Now a Middling-Size Downturn

It should bring relief from U.S. price rises, but not enough to cheer

Is it a "sloom," an oddball mix of slump and boom? Is it an "excession," an expansionary recession? Is it merely a forward retreat? Whatever the U.S. economy is going through is as much a matter of semantics as statistics. But the confusing numbers will quickly clear up. Even if the economy is not now in a recession, the latest oil price rises by the OPEC cartel further ensure that a downturn will soon begin.

That is the view of almost all the experts, including the ten members of TIME'S Board of Economists. Their unanimous opinion is that 1980 will be a year of middling-size recession. It will bring lower inflation, easier interest rates and higher unemployment, but not so much as to create either tremendous pain or fast, fast, fast relief.

The current indicators are as perplexing and contradictory as a set of cooked books. Consider the liabilities: America's factories are producing less than they did last March; auto sales are moving like an Ypsilanti car without antifreeze; and the construction of new houses, the traditional harbinger of economic swings, is down from a rate of 2.1 million a year ago to 1.5 million now. But count the assets: a record 97.6 million Americans are at work in civilian jobs, and their personal income and spending rose rather smartly last month, although many of the gains were the puffy results of inflation. People seem pessimistic about the economy, yet rather confident of their own careers and futures. Many businessmen, their profits climbing and their cash registers jingling, say that if this is a recession let's have more of it.

They will get their wish soon enough. Six members of TIME'S board* believe that the gross national product will decline this month and keep right on heading down. All of them agree that there will be a fall-off in the first and second quarters of 1980. A recovery, they figure, will not begin until autumn and perhaps not until early 1981.

The recession is--or will be--a consequence of inflation and the necessary policies of tight money and higher interest rates that have been adopted to combat it. Last week's oil boosts will swell inflation still further and bring on more countermeasures. But in the campaign against inflation, TIME'S economists neither expect nor advocate mandatory wage and price controls. To spur business capital investment, they anticipate that taxes will be cut, if not in 1980 then early in 1981. As a consequence of recession, they figure that the 1980 budget deficit will be far higher than President Carter predicted only four months ago. Highlights of the board's daylong meeting last week:

RECESSION. The slump should be sharpest early in the new year. During each of the first two quarters, real economic growth--that is, the gross national product adjusted for inflation--is expected to tumble at an annual rate of 4%. In the third quarter, according to the median forecast of the board members, there will be a 1.5% decline.

Consumers will lead the way down. They are running out of cash, credit and savings; also, they will have to pay much more for oil-related goods and services as varied as food and rents (tractors and furnaces burn fuel). So consumers will be obliged to buy less of almost everything else, notably cars, appliances and other durable goods. Squeezed by tight money, the construction rate of new homes and apartments could go as low as 1.2 million by March. As demand wanes, businessmen will further reduce production and inventories. But by late fall or early winter, their shelves and warehouses will be fairly empty, and they will have to stock up with new orders. This should send the economy up again.

How severe will the slump be? TIME'S economists figure that, from this autumn's high to next year's low, the G.N.P. will decline a total of about 2.4%. That would be much less than the 5.7% plunge in 1974-75.

PRICES. Inflation will abate, but not soon enough or substantially enough to cheer about. Recessions are usually slow to take the steam out of prices, and a tight money policy requires months to produce results. In fact, high interest rates will continue to add to inflation until they start to curb overall demand, and then prices are expected to taper off. Despite rising unemployment, wages and benefits stand to accelerate. They increased about 8% this year, or much less than the rate of inflation, and workers can make a strong case for more, just to catch up.

The Board of Economists expects the cost of living index, which has been rising at a 13% rate for months, will be going up at a pace of 9% or a bit more next December. The economists admit, however, that they and almost all the other experts have grossly underestimated inflation's staying power in the past several years. Cracks Otto Eckstein, head of Data Resources, Inc.: "I have been predicting the inflation rate for maybe 20 years, and I must have got it right about three times."

