 Well, good afternoon. First of all, how's the sound? Are we coming through in the back? I want to take a minute here of mourning and pitying Kathy for having to sit through this talk twice today. At the end of this talk, be sure to ask her about the law of diminishing marginal returns in economics. Pleasure to be here with you today in the future home of the Santa Cruz Warriors, very exciting developments happening. So that's very good news. My job at Comerica is to have lots of different jobs. One of the things is to advise senior executives within the bank about overall economic conditions. Another thing that pulls me out of the bank is doing talks like this, which I really enjoy doing, because I haven't been with Comerica that long, which is my way of saying it wasn't my fault. I've been coming up on my first anniversary. It's very important to come out into the community as a Comerica supports and to talk with local business leaders and really get a good sense of what's going on. As part of that role, I am responsible for ruining people's lunches, ruining their breakfast, ruining their dinners. But today, we're going to try and give a little more of a balanced talk. Economics as a profession really has doubly earned its reputation as the dismal science over the last few years. There hasn't been a lot of tremendous good news to talk about. But I think we're on a turning point in the economy. Now, there's certainly events here in California out of another layer on top of that with the big misses on the California state budget. I will try my best to avoid any questions that have to do with local politics. But go ahead and fire away at the end of this. So the standard economic talk is where we come from, where we now, and where we're going. So let's go ahead and dive into this. As you all know, the Great Recession, the second worst economic event of the last 100 years, an event that will probably leave an indelible imprint on us, just like the Great Depression left on our grandparents and great-grandparents. It ended technically in June of 2009. We're almost three years into a so-called economic recovery. And I have to ask you, are you having fun yet? And the answer I get, say a year ago, was universally no. The good news is the answer now depends on who I ask, where I ask it, and what business they're associated with. I mean, certainly, if you're a durable goods manufacturer in the upper Midwest and you're connected with the auto industry in some way, shape, or form, you're saying, yeah, things are getting better. If you're a driller for petroleum and the Dakotas in Pennsylvania with the Marcellus Shale in Texas, you're saying business is great, except maybe natural gas. We'll talk about that in a little bit. But here in California, if you're involved in residential real estate, Florida real estate markets, Phoenix, other places like that, you're saying what recovery. And we do need to talk about that. We do need to talk about why this has been somewhat of a hobbled recovery and what's going to change, I think, going forward. What's going to stay the same and what's going to change? Now, in order to understand the somewhat hobbled recovery, incomplete recovery that we have, I put three sets of factors that I think are critical to really understanding the trajectory of the economy right now. And the first I'm going to call short-term or transient economic events. Now, Federal Reserve Chairman Ben Bernanke used this term transient events last year, almost a year ago, coined the term really in terms of the popular media, talking about the high energy prices in early 2011, the very bad weather that happened in the first quarter of 2011, and then, of course, the Japan disaster resulting in supply chain bottlenecks around the world coming back to affect the US in terms of disrupting auto production and things like that. Now, the thing to remember here is that there's nothing new about transient events. They are always going to be with us. What is new for this economy is that in a low to moderate growth economy, we have to watch out for them. And the analogy is this, very simple. When you're cruising at 30,000 feet, you hit some turbulence. There's always going to be turbulence, right? In a low growth economy, cruising at the treetops, you really have to watch out for the down drafts. And in a one and a half to two or 2%, two and a half percent economy, we do have to watch out for them. We've already hit some transient events this year. We've hit high energy prices, deja vu all over again. We went through a cycle of high energy prices. We had some weather events that actually worked in the other way. We had positive weather events, very good weather, warm weather in late 2011 and December. And then January and February of this year, artificially boosted a lot of economic data. And then we see ourselves coming down off the other side of that. And there's always going to be natural disasters. The situation in Japan, pick your favorite disaster, it's going to happen. And so in a low growth economy, we simply have to be a lot more aware of these issues and think about how they affect us both nationally and locally. On a more structural level, we have to talk about medium term economic effects, factors that are going to be with us for maybe another year, two, three or four years after that. And first and foremost is the housing market and California being one of the epicenters of the housing meltdown. I really don't need to explain this to you. I'll just say if you're Joe and Jane average across the US and you bought your house for $300,000 in 2006, congratulations, you now own a $200,000 house. House price is down a third in value nationwide, a tremendous drag on the overall wealth of most households for most peoples or primary investment. So a huge negative wealth effect on the economy. A negative wealth effect if you look up your macroeconomics 101 in the glossary, it says negative wealth effect, I feel lousy. That's all it is. I feel much less wealthy. I don't have the equity in my home. I can't pull it out and go shopping, things like that. And that brings us right to point number two, the consumer. What's different about consumer spending now than say four or five years ago? Well, we're used to thinking, and I'll put it this way. When I started as a professional economist way back when I was about this tall and I had a full head of hair and it used to be an economic chestnut that said never underestimate the power of the consumer to drive the economy forward. And the