The Year of Big Splashes

By Stephen Koepp

The economy during 1985 carried U.S. business ahead at the sleepy pace of Ol' Man River. Rolling along at a modest 2.4% rate, it provided most companies with just enough propulsion to make for a comfortable ride. But if the economic mainstream was smooth, the trip for many voyagers was as hair-raising as a Snake River rafting expedition. In 1985 a parade of slumps, scandals, panics and just plain goofs rocked the business world. All the while, an unprecedented wave of acquisitions was swallowing up such well-known corporate names as ABC, RCA, Nabisco, General Foods and Revlon.

Halfway through 1985, the nearly three-year-old economic recovery seemed about to end. Second-quarter growth in the gross national product was a slow 1.1%, compared with 3.7% in the previous period. But the low level of inflation, about 3.5% for the year, enabled the Federal Reserve Board to ease up on interest rates. "The Fed is riding to the rescue," Economist Walter Heller said in May. As a result, more credit began flowing to businesses. Between April and July, the prime rate fell by a point, to 9 1/2%, where it ended the year.

The economy began to pick up in the latter half of 1985, buoyed by heavy consumer spending. Outstanding installment credit jumped 15%, to a record $530 billion. Shopper confidence was partly the result of good news in the job market. Unemployment inched downward from 7.3% in January to 7% in November.

Even as the economy quickened, though, a major problem was looming offshore: a $145 billion U.S. trade deficit. The prime cause for the yawning gap between exports and imports was the strong U.S. dollar. American businesses found it increasingly difficult to compete in foreign markets because their wares were too expensive. At the same time, low-priced imports pummeled U.S. industries at home. The trade imbalance held back the economy and raised protectionist fervor to a level not seen since the Great Depression. More than 200 anti-import bills surfaced in Congress, including measures to keep out shoes and textiles. "The protectionist pot is about to boil over," Senate Majority Leader Robert Dole proclaimed on a trip to Japan in August. "I have never seen stronger congressional sentiment for acting on the trade front."

Japan came under intense criticism for flooding the U.S. with its products while blocking imports. Said Pennsylvania Senator John Heinz: "We need to retaliate against Japan. They deserve it." Sensing a trade war brewing, Prime Minister Yasuhiro Nakasone appeared on Japanese television in April to ask his countrymen for help. Said he: "If each Japanese buys $100 in foreign goods, the increase in imports from that would amount to $12 billion, and foreign countries would be happy."

After denouncing import quotas as "ineffective and extremely expensive," President Reagan pledged in September to create a $300 million war chest to help U.S. companies finance exports. Treasury Secretary James Baker met with finance ministers and central bankers from Japan, Britain, France and West Germany at New York City's Plaza Hotel and agreed to help bring down the runaway dollar. Prodded by Government intervention in foreign-currency markets, the dollar by December had declined 18% from its peak in February.

In heading off the trade crisis, the Administration adopted a new, take-charge stance in international economic affairs. During the President's first five years in office, the U.S. had followed the hands-off policy advocated by Treasury Secretary Donald Regan, a fan of free-market solutions. But after White House Chief of Staff Baker swapped jobs with Regan in February, the Administration began taking a more active role. Less than a month after the Plaza Hotel meeting, Baker unveiled yet another ambitious blueprint for repairing the global economy, this time a plan to defuse the Third World debt bomb. Baker contended that previous stop-gap efforts to solve the problem relied too much on austerity measures that prevented developing countries from rebuilding their economies. Speaking to a conference of 9,000 moneymen in the South Korean capital of Seoul, Baker called for a three-year lending increase of $29 billion, mostly from commercial banks.

Banks ordinarily would have been reluctant to extend more money to the debtors. But the Government's support made such big-city institutions as Citicorp and Chase Manhattan more willing to take the chance. Indeed, U.S. banks generally grew healthier in 1985 as they emerged from a two-year crisis of confidence among investors and depositors. Some other U.S. banks, though, had a tumultuous year. More than 115 failed during 1985, the highest number since the Great Depression. Most were small ones buried under a pile of failed farm loans.

