Unexpected Signs of Health

By Edward E. Scharff

Spring brings a Wall Street rally--plus hints of recuperation elsewhere

The economy last week behaved like a long-term invalid who has trouble believing his doctor's reports that he might actually be getting better rather than worse. Despite some conflicting symptoms, the economy continued to exhibit much more vigor than most observers had thought possible. This year, after all, was once widely expected to produce another recession. To be sure, some Cassandras, including several top officials in the Reagan Administration, warned that the economy's improvement was largely illusory and that a renewed bout of business stagnation might hit by this summer.

The clearest sign of good cheer was a stock market rally that sent the Dow Jones industrial average surging last Wednesday to 1,015.22, an eight-year high. The market eased off later to end the week at 994.78. Wall Street has been strong since last fall, when polls showed that Ronald Reagan might defeat Jimmy Carter and bring a more pro-business atmosphere to Washington. Says Monte J. Gordon, research director for Dreyfus Corp., a large New York investment firm: "Reagan has been an aphrodisiac for the market."

Wall Street economists generally feel that business looks much stronger now than a few months ago. Gary Wenglowski, director of economic research for the investment banking firm Goldman Sachs, previously predicted that the economy would dip in the first half of 1981. But now he foresees a "less severe slowdown that will not be deep enough or long enough to call a recession." Agrees Roger Birk, chairman of Merrill Lynch, the largest brokerage house: "This is not a recession year; it is a transition year."

Even Detroit, now slogging through the auto industry's third year of depression, had reason to celebrate last week. Domestic auto sales during the middle ten days of March jumped by nearly 30%. Of the three largest automakers, only Ford continued to suffer a sales decline, while Chrysler and General Motors sales were up sharply. The sales spurt, no doubt sparked by the industry's rebate deals, showed that the American public is willing to buy Detroit's products when the price is right.

The best evidence of the economy's vitality was the preliminary figure for the gross national product in the first quarter. Administration officials project an increase in the G.N.P. at an annualized rate of 5%. Although few forecasters expect the economy to maintain that relatively torrid pace throughout the year, Otto Eckstein, president of Data Resources, a business consulting firm, believes that the first quarter's results were a sign that the economy may slow down but will not contract this year. Says Eckstein: "I don't see any negative quarters."

The economy will be further buoyed by the recent decline in interest rates. The prime rate, the price for loans that banks usually charge their best corporate customers, declined last week to from 17% to 17.5%; it started the year at a record high of 21.5%.

So far, however, the decline in interest rates has been limited to short-term loans. Long-term interest rates, which affect consumers through home mortgages, remain at near record levels--a disturbing sign that financiers are not yet ready to bet heavily that inflation will subside in the next few years.

Ultimately, both long-and short-term interest rates will depend largely on the Federal Reserve Board's handling of the money supply. The nation's central bank seems intent on keeping the supply tight to avoid a repetition of last year's experience, when the money flow was sharply increased and the prime rate dropped from 20% to 10.75% in less than four months. That sudden decline led to a new burst of growth--and of inflation. Economist Eckstein thinks that the Federal Reserve may finally have mastered the delicate art of monetary control. "We have just had the first re-entry from money explosion perhaps in history," he marvels. "It really looks as if the Fed was able to bring the money supply under control without killing the economy."

While many private economists are talking about the strength of the economy, the Reagan Administration is concentrating on its weaknesses. "We have a very soft, soggy economy," said Treasury Secretary Donald Regan last week. Murray Weidenbaum, chairman of the President's Council of Economic Advisers, downplayed the economy's strong performance in the first two months of the year by noting that "March came in like a lion and is leaving like a lamb." The President's new independent Economic Policy Advisory Board, which includes former Treasury Secretaries George Shultz and William Simon and former Federal Reserve Chairman Arthur Burns, was equally downbeat at its first meeting with Reagan last week.

The pessimism among the Reaganauts is partially a tactic to help push the Administration's economic program through Congress, but it also reflects their concerns about underlying weakness in some parts of the economy. Housing starts, always a crucial business sector, dropped by 25% in February. And the Commerce Department's index of leading indicators, a key barometer of future economic activity, fell 3% in February, its third decline in a row.

The Administration is afraid that the economy is beginning to slow down at a time when there are few signs of relief from inflation. Government figures released last week showed consumer prices increasing at an annual rate of 12.7%. The principal cause of the latest runup in prices was a spurt in the cost of energy following annual rates Reagan's action in January to lift the remaining price controls on crude oil and gasoline.

Many economists had expected oil prices to jump even more after decontrol. Price increases, though, were held back a little by the high oil stocks around the world. Walter Heller, former economic adviser to President Kennedy, also pointed out that lower than expected increases in housing and food prices had acted as a brake on inflation, and he foresees less steeply rising prices for a few months.

Any improvement in inflation, however, could be set back by last week's proposed new contract between major Eastern coal-mine operators and the United Mine Workers. The contract, which is expected to be ratified this week, would give the miners a 36% wage and benefits increase over the next three years. The coal settlement could set a pattern for other major labor contract negotiations scheduled for later this year, most notably in the aerospace and construction industries. In recent years, one union's inflationary wage settlement has generally become the next union's negotiating floor. But that trend may be ending, especially in the auto, steel and rubber industries. Workers at Chrysler have already had to make wage concessions as part of the Government's rescue program. Workers at Ford and General Motors may soon have to follow suit in order to avert job losses.

The Reagan Administration wants to get wage concessions from the autoworkers in exchange for negotiating "voluntary" limits on the sale of Japanese cars in the U.S. Last week the Administration was still engaging in an elaborate diplomatic maneuver with the Japanese government over auto imports. The U.S. does not want to ask the Japanese formally to limit exports, but it would like Tokyo to do it anyway. Reagan and other U.S. officials told visiting Foreign Minister Masayoshi Ito that it expected imports to drop from the 1980 level of 1.9 million cars to about 1.6 million this year.

The biggest question of all in the economy remains the consumer, whose purchases make up some two-thirds of the nearly $3 trillion G.N.P. Last spring consumers slammed shut their wallets, and the economy went into a dizzying free fall, tumbling at an annual rate of 9.9% in the second quarter. Will consumers spend money this spring, or will they decide to keep those wallets closed? There are a few disquieting signs. In California, where the housing market has been booming since the 1973-75 recession, real estate agents report that sales are slowing. Says Los Angeles' Fred Sands: "For the first time in years, we're seeing a flattening in the market. Home prices at or below $200,000 are very difficult to sell." Leonard Reedy, who farms 3,000 acres in Clyde, Kans., reports that high interest rates and low crop prices are killing farmers in his region. Says he: "We've got to do something to get prices up or else have another Grapes of Wrath book writ about us." Joe Lewis has owned a small musical instrument store in Atlanta for more than ten years, but last week he closed up shop for the last time, saying: "I survived the last recession, but this time I'm not making it."

Inflation is battering family budgets, and it will be difficult for consumers to keep up the high-consumption pattern of the past year. The average family's real spendable earnings, the amount left after inflation and taxes, has declined by 4.4% over the past year. While Congress argues over the proposed Reagan tax cut, consumers could stop buying and depress the economy even further. For millions of Americans and for their economy as a whole, that tax cut cannot come soon enough.

--By Edward E. Scharff.

Reported by David Beckwith/Washington and Janice C. Simpson/New York

With reporting by David Beckwith/Washington, Janice C Simpson/New York

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