The Nine Problems That Could Derail The Recovery in 2011

Lost in the optimistic talk about the economic recovery around the world are the things that brought the recession on and the new challenges which may appear next year.

The US stock market is back to pre-Lehman levels. Many companies are expected to report record earnings for the current quarter. The new tax structure, to a great extent the same as the old one, may have already started to lift consumer spending.

There are several powerful forces which are dangers to the recovery:

1. Spending Hangover

Consumers and business may have exhausted themselves in the fourth quarter. Shoppers have dipped into the savings they have made during the recession and may have begun to re-leverage themselves. That may cause a spending hangover in 2011.

2. Price of Oil

The price of oil has begun to push back toward $100 and gasoline prices have topped $3 per gallon for regular and $3.50 for premium. OPEC looks ready to hold production as it is. There are few reasons for cartel members to stop a trend which will make them richer than they already are. The Chinese appetite for crude and an unusually cold winter in the norther hemisphere will drive up demand.  Europe’s recovery is already threatened by cold and bad weather. And, largely forgotten among the other reasons for a shortage of crude, at least a temporary one, are the occasional periods of unrest in big oil producers like Nigeria.

3. Job Creation

There is still too few jobs being created in the American economy. The Fed has admitted that unemployment levels will stay above 9% next year. Small businesses are a critical engine for any recovery. Most have little access to bank credit which makes expansion very difficult. The notion of a jobless recovery only makes sense for so long. The consumer is still two-thirds of American GDP. “Normal” unemployment is about 5%. That is a level which may not be reached for years.

4. Bad Housing Market

The housing market is worse each month. Ten million US mortgages are still underwater. The people who own these homes have no access to equity loans. Research shows these homeowners are more likely to default. Potential buyers find it a challenge to get mortgages from banks. Those who can get this sort of credit think, the value of homes is still dropping. More inventory will hit the market as banks put nearly 2 million homes on the market as they complete the foreclosure process.

5. Earnings

Earnings may not be as good as expected. Bank earnings will almost certainly be down. Institutional activity is still slow and the same is true with M&A. Large financial firms still hold hundreds of billions of dollars in distressed assets. These include commercial loans and private equity transactions many of which may never regain their initial value.

6. Austerity

The notion of Austerity has become so prevalent in Europe that US politicians have begun to consider it. Congress was only willing to approve a new cap on the federal debt until March. There will be a war between the two parties over government spending. A large cut in federal funding for thousands of initiatives will almost certainly harm the public sector as it sheds jobs. That has already begun at the state level, and the states may become a blue print for Congress. Austerity measures in the UK will cost 400,000 government jobs. That number could be much larger in America.

7. Global Instability

The world is more unstable than it was a year ago. The most visible example of that is Korea. A war, no matter how small and contained it is, between the two Koreas would damage confidence that the world has become a safer place because potential trouble in the Middle East and Africa are contained. Korea was, until very recently, a part of the world that was considered stable.

8. Inflation

Commodities prices are up around the word. Crude oil is the most obvious example. Agricultural commodities are not mentioned as often, but cotton, soy beans, corn, and meats have each moved to nearly an all-time highs. Those prices will be passed on to businesses and consumers. If they cannot be, the companies which use them will suffer compressed margins which will lower both profits and capital expenditure. Inflation is still hiding for the most part, but it is only a quarter or two away from becoming a real problem.

9. Global Economy

The economies of several European nations could still collapse. This would have two immediate effects. The first is that consumers in the region may be over-taxed by their governments trying to reduce deficits. That would damage the flow of imports for consumer goods which is a challenge to both the US and Chinese economies. The sovereign debt of many eurozone nations is held by multinational banks. Defaults could cause another series of incredible bank losses like those the happened only two years ago.

A recovery from a deep recession does not look like past recoveries. That is said too often. But, now, it is forgotten in many circles that are nearly giddy with the prospect that the economy has started to improve that the challenges to this recovery are huge.

Douglas A. McIntyre