5 Economic Disasters That Haven't Happened

Rick Newman, US News July 6, 2011

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By Rick Newman

Posted: July 6, 2011

You're in a lousy mood. Justifiably so. It's been two years since the recession ended and a recovery supposedly began, yet the job market still stinks, housing remains a mess, and the bozos in Washington seem to do more harm than good. Consumer confidence is getting worse, not better, and talk of a double-dip recession hovers like a thunderhead over a summer barbecue.

Those are legitimate problems that are showing up in the real economy. Economic growth so far this year has been disappointingly low, and far below levels needed to notch a meaningful pickup in hiring. Many consumers aren't spending because they're worried about jobs, and many companies aren't hiring because consumers aren't spending. Policymakers in Washington, meanwhile, seem to have run out of ideas for how to stimulate the economy. Instead of action, we're settling into a grudging acceptance of stagnation.

[See why U.S. companies aren't so American anymore.]

There is considerable hope amid all this gloom, however. Here's the catch: The good news largely amounts to bad things that haven't happened—the kind of good news that's hardest to appreciate. Part of the reason for the economic pullback this year is fear over a steady stream of turbulent events that could upend the global economy--if they hit critical mass. But so far, virtually every one of those things has come and gone while producing ripples, but not waves. "We've had a series of modest shocks that are slowing things down," says Ethan Harris of Bank of America Merrill Lynch. "The question is, when do the shocks go away?"

The answer is that some of them are already dissipating. And when it starts to look like there's more turbulence behind than ahead, it could mark the moment when the economy turns the corner in earnest. Here are five potential disasters that have worried economists but failed to materialize:

A major spike in oil prices. At the beginning of the year, oil was about $90 per barrel. As unrest in the Middle East intensified, prices peaked at more than $113 per barrel. Economists think that $120 oil might be the tipping point at which a double-dip recession becomes likely. But even below that level, rising energy prices cut into disposable income, which means people have less money to spend on other stuff. And $4 gas in particular tends to depress consumer confidence far more than other types of price increases. So, much of the economic weakness so far this year is due to the real and psychological impact of rising oil and gasoline prices.

[See why gas and food prices are likely to drop.]

But those worrisome price spikes have reversed course over the last several weeks, with oil now trading around $95 and gas prices retreating from the $4 mark in early May to about $3.65 today. That downward trend may continue. The recent coordinated release of 60 million barrels of oil from the reserves of the United States and other nations didn't amount to a significant new supply source, but it did signal the willingness of governments to intervene in markets, if necessary, to push energy prices down. That dampened speculative fervor that may have been contributing to rising prices. Slow growth in many of the world's biggest economies—such as Europe, Japan, and the United States—ought to keep demand for oil from overheating, as well. Discord in OPEC means it will be harder for the oil cartel to deliberately limit supplies and boost prices. Oil prices are volatile and will probably continue a gradual rise over time, but for now, consumers seem to have gotten a respite. Investment bank UBS recently advised its clients that the downward trend in energy prices should put more money in consumers' pockets, boost spending, and help goose economic growth in the second half of 2011.

Financial panic in Europe. It's beginning to seem like an annual summer ritual: Greece or some other peripheral European nation nearly goes bankrupt, roiling markets until policymakers sweep in at the last second with a bailout. But the longer this goes on, the less likely a crisis actually becomes. One of the big problems with the financial situation in Greece, Ireland, Portugal, and perhaps Spain is that European banks hold much of their debt and would incur steep losses if those nations default on their obligations. That leads to the "contagion" scenario, in which banks across Europe, and perhaps the world, begin to call in their loans and refuse to lend to each other. But every time Europe's bailout barons forestall the day of reckoning by six or 12 months, they give the banks more time to offset potential losses and prepare for a default, if it happens.

[See why Europe's debt crisis will keep coming back.]

The biggest worry is that a debt restructuring--or worse, a chaotic, unplanned default—by one of these troubled nations would produce a global panic similar to what happened after Lehman Brothers collapsed in 2008. But Lehman failed abruptly, with its many global creditors stunned to discover that there would be no bailout for the troubled firm. The Greek situation, by contrast, has been telegraphed for months, with detailed public analysis of Greece's liabilities and the benchmarks it must hit to keep earning its bailout payments. "Commentators blame euro zone policymakers for kicking the can down the road," says Jacob Funk Kirkegaard of the Peterson Institute for International Economics. "But buying more time is quite sensible if they use that time to build resilience against contagion."

