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Between 2008 and 2019, excess capacity, slow growth, and never-ending central bank liquidity injections suppressed interest rates and encouraged corporations to magnify profits by increasing their debt. This meant that the corporate sector came into the 2020 recession with record indebtedness.

As central banks flooded financial markets with even more liquidity over the past 16 months, interest rates/yields fell to the lowest level on record, and companies borrowed even more. Nonfinancial companies issued $1.7 trillion of bonds in the U.S. alone last year, nearly $600 billion more than the previous high (Dealogic). By the end of March, non-financial debt reached $11.2 trillion (Federal Reserve), about half the size of the U.S. economy. See Pandemic Hangover: $11 Trillion in Corporate Debt.

With global demand/capacity utilization rates still well below 2019 trends and uneconomical pricing for most assets everywhere, compelling capital expenditure opportunities are now scarcer than cash. As the economy rebounds from the depths of the pandemic shutdown, many business models are in flux, and downsizing of commercial/office space is a common theme. Using cash to reduce debt is the logical move.

A similar impulse has been evident in US households since the 2008 crisis as home prices slumped with investment yields and an aging population increasingly values financial stability more than discretionary spending.

According to the New York Fed, US households spent just 29%, 26%, and 25% of the three pandemic stimuli cheques over the last year, with the balance used to increase savings (which includes paying down debt). Deleveraging strengthens corporate and household balance sheets but detracts from Gross Domestic Product and increases the need for government spending as an economic stabilizer.

Economist Richard Koo’s 2009 book The Holy Grail of Macro Economics: Lessons from Japan’s Great Recession explains the 15-year long recession that followed the bursting of Japan’s real estate, debt, and stock market bubbles in 1989 and compares it with the US market crash of 1929, the Great Depression and the 2008 Financial Crisis. The book stimulates much food for thought about our current cycle globally.

Koo uses a century of history to show that when the corporate and household sectors are striving to reduce debt and rebuild balance sheets, monetary prods cease to stimulate spending. The payback period is both painful and essential:

“…one of the key characteristics of a balance sheet recession…is that monetary policy becomes useless. People in Japan have already experienced this first-hand: monetary policy had no effect, even though interest rates remained at our near zero from 1995 to 2005. The stock market did not rally, and the economy did not recover. In contrast, the late 1980s asset-price bubble happened when the official discount rate stood at 2.5 percent. Yet just a few years later, in February 1993, the same policy rate of 2.5 percent had no stimulative impact whatsoever. Nor, subsequently, did an interest rate of 0 percent.”