TIME: Almanac 1993/TIME Almanac 1993.iso/time/082090/0820012.000

Text File | 1992-08-28 | 10.9 KB | 217 lines

                                                                                THE GULF, Page 38

Full Tilt into Trouble


The oil shock triggered by Iraq's seizure of Kuwait could plunge
the U.S. into a long-feared recession -- or has it already
arrived?

By JOHN GREENWALD -- Reported by Richard Hornik/Washington and
Thomas McCarroll/New York


    "Does this feel like a recession, or is it just me?" For
several months, that question has been nagging at millions of
Americans as the U.S. economy poked along in the slow lane.
From New England computer makers to California missile
builders, many industries that boomed in the go-go '80s have
slumped in the slo-mo '90s. But the sudden spurt in the cost
of crude oil brought on by Iraq's invasion of Kuwait -- from
about $20 per bbl. on Aug. 1 to a high of more than $28 per
bbl. last week -- threatened to turn an already painful slowdown
into a full-blown recession. Says Richard Bermer, an economist
for Salomon Brothers: "The question is no longer whether there
will be a recession but how deep it will be and how long it
will last."

    A slump would bring an end to a record peacetime expansion
that has endured for more than 7 1/2 years. In Washington the
normally bullish U.S. Chamber of Commerce added its voice to
the growing chorus of recession forecasters last week. Said
Richard Rahn, the group's chief economist: "We anticipate that
the economy will grind to a virtual standstill during the third
quarter and actually contract by 1.4% in the fourth quarter."
While Rahn acknowledged that "Iraqi adventurism in the Middle
East is exacerbating this country's economic woes," he
attributed the grim outlook to the tight-money policies of the
Federal Reserve Board, which has kept interest rates high out
of fear that inflation could shoot up from its current level
of about 5%. Said Rahn: "I would hope this would wake up the
Fed, but there have been cannons roaring for months now."

    The recession alarms swiftly spread to the world's financial
markets, where stock prices plunged. On Wall Street the Dow
Jones industrial average fell 93.31 points Monday, then
recovered a bit, but closed the week at 2716.58, down a total
of 93.07. As recently as July 16, the Dow had climbed to an
all-time high of 2999.75. In Japan, which is almost wholly
dependent on foreign oil, the Nikkei Index of 225 stocks closed
Friday at 27,329.55, down 7.4% for the week and 11.4% since
Iraq invaded Kuwait on Aug. 2.

    As the markets gyrated, higher crude prices began to ripple
through the economy, shocking motorists at the gas pumps and
boosting the cost of producing petrochemicals and plastics.
Airlines, which spend 15% of their operating costs on jet fuel,
were particularly hard hit. Most major carriers added a 5.3%
fuel-cost surcharge to their ticket prices. In response,
Transportation Secretary Samuel Skinner summoned airline
executives to Washington this week to ask them about the
surcharges.

    The oil shock hit Americans where they live. Interest rates
on home mortgages, which had been hovering at about 10%, began
creeping up because lenders expect inflation to rise. That
raised monthly costs for householders with variable-rate
mortgages and made borrowing more difficult for new home
buyers. In kitchens and corporate boardrooms across the
country, worried consumers and executives were examining their
budgets and rethinking their spending plans. Notes Alan Meltzer,
a professor of economics at Carnegie Mellon University:
"People don't know what kind of environment they will be in,
so they are postponing decisions."

    In a TIME/CNN poll conducted last week by Yankelovich Clancy
Shulman, 44% of the adults questioned said they expect economic
conditions in the U.S. to get worse; 29% felt that way in July
and 20% in February. An overwhelming 84% of those polled think
inflation is likely to increase, while 74% think interest rates
will rise and 68% believe unemployment will grow. The majority
of those in the survey, 55%, believe a recession is coming, up
from 41% in July. In the view of 44%, a recession has already
arrived, although 49% remain unconvinced.

    By the generally accepted definition, a recession is at
least two straight quarters of declining GNP. Even though the
economy managed to eke out a feeble 1.2% rate of growth in the
second quarter of 1990, many economists argue that the current
slowdown already merits the title of recession. The pessimists
gained a measure of support last week from a Federal Reserve
report that noted that economic growth "was slow or had
slackened" in June and July. "The textbook definition of
recession doesn't matter," says Donald Straszheim, chief
economist for Merrill Lynch. "The economy is so weak that it
looks like a recession to an awful lot of people." Declares Rose
Marie Moore, who was recently laid off from a Massachusetts
textile mill: "I'm nervous and scared. I've had my job for 10
years, and now I'm going to have to find another one. It's
rough."

    The evidence of a U.S. recession is growing more abundant
by the week. Trouble spots range from rising unemployment,
which increased from 5.2% in June to 5.5% in July, to falling
U.S. corporate profits, which declined 12% in the first half
of 1990. Meanwhile, the savings and loan crisis inspired
regulators to impose strict new lending standards, which helped
bring on a credit crunch earlier this year. Homebuilding, a key
barometer of economic health, sank to a meager annual rate of
1.18 million units in June, the lowest level since 1982.
Although rising consumer spending kept the expansion rolling
during the 1980s, consumer outlays were flat in the first half
of this year as cautious Americans trimmed back their buying.

