THE ECONOMY AT THE TURNING POINT

FOR all its emotional impact on the nation, the Viet Nam war does not provoke the most widespread dissatisfaction with President Nixon's policies. Almost to a man, U.S. citizens feel frustrated by the persistence of inflation and its pervasive effects--high prices, oppressive interest rates and a severe scarcity of credit. Of those who were questioned in the latest Louis Harris poll, published last week, 51% gave Nixon a negative rating on Viet Nam; an overwhelming 79% disapproved of his handling of inflation.

Their frustration is likely to increase during the winter and spring. The economy is at a new and potentially dangerous turning point; inflation is hanging on, but the pace of business is slowing down. Government economists fear that in the early months of 1970, unemployment and prices will be rising simultaneously--and that it will bz almost a miracle if the U.S. does not experience that unhappy combination of events.

In the rough months ahead, U.S. business faces:

HIGHER PRICES. Despite the Government's year-long policies of tax surcharge, budget hold-downs and the tightest money since World War II, the hangover from the previous boom years is proving hard to cure. Economists predict that prices, which have been climbing at an annual rate of more than 5% this year, will be rising at about a 3% or 4% pace around the middle of 1970 (see TIME's Board of Economists, page 88).

SLOWER BUSINESS. There are increasing signs that the Nixon Administration's restraints are finally beginning to hold back business. Some economic indicators remain strong. Factory orders for durable goods, notably steel, engines and turbines, bounced up sharply in September, and capital spending, according to the McGraw-Hill survey released last week, is expected to rise about 8% next year. But largely as a result of the Government's deflationary policies, industrial production has fallen for the past two months, and auto sales dropped in October. Profits are also sluggish. Most economists foresee a decline in earnings and little or no real growth in the gross national product during the first half of 1970.

FEWER JOBS. The unemployment rate, which long held at 3% or 3.5% of the nation's labor force, was 3.9% in October, when 2,800,000 workers were out of jobs. As business activity slows, the rate is likely to rise to 4.5% or 5% in the next few months, and to as much as 10% among Negroes, because the labor force keeps increasing while the number of jobs shrinks.

STRIKES. The current walkout by 147,000 General Electric workers is only a foretaste of the acrimonious labor struggles that loom in the immediate future. Next year will be clotted with labor negotiations. Contracts covering some 4,000,000 workers in such basic industries as railroads, trucking, autos, construction, rubber and meat packing will expire in 1970. Unionists will press strongly for wage gains to keep ahead of inflation. Caught in a profit squeeze, management is likely to resist with equal vigor.

Tightrope Act. According to the Government's timetable, the tension and strain should begin to slacken around mid-1970. By then, if all goes according to plan, enough inflationary pressure will have been wrung out of the economy to permit a resumption of real growth without sending prices soaring once more. That would set the stage for realization of the Administration's economic aims for the '70s: full employment, balanced growth at 4% to 4.5% a year in real gross national product, and price increases averaging only 2% a year.

To reach those optimistic goals, federal economic managers will have to perform an exquisitely difficult tightrope act, balancing between the dangers of recession on one side and continued inflation on the other. They will very soon have to change their economic policy, exercising a delicate precision of timing and extent in order to get the economy moving again about next June. Most economists reckon that to extend a period of no growth much beyond then would risk starting the same sort of serious recession that the nation experienced under a Republican Administration in 1957-58 and in 1960. Republican Senators and Congressmen who must run for re-election a year from now devoutly want to avoid a recurrence.

The alternative danger is that too early loosening of the restraints might cause too rapid expansion in mid-1970, along with a continuing dose of inflation. In that case, the nation would have gone through its current economic pains for nothing. Prices would continue to climb swiftly, and sooner rather than later the Administration would have to start a stiff anti-inflationary program all over again.

Time to Change. At the highest levels of Government, an intense debate is under way. How soon, and by how much should economic policy be eased? More and more economists have been revising their thinking lately to follow University of Chicago Professor Milton Friedman in stressing the importance of money supply as a regulator of economic activity. Meanwhile they still accept John Maynard Keynes' emphasis on government intervention through tax and spending policy to stabilize business trends. The great majority of economists today might be called "Friedmanesque Keynesians."

Money supply can be measured in several different ways, but all the gauges agree that the Federal Reserve has been taking the rare and extreme step of actually reducing it. If the shrinking continues, or even if the supply is not soon expanded, banks will have a much tougher time meeting business demands for loans to build, modernize and hire. Changes in money policy usually take half a year or more to reverberate through the economy. Thus the nation will be feeling the most severe effects of today's tight money some time next spring and summer. Speaking to insurance executives at a seminar in Manhattan last week, Friedman repeated his warning that unless monetary policy is relaxed soon, the nation will be "heading for a very severe economic slowdown," with unemployment rates of 7% to 9%.

