> …has drawn attention to the relentless build-up in corporate debt in the US, where companies now owe a record $10tn — equivalent to 49 per cent of economic output. When other forms of business debt are added in, including to partnerships and small businesses, that already extraordinary figure increases to $17tn [83% of GDP, the highest ever].
> Even before the pandemic, the level of corporate leverage was beginning to cause alarm. At the end of last year, the IMF issued a striking warning: as much as $19tn of business debt in eight countries led by the US — or 40 per cent of the total — could be vulnerable if there were a “material slowdown” in the economy, a scenario that, if anything, now seems tame.
I like to think of it this way:
At present, a business that is barely-investment-grade (say, BBB-/Baa3) can borrow for a decade at just over 3%/year. A risky business that is rated as junk (i.e., below BBB-/Baa3) can borrow for a decade for as little as 6% to 7%/year. The interest payments are tax deductible, so the effective annual cost to borrow is around 2.5% for barely-investment-grade and around 5% for junk, give or take. As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? And if they can justify using borrowed money to buy back shares, keeping their stock options in-the-money, why not do it?
Many US companies in mature industries (think energy, hospitality, travel, transportation, etc.) have been doing exactly that, to the point that corporate debt is now the highest ever in relation to US GDP. And it has worked beautifully... that is, until a global pandemic suddenly cut their revenues by 10% to 20% or even more, instantly flipping those expected earnings into losses. People are no longer traveling as much, or going to restaurants as much, or going to the office as much, etc.
All of a sudden, all those businesses are losing money on all that borrowed money -- they are losing so much, in fact, that many have had to borrow even more during the pandemic to be able to continue paying interest on prior borrowing and avoid going into bankruptcy.
>As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it?
Back in the day, people were responsible for their Choices. So if some unforeseen happened, a savings was considered a good thing. Today, a CEO can just shrug and say “meh, pandemic” and the government is suppose to be the lender of last resort.
This is the moral hazard that we were all afraid would happen after 2008.
Good question. But the issue of kicking the can about insolvency played a huge role in the Great Depression. At that time, and having had one major global conflict behind the largest sovereign states in the world, I have no clue why people in power continued placing the same bets with even higher amounts attached.
I do think the safety net of shared consequences has made it safer for them to get away with it. Companies will take huge risks because, while the equity holders stand to lose everything, so too do the workers. And they know the downward pressure on those workers forces them into choosing between their needs and their time. I mean, look at gaming companies like Bethesda and Rockstar Games. The downward pressure on having to deliver a billion-selling title because they deliberately limit staff and new IP opportunities, contract more and more labor. It's a framework of continuous stress and instability. Companies optimize for stress all the time. I've seen it firsthand across meetings with Inc. 5000 and Fortune 500 logos.
Yes, the simple fact is that an optimal capital structure in the current environment benefits heavily from debt because a lower cost of debt means a lower cost of capital.
If central bank rates were too low, we would see inflation, but we don't. Rates are so low because savers want to save more than borrowers want to borrow. Corporations are just taking advantage of the large pool of savers that's already out there.
I suspect we have been saved from massive inflation mostly by Moore’s law. The prices for computing and telecom have been going down massively for the last few decades, and that has been enough to offset the higher prices for things like health care and education.
When that comes to an end, so will our low inflation environment.
Of course the other variable is that the world uses the dollar as their reserve currency. If that comes to an end all hell will break loose.
Not OP, but I don't see any data suggesting that assets are inflating. For real estate, inflation adjusted price per square foot hasn't changed for most of the US [0] (west coast admittedly has ballooned but that's because their cities are built in valleys with a fixed amount of land and restrictive zoning causing a fixed amount of housing and thus bidding up home prices; not a problem for most of the country though). As for equities, Annualized S&P 500 Return (Dividends Reinvested) from 2005-2020 are 6.738% [1] versus 7.690% for 1990-2005 [1].
Central banks are creating trillions of dollars of fiat out of thin air to push down interest rates to their targets. While there is an enormous amount of capital chasing yield, contributing to yield compression, central bank monetary policy is the primary cause of zero or negative interest rate policy.
Great opportunity to wash these companies through bankruptcy, wipe out the shareholders, leaving the buyer with a profitable, operating business. As a bonus you’ll get the politicians behind you as you’ll be saving jobs — jobs that never would have been at risk except for the excess liquidity still flushing through the system.
Something I have never seen a good answer to or explanation of: what is an "appropriate" debt or leverage ratio for a healthy company?
Obviously, a private company with hundreds of millions in stable recurring revenue shouldn't operate debt-free -- debt can be a useful tool, even if only as a rainy-day tool for situations such as the recent pandemic.
In other words, corporate debt -- and especially low-interest and covenant-free debt that is secured using recurring revenue -- seems like a capital allocation (corporate finance) tool with a set of trade-offs relative to cash and venture investment. But, how much debt is "too much"? I feel like those of us who work in software can sometimes forget that for most industries, venture capital isn't even an option, which means debt can be one of your only growth financing sources of capital -- and even for those in software, some companies are not venture-fundable but might still be debt-fundable.
It's clear that the PE firms that load up billion dollar companies with billions in debt are just playing a speculative finance and asset strip-mining game. But, it would be a shame if we invested all of this time, money, and regulation into a robust "financial capital banking sector", and we can't even rely on it for capital that businesses can use to create jobs, service customers, and smooth the rough patches in the economy.
> Obviously, a private company with hundreds of millions in stable recurring revenue shouldn't operate debt-free -- debt can be a useful tool, even if only as a rainy-day tool for situations such as the recent pandemic.
