TIME: Almanac 1993/TIME Almanac 1993.iso/time/021290/0212208.000

Text File | 1992-08-30 | 16.7 KB | 363 lines

                                                                                BUSINESS, Page 48

Better Watch Out

The President's budget assumes the economy will shake off its
slump, but America's debt burden leaves it highly vulnerable to
a recession

By RICHARD HORNIK -- With reporting by Barry Hillenbrand/Tokyo,
Wiliam McWhirter/Chicago and Nancy Traver/Washington


    The life signs of the U.S. economy have been shaky for
months, as if it had a mild case of the Shanghai flu. Inflation
is drifting upward, while economic activity seems stuck in a
quagmire of intense foreign competition and excessive debt.
During the last quarter of 1989, the economy grew by only 0.5%,
the slowest pace in three years. Warns Kazuaki Harada, chief
economist of Japan's Sanwa Bank: "The real U.S. situation is
worse than the growth-rate figures would indicate." Federal
Reserve Board Chairman Alan Greenspan, whose finger is closest
to the American economic pulse, thinks the current slump is
probably only a "temporary hesitation" and believes the U.S. can
avoid a recession. But as he told the Joint Economic Committee
last week, "I wouldn't want to bet the ranch."

    The possibility of a recession has become a red-hot topic in
recent weeks, in part because so many indicators have been
flashing alarms. U.S. industry is operating at 82.5% capacity,
the lowest in two years. Construction spending is at the slowest
pace since the 1981-82 recession, corporate profits are
declining, and the U.S. auto industry has already entered a
recession of its own.

    Consumers, whose spending represents two-thirds of the
economy, generally think the U.S. will steer clear of a
recession in the next twelve months. In a poll for TIME/CNN by
Yankelovich Clancy Shulman, 60% of those surveyed think a 1990
recession is unlikely, vs. 32% who believe one is probable. Yet
consumers have no great expectations of resurgent U.S. growth
this year: 64% think conditions will stay the same, while only
14% see an improvement, and 20% expect things to get worse. One
concern is unemployment: 60% of those polled think U.S.
joblessness, which remained at 5.3% in December and January, is
likely to grow this year.

    A 1990 recession could be deep and painful. Most economists
agree that the record borrowing binge of the 1980s has left the
U.S. economy's private sector singularly unprepared for tough
times. Worse still, the Government's fiscal profligacy in those
years has drained it of any reserves that could be used to
counter recessionary forces. In the postwar era, the most
commonly prescribed medicine for an economic downturn has been
fiscal stimulation. But persistently high federal deficits, even
during periods of robust economic growth, have taken that option
off the shelf. Some economists fear that if a recession does
strike, Washington could succumb to policy paralysis.

    The slowdown is already undermining the credibility of the
Bush Administration's first full-fledged budget, which calls for
expenditures of $1.23 trillion in fiscal 1991. Budget Director
Richard Darman was able to squeeze under the
Gramm-Rudman-Hollings deficit target of $64 billion but only by
using assumptions that call for a quick rebound in economic
growth, coupled with a rapid descent of interest rates. Many
economists view that combination as highly implausible. While
the Administration predicts economic growth of 2.6% in 1990 and
3.3% in 1991, the blue-chip survey of 51 economists puts the
figures at 1.7% and 2.2%.

    If the economy grows more slowly than the Administration
predicts or, in the event of a recession, actually shrinks, the
budget deficit will balloon because of declining tax revenues.
Congressional Budget Office projections, which match those of
most economists, indicate that this year's budget-cutting
exercise will be twice as difficult as the Administration
contends. The CBO says $74 billion in spending cuts and revenue
increases will be needed to hit the GRH target, while the Office
of Management and Budget puts the number at only $36 billion.
Says Leon Panetta, House Budget Committee chairman: "This
discrepancy in the figures presents Congress with a terrible
political and legislative dilemma. Do we raise taxes and cut
programs or all get optimistic together?"

    As in the past, Congress is likely to take the latter
course, joining the Executive Branch in dodging its fiscal
responsibility. This year the economy's weakness may provide the
excuse for postponing action on the deficit, since spending cuts
could aggravate the slowdown. Unfortunately, a decade of annual
budget deficits of more than $100 billion has shifted the burden
of controlling the economy almost completely to the Federal
Reserve Board. "The problem is that we have only monetary policy
to rely on," says Lyle Gramley, chief economist for the Mortgage
Bankers Association and a former Fed governor. "It would be
wonderful if we had a $100 billion budget surplus, so that we
could have a small tax cut to stimulate the economy instead of
having to rely on interest rates."

