1970: The Year of the Hangover

IN business, 1970 was the year of the hangover. The nation suffered the painful consequences of the economic overindulgence that began in 1965 when Lyndon Johnson expanded both welfare programs and the war in Viet Nam without benefit of a tax increase. That policy resulted in one of the longest, most severe inflations in American history: five years of accelerating price increases. In the so-far unsuccessful struggle to contain that inflation, the U.S. in 1970 stumbled into a recession that Richard Nixon had promised to avoid.

It was the fifth recession since World War II--and the mildest--but it interrupted the greatest advance of prosperity that the nation had ever known. The shock of unexpected reverses left deep psychological scars on businessmen, workers, shareholders and politicians. Almost every segment of the population felt aggrieved. Reflecting the uncommon discontent, Brooks McCormick, president of International Harvester Co., said: "The nicest thing about 1970 is that it's over."

Most statistical indexes slumped. Falling in every month but two, industrial production sank 5.3%. Almost one-quarter of the nation's industrial capacity lay idle, creating a large gap between the actual and the potential growth of the economy, if its resources of manpower and plant had been fully utilized.* Retail sales foundered, and corporate profit margins retreated to their lowest level in twelve years. The nation's real output of goods and services declined about .2%. That happened because the 5.3% price inflation more than offset the 5.1% growth of gross national product.

Last week--much later than had been previously expected--the sheer momentum of the mighty but misfiring U.S. economic machine lifted the annual rate of G.N.P. over the $1 trillion-a-year mark. Despite the tarnish that inflation placed on that achievement, President Nixon appeared for ceremonies at the Commerce Department's new gross national product clock--a brightly lit and buzzing electronic gadget that ticks off the nation's estimated economic growth at the rate of $2,000 a second. Said Nixon: "We hope to keep it moving, and perhaps move it faster in the years ahead."

Spasm of Cost Cutting. When 1970 began, few corporate chiefs foresaw a slowdown as great as the one that occurred. They reacted with a spasm of cost cutting, which Federal Reserve Chairman Arthur Burns calls "more widespread and more intense" than at any time since World War II. Unprofitable products were dropped, inefficient factories closed, research projects curtailed, advertising budgets pruned. It was the year of the layoff. Labor hoarding gave way to payroll paring at every level. Liaison men, coordinators and other functionaries with fuzzily defined duties proved to be particularly vulnerable. Layers of superfluous executives, built up over the euphoric years, were fired or pushed into early retirement. As part of one hold-down, the assistant controller of a Pittsburgh steel company daringly recommended that his job be consolidated with that of his boss. It was --but the assistant got the ax. Adding irony to his agony, he was then asked by the controller for a final evaluation of the staff. "Well," he replied, "I'll start by telling you that you're the worst boss I've ever had."

Unemployment rose from 3.9% in January to 5.8% in November, the highest in seven years, and 4,600,000 people were out of work. Surprisingly, job lessness among blacks increased at a rate well below its historic pattern in business slumps. For many years, the black unemployment rate has been twice or more the white rate; this year the ratio shrank to 1.73 to 1. Reasons: there has been some decline in discrimination, blacks have built up seniority by now, and they have many jobs in service trades, in which layoffs have not been as severe. Joblessness among professional and technical workers doubled, as did the number of persons unemployed for 15 weeks or more, a figure that is considered a crucial measure of real hardship. Early this month some 1,300 Los Angelenos turned out to take examinations in the hope of qualifying for 112 city jobs as unskilled laborers at $540 a month.

Who Needs Hollywood? The Government's reduction in war spending accounted for much of the new unemployment. Labor Secretary James D. Hodgson points out that at least one-third of the rise in joblessness during the past 18 months came from defense cutbacks: net reductions of 500,000 servicemen, 130,000 Defense Department civilian employees and 1,500,000 defense workers. Stubborn pockets of high unemployment in Seattle (10.9%), Wichita, Kans. (9.3%), and Bridgeport, Conn. (7.1%) bear witness to the disrupted careers of Americans who once got high pay in high-technology industries. Some have moved to Europe or Mexico in search of work. Boston Engineer Arnold Limberg once earned $20,000 a year preparing secret reports on moon-landing test procedures. After his firing, he turned in desperation to odd jobs. Limberg charges $5 an hour for yard work, $6 for painting and $7 for roofing or carpentry. "You name it, I'll do it," says he. "In a good week, I sometimes earn $200."

