SPECIAL COMMENTARY February 10, 2009

Five Key Questions for Decision-Makers

John Silvia, Chief Economist
john.silvia@wachovia.com
704-374-7034

Executive Summary 1
For decision-makers in both the private and public sectors there are five economic
issues that demand our attention. Each of these five areas will be reviewed in turn in
this report. 2
ƒ First, the strength and character of the general economy
ƒ Second, the specific issues associated with housing
ƒ Third, the role of financial and credit markets
ƒ Fourth, the impact of fiscal stimulus
ƒ Fifth, the international response to our economic and policy choices

I. Signs of Recovery and the Changing Character of Domestic Demand

Since the credit bubble burst in August 2007, banks and other lenders have grown We expect below-trend
increasingly restrictive in their lending practices. As a result, our outlook is framed growth for the next two
by the character of America’s credit cycle, which will dictate the pace and nature of years.
the economic recovery. The pattern of this credit cycle and its focus on risk
avoidance dictates a deleveraging of the American financial system on both the
demand and supply sides. On the demand side, consumers must strengthen their
balance sheets by paying down debt, boosting savings and rebuilding equity in their
homes. All of this will require the consumer to reduce spending. On the supply side,
the banking system must rebuild its capital base, which means it must sell stock and
restrain lending. The result is below-trend growth for the next two years (Figure 1).
Deleveraging compels strapped consumers to repair their balance sheets. Real
personal consumption expenditures tumbled at nearly a four percent annual rate for
the second half of last year. We look for further retrenchment over the next few
quarters. Consumers have turned exceptionally cautious in light of the recent spike
in the unemployment rate and abrupt tightening in credit. Significant declines in
house and equity prices this past year have eroded household wealth, which has and

1 Presentation to the American Bankers Association’s LLAC Winter Conference, Feb. 5, 2009 in

Washington, DC. Thanks are due to Sam Bullard, Jay Bryson, Azhar Iqbal, Mark Vitner and Adam York
for their contributions.
2 These five questions were suggested as the focus for my comments by the ABA staff.

This report is available on www.wachovia.com/economics and on Bloomberg at WBEC

 Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

should continue to weigh on consumer spending. Consumers are not the only ones
feeling rattled. Businesses will likely tighten spending in reaction to depressed
demand by continuing to pare back fixed investment spending and by drawing
down inventories, which will depress growth in coming quarters.

Figure 1 Figure 2
Real GDP Real Personal Consumption Expenditures
Bars = Compound Annual Growth Rate Line = Yr/Yr Percent Change Bars = Compound Annual Growth Rate Line = Yr/Yr Percent Change
8.0% 8.0% 8.0% 8.0%

6.0% 6.0% 6.0% 6.0%

Forecast Forecast
4.0% 4.0% 4.0% 4.0%

2.0% 2.0% 2.0% 2.0%

0.0% 0.0% 0.0% 0.0%

-2.0% -2.0% -2.0% -2.0%

-4.0% -4.0% -4.0% -4.0%

GDPR - CAGR: Q4 @ -3.8% PCE - CAGR: Q4 @ -3.5%
PCE - Yr/Yr Percent Change: Q4 @ -1.3%
GDPR - Yr/Yr Percent Change: Q4 @ -0.2%
-6.0% -6.0% -6.0% -6.0%

2000 2002 2004 2006 2008 2010 2000 2002 2004 2006 2008 2010

Source: U.S. Department of Commerce and Wachovia

U.S. Consumer: From Economic Driver to Economic Drag

The combination of Consumer spending is expected to be a significant drag on economic growth
deteriorating throughout 2009 (Figure 2). During the previous recession, consumer spending
employment prospects remained steady thanks to the solid underpinning of rising home prices and easy
and tightening credit is credit. This cycle will be different as home values have dropped and credit
a powerful one-two availability has been cut. Consumers have turned exceptionally cautious in light of
punch. the recent spike in the unemployment rate and the abrupt tightening of credit. The
combination of deteriorating employment prospects and tightening credit is a
powerful one-two punch that has led to substantial cutbacks in discretionary
purchases (Figure 3). Spending for big-ticket items has been hit hardest, especially
motor vehicle sales. Consumers are also ratcheting back purchases of big-ticket items
such as furniture, household appliances and home electronics.

