by Michael Roberts
The debt owed by corporations in the major economies has risen
since the end of the Great Recession in 2009. With global growth
slowing and the prospect rising of an outright global recession
recurring ten years after the last one, the debt held by corporations
may soon become so burdensome to a sufficiently large number of
companies that it triggers a round of corporate bankruptcies. The banks
will then see a sharp rise in non-performing loans. That could lead to a
new credit crunch as banks refuse to lend to each other.
Such a credit squeeze briefly erupted last month, when the US Federal
Reserve was forced to inject over $50bn into the banking system in
order to reverse a very sharp rise in inter-bank interest rates as
cash-flush banks refused to help out weaker ones. The cause of that
squeeze was a rise in the supply of government bonds as the Trump
administration issued more to cover its rising budget deficit. Some
banks were not able to fund the purchases they were committed to without
borrowing. So, as bank reserves held with central banks in US, Europe and Japan have surged, interbank money market volume has declined.
As a result of this shock to the credit markets, the Fed has returned
to the market to buy short-term Treasury bills to restore bank
liquidity. So, having ended quantitative easing (buying bonds) and
started to hike its policy interest rate last year, the Fed has had to
backtrack, cut rates and re-introduce QE again. More than half of
central banks are now in easing mode, the biggest proportion since the
aftermath of the financial crisis. During the third quarter of 2019, 58%
of central banks cut interest rates.
In its latest Global Financial Stability report, the IMF expressed its worry that: “corporations
in eight major economies are taking on more debt, and their ability to
service it is weakening. We look at the potential impact of a material
economic slowdown—one that is as half as severe as the global financial
crisis of 2007-08 and our conclusion is sobering: debt owed by firms
unable to cover interest expenses with earnings, which we call corporate
debt-at-risk, could rise to $19 trillion. That is almost 40
percent of total corporate debt in the economies we studied, which
include the United States, China, and some European economies.”
And in emerging markets: “external debt is rising among emerging
and frontier economies as they attract capital flows from advanced
economies, where interest rates are lower. Median external debt has
risen to 160 percent of exports from 100 percent in 2008 among emerging
market economies. A sharp tightening in financial conditions and higher
borrowing costs would make it harder for them to service their debts.” Tobias Adrian and Fabio Natalucci, two senior IMF officials responsible for the Global Financial Stability Report, said: “A
sharp, sudden tightening in financial conditions could unmask these
vulnerabilities and put pressures on asset price valuations.”
I have suggested for some time (years) that corporate debt could be the financial trigger for a new recession.
It was housing debt (sub-prime mortgages) in 2007-8; now it could be
corporate debt (through ‘leveraged loans’ ie loans companies already
loaded with debt).
Now it seems that the IMF is catching on to that possibility. Ex-Goldman Sachs chief economist and now columnist for the FT, Gavyn Davies, has also latched on to this growing risk. Davies commented: “I argued in March that this problem was not yet dangerous, but that was probably too complacent.” He was complacent, he says, because “Although
US corporate debt-to-income ratios were already close to all-time
peaks, other aspects of company balance sheets and financial flows were
in much better shape. Profit margins were still fairly robust, the net
financial balance of the corporate sector was in comfortable surplus,
interest-to-income ratios were low and debt-to-equity ratios were
healthy.” But now: “In the last six months, the condition of
US corporate finances has become more worrying. As in other major
economies, profit margins have come under increasing downward pressure,
because producers’ wage costs have been rising more rapidly than selling
prices to the consumer.”
As a result of shrinking profit margins and slowing revenue growth,
earnings for S&P 500 companies are now estimated to have fallen in
the past 12 months, down from 20 per cent growth in 2018. Furthermore,
earnings growth for the large quoted companies contained in the S&P
500, including foreign profits, has been much higher than the figure for
the entire company sector in the domestic economy. Those figures show
that US profits have risen by only 6 per cent in the last three years,
compared with an increase of 50 per cent for the S&P 500. And
non-financial sector profits are actually lower than in 2014! It’s a profits recession.
In a previous post ahead of Davies, I looked at the earnings results
of the top 500 companies by stock market value in the US, S&P-500. With
nearly all results in for the second quarter of 2019 ending in June,
total earnings (profits) are up only 0.5% and sales revenues up only
4.7%. After taking into account current inflation, real earnings
were negative and revenues barely positive. And that’s for the top 500
companies. For the smaller companies, the situation is even worse.
