TIME: Almanac 1995

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<text id=90TT2191> <title> Aug. 20, 1990: Full Tilt Into Trouble </title> <history> TIME--The Weekly Newsmagazine--1990 Aug. 20, 1990 Showdown </history> <article> <source>Time Magazine</source> <hdr> THE GULF, Page 38 Full Tilt into Trouble </hdr> <body> The oil shock triggered by Iraq's seizure of Kuwait could plunge the U.S. into a long-feared recession--or has it already arrived? By John Greenwald--Reported by Richard Hornik/Washington and Thomas McCarroll/New York "Does this feel like a recession, or is it just me?" For several months, that question has been nagging at millions of Americans as the U.S. economy poked along in the slow lane. From New England computer makers to California missile builders, many industries that boomed in the go-go '80s have slumped in the slo-mo '90s. But the sudden spurt in the cost of crude oil brought on by Iraq's invasion of Kuwait--from about $20 per bbl. on Aug. 1 to a high of more than $28 per bbl. last week--threatened to turn an already painful slowdown into a full-blown recession. Says Richard Bermer, an economist for Salomon Brothers: "The question is no longer whether there will be a recession but how deep it will be and how long it will last." A slump would bring an end to a record peacetime expansion that has endured for more than 7 1/2 years. In Washington the normally bullish U.S. Chamber of Commerce added its voice to the growing chorus of recession forecasters last week. Said Richard Rahn, the group's chief economist: "We anticipate that the economy will grind to a virtual standstill during the third quarter and actually contract by 1.4% in the fourth quarter." While Rahn acknowledged that "Iraqi adventurism in the Middle East is exacerbating this country's economic woes," he attributed the grim outlook to the tight-money policies of the Federal Reserve Board, which has kept interest rates high out of fear that inflation could shoot up from its current level of about 5%. Said Rahn: "I would hope this would wake up the Fed, but there have been cannons roaring for months now." The recession alarms swiftly spread to the world's financial markets, where stock prices plunged. On Wall Street the Dow Jones industrial average fell 93.31 points Monday, then recovered a bit, but closed the week at 2716.58, down a total of 93.07. As recently as July 16, the Dow had climbed to an all-time high of 2999.75. In Japan, which is almost wholly dependent on foreign oil, the Nikkei Index of 225 stocks closed Friday at 27,329.55, down 7.4% for the week and 11.4% since Iraq invaded Kuwait on Aug. 2. As the markets gyrated, higher crude prices began to ripple through the economy, shocking motorists at the gas pumps and boosting the cost of producing petrochemicals and plastics. Airlines, which spend 15% of their operating costs on jet fuel, were particularly hard hit. Most major carriers added a 5.3% fuel-cost surcharge to their ticket prices. In response, Transportation Secretary Samuel Skinner summoned airline executives to Washington this week to ask them about the surcharges. The oil shock hit Americans where they live. Interest rates on home mortgages, which had been hovering at about 10%, began creeping up because lenders expect inflation to rise. That raised monthly costs for householders with variable-rate mortgages and made borrowing more difficult for new home buyers. In kitchens and corporate boardrooms across the country, worried consumers and executives were examining their budgets and rethinking their spending plans. Notes Alan Meltzer, a professor of economics at Carnegie Mellon University: "People don't know what kind of environment they will be in, so they are postponing decisions." In a TIME/CNN poll conducted last week by Yankelovich Clancy Shulman, 44% of the adults questioned said they expect economic conditions in the U.S. to get worse; 29% felt that way in July and 20% in February. An overwhelming 84% of those polled think inflation is likely to increase, while 74% think interest rates will rise and 68% believe unemployment will grow. The majority of those in the survey, 55%, believe a recession is coming, up from 41% in July. In the view of 44%, a recession has already arrived, although 49% remain unconvinced. By the generally accepted definition, a recession is at least two straight quarters of declining GNP. Even though the economy managed to eke out a feeble 1.2% rate of growth in the second quarter of 1990, many economists argue that the current slowdown already merits the title of recession. The pessimists gained a measure of support last week from a Federal Reserve report that noted that economic growth "was slow or had slackened" in June and July. "The textbook definition of recession doesn't matter," says Donald Straszheim, chief economist for Merrill Lynch. "The economy is so weak that it looks like a recession to an awful lot of people." Declares Rose Marie Moore, who was recently laid off from a Massachusetts textile mill: "I'm nervous and scared. I've had my job for 10 years, and now I'm going to have to find another one. It's rough." The evidence of a U.S. recession is growing more abundant by the week. Trouble spots range from rising unemployment, which increased from 5.2% in June to 5.5% in July, to falling U.S. corporate profits, which declined 12% in the first half of 1990. Meanwhile, the savings and loan crisis inspired regulators to impose strict new lending standards, which