TIME: Almanac 1993/TIME Almanac 1993.iso/time/073189/07318900.013

Text File | 1992-09-23 | 11.1 KB | 212 lines

                                                                                BUSINESS, Page 32

Special Report: The Big Slowdown

Adrift in the Doldrums


As the economy weakens, the Federal Reserve will have to steer
carefully to avoid a recession

By Barbara Rudolph


    The words sounded like those of a business leader lecturing
the U.S. central bank about the dangers of letting the economy
slump too far: "It is prudent for the Federal Reserve to
recognize the risk that such softness (in the economy)
conceivably could accumulate and deepen, resulting in a
substantial downturn in activity." Yet the statement came from
Fed Chairman Alan Greenspan, who went public with a surprisingly
frank assessment last week that, at least for the moment, a
recession has replaced inflation as the leading threat to the
U.S. economy. In his midyear report to Congress, Greenspan
confirmed that since early June, the Fed had been allowing
interest rates to fall in an attempt to prevent the sluggishness
from becoming too pronounced. Said he: "What we seek to avoid
is an unnecessary and destructive recession."

    The signals are abundant that the nearly seven-year-old
expansion is stagnating. Retail sales are anemic, business
inventories are growing, industrial output is shrinking, and
the housing industry is struggling. Economists almost uniformly
agree that growth during the next year will be very slow, but
are divided about whether the U.S. will fall into a recession.
The optimists forecast a "soft landing," characterized by
minimal growth but no severe dislocation; the pessimists believe
the long-running expansion is due for a bona fide recession,
with widespread bankruptcies, loan defaults and layoffs.

    The Bush Administration last week acknowledged the
economy's weakened position when it predicted growth of only
2.7% for the year, down from the Reagan Administration's
five-month-old projection of 3.5%. The White House forecasters,
looking through the rose-colored glasses favored by most
Administration economists, calculate a growth rate of 2.6% for
1990, but a consensus of 52 economists surveyed by the Blue Chip
Economic Indicators holds that the economy will grow at a rate
of less than 1.5% during the final half of the year and at about
the same sluggish pace in 1990. Says Norman Robertson, chief
economist at Pittsburgh's Mellon Bank: "The slowdown is now a
reality. It has arrived." Two out of three of the Blue Chip
forecasters expect that the economy will fall into a recession
by sometime next year.

    Despite slipping retail sales, most consumers profess
relatively little fear about the economy. In a TIME/CNN poll
conducted last week by Yankelovich Clancy Shulman, 6 out of 10
adults described current conditions as fairly good or very
good, down only a trifle compared with January. Looking ahead
to the next twelve months, 72% expected conditions to stay the
same or improve, while just 24% of those polled saw the economy
getting worse. Asked about their spending plans in the coming
year, 65% said they thought it would be a good time to buy a
major household item -- a refrigerator, for example, or a
television set.

    To some extent, however, action belies bravado. Consumer
spending, which typically accounts for two-thirds of economic
activity and provided most of the oomph for the expansion, is
starting to falter. Auto sales have stalled dramatically,
contributing to a drop in total retail sales of 0.4% last month
and 0.1% in May, the first back-to-back monthly declines since
September and October of 1986. Industry is showing the same
trend. U.S. factories operated at 83.5% of capacity in June,
down from a high of 84.3% in January, a strong indicator that
the economy has passed the peak in its current growth cycle.

    Despite concerns that the expansion will falter, most
economists believe a modest slowdown is necessary to suppress
inflation, which had grown particularly stubborn in the past
two years. Consumer prices rose at an annual rate of 5.9% during
the first half of 1989, up from 4.1% last year. "The economy
was running too fast for its own good," says Francis Schott,
chief economist for Equitable Life Assurance. "It was working
itself up to an inflationary frenzy."

    Sensing the inflationary pressures early last year, the Fed
tightened credit and dampened growth. In June the Fed was
helped in its task by falling energy costs. The Government
reported last week that consumer prices last month increased at
an annual rate of just 2%, the slowest pace in 16 months. While
Greenspan said he sees inflation as a lingering menace, he
confirmed that for the moment it has been eclipsed by a need to
keep the economy afloat. As a result, interest rates on
three-month Treasury bills have fallen from a high of 9.4% in
late March to 7.9% last week. The clarity of the Fed's purpose
has sent Wall Street on a bullish stampede to post-October
1987-crash highs. Last week the Dow Jones average climbed 53
points, closing at 2607.36.

    Economists have been hoping that a modest slowdown would
help ease another thorny problem, the U.S. trade deficit, by
suppressing the American appetite for imported goods. So far,
that has not happened. The Government announced last week that
the trade deficit swelled to $10.2 billion in May, up from $8.3
billion in April. Especially troubling was a 4.3% rise in
imports, to a record $40.7 billion, which suggested that foreign
brand names remain a powerful enticement for U.S. shoppers.

