MORGAN STANLEY DEAN WITTER
Multi-Asset Research
Global
Economics
Global Investment Research
July 2001
Stephen Roach, Chief Economist
+1 (1)212 761 7153
stephen.roach@morganstanley.com
Global Rebalancing
Please refer to important disclosures at the end of this report.
MORGAN STANLEY DEAN WITTER
Morgan Stanley Dean Witter Global Economics
Stephen S. Roach
David A. Jones
Robert S. Brown
Chief Economist
Associate Director of Research
1-212-761-7153
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Global
Joachim Fels
Currency Economics
Karin Kimbrough
Stephen Li Jen
Currency Economics
Melanie Baker
Joseph Quinlan
Global Economics
Rebecca McCaughrin
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Europe
Eric Chaney
Christel Rendu
Joachim Fels
Elga Bartsch
Mark Miller
Donui Agbokou
Euro Zone
Euro Zone
Euro Zone
UK
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Serhan Cevik
Oliver Weeks
Emerging Markets Europe
Emerging Markets Europe
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The Americas and Dollar Bloc
Richard Berner
David J. Greenlaw
Ted Wieseman
Gray Newman
United States
United States
Robert A. Feldman
Karin Ri
Takehiro Sato
Andy Xie
Denise Yam
Daniel Lian
Anita Chung
Chetan Ahya
Japan
Japan
Japan
Non-Japan Asia
Latin America
Asia
Non-Japan Asia
India
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Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 1
MORGAN STANLEY DEAN WITTER
Global Relapse

So far this year, we have slashed our estimate of world GDP growth for 2001 to 2.5% from 3.5%. Relative to our baseline growth scenario of 4.2% prevailing early last October, these changes bring the cumulative downward revision to 1.7
percentage points over the past eight months. Our current baseline for 2001 represents nearly a 50% slowing in the pace
of global activity relative to the boom-like outcome of 4.8% for 2000. The risk remains that there will be more cuts to
come -- especially for 2002, where we are currently forecasting a rebound in global growth to 3.7%.

Our call for a global downshift is dominated by a US economy that we think is now in mild recession. The US accounted for nearly 40% of total global growth in the five years ending in mid-2000. Not only is that 40% now in the process
of going to “zero,” but the world is lacking an alternative growth engine to fill the void. Reflecting the new connectivity
of globalization -- global trade, globalized supply chains, and balance-sheet adjustments of multinational corporations -an engineless world is now on the brink of a rare synchronous recession.

The balance of our forecast cuts have been spread around the world, initially skewed toward non-Japan Asia and the
NAFTA bloc — regions of the world we judge to be most sensitive to US-led IT and other inventory linkages. We expect Europe to be hurt the least, given the region’s structural autonomy, fiscal support, and improving domestic demand;
our downwardly revised European growth estimate for 2001 is 2.1%, still about double the gain we now expect in the
US. In the climate we foresee, the world economy will have to face two “firsts” — the first recession of the Information
Age and the first recession of globalization. That raises great uncertainty about the severity and duration of the crossborder repercussions of a US economy in recession. Four downside risks are most disconcerting: the possibility of further cuts to the developing world, a deeper recession in the US, the downside of the global IT and manufacturing cycles,
and financial-market distress.

With these revisions, our global growth forecast has pierced the lower bound of the 3.0–3.5% range that has been associated with global soft landings of the past. It is now right on the cusp of the 2.5% global recession threshold. For financial markets, the debate will shift increasingly to the shape of the coming recovery in the US and global economies.
Given a likely purging of America’s structural excesses — negative personal savings, excess IT capacity, and a record
current-account deficit — the odds favor more of a U- or L-shaped recovery than the V-shaped upturn now being discounted by the markets.
Annual Percent
10
9
2000
8
7
6
5 World
4
Europe
3
2
1
0
-1
World Growth at a Glance
2001E
2002E
U.S.
Other
Latin
Dollar Bloc
America
Japan
Source: Morgan Stanley Dean Witter Research
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Non-Japan
Asia
10
9
8
7
6
5
4
3
2
1
0
Page 2
MORGAN STANLEY DEAN WITTER
Global Relapse
We have cut our baseline global
growth estimate to 2.5% in 2001,
depicting a world economy on the
cusp of recession.
World GDP Growth
Percent
8
7
6
5
4
3
2
1
0
8
7
6
5
4
3
2
1
0
Average 1970-1999: 3.7%
Forecast
Years of Global Recession
71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01
Source: IMF, Morgan Stanley Dean Witter Research
Share of Global GDP: 2000
Europe
21%
Non-Japan Asia
23%
With the US apparently in recession,
the engine of global growth has likely been temporarily derailed.
Japan
7%
US
22%
Our estimates suggest global trade
growth is slowing from 12.8% in
2000 to 4.3% in 2001 -- the sharpest
slowdown on record.
World Trade Growth
Percent Change
14
12
10
8
6
4
2
0
-2
-4
1970
1974
Global Trade volume of goods and services
Global Real GDP
1978
1982
Source: IMF, MSDW Research Estimates
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Other
20%
Latin America
8%
1986
1990
1994
1998
2002E
Page 3
MORGAN STANLEY DEAN WITTER
World without an Engine
US Share of World GDP Growth
Percent
40
30
America’s leadership role in the
global economy has been sharply
diminished.
20
10
0
-10
90
91
92
93
94
95
96
97
98
99
00
01E
Exports to the US as a Share of GDP
Percent
35
30
Trade linkages spread the US-led
downshift, especially to East Asia
and America’s NAFTA partners.
25
20
15
10
5
0
Euroland
Japan
China
Korea
Taiwan
Mexico
Canada
Where's the Next Engine?
Percent, YOY
12
Industrial Production
9
6
The world is lacking a candidate to
fill the growth void left by a faltering
US economy.
3
0
-3
-6
US
-9
-12
Jan-98
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Jul-98
Jan-99
Jul-99
Jan-00
Europe
Jul-00
Japan
Jan-01
Jul-01
Page 4
MORGAN STANLEY DEAN WITTER
Global Transmission
Trade as % of World GDP
Percent
25
20
Globalization is central to convergence; it reflects the increased connectedness of the world economy
though trade flows . . .
15
10
5
0
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
Source: International Monetary Fund, Morgan Stanley Dean Witter Economic Research
Multinational Corporate Activity
US$, Trillions
14
Global Exports
12
. . . as well as through sharply expanded activity of multinational corporations.
Global Foreign Affiliate Sales
10
8
6
4
2
89
A ubiquitous and transparent Internet adds a new technology-led dimension to globalization and international convergence.
90
91
92
The
Millions of Users
180
U.S.
160
Western Europe
140
Non-Japan Asia
120
Japan
100
Latin America
80
60
40
20
0
1997
1998
1999
93
Please refer to important disclosures at the end of this report.
95
96
97
98
99
Internet Explosion
2000E
Source: Morgan Stanley Dean Witter Estimates
Global Investment Research – July 2001
94
2001E
2002E
2003E
2004E
Page 5
MORGAN STANLEY DEAN WITTER
Sources of Global Downshift
Real Short-Term Interest Rates
Percent
7
G-10
G-10, ex-US
6
The lagged impacts of last year’s
monetary tightening are restraining
global growth in 2001.
5
4
3
2
1
0
Jan-84
Jan-86
Jan-88
ACWI
40
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Faltering Equity Markets
Percent Return
50
A flattening of the wealth effect is
also constraining global activity,
especially in the wealth-dependent
United States.
Jan-90
S&P
30
20
10
0
-10
-20
-30
90
Percent
12
10
8
Rising corporate financing costs are
also impeding economic activity.
91
92
93
94
95
96
97
98
99
00
1-Jul
U.S. Credit Quality
Percent
3.0
Default Rate (Speculative Grade, left)
AA Corporate Spread (right)
2.5
2.0
6
1.5
4
1.0
2
0.5
0
0.0
Jan-90 May-91 Oct-92 Feb-94 Jul-95 Nov-96 Apr-98 Sep-99 Jan-01
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 6
MORGAN STANLEY DEAN WITTER
Unwinding the Energy Shock
Natural Gas Shock?
$/MMBtu
12
$/Barrel
40
Henry Hub Natural Gas Spot (Left)
10
While crude oil prices are down from
their highs, consumers are now feeling the full force of surging natural
gas prices . . .