subheading of that was never underestimate the power of the consumer to spend more money than they have. Well, how can a consumer spend more money than they have? Well, they did it in the 90s and we did it again back in the 2000s. You can do that three ways. One, you can pull the equity out of the home. You can do the cash out, refi and give your kids $10,000 to pay for college and you take 5,000 and go to Vegas. And that's the way the split usually goes. You can ramp up your credit card debt, right? And that's what we did, we leveraged up and you can drive your savings rate down, essentially save no money. And that's exactly what happened. The national saving rate went down to about 1% before the recession. We're now back up to about 4.5%, which is good news. Every little bit helps. It provides more insulation for households. But let's think, every extra dollar that I save is good for the long term, but it's a dollar I'm not spending. So there has been a drag on retail sales because of that. And then the final medium term factor, state and local government. And for many states, unfortunately, I would say this is a factor that is ending. If I went up to Pennsylvania or Michigan or someplace like that, I'd say, well, state and local finance is starting to look better. And I don't really have to tell you that California is still in the thick of things and you know better than I, big revenue shortfall at the state level and ongoing issues that are gonna roll down to the municipalities. If you total all state and local spending across the country up, it is 50% larger than federal spending. And of course, the states and the municipalities can't do the deficit financing that the federal government can do. So there was immediate cutback in total government spending as a result of the recession. By and large, we're starting to come out of that. But of course, there's like the Robert Frost poem, there's some more miles to go here before we sleep to really put that issue behind us. And then finally, some longer term economic factors to think about. If I did a poll of this audience and most audience and I asked you, I'll answer my own question, the easiest kind of poll, I answer my own questions and never fails, right? So I'll ask you, what do you think overall economic growth should be in a fully functioning U.S. economy? You're gonna tell me 4%, 5%, maybe the optimist out there, 6%, fully functioning U.S. economy. I'm gonna dial that back and say that in this particular period of time we're in right now, a fully functioning U.S. economy grows about three to three and a half percent. It doesn't mean we're doing anything bad. It simply means we're at a different part of our economic development in terms of the overall productivity cycle and labor force growth and things like that. China, maybe potential GDP in China is anywhere from six to seven to 8%, but they're an agricultural economy developing into an industrial economy or an industrial economy developing into a post-industrial information age economy, so a different part of our economic cycle. And then finally, of course, federal government spending. We are in an era of fiscal tightening. There's no way to get around that. Secretary of Defense Panetta has already publicly acknowledged that the Defense Department cannot support a military force that can fight two wars simultaneously, like we've had, they are scaling back one war and some type of smaller conflict. So the cuts are coming. And that sort of brings me to what I think is a very, very serious point and an action point for everyone in this room. And that's the upcoming fiscal cliff. You may have heard about this. If nothing else changes from today, the Bush-era tax cuts are gonna expire at the end of this year. The Obama-era tax cuts are going to expire at the end of this year. So big effective tax increases at the same time that the automatic cuts from the failure of the super committee, remember them from last year, super committee did not come up with any kind of agreeable plan. So automatic cuts are in store in defense, particularly, and many other parts of the discretionary budget. So we go to big effective tax increases at the same time that spending comes down, massive fiscal tightening in store if Congress doesn't do anything. Now my expectation is that after the election, a lame duck Congress does round the shoulders off the fiscal cliff, which means being smart about how to let maybe some of the provisions of the tax cuts continue, maybe some of them phase out gradually, some reduction in spending. But we wanna do this in a smart way. Right now there is a huge blunt instrument about to come beating down on the head of the economy if nothing else changes. So my hope is that Congress does the right thing and thinks about how to do this in a very smart way. Now I can do another poll here very quickly and say how many of you have a lot of faith in Congress's ability to do the right thing in the smart way. All right, so there we go. But my expectation is that the shoulders of the fiscal cliff do get rounded off. We do see a little bit of headwind going into 2013, but not enough to derail the economy. So where are we now? If there is a bright spot in the US economy is durable goods manufacturing, a particularly auto related manufacturing. Car sales, speaking of cliffs, fell off the cliff during the recession down to a nine million unit pace or a backup to a 14 and a half million unit pace. The great thing about cars in Detroit figured this out a long time ago, they wear out. They have to be replaced. And for many financially strapped households they're gonna keep their car going even if they lose the house. You gotta have the car to go to work. So essential part of their ability to function economically. Incidentally, complete sidebar here. We're gonna sell 14 and a half million units in the US in terms of auto sales. How many auto sales in China this year? Let's pick a number, 18, 19, maybe 20, right? So the future of the auto industry is really Asia. The markets there are expanding very, very rapidly. Another key factor for the economy right now is improving measures of both consumer and business confidence. I'm gonna discount the consumer confidence numbers a little bit. They really go up and down with the stock market and gasoline prices. Consumer confidence is a phone survey. How do you feel about the economy? I feel lousy. Okay, great. I feel so lousy when the going gets tough, the tough goes shopping. Consumer confidence does not equal consumer spending. Very