Why obviously? Seems to me when a crisis hits the last thing you want to have is debt you need to pay back. For example, should Apple, with their huge mountain of cash, have debt? Do they need debt?
I guess one can also ask the same about countries. Do they really have to maintain some level of debt in order to have a healthy economy? Why not just have a big bunch of cash put aside for a rainy day? How is this "obvious"?
I think we are conflating "available credit" and "utilized credit". (Or, rather, I didn't clarify that myself.)
Available credit is something like, "Company X has $100M in annual revenue and a $5M line of credit, which is not presently utilized." Arguably, such a company is better positioned than the same company X without the $5M credit facility. The cost of the annual fee to maintain the credit facility will be miniscule compared to the security provided by having $5M instantly available in a rainy day scenario. This is the way by which I mean some corporate debt (specifically: available revolving credit) is "obviously" a good idea.
You're right that term loans involve more trade-offs: interest, maturity, etc. But those are still trade-offs, not always downsides. Assuming even a modest annual-interest-rate-beating growth rate in the business with a high probability that such growth materializes, the debt can make the business easier to manage and actually increase the probability of sustainable growth. That's the other way in which I believe that debt can be an obvious benefit.
But obviously if you take too large a term loan, it can be disastrous, thus my question about debt ratios. For example, for company X above, it's obvious to me that a $100M term loan would probably be dangerous. But, a $10M term loan vs $5M? Not sure. That's why I am curious about ratios.
> For example, should Apple, with their huge mountain of cash, have debt? Do they need debt?
Obviously not. Debt is for companies that have already utilized most of their cash, right? Or have future cash flows that they want to access now before the cash actually materializes. Apple, by contrast, should probably become an investor or lender, since it doesn't know what else to do with its excess cash. It certainly serves no purpose being hoarded on their balance sheet.
You can create debt in jurisdiction A collateralised with assets (even cash!) in jurisdiction B... potentially without any tax implications. I expect Apple can borrow money basically for free, so there's probably a bunch of financial-engineering type reasons that debt would be useful to them.
> Seems to me when a crisis hits the last thing you want to have is debt you need to pay back.
I think that when a crisis hits the first thing you want is cash, and that means the last thing you want is to have just spent all your cash paying off debt.
Imagine that you need to buy $100,000 of inventory to sell, and you have $100,000 to spend. If you spend all your cash on inventory, then you have zero dollars on hand. When your account comes back and tells you that you need to pay another $10,000 in taxes — now you need to borrow, and it's a lot more difficult to borrow with nothing in the bank than with $100,000. When one of your customers trips and falls on the just-washed bathroom floor, you need money to compensate him. Not having cash is pretty awful: necessary cash outflows can be spiky, and income can be spiky, but the spikes do not necessarily need to align. This can lead to a cash flow crisis, and eventually to a restructuring bankruptcy.
OTOH, if you had borrowed the money to buy that inventory, then yes you would have had to pay $110,000 or $105,000 or whatever, but you would also have had the freedom that cash gives you. Borrowing would have smoothed out a major expense, and permitted you to pay it off in smaller chunks, making a cash flow crisis less likely (although of course still possible).
Consider right now, with the whole COVID-19 situation. It could very well make sense to borrow at a good interest rate: the difference between the interest rate on debt and one's investment return rate is essentially the cost of insurance to have cash on hand. Note that sometimes this can even be negative: it is possible even now to get 0% interest-rate credit cards with terms of over a year: you can invest the cash and pay it off in twelve months.
Debt used to create value or accelerate value creating processes is good debt. Debt used for stock buybacks, paying off interest on existing debts, executive bonuses, etc. is bad debt. It is pretty straightforward, we just seem to have lost our connection between the stock market valuation and the actual value of companies. We were content watching companies increase in value when they were actually stagnating and drowning in debt.
Think about a company as an entity that invests in projects with the goal of maximizing the time-adjusted return. The company must fund those projects with either debt or equity, and each funding source has a cost. The optimal debt load is one such that the projects undertaken by the company are funded at the lowest cost.
This is a nice theoretical answer, but I am looking for something a little more practical. Also, assume that a company has already acquired all its "expensive capital" via venture markets and sale of private shares. Given the current metrics of the business, how should it decide how much "cheap capital" to acquire via the debt markets?
It’s perhaps a high level answer but it’s not theoretical, if you are interested in diving deep I would highly recommend Professor Damodaran’s corporate finance course, he is the gold standard and it’s available for free on YouTube. Without repeating the entire course I’ll try and expand. The critical business metric is free cash flow, all operational data leads to that. We can project the firms free cash flows out over a period of years. Now the question is: how much should we spend to get this stream of cash? It’s not simply less than the sum of the cash flows, because the ones that come later are worth less than the ones that come sooner. To account for this, we “discount” those cash flows at a specific rate, the weighted average cost of capital. This number is where we bring in the mix of debt and equity in the firm and contains the cost of equity financing and the cost of debt financing, which mostly has to do with what interest rate the firm can borrow at. There is an optimal quantity of debt that minimizes this discount factor, thus maximizing the value of the future cash flows, it’s convex. If we can spend less than those summed discounted cash flows, funded with that optimal mix of debt and equity, we are NPV positive. This means we are generating real economic profits with our business activities.
I just want to thank you again for that YouTube recommendation for Prof. Damodaran’s course. It is exactly what I am looking for. In particular, the middle part of his course (“the financing decision”) is specifically about how to think about debt vs equity mix.
