The American economy, jarred into recession by the outset of the Persian Gulf crisis five months ago, is apparently on the path toward recovery, boosted by the financial market's enthusiastic reaction to the opening days of the war against Iraq.
But with the Bush administration warning the public to prepare for a drawn-out conflict, forecasters are distinctly uneasy about declaring an economic victory. Various scenarios -- running from optimistic to worst-case outcomes -- have emerged from the complex computer models forecasters use to chart the economy's future. The key elements of those scenarios involve the innate capacity of the American economy to bounce back from trouble, the price of oil, the confidence of consumers and business and the fragile condition of the nation's banking system.
From an economic standpoint, the outbreak of fighting already has produced a crucial result. The sharp drop in oil prices after Jan. 16 and a smaller but still important decline in long-term interest rates have been distinct pluses in reversing the economy's decline. Lower oil prices, which could mean a decline in gasoline prices of at least a dime or more a gallon at the pump and larger savings on home heating oil, should help ensure that the current economic slump does not drag on.
In the most common scenario, the slump ends no later than this spring. A more optimistic outlook, from Bush administration economists among others, has the economy turning upward as soon as the next month or two.
The worst-case scenarios, on the other hand, are brewed from a combination of an extended, bloody war, a traumatized American public and a crisis in the nation's banking system.
If the war were to continue into the spring with daily reports of high American casualties, how would the American public react? It was the virtual collapse of consumer confidence following Iraq's Aug. 2 invasion of Kuwait that did much of the economic damage last fall. Might a lengthy war and perhaps rising protests against it further undermine consumer attitudes and cause them to cut back even more their plans to buy new cars, homes and other goods?
Such a development cannot be completely ruled out, but it is not what most forecasters believe is probable. For example, when DRI/McGraw-Hill Inc., an economic forecasting and consulting firm in Lexington, Mass., updated its forecast last week, it assumed a six-month war with a slow ground offensive that ultimately would cost $75 billion.
But even with that long a conflict in its model, DRI concluded that the economy will turn upward in late spring and that consumer confidence will slowly improve.
"It is bad for the economy," said DRI chief economist Roger Brinner. "We have a real war, and consumers are not going to feel good about the world. But we will still get a rise from the awful lows in confidence. There is an existential relief that something finally is happening."
The gains will be limited by the length and horror of war, however. Explained Brinner, "If we get into a ground war, I just can't believe the consumer is going to spend, with thousands of casualties being reported. ... The consumer has a little more real income to spend" as a result of lower oil prices "but will not be in a mood to spend it."
In Brinner's forecast -- which resembles other relatively cautious forecasts these days -- civilian unemployment peaks next summer at 7.2 percent, up from 6.1 percent last month and 5.3 percent during most of 1989 and early 1990.
Once the war is over, consumer and business confidence bounce back and so does the economy, with the "real," or inflation-adjusted, gross national product rising at more than a 4 percent rate in the second half of this year. In the last three months of 1990, real GNP fell at an annual rate of 2.1 percent. Meanwhile, higher unemployment rates and more idle factory production lines are expected to help hold consumer price inflation to a rate of about 3 percent, half the 1990 pace.
Defense spending rises as a result of the war, but DRI does not expect it to provide much of a stimulus for the economy until after the war is over and decisions are made about how to replace the bombs, missiles, planes, tanks and other equipment used up in the fighting.
DRI does not believe the war's cost, which is assumed to be financed by borrowing and payments from U.S. allies, will cause serious problems for financial markets. Federal Reserve Chairman Alan Greenspan shares that view.
A more optimistic scenario is easy to sketch and is probably more likely to happen than the worst-case alternative.
The obvious route to a quicker end to the slump is either a shorter war or one in which American casualties remain low despite its length. In that case, consumers and business confidence might rebound as they anticipate a successful end of the war even while the fighting continued.
A short war also could boost the economy by knocking oil prices on down to $15 or $16 a barrel from the $20 to $22 range now prevailing, some analysts believe. Earlier this month oil prices were in the high $20 and on the eve of the war reached $32.
Even without such a surge in confidence, the downturn still could hit bottom within a month or two, as the administration predicts it will, if the war does not further undercut confidence. There were signs in both the fourth-quarter GNP report and the December industrial production report that the worst of the recessionary forces were waning, as Greenspan said earlier this month probably was the case.
"The numbers make me more optimistic," said Commerce Undersecretary Michael Darby after the GNP report was released Friday. Darby noted that business inventories fell sharply in the fourth quarter, suggesting the stage may be set for some modest production increases before long.
"The inventory story is a real one," Darby said. "It is hard to have a big recession without an inventory problem." While declines in economic activity that have already occurred probably ensure that first quarter GNP will also be down from the fourth quarter, "the inventory situation argues that the first quarter will be a bit better."
When the shooting war began Jan. 16, the stock, bond and oil markets all rallied. The key to the upbeat response was the apparent inability of Iraqi forces to damage or even pose a serious threat to oil fields and production facilities in Saudi Arabia.
"U.S. Air Force mastery of the sky implies that Saudi oil production is not at risk from Iraqi attack," said Charles Lieberman, managing director of Manufacturers Hanover Securities Corp. in New York. "With ample supplies worldwide, oil prices should decline significantly in the days ahead, even from current levels."
