Nobel economics laureate Paul Krugman once made the stupid argument that “debt doesn’t matter.” Dick Cheney back during the 2002 Washington budget debates over the wisdom of making new tax cuts amid huge costs to finance the new Washington War on Terror, made the equally stupid comment, “Reagan proved that deficits don’t matter.” In the real world, where debts of private households, of governments like Greece or Portugal or Detroit City, or private corporations like Chesapeake Energy or General Motors, effect jobs, technology, entire communities or nations, debt certainly does matter.
Corporate Debt Time Bomb
Even more dangerous than the enormous rise in US National Debt since 2000, to levels today of over $19 trillion or 108% of GDP, is the alarming rise since 2007 in US debt of corporations, excluding banks. As of the second quarter of 2015 high-grade companies tracked by JPMorgan Chase paid $119 billion in interest expenses over the year, the most in debt service costs since 2000. Disturbing is that that was despite record low debt borrowing costs of 3%. US corporations took advantage of the Fed’s unprecedented near-zero interest rates to borrow up to the hilt. It made sense were the economy really improving. Now with a significant recession looming in the USA, the debt is suddenly a problem. i This is the true reason the Fed is unable to raise interest rates beyond the purely symbolic 0.25% last December. The US corporate debt pyramid would topple. Yet the zero interest rates are wreaking havoc for those investors or insurance companies invested in bonds for “security.”
Now signs are appearing that point to very serious developing corporate debt problems. Delinquencies–late debt repayments of 30 days or more–in the US corporate sector are rising significantly in recent months. In a genuine economic recovery, business debt delinquencies fall, as all ships are floated by a rising tide of recovery. Delinquencies are costly and avoided whenever possible. An early sign of a weakening economy on the other hand, is a rise in corporate debt delinquencies. Delinquencies lead to defaults lead to corporate bankruptcy of not reversed by an improving economic environment. And the real US economic environment is anything but improving.
A recent analysis by US economist Michael Synder compared business debt delinquencies in 2008 just before the Lehman Brothers collapse. Then, delinquencies were rising at a very frightening pace he notes, “and this was a very clear sign that big trouble was ahead. Unfortunately for us, in 2016 business debt delinquencies have already shot up above the level they were sitting at just before the collapse of Lehman Brothers, and every time debt delinquencies have ever gotten this high the US economy has always fallen into recession.”
According to another analysis by Wolf Richter, delinquencies of commercial and industrial loans at all US banks, after hitting a low point in end of 2014 of $11.7 billion, have begun to balloon. “Initially, this was due to the oil & gas fiasco, but increasingly it’s due to trouble in many other sectors, including retail. Between Q4 2014 and Q1 2016, delinquencies spiked 137% to $27.8 billion. They’re halfway toward to the all-time peak during the Financial Crisis in Q3 2009 of $53.7 billion. And they’re higher than they’d been in Q3 2008, just as Lehman Brothers had its moment.”
Richter also notes that the debt problems are spreading to US farms which today are very much a corporate business: “Slumping prices of agricultural commodities have done a job on farmers, many of whom are good-sized enterprises. Farmland is also owned by investors, including hedge funds, who’ve piled into it during the boom, powered by the meme that land prices would soar for all times because humans will always need food. Then they leased the land to growers.” But as Richter relates, “Now there are reports that farmland, in Illinois for example, goes through auctions at prices that are 20% or even 30% below where they’d been a year ago. Land prices are adjusting to lower farm incomes, which are lower because commodity prices have plunged.
Now delinquencies of farmland loans and agricultural loans are sending serious warning signals. These delinquencies don’t hit the megabanks. They hit smaller specialized farm lenders.” He notes that delinquencies of farmland loans jumped 37% from $1.19 billion in Q3 2015 to $1.64 billion in Q1 this year.
Zero rate bubble danger
Many think that the aim of the post-2008 Fed Zero Interest Rate Policy was to stimulate investment into the economy to avert a new economic depression. Far from it. Since the first onset of the US sub-prime real estate crisis in March 2007, total US corporate debt levels, according to Standard & Poor’s, has ballooned to an all-time high level of $6.6 trillion as of the beginning of this year. In the past five years since 2011 alone corporate debt, amid virtually free Fed-inspired interest rates after tax adjustments, has increased by an eye-popping $2.8 trillion, at least 40% more net and total debt than in 2007. In 2016 the rise in corporate debt, annualized, is running at an alarming $1.4 trillion annualized rate, nearly double the rate prior to the financial collapse of September 2008.
Had that rise in corporate debt been used, as was the prudent corporate norm until recently, to finance plant, new more modern equipment and other long-term productive assets, such debt would have generated an income flow that would suffice to repay the debt, usually with a nice surplus profit to boot. It would also have boosted job creation and real economic growth, not the faked US Government virtual GDP growth.
This corporate debt binge has gone to nothing so productive. Instead it’s fueling an out-of-control stock market bubble, as seen in the all-time highs on the S&P 500 stock index. Corporations are using their near-free debt to buy back their own stock shares, a dubious practice which benefits only the stock price of shareholders but adds not an ounce of net productive gain to the real economy. Or it has gone to finance corporate mergers and takeovers, which again do not add net gain to the real economy but rather the opposite—job cuts, plant closings and asset strips. Highly profitable for Wall Street and for financial operators, not for the real economy.
As a totality US corporations today have a far greater vulnerability in terms of levels of debt in relation to revenues or income than at the onset of the 2007-2008 financial tsunami.
The Federal Reserve, along with the European Central Bank and the Bank of Japan have reverted over the past two years to the unprecedented and ludicrous policy of zero interest rates to keep their financial Ponzi bubble inflating, not bursting. The ECB and Bank of Japan recently have actually gone to negative interest rates meaning banks pay the ECB or BOJ to place reserves in the central bank. The Fed is considering such a negative rate policy shift. Today it has been calculated that more than $13 trillion worth of government bonds globally now have negative rates. That’s more than one-third of all government bonds. That means someone buying those bonds and holding until it matures, will actually lose money. Only because major pension funds and insurance companies are required by law, originally for reasons of safe and prudent long-term investment, to buy only high-rated government bonds can the negative rate bonds find buyers.
Now, for the same reason, high-rated corporate bonds are being offered paying negative interest rates. Bloomberg Business reports that $512 billion worth of corporate bonds now have negative rates, 11 times more corporate bonds with negative yields than there were six months ago. With so much of government bonds paying negative interest, and now an exploding share of the US corporate bonds, the solvency risks of US pension funds and insurance companies is growing alarmingly in a chain-reaction follow-on effect.
The alarming warning signal of trouble in the US corporate bond market with soaring rates of debt delinquencies, and the fact that since the collapse of the US shale oil industry Wall Street and other major bank creditors have been tightening criteria for extending more debt, say to me that the US economy is on the precipice of a new debt default implosion that will make 2008 appear a financial market hiccup by comparison. Maybe this reality is behind the utterly irrational Washington hysteria against Russia and now against China. If you run out of targets from whom to rob assets peacefully through stock market and bond manipulations, try the old method of gunpoint. Only this time the intended victims are not reacting at all as victims, but as defenders of their sovereignty. Something new and unexpected by Washington and their Wall Street patrons.
F. William Engdahl is strategic risk consultant and lecturer, he holds a degree in politics from Princeton University and is a best-selling author on oil and geopolitics, exclusively for the online magazine “New Eastern Outlook”