A wide variety of industries fell into serious trouble in 1970. Moviemakers struggled unsuccessfully to overcome the handicap of lower labor costs and government subsidies that have lured American producers overseas. About half of the films shown in the U.S. this year were foreign-made. Short of cash, many studios sold off valuable real estate, chopped production and consolidated offices. About 80% of the members of the Screen Actors Guild had no work. Quipped Bob Hope: "The only actor still working in California is Ronnie Reagan."

Among other depressed industries, airlines had their worst year ever because of soaring operating costs, meager traffic growth and huge outlays for jumbo jets. A sensitive indicator of the U.S. economy, airline traffic goes into a dive whenever business in general weakens. This year companies reduced business travel, presidents moved back to the tourist-class cabin, and families postponed faraway vacation trips. The nation's twelve major airlines expect to lose as much as $125 million before taxes in 1970; Trans World Airlines alone will show a deficit of up to $65 million. The industry predicts even bigger losses in 1971 and 1972, although it has made stringent economies. The number of flights has been reduced, and United even saved $250.000 a year by eliminating macadamia nuts on most runs (passengers get peanuts instead).*

Highway Robbery. For automakers, 1970 was the toughest year in at least a decade. Buyers spurned big models in favor of less profitable compacts, minicars and fast-increasing imports (now 15% of the U.S. domestic market). Restive dealers grumbled over what they considered to be excessive factory control, reductions in their price markups, and the "dumping" of unwanted cars on their sales lots. Discontented customers demanded more reliability and easier repair--at a time when management found it increasingly hard to maintain quality output in their plants, in great part because of worker unrest. The eight-week strike against General Motors made a weak year even worse. In 1970 the U.S. is expected to produce 6,550,000 cars, down from 8,219,000 last year.

There were many other causes of business distress. While consumer demand for goods and services softened, U.S. labor's demands for more wages and fringes hardened. The nation lost more working time through strikes--60 million man-days--than in any year in the past decade. Major union contracts negotiated in the first nine months of 1970 called for annual increases averaging 10%. In a modern form of highway robbery, the militant Teamsters imposed a 15% increase, thus setting a target for the rest of organized labor. To head off what could have been a nation-paralyzing strike, Congress voted to give a boost of 13 1/2% to some 350,000 railway workers. Wage-push inflation got its strongest nudge in construction; union craftsmen wrung out raises averaging 17 1/2%. As a result, many skilled workers will be earning about $20,000 a year by 1972. Building pay is so lofty partly because many of the 18 craft unions have for years resisted opening their ranks to newcomers.

On top of the economic problems, social and racial tensions aggravated businessmen's distress in 1970. Shoplifting has tripled since 1959. The trend alarms many merchants, who point out that pilferage now costs them--and their customers--2 1/2-c- out of every dollar of sales. Insurance executives, defending themselves against the public outcry over mass cancellations of burglary and fire policies, argue that private companies can hardly be expected to absorb the cost of crime and urban violence.

Change in Psychology. Most of 1970's economic headaches, however, were caused by the deliberate action of Government. In its belated battle to control inflation, the Federal Reserve Board had set its monetary dial at "full stop" in mid-1969. Between then and February of this year, the board squeezed the nation's money supply so severely that it rose at an annual rate of only .2%. The effect was to throttle bank lending, drive interest rates to their highest level since the Civil War, and ultimately to slow down business in general.

Through the early part of the year, inflation psychology kept its grip on the minds of investors and businessmen. Then, in the space of a month, two events turned the mood from hope to gloom and brought the nation closer to financial panic than at any time since the 1930s.

