Economic Fallout: A Break from the Gloom

By THOMAS McCARROLL

On the morning after American-led forces launched the massive air attack on Iraq, traders at the New York Stock Exchange began their day with a minute of silence in honor of U.S. troops in the gulf. The moment of reflection turned out to be the only lull of the day. The opening bell was immediately followed by wild cheers and shouts of "Buy! Buy! Buy!" When the excitement was over, the exchange had recorded one of its busiest days in history. The Dow Jones average rose more than 114 points, the second highest one-day gain ever, to 2623.51. "The best scenario possible seems to be taking place," declared James Bellini, head of equity trading for the firm Dain Bosworth. "People realized that the outbreak of war was not as negative as they anticipated."

Stock and commodity exchanges around the world shared the Big Board's near euphoria. A huge logjam of financial uncertainty had been broken. Ever since Iraq's invasion of Kuwait raised the threat of war in the Middle East last August, business in many parts of the globe has suffered because so many decisions have been put on hold. In the U.S. the specter of a major war has created a virtual paralysis in an economy already plagued by recession, deep budget deficits and troubled banks. "It's frightening," said Mitchell Fromstein, CEO of Manpower, the employment-services company. "We're watching a war being superimposed on top of a recession. People are just frozen in place until they see what it is they're facing."

But last week's initial taste of success by allied forces raised the possibility that the gulf war might be a short one, lasting a few weeks instead of many months. That inspired investors to surmount their crippling fears of a long, costly war that would plunge the U.S. into a near depression. Stock markets turned bullish in all parts of the world as buyers big and small poured in from the sidelines, heartened by a plunge in oil prices. Said Donald Clark, chairman of Household International, a finance and insurance firm: "I'm more optimistic today simply because we have put the uncertainties of the terrible situation behind us. In fact, I'm downright elated."

The first Iraqi missile attack on Israel gave investors pause, but they resumed their bullishness when there was no immediate retaliation. The Dow Jones average closed the week at 2646.78, up a record 145.29 points. In Germany the Frankfurt exchange registered its largest single-day advance in history and gained more than 1.6% for the week, while Tokyo's Nikkei index rose 2.4%.

The reaction was just the opposite of what the markets had been bracing for. Investors were expected to panic once the shooting started. Fearing a meltdown similar to the October 1987 crash, brokerage firms and mutual-fund companies deployed extra staff and canceled vacations to meet the anticipated stampede of customers. Many exchanges, including the New York and London markets, considered plans to shut down temporarily, as they did at the start of World War I and the end of World War II. Instead, they enacted emergency rules to limit wide market gyrations. Rather than prevent a crash, the so-called circuit breakers acted mainly to brake the wild upward surges.

The bullishness may be premature, but some economists welcomed the markets' reaction as the first sign of economic recovery. Alan Greenspan, the Federal Reserve Board chairman, expressed optimism that the economic plunge had stabilized and might end by late spring or early summer. "The extraordinary decline in oil prices, assuming they stay down, would clearly have a major effect on consumer purchasing power," Greenspan said. Meanwhile, "a sharp decline in long-term interest rates should, at least in part, be of help to home building, which surely needs it," he said.

The U.S. recession so far has been steep and painful. During the October- December quarter, the economy shrank at an estimated 4% annual rate. Last week a barrage of grim statistics underscored the situation. Housing starts fell 13.3% last year, to the lowest level since the 1981-82 recession. Industrial production declined at a rate of 8% during the final quarter of 1990, and the tailspin showed no sign of a letup. Domestic auto sales during the first 10 days of January were more than 31% lower than during the same period a year ago. "Nobody is selling anything. Times couldn't be worse," said Robert Lutz, the blunt-spoken president of Chrysler. "The only people buying are those with 90,000 miles on their cars or people who have had their cars stolen or burned." Concurs his colleague John Rock, general manager of the GMC truck division: "Everybody's in neutral and idling."

The slump is leaving a junkyard of bankrupt companies in businesses ranging from retailing to innkeeping. Last week Eastern Air Lines, which has struggled in bankruptcy since March 1989, closed down after 62 years of flying. The carrier, which has 18,000 employees, was forced to halt operations because of a cash shortage and lack of any buyers. Since December, Continental and Pan Am have filed for Chapter 11 protection.

