Is U.S. Fed chair Janet Yellen creating a zombie economy?
Low rates and low taxes are supposed to fight deflation. What if they're doing the opposite?
Zombies are popular in TV, books and film. Nowit seems thateconomics isimitating art.
A newtheory says that instead of stimulating the economy and getting the world back on track, bargain basement interest rates and handouts to investors in the form oflower taxes may be causing the opposite effect,creating a worldwideplague of walking undead companies.
Speaking to the House of Commons finance committeeyesterday,Bank of Canada governor StephenPoloz defended his surprise January cut in interest rates, saying that eventually it would help use up Canada's spare capacity.
As Poloz's comments indicate, the theory turns conventional economics upside down.Low rates are supposed to make deflation disappear as companies and consumers borrow and spend.
But even a conventional pro-market publication like The Economist has observed the phenomenonhappening in the past, specifically in Japan.
"The zombies make Japanese business look comedic," said The Economist in 2011. "Around two-thirds of all Japanese firms do not earn a profit (at least for tax purposes)."
Dead firms walking
The phenomenon was something the magazine had been watching for a decade as explained in a 2004 article called Dead Firms Walking.
"Weak companies and wobbly banks clung to each other in mutual defiance of reality," reported The Economist. "Over time, this led to the emergence of so-called 'zombies' companies that are competitively dead, but, sustained by their banks, continue to walk the Earth and give healthier firms nightmares."
In the newscenario, the role of Japan's wobbly banks has been taken by central bankers, creating a worldwide plague of companies that are themoaning, groaning walking dead.
The financial website Zerohedge didn't use the Z-word, but its description of the global phenomenonwasalmost the same as the oneThe Economist used for Japan.
"By keeping rates artificially suppressed," said Zerohedge,"the central banks of the world effectively make it impossible for the market to purge itself of inefficient actors and loss-making enterprises."
Just asin Japan, companies with access to cheap loans continue to borrow and add to output long after the world has enough ofthe product it is offering. The perfect example? The oil industry.
So far, oil company results have reflected the boom times when oil prices were high and the market had nowhere to go but up. This week, we will see a more realistic picture as oil companyfinancial resultsreflectplummetting prices.
Production glut
And yet despite low oil prices, those same oil companies continue to produce huge amounts, far more than world markets can absorb. The writers at Zerohedge make the casethatfinancially weak companies, enabledbycentral banks offering artificially low interest rates,are to blame.
Energy is only an obvious example.There are also record stockpiles of cotton, hitting their highest level since the U.S. government started counting. There are gluts ofironand steel.
It is harder to measure gluts in other products and services, but it is likely thataccess to cash far below natural market rates meanscompanies everywhere areproducing too much.
In Japan, where The Economist first saw the problem emerging, it hasn't gone away. When the wobbly banks got into trouble, the Japanese government did the same thing for them that they had done for the zombie companies.
If The Economist was right about Japanese zombie companies more than a decade ago, then the entire countryhas nowbecome a zombie economy.
Wary consumers
This week, the rating agency Fitch downgraded Japan's credit rating again. It is now five notches below the AAA rating that rich stable countries like Canada normally expect.
The danger is that Japan's problemsmay be a warning of what is beginning to happen in the widerworld.
Despite that economy's huge capacity to produce goods and services, consumers are unwilling or unable to spend. And unlike companies, ordinary peopleare unwilling to borrow more.
In Japan, and increasingly everywhere else as well, the only way to get consumers to buy more is to push prices down. A general decline in prices has a name. It is called deflation, and it is supposed to be what banks are using low interest rates to fight.
This is not what most worry-warts had expected.
It is well-known that longer-term government interference in an economycauses distortions.The fearused to be thatartificially low rateswould create an overheated economy, sending inflation soaring and wiping out the value of money.
That may happen eventually. But in the meantime,those low rates may behaving the opposite effect.
If so, we are creating aworld economy swarmed withcompanies that just can't die, producing more than the world can consume. And if it continues,at some point,something's got togive.
Follow Don Pittison Twitter:@don_pittis.
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