Earnings are down over 10% from last year and revenues up only 2.2%, or
flat after inflation. Excluding the finance sector, earnings would be
down 21%. A sector analysis shows that the retail sector did best as
the American consumer went on spending, along with the finance sector.
But productive sectors like technology saw a 6.3% fall in profits. And
that is key. For the first half of 2019, the earnings are in negative
territory compared to a 23% rise in the first half of 2018. And the
forecast for Q3 earnings is for a further fall of 4.3% yoy.
Davies reckons that: “The deterioration in profits growth has
been accompanied by more aggressive corporate financial behaviour, while
real capital investment to expand productive capacity has been cut
back. According to the IMF stability report, share buybacks, dividends
and merger and acquisition activities — financed by leveraged loans and
high-yield bonds — have surged in 2019. These activities have spread to
small and medium-sized firms, which the IMF says are particularly
vulnerable on the profit front.” Exactly. As profitability (and
now even the mass of profits) falls, companies have tried to counteract
this with financial speculation. That might be okay for large firms with
considerable cash reserves but not for smaller companies that are not
cash-rich.
So Davies now concludes exactly what I argued some time ago. “Taken
in isolation from other economic shocks, such corporate financial
weaknesses are unlikely to trigger a recession, but they could certainly
exacerbate the effects of other contractionary shocks. This is what
happened in 2008, when a medium-sized shock in the subprime mortgage
market caused an enormous downturn in economic activity. The impact of
the trade disputes on business confidence, which has been collapsing in
recent months, is the most obvious current threat.”
At the same time as Davies reached this conclusion, the chief US economist for the Societe Generale bank, Stephen Gallagher, argued that US recessions are typically preceded by an erosion in corporate profit margins,
or profit per dollar of revenue. Costs generally rise near the end of
the cycle while sales flatten out. There is a profit cycle – something
that readers of this blog will know well. The current profit margin
cycle (the blue line in the graph below) is reaching the point of a
recession. The graph shows the historic trend in profit margins at
various stages of the business cycle, as well as the margins in this
cycle.
Gallagher points out that US profit margins have been squeezed since 2016. “The erosion in margins is the key to business-cycle dynamics,” says Gallagher.
“If the U.S. does enter a recession in 2020, history is very likely to
view it as a trade-war recession. But trade tensions are only the
catalyst, not the main cause.” he says. “With a backdrop of weak profit expectations, the trade uncertainty poses serious challenges for business planning,” Gallagher argues. “In an environment of much stronger profit margins, the same trade uncertainty would likely pose less of a deterrent.”
As economic historian and author of Crashed, Adam Tooze tweeted, “What
if we orientate our analysis of business cycle around what is
presumably the basic driver of business activity i.e. corporate profits,
rather than intermediate factors that may or may not seriously impact
those profits e.g. tariffs?” Exactly. A financial crash or a trade
war does not lead to an economic recession unless there are already
serious problems with profitability.
It is not just Gavyn Davies and the IMF that are waking up to the
financial and debt risk. In a speech on 25 September, Fed governor Lael
Brainard said that “financial risk-taking by US companies in the
form of payouts and M&A has increased — in contrast with subdued
capital expenditures. Surges in financial risk-taking usually precede
economic downturns. As business losses accumulate, and delinquencies and
defaults rise, banks are less willing or able to lend. This dynamic
feeds on itself.” So the Fed must act with new monetary easing: “The
Fed will decide whether to activate its countercyclical capital buffer
in November. This mechanism enables the Fed to require the nation’s
largest banks to increase capital buffers against the time when economic
stresses emerge.”
Over in Japan, it is the same story. The Bank of Japan’s chief
Kuroda called for a mix of steps to boost economic growth. He returned
to what used to be called the three arrows of Abenomics:
monetary easing, flexible fiscal spending and structural reforms to
raise the country’s long-term growth potential. Kuroda is still
convinced that central banks can save the day, even if governments
should also help with fiscal stimulus measures. “We are equipped
with unconventional tool kits, so there is no need to be too pessimistic
about the effectiveness of monetary policy.” Kuroda hinted at further easing as early as this month.