Enjoy! I hope you find corporate finance as cool as I do. He’ll cover this but keep in mind there are a few differences with a firm such as yours who’s investors are less diversified.
There's a fair amount of thought behind what the ideal debt ratio should be for a company, but basically the goal is to minimize the cost of capital while maximizing market value.^[1]
That period in the 70s also corresponds with the moment that US dollars lost any ties to gold.
There is a natural rate of interest in an economy. When the central bank artificially lowers interest rates you get malinvestments. This is only possible with fiat currencies because you can't print gold.
None of this would be possible if interest rates were at (say) 5% which is about the historic average, or at early 90s (double digit) levels.
This ends dramatically. I'm guessing with a less dramatic version of Zimbabwe or the Weimar republic.
> This is only possible with fiat currencies because you can't print gold.
on the other hand, if the world was still on a gold standard, then the gov't couldn't have printed stimulus packages, and it would lead to more poverty and misery in the short to medium term (even if that would've been better in the long term, which is a debatable outcome).
Fiat is only as good as the gov't handling it. It can indeed be abused more than gold can. But it's also more powerful than gold. A tool, in the hands of the capable, can do wonders. So the debate around monetary policy should be how to achieve the best results.
> if the world was still on a gold standard, then the gov't couldn't have printed stimulus packages
Sure they could, borrowing is still allowed. And the government can just declare "property rights are lovely but we're suspending them in this emergency, here are some IOU for after we raise taxes to cover this". Which would have a largely equivalent effect in real terms to money printing but much easier to understand.
> Fiat is only as good as the gov't handling it.
The government is consistently made up of financial incompetents. Most governments struggle to deliver a balanced budget when they try. All the people who know how to make good financial decisions are in private industry making them.
> And the government can just declare "property rights are lovely but we're suspending them in this emergency, here are some IOU for after we raise taxes to cover this". Which would have a largely equivalent effect in real terms to money
In no way this has the same effect. The uber wealthy have an even easier time of hiding their property in this case, and the mid wealthy react much worse (violently) to private property forfeits than to the usage of printing press (which as you say most of us don't even understand).
> Most governments struggle to deliver a balanced budget when they try. All the people who know how to make good financial decisions are in private industry making them.
This is very old bullshit, and thinking like this leads to parties trying to be cool by hiring people from industry with the consequent terrible results ( this trope is so old its even parodied on yes minister).
> The uber wealthy have an even easier time of hiding their property in this case, and the mid wealthy react much worse (violently) to private property forfeits than to the usage of printing press
The uber-wealthy are the major beneficiaries of money printing, they are going to come out of the stimulus ahead. And people probably wouldn't be violent, it would be about as difficult as collecting taxes - ie, not that bad.
> This is very old bullshit, and thinking like this leads to parties trying to be cool by hiring people from industry with the consequent terrible results ( this trope is so old its even parodied on yes minister).
Being unable to identify that the person who they hired is, effectively, scamming them is a clear sign that they are financially incompetent. It isn't hard for someone with a good grasp of accounting to figure out if someone else is bettering or worsening a financial position. Particularly for government work which is neither novel nor commercially risky.
Private industry is certainly not immune from incompetence or accounting scandals. Wirecard just happened, and history has many other examples. Corruption exists in both private and public sectors.
> Private industry is certainly not immune from incompetence or accounting scandals. Wirecard just happened, and history has many other examples. Corruption exists in both private and public sectors.
This is getting way off-topic, but there is one key advantage to private industry: there are typically competitors. A bad CEO can ruin one firm, but a bad politician can ruin a country. Also typically, a bad CEO may not use armed men to force his employees to do things; a bad politician may.
Lehman Brothers didn't ruin the country? At least there were competitors that could take up the slack, oh wait they all made the same mistakes and basically ruined the entire world.
A CEO can outsource labor and materials procurement to countries where armed men are coercing employees/slaves. It's quite likely a company is outsourcing human rights violations. They can also put out marketing campaigns during pandemics worshipping "heroes" while putting their employees in harms way for no extra pay. There has also been a rash of hostile environments involving sexual harassment and racist behavior. Coercion doesn't always require a gun in your face.
Also remember the gold bonds. Before FDR, you could buy government gold bonds or government money bonds. The gold bonds were payable in gold, and with that extra reliability paid a lower interest rate.
From 1914 to 1929, the government inflated the money so the dollar was worth about half what the official exchange rate was. (I'm pretty sure this was the main cause of the bank runs as people suddenly rushed to convert their dollars to gold.) FDR decided to pay the gold bond holders in dollars instead of gold, effectively confiscating nearly half of the money.
The runs stopped when FDR suspended exchanging dollars for gold. Once people realized that the official exchange rate was a 50% off on gold sale, there was no stopping the rush to exchange.
And they'd be even more upset about the everyone-since-Roosevelt money confiscation, if it hadn't been obscured by being done through currency debasement.
> "Property rights are lovely but we're suspending them in this emergency, here are some IOU for after we raise taxes to cover this"
Gold standard + IOU is not the gold standard. I suppose they could be separate currency denominations, but then it is far from guaranteed the IOUs can be converted to goldbacks.
> Most governments struggle to deliver a balanced budget when they try.
Actually, suggesting that many rich governments should balance their budgets is financial incompetency.
> All the people who know how to make good financial decisions are in private industry making them.
I don't understand how people can look at the near-zero price and wage inflation and then claim America is suddenly going to become Zimbabwe without going through an intermediate phase of "slightly higher inflation", like 5 or 10%.
