Despite a series of economic reports pointing to a continuing anemic recovery, Research Affiliates founder Rob Arnott believes the odds of a double-dip recession remain above 50%.

His reasoning is simple: Without the stimulus package that keeps trickling its way through the economy, GDP would never have emerged from the Great Recession in 2009.

Arnott is no fan of the stimulus. But he believes that the inventory rebuild in the second half of 2009, on its own, was insufficient to move the needle into positive numbers. The same goes for the rest of the private sector.

If all the 2001 and 2003 tax cuts are extended, that might be enough to keep the odds of a double-dip just below 50%. Why? Because the economy is still overly dependent on consumer spending and, at present, the folks who earn over $200,000 a year are the only ones capable of spending, Arnott believes. Everyone else is de-leveraging.

Arnott acknowledges that even affluent people are hardly in a mood to spend in a big way, and a tax increase won't perk up their pocket books. Earlier this year, signs surfaced that there might be a spending revival among rich folks, but the Greek crisis and the flash crash poured cold water on that short-lived boomlet.

Even if all tax cuts are extended, the situation is far from optimal. "If the tax cuts are extended, I think the odds of recession fall below 50/50," he says.  "But, the tax cuts can only "stick"-long-term-if spending is also slashed.  Spending that isn't covered by current tax receipts (i.e., deficit spending) must eventually be covered by future tax receipts."

Positive signals from the real economy don't impress Arnott. Manufacturing may be staging an impressive rebound, but there's one serious problem. Today, Arnott notes that manufacturing is a much smaller part of the overall U.S. economy than it was 20 or 30 years ago, so its contribution has shrunk.

Weaning ourselves off of debt-financed consumption is going to be a long, drawn-out process. When stimulus spending tails off to a trickle next year, growth in the service-based private sector may advance at a glacial pace, but state and municipal governments are likely to continue downsizing their bloated work forces.

So by 2011, Arnott, who manages PIMCO's All Asset and All Asset All Authority funds, suspects there could be a growing chorus of voices wailing about deflation. And they could well be wrong.

Why? As a nation, we are likely to be faced with three choices to escape from the mess we are in. Door Number One would entail a dramatic increase in taxes. Door Number Two would require a major abrogation of the social contract, e.g., entitlements, possibly combined with a default on U.S. Treasurys. Door Number
Three would simply be a well-orchestrated reflation.

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