Image: Wall Street sign © Corbis-SuperStock

Related topics: stocks, economy, China, India, Anthony Mirhaydari

If you're like most people, you don't hold the economy in high regard. In fact, you probably think it stinks.

It's not for lack of effort. The Federal Reserve has created more than $2 trillion in new cash to go out and buy assets, including U.S. Treasury debt and mortgage securities, in an effort to get things moving. Short-term interest rates have been near zero since 2008.

The government has spent trillions more on stimulus packages, from then-President George W. Bush's stimulus checks in 2007 to President Barack Obama's $787 billion package to the payroll tax cut approved in December. There was the $700 billion bank bailout. The American International Group (AIG, news)bailout. The automaker bailout. The Bear Stearns dowry to JPMorgan Chase (JPM, news). Cash for Clunkers. Cash for washers. The homebuyer tax credit. The federal takeover of Fannie Mae and Freddie Mac.

And it wasn't just us. The Chinese spent $585 billion on a stimulus package. The French cut taxes on restaurant meals. Interest rates were cut around the world. Between August 2007 and May 2009 -- just before the recession officially ended -- the team at the ISI Group counted no fewer than 837 stimulative policy initiatives worldwide.

Yet through it all the economy has acted like a black hole, sucking in stimulus spending and cheap money and yielding very little in return. Each new effort, which carries ever-greater risk of inciting runaway inflation or a new government debt crisis, falls short. We can't resist the relentless gravitational pull of the Great Recession.

The good news is that the U.S. can escape this "black-hole economy," but it means tackling three huge political and economic problems that are keeping the recovery in check. Here's a look at what needs to happen.

Economists out of touch

Image: Anthony Mirhaydari

Anthony Mirhaydari

According to the economists, we're entering the third year of an economic expansion. But this black-hole economy is not something we're imagining. That's especially clear when you compare this recovery with the rip-roaring years in the 1990s -- the last time wages and living standards enjoyed a real boost. That was economic growth fueled by income gains, not one artificially inflated by easy credit and an epic housing bubble.

Today, unemployment has moved back above 9%. Incomes are stagnant. Prices are on the rise. Home values are falling again. The U.S. Treasury faces the specter of debt default. Health care and higher education are increasingly unaffordable for millions trying to achieve the American Dream.

The numbers tell a sad story. According to Credit Suisse, the economy is nearly 8% behind the typical recovery seen in the wake of a severe recession. Consumer spending is nearly 11% below where it should be. Business investment is nearly 19% too low. Wages are 9.5% too low.

It's no wonder that a majority of Americans believes the economy is in recession or depression, according to a recent Gallup poll.

The 3 hurdles ahead

There are several reasons all that stimulus hasn't worked.

The Europeans short-circuited the recovery last summer with the panic that led to the Greek bailout. There was talk of a double-dip recession. Fear returned to the financial markets.

Then, last August, Fed Chairman Ben Bernanke fended off the growth scare with a speech in Wyoming laying the groundwork for the $600 billion "QE2" money-printing stimulus that launched in November and is set to end next month. (For more on QE2, see my May 4 column, "How the Fed made the rich richer.")

But now growth is stalling again, with factory activity plunging and jobless claims rising. The European debt problem is flaring up and spreading from the periphery to semi-core countries like Spain and Italy. Japan, the world's third-largest economy, has fallen into a new recession.

The Citigroup U.S. Economic Surprise Index -- which drops when reported economic data come in below Wall Street's expectations -- has fallen to levels not seen since this past August. And the imminent end of QE2 has raised fears about what happens when you stop feeding the black hole.

The deeper issue here is that the United States is dealing with at least three big structural problems: the fallout from an epic asset price bubble and credit crisis; a runaway fiscal deficit and growing public debt problem; and the competitive implications of globalization. These are the sources of our black-hole economy.

Each one alone would be enough to limit an economic recovery and expansion. Combined, they explain why the results of the last three years have been so underwhelming.

The good news? There's a way out.

Beating the bubble

The first issue -- fallout from the credit bubble -- will simply take time, according to the work of Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard. Home prices must fall. Large debt piles must be repaid or restructured.

In their seminal work "The Aftermath of Financial Crises," they find that recessions resulting from bank panics are "protracted affairs" that dampen economic growth for a decade afterward. The job market takes a big hit, too, with unemployment jumping an average of 7% during the down cycle, which lasts an average of four years. We saw a 5.7% increase in the unemployment rate from March 2007, hitting a peak of 10.1% in October 2009.

There is also a large hit to the government's finances: The inflation-adjusted value of the public debt has risen an average of 86% in post-World War II recessions, due mainly to drops in tax revenues and the cost of economic resuscitation efforts. Since late 2006, the U.S. debt load has jumped 51% to $14.3 trillion.

Boosting the budget

This brings us to our second issue: fiscal retrenchment. Cutting Washington's budget deficit and paying down the debt would be painful, but doing so is possible. Much depends on returning the economy to health -- which would been a lot easier if we'd had no national debt and a budget surplus at the start.

As I said in my Feb. 4 column ("Pulling the plug on the economy?"), much of the current U.S. fiscal problem is related to the downturn. As growth picks up, tax revenues will rise and spending will fall -- automatically closing some of the budget gap, which stands at more than $1.6 trillion, or 11% of gross domestic product, up from 1.2% in 2007.

The Congressional Budget Office estimates that if the Bush tax cuts and stimulus spending ended, the federal deficit would fall to an average of 3.1% of GDP from 2014 to 2021. Moody's is less optimistic and puts this remainder -- the "structural deficit" -- at 6.5%.

