The recent correction in the US stock market is now being characterized as a fleeting aberration – a volatility shock – in what is still deemed to be a very accommodating investment climate. In fact, for a US economy that has a razor-thin cushion of saving, dependence on rising asset prices has never been more obvious.
NEW HAVEN – The spin is all too predictable. With the US stock market clawing its way back from the sharp correction of early February, the mindless mantra of the great bull market has returned. The recent correction is now being characterized as a fleeting aberration – a volatility shock – in what is still deemed to be a very accommodating investment climate. After all, the argument goes, economic fundamentals – not just in the United States, but worldwide – haven’t been this good in a long, long time.
But are the fundamentals really that sound? For a US economy that has a razor-thin cushion of saving, nothing could be further from the truth. America’s net national saving rate – the sum of saving by businesses, households, and the government sector – stood at just 2.1% of national income in the third quarter of 2017. That is only one-third the 6.3% average that prevailed in the final three decades of the twentieth century.
It is important to think about saving in “net” terms, which excludes the depreciation of obsolete or worn-out capacity in order to assess how much the economy is putting aside to fund the expansion of productive capacity. Net saving represents today’s investment in the future, and the bottom line for America is that it is saving next to nothing.
Alas, the story doesn’t end there. To finance consumption and growth, the US borrows surplus saving from abroad to compensate for the domestic shortfall. All that borrowing implies a large balance-of-payments deficit with the rest of the world, which spawns an equally large trade deficit. While President Donald Trump’s administration is hardly responsible for this sad state of affairs, its policies are about to make a tough situation far worse.
Under the guise of tax reform, late last year Trump signed legislation that will increase the federal budget deficit by $1.5 trillion over the next decade. And now the US Congress, in its infinite wisdom, has upped the ante by another $300 billion in the latest deal to avert a government shutdown. Never mind that deficit spending makes no sense when the economy is nearing full employment: this sharp widening of the federal deficit is enough, by itself, to push the already-low net national saving rate toward zero. And it’s not just the government’s red ink that is so troublesome. The personal saving rate fell to 2.4% of disposable (after-tax) income in December 2017, the lowest in 12 years and only about a quarter of the 9.3% average that prevailed over the final three decades of the twentieth century.
As domestic saving plunges, the US has two options – a reduction in investment and the economic growth it supports, or increased borrowing of surplus saving from abroad. Over the past 35 years, America has consistently opted for the latter, running balance-of-payments deficits every year since 1982 (with a minor exception in 1991, reflecting foreign contributions for US military expenses in the Gulf War). With these deficits, of course, come equally chronic trade deficits with a broad cross-section of America’s foreign partners. Astonishingly, in 2017, the US ran trade deficits with 102 countries.
The total debt of American non-financial corporations as a percentage of GDP has reached a record high of 73.3%
AMERICA’s companies have been powering ahead for years. Amid growing profits, the recession that began in 2007 seems an increasingly distant memory. Yet the situation has a dark side: companies have binged on debt. For now, as the good times have coincided with a period of record-low interest rates, markets have been untroubled. But a shock could put corporate America into trouble.
No matter how it is measured, the debt load looks worrying. When calculated as a percentage of GDP, the total debt of America’s non-financial corporations reached 73.3% in the second quarter of 2017 (the latest available data). This is a record high. Measured against earnings before interest, tax, depreciation and amortisation (EBITDA), the net debt of non-financial companies in the S&P500 hit a ratio of 1.5 at of the end of 2016, a level not seen since 2003. And it remained nearly as high in 2017 (see chart).
To be sure, things are less worrying than they were before the financial crisis. According to a recent analysis by S&P Global Ratings, a ratings agency, for example, debt is now more evenly distributed. Only 27% of American firms in 2017 were highly levered (defined as a debt-to-earnings ratio higher than five), down from 42% of firms in 2007, meaning that fewer firms are immediately at risk.
The use of the extra debt was also somewhat different. Bob Michele of J.P. Morgan reckons that in recent years much of it was used by companies to finance share buy-backs, essentially for purposes of balance-sheet management (rather than, say, big expansions or acquisitions).
“The ratio of wealth to income is “at pretty dizzying levels right now,” Previous busts were preceded by periods of rising asset values and low saving, and the current wealth-to-income level surpasses that seen in the run-up to earlier recessions.”