Brace for 1930s-style economic disorder — especially if interest rates keep climbing

The world is soon headed for a period of serious economic disorder, warns Ray Dalio, founder of the world’s largest hedge fund, Bridgewater.

And (to paraphrase what a 1970s brokerage-firm commercial used to say about E.F. Hutton) when Dalio speaks, people need to listen.

Especially with his alarming warning backed up by historical experience and by current trends.

The essence of Dalio’s message: Economic disorder looms as a result of the combination of three factors all too reminiscent of the economically turbulent 1930s.

The first: The world has never been indebted before as it is today.

The second: Populism driven by income inequality has become the order of the day in all too many countries, including most importantly the United States.

Finally: Rivalry between major world powers like China, Russia and the United States has echoes of the world geopolitical tensions experienced in the first half of the 20th century with the rise of Germany as an economic powerhouse.

Anyone who thinks that the world does not have a major debt problem hasn’t been paying attention.

According to the Institute for International Finance, world debt at the end of 2022 hit a record $300 trillion, or some 350% of world GDP.

That is around 50 percentage points of GDP higher than it was on the eve of the 2008-2009 Great Economic Recession.

Meanwhile, per the Bank for International Settlements, if interest rates were to reach the levels of the mid-1990s, the debt-service burden for developed economies would be the highest in history.

Unfortunately, there is every prospect that interest rates in the developed countries will reach or surpass their mid-1990s level.

Over the past year, both the Federal Reserve and the European Central Bank have raised interest rates to combat inflation at the fastest pace since the early 1980s.

At the same time, both Fed Chairman Jerome Powell and ECB President Christine Lagarde are warning that interest rates might need to be raised further in light of inflation’s current stickiness.

They have also warned that interest rates will stay high for longer than the market currently expects.  

The one sector for which high interest rates could be particularly problematical is the real commercial-property space.

Already struggling with low occupancy rates in a post-COVID world, the last thing this sector needs is high interest rates.

This is especially the case at a time when it has $500 billion a year in debt to roll over in the next three years.

This could add renewed stress to the US regional banks: Commercial property represents 28% of their balance sheets.

The political calendar suggests that debt problems could coincide with increased domestic political strife, especially in the United States.

Polls indicate that the nation has never been as politically polarized as it is today in the post-war period.

They also suggest a divisive Donald Trump very likely could be the Republican Party’s nominee in the 2024 presidential election.

As if the debt and domestic political problems were not a sufficient challenge for the global economy, there’s the real prospect that the world’s already difficult geopolitical environment could take a turn for the worse.

This would be particularly the case were China’s President Xi Jinping to take a page out of Russian President Vladimir Putin’s playbook and embark on a Taiwanese military adventure to divert attention from a struggling domestic economy.

It hardly helps that Taiwan supplies around half of our electronic chips and an even higher proportion of the more sophisticated of these chips.

All of this suggests the Fed and the ECB could be playing with fire in their single-minded quest to defeat inflation with ever higher interest rates.

As Dalio usefully reminds us, hewing to a hawkish monetary policy by allowing banks to fail and the money supply to contract wasn’t the wisest of monetary policy decisions in the 1930s when the world economy was plagued as it is today with high debt, domestic political strife and large geopolitical challenges.

There is every reason to think monetary-policy overkill would not be a good idea today as well.

Desmond Lachman is a senior fellow at the American Enterprise Institute. He was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.