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Energy, Budget, Interest Rates Impacting Economy Cole Gustafson, professor of agribusiness and applied economics at North Dakota State University, sees Jan. 31, 2006, as a significant date that could have an impact on the U.S. and the global economy. That’s the day Alan Greenspan will retire as Federal Reserve chairman. Fed policies may not actually change much, he says, but the change will create some uncertainty until it becomes clear what direction they will go. In the meantime, the Greenspan-led Federal Reserve has continued to raise interest rates, a fraction at a time, every time it has met over the past year. How stands the world economy? Gustafson, speaking at the 2005 Ag Lenders Conference held recently in Fargo, said that the worldwide economy has done very well, with growth in the global gross domestic product. Most economists view the economy as being near the top of its cycle, expecting some downturn. The hurricanes that devastated the U.S. Gulf Coast and other natural disasters throughout the world have had an impact on the world economy. The damage from hurricanes Katrina and Rita has been a major economic event, costing losses of $200 billion to date. Additional losses in the private sector and massive insurance claims will drive the figure much higher. This major event in the U.S. economy has a worldwide effect as well, because of the size of the U.S. economy. Global economic trends show that developing countries are now driving growth in the world economy. Countries like China and India have a capacity for 15% increases in demand for resources like steel and oil annually. Europe, on the other hand, has been slow, Gustafson says, especially France. That country has an unemployment rate of 20%, or even higher among young people. World oil demand is forecast to increase by over 50% by 2020, which will likely sustain high oil prices for the immediate future. The OPEC countries have been the major source of imported oil for the United States historically, but the worldwide demand situation may make it necessary to increasingly rely on non-OPEC suppliers. The U.S. economy has been almost identical to the world economy in terms of growth in GDP. Even before the devastating and costly hurricanes, some decline could be detected in the national economy. The first impression was that the hurricane damage would have a negative effect, but October economic figures were actually higher than forecast. Gustafson says this was a result of new federal funding coming in and providing a stimulus in the form of spending for rebuilding and replacement goods. This provides a short term boost that will probably decline later on. Capital spending by businesses has been strong, but that represents a relatively small part of the total economy. Other sectors have been flat, including consumer spending, which is now the major driver of the U.S. economy. Gustafson says the business cycle is currently in expansion, but there is no “excitement” as in past up cycles. He says the economy won’t feel good until consumers do, and consumer confidence was flat and had been turning negative even before the hurricanes. So why does the Federal Reserve feel it’s necessary to increase interest rates? Gustafson says the Fed has sensed the start of inflation, and inflation is the Fed’s number one concern. On the other hand, unemployment has remained relatively high, in the 5 to 6% range, in spite of the expanding economy, but the Fed has not paid much attention. The Federal Reserve has been concerned with shifts in spending and saving, especially the low rate of saving. Spending and the level of consumer debt are up, leading Greenspan to try to lower the consumer’s appetite for debt with interest rate hikes. Gustafson says Greenspan will be remembered for the unprecedented growth in productivity during his tenure, largely due to computerization of the workplace. Productivity increased over 4% this year. The budget deficit is another major concern for the Fed, and economists in general. Spending for hurricane relief and rebuilding will be adding to the deficit, raising questions about whether government dollars are being spent wisely. Gustafson sees the rise in energy prices coming through the economy, a process that will take about six months. Higher prices will likely continue for the next six months to a year, he says. During that period interest rates are also likely to increase. Resulting Global Oil Demand Global Oil Demand by Region (million barrels per day) Source: International Energy Agency
Demand Annual Change Annual Change (%) 2005 2004 2005 2006 2004 2005 2006 North America 25.61 0.83 0.26 0.33 3.4 1.0 1.3 Europe 16.33 .017 0.05 0.03 1.0 0.3 0.2 OECD Pacific 8.64 -0.18 0.11 0.06 -2.0 1.3 0.7 China 6.79 0.86 0.36 0.49 15.4 5.5 7.2 Other Asia 8.80 0.47 0.28 0.27 5.9 3.3 3.1 Subtotal Asia 24.23 1.15 0.75 0.83 5.2 3.2 3.4 FSU 3.78 0.15 0.04 0.05 4.2 1.0 1.2 Middle East 6.07 0.33 0.30 0.31 6.1 5.2 5.1 Africa 2.89 0.07 0.09 0.09 2.7 3.2 3.1 Latin America 4.95 0.19 0.10 0.11 4.1 2.0 2.3 World 83.88 2.89 1.58 1.75 3.6 1.9 2.1 Federal Funds Rate
A String of Deficits
U.S. Economic Trends: Service vs. Manufacturing
Work With Your Banker To Manage Rising Interest Rates Farm and ranch owners and operators can actively manage interest rate risk by making adjustments to personal and business finances. The American Bankers Association Center for Agricultural and Rural Banking offers the following advice to help farmers and ranchers manage their exposure to possible future interest rate increases:
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