Still Sighting Favorable Signs

By John Greenwald

TIME's Board of Economists expects slower growth but no new slump in '84

From the start, the rebound from the grinding 1981-82 recession has been filled with sharp surprises.

First the recovery took off far more powerfully than nearly all experts had expected. Now the prospect of further giant federal deficits is raising fears that the upturn may abruptly end. Such concerns have sent the Dow Jones industrial average plummeting 110 points in the past month. At a meeting last week in Manhattan, the members of TIME's Board of Economists foresaw continued growth this year, but predicted that the recovery's pace would slow. Said Walter Heller, who was chief economic adviser to Presidents Kennedy and Johnson: "The expansion won't peter out, but it will peter down."

The board expects the slowdown to continue right through the presidential election. Members look for the annual growth rate of the gross national product to fall from 5.2% in the first quarter to 4.1% in the fourth, with 4.5% expansion for the year.

The major cause of concern for TIME's board was President Reagan's budget, which Heller called "the most reckless in modern history." According to estimates by board members, there will be annual deficits of close to $200 billion during at least the next three years. Such shortfalls threaten to drive up interest rates and eventually abort the recovery. Board Member Charles Schultze, a Brookings Institution senior fellow, who was unable to attend the meeting because of bad weather on the East Coast, said in an interview afterward: "These deficits will do damage to investment and long-run growth. They will hurt housing, business investment, exports and American industries that compete with imports."

For now, however, the economy remains upward bound. Said Alan Greenspan, a New York consultant who was President Ford's chief economic adviser: "The slowing from the peak pace of last year has been remarkably modest. And far more important, there is no evidence of imminent deterioration."

Last week brought fresh evidence that consumer spending, which fueled the first year of the recovery, continues strong. The Government reported that retail sales jumped 2.2% in January, to a record $104.4 billion, for the best gain in eight months. Included was a healthy 1.2% increase in auto sales. Consumers showed their confidence last December by adding an unprecedented $6.6 billion to their debt. Moreover, Americans' personal income last month rose 1.1%.

Capital investment has traditionally been the driving force in the second year of a recovery, and TIME's board was confident it is assuming that role again. Heller found the Commerce Department's forecast of a strong 9.9% increase in 1984 business capital spending too low and suggested that the actual rate will be closer to 14%. Greenspan cautioned, however, that most of the investment has been going for items like computers rather than for factories that are financed by expensive long-term borrowing. He called outlays for new plants "dead in the water."

The capital-spending outlook was buttressed last week by a spate of Government indicators. One report showed that January industrial production surged 1.1%, the largest increase in four months. Factories last month ran at 79.9% of capacity, up from 79% in December. January housing starts, meanwhile, jumped 15%, to an annual rate of 1.92 million units, the highest in five years.

Another recent good economic sign is the stunning turnaround in the rate of unemployment. After climbing from 7.3% in mid-1981 to a post-World War II high of 10.7% in November 1982, joblessness has been heading downward spectacularly fast. By last month it had fallen to 8%, the quickest descent in more than 30 years. TIME's board expects that decline to level off soon, however, leaving unemployment at 7.7% this summer and 7.4% at the end of the year.

Members noted that the drop in joblessness was greatly aided by an unexplained fall in the rate at which people have been joining the work force. Said Heller: "The real surprise was that labor-force growth dropped, instead of accelerating as it usually does in a recovery." Far fewer women, in particular, are seeking jobs. Only 900,000 looked for work last year, compared with about 1.5 million annually during the late '70s. "It is interesting to speculate about the reasons for this," Heller added, "but nobody really knows why it is happening."

The board was pleased with the continued success of the fight against rising prices. "Inflation has gone through a watershed," said Heller. "I won't say we're home free, but we're in a new phase." He noted that the so-called core rate of inflation, which measures the underlying level independent of temporary factors like bad weather, has dropped from 9% in the late '70s to between 4% and 5% at present. That skid was caused by a combination of factors, including the recession, lower energy prices, the deregulation of transportation and other industries, and strong foreign competition.

Still, the TIME board was concerned about future price trends. "We are about to see the first signs of wage acceleration," warned Greenspan. With the slump over, workers are seeking to recoup some of the wage and benefit increases that they recently sacrificed. And while union members make up an estimated 16% to 17% of the labor force, their contracts traditionally have had a strong impact on general wage settlements. The bargaining talks between the United Auto Workers and Ford and General Motors, which begin this summer, could be pacesetters.

The crop damage caused by last summer's drought and this winter's freezing weather is also pushing up prices. January's Producer Price Index jumped .6%, or as much as it rose during all of 1983, a consequence of the increase in food costs. Grocery shoppers are likely to feel that for several months. Nevertheless, the board expects consumer prices to rise some 4.75% in 1984, compared with 3.8% last year. Five years ago, the U.S. price level shot up 13.3%.

The board also feared that the U.S. dollar, which has been at very lofty levels for months, could come down too fast. The currency, under pressure partly because of a record $69.4 billion U.S. trade deficit for 1983, was worth 2.68 West German marks last week, compared with 2.82 in mid-January. Said Rimmer de Vries, chief international economist for Morgan Guaranty Trust: "I would say, basically, that the dollar has peaked."

De Vries expects it to slide some 5% to 10% this year. A much faster decline, however, could cause extensive problems for the U.S. and the rest of the world. While it would help American industries that must compete with foreign goods, and thus narrow the alarming trade deficit, too rapid a fall would hurt the battle against inflation.

Each 10% drop in the dollar's exchange value could raise the U.S. price level by as much as 1.5 percentage points by boosting the cost of imports. A panicky flight of foreign investment would also result in higher interest rates. The large inflows of capital from abroad have been helping to keep American borrowing costs down.

A collapsing dollar could harm other countries too. The strong U.S. currency makes imported goods cheap and thus stimulates the economies of foreign nations. Their sales to the U.S. of everything from Japanese watches to French wines are the basis for the widening U.S. trade gap. Said De Vries: "Our trade deficit is a tonic to the rest of the world. So, thinking from that point of view, it has been very constructive to have a trade deficit and a strong dollar."

De Vries added that the powerful U.S. currency, which remains strongest against West European ones, has been as much a reflection of Europe's economic weakness as of America's strength. "It is basically a vote of confidence for the U.S. and a vote against Europe," he said. "I don't think anybody has a great deal of confidence in a European recovery this year. It is still very, very slow." De Vries warned that forecasts of 1984 European growth ranging from 1.5% to 2% "may be optimistic."

The board's deepest worry, however, remained the chasm between the amount of money the U.S. Government is spending and the amount it is bringing in through taxes. "The budget deficit will continue rising unless we change policy," said Board Member Alice Rivlin, a former director of the Congressional Budget Office, in an interview. To slash the deficit, Rivlin proposed steps that included a halt to cost of living boosts for most Government entitlement programs, including Social Security, and a freeze on other spending. Defense outlays might be limited to increases of 3% after adjusting for inflation. She would also levy a temporary income tax surcharge while Congress addresses the problem of fundamental tax reform.

Any solution to chronic budget deficits, however, will probably have to wait until after the November elections. Neither the Administration nor Congress at this time seems willing to face up to the deficit issue. Yet without a vigorous attack on that problem, the long-term outlook for the recovery will continue to deteriorate. --By John Greenwald