A Lusty, Lopsided Recovery

By Charles P. Alexander

Executives and economists fear that huge deficits will slow growth

Federal Reserve Chairman Paul Volcker calls the U.S. economic recovery, which reached its first birthday this month, "a lusty infant." Ronald Reagan proudly notes that output is "growing faster than even we expected." The rebound has rescued some 2 million Americans from unemployment and given millions more a new feeling of confidence. Families are buying more shirts and sofas, carpets and computers, autos and airline tickets now than they were in the bleak autumn of 1982. Factories are bustling again as companies hurriedly build up inventories to make sure they stay ahead of demand. The Federal Reserve Board reported last week that industrial production hit an all-time peak in October, up 14.8% from the recession's 1982 low point.

As sales have surged, so have profits. A Wall Street Journal survey of 506 major companies found that earnings were up 29% in the July-September quarter, compared with the same period a year ago. Some of the most dramatic improvements came in several industries hit hard by the recession. Profits jumped 44% in the forest-products business, 58% for rubber companies and 93% for airlines. The auto industry had the most stunning turnaround of all. After losing $187 million in 1982's third quarter, General Motors, Ford and Chrysler earned $1.2 billion in that period of 1983.

In the past, such rosy figures would have been cause for unbounded optimism. But not this year. Many economists and businessmen remain unusually subdued and concerned. Reason: the recovery is endangered by the federal budget deficit, which threatens to top $200 billion in each of the next few years. The deficit has been largely responsible for keeping real, or inflationadjusted, interest rates at unprecedented heights. The difference between the prime rate that banks charge corporate customers (currently 11%) and the inflation level is now about 6 percentage points, or roughly twice as large as in previous recoveries.

As the economy gathers strength, the credit needs of private business could collide with the Government's heavy borrowing and push interest rates higher. Some economists fear that a serious slowdown in growth, or even a new recession, could come in 1985. Warns Henry Kaufman, widely respected chief economist for Salomon Brothers, the Wall Street investment firm: "The durability of this economic expansion is going to be significantly limited by the huge deficits in the federal budget." Industry leaders share that anxiety. Says John Smale, president of Procter & Gamble: "The size of the federal deficit is a national problem of substantial urgency that must be addressed with statesmanship, vigor and speed."

Despite the growing alarm, Congress rushed to adjourn last week without facing up to the budget dilemma. The consequences of such inaction could be severe. Even if the infant recovery survives, it may grow up deformed, with some parts of the economy performing far worse than others. Onerous interest rates could stall comebacks by the housing and auto industries. The high cost of borrowing money could depress capital spending and thus continue to devastate key business sectors such as steel, construction equipment and machine tools, which have barely begun to climb out of a deep slump.

Martin Feldstein, the President's chief economic adviser, fears a "lopsided recovery that would be slower paced and more fragile than a balanced recovery." Other Administration officials, however, have repeatedly brushed aside Feldstein's concerns. Says Treasury Secretary Donald Regan: "I wish economists would sit back and relax. [This will be] one of the greatest recoveries in history."

That may depend upon the actions of the Federal Reserve's Open Market Committee, which met last week to set guidelines for the Government's monetary policy. So far this year, the Fed has tried to follow a narrow course that would promote the recovery and yet prevent a new burst of inflation. After the U.S. money supply grew at an alarming 12% annual rate in the spring, the Reserve Board tightened its policy. By October, the pace of money growth slowed to less than 2%, and the Fed's tough stance kept short-term interest rates at a steep 8.5% to 11% level.

The decisions made at last week's Open Market Committee meeting will not be made public for a month. But a summary just released of the Federal Reserve's October session reveals that the committee agreed on a "slightly lesser degree of restraint." Wall Street experts doubt, however, that the Fed will push down interest rates substantially. Says Stephen Roach, senior economist at the Morgan Stanley investment firm: "My feeling is that the Fed will maintain a wait-and-see attitude through the rest of the year."

The Reserve Board's cautious policy las kept mortgage rates hovering around 13.5% and stalled the housing recovery. The Commerce Department reported last week that housing starts dipped 3.8% in October, after a 12.2% decline in September. The National Association of Home Builders expects starts to total 1.7 million units this year, a 58% increase over 1982, but it predicts no further growth in 1984. That would be a poor recovery by past standards. After the 1973-75 recession, housing starts rose for three years and peaked at more than 2 million.

