Robert F. Wescott, Ph.D. Global Economic Growth Prospects: 2007 and Beyond Keybridge Research LLC Washington, DC

4 Forces Shaping World Economy in Tighter monetary and fiscal policies: 2. Still high energy prices: 3. Strong global productivity: 4. Trade opening:

Global Liquidity Now Slowing U.S. monetary base plus world foreign exchange holdings (percent change, year on year) Sources: Federal Reserve, IMF COFER database

Oil: A Growing Burden on the World Economy Source: EIA, IMF WEO Global Slowdown Trigger Level?

Economic Prospects Global growth downshifts from 5% to 3.5 or 4% Global growth downshifts from 5% to 3.5 or 4% – adjustment to higher interest rates, high energy prices – consensus view of 5% too high as real incomes slow Growth convergence: E.U. and Japan up to 2.5%, Growth convergence: E.U. and Japan up to 2.5%, E.U.: profits spur investment, consumption recovers, pent up demand E.U.: profits spur investment, consumption recovers, pent up demand Japan: land prices rebound, credit increases, provide lift Japan: land prices rebound, credit increases, provide lift U.S. down—2.0% as housing slows U.S. down—2.0% as housing slows China, India still strong, 7-8% China, India still strong, 7-8% Other Asia, Latin America, Eastern Europe— decent growth (4-5%) Other Asia, Latin America, Eastern Europe— decent growth (4-5%)

Financial Prospects Global interest rates: have already peaked at 5.25% (U.S.) Global interest rates: have already peaked at 5.25% (U.S.) Global equities: have liked “Goldilocks” worldview, but likely to suffer if U.S. really slows to 2% GDP growth Global equities: have liked “Goldilocks” worldview, but likely to suffer if U.S. really slows to 2% GDP growth Currencies: $ depreciates. Euro, yen, and RMB appreciate. Currencies: $ depreciates. Euro, yen, and RMB appreciate. U.S. equities: at risk, particularly housing, lumber, autos, mortgage lenders (especially sub-prime lenders) U.S. equities: at risk, particularly housing, lumber, autos, mortgage lenders (especially sub-prime lenders) EU equities: profits should help sustain equity rallies EU equities: profits should help sustain equity rallies Eastern Europe equities: generally favorable Eastern Europe equities: generally favorable

Housing Prices Rising Worldwide Percent Change, Source: The Economist

Housing’s Disproportionate Contribution to U.S. Job Growth Source: BLS

Mortgage Equity Withdrawal Can Almost Entirely Explain the Decline in U.S. Saving Source: Federal Reserve, BEA, Office of Thrift Supervision, ISI

Housing’s Contribution to U.S. GDP Growth, Channel Growth, ‘01- ’05 Effect on GDP Contribution to GDP Growth Residential Investment $343.4 billion 100% Housing Wealth $4,285.9 billion 7% $300.0 billion Cash Out From Refinancing $ billion 100% $1,219.0 billion Total housing contribution to GDP growth: $1,862.4 billion Total U.S. GDP growth: $2,918.3 billion Housing share of GDP growth (percent): 64%

U.S. Housing Downturns Tend to be Deep Decline in Housing Starts, Last Five Housing Market Downturns Source: Census Bureau Average Decline: 51.2%

U.S. Housing Slowdown Has Already Started Source: National Association of Home Builders NAHB/Wells Fargo Housing Market Index,

8 Observations About the Changing Global Economy 1. Centers of activity will shift 1. Centers of activity will shift 2. Consumer landscape will change 2. Consumer landscape will change 3. Energy and environmental problems will grow 3. Energy and environmental problems will grow 4. Emerging markets will have both inflationary and deflationary effects 4. Emerging markets will have both inflationary and deflationary effects 5. Battleground for talent will heat up 5. Battleground for talent will heat up 6. Key secret of emerging markets: productivity and appreciating currencies 6. Key secret of emerging markets: productivity and appreciating currencies 7. But investors beware: diversification is falling 7. But investors beware: diversification is falling 8. Risks to consider 8. Risks to consider

1. Centers of economic activity will shift profoundly – globally and regionally Today Asia (excluding Japan) represents 13% of world GDP; the E.U. represents 30%. Today Asia (excluding Japan) represents 13% of world GDP; the E.U. represents 30%. In 2025 Asia and the E.U. will each be 20%- 22% of the world economy. In 2025 Asia and the E.U. will each be 20%- 22% of the world economy. The U.S. will remain the world’s largest economy. The U.S. will remain the world’s largest economy. Regional shifts: toward regional capital cities (Kansei, Kanto) Regional shifts: toward regional capital cities (Kansei, Kanto)

China’s Trend Has Been Sharply Upward Source: IMF

Sources: Angus Maddison, The World Economy: A Millennial Perspective and International Monetary Fund China, U.K., U.S., Japan, GDP, % of World Total, PPP Basis

“Asian Tiger” Five Phase Growth Cycle Pre- Takeoff (5 yrs) Takeoff (10 yrs) Maximum burst (10 yrs) Consolidatio n (10 yrs) Slow-down (10 yrs) Japan % % % % % Taiwan % % % % 6.6% % Korea % % 5.8% % %---- Thailan d % % % %---- China % % % %---- Average Per Capita Income Growth %

China: Fitting the “Asian Tiger” Growth Profile Average Annual Growth in Per Capita Income

2. The consumer landscape will expand significantly $5,000 in income is a threshold above which spending can go to discretionary items (like Italian silk scarves) $5,000 in income is a threshold above which spending can go to discretionary items (like Italian silk scarves) Spending power in emerging markets will jump from $4 trillion today to $10 trillion in Spending power in emerging markets will jump from $4 trillion today to $10 trillion in Already Poland has more people with a Danish income level than Denmark. Already Poland has more people with a Danish income level than Denmark. Soon China will have more people with a German income level than Germany. Soon China will have more people with a German income level than Germany.

