The U.S. has moved beyond the 2008 financial crisis to a thriving economy. However, many experts are ignoring a problem that keeps undercutting the good news. And the problem continues to get worse.
US commercial debt has ballooned to over $3.7 trillion. This includes corporate debt securities and industrial and commercial loans. This commercial debt now comprises 42 percent of GDP, up from 35 percent ten years ago. This commercial debt to GDP ratio is the highest since World War II. To clarify, the debt amounts to $20,000 per U.S. citizens or $800 for every individual on the planet.
The all-time high corporate debt to GDP ration is especially problematic because the last three recessions in the U.S. were preceded by similar ratios in 1990, 1999, and 2007. It’s a certain sign that companies have become vulnerable to economic forces.
How did this happen? Look no further than the policies of the Federal Reserve Bank. The initial financial crisis in 2008 was partially caused by artificial low interest rates set by the Federal Reserve to make borrowing easier and more attractive. The crisis was the result of borrowers who were unable to repay their loans. Unfortunately, the Federal Reserve has continued to keep interest rates low. Borrowing has remained easy, resulting in a historic indebtedness.
The Federal Reserve is not the only central bank that has embraced low interest rates. Central banks around the world have followed suit and continue to keep interest rates low. Some are even considering lowering them further, establishing a negative interest rate. As a result, the global debt has climbed to an unprecedented $244 trillion.
As interest rates remain low and indebtedness continues to climb, the possibility of a recession could result in an economic disaster. Corporations with high debt are borrowing even more money at low interest rates, creating a risk of eventual default. This is referred to a leveraged lending, and it grew by 20 percent last year, to $1.1 trillion.
According to hedge fund manager Stanley Druckenmiller, many corporations who have borrowed at the low interest rates will likely find themselves in financial trouble as the next recession approaches. Others share this opinion, and many believe the next recession could be as close as 2020. The U.S. and China trade wars appear to be worsening, which will only exacerbate a bad situation. The May job increase of 75,000 new jobs was lower than expected. Mr. Druckenmiller states that an interest rate of between three and four percent would stem corporate borrowing. The Federal Reserve, however, isn’t listening and is considering lowering interest rates once again.
For investors, the current situation does not reflect the general jubilation over a growing economy. The high level of debt may bring about a severe economic downturn.
The news isn’t all dismal. The corporate sector is showing a healthy financial surplus. And there is no sign of the housing bubble that preceded the 2008 financial crisis. The current high corporate debt situation needs to be seen as a warning. While corporate profits are showing signs of declining, they are still high. They remain at 11.3 percent but are shrinking half a percentage point annually.
However, any change in the economic climate could leave corporations extremely vulnerable, especially those with leveraged loans. The Federal Reserve should be taking action now and raise the interest rate before it is too late.