Besides, the use of gold has no bearing on "M2", which is quite important in the modern economy.
And all the classic hyperinflation cases were forex-driven: either the country's exports fell below their ability to import necessities like food and oil, or (in the case of Weimar) they were forced at gunpoint to hand over gold.
So long as the US continues to produce enough food and oil domestically, it's very well insulated against hyperinflation.
You make some really interesting points. Allow me to reply with a bit of speculation:
1) Peruvian, Bolivian, Argentinan hyperinflation were purely printing-press inflations, without forex being the culprit.
2) Inflation is strongly affected by expectations. If everyone think prices will go up 5%, then we all increase salaries/prices by that and we self fulfill the prophecy.
3) 5-10% inflation is actually quite high for modern standards. We are not in the 70s anymore.
4) Lastly, the main point: onxe you get there, there is a high chance that the dollar will lose its place as the world's currency. Then, inflation accelerates and you enter a spiral.
The good counterpoint here is Japan, which has insanely high public debt (about 200% of GDP), invented quantitative easing, and has struggled to hit 2% inflation for several decades now.
If Japan hasn't been able to hit a hyperinflationary spiral based on its debt-fueled trajectory, then the US (which is far less along that path) isn't going to be hitting it anytime soon.
As nuts as it sounds I suspect high levels of debt may be a hint that there isn't enough money printed into the economy and the debt is a symptom. That more supply doesn't drop the demand significantly seems like a hint. I would love to hear counterarguments because this seems odd even to me.
I suspect it is quite possible that we can vastly increase the money supply in circulation without vastly effecting inflation. There have been a number of injections of money into the economy over the last decade or so, and inflation has been incredibly stable. Perhaps the world's ability today to rapidly ramp up production to meet increased demand helps keep prices relatively stable. It could be that the complexity in today's economy acts like what is seen in complex ecosystems, where relative stability of the overall ecosystem is maintained by all the built up ecological relations among species.
Japan is aging and also had a strong saving culture to begin with. For money to inflate consumer prices, consumers have to be circulating the money around.
QE tends to inflate stock prices and real estate, things that institutional investors like sitting on. These however are not necessarily reflected in some measures of inflation; US CPI doesn't include stocks, and it involves what can best be described as a guesstimate for rents. So this may be Goodhart's law in action: "When a measure becomes a target, it ceases to be a good measure."
2) is definitely true, and was how Brazil was able to "reset" expectations with the Real. But at the moment, expectations are low?
3) I'm not sure I understand this, other than a question of mapping quantities to sentiment - I don't think it makes sense to say that 10% would be "hyperinflation"?
4) Like the old joke about not having to outrun the bear, who's going to overtake you? Is the Euro sufficiently uncoupled? 2008 financial crisis suggests not.
(Possibly the most plausible dystopia is "US becomes a Latin American country", complete with US-backed coup)
I think 3 is flawed in general, since 5% price increase often does not result in 5% salary increase. Wages have not kept up with inflation/CoL especially at the bottom, for decades. Instead, consumption would probably drop, especially for non-essentials. If consumption is low, prices would also probably remain low, or possibly lower, especially for non-essentials. For high-demand essentials, probably supply/demand is more likely to create higher costs, than inflationary sources.
Right now I think a lot of people are in hunker-down mode. Without outrageous consumption to increase demand, reduce supply, raising prices and CoL to force increased salary demands, I don't think this self-fulfilling inflation will happen.
Maybe the danger is people being overly-flush with cash after COVID-19 passes, but that looks like it'll be pretty far down the road, and I think we're also due for a bubble to pop on Wall Street, which will probably also hamper inflation.
A bit like the coronavirus, that depends whether the government takes appropriate action and what they've raised rates to by that point.
If the government of the US has become too dysfunctional by then, sure; but I continue to not understand why Americans seem to embrace the dysfunctionality and political helplessness. America could choose to fly itself into the twin towers, but it could also .. choose not to?
"There is a natural rate of interest in an economy."
Yes, and the base rate is zero. Since reserves are costless to produce and banks can't get rid of them in aggregate the base rate should always be zero.
It is rates above zero that are unnatural since by definition they are a market intervention that reduces the price of all other assets and drives up yields artificially.
The state shouldn't be paying a Basic Income to banks in the form of interest on reserves. Banks should earn their crust by lending productively.
Beyond that the rate of interest is the one estimated by the lender to be sufficient to cover the risk of discounting your collateral into the state's liquidity.
Banks are really just pawnbrokers with shinier suits and better PR.
The base rate is non-zero because capital has non-zero cost. Interest is just the limit of the cost of capital. If you don’t have a fed, or if the fed does nothing then interest rates will converge on their own to a positive value.
The natural interest rate refers to the interest rate in a free market of banking. In a free market interest rates would not be zero otherwise the bank can’t make any money...
A gold standard doesn't prevent manipulation of interest rates. The Federal Reserve manipulated interest rates while on a gold standard. One of the reasons they would increase or decrease interest rates was to manage the desired gold stock.
The reason the US abandoned the gold standard was the (inevitable) failure of centralized fractional-reserve banking. By 1971 the U.S. was effectively insolvent in its ability to cover foreign holdings, and feared a run on the dollar. U.S. gold reserves couldn't keep pace with the expanding money supply and increasing demands by foreign holders for redemption of their dollars.
Two things mentioned in the article (a) US tax advantaging of a debt-laden structure and (b) LBOs actively punishing firms for not carrying an "efficient" level of debt are probably more important. Note that LBOs were invented in a period of double digit interest rates.
