We have to wonder whether this year is going to be yet another where economic forecasters prove to have been overly optimistic.
The U.S. has to dodge domestic and international bullets.
T here is an old proverb that man plans, God laughs. No matter how carefully one might plan, all too often, something unforeseen occurs that tears those plans asunder.
Something similar might be said about economic forecasting. No matter how careful the economic forecaster might be, all too often, something unforeseen occurs that makes the forecasts look foolish in hindsight. An egregious example of this occurred in 2008, when economic forecasters generally believed that the U.S. economic recovery would continue at a satisfactory pace. They did so only to find out that the bursting of the subprime credit and housing-market bubbles precipitated the deepest post-war economic recession up to that time.
For this new year, the economic-forecast consensus is that the economy will continue to recover, albeit at a slower pace than last year, while inflation will continue its moderation towards the Federal Reserve’s 2 percent target. However, with all of the serious downside economic risks that are in plain sight, both at home and abroad, we have to wonder whether this year is going to be yet another where economic forecasters prove to have been overly optimistic.
Among the more serious of these risks is the slow-motion train wreck that is occurring in the commercial-real-estate sector. That disaster is the result of overbuilding that was encouraged by years of overly easy monetary policy and by major behavioral changes observed during the Covid-19 pandemic. In the pandemic’s wake, employers found that they did not necessarily need workers in the office each day, meanwhile consumers gravitated toward the greater convenience of shopping online rather than at a mall.
Underlining the dire state of the commercial-property sector is the fact that, at the national scale, office vacancies are now at a record level of over 18 percent. Even worse, they are expected to rise further as leases continue to expire. This has caused office-property prices to fall by 20 percent, and Morgan Stanley predicts that such prices will fall by 40 percent from their March 2022 peak.
It also raises questions about how property developers will manage to roll over the $500 billion in maturing property loans this year at much higher interest rates than those at which those loans were originally contracted. One matter of concern is that major commercial-property companies like Brookfield and Blackstone are walking away from their mortgages and handing back the keys to the lenders.
The risk that the commercial-property market poses to the economic recovery is that it could precipitate a wave of loan defaults that could trigger another round of regional bank crises and cause major problems for city government budgets. This is especially likely since the regional banks are heavily exposed to commercial-property lending and already have large mark-to-market losses on their Treasury bond portfolios as a result of higher interest rates. According to a recent National Bureau of Economic Research study, 385 regional banks are in danger of failing because of expected property-loan defaults.
The last thing that an already slowing U.S. economy needs is a regional-bank credit crunch that would hit hard the all-important small- and medium-sized corporate sector. After all, that sector accounts for almost half of overall U.S. economic activity and employment.
Even if our economy somehow manages to avoid the commercial-real-estate bullet, it would need to be very lucky to dodge the dangerous geopolitical bullets that are in plain sight. We now have two hot wars: Russia and Ukraine, and Israel and Hamas. Those wars have the potential to spread into wider regional conflicts that could have serious consequences for world food and energy prices. Meanwhile, U.S.-China relations are at a low ebb that could have untoward consequences for supply chains and world trade, especially if China were to stir the pot over Taiwan and the South China Sea.
Donald Rumsfeld famously spoke of known knowns, known unknowns, and unknown unknowns. When it comes to economics, it is often the unknown unknowns that upset the apple cart. That is yet another reason why we need to be very careful about the consensus economic view that assures us that everything in this new year is going to turn out just right for the economy.