Federal Reserve Chair Jerome Powell has been on a rampage at the printing press since the United States contracted a severe case of the Coronavirus. Powell and his associates have not been shy about repeatedly rescuing financial markets with ultra-low interest rates, quantitative easing infinity, and even junk debt to shore up the debt-laden economy and prevent it from slipping into a comatose state. But the U.S. economy might need to be concerned about the living dead roaming the marketplace as the Powell Putsch formula crafted in the Eccles Building laboratory might spawn a new generation of zombies in America.
Born in Japan
It has been more than 30 years, but Japan has yet to recover from the Lost Decade of the 1990s. Anemic growth, deflation, and rising unemployment – this was the new normal for Tokyo for a long time. The world’s third-largest economy has made some progress over the years by recurring fiscal and monetary actions that have created unintended consequences, such as the zombification of the market. Unfortunately, the COVID-19 pandemic is undoing the nation’s accomplishments, threatening Abenomics with a deep recession that may linger for several quarters to come.
But what is all this talk of zombification and Japanification? Are these new motion pictures that combine the artistic elements of Akira Kurosawa and George A. Romero?
A zombie firm is a company that can pay only the interest on its debts and not the principal or requires consistent bailouts in order to stay open. This has been commonplace in Japan for three decades as every level of government has extended loans, cheap credit, and subsidies to unprofitable and mismanaged businesses. China has also been zombified, but the communists are a bit more clandestine and clever in masking their routine bailouts. Now, it is America’s turn to be the mad scientist from an old Universal horror film.
Before we dive into the specifics, consider this finding from the Bank of America back in the good old days of January 2020: The number of zombie companies reached a level unseen since the financial crisis. What’s more, 40% of publicly traded companies lost money over 12 months. In other words, “When there is no more room in hell, the dead shall walk the earth.”
The U.S. central bank employed another unprecedented move by acquiring low-rated bonds and exchange-traded funds (ETFs) comprised of junk debt as part of its latest $2.3 trillion short-term liquidity injection. Under this program, it is apparent that the primary beneficiaries will be overleveraged private equity firms and deeply indebted borrowers who survive tomorrow by using debt to get more debt.
Before the Coronavirus, zombie firms were already forming across America, thanks to a decade of cheap money. The $13 trillion corporate debt bomb was about to explode anyway, accounting for nearly half of gross domestic product. With a tightening Fed and incremental rate hikes over the last 18 months, these companies hemorrhaging red ink were unable to generate enough money to pay the interest. Then COVID-19 happened, which turned out to be a blessing for these businesses on life support.
While the main headline in the business press was a Fed acting to resolve a liquidity crisis, the other story just as important was the Fed preventing a solvency crisis. During the 11-year bull run, a lot of companies could have saved for a rainy day, but they chose instead to max out their credit accounts. Now, credit spreads are rising, which is a reliable indicator for defaults and a predictor for businesses turning to the government for a helping hand.
The Fed’s market interventions ensure that cold corpses can continue walking at a snail’s pace. Not only are subpar investment-grade bonds being scooped up by the central bank but also companies can access the credit markets without paying too much interest. And, if you belong in any of the favored industries, you will receive direct aid from Uncle Sam. It is a case of privatizing gains and socializing losses.
Since a lot of small- and medium-sized businesses are critical to the global supply chain, the federal government may have no other alternative but to bail out these organizations. It is a decision that will haunt the U.S. economy because these perpetually government-supported firms feast on the flesh of American ingenuity and productivity, forcing the misallocation of finite resources so they can avoid the pits of obscurity.
These economic lessons are moot, however. In the intellectually bankrupt political arena, fatuously acting with reckless abandon in the middle of a crisis is a win-win scenario. Politicians and bureaucrats pretend to be saviors of the masses, despite throwing caution to the wind. The business community behaves as benevolent entities that were victims of circumstances rather than drunken sailors with easy money.
Free Enterprise vs. Business
In a 1978 lecture, legendary economist Milton Friedman pontificated, “You must distinguish sharply between being pro-free enterprise and being pro-business.” The idea is that businesses will favor free enterprise on a fundamental level, but they will oppose it when it applies to them, which has been evident over the years any time there is the slightest of hiccups in the economy. In the wake of the Coronavirus, nearly every industry imaginable applied for taxpayer assistance. Sure, it was not John Q. Public’s fault for what happened, but this is why it is imperative to save enough capital for a rainy day, adapt to evolving market conditions, and ensure you can weather any economic storm. During a recession or COVID-19, we learn who are the true titans of private industry and who crumble under the weight of recession.
Read more from Andrew Moran.