When all other unconventional monetary tools fail to resuscitate the global economy, the dead shall walk the earth. Since the financial crisis ended a decade ago, many of the world’s largest economies have been on life support, relying on easing just to survive and offering the illusion of being alive. As reality sets in and growth slows down from an already anemic pace, the rest of the world is being infected with a zombie strain. They’re coming to get you, European Central Bank President Mario Draghi, People's Bank of China Governor Yi Gang, and U.S. Federal Reserve Chair Jerome Powell.
In economics, the term “zombie” refers to a bank or business that requires bailouts from the government or a central bank to keep its doors open because it is unprofitable and solvent in name only. In the 1990s, Japan suffered a Lost Decade, a period of stagnation following an asset-bubble collapse in 1991 and 1992. Tokyo attempted to defuse the situation by bailing out the banks with capital infusions, including government loans and cheap credit from the Bank of Japan. This allowed financial institutions to delay acknowledging losses, metastasizing into zombie banks. The practice then spawned a generation of zombie businesses because banks kept lending new funds to unprofitable companies. Japan only recently has recovered from this sour period by ending this failed policy, but a recession lies just beyond the Land of the Rising Sun.
With the world apparently still recovering from the recession, three big powers are experiencing their own living-dead invasion: the United States, China, and Europe.
Big Trouble in Little China
To keep China’s economy afloat, Chinese entities have survived on bank loans and local government support. This was amplified when the People’s Bank of China (PBOC) and Yi Gang lowered the reserve requirement ratio several times in the last year, encouraging banks to lend more to enterprises. The result? In May, lending to small and micro firms surged 21% to $1.5 trillion; it is unknown if these corporate ventures will work out. At the same time, corporate debt is the highest in the world, skyrocketing to 162% of gross domestic product.
Beijing has acknowledged that it has an influx of the undead. The country recently has eliminated nearly 2,000 zombie firms, and its goal is to dispose of thousands more by next year. But the cooling economy and potential social unrest might delay the process. President Xi Jinping, speaking to the National People’s Congress, reassured everyone that the issue would be resolved properly.
The solutions put forward vary, from permitting municipalities to issue off-budget bonds to the feds handing out subsidies. Analysts are warning that it would be difficult to wipe out the disease because it would lead to skyrocketing unemployment at a time when Beijing finally brought the unemployment rate down to 3%. What the government could do is merge the deceased with healthy enterprises, something that has happened in the past.
JPMorgan Chase said that China may need to adopt a zero-interest-rate policy (ZIRP) like everyone else -- the main rate is 4.5% -- just to prevent the outbreak from engulfing the entire economy.
Whatever happens, it is critical for China to kill off the undead because that would support prices, boost profits, improve trade relations, and shift investment to more productive firms during this downturn.
European Vacation
Despite using every tool at its disposal, the European Central Bank (ECB) has yet to achieve considerable growth in the eurozone. Several rounds of quantitative easing, bailouts, and ZIRP have done nothing except increase debt, overleverage companies, and cause consumers to save their money in microwaves.
Instead, the ECB is enabling the rise of the undead. This was confirmed by the Institute for Economic Research in a 2017 report that said zombie companies and banks are prevalent in the European Union, and they are being kept alive by toxic loans and debts. The Bank of America echoed the findings, noting that 10% of publicly traded firms are the living dead.
What is happening is an increase in cold bodies. European banks are struggling and cannot lend, so companies cannot grow. The real issue is that banks are propping up disembodied firms by extending loans instead of demanding repayment. Rather than proffer credit to organizations that could grow, banks are handing out money to companies with which they already maintain a relationship. This turns the bank and the business into the undead.
The ECB has embraced ZIRPs, but Draghi revealed he is prepared to dip into negative territory to spur growth.
Does this even matter anymore? Equities surged on the remarks and the EUR/USD exchange rate plummeted, which is common whenever easing is hinted at or announced. Unfortunately for the trade bloc, there is nothing left in the tool kit to revive the region’s dead carcass.
Europe’s zombie problem exposes the reality that the eurozone never really recovered from the Great Recession. Any gains have been founded on a mirage, created by historically low rates, money-printing, and bailout measures. Much like Dr. Viktor Frankenstein’s creation, a monster walks among Europe.
The United States of Zombies
The United States faces its own epidemic, too.
Recently, two interesting analysis pieces were published. Albert Edwards, a strategist at SG Securities, said the U.S. economy is in an ice age. And the Bank of International Settlements -- the central banks’ central bank – warned that America and the rest of the world have way too many zombie businesses and noted that there is a correlation between suppressing rates and the number of undead companies.
Since the Federal Reserve is likely to bring interest rates down from their current range of 2.25% to 2.50%, meaning debt is cheap, the zombification of Corporate America will expand. What’s more, ultra-low rates impact profitability and solvency of insurance outfits and pension funds and produce ubiquitous mispricing in financial markets.
Albert Edwards
This is bad news for the United States because a swelling population of walkers means inept management, low-quality products, horrible service, abysmal prospects, and gradual decay and slow death wreaking havoc on the marketplace. Think Radio Shack on steroids.
Don’t tell that to the delusional bankers, though. They believe they can “extend and pretend”: extend the term of the loan and pretend it will be repaid, like Captain Louis Renault and his bar tab at Rick’s in Casablanca.
Zombie Apocalypse
It is estimated that about one-fifth of the world’s companies are zombies. Just as the living dead need human flesh, the walking dead also need easy money and cheap credit to roam the planet. The global economic infrastructure can be likened to a game of Jenga right now – one wrong move and the entire tower tumbles down. The zombie apocalypse is nigh.
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