JOBS. The success story of 1979 has been the remarkable rise in jobs, but opportunities will dry up next year. Though plenty of openings will remain for the skilled, untrained workers will be let go and let down. Unemployment, which dropped slightly last month to 5.8%, is expected to rise to 7.7% by the final quarter of 1980. That will be not nearly as severe as the recent peak of 9% in May 1975. Most board members agree that unemployment will hit a high around Election Day in November, which will hurt Jimmy Carter, and that the jobless rate again will start declining as the economy picks up at year's end. However, one member, Consultant David Grove, who has long been pessimistic about the job situation, predicts that the worst will come in the second half of 1981, when he sees unemployment at 9 1/4%.

INTEREST RATES. They are probably past their peak now, but don't bet on it. Rates are so high that Art Buchwald jokes that Chase Manhattan is charging more than the Mafia.* As the recession dampens credit demand, prime rates are expected to come down to about 91/2% by next year's end. In 1981, predicts Beryl Sprinkel, a money expert who is executive vice president of Chicago's Harris Trust & Savings Bank, rates could fall still further. But if the dollar's value declines by much in world markets, the Federal Reserve may be forced to tighten credit still more in order to attract foreign deposits and thus prop up the dollar.

THE DOLLAR. As the budget rises and the U.S. trade deficit increases because of higher oil import costs, the dollar probably will decline a bit more against the West German mark and other strong currencies. The freezing of Iran's assets may move other OPEC governments to sell some of their dollar holdings to escape any chance that they also might be frozen. These switches would weaken the greenback. Says Consultant Robert Nathan, a member of TIME'S board: "It is entirely possible that the dollar picture will become more critical in the next four to five months." Still, the board does not believe that the dollar's position as the key international currency will be seriously challenged. There are not nearly enough German marks, Swiss francs and other currencies in circulation to replace it.

Even so, governments as well as individuals are transferring more and more of their wealth out of paper currencies and into gold and other precious metals. For years, the rise of gold prices has paralleled the advance of oil prices. In the past twelve months, OPEC oil has gone up about 100% and gold has jumped 120%. OPEC governments, as well as the new millionaires and the widening middle class in the oil-producing countries, are eager to put their money in immutable, unfreezable bullion. Gold, which sold for $266 per troy ounce last May, approached $500 last week. Coins and bars surged largely because of high investment demand stemming from fears over Iran, OPEC'S latest price gouging, and some petrodollar zilLionaires' purchases by the ton.*

U.S. Government officials tirelessly assert that gold fever will have no debilitating consequences for the world monetary system or the dollar. That argument ignores the point that gold is a most unproductive investment. Much of the money that people put into gold is not directly reinvested and ultimately goes to the main producers, South Africa and the Soviet Union. If the money were deposited in banks or spent for stocks and bonds, it would be put to use for loans and investments that finance new enterprises, corporate expansions, jobs and wealth.

Gold can and does fall quickly on good news, but several forces tend to hold it up. The Soviet Union is rumored to be keeping supplies tight. More money is pouring into the OPEC nations, and pouring right out into gold. Europe's central banks have reason to use their financial muscle to support the gold price. When bullion rises, the gold holdings of those banks become more valuable, and their governments have greater borrowing power. By borrowing against their gold, governments can put off such painful anti-inflationary steps as raising taxes. Among the countries that have borrowed against their bullion reserves for this purpose are Italy and Portugal. While such moves set back the global battle against inflation, the rise in gold has one benefit for the U.S. The swelling value of the nation's gold reserves in Fort Knox--in the past year it has risen from $56.9 billion to $114.2 billion--helps support the dollar. That was one reason why the dollar stood up fairly well in trading last week.

Of course, so much of the fate of gold, the dollar and the whole economy depends on energy prices. Economic Consultant Alan Greenspan was encouraged that price rises have caused gasoline demand to fall more than had been generally expected. Gas consumption has dropped about 4.7% this year, indicating that any moves to put a fat federal tax on gas would lead to further beneficial declines. But additional increases by OPEC, noted David Grove, would not help at all because they would inspire cartel members to produce less; they could get the same amount of money, or more, with lower production.

