I’m trying to sort through my thoughts on the economic outlook.Things that will limit the decline in employment:

1. Housing construction is already at a very low level. I think that more of the decline in housing starts is behind us than is in front of us.

2. There are very large sectors of our economy that are not going to experience layoffs of as much as 1 percent of their workers: health care, education, public employment

3. The “OPEC tax” has been reduced considerably

Things that suggest trouble ahead:

1. Lack of foreign demand. I always thought that the shock would be a decline in house prices accompanied by a weaker dollar, meaning that the challenge would be to shift employment out of housing and into industries that export or compete with imports. We’ve gotten the negative housing shock, plus a shock to the financial services sector, but foreign demand is not increasing to pick up the slack.

2. The decline in the stock market. This signal to American companies could not be clearer: do not purchase any new capital.

3. The fact that the financial sector is de-leveraging much faster than it is shrinking. We’re in the zombie banking phase, big time.

4. The fact that policymakers are focused on avoiding home foreclosures. Their obsession with this will keep the housing market out of balance for a decade.

(Note that Sheila Bair of the FDIC, instead of doing her job and closing banks to take care of #3, is making a name for herself by being the leading proponent of the bad #4.)

5. The fact that our economy is post-industrial, and traditional Keynesian economics does not take that into account. I still cannot picture unemployed investment bankers joining road-repair crews.

6. A sense that there are more shoes to drop. Commercial real estate, for example.

7. How does New York City adjust? I know somebody there who owns a few houses, financed in part by mortgages. Let’s say that he owes $2 million, and a year ago the houses were worth $5 million. He has no job, but with $3 million in equity, he felt rich. He sent his kids to summer camp in Switzerland. Suppose that when this all shakes out his houses are worth $1.5 million Then he’s broke. I think that a lot of New York wealth is vulnerable in that way. Lots of real estate tycoons with rich-guy lifestyles who could easily be completely bankrupt in another year or two.

The best of all possible worlds would be a huge shift in capital flows, with the U.S. doing more of the world’s saving and other countries becoming more reliable places to invest. We would earn high returns building up capital in India, China, and the developing countries. They would increase their demand for our goods and services.

The worst of all possible worlds would be every country following our protectionist lead. The auto bailout is, if you think about it, the modern equivalent of the Smoot-Hawley tariff. If other countries retaliate by protecting their own precious domestic industries, that is the equivalent of a trade war.

On net, my outlook is pessimistic. I wish I could be otherwise.