World Business Academy by the Economic Forecast Committee Of

World Business Academy

Rekindling the Human Spirit in Business

By the Economic Forecast Committee of the World Business Academy

EconForecast is a publication for subscribers, Members, and Fellows of the World Business Academy. It presents a 12-month rolling economic forecast and a macro- economic analysis of social and political conditions throughout the world. The Economic Forecast Committee of the World Business Academy includes econ- omists, business executives, academics, and others who collaborate to create this report by consensus. This issue was derived from a meeting that took place De- cember 1, 2009. World Business Academy

OVERVIEW For more than a year, the Academy has correctly predicted that the global recession would end in the third quarter of 2009. It ended due to the cumulative economic activity of China, Southeast Asia, Brazil, the United States, Europe, and Australia. We still do not see a double dip recession, but rather a gradual L-shaped recovery based on solid fundamentals. In hindsight, this economic crisis was more severe than the Great Depression, which was largely confined to the Western industrialized countries. The De- pression collapsed the real economy but not the financial system. Now that the world has a truly global economic system, the crisis reached around the world. Policymakers had to revive the real economy and the financial system in tandem, a much more difficult challenge. The pervasive nature of the crisis created its own self-fulfilling fear as people worried that if it could not be fixed everywhere, it could not be fixed anywhere. The upside of post-crisis events is that after the fall of Lehman Brothers, governments responded to frozen credit markets in a timely fashion with enormous stimulus packages and liquidity injections that created enough of a floor under economic activity to avoid an economic Armageddon. The key banking sector regulators (the Fed, Bank of England, and the European Central Bank), as well as China’s state-directed banks, flooded the system with liquidity as they had to, so they could restart the financial circulatory system while they were stimulating the real economy. A strong cautionary note: as sanguine as we are about the L-shaped recovery, we believe that the United States and its allies must enact fundamental, coordinated financial reforms during the next 12 months so that the financial system does not remain susceptible to a second collapse.

• Climate change Before the December Copenhagen meeting, investors and businesses with combined assets over $13 trillion called for a strong deal on carbon that would unlock billions in investment, the same way the introduction of electricity and railroads did. They didn’t get the deal. What they did get in Copenhagen was significant—the world’s two biggest superpowers and two biggest polluters at the table, try- ing to protect their sovereignty, but by the very act of showing up, sitting down, and agreeing to set goals, demonstrating that they know there is a crisis and some cooperation is in order. Their participation sheds a more positive light on the Copenhagen agreement among major emitters (however sketchy and unenforceable) to share a bit of financing, technology, and unverifiable information about national progress on cutting emissions.

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Not all countries signed on, and those that did couldn’t agree on a timeline for a binding deal or even global targets for cutting emissions. Canada was a notable spoiler. But key developing countries like China, India, Brazil, and South Africa came in the tent, even as rich and poor nations continued to argue about equity, money, and technology. Developed nations’ modest monetary pledges of aid for climate change technology and adaptation underscored the extent to which they were focused on balancing international and domestic political expedien- cies (and endemic corruption in the developing world) more than on confronting climate change realities. The agreement will spread awareness of the need to significantly limit average global temperature increases, although the Copenhagen goal of limiting increases to 2 degrees Celsius is unlikely to be achieved. It is inadequate in any event because of the negative environmental feedback loop that has already begun. Much of the real work ahead will occur outside the chaotic UN Climate Conven- tion framework, within the much smaller group of about 30 nations who account for 90% of global emissions. We believe that Copenhagen will go down as the first step in a long, multi-step process to fight climate change, and ultimately reduce greenhouse gas emissions using the young science of geoengineering. In the meantime, private investment in green sector technology has grown by over $1.2 trillion since 2007, according to the Climate Prosperity Alliance. Over the next 12 months, investment in clean energy, efficiency, and information technology will accelerate and drive global economic growth despite the fact that our present accounting models do not adequately capture the intangible value of such technology. • International trade and finance Reform of the global financial system is proceeding at a snail’s pace despite ear- nest conversations in G-20 meetings and elsewhere. We cannot achieve a lasting economic recovery without enacting regulatory reforms to end the casino-like nature of the financial system. The financial sector’s appetite for highly leveraged, risky activity and novel financial products is as strong as ever. If anything, the structural problems have become worse as a result of government bailouts of the Too Big To Fail crowd and the post-crisis consolidation of the U.S. financial industry. There are a number of key destabilizing factors in the global economy but two in particular cross all borders. • The $600 trillion pool of unregulated derivatives. As we have said, derivatives are in essence securities and should be subject to the registration requirements of the 1933 Act and the disclosure requirements of the 1934 Act. Proposed reforms to require derivatives to be traded through clearinghouses are not enough, even if the requirement extended to both