First, stock prices plummeted. From Jan. 1 to May 26, which was the blackest day of the bear market, the Dow-Jones industrial average sank from 800 to an eight-year low of 631. During that period alone, the paper loss for securities listed on the New York Stock Exchange was $113 billion, and the nation's 31 million investors lost an average of $3,645 each. The losses were even more severe for stocks on the American Stock Exchange and on the over-the-counter market. The latter came close to collapse for many days during the late spring. Since then, the stock market has rebounded, though many faded glamour stocks remain 70% below their highs of a few years ago. The Dow-Jones average closed last week at 823, far down from its alltime high of 995 in February 1966.

Biggest Collapse. The second shattering event of 1970 was the biggest collapse in U.S. corporate history. On June 21 the Penn Central Transportation Co., owner of the nation's largest railroad, went bankrupt. The Penn Central had long been a victim of mismanagement and executive infighting, but it was pushed right off the tracks by its inability to refinance $152 million of its commercial paper. Such paper is a form of unsecured, short-term IOU. When money became difficult to borrow from banks, scores of corporations issued commercial paper to raise funds. Because such securities are usually bought by other companies that have spare cash to invest, a series of defaults could have spread financial shock waves throughout the U.S. business community. The Penn Central debacle caused well-founded fears that the $40 billion market in commercial paper might fall apart, starting a series of business failures.

The Federal Reserve's prime job is to prevent just such disasters. After Texas Congressman Wright Patman, an archenemy of banks and railroads, blocked the Nixon Administration's efforts to prop up the Pennsy with a $200 million loan guarantee, the Federal Reserve moved swiftly to steer the financial system out of danger. The board made a special point of offering to advance credit to commercial banks through its "discount window," providing them with much needed funds for relending to corporations that had to pay off commercial paper. The mechanism was conventional, but the need for speed was so urgent that five top officers of the New York Federal Reserve Bank spread news of the rescue scheme by making weekend phone calls to key Manhattan bankers. Banks borrowed heavily from the Federal Reserve, and advanced some $2 billion to cash-shy corporations. In addition, the board relaxed its controversial Regulation Q, which had limited the amount of interest that banks could pay for large deposits. Result: banks picked up $13 billion more by marketing certificates of deposit.

The Federal Reserve Board thus narrowly averted a liquidity crisis--but not without a few tense moments. Some financially embarrassed companies had trouble refinancing their commercial paper. In one case, Chrysler Chairman Lynn Townsend flew to Manhattan and arranged a $400 million increase in the company's line of credit from a group of banks. Many other cash-hungry companies were not so fortunate. Business failures in 1970 rose to a three-year peak of about 10,000, and the sums of money involved reached an alltime high.

Companies that had thrived by borrowing and expanding recklessly simply collapsed. Several franchising chains took a clobbering, including International Industries' House of Pancakes, Joe Namath's Broadway Joe's and Minnie Pearl's Chicken System. So did computer software firms and rickety conglomerates. Flamboyant, fast-talking entrepreneurs toppled like dominoes. Among them was Bernard Cornfeld, the expatriate supersalesman who had built Investors Overseas Services into the largest mutual fund organization selling shares to foreigners. Denver's John King, whose King Resources sold interests in oil wells and other holes in the ground, tried to come to Cornfeld's rescue with a loan. Instead, King himself was caught in a money bind and ousted by his board. Keith Barish, 26, a financial whiz who had made Nassau's Gramco Management Ltd. the second-ranking offshore mutual fund complex, was also hit by a wave of fund redemptions that forced him to suspend some operations. Several big-thinking Texans were deflated. James Ling, whose merger magic had expanded a tiny electrical firm into a $3.75 billion conglomerate, Ling-Temco-Vought Inc., was deposed by nervous bankers. Oil Millionaire John Mecom petitioned for bankruptcy.

Ripples from the Rates. Much of the financial distress has been alleviated since the Federal Reserve Board again began expanding the money supply. Since Arthur Burns took over as chairman in February, the board has fairly consistently increased the money supply at an annual rate of 5% or 6%. Because it usually takes six to nine months for changes in money policy to turn the economy around, the effects of ease have only recently been felt.

