A Series of Bad Signals

By John Greenwald

In its youth, the recovery from the last recession was a lusty prodigy that grew faster than any other upturn in the past three decades. The rebound, which started in November 1982, is now in its 30th month. Post- World War II recoveries have typically lasted just 45 months, and this one is beginning to show its age.

"There is always some disappointment at this stage of an economic expansion," says Edward Yardeni, chief economist for the Wall Street firm of Prudential-Bache. "It is typical for an economy in the third year of an expansion to start to slow down."

Even so, forecasters were not prepared for the burst of alarming signs that flashed from Washington last week. The most worrisome was a Commerce Department announcement that the gross national product had grown at only a 1.3% annual rate in the first quarter of this year. That was well below the sluggish 2.1 % estimate that the Government issued last month and the smallest GNP gain since the .5% increase in the final quarter of 1982. Noted Walter Heller, chairman of the Council of Economic Advisers under Presidents Kennedy and Johnson: "The economy is pretty weak at the moment. We have had a lot of conflicting signals from the economy lately, and some have been concealing the fact that it has been performing poorly."

The unexpectedly sharp drop in GNP growth was the latest gyration in what has become a remarkably zigzag pattern of expansion. A year ago, the economy amazed experts by racking up a booming first-quarter increase of 10.1% at an annual rate. The gain dwindled to 1 .6% in the third quarter but then rebounded to 4.3% in the last three months of 1984. "The economy is exhibiting a split personality," says Allen Sinai, chief economist for Shearson Lehman Bros., "and it may continue to do so for some time in the future."

Nonetheless, neither Government nor private economists foresee a new recession this year. Said Heller: "We should not overemphasize just one quarter. This economy is not on the skids. There is enough steam in the boiler to keep things going." Predicted Charles Schultze, who was Jimmy Carter's chief economic adviser: "For the rest of this year and into next year you still ought to see a moderate but erratic expansion."

Such confidence reflects the absence from the economic picture of many of the warning signs that traditionally signal the end of a recovery. Interest rates, for example, have been falling rather than rising, which would have threatened to choke off the recovery. Renewed rapid inflation at the consumer level, another yellow light, is also not visible.

The extent of the first-quarter slowdown was confirmed last week by a spate of key indicators. The Commerce Department said consumer spending, which accounts for two-thirds of the GNP, fell .5% in March to record its sharpest drop in 1/3 months. At least part of the recent buying weakness reflects a monumental Government snafu. The Internal Revenue Service's glitch-filled installation of new computers kept consumers from receiving $6.8 billion in tax refunds in February and March. Those refunds would probably have been quickly spent and helped the economy.

News of the spending slump followed a Government report two weeks ago that March retail sales had tumbled 1.9% in the largest falloff since 1978. Shoppers have been walking away from some U.S.-made autos as well. Led by a 14.3% decline at General Motors, the number of cars sold by American manufacturers and foreign firms with U.S. plants dipped 6.6% in the first 10 days of April.

The sales slowdown was foreshadowed by a heavy accumulation of debt by shoppers earlier this year. Consumers took on a record $10.4 billion in new loans in February, and that heavy burden has already depressed buying. Consumers now owe more than $620 billion in revolving credit and personal loans, or about 23% of their overall after-tax earnings. That means that more than one dollar out of every five of disposable income must go to repay that borrowing. "The rate of increase in consumer debt is worrisome," says Alan Greenspan, a Manhattan-based economic consultant. "There is no doubt that this is one important negative aspect to the outlook."

Manufacturers have been taking their lumps as well. The Government announced last week that industrial production rose just .3% in March, after dropping .2% the previous month. Moreover, U.S. factories, mines and utilities operated at a slack 80.8% of capacity in March, unchanged from February and down from 81.2% in January.

