The Tail Is Going To Wag The Dog

One of the formerly popular concepts in economics and global politics that was debunked during the recent recession was that of decoupling. The simple idea was that with the emergence of new economic powers around the world like China, Brazil, Russia, India and the European Union, the importance of the United States had begun to decline. In essence, these newly powerful countries were thought to have become able to thrive independently of the US and any American problems would not spread. Obviously the 2008-2010 recession proved this incorrect as problems on this side of the pond quickly spread abroad and recessions followed in many other countries.

A key fact in that is often overlooked in the decoupling myth is the effects that the rest of the world have on the United States. The term 'decoupling' is obviously incorrect, however, the US is no longer as dominant a power as it was over the past few decades. This will become increasingly evident as the European Union faces an existential crisis caused by a number of its Mediterranean members.

Starting with Greece and quickly followed by Spain, Portugal and perhaps Italy and Ireland, the EU's common currency is going to be threatened. It is a serious possibility that the currency will fail or be forced to eject some of its members. When either of these events happen, the Euro zone will be thrust into its most serious recession since the Second World War. Trade agreements will break down while new currencies will be introduces and experience severe growing pains. The entire Euro area will face growing civil unrest as draconian fiscal austerity will be introduced and currencies devalued.

Much like the American problems emanated across oceans in 2008, the European problems will quickly spread around the globe. As the contagion moves into the United States financial institutions will again begin to experience lending and borrowing problems due to fear of counter-party exposure to European sovereign debt emerges. This problem will probably not cause a return to the 2008-2009 state of frozen credit but will hamper lending to governments around the world. When this happens, interest rates will quickly rise and threaten the young economic recovery.

In the end, the likely threat to recovery caused by the European contagion will likely be enough to force the US, Europe and many other parts of the world back into recession. A double dip will be experienced. This second dip will likely be much longer in duration than the 2008-2010 dip because governments, such as the US, will find it difficult to finance artificial stimulus measures which could mitigate the decline.

Unlike the past recession where the United States drove the rest of the world into decline, a future recession will likely be an event where the US is driven into decline by the rest of the world. The tail is going to wag the dog...