Neither a high gasoline tax nor rationing found enthusiastic support on the board. When asked to choose between the two, members split. Economist Arthur Okun, of the Brookings Institution, argued that if President Carter called for a high gasoline tax, his anti-inflation struggle would lose credibility. Asked Okun: "How could the Government convince labor that it has a serious policy of price restraint?" Most of the economists believe that rationing would be a bureaucratic nightmare and unfair to many people. But Economist Walter Heller, of the University of Minnesota, reluctantly favored it over a tax. Said he: "Rationing is a can of worms, but it is better than a can of snakes. It would cause no price increase; it would be a flexible instrument to cut demand, and it would be a dramatic way to show the world that the U.S. is no longer a nation of gasaholics."

A most discouraging aspect of rising oil prices, said Okun, is that the recession will only temporarily and modestly constrain inflation. At very best, the rate of price increases will come down to 8%. After the 1974-75 recession, inflation was 5%, which at that time was considered "intolerable, horrible and unacceptable." Indexing, which automatically raises wages and pensions along with the price index, is not a cure but a disease that institutionalizes inflation, added Okun. He estimates that "if all payrolls were indexed instead of the roughly 15% that are now, the consumer price index would have risen more than 20%, not 13%." Inflation is only one consequence of increasing energy costs, said Economist Murray Weidenbaum, a visiting scholar at the American Enterprise Institute. He believes that U.S. industry's reasonably successful drive to restrict energy consumption may be hurting productivity because companies are reducing the use of energy-gulping machines.

Although President Carter will face tremendous political pressure during election year to curb prices, board members felt that he would not try to impose mandatory wage and price controls, and that any attempt to do so would be disastrous. With the exception of Beryl Sprinkel, who figured that there is almost a 50% chance that the President will go for controls, most board members gave that prospect only a 20% to 40% chance. Carter first would need congressional authority and, as the debate raged on Capitol Hill, businessmen would rush to raise prices to get in under the wire. Further, board members argued, controls would not affect three major sources of price increases: OPEC; Federal Reserve Chairman Paul Volcker, who does so much to set interest rates; and God, who creates the weather that determines the size of harvests.

Many of TIME'S economists detect that the Administration is cutting big and small federal programs extremely sharply to hold down the budget deficit and take some heat away from rising prices. Still, Carter's aides are probably underestimating the size of the deficit. A recession would pull down tax receipts and increase federal spending on unemployment compensation, food stamps and other social programs. While the White House officially maintains that the 1980 deficit will be about $30 billion, some of TIME'S economists expect it to approach $50 billion. The problem will continue into fiscal 1981, which begins next October. Says Joseph Pechman of the Brookings Institution: "It is a very dismal budget outlook, and there is going to be a real fight. I don't think Carter can get spending much below $610 billion and, even at that, he has got to be tight on everything."

The deficit may well be swelled by a tax cut, if not in 1980 then in 1981. Congress has many ideas for reducing Social Security taxes; on Jan. 1, they will rise from $1,404 to $1,588 a year for anybody earning $25,900 or more. The Board of Economists expects that, in all, taxes will be cut by about $30 billion, including a reduction of some $10 billion for business, probably in the form of liberalized depreciation. Though such a move would increase the deficit at first, it would soon after pay dividends. By helping to sharpen the nation's efficiency, it would combat many of the problems that the U.S. economy encountered in a year of troubled change: 1979.

Climaxing a decade of disillusionment, the year 1979 tested Americans' capacity to absorb economic shock. Consumer prices doubled during the sputtering '70s, but it was in the decade's final year that the previously unthinkable became commonplace reality. The year that brought 13% inflation, 14% mortgage rates and 15 1/4% prune rates also saw $225-a-day hospital rooms, $500 off-the-rack men's suits, the 25-c- Hershey bar and the $3.50 martini. Millions of Americans had to postpone their dreams for a home of their own; the average price of a few-frills new house surged from $59,000 to $65,000. Crude oil spurted to $45 per bbl. on the spot market, and gasoline sold for up to $1.28 per gal. at the pump.