Figure 3 Figure 4
Consumer Discretionary Spending Discretionary Spending
Share of Total Consumption December-2008
Other
47.0% 47.0% Discretionary
19%

Housing Away
46.0% 46.0% from Home
1%
Alcohol & Tobacco
45.0% 45.0% 3%

Clothing & Shoes

4% Non-Discretionary
44.0% 44.0% Recreation 57%
4%
Furniture &
HHEquip
43.0% 43.0% 4%
Motor Vehicles
Discretionary Share: Dec @ 42.8% 3% Food Away from
42.0% 42.0% Home
5%
1998 2000 2002 2004 2006 2008

Source: U.S. Department of Commerce and Wachovia

Consumers have also cut back on restaurant dining, travel, clothing purchases and
are making fewer trips to the shopping mall. Despite lower prices for many
consumer goods, purchasing power will likely still be constrained by slower income
growth. The wealth effect will also cut into purchasing power, with falling home
prices and the stock market collapse cutting household wealth. A conservative

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Five Key Questions for Decision-Makers
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estimate of the wealth effect would cut spending between $300 and $400 billion this
year.
A retrenchment in consumer spending is long overdue, in our opinion. Consumer
spending had risen faster than income during the past several years, with purchasing
power being bolstered by abundant and inexpensive credit. The credit boom helped
to send the saving rate to roughly zero percent. At its peak, consumer spending and
residential investment accounted for 76.5 percent of GDP, some three percentage
points above the average maintained since 1990. The ending of the housing boom
began to send the consumption/GDP ratio back toward its historic norm. Even
when spending begins to rise again, we expect the rate of growth to remain slightly
below income growth, thereby allowing for the saving rate to gradually recover.
Recession Probability Dictates Continued Recession
Unfortunately, the probability of recession for the next six months remains high The current recession
(Figure 5). Our model looks at a very broad set of predictors and these suggest the will likely continue
current recession will likely continue through at least the first half of this year. 3 through at least the
Economic problems began to show up in our model in the fourth quarter of 2007 as first half of this year.
the recession probability rose sharply to 75 percent and since then the probability has
remained extremely high.
Figure 5

Recession Probability Based on Probit Model

Two-Quarter Ahead Probability
100% 100%

80% 80%

60% 60%

40% 40%

20% 20%

Two-Quarter Ahead Recession Probability: Q4 @ 99.4%

0% 0%
80 84 88 92 96 00 04 08
Source: Wachovia

3John E. Silvia, Huiwen Lai, and Sam Bullard, “Forecasting U.S. Recessions with Probit Stepwise
Regression Models”, Business Economics, January 2008, pp. 7-18.

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 Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

Figure 6
Signs of a Recovery: Indicators to Watch

ƒ First-time jobless claims remain at a very high

600,000+ level.
ƒ We would expect these claims to begin to drop
Initial Claims towards 500,000 sometime in the spring suggesting
that job losses will diminish as the year moves
along.

ƒ The index is computed such that a reading of 50 is

considered break-even. This monthly survey is
ISM currently in the mid 30s.
Manufacturing ƒ We would expect this index to remain below 50
Index through the second quarter and show signals of
expansion by midsummer.

ƒ Profits are a longer lagging indicator, and at

present are declining at a 20 percent-plus pace.
Corporate ƒ We expect the year-over-year declines to turn
Profits around. Improvement by midsummer would
signal growth in employment and business
investment by early next year.