35
Brent Crude Oil Spot (Right)
30
8
25
6
20
15
4
10
2
5
0
0
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Nominal vs Real Oil Prices
US$/Barrel, West Texas Crude
50
. . . yet in real terms, oil prices remain below levels of the early 1980s.
Nominal
40
Real
30
20
10
0
Jan-70
Jan-76
Jan-82
Jan-88
Jan-94
Jan-00
Saudia Arabia: Response to Oil Shocks
Billions of US Dollars
120
Domestic Investment
100
OPEC producers tend to save, or
recycle, petrodollar windfalls —
usually providing a boost to dollardenominated assets.
Domestic Savings
80
Petroleum Export Earnings
60
40
20
0
1971 1974
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
1977 1980 1983
1986 1989 1992
1995 1998
Page 7
MORGAN STANLEY DEAN WITTER
Post-Bubble Global Economy
ACWI Index
US$
400
350
World equity prices have fallen 30%
below their highs of last year.
300
250
200
150
Jan-95
Jan-96
80
Jan-98
Jan-99
Jan-00
Jan-01
Equity Market Capitalization
as a Share of GDP
Percent
120
The sell-off in global equities should
hit the US the hardest.
Jan-97
US
Europe
Japan
NJA
40
0
90
91
92
93
94
95
96
97
98
99
Percent
150
125
America’s households are most
exposed to the negative wealth
effects.
00
150
H ousehold equity holdings
(percent of disposable incom e)
100
125
1990
1998
100
75
75
50
50
25
25
0
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
U.S.
Japan
Germany
0
Page 8
MORGAN STANLEY DEAN WITTER
A New Culture of Risk
Equity Market Valuations
(Last Plotting: July 2, 2001)
Percent
100
80
Europe
US
60
Valuation strains are finally starting
to take a toll on global equity markets.
40
20
0
-20
-40
Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00
Overly-Optimistic 2002
2001
While markets have capitulated on
the near-term earnings outlook, optimism remains for 2002.
ACWI Consensus Earnings
S&P 500 Consensus Earnings
World GDP
As of 1/1/01 As of 6/22/01
11%
-1.0%
10%
-5.6%
3.5%
2.5%
2002
17%
19.1%
3.8%
US Stock Market: A New Era or Irrational Exuberance?
1600
1200
120
S&P Composite Prices (Left)
Major Innovations
S&P Composite Real Earnings (Right)
1. National Railway
2. Car
3. Factory Assembly Line
4. Nationwide Telephone
5. Radio
6. Rural Electrification
800
1
400
2
4
3
6
5
0
90
60
30
0
1871 1882 1894 1906 1918 1929 1941 1953 1965 1976 1988 2000
Source: Robert Shiller, Yale University, Morgan Stanley Economic Research
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 9
MORGAN STANLEY DEAN WITTER
Rebalancing: Globalization of the Information Age
Global growth is likely to be increasingly driven by a convergence of
global IT demand toward US norms.
Percent of Nominal GDP
28
26
Europe should lead the demand
catch-up, becoming the world’s largest IT buyer over the 2000–05 period.
28
Catching up scenario: ICT Capital Stock
26
24
24
22
22
20
20
US
Europe
Japan
18
16
14
90 91 92 93 94 95 96 97 98 99 00E 01E 02E 03E 04E 05E
Greatest Engineering Achievements of the Twentieth Century
1. Electrification
2. Automobile
3. Airplane
4. Water Supply and Distribution
5. Electronics
6. Radio and Television
7. Agricultural Mechanization
8. Computers
9. Telephone
10. Air Conditioning and Refrigeration
Source: National Academy of Engineering, 2000
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
11. Highways
12. Spacecraft
13. The Internet
14. Imaging
15. Household Appliances
16. Health Technologies
17. Petroleum and Petrochemical Technologies
18. Laser and Fiber Optics
19. Nuclear Technologies
20. High Performance Materials
18
16
14
Page 10
MORGAN STANLEY DEAN WITTER
Rebalancing: Globalization of Shareholder Value
Equity Market Capitalization/GDP
Percent
140
120
The globalization of the equity culture is a key element of convergence
toward America’s New Economy
norms.
90
100
99
80
60
40
20
0
Latin America Far East Free
Free
ex-Japan
US$, Billions
So, too, is a surge of cross-border
M&A activity.
Europe
US
UK
Japan
Cross-Border M&A for the US, Japan and Euroland
450
400
350
300
250
200
150
100
50
0
1990
1992
1994
1996
1998
2000
Source: Thompson Financial Service
Percent
Venture Capital Investment as a Percentage of GDP
0.18
0.15
1995
1998
0.12
Moreover, there is now reason to
believe that America’s venture capital culture is starting to go global.
0.09
0.06
0.03
Ca
na
da
U
N
eth SA
er
lan
ds
U
Be K
lg
i
N um
or
wa
Fi y
nl
an
Eu d
ro
G pe
er
m
an
Fr y
an
Sw ce
Sw e d
itz en
er
la
n
Ire d
la
n
Po d
rtu
ga
l
Ita
ly
Sp
D ain
en
m
a
A rk
us
tri
G a
re
ec
e
Ja
pa
n
0.00
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 11
MORGAN STANLEY DEAN WITTER
Rebalancing: Globalization of Labor Markets
Percentage of Service Sector to Total Output
The service intensity of America’s
work force has increased the potential for IT-led white-collar productivity enhancement.
Percent
80
70
60
50
40
30
20
10
0
1984
US
UK
1998
Japan
Germany
Source: OECD
Ratio of University to Non-University Workers
Increased enrollment in higher education has separated America from
the pack, making it better equipped
to boost knowledge-worker productivity.
Ratio
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
Total Services
US
Business
Services
Personal
Services
OECD Average
Manufacturing Construction
Source: OECD
Share of Silicon Valley Start-ups
by Ethnic Origin
Percent
25
20
Immigration has played a key role in
driving start-ups in America’s New
Economy.
Indian
Chinese
15
10
5
0
1980-84
Source: Saxenian and OECD
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
1985-89
1990-94
1995-98
Page 12
MORGAN STANLEY DEAN WITTER
Rebalancing: Globalization of Innovation
Trends in National Innovative Capacity
Innovation
300
Germany
250
America’s lead in the global innovation sweepstakes is starting to narrow.
Japan
Switzerland
US
200
150
100
50
0
1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995
Source: Stern, Porter and Furman “The Determinants of National Innovative Capacity”
Researchers per 10,000 in the Labor Force
100
Japan
85
The share of a nation’s workforce
engaged in research activities is key
to its innovative potential.
US
OECD
EU
70
55
40
25
81 82 83
84 85 86 87 88 89 90 91 92 93 94 95
Source: OECD
Business-Funded R&D as a Percentage of GDP
Percent
3.0
1990
2.5
1998
2.0
R&D spending also is an important
driver of innovative capacity.
1.5
1.0
0.5
0.0
Finland
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Sweden
Germany
US
Japan
Page 13
MORGAN STANLEY DEAN WITTER
Cyclical Rebalancing
Unemployment in the G-7
12
1990
10
Cyclical imbalances should work
against the US; the absence of American labor market slack is notable in
that regard.
May-01
8
6
4
2
0
Japan
USA
UK
Germany
Canada
France
Italy
Source: National Statistical Agencies
Note: 1990 Germany data are for West Germany only; Italy data are from 1993
Household Savings as a Percentage
of Disposable Household
Income
United States
Japan
Germany
Percent
20
15
A savings-short US economy may
well have to pay a premium to import
foreign capital.
10
5
0
82
84
86
88
90
92
94
96
98
00
Source: OECD
Current Account as a Percentage of GDP
8
USA
6
Given America’s massive external
imbalance, that premium may take
the form of a sharp depreciation in
the dollar.
Japan
Germany
4
2
0
-2
-4
-6
80
82
Source: OECD
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
84
86
88
90
92
94
96
98
00
Page 14
MORGAN STANLEY DEAN WITTER
Perils of the Digital Divide
Connectivity and Computer Literacy: 1998 (per 1000)
High-Income Countries Low-Income Countries
A wide gap currently exists between
the haves and have-nots of Internet
access.
Telephone Mainlines
Mobile Penetration
Television
Cable Subscribers
College Enrollment (% 1997)
Personal Computers
1990 PPP
Dollars
20,000
Will the digital divide — income and
wealth disparities between computer
users and non-users — spark new
global inequalities?
