Where are the American and global economies headed? Last year, there were two sides to the debate. One camp argued that the recession in the United States would be V-shaped - short and shallow. It would last just eight months, like the two previous recessions of 1990-1991 and 2001, and the world would decouple from the U.S. contraction.
Others, including me, argued that, given the excesses of private-sector leverage (in households, financial institutions and corporate firms), this would be a U-shaped recession - long and deep. It would last about 24 months, and the world would not decouple from the U.S. contraction.
Today, 20 months into the U.S. recession - a recession that became global in the summer of 2008 with a massive recoupling - the V-shaped decoupling view is out the window. This is the worst U.S. and global recession in 60 years. If the U.S. recession were (as most likely) to be over at year's end, it will have been three times as long and fives times as deep - in term of the cumulative decline in output - as the previous two.
Today's consensus among economists is the recession is already over, the U.S. and global economy will rapidly return to growth, and there is no risk of a relapse. Unfortunately, this new consensus could be as wrong now as the defenders of the V-shaped scenario were for the past three years.
U.S. data - rising unemployment, falling household consumption, still declining industrial production, and a weak housing market - suggest America's recession is not yet over. A similar analysis of many other advanced economies suggests that, as in the United States, the bottom is quite close but has not yet been reached. Most emerging economies may be returning to growth, but they are performing well below their potential.
Moreover, for a number of reasons, growth in the advanced economies is likely to remain anemic and well below trend for at least a couple of years. The first reason is likely to create a long-term drag on growth: Households need to deleverage and save more, which will constrain consumption for years. Second, the financial system - both banks and non-bank institutions - is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending.
Third, the corporate sector faces a glut of capacity, and a weak recovery of profitability is likely if growth is anemic and deflationary pressures still persist. As a result, businesses are not likely to increase capital spending. And fourth, the releveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private-sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.
Domestic private demand, especially consumption, is now weak or falling in overspending countries (the United States, Britain, Spain, Ireland, Australia etc.), while not increasing fast enough in oversaving countries (China, Germany, Japan etc.) to compensate for the reduction in these countries' net exports. Thus, there is a global slackening of aggregate demand relative to the glut of supply capacity, which will impede a robust global economic recovery.
There are also two reasons to fear a double-dip recession. First, the exit strategy from monetary and fiscal easing could be botched, because policy-makers are damned if they do and damned if they don't. If they take their fiscal deficits (and a potential monetization of these deficits) seriously and raise taxes, reduce spending and mop up excess liquidity, they could undermine the already weak recovery.
But if they maintain large budget deficits and continue to monetize them, at some point - after the current deflationary forces become more subdued - bond markets will revolt. At this point, inflationary expectations will increase, long-term government bond yields will rise, and the recovery will be crowded out.
A second reason to fear a double-dip recession concerns the fact that oil, energy and food prices may be rising faster than economic fundamentals warrant, and could be driven higher by the wall of liquidity chasing assets, as well as by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy, as it created a major income shock for the United States, Europe, Japan, China, India and other oil-importing economies. The global economy, barely rising from its knees, could not withstand the contractionary shock if similar speculative forces were to drive oil toward $100 a barrel.
So, it seems clear: The end of this severe global recession will be closer at the end of this year than it is now, the recovery will be anemic rather than robust in advanced economies, and there is a rising risk of a double-dip recession.
Nouriel Roubini is professor of economics at New York University's Stern School of Business and chairman of RGE Monitor.