sort of soft survey. The business confidence numbers I pay a lot more attention to. They measure very specific things like how much are you going to invest in capital this year? How many people are you hiring? Things like that. And the good news there for both measures really is we're starting to see some lift. Typically in a recession these measures of confidence come down hard and they come right back up the classic V shape. What we've seen over the past couple of years and what's made this recovery so challenging, they came down hard all right and then they pancake flat. Toward the end of 2011 and early 2012 we've seen some lift which is very, very good news particularly on the small business side particularly small business hiring is starting to come back. You can understand, we can all intuitively grasp what has caused the caution on small business hiring. A large business, IBM, Xerox pick your favorite company, they add a few employees or adding a very small percentage to their workforce, right? Local mom and pop company with five employees, you add one, you're expanding your workforce by 20%, a huge commitment. So you want to have some confidence about the economy before you do that. The good news, hiring at the small business level is coming back because of some of that hiring the unemployment rate is now down to 8.1% still very much higher than we would like but significantly better than 10.2% a couple of years ago. Now I can't stand up in front of you without being the classic two-handed economist. I'm gonna say on the one hand the unemployment rate has come down for good reasons about half the unemployment rate for good reasons. On the other hand, about half the improvement in the unemployment rate due to not so good reasons declining labor force participation rates simply means that fewer working age adults as a percentage of the overall population are in the labor force. Prior to the recession, we saw declining male labor force participation rates. We've seen that for a decade and a half, two decades. And to balance that, we've seen an increase in female labor force participation rates. As you all know, more and more women entering the workforce. Since the recession, we've seen both of them hooking down. So both men and women on net are exiting the workforce which is bringing the unemployment rate down but for not entirely the best of reasons. The Federal Reserve remains very much in the news. They are committed to Federal Reserve Chairman Bernanke has made an unprecedented promise to keep short-term interest rates low until the end of 2014. He can do that because his term expires in the beginning of 2014. So here's where presidential politics matter. Romney gets elected, Bernanke's not gonna be reappointed. The Fed may raise interest rates before the end of 2014. President Obama gets re-elected, Bernanke stays then, he can fulfill his promise. So there is a political spin to the Fed's promise right now. They are still engaged in Operation Twist which is the program of selling short-term assets, short-term bonds and buying long-term bonds. But the idea of twisting down the long end of the yield curve or keeping long-term interest rates low and you can see that in your 30-year mortgage rates right now. Historically low, hovering around 4% or so depending on which ones you're looking at. Operation Twist was actually first tried about 1962, 1963 and the name does actually come from the twist when Chubby Checker was twisting away. It's a good thing they didn't try this in 1976 when we were doing the funky chicken and all that sort of thing. I don't know what it would look like but I'm just glad about that fact. All right, so inflation measures are easing. We have had a push from energy prices, national average gasoline price. A few months ago it was up to 392 a gallon oil. West Texas Intermediate up to 110 bucks. Now down to 95. For most parts of the country, gasoline prices are on their way down. Now don't you feel special being here in California? Gasoline prices have actually ticked up a little bit. For some strange reason, I don't know why this happens. All the refineries tend to shut down and go through maintenance and gear up to their summertime production all at once and that drives gasoline prices up in the short term. I'm sure it's pure coincidence but it seems to happen year after year after year. Now once we get through this cycle, I do think we'll see some more easing of gasoline prices here locally because crude oil prices are on the way down. Saudi Arabia has made very public commitments to increased production. The world is awash in hydrocarbons. The only thing that's keeping hydrocarbon prices elevated even up to this point are geopolitical tensions right now and it seems to me at least a mild dialing down of tensions between Iran, US and Israel. All right, domestically election year as you all know, I think the Democrats are gonna spend an awful lot of time telling you how bad the Republicans are. The Republicans are gonna spend as much time telling you how bad the Democrats are and nothing gets done in Washington so nothing new really coming out in terms of tax reform or anything like that until we get through the election cycle. The Eurozone remains very much in the news, a grease being the tail that's wagging the rest of the world economy. How big is the Greek economy? Well, let's put it in perspective. At the beginning of the Eurozone crisis a couple years ago, the Greeks represented 3% of the Eurozone economy. Today they represent 1% of the Eurozone economy. If you put it all together, what does the Greek economy do? It exports beaches and olives and that's about it. It's about the size of the Philadelphia metro area in terms of economic impact. Why is it so important? Well, it's not the magnitude of the situation but the potential for contagion default through the rest of the European economies. Because Greece has already defaulted, they're in technical default, they're not paying the interest on their bonds. There has been a bailout package approved by the European Central Bank and the other European leaders and now that package is out the window because of the change of government in Greece. So until the political situation stabilizes in Greece, there's not a functional agreement. My sense of the matter is that the Greek politicians are really maneuvering public opinion at this point to make sure that everyone in Greece blames the rest of the Eurozone for how terrible these austerity conditions will be. They will go ahead and implement