TH L IS LE A IS SS YO ST YO US U I UB SC SS R RIB E( U SE E E P UN 1100 13th Street, NW / Suite 750 / Washington, DC 20005 • Special Issue Dear Client: Washington, October 2011 Let’s talk about inflation. Sure, there’s little to worry about now. The slow economy will keep a damper on demand through 2012, and ample supplies of resources… from workers to raw materials…mean little pressure on wages or prices for at least the next year or so. INFLATION But come 2013 or soon after: Watch out. Annual inflation of 5%-6% or more is a good bet, even if economic growth remains pokey. If the pace picks up, inflation will climb even higher. Worse, the trend may continue for years. ECONOMIC FORECASTS Here’s why: A toxic cocktail is in the works… a powerful brew that makes a strong upward cycle of prices nearly inevitable. The main ingredient: The government’s crushing debt load… already equal to 67% of the U.S.’ annual GDP and headed higher with each year’s budget deficit. Add Washington’s inability to control it. Hamstrung by politics, the two parties show no signs of making the painful compromises that are needed to pare annual deficits enough to rein in debt. GDP growth Slipping under 2% this year, about the same in ’12 Interest rates 10-year Treasuries near 2% through mid-’12 Inflation Slipping back to 2% in ’12, after hitting 3.3% in ’11 Unemployment Stuck at about 9% through most of ’12 Crude oil Trading in the $85-$90/bbl. range into Jan. Manufacturing Industrial output slowing as growth cools overseas Complete economic outlook at kiplingerbiz.com/outlooks Throw in the faltering economy and the Federal Reserve’s reluctance to raise interest rates for fear of throwing the country into another recession… And you have a recipe for inflation. Skeptics who say that inflation comes from too much money chasing too few goods…clearly not the case in today’s economy… are humming the wrong tune. An overheated economy isn’t the only route to inflation. It’s a bit of a self-fulfilling prophecy, magnified by the enormous quantities of debt involved...$5 trillion in maturing Treasuries must be rolled over each year. Expectations of inflation push up interest rates on long-term Treasuries as investors demand higher returns to compensate for erosion in their holdings’ value. Prices of other assets are bid up as some holders of Treasuries coming due seek alternatives…stocks, commodities and so on…that may appreciate in value. And goods and services…and the labor to produce them…start to cost more. Fearing that products they want or need will only carry a higher price tag tomorrow, consumers opt to spend more and save less today. With greater demand, prices rise. So borrowers will win and creditors will lose. Debtors, including Uncle Sam, will pay back loans in dollars that aren’t worth as much as when they borrowed them. In nominal terms, assets, including homes, will be worth more…a help to homeowners with underwater mortgages. But in real terms…little or no gain. Inflation may even be stimulative, prodding the economy into faster growth. But once unleashed in a slow economy, inflation is hard to vanquish. Order online at kiplinger.com/go/kipletternov or call toll free 1-888-532-6789. AG E 4 ) THE Private sector hiring is picking up…a sign of slightly better growth ahead. ECONOMY Expect businesses to add 100,000-150,000 jobs a month during 2012... minus 20,000 or so as governments continue to retrench. That’s too few net jobs for a boom in consumer spending and to provide much of a jump start to the recovery. Business hiring is resilient, though, bouncing back after an anemic August showing. Private sector jobs rose by 137,000 in September, after just 42,000 a month earlier. That’s not enough to lower unemployment. It’ll stay at 9.1% the rest of 2011. The numbers of those out of work at least six months or who quit looking keep rising. Be grateful for the spurt in construction over the summer months... building of offices, malls, private hospitals, power plants and university facilities. It propped up sagging third-quarter GDP, probably putting growth at 2%. A much lower rate of growth would signal that recession is nearly certain. As it is, we expect growth to remain at about 2% through year-end, though more of the gain will come from retail sales and spending on equipment, less from building. Holiday retail sales…up at least 5% from the Nov.