Economists blamed the weak manufacturing performance on the strong U.S. dollar, which has been making imports that compete with American goods attractively cheap while pricing U.S. exports out of foreign markets. The resulting trade deficit is likely to reach $140 billion this year, an increase of almost $20 billion over last year. "The enormous trade gap is taking the ground out from under domestic production," says Barry Bosworth, a senior fellow at Washington's Brookings Institution. M.I.T. Economist Lester Thurow goes further. Says he: "The goods-producing sector of the economy is already in a recession."

Employment figures released earlier this week indicate that manufacturing remains distressed. They show that while 260,000 workers were added to the job rolls in March in service occupations, the size of the manufacturing labor force fell by 26,000. That left the unemployment rate at 7.3% in March, for the second straight month. Since 1980, 2 million workers have lost jobs, mostly in goods-producing industries, because of the dollar's strength.

The flurry of economic reports last week was not entirely gloomy. March housing starts jumped a robust 16.2% to record the best residential construction showing in 22 months. The surge was paced by a 54% increase in new apartment units as good weather spurred work and developers raced to get projects under way ahead of proposed tax reforms that could trim their profits. Meanwhile, housing permits, an important indicator of future starts, climbed 10.9% in March.

What disturbs economists most at present is the possibility that the dollar may come crashing down from its still lofty heights. After the GNP figure was announced last week, the dollar slumped sharply on world money markets. Though falling interest rates and the slowing economy have caused the U.S. currency to drop from its late-February record highs, it remains some 70% stronger than it was in 1980. A further 10% to 15% drop through the rest of 1985 would make U.S. goods cheaper and benefit the economy, but a dollar collapse would be devastating. Says Alice Rivlin, director of economic studies at the Brookings Institution: "The single greatest threat to the economic recovery is a precipitous fall in the dollar."

Such a decline would mean that foreigners were pulling vast sums of cash out of the U.S. Since money from abroad has been helping to finance the huge budget deficit, the outflow of funds would drive up interest rates. Meanwhile, the Federal Reserve would be tempted to force borrowing costs still higher in order to encourage the foreign capital to return. The outcome of all those actions would probably be a painful and prolonged recession.

A new American downturn would be felt by nations that have been fueling their economies by exports to the U.S. At next month's economic summit conference in Bonn, Treasury Secretary James Baker and President Reagan will make a plea to U.S. trading partners to take up any slack caused by the slowing American expansion. Last week, during a meeting of the policymaking committees of the World Bank and the International Monetary Fund, Baker heard foreign complaints that the U.S. must get its budget and trade deficits under control if the outlook for world economic growth is to remain favorable.

How the U.S. economy fares during the coming year will depend in large part on the actions of the Federal Reserve. Faced with problems ranging from a sagging recovery last fall to an Ohio banking crisis in March, Fed Chairman Paul Volcker has been allowing the money supply to grow more rapidly to keep credit affordable. With inflation still in check, the central bank will be tempted to continue its looser-money policy. "Right now the economy's giving off a mixed picture," says Manuel Johnson, Assistant Treasury Secretary for Economic Policy. "But if we can be sure that monetary policy won't tighten over the course of the year, then we can be sure of a continued solid expansion."

A return to substantial GNP gains will be needed if the White House's ambitious economic forecasts are to prove correct. The Administration last week trimmed its outlook for 1985 growth from 4% to 3.9%. That goal remains well above the 3.5% level that many private economists have been predicting, and may even be out of reach. Concedes Commerce Secretary Malcolm Baldrige: "If this estimate we have now isn't changed, we would need to average 4.9% growth for the next three quarters. That would be difficult to achieve."

The failure to meet the Administration's growth objectives would be more than an embarrassment; it would cause the already elephantine budget deficit to become larger and more menacing. The White House last week predicted the budget shortfall in fiscal 1985 would total $213 billion and then decline to $177.4 billion the following year. Continued economic weakness, though, could make those projections wildly optimistic. John Langum, president of Business Economics, a Chicago consulting firm, predicts that if the economy goes into recession, the deficit will jump to $400 billion in 1986. --By John Greenwald. Reported by Bernard Baumohl/New York and Christopher Redman/Washington

With reporting by Reported by Bernard Baumohl/New York, Christopher Redman/Washington