The Economy: Are We in for a Double Dip?

By Bernard Baumohl

Sometimes the economy seems to fall prey to the quick hands of a magician. Now you see a recovery. Now you don't! Barely a month after economists proclaimed the end of the 1990-91 U.S. recession, some are beginning to wonder whether they will have to eat their words. Their doubts come on the heels of some disturbing evidence -- rising layoffs, a traumatized banking system and crippling debts -- that the economy may be in worse shape than anyone suspected. The pessimists believe the recovery could soon sputter out and turn into another recession, the second half of a so-called double dip. That happened in five of the past eight recessions, as the economy recovered for one or two quarters before suffering a relapse.

For the moment, most forecasters see enough life in the economy to keep it out of new trouble. The sale of single-family homes increased to an annual rate of 525,000 units in June, up 27% from January's low. The surge in home buying may boost new construction and stimulate sales of such durable goods as furniture and kitchen appliances. Business inventories have been trimmed down, so any increase in demand could rev up new factory production. "A double-dip recession can't be ruled out, but it's not a high risk," says Gordon Richards, an economist with the National Association of Manufacturers.

Yet this recovery is unlike most others. In a survey, 51 top economists predicted that the economy would grow at a 2.7% rate in the July-September quarter, less than half the speed of the average postwar recovery. New signs of weakness emerged last week when the Federal Reserve Board's "beige book," a document summarizing economic conditions around the country, reported that the recovery "has lost some momentum" since last spring. To supply more fuel, the Fed last week dropped the influential Federal Funds rate from 5 3/4% to 5 1/2%, its lowest level in more than a decade.

A small but anxious group of economists, however, believes the latest Fed tactic is too little, too late. They say the economy is now structurally damaged and incapable of bouncing back anytime soon. Hanging ominously over every sector -- individuals, business and government -- is a crippling pile of debt that amounts to $10 trillion, double the size of the entire U.S. economy. Consumers, far and away the most powerful stimuli in the economy, seem determined to slash spending and pay off loans. The government said last week that consumer installment debt fell 3% in June, the sixth drop in seven months.

Businesses are under great stress as well. Regulators have cracked down on banks, prompting them to cut back drastically on their lending. Companies drowning in debt are slashing capital investment and firing employees. Nearly 1 million workers have been laid off so far this year. Even the government, usually a reliable spender of last resort in a recession, will be absent this time because of record deficits at every level -- local, state and federal.

Lacking any other solutions, most economists look to the Fed and its newly reappointed chairman, Alan Greenspan, for the next move. "I consider the tight monetary policy pursued so far by the Fed as blatantly irresponsible," says Philip Braverman, chief economist of DKB Securities. "Inflation is not the enemy any longer. The real enemy is recession." So far this year, wholesale prices have fallen at a 1.7% annual rate, a trend that will give critics of the Fed more leverage in arguing for interest rates even lower than Greenspan has already pushed them. And as the 1992 elections approach, the political clamor for easier credit may grow deafening.

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Steve Hart

CAPTION: WHICH WAY NEXT?

With reporting by Jerome Cramer/Washington