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standardized and customized derivatives. Derivatives should be traded on regulated exchanges, especially in light of the fact that in the third quarter, commercial banks’ holdings of derivatives rose to $204.3 trillion, up by $804 billion from the second quarter. The derivatives pool is not any safer than the day derivatives unraveled for Bear Stearns, Lehman Brothers, AIG, and others. This shocking and highly volatile situation must be addressed. Whether the global community or individual political entities have the political will to enact this reform is doubtful. • Governments’ lack of progress in creating a level playing field in international financial regulation and taxation. London, New York, and other competing financial centers resist national reforms, such as regulating derivatives and taxing financial transactions, with bogus and self-serving arguments that they will be disadvantaged if other jurisdictions do not follow suit. Financial institutions’ success in holding reforms at bay is testament to their enormous lobbying power and the disproportionately large size of the financial sector in relation to the rest of the economy. The euro now accounts for 35% of global reserves, earning it the status of a global reserve currency. It will remain strong, buoyed by purchases from Eastern Europe. The stronger euro has hurt some European exporters who have been moving blue-collar jobs overseas. China continues to diversify its dollar holdings. All around the world, it is buying commodities, companies, and other assets, but most fundamentally, it is buying opportunities—especially the transfer of technology and access to new markets.

UNITED STATES The U.S. recession ended in the 3rd quarter of 2009, validating our earlier predic- tion that it would end in the 3rd or 4th quarter of this year. The index of leading in- dicators increased in November for the 8th consecutive month, capping the longest series of gains since 2003-04. Americans owe less We still predict that the U.S. recovery will be slow but solid— assuming we achieve meaningful reforms of the healthcare and Outstanding credit card bills in Oc- tober were down 8.5% from a year financial systems. earlier, reflecting both consumer payments and bank write-offs. At the end Consumers are deleveraging, but consumer confidence is slowly of September, unused equity home improving and will continue to lift consumer spending, the tra- lines of credits were down 25% from ditional engine of the U.S. economy, despite tight credit, wage their peak at the end of 2007. losses, and reduced housing wealth. Preliminary figures show

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that consumer confidence rose to 73.4 in December—up from 67.4 in November, and from an average of 65 for the first nine months of the year. Nevertheless, consumer spending will not and should not return to its overheated pre-crisis levels of 76% of GDP.

• A sustainable real economy • Healthcare The United States cannot achieve a sustained economic recovery without healthcare reform. Rising Medicare and Medicaid costs are the biggest driver of the federal deficit. The current Senate bill falls far short of real reform. Real reform will require injecting competition into the oligopolistic insurance industry, and eroding its practice of diverting premium payments away from quality healthcare and into insurance executives’ multimillion-dollar salaries and their mega-million-dollar perks and fleets of corporate jets. Any healthcare bill will be reform in name only unless it reduces the pool of the uninsured; provides a choice of affordable plans; imposes cost-controls on Medicare; provides new incentives for cost-effective care; and protects consumers from discrimination based on pre-existing conditions and from annual or lifetime caps on their reimbursable costs. • Jobs Unemployment has about hit its peak, but it will continue at a high level into 2010, gradually falling from the first quarter as the economy creates more jobs in the clean energy and information technology sectors. Unemployment dipped from 10.2% in September to 10% in October. About 20,000 people lost their jobs in October, and about 11,000 in November—a big drop from the more than 700,000 jobs lost on average each month between January and March 2009. But wage earners are still suffering. About 52,000 of the new jobs added in November were temporary. About 18% of Americans are unemployed or underemployed1; 30% of households include someone who has lost a job and hasn’t found another; and one of four American children are dependent on food stamps. Some new jobs will be created as foreign companies relocate to the U.S. to compensate for the stronger euro. German steelmakers and automakers have seen a drop in their exports to the U.S. because the euro’s strength against the dollar has made their products too expensive to compete in the U.S. market. Daimler, steelmaker ThyssenKrupp, and others are shifting production to the United States. Korea’s Kia, controlled by Hyundai Motor, has opened a new auto plant in Georgia to expand its growing share of the U.S. market. Some foreign companies will gain a foothold in the U.S. market through new

1 The underemployed includes the vast pool of underutilized skilled workers who have taken menial jobs such as fast food workers because that is the only job they can get.