567
265
662
184
59
311
37
8
138
28
6
6
Global Income Disparities
Differential Income Growth in per capita GDP
16,000
Low-income quartile countries
Middle-low-income quartile countries
Middle-high-income quartile countries
High-income quartile countries
12,000
8,000
4,000
0
Source: OECD and IMF
1900
2000
United States
There is evidence of a digital divide
within countries as well — at both
ends of the prosperity spectrum.
China
Percent of Group
Using the Internet in 1998
White non-Hispanic
37.7%
Distribution of Internet
Users by Province in 2000
Beijing
21.24%
Black non-Hispanic
AIEA non-Hispanic
API non-Hispanic
19.0%
29.5%
35.9%
Guangdong
Shanghai
Jiangsu
Hispanic
10.0%
Other
12.94%
11.21%
5.91%
50.0%
Source: US Department of Commerce and China Internet Network Information Center (CNNIC)
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 15
MORGAN STANLEY DEAN WITTER
Global Pension Challenge
Dependency Ratios: Working Age per Retiree
Ratio
14
World
12
A demographic time bomb is ticking
around the world that makes the task
of pension reform increasingly urgent.
Developed Countries
10
US
8
Less Developed Countries
6
China
4
2
0
1999
2050E
Source: United Nations Development Program
Demographic Headwinds:
Shifting Mix of Global Aging by 2030
(Share of population growth of elderly 60+ cohort)
Asia will account for a disproportionate share of global aging over
the next 30 years.
China
29%
Asia ex China
29%
OECD countries
14%
Transitional economies
28%
Source: World Bank
Pension Spending as a Percentage of GDP
Percent
20
OECD Countries
Pension spending will rise sharply as
a share of global GDP over the next
50 years.
15
China
Asia (less China)
10
5
0
1990
2000
Source: World Bank
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
2010E
2020E
2030E
2040E
2050E
MORGAN STANLEY DEAN WITTER
Page 16
A New Financial Architecture
• Likely Changes
– Infrastructure enhancements: Transparency, standards, compliance incentives,
eliminating pegged exchange rates
– Coping with volatility: Expanded FX reserves, prearranged credit lines, debt restructurings, taxing capital inflows, new contagion lending facility
– Curbs on private creditors: Bail-ins, collective action clauses, encouraging
longer-term financing, heightened oversight of highly leveraged borrowers
– IMF and World Bank: Refocusing and reform — less is more
• Unlikely Reforms
– New international authority
– IMF with expanded lender-of-last-resort capabilities
– Global credit insurance schemes
– Currency target zones
• Message from G-7
– Reluctant to coordinate, except in crises
– No endorsement of radical change in architecture
– Best international policy is collection of best domestic policies
– Exchange-rate regimes shift from fixed to floating
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 17
MORGAN STANLEY DEAN WITTER
Europe’s Competitive Challenge
Hourly Compensation in Manufacturing
Europe is finally making progress in
narrowing the global competitiveness
gap.
US$ per Hour
32
Wages
28
24
20
16
12
8
4
0
Benefits
Compensation Total
UK US Eur. Jpn. Fra. Ger.
UK US Eur. Jpn. Fra. Ger.
1985
UK US Eur Jpn. Fra. Ger.
1995
1999
Benefits: Share of Total Hourly Compensation
Percent
60
50
The European model places a greater emphasis on the social contract of
outsized benefits.
40
30
20
10
0
UK US Jpn. Fra. Ger.
1985
UK US Jpn. Fra. Ger.
1995
UK US Jpn. Fra. Ger.
1999
PCs per Worker: 1997
120
100
80
Europe lags the US in its commitment to information technology.
60
40
20
0
Nor.
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
US
Swe.
Switz.
Den.
Neth.
Fra.
EU
Bel.
Ger.
Ita.
Page 18
MORGAN STANLEY DEAN WITTER
More to Come on Japanese Restructuring
RoA = Recurring Profit / Total Assets
Percent
16
14
12
Japanese restructuring is focused on
boosting ROA back toward historical
norms.
10
8
6
4
2
55
60
65
70
75
80
85
90
95
00
Compensation/GDP
Percent
60
55
Restructuring tactics should focus on
slashing labor compensation costs,
we believe.
50
45
40
35
55
60
70
75
80
85
90
95
00
Capital Stock Relative to GDP
Ratio
Corporate Japan will also have to
rationalize excess capacity.
65
2.5
2.3
2.1
1.9
1.7
1.5
1.3
1.1
0.9
0.7
0.5
55
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
60
65
70
75
80
85
90
95
00
-2
Page 19
MORGAN STANLEY DEAN WITTER
A Resilient Chinese Economy
Chinese GDP Growth
Percent
16
14
After seven years of GDP deceleration, Chinese growth now seems to
be picking up.
12
10
8
6
4
2
0
90
91
92
93
94
95
96
97
98
99
00
01E
02E
China's Export Recovery
Percent, Y/Y
50
40
30
China’s export dynamic is beginning
to feel the chill of the global slowdown.
20
10
0
-10
-20
Sep-97
Mar-98
Sep-98
Mar-99
Sep-99
Mar-00
Sep-00
Mar-01
Sep-01
Source: Ministry of Foreign Trade and Economic Cooperation
FDI in China
US$, Billions
70
60
In anticipation of WTO accession,
foreign direct investment into China
appears to be rebounding sharply.
50
40
30
20
10
0
1993
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
1994
1995
1996
1997
1998
1999
2000
2001
Utilized Signed
MORGAN STANLEY DEAN WITTER
Latin American Risks
Latin America remains dependent on
foreign trade — although less so
than Asia.
Current-account deficits remain
more of a problem than fiscal shortfalls in this region.
Latin America’s external financing
needs are increasingly covered by
foreign direct investment.
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 20
Page 21
MORGAN STANLEY DEAN WITTER
US Overview

After five years of extraordinary vigor, we believe the US economy has slipped into a mild recession. After decelerating
to a 1.5% pace in the three quarters ending in 1Q01, we now look for real GDP growth to contract by a 0.5% annual rate
in the second and third quarters of this year before rebounding in the fourth quarter by just 2.5%.

Risks remain on the downside of our short and shallow recession call. Three factors are most worrisome in this regard
— the excesses of an IT overhang, a negative consumer wealth effect, and a current-account/dollar crisis. Should any of
these pressures intensify, there is a distinct risk we could deepen and lengthen our recession call.

In a still-subdued inflationary climate, a shortfall in volume growth should lead to significant pressure on corporate profits. This could well be exacerbated by a margin squeeze resulting from pressures on energy costs, financing costs, technology costs, and labor costs. Reflecting these concerns, we now look for after-tax corporate profits to contract by
11.0% in 2001 — a dramatic reversal from the 13.1% increase we estimate for 2000 and at odds with more optimistic
earnings expectations still embedded in the stock market. This could heighten the risks of a further stock market correction and its concomitant wealth effect.

Despite aggressive Fed easing, US recovery prospects should be restrained by the confluence of cyclical and structural
factors. The former are traceable to the cost-cutting stemming from the ongoing earnings recession, and the latter reflect
the post-bubble excesses of a negative personal saving rate, an outsized capacity overhang, and a record current-account
deficit. The result could well be an “American-style L” -- with US GDP growth averaging just 1.5% to 2.0% over the
2001-03 interval.
US Forecast at a Glance
2000
2001E
2002E
(%, Year-Over-Year Change)
Real GDP
Inflation (CPI)
Industrial Production
Capacity Utilization (%)
Corporate Profits (After-Tax)
5.0
3.4
5.6
81.3
13.1
QI
QII
1.1
3.2
-2.5
75.7
-11.0
2001E
QIII
QIV
3.0
2.4
1.0
74.3
8.4
QI
2002E
QII
QIII
QIV
(%, Sequential Quarterly Change at Annual Rates)
Real GDP
Gross Domestic Demand
Unemployment Rate
1.3
0.0
4.2
-0.5
0.2
4.6
E = Morgan Stanley Research Estimate
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
-0.6
-0.8
4.9
2.5
2.5
5.0
4.3
4.6
5.0
4.7
5.1
5.0
4.0
4.5
5.0
3.1
3.1
5.1
Page 22
MORGAN STANLEY DEAN WITTER
America Heading for Recession
Morgan Stanley US Growth Forecast
Percent
6
Average 1996 to mid-2000:
4.5%
5
Our baseline case calls for a short
and mild recession, followed by a Ushaped recovery; risks remain to the
downside.