-Dec. 2010 period. Not as good as last year’s 7% jump in holiday buying, but better than most anticipate, given the plodding economy. With unemployment stuck above 9%, stock markets on a roller coaster and consumer confidence down, it would come as no surprise if Santas were tightfisted. But the season may reprise the 2009 holiday performance, when fourth-quarter profits zoomed past expectations to a healthy $24 billion. By keeping a tight rein on costs, retailers should come out fairly well. Inventory levels will be held in check. Look for purchasing managers to hold off placing reorders till they’re sure that supplies won’t be left on shelves. They’d rather risk forgoing additional sales than be forced into the deep discounts that they had to take in 2008. So...fewer bargains available for frugal customers. And retailers will be extra cautious about hiring...just an 8% upward bump from the number of jobs added in Oct.-Dec. last year. Retail employment will grow by 7% less than in late 2007. And fewer of those hires will go full-time in 2012. TRADE Bashing China’s currency policy is a popular game in Washington these days. But don’t expect a bill seeking sanctions for money manipulation to succeed. Even if the legislation gets through the Senate, House leaders won’t bring it to a vote this year. That’s fine with Obama. He wants to avoid a trade fight with the Chinese, whose companies would face retaliatory tariffs if Beijing keeps the yuan undervalued. Still, rhetoric against China will increase…including from some Republicans who want to be seen as fighting for U.S. jobs in the midst of the economic slowdown. The yuan has appreciated by 30% since 2005, but it’s still undervalued by up to 25%. TECH Facial recognition software will add a new level of security to your computer over the next few years. Such applications are already usable on the iPhone and are being tried by police and border agents, raising some civil liberties questions. The use of the technology will expand to automated teller machines and other devices. The programs are most effective when a user downloads a picture for later comparison, an easy step now that many portable phones, tablets and laptops have cameras. One practical function: Using a photograph to log on instead of a password. If the device user’s facial features don’t match the picture on file? Access denied. Out in front: Google’s Picasa, Microsoft’s Live Photo Gallery and Viewdle. Coming soon: A new type of mouse for navigating on U.S. computers. The Penclic Mouse, now in use in Europe, is a cross between a pen and a joystick. It moves like a pen, which makers say is more natural than rolling a regular mouse. The device will be sold by Best Buy, Wal-Mart and other major retailers. Order online at kiplinger.com/go/kipletternov or call toll free 1-888-532-6789. ELECTIONS 2012 Republicans will pick up more governors’ chairs in next year’s elections, no matter how the presidential campaign turns out. President Obama won’t have long coattails in some states with competitive chief executive races, so the GOP will be able to add to its already considerable edge over Democrats. For now, there are 29 Republican governors, 20 Democrats and one independent. Best chances for GOP gains: North Carolina, New Hampshire, Montana and Washington. But more states will lean Republican if the economy stays weak. The other 10 states electing governors next year: Missouri, North Dakota, Utah, Indiana, Kentucky, Delaware, Vermont, West Virginia, Mississippi and Louisiana. One potential bright spot for Democrats: West Virginia. The narrow win by Gov. Earl Ray Tomblin in the Oct. 4 special election gives him an edge. FEDERAL Look for the congressional deficit-cutting committee to start thinking small. BUDGET But in this case, small is still a really big number: $1.2 trillion. Agreement on larger reductions over 10 years…up to $5 trillion…won’t happen before Nov. 23, the deadline for the panel to submit its recommendations to the House and Senate. Massive savings can’t occur without tax hikes, and the GOP won’t go there. Just agreeing on the smaller number will be difficult, given the tense political climate. But the 12 panelists will be spurred by the knowledge that automatic cuts kick in if they can’t reach an agreement before the deadline to slash at least $1.2 trillion. A big chunk of savings will come from shrinking troop levels in Afghanistan and Iraq. Some military procurement programs will be squeezed, too. Farm subsidies and some business tax loopholes are also on the table, along with tweaks to Medicare. Certain to face the budget ax this fall: U.S. assistance to other countries. While it amounts to just 1% of federal spending, there is broad support to cut money for the State Dept. and international economic development and health programs. Some critics want to