The world is terrified of Greece, a nation with a gross domestic product roughly the size of North Carolina's and an economy that, as one investor quipped, peaked in 450 B.C.
Maybe we're all overreacting? Maybe. But the biggest threat that Greece imposes on the U.S. isn't direct. It doesn't even have much to do with Greece per se. It's that if ripples from Greece's fallout have even a minor impact on the U.S. economy, there's little we can do other than sit there and take it. Our immune system against economic ills is exhausted. And when a patient's immune system is exhausted, even a mild cold can be vicious.
How does Greece affect us at all? The worry is that Greece's mess will hammer the euro currency. This is already happening somewhat. Late last year, one euro was worth more than $1.50. Today, it's worth just over $1.20, and plenty expect it to reach parity ($1.00) before long.
That's where things start getting real itchy. With consumer spending and housing construction still moribund, most recovery forecasts rely on a surge in exports. The idea is a weak dollar will spur exports to other economies like China, South America, and Europe.
But thanks to Greece, the dollar is now the strongest it has been in years. As long as that's the case, you can kiss growth from exports goodbye -- and perhaps the recovery as well. That's why companies with large foreign-currency exposure like Philip Morris International
So let's say Greece does push the U.S back into recession. The question you have to ask is "What do we do then?" Or really, it's "What can we do?" And for both governments and businesses, the answer is not very much. Our quiver of recession-fighting weapons is empty. As PIMCO CEO Mohamed El-Erian put it, the world has "already used its spare tire(s)."
What are those spare tires? There are three big ones.
(1) Interest rates
When the economy starts cracking up, the standard response is for the Federal Reserve to slash interest rates. This is the most popular weapon against recession because it's extremely easy to implement and can be quite effective.
Problem is, we can't lower interest rates any further. The short-term rates controlled by the Fed are already pegged at 0%, which is as low as you can go.
The danger here is falling into a liquidity trap. It's what happens when consumers realize that with interest rates bottomed out at 0%, deflation will become an ever-living problem. Eventually you get a self-fulfilling cycle where expectations of lower prices stall consumption, which begets lower prices, which stalls consumption, and on and on. This is basically what Japan suffered through for the past two decades -- negligible interest rates and an economy that has gone nowhere. It hasn't been fun.
Between the Bush stimulus checks of 2008 and the monster stimulus package of 2009, Washington has committed nearly $1 trillion to stimulus. Much of this has been wasted, politically driven, and poorly targeted. On the whole, though, there's broad consensus that the stimulus has done plenty of good. Whether you believe the Congressional Budget Office's estimate of up to 2.4 million jobs saved or created, or Moody's Economy.com estimate of 1.59 million, or economic consultant Macroeconomic Advisers' estimate of 1.06 million, the fact is the economy is stronger today because of the stimulus.
But so much has already been spent, and the spending is so contentious, that the thought of another stimulus seems unlikely even if it's totally necessary. All budgetary wiggle room and political bargaining power was spent last year.
Same goes for bank bailouts. Yes, banks now have much stronger capital and liquidity ratios than in years past. But they're also larger than before, meaning a potential failure could make 2008 look like cheesecake. If one of the mega banks like Citigroup
(3) Corporations cutting back
For nearly all businesses, the main response to a recession is to lay off excess workers, sell unnecessary assets, shut down idle factories, and scale back on fringe expenses. "Get lean and mean," as they say.
This has happened in awesome ways lately. As wretched as this recession was, first-quarter S&P 500 profits were actually higher than they were in late 2005. You can chalk that up to companies running obsessively tight ships, propping up profits as much as possible.
But there's only so much cost-cutting and plant closings you can do, and most of what's possible has already been done. The holiday parties have been eliminated. The job redundancies have been cut. The factories have been shut down. My parents' workplace even jacked the coffee machine. The low-hanging fruit is long picked, and the only thing left to purge if business heads south again is corporate profits.
Where to now?
No one knows what Greece's fallout really means. Fears might be way overblown, and before long we may wonder what the ballyhoo was about. But again, the real risk isn't directly from Greece; it's that even a small reverberation from Greece could morph into something big only because we're out of recession-fighting bullets. The irony is that we may be more vulnerable than ever in the face of an otherwise solid recovery.
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Fool contributor Morgan Housel owns shares of Philip Morris International. Intel and Moody's are Motley Fool Inside Value picks. Moody's is a Stock Advisor choice. Philip Morris International is a Global Gains selection. The Fool has created a covered strangle position on Intel. Motley Fool Options has recommended a buy calls position on Intel, and has a disclosure policy.