A Double-Dip Recession?

In talking with several international leaders last week, it was clear that, while they are pleased with recent economic stability, they are concerned about how sustainable the recovery is.

As Canadian Prime Minister Stephen Harper told me, much of the current growth is due to stimulus measures from the world’s governments. He would like to see government leaders start thinking about an exit strategy to scale back these measures and return to growth led by the private sector.

If an exit strategy is not executed properly, one possible scenario is the “double dip,” which would involve the economy resuming growth but then falling back into recession. This is not expected to happen immediately, but it’s being talked about more and more, and I wanted to share with you what I’ve been hearing.

“A Real Danger”

One economist who believes the double dip is a “real danger” is Martin Feldstein, professor at Harvard University and the former head of the Council of Economic Advisors under President Ronald Reagan. Like Harper, Feldstein told me that the current economic upturn is being “force fed” by government stimulus and not driven by the usual business cycle in which growth begets more growth.

At some point, the stimulus programs have to end – be it Cash for Clunkers (which is already over), tax breaks for home purchases or historically low interest rates.

We talked in last week’s Investor Brief e-letter about the critical challenges facing the Fed and interest rates. Feldstein believes there will also be political pressure to keep rates low because unemployment is expected to remain a problem in the early stages of recovery. However, keeping rates too low for too long would lead to inflation.

Other reasons Feldstein sees potential danger include the stalling of financial reform as the administration focuses on healthcare, the burgeoning federal budget deficit with little talk of how to bring it back to more normal levels, and “the real disaster” looming in commercial real estate. (You can see my conversation with him here.)

“Not Terribly Worried”

Larry Fink, chairman of BlackRock, which manages more than $1 trillion, isn’t as concerned. He told me he understands the threats but believes they are not immediate and that the Fed and government will have time to manage them.

“The double dip, in my opinion, is not through inflation,” he said. “I don't see that at all. I think inflation could be a problem out two or three years, but I'm not terribly worried about that at the moment… I’m not frightened of known issues that we can look at out on the horizon. We have time to manage it.” (Watch my full interview with Larry Fink.)

No matter which side you come down on, the economic recovery’s sustainability is dependent on the government’s ability to unwind massive stimulus efforts in the right way and at the right time. I expect this to be the key question facing the economy, the stock market and investors in the coming months, and you can be sure we will follow it closely.



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