The global economy, artificially boosted since the recession of 2008-2009 by massive monetary and fiscal stimulus and financial bailouts, is headed towards a sharp slowdown this year as the effect of these measures wanes. Worse yet, the fundamental excesses that fueled the crisis – too much debt and leverage in the private sector (households, banks and other financial institutions, and even much of the corporate sector) – have not been addressed. Private-sector deleveraging has barely begun. Moreover, there is now massive re-leveraging of the public sector in advanced economies, with huge budget deficits and public-debt accumulation driven by automatic stabilizers, counter-cyclical Keynesian fiscal stimulus, and the immense costs of socializing the financial system’s losses.

At best, we face a protracted period of anemic, below-trend growth in advanced economies as deleveraging by households, financial institutions, and governments starts to feed through to consumption and investment. At the global level, the countries that spent too much – the United States, the United Kingdom, Spain, Greece, and elsewhere – now need to deleverage and are spending, consuming, and importing less.

But countries that saved too much – China, emerging Asia, Germany, and Japan – are not spending more to compensate for the fall in spending by deleveraging countries. Thus, the recovery of global aggregate demand will be weak, pushing global growth much lower.

The global slowdown – already evident in second-quarter data for 2010 – will accelerate in the second half of the year. Fiscal stimulus will disappear as austerity programs take hold in most countries. Inventory adjustments, which boosted growth for a few quarters, will run their course. The effects of tax policies that stole demand from the future – such as incentives for buyers of cars and homes – will diminish as programs expire. Labor-market conditions remain weak, with little job creation and a spreading sense of malaise among consumers.

The likely scenario for advanced economies is a mediocre U-shaped recovery, even if we avoid a W-shaped double dip. In the US, annual growth was already below trend in the first half of 2010 (2.7% in the first quarter and estimated at a mediocre 2.2% in April-June). Growth is set to slow further, to 1.5% in the second half of this year and into 2011.

Whatever letter of the alphabet US economic performance ultimately resembles, what is coming will feel like a recession. Mediocre job creation and a further rise in unemployment, larger cyclical budget deficits, a fresh fall in home prices, larger losses by banks on mortgages, consumer credit, and other loans, and the risk that Congress will adopt protectionist measures against China will see to that.

In the eurozone, the outlook is worse. Growth may be close to zero by the end of this year, as fiscal austerity kicks in and stock markets fall. Sharp rises in sovereign, corporate, and interbank liquidity spreads will increase the cost of capital, and increases in risk aversion, volatility, and sovereign risk will undermine business, investor, and consumer confidence further. The weakening of the euro will help Europe’s external balance, but the benefits will be more than offset by the damage to export and growth prospects in the US, China, and emerging Asia.

Even China is showing signs of a slowdown, owing to the government’s attempts to control economic overheating. The slowdown in advanced economies, together with a weaker euro, will further dent Chinese growth, bringing its 11%-plus growth rate towards 7% by the end of this year. This is bad news for export growth in the rest of Asia and among commodity–rich countries, which increasingly rely on Chinese imports.

An important victim will be Japan, where anemic real income growth is depressing domestic demand and exports to China sustain what little growth there is. Japan also suffers from low potential growth, owing to a lack of structural reforms and weak and ineffective governments (four prime ministers in four years), a large stock of public debt, unfavorable demographic trends, and a strong yen that gets stronger during bouts of global risk aversion.

A scenario in which US growth slumps to 1.5%, the eurozone and Japan stagnate, and China’s growth slows below 8% may not imply a global contraction, but, as in the US, it will feel like one. And any additional shock could tip this unstable global economy back into full-fledged recession.

The potential sources of such a shock are legion. The eurozone’s sovereign-risk problems could worsen, leading to another round of asset-price corrections, global risk aversion, volatility, and financial contagion. A vicious cycle of asset-price correction and weaker growth, together with downside surprises that are not currently priced by markets, could lead to further asset-price declines and even weaker growth – a dynamic that drove the global economy into recession in the first place.

And one cannot exclude the possibility of an Israeli military strike on Iran in the next 12 months. If that happens, oil prices could rapidly spike and, as in the summer of 2008, trigger a global recession.

Finally, policymakers are running out of tools. Additional monetary quantitative easing will make little difference, there is little room for further fiscal stimulus in most advanced economies, and the ability to bail out financial institutions that are too big to fail – but also too big to be saved – will be sharply constrained.

So, as the optimists’ delusional hopes for a rapid V-shaped recovery evaporate, the advanced world will be at best in a long U-shaped recovery, which in some cases – the eurozone and Japan – may be long enough to stretch into an L-shaped near-depression. Avoiding a double dip recession will be difficult.

In such a world, recovery in the stronger emerging markets – the great hope for the global economy – will suffer, because no country is an island economically. Indeed, growth in many emerging-market economies – starting with China – is highly dependent on retrenching advanced economies.

Fasten your seat belts for a very bumpy ride.

This article is from Project Syndicate.

From the Financial Times:

Sagging Global Growth Requires Us to Act

By Nouriel Roubini and Ian Bremmer

It looks as if the global economy is heading for a serious slowdown this year. Emergency austerity programmes in some countries will put a drag on growth. Inventory adjustments will run their course. The effects of tax policies that steal demand from the future – such as the US “cash for clunkers” scheme, tax credits for home buyers or cash for green appliances – will fizzle out. Labour market conditions will remain weak. The slow and painful deleveraging of balance sheets and income-challenged households, financial institutions and governments will continue.

