Kiplinger Connection
The Economy • Business Costs • Federal Deficit

The Economy: Last week was historic, dramatic, and, still, enigmatic.
Business Costs: Speaking of history, China is unionizing as the U.S. goes robotic.
Federal Deficit: At $10 trillion, the national debt is double of a decade ago.

The Economy
It’s historic. It’s dramatic.
It will avert a threatened financial meltdown. The government’s plan to take over banks’ bad debt will pour lubricant into a credit market that’s seizing.

Will it keep the economy out of recession?
Probably. It cuts the odds of a contraction that lasts for two or more consecutive quarters.
But it sure won’t spark a strong recovery.
We expect GDP next year to grow about 1%.

All the fundamental weaknesses remain.
Consumer spending lacks any oomph, and is likely to shrink in the coming quarter. And because energy and food prices are still elevated, they’re eating up a bigger share of income than usual, leaving less for autos, apparel, and other goods and services.

Wage gains lag inflation, so most Americans find their paychecks don’t go as far as they used to.
What’s more, consumers are buried in debt ... $2.6 trillion by the end of the year, nearly $8,500 for every man, woman, and child in the country.
Meanwhile, more and more folks are out of jobs. By early next year, unemployment will hit 6.5% or so. The number of net jobs lost each month will get worse before it gets better, and the economy won’t add jobs until late in 2009.

The housing market is still a huge negative. The massive federal takeover of mortgage-backed debt will help bring about a bottom sooner rather than later, as clearer market values are established, foreclosure rates stabilize, and the number of workouts increases. But it won’t eliminate the huge overhang of unsold homes, prevent further price declines, or give back to consumers the equity they have lost.

Don’t expect any lift from business spending, either. Business managers are becoming even more cautious, and capital spending won’t grow at all next year.
Tighter credit will make it tougher even for businesses that want to expand. As we outlined in last week’s Letter, Main Street banks ... although largely unscathed by Wall Street’s meltdown ... will nevertheless be stingier lenders in coming months.

Even the brightest star in the economic firmament ... exports ... is dimming.
Weaker global markets mean they won’t grow as swiftly in the coming year. Slowdowns in European economies, Japan, and Canada will shave a percentage point or so from growth in U.S. sales overseas next year, holding it at roughly 7%.
Federal spending will push higher, as the government absorbs the bad debt.
But that won’t provide a direct economic kick. In fact, it diminishes the odds of tax cuts or other fiscal stimuli. And state and local governments will cut back.

The Federal Reserve has more than Wall Street to keep it awake at night.
It’ll issue regs to help consumers who can’t keep up with credit card debt. The new rules will make card companies wait 30 days before boosting interest rates when a payment is missed. They’ll also put limits on how much rates can be hiked for existing balances and mandate clearer disclosure. The regulations will lead firms to shorten expiration dates for cards, increase their fees, and tighten standards.
But the Fed’s card regs may be too little, too late to avert severe problems. Consumers are already over-leveraged.
Debt on plastic will top $1 trillion this year.

Volatile stock prices are forcing more seniors to put retirement on hold. Even before the latest eye-popping market drops, workers confident of their ability to afford retirement hit an 18-year low. A lot more of them will just stay on the job.
Businesses threatened by a skills shortage will benefit in the near term. That’s also true for the federal government, which faces a big loss from retirements.
But there are some downsides. Older employees are a lot more expensive, and younger workers hoping to move up may feel stuck and look for work elsewhere.

