The world economy is in trouble. Not only are there clear indications of a substantial slowdown in a number of the world’s key economies, there are also growing signs that we could be on the cusp of a worldwide wave of commercial property loan defaults.
Those defaults could put great strain on the global financial system and trigger a meaningful global economic recession. The good news is that those developments should bring in their wake lower inflation in general, and lower international energy and food prices in particular.
That should help both the Federal Reserve and the European Central Bank achieve their inflation targets and should encourage them not to delay the start of an interest rate cutting cycle. Such interest rate cuts would provide much needed support to a weakening world economy and a challenged financial system.
A slew of negative economic data releases provides evidence for the global economy’s troubles. It now turns out that Germany, Europe’s main engine of economic growth, is likely already in recession. The country recently slashed its 2024 gross domestic product growth expectations to 0.2%, down from its previous 1.3% estimate, with government officials calling the economic situation “dramatically bad,” and “in troubled waters.”
Japan and the United Kingdom, the world’s fourth- and sixth-largest economies, respectively, are in similar situations. Japan’s unexpectedly weak GDP growth late last year cost it its spot as the third-largest economy, and the U.K slipped into recession last year as well following two quarters of shrinking GDP. More troubling yet is the dismal economic data coming out of China, the world’s second-largest economy and until recently its main engine of economic growth.
The IMF expects its GDP growth to slow significantly in the coming years, amid weakened demand for exports, dim consumer spending, and increasingly worrying deflation. Last year China’s rising debt levels caused Moody’s to cut its credit outlook, which, combined with mounting property market stress, leaves little doubt that China’s outsized housing and credit market bubble has burst.
Over the past year, housing prices have been falling and property developers have been defaulting on their debt mountain. The most dramatic example is Evergrande, which was once China’s biggest property developer and has now been ordered to liquidate.
At the same time, investor confidence has evaporated in response to the government’s poor handling of the Covid crisis, its heavy-handed clampdown of the tech sector, and its suppression of economic data and criticism, leading to the first negative foreign direct investment in decades.
Underlining this loss of confidence, China has had one of the world’s worst performing major stock markets over the past year. Its benchmark CSI 300 has lost more than a third of its value since 2020, and is entering a fourth year of declines.
All of this suggests that China could be well on its way to a Japanese style lost economic decade and to a prolonged period of price deflation. That could lead to a slowdown in world aggregate demand and a decline in international energy and food prices.
It could also lead to China exporting deflation to the rest of the world through a weakening currency and through its efforts to deal with its domestic industrial overcapacity.
Compounding these problems, the world banking system is nursing massive mark-to-market losses on its bond portfolio as a result of central banks’ interest-rate increases.
Those circumstances raise the risk that the commercial property crisis could lead to a deflationary debt spiral that could push the world into recession. Unfortunately, there are indications that we could be on the cusp of a wave of commercial property debt defaults both at home and abroad.
In Covid’s aftermath, across the globe there has been a marked shift to working from home and to shopping online. That has led to soaring office vacancy rates and plunging commercial property prices in the U.S., Europe, and the U.K. In the U.S., vacancy rates have hit an all-time high of 19.6% in major cities. It’s difficult to see how, over the next few years, property developers will be able to roll over the large amounts of loans that mature at considerably higher interest rates than those at which they were originally contracted.
The resilient U.S. economy has weather the Fed’s 5 ¼ percentage point increase in interest rates surprisingly well. The widely forecast economic recession for last year did not materialize. This year we might not be so lucky, should high interest rates and the commercial property woes trigger another and more vicious round of the regional bank crisis. That would especially be the case if our export demand is hit hard by a slumping world economy.
In 2008, the world paid a heavy economic price for the Fed’s tardiness in responding to the emerging subprime loan and housing market crisis with significant interest rate cuts. We have to hope that both the Fed and the ECB have learned the right lessons from that painful experience and that they start to cut interest rates soon to support the world financial system. If not, we should brace ourselves for another painful U.S. and world economic recession.