Source: Wachovia
II. Housing Markets: Prices, Inventories and Regional Impacts
Rising unemployment, One of driving factors of the credit crunch was the housing market as the lack of
plunging stock prices available credit made it tougher for potential homebuyers and builders to qualify for
and tight credit new loans. This put downward pressure on housing prices and led to even tighter
conditions are hardly a lending standards making it tougher still for potential homebuyers to qualify. This
formula for increased vicious cycle is still playing out as home values are falling across the country and the
home sales. pool of qualified potential homebuyers is growing smaller. New home construction
is likely to fall further. Rising unemployment, plunging stock prices and tight credit
conditions are hardly a formula for increased home sales.
Housing remains a very weak link in the U.S. economic outlook. Not only is
residential construction activity continuing to decline, but falling house prices and
rising mortgage delinquency rates also continue to put pressure on credit markets
(Figure 7). A vicious negative feedback loop has been in play for some time.
Tightening credit conditions will likely lead to a further slowdown in sales. This will
be followed by additional economic weakness, resulting in larger home price
declines, higher mortgage delinquency rates and culminating in even tighter lending
standards. We expect a much deeper and drawn out housing cycle with a bottom
still a ways off. New and existing home sales are both expected to bottom by
summer with housing starts to follow (Figure 8). Residential construction should
bottom this year. The bottom, however, will now be significantly lower than

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Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

previously thought, as tighter credit conditions for home buyers and builders will
send activity well below recent lows.

Figure 7 Figure 8
Home Prices Housing Starts
Year-over-Year Percentage Change Millions of Units
24% 24% 2.4 2.4
20% 20% Dashed Line is Underlying Demographic Trend
2.1 2.1
16% 16%
12% 12% 1.8 1.8
8% 8%
1.5 1.5
4% 4%
0% 0% 1.2 1.2

-4% -4%
0.9 0.9
-8% -8%
-12% -12% 0.6 0.6
Median Sale Price: Dec @ $174,700
-16% Median Sales Price 3-Month Mov. Avg.: Dec @ -12.4 % -16%
0.3 0.3
FHFA (OFHEO) Purchase Only Index: Nov @ -8.7 %
-20% -20%
S&P Case-Shiller Composite 10: Nov @ -19.1 %
-24% -24% 0.0 0.0
97 99 01 03 05 07 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Source: National Association of Realtors, FHFA, S&P Corp. , U.S. Dept. of Commerce and Wachovia
Understanding where we are in the housing correction is critical in developing a Understanding where
coherent outlook for the broader economy. The current housing cycle is largely we are in the housing
without precedent in timing, depth and breadth. Past housing slumps tended to correction is critical in
follow the business cycle. The construction slump preceded the broader economic developing a coherent
slump by about two years, with sales tumbling once easy and inexpensive mortgage outlook for the broader
credit disappeared. The initial tightening of credit followed a dramatic increase in economy.
delinquency rates on most subprime mortgages, which were poorly underwritten
and thinly collateralized. As a result, delinquency rates soared well ahead of any
noticeable slowing in the broader economy, which is something never seen before.
By contrast, the more recent rise in mortgage delinquency rates and defaults is the
result of the deteriorating economic environment. Unfortunately, the continuing rise
in the unemployment rate will send delinquency rates still higher.
Unusual Breadth: Regional Impact
The breadth of this housing slump is also unusual, but the bulk of the housing boom The breadth of this
and bust took place in just a handful of states—Florida, California, Arizona, and housing slump is also
Nevada, which accounted for the greatest amount of speculative home-buying and unusual, but the bulk of
also saw the largest price gains and declines in the country. Other notable hot spots the housing boom and
that turned brutally cold include the outer suburbs of Washington, D.C., the greater bust took place in just a
New York area, the greater Boston area and some of the coastal metropolitan areas in handful of states.
the Carolinas and Georgia. There are also a few places where prices have slumped
even though they never enjoyed a housing boom. Most of these areas are in the
Midwest, and include the areas in and around Detroit and Cleveland. Housing
prices have fallen precipitously in these areas largely due to extremely depressed
economic conditions, a disproportionate amount of subprime lending and
deteriorating demographics.
III. Credit Markets
We have seen the patterns of credit move toward a deleveraging of the economy
against the prevailing pattern of the past 25 years. What forces account for this
momentum shift in the credit cycle and what does it mean for 2009?
Credit expansion has characterized economic growth over the past few decades
especially during the recent economic upturn that lasted from 2001 to 2007 (Figure 9).
Innovation in the credit markets resulted in an apparent solution for every situation.
A vast number of credit instruments were developed during the expansion to fill in

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 Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

the gaps of creditor and borrower needs. In many ways, it appeared that credit
markets were becoming more complete. They could meet the credit needs of both
borrowers and creditors across the spectrum. In addition to a long period of low,
short-term interest rates, credit expansion was also enhanced by easier credit
standards, which effectively meant a greater supply of credit at any interest rate
across the risk spectrum.

