Risking another US recession

Without addressing the multiple challenges posed by the banking system, oil prices, Europe and Asia, the US is at risk of sliding into a recession in 2012.

Just as the US economy appears to be improving, four sets of forces could thrust America into an abyss rivalling the Great Depression.

First, for decades, Washington pursued more open global trade and domestic deregulation, which unleashed great potential for innovation and growth. China and other nations, however, have abused freer trade through export subsidies and import barriers to boost their economies at the expense of others. And in some industries, a few players have amassed great monopoly power – notably, large financial houses on Wall Street and Europe now have an iron grip on lending.

The Great Recession was caused by too little demand for what US and European workers make and faulty banking practices. During the years prior to the collapse, China and other Asian mercantilists undervalued their currencies to increase exports but refused to purchase nearly as much as they sold in the United States and Europe. Unemployment in the West should have resulted, but banks kept things going by lending too much to consumers on their homes and credit cards. When mortgages and mortgage-backed securities failed, the system collapsed.

Since mid-2009, stronger exports and manufacturing have powered a modest US recovery. However, little has been accomplished to curb Asian mercantilism or the Wall Street casino culture. Now, China is addressing its own housing bubble and bank troubles by again devaluing its currency to further boost exports, and US banks are again busy trading, taking bets but not making loans to small and medium-sized businesses. Next year, more competition from China and the credit shortage will combine to slow US growth and jobs creation.

Second, oil is rising above $US100 a barrel again, and higher gas prices will limit consumer spending on other items this winter. Yet President Obama, to placate his political base, continues to slow, stall or stifle most new petroleum projects.

Third, European leaders, to tackle their sovereign debt crisis, are cutting spending and raising taxes, but not dealing with flaws in the eurozone architecture – most importantly, the absence of EU authority to tax, spend and even things out a bit among richer and poorer regions.

The 50 per cent haircut imposed on private creditors by the Greek bailout, coupled with heavy bank holdings of government bonds, have caused depositors to flee commercial banks in Mediterranean economies and banks across Europe to withdraw from lending outside their home markets. Over the last six months, the money supply and lending have contracted at an alarming pace in the Mediterranean economies and Ireland, and are hardly adequate elsewhere in Europe.

Draconian austerity and tight money did much to turn the 1929 panic into the Great Depression, and very similar conditions are unfolding in Europe today. With an economy almost as large as the United States and China combined, the European recession will depress exports and stress banks in the United States. Alone, conditions in Europe might not cause another US recession, but in concert with China’s renewed mercantilism, banking problems and higher gasoline prices, those could sink America quite nicely.

Fourth, US unemployment remains stubbornly high and the recovery has failed to pick up steam, in some significant measure, because businesses cannot find qualified workers. Yet many college graduates remain unemployed or underemployed, because America’s high schools and universities do too little to encourage students to study engineering and other technical disciplines.

With all these problems percolating, the president spends nearly all his time campaigning, telling Americans things can’t be improved much more for now and the best they can expect is a $20 a week break on their payroll taxes. And Congress foolishly lets him set the agenda.

Without genuine efforts to redefine the rules of trade with Asia, refocus US banks on the quaint business of making loans to finance business expansion, develop more domestic oil, insulate America from the suicidal instincts of European leaders, and require schools and universities to emphasise skills the economy needs, the US economy will continue its low-grade recovery or even slip into a recession that could last a decade.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former chief economist at the US International Trade Commission.

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