If everyone from drivers to drinkers was victimized, the Chicken Little pessimists, who had bet on bullion and other precious metals, were made to look prescient. Among the winners were people who had shrewdly put away dimes, quarters and half dollars minted before 1965; at year's end an original $1,000 in those almost pure silver coins was worth $16,300. But anybody who had put his money in a savings bank was a sucker; a $1,000 deposit declined in real value during the year to about $900, after inflation and taxes on the interest receipts.

Only a few years ago, the orthodox wisdom was that the U.S. would never suffer such hyperinflation, but that if it ever did, the whole economy would be shattered and the democratic political system would be endangered. Yet in 1979 the economy showed a remarkable resiliency and a resistance to deep recession. People learned to cope. They reduced their spending for gas-thirsty big cars and such little luxuries as hardcover books, records and tennis equipment. But they kept right on spending for other goods, particularly the high-quality and the durable, in part because they figured that almost everything would cost more tomorrow and they had better buy products that would last.

They spent even though real personal income declined. Americans fought against the shrinking of their incomes in three ways: they sent more and more spouses to work; they drew down their personal savings; and they plunged more deeply into debt. But these defenses are rapidly being exhausted. Fully 60% of all U.S. women aged 20 to 64 hold paying jobs; not many more housewives are in a position to go to work. Savings have declined since the early 1970s from 7.4% of income to a modern low of 4.3%. Consumer installment credit has surged from $210.8 billion in 1974 to $369.3 billion in the third quarter of 1979. In brief, the American consumer will soon be forced to reduce his spending, and this will be a mainspring of the recession.

People in certain fortunate industries and regions will probably avoid adversity, as they did in 1979. Those in the Southeast generally did well because the region's beneficent climate and low wage rates continued to attract business. The Southwest surged because its oil and natural gas were in heavy demand. Farmers in the Midwest grain belt and the far West prospered, largely because a hungry world increased its call for what America produces best: food. Average farm incomes increased 117% from 1970 to $23,263 per family in 1978 and are higher now. The region that fared best of all was the intermountain West because it is a trove of oil, gas, coal, shale and almost all the increasingly precious energy resources. Construction cranes climbed like church spires in Denver, Salt Lake City and other booming communities.

While they rose, older cities that depend on basic industries declined. As sales of U.S.-made autos tumbled 16.7% in the last six months, largely because of infuriating gasoline lines and inflating gasoline prices, recession and high unemployment struck Detroit, Flint and other carmaking capitals. Also hurt were the industry's supplier cities: rubbermaking Akron, glassmaking Toledo, steelmaking Youngstown. Layoffs in the auto industry mounted to 116,000 workers (out of a total 765,400), and in steel to 45,000 (out of 466,859). Unemployment also ran higher than the national average in the metropolitan areas that live off heavier industries and old lines of commerce.

Their growth prospects evaporated largely because many industries became increasingly outmoded and continued to lose their edge in global competition. America was living off its accumulated capital stock, a consequence of its people's unwillingness or inability to save and invest. While the U.S. spent scarcely 10% of its national income on new factories, mines, tools and transportation systems, its allies and competitors the West Germans and the Japanese were investing 15% and 16.2%, respectively, of their incomes in such capital goods. One result: U.S. productivity, which had risen an average 3% a year in the 1960s, declined by more than 1%. There were other reasons for this deterioration in production per hour worked. Among them: the heavy burden of Government regulations, the entry of so many untrained first-time workers into the labor force, and the decline of research and development, in part because managers have concluded that inflation makes the payoff too distant, too uncertain. Turgid productivity, which aggravated inflation and contributed to the debauch of the dollar in world markets, is as serious as any problem that the nation faces as it enters the 1980s.

