A Jekyll And Hyde Economy

Consumers are still driving demand, but Asia is hurting manufacturers

It's the economy with two faces. The Asian financial crisis is knifing through U.S. manufacturing, cutting exports to the bone and slashing commodity prices. Companies such as Polaroid are curbing shipments until swelling inventories can be sold. Profits are harder to come by. Yet service companies are scrounging for help: Manpower Inc. says white-collar hiring leaped 13% in the spring. Wages are up smartly, as are incomes. The stock market is booming, interest rates are low, and Americans are buying--producing happy retailers and the biggest housing boom in a decade.

Which side will prevail? During the first quarter, the domestic economy was in control. Consumer demand surged, and the economy rocketed along at a 5.4% annual clip. But in the second quarter, the deepening Asian crisis and the strong dollar were the dominant forces. Factory output dropped 0.6% in May, and 29,000 factory jobs vanished in June. May's trade deficit, at $15.75 billion, was a record. When the Commerce Dept. tallies second-quarter results on July 31, the figures will likely show that the economy didn't grow at all. Forecasts range from a 1.5% drop in gross domestic product to a 1% rise.

So is this it--the beginning of the end of the nearly eight-year expansion? Probably not. In the worst case, "we could be looking at two negative quarters this year--a mild recession," says David A. Wyss, chief economist for Standard & Poor's DRI. But most forecasters see a happier scenario: The decline in exports to Asia will soon bottom out, and factories will get a boost when strike-shuttered General Motors Corp. ramps up again. Then--barring a sharp retreat in the stock market--strong consumer demand and capital investment will dominate once again. "People have jobs, confidence, incomes, and strong assets--they're not going to stop spending," says Everett M. Ehrlich, president of economic consultant ESC Co. The consensus: By the fourth quarter, growth will be back above a 3% annual rate before the economy settles into a more moderate pace in 1999.

INFLATION? That's what the Federal Reserve expects. Giving his midyear view of the economy on July 21, Fed Chairman Alan Greenspan warned that "the potential for accelerating inflation is probably greater than the risk of protracted, excessive weakness." So the Fed is leaning toward raising rates, not easing them. That helped send the Dow tumbling 166 points on July 21 and 22.

Talk of overheating seems strange in places where Asia's woes are now hitting home. The port of Los Angeles has so many unused containers that they're being welded into a retaining wall on the Pacific Coast Highway in Malibu. On July 21, Walt Disney Co. said steep drops in video sales to Asia and fewer Japanese tourists at Disneyland helped shave its earnings by 12.2%. AMP Inc., a maker of electrical connectors, shut down plants in Pennsylvania and North Carolina on July 17 because of slumping sales across the Pacific.

The collapse of commodity prices, prompted by the Asian crisis, is also rippling through the U.S. economy. The sharp drop in oil has idled 14% of the offshore rigs in the Gulf of Mexico, and prompted Nabor Industries Inc. to slash 1,400 jobs. Washington is talking about emergency relief to help farmers who are watching prices plunge and export orders evaporate.

Meanwhile, many high-tech highfliers have been feeling the pinch--both from Asia and from price wars in the U.S. At Compaq Computer Corp., profits before acquisition charges fell 87%. Chip giant Intel Corp. reported a 29% drop in profits and a contraction in shipments. One reason: Makers of hot-selling sub-$1,000 PCs are using lots of non-Intel chips. Another high-tech victim is Hewlett-Packard Co., which warned that profits for its fiscal quarter ending on July 31 would be flat because of slow sales to Asia. Computer Associates issued a similar warning the next day.

Then there's Detroit. In the second quarter, the U.S. market surged to a rebate-fueled annual sales rate of 16.6 million, helping Chrysler Corp. and Ford Motor Co. post record profits. But analysts, who say sales for all of 1998 will total 15.3 million units, predict that activity will slow in the second half.

The big question is when GM will resume production. The auto giant's virtual shutdown trimmed half a percentage point off second-quarter growth, while its 73% drop in operating earnings exacerbated the 2% earnings gain by 85 other companies in BUSINESS WEEK's flash profits survey. GM's pain is being felt across industrial America. Chicago's A. Finkl & Sons, which makes molds used by auto-parts suppliers, stretched its annual summer shutdown from two weeks to three because of strike-softened demand. "Customers are asking us to hold their orders" for up to a week, says Chief Financial Officer Joseph E. Curci.

Yet forecasters say the stage may be set for a healthy fourth-quarter rebound. If GM can settle its labor problems in August, its restart alone could add 1.3% to fourth-quarter GDP, says Joel Prakken, chairman of St. Louis-based Macroeconomic Advisers.

SERVICE STRENGTH. If things keep perking along in the service economy--where 80% of the U.S. workforce is employed--the manufacturing slowdown will be remembered as a minor blip. The service sector has added 1.4 million jobs this year, including 215,000 in May. In all, service companies' profits grew 20% on a 16% rise in sales during the spring quarter, according to the flash profit report.

For proof, check the mall--if you can find a parking spot. With real aftertax incomes rising at a 3.6% annual rate, Americans are spending freely. Second-quarter retail sales were up 8%. At Wal-Mart Stores Inc., same-store sales were up 9% in June. Consumer confidence and low interest rates are cranking up the housing market to its hottest level in 13 years. Builders started new houses at a 1.6 million-unit annual pace in June.

Will consumer confidence ebb? Not as long as the stock market remains strong. Even with current drops, key market indexes are in record territory. "Most consumers don't even know that Asia has happened," says James E. Glassman, chief economist at Chase Securities.

Are they simply blind to the dark side? Perhaps. But given the strength they see around them, Americans can be forgiven for not looking overseas for trouble. As long as Wall Street keeps smiling, consumers will, too.

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