Figure 9 Figure 10
Domestic Nonfinancial Debt U.S. Household Debt
As Percent Of GDP U.S. Household Liabilities to Net Worth
250% 250% 28% 28%
Nonfinancial Debt: Q3 @ 228.4% Liabilities to Net Worth: Q3 @ 25.8%
26% 26%
225% 225%

24% 24%

200% 200%
22% 22%

20% 20%
175% 175%

18% 18%

150% 150%
16% 16%

125% 125% 14% 14%

82 84 86 88 90 92 94 96 98 00 02 04 06 08 82 84 86 88 90 92 94 96 98 00 02 04 06 08

Source: Federal Reserve Board, U.S. Department of Commerce and Wachovia

Near the end of the past economic expansion, excesses in credit markets were
rampant and were characterized by easy lending standards. Consumers benefited
from this credit environment as housing finance became democratized and auto
loans and credit cards were widely available (Figure 10). Businesses large and small
benefited from this accommodative lending environment as well. Some borrowers
overstated their income and some lenders never bothered to check. Over the past
year and a half, however, we have witnessed significant backtracking which has led
to a sharp curtailment of credit and to the current economic downturn.
Credit markets are still Credit markets are still searching for a new balance between risk and reward. There
searching for a new is also a trend toward a more conservative view of risk-taking in general. Over the
balance between risk past few months, we have already witnessed significant declines in the federal funds
and reward. rate and Treasury yields, but private-sector borrowing rates have not yet receded,
especially those farther out on the yield and credit curves.

Figure 11 Figure 12
LIBOR to Federal Funds Effective Rate Spread TED Spread
Basis Points Basis Points
400 400 450 450
LIBOR to Federal Funds: Jan @ 94 bps TED: Jan @ 103 bps
350 350 400 400

300 300 350 350

250 250 300 300

200 200 250 250

150 150 200 200

100 100 150 150

50 50 100 100

0 0 50 50

-50 -50 0 0
2004 2005 2006 2007 2008 2009 2004 2005 2006 2007 2008 2009

Source: Federal Reserve Board, British Bankers Association and Wachovia

At the short end of the curve, rates are still driven by the Federal Reserve. Our
expectation that the recession will continue and that consumer spending and housing

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Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

will continue to struggle lead us to believe that the Fed will continue on its liquidity
provision path until next year. Short-term interest rates in general will remain low
for an extended period of time. Moreover, we have seen in recent weeks an
improvement in private market spreads such as the LIBOR-to-Federal funds and the
TED spread (Figure 11 & Figure 12). This suggests that credit supply may be coming
back into the market and that the worst of the credit problem may have passed—at
least at the short end of the curve.
The Other End of the Maturity Street
Financial markets have evidenced only modest improvement in credit spreads and Financial markets have
credit supply at the long end. In addition, the benchmark 10-year Treasury yield has evidenced only modest
drifted upward since the start of this year. In the credit sphere, the recession and improvement in credit
poor earnings continue to limit issuance in the face of a skeptical market buyer. As a spreads and credit
result, we have seen very little improvement in bond spreads over Treasuries (Figure supply at the long end.
13). Over the next three months we expect very little improvement. The Fed has
certainly been helpful in areas such as mortgage backed securities, where it has been
a direct buyer, but such help has not spread much wider.
We remain concerned about the middle to long end of the Treasury curve. For now,
the safe haven trade appears to be working. Longer term, we are concerned that
fiscal deficits, inflation expectations and anti-China/trade rhetoric will dictate rising
rates. We also have concerns that yields on longer-dated debt instruments will drift
upward as inflation expectations rise and the flight-to-safety trade falls away. In
addition, dollar weakness may reappear as this year ages and this would add to our
inflation concerns as well as introduce currency risk into the mix.

