Beginning to Build Up Steam

By John Greenwald

TIME'S Board of Economists sees a stronger recovery but fears huge deficits

The U.S. economy, which looked so feeble just six months ago, is snapping back from the most painful slump since the Great Depression with a vigor that is surpassing even optimistic expectations. That was the conclusion of TIME'S Board of Economists, which met last week in New York City. Said University of Minnesota Professor Walter Heller, who was chief economic adviser in the Kennedy and Johnson Administrations: "After several years of recession and stagnation, this recovery is the real thing."

The TIME board was particularly heartened by the rapidly brightening outlook for consumer spending, which accounts for some two-thirds of the U.S. gross national product. As a result, the board now predicts that G.N.P. will grow at a robust annual rate of 6% in the second quarter. That represents a significant increase from the 4.3% rate members forecast when they met in February, and would approach the 7% clip that postwar recoveries have averaged during the first year after a recession.

The key barrier to a brisker turnaround remains the federal budget deficit, which the board expects will reach an unprecedented $205 billion in the current fiscal year. The members were chagrined, and even a little shaken, by the failure of Congress and the White House to agree on a new budget last month and offered some deficit-cutting proposals of their own (see box).

The deficit is a menace because massive Government borrowing is likely to keep interest rates up and force companies to delay investments in new plant and equipment. Such outlays have been lagging for more than two years and now are precisely what is needed for solid business growth. Said Alan Greenspan, a New York City economic consultant and unofficial adviser to President Reagan: "If the President and Congress agreed on a credible plan to cut the deficits that loom for the next ten years, the effect would be nothing short of spectacular. It would mean a major economic expansion, which would probably pro-feed at a highly noninflationary pace."

The short-term outlook has turned so favorable so fast that even some apparent signs of weakness are actually harbingers of strength. The Government last month cut its estimate of first-quarter G.N.P. growth from the previously reported 3.1% to 2.5%. But the revision was disguised good news, because it included an $8 billion drop in manufacturing inventories. Without that backlog of unsold goods, firms will have to hire more workers and step up production to meet rising demand.

Many companies are already doing just that. Manufacturers used 71.1% of their productive capacity in April, a 1.3% increase over March and the highest level in 13 months. Meanwhile, the average number of hours that workers spent in manufacturing jobs rose from 39.6 a week in March to 40.1 last month. With factories humming at a faster pace, new orders continued to rise. Led by a big jump in commercial aircraft contracts, April capital goods orders were up a surprising 9.6%. Board Member Otto Eckstein, chairman of the Massachusetts-based Data Resources economic forecasting firm, was unable to attend last week's meeting but said in an interview afterward: "It now looks as if plant and equipment spending is already in an upswing, and this is happening sooner than many had previously thought." Data Resources expects such investments to grow at a steady 5% pace for the next two years.

The outlook for corporate profits is also brightening, as the booming stock market attests. Companies closed aging plants and slashed payrolls during the recession, and now they have fewer expenses. Analysts thus look for corporate earnings to rise by as much as 30% above the depressed levels of 1982.

Probably the best news for the economy is that consumers, who had been hanging onto their cash, seem to be ready to spend. Consumer confidence, as measured by the University of Michigan Surveys of Consumer Attitudes, is now rising faster than at any other time since the poll began in 1946. The survey index jumped a total of 20% in March and April and is expected to show another hefty gain in May. "We are talking about a surge in consumer confidence that really has not been seen before," said Richard Curtin, the survey director and a guest at last week's meeting. "In fact, we have never reported more consumers who expect the economy to improve during the next year."

The outbreak of optimism could lead to a pickup in spending on everything from video games to station wagons. For three straight months, a record number of families have told the Michigan researchers that they thought the time was right to buy a new car. In addition, the survey reports that the number of people who believe that it is a good time to buy a home now matches the peak year of 1977. One reason for their confidence: mortgage rates now average about 13%, down from a peak of 18% in October 1981.

Although all the renewed optimism may not show up as new business, some of it is already flowing into the marketplace. Sales of new U.S. autos are running 6.5% ahead of last year's level, despite a 3.3% dip in the second ten days of May. Builders have been starting new homes at an average annual rate of 1.6 million units this year, the highest level since 1979. Meanwhile, April retail sales rose 1.6% over the strong level of March.