More than any other single factor, business leaders cite the uncertainty of the war as the nemesis of economic recovery. Not knowing what they face, people put off major commitments. "You tend to freeze hiring levels and postpone any major decisions on new technology," says John Ettlie, director of the Office of Manufacturing Management Research at the University of Michigan. The paralysis has spread beyond the U.S., since the gulf crisis has boosted oil prices and interest rates around the globe. French Prime Minister Michel Rocard has cited a "tendency toward inertia that is gaining ground in the face of these immense risks." Adding to the sense of suspended animation is the increase in corporate security measures, which at many companies has included a ban on most foreign travel.

War fears have curbed consumer spending as well. "With the gulf crisis, consumer confidence is destroyed," says Walter Minnick, president of TJ International, a Boise manufacturer of building materials. "Committing to a new home is a major decision, and a postponable one, so a lot of people are postponing."

A commonplace of economic wisdom is that wars are good for the economy. In World War II and the Korean War, spending on military hardware helped fuel years of prosperity. But this time the military buildup came before the war, in the 1980s, and its locomotive power is spent. The gulf war will draw from that huge inventory of big-ticket hardware. Most of the new spending on the confrontation with Iraq, estimated at $10 billion for 1990 alone, will go toward food, fuel and other items that do little to boost U.S. industry. "This war is different," says Gordon Adams, director of the Defense Budget Project. "They've already bought all the tanks and missiles they need, and 'Rosie the Riveter' is already working."

As a result, the best war for the U.S. economy -- not to mention the troops doing the fighting -- is a short one. The end of combat would bring many economic stimulants: cheap oil, lower interest rates and a surge in consumer confidence. "People have been inclined to say, 'Let's wait and see what happens,' " says John Makin, director of fiscal-policy studies at the American Enterprise Institute, a conservative think tank. "If in a month's time they know what has happened, then you have six months' worth of postponements that people will address, so you could get a little jump in spending." Says Daniel Cotter, chief executive of the True Value hardware- store chain: "A short war and a resounding victory would certainly boost the psychology and spirit of consumers."

But until peace is declared, consumers and business leaders cannot fully put aside their fears of a far grimmer scenario, one in which the U.S. and its allies become trapped in the quicksand of a war lasting several months to a year. A bloody, painful conflict would keep oil prices and interest rates high, choking the U.S. economy and worsening the slump in parts of Europe and Asia. The conflict would be devastating for American morale as antiwar sentiment spread. "Its major impact may be in polarizing the American people," says Jack Wing, chief executive of the Chicago Corp., an investment firm. "Divisiveness and polarization are the things on which instability and fear are built. That's not going to do anything good for the economy." Says True Value's Cotter: "When troops are dug in and bloodied, it affects everyone. You don't feel the same way about yourself when you've got loved ones fighting for you. People just don't go out and spend freely."

The cost of a long war could severely aggravate U.S. fiscal problems. A protracted conflict, the Congressional Budget Office reckons, could cost the U.S. as much as $86 billion over the 1991-92 fiscal years. The cost would sharply aggravate this year's budget deficit, which is expected to top $300 billion for the first time. The increased federal borrowing would put further upward pressure on interest rates at a time when the economy needs easier, not tighter, credit. Says Paul McCracken, former chief economist to President Nixon: "If we are going to launch a major military operation, we have to pay for it. Our experience with 'guns and butter' during Vietnam was not a very satisfactory one. The public needs to be told. There will probably be a need for another large tax increase."

Even after the war is over, sooner or later the global economy will have to deal with many problems that arrived before the gulf crisis. Among them: the fall of real estate prices in many countries, the banking crisis in the U.S., the crumbling Soviet economy and rising tensions in global trade. The return to robust economic growth is likely to be very gradual, especially in the U.S. Says Lyle Gramley, chief economist for the Mortgage Bankers Association: "This may be a recovery that still feels like a recession." One bright spot is that as long as the U.S. can avoid a catastrophic recession that could harm its trading partners as well, the still healthy economies of Japan and Germany should provide some stimulus for the rest of the world. Japan expects its economy to grow as much as 4% in the coming year, with only 3% inflation, while projected growth for the German economy is 3%.

In many ways, the U.S. is already moving toward a smarter, sounder economy after the excesses of the 1980s. Says Gramley: "We are going back to the kinds of prudent, cautious lending standards that prevailed two to three decades ago. That was very much needed. We will be delighted over the long run that we did this, however much it hurts now." That is a good sign, but until the end of the war, the virtues and strengths of the U.S. economy are likely to be partially hidden by the gloom.

With reporting by Gisela Bolte/Washington, Lee Griggs/San Francisco and William McWhirter/Chicago