The Dips Don't See a "Double-Dip"

If ever there was a reason to worry about a "double-dip" recession, here it is: according to Reuter's, "Few economists see a double-dip recession as a credible threat right now."

Let us not forget that a couple of years ago, "few economists" saw a severe bear market that would lop more than 70% off the Nasdaq as a credible threat. Even fewer saw a coordinated global economic slowdown as a credible threat. And how many envisioned the possibility of a U.S. recession? Perhaps a handful. All the others failed to notice the "credible threat" which saw S&P 500 profits post their biggest decline in history.

If there is any "credible threat" out there, it's the threat to your investment funds posed by listening to the opinions of major news agencies and economists.

While the spin-doctors don't foresee another downturn in GDP, common sense and a simple perusal of the evidence suggests that a double-dip is indeed a very likely possibility.

First off, are we really to believe that the longest and greatest economic expansion in modern U.S. economic history will be followed by a mere one quarter decline in output? Is that realistic? If history and common sense are any guide, a large expansion should be followed by a significant contraction, if not a large one. But even disregarding the historical record, we can still find plenty of reason to expect a double-dip.

Recessions are Good and Necessary

The "job" of a recession is to clean the "fat" out of the system, mop up excess, and pave the way for the next expansion. Until that process is complete, there isn't much from which a legitimate expansion can arise.

Recessions put weak companies out of business. In so doing, resources (skilled workers, capital) are freed up to be deployed more efficiently elsewhere. For example, Wall Street analysts who touted bankrupt Internet stocks are redeployed at local fast food restaurants to serve people in a capacity for which they are much better suited.

Stronger businesses that have used the contraction to firm up their bottom lines and grow more efficient are able to take advantage of these resources during the ensuing expansion. The economy emerges from a recession leaner, more efficient and in good shape for the next wave of growth and progress.

But in a mild, one-quarter downturn, many weak companies are able to pull through by the skin of their teeth. Thus they continue to suck up space and resources that could better be utilized elsewhere. For example, CNBC commentators, who should have been laid off, continue to prattle on and the dazed public continues to sit slack-jawed in front of the idiot box, hanging on their every word, doing nothing for the economy. Employees and capital are tied up in corporate time-bombs, just marking time before their inevitable demise. The excess that caused the recession remains in the economy, serving only as an anchor with which to weigh down future expansion.

Recessions Make Us Stronger

During a recession, trade imbalances should narrow. This makes the economy more self-sufficient, self-reliant and thus economically stronger. However, the "mini-recession" has done nothing of the sort. The U.S. trade deficit remains at a monstrously high level. We remain exceptionally dependent upon the influx of foreign capital to prop up our markets, our currency and our economy. Our dependence on foreign capital is just as great as before the recession, leaving us just as vulnerable to the whims and fancies of foreign investors. We've seen no improvement and must continue to hope that foreigners keep feverishly buying our goodies forever.

Given that the aforementioned are what is "supposed to" happen in a recession, it's logical to assume that these factors will serve to weigh upon future growth. If you don't firm up the foundation, the economic structure isn't likely to grow very tall. Hence the increased prospects for a double dip. If the recession did little to improve our economic strength and efficiency, we can't possibly hope for strong economic growth and we remain vulnerable to further economic contraction.

History shows us that a substantial number of recessions were of the double-dip variety. The recessions that began in 1957, 1960, 1969, 1973 and 1980 were all characterized by an initial decline, followed by a rise in output and then another dip into negative territory. Given that many of the factors that weakened our economy are still in place, is it reasonable to assume that we'll avert a double-dip this time around?

Arguably, this recession has been rather unusual in the sense that consumers have continued to spend and home values have continued to rise. But as much as human beings like to believe otherwise, no party lasts forever. There is indeed a limit to how much consumers can spend and housing prices will not continue to climb indefinitely. No market has ever proceeded indefinitely higher. It's not likely to happen this time around either.

The Coming Trade Wars

But there's still another storm cloud brewing in the horizon: trade wars. The foolish efforts of the government to shore up an inefficient and outdated steel industry with import tariffs are already beginning to show their inevitably disastrous results.

The U.S. government has its knickers all in a twist about the European Union retaliating with its own duties on imported steel. As though the rest of the world would sit idly by while the U.S. imposed non-competitive restrictions upon world trade. But it doesn't stop with steel. The EU is mulling the possibility for duties on U.S. fruit juices, textiles and motorcycles. In response to U.S. duties on Canadian lumber, Canadians have retaliated by slapping tariffs on imported tomatoes.

You might not think that a bit of fruit juice and a handful of tomatoes are likely to push the global economy over the brink. But the point is that one set of tariffs inevitably sparks a chain of increasing retaliation and further restrictions on world trade. Protectionist legislation pushed the U.S. economy from downturn into full blown depression during the 1930s. Similar actions now aren't likely to result in much good for the U.S. or global economies.

Not to mention that steel tariffs do nothing but postpone the inevitable decline of an industry that has refused to right itself even after 30 years of off and on government massaging. And the process of keeping a sickly industry alive serves only to threaten the rest of the economy.

Not only do U.S. steel companies get to "enjoy" higher prices due to the tariffs, but so do you and I and every other industry that relies on steel. Take a look around you at how much business is built with steel and you'll understand that we're talking about a significant increase to costs.

And rest assured that it's not only "foreign steel" that will increase in price. How likely is it that U.S. steel prices will remain stable when the competition's price has been jacked up 30%? In essence, U.S. steel makers how have the green light to raise prices 29% and still be cheaper than "the other guy". Who pays the price? The rest of the economy. Chalk up another detriment to recovery.

Rising Fuel Costs

And just when you though it was safe to get back in your car (made of steel, by the way), gas prices are shooting higher. I can't think of any industry that isn't impacted by fuel prices. Of course, nearly every consumer who travels will see a greater part of his income diverted to fuel costs. Remember that "lower gas prices" were recently touted as a major reason why an economic rebound was just around the corner.

A few weeks ago the U.S. Energy Dept. reported that gas prices will rise much higher than it had anticipated. Mind you, the latest forecast was based on average crude oil price of $20.70. Crude is currently trading at over $26, so add another 25% to "much higher". Add increased Middle East tensions and U.S. gun slinging in Afghanistan and possibly Iraq to the mix and you have a recipe for still higher fuel prices.

It would indeed be something if the U.S. were to limit its contraction to a mere one quarter. The historical record could be tossed out on its ear as nothing more than an outdated relic from which we have nothing to learn. Perhaps higher fuel prices, trade wars and increased military spending and bombing will serve only to strengthen our economy.

And maybe the U.S. can continue to drag around excessive debt and all the fat that the one-quarter recession failed to eliminate. Maybe the U.S. can lug all of that on its back and still expand at a healthy clip. Maybe we won't see a double-dip and maybe the S&P 500, contrary to anything it's ever done before, can launch a bull market from a p/e of more than 40, even when past bull markets have always begun from p/e's under 10. Maybe Mary Meeker and Henry Blodget will turn out to be right after all, and maybe their pet stocks will rise the 3000% required for their followers to break-even on their purchases.

Maybe none of those bearish factors are "credible threats". Maybe. But I'm not betting on it.