TIME: Almanac 1993/TIME Almanac 1993.iso/time/030689/03068900.016

Text File | 1992-09-23 | 8.4 KB | 161 lines

                                                                                BUSINESS, Page 50

Feeling the Heat


A burst of inflation rattles the stock market, sends interest
rates bolting, and threatens to put the Fed and the White House
on a collision course

By John Greenwald

    Has the economic bane of the 1970s returned to haunt the
late 1980s? For several years, inflation has seemed like a
vanquished problem of another era. Price increases during the
past half-decade have been remarkably small, never more than 5%
annually. Vigilant economists have spotted warning signs from
time to time but never any present danger. Now, however, comes
fresh evidence that inflation may be making a comeback at a
time when it could play havoc with the aging economic expansion
and the new Administration. A serious rise in prices would force
the Federal Reserve to fight back by pushing interest rates
higher, which runs the risk of choking the economy, boosting the
federal budget deficit, and ballooning the cost of President
Bush's savings and loan bailout.

    The primary U.S. inflation signal flared brightly last week.
Propelled largely by the fast-rising cost of food and gasoline,
the Consumer Price Index increased 0.6% in January, which would
amount to a worrisome 7.2% if it were to continue through the
year. That marked the strongest monthly inflationary surge since
January 1987, when prices jumped 0.7%. But the rate then slowed
to a modest 4.4% for 1987 and 1988.

    After the latest numbers became public, Federal Reserve
Chairman Alan Greenspan gave moneymen an anxiety attack by his
frank acknowledgment of the problem. Testifying before Congress,
Greenspan called the CPI report "disturbing" because it
suggested that the U.S. economy was close to overheating despite
the Fed's eleven-month effort to slow it down by subtly
tightening the credit supply. Noting that last week's report
followed January's startling 1% rise in the Wholesale Price
Index, a leap of 12.7%  on a compounded annual basis, Greenspan
warned, "If inflation re-emerges, I think a recession will move
up on us much more quickly than we can imagine, and when it
occurs it will be a prolonged one."

    The inflation news sent tremors of alarm through homes,
offices and executive suites, where memories of the inflation
battle of 1981-82 still linger.  Those fears were quickly
rekindled when major banks, led by Chase Manhattan, boosted
their prime lending rate from 11% to 11.5%, the second increase
in two weeks. At week's end the Federal Reserve confirmed the
quickening trend by raising its discount rate, which is the
rate it charges banks for short-term loans, from 6.5% to 7%.
Anticipating the effects that rising rates will have on
business and the economy, the Dow Jones industrial average
plunged 42.5 points in one session after the inflation numbers
were released last Wednesday. Over the course of the week,
investors sent the Dow falling to 2245.54, down 79.28 points.

    The CPI report cast a spotlight on the quiet but crucial
duel between Greenspan and George Bush over U.S. economic
policy. In its stand against inflation, the Fed has resolutely
tightened credit since last March, when the prime rate stood at
8.5%. But Bush, even though he pledged during the fall campaign
to drive inflation down to 2%, insisted two weeks ago that he is
not "overly concerned" about the threat of rising prices and
cautioned that he "would not like to see" the Fed push interest
rates higher. In Tokyo last week, Bush asserted that the Fed
might be overreacting to the inflation report. Said he: "I
don't think you can make a judgment on one month's figures." But
the President added that while he and Greenspan have "got a
little difference of interpretation" about the data, "that's the
only difference we've got."

    Nonetheless, the separate perceptions that divide the White
House and the Fed remained glaringly obvious. On the day before
the CPI figure was released, Greenspan told Congress that "the
current level of inflation, let alone an increase, is not
acceptable." But on the same day, Michael Boskin, chairman of
Bush's Council of Economic Advisers, testified, "I do not yet
see a serious increase in the underlying inflation rate."
Boskin edged a bit closer to the Fed chairman by adding that if
prices do begin soaring, the Administration will "take quick
action" and "support a policy that avoids an acceleration of
inflation."

    But as Greenspan battles inflation with a tight monetary
policy, he will present the Administration with serious
handicaps in meeting its fiscal goals. Any jump in borrowing
rates would raise to even more astronomical levels the huge
cost of bailing out the S & L industry. While the Administration
put the total ten-year price tag at $90 billion when it
announced its rescue plan last month, that forecast was swiftly
raised to $126 billion. Last week Treasury Secretary Nicholas
Brady said the cost is now expected to reach $157 billion.

    A spurt in interest rates could make even that projection
seem unduly optimistic. The higher rates would boost the
Government's cost of borrowing for the bailout, as well as
worsen S & L losses by raising the interest that the thrifts
must pay depositors. To calm fears of a possible run on
deposits, Greenspan said last week that the Fed will provide
cash to any insolvent S & Ls that need it to meet withdrawals.

    Most important for Bush, runaway interest rates would cast a
pall on the Administration's sunny outlook for economic growth,
which is central  to its plans to cut the budget deficit. The
White House expects the economy to expand by a robust 3.3% in
1989, vs. the 2.7% growth rate predicted by a consensus of top
private forecasters. The Administration's scenario for a
fast-moving economy would raise more than $80 billion in fresh
tax revenues and help Bush meet the $100 billion deficit ceiling
mandated by the Gramm-Rudman law for fiscal 1990.

    But Bush may be handing over the economic throttle to
Greenspan by failing to take any tough deficit-reduction
measures that might remove the heat from prices and interest
rates. The Administration has little real chance to hit the
Gramm-Rudman target without a tax increase, which Bush has
ruled out, or politically unpopular spending cuts, which the
President seems loath to initiate. Bush's strategy of leaving
the hard choices to Congress has led so far to budget gridlock.
Concedes a senior Administration official: "If Congress accepts
our budget, economic growth and inflation and interest rates
will take care of themselves. But if the bickering drags on, the
Fed is going to give us all a hard time."

    Across the Atlantic, European financial leaders were
startled by the signs of U.S. inflation and the budget
stalemate, which they fear could lead to an eventual global
slowdown. In a joint statement, France and West Germany pledged
to coordinate efforts to keep their inflation rates in check.
Said William Martin, chief economist for Phillips & Drew, a
leading London brokerage: "Bush hasn't made any headway, and
there is enormous skepticism about his progress."

    That lack of movement has left Greenspan little room to
waver in the battle to keep inflation from getting out of hand.
U.S. factories are running at near peak capacity, and
unemployment has been at a 14-year low. The rising costs of
production have prompted some experts to fear that an
inflationary wage-price spiral could be ready to begin.

    Still, Fed watchers say Greenspan has the savvy to brake the
economy without skidding it into a recession. Many credit the
Fed with helping prevent a slump by easing credit after the 1987
stock crash. "Ever since the market meltdown, Greenspan has been
walking on eggs," says Pierre Rinfret, a New York City-based
economist. "He's making every move very cautiously."

    Greenspan seemed determined to maintain that cautious pace.
While he and Bush share a long acquaintance and are described by
aides as "very comfortable" together, the Fed chairman vowed to
continue his efforts to  reduce inflation. When Colorado
Democrat Tim Wirth noted that the Fed seemed to be caught in
the midst of a dangerous "high-wire act," Greenspan solemnly
replied, "It is." Unless the Administration and Congress can
find a credible way to cut the budget deficit, the Fed's
daredevil performance will remain the only act in town.