The 5 big hurdles on the road to lasting economic recovery

A home for sale in Haight Ashbury, San Francisco. The US housing crisis is a destabilising influence on the global economy. Photograph: Robert Galbraith/Reuters

The first indications of the damage caused by the financial turbulence of the past few weeks will be seen on Wednesday, with the manufacturing figures from around the globe. These purchasing managers' indices are closely watched as indicators of industrial orders, and output and any readings markedly below 50 will sound recessionary warning bells.

At the Bank of England, as at the US Federal Reserve and the European Central Bank, there is a weary acceptance that the recovery from the recession of 2008-09 has received yet another setback. Even so, the view is that after a tough few months, the pace of growth will pick up gradually in 2012.

There are alternative views. Nouriel Roubini, the Dr Doom of economics forecasting, told the Wall Street Journal earlier this month that Marx was right when he said capitalism could destroy itself by continually shifting income and wealth from labour to capital.

The greens say it proves that EF Schumacher had it right when he wrote Small Is Beautiful almost four decades ago, and that the world is now being pushed beyond its carrying capacity by an orgy of excess.

The Austrian school of economics says that the sluggish global economyis the result of central bank governors and finance ministers ignoring the teachings of economists Friedrich Hayek and Joseph Schumpeter. Rather than prop up failed banks, policy makers should have let them go bust. The consequence of not doing so is that the west now has a motley collection of zombie banks that are not fit for purpose.

Finally, there are the followers of John Maynard Keynes, who say the problem is that there was a dangerous reversion to economic orthodoxy once the global economy started to recover in the spring of 2009. The Keynesians see the solution as more quantitative easing, less fiscal austerity and public infrastructure projects to kickstart demand.

History would suggest that Sir Mervyn King, Ben Bernanke and Jean-Claude Trichet are right to be cautiously optimistic. Over the past 250 years, industrial capitalism has displayed a remarkable ability to regenerate itself. The mainstream view is that it will do so again, even though the severity of the shock to the financial system means the process will be slower than usual.

But confidence has been dented in recent months as it has become clear that the road to lasting recovery is obstructed by five big hurdles.

1. Europe's debt crisis

Easily the biggest short-term challenge currently is the need to sort out Europe's sovereign debt crisis. King has identified Europe as the biggest threat to Britain's economic prospects and the Bank can already detect evidence that the bickering over Greece's bailout, the perceived vulnerability of Italy and Spain, and fears that already weakened banks could be wiped out by losses on eurozone bonds is having an impact on the willingness of banks to lend. There are already echoes of 2007-08, when interbank lending dried up and the cost of insuring banks against default rose sharply.

The duration and depth of the crisis in Europe mean financial markets are no longer going to be mollified by stop-gap solutions. They want to see the size of Europe's bailout fund massively increased; they want the Germans to agree to common European bonds in order to provide collective security for the weaker members of monetary union; and they want Europe to move quickly towards full economic union. It is not just dealers on Wall Street and the City who see closer integration as the alternative to collapse: George Osborne believes that too.

2. The US housing market

The second obstacle is the American housing market, which has seen a deeper slump over the past five years than was suffered during the Great Depression. Prices are still falling and with a quarter of households in negative equity and mortgage arrears on the rise, consumers feel progressively less well off and that makes them reluctant to spend. The Federal Reserve's quantitative easing programme is designed to help homeowners by driving up the cost of US Treasury bonds, which reduces the interest rates paid on the money Washington borrows. Lower bond yields feed through into cheaper fixed-rate mortgages.

But the desire of consumers to pay down their debts means QE has so far proved ineffective as a cure for the woes of the real estate market. Other more radical solutions are now being canvassed such as federal loans for those homeowners whose mortgages are under water to cover the negative equity. While politically attractive to the Obama regime, this would have trouble getting through Congress even if the programme involved Washington getting a slice of the proceeds when house prices start to rise once more.

3 and 4. Global imbalances

Giants three and four are the two aspects of globalisation that were at the root of the crisis in the first place – the imbalances between creditor and debtor nations, and the financial system.

Little progress has been found through official channels – the International Monetary Fund and the G20 – to deal with the former, running the risk that the global economy will find a new equilibrium through debtor countries deflating rather than through creditor countries reflating. Economists at Lombard Street believe the key imbalance – between China and the US – may eventually be resolved by rising prices in China, which is pushing up the real (inflation-adjusted) exchange rate. Other analysts believe China's continued trade surplus with the US will fan protectionist pressures.

The good news on the global financial system is that banks have spent the past three years building up their capital. Prudential oversight has also been strengthened in countries like Britain through the Bank of England's financial policy committee. The bad news is that flows of credit to the new businesses that will generate the next economic upswing are still lacking. And the regulatory reforms necessary to prevent a future speculative frenzy are incomplete.

5. Oil prices

Finally, there are oil prices. Despite the slowdown of recent months, a barrel of Brent crude is still changing hands for more than $110, five times its price a decade ago. The expectation is that the cost of energy will come down over the coming months, boosting the spending power of consumers. But a return to the 1990s – when oil at $10 a barrel was one reason for strong global growth – appears to be over for good.

Faced with these five challenges – sovereign debt in Europe, a bombed-out US real estate market, an under-valued Chinese currency, a dysfunctional banking system and high oil prices – it is little wonder policy makers are mulling over what more they can do to keep the recovery going. The global economy has slowed to a stall; it would not take much for it to crash land.