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U.S. subsidiaries that will be able to qualify for a host of federal contracts, grants, and other support that Congress typically limits, in varying degrees, to American companies. New subsidiaries in the fields of clean energy, energy- efficiency, information technology, and automotive manufacturing will particularly benefit from federal procurement preferences, financial aid, and incentives, as well as from transfers of U.S. technology through joint ventures with other U.S. firms. For example, Suntech, China’s largest solar panel manufacturer, is building a new plant near Phoenix, the first manufacturing plant in the U.S. built by a Chinese solar company. Suntech already has about 12% of the U.S. solar panel market, and its “made-in-the-USA” panels will not only cut its shipping costs but help it win contracts to retrofit federal buildings. Two leading Chinese automakers have entered into deals with U.S. car-battery suppliers in the race to build electric cars. This trend of non-U.S. companies developing a base in the U.S. will continue throughout the next 12 months covered by this report. • The stimulus program The still-nascent U.S. economic recovery will require further government support to generate the level of growth necessary for the U.S. to grow its way out of debt. The Administration has rightly called for a new jobs program to include federal spending on bridges and highways, small business tax cuts, and federal subsidies for retrofitting homes to make them more energy-efficient. The Congressional Budget Office reported that thefirst stimulus package saved or created 600,000 to 1.6 million jobs, but the jobs package that the House passed in mid-December is much smaller than the Administration requested. We reiterate that Congress should enact a direct federal hiring program along the line of FDR’s Public Works Ad- ministration that put people back to work during the De- pression. States and localities face massive deficits due to loss of tax revenues, rising demand for social services, and losses from bad investments. Struggling local governments, utilities, transportation agencies, and related entities are having to fork over huge fees to Wall Street on complex investments gone bad, as detailed in a recent Business Week exposé. The terms of many of the deals, too sophisticated for many small public entities, protected the bankers and exposed the public to huge losses and fees. Legislation pending in Congress would eliminate some of the practices, including small localities’ use of derivatives. Many state constitutions prohibit deficit spending, which makes it particularly important for Congress to enact a second stimulus package to create new jobs, provide a social safety net, and offset the states’ fiscal problems which will worsen as states grapple with insolvent public pension funds. State and local governments should provide a more accurate picture of their

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finances by improving their accounting methods to include infrastructure and other public assets on their balance sheets—a step which would also lower their borrowing costs. For example, a bridge built in 2009 with an estimated 100-year useful life should not be treated as an expense in 2009, but as an asset acquired in 2009 that is amortized over 100 years. • U.S. national debt and deficit The U.S. national debt and budget deficit have grown rapidly, spurred by rising Medicare costs, oil imports, military spending, and falling tax revenues. The deficit and debt are both manageable by historical standards: o The national debt is about 55% of GDP today, compared to about 122% in 1945. o The federal budget deficit is about 10% of GDP today, compared to about 29% in 1942. o The 25-year post-war economic boom triggered by the Marshall Plan reduced the debt-to-GDP ratio to about 30% by the 1970s. o As a share of GDP, the debt loads of Germany, Japan, Britain, and other industrialized countries are higher than the U.S.2 The federal government has been borrowing heavily but on very favorable terms. In 2009, the government added almost $2 trillion in debt but paid less interest on its debt than it did in 2008. “The government’s average interest rate on new borrowing last year fell below 1 percent. For short-term i.o.u.’s like one-month Treasury bills, its av- Flight to safety erage rate was only sixteen-hundredths of a percent,” according “Even though the United States to the New York Times. was the epicenter of the global crisis, investors viewed Treasury Those favorable rates will rise in 2010. The U.S. is only one of securities as the least danger- several countries that need to finance a wave of short-term debt ous place to park their money.” coming due, and the factors that kept borrowing costs so low –New York Times have already started to change (e.g., the Fed’s purchase of over $1.5 trillion worth of Treasury bonds and government-guaran- teed securities related to mortgages, and investors’ view of Treasuries as a safe haven in an economic storm). Just a 1% increase in the Treasury’s borrowing costs would cost taxpayers another $80 billion a year. Such an increase is likely during the next 12 months covered by this forecast. The Administration predicts that interest payments on U.S. debt will go up from $200 billion this year to over $700 billion a year in 2019. That $500 billion is reportedly “more than the combined federal budgets this year for education, energy, homeland secu- rity and the wars in Iraq and Afghanistan.” The Academy believes that the federal government could take numerous steps to avoid