Forecast
4
3
2
Average 2001-2002:
2.4%
1
0
-1
00Q1 00Q2 00Q3 00Q4 '01Q1 01Q2 01Q3 01Q4 02Q1 02Q2 02Q3 02Q4
Manufacturing Inventory-to-Sales Ratio
Ratio
2.0
Trend: 1981-2000
1.8
An inventory correction seems likely
to keep the economy contracting
through mid-year.
1.6
1.4
1.2
Jan-81
Jan-84
Jan-87
Jan-90
Jan-93
Jan-96
Jan-99
Watch the Second Derivative
Percent
Change in Year-over-Year Real US GDP Growth from Previous Year
12
Recessions
8
The sharp slowing of the US economy over the past year falls short of
the downturns that have sparked the
V-shaped rebounds in the past.
4
0
-4
-8
I-59
II-63
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
III-67
IV-71
I-76
II-80
III-84
IV-88
I-93
II-97
III-01
Page 23
MORGAN STANLEY DEAN WITTER
Cost-Cutting at Work
Corporate Profits: Cyclical Comparison
Index, Peak = 100
115
After-Tax Corporate Profits/GDP
110
105
This is likely to be an unusually steep
earnings recession.
100
95
90
Present Cycle*
85
Average, Previous Four Cycles
80
-5Q -4Q -3Q -2Q -1Q
0
1Q 2Q 3Q 4Q 5Q 6Q 7Q 8Q
Cost-Cutting: Capital
Index, Peak = 100
110
Cost-cutting initially has been focused on the pruning of capital
spending, especially IT.
Business Fixed Investment
100
90
Present Cycle*
80
Average, Previous Four Cycles
70
-8Q -7Q -6Q -5Q -4Q -3Q -2Q -1Q 0
Index, Peak = 100
100.5
1Q 2Q 3Q 4Q 5Q 6Q 7Q 8Q
Cost-Cutting: Labor
Nonfarm Payroll Employment
100.0
Businesses have just started to cut
labor costs in an effort to boost profit margins.
99.5
Present Cycle
Average, Previous Four Cycles
99.0
98.5
-8M -7M -6M -5M -4M -3M -2M -1M
* Peak tentatively designated as October 2000.
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
0
1M 2M 3M 4M 5M 6M 7M
Page 24
MORGAN STANLEY DEAN WITTER
Purging Structural Excesses
An unprecedented decline in personal savings leaves the American consumer highly vulnerable to a negative wealth effect.
Where Has All the Saving Gone?
Percent
16
14
12
10
8
6
4
2
0
-2
1947
Personal Savings Rate, NIPA Measurement
Personal Savings Rate, Flow of Funds, FRB
1953
1959
1965
1971
1977
1983
1989
1995
2001
Capital Spending Overhang?
Percent
15
Non-Residential Fixed Private
Investment as a Percentage of GDP
12
Driven by surging IT, there is a risk
of a classic capacity overhang.
9
6
Jan-46
Jan-54
Jan-62
Jan-70
Jan-78
Jan-86
Jan-94
Jan-02
Twin Excesses
Percent
2
1
A savings-short US economy has
become overly dependent on foreign
capital to finance booming investment.
0
-1
-2
-3
-4
Current Account as a Percentage of GDP (Left)
-5
Jan-60
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Jan-66
Jan-72
Jan-78
Jan-84
Jan-90
Jan-96
Jan-02
Page 25
MORGAN STANLEY DEAN WITTER
Capacity Overhang in the New Economy
IT Overhang
Percent
60
IT/Capital Equipment and Software (Left)
Capital Equipment and Software/GDP (Right)
50
Under the guise of the New Economy, America has embarked on a
massive IT binge.
10
40
8
30
6
20
4
10
2
0
0
Jan-46
Much of this investment has been
justified on the basis of increasingly
shorter product cycles — a dubious
assumption, in our opinion.
Percent
12
Jan-55
Jan-64
Jan-73
Jan-82
Jan-91
Jan-00
Replacement Share of Gross Investment:
Equipment and Software
Percent
80
70
60
50
40
30
20
10
0
1961-64 1965-69 1970-74 1975-79 1980-84 1985-89 1990-94 1995-99
Growth in “Potential” Productivity
3.5
If IT spending slows, productivity
gains could fade quickly.
3.0
Percent change from year
ago, smoothed
2.5
Labor Productivity
2.0
1.5
Capital
deepening
impact
Time-varying (TFP)
1.0
0.5
0.0
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 26
MORGAN STANLEY DEAN WITTER
Pruning White-Collar Bloat
Shifting Mix of Employment
Over the past 17 years, white-collar
growth has averaged 2.3%, double
the 1.1% growth in other occupations.
Percent, YoY
6
5
4
3
2
1
0
-1
-2
1984
1986
Other Employment
1988
1990
1992
1994
1996
1998
More Managers, More in Services
Percent
26
White-collar hiring has been increasingly skewed toward services and has
become increasingly top-heavy with
managers.
White-Collar Employment
2000
Percent
72
70
24
68
22
66
20
Managerial Share of White-Collar (left)
Private Services' Share of Managers (right)
18
62
1983
1985
1987
1989
1991
1993
1995
1997
1999
White-Collar Efficiencies?
Ratio
Ratio
1.2
1.8
Managers/Professionals (left)
1.7
Within the white-collar function,
back-office efficiencies have been
offset by an ominous build-up of
managerial bloat.
64
1.1
Knowledge Workers/Information Support (right)
1.6
1.0
1.5
0.9
1.4
0.8
1.3
0.7
1.2
1.1
0.6
1983
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
1985
1987
1989
1991
1993
1995
1997
1999
2001
Page 27
MORGAN STANLEY DEAN WITTER
Consumers at Risk
Loss of Confidence
Index
160
140
As layoffs mount, the American consumer has turned increasingly skittish.
Conference Board Confidence Index
U of Michigan Index
120
100
80
60
40
Jan-90
It will take a sharp consolidation of
consumption to bring consumer demand in better alignment with purchasing power.
Percent
7
6
5
4
3
2
1
0
-1
Jan-90
The excesses of consumption have
been financed by a record surge in
household debt.
Percent
130
120
110
100
90
80
70
60
50
40
Jan-80
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Spending Overhang?
Real Consumer Expenditures
Real Disposable Income
Jan-92
Jan-94
Jan-96
Jan-98
Consumer Credit Bomb
Jan-00
Percent
15
14
13
12
Total Outstanding Consumer Credit -- Installment + Mortgage (Left)
11
10
Consumer Debt Service (Right)
9
Jan-84
Jan-88
Jan-92
Jan-96
Jan-00
Page 28
MORGAN STANLEY DEAN WITTER
Perils of the Wealth Effect
A Shaky Foundation
% of GDP
2
Current Account Deficit (left)
1
America’s growth dynamic is built on
the shaky foundation of a still overvalued stock market and excessive
reliance on foreign capital.
Jan-1980 = 100
1600
S&P 500 (right)
1400
1200
0
1000
-1
800
-2
600
-3
400
-4
200
-5
0
Mar-86
Mar-88
Mar-90
Mar-92
Mar-96
Mar-98
Mar-00
Mar-02
The Wealth Effect at Work
$, Trillions
14
Percent
14
Household Equity Holdings (Left)
Personal Savings Rate (Right)
12
The $8 trillion appreciation in
household equity holdings since late
1994 enticed wealth-dependent consumers into depleting their personal
savings.
Mar-94
12
10
10
8
8
6
6
4
4
2
2
0
0
-2
-2
90Q1 91Q1 92Q1 93Q1 94Q1 95Q1 96Q1 97Q1 98Q1 99Q1 00Q1 01Q1
Composition of US Private Trusteed Pension Assets
Percent
However, as pension regimes shift
from defined-benefit to definedcontribution schemes, wealth preservation will likely become a paramount objective of individual investors.
100
90
80
70
60
50
40
30
20
10
0
Defined Benefit
Defined Contribution
77
79
81
83
Estimates by Federal Reserve
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
85
87
89
91
93
95
97E
99E
Page 29
MORGAN STANLEY DEAN WITTER
Cyclical Dynamics
Consumer Resilience
Percent
12
10
While real income growth remains
solid, consumer confidence is starting to weaken — an ominous portent
for the US economy.
