U.S. Economy: Five Ways to Profit in 2011 - Even With A Double-Dip Recession

2010 was a dull year for the U.S. economy.

But don't expect a repeat in 2011.

In fact, as we enter the New Year for the U.S. economy, investors face some major risks.
Should the U.S. Federal Reserve opt to maintain its record-low level of interest rates, it's very
likely that we'll see the kind of virulent inflation that will send commodity prices skyward,
and it could inflict some real long-term damage in the process.

With higher rates, the U.S. economy could experience its second downturn in three years,
the kind of "double-dip" recession that would boost an already scary jobless rate - while also
sending U.S. stocks into a bearish tailspin.

Uncertainty is the watchword for U.S. economy in the New Year.

Investors need to position themselves to cash in, should the currently anemic U.S. advance
continue... while at the same time making sure to protect themselves against a potential
downturn.

As contradictory as that might sound, it is possible to do both.

Unstable Backdrop

A burst of growth late in 2009 hinted at a full-blown recovery. But 2010 turned into a
disappointment, with gross domestic product (GDP) growth creeping along at a wheezing
2.0% pace.

Inventory buildups - a situation that can't continue - have artificially inflated growth
figures. Final sales to end-consumers - probably a much better indicator of real U.S. growth - have advanced at just a bit more than 1.0%.

This uncertainty has investors asking: What's in store for the U.S. economy in the New
Year? Will we see a vigorous recovery? Or are we headed for a "double-dip" recession -
complete with higher unemployment rates and another bear market in U.S. stocks?

Most investors probably believe that 2011 will likely be a carbon copy of 2010 - just more
of the same.

But I think that's highly unlikely. The New Year is unlikely to resemble 2010, because the
economic backdrop is far more uncertain and unstable.

Housing Woes

Record levels of fiscal and monetary stimulus are accompanied by low inflation and an
anemic level of economic growth. If this level of monetary stimulus is continued through 2011,
inflation will have to return with a vengeance.

Housing is also a problem. After the temporary surge caused by federal homebuyer
subsidies that ended last spring, U.S. housing prices seem to be heading downward again.

That's not a surprise: Housing prices in this country remain well above their long-term
average in terms of family incomes, and the inventory surplus caused by the "bubble" hasn't
been resolved.

Indeed, I would estimate that the final bottom in the housing market is still maybe two
years away. Prices still must decline by an average of 10% to 15% - with the biggest decline
slated for the Washington, D.C., suburbs, where prices have been "artificially" propped up by
the government expansion of 2007 to 2010.

This further decline will weaken bank balance sheets, creating trouble for the U.S.
financial-services sector.

Fuel for A Double-Dip Recession

A real resurgence in inflation would - after a battle with U.S. Federal Reserve Chairman
Ben S. Bernanke (who at this stage faces considerable opposition from the Fed) - lead to an
increase in interest rates, and probably a substantial one, at that. That would undoubtedly lead
to a recessionary relapse - one that's accompanied by another banking crisis, as the declining
value of the bonds banks hold on their balance sheets would be exacerbated by additional
housing-loan losses.

Technically, it would be quite difficult to officially imbue such a downturn as a doubledip
recession - chiefly because it would begin around three years after the previous recession ended in June 2009 (it had its start in December 2007).
The two recessions of 1979 - 1980 and 1981 - 1982 are generally considered separate
economic events. Yet both had the same underlying causes: a surge in oil prices and the Fed's
policy in tightening interest rates to extraordinary levels. In this case, if the second "dip" is
brought on by Fed tightening, it isn't likely to occur until after 2011.

Even if the new Republican Congress harasses the Fed into tightening substantially by
the end of the year, the effect on the economy will take some time to kick in. While the
commodities bubble may well burst during 2011, as global monetary policy is seen to be
changing direction, the Fed is likely to delay major tightening until 2012, which would delay
the second downturn until late that year - or even until 2013.

Every Cloud...

Despite the many concerns related to monetary policy, there is some good news on the
fiscal side of the U.S. economic ledger.

While the new Republican Congress is likely to extend the Bush tax cuts, those are already
built into the current economic position. So their extension will have little effect.

However, if the new Congress cuts back on government spending - as it has promised, and
as the Republican congresses of 1995 - 1998 also did - there will be a stimulative effect on the
U.S. economy. (It's only fair to note here that the Republican congresses of 1999 - 2006 did not
cut back on spending, meaning that this remains a risky assumption.)

In country after country, it has been shown that increasing public spending tends to
depress output, as resources are diverted to less-productive needs. That's especially true when
a government goes into deficit-spending mode to do so, since its massive borrowing tends to
"crowd out" private-sector borrowing.

For similar reasons, cutting spending is stimulative, since that frees up capital for the
private sector. And the private sector tends to find more innovative and productive uses for
that capital.

You can see this effect in Germany, which has outperformed earlier forecasts even as
it runs the rich world's smallest budget deficits. In Britain, too, the government's turn to
austerity has been accompanied by a surge in output, with GDP growing at 3.2% per annum
in the latest quarter - versus the inflated 2.0% advance here in the United States.

A "Bottom-Line" Outlook for the U.S. Economy

Clearly, if Congress cuts back on government spending in the New Year, we can expect to see some acceleration in growth.
However, that acceleration will be brought to an end - probably in 2012 - by the surge in
inflation from the U.S. central bank's amazingly accommodative monetary policy, which will
cause a rise in interest rates and a crash in commodity and U.S. Treasury bond prices.

This development - combined with the still-troubled U.S. housing market - will spawn
a new (actually, a renewed) banking crisis. And that will make the next recession an
exceptionally nasty one, with a market "bottom" and spike in unemployment that's deeper
and more damaging than the predecessor that ended in 2009.

However, there could be a good-news outcome to this gloom, provided that the second
"dip" is followed by restrained public spending, bank bailouts are avoided, and interest rates
are boosted to a level that's at least 2% to 3% above the inflation rate. If those conditions
are met, U.S. growth will resume at the traditional brisk U.S. rate, probably with a postrecessionary
catch-up to absorb the high level of unemployed people and other resources that
have stood idle.

That brings us to my bottom line for this New Year U.S. economy outlook.

If, as I expect, Congress cuts public spending substantially, while the Fed pursues easy
money as long as it can, my prognostication is for rather faster growth in 2011, followed by
a nasty financial crisis and second "dip" in 2012 and 2013. After that, if fiscal and monetary
policies have been restored to a more normal track, the U.S. economic recovery that follows
that nasty spell should be as brisk as what we experienced in the very strong stretch that took
place from 1983 - 1985.

Now here's how to profit from it.

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