By Tom Ozimek
Elon Musk predicted that the U.S. economy will be in for a hard slog until at least the spring of 2024, joining a growing list of ominous warnings about America’s economic outlook after a series of recent high-profile bank failures.
“Tough sledding until spring next year is my best guess,” the Tesla CEO said in a Wednesday post on Twitter.
Musk was replying to a post about Federal Reserve economists predicting a “mild recession” later this year, followed by a gradual recovery over the next two years.
The Fed forecast came by way of minutes of the March Federal Open Market Committee (FOMC), which showed policymakers highly focused on the banking sector turmoil sparked by the collapse of Silicon Valley Bank (SVB), as well as routine issues of inflation and the impact of tightening financial conditions.
“Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years,” per the minutes.
Soaring inflation forced the central bank to embark on an aggressive rate-hiking cycle that has led to a tightening of financing conditions for businesses and households, with borrowing costs having “increased notably,” per the minutes.
Raising the benchmark interest rate that banks use to lend money to each other made consumer and business loans more expensive and harder to get.
“Credit quality was strong overall, although it had worsened a bit for some borrowers. Expectations for future credit quality continued to deteriorate in some markets,” Fed officials said during the meeting, the minutes indicate.
Some economists have warned of a looming credit crunch and that its impact on the economy would be dire.
Looming Credit Crunch
Economist Mohamed El-Erian, president of Queens’ College, Cambridge, and adviser to Allianz and Gramercy, wrote in a Sunday op-ed in the Financial Times that “the flashing red light resulting from a speed-of-light run on the U.S. banking system, or what economists broadly refer to as financial contagion, is behind us.”
“Instead, red has become a flashing yellow due to the slower-moving economic contagion whose main transmission channel, that of curtailed credit extension to the economy, increases the risk not just of recession but also of stagflation,” El-Erian warned.
A year of rising interest rates put smaller banks under pressure as they competed for deposits that were flowing into Treasury bonds and money market funds that offered higher rates of return.
The recent bank failures added to those pressures as depositors withdrew their savings from regional banks in favor of their bigger peers, widely considered “too big to fail” and so more likely to get bailed out in case of trouble.
El-Erian expects that deposit outflows from smaller banks are unlikely to be reversed in the near future. The continued deposit exodus will instead force smaller lenders to pull back, starving small- and medium-sized businesses of credit.
Bigger banks, which are the beneficiaries of the deposit shift, are unlikely to fill the borrowing gap at scale and so, El-Erian believes, “system-wide credit will contract.”
Already there are signs of a credit crunch as lending by U.S. banks in the last two weeks of March plunged by the biggest amount on record.
Fed data shows that commercial bank lending in the United States fell by $105 billion in the two weeks ending March 29—the largest pullback in the measure on record, which dates back to 1973.
“We are on the cusp of a credit contraction that will play out over the next several quarters, probably reaching its apex toward the end of this year or the beginning of next year,” El-Erian wrote.
He believes the Fed should complete its rate-hiking cycle to get inflation down to reasonable levels before trying to offset the credit crunch with looser monetary policy.
“Failing that, we will be dealing with a higher probability of the even trickier challenge of stagflation.”
Stagflation is the toxic mix of slow growth and high inflation.
Other Challenges
Faron Daugs, founder and CEO at Harrison Wallace Financial Group, told The Epoch Times in an emailed statement that he expects bigger U.S. banks to remain unaffected by the sharp rise in interest rates over the past year though he believes smaller banks still face considerable risk.
“The bigger issue for this year is the $1 trillion worth of refinancing and commercial real estate due this year,” Daugs said.
Ultra-low interest rates led to commercial real estate borrowing that was financed at very low rates.
“Now they’re going to have to refinance at probably 3 to 4 to 5 percent higher than where they were, and many of them are just not going to be able to afford to do that,” he said.
“Our concern is potential defaults and foreclosures, and that’s something that’s looming in the bigger banking system that we have to be very cognizant of,” he said.
A number of market analysts have also warned that, as leases expire, tenants will reduce the amount of square footage they will rent and vacancy rates will soar.
This may force landlords to cut rents to keep tenants, with lower rents and higher vacancy rates driving down revenue.
Jack Prenter, CEO at Dollarwise, told The Epoch Times in an emailed statement that he, too, sees defaults coming on commercial real estate loans. But for everyday Americans, the bigger risk is having too much high-interest debt.
As interest rates rise and borrowing costs increase, people should focus on reducing their credit card debt and generally be more cautious about taking out more loans, according to Prenter.
“Stop taking out long term loans to buy vehicles that you can’t afford. Now is the time to buckle down and cut your spending as much as possible,” Prenter said.
