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Why the U.S. is vulnerable to a recession

In the U.S., once seen as an island of prosperity in a world of economic malaise, a fear of recession now hangs in the air. While there are creditable arguments that the globe's foremost economic power can muddle through without much harm, the question persists: What could go wrong?

Leading up to the cataclysm that rocked civilization eight years ago, defaults on subprime mortgages were growing. But the conventional view at the time held that the housing problem could be "contained."

In 2007, the economy was expanding at a healthy-looking annual pace of around 4 percent. Then the bottom dropped out. Those subprime loans proved to be a powerful poison whose ill effects reached everywhere.

This time, the culprit is China. In recent years, its voracious growth begat demand for commodities produced by emerging market nations, which begat overspending on those tyros' home turf, which begat a fad among developed countries to invest in them. Once China's growth contracted, so did everything else along that daisy chain.

Dennis Nally, chairman of Pricewaterhouse Coo... 01:41

As bad news rolls in from overseas and the domestic stock market swoons, you hear a lot of rationales for why the U.S. will be spared. For one thing, overseas weakness has never hurt us in modern times. As in 2008 and the 1930s, it was always the other way around.

The Asian financial crisis of the 1990s had little effect on the U.S. economy, for instance. And nowadays, an Economic Fortress America still seems to be standing: Unemployment is dropping, payrolls are expanding, gasoline prices are tumbling and consumer confidence remains high.

But consider these disquieting factors:

The stock market may be right. U.S. stocks are now firmly in correction territory, meaning more than 10 percent off their recent high. Some shrug off the market slide as merely an irrational overreaction to current headlines. Economist Paul Samuelson joked a half-century ago that "the stock market has predicted nine of the last five recessions." After all, the 1987 crash, which vaporized $500 billion in a short time, had no impact on the U.S. economy.

Using Samuelson's measure, the market is correct about the economy's course more than half the time. So the odds are better than even it's right this time.

Former U.S. Treasury Secretary Lawrence Summers noted that while "markets do sometimes send false alarms and should not be slavishly followed, the conventional wisdom essentially never recognizes gathering storms." The market is a prediction forum, he pointed out, and it usually does better than pollsters in calling elections.

Summers finds it "ominous" that the market these days often fails to rally on good news. On Friday, Jan. 8, for instance, it fell despite a strong jobs report and a rebound in Chinese stocks.

The U.S. isn't an island, after all. True, ours isn't an export-based economy. And Americans do have a relentless appetite for imports, especially now that the robust dollar makes them even cheaper. Chances are, we'll continue to gobble up all the foreign-made goods we want.

But at the same time, exports have been a rising segment of U.S. GDP, reaching 13.6 percent of the total in 2015 from 10.6 percent 10 years before, according to the World Bank. For the biggest U.S. companies, which make up the Standard & Poor's 500, overseas sales constitute a third of revenue, by Goldman Sachs' reckoning.

For the quarter ending in December, S&P 500 companies showed an earnings drop of 3.7 percent compared with the year-ago period. This marks the third straight quarterly decline -- guess where a lot of that came from.

GDP growth isn't much of a bulwark. Time was when a strengthening dollar, plummeting oil prices and an emerging market crisis were nonevents for the U.S. Namely, 1997, when overly indebted Asian economies wobbled on the brink of default. The so-called Asian Contagion spread to Russia and Brazil in 1998. Other than briefly rattling the U.S. stock market, that was the extent of it for Americans.

Maybe not so much today. U.S. GDP growth has decelerated again over the past year. In the fourth quarter of 2015, it rose at an annualized rate of only 0.7 percent. Back in the late 1990s, U.S. GDP was growing at over 4 percent yearly. Now it lacks that cushion.

No real weakness lurks in the U.S. The problem comes from offshore, namely from energy.

Falling oil prices are sapping once-thriving U.S. oil producers, and this has had a ripple effect throughout other segments of the economy. Manufacturing is a notable casualty. In an odd way, it echoes the early 1970s oil embargo by OPEC, which demonstrated how intertwined world economies were becoming. But this time, instead of jacking up oil prices, OPEC is pushing them down through overproduction.

The Federal Reserve is out of bullets. To pull the U.S. out of the Great Recession's listless aftermath, the U.S. central bank kept short-term interest rates ultra-low for more than seven years. It also embarked on a vast bond-buying program, known as quantitative easing, or QE. This was intended to pump money into the economy, a move that expanded the Fed's balance sheet to more then $4 trillion, from $800 billion.

But the Fed has ended QE, and in December it raised interest rates by a quarter percentage point. If catastrophe visits again, Fed Chair Janet Yellen has little left to fall back on. In 1998, as a preemptive measure to forestall the Asian Contagion from spreading here, the Fed lowered rates by half a percentage point to 4.75 percent.

Joseph LaVorgna, chief U.S. economist at Deutsche Bank, finds that chances of a recession in this country have risen to 40 percent. He might be optimistic. Other forecasters are even more pessimistic, predicting the U.S. will be pulled down by the global economic undertow by year-end.

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