Until recently, the Administration has been monolithically united on the need for tight money. Presidential Counselor Arthur F. Burns, who is scheduled to become Federal Reserve chairman in January, said last month that "we will not budge." Simultaneously, however, Labor Secretary George Shultz began arguing for an immediate but moderate expansion of money and credit. Though he lost the argument, he soon may gain an important ally. Paul McCracken, chairman of the President's Council of Economic Advisers, believes that the severely restrictive policy has been correct so far, but now he is beginning to wonder whether the time has come to advocate some loosening. He admits that the present monetary and fiscal policies, if continued indefinitely, "would make it impossible to sustain full employment."

Keep Them Guessing. The ultimate decision will be left to William McChesney Martin, the outgoing Federal Reserve chairman, who has a reason to favor continued stringency. Twice since 1966, Martin's board has made major errors in expanding the money supply too much and too soon. The Fed committed its worst error in mid-1968, when it increased the money supply by 14% to counteract the expected deflationary effects of the surtax. That action sharply accelerated the current inflation. Martin now wants to restore his reputation as a sound-money man by making sure that inflation is effectively constrained during his last few weeks in office.

The easing in policy, whenever it comes, will be slight and gradual. The erratic swings--from extreme looseness to tightness and back again--in past Federal Reserve policy have created an economic credibility gap. Businessmen, consumers and labor leaders generally seem convinced that at the first signs of recession, the Federal Reserve will again switch to an open-handed expansion. This time the change must be carried out with such finesse that, as one high Administration policymaker says, "there will be a guessing game for months." Bankers, businessmen and economists will have to try to figure out whether or not movements in interest rates and bank reserves indicate that the Federal Reserve has actually altered policy. The Administration's policymakers recognize the danger that any shift may be too slow and too gradual to head off a recession, but they seem prepared to take the risk in order to break inflationary psychology. They feel that they are practicing a form of brinkmanship.

One ominous question is whether inflationary psychology has become so pervasive that it can be cured only by a rattling recession. The public realizes that the people who bet on inflation in past years have been rewarded, while those who pursued prudence have been punished. The businessman who raised his prices in recent years lost few if any customers but increased his profits; the businessman who did not raise prices saw his earnings drop. The consumer who borrowed for a spending spree is paying off his debt in cheapened dollars; the consumer who saved instead is holding dollars that have depreciated. Today most economists believe that inflationary expectations can be conquered by a mild downturn in business. At a time of no growth, they argue, businessmen who hiked prices would lose markets. Complaints from customers annoyed by past increases last week caused Bethlehem Steel and Armco Steel to cut prices on some important products.

"It Could Be Dynamite." TIME correspondents last week queried scores of businessmen, economists and consumers--and they found a surprising consensus that the nation can stand a brief and mild slowdown. But almost everyone views a 1950s'-style recession with grim foreboding. Past recessions brought unemployment rates as high as 71%, and that would not be tolerated either by the middle classes grown accustomed to full employment or by ghetto blacks who have been brought into the labor force by the boom of the past few years. Economist Michael K. Evans of the University of Pennsylvania calculates that a 7% total jobless rate "implies unemployment rates of 15% for Negroes, and 35% for Negroes under 25." Byrd Brown, president of the Pittsburgh N.A.A.C.P., warns that if blacks who have just got their first jobs lose them, "it could be dynamite."

Few experts minimize the pain that a recession would cause. A large number argue that the nation must increase and expand its unemployment compensation and job-training programs. And businessmen generally say that they intend to continue their own training programs for the hard-core unemployed even if the economy goes into a downturn. William F. Butler, vice president of Chase Manhattan Bank, says that if increased joblessness is the price of curbing inflation, then "the unemployed perform an important social service by being out of work. I do not see why they should not be paid for it."

Margin for Error. Whatever happens, inflationary pressures will remain strong for years to come. Demands for new and expanded Government spending to fill unmet social needs will be enormous. The strain on the federal budget would be partly relieved by a tapering off of the Viet Nam war, which at its peak cost the U.S. close to $30 billion a year. By June 30, the end of the current fiscal year, Viet Nam expenditures are expected to be down to an annual rate of $17 billion. Even so, federal spending will keep rising. The budget is likely to go up from $192.9 billion this year to more than $200 billion in fiscal 1971. Financing these expenditures without incurring inflationary deficits will be a continuing headache.

As they steer their difficult course between recession and inflation, Nixon economists have some margin for error. An economy that is pressing national production toward a trillion dollars a year, a level that the U.S. will reach in 1970 or 1971, has the size and resiliency to recover from general policy misjudgments. But the margin is not great. Too many citizens would lose their jobs in a sharp slump, or see their wages buy less in a continued inflation. Quite literally, they cannot afford a bad miscalculation.

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