A bank collapse, civil disturbances, “stagflation,” and a commercial real estate implosion are all possible outcomes of the Federal Reserve’s current campaign of anti-inflation rate hikes, one economics professor says. 

Investopedia interviewed Richard Wolff, professor emeritus of economics at the University of Massachusetts, Amherst about stresses the Fed’s rate hikes are putting on the economy. Wolff is the author of 12 books on the economics of capitalism, socialism, and democracy and is a visiting professor at the New School University. He has taught economics at Yale, The City College of the City University of New York, and the Sorbonne in Paris. Wolff gave an expansive overview of the risks the U.S. economy faces in a time of high interest rates. 

Key Takeaways

  • Richard Wolff is a professor emeritus of economics at the University of Massachusetts, Amherst.
  • Wolff said in the wake of the Fed’s interest rate hikes, more industries could succumb to the pressure being put on the economy.
  • Banks, exports, and commercial rents could all crack next, he said.

We asked Wolff what parts of the economy could break as the Fed’s benchmark interest rate—at its highest since 2006—keeps climbing:

“It breaks the banks because most of them have bought long-term bonds, whose prices go down as interest rates go up, which is something you learn in the equivalent of a first grade in studying economics, but which seems to have come as a thunderclap of amazement to the Silicon Valley Bank directors and the many other banks that have the same problem to varying degrees. 

It is perfectly possible that we have stagflation, or that the inflation heats up again, or even that it just stays the way it is. That has consequences. Why? Because world trade depends, among other things, on relative prices. 

I’ll give you a hypothetical consumer sitting in Cairo, Egypt. They have the ability to buy objects that come from China, or from Sweden, or from the United States or from Brazil. And one of the factors governing their decisions is the relative prices of these things, taking into account exchange rates between currencies. The price is part of the story. And if prices were going up, you are pricing yourself out of markets. 

The big sufferer right now is Europe, because the inflation rates in Europe are considerably higher than they are here. If you’re paying attention to what’s going on in France, you will get a foretaste of what could happen here, even though Americans need to pretend that those things don’t happen here. They do and they will. 

Europeans are pricing themselves out of the world market. Europe is in a condition to make America look good, and that is not easy these days.

The Netherlands has a 15% to 17% inflation rate, three times what it is here in the United States, Europe as a whole, 10%, Britain, 12% to 15%. These are numbers we used to associate with so-called Banana Republics, but these are not. Europe has so many other problems, it can’t possibly handle what it is doing. 

It’s going to mess up international trade. It’ll be much more disruptive than having a freighter stuck sideways in the Suez Canal. The United States is at risk of losing markets around the world because it’s pricing itself out if it doesn’t deal with the inflation. 

Since it only uses raising interest rates, it bumps up against collapsing its own banking system. So to retreat from that, we saw what the Fed did. It only went up a quarter point where before it had been thinking of half a point or maybe even three quarters again.

But now, to save the banks, you’re once again confronting the inflationary problem. You’re seeing an economy that is herky-jerky, going from one problem to the next, discovering that the solution to the first one worsens the second one. 

It’s like an ancient person in the last days of their life in the hospital being told by the doctors, `We can’t give you this medication for that disease, because it clashes with the other medication for your other disease.’ And at a certain point, you say goodbye to everybody you love and it’s over.

Then there are other sectors we don’t even know about waiting to explode in this economic system, or problems that in other circumstances—again, the metaphor would be an old person sick in the hospital—problems that we probably could have muddled our way through now are much riskier because they are arriving at a time when the system is already maximally stressed. 

I’ll give you one example: commercial rents. All over the country. We have office towers in every city. And those office towers are now a quarter to a third empty. The reason is that the pandemic made people work from home, and considerable numbers of these workers are not about to go back to work, not anytime soon. And even strong efforts to pressure them have been mixed in their results. 

The economics here are very serious. Empty offices don’t pay rent. Landlords of office buildings that are the bedrock of the center of most American cities now are in deep trouble. All of them were built with massive bank loans. They borrowed money. They issued bonds. They’re in debt up to the wazoo to build the office tower premised on the marketing, which told them every office in that place would be leased at a nice flat rate. All of that’s gone. The offices are empty. 

That has meant they’ve had to drop the rates to get even those offices that are now filled, filled, and they’re not raising enough revenue to pay off their debts. It’s only a matter of time now. It’s no longer a question of whether, it’s just a question of when the cascade of office loans crashes on the system. 

We’ve already seen how bad it can be because the death of the mall, which has been going on for years, has really stressed the banks who funded all those malls. It’s still going on, but the height of it was several years ago. We could handle that then. We can’t, on top of that continuing, handle an office catastrophe at this point. Nobody knows yet how bad it is or what forms the disintegration will take. 

What will be the impact of downtown urban development with empty buildings? Convert them into housing? Not now. Because why? Because mortgages are so high that you can’t rent the damn thing as an apartment any more than you could rent it as an office. 

What do you do under those circumstances? Everybody sticks their finger up their nose and doesn’t have any answer to these questions. All of them are made worse by the inflation. All of them are made worse by the rising interest rates whether or not it solves the inflation problem.”

This interview excerpt has been edited for brevity and clarity.

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