All Shook Up

By John Greenwald

"I want to say we're in a recession, but that's not a strong enough word. In some regions it's a depression."

-- William Hensler, chief executive, Wickes Lumber

"I was disbelieving. You're never quite ready for it. What kind of economy have we created that sacrifices people in their prime?"

-- Clothing executive, 47, laid off after 29 years with his company

When the new decade dawned 10 months ago, the promise of a bright and peaceful new world filled the air. The U.S. and its allies had won the cold war, and Americans looked forward to raking in a substantial peace dividend as their just reward. In Europe, countries that had been bitter rivals for centuries marched toward economic partnership in 1992. Eastern Europe, mired for decades in communist stagnation, threw off its shackles and rushed to join the capitalist world. In Asia, a proud Japan stood as the world's new financial superpower and the chief lender to the rest of the globe.

What a difference an invasion makes. The enchanted moment is gone. From stock markets to supermarkets, high anxiety rules the day. Iraq's march into Kuwait on Aug. 2 has proved to be the catalyst that brought the world's ( economic weaknesses to bear all at once: America's profligate spending, Japan's speculative fever, Eastern Europe's huge renovation bill, the Third World's monumental debt.

Now the specter of war, rapacious oil prices and a far-reaching recession haunts political and business leaders everywhere. After a record eight-year peacetime expansion, the U.S. is in the midst of a slump that could swiftly spread to America's trading partners. Japanese investors have lost nearly $2 trillion of wealth as shares on the Tokyo Stock Exchange declined more than 40% since last December. The stunned Japanese are paring back their lending just as Eastern Europe and Third World nations desperately seek cash to pay runaway oil bills.

At a time like this, consumers and investors seek signs that people in charge are doing the right thing. But they have got precious little reassurance from Washington, where the House last week rejected the long- negotiated $500 billion deficit-cutting package, triggering a government shutdown and the furloughs of thousands of federal employees. "The government looks like it has lost control of the country," says Dwayne Andreas, chairman of the agricultural conglomerate Archer Daniels Midland.

While Washington fiddles, the faltering U.S. economy has started imposing hardships that recall the severe slumps of the 1970s and early 1980s. Major American companies are slicing costs to the bone and declaring sweeping layoffs. "It's going to be brutal. Many businesses are broke, but won't admit it yet," says Irwin Jacobs, a Minneapolis financier. Chase Manhattan, the second largest U.S. bank, is letting go 5,000 employees, or 12% of its work force, in a struggle to remain solvent. McDonnell Douglas, the No. 1 defense contractor, is slashing its payroll by 17,000 workers, or 13%. At the General Electric plant in Louisville that makes refrigerators, dishwashers and other appliances, managers plan to lay off as many as 500 of the plant's 10,800 workers because of falling sales. "This is not just a thing we're forecasting," said a spokesman. "We're experiencing it."

The sense of panic is palpable. "Almost every day I get calls from friends in large companies who have been let go," says Michelle Straussburger, a Chicago-based designer of home interiors. "A lot of the companies I work with are down to half the business they had a year ago." The government gave fresh evidence of the worsening pain last week, reporting that the unemployment rate climbed to 5.7% in September, up from 5.6% in August, for the third increase in a row. Not since the 1981-82 recession had unemployment risen for three straight months. In several Midwestern and Southern states, the jobless rate has already topped 7%. Since July, the U.S. has lost nearly 500,000 jobs.

Aggravating the slump is a worldwide credit crunch that affects everyone from auto shoppers to Third World governments. Many lenders who were burned by bad loans in the 1980s are now prudent to a fault. Says Jacobs: "The banks are basically pushing panic buttons everywhere. They are saying, 'We don't care about your situation, we want our money now.' " At the same time, the big cash exporters of the 1980s now have little to spare. Japan, which was a net buyer of $26 billion in U.S. bonds last year, dumped them to the tune of $9 billion in the first half of 1990. And after last week's unification, the German government may lavish nearly $700 billion over the next 10 years on rebuilding its eastern area.

But the current gyrating cost of crude is the single most volatile factor in the world economy's fate. Since the Iraqi invasion, the price of oil has nearly doubled, to a spot rate of $37 per bbl. at the end of last week. America's monthly bill for imported oil has risen in proportion, to an estimated $7 billion, with the increase acting as a depressant on the economy. The price of regular unleaded gasoline has climbed 27 cents a gal., to $1.35, since early August. At these price levels, the heating-oil bill for the average Northeast homeowner could rise 50% this winter, to an estimated $1,200. The most immediate threat is an outbreak of war in the Persian Gulf, which could send oil prices into the $50-per-bbl. range and trigger double- digit inflation.

War rumors have whipsawed the world's stock markets, heightening the mood of impending economic disaster. The Dow Jones average closed at 2510.64 last week, up 58 points for the week but down almost 500 points from its peak in July. Other markets have been hit even harder. In the shadow of Tokyo's debacle, Taiwan's exchange has fallen 80% since February, a collapse so sharp that it has prompted several local investors to commit suicide.

