Anthony Mirhaydari
Call it the summer of despair. Maybe it's the sweltering heat. Maybe it's the violent solar storm that's pelting the ionosphere with charged particles. Whatever the cause, noble traits like patience, empathy and confidence seem to be in short supply.
The attention in recent weeks has been on debt and how to deal it, and not just in Europe. Uncle Sam lost his pristine "AAA" credit rating. Politicians in Washington have proved more intransigent than usual. Chinese communists are threatening to dump the dollar and are warning Americans that the "good old days" of borrowing from them are over.
Wall Street investors are jumpy. Witness the reaction Tuesday when the Fed announced it would leave interest rates low into 2013 -- a big rally turned into big losses, then returned, with the Dow Jones Industrial Average ($INDU) ending the session up more than 400 points.
But there's much more to worry about than debt. Navy Seals, members of the same group that killed Osama Bin Laden, died in a helicopter crash just when Afghanistan was being forgotten. Austerity and despair can now be seen in the streets of "rich world" capitals Tel Aviv and London.
Are mysterious dark forces at work? Sometimes I wonder. The Standard & Poor's 500 Index ($INX) lost exactly 6.66% on Monday.
But here's the deeper truth: The global economy is teetering on the edge of recession -- or worse. And if it falls, we might not be able to fix it for a long time. Here's why, as well as some specific advice for investing in this mess.
We had our chance
As I've discussed in my recent columns and blog posts, the recovery was always set to be slow, grinding and vulnerable to shocks because of the structural issues facing it. We have the problem of long-term unemployment caused by a gutting of manufacturing and construction. We have the problem of a deep recession caused by the 2008 financial crisis. And we have the problem of too much debt, which has passed from households to banks and now to governments.
Basically, we had one shot to get it right. And we screwed it up.
Fiscal stimulus -- government spending -- could be deployed only for so long. Eventually, credit agency worries about deficits stemming from unfunded entitlements and a graying population would force budget austerity. That's where we are now, and the inevitable spending cuts and tax increases will act as a drag on growth.
Monetary stimulus from the Federal Reserve could work only until ultralow interest rates and quantitative easing incited higher inflation, a devalued dollar and higher commodity prices. All three of these economic drags were at work a few months ago. And with consumer price inflation growing at a 3%-plus annual rate, it wouldn't take much for them to reassert themselves.
The key was to relaunch the private economy with enough momentum to achieve escape velocity: Grow fast enough to overcome structural drags, overcome the pull of gravity to become self-sustaining and gain enough altitude so the removal of federal stimulus wouldn't cause the whole thing to crash back to Earth.
But the launch was bungled.
What went wrong
The spending package was too small and ill-conceived, with half devoted to temporary tax cuts (which, historically, don't help much) and much of the rest focused on keeping government workers in their jobs. Nothing much was done to fix the problems in the housing market, including negative home equity and difficulties related to short sales. Washington's focus turned too soon to things like health care, immigration and Wall Street reform instead of jobs, exports and encouraging corporate investment.
More recently, an opportunity to solve the medium-term budget issues -- with sound recommendations issued by the Simpson-Bowles Commission last December -- was wasted. Taking the right steps here would've kept the rating agencies at bay and opened up additional capacity for more short-term stimulus boosts, such as an extension of unemployment benefits or the payroll tax cuts. Both of these are set to expire later this year.
The economy left the launch pad with half its engines lit -- then it hit bad weather.
A new lineup of woes
The new problems started in spring of 2010 with the panic over the Greek bailout and the shock to confidence from the financial reform efforts and the BP oil spill. They continued with the Irish bailout. And they took a new form this spring with the Japanese earthquake/tsunami/nuclear disaster, the Arab spring and an energy price spike.
Without the structural drags, these issues would've just been turbulence. But now, they are grave threats. The Fed tried to save us with its $600 billion QE2 bond-buying initiative, but its positive influence was eclipsed by the negatives. Higher food and fuel prices trimmed consumer confidence.
