From the December-January 2008 issue of Treasury & Risk magazine

Recession? Inflation? Choose Your Poison

By most measures, 2008 is not presenting a pretty economic picture. The downside risks are profuse--from the collapse in home prices, to the potential for additional trauma from the subprime market, to the supply and price issues in energy and raw materials. For the first time in years, the U.S. is the principal global slacker in terms of economic growth. While the weakness in the dollar can ultimately help our export imbalance and deter some of the movement of jobs overseas, it also significantly reduces our buying power as a nation and diminishes our leverage in global markets. Although a measured response from the Federal Reserve may avert recession, the nation could still face a politically uncomfortable economy--feeble growth in consumer income and assets as home values contract, salaries grow minimally and the markets gyrate, while simultaneously prices on such essentials as energy, medical care and now even food are trending upward. Treasury & Risk has asked economists M. Cary Leahey of Decision Economics, Milton Ezrati of Lord Abbett and John Lonski of Moody's Investors Service to suggest strategies for weathering the unfavorable economic clime.


Watching Overseas Grow
M. Cary Leahey
Senior Managing Director,
Decision Economics Inc.

Worries about recession risks abound when talking about the economic outlook for 2008. Real energy prices are high, the two-year-old housing recession shows few signs of quitting, and the financial markets are in
turmoil. Is there a ray of sunshine in what otherwise portends to be a disappointing, if not dismal, 2008? Surprisingly, yes--but one that companies need to prepare for if they are to benefit.

The overseas economic backdrop is the strongest in 35 years. (See chart) Since 2006, the U.S. has gone from the G-7 economic growth leader to growth laggard. GDP growth dropped to 2.1% in 2007 from 2.9% in 2006, while overseas GDP growth is expected to remain unchanged at 6%. Next year, U.S. GDP growth should fade a bit more to 1.9%, while overseas GDP growth fades to only 5.7%. At the same time, the dollar has been in decline for five years and has now more than reversed the previous seven years of appreciation to confine it to its lowest level since 1995.

This "decoupling" of U.S. and overseas growth is an important development, with serious implications for U.S. companies. Thanks to the dollar's feebleness and the economic strength overseas, one would expect U.S. exports to rally, and indeed they did rise almost 10% in the past year--the most significant surge since the late 1980s. Manufacturers with strong international presence--particularly in rapidly growing regions--might hope to weather the expected slowdown in domestic demand for their products and services by shifting their attention and sales abroad.

But there are no guarantees. Take, for instance, the export history with Asia. The share of U.S. exports more than doubled to India and China in 2006, to 6.3% from 2.6%, but was offset by a sizable drop in the rest of Asia's share from 23% to 18%. About half of that dip in export share came from the reduced importance of Japan and about a quarter came from Asian tigers like South Korea.

Mexico remains a wild card, despite its NAFTA status and proximity. In 2006, The Mexican share of U.S. exports fell marginally to 13% from 14% the year before. The reason is simple: Mexico's economy has been losing out to the rising tide of exports to the U.S. from the burgeoning Chinese and Indian economies. Even with the weak dollar, it leaves Mexico with less money to buy more from the U.S.

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