A Quickening Recovery Faces Danger

OUTLOOK / TIME BOARD OF ECONOMISTS

As business moves into its traditionally bustling fall season, signs of a quickening recovery from the nation's most severe postwar recession are multiplying. Employment, store sales, industrial production and corporate profits have all turned up; the leading indicators --those statistics that tend to foreshadow future economic trends--have shown an exceptionally strong rise in the past five months (see chart). Yet the figures are breeding no euphoria; instead, many bankers, businessmen and economists see danger signals ahead. Their big worry is that a combination of resurging inflation, tight money, climbing interest rates, and inadequate Government stimulus to the economy will choke off the recovery, possibly as early as the middle of next year, before it has done much to bring down the nation's high unemployment rate, and perhaps even tip the economy into a new slump by 1977.

Tax Cuts. Those fears were analyzed last week by members of the TIME Board of Economists, who gathered in Manhattan to chart the probable course of the recovery over the next year or so. It was a spirited session marked by unusually sharp arguments between conservatives and liberals, and even some quarrels on specific points between ideological allies. Republicans Murray Weidenbaum and Beryl Sprinkel insisted that the recovery could keep going through 1976 and beyond with no more stimulus than the Ford Administration now plans, which will probably include acceptance of an extension of this year's temporary tax cuts. They believe any effort to force-feed greater growth could be severely inflationary. All six of their colleagues present at the meeting voiced deep worry that unless Washington shifts soon to more expansionary monetary or fiscal (tax and spending) policies, the upturn will begin to fizzle out around the middle of next year.

Most of TIME's economists expect real gross national product--the output of goods and services discounted for inflation--to sprint up at an annual rate of about 7% for the rest of this year and through the first half of 1976. Prices in that time will probably rise at a 7% to 8% annual rate, a disturbingly rapid pace after so deep a recession as the U.S. suffered in 1973-74, but much better than the 15.4% compound annual rate of inflation the U.S. suffered in July. Unemployment, which fell from 9.2% in May to 8.4% in both July and August, will come down, but painfully slowly. It may well still be above 8% by year's end, and will decline only to 7.5% or a trifle less by late 1976. These forecasts, which are roughly in line with predictions voiced to a congressional task force last week by President Ford's chief economic adviser, Alan Greenspan, underscore an important point: the recession dragged the U.S. economy so far down that several years of unusually strong growth, not just one, will be needed to return the nation to full prosperity.

The short-range forecast of a healthy though hardly exuberant recovery is supported by reports from businessmen round the country; generally they are pleased with the first signs of revival, though many are impatient for more substantial evidence that activity has picked up. "It looks like a slower than normal recovery," says Chicago Banker Edward Boss. The brightest portent so far is department-and specialty-store sales, which have spurted rapidly in recent weeks. In Boston, Filene's and other stores with fancy boutiques are getting a healthy run from shoppers, many willing to pay up to $75 for a pair of shoes, while such mass merchandisers as Outlet Co. stores report business running 6% to 10% ahead of last year. Retail trade is also healthy in Los Angeles and Chicago; in August, Sears, Roebuck posted its biggest monthly sales gain since last October.

Many individual firms round the country are also feeling the first flush of recovery. In Waltham, Mass., Hewlett-Packard's medical electronics plant reports that orders are up 20% over a year ago, while in Norwood, Mass., Northrop Corp. is expanding its precision products plant to accommodate demand. Officials at Whirlpool Corp. in Michigan report that sales of appliances have been climbing since June.

The hardest-hit industries remain housing and autos, which have played key roles in lifting the economy out of past recessions. Housing starts are now running at about 1.2 million annually, v. 1.3 million last year and 2.5 million in early 1973; they are generally not expected to increase much this year. Sales are depressed by high mortgage rates --still above 9% in many parts of the country--and the rapidly increasing cost of housing. On a national average, newhouse prices are almost 8% higher than a year ago, and some have risen more than that. In Sharon, Mass., for instance, houses that sold last year for $39,000 carry $46,000 price tags today. Auto sales, though picking up, are still soft. Estimates now are that U.S. car sales, which in 1974 hit 7.4 million units, will slip below 7 million this year for the first time since 1962.

Greater Inflation. In the longer run, members of the TIME board foresee some more serious threats to the recovery. One is the resurgence of inflation from a roughly 5% annual rate last spring to July's 15.4%. Though no one expects prices to keep rising at that clip, Otto Eckstein figures they will go up at a rate of 10% or more for the rest of this year. The 7%-to-8% price rise that most members foresee for the coming year pleases no one. Sprinkel considers that an argument for pursuing only moderately expansive monetary and fiscal policies. If that is done by the end of 1976, he thinks, price rises and unemployment rates could both be heading down sufficiently to leave the U.S. poised for further recovery. On the other hand, he argues, if the Government tries to pump enough money into the economy to prompt a faster rebound, it will only fan greater inflation that eventually would force a crackdown on demand. "We have one more chance now," he warns, "and if we blow it, we are going to have a very serious recession."

