The United States Recession: How Deep? How Long?

ACCORDING to the federal Department of Labor, the United States lost 1.1 million jobs over the past five months. Now that the nation has tumbled into a serious recession, the worthwhile questions are how deep and how long? No matter what you may have read, the Federal Reserve has yet to ease its policy. To date, cuts in short-term interest rates by the Fed, including the lowering Dec. 18 of the discount rate charged by the Fed on loans to commercial banks, have not induced a pickup in money growth. Lower bank reserve requirements, announced on Dec. 4, may help shore up bank profits. Under present Fed procedures, however, they will not add to the money supply which fuels economic growth.

Thus, 1991 promises to be a tough year on Main Street. Despite these problems, next year could be surprisingly favorable for Wall Street.

Employment, income, consumer spending, production, investment, and profits will all continue to drop through the second quarter of 1991. The decline in consumption is likely to be substantial, but not catastrophic. Housing and business investment in structures may be down a lot.

Unemployment is likely to rise well above 7 percent, and the Federal budget deficit may soar above $300 billion. In this setting, Democrats will launch their drive to regain control of the White House in 1992 - in addition to boosting lopsided majorities in the House and Senate.

In time, the Fed will reflate. When it does, the economy will rebound. While both the timing of Fed actions and their ultimate impact on the economy are uncertain, employment and earnings should be on the mend by next fall. In turn, consumer spending and business investment should register normal rebounds. Profits, hit hard over the past two years, should bounce back.

US interest rates are likely to continue to decline during the first half of 1991. They may well inch up when the economy recovers. However, if inflation remains under control as expected, the increase in rates in the fall of 1991 should be modest. The dollar has been on the skids for more than a year. This trend is likely to continue for another six to nine months. The Japanese yen and the German mark may well appreciate further.

This scenario could have exciting implications for financial markets. Easier money, fairly stable interest rates and low inflation could lead to notable gains in the valuation of equities. Wall Street has already been through a three-year recession. Companies have pared costs. A combination of higher trading volume and higher prices could produce an explosive improvement in profits for firms that survive the shake-out.

However, the road to this promised land will be full of deep potholes. The threat of financial crisis - triggered by the failure of a large bank or insurance company - remains the wild card in the outlook in 1991.

There are unpaid invoices outstanding for the financial excesses of the 1980s. The system of federal deposit insurance desperately needs an overhaul from top to bottom. American banks are accident prone. Loans to real estate investment trusts, lesser developed countries, the oil patch, leveraged buyouts, and commercial real estate are just a few examples.

Nevertheless, the risk seems remote that Washington will let financial failures could get out of hand in a way that would do serious damage to the real economy.

Meanwhile, corporate profits are down sharply. Pretax operating profits (which eliminate inventory gains or losses and use constant, ``economic'' depreciation charges) declined at an annual rate of 14 percent in the third quarter.

The erosion in profitability has been the Achilles' Heel of the nation's longest peacetime economic expansion. In fact, the profit slump reflects fundamental imbalances in the economy - imbalances that cannot be rectified short of a significant recession.

In technical terms, private service firms have been hiring workers for the past two years to produce marginal product at a marginal loss. As a result, total employment in the private service sector has risen beyond any conceivable need. Productivity is down. Unit labor costs have risen.

One result of prolonged tight money is that these higher costs simply cannot be passed along. Thus, profit margins won't be restored without substantial layoffs. Ripple effects from rising unemployment will be the primary forces leading to further reductions in consumption and investment during the first half of next year. Fasten your seat belt.

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