Among U.S. companies and consumers, the weakening economy has contributed to a national sense of uncertainty and malaise. In a TIME/CNN poll conducted last week by Yankelovich Clancy Shulman, only 42% of the adults surveyed said that | things were going very well or fairly well in the U.S. at the moment. That was down sharply from 52% in September and marked the lowest level of confidence that the survey has found since the recession of 1982.

Since consumer spending amounts to two-thirds of the economy, talk of a recession can be a self-fulfilling prophecy. "The recession starts in the heart, then is reflected in the charts," explains a senior Italian banker stationed in the U.S. "If you look into the hearts of people right now, you see a recession."

The Bush Administration has avoided using the R word, which officially is defined as six months of economic contraction. "We don't believe we're in a recession right now," White House spokesman Marlin Fitzwater said two weeks ago. But many economists contend that the slump actually began last summer. "The economy was headed toward a recession before Iraq invaded Kuwait," says Allen Sinai, chief economist for the consulting firm Boston Company Economic Advisors. "The invasion was just the nail in the coffin." Richard Hoey, chief U.S. economist for the British investment firm Barclays de Zoete Wedd, concurs: "Only the severity of the recession is uncertain."

Some economists fear that a sharp downturn could have a snowballing effect because of the high levels of debt the U.S. piled up during the 1980s and the shakiness of the financial system. Leveraged by buyouts and other takeover deals, many companies are already hard pressed to make their payments. At the same time, banks and insurance firms are tottering beneath huge portfolios of bad real estate mortgages.

The problem is that the U.S. Government stands behind these institutions like a pillar of Jell-O, since it is already committed to an S&L bailout that could cost $1 trillion and owes a national debt of $3 trillion. If more bailouts are needed, the U.S. would have to borrow so much money from the credit markets that interest rates would be pushed upward in the midst of a recession, which would make conditions even worse. "We are skating on what may seem to be firm ice," says Harvard political economist Robert Reich. "But it is thinning rapidly, and we really don't know how thin it is."

After beginning in the Northeast last year, the slump has gradually spread to the heartland and other regions. The construction industry has creaked to a virtual halt after a decade of overbuilding. Says Paul Beitler, a Chicago developer: "The lights in our industry have just gone out. There are going to * be some very tragic times. Within the next four years, 50% of the workers in construction and real estate could be unemployed." Even in California, where the building market has known no direction but up, Kaufman and Broad Home Corp. of Los Angeles reported a 5% drop in third-quarter profits as nervous home buyers delayed housing purchases. "Uncertainty is 90% of the problem," says Chad Dreier, the company's chief financial officer.

Businesses too have begun to jump on the recession bandwagon, putting aside their plans for new projects. Until recently, Airways Rent-a-Car aimed to expand from its Chicago base into 100 U.S. cities. But the family-owned business has cut back its goal to just 25 markets. Says Michael Zaransky, the rental firm's president: "I'd rather be tight and out of cars than stuck with too many. It's just too costly."

Even after years of belt tightening that was supposed to make companies more competitive, many firms are still cutting deeply into their white-collar work forces. The firings have thrown secretaries and managers alike into an increasingly hostile job market. "I was in shock," says a former top executive of a Midwestern men's clothing retailer who was laid off in August. The dismissal left the middle-aged breadwinner with six months' severance pay and three college-age children. "Right now, companies are paring down just to survive," he says. "But the fact that ((the economy)) hits home and strikes you personally is something you're never quite ready for. The recognition is just too painful for you and your family."

The downturn is even starting to rearrange where Americans live. In Massachusetts an estimated 18,000 more people fled the state than moved into it this year as unemployment climbed past 6%. Some favored destinations: California, Texas and Florida. Nearly a quarter of the state's 93,000 layoffs occurred in such high-tech companies as Digital Equipment and Data General, which have been caught by the double whammy of economic stagnation and technological changes that passed them by.

The sagging U.S. economy will send tremors around the globe. Since Americans are the world's biggest spenders on everything from Colombian coffee to Japanese cameras, a slowdown in U.S. buying cuts deeply into the revenue of foreign countries. That means more pain for impoverished Third World countries and slower growth for wealthy U.S. trading partners.

In Japan the epic slide of the Tokyo stock market began with fear of rising interest rates at home, and has been accelerated by rocketing oil prices abroad. Tokyo's Nikkei index has fallen from its peak of 38,915 last December to a closing price of 22,828 last week. "This has probably been the largest bear market in any country since World War II," says Peter Tasker, head of research at Kleinwort Benson International in Tokyo. In a fleeting burst of euphoria, the index zoomed a record 13% last Tuesday, but much of the gain was the result of frantic government moves to shore up the market. Among other things, the Finance Ministry gave investors easier access to borrowed money and curbed the hours of futures trading.

The stock collapse has shaken Japan's giant banks, which raise vast amounts of capital on the market by issuing shares and pour money back in for investment purposes. As the value of their shares and portfolios plunged, the banks cut back their lending, contributing to the worldwide capital crunch. "The golden age of Japanese financial institutions is over," says Masaharu Usuki, a government economist.