Index
180
Real Disposable Income (Left)
Conference Board Consumer Confidence (Right)
140
8
6
100
4
60
2
20
0
-2
Jan-80
-20
Jan-84
Jan-88
Jan-92
Jan-96
Jan-00
Productivity growth typically slows
at the end of a long-cycle expansion.
US Unit Labor Costs
Percent
Consequently, we believe that there
is still upside risk to unit labor
costs.
6
5
4
3
2
1
0
-1
Apr-91
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Current Cycle
Forecast
Oct-92
Apr-94
Oct-95
Apr-97
Oct-98
Apr-00
Oct-01E
Page 30
MORGAN STANLEY DEAN WITTER
Inflation Dichotomy
Decomposing the Core CPI
Percent
7
Commodities Less Food &
Energy
Services Less Energy
6
There is a marked contrast between
the inflation dynamic in laborintensive services and that in the
goods-producing sector.
5
4
3
2
1
0
-1
Jan90
Jan91
Jan92
Jan93
Jan94
Jan96
Jan97
Jan98
Jan99
Jan00
Jan01
Jan02
US Cost Squeeze
Percent
6
Unit Labor Costs
5
Average Spread 1990-1996
1.5%
4
There has been a noticeable loss of
pricing leverage in recent years.
Jan95
CPI
Average Spread 1997-2002E
0.5%
3
2
1
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Reversion to the Mean?
Percent
6
Total CPI
5
4
Most still expect inflation to remain
well below its secular norms.
Core CPI
2000 CPI:
3.4%
Implied 10-Year
Inflationary
Premium: 1.67%
3
2
1
0
1950-98
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
ex-1970s
1960-98
ex-1970s
Page 31
MORGAN STANLEY DEAN WITTER
Bond Market Risk
Inflation and the Bond Market
The recent rally in bonds reflects
both a drop in real interest rates and
a sharp reduction in the inflationary
premium.
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Real Rate on 10-Year TIPS
Implied Inflation Premium
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Jan-97 Jul-97 Dec-97 Jun-98 Nov-98 May-99 Oct-99 Mar-00 Sep-01 Feb-01 Jul-01
Net National Saving as a Share of GDP
Percent
15
Total Savings
Unfortunately, a reduction in private
saving appears to be offsetting the
elimination of public sector
“dissaving.”
Private Savings
Government Savings
10
5
0
-5
1960s
1970s
1980s
1990s
01Q1
Social Security Trust Fund Balance
A demographic time bomb will transform the social security surplus into
deficit by 2015 under the baseline
scenario, putting renewed pressures
on America’s fiscal position.
4
2
0
-2
-4
-6
-8
-10
-12
-14
2
1
0
-1
-2
-3
-4
-5
-6
-7
Trillions of Dollars (Left)
Percent of GDP (Right)
2000
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
2010E
2020E
2030E
2040E
2050E
2060E
2070E
Page 32
MORGAN STANLEY DEAN WITTER
The Cyclical Clock
Average Length of Business Cycle Expansion
Months
140
123
120
100
There has been a dramatic lengthening of the business cycle over the
past 140 years.
4 Cycles
73
80
6 Cycles
60
11 Cycles
40
9 Cycles
27
23
1854-1899
1900-1929
46
20
0
1933-1960
1961-1991
Current Cycle
Length of Recent Business Cycle Expansions
Months
140
123
120
The current expansion has now exceeded the long-cycle outcomes of
the 1960s and 1980s, making it the
longest postwar expansion on record.
106
92
100
80
58
60
36
40
20
0
1961-1969
Months
25
The current cycle may bear greater
resemblance to those of the preWorld War II era than to those of the
more recent period.
1970-1973
1975-1980
1982-1990
Current Cycle
Tale of a Different Business Cycle?
Average Length of Recessions
21
20
15
11
10
5
0
1854 - 1945
19 Peacetime Cycles
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
1945 - 1991
7 Peacetime Cycles
MORGAN STANLEY DEAN WITTER
Page 33
U.S. Economic and Interest Rate Forecast
Real GDP and Related Items, 2000-2002E
Forecast Date: June 4, 2001
Year over Year
Real GDP
Domestic Final Sales+
Personal Consumption Expenditures
Business Fixed Investment
-- Structures
-- Equipment
Residential Investment
Exports
Imports
Federal Government
State & Local Government
2000
5.0
5.6
5.3
12.6
9.1
13.7
-0.5
9.0
13.5
1.5
3.5
2001E
1.1
2.0
2.5
-0.6
7.2
-3.1
0.2
-0.2
1.5
2.8
2.1
2002E
3.0
3.1
2.7
2.3
-4.8
5.0
15.9
4.3
6.3
2.7
1.6
Business Indicators++
Nominal Merchandise Trade Deficit
Current Account as a % of GDP
Change in Real Nonfarm Inventories
$459.9
-4.4
55.8
$461.8
-4.2
-14.3
$498.5
-4.4
21.4
1,575
17.2
5.6
4.0
1,666
16.3
-2.5
4.7
1,935
16.8
1.0
5.1
After-Tax Profits
$641.4
-- Percent Change from Prior Year
13.1
Disposable Personal Income (Pct Chg)
2.8
Personal Saving Rate
-0.1
$570.8
-11.0
2.4
-0.3
$621.4
8.9
3.3
0.2
Prices and Costs (Percent Change)
GDP Chain Price Index
2.1
Consumption Prices ex Food & Energy
1.6
Consumer Price Index
3.4
Consumer Price Index ex Food & Energy 2.4
Producer Price Index
3.7
Compensation Per Hour
5.1
Productivity
4.3
Unit Labor Costs
0.7
2.2
2.0
3.2
2.7
3.9
5.6
1.2
4.4
2.1
1.9
2.4
2.4
2.2
5.3
2.5
2.7
Housing Starts (Thous)
Light Vehicle Sales (Millions)
Industrial Production (Pct Chg)
Civilian Unemployment Rate (Percent)
Percent Change
From Prior Quarter**
Q4 to Q4*
2000
3.4
4.5
4.5
10.5
12.7
9.8
-2.6
6.7
11.3
-1.3
2.7
2001E
0.7
1.4
2.0
-4.3
0.7
-5.9
6.5
-1.3
-0.1
3.4
1.8
2002E
4.1
3.9
3.0
7.6
-3.6
11.9
12.3
7.1
7.9
2.4
1.9
Actual
4Q00 1Q 01E
1.0
1.3
2.2
2.9
2.8
2.9
-0.1
2.1
10.4
17.2
-3.3
-2.6
-3.6
2.9
-6.4
-2.7
-1.2
-9.1
3.8
4.9
2.5
4.7
2Q 01E 3Q 01E 4Q 01E
-0.5
-0.6
2.5
-0.4
0.8
2.3
0.8
2.2
2.0
-7.7
-9.7
-1.4
4.3
-8.7
-8.0
-11.6
-10.0
1.2
-2.4
6.0
20.9
-3.5
-1.3
2.2
3.1
3.6
2.8
1.7
4.7
2.5
0.0
0.6
2.0
$488.1 $449.4
-4.6
-3.9
50.5
-25.1
$461.7 $469.2 $467.1
-4.3
-4.4
-4.3
0.1
-19.5
-12.5
1,539
16.2
-0.9
4.0
1,625
17.2
-6.5
4.2
$626.4 $607.2
4.4
-4.3
0.7
2.3
-0.7
-0.9
2.3
1.6
3.4
2.5
3.7
5.7
3.3
2.3
*Annual average for Business Indicators
**Annualized percent change from prior period, unless noted
E = Morgan Stanley Dean Witter Research Estimates
2.1
2.2
2.9
2.7
3.6
5.2
0.4
4.8
2.2
1.7
2.5
2.3
1.9
5.3
3.3
1.9
2.0
2.6
2.9
3.2
4.1
6.6
2.0
4.5
1,554
16.3
-3.6
4.6
1,675
15.9
-6.2
4.9
$572.8 $543.3 $559.9
-11.9
-17.0
-10.6
1.2
7.7
-0.1
-0.8
0.4
-0.1
3.2
2.3
4.2
2.7
5.5
5.2
-0.1
5.2
1.7
2.0
3.4
2.5
4.3
5.2
0.3
4.9
1.5
1.9
1.7
2.5
2.2
5.3
-0.4
5.7
2.0
1.8
2.4
2.4
2.5
5.3
2.0
3.2
+Final sales less net exports
++Billions of dollars; real in billions of chain-type 1996 dollars
Interest Rate Outlook
Fed Funds
Target
Prime
LIBOR
3-Mo.