    Some economists believe the slack period will be
short-lived and will be followed by renewed growth, a scenario
that has them searching for metaphors. David Hale, chief
economist of Chicago's Kemper Financial Services, characterizes
the slowdown as an "output pause." Geoffrey Moore, an economics
professor at Columbia University, talks of a "stutter step."
Economist Lyle Gramley, a former Fed governor, says that by late
1990 the slowdown may be followed by a period of "economic
refreshment."

    Some of the optimists expect the expansion to be kept
afloat by three major forces: exports, housing and capital
spending. No one thinks exports will repeat the explosive growth
of last year, when sales abroad jumped nearly 30%, thanks
largely to a declining U.S. dollar. One reason U.S. firms should
find receptive markets overseas is that the economies of Western
Europe and Japan are still rapidly expanding. European Community
members are expected to sustain 3% growth in 1989, and Japan is
likely to show a 5% gain for the fiscal year ending next March.

    For the moment, though, U.S. exports are moving
erratically. During the first four months of the year, America's
overseas sales grew at a healthy 15% annual rate, but fell 0.9%,
to $30.5 billion, in May. Those who predict a soft landing see
the one-month reversal as only a temporary setback; others are
more troubled. Says Allen Sinai, chief economist of the Boston
Co. Economic Advisors: "The trade-deficit report is yet another
sign of the potential for a recession sometime within the next
six to nine months."

    Homebuilding could be another strong foundation for the
economy. Real estate usually takes a tumble just before a
recession begins and stages a comeback as a recovery takes hold.
This time some economists predict that the housing industry,
aided by falling mortgage rates, may bounce back later in the
year. Last week the Government reported that housing starts
during June rose 7%, to an annual rate of 1.4 million. Even so,
some experts are cautious about predicting a housing boon
because the rise was entirely attributable to an increase in
multifamily houses and apartment buildings. There was no growth
in single-family-home construction, which forms the largest part
of the industry.

    While soft-landing scenarios provide reassuring reading,
some economists think such forecasts belong on the fiction
shelf. If U.S. economic history is any guide, a soft landing is
a long shot. That kind of gentle slowdown occurred only once
before, in 1967, when the military buildup during the Viet Nam
War fueled a demand for capital goods.

    If a recession does occur, it may well be triggered by a
sharp erosion in consumer confidence. Americans are saddled with
hefty debt loads and could easily become jittery if the economy
weakens. Says Doris Drury, president of the Center for Business
and Economic Forecasting in Denver: "I'm leery of debt. If we
could have a recession on the order of 1981 or '82, that could
be a real problem." Consumer debt has increased from $1.7
trillion to $3.3 trillion since the expansion began in late
1982. If Americans cut back abruptly on their spending, the
effects would ripple through the economy. Businesses would
respond to the sales falloff by reducing their own spending and
laying off workers, which would spark a further drop in consumer
spending.

    Deborah Johnson, a senior economist for Prudential-Bache
Securities, foresees the possibility of what she dubs a
"couch-potato recession." Her scenario: well-off baby boomers,
who have already purchased their compact-disc players and
microwave ovens and typically have children to provide for, will
spend more time at home and do less shopping. According to
Prudential-Bache's Yuppie Consumption Index, these consumers cut
their spending 2.4% in the period from December through May.

    The tremendous buildup of business debt during the long
expansion leaves the economy even more exposed to the effects
of a recession. Since late 1982, corporate debt has more than
doubled, from $1.1 trillion to $2.2 trillion. Investors in junk
bonds, the high-yield securities that account for $225 billion
in debt, could be among the first to feel the pinch. According
to a study conducted for a group of junk-bond issuers by the
economic consulting firm Data Resources, 1 out of every 8 will
default if the economy falls into a soft landing. A major
recession could produce a 1-in-5 default rate over five years.
This year some $3 billion worth of junk bonds either have
defaulted or were forced into a restructuring. The failure rate
is well ahead of last year, when about $4 billion in junk bonds
collapsed during the entire twelve months.

    In the final analysis, everyone from corporate chieftains
to cab drivers realizes that the expansion cannot go on
forever. "Someday, some event will end the extraordinary string
of economic advances that has prevailed since late 1982,"
Greenspan told Congress last week. So far, Greenspan has
provided a delicate touch in stifling inflation without making
the kind of sudden moves that could trigger a recession. The
U.S. may be in for only a brief and relatively innocuous
reversal like the one in 1961 rather than the painful
contraction of 1981-82, when the unemployment rate averaged
8.7%. The current slowdown "is not a good thing, but it's the
cost of a good thing," says economist George Stigler, a Nobel
laureate and professor at the University of Chicago. Americans
can only hope that if they pay now, they can fly again later.


-- Gisela Bolte/Washington and Thomas McCarroll/New York