(there is an argument that USD interest rates are "too low" due to market reasons, because USD is the global reserve currency. I suspect leveraging global reserve status to apply strategic sanctions is, at least over the short term, far worth more the US than any resulting malinvestment. If not, we'd all be using Bancor for exchange.)
Limiting the money supply on the basis of quantity of some arbitrary metal is in no way creating a 'natural' interest rate in the economy.
Gold acts as an 'independent, non-political' arbiter, but it's nowhere near 'natural'.
How does the discovery of a lot of Gold, somewhere on the planet, related to the 'natural' productivity and growth of a nation?
There's no such thing a 'natural' interest rates - we have to decide how much currency we want in circulation, and we try to use 'objective rules' to do that, and try to keep that system as far away from the Political System as possible.
But since 2008, we are definitely playing with fire in terms of the funny business and 'breaking of our own rules' we are doing at the Fed, i.e. by accepting crap mortgages as collateral etc..
Actually, the last time we had high inflation, the fed kicked interest rates up[1]. So I don’t know if we end up like Zimbabwe. The fed would likely step in well before something bad happened.
That isn't true for gold - historically it has destabilized economies several times by having both too little and too much gold relative to the true size. The gold standard has caused many wars and travesties as conquest was started for the sake of raising their economic cap above deflation, let alone debasement of currency.
A "natural rate" of interest doesn't seem like a meaningful concept to me, to be pedantic. There is nothing natural about it, it is all tautological based upon what "works". Closest concept to it I see is the currency vs productivity mapping for what causes real inflation. Given that universal value is a mere mentally convenient myth everything is fuzzy anyway.
A growing number of netizens are starting to believe that we are already living in an American Weimar Republic. And it's hard not to see the many social and political parallels - I'm not familiar with the economic side of Weimar Germany.
I'm not sure why you are being downvoted. All we see is bubbles, inflation, inequality, record low interest rates and stagnant wages, but apparently printing trillions and and not having a gold standard has nothing to do with it. Sure.
> apparently printing trillions and and not having a gold standard has nothing to do with it
Printed trillions because of Covid-19. It would have been grim situation without the stimulus. 12-14% unemployement, no stimulus would have closed thousands of business, and would have increase unemployement. People who has money (Silicon valley engineers) is not going to invest in rural Ohio.
Wages are stagnated because of policies and misinformation. Federal minimum wages should be raised at least $12 and tied to inflation with universal health care.
Inflation is record low. Not sure what you talking about.
Its time to be robin hood. Tax high income, tax stock buy backs, higher capital gain taxes etc.
Its pathetic that people making $500k/year pays less than $75k in Federal income tax (14%).
Minimum wage doesn’t need to be raised. Any time that you place an artificial price floor or ceiling on supply in a competitive market you distort it. Private industry should not be in the job of providing a social safety net.
That’s government’s job. We should have universal healthcare, expand the earned income tax credit and make it easier to distribute throughout the year and increase taxes to fund it.
But I noticed that you called out people making $500K instead of $200K. Why? Maybe because $200K is not considered “rich” by most people on HN?
Why not raise taxes on everyone that has a household income of $130K since that puts you above 80 percentile of households income or $184K since that puts you in the 90 percentile?
“Tax the rich” often translates to “tax people who make more than I do.
> Private industry should not be in the job of providing a social safety net.
Someone should. Instead of taxing industry, and transferring wealth to poor, its best way to increase wages for the bottom 20%. They will spend that and increase economic activities.
> I noticed that you called out people making $500K instead of $200K. “Tax the rich” often translates to “tax people who make more than I do.
I didn't call anyone, nor I said: "tax people who make more than I do". I used to work in silicon valley. Now a business owner. I said it's pathetic that people (like me) who make $500k/year pay less than $75k in federal taxes.
Someone should. Instead of taxing industry, and transferring wealth to poor,
Increasing the minimum wage and paying someone more than their market value is a tax.
Increasing minimum wage is a one size fits all solution. “A livable wage” doesn’t take into account the different needs of my teenager living at home flipping burgers for some pocket change and that same burger flipper standing beside him who is a single mom of three. The EITC does take that into account.
As would be any combination of increased pricing if minimum wage was increased, increased unemployment because automation becomes much more attractive, decreased earnings affecting stock prices which affect public pensions which would cause an increase in taxes to make up the shortfall.
If we increased the EITC, and raised taxes to fund it, we wouldn’t have to worry about food stamps.
Source that a higher minimum wage leads to those undesired outcomes. My best reading of research into the effects of minimum wage increases is that it doesn't lead to higher unemployment, but may result in reduced hours, which is a different kind of raise.
Reduced hours still doesn’t bring in more money if they need it. But if you can trade automation or outsourcing for human labor, where is the tipping point where it just makes sense to outsource?
Reduced hours leads to either the ability to work more jobs, or achieve more education, or achieve more leisure, or some other alternative. In all cases, you are better off if you make the same amount of money and work fewer hours.
Automation is going to happen whether min wage is $8 or $12 or $15, it is just an inevitability. But, the US has never had high unemployment due to technology making us more productive. Those who worked certain jobs would have to find different work, but that doesn't mean that there won't be work for them.
How many people working minimum wage jobs can afford “leisure”?
No other time in history has technology taking out whole industries. Tesla is worth more than any of the car makers and employs many fewer people. The five major tech companies have fewer workers and paying them more. The US has never seen such income disparity as it sees now.
