It will come as no surprise to restaurateurs that we are in the midst of a turbulent and complex economic cycle – one whose reach extends across the world and back again and whose elements intertwine. “We are experiencing an unforeseeable convergence of events that seemed so divergent but actually aren’t,” says Joan Lamm-Tennant, PhD, Global Chief Economist, Guy Carpenter & Co. Principal among them:

Food price inflation. The World Food Program states – and countless experts concur – that the roots of higher food prices are increased energy costs; rising demand from economic growth in emerging economies (notably China, India, Russia, Brazil); the growth of biofuels; and increasing climatic shocks, such as droughts and floods. Rising fertilizer prices, commodity speculation, and the weak dollar also factor in. Perhaps the biggest debate is over the impact of biofuels, which divert both crops from food and agricultural land from food production. The World Bank lists the effect of producing fuel from crops – corn in the U.S. and rapeseed, palm, and soy oil in Europe – as the primary cause of rising food prices; the International Food Policy Research Institute estimates that it accounts for between one-quarter and one-third; U.S. Agriculture Secretary Ed Schafer calculates it at most 3%. “Everyone admits it has had an impact; about one-third is where most studies come out,” says Michelle Reinke, Dir., Legislative Affairs, the National Restaurant Association. “Ethanol is not the only factor in spiking food prices, but it is the only policy-based one the government can change.” The NRA is actively participating in efforts to influence just that, but Michelle predicts it’s unlikely Congress will act soon. “We’re in for a long-term adjustment. The dramatic increases for agricultural commodities that restaurateurs are seeing aren’t seasonal or short-term supply disruptions. Prices – especially for corn and vegetable oils – are not going down for some time.” The U.N.’s Food and Agriculture Organization and the Organization for Economic Cooperation and Development predict that commodity prices for the coming decade are going to rise higher and higher.

The cost of oil. Greater global demand is also at work in the rising cost of oil – which has a far-reaching impact on the entire economy. As with food prices, there is some debate about the relative role of underlying forces. Some, notably Saudi Arabia and other OPEC members, take the position that speculators seeking better returns in commodities, particularly crude oil, are driving up prices. A Federal task force will be looking at the role of speculators in the commodity markets, but U.S. Energy Secretary Samuel Bodman has said soaring crude prices are the result of oil production not having kept pace with demand, especially from developing countries like China and India, where it has been soaring. (Indeed, BP reports that global oil consumption grew 1 million barrels per day in 2007; global production fell 130,000 barrels per day.) While Saudi Arabia promised a 200,000-barrel per day production increase in July on top of a 300,000-barrel per day increase in May, experts seem to agree that OPEC will try to keep prices as high as possible until it erodes demand. “America uses the equivalent of 25 barrels of oil a day per capita, whereas in China it is 2 barrels,” says Joan. “As the Chinese continue to emulate our lifestyle, there will be a rapid increase in their per capita consumption, which will more than offset any fuel conservation efforts Americans implement.” Many say solutions for the U.S. are to reduce consumption, produce greater domestic supply, and encourage alternatives – which would make us less vulnerable to foreign interests and stimulate global competition. While the U.S. is the world’s third largest producer, writes Robert J. Samuelson, Newsweek columnist, it imports about 60% of its oil, up from 42% in 1990. “And we’ll import lots more for the foreseeable future,” he predicts. Increasing U.S. production will be a hot topic, as will artificial manipulation of the market. But most experts say that if the oil bubble is going to burst, it won’t be anytime soon.