In searching for solutions, Americans could no longer put their faith in those two old reliables, technology and economic theory. The failings of technology were exposed by the radioactive clouds rising from Three Mile Island, the flames spitting from the DC-10 that lost an engine over Chicago, the poisons seeping into the Love Canal. The frustrations of economic theory were revealed by the inability of the disciples of John Maynard Keynes, the British economist whose market-manipulating philosophies have dominated policymaking since the 1950s and 1960s, to deal with the stagflation realities of laggard growth, runaway prices and receding productivity in the post-industrial era.

No single intellectual rose to replace Keynes, or to refute successfully all his theories, but a number of young economists came forward with provocative new theories for the 1980s. Harvard's Martin Feldstein, Stanford's Michael Boskin, the University of Chicago's Robert Lucas, Yale's William Nordhaus, along with many others, propagated ideas that were both moderate and eclectic. They were new Jeffersonians, arguing that Government governs best when it governs least. They contended that Government should: tinker less with the economy; adopt consistent, year-after-year policies of moderate money growth; reduce Government spending and restrictive regulation; and generally give more freedom to corporate managers, aspiring entrepreneurs and innovators. The new school of thinkers were called "supplyside economists." Unlike the Keynesians, who aim to induce demand and consumption, they would promote supply and production by cutting taxes and offering other incentives to foster savings and business investment.

These rather radical theories from academe gained many converts in Government. Federal Reserve Chairman Paul Volcker gave money managers a new sense of confidence not only by severely constricting the previously excessive expansion of the money supply but also by pledging to keep that growth at steady, moderate, inflation-fighting rates for years to come. His predecessor, Treasury Secretary G. William Miller, was one of many in Washington pressing for faster tax write-offs for business capital investment in order to expand supply, enhance productivity and sharpen American efficiency. To further free up capital for investment, Senate Finance Chairman Russell Long and House Ways and Means Chairman Al Ullman were urging tax cuts for individual earners, savers and corporations.

In its first unanimous report in 20 years, the bipartisan Joint Economic Committee recommended reductions in taxes and regulations and other investment-stimulating measures. Jimmy Carter called for gradually relaxing the federal limits on the amount of interest that savings institutions can pay on deposits. Various Congressmen submitted a hopperful of bills that would exempt some savings interest and stock dividends from federal income taxes.

So while the year ended on a whimpering note, with portents of tougher months ahead, there were signs that public policies and private decisions were moving in directions that might lead to better times in years ahead. The rise of women in the work force, a product of their own expanded consciousness as well as declining discrimination and sheer economic need, promises to enhance substantially the nation's talent pool. The ma turing of employees, as the postwar baby-boom generation grows into its late 20s and 30s, will contribute to a more experienced, more productive labor force. The decline of extremism on the part of some environmentalists and regulators on one side, and economic developers on the other, should lead to productive compromises that will stimulate jobs and wealth.

Even the ceaseless climb of OPEC's prices and the crisis in Iran may be awakening the nation to the reality of its energy peril and the need to deal with it through tough measures and some sacrifice. At year's end Congress was moving at long last toward adopting an energy policy, and President Carter was weighing means to reduce the use of gasoline, perhaps by calling for odd-even-day sales or a system by which each motorist could drive his car only six days a week. Despite the very real dangers brought on by the scarcity of oil, the nation did have enough energy, if it was willing to spend the capital and make the compromises necessary to exploit coal, shale and other secondary supplies.

Thus from White House to state house and on Main Street America, the feeling was widespread that the U.S. was at a decisive time of choice. If the nation was willing to pursue policies of capital formation, Government deregulation, energy development and conservation, then the new decade that was beginning with a sigh could well wind up with a surge. qed

The members of the board: Harvard's Otto Ecktein; Consultant Alan Greenspan; Consultant David Grove; University of Minnesota's Walter Heller; Consultant Robert Nathan; Brookings Institution's Arthur Okun; Brookings' Joseph Pechman; Harris Bank's Beryl Sprinkel; Yale's Robert Triffin; American Enterprise Institute's Murray Weidenbaum. Not quite. New York City loan sharks charge at least 5% on small loans--per week. The rate on a yearlong loan totals 260% simple interest. -- At last week's prices, a metric ton of gold was worth about $15 million.

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