Are We Slipping Back Into a Recession?

Federal Reserve Chairman Ben Bernanke is speaking today on the state of the economy. We know what he'll say. The economic recovery is proceeding, but slowly. The unemployment picture is improving, but slowly. The question is whether all this slowness will lead not only to a slowdown, but to a turnaround. Are we heading to a double-dip recession, as Robert Reich and other economic commentators have suggested?

Let's weigh the evidence:

Why the recovery is in deep trouble:

1. Housing will have a horrible summer: Since the housing credit expired, home sales are going to fall off a cliff. Canary in coal mine: mortgage applications hit their lowest level since the late 1990s. Practically nobody expects any better than a miserable summer for housing. The implications are fairly straightforward and depressing. Depressed home prices can tug down consumption, and until residential investment recovers, jobs can't grow in major industries surrounding real estate, like construction.

2. Consumers aren't spending enough: In April, consumer credit fell for the 17th month in two years, the longest period of de-leveraging in 70 years. That's good for families' credit ratings. It's bad for aggregate demand and hiring prospects. Consumption is two-thirds of the economy. When two-thirds of your body feels sick, it's hard to feel like you're getting better.

3. Unemployment is sticky: We're still kissing 10 percent unemployment. The private sector grew by a paltry 41,000 jobs in May, one-tenth the number of short-term jobs created by the Census. Discouraged workers are up. After a decade of real estate-fueled growth, there's no logical engine for America's next jobs boom.

4. The stimulus is drying: For months, personal spending and state budgets survived because of direct transfers from the federal government. But the Recovery Act is winding down and with deficit concerns eclipsing stimulus concerns in Washington, it's possible that state cutbacks could dramatically exceed federal spending in the closing months of 2010, which would hold back the recovery.

5. The European crisis: There are a lot of unknowns here, but let's count at least three reasons that international instability could hurt the U.S. First, debt tremors in Europe are shaking up the stock market. When families with money tied up in stocks see the Dow on a roller coaster ride, they can become nervous about future gains and cut back on large expenditures, which hurts aggregate demand. Second, U.S. banks have significant exposure to European banks (about $1.1 trillion in derivatives and loans) that could still face reduced investment and even huge defaults of government debt. If Europe sneezes, the U.S. financial sector gets a cold and the American economy suffers all the symptoms. Third, U.S. exports will fall if Europe squeezes its big wallet with a national austerity project.

Why the recovery is on track:

1. Employment has been growing all year: May was a weird month, but take the long view. Employment fell for more than a year, and now it's growing at a pace of several hundred thousand jobs a month.

2. Consumer confidence is up: Consumers might not be borrowing, but they're feeling fine! The Consumer Confidence Index, a rough measurement of how Americans are feeling about their wallets, has grown for the last three months. Confident consumers who are also paying down debt (see above) suggests that a consumer-driven recovery, when it's really here, will be substantial and sustainable.

3. Retail is having a good year: After seven straight months of gains, economists think retail sales grew again in May. Auto sales, spurred by cheap gas, are driving this recovery.

4. Manufacturing is still rocking: Economic activity in the manufacturing sector expanded in May for the 10th consecutive month, on the back of new orders and production. Inventories disappeared in 2009 and businesses -- especially in the tech industry -- are still ramping up orders and creating new jobs in manufacturing (via CR).

5. The European crisis: Yep, this one goes in both categories. The European crisis is scary, but it puts a lid on two things we don't want to rise: interest rates and oil prices. Instability in Europe is making investors jittery and shaking up the stock market, but in the short term it could help the United States. A flight to safety is making it easier for the U.S. government, businesses and home owners to borrow. What's more, a stop-start European economy means falling oil prices, giving car-owners relief at the pump and window-browsers more reason to splurge on that Ford truck now.