As U.S. Toasts the Good Times, Optimism Does Not Go Unchecked

By LOUIS UCHITELLE

So far, the Asian financial crisis has hit the Boeing Company with all the force of a wispy feather. An Indonesian airline delayed delivery of three planes for less than a week, and some Asian airlines have talked about giving up options to buy new jets. But not one actual order has been canceled, and the Boeing assembly lines are straining to keep up with demand.

Behind that picture of good fortune, however, is a disquieting fear.

Nearly one-third of Boeing's backlog of orders are from Asian airlines. If they began to cancel, Boeing would be in trouble.

The United States economy, like so many of its premier companies, is in a similar position. There is plenty to celebrate, but the boom is precarious. The odds are that the economic expansion that began in 1991 will last at least another year, becoming, by December, the second-longest period of uninterrupted growth in half a century, trailing only the 1960's. All 52 forecasters surveyed monthly by Blue Chip Economic Indicators expect 1998 to be another year of growth. But that does not rule out the possibility of trouble.

The Asian crisis has raised the most alarms, but there are other, sometimes related, threats -- a consumer debt crisis, a sharp decline in stock prices, a punishing trade deficit. Unemployment could rise if corporate profits shrank, bringing fresh cost cutting and layoffs. Some experts even raise the specter of deflation, which could pull down incomes as well as prices, leaving many Americans without enough money to pay off their debts.

All this sounds unduly pessimistic today, as the good times continue to roll. But scary images are woven prominently into the forecasts. Even the optimists struggle with them.

"People are talking of the domino effect: If Korea and Japan are down, who are we in America to think that our economy can grow, anyway?" said Stephen S. Roach, chief economist at Morgan Stanley, Dean Witter, Discover & Company. "I hear that line all the time, and I totally reject it. Over the last two years, the United States economy has defied seers of an imminent slowdown, and it will again in 1998."

The Asian currency devaluations and stock market selloffs, the bankruptcies, bank failures and collapsing consumer demand in that part of the world have shifted attention from the United States economy's strengths to its vulnerabilities.

Boeing production would be hurt if the downturn were to spread to China, Singapore and Taiwan, said Lawrence W. Clarkson, a senior vice president. Quite apart from Boeing, a spreading Asian crisis could frighten Americans enough that they would stop spending, or sell their stocks, or do both. So far, neither has happened, although people have been hearing every day about what the Asian trouble could do to them. The economy's strengths have prevailed.

The gross domestic product grew by nearly 4 percent last year because of bursts of consumer spending, mostly on credit, and big outlays by business for new equipment. This rapidly expanding output of goods and services helped to push corporate profits to their highest levels since the 1960's.

The strong profits, in turn, played a big role in driving up stock prices, adding to the wealth of tens of millions of American shareholders and encouraging them to spend. Ample work also gave people more money and encouragement to spend. The work force grew by almost three million jobs, the unemployment rate fell to its lowest levels in years, and weekly wages rose slightly faster than the inflation rate for a majority of workers.

"For the first time in years, there have been real, broad-based wage gains," said Lawrence Mishel, chief economist at the Economic Policy Institute in Washington. Of course, the wage gains, adjusted for inflation, do not get typical workers back to what workers earned in the 1970's and 1980's. But spirits are lifted anyway.

"Consumers judge small income gains more favorably than they did in the past," said Richard Curtin, director of consumer surveys at the University of Michigan's Consumer Research Center. "Their expectations have fallen. They expect their living standards to improve, but only in modest increments."

The increments have indeed been modest. Wages have been gaining ground not so much because of big raises, but in large part because inflation has been so low -- less than 2 percent over the last 12 months.

The persistently low inflation rate has inhibited the Federal Reserve from slowing the economy, a step that would halt, in the process, the gains in wages and jobs.

"Lots of things can happen to the American economy in 1998," said David Collander, an economist at Middlebury College, "but the most likely thing is that it will keep on growing as long as inflation does not accelerate and the Fed does not step in."

In the Fed's eyes, a strong economy normally produces shortages. With demand rising, there are not enough goods and services to go around. So businesses, in effect, ration what they have by raising prices. Or they raise prices to pay for wage increases. Either way, the inflation rate rises or seems about to do so. And the Fed, in response, slows the economy by raising interest rates to discourage spending and investment. Often in the past, the Fed has raised rates too much and recessions have developed.

This time, however, the pricing pattern is broken. Prices have not risen, even as wages have. Despite strong demand, goods and services are plentiful, not scarce. The Asian crisis plays a role here. With consumers in Korea, Thailand, Malaysia, Indonesia and Japan buying less, those countries are exporting more of their merchandise to the United States, at ever lower costs in dollars, because their currencies are falling in value.

The rising supply of Asian goods comes at a time when United States companies have stepped up production capacity at home. The machinery and floor space used in domestic production have grown over the last two years at an annual rate of more than 5 percent, new Government figures show. That is nearly double the growth rate in the early 1990's.

