A double dip recession in the US remains unlikely, in spite of the weak second quarter and downwards revisions to earlier GDP data. All the leading indicators suggest that it is not going to happen. And, even if it does happen, it's not the worst outcome.
A double dip is not what markets or politicians should be focusing on. Their real concern ought to be the fact that growth is set to be weak at best for the next decade. We are entering a 'new normal', with GDP expanding in the range 1% to 2% per year in the US for the coming five to ten years, rather than in the range 3% to 4% that we saw in the preceding few decades.
That means a new normal for asset markets too: ultimately, the performance of all asset classes is driven by the growth of the economy as a whole, so we should expect safe, high yields to be harder than ever to find in this world.
The problem is debt: historically high levels of household and government debt. High-debt recoveries are much slower and more prolonged than 'normal' cyclical recoveries - they tend to be L-shaped. It's common sense, really: in order to build up high levels of debt, we must have spent a long time living beyond our means. We cannot live beyond our means forever: sooner or later, people will stop lending to us. That's already happened for the household sector. And it is now starting to happen for the government sector too - as S&P's recent downgrade of US government debt illustrated.
Household deleveraging (paying down of debt) is already well underway. The household debt to income ratio in the US has come off its peak since the recession and is continuing to trend downwards, with a mixture of default on housing loans and net repayments of those and other, unsecured loans. That trend is desirable and probably unavoidable.
But government deleveraging has not yet started. The fiscal deal cut at the last minute by the Obama administration and the Houses of Congress is a sticking plaster that will barely get us through the coming year. A genuine, long-term solution to the fiscal mess is essential if the US downgrade is not to become a self-fulfilling prophecy, either via outright default or rampant inflation.
That solution will involve higher taxes, whatever the Tea Party say. Taxes in the US, particularly on the richest part of the population (as Warren Buffet has recently argued), are low by the standards of any other major developed economy. Of the twenty-eight countries in the OECD, only two have a (marginally) lower government share of national income than the US, but the US is just a middle ranking economy in terms of the growth it has achieved over the last two decades. There is good evidence that a government share of income much larger than 40% is damaging for growth. But there is no evidence that it makes any difference once you get below 40%. The US is at 32%.
What does make a difference is sound government finances, whatever the size of government. Restoring that will be slow and painful and, with households doing the same, the outlook for growth is bleak for the next several years at least.
But the alternative is worse. The alternative is some kind of default, resulting in a major downgrade of US government debt across the board, triggering a global sovereign debt and banking sector crisis that would make 2008 / 2009 pale into insignificance. The default could be that the US does not make its coupon payments - not because it can't but because it chooses not to. Or it could come through a major devaluation of the dollar as its status as the world's reserve currency finally collapses.
Either way, the implications for the US and global economy would be disastrous: credit crunch, currency wars, trade and capital controls, and depression. A re-run of the 1930s: and we know how that ended.