I think a big assumption in the V-shaped recovery theory is that the U.S. economy was relatively healthy going into the crises. And that once demand returns to normal, businesses will continue to post record high profits.
This idea couldn’t be farther from the truth. Data published in the WSJ on March 10, 2020 showed that:
- 1 in 6 publicly traded U.S. companies did not earn enough to cover their interest payments before the COVID-19 crises.
- In the first half of 2019, 40% of all leveraged loans went to companies with a debt-to-earnings ratio of 6:1 or higher.
- the IMF conducted a stress test that showed an economic crises half the size of 2008 would put 40% of corporate debt at risk of default in the 8 of the largest world economies.
I find it very odd that stories like these were EVERYWHERE in March, 2020. Then as stocks began to skyrocket and firms started making back losses, they practically vanished from the media.
If you are comfortable with these debt levels and believe we can keep increasing debt without a market contraction, then by all means continue to invest. Just wanted to get the information out since I haven’t see much of this lately.
The Fed can give the banks money to keep lending to corporations. Importantly, the Fed cannot erase debt, so all those bad loans the bank gave out will still be in place.
This means that whenever lending restrictions get tighter (e.g. bad companies can’t take out loans to pay off other loans) those companies will default.
Theoretically, the Fed could continuously feed money into the banks and keep lending standards low so that they could keep making bad loans to bad companies that can’t afford them. This is what Japan did and they have been in a 30 year recession ever since.