Times Board of Economists : Huge Risks Seen in ’86 Amid Prospects of Modest Growth

The Times is expanding its Board of Economists, offering a broader range of opinions. The three new members are Irwin L. Kellner, chief economist at Manufacturers Hanover in New York; David Gordon, professor of economics at the New School for Social Research in New York, and Michael J. Boskin, professor of economics at Stanford University.

Like most economists, Don R. Conlan is worried about the farm crisis, record consumer debt and loans to the Third World--any one of which could throw the economy into a tailspin. So when Conlan, president of Los Angeles-based Capital Strategy Research Inc. and a member of The Times’ Board of Economists, offers his forecast for 1986, he tries to cover all possible outcomes.

“Things are either going to be a lot better--or a lot worse,” Conlan says. But, he adds, “There’s a 10% chance I don’t know what the hell I’m talking about.”

Conlan’s hedged outlook is not unusual these days. Interviews with Conlan and the seven other members of The Times’ Board of Economists show that most agree that the economy will continue to grow next year at a modest pace with little chance for a recession until 1987 at the earliest.

Most predict an annual growth rate in the gross national product of between 2.5% and 3.5% next year, compared to an expected 2.4% growth rate this year. The economy, most say, will become more robust in the second half of next year, aided in part by the falling dollar and by lower interest rates, which could drop by as much as one percentage point from current levels.

The panelists also say inflation will remain low, although it could increase to as high as 4.5% from the 3.2% expected for this year. Slight gains will be made in reducing unemployment from the current 7% level, the panelists say, but the level still will remain high by historical standards in a recovery.

Nevertheless, while generally optimistic, many of the economists say the chances of a major economic crisis have grown over the last year.

“There are more risks on the downside than (opportunities) on the upside,” says Lawrence R. Klein, a Nobel-laureate economist at the University of Pennsylvania’s Wharton School. “The world and domestic economy have a high degree of vulnerability.”

“The potential for disaster is very great,” says Robert Lekachman, a professor of economics at the City University of New York who puts the chances of a major crisis as high as 50%. “Avoidance of it depends on a certain amount of good luck and good management by the Federal Reserve and Treasury.”

However different their individual views, the economists agree on the sources of potential trouble:

- High levels of corporate debt. The massive amounts of corporate borrowing to finance leveraged buy-outs, mergers and anti-takeover defenses is a time bomb waiting to explode in the next recession, the panelists fear.

Corporations’ ability to service these loans “assumes a pattern of continued economic growth and inflation,” Conlan says. “But deflation and a fall in economic activity could render these (loans) uneconomic, to put it mildly.”

- Third World debt. While such debtor nations as Brazil and Argentina have recovered somewhat, the chances of a major default by one or more remains high, economists fear.

“To the degree there is a U.S. slowdown or recession, the problem will come right back,” says David Gordon, professor of economics at the New School for Social Research in New York. “It’s not been resolved by recent International Monetary Fund and World Bank austerity programs.”

- Record levels of consumer debt. Like Third World borrowers, consumers can service their credit-card debts and other borrowings “as long as they have good incomes,” Klein says. But a recession would depress incomes “and then consumers will have trouble servicing the debt.”

- The farm-debt crisis. So far the high level of farm foreclosures and bankruptcies have primarily hurt smaller farm-oriented banks in the Midwest. But continuing defaults on farm loans could mushroom and affect other segments of the economy, Lekachman says.

- Falling oil prices. A modest decline from the current price of about $27.50 per barrel could stimulate the economies of major oil importers such as the United States and Japan.

But a larger fall to $20 per barrel or lower would severely hurt such oil exporters as Mexico and Venezuela, raising the possibility that they might default on their loans to Western banks, says Irwin L. Kellner, chief economist at Manufacturers Hanover in New York.

A precipitous collapse in oil prices also would trigger more headaches for banks burdened by domestic energy loans, the economists fear.

The economists are worried that the occurrence of any of these troubles could trigger a series of failures in the already weakened U.S. banking system and erode confidence in the nation’s financial system.

That, in turn, could prompt foreigners to pull money out of the United States and force regulators to undertake massive bail-outs similar to the 1984 rescue of Continental Illinois Corp.

They also are concerned that the occurrence of any of these problems could make a recession far worse than it otherwise would be.

“I can’t see how it would stay a conventional recession too long--there are too many eggshells,” says Conlan, contending that a recession would quickly mushroom into a “severe recession.” Such a recession, he fears, could be a coup de grace for steel and other industries severely weakened by import competition and other woes.

But the economists say that a recurrence of a 1930s-style Depression is remote. “The only thing that could cause a huge downturn is a sequence of bad events--banking failures, outright defaults by debtor nations, loss of confidence in financial markets, protectionism--snowballing all at once,” says Stanford University economist Michael J. Boskin. Such a combination, he contends, is highly unlikely.