CNBC -- Bears Battering Bulls (Click for Video)

CNBC --  Insight on employment and the markets, with Ian Bremmer, Eurasia Group and Nouriel Roubini, Roubini Global Economics and NYU Stern School of Business.

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CNBC -- Fixing the Financial System (Click for Video)

CNBC --  The financial reform bill is headed to the Senate later this month, with Chris Whalen, Institutional Risk Analytics; Ian Bremmer, Eurasia Group and Nouriel Roubini, Roubini Global Economics and NYU Stern School of Business.

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CNBC -- Final Thoughts (Click for Video)

CNBC --  Concluding market insight, with Ian Bremmer, Eurasia Group and Nouriel Roubini, Roubini Global Economics and NYU Stern School of Business.

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CNBC -- Banks Too Big to Fail, Too Big to Bailout: Roubini

European governments face the quandary of being unable to afford to bail out banks that are still considered too big to fail, while the global economy is heading for a slowdown in the second half of the year, economist Nouriel Roubini of Roubini Global Economics told CNBC Tuesday.

Governments are running out of ways to counter a "massive slowdown" or the risk of a double-dip recession, Roubini said.

"A year ago we had all these policy bullets," he said. "We could push down rates to zero, we had (quantitative easing), we could do a budget deficit of 10 percent of GDP (or) backstop the financial system."

Read More

CNBC: The Kudlow Report -- Crisis Economics: Discussing whether the recession is headed for a double-dip, with Nouriel Roubini, Roubini Global Economics chairman.  (Click for Video [6:48])

A longer and more detailed analysis of this proposal of mine for an orderly restructuring of Greece's public debt is available to RGE clients: Order from Chaos 

From the Financial Times: 

It is time to recognise that Greece is not just suffering from a liquidity crisis; it is facing an insolvency crisis too. Rating agencies have started to downgrade its public debt to junk level, while spreads on Greek sovereign bonds last week spiked to new highs. The €110bn bail-out agreed by the European Union and the International Monetary Fund in May only delays the inevitable default and risks making it disorderly when it comes. Instead, an orderly restructuring of Greece’s public debt is needed now.

The austerity measures to which Greece signed up as a condition of its bail-out require a draconian fiscal adjustment of 10 per cent of gross domestic product. This would prolong the country’s recession and still leave it with a public debt-to-GDP ratio of 148 per cent by 2016. At this level, even a small shock is likely to trigger a further debt crisis. Sharp austerity may be needed – as agreed by the Group of 20 over the weekend – to stabilise debt-to-GDP ratios by 2016 in advanced economies; but for Greece such “stabilisation” would be at levels that are unsustainable.

Read MORE

From the NYT:

By Paul M. Barrett

In late March, the former Federal Reserve chairman Alan Greenspan told Al Hunt of Bloomberg Television that the financial crisis had been a “once in a century” shocker. “We all misjudged the risks involved,” Greenspan said. “Everybody missed it — academia, the Federal Reserve, all regulators.”

Well, not everyone. A number of prominent scholars warned long before the meltdown of 2008 that something awful was approaching. Greenspan and his successor, Ben Bernanke, chose to ignore the alarms.

Please read RGE's view of the significance of China's announcement of more currency flexibility in the following RGE STRATEGY VIEW (clients only): 'Yuan Upmanship': Interpreting China's FX Regime Change.

PBS NEWSHOUR -- Economists Examine Potential for Longer Recession (Click for Video [7:21])

PBS NEWSHOUR -- Transcript

There is an ongoing debate among global policymakers about when and how fast to exit from the strong monetary and fiscal stimulus that prevented the Great Recession of 2008-2009 from turning into a new Great Depression. Germany and the European Central Bank are pushing aggressively for early fiscal austerity; the United States is worried about the risks of excessively early fiscal consolidation.In fact, policymakers are damned if they do and damned if they don’t. If they take away the monetary and fiscal stimulus too soon – when private demand remains shaky – there is a risk of falling back into recession and deflation. While fiscal austerity may be necessary in countries with large deficits and debt, raising taxes and cutting government spending may make the recession and deflation worse.

From Outlook Money:

By Rajesh Kumar

In September 2006, Nouriel Roubini, a professor of economics at New York University, speaking at the International Monetary Fund (IMF), warned that the US economy would suffer a once-in-a-lifetime housing bust and a deep recession. The warning was received by the audience with a fair amount of skepticism, as the US economy, though looking a little weak, was still growing, with low inflation and unemployment. But, as events unfolded afterwards, the prediction by Dr. Doom, as Roubini is famously—or infamously— known, started coming true.

Interestingly, though the recent economic crisis has been termed as once-in-a lifetime, or diffi cult to predict, Roubini was not the only whistle-blower. Economists like Robert J. Shiller of Yale University and Raghuram Rajan of the University of Chicago also highlighted different areas of trouble, but, perhaps, only Roubini anticipated the extent of the damage. In the same IMF address he concluded that the financial system could face a systemic risk, and it did. In the words of Nassim Nicholas Taleb, the author of Black Swan and Fooled by Randomness, Roubini was the only professional economist who really predicted the crisis of 2008.