War limbo keeps economy on hold

A sharp slowing in the fourth quarter coincides with stock-market jitters over Iraq.

Call it the Baghdad factor.

The US economy - the largest on the globe - is now haunted by the specter of war. Until the future of one of the most important areas of the world is decided, the American economy appears to be in a period of anxious limbo. Businesses are not building new factories, consumers are rethinking their vacations, the value of the dollar is shrinking - and the US stock market is back to a familiar slide.

This has many economists lowering their forecasts for growth this year. And, while most of them still think the economy will show growth over the year, a significant minority believe uncertainty about war could knock it back into recession.

If the US economy does falter, it could have vast implications for international growth - which is already weak. And the prospect of lower growth here could spur Congress to pass a stimulus package sooner than planned.

Thursday, economists will get some idea of how much momentum the economy has lost when the Commerce Department releases its first estimate of GDP in the fourth quarter. Early estimates suggest a gain of about 0.5 to 1 percent, making it the weakest quarter of the year.

Tuesday, the government reported that orders for big-ticket items - durable goods, such as automobiles and computers - rose only 0.2 percent in December. "Wednesday's durable-goods report is further evidence that the manufacturing sector is flat in the water," says Thomas Duesterberg, president of the Manufacturers Alliance/MAPI, a Washington business-research group.

The Federal Reserve will discuss the economy's strengths and vulnerabilities, after meetings on interest-rate policy Tuesday and Wednesday. Most analysts expect it to leave short-term rates alone.

"The debate for the Fed ... is whether to abandon their neutral stance and move their bias towards ease," says William Sullivan, executive director of fixed- income research at Morgan Stanley in New York. "I think they will sustain their neutral bias because they know there is a lot of fiscal stimulus coming soon."

Calls for Washington's help

But increasingly, economists are convinced of a need for help from Washington.

Stuart Hoffman, for example, an economist at PNC Financial Services Group in Pittsburgh, believes the fourth quarter was weaker than he estimated a few months ago. He's yet to change his numbers for the first quarter. But, he says, "I don't like what I smell, from the stock market down to the affect on the oil markets and ... business confidence."

Gregory Wingfield, president of the Greater Richmond Partnership in Virginia, attests to the decline. His group normally gets 100 visits annually from companies looking to build new factories or offices. Last year, 85 came - and few made investment decisions. "They cited the pending war with Iraq, the unstable stock market, and their companies' finances," says Mr. Wingfield.

Many businesspeople are listening to gurus devise scenarios. Robert Hormats, vice chairman of Goldman Sachs International, sees three possible courses for the crisis. The first, he terms "The Rumsfeld Dream" - a quick war with no oil disruptions. "This is good for confidence," he says. He terms a second possibility "The Colin Powell nightmare" - a long, nasty war that saps confidence and keeps oil prices high. The third, he calls "The Greenspan-insomnia scenario" - no war, no peace, high oil prices, and more hesitation to invest.

Michael Cates, who runs an Avis franchise at his local airport in Bedford, Mass., feels he's trapped in the Greenspan scenario. A year ago, he was renting 75 to 80 cars each morning as the first group of businessmen arrived. Now, a big day for him is 35 to 40 cars. "Business travel is cut back," he says.

The business uncertainty is wreaking havoc on Wall Street. In the last two weeks - as the Iraq rhetoric has escalated - the Dow Jones Industrial Average has shed nearly 800 points, or about 10 percent of its value.

"Uncertainty is another word for risk and as there is more uncertainty, investors will demand a higher return," says Scott Jacobson, an investment strategist at Jefferies & Co. in New York.

A spreading malaise

Wall Street's malaise is spreading to foreign markets, too. London's benchmark index hit an eight-year low Tuesday. Frankfurt and Tokyo stocks are also lower. "We are seeing a lowering of expectations for global growth," says Eswar Menon, a portfolio manager at Loomis International Equity Group in Boston.

Nor is the prospect of war helping the US dollar, which has tumbled on foreign-exchange markets. "There is a perception that a war without France and Germany may increase the dollar weakness," says Mr. Menon.

The financial turmoil is chipping away at consumer confidence, too. Tuesday, the Conference Board said its index showed confidence falling in January for the second straight month. "Consumers have grown increasingly cautious about the short-term outlook," says Lynn Franco, director of the board's Consumer Research Center in New York.

The uncertainty is leading some to reevaluate both spending habits and travel plans - and many are opting to stay closer to home. One of those is New Yorker Debby Toussie, who enjoys taking European biking vacations with her husband. But, she says, the threat of war has caused them to shift to a biking trip in Utah or Arizona. "I really want to be in my own country in a place that is friendly to Americans," she says.

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