A year ago, I said, “2011 may be an exciting year but probably not a comfortable one.” Despite budget problems in Europe and in our own country, things were generally dull, although the economy stayed in the doldrums as I anticipated.
Nevertheless, I continue to be a pessimist about prospects for the national and global economies over the next few years. I think there is a strong likelihood that conditions will be worse at the end of 2012 than they are now.
My pessimism is based on a subjective reading that upside potential for the economy is limited. At best, we will have the slow growth that typifies recoveries from deep financial crises. Output may grow by a couple percent and employment may rise enough to drop the unemployment rate slightly. But there is no plausible scenario for a return to growth that would bring unemployment back below 6 percent in the next two years.
Unfortunately, there are plausible reasons the economy might well deteriorate. Here are three:
China has been on an economic tear for 33 years. That is simply wonderful for the global economy in the long run. But, like any other economy that enjoys a long period of high growth, imbalances increasingly build up and poor economic decisions are made more often.
In China, this is most evident in real estate and construction. There is much evidence that China is in the throes of an unsustainable bubble every bit as bad as those we've seen in the United States, Ireland or Spain, with billions going into commercial and residential buildings that have no economic purpose. And there are many signs the bubble is about to pop.
Finance in China is still opaque and dominated by state-owned banks that are subject to little market discipline and even less regulation. The technocratic Chinese government is quite proud of its growth record, but it has never had to weather even a garden-variety recession.
Moreover, much more than in a democracy, the entire Chinese political and economic regime depends on continued growth, so that economic progress overcomes popular dissatisfaction with lack of political freedom and with corruption that hurts the poorest classes the most.
China has been an economic engine that has pulled the rest of the globe along for the past four years. Much of the strong growth in resource-exporting countries in Africa and South America hangs on Chinese demand. Ditto for U.S. farms and mines. Like it or not, China now plays such a major role in the global economy that no other major nation can expect to be unaffected by a downturn in that nation.
Europe is a second area of concern, even though we are in a temporary lull from the crisis atmosphere that prevailed in the first weeks of December.
The European Central Bank has flooded the eurozone with liquidity in the form of nearly unlimited low-interest loans to banks. This can help stave off collapse, but it cannot solve the underlying problems of a single currency. And there is no guarantee that other factors nevertheless won't bring things to a head. The periodic crisis meetings of EU heads of state demonstrate continuing political impotence. And the domestic political pressures in key countries like Germany and France that underlie such collective impotence are getting worse rather than better.
The worst threat comes from ourselves, however. A decade ago, with very modest budget surpluses at an unsustainable peak in the business cycle, we were near to having the fiscal cat in the bag. But then we threw the bag away with a return to the suicidal mentality that “deficits don't matter.”
Now, we are in a de facto recession, even if an official committee says we are not. The deficit has ballooned. Political deadlock has worsened. The deficits are unsustainable in the medium and long runs but will only be reduced by higher taxes and lower spending. Yet such tax increases and spending cuts both inherently slow an economy.
Democrats remain fixated on tax increases only for the rich and the maintenance of existing entitlement programs. The Republicans oppose any tax increase and don't have credible programs for reducing entitlements.
The perversion of Senate rules so 60 votes are needed to pass even a resolution honoring apple pie means that we are likely to stay in deadlock after the 2012 election. That means fiscal problems will be resolved only when forced by external events. And that inherently increases the likelihood of a severe recession.
Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.