them but they're really shielding themselves from a political fallout. So it's a political maneuver. My expectation is that Greece does not lead the Eurozone. The downside of that is absolutely almost incomprehensible. When you think about it, if Greece was to lead the Eurozone, what would happen? Well, they have to reissue a currency, right? They would be under tremendous pressure not to let institutions fail, businesses go bankrupt, et cetera. So they would likely go into a state of monetizing their economy, crank up the printing process, hyperinflation, driving down standard living everywhere, virtually overnight becoming a third world economy and most importantly, losing all the revenue sharing that happens within the European Union. It would sincerely be cutting off their nose despite their face. So I think Greece has tremendous incentive to stay in the EU. Now the risk, of course, is with Greece in default and this very unstable political situation, all eyes are now on Italy and Spain and the larger European economies that really do matter to the global financial sector as long as these credit spreads don't blow out in Spain and Italy, I think we can see Europe muddling through this crisis one step at a time. So we have a sovereign debt crisis which has contributed to a banking crisis because the European banks hold all this debt. I'm a European bank and the assets that I'm holding are now worth 30 or 40 cents on the dollar so my capital ratios are out the window and I can't lend money. So we go from a sovereign debt crisis to a banking crisis to a private sector global or eurozone-wide economic crisis. Most Southern tier European economies are in deep recession, Greece, Italy, Spain, Portugal. The core of Europe, Germany and France are in mild recession. Northern Europe probably skirting recession so it's a very geographically based recession right now. The farther south you go in Europe, the worse it gets. You put it all together and the EU as a whole is in mild recession, mild to moderate recession this year. Why is that important to us? Oh, for three key reasons and I'll go through them in order of importance and it's sort of counterintuitive. The least important but still significant part of it is 20% of US exports go to the eurozone. So it does hurt our ability to export so it hurts US companies that export to the eurozone. Another important reason is the fact that the eurozone is a source of investment funds for many developing countries worldwide so investment dials down, global economic growth dials down because of that. But the biggest reason and the hardest one to quantify is the fact that the eurozone financial institutions occupy a significant space in the US financial industry, the so-called shadow banking system, the unregulated banking market. And so here's a situation that we do have to watch out for. Perhaps the eurozone crisis escalates, we get into full-blown banking crisis, a massive liquidity contraction in the eurozone, a pullback of those assets in America back to Europe and we find a big gaping hole in our financial system here which would require federal reserve intervention. So that's why we have very much a vested interest in stabilizing Europe and that's why the federal reserve system has engaged in currency swaps and all these other things to help stabilize Europe, definitely in our best interest. Asia also facing challenges, China cooling down from a nine to 10% GDP growth rate in the range of seven, maybe six and a half, seven percent or so, India likewise, Japan coming off the other side of their post-earthquake rebuild so their growth is starting to cool down. So right when Europe is really hitting the skids, we're seeing less growth in Asia so the concern right now is this cooler global macroeconomic environment is really not helping things. Now my hope and my sense is that there is enough endogenous growth within the US to overcome these external drags but that's really the knife edge that the economy is balanced on right now and that does flavor my forecast for the next couple years. All right, so that's where we've come from, where are we now and where are we going? This is a graph showing my gross domestic product forecast for the next couple of years. Blue bars there are history and we see the big down cycle through 2009 GDP falling at one point at a 9% annualized rate. We haven't seen a free fall like that in quite a long time, I hope we never do again. Coming out of 2009 into 2010 we see the nice up cycle and then we hit something else, it changed, right? And that's when the debate really started about what's different about this recovery? It's not classic up, up and away, it's somewhat tepid. We get into 2011, we almost go back into double dip recession. Most people I think don't realize how close we were in the first half of 2011, that first quarter 0.4% growth, second quarter is just about 1%. The good news in the 2011 story is that every quarter we saw more growth, finishing at 3% in the fourth quarter. About half of the growth in the fourth quarter came from inventory accumulation, which is fine but we can't count on that quarter, after quarter, after quarter. Pretty soon businesses are up to their gills in inventory and they're not gonna produce. What we're seeing in early 2012 is a correction on the inventory cycle. So that's why I bring growth down back closer to 2% for the first half of 2012 and then elevating a little bit and then again we see a little bit of headwind, fiscal drag from the fiscal cliff in early 2013. Now what's that green line doing in that chart? Very important green line at 2% GDP growth. The reason why the green line is in that chart is that represents a cutoff point for me between saying on the south side of that line, below that line we can be in a technically expanding economy that doesn't really feel like it's recovering. Above 2% growth then we have the rising tide that lifts all boats. Why is that true? Well I have to do my Richard Nixon impersonation to illustrate this point and you'll see this when I get into it. The reason why that's true is you can take two numbers. The first number we'll call 2% long-term productivity growth which means as an economy we continue to do more with less. Productivity growth is a good thing for the US economy so 2%, right? So you know where I'm going with this, right? Let's take another number, 2% GDP growth, here it is. You put those two numbers together and you can have a technically expanding economy as zero to 2%, we're still expanding but