Two economic indicators hammered the markets today, causing new worries of a second recession.  The biggest bombshell came from the Philadelphia Fed’s economic index, which dropped from an anemic +2 in July all the way to -30.7 in August:

Manufacturing in the Philadelphia region unexpectedly contracted in August by the most in more than two years as orders plunged and factories shed workers.

The Federal Reserve Bank of Philadelphia’s general economic index plunged to minus 30.7 this month, the lowest since March 2009, from 3.2 in July. The August gauge exceeded the most pessimistic projection in a Bloomberg News survey in which the median estimate was 2. Readings less than zero signal contraction in the area covering eastern Pennsylvania, southern New Jersey and Delaware.

Stocks extended their decline after the figures showed weaker demand from consumers and companies in the U.S. and abroad is posing a risk to the industry that spearheaded the recovery. Fewer customer inventories may indicate producers will see a smaller decrease in orders should the U.S. economy falter.

Leading the drop was a fall in new orders in the region, which pushed the Philly Fed’s orders index from +0.1 to -26.8.  The shipment index also fell from +4.3 to -13.9.  Their employment index also fell from +8.9 to -5.2, a number which indicates that the next jobs report won’t be very good for the Obama administration.

On top of that, existing home sales fell 3.5% in July to a new low for 2011, and this year now lags last year:

The number of people who bought previously occupied homes dropped in July. The third decline in four months suggests the depressed housing market won’t help the U.S. economy recover this year.

Home sales fell 3.5 percent last month to a seasonally adjusted annual rate of 4.67 million homes, the National Association of Realtors said Thursday. That’s far below the 6 million that economists say must be sold to sustain a healthy housing market.

And this year’s pace is lagging behind last year’s total sales. The 4.91 million last year were the weakest sales figures in 13 years.

The dismal report on home sales contributed to a rough day on Wall Street. Stocks plummeted in morning trading on fears that the global economy is slowing. The Dow Jones industrial average fell 500 points within the first hour of trading.

The Fed says that the risks of recession have risen in the past six months, but that it’s still “quite low“:

Despite “anemic” U.S. growth so far this year, the risk of a double-dip recession is “quite low”, a top Federal Reserve policymaker said on Thursday.

“The risk of a recession is somewhat higher than it was six months ago. That said, I think the risk of a recession is still quite low,” William Dudley, the president of the Federal Reserve Bank of New York, told New Jersey business leaders.

Dudley said that only some of the restraints on growth, such as high oil prices and Japan’s earthquake in the first half of the year, can be considered temporary.

He’s heartened by the fact that the Treasuries market appears to be booming despite its recent downgrade from S&P.  In fact, the 10-year Treasury note fell below a 2% yield for the first time ever as investors sought shelter in American sovereign debt.  That has other economists more worried about the double dip than Dudley:

The data added to concerns that the U.S. economy will head back into recession at the same time as the country’s rising debt load and record deficit leaves the government and the Federal Reserve with fewer options to stimulate the economy.

“It looks pretty bad across the board,” said Gus Faucher, director of macroeconomics at Moody’s Analytics in West Chester, Pennsylvania.

The data sparked a frenzy of buying that sent benchmark 10-year note yields as low as 1.97 percent, smashing through the previous low yield of 2.038 percent.

In other words, Obamanomics isn’t working, and we’re not going to fix the problem with another short-term stimulus.  The Chinese learned that lesson the hard way:

To shield its economy from the fallout of the 2008 financial crisis, Beijing orchestrated a massive economic stimulus. It invested billions in infrastructure projects and encouraged banks to open the credit spigot to fund construction of apartments, office towers and retail centers.

The strategy catapulted China past Japan to become the world’s second-largest economy; its growth helped keep the global slump from deepening. China splurged on Australian iron ore, Chilean copper and Saudi Arabian oil to fuel its construction boom. While the U.S. economy was mired in recession, with negative year-over-year growth in gross domestic product in 2008 and 2009, China’s economy expanded by more than 9% annually over the same period.

But like taking steroids, there were side effects. The burst of credit has fueled inflation, which is proving painful for average Chinese. Soaring prices for pork, vegetables and other staples have authorities worried about the potential for social unrest. So has a property bubble that has put home ownership out of reach of millions, exacerbating the gulf between rich and poor.

Meanwhile, the nation’s debt levels have reached new heights. A national audit released in June found outstanding loans to local governments, among the biggest players in the building binge, amounted to $1.65 trillion, or nearly a third of China’s GDP. …

But the big concern inside and outside of China is a so-called hard landing. If Europe and the U.S. fall back into recession and demand for Chinese-made goods declines, Beijing won’t be able to juice its economy like it did the last time around.

“It’s a lesson on the limits of stimulus. The more you do it, the less and less you’ll get out of it,” said Patrick Chovanec, a professor at Tsinghua University’s School of Economics and Management in Beijing. “You’ve already tapped all the good investments out there. A second time, you’d just be shoveling money out the door…. It will just compound their problems.”

Actually, this article reminds me of Paul Krugman’s space-invaders scenario.  China did what Krugman suggested — built a whole lot of assets that weren’t needed.  Now they have empty malls, apartment buildings, and public venues with no use for them at all except as curiosities.  In spending capital on useless assets, China now has no capital to use in a second downturn, and has no ability to convert the assets they built into more effective liquidity for more flexible policies.

Short-term gimmicks are the problem, not the solution.  We need deregulation in order to stimulate investment and a tax system that rewards innovation and expansion, not crony capitalists.