3-Mo.
6-Mo.
May 31, 2001
01Q2
01Q3
01Q4
4.00
4.00
3.75
3.75
7.00
7.00
6.75
6.75
3.99
4.35
4.15
4.25
3.61
3.75
3.60
3.75
3.56
3.90
3.78
4.00
4.17
4.00
3.95
4.25
4.90
4.20
4.11
4.38
5.37
5.10
4.90
5.00
5.75
5.55
5.30
5.30
02Q1
02Q2
02Q3
02Q4
4.00
4.50
5.00
5.00
7.00
7.50
8.00
8.00
4.50
5.15
5.60
5.60
4.00
4.60
5.00
5.00
4.30
4.80
5.05
5.05
4.60
5.00
5.10
5.10
4.73
5.13
5.23
5.18
5.20
5.35
5.45
5.35
5.30
5.40
5.45
5.35
Date*
1,811
16.0
-1.8
5.0
*All forecast values are for the end of the designated period.
*All forecast values are for the end of the designated period. E = Morgan Stanley Estimates
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Treasury Yield Curve
2-Yr.
5-Yr.
10-Yr.
30-Yr.
MORGAN STANLEY DEAN WITTER
Page 34
Global Economic Outlook: GDP and Inflation
1998
GNP/GDP Growth (%)
1999
2000 2001E
29-Jun-01
2002E
1998
1999
CPI Inflation (%)
2000 2001E
2002E
Global Economy
Industrial World
2.8
2.7
3.5
3.4
4.8
4.1
2.5
1.3
3.8
2.5
3.7
1.2
2.3
1.3
2.6
2.5
2.6
2.3
2.5
1.7
US
4.4
4.2
5.0
1.1
3.0
1.6
2.2
3.4
3.2
2.4
5.3
3.3
–0.4
4.7
4.5
3.6
3.7
4.7
3.5
1.8
1.5
2.1
3.7
3.3
2.7
0.9
1.0
1.3
1.5
1.7
–0.1
4.5
2.7
2.6
4.0
2.6
2.6
2.2
2.2
1.9
Europe
EMU
2.8
2.8
2.5
2.5
3.3
3.4
2.1
2.2
2.7
2.7
1.4
1.1
1.2
1.1
2.4
2.3
2.4
2.6
1.8
1.6
Austria
Belgium
Denmark
Finland
France
Germany
Greece
Ireland
Italy
Netherlands
Norway
Portugal
Spain
Sweden
Switzerland
UK
3.3
2.4
2.8
5.5
2.8
2.7
2.1
4.0
3.2
4.0
2.9
5.7
3.5
3.0
3.3
2.0
3.7
8.6
1.8
4.1
1.6
3.5
9.8
1.6
3.9
0.9
3.3
4.0
4.1
1.5
2.3
3.0
4.1
11.0
2.9
3.9
3.3
4.1
3.6
3.5
3.0
2.1
2.5
1.5
3.0
2.5
1.5
3.2
6.8
2.1
2.4
1.3
2.8
2.8
2.4
1.8
1.9
2.4
2.8
1.9
4.5
2.8
2.5
4.0
8.0
2.6
3.1
2.6
3.0
3.2
3.4
2.2
2.8
0.9
1.0
1.9
1.4
0.7
1.0
4.8
2.4
2.0
2.0
2.3
2.8
1.8
-0.1
0.0
3.4
0.6
1.1
2.5
1.5
0.5
0.6
2.6
1.6
1.7
2.2
2.3
2.3
2.3
0.5
0.8
1.5
2.3
2.6
3.0
3.4
1.7
1.9
3.2
5.5
2.5
2.5
3.1
2.9
3.4
1.4
1.6
2.9
2.6
2.4
2.1
2.7
1.6
2.6
3.0
4.7
2.8
4.4
3.2
3.8
3.7
2.3
1.4
2.0
1.6
1.6
2.3
2.0
1.1
1.6
3.2
4.8
1.8
2.5
2.6
3.2
2.5
1.9
1.3
2.9
Australia
Canada
New Zealand
Emerging Europe
3.2
3.8
4.3
3.7
2.4
2.6
1.6
0.8
1.2
5.6
1.7
4.8
39.2
23.0
21.0
18.2
16.4
Czech Republic
Hungary
Israel
Poland
Russia
Turkey
South Africa
–2.3
4.9
2.3
4.8
–4.9
3.3
0.6
–0.8
4.5
2.1
4.1
3.2
–5.1
1.2
3.1
5.2
5.8
4.1
6.7
7.2
3.1
2.6
4.1
1.6
3.4
4.1
-7.2
2.6
3.5
4.5
4.2
4.7
5.3
5.2
3.1
10.7
14.2
5.5
11.8
84.4
86.7
6.9
2.1
10.0
5.3
7.3
36.6
64.8
5.2
3.9
9.8
1.1
10.1
20.5
56.4
5.3
4.3
8.9
0.5
6.2
15.0
55.8
5.9
4.6
6.5
2.1
5.8
10.0
59.2
4.0
Japan
Asia Ex-Japan
–1.1
2.1
0.8
6.5
1.7
7.3
-0.8
5.4
0.2
6.5
0.6
6.2
–0.3
1.7
–0.6
1.5
–0.8
2.4
–0.6
3.3
7.8
–5.3
6.4
–13.1
–6.7
–7.4
–0.6
0.1
4.6
–10.2
7.1
3.0
6.4
0.8
10.9
5.8
3.3
5.9
5.4
4.2
8.0
10.5
5.7
4.8
8.8
8.5
3.9
9.9
6.0
4.3
7.5
3.2
6.4
2.7
4.5
3.0
2.5
4.1
2.5
2.0
7.8
4.3
6.5
4.0
6.5
5.0
4.0
7.0
4.5
4.5
–0.8
2.8
13.2
58.0
7.5
5.3
9.7
–0.3
1.7
8.1
–1.4
–4.0
4.8
24.1
0.8
2.8
6.7
0.4
0.2
0.3
0.4
–3.7
4.2
3.8
2.3
1.6
4.3
1.3
1.3
1.6
1.0
-1.0
4.5
9.0
4.1
1.7
7.0
1.3
1.0
2.0
3.0
1.0
5.1
6.5
3.0
2.5
6.0
2.0
2.0
2.5
China
Hong Kong
India
Indonesia
Korea
Malaysia
Philippines
Singapore
Taiwan
Thailand
Latin America
2.1
0.1
4.3
3.2
4.4
9.4
8.6
6.5
5.5
5.4
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Venezuela
3.9
0.2
3.9
0.5
4.9
-0.4
0.2
–3.4
0.8
–1.1
–4.3
3.8
1.4
–6.1
-0.5
4.5
5.4
2.8
6.9
3.6
3.2
2.0
3.6
4.5
3.0
3.0
0.5
5.0
3.0
4.0
5.5
3.5
6.2
3.0
3.0
0.7
1.7
4.7
16.7
18.6
6.0
29.9
–1.8
8.9
2.3
9.2
12.3
3.7
20.0
–0.7
6.0
4.5
8.7
9.0
3.7
13.4
0.5
5.1
3.5
9.5
5.5
4.0
15.0
1.0
4.7
3.0
9.0
4.5
4.0
20.0
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
MORGAN STANLEY DEAN WITTER
Page 35
Global Economic Outlook: Interest Rates, Bond Yields, and Currencies
3-Month Euro Rates (%)
Jun 29 Sep01
Dec01
10-Year Bond Yields (%)
Mar02
Jun 29 Sep01
Exchange Rates
Dec01 Mar02
Jun 29 Sep01
Dec01
Mar02
G-3 Countries
US
Euro
Japan
3.8
4.4
0.08
3.9
4.1
0.10
4.0
4.1
0.10
4.4
4.3
0.10
5.4
5.0
1.2
5.3
4.8
1.1
5.4
5.3
1.0
5.5
5.5
1.1
0.85
124
0.96
120
0.91
115
0.95
110
Dollar Bloc
Canada
4.4
4.2
4.3
4.6
5.9
5.6
5.7
5.7
1.52
1.56
1.50
1.48
Non-EMU Europe
Denmark
Switzerland
Sweden
UK
4.8
3.1
4.5
5.2
4.5
2.8
3.9
4.5
2.8
3.6
5.0
5.1
4.6
2.8
3.6
5.4
5.3
3.3
5.3
5.3
5.0
3.3
5.4
5.2
5.4
3.6
5.2
5.4
5.6
3.8
5.1
5.6
7.45
1.52
9.18
0.60
$/GBP 1.41
7.46
1.56
9.25
0.66
1.45
7.46
1.52
8.70
0.66
1.38
7.46
1.56
8.80
0.67
1.42
Note: Data are end-of-period values. European exchange rates are against the Euro except where noted.