we're not generating any new jobs. So we have to be above 2% to feel like we have a rising tide to lift all boats. The leading edge of the economy is lifting the lagging edge. Throughout most of 2011 we didn't feel like we were there and that's why, you know, and that feeling that most people had is absolutely true. It was an expansion but things really weren't getting a whole lot better. We remain uncomfortably close to that 2% line. I think we start to feel like we're above it but there's enough uncertainty here that I would watch that very carefully and I think for the first half of this year we'll be right on the edge. All right, labor market conditions, the blue bars there represent monthly job creation. We see the big surge in December, January and February, weather aided, things like temporary hiring elevated during that period and it looks like we got a little bit ahead of ourselves, a little bit over our skis in terms of hiring. We get back into April, excuse me, March and April, the last two data points on the right and we see the cycle back down. Now, April at 115,000 jobs is not enough to sustain a recovery. I am hopeful and my expectation is we start to come back up because if you look at the broad set of labor market data out there, not just the BLS numbers, Bureau Labor Statistics but all the other stuff, it's they're starting to look like, yeah, this was just a temporary cycle. We have to watch that very carefully. We need to be in the range of about 150,000 jobs per month on average, we can fluctuate around that but 150,000 jobs per month on average or more to feel like this is a self-sustaining economic expansion. If you look at the red line below that, that's the unemployment rate on the right-hand side scale it's very easy to follow this. Look early in 2011 on the left-hand side of the graph, we had some nice job creation numbers, the unemployment rate came down, it dips down. We stall out through mid-year 2011, the unemployment rate actually increased slightly. We go into this nice surge in December, January, February brings the unemployment rate down again. So we need to be above that range of about 150,000 jobs per month. I tend not to look at the unemployment rate as a key metric for the economy. It can be very misleading because it can go up and down for good and bad reasons. What I look at and what I would encourage you to look at are the simply the payroll job gains, the raw number of additions to the jobs. 150,000 or more is what we need to sustain the recovery. All right, inflation very much in the news. We did get a surge this year from higher energy prices but we are now in a period of disinflation. That doesn't mean deflation, economists like to coin incomprehensible words and here's a whole set of them. Inflation is when wages and prices come up together. Now I just said something very important because we focus on the prices. It has to be a wage price spiral because unless, if prices go up but not wages, it's a self-correcting phenomenon, right? Prices go up, my wages aren't, so I can't buy anymore so demand falls and prices come back down. So real true inflation is wages and prices coming up. Disinflation is when the rate of that increase in prices goes down and that's what we see after prices spiked in 2008, we're coming back down to the zero line, that's a disinflation, we go below the zero line, that's deflation. So we are in a period right now of disinflation, reducing inflation. That gives the Federal Reserve a little more operating room and probably a little more push to go into another round of quantitative easing. I said operation twist continues through June. What happens after June? My expectation is if we have continued soft data and oil behaves itself, the Fed will engage in yet another program to keep long-term interest rates low. They are very, very concerned about the housing market. They would not wanna see a snapback in long rates and mortgage interest rates putting another headwind on the housing market and these inflation numbers at about 2% or less for both the producer price index and the overall consumer price index really gives the Federal Reserve plenty of room to go ahead and do something without overheating the economy because again, inflation is wages and prices together. We're not really at 8.1% unemployment, we're not gonna see the overall pressure on the wage side. All right, so I wanna make sure I really ruin your lunch before I give you the good news and I'm gonna do that with this house price graph here. The blue line is a case-shoulder house price index. The green line is income growth in the US, just index so they happen to cross in 2002 just to illustrate a point. That coming out of the 2001 recession, house prices, the blue line were weak relative to income, the green line, house price is below and that means housing is very affordable. Your house is a good buy, you're gonna get a lot for your money. We accelerate above that in terms of house prices in 2005 and six, house prices are increasing at 15, 16% a year on average, well above the green line so houses are very pricey, affordability goes down. You're not getting a lot of a bang for your buck but look how far we've come down below that green line. Housing affordability, three things go into housing affordability. Prices relative to income and then bringing in mortgage rates. Mortgage rates very, very low. So housing affordability right now is historically high. You get the most house for your money now that you're probably gonna see for the rest of your life. Now my expectation is that we do start to see some correction here. I'll call that a long, soft bottom in terms of house prices and incidentally economists are the only people who can use that term with a straight face. It's a long, soft bottom in terms of house prices. Not a big snap back but we're already seeing, we're seeing multifamily construction come back. We're seeing prices start to level out and we're seeing a more and more, I think positive interest in overall housing markets. All right, here's a graph on auto sales talking about some high points for the US economy. 