    Bush hopes to spur investment by cutting the tax on capital
gains, but 50% of adults surveyed in the TIME/CNN poll oppose
the idea, vs. 36% who favor it. The President's proposed Family
Savings Accounts would be more popular: 72% of those surveyed
are in favor of giving savers the incentive of tax-free interest
on deposits. But consumers doubt that they will get any tax
breaks this year. Most of those polled expect levies to go up
(51%) or stay the same (43%).

    The only remaining stimulus is interest rates, yet the Fed
is of no mind to lower them just now, Greenspan said last week.
The high deficits, coupled with a low rate of savings in the
U.S., are forcing the Fed to keep interest rates up in order to
attract foreign money to finance new federal borrowing.
Greenspan faces domestic pressures as well. Because inflation
has remained at a persistent 4% or more, the Fed has been
hesitant to pump more money into the economy, even though it is
slowing. For the most part, Greenspan has struck a delicate
balance. Yet the word stagflation, last heard in the 1970s, is
being revived to describe the current potential for no-growth
inflation.

    Greenspan's challenges will increase in the coming year.
Aside from a softening economy, the shape of finance and credit
in the U.S. is changing. More than a decade of ever loosening
regulation of credit terms and conditions led first to financial
debacles in savings-and-loan associations and currently to
widespread concern about the health of many banks in general.
Says Robert Litan, a senior fellow at Brookings Institution:
"One could make the case that our banking system is more fragile
now than at any time before a recession."

    Because federal agencies have begun to reassert regulatory
control over the past two years, credit terms are tightening up.
The Government has required banks to boost their ratio of equity
to total outstanding loans, so that institutions will have more
of their own holdings at risk. As a result, banks are being more
careful about making loans and borrowers are finding it harder
to get credit.

    Potentially more worrisome is a different kind of credit
contraction, a cyclical one. In the gaga '80s, lenders used
practically every debt instrument imaginable. Junk bonds were
issued in an almost endless variety of complex forms. The
consumer got into the act as well. Home-equity loans and lines
of credit, which are basically latter-day relatives of the
second mortgages that led to so many foreclosures in the 1930s,
rose from $20 billion in 1985 to $75 billion in 1988. At the
same time, creditors lengthened maturities. The average auto
loan is now payable over 48 months, up from 36 in 1982. Says
James Grant, editor of Grant's Interest Rate Observer: "The
1980s were to debt what the 1960s were to sex."

    The excesses of the 1980s left both borrowers and creditors
"loaned up." As a whole, the country's total outstanding debt is
more than 180% of the GNP, almost a third higher than the
postwar average. Consumer debt totals some $4.3 trillion, with
total business debt about half that. Banks traditionally limited
the sum of their loans to about 55% of assets and invested the
remainder in government bonds and low-risk corporate
instruments. But those loans now make up uncomfortably close to
70% of assets. Today both sides of the credit equation are less
willing to take a chance: the debtor doubts that the money he
borrows to invest will pay off in higher profits, while the
lender is dubious about the borrower's ability to repay.

    The decline in that sort of mutual confidence is a sign of a
contracting economy. Says Carl Steidtmann, chief economist for
Management Horizons, a retailing research firm: "The consumer
looks at his own situation and feels somewhat ill at ease, slows
down his accumulation of debt and steps up his savings rate."
Businesses, which try to gauge the confidence and appetites of
their customers, currently see very little to like. As a result,
business borrowing is growing at a slower pace than at any other
time during the past decade.

    Even if the eight-year-long Reagan recovery limps through
1990, credit contraction and stagflation will leave many
casualties. The most exposed sector is corporate America,
particularly its most leveraged members. The Bush budget assumes
that pretax corporate profits this year will rise almost 20%,
to $360 billion. But forecasters like M. Kathryn Eickhoff, a
former colleague of Greenspan's, think profits will stagnate at
best. Says she: "These conditions will mean a real squeeze on
the restructuring plans of highly leveraged companies." The net
effect: many highly leveraged firms will find it difficult to
make their interest payments.

    These second- and third-generation effects are difficult to
measure and almost impossible to predict. But the ripples do
spread: tight credit combined with a lagging economy could
increase the number of people who lose their jobs, which in turn
would boost the number of personal bankruptcies and mortgage
foreclosures. That will put more pressure on weak financial
institutions and create new demands on the federal budget. The
bailout of the thrift industry, expected to cost $300 billion,
could certainly rise further if property values continue to
drop. The problems of commercial banks, which so far have been
limited to regional downturns in the Southwest and the
Northeast, could spread. Says banking expert Litan: "Even a mild
recession would wipe out the $14 billion in reserves of the
FDIC."

