In previous blogs, we have discussed how the government debt is becoming an increasing problem for the US economy and why the new stimulus by the Federal Reserve is increasing fiat risk. But there is another problem that is becoming increasingly relevant: zombie companies. Definitions used for this term vary somewhat, but they are often described as companies that are unable to cover interest costs on their debt with net income for three years in a row.
The percentage of zombie companies in the US have already been steadily growing despite a strong downtrend of the interest rates during the same time period. This is already a troubling trend, because it means that a lot of companies in the US are increasingly relying on raising debt to stay alive.
The percentage of zombie companies is already nearing 20%.
As part of the stimulus for the economy, the Federal Reserve has implemented nine emergency lending programs. This includes buying up bank debt to businesses in trouble. Companies that would otherwise have to file for bankruptcy are being kept alive this way. While these loans are helping the economy in the short term, they could create additional longer term issues.
The new lending stimulus for US companies also creates a lot of new zombie companies, a lot of which should not have any reason to stay alive. In any economy, bad companies have to fail in order for the solid ones to flourish and new ones to rise. Zombie companies are overall less productive yet use up a lot of resources, leaving less for the more productive companies. So, long term, these lending programs can actually hurt the economy by limiting the growth potential of the economy.
Once the stimulus disappears, those companies that were being kept alive through stimulus will be in increasing trouble. A lot of default on debt is likely to occur, resulting in a surge of bankruptcy filings. Fuel would be added to the fire once interest rates bounce again.
These concerns do not mean that the Fed is wrong in their approach as the global economy is seeing massive issues due to the Coronavirus and these drastic times call for drastic measures. But it is important to understand that the stimulus does pose certain risk for the future development of the economy.
Not just the US
This article focuses on the US, but this is definitely not the only economy experiencing hardship due to the Coronavirus. It is hitting the entire global economy, meaning increased investment risk everywhere. Deutsche Bank’s CEO has warned about a rise in zombie companies in Germany due to government aid to companies, adding that one in six companies could become a zombie company. This could become a real issue, especially since Germany is the largest economy in the European Union.
The rise in zombie companies as a result of stimulus measures for the economy is yet another reason why traditional investments are becoming increasingly risky, and with that, diversifying into alternative investments is becoming more important for a well-balanced investment portfolio. So it is likely that more (institutional) investors will increasingly look at digital assets like Bitcoin to diversify their holdings.