“Records were shattered on debt, GDP, and leverage”, SocGen’s Stephen Gallagher writes, recapping what will be remembered as one of the most harrowing stretches for the US economy in recorded history.
What comes next is obviously the subject of considerable debate. On one side are the likes of Larry Kudlow who, at least in part because of his current job title, continues to insist that a “V-shape” recovery is all but assured.
On the other side are the “pessimistas”, as Kudlow famously dubbed anyone who was calling for a recession in December of 2007, on the eve of the GFC (note that in the linked article, The National Review has since changed “pessimistas” to just plain “pessimists”, in an amusing attempt at retroactive political correctness). These folks (the pessimists) argue that irrespective of how robust the recovery turns out to be, structural damage, “scarring”, and the legacy of the debt incurred during the pandemic will serve as a drag for years to come.
The figure speaks for itself. But just in case, what you’re looking at above are all-time records for both investment grade and high yield debt issuance for a single year. Junk bonds blew past the old annual mark set in 2012 earlier this month, while blue-chip debt issuance smashed its annual record in August.
While this may not impede the recovery in the near-term, SocGen’s Gallagher cautions that it could weigh over the medium- to longer-term.
“Our forecasts for US GDP growth for 2020 have been among the upper end in peer surveys… yet for 2021, our forecasts are among the weakest”, he writes, before explaining that the bank’s relatively downbeat medium-term outlook is “mostly because of heavy debt overhang on companies”.
What I encourage folks to consider when thinking about this issue isn’t so much normative concerns about whether debt is “good” or “bad” or whether the Fed’s “moral hazard” liability should offend anyone’s delicate sensibilities.
Rather, what’s important is the mechanical (mathematical, deterministic) read-through for businesses who will need to service the debt.
Gallagher makes this explicit. Even after GDP (the denominator) rebounds, leverage will be high. There are four ways to deal with that, Gallagher says. One is the “hard way”, which is to “remain very disciplined on costs and forceful on revenue gains”. That would prioritize productivity instead of employment. Another way is to slash debt by shrinking businesses, which Gallagher notes is “exactly what we don’t want to see happen”.
Speaking of things nobody wants to see happen, a third method is just to throw in the towel and reorganize in bankruptcy. A fourth is government forbearance, which for now just applies to PPP loans, but could in theory be extended.
Ultimately, Gallagher comes back to the inescapable reality. “There is no easy way to reduce such leverage”, he says. While companies can prioritize profit growth and cash flow, SocGen frets that is “likely to slow hiring in 2021 and beyond”.
Don’t tell Larry.
Some amount of this will end up on the Fed balance sheet.
The system we have now requires it to ever expand. Shrinking credit? No way. We need to continue to expand credit or the whole thing collapses.
There is no going back to the discipline and interest rates we had through, like, the GFC. That is a bygone era. We made choices as a society and we have to live with them. Granted, none of use had any say. But, here we are.
What stinks and is absolutely terrible about this path is the negative consequences for our society. That this borrowing is not being put enough toward furthering productivity, toward creating industries, toward creating jobs and future tax revenue, stinks. (Capital gains taxes paid by the wealthy who benefit disproportionately is not a benefit of this new system, but a sign of the system’s corrosive effects.) Would be great if somehow some meangingful portion of the llargesse could benefit small business and startups. No big brain people I follow seems to have good ideas to help this part of the ecosystem. Maybe there is no helping it. Maybe this has to play out and we start again. Maybe we could at least use the tax code to provide benefits to smaller firms to build and expand. As a way to help balance things out.
This is a big part of why I advocate for UBI. It’s becoming more and more likely (almost a certainty at this point) that this debt will either end up on the Fed’s balance sheet and/or be inflated away. There is virtually no path where our economy grows enough to support any sort of monetary normalization with the amount of corporate debt in our economy. UBI can help achieve the simultaneous goals of creating inflation and also redistributing wealth to the folks who didn’t see the benefit of all the monetary largesse of the last two decades.
I am reminded of Woody Allen’s take on relationships:
“A relationship, I think, is like a shark. You know? It has to constantly move forward or it dies. And I think what we got on our hands is a dead shark.”
(Like an economy which has to grow in order to survive.)
Jubilee is a way out.
Big worry is if the next recession breaks the dollar. Fed won’t be able to respond, public corporations will have to raise capital the ugly way, and sell equities into what would normally be a bottom. King dollar