Opinion: The Federal Reserve is about to create a lot more zombies
Corporate zombies, that is. Kept alive by easy-money policies, companies that should have gone out of business keep staggering around.
By Brett Arends, Columnist June 24, 2019
Long-term interest rates just fell off a cliff.
And if you think they can’t keep falling, think again.
Albert Edwards, a strategist at SG Securities, pointed out in a recent note that none of the experts surveyed by the Wall Street Journal at the start of the year predicted 10-year Treasury yields would fall below 2.5%.
Current level: 2%.
No fewer than 12% of non-financial companies on major developed stock markets could be “zombie” companies.
I guess we can toss those forecasting models out the window.
He adds that mainstream economists have been saying for years that long-term rates would never end up at zero percent.
Yet rates in Europe are now negative. People are paying half a percent a year for the privilege of lending money to the government of Switzerland. Even in the U.S., 10-year rates adjusted for inflation are only 0.29%. A generation ago, they were typically 2% or better.
Western economists used to say that zero percent rates were a weird and unique thing you only saw in Japan — like people eating raw puffer fish and hoping not to die. It would never catch on over here, they said.
But they already have. Today European rates are even lower than those in Japan.
When U.S. rates first collapsed in 2011-2012, we were assured it was a freak one-off event and was never going to happen again.
When it happened again in 2016, we were told it was, well, a “two-off” event that was certainly never going to happen a third time.
Now it’s happening a third time, and I guess we’re waiting for the official line on why, once again, this is just a temporary derangement and nothing to worry about.
But the Bank for International Settlements — the central banks’ central banks — says there is something to worry about, and it’s the reason that economic growth, inflation and interest rates can’t get off the ground: zombies.
No, I’m not making this up.
The BIS says there are way too many zombies around, and they’re killing the economy, and it’s all the fault of low interest rates.
We’re talking “corporate zombies,” of course.
Extend and pretend
The BIS found that, ever since the 1980’s, falling interest rates have made it easier and easier for bad companies with lousy management and terrible products and dismal prospects to stay in business long after they should have gone the way of all flesh.
These “zombie” companies can stay alive — or whatever the correct term is for zombies — if they can just keep borrowing. Bankers call this “extend and pretend” (as in, “extend the term of the loan, and pretend it’s ever going to be repaid.”)
And when money gets cheaper, that’s great for zombies. Lower interest rates are correlated with rising numbers of zombie companies, the BIS found.
And there are a lot of zombies around. The BIS reckons no fewer than 12% of the non-financial companies on major developed stock markets could be “zombie” companies, at least by a loose definition.
This is an epidemic. In the early 1990’s, the figure was about 2%.
Zombie companies are bad for the rest of the economy. Forget about being an economist: Think about the worst company you ever worked for. Think about all the waste that took place — all the money, time, effort and potentially valuable real estate wasted by idiot managers and self-serving bureaucracies and terrible technology and all the rest.
Replicate that to make up 12% of the economy. There. Now you understand why economic growth has been so sluggish for a generation. Now you know why the stock market is so hooked on the Federal Reserve.
Hey, don’t blame me. Blame the BIS.
We’d all be better off if badly run companies were put out of their misery, economists agree. But as long as interest rates are low and debt is cheap, they keep staggering around.
The price of junk
Zombies have never had it so good. As the interest rate on 10-year Treasuries has fallen, so have rates on junk bonds. In other words, the rate paid by zombie companies.
Since the start of the year, the typical high-yield bond yield has fallen by a quarter, from 8% to 6%, according to Bank of America Merrill Lynch.
Albert Edwards says we’re in an economic Ice Age. The BIS says we’ve got too many zombies. The U.S. president is a clown. There’s a horror movie in this somewhere.
But look on the bright side. Wall Street’s having another party.
The Dow Jones Industrial Average has risen nearly 2,000 points since investors began expecting falling interest rates earlier this month. The S&P 500 Index has climbed 7.5%. What could possibly go wrong?
Brett Arends is a MarketWatch columnist.