50-50 Chance of Recession in ‘87, Chapman Study Says

Although the growth of Orange County’s economy is expected to outstrip the nation’s during 1986, the prosperity may yield to a new economic slowdown in 1987.

According to Chapman College’s 1986 economic forecast, Orange County can look forward to a resurgence in the construction industry, increased growth in new jobs, continued increases in personal income and a narrowing of the gap between local residents’ ability to purchase homes and the national average.

Tempering the relatively strong outlook for next year are predictions of a still-bloated federal budget deficit, a growing potential for recession in 1987 and lower gains locally in new employment within the county’s manufacturing sector.

Still, according to projections just released by Chapman’s Center for Economic Research, Orange County will outperform the nation as a whole next year in terms of its gross product, or the value of all goods and services produced locally.

‘Unusual Breakdown’

While the gross national product is expected to grow by 7.1% during 1986, James Doti, dean of the Chapman College School of Business and Management and the author of the school’s annual forecast, said the local equivalent of the GNP would increase by 8.1%.

Doti also said he suspects that an “unusual breakdown” in the relationship between the money supply and spending may be occurring. Usually, the movement of money out of long-term investments and into cash and checking accounts is followed by a spurt in economic growth as individuals and businesses begin spending the money, he said.

But Doti said he believes that because the basic measure of the money supply, known as M1, now includes some interest-bearing checking accounts, people are using it for savings when interest rates for long-term savings accounts drop, as they did last year. The result, he said, is that the traditional spending spurt may not occur in 1986.

Recession in 1987

In addition, he said, he believes that the rates for interest-bearing checking accounts will drop in 1986, increasing the incentive to move large blocks of money back into longer-term savings accounts.

Doti said there is little likelihood of a recession occurring next year, but is predicting a “50-50 chance” of a national recession in 1987 because of his perception that the liquid money supply will shrink and spending will taper off toward the end of 1986.

Several other recently released economic forecasts also have raised the specter of a recession beginning late next year or in 1987.

Doti, who received his doctorate in economics from the University of Chicago, adheres to the monetarist economic

which holds that changes in the money supply--rather than government policies--are the primary factors affecting the economy.

Chapman’s Orange County economic forecast is based largely on assumptions of what will happen nationally in 1986, and those assumptions are rooted in Doti’s monetarist approach. The Chapman forecast’s accuracy in recent years has been helped by the Federal Reserve Board’s 1979 decision, in effect, to follow a modified monetarist approach as it attempts to maintain a steady, long-term growth in the money supply.

The key elements of Chapman’s 1986 forecast, for Orange County and the nation, include:

Employment

Local employment levels should increase 5.7% for the year, the highest annual increase since 1984.

For the sixth year in a row, service-related jobs are expected to post the greatest growth rates, posting an overall gain of 6.4% for the year, contrasted with a gain of only 3.3% in the manufacturing and other goods-producing sectors.

The slow rate of employment growth in the manufacturing sector locally, Doti said, can be attributed to a sluggish aerospace industry, which is suffering from the effects of low levels of investment, weak overseas markets and heightened foreign competition.

Still, the situation for Orange County’s aerospace industry could be worse. High levels of defense spending have helped offset losses in commercial sales. And by late 1986, Doti said, local aerospace firms should see some improvement in non-military exports.

“We think that you’re going to see some increases toward the end of 1986,” Doti said. “At that time you’ll see some of the impact of the lower value of the dollar.”

Personal Finance

The Chapman report projected a rise in personal income in Orange County of 7.9% during 1986, to $39.5 billion from $36.6 billion, significantly higher than the statewide 7.5% hike in personal income predicted by economists for the Bank of America.

Orange County’s taxable retail sales dropped in 1984 but recovered somewhat in 1985, and the Chapman forecast predicted that taxable sales during 1986 will total $23.5 billion, an annual gain of 13.1% compared to a 12.1% hike in 1985.

Although many economists express alarm over the rise in consumer debt, the Chapman report suggested that solid growth in taxable sales should continue throughout 1986, largely because personal income is expected to stay high and many consumers are expected to retain their access to credit by paying off their charge-card balances at the end of each month.

For Orange County’s first-time home buyers, 1986 could be a good year, as hikes in personal income, coupled with continued low interest rates and lower housing-appreciation rates, are expected to make owning one’s own home a reality.