The majority of board members vehemently dispute that view. In their opinion the hardest inflationary push comes from food and fuel prices, which cannot be controlled by monetary and fiscal policy. "Oil and food prices," says David Grove, "have a life of their own." Arthur Okun adds that they are shooting up largely because of "self-inflicted wounds," resulting from Government actions. For example, most of the board members score the Administration for too readily allowing the Soviet Union to purchase 10 million metric tons of U.S. grain and kicking up American living costs; Eckstein calculates that food prices are likely to rise 10% between June 1975 and June 1976, and about 3% of that increase will result from the Russian purchases. Robert Nathan, Joseph Pechman and others argue that the Administration should negotiate an agreement that would keep Russian purchases each year within a specified range; the Administration is indeed now trying to work out a long-term grain arrangement with the Soviets, but seems to have a much more limited agreement in mind (see story page 64).

Run-Up. Most of the economists are also deeply worried that the long battle between President Ford and Congress over energy policy will end in abrupt decontrol of U.S.-produced oil and a damaging price runup. They score Congress for rejecting Ford's plans for gradual decontrol and the President for vetoing last week a six-month extension of the price curbs (see following story). Says Eckstein: "It is a classic case of the right and left ganging up on the responsible middle because of the weakness of leadership in the White House and Congress." Most board members also expect the cartel of oil-producing countries to raise the price of foreign crude another $1.50 per bbl. this month, adding further to consumers' oil bills.

In any case, a majority of the board maintains, inflation is not being caused by excess demand: U.S. industry is operating at only 70% of capacity, and the economy is producing $250 billion fewer goods and services per year than it could if it were operating at full potential. According to their argument, present fiscal-monetary policies will restrain not inflation but a faster recovery. Grove figures that in calendar 1975 the Government, through tax cuts and increases in spending, will pump $73 billion of new stimulus into the economy, an amount equal to nearly 5% of the total worth of all goods and services produced. Next year, he reckons, if present tax and spending plans are not revised upward, the amount of stimulus will fall to $29 billion, or only 1.7% of G.N.P. --even with an extension of the tax cut. "That," says Grove, "is one of the reasons you are going to get a significant slowdown in the rate of recovery in the second half of next year and into 1977."

Most board members are also unhappy about what they regard as the Federal Reserve Board's tightfisted money-supply policy. Fed Chairman Arthur Burns has set a money growth target of between 5% and 7 1/2% over the next ten months. According to Pechman, expansion of the money supply in the past two months has been close to zero. That, say Okun and Walter Heller, has been the chief cause of the sudden climb in interest rates recently. The bank prime rate on business loans has gone from as low as 7% in early June to as much as 8% last week. Weidenbaum, who believes the recovery and loan demand will continue to strengthen, reckons that even if the Fed increases the nation's money supply by 8% from now through next year, the prime rate will move up to 9% by the end of 1976. He is reconciled to that prospect, but Okun and Grove fear that such a rise would pull investment money out of the mortgage market, hurt the housing industry and put a damaging crimp in business spending for new plant and equipment.

Many members of the Board of Economists think the best strategy for speeding up the recovery and keeping it going past mid-1976 would be a combination of new tax cuts and more federal spending. The most comprehensive proposals were offered by Heller. He would 1) extend this year's individual income tax reductions for at least twelve months beyond the present expiration date of Jan. 1, 1976, 2) increase the size of the cut from its present $8 billion to $12 billion, and 3) add whatever was necessary to offset the impact of higher oil prices--anywhere from $5 billion to $8 billion. Thus Heller wants a tax cut next year totaling between $17 billion and $20 billion. He would also press for $2 billion in additional revenue sharing for cities, an expanded public service job program and even some public works projects.

Needed Lift. On monetary policy, Heller, Okun, Pechman and Grove agree that the Fed for at least a year should pump out as much money as might be needed to keep interest rates relatively stable. That, they assert, would give a much needed lift to the credit-hungry housing field, spur an increase in capital spending and get the recovery moving quicker and unemployment down faster. Again Banker Sprinkel dissented. He noted that it required a money growth rate of 14% to keep interest rates steady last spring and asserted that any attempt to maintain such an expansion pace for a year would surely bring on severe inflation and abort recovery.

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