The Global Economy Is Falling Apart

But the recovery can still recover. Here's how we got in this mess -- and how we might yet get out.

The economic panic attack just went global.

Stocks are collapsing across the world from London to New York to Tokyo. The Dow plunged 300 513 points* and the S&P fell even farther, as U.S. markets suffered the worst nine-day slump since March 2009. Meanwhile two-year Treasuries hit a record low. Central banks are intervening in Japan and Europe. Everything seems to be falling apart at once. Why? And can the U.S. avoid slipping back into recession?

Before we continue hyperventilating, let's review how we got here.

A Month of Awful News

June was a very weak month for the U.S. economy, and our data from July so far isn't looking good. Some quick highlights:

• Hiring was nearly stagnant in May and June.
• Real consumer spending fell from April through June.
  
• Small business optimism has been falling four months running. 
• Home sales continue to struggle. 
• The manufacturing sector is flirting with contraction.
• U.S. growth was less than 1% in the first half.

These would all be very bad signs in a healthy economy. In a weak recovery -- a time when business activity should be above average -- they're even worse. Although we appeared to climbing out of the abyss in early 2011, it no longer looks like we're even treading water. In fact, we may be drowning again.

What Went Wrong?

As we flipped the calender to 2011, the first half of the year was plagued by a number of unfortunate events. Instability in the Middle East put pressure on oil prices. A severe earthquake in Japan rattled the markets. Increasing global commodity prices reduced Americans' purchasing power and killed their confidence. Fiscal tightening by the state and local governments has also created a headwind for hiring. More recently, the U.S. appeared to be on the verge of default or downgrade, thanks to self-induced crisis. Separately, renewed concerns arose about Eurozone fiscal problems.

What happened when negative economic shocks hit and perceived risk grew? Consumers and businesses became nervous and began to spend and invest less. All of those ugly economic reports we saw over the past few months were the result.

Is Another Recession Inevitable?

At this point, we can't see many bright spots to point to. If the U.S. economy remains on the downward slope that it's been on since April, then a double dip will be hard to avoid. Will it find a different path back to a firmer recovery?

Optimists will note that some of the problems above were temporary. The Middle East has become more stable. Japan is recovering from its devastating quake. Energy prices have begun to decline. The U.S. debt debacle appears to be over. If consumers and businesses see that most of the issues we were experiencing since last spring are no longer a threat, then spending and investment could return.

And they had better. The government isn't going to provide any boost to the economy. Instead, federal, state and local governments are now on an austerity regimen, which will make a recovery even more difficult. The Federal Reserve might decide to help, but unless either the economy worsens in a more dramatic fashion or deflation concerns resurface, it may have a tough time justifying additional stimulus.

So if consumers and businesses manage to regain their confidence, then the U.S. may avoid a double dip. But if sentiment falls farther over the next several months, we might have to close the book on this recovery.

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*When this article was first posted, the Dow was only down 300, which looked pretty bad until it closed down 513, or 4.3%.

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