Economy Dips, No Dive in Sight

Rising imports and GM strike may contract the economy for first time in seven years. But experts see upturn in late '98.

The last time the US government reported that the economy shrank, George Bush was president, kids started wearing flannel shirts as part of the grunge look, and viewers puzzled over who killed Laura on "Twin Peaks."

Well, those nasty economic numbers from 1991 may be back, even if flannel has now given way to polyester.

Economists are beginning to predict that when the Commerce Department reports the nation's second quarter gross domestic product next Friday, it may show that the economy contracted for the first time in seven years.

Any downturn would have wide-ranging implications: It would help keep a lid on interest rates, which would affect the affordability of housing; it would cut into corporate earnings and thus likely unsettle the stock market; and, it may suddenly give political challengers something to talk about for the fall election.

Behind the downturn is the strike at General Motors, a flood of imports from Asia, and a drawdown of corporate inventories. Still, few economists are yet uttering the "r" word - recession.

"Under the circumstances, the recession risk is incredibly low," says Bruce Steinberg, chief economist at Merrill Lynch & Co. in New York. Instead, economists predict an improving economy through the last half of the year - after a brief slowdown.

"We will have a strong rebound, particularly at the end of the year," predicts Brian Fabbri, chief economist at Paribas Corp., a Wall Street investment bank.

Before any rebound takes place, some dark clouds have to dissipate. The GM strike, for example, could cut deeply into the current quarter's economic growth.

On Tuesday, labor leaders warned the strike could stretch into September. If that happens, economists expect the strike will knock a full percentage point off the third-quarter numbers, which are expected to show only modest growth even if the strike ends tomorrow.

And, it's hard to predict when the Asian economies will turn around. Currently, Asian countries, with devalued currencies, are sending a record amount of goods to the US. July is the peak season for imports destined for retail shelves.

Welcome bad news

Some of this gloom is welcome at the Federal Reserve, where Alan Greenspan has been warning that the economy could not continue to grow at its first-quarter level when it shot up at a 5.4 annual rate.

This week the Fed chairman, in his semiannual report, told Congress that if the labor markets remain tight and consumers keep buying, "the risks of a pickup in inflation remain significant." But Mr. Greenspan also warned that the Asian economic problems "could intensify and spread further."

The bond market cheered Greenspan's comments as interest rates fell. "We are interpreting the chairman that an interest rate rise is a remote possibility at best," says William Sullivan, a senior economist at Morgan Stanley Dean Witter & Co. in New York.

Even so, the Dow Jones Industrial Average dropped 105.56 points on Tuesday - and was off again Wednesday morning - as corporate earnings continued to disappoint investors and Greenspan dashed hopes of a rate cut.

In the coming weeks, investors will be watching the US dollar closely. So far the strong dollar has helped keep inflation in check as lower-cost imports have flooded the country. But some economists believe the dollar will start to weaken later in the year. As the dollar weakens, import prices may rise, perhaps adding to inflation.

For this reason, economist Robert Brusca of Nikko International, a Wall Street investment bank, is predicting that the inflation rate will rise to 4.1 percent by the first quarter of 1999.

"This is the endgame for the nirvana economy," he says, warning of slipping economic growth and rising inflation.

Over the short term, economists will also be watching the unemployment report that is released the first week of August. The expectation is that the July jobless rate will rise slightly, to 4.6 percent. "It's desirable to see it rise to alleviate labor shortages," says Sung Won Sohn, chief economist at Norwest Corp., a Minneapolis-based bank.

Tight labor market

The tight labor market is a major difference between the economy today and in 1991. Seven years ago, companies were downsizing their work force. It was a terrible job market.

Today the labor market is so tight that companies are trying to sign up high-school students before they graduate. Greenspan observes that labor markets have become "increasingly taut" during the first half. But, he adds, rising wages so far have been offset by strong gains in productivity. In fact, Greenspan believes the current slowdown is beneficial, calling it a "transition to sustainable growth."

Yet it's unclear how Wall Street will react to this lower level of growth. The stock market has been an important spark plug for the economy. But some analysts believe stocks are fully priced. The Standard & Poor's 500 is at its highest price-to-earnings ratio since 1891. "How long will the rally last?" asks Mr. Sohn.

To answer that question, investors will be keeping an eye on consumer spending. So far, consumers, flush with rising incomes, are hitting the malls. Sohn estimates real consumer spending rose at a 5 percent annual rate in the second quarter. However, this will start to slow. The GM strike, for example, has removed cars from dealers' lots. And dealers are not offering rebates to entice buyers. Even so, Sohn estimates real consumer spending for the year will grow by 4 percent - still a hefty rate.

And, finally, economists will be watching the elections in Japan, where voters will be choosing a new prime minister. How he fixes the cyclical and structural problems is important. "It is said that the growth rate is determined in the US, but the interest rate is determined in Japan," says Sohn, noting that the Federal Reserve will be watching Asia closely.

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