But as I have discussed in detail before, monetary policy easing has
failed to restore pre-2007 growth rates and is now unable to stop the
oncoming recession. Indeed, interest rates globally are at record lows
and even negative in many major economies, and yet the world economy is
still slowing to a stop.
At the recent IMF-World Bank meeting, former governor of the Bank of
England during the Great Recession, Mervyn King reckoned that the “world
economy is sleepwalking into a new financial crisis because mainstream
economics and official institutions have still not changed their
complacent and faulty ideas before the last crash. By
sticking to the new orthodoxy of monetary policy and pretending that we
have made the banking system safe, we are sleepwalking towards that
crisis.” King went on: “resistance to new thinking meant a repeat of the chaos of the 2008-09 period was looming.” This was rich of King, who before 2007 has remarked at how well the world economy was doing – ‘a nice decade’ he called it. He too was stuck in the ‘old thinking’ then.
Echoing my own view of what I call The Long Depression,
King said the world economy was stuck in a ‘low growth trap’ and that
the recovery from the slump of 2008-09 was weaker than that after the
Great Depression. “Following the Great Inflation, the Great Stability and the Great Recession, we have entered the Great Stagnation.” King supported the view regularly expressed by Keynesian former US Treasury secretary Larry Summers of the concept of secular stagnation, a permanent period of low growth in which ultra-low interest rates are ineffective.
If monetary policy is now useless despite the vain hopes of Powell at
the Fed or Kuroda at the BoJ, what is to be done? King claims the
problem was “a distorted pattern of demand and output” ie
excessive investment in China and Germany and insufficient investment
elsewhere. There has to be a global shift in savings and investment.
But apart from the obvious question of how such a shift could possibly
be achieved without international cooperation, it is not a ‘global
imbalance’ that is the problem. There has been such an imbalance for
decades. The US, UK etc have regularly run current account deficits
while Germany, Japan and China have run surpluses. And yet economic
growth has still taken place. The cause of regular and recurring crises
can be found in the arguments of Gavyn Davies, not Mervyn King.
Everywhere, whether among mainstream economists or official
institutions, the cry now is for ‘fiscal stimulus’. For example,
Laurence Boone and Marco Buti, OECD economists call for Right here, right now: The quest for a more balanced policy mix. “while
monetary policy is widely recognised as facing increasing constraints,
fiscal policy and structural reforms need to play a stronger role. In
particular, fiscal policy could become more supportive, notably in the
euro area. Undertaking the right type of public investment now – in
infrastructure, education or to mitigate climate change – would both
stimulate our economies and contribute to making them stronger and more
sustainable.”
Just as Keynes claimed it would be necessary in the 1930s Great
Depression, now, as the Long Depression enters its tenth year, the
answer is for higher government spending, tax cuts and budget deficits
(and don’t worry about rising government debt any longer). But just as
fiscal stimulus did not work in the 1930s (instead it took a world war and governments taking control of savings and investment), so it will not work this time either. And that is assuming that politicians will even try it.
Fiscal stimulus and government ‘management of the economy’ is the
touchstone of Keynesian and post-Keynesian thinking, including so-called
Modern Monetary Theory (MMT).
The only real difference between Keynesian and MMT stimulus is the
latter think it can be done without issuing bonds to fund it: ‘printing
money’ is just fine.
The real shock is that even some Marxists consider that fiscal
stimulus and more government spending is all we need to avoid a new
slump. The question of falling profitability and profits highlighted by
Gavyn Davies is apparently not relevant at all. The profitability of
capital apparently plays no key role in this profit-making capitalist
system. You see profits come from investment, not vice versa. So all
we have to do is boost investment.
Take a recent article by John Weeks, a longstanding leftist (Marxist?) economist who once wrote a brilliant paper back in the 1980s (John Weeks on underconsumption) that
showed Marxist crisis theory had nothing to do with a lack of effective
demand caused by the underconsumption of workers. Weeks is now the
coordinator of the Progressive Economy Forum, a leftist think-tank. He
now writes: “Market economies require policy management: (as) Keynes taught us.”