Also when producing physical goods, the more goods you produce, the more people you need to hire.
Microsoft doesn’t need to hire more people when it sells more copies of Office or Windows, Neither does Google need to hire more people to meet demand. Apple needs to hire more people to meet demand of hardware products - but those are all in China.
Amazon is the only company in Big Tech that actually hires more Americans when demand increases.
That's just optimal game theory at play. Higher taxes on the wealthy have literally no effect in the long term on there ability to purchase goods because they are only bidding against other wealthy people who are subject to the same taxes.
It's not a competitive market -- employers have more market power than employees. That's why in practice minimum wage increases don't have much of an effect on unemployment. Here's a recent paper on the topic (that cites many of the previous papers that have similar findings): http://digamoo.free.fr/azar719.pdf
If that were the case that employees don’t have any choice, you wouldn’t hear stories about farmers who couldn’t get American day laborers at any price - even upwards of $20/hour or more. There are some jobs that Americans won’t do at any price.
No minimum wage? In this world of accelerating automation and dropping real wages? That argument is right up there with 'let them starve'.
Are Socialists correct, than our society depends upon a slave class to function? Because so often a suggestion that people earn a humane wage, is met with blanket resistance and dire predictions that the economy will be ruined.
What do you think is going to happen if you increase minimum wage to the point where it makes automation a more affordable alternative?
Also, you did see the part about expanding the earned income tax credit and providing universal healthcare didn’t you? I’m not saying let anyone starve. I’m saying that’s society’s responsibility through taxation and redistribution.
> What do you think is going to happen if you increase minimum wage to the point where it makes automation a more affordable alternative?
This is going to happen anyway. Walmart is planning to go cashierless. Taco bell has kiosk for ordering. New PlayStation manufacturing plant is fully automated.
Universal Basic Income is the solution. I don't even think 20% of the population is doing even a simple task.
If you are actually concerned about helping the poor, then as user scarface74 points out, increasing EITC is a better approach than a minimum wage increase.
Progress has been happening in our economy for over 200 years now. There is always the next boogeyman that is going to ruin the economy, yet it never materializes.
And if automation does in fact cause harm the way you suggest it will, and it might, then we do what we must as a society to alleviate that issue. Trying to hold back the inevitable is a bad economic strategy.
There is a huge difference. While progress before meant that workers could be more productive, the amount of workers you needed increased as the amount of goods that were produced increased. It took more people to produce more value.
It doesn’t take any additional people if MS sells one copy of Windows or Office than if they sell a million. The same is true for Facebook, and AWS (of course the retail side needs more but that’s even becoming more automated). As I said below, Apple and Amazon are the only two of the five big tech companies that have products or service that requires a lot of people as they scale and Apple’s “employees” are contract workers overseas.
That also means that the modern “factory workers” - software engineers, product managers, etc. produce an outsized value, are a larger multiplier and get paid a lot more.
The entire concept of software and is that the marginal cost is 0. If it gets to the point where there is a one to one ratio between worker and service, it becomes yet another commoditized race to the bottom.
There is also nothing stopping many of the three billion people in India and China from producing these services and now all of the protectionist policies in the world won’t protect “good American jobs”.
But as far as Amazon and Apple, that’s just the point. Apple’s “manufacturing employees” are overseas and Amazon is trying to automate more so that they don’t need as many FCs.
Personally I see accelerating automation as a pro and not a con for raising minimum wage - it encourages investment into R&D, boosts productivity, and would make a damn good export.
Granted it would be a bit of a pain and call for other measures for remediation after the spread of automation but the goal of a job is productivity in the first place - we don't dig ditched with spoons.
If taxes were that easy, we wouldn’t need so many accountants in the US. In reality, there are a bunch of ways a person makes $500k and pays less than $150k in taxes.
- For example, if it’s paid as carried interest, they only pay a 20% tax rate.
- They could itemize deductions.
- A farmer could buy a brand new truck and call it a business investment.
- If you’re a pass-through entity you only pay a 20% rate
$500k is the income. The entire point is that business and personal expenses overlap considerably for farmers so they have wide range for tax purposes.
It’s an inefficiency in the tax code which allows a person to have income of $500k and pay less than 31% in taxes.
This is a very informative article, but it has one major deficiency.
I have a general rule that when we are looking at something going bad in our country, one of the things to do is look at how the issue is handled in other countries, like are they doing it better or worse, and what can we learn from that that might help us decide what to do here.
With that in mind, the article should have covered how this whole corporate debt issue is handled in other countries. Are they doing better or worse? Perhaps someone who has some knowledge here could make a comment.
Well, Japanese companies used to have a lot of debt in the 80s and when the crash came, a lot of them got hurt. Now, they're mortally afraid of debt and cant for the life of them ever expand their revenue. Japan is a cautionary tale of what happens when people save too much money, are too risk-adverse, and are unwilling to borrow.
The BOJ has been trying to get inflation up for decades with some of the lowest rates around and it hasn't worked. The country has been in a recession for a good 30 years and no amount of monetary policy manages to make things any better.
Debt is a really powerful force, both positive and negative. I think for some businesses, like real estate, it makes sense to have a lot of debt, and others, like brick and mortar retailers, where debt can very easily destroy your entire business.
Perhaps an unorthodox way of looking at things, but it's very intersting take a step back to consider what 0 to low interest rates might accomplish for society:
- Low interest rates mean it makes no sense to simply keep cash, it's better to invest in something productive. For companies that's new projects/ideas which create jobs, for individuals that might be spending on goods to stimulate the economy or buying a house.