A flat housing market would eventually crimp sales of building materials and home furnishings, from timber to toilets. The lumber industry is still shaking off the recession and is hardly prepared for a new shock. In the Northwest, the number of sawmills has declined by about 13% since 1979, and their work force has dropped by 20%, to 96,000. Says H.A. Roberts, executive vice president of the Western Wood Products Association: "We're more efficient these days, and sales volume is relatively good. But we're not nearly as healthy as in 1979."

The auto industry's resurgence is also vulnerable. Sales of U.S.-built cars in the first ten days of November were up 5.6% from a year ago. That increase, however, was less than the 18% gain recorded during the first ten months of 1983. The industry is still selling cars at a pace 35% below the peak rate in 1978. If interest rates begin to creep up, customers could start shunning the showrooms once again.

Even so, Detroit's turnaround has given hope to the struggling steel industry. Says Bernard Lashinsky, chief economist for Inland Steel: "The recovery is real. It is strong. But it is very lopsided." While shipments to the automakers have climbed, sluggish capital spending has held back sales of steel products to builders and machinery manufacturers. In the third quarter, 15 major steel companies lost a total of $527 million, not much less than the $603 million deficit they suffered in the same period of 1982. Though steel executives hope to move into the black next year, they remain cautious about the outlook. Says David Roderick, chairman of U.S. Steel: "The capital-goods sector is going to improve in 1984, but nobody is anticipating a major boom."

As long as steel companies remain depressed, so will their suppliers of raw materials, including some parts of the coal industry. In West Virginia, where many mines are dependent on steel's fortunes, employment in the coal business is down 41% since 1981. But one hopeful sign for the industry is that electric-power generation is currently up 3.8% over a year ago. Coal stockpiles at power plants have dwindled to a 78-day supply, down from 99 days' worth last year at the same time, and utilities will probably have to step up their purchases of fuel in 1984.

The machine-tool industry, which is totally dependent on capital spending, remains a disaster area. Orders for tools will total about $1.5 billion this year, barely 1% more than in 1982, and 73% less than the level of 1979. "Some companies will have their worst year since 1935," says Joseph Franklin, an economist with the National Machine Tool Builders' Association. Employment in the industry has dropped 36% since 1981.

Machine tools, steel and autos are among the many U.S. industries badly hurt by the historically high value of the dollar in international trade. High American interest rates have encouraged many foreigners to convert their money into dollars for investment in the U.S. That has sent the value of American currency to new peaks on exchange markets and made imports unusually cheap in the U.S. Foreign companies, led by the Japanese, have captured 27% of the American machine-tool market. Manufacturers in Taiwan, Singapore and South Korea have made new inroads into the American furniture business. "The trend is particularly frightening for dining-and living-room furniture," says G. Alex Bernhardt, president of Bernhardt Furniture in Lenoir, N.C., one of the oldest U.S. manufacturers. "I estimate that 20% to 25% of sales are imports."

The high value of the dollar has also made American goods exceptionally expensive overseas. U.S. exports are off 6% this year, after a 9% drop in 1982. While many export industries have started to improve, shipments of farm products and capital goods are still weak. Overseas sales of earthmoving equipment, for example, are down 35% this year. Sluggish exports combined with rising imports will drive the U.S. trade deficit to a record $60 billion for 1983, according to Sara Johnson, an economist with the Data Resources forecasting firm.

After a year of expansion, the U.S. economy has regained a surprising amount of momentum, but the progress has been spotty and fundamental difficulties remain. Says Philip Caldwell, chairman of Ford Motor: "The federal budget deficit and the trade deficit are basic problems threatening the country's long-run health and the standard of living for all Americans." Unless the President and Congress deal with those problems, they cannot be sure that the economic recovery will develop from its lusty infancy to a ripe old age.

--By Charles P. Alexander.

Reported by Jay Branegan/Washington and Raji Samghabadi/New York

With reporting by Jay Branegan/Washington, Raji Samghabadi/New York This file is automatically generated by a robot program, so viewer discretion is required.