You see back in the Golden Age of the 1960s when economic policy-makers
followed Keynes and intervened with fiscal measures to manage the
economy, there was high economic growth and no crises. It was only when
Keynesian management was dropped by neo-liberal governments that crises
ensued.
Weeks now argues that “capitalist economies do suffer
periodically from extreme instability, the most recent example being the
Great Financial Crisis of the late 2000s. These moments of extreme
instability, recessions and depressions, result … from private demand
“failures”; specifically, the volatility of private investment and to a
lesser extent of export demand.” Weeks correctly points out that
it is the volatility in investment that causes booms and slumps, not
private consumption. But what causes the swings in investment? Weeks
offers a straight Keynesian answer: “The instability results because investments are made in anticipation of future economic conditions, which are uncertain.”
So it is uncertainty about the future – a subjective cause and nothing
to do with the objective picture of the current profitability of
investment.
If Weeks (and the Keynesians) are right, then indeed, “public
expenditure (can) serves to compensate for the inherent instability of
private demand. This is the essence of “counter-cyclical” fiscal policy,
that the central government increases its spending when private demand
declines, and raises taxes when private expenditures create excessive
inflationary pressures. During 1950-1970 that was the policy consensus,
and it coincided with the “golden age of capitalism“.
But it is not right. First, the golden age did not come to an end
because Keynesian policies were dropped; on the contrary, Keynesian
policies were dropped because the Golden Age came to an end. And that
was because the profitability of capital took a serious dive from the
late 1960s to the early 1980s in all the major capitalist economies. As a
result, investment was volatile and economies suffered several slumps.
Far from Keynesian demand management stopping these swings, even in the
1950s and 1960s, they actually exacerbated them. At least that was the
view of the leading British Keynesian economist of the 1960s,
Christopher Dow, who summed up his monumental history of the period: “The
major fluctuations in the rate of growth of demand and output in the
years after 1952 were thus chiefly due to government policy. This was
not the intended effect; in each phase, it must be supposed, policy went
further than intended, as in turn did the correction of those effects.
As far as internal conditions are concerned then, budgetary and monetary
policy failed to be stabilising, and must on the contrary be regarded
as having been positively destabilising.” (JCR Dow, The Management of the British Economy, 1964)
Second, investment does not lead profits, but vice versa in a
capitalist economy. It is not the lack of private demand that causes a
crisis; but a crisis is just that: a lack of effective demand. But this
‘realisation’ crisis, to use Marx’s term, is the result of the
profitability crisis. That is where any proper analysis should start
on the causes of crises – as now Davies and Tooze suggest. I and others have presented both theoretical (Marxist) and empirical support for this causal connection.
Keynesians
may deny it, but it seems that even mainstream economists like Gavyn
Davies have now woken up to this causal connection. If this is right,
then attempts to avoid a new slump using fiscal policies will not curb
or reverse the fall in corporate profits and investment – and thus will
not avoid a new slump.
There is already a global manufacturing recession. The German economy as a whole is in virtual recession, according to its own central bank, the Bundesbank.
China is now growing at its slowest pace in nearly 30 years. The
trigger points for a global slump are multiplying. We have riots and
protests against austerity cuts in several ‘emerging economies’ as the
global slowdown hits exports and revenues: in Lebanon, in Ecuador, in
Chile, in impoverished Haiti. At the same time, the larger emerging
economies are either in a slump (Argentina, Turkey) or in stagnation
(Brazil, Mexico, South Africa).
Even in the US, the best performing major advanced capitalist
economy, growth is slowing, while investment and profits are falling. And within that, one of America’s major companies is in deep trouble.
The grounding of the 737 Max jet after two tragic crashes has quietly
lowered US growth, reduced productivity and trimmed earnings at a number
of American companies. Boeing is no ordinary company. It is the largest
manufacturing exporter in the US and a very large private employer. Its
products cost hundreds of millions of dollars and require thousands of
suppliers. It is no surprise that benching Boeing’s fastest-selling
aircraft is having ripple effects throughout the economy. Economists
put the drag on growth from Boeing at around 0.25 percentage points in
the second quarter while the White House Council of Economic Advisers
reckoned the damage was even greater: Boeing’s troubles cut GDP from
March through June by 0.4 percentage points.
Monetary and fiscal policy will be helpless in stopping any oncoming economic tsunami.
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