Pacific Northwest Association of Rail Shippers September 19, 2013

Pacific Northwest Association of Rail Shippers September 19, 2013 Dr. Lynn Michaelis President, Strategic Economic Analysis Partner, FEA lmichaelis@getfea.com 206-434-8102

Key Messages for Today Bubble #2 created a global financial crisis and nearly global depression Aggressive policy actions have stabilized situation, but not strong economic growth Several challenges remain particularly in Europe Expect modest growth through 2014, with accelerating growth in 2015-16 Inflation not a serious issue near term, but. Fed Response to stronger growth?

Today s Agenda Brief History Discussion Highlight Global issues U.S. Economy: Policy and Consumer Housing Outlook: recovering? Implications for industrial production/shipping Summary of key messages

$000 Froth in Housing Prices: Greenspan Bubble #2 240 220 Median Existing Price Crisis Starts 200 180 160 140 Sept. 2008 120 100 1999Q1 2001Q1 2003Q1 2005Q1 2007Q1 2009Q1 2011Q1 2013Q1

Annual Growth Great Recession and Pathetic Recovery WHY? 8.0% GDP growth 6.0% 4.0% 2.0% 0.0% -2.0% -4.0%

% year over year 6 Even bigger cycle in Industrial Production 5.0% GDP vs. Industrial Production 0.0% 2001Q1 2003Q1 2005Q1 2007Q1 2009Q1 2011Q1 2013Q1-5.0% -10.0% GDP Ind Prod Packaging -15.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Jan 1990 = 1 Cass volume index of freight shipments: similar to industrial production 1.4 1.3 1.2 1.1 1.0 0.9 0.8 Source: Cass Information Systems

Billion bf $/mbf Fundamental Change Every Decade!!! 85 75 Demand vs. Capacity Price and operating rates I II III IV I II III IV 450 400 65 55 45 35 25 Demand Capacity 1975 1980 1985 1990 1995 2000 2005 2010 350 300 250 200 150 100 1977 1983 1989 1995 2001 2007 2013 DF green 2x4 price ytd

Today s Agenda Brief History Discussion Highlight Global issues U.S. Economy: Policy and Consumer Housing Outlook: recovering? Implications for industrial production/shipping Summary of key messages

World growth fell below 2%, Pathetic rebound 12% 10% 8% 6% 4% 2% 0% -2% -4% -6% World Europe U.S. Asia Ex Japan 2006 2007 2008 2009 2010 2011 2012 2013

Massive action by Major Central banks Monthly Central Bank Assets (Dollar Equivalents on Left Scale) June 2006 to December 2014 $ Billions Federal Reserve Bank of England ECB Bank of Japan Swiss National Bank 13000 12000 11000 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 2014 estimate Feb-11 Feb-12 Feb-13 Estimates in USD Total: $11.6 tr Swiss: $1.38 tr BOE: 520 bn ECB: 3 tr BOJ: 2.9 tr US Fed: 3.8 tr

Aggressive monetary policy everywhere! Dollar remained stable 140.0 130.0 120.0 110.0 100.0 90.0 80.0 Broad Trade $ 1997=100 2000-01 2002-01 2004-01 2006-01 2008-01 2010-01 2012-01

Serious imbalances in Europe Decline Stagnation Slight growth Strong growth

The European Family! 1

Unemployment tells the story! Deflation, depression vs. patience 15 Unemployment rate (%) Country 2009 2013 Change Germany 8 6 (2) France 9 11 2 PIGS: Italy 8 12 4 Portugal 10 18 8 Spain 16 27 11 Greece 9 27 18 Euro Zone average 9 12 3

Challenge for China: Promoted growth through investment/debt Share of China GDP Investment Net Trade Consumer Government Shares of Investment Construction Capital--Bus Other Inventory

Million Units 17 China s Housing Start Cycle, but trend over 5 million/year 16 14 12 Commodity Housing Starts* Started Completed 10 8 6 4 2 0 2005 2008 2010 2011 2012 2013

Massive high rise projects EVERYWHERE! 18

Shanghai: The New city-- Pudang

Beijing Traffic in 1987

Great Wall 1987 Shorts?

