Monday, December 27, 2010

US Recovery Facing Strong Headwinds In 2011

Though the recession officially ended in June 2009, when the economy started to grow again, many Americans still feel the lingering after effects.

Gross domestic product, the broadest measure of the country’s output, grew at an annualized rate of 3.7 percent in the first quarter of 2010. But then it stalled, with the rate falling to a mere 1.7 percent in the second quarter and 2.6 percent in the third quarter.

Some believe that the $858 billion tax-cut compromise between President Obama and Congressional Republicans will stimulate the economy by putting more cash in the hands of consumers.

Additionally, unemployment insurance benefits for the long-term unemployed were extended, yet again. This will keep these people afloat and recirculate that money back into the economy.

However, these moves have only inflated the government’s huge debt burden (now $13.9 trillion) and pushed onerous decisions further off into the future, when they will be even more difficult to grapple with.

Analysts at large bond brokerages say the extension of the Bush tax cuts will push the federal deficit to about $1.4 trillion in fiscal 2011.

After the tax extension was signed into law, Moody's Investors Service warned that the tax deal raises the chance that it would issue a negative outlook on the U.S. government's AAA credit rating.

Unemployment benefits have overwhelmed many states, who have turned to the federal government for help.

According to the Economic Policy Journal, over 60% of Americans receiving state unemployment benefits are getting these directly from the US government, as 32 states had borrowed $37.8 billion from Uncle Sam to fund unemployment insurance as of May. Obviously, the problem has grown worse since then.

Roughly 15 million Americans do not have jobs, which is cutting into tax revenues, increasing unemployment payouts, and hurting consumer spending. At 9.8 percent, the unemployment rate remains at its highest level since the early 1980s.

Unfortunately, even the optimists recognize that unemployment is likely to remain above 9 percent through all of next year. And even if the economy managed to grow at 4 percent in 2011, that would hardly alter the unemployment picture.

Economists estimate the economy would need to grow by 5 percent for a full year to push down the unemployment rate by a full percentage point.

There are many reasons to question the ability of a recovery to take truly hold.

The US economy is overly reliant on consumer spending, which accounts for a whopping 70 percent of GDP. With so many people out of work, earning less, and working only part-time, spending is strained and will remain so until those problems are rectified.

The housing market remains anemic, and continues to be a drag on the economy. Nearly a quarter of all mortgages are under water. Home ownership continues to decline. Foreclosures are up. Demand is down. And home values are also down; US homes will lose a whopping $1.7 trillion in value in 2010.

Aside from the housing market, financial markets and the US banking system also remain vulnerable to the continued fallout from the European debt crisis. So far, the problems have been limited to the smaller economies of Greece, Ireland, and Portugal. Should a larger economy (such as Spain) reveal similar strains, the ensuing panic could be widespread and the effects crippling.

Then there is the mounting concern about the tattered balance sheets of state and local governments. At least a few — such as California, Illinois, New York, Michigan and even Texas — may eventually require a federal bailout. Given the current political environment, such an outcome would be deeply unpopular.

After gutting budgets, many states have no reasonable way to further reduce deficits and spending. They face a quandary that seems to lack a solution. No US state has defaulted since Arkansas, during the Great Depression. That could change in the next year or so.

States continue to borrow in order to fund their day-to-day operations, continually worsening their already burdensome deficit problems. The states are truly too big to fail, and that is the horrific prospect currently facing the federal government.

The state deficit problems are enormous and unwieldy, making them the next bubble to inevitably burst. The Center on Budget and Policy Priorities estimates that the cumulative state budget shortfalls are somewhere around $425 billion for fiscal 2009 through fiscal 2011.

When this economic domino falls, or any of the aforementioned, the prospects of recovery will fall with it.

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