The economists also express a high degree of confidence in the government’s ability to avert a major disaster. Government policy-makers, they say, understand the economy much better than their predecessors in the 1920s and ‘30s, when ill-conceived government policies helped bring about the Depression.

But the economy still could easily lurch into a recession, many of the economists say. Based solely on historical trends--previous post-war recoveries lasted only an average of three to four years--a recession would be due next year, they note. The current recovery began in the fourth quarter of 1982.

‘We May Be in Recession’

New York-based economic consultant A. Gary Shilling, concerned that the high level of debt is making consumers and businesses more cautious, contends that “we may be in a recession already” or that one will start as early as the first half of next year.

He also is concerned about interest rates, which although declining over the last year, are still relatively high by historic standards when adjusted for inflation.

Boskin also is worried that a recession may be triggered by the combination of tax reform and the Gramm-Rudman deficit-reduction bill recently signed by President Reagan.

By eliminating the investment tax credit and making depreciation write-offs less generous, the tax-reform bill passed by the House this month--if it becomes law--would discourage investment spending so much as to start as recession, Boskin contends. Gramm-Rudman, by forcing cutbacks in government spending, would further depress the economy, he argues.

Most of the economists agree that growth will remain sluggish at least through the first half of 1986, thanks in part to weak consumer spending and slow business capital investment.

“It’s going to be a mediocre performance,” Klein says, predicting an overall annual growth rate in the gross national product of 3% next year. Other forecasts from the panelists range from Boskin and Kellner at 3.5% to Shilling at 2%.

Jobless Rate ‘Disgraceful’

The economy is not robust enough to generate enough new jobs to significantly cut the unemployment rate, Lekachman contends, calling the current rate of about 7% “disgraceful.”

But George L. Perry, senior fellow at the Brookings Institution research organization in Washington, argues that “by late next year, the pace of the expansion will be quickening.”

He says the weakening dollar will help improve corporate profits, lower bond rates will improve business borrowing capabilities and the strong stock market will reduce the cost of equity financing for corporations.

Perry also sees the economy benefiting from budget-cutting pressures in Congress. The negative impact on the economy by a decline in government spendingwould be more than offset by the positive impact of lower interest rates resulting from reduced government borrowing to finance the deficit, he contends.

As a result of these and other factors, Perry says he does not see a recession coming in 1987. Klein, even more optimistic, says he doesn’t anticipate a recession until 1990.

Kellner, another optimist, contends that the falling dollar--which has dropped considerably since February--will finally begin to contribute to boosting U.S. exports next year. “The trade deficit will cease to be a drag on the economy and in 1986 will actually help economic activity by shrinking,” Kellner says.

Trade Deficit Outlook

On the other hand, Shilling doesn’t see much improvement in the U.S. trade deficit, despite the declining value of the dollar, which has made U.S. exports cheaper.

He points out that foreigners still view the United States as the world’s economic locomotive and thus place special importance on selling their products in this country.

He also contends that foreign firms in recent years did not cut prices of exports to the United States as much as they could have to compensate for the rise in the dollar.

Consequently, he argues, they won’t have to raise prices as much now to compensate for the falling dollar, which will keep their products competitive with U.S. goods.

Domestically, Kellner notes that the easy credit policies of the Federal Reserve in 1985 have led to the fastest rate of monetary growth in any post-war year. That, he contends, will soon translate into faster economic growth.

In addition, Kellner argues, the current recovery has seen the biggest sell-off of business inventories of any non-recession period since World War II. Consequently, he argues, businesses will be building inventories next year, adding further to economic growth.

Most of the Times’ panel also agrees that inflation will continue to be subdued in 1986, the result, in part, of falling oil prices and moderation in wage increases. Perry, for example, says he expects inflation to be about 4% to 4.5% next year.

Fall in Interest Rates

Continued low inflation in turn will discourage the Fed from tightening the money supply and possibly precipitating a recession, the panelists agree. Consequently, they agree that interest rates are likely to fall further from current levels.

Klein, for one, predicts that short-term Treasury bill rates could fall to as low as 6% from the current level of about 7%.

Some of the economists, however, are concerned about the plight of lower-income Americans, noting that the gap between rich and poor has widened in recent years.

Gordon, the most liberal of the Times’ economists, says that even with the current recovery, most Americans have become worse off.

After adjusting for inflation, he argues, the wages of 70% of Americans have been declining. With the push for wage concessions and cutting of government spending on social programs, the prospects for these Americans are worsening, he contends.

“The bulk of people have not been doing very well for awhile, and I can’t see any signs of encouragement or optimism for them,” Gordon says, adding that “it’s not much fun to be not rich in this country.”