Vehicles Registered per Capita Vehicle Registrati on Country/Year Per Capita Income 0.01 (1 in 100) China, 1997 $3,695 Korea, 1973 $3, (1 in 20) Korea, 1988 $8,934 Taiwan, 1981 $6,628 Mexico, 1974 $7, (1 in 10) Korea, 1991 $10,973 Taiwan, 1987 $9,992 Mexico, 1981 $10, (1 in 5) Japan, 1971 $11,400 Korea, 1995 $13,864 Taiwan, 1992 $13,458

The “Sweet Spot” for Car Ownership is between $4,000 & $9,000 Per Capita Income 0 $3,000 $6,000 $9,000 $12,000 $15,000 $18,000 $21,000 1 Vehicle Registration per Capita Per Capita Income-US$ PPP Basis China (1997) Korea (1973) India (2002) China (2002) Korea (1981) Korea (1991) Taiwan (1987) Thailand (1996) Korea (1991) Taiwan (1987) Thailand (1996) Mexico (2000) Korea (1995) Japan (1971) Korea (2002) Taiwan (2001) Japan (1976) $3,400 $4,900 $6,700 $9,100 $12,400 $19,200 Average of Japan, Taiwan, Korea, Thailand, China, and Mexico

3. Demand for natural resources will grow; put strain on the environment Oil demand projected to grow 50% in the next 20 years Oil demand projected to grow 50% in the next 20 years But China cannot use oil as U.S. and Europe do But China cannot use oil as U.S. and Europe do Growing demands for steel, aluminum, copper, minerals, water Growing demands for steel, aluminum, copper, minerals, water Pressing need for alternate fuels, new transportation technology Pressing need for alternate fuels, new transportation technology

Sources: International Iron and Steel Institute, Japan Iron and Steel Federation, Barraclough: Steelmaking, Hogan: The Economic History of the Iron and Steel Industry in the U.S, Hudson & Sadler: The International Steel Industry China, U.S., Japan, Steel Production, Millions of tons <10% of world (1843) 36% of world (1900) <5% of world (1950) 19% of world (1974) <4% of world (1980) 29% of world (2005)

World CO 2 Emissions Are Rising and Asia is the Biggest Polluter Source: Energy Information Agency, U.S. Department of Energy

4. For Goods that China Buys… China’s Share of World Imports of Metal Ores & Concentrates Source: UN ComTrade

…Prices Go Up Source: United States Geological Survey Average US Market Spot Prices, Indexed to 1996 Prices

But for Goods that China Sells… China’s exports have increased 3X in 5 years

…Prices Are Held Down U.S. Import Non- energy Import Price Index 1990 = 100 U.S. Core CPI, Index 1990 = 100

5. Battleground for talent will shift Shift from production to knowledge-intensive industries (science, technology, culture, arts, entertainment) Shift from production to knowledge-intensive industries (science, technology, culture, arts, entertainment) In U.S., 5% of jobs were in these industries in 1900, but 40% today are. In U.S., 5% of jobs were in these industries in 1900, but 40% today are. In Italy, 13% are today, but this will increase. In Italy, 13% are today, but this will increase. 33 million university-educated young professionals in developing countries today (more than twice the number in advanced countries) 33 million university-educated young professionals in developing countries today (more than twice the number in advanced countries)

Talent Percent of population ages with a B.A. degree or above Source: Florida and Tinagli, “Europe in the Creative Age,” Feb. 2004

6. Key Attractions of Emerging Markets: Rapid Productivity Growth & Appreciating Currencies Source: IMF While Poland’s productivity has increased 4.2% a year, the Zloty has appreciated by roughly 3% per year against the currencies of all its trading partners. Polish Zloty, real effective exchange rate, 1995 = 0

Average Correlation Between US & Emerging Market Equity Indices 7. Together We Rise, Together We Fall! Tighter Linkages Between Equity Markets Source: Global Financial Data. Equity market indices for Argentina, Brazil, China, India, Mexico, South Africa, South Korea, Taiwan, Turkey, Venezuela, and the United States.

8. Risk: Can Disequilibrium Continue? Source: IMF WEO Current Account Balance as a Percent of GDP China Produces The US Consumes

Problems from China’s over saving Inefficient use of capital (zero returns) Inefficient use of capital (zero returns) Stirs protectionist backlash from trading partners Stirs protectionist backlash from trading partners Impediments to Shift to Domestic Demand Confucian work ethic (Japan and Korea, etc. maintained 30% saving rates for years) Confucian work ethic (Japan and Korea, etc. maintained 30% saving rates for years) One child policy (“1-2-4” problem, dependency ratio up starting in 2010) One child policy (“1-2-4” problem, dependency ratio up starting in 2010) Weak Social Security system Weak Social Security system Banking system weak, may not be able to support consumerism Banking system weak, may not be able to support consumerism