Kiplinger Connection
The Economy • How Does It Compare? • Energy

The Economy: Lower oil and deflation both will have a short duration.
How Does It Compare?: No Great Depression; more the ’70s recession.
Energy: Renewables are about to shine, growing 35 percent in 2009.

The Economy
Look for the cost of living to shrink for another month or two, as drops in energy prices work their way through the Consumer Price Index. The 1% decline in the index in October was the largest monthly slide since 1947.
But deflation isn’t going to replace inflation. Despite decreases in the CPI this fall, the Dec. 2008 index is likely to show a gain of about 3% over Dec. 2007, and we anticipate an inflation rate of about 1.5% in 2009, measuring Dec. over Dec. That may disappoint many U.S. consumers: A recent national opinion survey found that 40% of households expect inflation to be zero or negative next year.
Oil prices would need to hit $40 a barrel and stay there for many months to cause the CPI to decline over 2009 ... and such a sustained collapse is not likely. In fact, we currently anticipate crude oil prices rebounding next year to about $75.

Is America on its way to becoming a nation of savers? Fat chance.
It’s true that as a whole consumers are socking more away. The savings rate is on its way from a low of less than half a percent in 2006 to about 5% by 2010. Folks almost always start to save more during and following economic downturns, spurred by worries about job losses. Then, after a few years, the rate dwindles again.
A 5% rate is no great shakes ... only about half the levels that were reached following economic downturns in the ’70s and ’80s. It’s also only about half the rate of some other major economies, such as France and Germany. Compared with Japan, a 5% rate doesn’t look too bad, however. After years of rock-bottom interest rates, that country’s famously high savings rate of 15% has dwindled to a mere 3%.
Some of the shift isn’t even voluntary this time. It’s tough to borrow in this tight credit environment, forcing many consumers who typically spend more than they earn to cut back. That raises the aggregate savings rate for the country.

One thing that should keep savings a bit higher for longer than usual:
The rapid evaporation of consumers’ equity ... in both homes and stocks. For the past decade, consumers have counted on the value of their 401(k) accounts and their homes to backstop their free-spending habits. Odds are the swiftness and depth of the recent decline will spur them to stick with a tighter savings regime.

Need more evidence of consumers’ distress? Auto insurance fraud is up. Apparently, some cash-pressed consumers are resorting to torching, drowning, or dumping SUVs, pickups, and cars to get out from under auto and other loans. Scores of cars reported stolen are turning up in Lake Erie and in western deserts. Dozens of expensive vehicles were left at water’s edge in Gulfport, Miss., just hours before Hurricane Gustav hit. Crime rings are making hay, smashing cars on request.

Vehicle fire claims alone are up 8% ... 13% to 18% in N.Y., Ind., and Mich.

Employers will get needed clarification under new family medical leave regs.
Long-awaited revised rules take effect in Jan. Among the beneficial changes: Workers can’t wait to tell employers that an absence was family medical leave. They must do so during customary call-ins. Employers can require re-certification of serious conditions every six months and contact doctors directly to fill in blanks.

Bankers’ pay will take a hit next year, following the 2008 financial meltdown. Execs at most big financial institutions will give up their bonuses this year. But ...
Bonuses will be back in 2009, though much smaller and with more strings. Base salaries will go up, but not as much as bonuses go down. And compensation will be more closely tied to long-term goals rather than short-term revenue growth. Stock grants and other deferred compensation, for example, will be ratcheted down if the company performs poorly. And compensation pools will be based on measures that take capital costs and risks into account ... discouraging get-rich-quick schemes.
Look for the trend to spread beyond financial firms to bigwigs elsewhere.

How Does It Compare?
What are the odds this recession will become another Great Depression?
Slim, in our judgment. Yes, this is the worst financial crisis since then. But it’s not as bad an economic crisis ... more comparable to, say, the mid-’70s.
The Depression was a global economic collapse on an immense scale, measured in multiples of today’s statistics of pain.
It was preventable, and the lessons learned greatly cut the likelihood of a reprise of that decade.
So ... we foresee a moderately severe recession, more akin to the declines of the mid-’70s or early ’80s.

