerging C. Europe 3.1 4.0 3.7 4.2 Emerging World 4.2 6.1 4.6 5.3 World 3.5 4.6 2.7 3.4

Estimates of G6 Output Gap 20 Estimates of G6 Output Gap 3 % yoy 2 Goldman Sachs 1 L:\shared\world\global\glbchrt.grf no animation GS = yellow IMF = blue OECD = green -1 -2 OECD IMF -3 -4 -5 80 82 84 86 88 90 92 94 96 98 00 02

OECD Headline & Core Inflation 21 OECD Headline & Core Inflation 1.0 1.5 2.0 2.5 3.0 96 97 98 99 00 01 02 03 % yoy Headline CPI Core CPI L:\shared\world\global\glbchrt.grf Core CPI = blue Headline CPI = yellow no animation

US Hardware & Communications 22 US Hardware & Communications Equipment Spending -10 10 20 30 40 50 80 82 84 86 88 90 92 94 96 98 00 02 % yoy Investment Spending Orders, 3mma L:\users\wahhaz\ict\usdata.grf Orders = blue Investment spending = yellow no animation

ICT Spending Projections1 23 ICT Spending Projections1 ICT Spending Hit to GDP2 (% Growth) (% pts) 1999 2000F 2001F 2001F US 15.4 22.9 - 2.4 - 1.0 Japan 5.1 20.1 10.6 - 0.5 Germany 6.4 9.6 4.3 - 0.1 France 16.2 24.1 10.8 - 0.4 UK 4.0 6.0 2.7 - 0.1 G5 11.6 19.6 2.3 - 0.7 1 Assuming level of orders remains unchanged at average level between Dec '00 and Jan '01 throughout 2001. 2 Direct impact on nominal spending. Total impact on real GDP will be higher.

24 Oil Price Forecast 72 74 76 78 80 82 84 86 10 15 20 25 30 35 99 00 01 02 (Million Barrels) WTI Global Global supply US$/bl Forecast demand L:\shared\world\global\oil3.grf WTI = blue Global Demand & supply = yellow no animation

Terms-of-trade or balance of 25 Impact of Oil Price Change on Terms-of-Trade Terms-of-trade or balance of payments loss* 1978-80 US Japan Euroland OECD 1973-74 1.0 2.6 3.0 1.9 2.5 3.7 3.8 3.2 1989-91 0.6 0.9 0.8 0.7 1998-01 % of GDP * Negative figure indicates a terms-of-trade gain. The terms-of-trade loss is calculated by multiplying the percentage increase in the dollar price of oil by the share of oil and gas imports in GDP. We assume the price of brent oil rises from $13.1bbl in 1998 to $26.5bbl in 2001.

US Real Financial Conditions Index 26 US Real Financial Conditions Index 95 95.5 96 96.5 97 97.5 98 98.5 99 99.5 100 94 00 01 02 Tighter Easier L:\shared\world\global\usfcid.grf no animation

US Saving Rate at Record Low 27 US Saving Rate at Record Low -2 2 4 6 8 10 12 14 4.0 4.5 5.0 5.5 6.0 6.5 80 82 84 86 88 90 92 94 96 98 00 02 % Household Saving Rate Net Worth/Disposable Income Ratio Ratio, inverted Q1 estimate L:\shared\world\global\ussav.grf Net worth = blue Household saving = yellow no animation

US Personal Saving Rate (% of Disposable Income) 28 US Personal Saving Rate (% of Disposable Income) Change, Predicted Change, Predicted Change, Predicted Change, Actual (wealth stays flat) (wealth rises 5%) (wealth rises 10%) 00Q1 - 1.3 - 1.1 - 1.1 - 1.1 00Q2 + 0.1 - 0.8 - 0.8 - 0.8 00Q3 - 0.5 + 0.5 + 0.5 + 0.5 00Q4 - 0.6 + 0.1 + 0.1 + 0.1 01Q1 + 0.9 + 0.9 + 0.9 01Q2 + 0.9 + 0.7 + 0.5 01Q3 + 0.8 + 0.5 + 0.1 01Q4 + 0.9 + 0.5 + 0.1 Source: Department of Commerce. Our Calculations.