- High interest rates are a considered a way to reduce "risky" investments. But in reality, interest is rent seeking on capital which benefits (1) lenders/banks (2) capital holders. Cheap capital enables more projects with positive ROI (above cost of capital) to be persued. And this is good for society as it drives innovation and allocates capital to innovators instead of locking it under stagnant rent seeking. Lest you worry, this doesn't hurt capital holders, as they can instead proactively invest in companies and make the same or larger returns, but now capital is allocated by merit of the project being invested in instead of by simply who can afford it because it meets some threshold. This unlocks the "long tail" of innovation. This is what is referenced in the article: 1970s Hertz took a risky bet using debt which paid off to record profits.
- Higher interest really means higher long run inflation. If you can just let money sit in a bank, doing nothing directly productive for society, and there is suddenly more of it, prices will adjust accordingly. With low interest rates, money supply will adjust with GDP growth from innovation and prices might even be reduced by higher competition and discovery of efficiencies. As long as innovation (enabled by access to capital) stays on pace with money supply, inflation stays low.
This is of course a very optimistic way of looking at things which doesn't consider the effect of things like wage growth which has all but stopped. One could argue in a non-inflationary environment that might be ok, but this is a larger topic having to do with social mobility goals rather than just the economics.
> Higher interest really means higher long run inflation.
In orthodox macro, higher interest rates -> reduced investment -> reduced demand -> reduced inflation. This is pretty much empirically proven by how central banks have been able to control inflation in the West.
The way I see it is the "search for safety", especially where negative interest rates are concerned. There are two huge concentrations of safety-seeking money in the modern economy: pension funds and oligarchs. The pension funds more or less have to buy government bonds in a certain ratio, regardless of the price. Whereas the oligarchs have hundreds of billions they need to keep anonymously in a stable economy - ie dollars, pounds, and euros.
Things like the Apple "cash" pile of $245bn represent a lot of floating wealth too.
Ultimately, if we don't get real wealth taxes, interest rates will be forced negative simply by the market and the huge volume of safety-seeking money.
It's always strange to see the "orthodox" macro realtionship take precedent over emperical results (see article and figure 1 scatter plot: https://www.stlouisfed.org/publications/regional-economist/j...). In the short term, the orthodox thinking might be correct and an effective lever for the economy, but long term, it's clear that high interest leads to higher inflation AND less innovation which are bad outcomes IMHO.
I agree with your observation for the demand to keep money "safe". We should define what that means. Historically, if you choose to keep wealth in a stable cash with real interest rate (nominal interest rate minus inflation rate) that is positive or zero, it's safe as it retains or grows its buying power. The "or zero" part is important as it allows for a zero interest environment if that also means low inflation.
Some may even argue that a reasonable negative interest rate is "safe" and it's just like a "wealth tax" which is the cost of service for keeping large sums of money at the bank. Shouid safety be free (no negative rates)? I would say maybe yes, but safety shouldn't also reward you... and positive interest rates do exactly that.
The 'Elephant in the Room' here is the chart they did not show, and it's interest rates, which have been steadily declining. You can't fight the impetus for the system to want to give you free money because in the race to equilibrium, your competitor will do it, which leaves you with little choice.
Imagine that some industries are 'thin margin' and naturally going to be competitive, and a little prone to failing if there is a hiccup.
What 'low interest rates' do is exacerbate that quite a lot - so that only a little hiccup is needed to blow you up.
There is a really, really interesting national parallel between the fall of Spain in the 2008 crisis and this story. The 'accepted narrative' is that when the Euro came along, Spain acted 'irresponsibly' and borrowed too much. But a more careful analysis (from an FT interview no less!) showed that they actually acted rationally given the very cheap money flowing in from 'Rich Europe' at the time.
So the overarching issue is real: there's a lot of corporate debt. But it's a financing instrument like any other, it might actually make sense for companies to be leveraged to some extent. Credit runs the economy, this is a form of credit.
I think a much bigger 'meta' look at this from the FT Economists would be warranted - instead of looking at this as more of a 'corporate activity' kind of thing, look at it from an economic equilibrium perspective in terms of defining 'how much debt' is actually good, or bad, and why.
From what I understand, the basic problem is this. The way things are supposed to work is corporations take their profits and divide them up in two ways. Part goes to paying the owners, like dividends to stockholders. Part goes in investing in the future, like research and building factories.
The problem is that for a long time a large proportion of companies have been paying out an increasing portion of their profits to pay off massive and ever increasing debts. They still keep paying profits to the owners, and so they have ever less left for investing in improving the company. That in turn means poor growth and being less competitive in world markets.
And even worse when the economy goes through a bad period, many thousands of companies can no longer pay their huge debts and go bankrupt, with great damage to the economy.
Instead of free market finding the proper risk-adjusted yield for a bond, we are swinging between over-regulated squeeze (shut down non-blue chips companies from access to capital) and free-for-all central bank buying bonanza (carpet-buying of corp bonds). It is either very hard for business to get access to capital, or CB makes it excessively easy.
Somehow FT makes is look like it is some "financial engineering" fault that companies are "addicted to debt". How about letting willing debt buyers get into transaction with willing debt sellers? That simple.
"Pension funds and insurance companies bought the debt in bulk"
Is it fair to say that pension funds are largely to blame for this? Corporations can't acquire debt if nobody offers them money. Insurance companies too, of course, but pension funds in particular are at least theoretically supposed to be protecting the workers. Hard to see how debt-funded corporations (I'll mention Uber as an egregious example) are in alignment with the interest of the workers.
