Salomons Judgement

Due to the low policy rates, the difference between healthy companies and so-called zombie companies is hardly noticeable. This blind spot leads to malinvestment. It is time to put an end to this ‘free money’.

Although Halloween is over, zombies are still among us. At our annual Kempen Outlook seminar at the end of 2017, I mentioned them in a story about mounting corporate debts. I argued that those debts can become a problem when financed too easily and interest rates are starting to rise.

Recently an interesting presentation was given by Claudio Borio. He is an economist at BIS, the central bank of all central banks. In ‘A blind spot in today’s macroeconomics?’, he establishes a relationship between low productivity growth and ‘free money’ and the fact that even less solvent businesses have been able to keep up their own funding. And that is bad news for future growth.

When interest rates remain too low for too long, zombie companies arise; these are businesses that can only exist by the grace of ‘free money’. A simple definition also used by the OECD  is that the term applies to companies of at least ten years old with insufficient margins (EBIT) to meet their interest payments. Another factor is the low expected growth rates of these companies within their own sector.

Based on 32,000 companies in 14 countries, Borio draws some remarkable conclusions. Since 1980, the number of zombie firms has increased from 0% to 10%. Zombies also remain zombies for a longer period of time; this probability has gone up from 40% to 65%. But how do they survive? As a good academic, Borio is cautious when it comes to drawing strong conclusions. He points out that since the start of this millennium, there has been less pressure on companies to reduce debts than before.

Before 2000, the behavioural difference between zombie and healthy companies was very clear. Zombie companies paid higher interest rates and did not just reduce their debts, they also cleaned up their balance sheets and made investment cuts. Nowadays, there are hardly any differences. The result is a misallocation of capital.

Low interest rates create incentives with undesirable effects. Just as electrons act strangely when temperatures reach absolute zero, investors start showing strange behaviour when interest rates are at 0%. Borio suggests that the existence of zombie companies is directly related to low policy rates. In this way, he shows us that macroeconomists also have their blinds spots. Economies and markets only work well when cleaned up occasionally.

It’s about time we put an end to free money.

The author

Roelof Salomons


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