17 million units sold roughly in 2006. We come down the cliff. That big spike in 2008 was a highly successful, massively enduring, completely politically neutral cash for clunkers program. And then we climbed back up after that. The good news is we are on a sustained increase. The average age of the auto fleet, 11 years. Cars need to be replaced. I do think we'll continue to see a growing and healthy car demand. Very good thing. Why is that happening? What makes that possible? Well, to illustrate that point, a spaghetti graph here, this is what they tell you never to put up here in economics class, an incomprehensible graph. So we'll take it one at a time. The red line is the financial obligations ratio that the Federal Reserve puts out. That's your total debt, mortgage, car payment, things like that as a percentage of income. What this illustrates is in 2009, excuse me, in 1990, on the left-hand side of the scale, coming out of the 91 recession, households were deleveraged. We didn't have a lot of debt at that point. Into the 2000s, we're ramping up the debt. We're piling it on. We get to a historically high point in 2007 and then the recession hits, right? So right when households are most vulnerable, that's when the recession comes. We've seen a massive deleveraging laying off the debt. We're paying the debt down. We're getting rid of the debt hopefully voluntarily and unfortunately a lot of it is involuntary because that represents a lot of foreclosures too. Dileveraging coming back down. We're now down at historical low levels in terms of household debt. So I think the deleveraging process has pretty much run its course at the time, which is a very good thing because as deleveraging has increased, we're starting to bottom out. The blue line there represents the year-over-year change in non-revolving credit, which is primarily auto loans. So we've deleveraged and we're starting to see the auto loans come back as a result of that. So households, even though we have a high unemployment rate and lots of headwinds out there, households are feeling a little more comfortable and can go out and take on an appropriate amount of debt. Now that doesn't mean we're gonna leverage right back up overnight, but I do think that the deleveraging process is bottoming out. All right, so I'll talk about some upside and downside risks in a couple minutes on the local economy and then I'd be glad to take any questions. Now, because I'm an economist, I'm not happy until you're nervous. So I'm gonna talk about the downside risks and there's a really good reason for that. You miss the upside, you leave some money on the table, right? You miss the downside, you go out of business. So let's pay attention to the downside risk and we'll talk about the upside. First and foremost are the jobs numbers. I think that's where we're gonna see some, either some positive change or we're gonna start to see an uh-oh moment over the next couple of months. My expectation is the job numbers do come back up. If they do not, we're gonna have to dial down the second half of 2012 and 2013 forecast. Again, my expectation is we do come back up into the range of 150 to 200,000. The Eurozone, for reasons that I've said, a Eurozone financial crisis, maybe it gets worse. I did not expect the capitulation of the Greeks on this. I thought that that situation was resolved. It is not until they get a stable government in and as long as that situation is not resolved that it adds more stress to the much larger economies of Italy and Spain and others. The fiscal cliff. If Congress does not do anything, there is a big headwind right around the corner and we have to watch out for that. My assumption is Congress does the right thing. It doesn't mean profligate spending. It doesn't mean ignore the problems. It means do it in a very smart way as opposed to the blunt instrument that's right now hanging over the economy to stretch a metaphor, sort of like the sort of Damocles over the US economy. If we do hit a fiscal cliff very hard, situation in Europe worse than expected. If we have weak job growth, I would expect the consumer to retrench, to pull back and at that point, the housing market languishes. Perhaps we get some more bad news out of Asia. So this is how economists have fun. We can think about zombies and asteroids and everything else that can happen bad with the economy. But there are a lot of very serious factors out there. And the way this ends up, sort of the end game to all these risk factors is what I call the zombie economy, where we really can't get out of our own way. What is the zombie economy? It works like this. We've already had a couple rounds of fiscal stimulus, right? The Bush administration has borrowed a lot of money for fiscal stimulus at the end of that term. So our debt went up. We tried to stimulate the economy. Maybe it doesn't lift. The Obama administration tried fiscal stimulus. We borrow some more money, the debt goes up. Maybe the economy doesn't lift. Maybe we do it another time. We borrow some more money, stimulate the economy, it doesn't lift. In the meantime, our debt ratios are now out the window and it gives pause to the people who are lending us this money to begin with. China and other creditors, maybe they say, well, your economy isn't lifting. You're not gonna be able to pay us back unless you monetize your debt, which is cranking up the printing presses and creating some inflation so that you pay us back with cheaper dollars. I'm not gonna buy your paper anymore at which point long-term interest rates shoot up when we have a massive economic headwind. Now that is not the forecast, but that's the uncomfortable reality of our current situation. We've taken a step closer to the zombie economy than what we would like to be. I think we're headed in the right direction, but we need to back away from that scenario and the way we back away from that scenario is having appropriate and responsible fiscal policy. Again, not a blunt instrument, but smart policy. However, now all that said, what's the upside? We were at 254,000 jobs per month in December, January, and February. Maybe we come back up there. If we stay at that level by the end of the year, this economy feels a whole lot different than what it does today. Consumers start unleashing even more pent-up demand. We talked about the auto industry. There's huge pent-up demand for housing. Well, how can there be with so many excess homes on the market? Let's break down the housing market segment by segment. First of all, we'll do a real poll this time. How many of you have a 25-year-old living in the spare bedroom, or the attic, or the garage, or wherever, there's always one, right? They wanna get out of the spare bedroom as much as you want them out, right? So a whole generation of kids now wanna get into their starter homes. Huge pent-up demand. Maybe you bought your starter home in 2005 and you're stacking the kids up in bunk beds right now. You