A Year of Rolling Sevens

By Charles P. Alexander

Americans are going into 1985 a little older, maybe a little wiser and, in most cases, a little richer. From an economic standpoint, 1984 was a year to cheer. Unemployment dipped, interest rates finally slipped, and inflation stayed cowering in its cage. Many businesses raked in record profits. Most important, Americans relished an estimated 5.3% rise in real disposable income, which is the amount of money people have left after taxes, adjusted for inflation. That fueled a feeling of prosperity and helped propel President Reagan in his re-election romp.

But, while it was a year of living well, it was a year of living dangerously. The financial system, still feeling the aftershocks of the last recession, wobbled and might have toppled if Uncle Sam had not rushed to the rescue of the Continental Illinois bank. In addition, the economy was menaced by those terrible twin deficits in the federal budget and foreign trade. These two monsters dragged down the rate of growth in the second half of the year and threatened to stall the recovery.

Early in 1984, though, the economy seemed unstoppable. For the first half of the year, growth in the gross national product, after adjustment for inflation, reached 8.6%. Some economists feared that so exuberant an expansion ) would cause inflation to accelerate. To prevent that, the Federal Reserve Board in the spring tightened the money supply and let interest rates rise. The prime rate, which banks charge for corporate loans, climbed from 11% in March to 13% by June.

As the election campaign heated up, the Administration had harsh words for the Federal Reserve, where Chairman Paul Volcker stood firm for a restrictive policy. Said Treasury Secretary Donald Regan in May: "If the Fed continues on its tight path now, it will have an effect on November and December. Is that politics, and does that have us worried? You bet your life it has us worried."

The growth rate dropped to 1.6% in the July-September quarter, but the slowdown came too late to have much impact on the election. Moreover, the Federal Reserve realized that it had been too stringent and opened up the money-supply spigot. That helped send the prime rate down to 10.75% by late December. In the fourth quarter, growth picked up to an estimated 2.8% pace. Concluded Commerce Secretary Malcolm Baldrige: "This year the economy came in like a lion and is going out like a lamb."

On average, 1984 was more lion than lamb. For the year as a whole, growth amounted to about 5.3%. That was enough to slash the civilian unemployment rate from 8.2% to 7.2%. The number of Americans with jobs rose by nearly 3 million, to 106 million.

Despite that record, the Roman Catholic bishops of the U.S. felt compelled to speak up for those who have not shared in the general prosperity. A controversial draft of a pastoral letter presented to the National Conference of Catholic Bishops criticized the "massive and ugly" failures of American capitalism. Noting that more than 15% of the U.S. population lives below the official poverty level, the bishops called for increased Government spending on welfare and jobs programs. Critics maintained that the bishops' economic prescriptions had been tried in the past and failed. Said William Simon, a former Secretary of the Treasury: "We threw a trillion dollars at poverty, and we have more poverty now than ever before."

The low level of inflation was one of the most encouraging features of the 1984 economy. For the first eleven months, consumer prices rose at an annual pace of 4.1%. The key to that performance was the restraint shown by workers in wage and benefit demands. Compensation per hour rose an estimated 4.2% in 1984. The climate of slow inflation was not comfortable for everyone, however. Farmers were hurt by weak grain and livestock prices and a plunge in land values.

Plentiful supplies of oil helped hold down inflation. In October, Norway broke ranks with other oil producers and dropped the price of a barrel of its high-quality crude from $30 to $28.50. Britain followed with a $1.35 reduction, to $28.65. At an emergency meeting, the Organization of Petroleum Exporting Countries patched together an agreement on production cutbacks, designed to prop up the price of its bench mark Arab Light crude at $29. But many oil experts doubt OPEC can hold that line much longer.

The good news on energy prices and wages, combined with strong sales, helped a broad range of industries generate healthy profits. Corporate earnings rose 33% during the first nine months of the year over the same period in 1983. Among the biggest winners were the auto companies. General Motors' earnings were up 50%, Ford's 101% and Chrysler's 204%.

While rolling in profits, the car companies were roiled by protests over the compensation of their top executives. Ford revealed that Chairman Philip Caldwell earned $1.42 million in salary and bonuses in 1983, and General Motors said Chairman Roger Smith took in $1.49 million. "A scandal and an outrage," charged Marc Stepp, vice president of the United Auto Workers. William Brock, the U.S. trade representative, was incensed by the bonuses and warned that the Administration might not ask Japan to renew voluntary quotas on auto exports when the curbs expire in March. "Our reluctance," he said, "is a mile wide and a mile deep."