Until the war actually began, the most common worst-case forecast involved severe damage to Saudi oil fields, soaring oil prices, plunging consumer confidence and falling incomes. With high oil prices came rising inflation, preventing the Federal Reserve from counteracting the worsening recession by lowering interest rates.
The remaining potential danger to the economy, in the view of many forecasters, is a disaster in the troubled U.S. financial system. None of the several hundred bank failures of recent years has shaken consumers' basic faith in the banking system because the vast bulk of their deposits are federally insured and, in the case of larger banks going under, uninsured deposits have been protected by the government as well.
Nevertheless, there is always the risk that the failure of one or more large banks could finally shake that faith. Bank runs triggered by that lack of confidence, even if successfully stemmed by the Federal Reserve pumping money into the banks, conceiveably could frighten households and businesses to the point that they simply stop spending except for absolute essentials.
At the very least, such a disruption of the banking system could drive down the price of bank stocks and make institutions even less willing to make loans than they already are. Large loan losses have eaten into the capital of many banks just as federal regulators are requiring institutions to have high higher levels of capital. At the same time, the losses and poor prospects for earnings have driven down their stock prices.
Taken together, these pressures have made capital-short institutions far less willing to lend money as they did in the past. Indeed, instead of increasing the amount of lending on their books, some banks, such as Citibank and Chase Manhattan -- Nos. 1 and 3, respectively, among U.S. banks ranked by assets -- shrank their balance sheets by a total of more than $22 billion last year.
Many large U.S. money-center and regional banks will remain at risk, particularly up and down the East Coast, until the market for commercial real estate -- office buildings, shopping centers and the like -- stabilizes. The bulk of the banks' losses last year were due to bad loans on such properties.
Fed Chairman Greenspan blames the drop in lending these forces have produced -- the so-called credit crunch -- for part of the current economic slowdown and cites it as one reason interest rate reductions engineered by the Fed have had so far given the economy so little boost. And he said last week that action urgently needs to be taken to encourage more lending. He declined to say, however, what moves the Fed is considering other than further interest rate cuts.
If a series of bank failures and runs caused credit to dry up even more than it has, and the Fed and other bank regulators could not get the system functioning well again, the U.S. economy might be squeezed hard enough to extend the slump for many months. Almost no expert believes that will happen; rather, the worry is that the continuing credit crunch will keep the recovery anemic.
Last week, Robert D. Reischauer, director of the Congressional Budget Office, told Congress that the CBO expects the recession to be short and mild, ending by midyear. But in an alternative "low-growth" forecast, the driving force is a credit crunch that "is assumed to become substantially worse than it currently seems. This turn of events would weaken private domestic spending," Reischauer said.
But there are more optimistic alternatives around than pessimistic ones -- though forecasts such as DRI's remain the most common view. A handful of economists, such as Robert Giordano, director of economic research at Goldman Sachs & Co. in New York, believe the economic turnaround could come quickly enough to cause real GNP to increase this quarter rather than decline.
"December's increase in hours worked points to a slight rise in real GNP in the first quarter of 1991," Giordano wrote recently. "An even larger rise could be in store if all of the surprising lengthening of the workweek in December turns out to be real rather than statistical."
Giordano went on to cite evidence that the nation's battered housing market may be stabilizing and that business plans to invest in new plants and equipment indicate "that businesses still regard recent production and spending cuts as short-lived."
Two other positive signs came from last week's report on GNP.
First, the nation's trade balance improved substantially as exports continued to rise while imports fell. When the trade deficit gets smaller, demand for and production of American-made goods and services rises, boosting GNP and employment. Most forecasters are counting on further trade gains as a major impetus for the economy in 1991 and 1992.
Second, the economy's fourth-quarter drop was heavily concentrated in the automobile industry. If the production of new cars and trucks had not declined substantially last quarter, the Commerce Department said, real GNP would not have fallen. The good news is that such a big drop in auto assemblies is not likely to be repeated this quarter.
On a seasonally adjusted basis, new car production dropped from an annual rate of 6.9 million units in the third quarter to a 5.5-million-unit rate in the fourth, a huge 24 percent decline. While poor sales results may cause automakers to trim their production plans -- General Motors Corp. announced last week that it was doing so -- the latest published figures indicate a small first-quarter increase in the industry's output rather than a decline.
A turnaround in auto production could be the spark that signals that the economy has hit bottom. If it came soon enough, there still is a remote chance that the current slump would not be officially labeled as a recession by the arbiters at the National Bureau of Economic Research.
Whenever the turn comes, the economy still will face some serious problems: The capital-short banking system still will be under severe pressure; many metropolitan areas will have so much empty office space it will take years to fill it; falling home values will have hurt many family pocketbooks; and after the long expansion of the 1980s, consumers are well stocked with appliances and cars.
In addition, the federal budget deficit will be hitting new highs of well over $300 billion dollars, pushed up by both the war and the incredibly costly cleanup of the thrift industry debacle. There will be little, if any, room for added federal spending.
All of those conditions argue for a subdued expansion once the initial bounce back from the current decline is finished. In the meantime, the war remains the primary source of worry and uncertainty.
Until its outcome is known -- though no one doubts that the allied forces will prevail -- as well as how that outcome is achieved and at what cost, the nation's immediate economic future is not going to become clearer.