US economy not likely to fall into second recession

Posted July 21, 2010, at 4:21 p.m.

Just as we are climbing painfully and slowly out of a very deep recession, along comes a small army of commentators to warn us that a second big hole is lying just a few steps ahead. And, they say, we are about to fall into it. So before we have fully recovered from the current recession, we seem to be headed for a new one.

Are we truly headed for a double-dip? Not if you look at the U.S. economic data alone; these data tell us that we are on the path to recovery, even if the recovery is slow and halting.

For starters, the total output of the U.S. economy — the gross domestic product — has risen every quarter since the spring of 2009. Consumer spending, a needed stimulus in any recovery, is increasing slowly but steadily, and industrial production has been up every month since June 2009. Also, inflation is low and productivity is rising rapidly. Though several economic indicators have performed badly in recent weeks, the dominant trends are positive.

While these domestic figures are encouraging, a different picture emerges if we focus on Europe. At first glance, European events seem to point to a probable double dip.

The first indications of a faltering European economy came early this year. Greece’s government had been running a huge budget deficit — 13 percent of total national output. So Greece was forced to borrow heavily, mostly from abroad; and foreign lenders began to fear that the Greek government would default on its bonds. Foreigners were willing to loan money to Greece, but only at very high interest rates that would cover the risk of default. Greek finances appeared on the verge of collapse.

Shortly after the Greek problem emerged, suspicion fell on other European countries that also were running big budget deficits, and on the banks in those countries. Spain, Portugal and Ireland seemed to be in especially big trouble. In Spain, many savings banks were in danger of failing, and the Spanish government had to arrange for other banks to take them over. Some doubted that the Spanish government could finance all these takeovers.

But how could these troubles in Europe lead to a double-dip recession in the U.S.? Several answers have been given.

To begin with, European financial stress could affect the health of many U.S. banks with close financial ties to Europe, putting them in danger. Also, to reduce their budget deficits, several European governments plan to raise taxes and cut government spending severely.

If these measures are too severe, they could lead to fresh recessions and these in turn could seep over into the U.S. economy. This would raise the likelihood of a double-dip here.

And, last, U.S. banks might get so anxious about Europe’s financial future that they become extremely cautious about their own lending. If U.S. bank lending starts to dry up again, as it did in 2008, we might indeed face a fresh recession.

So if the domestic news is fairly good, and the news from Europe poses dangers for us, what actually lies ahead?

First, remember that Europe is less critical to U.S. economic health than it used to be. Now we depend much more on other partners in international trade and finance, among them Japan, Canada and Mexico and many rapidly growing economies including China, India and Brazil.

Further, the European countries are already fighting to prevent a renewed financial crisis. Recently, Greece and Spain have acted boldly to reduce their deficits. If their austerity measures are too severe and a recession follows, this will not affect the U.S. in a major way — precisely because these countries are not among our most important economic partners.

Also, in the last few weeks, Greece, Spain, Ireland and Portugal all have issued new government bonds that were quickly purchased by foreign investors — and this shows new confidence in these countries.

Last, but not least, many European countries have joined to create a huge $950 billion fund to guarantee the debt of weak European countries, including Greece.

The bottom line? My crystal ball, though cloudy, tells me that we’re not likely to drop into that dreaded second hole.

Edwin Dean, an economist and seasonal resident of Vinalhaven, writes monthly about economic issues.

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