Corporate foie gras

Net debt for non-fin

One of the arguments put forth in the bull vs. bear debate is that the solidity of US non-financial corporations have never been stronger. The amount of cash held by non-financial corporations has risen 150 per cent since the depth of the crisis in 2009. With such a massive cushion to stave off whatever the market may throw at them, they will be able to cope, or so it is held.

In addition, we know that financial corporations are flush with cash, or excess reserves held at the Federal Reserve. Throughout the various quantitative easing (QE) programs conducted by the Federal Reserve, commercial banks have been force fed cash as ducks on a foie gras farm. This has swelled their excess reserves to the unprecedented, and what would be thought unimaginable only few years’ back, level of US$2.6 trillion.

With all this cash the system should be, again according to the perma-bulls, more than ready to withstand the shock from the ongoing global deleveraging, a stronger dollar, emerging market blow-ups and the forthcoming US recession.

We beg to differ. When it comes to excess reserves they are most likely already “spoken” as a form of collateral in shadow banking chains. While the initial effect from QE on the shadow banking system was massive deflationary shock as all the high quality securities used in re-hypothecated collateral chains were soaked up by the Federal Reserve, it is a safe bet that excess reserves has to some extend filled that void.

In the non-financial sector on the other hand cash is, well, plain old cash. With more than US$1 trillion of the stuff on their balance sheet complacency is destined to be prevalent. And it is.

Credit market instruments, id est. debt, have also risen at a tremendous rate. Net debt, that is credit market liabilities less cash, has actually never been higher. As the chart below shows, sitting at more than US$6.6 trillion, non-financial net debt outstrips even the high from 2008.

Now, if we express the gargantuan debt load as share of market value of non-financial equities outstanding things looks not only sustainable, but outright sound. At only 30 per cent the debt to equity ratio is at multiyear lows. We need to go all the way back to the peak of the dot-com folly to find today’s equal.

And it is exactly the folly of the dot-com (and went) that best epitomizes todays manic corporate debt issuance. According to Bloomberg more than US$2.7 trillion in stock buybacks has been effectuated over the last six years. We would be amiss if we didn’t mention that this spending spree, not on capital goods or R&D that will help propel future growth mind you, but on liability massaging, coincided with ZIRP.

Investors desperate for yield have more than happy to lend US Inc. trillions of dollars, even though it is used mainly to buy back own stock. Not surprisingly this also help goose the market value of equites outstanding; also known as the denominator in the ratio presented in our chart.

So more debt begets higher market value of equites which in turn improves the debt/equity ratio which gives the incentive to issue more debt ad infinitum. Or in a slightly simpler version, debt beget more debt.

We have seen the story before. In the shaded grey areas we highlight episodes when the virtuous relationship turns ferociously vicious. Remember, markets take the escalator up, but the elevator down. And the longer the escalator the further down the elevator goes.Net debt for non-fin

Source: Federal Reserve Flow of Funds (Z.1),

When the US recession hits (see here for more) the massive gap between the green and red line in our chart above will close in short order and the calamity will be even worse than last time, which incidentally was far worse than the time before that.

And this Ladies and Gentlemen is aggregate demand management in practice where, for some unexplained reason, the abundance of savings does not clear the market for investable funds not even at the zero lower bound.

The fact that central bank perverts capital markets and is to a large extent responsible for the very same secular stagnation central bankers believe they must fight seem lost on today’s intelligentsia.

Ceterum censeo Federal Reserve esse delendam


  1. So there is no value in iPhones?
    They came out of the Apple workshop and satisfied wants that were previously unrealized. Demand was literally created by the (ingenious) supply.
    It would seem that value DOES come out of the workshop–as well as in the satisfaction of wants.

    As to the next recession, as long as rates are ZIRPed, it allows for higher amounts of debt. 17 or 18 million cars are being built in USA with help from low finance rates. And yet, most of these loans are not sub-prime.

    Historically, recessions are triggered as an unwinding of land speculation that have piled up questionable mortgages held by banks. Maybe the next recession will be different, but it seems that there is still plenty of room for expansion of both GDP and debt. Call me in a few years.

Leave a comment