Figure 13 Figure 14
Aaa and Baa Corporate Bond Spreads Consumer Loan Delinquency Rate
Over 10-Year Treasury, Basis Points Seasonally Adjusted
4.5% 4.5%
700 700
Consumer Loans: Q3 @ 3.7%
Aaa Spread: Jan @ 253 bps
Baa Spread: Jan @ 563 bps
600 600

4.0% 4.0%
500 500

400 400
3.5% 3.5%
300 300

200 200
3.0% 3.0%

100 100

0 0 2.5% 2.5%
90 92 94 96 98 00 02 04 06 08 1991 1994 1997 2000 2003 2006

Source: Federal Reserve Board and Wachovia

On net, the changes in risk versus reward calculations by both borrower and lender
dictate that the growth in consumer spending over the outlook period will be
sluggish relative to the trend of prior expansions. Residential construction and
business equipment spending will exhibit sub-par growth in the period ahead, in our
opinion. Consumer delinquencies are expected to continue to rise (Figure 14).
Moreover, if taxes are raised (windfall profit taxes, corporate taxes, dividend and
capital gains taxes, for example), then the after-tax reward for risk-taking would be
further diminished. The net result is that the demand for credit would be limited.
Weak U.S. and foreign growth suggests that the supply of credit through savings and
profits would also be very limited relative to prior recoveries.

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 Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

IV. Fiscal Stimulus: Help Today but Burden Tomorrow?

In an effort to revive the ailing economy, various policy measures will be considered.
A second stimulus program, which should provide a boost to growth at least in the
short run, is likely to be passed in coming weeks. However, unintended
consequences of the policy mix could offset much of the stimulus. Higher taxes on
dividends and capital gains as well as increased income taxes for higher-income
individuals could provide a disincentive to work. A more interventionist
government could alter private risk/reward calculations, which could be negative
for long-run growth prospects. What little economic growth we had in 2008 was
made possible by strong global growth. With housing and consumer spending
struggling, we project that the severity of the current recession will be somewhere
between the 1973-75 downturn and 1980-82 twin recession periods. Unemployment
is likely to rise to 9.5 percent by late 2010. Given this economic background, we have
seen a rapid rise in federal spending and a rapid rise in the federal deficit since the
recession began (Figure 15 & Figure 16).

Figure 15 Figure 16
Federal Government Spending Ex. Interest Payments Federal Budget Surplus or Deficit
Year-over-Year Percent Change, 12-Month Moving Average
As a Percent of GDP, 12-Month Moving Average
30% 30% 4.0% 4.0%
Spending Ex. Interest Payments: Dec @ 20.3% Surplus or Deficit as a Percent of GDP: Dec @ -5.9%
25% 25%
2.0% 2.0%
20% 20%