    In one of the franker elements of his introduction to this
year's budget proposal, Darman pointed to a number of other
potential problem areas, or Hidden Pac-Men, as he called them.
On the financial side they include:

    -- Over $1 trillion in outstanding loans and loan
guarantees of federal credit programs, including the Farmers
Home Administration (FHA) and the Government National Mortgage
Association (Ginnie Mae). Darman concedes that future claims
against these programs will be in the "tens of billions of
dollars" and would be "substantially higher" without continued
economic growth.

    -- More than $4 trillion in coverage through federal
insurance programs, like FDIC, for crops, disaster relief and
pension funds. Federal insurance of private pension funds covers
$800 billion in assets, yet by one estimate its liabilities
already exceed its funds by $17 billion.

    In short, neither the public nor the private sector can
afford a recession now. Although the U.S. has had its longest
peacetime expansion in history, America failed to save for a
rainy day. The storm clouds first appeared on the horizon more
than two years ago, when the S&L industry collapsed. The
Government had a window of opportunity to begin getting its
fiscal house in order, particularly with the arrival of the Bush
Administration, but the President's no-new-taxes pledge has made
it impossible for him to reach meaningful compromises with
Congress on deficit reduction.

    What can be done, then, to revivify the stagnating American
economy? Some economists think the U.S. may find help overseas.
The economies of Japan and West Germany are robust, and new
markets in Asia and Eastern Europe could provide ready outlets
for U.S. exports. C. Fred Bergsten, director of the Institute of
International Economics, believes the U.S. could have an
export-led recovery if the dollar were devalued quickly through a
concerted effort of America's major trading partners. A cheaper
dollar might be somewhat inflationary, but the sluggish
economy's low level of demand would dampen that effect. Such a
move would also enable the Fed to worry less about keeping up
interest rates to defend the dollar's strength. If the strategy
were successful, the Administration's optimistic scenario might
come true and give the U.S. another chance to start whittling
away at its mountain of debt. In that case, American debtors
should seize the opportunity, because they may not get another
chance.


____________________________________________________________
HOW AMERICANS SEE IT

During the next twelve months, do you think a recession will
occur?

                                         Jan. 1989    Jan. 1990
   Likely                                  34%          32%
 Unlikely                                59%          60%

During the next twelve months, do you think economic conditions
in this country will get better?

                                         Jan. 1989    Jan. 1990

    Become worse                            22%          20%
 Stay the same                           60%          64%

In the next year, do you expect that the Government will raise
taxes?

     Raise taxes                             51%      Lower
taxes                             4%      Keep taxes where they
are now          43%

Do you favor or oppose the following proposals:

                                            Favor       Oppose

Reducing Social Security payroll taxes       29%          67%

Reducing the capital gains tax               36%          50%

Allowing depositors to earn tax-free interest on savings
accounts                 72%          24%

[Telephone poll of 1,000 adult Americans for TIME/CNN on
Jan.31-Feb.1 by Yankelovich Clancy Shulman. Sampling error plus
or minus 3%.]


____________________________________________________________
BUDGET HIGHLIGHTS (in billions)

SPENDING CHANGES                                         Fiscal
'90   Fiscal '91      Defense $296.3        $303.3

Two of the army's 18 active-duty divisions would be eliminated;
spending on the B-2 bomber would continue.

     Education and Social Services           37.7          41.0

Head Start, a program to prepare children for school, would
have its spending authority increased 36%, to $1.9 billion.

     War on Drugs                             6.9           9.7

An extra $813 million would be provided to fight drug
traffickers by bolstering patrols at the Mexican border, among
other tactics.

     Science and Space                       14.1          16.6

NASA's budget would grow 18%, the largest percentage increase
for any major agency, to $14.1 billion.

     Health                                  42.9          48.2

Funds to fight AIDS would increase 18%, to $3.5 billion.

     Environment                             17.5          18.2

The Environmental Protection Agency's operating budget would
grow 12%, to $2.2 billion.


NEW REVENUES   Total Gain      Capital-Gains Tax        $4.9

The Administration expects that a cut in the tax rate on
capital gains would initially spur asset sales and therefore
generate new revenues.

     Telephone Tax                                       1.6

Bush will extend a 3% tax on long-distance calls, scheduled to
expire at the end of this year.

     IRS Reforms                                         2.5

The Administration hopes that greater efficiency at the IRS
will bring in larger tax revenues.

     Air-Travel Tax                                      0.5

Bush would increase the tax on airline tickets from 8% to 10%.

     Payroll Tax                                         3.8

Assessing federal payroll taxes on all state and local
government employees (a few states are now exempt) would produce
substantial new revenues.

     Assorted Fees                    5.6

Among the proposed fees; a $25-a-year charge for boaters who
use waterways patrolled by the Coast Guard.


TOTAL DEFICIT      1989            1990            1991

                   $152 billion    $123.8*         $63.1*

* projected.