> Is it fair to say that pension funds are largely to blame for this? Corporations can't acquire debt if nobody offers them money.
About as fair as it is to say that people who wish to receive some income after retirement are to "blame" for this. Nobody can save without some other party (households, companies or the state) acquiring debt.
Junk bonds are hardly the only form of investment, and certainly not the safest, if your goal is to ensure someone's retirement. Moreover, corporate debt is at high risk of mass default in a market downturn such as the current one.
Any large pension fund has a large portfolio of bonds of all grades and yields. Most will still have the bulk allocated to investment grade government and corporate bonds. But the yields on safe investments have been so low for so long that they all see themselves forced to choose between riskier investments (leading to cheaper and cheaper debt as per article) or telling their participants that they need to save way more for their retirements.
That is true. But I'd say it's better for the funds to be honest with the participants than to try to pretend everything is fine and paper over lower returns with higher risk, because ultimately it won't be fine. Over-leveraging is a strategy that can bring short term results but is destined to fail in the long term — catastrophically.
Pension funds can maintain lower risk and boost their returns through pure alpha hedge funds, alternatives like real estate, pe, and vc, or through net long hedge funds.
Simply investing in low risk bonds and equities actually is more risky than one might think, especially since the historically negative correlation between the two has been breaking down recently.
But regardless, pension funds have obligations and should take on the necessary amount of risk so that they can pay out what is owed.
Good luck telling your state workers that they all need to take a pay cut (which is what lower pension returns really are) and/or your local citizens that they'll face a tax hike (if you don't want the state workers to take the hit), because you read in the FT that "companies are addicted to debt", and that we have this hunch that all this debt will collapse at some unknown time in the future.
Pension funds spend $trillions on investments. They have a lot of power to incentivize corporate behavior, in either a responsible or irresponsible direction. It seems to me that pension funds have been enablers of irresponsible corporate debt stockpiling. Pension funds had a choice, and I'm not sure they chose wisely.
Not sure what you're suggesting here concretely, or how you imagine pension funds actually work. Asset managers at pension funds need to make some target returns on their part of the portfolio (say 5% on high-yield corporate bonds). They're just mundane desk jobs, buying and selling contracts on computer screens. We're not talking about people playing golf with the CFO of Boeing or anything like that. What kind of incentivizing responsible behavior would you imagine them doing?
Yields on all debts have been structurally declining for more than three decades now. So all asset managers find themself forced to buy riskier and riskier debt at higher and higher prices (= lower and lower interest rates). If they don't, they need to tell their clients to expect lower returns / save a lot more for retirement, risking the clients taking their money to other asset managers promising higher returns.
> Asset managers at pension funds need to make some target returns on their part of the portfolio (say 5% on high-yield corporate bonds). They're just mundane desk jobs, buying and selling contracts on computer screens.
This may be precisely the problem. Pension funds have an oversized influence on our whole economy. They deserve much more care and scrutiny than this.
> risking the clients taking their money to other asset managers promising higher returns.
Not sure I agree with this. Pensions aren't operating in a competitive market, they're typically associated with a particular employer, acting on behalf of the employees.
> This may be precisely the problem. Pension funds have an oversized influence on our whole economy. They deserve much more care and scrutiny than this.
I completely agree on the abstract level, but I have no clue how to get anything actionable out of that.
> Pensions aren't operating in a competitive market, they're typically associated with a particular employer, acting on behalf of the employees.
The funds as institutions probably aren't, but the specific asset managers tasked with the implementation, either directly employed or contracted by the funds, certainly are operating in competitive markets.
The economy has been based on credit for a loooong time. I learned about how it works from Ray Dalio’s excellent video on how the economic machine works https://m.youtube.com/watch?v=PHe0bXAIuk0
Depends which sort of government: sovereign or otherwise (US state, Scotland, Eurozone member). Sovereign government don't really have debt in the sense you would recognise as debt.
Indeed. That's part of the "otherwise" - the reason why a Eurozone country struggles. They denominate in a currency issued by a foreign entity they don't control.
> Even before the pandemic, the level of corporate leverage was beginning to cause alarm. At the end of last year, the IMF issued a striking warning: as much as $19tn of business debt in eight countries led by the US — or 40 per cent of the total — could be vulnerable if there were a “material slowdown” in the economy, a scenario that, if anything, now seems tame.
I like to think of it this way:
At present, a business that is barely-investment-grade (say, BBB-/Baa3) can borrow for a decade at just over 3%/year. A risky business that is rated as junk (i.e., below BBB-/Baa3) can borrow for a decade for as little as 6% to 7%/year. The interest payments are tax deductible, so the effective annual cost to borrow is around 2.5% for barely-investment-grade and around 5% for junk, give or take. As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? And if they can justify using borrowed money to buy back shares, keeping their stock options in-the-money, why not do it?
Many US companies in mature industries (think energy, hospitality, travel, transportation, etc.) have been doing exactly that, to the point that corporate debt is now the highest ever in relation to US GDP. And it has worked beautifully... that is, until a global pandemic suddenly cut their revenues by 10% to 20% or even more, instantly flipping those expected earnings into losses. People are no longer traveling as much, or going to restaurants as much, or going to the office as much, etc.
All of a sudden, all those businesses are losing money on all that borrowed money -- they are losing so much, in fact, that many have had to borrow even more during the pandemic to be able to continue paying interest on prior borrowing and avoid going into bankruptcy.