helped bring on a credit crunch earlier this year. Homebuilding, a key barometer of economic health, sank to a meager annual rate of 1.18 million units in June, the lowest level since 1982. Although rising consumer spending kept the expansion rolling during the 1980s, consumer outlays were flat in the first half of this year as cautious Americans trimmed back their buying. The big question is how hard the oil shock will strike an economy that is already staggering. So far, crude-oil prices, which closed at $26.23 per bbl. last week, have jumped about 40% in recent weeks. For the moment, that is far less than the price hikes of the 1970s, which reached more than 300%. Those oil shocks gave rise to the dread combination of high unemployment and double-digit inflation, which became known as stagflation. Yet even the current oil run-up could have a substantial and damaging effect on the way Americans work, shop and spend their leisure time. Every $1-per-bbl. increase in the cost of crude oil acts like a tax to siphon income from consumers and companies. Laurence Meyer, a Washington University economist who runs his own forecasting firm in St. Louis, had predicted a recession even before the oil shock. If prices charged by the Organization of Petroleum Exporting Countries reach $30 per bbl. in the fourth quarter, Meyer says, the GNP would decline a painful 3.6% during the period. If oil levels off at $32 per bbl. next year, he predicts that unemployment would climb to 7.4% by the end of 1991 and add some 2 million people to the jobless rolls. The growing risk of a downturn increases the pressure on the Federal Reserve to lower interest rates. But Federal Reserve Chairman Alan Greenspan remains wary of inflation, particularly in the face of the latest oil shock. To help persuade Greenspan that it is time to budge, Treasury Secretary Nicholas Brady last week repeated Administration calls for cheaper borrowing costs. "Everybody wants lower interest rates," Brady said. "At this point in time in the U.S., economic growth is very important." Concurs Lyle Gramley, a former Federal Reserve governor who is chief economist for the Mortgage Bankers Association: "To refuse to ease interest rates now would be like deliberately choosing a recession to bring down inflation." A deep slump could inflict heavy damage on overleveraged companies and troubled banks whose books are already filled with junk bonds and sour real estate loans. According to Veribanc, a Massachusetts-based firm that rates banks and S&Ls, bad loans at U.S. banks rose a sharp 7.5%, to $48.6 billion, in the first quarter of 1990. Overall, nearly 1,400 banks, or about 11% of the U.S. total, lost money in the first quarter. That represented an alarming jump of nearly 20% over the same period a year ago. In Detroit rising oil prices could worsen the skid that the U.S. auto industry has suffered since the start of the year. The price increases threaten sales of profitable but fuel-thirsty vans, pickup trucks and full-size cars, including the Chevrolet Caprice and the Lincoln Town Car. That would mean further woes for General Motors, Ford and Chrysler, which temporarily shuttered 45 of their 62 U.S. and Canadian plants and fired or laid off 38,000 workers during the first half of the year. Higher gas prices could boost Japan's share of the U.S. auto market, which now stands at about 26%. While the Big Three have substantially improved their fuel economy in the past 10 years, they still lag behind the Japanese. GM raised the average efficiency of its fleet from 19.1 m.p.g. in 1979 to 26.9 m.p.g. last year, while Chrysler boosted its fuel economy from 20.5 m.p.g. to 27.7 m.p.g. At the same time, Toyota raised the average economy of its models from 24 m.p.g. to 31.7 m.p.g., and Nissan from 26.8 m.p.g. to 30.2 m.p.g. The rest of the transportation industry is certain to feel the pinch of higher oil prices. Although airlines have begun to pass along the increases in the form of surcharges, analysts warn that the policy could backfire by discouraging air travel. Says Robert Decker, who follows the industry for the Chicago-based investment-research firm Duff & Phelps: "Fuel prices are important, but the really important variable is what happens to the economy. If the economy falters, it will mean a significant reduction in profits, or losses, at some carriers." That could cripple such weak airlines as Pan American and TWA, already awash in red ink. The rising cost of travel will inspire many people to spend their vacations at home instead of heading to places like Florida's Walt Disney World. "People are afraid," says Fred Wright, a Houston travel agent. "If travelers don't get the fares they want, they're not going." The jump in gas prices has forced Wright to change his own travel plans. He said he will make fewer trips to visit family members in Oklahoma City, a distance of 450 miles, because the price of a tank of gas has jumped from about $8 to $12. "It makes you think twice," he says. In the end, the biggest impact of the latest oil shock may be psychological. "I'm paying off all my credit cards, and I'm going to throw them all away," says Dennis Eaton, a Phoenix gas-station manager. "If we go into a recession, I'm going to be cautious and control my own destiny." But the U.S. is already in a recession by many measures, and the country's economic destiny now seems to depend on how high oil prices climb and how long they stay at painful levels. </body> </article> </text>