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Fearing the worst: How crises in Middle East and Japan threaten a second great recession

By Peter Morici
web posted March 28, 2011

Crises in the Middle East and Japan threaten to thrust the U.S. and global economies into a second recession.

Since the economic recovery began in July 2009, GDP growth has averaged only 2.8 percent, a pace insufficient to bring unemployment down to acceptable levels. And that rate of growth leaves the economy too vulnerable to the slightest hiccup and a deceleration into recession.

Prior to the turmoil in the Middle East, economists were forecasting 3.5 percent growth for 2011, but the surge in oil prices to $110 a barrel and gasoline to $3.62 a gallon will likely shave half a point—perhaps more—from that rosy outlook.

Should oil surge to $140 a barrel, gasoline prices would pierce $4.00 a gallon and U.S. growth could slow to a mere 2.5 percent. That would be barely self sustaining and not enough to create many jobs—likely many fewer than the 1.5 million needed each year just to keep up with population and labor force growth.

Similarly, should the crisis in Japan keep its manufacturing shut down for more than a month or two, U.S. GDP growth could be slashed as much as another one half a point, again to something in the range of 2.5 percent.

A surge in the price of oil to $140 a barrel and an enduring crisis in Japan would do it. Growth would slow to 2 percent, businesses would start laying off workers, and voila it’s Armageddon.

The bankers may poo poo all this. After all Ben Bernanke will lend them more money at zero interest rates, they will trade on oil futures and restructure Japanese debt, and pay themselves big bonuses, again. You watch!

As for China, its mercantilist policies and hoard of dollars, euro and yen will permit it to avoid the worst of it. More stimulus spending—that must be used to procure only Chinese goods—to meet long neglected needs in health care, education and the like, will keep its economy humming and gaining ground on the West.

But Washington—Watch out! A second recession would be enough to put federal finances in the same box as the more troubled states and maybe Greece. The $9.5 trillion ten-year deficit projected by the CBO could easily jump to $15 or $20 trillion and the bond vigilantes could force Washington to merely print money—the interest rates Washington would have to pay on new bonds would become prohibitive.

Hyper inflation and a terrible second recession, or worse, could follow. ESR

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.

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