The market plunge has forced many institutional investors in Japan to dump foreign holdings to bolster their dwindling supplies of cash. While Japanese industrial giants still crave strategic mergers with glamorous U.S. firms, as in the case of Matsushita Electric's expected bid for Hollywood's MCA, they are less apt to invest in American real estate. Several Japanese investment firms that bought U.S. buildings during the 1980s are now quietly putting the edifices back on the market.

Some experts fear that Japan's superheated real estate market could be the next to collapse. By one estimate, the total value of all Japanese property has inflated to $15 trillion, four times the total value of all U.S. real estate, even though Japan is only the size of Montana."We are seeing a bubble effect," says Johsen Takahashi, a senior economist with the Mitsubishi Research Institute. "The stock market bubble has already burst, but the land- price bubble has yet to pop. That will happen next." A sharp decline in real estate prices would put Japan's banks and insurance companies in serious trouble, since they have loaned heavily to companies using property as collateral. "The collapse of land values would bring truly tragic results," said a senior Japanese banker.

For all the cracks in Japan's financial edifice, the country's economy is still running as reliably as a Honda. Economists expect Japan's GNP to grow a robust 4.5% this year and 4% in 1991. With oil prices climbing, the government's main mission is to prevent the inflation rate from rising above the current 3%, which by Japanese standards is worrisome. To cool the economy, the Bank of Japan has kept interest rates relatively high, which tends to aggravate tight-credit conditions in global markets.

Meanwhile, Europe's economic superpower, though still robust, is taking on new debts to rebuild its reunited eastern region. The enormous job has pushed estimates of Germany's budget deficit for the coming year from about $20 billion to as much as $83 billion. Observes Paul Horne, chief international economist for Smith Barney: "Incredible East German air pollution has pitted the massive walls of the Reichstag. That is an apt symbol for the deep hole being dug in the West German budget by the economic collapse of East Germany."

To repair the damage, Bonn must bail out an economy crushed by decades of communist rule. For starters, that will mean providing aid and helping to find jobs for nearly 2 million unemployed workers out of an eastern work force of 8.9 million. Moreover, the government must furnish loans and subsidies to 8,000 companies that are on the verge of bankruptcy.

The rebuilding task is diverting funds that Bonn might otherwise lend to East European countries that are staggering from the oil shock. In the past, Eastern Europe bought most of its consumption of 2 million bbl. a day from the Soviet Union at prices well below the market level. With that subsidy gone, the region faces stark choices: borrow to pay sharply higher oil bills or cut energy consumption and worsen the recession that already grips most East European countries.

Motorists in parts of the region routinely endure long queues for fuel. In Bulgaria they wait up to 12 hours for a few liters of gas. Many sleep in their cars to be ready when stations open in the morning. In Sofia, the capital, children armed with rags and detergent work the lines, cleaning windshields for a small fee. The urchins do a brisk business because of a nationwide shortage of windshield wipers.

Hard times have struck the West as well. In Britain, where the government has kept interest rates high to combat a 10.6% inflation rate, at least 1,800 companies have gone bankrupt so far this year. That is more than double the rate of business failures over the same period a year ago. To take the edge off the pain, Chancellor of the Exchequer John Major last week reduced a key & interest rate by a full percentage point, to 14%. At the same time, Britain said it would join the European Monetary System, which coordinates exchange rates among key members of the European Community.

The credit crunch and oil shock will cause new suffering in Third World countries, which already bear an overload of political and economic woes. In one of the most seriously affected nations, Bangladesh, officials estimate that the gulf crisis will cost the impoverished country $220 million a year in higher oil prices and $100 million in lost remittances from Bangladeshi workers who have fled Kuwait and Iraq. The Philippines, which imports almost all its oil, will have to borrow heavily to keep its factories running and prevent unemployment from soaring above the present rate of 12.6%. Deepening Third World troubles will affect the U.S., which counts on the countries to buy American goods.

The oil shock presents U.S. political and economic leaders with agonizing choices. To spur the slumping economy, the Federal Reserve Board would normally loosen credit and allow interest rates to fall. But Fed Chairman Alan Greenspan has been reluctant to do that because of the inflationary pressure of rising oil prices, which helped push the consumer price index to an annual rate of nearly 10% in August. Greenspan has suggested that interest rates would be allowed to fall if the Administration and Congress can reach a credible deficit-cutting agreement, which would reduce the pressure of government borrowing on the credit markets. As a result, Wall Streeters have been keeping one eye on Washington and another on the Persian Gulf.

In the meantime, consumers and business leaders will have to adjust to a climate radically different from the 1980s, when the economy was reliable and forgiving. "We're in tough times in a very dicey world. There's going to be a lot of fallout," predicts Donald Jacobs, dean of Northwestern University's Kellogg Graduate School of Management. In large part, the U.S. and the world are paying for the excesses of the 1980s, in which companies, consumers and speculators lived far beyond their means. It may take as much global leadership and cooperation to avert a worldwide recession as it will to remove Saddam Hussein from Kuwait.

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With reporting by Bernard Baumohl/New York, William McWhirter/Chicago and Adam Zagorin/Brussels