    The big question is how hard the oil shock will strike an
economy that is already staggering. So far, crude-oil prices,
which closed at $26.23 per bbl. last week, have jumped about
40% in recent weeks. For the moment, that is far less than the
price hikes of the 1970s, which reached more than 300%. Those
oil shocks gave rise to the dread combination of high
unemployment and double-digit inflation, which became known as
stagflation.

    Yet even the current oil run-up could have a substantial and
damaging effect on the way Americans work, shop and spend their
leisure time. Every $1-per-bbl. increase in the cost of crude
oil acts like a tax to siphon income from consumers and
companies. Laurence Meyer, a Washington University economist
who runs his own forecasting firm in St. Louis, had predicted
a recession even before the oil shock. If prices charged by the
Organization of Petroleum Exporting Countries reach $30 per
bbl. in the fourth quarter, Meyer says, the GNP would decline
a painful 3.6% during the period. If oil levels off at $32 per
bbl. next year, he predicts that unemployment would climb to
7.4% by the end of 1991 and add some 2 million people to the
jobless rolls.

    The growing risk of a downturn increases the pressure on the
Federal Reserve to lower interest rates. But Federal Reserve
Chairman Alan Greenspan remains wary of inflation, particularly
in the face of the latest oil shock. To help persuade Greenspan
that it is time to budge, Treasury Secretary Nicholas Brady
last week repeated Administration calls for cheaper borrowing
costs. "Everybody wants lower interest rates," Brady said. "At
this point in time in the U.S., economic growth is very
important." Concurs Lyle Gramley, a former Federal Reserve
governor who is chief economist for the Mortgage Bankers
Association: "To refuse to ease interest rates now would be like
deliberately choosing a recession to bring down inflation."

    A deep slump could inflict heavy damage on overleveraged
companies and troubled banks whose books are already filled
with junk bonds and sour real estate loans. According to
Veribanc, a Massachusetts-based firm that rates banks and S&Ls,
bad loans at U.S. banks rose a sharp 7.5%, to $48.6 billion,
in the first quarter of 1990. Overall, nearly 1,400 banks, or
about 11% of the U.S. total, lost money in the first quarter.
That represented an alarming jump of nearly 20% over the same
period a year ago.

    In Detroit rising oil prices could worsen the skid that the
U.S. auto industry has suffered since the start of the year.
The price increases threaten sales of profitable but
fuel-thirsty vans, pickup trucks and full-size cars, including
the Chevrolet Caprice and the Lincoln Town Car. That would mean
further woes for General Motors, Ford and Chrysler, which
temporarily shuttered 45 of their 62 U.S. and Canadian plants
and fired or laid off 38,000 workers during the first half of
the year.

    Higher gas prices could boost Japan's share of the U.S. auto
market, which now stands at about 26%. While the Big Three have
substantially improved their fuel economy in the past 10 years,
they still lag behind the Japanese. GM raised the average
efficiency of its fleet from 19.1 m.p.g. in 1979 to 26.9 m.p.g.
last year, while Chrysler boosted its fuel economy from 20.5
m.p.g. to 27.7 m.p.g. At the same time, Toyota raised the
average economy of its models from 24 m.p.g. to 31.7 m.p.g.,
and Nissan from 26.8 m.p.g. to 30.2 m.p.g.

    The rest of the transportation industry is certain to feel
the pinch of higher oil prices. Although airlines have begun
to pass along the increases in the form of surcharges, analysts
warn that the policy could backfire by discouraging air travel.
Says Robert Decker, who follows the industry for the
Chicago-based investment-research firm Duff & Phelps: "Fuel
prices are important, but the really important variable is what
happens to the economy. If the economy falters, it will mean
a significant reduction in profits, or losses, at some
carriers." That could cripple such weak airlines as Pan American
and TWA, already awash in red ink.

    The rising cost of travel will inspire many people to spend
their vacations at home instead of heading to places like
Florida's Walt Disney World. "People are afraid," says Fred
Wright, a Houston travel agent. "If travelers don't get the
fares they want, they're not going." The jump in gas prices has
forced Wright to change his own travel plans. He said he will
make fewer trips to visit family members in Oklahoma City, a
distance of 450 miles, because the price of a tank of gas has
jumped from about $8 to $12. "It makes you think twice," he
says.

    In the end, the biggest impact of the latest oil shock may
be psychological. "I'm paying off all my credit cards, and I'm
going to throw them all away," says Dennis Eaton, a Phoenix
gas-station manager. "If we go into a recession, I'm going to
be cautious and control my own destiny." But the U.S. is
already in a recession by many measures, and the country's
economic destiny now seems to depend on how high oil prices
climb and how long they stay at painful levels.