One obvious reason for the buying spurt is that Americans are making more money. The personal income of consumers jumped a total of $35.1 billion in March and April, the largest two-month gain in nearly a year, as employees worked longer hours and laid-off workers began returning to their jobs. Individuals are scheduled to start getting an extra $30 billion boost in July, when the third stage of the three-year tax cut takes effect. Moreover, the resurgent stock market has added nearly $500 billion to the wealth of consumers since last summer, and some people are starting to spend their market profits.

A growing number of workers are also leaving fears of worsening times behind them. The University of Michigan poll in April found that more people expected unemployment to drop than thought it would stay put or go higher. The jobless rate was 10.2% in April, down from the December peak of 10.8%. Said Curtin: "For the first time in almost 18 months, consumers talked more often about friends and relatives finding jobs or going back to work than about people losing jobs or not finding work." Although the respondents did not expect joblessness to slide dramatically, he added, they were relieved that the worst seemed over.

TIME'S economists also expect no more than a moderate decline in unemployment without a more vigorous long-term recovery. The board predicted that the rate will fall to 9.4% by the end of the year, which would still be a quite high level. Unemployment peaked at 9.0% during the severe 1973-75 slump, for example. But some members argued that such factors as the expansion of unemployment insurance and other benefits have taken some of the sting out of joblessness. Said Greenspan: "The conventional wisdom in the U.S. and Western Europe used to be that high levels of unemployment would be socially disruptive and lead to breakdowns in governmental institutions. The truth of the matter is that unemployment has gone well above what was expected and nothing happened. That is an extraordinarily important event because it says something fundamental about the nature of Western democratic institutions. Unemployment is no longer the hardship that it used to be."

The board expects that inflation, the other economic scourge of recent years, will remain under control as the recovery develops. Members look for prices to rise at an annual rate of just 3.5% this year, below even the 3.9% clip recorded for 1982. Last week the Government reported that consumer prices surged at a yearly rate of 7.2% in April, the largest gain since last July. But much of that increase was caused by a 5-c--a-gal. boost in federal gasoline taxes that took effect April 1.

The TIME board based its inflation forecast on the outlook for wage hikes, which have slowed substantially. Indeed, major union contracts negotiated in the first quarter actually call for wage reductions averaging 1.4% as a result of givebacks by labor. The drop was the first recorded by the Labor Department since it began tracking major collective bargaining agreements 15 years ago.

Energy costs are also unlikely to rebound any time soon. Crude oil prices have leveled off at about $29 per bbl. since the Organization of Petroleum Exporting Countries cut prices to that level in March. James McKie, chairman of the economics department at the University of Texas, noted that while OPEC has not collapsed, as some had predicted, the oil producers now seem powerless to push prices higher. He warned, however, that the group could regain its clout if Middle East strife once again restricts the flow of oil. Said he: "OPEC will now wait in the wings for its next opportunity, which, I feel viscerally certain, is sure to come."

Possible changes in Federal Reserve Board policies concerned TIME'S economists. While parts of the money supply have bulged far beyond Federal Reserve targets in recent weeks, the TIME board attributed that mainly to the shifting of consumer funds among different types of bank accounts. Some members feared that Federal Reserve Chairman Paul Volcker would look at the increase in some money-supply figures and decide to tighten credit again. Said Heller: "If Volcker forgets that it is not just our recovery that is at issue, but the fate of the debt-ridden countries and the European recovery, then we are in trouble."

Rimmer de Vries, chief international economist for Morgan Guaranty Trust, asserted that the financial woes of some Latin American countries, especially Brazil, have been worsening. Last week the International Monetary Fund and major banks decided to delay more than $1 billion in loans to Brazil because it has failed to take steps needed to narrow its balance of payments deficit. Said De Vries: "One of the critical financial issues facing governments remains international debt." He urged cooperation by banks, governments and multinational agencies like the IMF to pump cash into nations that cannot raise enough through exports to repay their borrowings.

Ultimately, the TIME economists agreed, the runaway U.S. budget deficit will have to be restrained before a full recovery can proceed. As long as annual deficits remain at the $200 billion level, the threat of renewed outbreaks of high interest rates will hang over the economy. On the other hand, if the deficit can be reduced, TIME'S economists foresee the U.S. and other Western economies setting off on the road to a strong, low-inflation recovery.

-- By John Greenwald This file is automatically generated by a robot program, so viewer discretion is required.