Housing appreciation rates have dipped substantially since 1980, and the 2.1% nominal increase in housing appreciation rates in 1985 translates, when adjusted for inflation, into no gain at all. The 1986 estimate of a 5.1% nominal gain is equivalent to a real increase of only 1%, the Chapman report said.

As a result, housing in Orange County will approach the 100% affordable mark during 1986, which, Doti said, means that a family with the median income of $40,000 “will be able to qualify to buy the average home.”

Chapman’s forecast also predicted that total bank deposits in the county will increase 17.9% during the year, to $17.4 billion from $14.8 billion. Of that total, 37% or $6.5 billion, is expected to remain in liquid demand deposits, up slightly from 36%--or $5.4 billion--of total 1985 bank deposits.

Construction

The increased personal income, growth in personal bank deposits and continued low interest rates in the county are expected to boost the building permit valuation rate by 12.5% during 1986, the Chapman report predicted. The projected record-high of $3 billion in total valuation for 1986 will be divided almost evenly between residential and commercial properties, Doti said.

Slight increases in the prime interest rate during 1986 may have some negative effect on building permits, he said, but long-term interest rates should stay low and residential and commercial construction activity should be strong during 1986.

And although the vacancy rate for office space in 1985 is running at 16%, “recent increases in the absorption rate suggest continuing growth in demand for existing office space,” he said.

Tourism

Local tourism in 1986 is expected to decline from this year’s highs, partly as a result of decreases in the rate of growth in the real money supply. A tourism index, one new feature of the 1986 Chapman report, suggests that declines in hotel vacancy rates during the last half of 1985 will be followed by fewer marketing promotions and rate discounts in the hospitality industry next year. The tourism index is based on movement at local theme parks, lodging establishments and eateries.

Small Business

Another new section of Chapman’s projections is a survey of small businesses which says that almost all the 200 small business owners who responded to Chapman’s poll are optimistic that economic growth will continue through the first six months of 1986. A full 93% of the respondents said they expect business conditions over the next six months to either remain the same or get better.

According to survey results, Orange County’s small business owners said poor sales were their biggest worries. The Chapman study says that on a nationwide basis, most entrepreneurs blamed uncertainties about upcoming changes in tax laws for keeping them awake at night. The Orange County businessmen also said the cost and quality of labor is a concern, and most said inflation and interest rates were less of a threat than in the past.

The Nation

Nationally, the Chapman report says the modest growth of the GNP predicted for the coming year will cause the inflation rate to increase a full percentage point, going from the 3.8% estimated for this quarter to 4.8% at the end of 1986.

Over the first half of 1986, the forecast says, the prime interest rate will dip to a low of 9.1% by the end of the second quarter but will rise throughout the last half of the year to close at an average of 9.6%, up slightly from an average of 9.4% projected for the last quarter of 1985.

In fairly close agreement with Chapman’s national forecast is Eggert Economic Enterprises, the Sedona, Ariz., publisher of the monthly Blue Chip Forecast, a consensus report based on input from 50 economists around the country.

In its latest forecast, Eggert said the GNP should advance 3.1% in 1986 but warned that a significant slowdown could occur in early 1987. Only six of Eggert’s panel of 50 economists expect a recession to begin next year, but publisher and economist Robert Eggert said his long-range forecast warns that businesses should enter 1987 “with caution.”

The Blue Chip Forecast is more optimistic than Chapman on inflation, predicting a 3.7% annual hike in the Consumer Price Index next year, contrasted with the annualized rate of about 4.3% projected in Chapman’s computer model. The Bank of America’s California forecast calls for a 5% inflation rate for the state while Security Pacific comes closest to Chapman’s forecast with a prediction of a 4% national inflation rate next year.

Both Chapman and Eggert’s panels see interest rates remaining generally flat during the year and Security Pacific said it expects interest rates to rise only slightly because of low expected inflation and stronger economic activity.

Two of the most serious economic imbalances facing Americans today--the trade deficit and the federal budget deficit--will remain virtually unchanged during 1986, but probably will show some improvement during 1987, the Chapman report predicts. Eggert said he and his panel are generally in agreement with the Chapman prediction but expect some early signs of improvement to begin showing in the fourth quarter of 1986.

Source: Chapman College, Center for Economic Research