2 Of these, only Japan currently poses the potential for systemic default.

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the full impact of this rise in interest expenses, and even eliminate it entirely, by consistently applying proper fiscal and monetary policy between now and 2019. The U.S. Treasury’s borrowing costs, like the risk of increasing the number of defaults in the upcoming wave of interest rate resets on adjustable rate mortgages, will keep downward pressure on interest rates even as growing inflationary pressure from other sources pushes in the other direction during the first and second quarters of 2010 and beyond. However manageable the public debt is now, it is a reminder of the need to curb a main driver of the deficit—federal Medicare costs. • Housing and commercial real estate The housing market in most parts of the country is showing signs of recovery, with notable exceptions like Nevada, California, Florida, and Arizona and industrial cities like Detroit. A stunning 14% or more of all borrowers are either delinquent on their mortgages or in foreclosure, according to the Mortgage Bankers Association. One in four homeowners are underwater, owing more on their mortgages than their homes are worth. The Administration’s $75 billion program to stem foreclosures by inducing banks to refinance mortgages has helped only a small frac- tion of the more than 650,000 borrowers eligible for permanent reductions in their mortgage payments. About 70% of modifications that involved only interest rate cuts rather than reductions in principal have failed. The Administration is stepping up pressure on lenders, especially foot-draggers like Bank of America that have benefitted from the bailout, to pick up the slow pace of mortgage modifications. But that will not be enough to stem the rise in home foreclosures throughout the first three quarters of 2010. The Fed will be hard-pressed to hike interest rates to combat the uptick in inflation in the 2nd quarter of 2010, which could pick up steam in Q3 and Q4, because so many adjustable rate mortgages (ARMs) are coming due for interest rate resets. Higher interest rates would trigger more foreclosures, more downward pressure on home prices, more underwater borrowers, even more foreclosures, more lost jobs in the construction industry, more dodgy mortgage-backed securities, more leverage, more fishy financial sector activity that could bring the whole show down, and so on—a downward spiral by any definition. What is the Fed to do? Herein lies the central dilemma for U.S. monetary policy. The Academy believes the Fed may be forced to raise interest rates by the second quarter of 2010 to combat inflationary pressures. If U.S. inflation rises, global monetary policymakers will be confronted with the need to make their own rate adjustments. This interest rate situation is so volatile that the Acad- emy will be issuing monthly updates on it.

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The Administration needs a new plan to help homeowners with adjustable rate mortgages if interest rates rise. Treasury must identify borrowers who are 10-25% underwater on their mortgages, barely able to service them but not in default, and who have demonstrated an ability to pay. A program to help these borrowers refinance would put a lid on fallout from the wave of mortgage defaults and foreclosures if the Fed raises rates in 2010 as is likely. The commercial real estate market has not yet bottomed out and we do not predict any solid recovery within the next 6-9 months. Smaller regional banks will be hit particularly hard by loan losses as bubbles in commercial and industrial real estate deflate. The market for commercial mortgage-backed securities remains weak, limiting capital for new commercial loans. The Administration will be carefully watching the commercial real estate mortgage market for signs of rapid decel- eration that could begin as early as February 2010. • Banking and financial system reform The Fed has made no serious attempt to regulate the banking industry, just as it did virtually nothing before the crash even though it had more than enough power to stop some of the most egregious practices that caused the crisis. All the same systemic risks are still there, perhaps magnified. The post-crisis consolidation in the U.S. banking industry has created even more financial institutions that are too big to fail, too big to exist, and that serve Main Street very little. To help Goldman Sachs and Morgan Stanley through the crisis, the federal government let them convert to commercial banks so they could benefit from a greater gamut of federal financial assistance. That gave them access to cheap capital that they used to resume their high-risk trading, and roar back to outsize profits. This focus on trading, not lending, has pro- longed the credit freeze. The 22 banks that got the most help from the federal bailout cut their small business lending by a total of $11.6 billion since reporting began in April. Financial institutions with less than $1 billion in assets were responsible for nearly 50% of all small- business lending during the 2nd quarter this year, compared to 22% for the biggest banks, according to Senator Carl Levin’s recent letter to Treasury calling for more attention to the needs of the nation’s 7,000 community banks. We agree with the Ad- ministration’s call to make TARP funding available for small business lending. Banks have rushed to repay TARP funds to escape federal oversight—especially limits on executive compensation— as well as the market stigma attached to bailout recipients. The Administration has lowered its estimate of losses from the bank bailouts, and announced that taxpayers have recovered or are on track to recover $185 billion of the traceable $245 billion of TARP funds poured into the banks. But

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taxpayers still face the risk of massive losses from federal assistance to four financial giants who sold mortgage guarantees—AIG, Fannie Mae, Freddie Mac, and GMAC. All are deep in debt to taxpayers, with no end in sight. The government’s combined capital commitment to them is already over $600 billion, a figure which captures only a portion of their government aid so far and which is likely to rise. During his Senate confirmation hearing, Ben Bernanke admitted that he did not anticipate a crisis of this magnitude, that the Fed was slow in protecting consumers from high-risk mortgages, and that it failed to require banks to maintain adequate capital ratios given the risks they were taking. The Fed’s track record makes clear that Congress must resist the Fed’s call to expand its authority beyond monetary policy by giving it regulatory authority as well. The Fed’s only argument for adding regulatory authority to its portfolio is that it needs the information it would gain as a regulator to formulate monetary policy. That is a specious argument in light of how easy it would be for Congress to give the Fed explicit statutory authority to access all information in the possession of bank and other financial institution regulators. Tax breaks on debt The World Business Academy has long Like the Fed, the SEC has failed to adequately supervise the called for restricting the business in- financial system and curb systemic risks, including those terest deduction and the double taxa- from the many new financial instruments being created tion of dividends to change the tax and traded. The SEC did finalize new rules that will bring code’s preferences for corporate debt minor reforms, designed: (1) to detect the next Bernie Ma- over equity. doff scheme by subjecting investment advisors to more oversight; and (2) to improve corporate transparency by requiring public companies to make new disclosures about ways their compensation policies could encourage risk-taking, and the qualifications of their corporate board members. The SEC delayed its final rules about shortselling and shareholders’ new power to nominate directors. Essential statutory and regulatory reforms include: • Requiring both standardized and customized derivatives to be registered under the 1933 and 1934 Acts and traded on regulated exchanges, while eliminating their priority under bankruptcy law; • Requiring credit rating agencies to earn their fees from investors rather than debt issuers, to eliminate their conflicts of interests that did so much to cause the crisis; and revising federal and state laws that routinely require and give undue weight to agency ratings; • Improving detection and prevention of systemic risks, and enhancing federal authority to break up institutions that present systemic risks; • Enacting at least a partial return to Glass Steagall—if not an inviolable wall between commercial and investment banking, at least a strong