0.0% 0.0%
15% 15%

10% 10%
-2.0% -2.0%

5% 5%
-4.0% -4.0%
0% 0%

-5% -5% -6.0% -6.0%

1970 1975 1980 1985 1990 1995 2000 2005 70 75 80 85 90 95 00 05

Source: U.S Department of the Treasury, U.S. Department of Commerce and Wachovia
Attempting to ascertain Unfortunately, the use of policy stimulus in the past (such as the 1970s) did not have
the implications of a the desired result, but rather stagflation was the reality of the day. Attempting to
change in economic ascertain the implications of a change in economic policy solely on the basis of
policy solely on the relationships observed in historical data which tends to be highly aggregated, is
basis of relationships unadvisable. 4 Individual behavior can change in reaction to policy initiatives, which
observed in historical could render those initiatives ineffective. We had a real-life example of this last year
data, which tends to be with the Economic Stimulus Act of 2008. While the stimulus did lead to a brief pick-
highly aggregated, is up in retail spending, it did not generate an ongoing economic recovery. Certainly
unadvisable. there were other factors involved, but the basic lesson was that such “rebates” were
simply handouts that did not alter individual incentives to work, save or invest. In
the short run, policy endeavors may appear effective at the macro level, but without
any change in individual incentives, there is no long term stimulus to the economy.
Debt/GDP: Flexibility or Trap Door?
One argument for the flexibility of fiscal policy to adopt a large stimulus with
associated large fiscal deficits is that the current U.S. federal debt to GDP ratio is
modest compared to nations such as Japan (Figure 17). We are not convinced that
this is effective reassurance primarily for two reasons. First, we depend on foreign

4 Lucas, Robert (1976). “Econometric Policy Evaluation: A Critique.” Carnegie-Rochester Conference

Series on Public Policy 1:19-46.

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Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

investors for much of the financing; nearly 60 percent of marketable debt is currently
held by foreigners. Despite a recent up-tick in domestic savings we will need
foreigners to foot a considerable portion of the coming bill. Second, future
deficits/debts are expected to rise quickly due to the entitlement spending boom
associated with the retirement of the baby boom generation. In our opinion, the
current low ratio of debt to GDP is a trap door which could lead to a much heavier
burden on future generations.
Figure 17

Government Debt
As Percent of Nominal GDP
175% 175%
United States: 2008 @ 68.6%
Japan: 2008 @ 166.5%
155% 155%
Germany: 2007 @ 65.0%

135% 135%

115% 115%

95% 95%

75% 75%

55% 55%

35% 35%
1991 1993 1995 1997 1999 2001 2003 2005 2007
Source: Global Insight and Wachovia

V. International Implications: Global Economy, Dollar, and Capital Flows

Net exports helped prop up U.S. GDP growth in 2008 despite weakness in domestic Every major foreign
demand. However, that support is winding down. Every major foreign economy is economy is either
either already in recession or about to slip into one, due in large part to the already in recession or
pernicious effects of the global credit crunch. Economic growth in the developing about to slip into one,
world has also slowed this year. Global GDP will likely expand an abysmally slow due in large part to the
one percent in 2009, the slowest year for global growth since records at the IMF pernicious effects of the
began in the 1970s. global credit crunch.

Outlook for the Dollar: Best Among a Weak Bunch

The U.S. dollar followed a downward trend against most major currencies between
early 2002 and mid-2008 (Figure 18). There are a number of reasons for the dollar’s
decline. For starters, the large U.S. current account deficit exerted downward
pressure on the greenback. Interest rate differentials moved against the United
States, which reduced the relative attractiveness of U.S. assets to foreign investors. In
addition, dislocations in credit markets caused new issuance of structured fixed

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 Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

income products, which foreign investors had purchased in droves, to plummet

starting in the autumn of 2007.
Figure 18

Trade Weighted Dollar

Major Curency Index, 1973 = 100
115.0 115.0

110.0 110.0

105.0 105.0
Forecast
100.0 100.0

95.0 95.0

90.0 90.0

85.0 85.0

80.0 80.0

75.0 75.0

70.0 70.0
Trade Weighted Dollar : Q4 @ 79.41
65.0 65.0
2000 2002 2004 2006 2008 2010
Source: Federal Reserve Board and Wachovia
We project that the dollar will continue to trend higher against most major currencies
in the coming year, before turning in 2010. The current account deficit is about to get
significantly smaller, which will exert fewer headwinds on the greenback. The
underlying trade deficit has narrowed markedly as real exports have grown much
faster than real imports. Now that oil prices have collapsed, the nominal trade deficit
should decline rapidly. In addition, foreign central banks probably will be cutting
rates more than the Federal Reserve in the months ahead. As interest rate
differentials narrow, foreign capital inflows should strengthen, which should lead to
dollar appreciation.
The value of emerging market currencies has depreciated over the past three months
as risk aversion has spiked and deleveraging has soared. As risk aversion retreats
from extreme levels, many emerging market currencies could recoup some of their
losses. That said, we project that the dollar will grind higher next year versus most
emerging currencies as central banks in developing countries cut rates due to
slowing economic growth and receding inflation.
Capital Flows Favor Only the Safest Assets: Risks, Regulation and Taxes
The latest Treasury International Capital System data indicate that not only did
foreign investors continue to eschew (Figure 19) riskier U.S. assets such as corporate
bonds and agency securities, but investors were net sellers of U.S. securities in
November (Figure 20). Strong foreign purchases of very safe Treasury bills kept total
capital inflows positive in November. Net purchases of long-term securities declined

