As a general rule of thumb, an economy in recession will experience one of three types of recovery. First is the V-Shaped recovery. The economy moves into two consecutive quarters of economic contraction as measured by GDP, but once a low is hit, markets quickly rebound, unemployment drops, and an overall recovery becomes self-sustaining. The second is a W-Shaped recovery. This is better known as the Double-Dip Recession. The economy hits a low, rebounds with vigor, only to fail to develop self-sustaining characteristics, at which point the lows are retested, before the economy finally gets enough steam to move back into expansionary mode.

The third type of recovery is the scary one, the L-Shaped Recovery.  Similar to the first two types, the economy hits a low, but instead of rebounding, it remains at the lows and moves sideways for an extended period of time. Japan experienced an L-Shaped recovery in the 90's in what economists have infamously dubbed, "The Lost Decade." Although no one wants to see a weakened U.S. or global economy, there are several economic happenings that may come together to cause a perfect storm.

A Slowing Chinese Economy

As the developed world has experienced an economic catastrophe during the last two years, China has actually grown at incredible rates. In fact, they have grown at rates so aggressive that the Chinese Government has intervened and forced banks to increase their reserve amounts, which in turn has led to fewer loans being given out. The effects of this slow removal of monetary stimulus from the market have caused Chinese economic numbers to begin contracting. As a matter of fact, PMI numbers out of China showed contraction for the second straight month in July. This contraction was not only in China, but throughout much of Asia. As China begins to slow down from their incredibly high rate of economic growth, the effects could be felt worldwide. Currently, China is expected to simply slow down, and not fall into actual recession. However, if demand from Europe and the U.S. continues to decrease, there could be trouble ahead for China. Add to this fire the fact that China is beginning to let their currency, the Yuan appreciate, and we could be headed for interesting times in China. A more expensive currency will make China's exports less attractive to already hurting buyers in Europe and the U.S. Consequently, China's exports, which are the primary driver of the Chinese economy, may begin to contract in a more threatening fashion.

EuroZone Fiasco

The EuroZone has been staging quite a rally against the U.S. Dollar over the past few weeks as investors have been selling the Greenback on poor U.S. economic news, and choosing to buy the Euro. This buying has also found further support as Spain had a very successful bond auction last week, where they were able to sell more government debt than previously expected. This reassured investors as it became evident there is adequate demand for EuroZone sovereign debt, even in the midst of the threat of default that is currently in the market. However, the European Central Bank is encouraging strict fiscal austerity measures to be adopted by struggling economies such as Greece, Portugal, Italy, and Spain. These austerity measures are frightening to President Obama's Administration and several high-profile economists in the U.S. such as Paul Krugman, who are convinced that if loose monetary policy is removed from a struggling economy trying to emerge from a difficult recession, the probability of a Double-Dip is extremely high. The thought is that if these countries are not performing well with loose monetary policy, how can they possibly grow and expand with even tighter fiscal conditions in place. At best, economists are saying the EuroZone will be in for an extended period of very sluggish growth. At worst, a Double-Dip will occur as economic reports begin to confirm investor fears of a lack of recovery and a run on equity markets and the Euro begin again.

Slowing U.S. Economy

It is now apparent to investors that the U.S. Recovery is hitting major roadblocks. Unemployment is proving to remain at stubbornly high levels as labor markets continue to stay in very weak conditions. The housing market rallied quite nicely from its lows in early 2009 as the $8000 tax credit for first-time home buyers artificially propped up the market. Now that this stimulus has been removed from the market, housing numbers are beginning to post dreadfully bad results. These weak economic numbers coming out of the U.S. have led to heavy selling of the Greenback as it becomes clearer that the Federal Reserve will not be able to raise rates for an extended period of time.

U.K. Inflationary Problems

The U.K. is the only country in the G3 that is facing the imminent threat of inflation. This is highly problematic for the U.K. economy. Typically, when an economy is facing inflation, the Central Bank will simply raise interest rates in order to stem inflation and bring back normalcy to prices. However, it gets difficult when an economy is in the midst of recession or sub-par growth as the U.K. is currently. If inflation continues to transgress target areas set by the Central Bank, the CB may be forced to raise rates. This could be disastrous for a very weak U.K. economy because as interest rates are raised, it will bring an even further slow-down to an already slow economy. This could thrust the U.K. back into recession, which could be disastrous for this fragile economy.

So, could a perfect storm be brewing? Many believe it is. A combination of a slowing Chinese economy, a very sluggish U.S. economy, EuroZone sovereign debt problems and the fear of premature fiscal tightening, and the threat of inflation in the U.K. could all serve to form a deadly combination. If several of these key factors begin to gain momentum in the coming weeks, we could see a massive return of risk aversion into the world markets. This would send equity markets, the Euro, and Pound tumbling, as investors once again rush into the U.S. Dollar to find safety. The storm may be upon us.