The Gloomiest Outlook Yet

Economists have long disputed the idea that they practice "the dismal science," but when TIME'S Board of Economists met last week to assess the state of the U.S. economy "dismal" was about the only word to describe their forecasts. In perhaps their gloomiest session ever, the economists predicted a continuation throughout the year of all the nation's present economic woes: torrid inflation, skyscraping interest rates, sluggish growth, stubborn unemployment, a deepening trade deficit. Worse, they foresaw a new and frightening threat: the possibility of a financial crisis from which some savings and loan associations might have to be rescued by the Federal Government.

The background is this: in addition to investing huge sums in new plants and equipment, U.S. corporations have gone on a speculative inventory binge, buying up metals and raw materials before prices go still higher. They are applying for bank loans at an astonishingly rapid pace; between February and May, bank loans to business expanded at an annual rate of no less than $45 billion. The Federal Reserve Board, rightly viewing the borrowing surge as inflationary, has deliberately refused to pump enough money into the banking system to accommodate the loan demand.

Despite the financial troubles of New York's Franklin National Bank (see following story), commercial banks are in no real danger. They have raised their prime rate on business loans as high as 11 1/2%, and they are paying between 11% and 11 3/8% on large-volume certificates of deposit (CDs) in order to attract funds. But the situation is different at "thrift institutions"--savings and loans and savings banks, which make mostly mortgage loans. Their income is held down by loans made years ago at relatively low interest, so they cannot pay anywhere near as much to attract deposits as commercial banks can.

Savings Outflow. In consequence, says Economist Alan Greenspan, "we are in for a massive hemorrhaging of [funds from] the thrift institutions," as depositors shift their money into higher-yielding investments. This process is known as "disintermediation," and there are some signs that it already has begun. The U.S. Savings and Loan League estimates that in April S and Ls suffered a savings outflow of $350 million, v. a net inflow of $831 million in April 1973. Ultimately, the process could bring home construction to a virtual standstill by drying up mortgage money, and could threaten the solvency of the thrift institutions themselves.

Though no one really expects them to go under, Greenspan fears that the Federal Reserve, working through the Federal Home Loan Bank Board, may have to step in "to prevent actual bankruptcies" by bailing out shaky S and Ls. To Otto Eckstein, the lesson of the danger is that "it is impossible for the U.S., with its present economic system, to live with double-digit inflation."

Yet, though the economists predicted some slowing of price increases, few saw any chance of bringing the rate for the full year below 10%. Greenspan predicts that retail prices will go up 10.4% for the year, making 1974 "the first calendar year of double-digit inflation since 1947." Eckstein frankly states that he can see "nothing but disaster" this year on the inflation front. He expects the consumer price index to rise 11.1% for the year and the wholesale price index to leap an incredible 17%. For length and severity, says Eckstein, the current U.S. inflation has already become the worst since World War I.

With wage-price controls dead, some businesses are boosting prices in order to increase profit margins. Raw-material prices continue to soar: last week the island nation of Jamaica announced plans to triple taxes and royalties on bauxite exports. The move will force up aluminum prices in the U.S., which gets 60% of its bauxite from Jamaica. Also, predicts Joseph Pechman, the U.S. is "going to begin to see a wage-price spiral." Wages have been rising at an annual rate of only 6 1/2% to 7%, but Pechman believes that unions in an era of soaring inflation will become much more militant in demanding big raises.

The one bright spot in the inflation picture is that wholesale farm prices in April fell an average of 3%, promising some long-overdue relief to food shoppers. But even that bit of cheer has worrisome implications. Declining agricultural prices mean less revenue from farm exports at a time when more money is going out of the U.S. to pay for imported petroleum. As a result, the nation's trade balance, which already has slipped back into deficit after showing a surplus for 1973, could go even deeper into the red.

Says Arthur Okun: "It may well be that those glorious surpluses of months gone by will be the last ones that we will see for a long time."

Though most board members still expect some pickup in production late this year, they doubt that it will be very strong. A revised Government estimate shows that real gross national product fell at an annual rate of 6.3%--one-half of 1% more than the original calculation --during the first quarter of 1974.

Greenspan projects a nearly invisible rise of two-tenths of 1 % in real output for the year. The unemployment rate has dropped slightly in the past two months, to 5%, but several of the economists view that as a statistical aberration and expect the rate to rise again to a peak of 5.5% to 6%.

Worst of all, board members can see no quick way out of the economic morass. As Washington rivets its attention on impeachment proceedings, says Robert Nathan, "the impossibility of getting anything out of the Executive Branch of the Government at this time means we are just going to drift." Banker Beryl Sprinkel urges the Government to "keep our [fiscal and monetary] policy reasonably tight, settle for 5% or 5.5% unemployment, and then the rate of inflation could drift down"--over the next three to five years. Okun sees only one quick way of stopping inflation: "Panic--a real shake-out in commodity markets, partly induced by some real credit difficulties" among speculators. And he gives even that scary solution only about a 1-in-5 chance of actually happening.

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