The issue of the year, then, is oversupply. In a number of industries -- autos, toys, paper, plastics, textiles, electronics -- production outstrips demand. The problem is how to get people to buy up all that is out there, not to spend less. And the Fed, partly in recognition, has left interest rates untouched for nearly a year.

"The global economy desperately needs all the yuppies it can muster," said Edward Yardeni, chief economist at Deutsche Morgan Grenfell, the Wall Street firm.

If they don't meet the challenge, the oversupply will push down prices, which may be a boon to consumers initially. But deflation means more than just falling prices. The price declines squeeze profits. Companies cut back through layoffs and less investment. Unemployment rises, the economy slows, and wages lose ground.

The real deflationary damage kicks in if the value of homes, cars, stockholdings and other property bought on credit drops so much that it is worth less than the debt still owed. With incomes weakening, people fall behind on their debt payments. Defaults rise -- they are frequent even now -- and the property, often held as collateral, loses more value. Banks, credit card companies and other lenders are hurt. There is less lending, and the crisis deepens.

Low interest rates help to avoid all this by bringing out the yuppies. Some rates have fallen even without action by the Fed. The 30-year home mortgage, for example, has dropped to around 7 percent, down more than a percentage point in the past year. The lower rate has stimulated not only home sales and construction but also demand for appliances, carpeting, furniture and many other home furnishings. The housing industry and its satellite suppliers account for nearly 10 percent of the nation's economic activity.

The lower mortgage rate means that the payment on a 30-year, $130,000 loan, the average home loan, has fallen by roughly $100, to less than $900 a month.

Forty percent of all mortgage applications lately are from home owners who are refinancing existing mortgages to lower their monthly payments and thus free up cash for other purposes.

"We are in a mini-refinancing boom, and that is definitely a kick for the economy," said David Lereah, chief economist at the Mortgage Bankers Association. "But if mortgage rates stay where they are, the refinancings and the housing activity will begin to decline in a couple of months as we run out of people willing to take advantage of a 7 percent mortgage."

Like many forecasters, Mr. Lereah expects the nation's economic growth rate to decline in 1998 to 2.5 percent, from nearly 4 percent last year. That would still be above the average annual rate during this recovery, which was weak until the surge in growth over the last 18 months. And 2.5 percent would still be enough, the forecasters argue, to keep the unemployment rate low and wages rising by a bit more than the inflation rate.

Their outlook assumes that the economy's strengths, not its weaknesses, will prevail. But the weaknesses are noteworthy, too.

Perhaps the most alarming is household debt, built up through credit cards, personal loans, mortgages and other borrowing. Household debt has risen to record levels today as a percentage of the personal income available to repay the debt. Measured this way, the debt load is nearly one-third greater than it ever was in the 1960's, 1970's or the early 1980's.

That makes repayment a problem, and personal bankruptcies are at a record level. So are credit card defaults. But the greater danger, some economists say, is that the debt might stop rising. The rate of growth in household debt is already beginning to slow as households cut back their borrowing. As they do so, the economy is deprived of a stimulus that contributed so much to the strong recent economic growth.

Debt has been a source of growth for years. Government borrowing in the 70's and 80's, evident in the rising national budget deficit, provided the main stimulus in that era, says Wynne Godley, an economist at the Jerome Levy Institute. Then, as the Government deficit leveled off and shrank, rising household borrowing took over the task of stimulating the economy. "Now if private credit stops rising, too," Mr. Godley said, "the motor is taken away from the expansion."

Nothing in economics happens in isolation. One dynamic feeds on another.

When consumers cut back on borrowing, spending slows, production declines, job creation slows, unemployment rises, and the economy weakens.

This downward slide is already mildly evident, some economists argue. If so, the Asian crisis will reinforce it. Sales by United States companies to Asian buyers are already shrinking. And rising imports from Asia, at fire sale prices as their currencies weaken, will chip away at the demand at home for American-made goods. In the struggle to sell, companies forgo price increases or cut prices, and corporate profits decline, pulling down stock prices in the process. Soon, millions of shareholders find a part of their wealth gone, and they pull back again on borrowing and spending.

That prospect focuses a lot of attention on prices. "The dominant economic issue this year will be pricing -- the difficulty in raising prices -- and what that will do to profits," said Bruce Steinberg, chief economist at Merrill Lynch & Company.

Asia's role in this process shows up, for example, at Varian Associates, a California-based manufacturer of medical instruments and equipment for making semiconductors. Varian reports that while sales in Asia have slowed sharply, a rise in orders in the United States and Europe, particularly the United States, has more than offset the Asian drag, and Varian's overall revenue is up -- for the time being.

"Fortunately, the International Monetary Fund has stepped into Asia with its bailout programs," J. Tracy O'Rourke, Varian's chairman, said hopefully. "Those programs usually work."

For now, his optimism still reflects the view of most forecasters -- but by no means all. "Something will go wrong for the American economy," said Albert M. Wojnilower, an economist at the Clipper Group, a Wall Street firm, "but it is too soon yet."