need another bedrooms, right? So you need to go into your nesting home. The nesters, their kids are now graduated from high school. They wanna go into their dink home. Dual income, no kids, right? Downsized a little bit. And then those people wanna go into their retirement home. So segment by segment by segment, there's huge demand for housing, but no one can move. Because no one wants to sell a house into a weak housing market. Job creation removes that constraint. Housing market comes back. We go into a big production surge. We start to get a lot of positive and reinforcing economic news. And the economy starts to feel a whole lot different by the end of the year. So there's a big upside story there about endogenous within the U.S. growth that may be enough to overcome some of the exogenous drags. And one more set of factors, a little more long term that I think is very important to talk about. We are on the verge of an energy manufacturing business incubation renaissance in the U.S. We're used to thinking about the U.S. economy, most of us in this room, being highly dependent on OPEC and other countries for oil imports and being at the mercy of Saudi Arabia and whoever. That's about the change. 10 years from now, we're gonna be a net energy exporter. The U.S. economy has a source of very cheap and highly abundant fuel, natural gas, that is changing the economy even as we speak. It's gonna take a while to get here. But the changes are on the way. Large corporations such as General Electric and others are bringing manufacturing back into the U.S. So energy intensive, high value added manufacturing represents a real ray of hope for the U.S. economy. Layer on top of that, things that we already do very well which is incubate new businesses and the role of academic institutions and business incubation is second to none in the world. You put all that together and you can really see a nice bright ray of sunshine if you sort of strain and look over the horizon for it. Not gonna get here tomorrow. Doesn't do anything about the fiscal cliff and all these other short-term issues but I think it should give everyone a very strong sense of optimism about the future of the U.S. economy. We're heading in a very, very good place in terms of revitalizing the manufacturing sector and perhaps we turn ourselves more into a balanced export economy. The model for Germany's done it. China maybe we have a little more balanced approach and that really adds a measure of stability that we haven't had over the last few decades. All right, so what's going on locally? We see a year over year job growth, the big down cycle in the U.S. economy in blue coming back up to about 2%. California as a whole having a much worse down cycle, more job losses, still below average. The metropolitan area numbers zigzag around. There's a lot more volatility the smaller geographic Unigo. So Santa Cruz, MSA, a growing about on average with California over the long term. Now my expectation is that we continue to see sort of moderate growth but I don't think this is gonna be a high growth economy. There's simply too many headwinds right now for an up and away economy but again the idea is a private sector starting to gain enough momentum to overcome some of these external drags. I'm gonna end here and we would be glad to take any questions. Can you talk about the impact of wealth and business leaving California? All right, I'm gonna do my best to put a halo over my head and be politically agnostic but this is an issue that I think is very, very important for everyone to talk about in the state of California. If California was its own national economy you would be the envy of the world, the resources, the talent, the industries that are here, the beautiful climate, everything you've got going. If you could simply fix the political system, right? So it's a political problem and on one side or the other problems both directions. The political reality in California is that you've tended to increase the cost of doing business. A very simple economic concept, cost of doing business, taxes, labor, energy, you put it all up to get, add them all up, the overall cost of doing business in California is far higher than almost every other place in the world. So that means you tend to drive out existing businesses, businesses that can pick their locations all else being equal are going to tend to want to be everywhere else. Now, all the states that touch California thank you for that, Oregon, Nevada, Arizona, where I'm based, Texas, we love you because the industry is coming out of the state. Now there's a trade-off here. California does a great job of incubating new businesses. Now, are you at a point where you're still incubating as many businesses as you're driving out of state because of these high costs of doing business? I think there's a tipping point here and I think California is probably past that point. Now, that doesn't help you solve the political problem. That's a huge problem. How do you make up a budget shortfall and all that without driving the cost of doing business even higher? I'm not gonna, I can't give you an answer for that. Thank God I'm not a politician. I don't, I feel very compelling, feel very concerned for your politicians having to deal with that, but it's a huge problem. And that said, let's take that a step further. What happens when businesses relocate elsewhere people tend to follow, right? And the way economists measure that, we call that net migration. How many people are moving into the state versus out of the state? Historically, California has been a population attractor right over historical decades. That is changing. You're losing population, net migration out of the state is now bigger than in migration and over the long term, I can find very few examples for a state or locality with persistent out migration that is economically healthy. So those things I think for the long term health of the state have to change. I don't think it's a fundamental economic problem. It is really a political problem and how you balance out these factors. I'll leave it there because I say anymore, I'm going to step on somebody's toes. With the loss of redevelopment funds locally and our higher than average unemployment rate, how important do you see the partnership between the public and private sectors in replacing that loss of revenue over the next four to five years? Well, I think, again, I won't even begin to give a political response to this, but I think the state needs to do everything it can do to foster