U.S. economy remains resilient, but numerous risks loom

The American economy has been something of a riddle recently—despite persistent inflation, rising interest rates and predictions of an imminent recession, it keeps rolling along.

Unemployment is at an all-time low of 3.4%, inflation, though sticky, has moderated and consumers continue to spend.

It’s a reflection of what Joe Brusuelas, chief economist for RSM US, says is the underlying strength of the American economy. He spoke with Neil Bradley, executive vice president for the U.S. Chamber of Commerce, during a recent wide-ranging discussion of economic issues affecting the middle market.

“The R word I have been using recently for the American economy is resilience, not recession,” Brusuelas said during the event, which was livestreamed on May 16.

Default risk

But risks remain, and the most immediate of those is the growing standoff over raising the nation’s debt ceiling. The so-called X date, when the government will exhaust its special measures and run out of money to pay its bills, is approaching, sometime in the next few weeks.

Though Brusuelas and Bradley were optimistic that Republicans and Democrats could reach a deal, it won’t be easy, and the process has pitfalls. Already, financial markets have been pricing in the chance of default of some kind, which Brusuelas pegged at around 10%.

“Ten percent is a nontrivial amount of risk,” Bradley said. “It’s a really big deal.” Making it more confounding, Brusuelas said, was that the risk stemmed from “essentially an artificial crisis.”

If anything could tip the balance into a worst-case scenario, Bradley said, it’s that one side in the talks could miscalculate the other side’s actions. “The danger is you press your advantage, and you stumble your way into default,” he said.

Accidents happen, and the price in this case would be staggering. As Brusuelas said, the gears of the economy would grind to a halt as interbank lending is disrupted, setting off an extreme downturn.

“If that freezes up, this could get very dangerous,” he said.

Still, both Bradley and Brusuelas expressed optimism that lawmakers would strike a deal in time. Bradley said he hoped that such a deal would be reached in a bipartisan way, and include the following features:

• Rescind pandemic aid that has not been spent.
• Come up with a framework to guide future spending that would allow for more rational decisions.
• Include policy measures, such as speeding up the permitting process for government projects that have already been approved. 

Recession risk

Lurking beyond the near-term threat of default is the risk of a recession. Brusuelas puts the chance of a recession at 75% over the next 12 months, but noted that recent economic data has continued to show an underlying strength to the economy. For this reason, he does not see a recession starting until 2024.

He cited strong retail sales for April and the still substantial $500 billion in excess savings that American households are carrying on their balance sheets, according to the San Francisco Federal Reserve.

When factoring in a strong labor market, Brusuelas said, the economy has room to run—provided, of course, that it avoids self-inflicted damage like a default on government debt payments.

Banking risk

Another area of risk in the economy centers around the nation’s small and midsize banks, which have experienced significant turmoil recently. These banks are no small issue to the health of the middle market since they account for a significant amount of lending in America’s real economy.

To start with, the recent turmoil in the banking sector highlighted the challenges of updating deposit insurance regulations. To have a one-size-fits-all insurance limit of $250,000, Brusuelas said, did not properly address the risks faced by middle market businesses that their deposits will be there to meet payroll and cover expenses.

“The current regulatory framework was built for two and three generations ago,” Brusuelas said. “We need to modernize it to accentuate the needs of small and midsize businesses that employ the majority of people.”

Commercial real estate risk

Another challenge for the nation’s small and midsize banks is in commercial real estate. Bradley said that the work-from-home trend has exposed a lot of cities to an emptying downtown core, with soaring vacancies.

“If you’re exposed to that on the banking side or the investment side, or in municipalities, you’re going to be vulnerable,” Bradley said.

Brusuelas added that about $1.5 trillion in commercial real estate loans that were made during the low-interest rate era will have to be rolled over at higher rates over the next 18 months. And that will affect many areas of the country, Brusuelas said.

“It’s all too easy to say this is a problem in Chicago, New York, Los Angeles and San Francisco,” he said. But 90% of commercial real estate loans outside of those areas are made by small and regional banks.

The distress “is going to be out in the burbs,” Brusuelas said. Policymakers, including at the state and local level, will need to devise creative policies to prevent this distress from escalating. “We need to get out ahead of this,” he added.

Brusuelas and Bradley cited the CHIPS and Science Act, which was enacted last year to strengthen America’s semiconductor industry.

While the CHIPS Act took time to put together, Bradley said, it was a more rational approach than acting hastily in the middle of a crisis—a lesson that may be useful for the current real estate upheaval.