BUSINESS, Page 32Special Report: The Big SlowdownAdrift in the DoldrumsAs the economy weakens, the Federal Reserve will have to steercarefully to avoid a recessionBy 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
