How Serious of a Threat Is Global Deflation? Nariman Behravesh Farid Abolfathi John Mothersole Dan Ryan Todd Lee Howard Archer Global Insight Teleconference.

Copyright © 2002 Global Insight

How Serious of a ThreatHow Serious of a Threat

Is Is

Global Deflation?Global Deflation?

Nariman Behravesh Nariman Behravesh Farid AbolfathiFarid Abolfathi

John MothersoleJohn MothersoleDan RyanDan RyanTodd LeeTodd Lee

Howard ArcherHoward Archer

Global Insight TeleconferenceGlobal Insight Teleconference

December 17, 2002December 17, 2002


1990s: A Deflationary Wave1990s: A Deflationary Wave

• The bursting of the Japanese asset and The bursting of the Japanese asset and investment bubblesinvestment bubbles

• The Asian CrisisThe Asian Crisis

• Deflation spreads to other parts of AsiaDeflation spreads to other parts of Asia

• The bursting of the high-tech bubble The bursting of the high-tech bubble

• Worldwide manufacturing deflationWorldwide manufacturing deflation

2Copyright © 2002 Global Insight


Commodity PricesCommodity Prices


Though Up in 2002, Commodity Prices Though Up in 2002, Commodity Prices Remain Well Below Recent LevelsRemain Well Below Recent Levels

2.0

2.4

2.8

3.2

1996 1997 1998 1999 2000 2001 2002

Commodity Research Bureau's Spot Market Commodity Price Index


With Prices For Many Soft Since JulyWith Prices For Many Soft Since July

0.8

1.0

1.2

1.4

1.6

2001 2002

Global Insight's World Manufacturing Cost Index less Oil & Shipping Rates*

(*Prices for ethylene, nonferrous metals, lumber, cotton, pulp, steel scrap, rubber and DRAM's)


Insights From Japan’s Insights From Japan’s DeflationDeflation


Disinflation, Deflation

Inflation Rates in Japan

-3

-2

-1

0

1

2

3

4

5

1985 1990 1995 2000

CPI GDP Deflator


Bursting Bubbles

• JAPAN• Stock market peak: December 1989.• Inflation: rising in 1990, volatile in 1991 (with surges

above 4% m/m)• GDP growth: 3+% q/q through 1991. • Overnight call rate peak: March 1991.

• United States• Stock market peak: August 2000.• Federal funds peak: January 2001.


Interest Rate Response

Real Interest Rates (Bubble peak at 0)

-3-2

-10

123

45

67

-1 0 1 2

Japan U.S.


Japan’s Slow Response Due To:

• Unfamiliarity with slow growth.• Return to “normal” (3-4%) growth rate expected.

• Anti-inflation bias.• Post-WWII generation of policymakers.

• Emphasis on fiscal rather than monetary expansion.• Public works projects.


Problems Peculiar to Japan

• Structural problems.• Overly-dependent on manufacturing, construction,

exports.• Low productivity in services.

• Bad Loans + Extreme Asset Deflation• Bad loans estimated at 8-40% of GDP• Asset prices now 1/4th of peak value.

• Money hoarding. Due to uncertainty, risk aversion.• 1990: M1 = 25% of GDP• Today: M1 = 65% of GDP


Japan: Causing Global Deflation?

Japanese Price Level

50

60

70

80

90

100

110

120

130

140

1990 1995 2000

In US$ In Euros


AsiaAsia


Asia Recovery ContinuesAsia Recovery Continues

-10

-5

0

5

10

AUS CHN HKG IND IDN KOR MYS PHL SGP TWN THA

Q4/01 Q1/02 Q2/02 Q3/02

(Real GDP, percent change from a year earlier)


Recovery Still Driven by ExportsRecovery Still Driven by Exports

(Percent change from a year earlier, Q3/2002)

-20

-10

0

10

20

30

AUS CHN* HKG IDN KOR MYS PHL SGP# TWN THA+

Private Consumption Business Investment Exports

* Private consumption represented by real retail sales; business investment from q1-q3; exports in nominal dollar terms

# Exports in nominal U.S. dollar

+ 2002 Q2 data


Consumer Demand is CoolingConsumer Demand is Cooling

-6

-3

0

3

6

9

12

AUS CHN* HKG IDN KOR MYS PHL SGP TWN THA

Q4/01 Q1/02 Q2/02 Q3/02

(Real NIA Private Consumption, percent change from a year earlier)

*Real retail sales


Exports Are SizzlingExports Are Sizzling

-30

-20

-10

0

10

20

30

AUS CHN* HKG IND* IDN KOR MYS PHL SGP* TWN THA

Q4/01 Q1/02 Q2/02 Q3/02

(Real NIA Exports, percent change from a year earlier)

*Exports in nominal U.S. dollar


Asia Exports Rely on US ImportsAsia Exports Rely on US Imports

(Percent change from a year earlier)

-20

0

20

40

Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02

Asia Exports U.S. Imports


Interest Rates Are near All-Time LowsInterest Rates Are near All-Time Lows

0

5

10

15

20

25

30

Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02

Australia New Zealand Malaysia Taiw an Thailand

Japan Korea India Singapore Philippines


Liquidity Decelerates Despite Low Interest RatesLiquidity Decelerates Despite Low Interest Rates

