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Zombies revisited

24 January 2019

 Salomons Judgement

Global debt is growing faster than the economy. This is less alarming than it may seem, but do keep a close eye on the zombies.

The impact of growing global debt on the economy is one of my favourite topics. The Institute of International Finance – the think tank of large international banks – in mid-January came up with a study in which it showed that the global debt mountain – companies, families and governments – has grown to 244,000 billion US dollars. That is 320% of the global GDP. And 5% more than last year.

So, debt grows faster than the economy does. On Twitter, the comparison was drawn directly with Japan, where the growth of corporate debt has stabilized. Government debt has risen to 250% of GDP. 100% in the United States. Dutch government debt is well below the European standard of 60% of GDP.

In my first job as an investor, I was allowed to select Japanese shares. The Asia crisis (in 1997, I’m getting old) became my baptism by fire. With my parsimonious Groningen character, at the time of this crisis I had the tendency to emphasize the disadvantages of having too much debt. The question is whether it really is a problem, let alone an urgent problem. As long as interest payments are low and cash flows grow sufficiently, it is not too bad. Governments also have something that companies and families don’t have: taxes and a printing press. But one cannot continue to stack stones forever. At some point, the mountain will collapse.

The canary in the coal mine? I mainly look at the debt of the business. The mix of growth and inflation is still comfortable. Most debt is fixed for a longer period of time. Otherwise, the financial director is not worth his money. But something is brewing. Not at the largest companies, where the net debt is 1.5 times the underlying cash flow. Once you exclude the 5% largest companies, however, it’s already 4 times and the number of companies with debt payments outstripping cashflows is on the rise. Here are the zombies I wrote about earlier.

Moreover, the quality of debt issued deteriorates. There are fewer covenants and by now half of the investment grade universe is of BBB quality. That’s only one downgrade away from junk. It’s therefore important to pay attention. Not only to the zombies, but also to the pension funds and insurers that have their liabilities as assets on their balance sheets.

Luckily, when the canary in the coal mine starts to suffocate, the banks will not immediately smother the economy. But if you want to start enjoying retirement, you’d better take a seat in the waiting room. One can build prosperity on debt, an economy runs on credit. But the chance that the debt mountain plays a role in the next crisis has not diminished since the credit crisis.

The author

Roelof Salomons

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