Economic Recovery Nears, but How Long Will It Last?

The speed and manner in which the American forces and their coalition allies won the Persian Gulf War has produced a significant change in the mood of individuals and business people across the United States.

The difference is palpable. It is reflected in the joyous homecoming celebrations, the parades and in the ubiquitous American flags and yellow ribbons tied around trees, automobile antennas--and even lighthouses.

These express feelings Americans have about themselves and their country that haven’t been seen since the end of the Second World War.

You can see it in the various surveys of the public’s mood. The Conference Board says that in February--even while the war continued--confidence posted its sharpest monthly rise in three years. And March saw an even bigger jump, after the war’s end.

The business mood has brightened too. Dun & Bradstreet’s industrial sentiment index rose sharply in February, with expectations for the months ahead at their highest since last summer.

Does this mean that America’s ninth postwar recession is over? Not quite. The war did not by itself cause the U.S. economy to turn down; other factors played a part--and they are still present.

There is no doubt that Iraq’s invasion of Kuwait last August did exacerbate the downward tendencies that were in evidence last summer, so the end of the war should provide at least some lift. When added to a number of other positive developments, it should lead to an end to this recession within a few months.

One reason for expecting economic activity to pick up soon is the state of business inventories. Usually they continue to rise after a recession has begun, as producers learn too late that sales have dropped. By the time production rates are trimmed below the pace of shipments, months have passed.

This time, business stepped on the brakes so quickly that inventories fell in the fourth quarter, even though sales were still rising. And shelves were half empty to begin with, thanks to widespread caution, use of computers and “just-in-time” inventory control.

The dollar’s value is another plus. Although it has increased from its recent lows, it is still generally regarded as undervalued against the currencies of Western Europe. This alone has boosted exports, leading to our first trade surplus with these nations since 1982. The rebuilding of Kuwait will further boost exports, especially of construction machinery and equipment, autos, communication facilities and so on.

Domestically, the war has already affected defense spending. Instead of declining, as it was programmed to do after the relaxation of tensions between the United States and the Soviet Union, defense spending has kept rising. This uptrend is likely to continue for a while--if only because the war has reminded policy-makers of the need to maintain a strong defense.

In the financial markets, stocks and bonds have rallied in recent months, adding significantly to household wealth. Such a rise has never failed to signal the onset of an economic recovery within a few months.

Other signs, taken together, point to an earlier, rather than later, end to the recession:

* Industrial raw materials prices stopped falling in March and have since moved higher.

* The purchasing managers’ index of industrial activity went up in February and March--its first two-month rise in almost a year.

* Department store sales have risen 2% in the past three months, after a fall of 0.2% in the prior three months, while new car sales have stabilized so far this year.

* Fixed-rate mortgages are at a four-year low. Combined with a drop in housing prices, it means that the average family is closer to affording a home than at any time in the past decade.

* Sales of new and existing homes rose in February, as did housing starts and building permits.

* The money supply has begun to rise, reflecting increased lending activity by the banking system, on the heels of an easing by the Federal Reserve.

* The federal budget deficit is rising, giving the economy a push.

Considering these factors, it is not difficult to envision the recession ending within a few months.

However, maintaining the expected recovery may turn out to be harder than extricating the economy from recession. This is because, as noted earlier, many factors that gave rise to this recession are still around.

They include the Tax Reform Act of 1986; the higher capital gains tax; consumer tax burdens, which have been increased; tightened regulatory standards; high debt loads, and commercial and residential overbuilding.

If these were not enough, government borrowing may put upward pressure on longer-term interest rates. Besides Washington, the governments of Kuwait, Saudi Arabia, Germany and Japan will be--or are--tapping the markets.

At some point this could discourage long-term borrowing by the private sector and even put the kibosh on rising equities’ prices. In this environment, one has to hope that the Fed will not reverse course and tighten up at the first sign of economic growth, believing that it means renewed inflation.