The Top 3 Things That Could Derail This Recovery

There’s no doubt that that the US recovery from the Great Recession has been at best modest. While we have not really seen any persuading signs of a double-dip recession, this recovery could easily get derailed and thwarted if any of the following three scenarios play out.

Business Insider actually ran a poll last week asking readers What Their #1 concern was about the US Economy. Here were the results. While I do have similar worries, my outlook & the priorities of each worry is a little different.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

My Top 3 Worries

1) Fiscal Consolidation and Tightening in 2013

We’re barely starting to see some strong signs of life in this recovery. Jobs are improving and some economic indicators are showing bullish signs. However, all of this can come apart in 2013 as we see some fiscal tightening brought upon by the “Automatic Cuts” that triggered last year when our politicians failed to come to an agreement.

Besides the fact that we are going to see “Automatic Cuts”, there is a small possibility that we see some further reductions in the US Deficit (either by Democrats or Republicans via Taxes or Spending), which would hurt the recovery really badly. How bad is deficit reduction in a time of economic weakness? Well just ask Japan (& Richard Koo), who tried Fiscal Consolidation in 1997 and 2001, which ended up in massive failures.  Japan is still to this day struggling with deflationary pressures. Pre-mature deficit reduction kills a recovery. Private-Sector savings during a recovery (especially one which was caused by the biggest financial crisis since the Great Depression) must stay high if we want true growth.

Just take a look at the following chart which shows Private sector Savings (which by an accounting identity is the mirror image of the Public Sector’s deficit) with Recessions highlighted in gray. As you see, anytime there was a significant reduction in Private Sector Savings, a recession followed. Not that I am hoping for a recession, but the fact that we want fiscal consolidation and will see fiscal tightening is a big concern of mine.

(Note: Realize one of the reasons we have not seen a double dip recession is because of the massive deficits wev’e been running for the past 3 years.)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2) Gas/oil prices & Iran

My second worry has to be gas and oil prices, which is ultimately tied to Iran. Right now, I believe the rise in oil/gas is transitory. I expect it to settle back a bit in the near future. A lot is tied to Iran, which is putting a MAJOR premium on prices. If the Iran situation blows over and everybody forgets about it, I can easily see oil and gas prices retreating back some. However, If I am wrong, and the Iran situation escalates, a spike in gas and oil prices could lead to some major demand destruction thus leading into a likely economic contraction.

While gas prices are high, we are not at this level yet (as explained in a previous post). But that does not mean gas/oil prices cannot take its toll on the recovery. If we do see higher prices for a long time, without any significant growth attached to it (meaning high prices from supply disruption and not from a demand-pull), then the recovery could really be derailed.

Here was a good post over at Econbrowser that talks about gas/oil prices. I also like following the chart below, which shows Energy Expenditures as a Percent of PCE. While different than Gas Expenditures, this is more useful as it shows how much Americans are spending on Energy, which takes up a bigger share of expenses. As of right now, we are below the ~6% inflation level.

 

3) Europe Collapsing

I was going to list “Political Dysfunction” as my 3rd worry, but it is hard to project this as there might be major changes in the congress and presidency which could really end up limiting any possible dysfunction.

However, Europe Collapsing has to be a real threat. For now, the LTRO plans have really “kicked the can down the road”. However, the core issue remains: Debt is too high (which as a currency user of the Euro, $EURUSD, is a big problem) as production falls. Yields have moved down to sustainable levels, however, this is definitely a temporary move.

Besides the core issue, Austerity is proving to be the wrong solution to Europe’s woes. Europe needs growth. No nation has ever successfully ”payed down debt”. The only way out of this is by Growth. However, the Europeans (Euro Zone nations) are not seeing any of this. Trying to grow via Austerity is like trying to lose weight by cutting of your arm. Yes, in the end you lose weight, however, was this a smart way to go? No, as your production (growth) in the future will be severely limited because of your missing one arm.

Here’s a chart of the EuroZone’s GDP growth by Quarter. As you see below, the EuroZone saw its first negative growth quarter since 2009. While the contraction is not depression-like, there is worry out there this recession can turn into something like 2008/2009 where the EurZone saw heavy deflationary contraction.

 

 

Tags: $MACRO $ECB $CL_F $UGA $RB_F $EURUSD

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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