Last year began with high expectations for the economy, but finished on a positive note only because last summer’s slump drastically reduced expectations.

GDP growth in the United States still remains anemic, and the catalysts that sparked the improvement last fall may now be losing momentum. Notably, as the economy improved through the fall, expectations for 2012 again rose sharply.

We can all hope those optimistic expectations will be realized.

Yet there is reason to think the recovery this fall was merely a temporary lull in ongoing global economic storms; storms that may grow worse.

If those overseas storms continue to rage, the U.S. economy will most likely face renewed headwinds as we proceed through the first half of 2012.

Europe remains an epicenter of the global storms. Political and economic experts regularly speculate about a collapse of the eurozone.

A financial crisis in the eurozone could both engulf the economies of Europe and send major aftershocks cascading through financial systems around the world. Fortunately, the eurozone has taken some strong steps to avert a financial meltdown in the banking systems of the European economies. But while a severe financial crisis seems relatively unlikely, the odds of a crisis have nonetheless risen as the debt contagion has spread from anxiety about Greece to worry about Italy and Spain.

To this point, the stop-gap measures implemented in Europe to deal with the debt crisis have failed to halt the contagion of anxiety, much less advance meaningful solutions to the long-term problems.

Perhaps more important, worry about the European debt crisis has overshadowed the risks of a severe recession in that region. Europe’s attempts to cope with the debt crisis by reducing government spending, along with its weakened banking system, represent potent drags on economic growth.

To make matters worse, European policy makers added to the economic drag by adopting restrictive monetary policies through most of 2011. Economies typically respond to restrictive policies with very long lags, so the effects of last year’s tightening should last for a good part of 2012.

Europe represents about 25 percent of world GDP, roughly the same size as the U.S. economy. If that much of the global economy suffers a severe recession, other economies of the world will find it hard to avoid domestic effects of that economic drag.

European slowing comes at a particularly bad time for China and other emerging markets because Europe is such an important export market for those countries.

Many of the emerging economies tightened monetary policy repeatedly last year as they battled ravaging inflation rates. Unfortunately, while restrictive monetary policy eventually reduces inflation, it also slows economic growth with a long lag.

Thus, just as China and other countries have reached the point where the lagged effects of monetary tightening have begun to slow their economies, slowing exports to Europe now threaten to take an additional bite out of economic growth. Like a plane that encounters unexpected wind shear as it lands, what otherwise might have been a gentle “economic landing” for the emerging economies could now become much harsher.

Fortunately, the U.S. economy seems to be in much better shape than most others.

For one thing, the accommodative U.S. Federal Reserve monetary policy should provide support for continued economic growth. Growth also re-accelerated last fall as the U.S. economy recovered from last summer’s slump.

Yet while U.S. growth has clearly improved, GDP growth remains anemic, and there are reasons to think that the rebound we experienced last fall may be losing momentum. Increased consumer spending helped drive the reinvigoration of the U.S. economy.

Yet because income growth has been weak, consumers were forced to rely heavily on savings and increased borrowing to fund increased spending. Household budgets have also become even more strained as taxes and the prices of many living costs (for example, food and energy) have risen faster than incomes.

Without strong after-tax income growth, rapid consumer spending growth eventually falls victim to “economic gravity.”

Certainly, too, the export growth that has been so important to the U.S. recovery since 2009 has lost momentum as the economic storms have picked up overseas.

Although the U.S. economy should weather a global slowdown better than most, it seems unlikely that the United States can simply ride out the international storms without further slowing in what has been a frustratingly anemic growth cycle.

For the foregoing reasons, we think the stormy economic weather will probably continue through at least the first half of 2012. And the debt crisis in Europe could turn normally cold winter storms into blizzards.

Eventually, however, the storms will subside and the global economy will improve. The economies of the world should have much brighter prospects in the second half of 2012.

While we need to prepare for the possibility of more storms over the coming months, we should also begin to plan ways to take advantage of the warming economic trends that will inevitably follow the storms.

Mike Del Tergo is senior vice president and senior portfolio manager at Key Private Bank, Maine. He is based in Portland and may be reached at 874-7188 or [email protected]


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