Kiplinger Connection
Global Economy • Midwest Flooding • U.S. Economy

Global Economy: Europe is entering a slump.
Midwest Flooding: Freight disruptions mean even higher prices.
U.S. Economy: No interest hikes till very late in the year.

Global Economy
Europe is following in America’s footsteps.
It’s headed down a trail of economic woes ... sluggish growth, rising inflation and unemployment. Given the close relationship, that makes sense: The U.S. captures more European Union investment than any other country. For Germany, France, Italy, Spain, and the Netherlands, it’s the top export market outside Europe. For the U.K., it’s the top, bar none.

EU economies are markedly slowing ... revealed in our recent visit, which coincided with talks between President Bush and EU leaders. But while we expect the U.S. to be past the worst of it by year-end, with modest improvement in 2009 ...
Europe won’t hit bottom until late this year or even early next. Germany will weather the slump better than others. Italy and Spain may suffer most.

Food, fuel, and housing costs are soaring throughout Europe. The 12-month inflation rate for the euro zone hit 3.7% in May. A year earlier, it was 1.9%. Similarly, in the U.K., consumer prices in May were 3.3% higher than they were a year earlier. The previous year they rose 2.5%, half a point above the official inflation target rate.
And, as in the U.S., a credit crunch is hurting businesses and consumers. Banks are reluctant to lend, though credit isn’t out of reach for sound businesses.

Look for the European Central Bank to raise interest rates next month and possibly one more time before year-end, despite the region’s wobbly economies. Unlike the Federal Reserve and the Bank of England, which has ruled out a hike for now, the ECB’s mandate is solely to fight inflation, not to boost growth as well.
The rate increases could bring the greenback below $1.60 to the euro once currency traders believe the Fed isn’t rushing to raise interest rates here.
But any moves will put pressure on the Federal Reserve to follow suit. That would bolster the dollar vs. the euro and help reinvigorate flagging EU exports to the U.S. We think Fed policymakers will do so late this year.

European demand for U.S. goods will stay strong, despite economic woes. With the weak dollar continuing to make U.S. goods and services very competitive, European companies and consumers see them as bargains. Especially popular: U.S. pharmaceuticals, oil, and gas drilling gear, U.S. fast-food outlets abroad, shopping expeditions to Fifth Avenue or Chicago’s Miracle Mile, and U.S. vacations.
Note that more Europeans are looking to the U.S. for private health care ... high quality at a lower price. One growth area: Second opinions by U.S. doctors.
Moreover, European investors aren’t deterred by the weak U.S. economy. Belgian-based InBev’s bid for Anheuser-Busch is a recent, high-profile example.

Midwest Flooding
The Midwest floods will take a huge toll on the region and the nation ...
Billions of dollars in damages to houses, farms, railroad tracks, businesses and other property, with cleanup, repairs and rebuilding taking years, in some cases. Congress is adding $2.65 billion to federal disaster programs, with more to come.
The national impact will include shipping delays and higher costs. Rail tracks through Illinois, the nation’s biggest rail hub, will be of limited use for weeks. The U.S. Army Corps of Engineers pulled equipment from 250 miles of Mississippi River locks, shutting down barge operations for two weeks or longer. Railway and barge owners and public highway agencies will have to spend billions in the year ahead to repair their bridges, roads, loading facilities and so forth.

Look for more crop losses on top of those from flooded unplanted farmland. Fields of corn that were sown late because of earlier heavy rains face rotting as they sit in mud and standing water. Plus the July heat will hinder pollination. Corn will fall 2 billion bushels short of normal yearly use ... soybeans, 400 million.
The losses will only fuel higher grocery bills as commodities get scarcer: Earlier estimates of a 5%-6% rise in prices this year will be revised up a point or so.

U.S. Economy
Financial markets are betting on an interest rate boost in Aug. or Sept.
But they’re probably wrong. More likely it will be very late in the year before the Federal Reserve starts pushing rates back up. The Fed will sit tight until then, waiting for signs that the economy is coming out of the doldrums. The markets are misinterpreting Fed Chairman Ben Bernanke’s inflation warnings, thinking they signal a rate hike soon. In fact, he’s jawboning to stabilize the dollar and to keep a lid on inflation expectations of businesses and their workers.

Consumer spending on discretionary items will stay low for a year or two. The combination of gloom about the economy and rising fuel and food prices is causing Americans to be more cautious and keep a tighter grip on their wallets.
That will make it tough for firms in discretionary goods and services ... everything from automobiles and appliances to clothing, traveling and dining out.
The cutback is already evident. In 2000, consumers spent 47¢ of every dollar on things they wanted, rather than had to have. That’s now down to 43¢.

Employers continue to send jobs abroad, but where they go is changing.
Mexico is becoming more popular, along with the Philippines, Brazil, Poland, Hungary, Romania, and the Czech Republic. India is losing some of its luster as wages go up ... 10%-15% in the past year...and more workers reject night hours, which are often necessary to meet the demands of U.S. customers and companies.
Meanwhile, manufacturers are starting to turn away from China as costs for fuel push up shipping. Each rise of $1 in the price of oil adds 1% to the cost of transporting goods. In some cases, it’s cheaper to keep production in the U.S. Some firms are eyeing Mexico to make furniture and rubber, steel, and paper goods.