The Upturn: Less Inflation, More Spending

A new year begins this week for the U.S. economy--fiscal 1976--and, while the champagne corks are not yet popping, there is reason for at least muted jubilation. The longest, most brutal recession in the lifetime of most Americans is now over, and a recovery is beginning. It is likely to be fitful at first, and the daily headlines will oscillate between bleak and bullish. But shortly after Labor Day, when the usual summer slack period is over, production and sales should be rising fairly rapidly.

Huge problems remain, largely because the economy has fallen so far from its previous peaks. More than 8 million Americans are out of work, a distressingly large number of them breadwinners, and the unemployment figure will remain uncomfortably high for two or three years. Production is running close to $250 billion below what it would be if factories were producing at optimum levels. Even with good growth, the economy will not climb back to its pre-recession peaks of late 1973 until late in 1976. At a tune when much of the world is crying out for the fruits of American production, the nation's machines and manpower remain grossly underused.

A Plus. Still, the pattern of upswing is clear, and its consequences will be not only economic but also political. Barring unexpected jolts, the economy should be rising as President Ford mounts his election drive. Historically, voters are swayed more by the economy's direction (which will be up) than by its level (which will be relatively low for months). Thus the economy should be a plus for Ford, who more and more appears to be a tough candidate for any Democrat to beat in '76.

Last week the Commerce Department reported the surest sign yet that a recovery is taking hold. The economy's index of leading indicators, which had fallen for eleven straight months until March, rose in May for the third consecutive month. This was the first three-month rise since 1972 in those indicators, which usually move ahead of the overall economy and fore tell its future course. Among the sensitive leaders that were up in May were new orders for consumer goods, contracts for plant and equipment, building permits, the size of the money supply and common stock prices (see following story). Those figures suggest strongly that the economy, which has been plunging since November of 1973, started growing again during the second quarter of 1975.

Economists are still unsure precisely when the turn-around occurred, but they are virtually unanimous that the recovery is going to be slow, at least at the out set. Arthur Okun of the Brookings Institution reckons that April may have been the low point; yet he warns that unless the Administration takes more stimulative action, "this will be the most ane mic recovery in postwar history."

Raymond Jallow, senior vice president of the United California Bank, calculates that the turn-around came in May and the recovery will be "gradual but not fantastic." Leif Olsen, senior vice president of New York's First National City Bank, is still uncertain whether the rebound has begun, "but it may have happened in June." Adds Olsen: "The important thing is that the turn around comes when the economy is at a very deep level.

We have a lot of excess capacity and unemployment, and it will take a long time to cure that."

The experts also agree that the major force behind the turn-around is the U.S. consumer. Battered by inflation and recession, his real income fell an unusual 6% from early 1974 through the first quarter of 1975. Now, at long last, his purchasing power is rising, because inflation, interest rates and taxes have all come down. Of the economy's turnaround, Jallow says, "The tax rebate was the trigger." Between rebates and outright tax reductions, the Government will put more than $18 billion into the consumers' pockets from May through December. Last week Ford said that he might ask for a continuation of those tax cuts into next year if the recovery does not proceed smartly. Even if it does, Congress is likely to extend the tax cuts through 1976, and perhaps beyond.

More Money. Recent polls show a marked rise in consumer confidence, and because he has both new optimism and more money, the consumer is beginning to spend strongly. One consequence is that even the two sickest major industries--autos and housing--are reflecting the first faint blush of recovery. Housing starts rose 14% from April to May. Auto sales climbed 5% from the first three weeks in May to the equivalent period in June, though they usually decline during that span.

Based on the latest portents, here is the forecast in detail:

Inflation will continue to slow. Largely because of the recession, the annual rate of consumer price inflation has declined sharply, from 12.2% last year to an average of 5% from March through May. Price rises should continue to be fairly moderate--in the 4% to 6% range for the rest of this year and next year --because so much slack will still remain in the economy. With production running well below capacity, businessmen will be reluctant to post egregious price increases; with unemployment sticking high, few union leaders will cry for outrageous wage rises.

Furthermore, it is unlikely that the U.S. will again suffer the two major blows that so severely aggravated inflation in 1973 and 1974: the quintupling of oil prices and the sharp rise in food costs caused by unusually bad weather round the world. This year's U.S. harvest appears to be big. As for oil prices, they will almost certainly rise again in September, despite Ford's warning to the OPEC cartel last week that another increase would be "very disruptive and totally unacceptable." But the rise, while harmful, will be nowhere near as great as in the recent past.

Interest rates will remain moderate.

They have dropped sharply in the past several months, largely because the Federal Reserve Board has expanded the money supply since mid-March at a high rate of 10.5%. That signaled the Fed's shift in top priorities, from righting inflation to righting recession. Now the Fed will not expand the credit supply at reckless rates; Chairman Arthur Burns, at 71, is determined not to go down in history as the man who rekindled inflation. But he is under pressure from politicians and bankers to keep money growing at a sustained rate. He has promised to increase it by between 5% and 7 1/2% over the next year.

Capital spending will come back, but slowly. Corporations so far this year have slightly reduced their spending to expand, modernize or automate their plants and machines. But for three reasons spending should start to rise late this year. First, the increase in consumer demand will motivate businessmen to expand to meet a larger market. Second, the recent relaxation of credit will make it easier to expand. Third, the increase in the investment tax credit --from 7% to 10% in the new tax law --will make expansion cheaper. Already they are increasing their orders for machinery, trucks and business cars.

Worker productivity will rise. In a recovery period, businessmen are always slow to hire back all the workers they need. Instead, they try to hold down wage costs and wait to make sure the recovery is real before starting to hire. As a result, a relatively constant work force produces an increasing amount of goods, and productivity rises. This means that the labor cost of producing each unit of goods declines, which is good for bringing down inflation but bad for bringing down unemployment.

Unemployment will remain high. The statistics for June are expected to show some improvement from the grim rate of 9.2% in May. But the improvement will be illusory because Government statistics will not fully account for the millions of students and graduates who have poured into the labor market but cannot find work. Real unemployment may well rise for some months, then taper to about 8 1/2% by year's end. It is likely to average close to 8% next year and more than 7% in 1977. Behind the cold numbers is the hard fact: each percentage point indicates that more than 900,000 Americans are out of jobs.

Putting all these factors together, it seems likely that the real gross national product will be growing at an annual rate of 6% or 7% in the fourth quarter. Some regions of the nation will do better than others. The West should lead the nation once the recovery gains momentum. The housing increase will lift the region's lumber and building supplies industries, and its other basic businesses--aerospace, electronics, paper --are also strengthening. The Southwest did not slump so badly as the rest of the nation, and thus its rebound may not be quite so pronounced. New England will lag, in part because its shoe, textile and other old industries are sluggish; however, many electronics companies along Route 128 outside Boston anticipate sales and profits gains this year. The Midwest and the South, their industries widely diversified, should do better than New England, but not quite so well as the West.

The early forecasts for next year are that the upswing should continue, with the economy rising 6% or more in 1976. That would be half again as much as the economy's long-term rate of real growth, but less than the 8% to 9% rates in the first years of most previous postwar recoveries. Thus the nation probably does not face a boom, but Americans should feel much happier about their economy several months from now than they do today.

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