US: A Stable Capital Stock Share = Collapse in ICT Investment 29 US: A Stable Capital Stock Share = Collapse in ICT Investment 2 4 6 8 5 6 7 8 9 10 11 12 13 % of % of GDP GDP L\shared\world\usa\global\global2.grf ICT Capital Stock = yellow ICT Business = blue Assuming 1990 - 1999 = white Assuming No Growth = green ICT Capital Stock ICT Business Fixed Investment Assuming 1990-99 Growth* Assuming No Growth** 90 91 92 99 94 95 96 97 98 00 01

US - Financial Balances 30 US - Financial Balances 8 7 % of GDP 6 5 4 Private Sector 3 Balance Fiscal Balance 2 1 L:\shared\world\global\glbchrt.grf Private Sector = yellow Fiscal Balance - white Current account = blue no animation Current Account -1 -2 -3 -4 -5 -6 -7 -8 83 85 87 89 91 93 95 97 99 01 03

Impact on GDP of Possible Global Shocks in 2001 31 Impact on GDP of Possible Global Shocks in 2001 Impact on GDP Direct Hit From US Gain from Collapse in Recession Collapse in Tech Total GDP % of GDP Via Exports1 Oil Prices2 Spending3 Effect US - 2.0 - 2.3 0.5 - 0.8 Japan - 0.2 0.0 0.7 - 0.5 Euroland - 0.1 0.2 0.6 - 0.2 Main OECD Countries - 0.8 0.5 - 0.5 - 0.8 1 This column shows the direct trade hit from a decline of 6% in exports to the US. This would likely happen if US domestic demand dropped by 3% in 2001 (relative to our main case forecast). The drop in US GDP would be around 2%. 2 This assumes average oil prices in 2001 drop by $10/barrel compared with our main case assumption of $22/barrel. 3 This assumes a drop in ICT investment in line with recent orders data. US tech spending decelerates from 22% growth in 2000 to 1% in 2001.

Euroland: Industrial Production 32 Euroland: Industrial Production -2 2 4 6 8 10 97 98 99 00 01 02 Industrial Production (YoY Chg) % YoY GS Leading Indicator Simulations L:\shared\europe\graphs\emu11\surveys\leading\leadingC Industrial Production = blue GS Leading Indicators = yellow no animation

Japan - Financial Balances 33 Japan - Financial Balances 83 85 87 89 91 93 95 97 99 01 03 -10 -8 -6 -4 -2 2 4 6 8 10 12 % of GDP Fiscal Balance Current Account Private Sector Balance L:\shared\world\global\glbchrt.grf Private Sector = yellow Current Account = blue Fiscal Balance = white no animation

Central Case & Downside Scenario Outlook for 2001: Central Case & Downside Scenario 34 GDP - annual average CPI - yoy, end-year % Change Downside Downside Central Case Scenario Central Case Scenario US 1.4 -0.6 2.4 1.1 Japan 1.5 0.8 -0.1 -0.2 Euroland 2.4 1.7 1.4 1.0 UK 2.2 1.6 1.5 1.2 OECD 1.8 0.6 1.6 0.9 OECD ex US 2.1 1.5 1.0 0.7

G7: GSWIRE Scenarios 35 GS Forecasts Actual/Forwards Baseline Boom % GS Forecasts Actual/Forwards Baseline L:\shared\v7\wklyanal\graphs\bd0101 or ask Fiona Boom Bust

Euro / US$ 36 +1 Standard Error Spot -1 Standard Error 02 EXCEL LINKED Excel file = L:/shared/world/gsdeer/gderrors.xls converted to = L:/shared/world/gsdeer/gserrors_ppt.xls this slide is linked GSDEER -1 Standard Error 02

US: BAA Corporate Bond Spread* 37 US: BAA Corporate Bond Spread* % Actual GS-Spread** Projections *Moody’s Baa-30 year Treasury **Out of Sample