Economy: More Sunny Skies or Cloudy Horizon? : Contradictions Make It Hard to Get Clear Picture
John and Carolyn Colwell are primed to start their own consumer spending spree during the next year. The couple, both sound editors in the film industry, just bought a new house in Granada Hills twice the size of their previous home. Their next step will be to fill it up with furniture.
But despite having to pay twice as much on mortgage payments and facing higher utility bills, the Colwells are confident about their financial well-being and plan to complete their home decorating project within a year.
“We feel very optimistic about the future, or else we wouldn’t have bought the home,” said John, 37.
A somewhat different attitude prevails these days among employees at Cross & Trecker Corp. A leading producer of machine tools, the Bloomfield Hills, Mich., company recently announced that it would lose money for the second straight quarter. Managers are now wielding their budget knives in a $12-million annual cost-cutting effort that, among other things, will pare the payroll by 300 jobs.
“There is no way of knowing when we will see some improvements in the market,” said Richard Priebe, director of public affairs at Cross & Trecker. “It could be sometime soon. It could take a number of months. That’s a question nobody can answer.”
As these contrasting examples suggest, the U.S. economy today shows signs of both health and disease, much to the bewilderment of corporate executives, government officials and investors.
The current combination of low inflation, low energy prices and improved interest rates seems the perfect prescription for economic growth to many. Indeed, the confluence of favorable forces is one Americans have awaited for years. And consumers, such as the Colwells, have displayed their confidence with robust purchasing of homes and automobiles.
Yet contradictory signs abound. Many of the nation’s factories are creaking along far below maximum operating levels, despite a falling dollar that was supposed to help U.S. manufacturers compete with foreign producers. Corporate profits are disappointing. After a boom earlier in the recovery, business capital investment has been meager.
Bank failures are continuing with record-breaking frequency amid a virtual depression in the oil patch and the Farm Belt. The United States in May imported more farm products than it exported, the first such agricultural trade deficit in at least two decades. A startling decline in the value of certain commodities--and the real estate on which they are produced--has caused widespread financial pain.
The paradox has left many wondering whether the U.S. economy is merely pausing for a breather during its fourth year of expansion or whether harder times are on the horizon. Optimists point to several signs. The Federal Reserve Board’s decision Thursday to reduce its discount rate for member banks will provide at least some push, as banks lower some rates in tandem. Most mainstream economists also expect consumers to continue buying at a healthy pace, manufacturing output to pick up and sales of U.S. manufactured goods to improve as well.
Expect Higher Growth
In light of such favorable forces, many economists anticipate a respectable growth rate of 3.5% to 3.8% for the remainder of 1986, according to a survey conducted by Blue Chip Economic Indicators, a Sedona, Ariz., newsletter. Such a performance would be a clear improvement over the sluggish 2.9% rate for the first quarter although significantly worse than the 4.5% growth rate predicted by those same economists in May.
But the truth is that the conflicting personalities within today’s economy confound the experts, and nobody can say with assurance what’s going to happen.
“In the past, when you had big drops in price levels and interest rates, you had a boom,” noted Richard Rahn, chief economist and vice president of the U.S. Chamber of Commerce after some disappointing economic news recently. “Why didn’t it happen this time?”
The outlook is complicated further by uncertainty surrounding the tax code, with some anticipated changes already dampening investment. In addition, the possibility of further budget cuts could make the economy worse before it gets better, economists say.
On one point, however, there is broad agreement: Further economic expansion will require help--from debt-saddled consumers who must continue with major purchases and from factories that must crank out a lot more goods.
Consumer Is Key
American consumers have carried more than their share of the load throughout the recovery that began in the fourth quarter of 1982. In fact, consumer spending has accounted for as much as 85% of the gross national product for the last two years, according to A. Gary Shilling, a New York economic consultant. “If he (the consumer) throws in the towel, we’ve had it,” Shilling declared.
Shilling’s observation speaks volumes about the challenges facing U.S. manufacturers. Their industrial customers have been slow to place orders, reflecting both the success of imports and also a widespread economic listlessness. Trade barriers can make it difficult for American producers to reach consumers in other countries. Also, nations in Europe and elsewhere haven’t enjoyed as strong a recovery as that in the United States, limiting the purchasing power of their citizens.
As a result, Reagan Administration officials have been pressing the governments of Japan and West Germany to stimulate their own economies, through lower interest rates and other policies. The Federal Reserve’s discount-rate decision only intensified the pressure. The officials thus far have obliged only partially, however, for fear of either renewed inflation or bulging budget deficits.
Spending by American consumers has been vigorous, meanwhile, thanks largely to lower interest rates and lower inflation. Falling mortgage rates have spurred a housing boom reminiscent of the late 1970s, while refinancings of home mortgages and cheaper prices for gasoline have added spending money to consumers’ pockets. The rise in stock prices earlier this year also has boosted consumers’ financial assets.
Many Favorable Factors
“I don’t think I’ve ever seen such a set of favorable factors all occurring at the same time,” said Tom Swanstrom, chief economist at Sears, Roebuck & Co.