Cutting into this would be hard but not impossible. According to an IMF study (.pdf file) I cited when I first explored this issue back in my Oct. 20 column ("Tea Party to the rescue?"), cutting the deficit by 1% of GDP would reduce economic growth by about 0.5% and increase the unemployment rate by 0.2%.

Assuming the structural deficit stands at around 4% of GDP, that translates to a drag on growth of about 2% and a rise in the employment rate of 0.8%. Hard to take. But the consequences of inaction, including higher interest rates and financial panic if the Treasury were forced to default, would be much, much worse.

Getting back to growth

That brings us to the third issue, which I believe holds the key to the economic growth needed to escape this black hole economy.

Since the likes of China and India opened their army of laborers to the world, U.S. wages have been pressured as factories here at home have been forced to compete with cheaper operations overseas. While we all enjoyed the drop in the cost of imported goods, the consequence has been a lack of real wage growth since the mid-1990s.

Thankfully, the U.S. economy is showing signs of renewed competitiveness as stagnant wages and a falling dollar have reduced the costs of U.S. manufacturing.

Also contributing has been a rise in energy costs (making global shipping more expensive) and dramatic wage inflation in places like China and India as talent shortages develop. Wages jumped nearly 70% in China from 2005 to 2010. In India, some 65% of employers are having trouble finding the right talent, according to ManpowerGroup, up from less than 20% last year. And we can't forget the other risks of foreign production that the Japanese earthquake and Arab Spring democracy protests have reminded us of.

Some companies, like Coach (COH, news), are now looking to move production even further afield to places like Vietnam and the Philippines. But others have decided that "Made in U.S.A." makes sense again.

Researchers at the Boston Consulting Group have noticed the shift. In an internal research document titled "The Return of U.S. Manufacturing," the team notes that China won't long be the world's default low-cost manufacturing center for producing goods for U.S. consumption. By 2015, they believe, productivity-adjusted Chinese wages will be close enough to U.S. rates that manufacturers producing goods for U.S. consumers will be indifferent about locating production in China or the United States.

Politicians, especially local and state officials, need to step up and help the process by easing regulatory constraints and red tape.

It's no secret that Texas, consistently ranked as one of the best places to do business in the country, is enjoying a much stronger recovery than the rest of the country. State-subsidized, nonunion auto plants in the South, such as the new Tennessee plant opened by Volkswagen (VLKAY, news)this week, are typical of the conditions manufacturers are looking for. The plant will pay starting workers about $27 an hour in wages and benefits -- lower than some autoworkers, certainly, but more than enough to interest sidelined workers now stuck in the ranks of the long-term unemployed.

There are plenty of examples. A $1.4 billion loan persuaded Nissan (NSANY, news)to build a $1.7 billion plant in Tennessee. State grants and tax incentives encouraged Bosch to hire several hundred workers in Charleston, S.C. Ford Motor (F, news)is building a new assembly plant in Louisville, Ky. after receiving $240 million in state funding. Caterpillar (CAT, news)is building a new plant in Winston-Salem, N.C., thanks to a $14.4 million incentive package.

All of this sets the stage for a factory-led renaissance that could put millions of industrious Americans displaced by the housing collapse back to work. These are the low-skil,l modestly paid jobs that are needed to rebuild the middle class, get away from the boom-and-bust asset price cycle, and help the economy grow fast enough to achieve escape velocity.

Can we turn the corner?

The problem with this optimistic view: We're running out of time. Economic growth is slowing again. Business confidence is taking a hit as governments in the developed world struggle to balance their books and pay their creditors. Investors are flocking to defensive stocks on a scale not seen since just before the 2007 bear market. (Read "3 safe plays for investors right now.")

We're set to stop feeding the black hole with stimulus spending, with the Fed and the Obama administration hoping the economy can stay afloat on its own. Republican ideas seem to boil down to even less stimulus at best and, among the more extreme members of the party, outright default on the nation's debt.

What we need is for politicians, from the president down to small-town mayors from Alaska, to do all they can to encourage entrepreneurs and business executives to invest and take risks. Government had a role in putting an end to the financial crisis. Now it's time to fix the budgets in a responsible way, cut costs as the rest of the economy has done and get out of the way. Small businesses should be offered the same incentives given to big multinational firms.

This is the insight expressed by economist and Federal Reserve historian Allan Meltzer. Instead of more spending and more stimulus, Meltzer wants to see a return to Reagan-era pro-growth measures including permanent tax cuts and regulatory streamlining. Tax credits and other incentives should be used to attract new investment. Businesses are sitting on massive cash reserves. They need to be encouraged to use it.

If things don't improve soon, we'll have no choice but to find out what's on the other side of the black hole.

Click here to become a fan of MSN Money on Facebook

For investors, the advice is simple and echoes the recommendations I've been giving in these pages for months: It's time to get defensive. For most conservative, long-term investors, this means cutting your allocations to equities and bonds and moving into cash.

Gold is perking up and looks very attractive again after being pulled down by the bursting of the silver bubble earlier this month. Gold mining stocks were hit really hard in the process and are overdue for a bounce back. This should benefit the exchange-traded funds Market Vectors Gold Miners (GDX)and Market Vectors Junior Gold Miners (GDXJ)in a big way. For the risk-takers out there, I've recommended ProShares Ultra Gold (UGL), which returns twice the daily return of gold futures, to my newsletter subscribers.

(For more on the long-term gold outlook, check out my Apr. 21 column, "Why gold could hit $5,000.")

At the time of publication, Anthony Mirhaydari did not own or control shares of any company or fund mentioned in this column. He has recommended the ProShares Ultra Gold to his newsletter subscribers.

Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.