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7 economic nightmares for Obama's 2nd term

Sand bags barricade the New York Stock Exchange on Oct. 29, 2012, during the arrival of Hurricane Sandy.
Sand bags barricade the New York Stock Exchange on Oct. 29, 2012, during the arrival of Hurricane Sandy. Andrew Burton/Getty Images

(Moneywatch) The drawback to winning a presidential election is you are stuck with the job. The economic situation confronting President Barack Obama at the start of his second term is light-years ahead of the one he faced when he first took office, but that doesn't mean it's all sunshine on the horizon. In fact, there are challenges ahead which, if they break the wrong way, could make all of us nostalgic for the good old days of 2008.

Nearly all of these problems are out of the president's power to stop or even slow down because they aren't happening in the U.S. They range from the collapse of the European Union to a massive slowdown in China and more.

Here's a look at seven worst-case economic scenarios that are worrying more than a few well-informed observers. 

Global problems, no solutions

Confusing arrows
Mavroudis Kostas/Flickr

What's unnerving a lot of analysts right now is there are far too many worst-case scenarios to choose from. Spin the wheel and it lands on something scary.

Tom Jacobs, co-author of "What's Behind the Numbers? A Guide to Exposing Financial Chicanery," believes something is going to jump out from behind the curtain and he doesn't think it matters what that thing is.

"Is it going to be the fiscal cliff? The slowdown in China? Japan importing and exporting historic lows? The fact we can't sell anything to Europe right now?" says Jacobs, who is also portfolio manager and lead advisor for the investment service Motley Fool Special Ops.

"It's kind of like you're standing there alone and on your left side is the Prussians, on your right side is the Huns, ahead of you is the Mongols, and behind you you've got some zombies. You don't know which is going to attack first."

It worried Jacobs, and others, that that the markets rose throughout the summer and early fall despite all the negatives. He agrees with what economist Nouriel Roubini wrote recently, "Markets that rise on both good and bad news are not stable markets."

"The stock markets reflect higher expectations than we are going to see in reality. Where the S&P is right now correlates with very low future earnings," says Jacobs. "We expect there will be a 10 percent to 40 percent drop in the S&P in next year."

"We're in a bind. We seem to have an economy that's better than other markets but who are we going to sell to?"

Software crashes stock market

New York Stock Exchange
New York Stock Exchange Richard Drew/AP

Technology is a great thing, until it turns on you. Nowhere are the benefits and the risks as high as with automation of trading markets. This has resulted in some very positive things: The price of trading has come down, information is passed to investors faster and there are fewer trading mistakes due to human error. And for the most part, trades are executed far faster. (Big exception: When NASDAQ crashed under the volume of orders on the day of Facebook's IPO.)

There are several downsides to a market run by software, however. One is that the trades go through so much faster that it can be hard to put the brakes on when a run occurs. The other is that the markets can now be the targets of cyberwar.

Robert Oak, the pen name used by the editor of the EconomicPopulist, came up with a hypothetical situation which is not nearly as far-fetched as you might like.

"It could start with an engineer at a firm that does high-frequency trading," Oak explains. "He's testing his unproven tweak to one of the algorithms the company uses on a live server. His unsecured code is then hacked by the Chinese, who infect it with malware. That virus starts issuing wild trades every pico second. It also accesses other external [high-frequency trading] firms via server ports and corrupts their systems. Now they are also issuing wild trades in derivatives every pico second. This malware cannot be easily removed and, due to the incredible speed of the HFT trading systems, China manages to crash electronic trading systems around the world. This then triggers collateral debt swap payouts and money market returns go negative. News of this races around the world via the internet and causes a run on all of the banks -- which moves at lightning speed thanks to online banking. The result is the collapse of the entire global financial system in the space of three hours."

If that strikes you as totally absurd, keep in mind one thing: All the programs and technology needed to make it happen have existed for several years.

Europe: A union with many problems

Protesters in Athens, Greece, on March 4, 2010, burn an E.U. flag.
Protesters in Athens, Greece, on March 4, 2010, burn an E.U. flag. Louisa Gouliamaki/AFP/Getty Images

In 1999, 17 member nations of the European Union formed the eurozone -- a group of nations sharing a single currency. For the first 8 years of its existence, the world's economy was growing and the eurozone functioned just as its founders had hoped. The financial meltdown in 2008 changed that. 