The contraction in GDP won’t be as extreme: Several quarters of declines in the low single digits, resulting in about a 2.5% drop from peak to trough. From ’29 to ’33, real national output dropped 30%.
Joblessness won’t hit one in four workers as it did in ’32, when most families depended on a single wage earner. Just north of 6% today, unemployment is likely to top out below 9% next year.

In the ’30s, millions lost their life savings ... wiped out as 9,000 banks across the country failed. With federal deposit insurance in place today, losses are minuscule in comparison.
Of course, stock equity worth billions has evaporated, and more people own stocks now than in the ’30s ... directly or in funds, IRAs, and 401(k)s.
But the market drop isn’t as drastic. The Dow Jones index is down a bit more than in ’00-’02 and ’73-’75, but less than the 89% plunge of ’29-’32. Though no one can predict the bottom, we expect that stocks purchased now will see strong gains over the next few years as the global economy recovers. In contrast, the Dow didn’t return to its pre-Depression high till the mid-’50s.
Homeownership was lower and foreclosures massive in the Depression. Today, an estimated 5% of U.S. homes are in foreclosure or at risk of being lost. As layoffs mount, that figure will climb, but home losses will also be dampened by government programs. Though double five years ago, 5% is still a small slice.

The sustained deflation of the early ’30s isn’t likely to be repeated today. Then, as soaring unemployment eroded consumer purchasing power, the Fed foolishly shrank the money supply by nearly a third…just the wrong medicine. Today’s wiser Federal Reserve is pulling out all the stops to get credit flowing.
Another big difference: Trade policy. The Smoot-Hawley tariff legislation of ’30 hiked duties on imports, leading other governments to do the same: From ’29 to ’33, U.S. export value fell by nearly two-thirds. Exports, still booming for much of this year, will grow again next year, though only by a modest 1%.

Key in both time frames: Government spending. The national debt grew over the ’30s by 150% and continued to soar through World War II. Today Congress and the White House (both the outgoing and incoming president) seem inclined to spend whatever is necessary to forestall a deep, long recession ... budget deficits be damned. Next year, the deficit is likely to top $1 trillion. At 7% of GDP ... a modern record but well short of the 30% of GDP it hit in ’43.
Finally, America’s financial safety nets were absent in the early ’30s. Though under severe and growing financial pressure, Social Security, Medicare and Medicaid, unemployment benefits, bank deposit insurance, and private pensions all provide support to millions of Americans ... employed, retired, or jobless.

Energy
With oil prices plunging, will enthusiasm for alternative energy evaporate?
We don’t expect it to, though venture capital plowed into renewable energy has plateaued this year at about $4 billion for U.S. projects. Look for a big jump in ’09, with investors pouring about $5.5 billion into solar, wind, biofuels, and other projects.
Here’s why: Investors know low oil prices won’t last. As global economies pick up speed in a year or so, demand for fossil fuels will once again surge. Although that won’t bring back the kind of hyper-inflated prices seen earlier this year, it will reestablish prices representing a fundamentally tight supply/demand balance.
Congress and President-elect Obama will tackle global climate change, imposing carbon emission curbs on industries and hiking demand for nonoil fuels.
And other legislative changes coming spell tax benefits for renewable fuels well into the next decade, luring investors with the promise of financial security.

The solar industry in particular is on the cusp of a boom. It’s getting a lift from a 30% tax credit for the purchase of solar power systems. Previously capped at $2,000, the credit was extended until Dec. 2016, and the ceiling on it removed as part of this fall’s credit rescue plan. That’ll make it affordable for both businesses and homeowners to install solar arrays capable of getting them off the grid entirely.
In eight years ... enough power for 8 million homes, from 2 gigawatts now to 32 gigawatts. But solar’s share of power capacity will still be small ... just 3%.