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partition; • Imposing a financial transactions tax on large transactions in stocks and derivatives, such as Senator Tom Harkin and Bernard Sanders’ proposed tax of 0.25% on stock transactions above $100,000, and a 0.02% tax on derivatives; • Reducing the U.S. tax code’s “debt bias” by: (1) restricting the business interest deduction and the double taxation of dividends, and (2) reducing the mortgage-interest deduction; • Requiring mortgage originators to keep some skin in the game by retaining an interest in the mortgages they originate; • Making the activities of hedge funds more transparent through new registration and reporting requirements; • Improving consumer protection by enhanced regulation of banking, investment, and credit practices; and • Giving bankruptcy courts the authority to modify the mortgage payments on a person’s primary home similar to the courts’ authority to modify commercial mortgages. There should be serious discussions about the specifics ofPaul Volcker’s recom- mendation to limit the government’s safety net to core commercial-banking— banks that make their money by old-fashioned banking—taking deposits, han- dling business payments, and the like.

EUROPE Many European countries face soaring debt burdens. Germany’s outstanding government debt is expected to rise next year to 77% of GDP, up from 60% in 2002. By next year, Britain’s public debt is expected to have doubled from 2002 levels, rising to 80% of GDP. Ireland’s public debt is likely to be 83% of GDP next year, up from 25% in 2007. Bulgaria, Hungary, and the Baltic states of Latvia, Lithuania, and Estonia all have foreign debt that exceeds 100% of their GDP. Germany, whose aversion to profligate public spending that could stoke inflation has roots in the hyperinflation of the post World War I era, is poised to issue a record amount of new debt next year, largely for social benefits. Government subsidies have compensated workers for lost wages as companies cut working hours to avoid layoffs. The subsidies are slated to expire next year, bringing 350,000 more job losses and raising unemployment to 8.3% in the absence of offsetting job gains through the mild economic expansion now underway.

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German business confidence is rising, but the economy remains weak after emerging from a recession during the second quarter. The government predicts the economy will grow about 1.2% next year, after contracting 5% last year. Most EU countries emerged from the recession by the 3rd quarter, but Spain and Greece are likely to continue to contract throughout 2010. Spain’s one-year drop in GDP was smaller than the EU average, but it still faces 19% unemployment, an economy that shrank for the sixth quarter in a row, and an inefficient and unfair two-tier labor system. Greece faces economic problems on many fronts, including downgrades in its sovereign credit rating, its banks’ exposure to problem loans in the Balkans, its stagnant work force, rampant tax evasion, and its lack of a plan to lower its deficit, which is above 12% of GDP, four times the EU-bloc limit of 3%. What Greece most needs is a consistent economic policy, even if it initially falls short of the EU ideal. There are signs that Britain’s economy is returning to growth and may emerge this quarter from an 18-month recession. Auto production and tax revenues are rising, although credit remains tight, unemployment high, and consumer confidence down. Despite its announced tax increases, including a 50% tax on bankers’ bonuses, the government plans to issue a record amount of public debt this year to finance the deficit. Prime Minister Brown’s Copenhagen pledge to cut carbon emissions 42% from 1990 levels by 2020—10 times the size of the cut President Obama offered—drew an outcry back home. His La- bor Party is widely expected to lose the upcoming elections to the Conservatives. Ireland’s GDP finally ticked upward in the rd3 quarter but the government attributed that to profits of multinationals based in Ireland, and cautioned against concluding that the recession was over. The uptick is no more than a glimmer of light; Ireland’s GDP dropped 7.4% in 2008, and economic recovery has a long way to go. Western European banks are exposed not only in Greece but in several weak Eastern European economies where they lent heavily, including Hungary, Po- land and the Baltic states. Despite the strong euro, the Eurozone’s trade surplus with the rest of the world remained high in October. EU farmers are demanding more subsidies and aid to boost exports to offset their lost income from falling food prices. Farm income fell 35% in Hungary due to its weak forint, 25% in Italy, and 20% in France and Germany. Farm income rose 14% in Britain due to the weak British pound, but the drop elsewhere in the EU portends continuing trade disputes over agricultural policies. The EU projects that the eurozone will grow 0.7% in 1010, after contracting 4% this year. The European Central Bank lacks the regulatory power of the Fed, but by its

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sound management and willingness to look at the risk of inflation, has partially compensated for the EU’s largely uncoordinated system of bank regulation at the national level. It has announced plans to wind down its emergency stimulus measures. The Bank of England has substantial regulatory authority and, unlike the Fed, is becoming increasingly willing to use it.