The brouhaha over executive pay injected a note of bitterness into negotiations on new three-year contracts between the auto workers and GM and Ford. In September, after two months of tough bargaining, the U.A.W. launched a selective strike against 13 key GM plants, which produce models accounting for nearly half of the company's sales and employ 62,700 of its 350,000 hourly workers.

The mood on the picket lines was militant, but negotiators on both sides realized that a long strike would cripple the industry in its battle with foreign competitors. After six days of talks, at 2:20 a.m. on Sept. 21, a bleary-eyed Owen Bieber, president of the U.A.W., announced what he called an "excellent settlement." The union took wage increases and lump-sum payments averaging only 2.25% a year, but GM agreed to an unprecedented job- security program. The company is putting $1 billion into a pool for payments ; to workers whose jobs have been eliminated by automation or the shift of production to overseas factories. The deal set the pattern for a similar contract at Ford.

While other industries enjoyed a banner year, banking endured some of its bleakest times since the Great Depression. Saddled with shaky loans to oil drillers, farmers and foreign governments, major banks suffered a 30% decline in profits during the first three quarters of 1984, and 79 institutions failed. In addition, Government regulators put 817 of the 14,700 U.S. banks on their "problem list." The worst problem was Continental Illinois, which started the year as the seventh largest U.S. bank. It would have collapsed under its bad loans if the U.S. Government had not provided a $4.5 billion bailout in July. Federal regulators took control of the bank, installed new management and fired most of the directors.

Such intervention went against the Administration's free-market philosophy, but regulators feared the stability of the entire financial system was in jeopardy. Said one top Federal Reserve official: "We did not know what would happen if we didn't rescue Continental. We could not take the risk." When Continental's fate was in doubt, the jitters affected even solid institutions. Manufacturers Hanover, for example, watched its stock price drop by nearly 11% in one day because of an unfounded rumor that it was in trouble.

High on the bankers' 1984 worry list were their loans to Latin American nations, which staggered under a $350 billion debt burden. In June representatives of the debtor countries huddled in Cartagena, Colombia, raising fears that they would form a cartel to bargain collectively for easier terms. Warned Colombian President Belisario Betancur: "We hear the far-off thunder of violent drums. We feel the winds of storms." Despite such rhetoric, most of the debtors chose negotiation over confrontation. Mexico persuaded the banks to stretch out its payments on $48 billion in loans, originally due between now and 1990, over 14 years at reduced interest rates. Brazil is seeking similar concessions. Argentina, however, played financial chicken with the banks, coming close to default. A day before one deadline, the country was bailed out by loans from several of its debt-ridden neighbors, including Mexico and Brazil. Argentina finally consented to an economic adjustment program overseen by the International Monetary Fund. In return, the IMF agreed to lend the country more than $1.6 billion.

The banks' troubles called into question the whole issue of deregulating the financial industry. Banks in recent years have gained new freedom to pay whatever interest rates they wish, move into different businesses like stock brokerage and open offices across state lines. After the banks' poor performance this year, critics are asking whether the institutions can safely handle so many swift changes. Several members of Congress are talking about slowing the pace of deregulation.

Some airlines are also discovering that deregulation is not always dandy. Since the industry was given increased freedom to set fares and pick routes in 1978, People Express and other new, cut-rate carriers have started shootouts in the skies. While such airlines as American, United and Delta reported strong profits in 1984, several others, including Pan American, Eastern, Western and Frontier, posted losses.

Increasingly fierce competition intensified congestion and stomach-wrenching delays at major airports. Under pres- sure from the Government, the airlines worked out a plan to move about 1,000 flights from peak-hour slots in New York City, Chicago, Atlanta and Denver.

No industry was more transformed in 1984 than telecommunications. In the boldest deregulation experiment of all, the Bell System carried out a courtmandated plan to break up into eight pieces: a shrunken AT&T, which kept its long-distance network, and seven regional companies to provide local service. The immediate results of the split were increased competition and confusion. Long-distance rates fell by 6% as AT&T battled with MCI Communications, GTE Sprint and other rivals. At the same time, though, the average cost of local service rose by 8%. Customers were befuddled by multipage bills, bewildered about whom to call for repairs and bedeviled by delays in the installation of new telephone lines. Said Jack Reiss, 83, a retired salesman in Harrisburg, Pa.: "I don't know why they broke up Ma Bell, but I wish they would put it back together."