More detailed exchange rate forecasts are available in Morgan Stanley’s FX Pulse weekly.
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
E = MSDW Research Estimates
MORGAN STANLEY DEAN WITTER
Page 36
May 29, 2001.
Tipping Point
Stephen S. Roach (Stephen.Roach@msdw.com)
Tipping Point is a delightful little book by Malcolm
Gladwell that made the rounds last year. The thesis is
simple and inarguable: Under certain critical conditions,
the cumulative effect of lots of little things can eventually
make a big difference. Based on the principles of epidemics, Gladwell maintains that many tectonic changes in the
world have come about from very small origins — from
product breakthroughs (Hush Puppies) and criminal activity (New York City’s falling crime rate) to technological
change (cell phone penetration) and medical discoveries
(cancer treatments). The tipping point comes at the moment a slowly starting dynamic reaches a critical mass and
then boils over into an irreversible sea change. I am beginning to suspect that the world economy is nearing a
critical tipping point, one that could pose a formidable
challenge to the US-led strain of globalization.
The Law of the Few. Gladwell has identified three rules
of the tipping point, each of which may well be applicable
to what lies ahead. The first is the Law of the Few — that
epidemics start small, and their transmission is dependent
on the unique nature of the messenger. The US-led downturn in the global economy fits this script to a tee. America
went from boom to bust in just six months, and the rest of
the world has been quick to follow. Underscoring that
point, we have again cut our below-consensus global
growth forecast, trimming our 2002 estimate for world
GDP growth to 3.7% from 3.9%. At work are downward
adjustments to Euroland, the UK, Malaysia, Hong Kong,
and Taiwan. Once again, I would stress that we may not
be done yet. I would continue to place the downside risks
to our 2002 global growth forecast in the 3.0–3.5% range.
Moreover, our downward revisions to 2002 follow yet another reduction to our near-term prognosis. We have just
pared our 2001 GDP forecast for Mexico, to 3.0% from
3.3%, and we think the odds are rising that currencyinduced pressures on Argentina will spill over into Brazil.
Nor does there appear to be any let-up in sight from the
original instigator of this global slowdown — the United
States. That was hammered home by a downward revision
to the government’s original estimate of 1Q01 GDP
growth, to 1.3% from 2.0%. On a revised basis, we now
expect world GDP growth to average 3.2% over the 2001–
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
02 interval — 0.5 percentage point below the longer-term
trend of 3.7%. The persistence of such subpar growth is
what could lead to a tipping point.
The Law of the Few tends to spread because of what
Gladwell calls “connectors.” Globalization, of course,
rests on the foundations of such connectivity — through
capital markets, cross-border trade, and information technology. Thus, contagion is likely to be the rule rather than
the exception. That’s especially the case as the world
economy loses its major source of dynamism, a once highflying US economy. With the rest of the world lacking in
self-sustaining domestic demand growth — especially an
IT-dependent Asia, a NAFTA-dependent Canada and Mexico, and a global-trade-dependent Europe — it is all the
more susceptible to a US-led downshift. Lacking a candidate to fill the void, an engineless world is more vulnerable
to contagion than a more balanced world would be.
The world economy could be nearing a
critical tipping point that challenges the
US-led strain of globalization.
The Stickiness Factor. The second rule of the tipping
point is the Stickiness Factor — the tendency of an important trend to become increasingly entrenched as it
spreads. That’s what the globalization of the New Economy is all about. The rapid growth of e-based connectivity
makes it virtually impossible to turn back the clock on this
new era of global commerce. The worldwide build-out of
a telecommunications infrastructure is a given. The questions pertain more to efficiencies on the supply side —
both profitability and capacity excesses — than to the demand side of this equation. Like it or not, such stickiness
probably solidifies the dependence of the rest of the world
on this US-led strain of globalization.
So, too, does the rapid expansion of global trade. By our
calculations, world trade hit a record of close to 25% of
global GDP in 2000, more than four times the share prevailing in 1970. Now this trade dynamic is running in reverse. Our estimates suggest that the nearly 13% surge in
2000 will be more than cut in half in 2001. The confluence
of e-based and trade linkages underscores the stickiness of
MORGAN STANLEY DEAN WITTER
globalization — yet another reason to stress the heightened
possibility of cross-border spillovers, or contagion.
The Power of Context is the third ingredient of
Gladwell’s tipping point. It speaks mainly of the sensitivity of individuals to their environment — and to forces that
may prompt unexpected and/or unusual reactions to such
conditions. Here, again, the context is globalization. As I
see it, the individual sensitivities that most stand out could
well be on the dark side of globalization, namely, widening
income disparities between the haves and the have-nots.
The risk is that these growing inequalities could worsen in
the context of the new strain of globalization. That could
arise from the “digital divide” — whereby the profusion of
new information technologies exacerbates the disparities
between the computer literate and those lacking such skills.
That sets up a tug-of-war, not only within nations but also
across borders, that could strain the fabric of globalization.
Page 37
the costs. In tougher economic times, that resistance can
only intensify. Protectionism is antithetical to everything
that globalization stands for. However, if a backlash arises, protectionism could be the gravest risk of all.
Second, any ascendancy of labor could well push the pendulum of economic power away from the decidedly procapital position it has occupied for much of the past decade. The effects of such a development could be manifested in two forms — sustained corporate earnings pressure
and/or higher inflation. Inasmuch as a persistently sluggish global economy hardly points to a restoration of pricing leverage, the cost pressures arising from a backlash
should take a disproportionate toll on business profits. In
the climate we envision, such cost pressures will squeeze
margins rather than trigger inflation. Inflation scares will
turn out to be false alarms, and earnings rebounds will end
up being short-lived.
Those tensions seem likely to be all the more acute in a
sluggish growth climate. It’s not that vigorous growth is
the rising tide that lifts all boats. But to the extent that it
does spark rapid hiring and income generation, it can temporarily mask economic hardship. Sluggish growth, by
contrast, unmasks the pain. The new math of the New
Economy leaves little doubt of how this downside plays
out. In the boom phase, scale and scope were everything.
Hypergrowth was the stuff of open-ended IT spending and
rapid hiring. The math of subpar growth turns these trends
inside out. As growth slows, cost excesses must come out
of the system, eliminating overhangs in both capital accumulation and hiring. In the jargon of the tipping point,
rapid growth is a very favorable context for globalization.
The risk is that subpar growth may not be.
A third potential impact of such a backlash could show up
in the form of an especially sharp toll on the perceived
rates of return on dollar-denominated assets. The dollar
looks especially vulnerable to me in this regard. I am the
first to concede that I have held this view for longer than I
care to remember. Yet I continue to believe that the offshore overhang of US dollars brought about by a record
current-account deficit leaves the United States highly vulnerable to the whims of ever-fickle global investors. I still
maintain that the day will come when global investors demand a premium for holding dollar-denominated assets.
When that occurs, then something has to give — either the
dollar, US equity prices, or bond yields, or some combination of the above. Financial markets are totally unprepared
for such a possibility.
What are the implications of such a backlash? Three
key possibilities come to mind — the first being that trade
liberalization might give way to some form of protectionism. To the extent that slow growth prompts mounting
layoffs, the political winds could well shift. The outcome
might lead to the erection of new competitive barriers that
would supposedly shield workers from the harsh winds of
globalization. The body politic is already sympathetic to
just such a possibility. From Seattle to Quebec City, recent
demonstrations of antiglobalists drive this point home. So,
too, do public opinion polls revealing that US workers oppose several aspects of globalization — especially trade
liberalization, immigration, and foreign direct investment.
Even during goods times, according to these polls, the benefits of such trends are thought to be largely outweighed by
Tipping Point is a great read and a provocative intellectual
exercise. It is also well grounded in reality, fitting the
script of many a Big Change in the world. Like all such
historical analytics, however, it works best after the fact,
lending itself all too well to the classic rearview mirror
critique. The problem, of course, is knowing whether a
tipping point is actually at hand for the global economy.