Housing and credit crises. Along with price inflation of food and oil, the significant challenge the U.S. economy faces is recovery from the housing and housing-related credit crisis – the toll of which continues to rise. The rate of foreclosures and the percentage of loans in the process of foreclosure in the first quarter was the highest recorded by the Mortgage Bankers Association since they began collecting data in 1979. And it’s not just in the subprime arena. The MBA reports that 23% of the foreclosures started were on prime adjustable-rate mortgages, notably in California. Rick Sharga, vice president, marketing, RealtyTrac, predicts that foreclosures are unlikely to peak until sometime this fall, as more loans made to borrowers with poor credit records are reset at higher levels. Properties piling up adds to the inventory of homes on the market and further drags down home prices. While there might be some regional pockets of improvement, Lehman Brothers economist Michelle Meyer predicts home prices will continue to decline another 10% – 15% by the end of 2009. Other factors contributing to the pain consumers are feeling are weak housing sales. Although also showing some hope (recent National Association of Realtors numbers suggest that buyers in the Northeast, Midwest, and West may be taking advantage of discounted rates), Michelle says sales will likely hit bottom at the end of this summer. Plus more stringent commercial lending criteria means homebuyers can’t get loans as easily. (Having suffered major losses themselves, major financial institutions and banks are less willing to extend new credit; credit is expected to remain tight.) All of which is leading to more calls for more aggressive government intervention to aid distressed homeowners – causing a debate that is likely to continue for some time.

Value of the dollar/interest rates. Lower interest rates have bolstered the economy but have taken a toll on the dollar, which weakened over the last couple of years to a record low in April. That, in turn, has pushed up prices for imports and increased the cost of living. On the other hand, the dollar’s weakness has made U.S. exports more competitive, which economists agree has helped buoy the economy from further slides. Treasury Secretary Henry Paulson has said that “solid fundamentals in the American economy” would eventually help the U.S. currency recover (but didn’t rule out some kind of intervention); Chairman Ben Bernanke has said that the Federal Reserve is “attentive” to the issue. In the spirit of what Chairman Bernanke refers to as “dual mandates” – encouraging economic growth while preventing further inflation (which it expects to moderate later this year and next year) – the Federal Reserve maintained its key rate at 2% in June. It cited tight credit conditions, the ongoing housing contraction, and the rise in energy prices, which are likely to weigh on economic growth over the next few quarters; the Fed also stated that while recent data indicates that overall economic activity continues to expand, driven in particular by household spending, that labor markets have softened further and financial markets remain under considerable stress. The Fed’s official statement assures that it “will act as needed to promote sustainable economic growth and price stability,” leading many analysts to predict a rate increase in September.

Consumer spending. The economy is feeling the effects of the powerful relationship between home prices and consumer spending, which represents more than two-thirds of the nation’s economic activity. Not only has the decline in home prices eroded what is typically people’s primary equity (Mark Zandi, Chief Economist, Moody’s Economy. com, estimates it has slashed $2.5 trillion from household wealth, or the equivalent of $25,000 per homeowner), but as real estate prices decline, so does an important bolster for spending: the ability to borrow against what was the increasing value of homes and/or sell them for a profit. Millions of Americans now owe more on their homes than they’re worth. In response to this and to the drain inflation is placing on discretionary spending, the Federal government is expected to pump a total $106.7 billion into the hands of eligible taxpayers in the form of rebates. The majority were sent during the initial round which began the end of April; most people will get their rebates by mid-July. While Joan Lamm-Tennant, Global Chief Economist, Guy Carpenter & Co. echoes an almost universal caution saying, “Providing incentives for consumers to spend is only a short term solution or reprise from the underlying fundamentals of our economy,” the rebates appear to be providing a boost. After-tax incomes and overall consumer spending are showing big gains: inflation-adjusted spending rose by 0.4% in May, the best performance since last August. It had been widely speculated that some of the rebates would go to pay off credit card debt and some into savings; that the high cost of fuel and food would simply eat the checks; and/or that people would just stay home. However, the Commerce Department reported that retail sales increased 1% in May, double what economists were expecting. The effect of rebate spending in restaurants has yet to be determined. Bob Goldin, Executive Vice President, Technomic, Inc., isn’t hopeful, saying that it doesn’t appear that the industry will benefit given that consumers have other nondiscretionary priorities. Technomic’s most recent consumer sentiment survey, released in early May, concluded that consumers will be far more likely to save/invest the money, pay off debt, and/or shop for necessities. Indeed, the May spending spree was not as widespread among retailers as economists had hoped, with shoppers clearly migrating to discount stores, which are reporting the bulk of sales increases.