A recent nationwide survey of consumer attitudes by the University of Michigan’s Institute for Social Research showed that about three-fourths of all families held positive attitudes toward home buying, the highest figure since the survey was initiated 40 years ago. “As long as this (consumer confidence) continues, we won’t see a consumer-induced recession,” predicted Bank of America economist Daniel Van Dyke.
Tom Gorman, 43, a mechanical designer from Castro Valley, Calif., is typical. “If it makes sense to buy, I won’t hesitate to buy it,” he declared. “I don’t see any problems with the economy for the next two years at least.”
His enthusiasm is not shared by all. Many experts doubt whether consumers will be able to maintain the pace of past spending increases because their incomes aren’t growing as rapidly. Wages are being held back by continued weakness in manufacturing that has kept the unemployment rate high, in the 7% range. And while jobs in the service sector have increased, they tend to pay significantly less than the manufacturing jobs that they are replacing.
Meanwhile, high consumer debt levels and a 4.4% national savings rate--the lowest in more than a decade--also will restrain spending in the coming months.
“It seems like people are spending a lot of money but saving a lot less,” said a 30-year-old Los Angeles investment banker. “I think that’s a bad sign. It shows that there’s consumer confidence, but people are spending more than their incomes can support.”
Some economists also believe that consumers have satisfied much of their demand for cars, furniture, appliances and other major goods because of their widespread buying earlier in the recovery.
‘A Leaner Summer’
“It’s going to be a leaner summer,” said William Wong, 35, a health-care compensation analyst who recently bought $5,000 worth of new furniture and other household goods after moving to a larger apartment. Wong, who got a smaller pay raise than he expected this year, has canceled a trip to Expo ’86 in Vancouver, eats out less these days and is shopping more carefully for bargains.
Such behavior could spell trouble for the nation’s retailers. “The consumers--who really sponsored and led this recovery--no longer have room to fuel continued expansion like they did in the past,” said Philip M. Hawley, chairman and chief executive of Carter Hawley Hale Stores Inc., which owns the Broadway chain in Southern California. “I really don’t see the underpinnings for any great vigor in this economy,” he added.
A rekindling of inflation, of course, could put a big damper on consumer spending. Some experts worry that the money supply has been expanding at an extraordinary rate, although the growth has yet to be reflected in higher prices. Many economists expect modest price increases in the remainder of 1986 as imported goods become more expensive in response to changes in the value of the dollar. However, if the increases are in the single-digit range, as most economists expect, the negative effects won’t be severe.
Further good news on prices also is a possibility. Although many observers had believed that oil prices bottomed out in late spring, recent evidence is to the contrary. Some grades of oil priced at $31 last November have nose-dived to the $10 range in recent days, and the Organization of Petroleum Exporting Countries remains unable to curb output.
Mixed Indicators
In contrast to the vigorous spending of consumers, the gauges of manufacturing activity are decidedly mixed--and a vital manufacturing sector is seen as critical for any substantial economic upturn.
The auto industry is having a healthy if unspectacular year with the help of incentive campaigns to lure consumers. Similarly, housing construction in California, the Northeast and some other regions has been encouragingly strong. But consumer spending has yet to ignite an overall boom in manufacturing, largely because many of those dollars have been used to buy imports. Moreover, the economy has been weakened by a litany of troubles facing major industries and the businesses that supply them.
Low farm prices hurt not only farmers but banks that have lent them money and manufacturers that sell them machinery. The deflation in commodity prices is an international problem that has cut sales of U.S. equipment to Latin America and other regions.
Indeed, some observers look at the troubles affecting commodity-related businesses as the painful process of wringing the lingering inflation out of the economy--with long-term consequences for businesses based on “hard commodities” that soared in value during the 1970s. “What’s going on now is not a business cycle--it’s a change in the structure of the country,” asserted John Rutledge, chairman of the Claremont Economics Institute.
A frenzy of commercial construction earlier in the recovery also has now stalled amid the sobering reality of vacant office space in many cities. “Even if interest rates fall to 1%, I don’t think anybody’s going to add to the stock of already mothballed office buildings,” said Sandra Shaber, an economist with Chase Econometrics.
Even the computer industry, frequently touted as essential to America’s future prosperity, isn’t immune to the economic doldrums, as many U.S. customers hold back on orders in reflection of the uncertain economic climate.
Little Help From Dollar
Sooner or later, the cheaper dollar is expected to make U.S. goods more competitive in price with those from foreign countries. So far, though, the dollar’s 35% decline against a basket of foreign currencies since February, 1985, hasn’t netted a dramatic increase in demand for American-made products. Less-developed countries, of course, can manufacture products with sharply lower labor costs than those in the United States, thus keeping their prices competitive.
Most analysts, however, cite a principal reason why the cheaper dollar hasn’t brought more rewards: Many foreign manufacturers established fat profit margins when the dollar was stronger and have been able to afford to limit their price increases now that it has fallen. The result of such behavior is that many foreign manufacturers so far have protected their shares of the market from U.S. competition.
