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The 4 Biggest Risks to the Economy

After four miserable years, the economy really is improving. Jobs are coming back. Production is on the rise. Debt is coming down. Confidence is going up. The improvement seems real. And I think it will continue.

But the best you can do when forecasting this stuff is to think in probabilities. The odds are good that things will keep getting better, but not perfect. If there's a 70% chance that the economy will improve this year, there's a 30% chance that something less enjoyable will happen. What might go wrong? Four threats should be kept in mind.

Gas prices
Two months ago, a gallon of gasoline cost an average of $3.18. Today, it's $3.52 and rising virtually every day. If you think it's bad now, just wait until the summer driving season.

What's behind the jump? Probably nothing happening here at home. U.S. refinery output is at an all-time high, and U.S. consumption of gasoline is the lowest in 11 years. The U.S. is now a net fuel exporter for the first time since 1949.

Rather, geopolitical strife is likely to blame -- which, of course, U.S. policy is part of. As my colleague Dan Dzombak explained, "The U.S. has been pushing a plan among Iran's major oil customers to embargo Iranian oil over the country's nuclear program ... In retaliation, the Iranians have threatened to close the Strait of Hormuz, the gateway for 20% of the world's oil." A physical constraint of oil doesn't even have to occur here. Just the fear of such an outcome is enough to push global oil prices higher.                                                                    

And that adds up fast. Americans consume about 358 million gallons of gas a day. When prices rise by $0.50 a gallon, an extra $65 billion a year comes out of consumers' pockets. 

These spikes tend to self-correct quickly, as higher prices push people to drive less. But that's what's dangerous. Less driving usually means fewer trips to the mall, a canceled vacation, and less eating out. That can help weaken the economy, as happened in 2008.

Europe
It's cliche to cite Europe as a threat these days, but that doesn't make it any less valid. Fallout from a Greece default or some other cataclysm within Europe's banking system could haunt the U.S. in two ways.

One, the U.S. exports more than a quarter trillion dollars of goods to Europe annually. A deep recession on the Continent could cut into that substantially, dampening what has otherwise been a strong point of the U.S. recovery -- manufacturing and exports.

Two, we could wake up one morning to learn that U.S. banks are more exposed to European assets than they assured us (how most financial crises begin). Scrambling to stem losses, they may then cut back on loan growth, reversing progress made on that front in the last year.                                                                                                                                        

In December, I asked Reuters editor Chrystia Freeland what average U.S. citizens should think about what's happening in Europe. She replied: "The single most important economic actor in their lives is [German Chancellor] Angela Merkel. She is also, more than anyone else in the world, going to be the person who determines who is the next president of the United States."

Politics
When S&P downgraded U.S. debt last year, its reasoning was clear: "The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenge," the ratings agency wrote.

The best example is last summer's debt-ceiling debacle, when Congress came within hours of willfully and voluntarily defaulting on the nation's debt. Throughout the ruckus, most analysts reassured that this was mere posturing, and that Congress would never actually allow a default. In hindsight, they were right. But what if it's different next time? What if, in the intrepid game of chicken we call legislating, each side calls the other's bluff and refuses to budge? It's hard to guess the circumstances, but some self-inflicted wound can easily be imagined. When we asked Motley Fool readers in January what worried them the most, almost half said dysfunctional politics. You can hardly blame them.

Facebook has a sign in its corporate headquarters that says "Move fast and break things." This seems fit for Congress lately. And while it may be a good motto for a young technology company, it's an awful way to run a country.

Something totally unforeseen
Author James Fallows once wrote, "What looks like tomorrow's problem is rarely the real problem when tomorrow rolls around."

There will be another crisis, another recession, and another panic. Many, in fact. And all will have something in common: They will be caused, at least in part, by factors and events that no one is talking about today. Japan could not have foreseen the economic hit caused by its tsunami last year. No one can predict the actions of a rogue trader. Wars, earthquakes, oil spills, assassinations... no one predicts these things because they can't be predicted. But they can have a huge impact on the economy.

Warning of "something unknown" might seem like a cop-out when making a list of risks, but it's probably the most important risk to think about. This is the basis of Nassim Taleb's best-selling book The Black Swan: It's the events we don't think about, or those considered highly improbable, that inflict the most damage. If everyone knows something is going to happen, it's probably nothing to worry about.

For more like this, check out my new e-book, 50 Years in the Making: The Great Recession and Its Aftermath, on Amazon for your Kindle or iPad. It's short, packed with data, and only costs a few bucks.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Editor's note: A previous version of this story understated the current price of gasoline. The Motley Fool regrets the error.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Quiz: How well do you know India's economy?

Question 1

Which of these products is India the world's largest producer of?

Poll Choice Options
  • Wheat
  • Rice
  • Milk
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