Since November, long-term interest rates have declined more swiftly than at any time in the last century. Rates on average-grade corporate bonds, for example, have fallen from 9.05% to 7.80%. A smaller drop in mortgage interest rates, which now average 8.45%, has helped builders to increase the annual rate of housing starts by 59% from January to November. The main force behind the housing rebound, however, has been an astonishing rise in federal subsidies and loans. About one-third of the houses and apartments built this year received some federal subsidy, and next year close to half of them will get aid from Washington.

Jumping Through Hoops. The year 1970 was also notable because, more than ever before, the talk about consumer protection turned into action. Many businessmen had long scoffed at consumerism: Campbell Soup President W.B. Murphy once called the movement "a fad, of the same order as the hula hoop." Through gutsy persistence--and with help from the ecological activists--consumer protectors have forced Government and business to change. This year businessmen had to jump through the hoops of federal regulations, frequently issued by agencies long considered too impotent to act.

Sometimes trivial, often aggravating, occasionally frightening, hundreds of rulings by federal arbiters made life tougher for businessmen. Last month the U.S. Forest Service infuriated lumbermen by sharply curtailing the amount of timber that they may cut in national forests. Loggers insist that the conservationist-inspired move will drive lumber prices through the roof as housing construction rises. Last week the Food and Drug Administration made its 350th move of the year against dubious or dangerous products. Having discovered traces of poisonous mercury in test samples, officials persuaded grocers to recall nearly 1,000,000 cans of tuna from the shelves for further testing. Depending on how much of the total tuna pack is finally classified as unsafe to eat (none so far), FDA experts estimated that the loss to canners may reach as high as $84 million.

For polluters, former Interior Secretary Walter Hickel poured trouble on oiled waters. Prodded by Hickel, the Justice Department sued a subsidiary of Standard Oil of California for flouting federal safety rules before the Gulf of Mexico fire and oil spill blackened the Louisiana coast. A court fined the company $1,000,000, the largest penalty for polluting ever imposed on an American firm. State governments also struck blows for the consumer. Wisconsin's Supreme Court found J.C. Penney Co. guilty of violating the state's 12% usury ceiling by collecting 18%-a-year interest on revolving charge accounts. In similar cases, a Connecticut court ruled against Sears, Roebuck, and this month Minnesota sued Montgomery Ward.

The auto industry found that it was becoming the national scapegoat not only for air pollution but for a grab bag of the nation's ills. Urban congestion? The auto caused it. Land-scarring superhighways? Detroit's fault. Last week Congress adopted a strong clean-air bill requiring carmakers to produce a nearly pollution-free auto engine within six years--despite pleas from the industry that it needs more time to devise the necessary technology. Reports TIME Detroit Bureau Chief Peter Van-derwicken: "The industry is reeling from these attacks. Its leaders are hurt and baffled by the flood of criticism. They are on the defensive and acting like it."

Shape of Tomorrow. Consumer Crusader Ralph Nader kept winning plaudits --and practical victories. In part because of the safer autos that he helped force automakers to build, highway fatalities are expected to show their first significant decline this year since 1958. The toll will drop 2%, to about 55,400. Speaking of automen's accumulating problems, Henry Ford II predicts: "Never before has American business been under such great pressure to change. Neither business in general nor the auto business in particular will survive in its present form."

While it tries to cope with longer-term problems, management can take at least some short-term comfort in the widespread prediction that business will improve during 1971. By most measures, the recession is over. Having suffered the headaches of the hangover, business will benefit increasingly from the stiff anti-inflationary medicine imposed this year. For one thing, productivity will increase in 1971, probably by 4% or more. That will contribute to a rebound in profits and a moderation in the rate of price raises.

Productivity will show gains largely because companies, having learned to live with less manpower, will be slow to take back the laid-off workers and executives. At the same time, there will probably be a reduction in the hiring of the newer, younger workers who have always provided the fresh ideas--the zip and leaven--for business. Unemployment will climb next year, probably exceeding 6% during some months before tapering off later in 1971. The members of TIME'S Board of Economists foresee relatively high unemployment, coupled with about a 3)% rate of real economic growth and close to a 4% rate of inflation. That would make for a total of something more than 7% growth in the gross national product, lifting it from $977 billion this year to $1.045 trillion or $1.055 trillion next year.