As a consequence, the trade deficit remains stuck at a record annual level of $170 billion, or 25% above last year. And the dollar hasn’t dropped at all relative to currencies from Taiwan, South Korea, Latin America and elsewhere that represent 40% of the U.S. trade, according to the National Assn. of Manufacturers.
“We have an unbalanced recovery and an unbalanced fall of the dollar,” complained Stephen Cooney, director of international investment and finance at the manufacturers association.
Consider the plight of such industries as steel and machine tools, which until recently symbolized the industrial muscle of the United States. Imports from Japan, South Korea, Europe and a host of less-developed nations have captured 23% of the steel market. Foreign competitors, notably Japanese, dominate 40% of the domestic machine-tool business by some estimates. In the case of both industries, U.S. customers--facing their own problems--are placing orders at disappointing rates.
Need Investment First
“The steel industry’s customers are not out there investing money in new and improved factories and production facilities,” lamented a spokesman for the Iron and Steel Institute. “And until they do, that is 65% to 70% of the steel industry that will be stagnant.”
Proponents of the softer dollar counsel patience, contending that it may take up to two years after the introduction of such a policy before its full benefits are realized in the form of increased U.S. sales. And they note some positive evidence already. In the first four months of this year, for example, imports of foreign wines dropped by 15% from the same period in 1985, according to the Wine Institute, a San Francisco-based trade association.
Yet others argue that the U.S. trade problems run deeper than the value of the dollar. By this view, American entrepreneurs suffer from the attitude that they don’t need to accommodate the rest of the world--a self-defeating approach in light of aggressive new competition from many countries. To cite an example, Charles H. Nevil, president of Meridian Group, a Los Angeles-based export management firm, points out that U.S. manufacturers typically fail to include foreign-language instructions in their export products. “The hard dollar was not the cancer and the soft dollar is not the cure,” he maintains.
Various other problems plague U.S. manufacturing. Although the deflation of oil prices was heralded as an economic boon--and it has helped consumers--many of the results have been negative. For example, more than 110,000 jobs have been lost in oil and gas extraction since January alone, according to the Bureau of Labor Statistics.
Trauma Has Spread
The drop in oil prices also has dealt a savage blow to companies that relied on the energy industry. To name just one industry, more than 13,000 jobs have been lost in the manufacturing of oil field machinery this year, Bureau of Labor Statistics figures show. And the trauma has spread. Lone Star Steel, a Dallas-based manufacturer of steel tubing for the oil industry, is operating its mills at an anemic 15% of capacity these days, which “might even be a high number,” said Judy Murrell, director of investor relations for Lone Star Technologies, the parent firm. Consequently, Lone Star recently slashed its payroll to 1,300 employees from 4,500.
Ironically, the negative kick to the economy in the 1970s--when oil prices skyrocketed--hasn’t been answered by an equally positive kick as prices have plummeted. The important though little-appreciated reason: Private industry isn’t as dependent on energy as it used to be. Examples range from lighter automobiles to commercial airline engines that guzzle less gas to changes in steelmaking technology.
“Energy is less important now than it was 10 or 15 years ago in terms of economic growth,” observed Thomas McHale, senior economist with Drexel Burnham Lambert Inc., a New York-based investment firm.
Reacting to less-than-hoped-for demand, IBM Chairman John F. Akers said in June that the computer giant would have trouble showing any earnings growth this year unless the national economy exhibited new signs of vitality. At the same time, Hewlett-Packard, another major high-tech company, announced a program of retirement and severance incentives intended to cut 1,500 jobs.
Expansion Plans on Hold
Hewlett-Packard spokesman Roy Verley could have been speaking for many companies when he explained why his firm’s expansion plans were on hold: “If you’re (already built) over capacity, there’s no way in the world that you’re going to build new plants.”
From the perspective of U.S. manufacturers, a key boost would be provided by further decreases in interest rates. Some major banks have already cut their prime lending rate for corporate customers by half a percentage point in response to the discount-rate reduction. Yet by historical standards the prime remains high relative to inflation, and some analysts argue that further rate cuts are required to help such beleaguered industries as energy and agriculture.
“We need to close the gap between inflation and interest rates,” said Jerry Henry, vice president for corporate plans of Du Pont Co.
Many also contend that the passage of tax reform would clear up uncertainties that have inhibited business investment. Du Pont, for example, estimates that the legislation’s provisions, including removal of the investment tax credit, could cost the company between $60 million and $70 million a year in the short run, with the long-term outcome uncertain.
By contrast, tax changes will save consumers 6% by some estimates, a development that could help drive the economy through the 1980s, according to Allen Sinai, chief economist at Shearson Lehman Bros.
Despite the assortment of good and bad news, many insist that the economy can’t help but improve in the coming months, if undramatically, in light of the exceptional combination of low inflation, low energy prices and improved interest rates.
“The puzzle is trying to figure out when--not if--these factors are going to come together to really get the economy going,” maintained Kathleen Cooper, senior vice president and chief economist at Security Pacific National Bank.