Singapore

0.0

2.0

4.0

6.0

8.0

Jan-01 Jul-01 Jan-02 Jul-02

M2 3-Month Treasury Bills Rate

South Korea

0

5

10

15

20

25


M2 Call Rate

Hong Kong

-5

0

5

10


M2 Base Rate

Taiwan

0

2

4

6

8


M2 Rediscount Rate

Percent change from a year earlier


Deflation Remains A ConcernDeflation Remains A Concern

(CPI, percent change from a year earlier)

-5

0

5

10

15

CHN HKG IND IDN KOR MYS PHL SGP TWN THA

2001 2002 Jan-Oct


Deflation Remains A ConcernDeflation Remains A Concern

(Percent change from a year earlier, 2002 Q3)

-15

-10

-5

0

5

10

AUS HKG IDN KOR* MYS PHL TWN THA*

GDP Deflator Import Price Deflator* Second quarter data


Fiscal Strain in AsiaFiscal Strain in Asia

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

AUS CHN HKG IND IDN KOR MYS NZL PHL SGP

2001 2002

(Fiscal balance over GDP, percent)


Outlook And RisksOutlook And Risks

• OutlookOutlook• Cautiously optimistic about 2003• Inflation will remain subdued in the near-term• Accommodative fiscal and monetary policy will continue• US growth rebound in 2nd half 2002 will boost exports • China, India, Korea, and Malaysia will lead the pack

• RisksRisks• Deflation• Dependence on U.S. imports• Non-economic shocks: Terrorist attacks, War on Iraq• Rapid consumer credit expansion• Fiscal strain


Real GDP Growth OutlookReal GDP Growth Outlook

(Percent change)

-2

0

2

4

6

8

10

China Hong Kong Taiwan India Australia

2001 2002 2003 2004


Real GDP Growth OutlookReal GDP Growth Outlook

(Percent change)

-2

0

2

4

6

8

10

Indonesia Korea Malaysia Philippines Singapore

2001 2002 2003 2004


Who Is Next?Who Is Next?


Parallels with JapanParallels with Japan

JapanJapan U.S.U.S. GermanyGermany

Weak Domestic DemandWeak Domestic Demand •• ••

DeflationDeflation •• ??

Real Interest Rates Too HighReal Interest Rates Too High •• ••

Real Exchange Rate Too HighReal Exchange Rate Too High •• •• ••

Fiscal RigidityFiscal Rigidity •• ••

Financial StressFinancial Stress •• ?? ••

Heavy Dependence on Bank Heavy Dependence on Bank FinancingFinancing

•• ••

High Debt LevelsHigh Debt Levels •• •• ••

Burst Asset BubblesBurst Asset Bubbles •• •• ••

Rigid Labor MarketsRigid Labor Markets •• ••

Poor Corporate GovernancePoor Corporate Governance •• •• ••


Growth in Real Domestic Demand Growth in Real Domestic Demand Versus Real GDPVersus Real GDP

United States

0

1

2

3

4

5

6

1999 2000 2001 2002

Per

cen

t C

han

ge

Real GDP

Real DomesticDemand



Germany

-2

-1

0

1

2

3

4

1999 2000 2001 2002

Per

cen

t C

han

ge

Real GDP

Real DomesticDemand



Japan

-1

0

1

2

3

1999 2000 2001 2002

Per

cen

t C

han

ge

Real GDP

Real DomesticDemand


Debt is High in Much of the G7Debt is High in Much of the G7

Hosehold debt as a percent of disposable personal income

United States

United Kingdom

Germany

Japan

80

90

100

110

120

130

140

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001*

Source: OECD; National statistics *Estimate


United StatesUnited States


U.S. - Deflation Is Not A Threat U.S. - Deflation Is Not A Threat

• U.S. growth has been closer to trend than most U.S. growth has been closer to trend than most other industrialized economiesother industrialized economies

• Policy has been and continues to be aggressively Policy has been and continues to be aggressively expansionaryexpansionary

• A falling dollar will helpA falling dollar will help

• Service sector inflation is still chugging along Service sector inflation is still chugging along

• However, there is no room for complacencyHowever, there is no room for complacency



U.S. - Growth vs. PotentialU.S. - Growth vs. Potential


0

1

2

3

4

5

1990-99 2000 2001 2002 2003 2004

Per

cen

t ch

ang

e in

rea

l G

DP

Potential History/Forecast


U.S. Consumer Price InflationU.S. Consumer Price Inflation

-2

-1

0

1

2

3

4

5

Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02

Goods Services Overall



Western EuropeWestern Europe


Western Europe overall deflation Western Europe overall deflation risks limited risks limited

• Growth in Western Europe averaged near to 2% over last Growth in Western Europe averaged near to 2% over last decade, so not a major output gap yet.decade, so not a major output gap yet.