Asia key driver of oil demand/prices 3000 2500 2000 1500 1000 500 0-500 -1000-1500 -2000-2500 -3000 MB/D Year-on-Year Changes 1,370-310 -1,020 2,765 690 FSU/E. Eur. Africa/Middle East S. America Asia Japan/ANZ Ind. Atl. Basin 1,265 2007 2008 2009 2010 2011 2012

Recession reset oil prices: Stability unless.. $150 $140 $130 $120 $110 $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 WTI Oil Price Per Barrel Recession Nominal In $2011 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

24 Summary of key international events Slower world growth Aggressive monetary policy by other major central banks Bottom line: U.S. dollar remains relatively stable Little boost in net exports No upward pressure on commodity prices

Today s Agenda Brief History Discussion Highlight Global issues U.S. Economy: Policy and Consumer Housing Outlook: recovering?

Looking for Sources of Growth: Usual actors missing in action Category For 2013.2 (In 2009$, Billion) Share of GDP % YA Overall GDP $15649 100% 1.4% Consumer 10705 68 2 Business Inv. (Equip.) 1558 10 3 Residential Inv. 486 3 15 Fed. Government 1168 7-4 S&L Government 1736 11-1 Net Exports (-451) (3) negative

27 Government Spending Has Been a Major Drag on Real GDP Growth 1.6% Contribution to Real GDP Growth 1.2% 0.8% 0.4% 0.0% -0.4% -0.8% -1.2% -1.6% Non Defense Federal Defense State and Local 2008 2009 2010 2011 2012 2013

The Federal Budget Deficit Picture Has Improved Markedly, but policy has NOT! Government Revenues and Outlays as Percent of GDP 26% 24% Outlays 22% 20% 18% 16% 14% 12% Dotted Lines are 1972-2012 Averages Revenues Source: Congressional Budget Office

Bipartisan Agreements Are Not Easy To Craft 29

30 Other QE and massive growth in High Powered Money Federal Reserve Assets Have Exploded 4,000 Billion $US 3,500 3,000 2,500 Other Mortgage-Backed Securities U.S. Treasuries 2,000 1,500 1,000 500 0 2006 2007 2008 2009 2010 2011 2012 2013

In 2009, fear of deflation: No immediate concern, but. 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% FEAR US CPI 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

% 2000-01 2000-08 2001-03 2001-10 2002-05 2002-12 2003-07 2004-02 2004-09 2005-04 2005-11 2006-06 2007-01 2007-08 2008-03 2008-10 2009-05 2009-12 2010-07 2011-02 2011-09 2012-04 2012-11 2013-06 Fed policy had two goals: Low short term rates 9 8 7 6 5 4 3 2 1 0 3 month T-bill 30 year mortgage

Another bubble in the making? 1800 1600 1400 S&P 500 QE1 launch QE1 Expanded QE2 Suggested Operation Twist unveiled 1200 1000 Operation twist extended 800 QE3 launched 600 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013

Million Units Unique housing start cycle: Deep and prolonged 2.5 2 Multi Single 1.5 1 0.5 0 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

One hidden inventory created by easy lending standards 70% 69% 68% 67% 66% 65% 64% 63% 62% Homeownership Rate 1991 1994 1997 2000 2003 2006 2009 2012

Million Units 2001 2002 2003 2004 2005 2006 2007 36 2008 2009 2010 2011 2012 2013 2014 2015 2016 This time housing starts lag, not lead recovery: inventory correction and household formations 2.5 2 Housing Starts Multi's Singles 1.5 1 0.5 0

Annual Growth Consumer Spending will rebound with jobs and wealth 5% 4% Consumer Spending Growth FORECAST 3% 2% 1% 0% -1% -2% 04 05 06 07 08 09 10 11 12 13 14 15 16 17

$000 Price Rebound should help boost remodeling expenditures as well Trillion $ Rebound in home prices Boost in consumer net worth 240 220 Median Existing Price 14 12 Home Equity* 200 10 180 8 160 6 140 4 120 100 2 0 2000 2005 2007 2009 2011 2012 2013 *SOURCE: FRB flow of funds

Real GDP Growth Will Accelerate in 2014-15 8% 6% 4% Potential GDP 2% 0% -2% -4% -6% -8% 06 07 08 09 10 11 12 13 14 15

Interest rate outlook: Depends on expectations and Fed actions 40 7% 6% 10-Year Government Bond Yield 5% 4% 3% 2% 1% 0% 3-Month T-Bill Rate 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

US Natural Gas is Dirt Cheap Relative to Gas Other World Regions and big boost for U.S. growth $20 $18 $16 $14 USD per Million BTU Germany Japan US (Henry Hub) $12 $10 $8 $6 $4 $2 $0 Source: IMF, FEA Calculations

