Watch out for the zombies.
The plethora of companies propped up by the European Central Bank will limit policy makers’ ability to withdraw monetary stimulus that’s been supporting the continent’s bond market since the financial crisis, according to strategists at Bank of America Corp. About 9 percent of Europe’s biggest companies could be classified as the walking dead, companies that risk collapse if the support dries up, according to the analysts.
“Monetary support in Europe over the last five years has allowed companies with weak profitability to continue to refinance their debt and stave off defaults,” analysts led by Barnaby Martin wrote in a note Monday. “This supports the point that our economists have been making: that the ECB will likely be very slow and patient in removing their extraordinary stimulus over the next year and a half.”
The strategists classify zombies as non-financial companies in the Euro Stoxx 600 with interest-coverage ratios — earnings relative to interest expenses — at 1 or less. The thinking goes that companies in this category are particularly vulnerable to rising interest rates.
The ECB’s dovish tone last week — pushing back the timing for a decision on the future of its bond-buying program until possibly October — confirms it will embark on a gradual pace of tightening in order to juice the economic recovery, according to Bank of America. It reckons the ECB’s taper will start in January 2018, with the first increase to the deposit rate projected in the spring of 2019, compared with consensus expectations for a hike in October 2018, according to overnight index swap contracts compiled by Bloomberg.
Similar studies confirm zombie firms litter the landscape across developed markets, and place the blame squarely on loose monetary policy. Last month, the Bank for International Settlements calculated businesses more than 10 years old whose earnings don’t cover interest expenses represent almost 10.5 percent of publicly listed companies across 13 advanced economies, compared with less than 6 percent pre-crisis.
Right before the collapse of Lehman, about 6 percent of European companies had a coverage ratio of less than 1.
Last month, the Bank for International Settlements calculated businesses more than 10 years old whose earnings don’t cover interest expenses represent almost 10.5 percent of publicly listed companies across 13 advanced economies, compared with less than 6 percent pre-crisis.
Why Zombies Matter
Low interest rates and high liquidity have not helped deleverage. Global debt has soared to 325% of GDP. Loose monetary policies have not helped clean overcapacity, and as such zombie companies perpetuate the glut in many sectors, driving down the growth in productivity and, despite historic low unemployment rates, we continue to see real wages stagnate.
The citizen does not benefit from the zombification of the economy. The citizen pays for it. How? With the destruction of savings through financial repression and the collapse of real wage growth. Savers pay for zombification, under the mirage that it “keeps” jobs.
Zombification does not boost job creation or buy time, it is a perverse incentive that delays the recovery. It is a transfer of wealth from savers and healthy companies to inefficient and obsolete businesses.
The longer it takes to clean the overcapacity -whcih stands above 20% in the OECD- and zombification of the economy, the worse the outcome will be. Because, when the placebo effect of monetary policy disappears, the domino of bankruptcies in companies that have been artificially kept alive will not be offset by the improvement in high added-value sectors. Policy makers have decided to penalize the high productivity sectors through taxation and subsidize the low productivity ones through monetary and fiscal policies. This is likely to create a vacuum effect when the bubble bursts.
Damned Either Way?
Bank of America provided the kicker: The ECB risks a big backlash if it were to tighten policy prematurely. Allowing a “credit tantrum to take hold would only pressure corporate interest costs again, and risk a rise of the zombie.”
Thank you not, central banks!
Mike “Mish” Shedlock