Russia In his state of the union speech last month, Prime Minister Medvedev said that modernizing the Russian economy is vital for the country’s survival in the 21st century. He called for Russia to eliminate its “humiliating raw materials depen- dence and reorient production to people’s real needs.” The debate has begun over what “modernization” means in Russia. Russia may have technically emerged from the recession during the 3rd quarter with 0.6% growth from the preceding quarter, with the help of interest rate cuts and government stimulus spending that created the risk of inflation. It is not clear whether Russia will maintain some anemic growth in 2010 or whether it will fall back into negative growth. Unemployment stands at 8.1%, and November’s 3.8% contraction in GDP was the best economic performance this year. The economy contracted 10.9% in the second quarter and 8.9% in the third. It will not recover to pre-crisis growth levels in the next 12 months. Russia continues to skillfully play its natural gas card. Last month, it negoti- ated a string of business deals with France, including one that will bring French participation in the South Stream gas pipeline, a competitor to the EU-backed Nabucco pipeline. France and Russia also signed an agreement for French Re- nault’s help rescuing the Russian manufacturer of Lada cars.

MENA (Middle East and North Africa) Abu Dhabi averted a major Dubai debt crisis involving the potential default of Dubai’s state-owned conglomerate Dubai World, by stepping into the breach with a $10 billion bailout for its high-flying neighbor. Nevertheless, the fallout will continue for some time. One likely effect will be to slow Western governments’ and institutions’ rush into the booming field of Islamic finance. Last year, the top 100 Islamic banks’ assets grew 66%. During the first 10 months of 2009, new Shariah-compliant bonds and loans grew 40% globally, year over year. In October, the British Treasury drafted rules to allow Britain to issue Shariah-compliant government debt, and the World Bank issued $100 million in Shari- ah-compliant bonds.

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The Dubai World crisis has highlighted the challenges of restructuring Shariah- compliant investments, which place lenders and borrowers in a form of part- nership rather than an orderly line of creditors. The episode has also reminded investors of the danger of relying on implicit government guarantees of state- owned companies’ debt. Some construed the episode as a cautionary tale about the danger of lending in frontier markets, whether in the Gulf, the Baltics, or emerging Europe.

ASIA As China and the other Asian economies lift the rest of the world out of the global recession, the engine of growth is increasingly the Asian consumer. Ag- gressive government stimulus programs have jumpstarted consumer spending across the region, especially in China, India, and Korea. This regional spending will continue, as will the upswing in intra-Asian tourism to Vietnam, Malaysia, and South Korea. Retail sales in China are growing 15% annually, but over the last 10 years, consumer consumption has fallen as a share of GDP. Consumer spending now accounts for only a third of China’s GDP. There are many obsta- cles to Chinese consumer spending becoming the engine of China’s economy.

China China is seizing opportunities around the world through strategic foreign direct investment, joint ventures, and long-term commodities contracts. Private Chinese investment funds are looking for market opportunities and find- ing them in new joint ventures, equity investments, and U.S.–based companies. Some of these business deals will open new markets and result in an invaluable transfer of technology to Chinese companies. GM and China’s biggest auto manufacturer, SAIC Motor Corp., which already operate joint ventures in China, are set to launch a joint venture in India that will give them a foothold in its competitive and fast-growing auto market. Chinese investors can leverage their U.S. funds by creating new companies based in the U.S. that will be able to qualify for federal financial assistance and incentives, as discussed above. These ventures also will expose Chinese companies to U.S. environmental regulation—which for all its faults, is characterized by a skill-set and mindset that could be put to good use in China. Foreign manufacturers are also moving to China to avoid import duties and gain access to China’s vast market. China is rapidly ex- panding its lead over the U.S. as the world’s largest auto market, largely due to subsidies and tax cuts that support the industry, and other policies such as higher gas prices and auto emissions standards that encourage the use of more fuel-efficient vehicles. Its November auto and truck sales were up about 100% year over year. Annual vehicle sales appear on track