The Nixon Administration wants more. It is hoping for a 6% spurt in real growth for the year--or an astronomical 8% if measured from this year's strike-depressed fourth quarter to next year's fourth quarter. That unlikely rate of gain would lift the G.N.P. to $1.060 trillion. Beyond that, Nixon is aiming to go into the 1972 elections having achieved both reasonably full employment and reasonably stable prices. Almost all economists outside the President's immediate circle agree that such a feat is nearly impossible in such a short time.

Nixon has tried redefining his targets to make victory easier. A year ago, his closest economic aides said that they were aiming to reduce the rate of inflation to 14% or 2% by the end of 1971. Now they say that 3%, or perhaps a bit more, would represent price stability. Until lately, Administration officers have defined "full employment" as a 4% rate of joblessness. Recently they began talking of getting down to "the 4% zone," and at his last press conference, Nixon implied that anything "lower than 5%" would be a commendable showing.

Gung-Ho for Growth? Whatever the numbers, the President has to decide on which of two policies to emphasize. Should he aim for a modest rate of economic recovery, risking a continuation of high unemployment? Or should he strive for a faster snapback, risking more inflation later? Every sign now indicates that the President, prodded by Chief Economist Paul McCracken and Budget Boss George Shultz, has made a decision to go for speedy, job-creating growth. It remains to be seen whether John Connally, Nixon's surprise choice for Secretary of the Treasury, will alter the strategy. Though he has Texas populist roots, Connally is considered to be an economic conservative.

The easiest way to put people back to work is to put more money into the economy. That can be done by expanding the budget deficit or increasing the money supply, or by using a combination of both. In either case the President's power is limited. He can increase the budget only if Congress agrees, and he may well run into resistance from Capitol Hill's fiscal conservatives, as well as from Democratic liberals who are not at all eager to help his re-election drive. One possibility is that Nixon will offer only token opposition to spending bills that he dislikes, and allow the budget to tumble $15 billion or $20 billion into the red.

Then there is the question of the money supply. In his speech to the National Association of Manufacturers three weeks ago, the President said that Burns had given him a "commitment" that the Federal Reserve Board would "provide fully for the increasing monetary needs of an expanding economy." The following week. Burns, in a typically Delphic passage in a speech, left policywatchers guessing as to whether any such deal had been struck. Most common guess: no. Besides, Burns is only primus inter pares on the Reserve's twelve-man Open Market Committee, which regulates the money flow. A number of anti-inflation hawks on the committee, notably the New York Federal Reserve's Alfred Hayes, recently voted against faster expansion.

A Matter of Mood. Even if more money pours forth from Congress or the Federal Reserve, the big question is how much jittery consumers will spend. "The consumer is the key to 1971," says Harvard's Otto Eckstein, reflecting the overall view of TIME'S Board of Economists. "If retailing does not do very well next year, nothing else will."

This year the American consumer has been saving at an unprecedented rate of 7.3% of his income, and banks have tried to attract more deposits by offering gifts like appliances, luggage and wigs for women. The average American family has a fat $7,610 put away in savings accounts. Usually, a lot of money begins to burn a hole in the consumer's pocket, and a splurge of spending begins. But the usual consumer psychology may have changed. Last week George Katona, a consumer expert who heads the University of Michigan Survey Research Center, reported that the consumer's confidence is low and still falling, largely because he is worried about his job security and about a prolonged recession. In marked contrast to earlier years, says Katona, today's consumers spend money freely only when they are in the right mood to do so, rather than because they urgently need goods and services. Katona believes that buying habits are more affected than they once were by such problems as racial conflicts, student riots, crime, even pollution.

In 1971, to a much greater degree than in most years, the state of the economy will be determined by the mood of the people. Compared with 1970, it should be a fairly good year for business. Whether it will be better than that will depend on what the President does, more through deeds than words, to inspire the confidence of the American businessman and consumer.

*The growth gap is measured in terms of constant dollars at the 1958 rate, in order to discount the effects of inflation.

*A small pack of macadamias had cost United 90, and the line had been using 5,000,000 packs a year. The peanuts cost 40.

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