The savings and loan industry also had its troubles. In March customers of 69 S and Ls in Ohio stampeded to withdraw money when the failure of a Cincinnati thrift threatened to bankrupt the state's private deposit-insurance fund. Ohio Governor Richard Celeste temporarily closed the S and Ls and required them to apply for federal insurance. Two months later, Maryland Governor Harry Hughes seized temporary control of 102 institutions after a similar panic developed.

The most talked-about slump of 1985 was in home computers. Sales dropped to an estimated 2.3 million from 1984's 3.3 million. Companies that had rushed to market with new products were violently shaken out of it. Coleco dropped its Adam computer in January, and IBM stopped production of its PCjr in March. Even so, sales of the more powerful personal computers used in business continued to grow, and demand for some very large units boomed. IBM's long-awaited new mainframe machine, which had been nicknamed the Sierra, costs about $5.5 million, but it still sold so briskly that economists predicted the machine alone would boost fourth-quarter GNP growth by a full percentage point.

Among the casualties of the computer troubles was Steven Jobs, the brash co-founder of Apple who started the firm in a California garage nine years ago. After a bitter power struggle with John Sculley, his hand-picked president, Jobs left in September, taking five top employees with him to start a new computer company. Said he: "I am but 30 and want still to contribute and achieve."

Though high tech was laid low, some traditional industries thrived. Detroit automakers sold 15.6 million new cars and trucks, up from 14.5 million in 1984. During late summer, normally a slow period, automakers offered 7.7% and 7.5% financing, which put car keys in the pockets of more than 800,000 Americans. Chrysler workers went on strike for eight days in October, demanding an end to the concessions made when the company was at the brink of bankruptcy in 1979-82. They won increases in wages and benefits that returned them to a par with their colleagues at Ford and General Motors. To gear up for foreign competition, GM put forth plans to build a $3.5 billion, state-of-the-art factory that will produce a new subcompact car called the Saturn. The company's announcement in January kicked off a furious battle among 36 job-hungry states that wanted the plant. The winner: Tennessee.

Profitable airlines battled in 1985 to expand their reach by acquiring less healthy ones, or parts of them. United paid $900 million in April for Pan Am's famed Pacific routes. Discount carrier People Express increased its service from 32 to 45 cities between January and August, then paid $300 million in November to acquire Frontier Airlines, which added 55 more cities in the West.

During 1985 the business pages often looked like the police blotter as investigators uncovered case after case of corporate crime. Big-name businessmen and corporations were accused of transgressions ranging from defense-contract fraud to money laundering. Paul Thayer, former chairman of LTV, the steel and defense conglomerate, and Deputy Secretary of Defense under Reagan, was sentenced in May to four years in prison for obstructing justice. Thayer had given friends inside information about upcoming mergers. E.F. Hutton pleaded guilty in May to a check-kiting scheme that bilked some 400 banks out of about $8 million.

The gaffe of the year, though, was a question of taste rather than legality. In April, Coca-Cola changed the formula of its flagship brand for the first time in 99 years. Gushed Chairman Roberto Goizueta at the time: "The best has been made even better." But Coke lovers rose up in anger at the new, sweeter taste. Three months later the company brought back the Real Thing, dubbing it Classic Coke. Said President Donald Keough: "The passion for original Coke was something that just flat caught us by surprise." By fall, old Coke was outselling the new by 3 to 1, but total 1985 Coke sales were up about 8%.

If Coke was surprised by an unexpected turn, then the third-largest U.S. oil company, Texaco, was mortified by one. A Houston jury in November ordered it to pay $10.5 billion in damages for snatching Getty Oil from Pennzoil in a takeover battle. A judge upheld the decision, but at year's end the two firms were trying to reach a compromise settlement.

Thousands of companies were busy reorganizing during 1985 as the merger fever touched nearly every industry. In broadcasting, Capital Cities Communications bought ABC in March for $3.5 billion, and General Electric picked up RCA, the parent of NBC, last month for more than $6 billion. Cigarette maker Philip Morris bought General Foods in September for $5.7 billion. Some ambitious deals, however, started to come apart even before the ink was dry. At year's end, Ted Turner's proposed $1.5 billion takeover of MGM/UA ran into trouble when the cable-TV king had difficulties raising the money. Nonetheless, an estimated 3,000 acquisitions took place in 1985. For all those companies, the afterglow of the big deal will soon wear off, and the job for 1986 will be to make the mergers work. --By Stephen Koepp