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Five Key Questions for Decision-Makers
February 10, 2009 SPECIAL COMMENTARY

for the second consecutive month. The $56.0 billion decline in foreign purchases of
U.S. securities was offset by the $34.3 billion drop in U.S. purchases of foreign
securities. Foreign investors continued to eschew agency securities and corporate
bonds in November. Purchases of short-term securities, especially Treasury bills,
remained strong. In the current environment, investors are flocking to the safest
assets.

Figure 19 Figure 20
Foreign Private Purchases of U.S. Securities Monthly Net Securities Purchases
12-Month Moving Sum, Billions of Dollars Billions of Dollars
$600 $600 $160 $160
Treasury: Nov @ $221 Billion
Corporate: Nov @ $50 Billion
$500 $500
Equity: Nov @ $37 Billion $120 $120
Agency: Nov @ $12 Billion
$400 $400
$80 $80

$300 $300
$40 $40
$200 $200

$0 $0
$100 $100

-$40 -$40
$0 $0
Net Securities Purchases: Nov @ -$22 Billion
3-Month Moving Average: Nov @ $14 Billion
-$100 -$100 -$80 -$80
98 99 00 01 02 03 04 05 06 07 08 2004 2005 2006 2007 2008

Source: U.S Department of the Treasury and Wachovia

In the current
Looking ahead, the risk avoidance trade will have a lasting impact on keeping environment, investors
foreign investors away from many corporate issues. In addition, the threat of greater are flocking to the
regulation and higher taxes on capital gains and dividends suggest that capital flows safest assets. After the
will likely decline relative to earlier this decade. After the flight-to-safety trade flight-to-safety trade
evaporates, the cost of credit to the U.S. is likely to rise. This will be evident in evaporates, the cost of
higher interest rates, lower price-earnings ratios or depreciation in the dollar relative credit to the U.S. is
to earlier this decade. likely to rise.
Conclusion
In sum, further declines in consumer spending, business fixed investment and
residential construction translate into continued contraction in real economic activity.
By the time the economy hits bottom in late 2009, real GDP will probably have
contracted more than three percent, the worst downturn since 1981-82. Employment
may post the worst performance in 50 years, with declines topping five million jobs,
or more than four percent of total employment. Underlying our forecast, however, is
the assumption that policymakers will take the necessary steps to prevent the global
financial system from locking up again. Should that assumption prove overly
optimistic, global economic growth would end up even weaker than our already
bleak outlook projects.

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Wachovia Economics Group

John E. Silvia, Ph.D. Chief Economist (704) 374-7034 john.silvia@wachovia.com

Mark Vitner Senior Economist (704) 383-5635 mark.vitner@wachovia.com
Jay H. Bryson, Ph.D. Global Economist (704) 383-3518 jay.bryson@wachovia.com
Sam Bullard Economist (704) 383-7372 sam.bullard@wachovia.com
Anika Khan Economist (704) 715-0575 anika.khan@wachovia.com
Azhar Iqbal Econometrician (704) 383-6805 azhar.iqbal@wachovia.com
Adam G. York Economic Analyst (704) 715-9660 adam.york@wachovia.com
Tim Quinlan Economic Analyst (704) 374-4407 tim.quinlan@wachovia.com
Kim Whelan Economic Analyst (704) 715-8457 kim.whelan@wachovia.com
Yasmine Kamaruddin Economic Analyst (704) 374-2992 yasmine.kamaruddin@wachovia.com

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