For AT&T, which is challenging IBM in the computer business, entry into the competitive world was rough. To cut costs, the company eliminated 11,000 of the 253,000 jobs in its AT&T Technologies branch. The stars of the divestiture were the seven Baby Bell companies. They earned $5 billion in the first nine months of 1984 and were favorites on Wall Street.

Unlike the telecommunications business, the nuclear power industry strained under a yoke of regulation. Ever since the 1979 nuclear accident at the Three Mile Island plant in Pennsylvania, stepped-up safety precautions have made the building of atomic power facilities an increasingly complex and expensive job. Utility companies stopped work on eight nuclear construction projects in 1984. Nuclear woes generated financial difficulties for several utilities, including Long Island Lighting and Consumers Power of Michigan.

The chemical industry had a Three Mile Island of its own when a gas leak at a Union Carbide plant killed some 2,500 people in Bhopal, India. The company faces a flurry of lawsuits that threaten its financial future. In the wake of the disaster, chemical manufacturers will have to take a hard look at safety procedures. Moreover, companies in all kinds of industries will need to examine whether their ways of doing business in foreign countries measure up to their standards at home. Said a shaken Warren Anderson, chairman of Union Carbide: "I think Bhopal has changed the world."

For many executives, the most pressing concern in 1984 was how to keep their companies from being swallowed by takeovers. To escape a bid by T. Boone Pickens Jr., the Texas oilman, Gulf sold itself to Standard Oil of California for $13.2 billion in history's biggest merger. Late in the year Pickens and two partners bought about 6% of the shares of Phillips Petroleum and announced a bid to take control. After several skirmishes in court, Pickens agreed to sell the shares to an underwriting group organized by Phillips for an estimated profit of $89 million.

Some Wall Streeters accused Pickens of "greenmail," the business world's version of blackmail. In a greenmail deal, an investor buys a large enough chunk of a company's stock to pose a takeover threat in the hope that its management will buy the shares at a premium. Pickens denies being a greenmailer, saying that he made a sincere bid to take over Phillips and that all company shareholders will benefit from his actions because the value of their stock will rise. The most venerable greenmail victim of 1984 was Mickey Mouse. Saul Steinberg, a New York City financier, bought 12% of the stock of Walt Disney Productions and then sold it to the company for a profit of $32 million.

Many corporate chiefs took a tough stance against takeover artists. Said William Norris, chairman of Control Data, a computer company: "We're not for sale. If anybody comes to try to buy us, we'll kick their butts out the door."

Among economic issues, the flash point of debate in 1984 was the federal budget deficit, which is expected to reach $200 billion this year. The deficit depressed Wall Street, alarmed businessmen and created a civil war among President Reagan's advisers. Treasury Secretary Regan argued that strong growth and spending cuts would take care of the budget gap, but Martin Feldstein, chairman of the Council of Economic Advisers, publicly maintained that a tax hike was needed. Said Feldstein, who resigned in July to return to teaching at Harvard: "The longer the deficits are allowed to persist, the greater are the risks to our economy."

Like most economists, Feldstein contended that the budget deficit helped keep U.S. interest rates high in 1984, which attracted about $100 billion in foreign capital to American investments. While the money from abroad helped finance the federal deficit, it also boosted the value of the dollar to new peaks. The dollar's strength was a boon to American tourists, who traveled overseas in record numbers, but it was a burden to U.S. companies that tried to compete with cheap imports or sell their products abroad. Primarily because of the robust dollar, the U.S. racked up a record trade deficit of more than $115 billion. If that trade gap keeps growing, economists warned, the U.S. could be headed for another recession.

The first order of business in the new Congress will be to tackle the budget deficit. President Reagan will make the initial move early in 1985 by proposing a new round of cuts in domestic spending. But the Democrats, and some Republicans, are not likely to go along unless the White House agrees to curb military spending and raise taxes. For the moment, Reagan is adamantly against a tax hike. Despite the urgency of the challenge, Congress and the White House seem no closer to resolving the budget dilemma than when it first arose in 1981. Only by breaking the gridlock can they ensure that the prosperity of 1984 will be a prelude to more good times ahead.