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to increase about 33%. China’s neighbors in Southeast Asia are feeling resentful as China’s export sector grows, fueled by currency interventions to keep the yuan low, state-directed cheap loans to manufacturers and exporters, and other state policies to boost exports. Vietnam recently devalued its currency, the dong, by 5% to boost its own fast-growing export industries, raising new tensions with other Asian exporting nations. With good reason, the flood of liquidity is raising concerns about bubbles in the property, commodities, and stock markets. China’s participation in Copenhagen, as calibrated as it was, marked a critical turning point in its willingness to join multi- An editorial in China Daily, often lateral efforts to curb climate change, but its offer to curb the viewed as a government mouth- growth in its emissions falls far short of what is needed. It of- piece, used the Dubai debt crisis fered to cut its energy intensity (carbon emissions per unit of as a lesson about the dangers of GDP) 40-45% by 2020 compared with 2005 levels. Even with “a real estate-propelled economic growth model.” Last week, China that cut, its CO2 emissions will grow about 90% if its economy imposed a national property sales grows by 8%, according to some estimates. tax to temper speculative buying. Fortunately, China is likely to beat its 2020 target just as it beat its internal 2010 target for increasing its domestic wind power capacity. Clean energy is likely to spread rapidly throughout China because of increased global competition for dwindling oil supplies, China’s desire to become a global leader in green manufacturing, and its need to control political unrest from pollution. China has overtaken the U.S. as the world’s largest carbon emitter. It will emit about 29% of global carbon emissions by 2030, according to the U.S. Energy Information Administration.

Japan Prime Minister Yukio Hatoyama’s new government faces many challenges as Japan’s “lost decade” approaches the two-decade mark. Japan’s debt is almost 200% of GDP. Its economy grew only 0.3% in the third quarter—1.3% on an annual basis—far less than the government’s initial assessment. Japan is struggling to deal with its economy being pushed into third place by China’s assent. Hatoyama must over- come the economic inertia caused by the power and corruption of the bureaucracy and other entrenched political and economic interests. He also must end the “Concrete Economics” that has misdirected public spending into un- necessary and wasteful public infrastructure projects. The independence already shown by new Financial Service Minister Shizuka Kamei, an old-guard power broker, dem- onstrates the challenges that Hatoyama faces in devising a coherent economic and monetary policy.

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India Consumers are fueling economic growth in India, spurred on by a government stimulus in the form of tax cuts, low interest rates, and disbursements of back pay for government workers. Major manufacturers are rushing into India’s surging auto market for small cheap cars like the fast-selling $2000 Nano that helped push November auto sales up 72% year over year. The number of new vehicles on the road will increase India’s demand for oil, burden its overcrowded roads, and create more environmental challenges. India’s small automotive export sector will continue its fast growth. India’s economy grew 7.9% in the 3rd quarter, up from 6.1% in the 2nd quarter, with growth spread among many sectors. The government’s projection that the economy will grow by 7-8% by the end of the fiscal year in March 2010 is likely a bit too optimistic if the government raises interest rates to dampen speculation in agricultural commodities. Food prices are at an 11-year high because of the damage to rice and wheat crops from last summer’s monsoon rains, the weakest since 1972. It remains to be seen how much of the growth is sustainable when the government winds down the stimulus, which it has said will continue well into next year despite rising budget deficits.

LATIN AMERICA Copenhagen failed to produce a broad deforestation agreement to pay poor nations to preserve their rain forests, but it did produce $3.5 billion in short- term financing that will help preserve Latin American rain forests and boost the region’s economies. Over half of Latin America’s global emissions come from deforestation. The region as a whole has a small carbon footprint, largely due to its use of hydropower to produce electricity. Smaller renewable energy projects like Argentina’s rural solar program, which has reduced the use of firewood by 75%, can serve as a model for new industries that can create jobs for displaced and retrained workers. Led by Brazil, Peru, and Uruguay, and supported by the economic and political turnaround in Bolivia, the Latin American region is picking up economic steam due to public spending, loans from state-owned banks, interest rate cuts, and social programs. The trend is likely to continue, barring further severe problems in the global economy. Chile has joined the OECD, invited as a result of its moderate style, stable

