(FORTUNE Magazine) – Weighing heavily on all Americans, the Gulf war has changed the economic environment. The most recent straws in the wind suggest that the worst of the decline is over. But the uncertainties and anxieties of battle could yet reverse any nascent favorable trend. Indeed, Federal Reserve Chairman Alan Greenspan worries that a long conflict could demolish it. The core problem so far has been that business confidence unraveled with the surging oil prices during those long months between August 2 and the start of fighting. Many companies coped by cutting payrolls. Call it a loss of nerve or call it prudence, but their response turned out to be critical. Employment dropped by 773,000, and the civilian unemployment rate climbed from 5.4% to 6.2% as businesses in almost every industry retrenched. The Fed's February 1 discount rate cut came just hours after the most recent unemployment reports. Real disposable income fell at a 4.5% annual rate in the first four months after the invasion. Income remained below the July peak even after a rebound in December. Consumers cut spending, and the already fragile economic expansion succumbed. Real GNP declined at a 2.1% annual rate in the fourth quarter. The war should prove less of a damper on business than the waiting did -- as long as the fighting doesn't drag on and oil remains readily available. Traders appear to have few doubts. Instead of spiking as anticipated after January 16, oil prices plunged. Refiners paid $32.68 on average for a barrel of imported crude in October, more than double the preinvasion price. FORTUNE estimates that refiners' costs for imported oil had fallen back to an average of $24.50 in January (see chart). Oil prices remain crucial to the economic outlook. ''We don't need Kuwaiti or Iraqi oil right now,'' says G. Henry M. Schuler, director of energy security programs at the Center for Strategic International Studies, a Washington, D.C., research organization. ''But there is no unused capacity anywhere.'' Temporary shortages and price increases could develop not just from war damage to the Saudi fields but from any disruption, such as the North Sea accident of 1988. Assuming that the war will be over in a few months -- still the most likely of the many imaginable alternatives -- what happens to oil prices then? At first they will probably collapse even if the Saudis clamp down production quickly. ''Fundamentals are irrelevant to current prices,'' says Schuler. ''They are determined by traders who are convinced there will be a glut.'' The Saudis may also help the world out with a spell of bargain-basement prices. But with OPEC united and hungry for revenues, oil should soon settle in the $25 neighborhood. While the winds of war have depressed sales in the automobile, travel, and many other industries, a few are starting to benefit. Producers of defense goods are getting a bit of extra business (see Cover Stories). Though the U.S. won't replace all the munitions and weapons lost in the fighting, it is likely to accelerate the development of advanced versions. Textile producers, which supply the Defense Department with some 10,000 items, including fabrics for sandbags, uniforms, cots, and chemical protective suits, have had a step-up in production that they expect will run through 1991. But Gordon Bronstein, chairman of the American Textile Manufacturers Institute's military subcommittee, says Desert Shield and the war have only ''stayed the ax'' that was about to fall on them. ''The increase is not significant enough to change the overall picture in the industry,'' he says. Military sales account for only about 2% of the textile business. Nevertheless, manufacturers are using the occasion to bolster their case for protection from foreign competition -- textiles, says the institute, are now a national defense issue. When the war is over, the need for equipment and manpower in the Mideast will be enormous. Saddam has cannibalized some of Kuwait's refineries to repair bomb damage to his own. And take it as a given that he will adopt a scorched-earth policy when he retreats from Kuwait. He has reportedly wired all the oil-producing facilities with explosives. Pre-August 2, OPEC suggested / that some $60 billion of investment would be needed over the next five years to meet increased world demand. Now add an estimated $40 billion for war repairs, not to mention the need to replace roads, airstrips, and other infrastructure. U.S. companies such as Fluor, Bechtel, and Dresser Industries should win sizable contracts, at least from Kuwait. It's hard to know who will get business in Iraq. Before the war, FORTUNE figured that real defense purchases of goods and services would decline about 1.5% this fiscal year and 8.5% next. Additional purchases because of the war will cancel out this year's drop and moderate the one in fiscal 1992. In his State of the Union message to Congress, President Bush said that his budget would keep government spending below inflation. Presumably the military will share in the pain. CONSIDERABLY more significant to the economy is the psychology of war. Thus far, despite their gloomy mood, consumers have spent practically all the money they can get their hands on. But Fed Chairman Greenspan told Congress that ''this is an economy which is subject, more than at any time I have seen in the recent past, to changes in psychology,'' suggesting that the pattern might not hold in the future. Recently consumers appeared to be feeling a little less shaky. The Conference Board's index of consumer confidence was down again for January, to the lowest level since May 1980. But the Board found a touch better mood after the war started than earlier in January. Sindlinger & Co., which samples the consumer psyche weekly, reported a sharp improvement in the weeks since the war began, albeit to a still subdued level. Greenspan's fear is that a prolonged war -- more than three months, in his view -- could send consumers into their bunkers, lengthening and deepening the recession. Would it do the same to businesses, already nervous about such other worries as the health of the financial system? Greenspan did not say. Making the important assumption that the war will not drag on and wreck business and consumer confidence, FORTUNE views the fragmentary evidence available so far as signs that the worst of the recession is behind us. Along with the rebound in incomes, real consumer spending ticked up in December in every major category except gasoline and clothing. Retailers, who never expect much from January sales in the best of times, report mixed trends after January 16. Auto sales trends are mixed too, with the pace through mid-January providing little pleasure for dealers and manufacturers. But the 6.2 million unit rate was not too shabby, considering that consumers have been spending 4.7% of their after-tax incomes on cars, nearly a percentage point more than at the bottom of the last three recessions. Increases in sales of radios, flags, and clothing decorated with flags added a fillip to the month for some stores. In general, large retailers detected little impact of the war on business. Mary Lorencz, a spokesperson for Kmart, says the big discounter's sales have held up ''nicely'' since the beginning of the year, with no dip after the war broke out. SUCH SIGNS could start to relieve the worst fears of business executives and stem the tide of employment declines. In the circular way the economic process works, that will raise incomes, setting the stage for further sales and employment growth. All along, consumers have shown they will spend it if they have it, despite their low level of confidence. They've saved less of their incomes in recent months than they did before the Iraqi invasion. FORTUNE expects real disposable income to rise a respectable 2.5% in the year ahead. Purchases of goods and services should match the gain. Though commercial real estate is dead, housing will manage a modest comeback this spring -- mortgage rates are hovering below 10%, and overbuilding is minimal. Increased sales of furniture and equipment will follow. Even sales of clothing and shoes, which have been weak for much of the past several years, should pick up moderately as employment starts to expand. And there's no consumer service recession. Outlays for doctors, dentists, car repairs, cleaning, laundry, recreation, and most other services have continued to increase. The only major component that has declined recently is airline travel. Barring nasty surprises from the war front, the economy should be expanding again by summertime.

BOX: OVERVIEW

--If the war ends, the economy will expand before summer. -- Consumers' incomes and spending will increase 2.5% in the year ahead. -- U.S. companies will share in rebuilding the Mideast.

CHART: NOT AVAILABLE CREDIT: NO CREDIT What U.S. refiners pay for a barrel of imported crude What share of income consumers spend on gasoline ROLLING THEM BACK A Parkville, Maryland, 7-Eleven cuts a penny. Oil's decline since November is putting a few extra dollars in consumers' pockets.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: Consumer spending A RESPECTABLE REBOUND Purchases of furniture, cars, clothing, and other goods will bounce back come spring. Services stumbled, but will resume their climb.