Runaway inflation. Since the Federal Reserve began "printing money" in 2008—through the huge bond-buying program known as quantitative easing—inflation hawks have been warning that the United States is on its way to becoming Weimar Germany. It hasn't happened, not yet anyway. In fact, the bigger worry for a while wasn't inflation, but deflation, since demand for many products fell so sharply during the recession that some prices plunged. Now, inflation has picked up enough to suggest that deflation isn't a problem. But widespread inflation doesn't look like much of a problem either. It is now about 3.5 percent on an annual basis, with gasoline and some food items rising by more than that over the last year. But many economists expect gas and food prices to come down over the next several months, which ought to produce tamer inflation of 3 percent or so.

[See who inflation hurts the most.]

It's still possible that the Fed's critics might be right, with all that extra money--which is mostly sitting on banks' balance sheets--working its way into the real economy and producing problematic levels of inflation. But for that to happen, wages need to start going up as well, since a spike in wages is usually what triggers prolonged inflation at the consumer level. Anybody gotten a big raise lately? Hardly. With high unemployment leaving a glut of workers in most industries, it's hard to see how wages could rise by much. Many consumers, in fact, struggle with the opposite problem: Their pay has stagnated, and many are getting by with reduced incomes. Fairly low inflation, meanwhile, means that interest rates are likely to stay low, since there's no need for the Fed to raise rates to combat rising prices.

A plunging stock market. As it became apparent earlier this year that the Fed would end its second quantitative easing program—"QE2"—on schedule at the end of June, some analysts worried that the stock markets would nosedive. The Fed used quantitative easing to boost demand for stocks and other risky assets, by buying up many safer investments, such as treasury securities and other types of bonds. That left investors with little choice but to put their money into the stock market, and the Fed's program did in fact coincide with a huge bull market in stocks. So it stood to reason that investors would bail out of stocks once the Fed stopped buying bonds.

[See how to ride out the "soft patch."]

But investors who own stocks have mostly stuck with them. Stocks were flat in June, but they rose about 4 percent during the last week of the month. And despite other unnerving events, such as the Japanese earthquake and the turmoil in the Middle East, stocks are up about 6 percent so far this year. The Fed made a deliberate effort to announce its plans to end QE2 well in advance, which gave investors time to prepare and helped eliminate last-minute speculation. The end of the controversial quantitative easing programs is also good news in itself, because it signals that the Fed feels the economy is strong enough to stand on its own two feet for the first time in three years. Many stock analysts are cautiously optimistic about the prospects for stocks in the second half of the year, partly because of the shocks they weathered in the first half.

A housing-led depression. The housing market usually springboards the economy out of recession, since pent-up demand for homes triggers a surge in spending on real estate and everything related to it, from HVAC units to furniture and appliances. Obviously that hasn't happened this time around. The housing bust is now in its fifth year, with average home prices down by more than 30 percent and continuing to fall. Economists have repeatedly underestimated the severity of the housing bust, predicting that prices would bottom out in 2009, then in 2010, and now in 2011. They've been repeatedly wrong, and the falling value of homes is one of the heaviest stones around the necks of consumers right now, since it reduces household wealth and makes people feel gloomy about the future.

[See why baby boomers are bummed out.]

It's a wonder that the economy has been able to grow despite the dreadful housing market. That indicates that the recovery, even though it's subdued, is being led by businesses rather than consumers. It can't go on like this forever, but housing must pick up eventually. When it does, it could add a second punch to the business spending that's driven economic growth over the last two years.

There's still much that could go wrong and surprise the cautious optimists. There could be a bursting asset bubble in China, a revolution in Saudi Arabia, a Middle East war, a devastating terrorist attack in Europe or the United States, a self-inflicted debt default by Uncle Sam or something totally unforeseen. But the longer an economic disaster doesn't happen, the closer we get to a recovery that actually feels like one.

Twitter: @rickjnewman

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The global economy is mysterious, even scary. Chief Business Correspondent Rick Newman connects the dots. In addition to his writing for U.S. News, Rick is the co-author of two books: Firefight: Inside the Battle to Save the Pentagon on 9/11, and Bury Us Upside Down: The Misty Pilots and the Secret Battle for the Ho Chi Minh Trail.

5 Economic Disasters That Haven't Happened

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