Record High Corporate Debt, QE Worked Then - We Know How To Deal With The Next Recession

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by: Tim Worstall
Summary

The Fed of NY looks at the record levels of corporate debt - oooh, scary!

But the debt load, the portion of profits required to repay it is much lower, less scary.

The real takeaway here being that QE worked, thus we know how to deal with the next recession. The recovery will be just great for us as asset owners.

Why Even Be Interested In Corporate Debt Burdens?

Every economic statistic needs to be put in its place, what is it being measured and how? But more than that, we need to make the connections to see what it's telling us about the world around us. The Federal Reserve Bank of New York examines the corporate debt load, noting that it's at record highs. That means, ineluctably, that quantitative easing worked, and did what it was supposed to do.

The implication of that is that we know what to do in the next economic emergency - deep recession. And with that knowledge, we as investors can profit. The lesson will be that, at bottom, buy assets, and then ride the monetary boom on the way up. It worked from 2009 on; it'll work again.

The Specific Debt Numbers

The NY Fed looks at the corporate debt burden in historical context:

Corporate debt burden That could be scary. We're at levels above those going into the past three recessions. If we were chartalists, we might think that was a signal that the recession is about to start. Or that it's going to be particularly bloody, corporate blood being spilled, when it happens.

Yet that's not really the way to look at it. What is the cost of carrying this debt burden is:

corporate debt burden It's EBITDA to interest expense, which is the interesting one. While the debt pile is larger than ever, the cost of servicing it is reasonable compared to the past couple of decades. We can't really compare going further back than that as the structure of the market has changed so much over that time. The other way of saying this is that interest rates are low at present. Which, of course, they are.

Thus QE Worked

We should go back to the basic idea of quantitative easing, QE, in the first place. Those Keynesian animal spirits of businessmen were low, uncertainty was high. That most variable of GDP components, business investment, was down in the dumps, and no one really saw it rising much. So, what to do? Artificially lower the return to safe assets like Treasuries, that's what. Do so by inventing some money and going out and buying a lot of them.

Which is what the Fed did; it created a few trillion dollars in the basement and used them to build out the balance sheet to $4 trillion and change. Much of which was buying those safe Treasuries - some corporates, MBS as well - so as to raise their price and lower their yield. The effect of this was to push investors out along the risk curve in search of yield.

Or, the flip side of the same aim, we wanted corporates to borrow a lot of money to invest so that this would pull us out of the recession. Corporates did borrow a lot, we're out of the recession, and the policy worked.

The Implication For The Future

So, QE worked then. That means that next time we face the same problem, we can follow the same policy. In macroeconomic jargon, monetary policy still works at the zero lower bound. We don't have to move to fiscal policy in order to fight a recession. This is good because monetary policy is purely in the purview of the Fed; there's no politics. We've not got to wait for Congress.

That means the next recession is likely to be much shorter. We've a new tool we didn't know about before, we've tested it, and it works. We'll no doubt use it again.

For Us As Investors

That fear of the next recession rather falls away. We know what will be done to solve it; unconventional monetary policy will be done again. We also know what happens then - asset prices soar; this being the very point of the exercise.

As to today, the same analysis tells us that record corporate debt burdens aren't a macro problem. Financing costs are well within reasonable levels. The only thing that might cause problems is a recession which causes a fall in the corporate income to finance the debt load. But that's exactly the point at which the monetary policy will kick in to lower those financing costs.

We've all heard of the Fed put in equity prices. We've now got one on interest rates and bonds as well. The very change - a recession - which could make that debt load a problem will bring about the policy change that will solve it.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.