Consumer confidence. Some experts say the U.S. economy is worse than we think; others say that it is proving more resilient than we give it credit for. Regardless which scenario proves to be more accurate, it will be directly tied to the resiliency of American consumers, which is why economists carefully monitor consumer confidence (while also noting that consumers do not always act in keeping with their statements to surveys). It’s difficult to be upbeat when the cost of living is on the rise, home values are declining, and business and employment conditions are generally weak. (The Labor Department reported that the U.S. lost jobs in May for the fifth consecutive month and that the unemployment rate registered the biggest one-month jump in more than two decades, from 5% to 5.5%.) Not surprisingly, the two principal indexes – the University of Michigan’s Consumer Sentiment Index and the Consumer Confidence Index, issued by the Conference Board – showed declines in June. The University of Michigan index dropped to the weakest level since May 1980; the Conference Board data registered a 16-year low and the fifth lowest reading ever. (Both report data monthly, based on household surveys of consumers about their feelings about the economy along with their own finances.) Lynn Franco, Director of the Conference Board Consumer Research Center, says that their numbers reflect sentiments across the board, including at the upper end. “Obviously, the lower incomes are being harder hit by rising prices, but everyone is pessimistic,” says Lynn. “We’re going to continue to see consumers rein in their spending,” she continues. “Consumers are spending on the essentials and curtailing their spending on the non-essentials; the big ticket and discretionary items they are holding back on at the moment. Dining out is viewed by many as discretionary and is one of the first services consumers will cut back on during uncertain times. While the silver lining to this otherwise dismal report may be that consumer confidence is be nearing a bottom, I’d say the remainder of this year looks to a challenging one for the restaurant industry.” That said, much will depend on what consumers judge to be essential purchases. Hudson Riehle, the National Restaurant Association’s Senior Vice President, Research and Information Services reports that, “Despite the host of challenges and economic bad news, May registered the single biggest sales volume for the restaurant industry. It is a testimony to consumers’ dependence on the industry.”

What to watch for. The Federal Reserve anticipates “somewhat better” economic conditions during the second half of 2008, consistent with their recently released projections, which see growth picking up further in 2009. Along with the downside risk of oil price increases, Chairman Bernanke’s major caveat is housing. “Until the housing market, and particularly house prices, shows clearer signs of stabilization, growth risks will remain to the downside,” he says. Many experts agree that housing is pivotal – as long as home prices fall and foreclosures rise, the financial system won’t find sure footing. Daniel Gross, senior editor, Newsweek, writes, “Reductions in the level of housing inventories for sale will be a hopeful sign. Other tea leaves are the weekly reports on jobless claims, retail chain stores, and mortgage application activity.”

As to when to look for those hopeful signs, there is some agreement – cautiously – with the Fed’s projections and with Treasury Secretary Paulson’s statements that we’ll have a second-half rebound; while in agreement, Mark Zandi warns it could prove to be a “dead-cat bounce” from the second wave of rebate checks this summer. While Joan Lamm-Tennant and other economists debate this downturn’s longevity, they agree that as with all economies, it is a cycle we will come out of. “You could say that this period is distinct, different than any other – but they all are,” she says. “What might distinguish this one is its persistence. The best advice I could give restaurateurs is to manage the cycle.”

Another accords appear to be that the economy is structurally sound, and that it’s not all bad news. There are winners and losers in every economic cycle – short term, there is enormous improvement in the trade balance and many sectors are benefitting from strong exports. And ultimately, extreme oil prices create pressure and greater incentives to conserve, find energy efficiencies, and develop alternatives – which generate new sources of growth. It may inspire what some say is a long-overdue shift in thinking and in behavior that will lead to a more sustainable environment and a more secure economy.

July 1, 2008.

NOTE: Next issue – successful coping strategies.