slice foreign aid to $30 billion, from $48 billion now. A more likely target for congressional budget cutters: $40 billion for 2012. Some programs will emerge unscathed…$3.1 billion for Israel, $1.3 billion for Egypt. One hard sell: Money for Pakistan, a nation Congress sees as unhelpful in U.S. antiterrorism efforts. In the end, the $3-billion annual outlay may be halved. REGS The Obama administration is starting to roll out new workplace rules to expand injury reporting standards and revamp whistle-blower protections. The Occupational Safety & Health Admin. changes will put new burdens on employers. One rule alters the threshold for disclosing injuries requiring hospitalization. If it’s adopted, firms will have eight hours to file a report if one employee is injured. The existing standard requires a filing only if three or more workers are hospitalized. Companies with 10 or fewer employees won’t have to comply. Also exempt: Electronics and appliance stores, publishers, insurance and advertising firms, hobby shops and other businesses that are classified as low-hazard employers. OSHA will hire and train more investigators for whistle-blower cases and give them better guidance, including new procedures for approving settlements. Look for the government to loosen rules for registering privately held firms. The Securities and Exchange Commission reporting rules now apply to companies with at least 500 shareholders and $10 million in assets. After the SEC’s change, probably next year, only those with more than 2,000 shareholders need file statements that must be audited. The records will also be made available for public inspection. Community banks will benefit, as will growing companies such as Facebook and Twitter, which sell private shares to raise money but aren’t ready to go public. Order online at kiplinger.com/go/kipletternov or call toll free 1-888-532-6789. AUTOS Some welcome news for drivers: Vehicles are becoming more crashworthy, largely because of SUV and pickup redesigns that take less of a toll on smaller cars during collisions. Fatalities from crashes between big and small cars have dropped by two-thirds from a decade ago because of the industry’s safety push. And the trend will only pick up speed as the newer, safer models being sold steadily replace older trucks and SUVs now on the road. More high-strength steel… already essential for improving fuel efficiency…will also bolster small-car safety. Down the road: Even bigger safety gains as automakers shift their focus to electronics that will help avoid collisions instead of making them more survivable. ENERGY Cheap natural gas and pricey oil are reviving interest in an old technology: Refining motor fuel from natural gas. Gas-to-liquids (GTL) refining was considered too capital-intensive for widespread adoption. But high crude prices and an abundance of natural gas supplies make the economics of GTL viable now. Petroleum giant Shell is a big player, with the world’s largest GTL project in Qatar. RAW The copper sell-off will soon come to an end. Now at about $7,000 a ton, MATERIALS prices are well off the $10,000 or so copper traded at this past summer. Supply constraints, such as disruptions at some major mines and declining ore quality, are likely to put a floor under prices for the red metal before they drop much further. Prices will rebound a bit when the economy strengthens, to $8,000 a ton... Even higher if central banks use monetary stimulus efforts to spur growth. As lithium demand continues to rise, look for miners to increase U.S. output of the light metal. Limited availability and a growing number of uses…from ceramics to high-end batteries…are creating supply concerns within the electronics industry. Nevada has large concentrations of salty brine deposits that yield lithium when dried. Lithium-bearing clays are also a promising new source of the material. New sources of phosphate will help curb soaring fertilizer prices. Peru, Iraq and Saudi Arabia are gearing up output, joining Morocco, which has huge reserves. New finds in Iraq could be some of the largest ever. Lots of potential supply closer to home, too...sizable untapped deposits in both the western U.S. and Florida. For now, environmental opposition will block development in the U.S. Yours very truly, October 2011 THE KIPLINGER WASHINGTON EDITORS Keep The Kiplinger Letter coming every week! You’re invited to take advantage of a special low introductory offer for new subscribers. Regular price: $117 Your Price: Just $49 for 52 weekly issues of The Kiplinger Letter. 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