Special Report: America's Run-Down Economy A Slump That Won't Go Away

By John Greenwald

In the afterglow of the allied victory in the gulf war last spring, the U.S. economy seemed ready to shake off its malaise. Consumer confidence rose sharply, and sales of cars and homes began to shift into high gear. But in the clear light of autumn, that hopeful moment seems long gone. Despite assertions from Washington and most economists that the recession ended last May, the recovery may be the weakest in postwar history, and many sectors could even be sliding backward. "The situation is far worse than the government would like us to believe, and things are going to remain this difficult for some time," says Bernard Brennan, chairman of Montgomery Ward. "I think we're naive to assume that we're out of the recession. It's even probable that the next phase could be worse than the first."

That gloomy assessment reflects one of the great ironies of current events. At the moment when democracy and free enterprise have triumphed over communism in the Soviet Union and Eastern Europe, the U.S. is paying the price of capitalism run amuck. Maimed by the prodigious explosion of debt that characterized the 1980s, the overburdened economy is undergoing a painful consolidation and a shift in values away from the fast-money, speculative practices that came at the expense of financial soundness and long-term growth.

The '80s left behind structural burdens that are likely to rob the U.S. of robust growth for several years. Among them: record federal deficits (the past fiscal year: $285 billion) and an orgy of overbuilding that has sent the commercial real estate industry into an out-and-out depression. The glut of empty office towers could take a decade or more to pare down. Beset by the | speculative hangover, the economy has expanded just 2.6% from 1989 through mid-1991. Economists predict that the economy will bump along at a sluggish pace of less than 3% a year through 1995.

The fallout from the '80s has given consumers, who account for two-thirds of all spending, an abiding fear of being laid off as companies retrench for lean times. Since the recession began in July 1990, more than 1.6 million jobs have been lost. The Labor Department reported last week that the unemployment rate in September slipped a notch, to 6.7% from 6.8% the previous month. While President Bush hailed the movement as "one more sign that the economy is strengthening," many economists and investors saw little to cheer. Among other grim signs, the labor statistics showed that the number of discouraged workers, those who have quit looking for jobs and are no longer counted among the unemployed, had risen by 100,000 in the third quarter, to 1.1 million. "The economy is going nowhere fast. There is some recovery, but still lots of flatness and recession," said Allen Sinai, chief economist at the Boston Co.

The unemployment report came two days after American Express said it would lay off 1,700 workers and take a $265 million write-off because of rising defaults among holders of its new Optima credit card. Ames Department Stores, meanwhile, said it would close 77 of its 448 stores and lay off about 4,500 employees early next year.

Spending is caught in what might be called a lending gridlock. Bankers, many of them saddled with bad loans and hampered by overzealous regulation, have been unwilling to lend. But even when they do make money available, many overleveraged consumers and companies are reluctant to borrow more. "You are not going to have a robust recovery until both borrowers and lenders are through making their balance sheets look healthier," says John Makin, director of fiscal-policy studies at the American Enterprise Institute, a Washington think tank.

The economy's few bright spots are flickering at best. Buoyed by exports of capital goods, some manufacturers have been adding jobs at a time when most other industries have been cutting back. But the government reported last week that orders for U.S. factory goods tumbled 1.9% in August following a strong increase in July. If manufacturing falters, the last best hope will be housing, which has benefited from a drop in fixed-rate mortgage costs. The Commerce Department said last week that sales of new single-family homes rose 6.7% in August, the sixth gain in seven months.

Burdened by the runaway federal deficit, Washington cannot cut taxes or increase spending to stimulate business growth, as it did in every other major downturn since World War II. Nor has the Federal Reserve Board's actions to lower interest rates provided much of a lift outside the housing market, even though the prime rate has fallen from 10.5% two years ago to 8% today. With inflation now down to a modest 2.7%, the Fed last week reportedly gave Chairman Alan Greenspan approval to reduce interest rates even further if he deems it necessary to bolster the recovery.