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economy, and strong institutions. Mexico’s economy was the hardest hit in the region as a result of its close ties to the U.S., which bought 80% of its exports. Its economy has resumed growth, which is likely to continue in the range of 2.5% to 3.5% next year, but its structural weaknesses recently led Fitch and S&P to downgrade its credit rating. Mexico’s over-reliance on its ever-declining oil revenues stands in stark contrast to the energy policies of Brazil, Latin America’s other large economy, which has become an economic powerhouse by becoming a leader in renewable energy. Last year, oil production from state-owned Pe- troleos Mexicanos fell at the fastest rate since 1942. Venezuela faces rising unemployment, over-reliance on oil revenues, uncertainty as a result of bank purges and closures, deep political divisions, and an inflation rate of about 26%. Unemployment is 7.5%, up from 6.1% a year ago. Ven- ezuela’s oil revenue collapsed as oil prices fell from last year’s record highs. Prices are still less than the $80/barrel the government is believed to need to maintain its spending levels. Vast oil reserves and hydropower systems haven’t been enough to keep the lights on and the water running. President Chavez took in stride a public outcry over power failures and blackouts, but when the outcry extended to his new water rationing in the capital, he told his citizens that three-minute showers were enough: “I’ve counted and I don’t end up stinking.” The situation in Venezuela will worsen in the year ahead. The recent landslide re-election of Bolivia President Evo Morales with over two-thirds of the vote is a landmark event that validates his ambi- tious efforts to create a dramatic social transformation that empowers the indigenous, impoverished minority that has long been marginalized by entrenched right-wing political and corporate interests. Bolivia’s natural resources will help produce 3-4% economic growth this year.

CONCLUSION A new world order is gradually emerging from the global financial crisis but without the bold action necessary to stem climate change, reform the financial system, and raise the standard of living in poor and rich countries alike. The world is slowly facing the truth that there is an international financial system and a planetary ecological system that cannot be denied by wailing against globalization. We are united, if not unified, by planetary laws of nature and capital flows that know no national boundaries. The severity of the recent economic collapse and the swiftness with which it

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infected every economy in the world taught world leaders a valuable lesson. Bold, concerted action is as imperative today as it was when the American pa- triot, Nathan Hale, warned, “We must all hang together, or assuredly we shall all hang separately.” Human civilization cannot accept failure as the outcome on climate change. We are not dealing with minor dislocations. We are dealing with the survival of civilization as we know it. Failure is not an option. It is in everyone’s interest to take decisive action now. To their credit, business leaders around the world, particularly in Europe, are rightly calling for more aggressive action on climate change. Nor can human civilization accept failure as the outcome on financial system reform. Global society is fortunate that its leaders calmly addressed the recent intertwined combined financial and economic collapse with a remarkably effective series of stimulus and market interven- tion measures, but their actions were only a start. Funda- mental reforms are necessary to avoid an economic collapse potentially greater than the one we just experienced. In the United States, it is tragic that Republicans in Congress have reduced themselves to rank political posturing, unani- mously opposing Obama Administration measures that have proven effective, as well as further essential reforms. To achieve meaningful financial industry and healthcare reform, the Administration will have to find creative methods to circumvent its political rivals’ obstructionist tendencies, and proponents of reform will have to re- engage in the political process. The global economy is once again rising. We can all share a sigh of relief— particularly those of us who realize how incredibly close we came to a financial meltdown. That collective sigh of relief is, however, not enough. We must become more determined than ever to prevent the global economic system from becoming that dangerous again. There are many signs that a new appreciation for shared responsibility has blossomed in Washington, Brussels, Beijing, London, Delhi, and São Paulo. The recent passage of the new EU constitution bodes well for a stronger steadying hand from Europe. The passing of the economic policy torch from the G-8 to the G-20 bodes well for a more balanced and multi-lateral approach. Taken together, these events lend credence to the Academy’s belief that we have reached an international economic turning point. The Academy also believes that the growing sense of shared responsibility will ultimately lead to the realization that the world must fight terrorism by increasing economic prosperity globally to dissolve the pockets of despair that nurture terrorists, as the Academy urged in an article published immediately after 9/11, “The Wisdom of Two Generals.”

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The global economy is being given another chance. We have a tremendous economic machine at our disposal which can create permanent upward economic expansion using fewer natural resources. We’ve just seen that global political leaders are capable of rising to a great challenge. Now we must bring that same degree of coordinated global response to our most intractable problems of climate change, peak oil, financial sector reform, income disparity, the North-South Divide, the economic and educational status of all people regardless of gender, and arms control. We must maintain the same vigilant oversight of political and economic leaders as we did when our attention was concentrated through the lens of pending economic doom. The main responsibility for what happens next lies with us, citizens of Planet Earth, breathing a sigh of relief yet staying alert to the real underlying fundamental challenges we must face. If we fail do so, we will inevitably all hang together. The choice is ours.

©World Business Academy. This publication may not be reproduced in whole or in part in any form (beyond that copying permitted by sections 107 and 108 of the U.S. Copyright Act) without written permission from the pub- lisher. For permission or information about this or other World Business Academy publications, please contact the Academy at [email protected]. EconForecast is not a financial or investment advisory service, and the opinions contained herein do not take into account your specific investment objectives, financial status, and particular needs. All opinions in EconForecast are informational only and are no substitute for independent research. Before making investment decisions, you should obtain advice from stockbrokers, financial advisers, lawyers, or other appropriate professionals. ©2009 World Business Academy, 308 East Carrillo Street, Santa Barbara, CA 93101 Phone (805) 892-4600 • Fax (805) 884-0900 • www.worldbusiness.org