Since then some eurozone nations -- such as Germany -- have weathered the economic turmoil fairly well. Others -- notably Portugal, Italy, Ireland, Greece and Spain -- have not, and this poses a very real threat to the continued existence of the entire EU. If the EU falls apart it will cause huge problems for the rest of the world at a time when the rest of the world already has more than enough economic troubles to deal with.

What makes Europe particularly scary is there are so many different ways that the situation could go bad and all of them look plausible. David Wright, managing director of Sierra Investment Management, offers this overview:

"The basic spooky case is that Europe will continue to spiral down. Spain and Greece are already in depression. Spain's economy has shrunk 25 percent, and getting worse. Recession may already have begun in Germany. There's no scenario under which the European economy can turn higher.

"Europe is the Wicked West that's going to impact everyone else in a bad way. It will cast wicked spells on U.S. multi-national corporations and wicked spells on emerging markets."

The rise of extremism

A petrol bomb thrown by protesters explodes near riot police in front of parliament on Wednesday, Nov. 7, 2012, during clashes in Athens, Greece.
A petrol bomb thrown by protesters explodes near riot police in front of parliament on Wednesday, Nov. 7, 2012, during clashes in Athens, Greece. AP Photo/Dimitri Messinis

There hasn't been a war between the major powers of Europe since the end of World War II nearly 70 years ago. The EU is definitely responsible for that, which is why it was awarded this year's Nobel Peace Prize. Economic chaos in the 1920s and '30s allowed extremist groups to seize power and eventually led to World War II. Bill McBride, who writes the blog CalculatedRisk, sees some unnerving similarities in what is happening today.

"You can't keep people in recession year after year like this," says McBride. "In Greece and Spain the unemployment rate for 18-to-34 year olds is over 50 percent. The last thing you want is a lot of 18-to-34 year olds sitting around with nothing to do."

This is a very similar situation to the one Europe confronted in the 1930s when people lost faith in their governments and turned to extremist groups for answers. McBride points to Greece, where the far-right Golden Dawn and Coalition of the Radical Left parties have both been gaining power.

"Look at Golden Dawn -- a year ago no one outside of Greece had heard of them. Inside Greece they were considered a joke. Not anymore. Golden Dawn is growing stronger every year."

He adds, "It could come from the Left or the Right. The Left would repudiate the debts and put in a more socialist government. The Right would be more socialist and anti-immigrant."

Anti-immigrant violence is on the rise in a number of nations, including Greece, Italy and Hungary. That isn't the only violence that's been increasing.

All those unemployed 18-to-34 year olds have found something to do: Riot. They are being joined by people from many other age groups as well. In addition to the lack of jobs, people are growing increasingly angry about cuts in government spending mandated by international lenders. Those cuts are slashing the social safety net just when it is most needed.

"The general unemployment rate in Spain is over 25 percent," says McBride. "Another quarter of recession or another couple of years and that will be over 30 percent. That will get you some really big problems. We're upset [in the U.S.] because the unemployment rate is 7.8 percent; imagine what they're feeling about it."

Germany stops footing the bill

Flags of European countries are displayed in front of a flag of European Union on September 4, 2012, in France
Philippe Huguen/AFP/Getty Images

What happens if EU nations that aren't broke decide they no longer want to give to the ones that are? Mark J. Grant, author of "Out of the Box and Onto Wall Street: Unorthodox Insights on Investments and the Economy," says if that happens then the European Union would collapse, taking the euro with it.

None of the EU nations that can afford to pay into the bailout fund are very happy about it. Most of the media attention about this has been on Germany because it is the Europe's largest economy. However, the Germans are far from alone.

"We've already seen the finance minister of Austria saying they are not going to allow any more of their country's money to be spent on other countries," says Grant. "We saw the same thing in the Netherlands -- they said that was it. They weren't going to spend any more money."

