One of the features of the credit crunch era has been the fall and if you like plunge in both interest-rates and bond yields. This first started as central banks cut official interest-rates sharply as the crisis hit. When that did not seem to be working ( the modern word covering that is counterfactual) they then moved to policies such as Quantitative Easing to reduce longer-term interest-rates and yields. Next came more interest-rate cuts and the advent of Qualitative Easing which for a while was called credit easing in the UK. This now comes under the banner of the Term Funding Scheme in the UK, or actual support for loans at the Bank of Japan or the TLTROs and securities purchases by the ECB ( European Central Bank).

So we saw official rates fall and then central banks realised the consequence of controlling rates which run from overnight to one month money. This is that there are plenty of other interest-rates such as bond yields and mortgage rates so our control freaks moved to lower them as well. After all their Ivory Tower economic models predicted economic triumph if they did. To ram all this home some places also went into negative territory for interest-rates from which no-one has yet returned with Denmark briefly giving it a go before preferring another ice bath. For the UK we were reassured that we were at the bottom of the cycle as Bank of England Carney told us that a Bank Rate of 0.5% was the lower bound. Of course he later cut to 0.25% and then told us that the lower bound was near to but just above 0%. This of course was silly on two fronts. Most obviously it ignored the fact that much of Europe and of course Japan already have negative interest-rates and it also led to the really silly expectation of a cut to 0.1%.

The rise of the zombies

It was only a few days ago that I pointed out that in my opinion the rise of zombie companies and businesses was strangling productivity growth. That reminded me of my description of Unicredit in Italy as a zombie bank around 5 years ago and of course it still is. But in the meantime thank you to @LadyFOHF for pointing out this from FT Alphaville.

It quotes the Bank for International Settlements or BIS on this subject.

One potential factor behind this decline is a persistent misallocation of capital and labour, as reflected by the growing share of unprofitable firms. Indeed, the share of zombie firms – whose interest expenses exceed earnings before interest and taxes – has increased significantly despite unusually low levels of interest rates (right-hand panel).

That bit could not have been written by me clearly as if it had “despite” would have been replaced by “because of”. This bit might have though.

Weaker investment in recent years has coincided with a slowdown in productivity growth. Since 2007, productivity growth has slowed in both advanced economies and EMEs

There are dangers in assuming that correlation does prove causation but look at the right zombie company chart. Just as growth was fading the central banks gave it another push and rather than the reforms we keep being promised we in fact got “more, more, more”. More worryingly the line continues to head upwards.

In case you are wondering here is their definition of a zombie company.

The BIS dubs a zombie company any firm which is more than 10 years old, listed and has a ratio of EBIT to interest expenses below one.

If you are wondering ( like me) that others could be on the list then so was Izzy at the FT.

This means Uber, which is now eight years old, only has two years and a public listing ahead of it, before it too can be classified a zombie.

That I find fascinating as Uber and similar companies are a modern era triumph supposedly.In my part of London I regularly pass people holding up their mobile phone as they track down their Uber taxi. To be fair it has usually arrived in the time it takes me to walk past and in fact if it takes longer than that some seem to get upset. So here we really have a quandary which is a zombie which is apparently extremely efficient!

The FT poses an issue here.

why does profitability not matter anymore? And where does the extended patience with unprofitable companies lead us in the long run? Surely, nowhere good?

I will go further as on this road we see strong hints as to why productivity growth has been so low ( in fact more or less zero in the UK) which will hold back wage and real wage growth. All of them together mean that economic growth will be restricted as we are reminded of 2% being the new normal on any sustained basis. If we throw in the official under measurement of inflation we then find we have little if any economic growth at all. Is that enough as a consequence of low interest-rates where the “cure” has in fact become part of the disease? Perhaps Tina Arena was right.

I pretend I can always leave
Free to go whenever I please
But then the sound of my desperate calls
Echo off these dungeon walls
I’ve crossed the line from mad to sane
A thousand times and back again
I love you baby, I’m in chains
I’m in chains
I’m in chains
I’m in chains

The banks

The official story is that low interest-rates are bad for the banks. But if this from @grodeau about Swedish banks is true in the UK which I believe to be so we may have been sold a pup.

In terms of margin they are doing better than before the credit crunch as we find we are feeding a whole field of zombies like this is some form of new Hammer House of Horror series. Or to answer the question posed by Obruni in the FT. Yes.

The ROEs of most major banks have been below their costs of capital since 2008. Are these zombies too?

The UK should not issue more index-linked Gilts

There are suggestions that we should do this and as ever I will avoid the politics and just look at the economics and finance. I spotted this yesterday from Jonathan Portes.

Failing to borrow long-term at negative real rates to fix roofs (& other things) over last 7 years an act of deliberate economic self-harm

This reminds me of the online debate he and I had a few years back. The issue he  is apparently glossing over can be summed up in the use of the word “real”. In a theoretical Ivory Tower world it is clear but beneath the clouds where the rest of us live it has changed a lot in modern times. Let me summarise some issues.

  1. Imagine inflation were to stay at around 4% ( these are based on RPI inflation) for a while. Our negative real rate would in fact be very expensive as we paid it.
  2. We do not know what we will pay as our commitment is in fact open-ended depending on inflation. As it is so I am dubious about negative real rate calculations.
  3. If we switch to wages growth we see that something has changed. If that persists then the real rate versus wages may turn out to be very different.

If I was borrowing I would borrow in terms of conventional Gilts where the 30 year cost at 1.9% is extraordinarily cheap and a known cost as in we know what we will be paying from the beginning. Putting it another way index-linked Gilts are tactically cheap but I fear they will be strategically expensive.

Comment

As we look at the new economic world we see that some are trying to escape but that progress for them has been slow. After all the US has merely nudged its rates to a bit above 1% and Canada has only moved to 0.75% this week. So it seems that we will have to get used to low interest-rates for a while yet as we note that they have come with lower productivity, wage growth and economic growth. Not quite what we were promised is it?