Business Costs
Foreign companies operating facilities in China will see costs zoom.
Blame it on Beijing’s state-run union, which has become more aggressive in labor-management disputes. It has the full support of the Chinese government, which wants to address worker concerns before they morph into political dissent. A big membership drive is forcing large foreign firms to let the union organize.
It’s the latest of several factors adding to business costs in China. A law that took effect Jan. 1 makes it harder for companies to fire employees. Plus labor shortages are forcing wages up, and tax breaks for foreign firms are gone.
Airlines keep looking to add extra fees, but there are ways to fight back.
Consider imposing tight rules on workers to avoid fees, as some firms do. Bar second suitcases for short trips, for example. They can add up to $130 for a round-trip. Also, veto company-paid upgrades, which can add up to $80. And encourage road warriors to book in advance to get early bird discounts on fares.
Large firms can cut deals, dropping add-ons from volume discount pacts that airlines typically make with corporations to get a leg up on their competitors.
Other cost saving measures: Insist that workers share a double room, add a Saturday night stay if it means a big cut in airline fares, put curbs on entertainment and reduce reimbursements for meals and various sundries.
The biggest saver of all: Cancel trips and opt for videoconferences instead.

A new free computer program can spur manufacturing productivity by letting lathes, presses, grinders, and other assembly-line devices communicate with each other electronically. That allows companies to monitor operations and identify bottlenecks with fewer managers ... less need to prowl factory floors.
The basic software is available online.
Also boosting productivity: More robots. They’re taking over lots of jobs, especially repetitive and potentially dangerous ones. Robots are being used more for cutting and packaging poultry, meat, and fish, as well as testing food samples for safety. Other uses for robots: Assembling solar and wind power systems, fuel cells, and advanced batteries. Plus they can produce more reliable cell phones, computers, and TVs because they’re not as prone as humans to make mistakes.

Look for more robots at the retail level, too. The cup of coffee you order at your favorite shop may someday be served by Justine, a prototype in the works from the European consortium Dexmart. Robots being developed by Fanuc, ABB, Adept Technology, and others can perform additional tasks, such as slicing sushi.

Federal Deficit
Washington’s rescue of credit markets will add to another brewing crisis.
The federal budget deficit is wildly out of control, with huge implications for government policy and, further down the road, for the nation’s economy.
Even before the latest move, the deficit was headed for $600 billion in 2009, a 50% spike over 2008. That means the government will be borrowing at least one of every five dollars it spends. In fact, the deficit would be well over $800 billion if Social Security surpluses weren’t included, a practice that hides the hard truth.
And deficits will grow exponentially, now that Washington is on the hook for hundreds of billions in uncertain debt. It’s too early to put a number on the cost to the government, but a body blow, at least in the short term, is virtually certain.

Making it worse, the national debt is skyrocketing ... $10 trillion by Jan. 20, when a new president takes over, almost twice what it was when Bush was sworn in.
That means rising interest payments ... about a tenth of the budget ... that mostly go overseas to pay the coupon on Treasuries held by foreign creditors.

The national debt is getting very close to 70% of GDP and will soon reach levels not seen since the mid-1950s. By comparison, Britain’s national debt is 43% of GDP. France’s, Canada’s, and Germany’s hover around 65%. Japan has the biggest debt ... a whopping 195% of GDP.
The budget crisis will tie the hands of the next president. Instead of a first 100 days filled with new initiatives, it’ll be like 1992, when Bill Clinton faced a big deficit and swapped a planned tax cut for a big tax increase. Neither Obama nor McCain dwells on the deficit now, but whoever wins in Nov. will be forced to next year.

McCain’s big tax cuts would be a hard sell. His plan to extend Bush’s cuts and add more would cost $627 billion over 10 years. Even if it spurred the economy and brought in more revenue, there would be a lag and the deficit would still rise. McCain’s plans to rein in spending ... freezing domestic programs at current levels and ending earmarks...would save only $20 billion a year, barely denting the deficit.
Obama wouldn’t fare much better. His tax hike on upper-incomers, along with cuts for most others, would add $595 billion in revenue over 10 years. But that wouldn’t go far in fulfilling his promises to spend $15 billion more a year on alternative energy, $18 billion on education and $100 billion on health care. Also at risk: More funding to rebuild the armed forces, expand job training, shore up Medicaid, lend more to small businesses, and boost science research.

And looming on the horizon: Almost certain bankruptcies for Medicare and Social Security if cutbacks aren’t made or new sources of revenue found.
Will big deficits hurt the economy?
Yes, if not addressed. At some point, they will lead to higher interest rates, tighter credit, and slower economic growth.