Today s Agenda Brief History Discussion Highlight Global issues U.S. Economy: Policy and Consumer Housing Outlook: recovering? Implications for industrial production/shipping Summary of key messages

%Year over Year Translates to Moderate Growth in Production 10.0% 5.0% Industrial Production FORECAST 0.0% 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1-5.0% -10.0% -15.0% IP Total IP Non-durables -20.0%

2013 rail volume growth by commodity Grain All Other Carloads Coal and Coke Metals & Products Grain Mill Products Metallic Ores Pulp, Paper & Allied Products Motor Vehicles & Equipment Total Rail Volume* Chemicals Intermodal Crushed Stone, Sand & Gravel Petroleum Products -20% -10% 0% 10% 20% 30% 40% 50% *carload shipments and intermodal Source: Association of American Railroads, Licensed Material Year to Date / Year to Date % Change

BBF Housing and exports push demand back to 70 billion bf 85 80 75 70 65 60 55 50 45 40 35 30 25 20 US Canada Net Exports 00 05 09 12 13 15 16

46 With Canada capacity limited, U.S. lumber output will fill gap U.S. Production Canada production 45 40 35 Other South West Coast 45 40 35 Eastern B.C. 30 30 25 25 20 20 15 15 10 10 5 5 0 2005 2009 2012 2015 2017 0 2005 2009 2012 2015 2017

92Q2 93Q1 93Q4 94Q3 95Q2 96Q1 96Q4 97Q3 98Q2 99Q1 99Q4 00Q3 01Q2 02Q1 02Q4 03Q3 04Q2 05Q1 05Q4 06Q3 07Q2 08Q1 08Q4 09Q3 10Q2 11Q1 11Q4 12Q3 13Q2 14Q1 14Q4 Capacity Utilized 105% Active truck capacity utilization: Good news for Rail? 100% Forecast 95% 90% 85% Long Term Average 80% 75% Sources: FTR Associates

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 F Millions of $ s N.A. Railroad capital expenditures $16,500 $15,000 $13,500 $12,000 $10,500 $9,000 $7,500 $6,000 $4,500 $3,000 $1,500 $0 Source: Wolfe Research, TTX

Surface freight trends 2007 2008 2009 2010 2011 2012 2013(F) Total Rail Volume -2.1% 40.4mil. Intermodal Volume -1.2% 14.1 mil. 2.4% 41.4 mil. -3.2% 13.7 mil. -14.5% 35.3 mil. -14.4% 11.7 mil. 11.9% 39.6 mil. 13.4% 13.3 mil. 4.1% 41.2 mil. 6.2% 14.1 mil. 0.7% 41.1 mil. 4.1% 14.8 mil. 2.9% 42.3 mil. 5.4% 15.5 mil. Container Imports 0.1% 20.2 mil. -6.2% 19.0 mil. -15.3% 16.1 mil. 13.6% 18.3 mil. 2.8% 18.8 mil. 4.5% 21.4 mil. 5.0% 22.5 mil. Container Exports 16.3% 12.3 mil. Dry Van Truckload Volume -2.5% 274 mil. Railroad Capital Exp. 15.7% $10.8 billion 4.8% 12.9 mil. -3.9% 263 mil. 5.5% $11.4 billion -7.7% 11.9 mil. -10.9% 234 mil. -10.9% $10.2 billion 6.9% 12.8 mil. 9.4% 207 mil. 5.8% $10.8 billion 6.7% 14.9 mil. 6.1% 220 mil. 28.0% $13.8 billion -1.4% 14.7 mil. 4.5% 230 mil. 5.9% $14.6 billion 9.0% 16.0 mil. 4.6% 241 mil. 3.6% $15.1 billion Railcar Deliveries -15.5% 63,156-5.1% 59,954-63.8% 21,682-23.7% 16,535 186.4% 47,350 39.8% 58,904-17.6% 47,485 Source: FTR Associates, TTX, AAR, IANA, ACT Associates

Key Messages for Today Bubble #2 created a global financial crisis and nearly global depression Aggressive policy actions have stabilized situation, but not strong economic growth Several challenges remain particularly in Europe Expect modest growth through 2014, with accelerating growth in 2015-16 Inflation not a serious issue near term, but. Fed Response to stronger growth?

Billion pieces Thankful not in mail or paper business 120 First-Class Mail Volume 100 80 60 40 20 0 1970 1980 1990 2000 2010 2012 SOURCE: US Postal service