One reason this recession has so profoundly hampered spending is that the middle class has been hard hit. Nearly 600,000 of the lost jobs belonged to middle managers and other white-collar workers as companies slashed their payrolls because of slow sales, crushing interest charges and tough foreign competition.

"There is no historical precedent for this," says Dan Lacey, an Ohio-based employment consultant. "This does not represent a recession," he says of the downsizing, "but a permanent shift in management thinking that is both structural and profound." Outplacement services are in heavy demand. William Morin, chairman of the job-search firm Drake Beam Morin, calls the latest round of corporate restructurings "the most aggressive I've ever seen."

Shell-shocked consumers have plenty to worry about besides losing their jobs. Debt burdens are now so heavy that Americans are filing for bankruptcy at a record annual rate of 880,000; the number could swell to 1 million for the entire year. At the same time, household tax burdens are rising because of increased levies by deficit-ridden state and local governments and last year's federal budget agreement, which boosted alcohol, tobacco and payroll taxes. According to the Tax Foundation, taxes will absorb a record 35.1% of Americans' income in 1991, up from 34.1% the previous year.

Yet the new levies seem unable to ease urban woes. In a survey last week of 62 members of the U.S. Conference of Mayors, 58% believed the economy's current problems were harming their communities more than the severe 1981-82 recession had.

A combination of fear, prudence and even trendiness has turned American consumers into chronic stay-at-homes. "This recession has become a state of exhaustion from the delusions of the 1980s," says Audrey Freedman, a management counselor for the Manhattan-based Conference Board. "There is a general public turning away from confidence in government, the private sector and enterprise itself. We're just tired."

Not everyone is worn out, of course. Foreign demand for U.S. products, spurred by the strength of foreign currencies in relation to the weak dollar, has created a boomlet for some manufacturing firms. "If we didn't read about it in the newspapers, we wouldn't know a recession has been going on," says George Schueppert, chief financial officer of CBI Industries, an energy- equipment company that has totted up $1.5 billion worth of new orders this year, largely from Asia and Latin America. But merchandise exports amount to just 7% of American GNP and can scarcely drag the economy out of the doldrums single-handedly. Moreover, the manufacturing boom could quickly go bust if nervous domestic consumers don't start opening their wallets soon.

Few industries have been whipsawed by stop-and-go shopping as severely as U.S. automakers. Despite a surge in July, their sales for the model year that ended in September totaled just 12.5 million units, the lowest level since 1983. With domestic auto plants now running at an average of just 65% of capacity, Detroit claims that no car-makers -- not even the Japanese -- are operating profitably in the U.S.

Fickle buying habits have left executives scratching their heads. "There is this very erratic pattern," notes Harold Poling, chairman of Ford, whose restyled Ford Taurus and Mercury Sable models have been slow to roll off new- car lots. "Dealers will have a positive week, then one when nothing happens. It looks like a long, drawn-out and weak time ahead."

That will be the painful consequence of the heedless and high-flying '80s. "We live in the box we've got ourselves in," says Lyle Gramley, chief economist for the Mortgage Bankers Association of America and a former Fed governor. "We are paying the price for what we did in the past with this enormous federal deficit. The price goes beyond the poor functioning of the economy now. Here we are, this great, wealthy, affluent nation, and we cannot afford to rebuild our highways or bridges. We cannot afford to have a really serious war on drugs. We cannot afford to improve our educational system. This is absurd."

Reinvigorating the economy will require substantial new investments in all the areas that Gramley mentions. That has already triggered a politically volatile debate about shifting funds from defense to education and other programs to foster long-term growth. But having triumphantly demonstrated the power of capitalism to doubters abroad, the U.S., ironically, now faces the test of showing that the American brand of private enterprise can still solve problems at home.

With reporting by Bernard Baumohl/Los Angeles, Gisela Bolte/Washington and William McWhirter/Detroit