• Core Eurozone inflation stayed in 2.4-2.6% range through Core Eurozone inflation stayed in 2.4-2.6% range through 2002. Inflation sticky in the dominant services sector.2002. Inflation sticky in the dominant services sector.

• Money supply growth strong, even allowing for distortions.Money supply growth strong, even allowing for distortions.

• ECB still has significant scope to cut interest rates. 50bp ECB still has significant scope to cut interest rates. 50bp cut on December brought key rate down to 2.75%.cut on December brought key rate down to 2.75%.

• If deflation really becomes a threat, there is ample scope If deflation really becomes a threat, there is ample scope for fiscal stimulus in the region, But authorities would have for fiscal stimulus in the region, But authorities would have to at least make the Stability and Growth Pact more flexible.to at least make the Stability and Growth Pact more flexible.


Eurozone - Growth vs. PotentialEurozone - Growth vs. Potential


0

1

2

3

4

1990-99 2000 2001 2002 2003 2004

Per

cen

t ch

ang

e in

rea

l G

DP

Potential History/Forecast


Eurozone Consumer Price Inflation: Eurozone Consumer Price Inflation: Goods and ServicesGoods and Services

0

1

2

3

4

Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02

Goods Services Overall



Western European Latest Annual Western European Latest Annual Inflation RatesInflation Rates

CPICPI CPICPI

CoreCore

PPIPPI CPI CPI CPICPI

CoreCore

PPIPPI

AustriaAustria 1.81.8 n.a.n.a. 1.21.2 NetherlandsNetherlands 3.2*3.2* n.a.n.a. 3.23.2

BelgiumBelgium 1.1*1.1* n.a.n.a. 0.70.7 NorwayNorway 2.1*2.1* 2.0*2.0* 3.3*3.3*

DenmarkDenmark 2.7*2.7* 3.1*3.1* 0.80.8 PortugalPortugal 4.0*4.0* n.a.n.a. 1.41.4

FinlandFinland 1.6*1.6* n.a.n.a. 0.50.5 SpainSpain 3.9*3.9* 3.6*3.6* 1.61.6

FranceFrance 2.2*2.2* 2.0*2.0* 0.60.6 SwedenSweden 2.3*2.3* 2.1*2.1* -1.0-1.0

GermanyGermany 1.1*1.1* 0.8*0.8* 0.30.3 SwitzerlandSwitzerland 0.90.9 1.01.0 -0.4-0.4

GreeceGreece 3.6*3.6* n.a.n.a. 1.91.9 UKUK 2.12.1 2.32.3 0.60.6

IrelandIreland 4.8*4.8* n.a.n.a. -0.4-0.4 EurozoneEurozone 2.2*2.2* 2.42.4 0.90.9

ItalyItaly 2.8*2.8* n.a.n.a. 1.11.1


Germany Deflation RisksGermany Deflation Risks

• Large output gap developing. GDP growth averaged just 1.3% Large output gap developing. GDP growth averaged just 1.3% over 10-years 1993-2002. Growth forecast at 1.0% in 2003, after over 10-years 1993-2002. Growth forecast at 1.0% in 2003, after 0.3% in 2002 and 0.7% in 2001.0.3% in 2002 and 0.7% in 2001.

• Unemployment at 10%. Consumer confidence at 5-year low.Unemployment at 10%. Consumer confidence at 5-year low.

• Major structural problems - Labor & product market rigidities.Major structural problems - Labor & product market rigidities.

• Stock market been weakest performing of the major industrialized Stock market been weakest performing of the major industrialized countries this year.countries this year.

• Debt levels have risen. Bankruptcies up sharply.Debt levels have risen. Bankruptcies up sharply.

• Property prices have fallen, but not collapsing.Property prices have fallen, but not collapsing.

• Banking sector problems mounting, but not as bad as in Japan. Banking sector problems mounting, but not as bad as in Japan. No signs of a significant credit crunch.No signs of a significant credit crunch.

• Locked into euro at too high a rate? Will euro rise markedly Locked into euro at too high a rate? Will euro rise markedly against dollar?against dollar?

• Real interest rates too high. Fiscal policy restrictive.Real interest rates too high. Fiscal policy restrictive.

• Policy paralysis?Policy paralysis?


Germany vs. JapanGermany vs. Japan


0201009998979695

4

2

0

-2

-4

4

2

0

-2

-4

German Growth (q-o-q) Japanese Growth (q-o-q)Japanese Annual Inflation German Annual Inflation


Reasons to Remain WorriedReasons to Remain Worried

• Weak domestic demand and growing output gapsWeak domestic demand and growing output gaps

• Huge amounts of excess capacity in goods-Huge amounts of excess capacity in goods-producing industriesproducing industries

• Weak commodity pricesWeak commodity prices

• Overvalued exchange rates Overvalued exchange rates

• Potential for policy mistakesPotential for policy mistakes


How Serious of a Threat Is Global Deflation? Nariman Behravesh Farid Abolfathi John Mothersole Dan Ryan Todd Lee Howard Archer Global Insight Teleconference.

Documents

deflation slide

percent slide

asia slide

gdp slide

dollar slide

year earlier slide

rate response slide

q2 data slide