That’s what intrigues me the most. The US has been on an
extraordinary ride, and the rest of the world may simply
have become overly dependent on the American way. It is
the excesses of that ride — and their likely purging — that
might lie at the heart of the next tipping point.
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
MORGAN STANLEY DEAN WITTER
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 38
MORGAN STANLEY DEAN WITTER
The New Global Contagion
Page 39
June 19, 2001
Stephen S. Roach (Stephen.Roach@msdw.com)
technology (IT) cycle, and the European manufacturing recession starting to broaden out, the world economy is essentially
The global currency crisis of 1997–98 was widely billed as the engineless — lacking a new source of growth to fill the void
first recession of the era of globalization. Like a fast-moving left by a once-booming US economy. Without an alternative
epidemic, the contagion of cross-border currency depreciation growth engine, the global economy is probably now in recesswept the world for 18 months — from Thailand in mid-1997 sion.
to Brazil in early 1999, and many points in between. Today, a
new strain of contagion is at work. And it could be even more
A new strain of global contagion is at
lethal than the financial-market contagion that afflicted the
work — driven by world trade, globalworld 3–4 years ago. It’s a contagion across the real economies of the world, transmitted by the confluence of crossized supply chains, and powerful multiborder trade, globalized supply chains, and multinational cornational corporations.
porations. And the risk is that this new global contagion has
only just begun.
To a large extent, this global recession is traceable to a new
The impact of a US-led economic slowdown on the rest of strain of contagion — enhanced connectivity that both amthe world is one major channel for this new strain of con- plifies and accelerates the linkages between the real econotagion. America’s role in precipitating this contagion is un- mies of the world. Three types of linkages are at work, the
first being cross-border trade. According to our estimates,
derscored by the downward revisions we have made to our
global trade now accounts for nearly 25% of world GDP, esglobal forecast in recent months. Our 2001 world GDP
sentially double the share prevailing in the 1970s. With the
growth estimate now stands at 2.4%, down sharply from the
major economies of the world simply trading more with each
4.2% prognosis that prevailed as recently as October 2000.
Fully 35% of that reduction is traceable to the direct effects of other, fluctuations in one country quickly spill over into other
countries. That’s especially the case when the world’s largest
cuts we have made to our US growth estimates; our current
economy — the United States — screeches to a virtual standUS GDP growth forecast for this year stands at just 1.1% —
less than one-third the 3.7% growth pace we were forecasting still as it did in the latter half of 2000. Foreign trade accounted for about 15% of US GDP in 2000, nearly double the share
last fall. The balance of the reduction to our 2001 global
prevailing over the 1980s. This increased openness of the US
growth forecast stems from cuts we have made to the rest of
economy is a double-edged sword; when America booms, the
the world, especially Europe, non-Japan Asia, and Latin
rest of the world benefits, but when America sneezes, the rest
America. Moreover, we have just cut our below-consensus
of the world can quickly catch a cold.
2001 growth prognosis for Japan to –0.8% from +0.2%.
It should be no surprise that the US economy has led the
world to the downside. After all, it played a disproportionate role in driving global growth for the past five years. In
1995 through 2000, our estimates suggest that the 4.5% average annual expansion of the US economy directly accounted
for 26% of the cumulative increase in world GDP. Adding in
the indirect effects of US imports from non-Japan Asia, its
NAFTA partners, South America, and Europe, the US appears
to have accounted for about 40% of the total increase in world
GDP over the five years ending in mid-2000. Courtesy of the
dramatic slowdown in the US economy that has subsequently
occurred, that 40% contribution is now in the process of going
to zero. Moreover, with Japan back in recession, non-Japan
Asia getting hit hard by the downturn of the US informationGlobal Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Increasingly globalized supply chains are a second characteristic of the new global connectivity that magnifies the crossborder impacts of a US-led slowdown. This, of course, is a
by-product of the worldwide trend toward outsourcing — the
creation of a network of offshore suppliers that reduces the
cost of production in the industrial world. Non-Japan Asia has
led the charge as the world’s leading IT outsourcer. Our
greater China economist Andy Xie estimates that IT exports to
the US accounted for as much as 40% of non-Japan Asia’s
total GDP growth in 2000. America’s NAFTA-based supply
chains are just as well developed. US exports account for
25% of Mexican GDP and 32% of Canadian GDP. Given the
extent of the linkages in global supply chains, America quickly exports the macro impacts of any inventory adjustments to
MORGAN STANLEY DEAN WITTER
Page 40
its offshore outsourcers. Little wonder that growth prospects last 50 years — the recession of 1990–91, when export growth
are now fading quickly in non-Japan Asia, Mexico, and Cana- slowed to an anemic positive comparison of around 3%, and
da. Those are the footprints of the new global contagion.
the contraction of 1960–61, when exports declined by only
about 2%. But exports generally decline during a global reThe increased role of multinational corporations in the world cession, and I am hard-pressed to believe that this time will be
economy is a third means by which the new global contagion an exception. The same verdict comes through loud and clear
is conveyed. Joe Quinlan, our resident expert on transin our own internal estimates of global trade. We now reckon
national flows of multinational corporations, has long stressed that world trade growth will slow to just 4.3% in 2001, onethat the trade statistics on exports and imports seriously under- third the 12.8% growth pace of 2000. That would represent
state the full extent of commercial linkages that bind the
the sharpest year-to-year slowdown in global trade on record.
world’s economies together. Of far greater importance in
The case for US export resilience in such a climate is a stretch,
driving cross-border linkages are the combined balance-sheet to say the least.
impacts of foreign direct investment and foreign affiliate sales
and transfers of multinational corporations. This is particular- All this suggests that there could still be several shoes yet
ly the case in Europe, which accounts for 75% of all earnings to fall in the US economy. The American consumer is high
of US-based affiliates of multinational corporations. Signifi- on everyone’s watch list, but, in my opinion, exports aren’t too
cantly, sales of Europe’s US-based affiliates were running at far behind. With exports accounting for about 11% of the US
nearly four times the pace of US imports from Europe in 1998 economy, our forecast of 7% export growth in 2002 accounts
(latest data available). For that reason, alone, Europe’s direct for nearly 20% of the 4% growth in overall GDP we are estiexposure to the US through cross-border trade — with Euro- mating over the four quarters of next year. That means every
land exports to the US accounting for only 2% of the region’s five-percentage-point shortfall in export growth — not an unGDP — misses the true vulnerability of the region to a US-led reasonable assessment of the downside risks to our own foredownturn (also see comment by Charles de Boissezon). The cast, in my view — would translate into a 0.5 percentage point
American downshift is hitting the US subsidiaries of European haircut on overall GDP growth. Of course, any such shortfall
multinationals especially hard. That, in turn, puts pressure on would then trigger a new round of global repercussions
the parent to cut costs in order to shore up global earnings.
through America’s offshore supply chain, further exacerbating
Add to that the 15% share of Euroland GDP that goes to exthe downshift in the world economy through yet another wave
ports — greater than shares in either the US or Japan — and
of cross-border contagion.
it’s not terribly difficult to fathom why the European economy
There can be little doubt of America’s outsized role in
is now slowing noticeably.
sparking the current global downshift. The very fabric of
The US response to global weakening is another manifesta- globalization is woven with the threads of increased worldtrade linkages, newly globalized supply chains, and the growtion of the new strain of contagion bearing down on the
global economy. With the growth dynamic in the rest of the ing scope of multinational corporations. In an upcycle, such
world slipping ominously toward recession, risks are building connectivity is the stuff of virtuous circles. In a downcycle,
of unexpected weakness on the US-export front — driven not the circle quickly turns vicious. Courtesy of the new contajust by slippage in the external growth climate but also by the gion of globalization, these shifts are now coming faster and
lagged impacts of the prolonged strengthening in the US dol- with greater force than ever before.
lar. We are currently looking for US exports to rebound by
7% over the four quarters of 2002. In light of the rapidly dete- On the heels of the US growth crunch, the world has gone
from boom to bust in less than a year. Sure, the authorities are
riorating global climate, I believe that the risks are tipping
trying to kick-start the US and the broader global economy.
decidedly to the downside of this forecast.
But just as virtuous circles tend to last longer than we think,
In past recessions, the peak cyclical decline in real US exports the same could be true of the vicious circle. Such are the perwas in the 6–20% range. There were two exceptions in the
ils of the new global contagion.
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
MORGAN STANLEY DEAN WITTER
Global Investment Research – July 2001
Please refer to important disclosures at the end of this report.
Page 41
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