November 15, 1978
Economists from Fourth District firms who convened at the Bank last week have scaled down their expectations for output and raised their estimates of inflation for this quarter and 1979. Half of the thirty economists expect at least one quarterly decline in real GNP next year. Retailers and producers of consumer goods are cautious over short-term sales prospects. Manufacturing and mining activity is supported by a high level of auto production, better-than-expected steel and coal production, and additional but small real gains in capital spending. Financial officers prefer tax relief as a remedy for the steady erosion in capital stock. The city of Cleveland appears to be approaching default.
Economists at the regularly scheduled meeting on the economic outlook held November 10 have considerably altered their expectations for output and prices from those given at a similar meeting last June. At that time, the group expected real GNP would increase at about a 3.0 percent annual rate this quarter and 2.5 percent in the first half of 1979. The latest set of forecasts, submitted before the November 1 actions to defend the dollar, indicates real GNP would increase at a 2.5 percent annual rate this quarter, followed by a 1.6 percent annual rate of increase in the first half of 1979 and a 2.0 percent annual rate of increase in the second half. The participants expect the inflation rate to increase at about a 7.3 percent rate in the first half of 1979 and 7.0 percent in the second half. Although in the aggregate the group expects the expansion to continue through 1979, seven economists expect a recession, and an additional eight a one quarter drop in real GNP in 1979. Moreover, policy actions taken on November 1 further altered expectations; at least a third of the group now anticipates a recession in 1979.
Retailers and producers of consumer goods remain cautious over near-term sales prospects. Some look for a relatively good Christmas season followed by sluggish sales through the winter months. Retailers, especially major chains, are reported to have large stocks of goods and are holding down placement of orders from producers. Department store officials are said to be buying cautiously, partly because of uncertain prospects and also because of more than ample stocks of goods. An official with a large food chain noted that consumers are paying more attention to specials and private brand merchandise in an effort to maintain a fixed food budget. He noted his chain is selectively expanding inventories as an inflation hedge.
Prospects for the auto industry in 1979 suggest a reduced level of sales and production, according to a group of auto producers and suppliers. Compared with an estimated domestic sales volume of 9.3 million units and 2 million imports this year, they expect domestic sales of about 8.7 million units and 1.8 million imports in 1979. An economist with an auto producer recently trimmed his 1979 forecast of domestic sales to 9.1 million and imports to 1.7 million units. He noted that imports will fall more than domestic sales because import price increases of the past year have not yet been reflected in prices paid by the consumers. He expects that part of that sales loss will result in an overall market loss of 100,000 cars in 1979. Auto suppliers, especially rubber and steel producers, report a continued strong level of orders from the two major auto producers.
Steel economists have become more optimistic over prospects for that industry. Several weeks ago, they anticipated a continued high volume of imports and inventory liquidation that would weaken production this quarter. More recently, price hedging coupled with an expected drop in the volume of imports this quarter will likely hold production at about the 87 percent capacity rate of the third quarter. However, a strike by steel haulers could curtail shipments.
Coal production has rebounded to the high levels of earlier this year, following a summer slump. A rail strike contributed to a runoff in coal stocks. Inventories of domestic coking coal, at a record low, induced a surge in imports from West Germany which brought charges of dumping. A freight car shortage is encouraging some coal producers to buy their own cars. The industry expects record production in 1979, but the operating rate would still not exceed 90 percent of capacity.
Mixed expectations mark prospects for fixed investment in 1979. Some economists expect real gains to exceed the 2 percent increase suggested in the latest McGraw-Hill survey. One producer pointed out that much of the recent increase in spending has been concentrated in trucks, autos, and communications. Moreover, some industries are expected to show either little gain or some decline in 1979. Heavy-duty truck production and off-highway tractors are estimated to be at or somewhat below 1978 levels, and machine tool orders will likely drop 20-25 percent in 1979, although a large backlog should sustain production. Others anticipate real gains of as much as 5 to 6 percent over 1978. They cite further strength in freight car production, industrial equipment—including gears and conveyor equipment for mining—and in industrial commercial construction.
At a recent financial seminar at this Bank, chief financial officers of Cleveland-area firms acknowledged that capital stock is being depleted because of inadequate provision for replacement cost of assets. Some asserted that competitive market pressures would not permit increases in prices to reflect replacement costs. Some also felt that financial markets would not accept changes in accounting procedures that would attempt to cope with the problem of inflation accounting. Others remarked that switching to LIFO penalizes income statements and may hinder a continuous upward trend in earnings, an objective of many firms. Several preferred tax relief rather than changes in accounting procedures as a solution.
A growing feeling of a number of observers is that the city of Cleveland can hardly avoid a default in 1978. A top administration official feels that Cleveland needs MAC-type assistance. Since the mayoral recall election last August, Cleveland's political leadership has remained divided on issues that affect the city's solvency. The administration's effort to raise revenues has been hampered by several factors: the city council's refusal to approve a $50 million bond issue until a detailed financial plan is submitted, the loss of the profitable water division to regional authority, and the reluctance of banks to refinance $15.5 million in below-investment grade city notes that are due December 15. Some analysts believe that even an eleventh hour rescue would only postpone an inevitable default until the spring of 1979.