The governments of all these nations are under increasing pressure from voters to stop giving away their money. A growing number of people in these countries see Portugal, Ireland, Italy, Greece and Spain as basket cases that will never be able to get back on their feet economically.

"What we're facing right now is a Greece that needs more money, Portugal that needs more money, Spain that needs money," says Grant, who is managing director of the corporate syndicate department for a publicly traded investment bank. "The EU leaders have summit after summit and they can't agree on any kind of basis to give anybody money. They keep putting it off and now we're two weeks or three weeks from Greece running out of money."

While that doesn't sound so good for the people of Europe, what does it mean to the U.S.?

"If Germany says it wouldn't fund [its neighbors] anymore, then the EU would collapse," says Grant. He says the biggest impact would come from the end of euro, the common currency used by 22 European nations.

"If the euro broke up, well you have to remember it's not just a currency," he says. "There are trillions of dollars of bonds denominated in euros. So if the EU breaks up then who is guaranteeing the currency of those bonds?" If they became worthless then the world's largest banks and corporations would suddenly be bankrupt. That would cause a systemic collapse of the fiscal system of the world."

China melts down

Hazardous
iStockphoto

The China Syndrome originally referred to a total meltdown at a nuclear power plant, a play on the idea that it would melt down "all the way to China" on the other side of the planet. Now the China Syndrome may be what happens if China itself melts down. There are already a lot of signs that this core world economy is already going critical.

Chinese government data shows second-quarter growth falling to a three-year low of 7.6 percent, as exports, consumer spending, and factory output weakened. The country is set for its weakest economic performance since 1999. There are also reports of massive slowdowns in real estate, all types of consumer spending, steel production in particular and industrial production in general.

The fact that Beijing is reporting slower growth at all is a bad sign. The People's Republic is notorious for the inaccuracy of its economic statistics. Vice Premier Li Keqiang, who is expected to be the nation's next premier, is on record as saying official gross domestic product figures are "man-made" and that he regarded them as being "for reference only."

This is bad news for the rest of the world but it could spell very big trouble for China.

China has made enormous strides in improving its standard of living in recent decades. The proportion of its population living at or below the poverty line has declined from 84 percent in 1981 to 13.1 percent in 2008, according to the World Bank. Despite that progress, the country is still estimated to have more than 100 million people living on $1.25 or less a day.

Strong growth in China is critical for sustaining that progress. With the weak social safety net in China, the government would be hard-pressed to take care of a large number of economically displaced people. Beijing is already seeing increased social unrest from people unhappy with a number of issues, including widespread corruption in both the government and private sectors, and fallout from a collapsing real estate market.

China's economic slowdown has already decreased demand for raw materials such as iron ore, and is beginning to hit resource producing nations like Australia, Canada and Brazil very hard. It's not just those countries that are in trouble, though.

"Europe is 20 percent of China's exports," says Wright, of Sierra Investment Management. "China is decelerating, and Marc Faber, speaking at a recent Barron's conference, said the country's true growth rate might be zero."

That's another meltdown that could go all the way through the world.

Everything stays the same

Fiscal cliff ahead
CBS

"What most people see as the worst case I see as something that needs to happen," says Mish Shedlock, a registered investment advisor representative for SitkaPacific Capital Management, who writes the blog Mish's Global Economic Trend Analysis.

For Shedlock the problem isn't Spain defaulting, China's economy coming to a standstill or the U.S. driving off that fiscal cliff. The problem is that they won't happen soon enough.

"The longer we delay tackling budget problems the bigger they get," he says. "The worst case is for things to continue as they are. Continuing to kick the can down the road will lead to disaster."

He doesn't have high hopes for this. Kick the can has been the policy choice of governments around the world since the financial crisis began in 2008. In the U.S. and Japan it's taken the form of borrowing money or printing it until the economy improves and growth takes care of the issue. In the EU it's meant staving off disaster with summit after summit that doesn't resolve anything but keeps the promise of a fix alive in investors' minds.

Few analysts agree with Shedlock that any of these worst-case scenarios would be a good way to resolve the world's economic woes. However, most if not all would agree that the longer we go without a solution the bigger the problems are getting.

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