On a road to recovery? Several factors pointing toward 2009 being a better year for commercial truck industry

Diesel Progress North American Edition, Sept, 2008 by Stephen Latin-Kasper

The 2009 forecast for the commercial truck industry is driven by a number of factors--inflation, interest rates, housing starts and emissions regulations--not necessarily in that order. The first three factors are all macro and intimately bound up with each other. The last one is micro, which may make it seem somehow of less consequence, but in fact, its impact is probably greater than the three macro factors combined.

It has been a long time since the U.S. has experienced a sustained inflation. The official number for yearend 2007 based on the Bureau of Labor Statistics' Consumer Price Index was 4.1%. The last time the U.S. economy registered an annual rate above 4% was 1990, when it registered a rate of 6.3%. In fact, the rate of inflation was 4.5% from 1987 to 1989 and then peaked in 1990, falling after the recession of 1991--largely as a result of huge productivity increases, which effectively ended a long wage-price spiral. As a result, the Federal Reserve was able to sustainably increase interest rates to a level consistent with healthy economic activity.

In 2008 and into 2009, that may not be possible. The similarities between now and 20 years ago include increasing oil prices and a weakening dollar. The differences include record federal government budget deficits and massive increases in demand for everything from commodities to finished goods in China and India. Of the two, the demand-pull inflation that has resulted from historically unprecedented growth in China and India is the more significant cause of fiscal and monetary policy decision difficulties in the U.S.

Unlike the late '80s, when there were problems that could be identified and fixed, such as monetary policy that allowed the dollar to depreciate, or OPEC members getting greedy, this current problem is technically not a problem at all in economic terms. It really should be thought of as an opportunity. In the long run, the addition of an Asian engine to the global economy is a good thing. So in an effort to get the terminology correct, it is probably best to think of the short-run upward pressure on global commodities prices as the result of a structural change in the global economy. What is happening now is akin to what happened in the U.S. between the '80s and the '90s as computer technology was absorbed into the daily fabric of our lives. It literally changed everything--from the way we manufactured goods to the way we communicated with each other. Structural changes require time to adjust to, and this particular change involves almost half of the people on the planet. We are going to be adjusting for a while.

In the short run, though, what should policy be? First, the Federal Reserve's decision to stop lowering rates in July was correct. The economy wasn't performing as badly as the media was portraying and there were larger issues that required attention--namely inflation, a weak dollar and a financial crisis that had led to a credit squeeze. Holding the line on rates will probably extend the credit squeeze, but in an economy that has generated record levels of debt (similar to the late '80s), that is good policy. The decision had a positive impact on the dollar, but no discernible impact on inflation. It should be remembered, though, that after realizing that inflation was rearing its ugly head again in 1987, when the average prime was 7.5, that it increased rates continuously until the average prime reached 11.5 in the second quarter 1989. After that, the average prime stabilized at around 10 and the Fed didn't push rates back down until the recession of 1991 finally removed what had clearly become excessive demand for credit from the U.S. economy.

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The Fed has clearly signaled at this point that it is going to fight inflation, which means that interest rates are probably going to go up. On the other hand, fiscal policy remains expansionary (inflationary). Since 2008 is an election year, there was never any doubt that it would be, and that puts even more pressure on the Fed to get monetary policy right. Therefore, it is highly likely that interest rates will start increasing by year end and into 2009. That the U.S. CPI registered 5.5% inflation (seasonally adjusted annual rate) in July makes that almost certain.

As for the housing sector, which has been in the media spotlight since the fourth quarter 2006, it appears to be the case that the worst is over. The rate of decline in housing starts is still negative, but has been getting slightly less negative through the first two quarters of 2008. And as was the case with Bear Stearns, it is unlikely that potential problems at Fannie Mae and Freddie Mac won't be covered one way or another by the federal government. Consequently, the financial sector may still be in crisis, but it is no longer the Fed's crisis and they are free at this point to act according to their mission, which is primarily to control inflation.

As stated before, there is no longer a good reason to believe that interest rates won't start to increase, and that has already led to a change in expectations of the price of money. Since businesses and consumers are expecting rates to go up in the future, they will desire to buy money (take loans) now. That will remain true through the end of 2008 and at least through the first half of 2009. The result is likely to be increased purchases of durable goods by businesses and consumers in the short run. The credit squeeze will make this process play out more slowly than it would have otherwise, but won't stop it.