its existing businesses, try to keep overall costs low, and promote an environment of business incubation. The public and private universities, academic institutions you have in California, again, are the envy of the world and the ability for those institutions to spin off new businesses. That's why Silicon Valley is here, right? And the ability for California to keep that in place, that is the future of the state. And I think doing things that can promote the health without driving, doing what you can do to prevent losing other businesses is absolutely paramount. Can you give us your thoughts on the $16 trillion national debt that we're now carrying and the fact that our interest rates are at historical lows and that just like we consumers, if and when rates do go up, that added burden, interest rate costs on the economy and $16 trillion doesn't look like it's the end? Can you give us some insight as to what you think that's gonna, how that's gonna play on the national economy? Yeah, a trillion here, a trillion there, pretty soon it adds up to real money, right? Now, it's true, we have a very low interest rates right now which means that the interest payments on the federal debt are actually very low, even compared to say 10, 15 years ago. We're getting a break, we finance the economy with very, very cheap money. However, at the same time, it means we have tremendous risk to interest rate increases. And if we believe we're in an environment of historically low interest rates and the only place to go is up from here, we better get a handle on it before interest rates snap back. What has contributed to the low interest rate environment? Two things that are entirely beyond our ability to control. One was the global recession, the flight to quality that happened because of that. We don't wanna lose money in stocks or whatever. We're gonna put them in US Treasury bonds, drives interest rates down. The other is the European crisis which has actually reinforced that flight to quality to the US keeping our interest rates low. At some point, Europe gets its act together, the global economy feels better and both those events unwind. And we better be ready for it because I do believe that we are at a secular low in interest rates and the only place to go meaningfully is up from here. You know, we're at a one point, what, eight, five, 10 year rate, maybe we go to one seven, we're not gonna go to zero and I think we're a lot more likely to go up to three before we go down to one. So it's very, very important to get the debt under control. Now, the way I measure the national debt, I scale it to the overall size of the economy. That is a percentage of GDP. If you look at all countries across the world, across history, countries that have kept their federal debt and GDP ratios at 5% or less tend to be stable countries, good global citizens that are around for a long time. When you cross that 5% threshold, these are countries that are more and more exposing themselves to outside risk. Well, we got up to 10.4% in 2009. So we blew past the 5% sort of bar. The good news is we had a lot of company doing it. We weren't the sole deficit offender in the world. Missouri loves company. Europe is right there with us. Now the situation that I get concerned about is perhaps Europe gets its act together and we don't, right? Then we start to emerge as a world's single deficit offender. Maybe we see some more credit downgrades. Countries like China say, I don't wanna buy your debt anymore. Upward pressure on interest rates and then this big debt overhang. We start to pay more and more interest rate, interest service on that debt because of that. The good news is we were at 10.4%. We're now down to about 7% or so. So we're going in the right direction. Current deficit projections bring us down to 4% or 5% in the next couple of years. So very good news. We're getting back into that safety zone. A little bit of debt for the US is a good thing. It requires treasury bonds, liquefies to the world, financial markets, great. A lot of debt exposes you to outside risk. So we're going in the right direction and we're making progress and now comes the other hand. I can't hold myself back. I've gotta be a two-handed economist. The reason why the debt is getting balanced in the short term is because of all the expected cutbacks and so forth on discretionary spending. Only one third of the federal budget discretionary spending. If we don't do anything about the two thirds of the budget on the non-discretionary side, look at the congressional budget office, the long-term projections, the debt blows out again by 20 years. So even though we're making progress, that progress is not sustainable. As long as we leave the non-discretionary side off the table, the non-discretionary side, social security and the Medicare Medicaid. Social security is a very easy fix. I'm convinced you can take any accounting class in any college and say, here's your project, fix social security. Okay, I'm gonna cap benefits. Bill Gates doesn't need to collect social security. I'm gonna raise the retirement age when social security was introduced in the late 30s. The life expectancy of a male at that point was about 58, 59 years. So the average recipient of social security collected for a matter of months and not years or even decades today. So the system is unsustainable. Let's allow for a little more internal rate of return, do some things like that. Okay, we'll fix social security. The deficit still blows out 20 years from now because we really haven't addressed Medicare or Medicaid. That's a much more significant problem. From a theoretical point of view, as an economist, I can take the comfort of looking at things from theory. The theory is this. Every single economic good out there gets rationed in some way, shape or form. You're either rationed by price or you're rationed by standing in line. We ration diamonds by price. If you want a diamond, you pay up for it. If you can't pay up for it, you don't get it. So we have to decide how to do this. We can take the UK as an example where we have a nationalized health service and think, okay, they rationed by standing in line. In the UK, you wait significantly for any kind of elective surgery. It can be months and years. Do we want that kind of system? We have to have a grown up discussion in this country about how we ration health care. And until we do that, we don't fix the long-term deficit issues. So we're going in the right direction, but there's still a structural problem out there.