Low Interest Rates Distorting Corporate Borrowing

Whenever the government intervenes in the economy, there are consequences. Many are negative given the inevitable distortion they cause to supply and demand. Since the interventions often include expensive programs supported by deficit spending, the focus of consequences is typically on the sovereign debt side. However, the actions have tentacles into the private sector side as well.

The Fed’s low interest rate policies were implemented to increase economic activity. The hope was that these rates would offer incentives for consumers to consume products and services, and for corporations to invest in capital expenditures to increase productivity and therefore promote further economic growth. Unfortunately, this has not occurred. Instead, the increased liquidity has created asset bubbles including in equities with valuations currently at record levels.

An example of a market distortion caused by the low interest rate policies since 2008 has been an increase in corporate borrowing at a time when many of these companies are already flush with cash that they have declined to invest in productive endeavors. This inappropriate borrowing is a direct result of the low interest rates are too good for companies to pass up. They therefore sell corporate bonds at low rates with the belief that interest rates will go up in the future.

An example of a grotesque debt accumulation is one of the more successful American companies, Google Inc. In 2011 at a time when their cash holdings were at $37 billion, Google sold $3 billion worth of bonds merely because low rates. This is but one demonstration of inefficient use of debt that will distort future decision-making in the future by these companies. Prior to the Google debt financing, in 2011 alone, a total of $17 billion in debt was too large tech companies that included Cisco systems Inc., Dell Inc. and IBM.

Since 2011 corporate borrowing has increased, moving to less well-heeled companies that are able to sell just above junk grade bonds at attractive interest rates. Buyers are willing to purchase these risky bonds at the low rates chasing yield for income, another result of the low interest rate Fed policies, with interest on bank deposits paying near zero returns. This sets up the potential for bad future consequences including depreciation in the face value of the bonds when interest rates increase, as well as weak companies being unable to repay the debt during the next inevitable economic downturn. These consequences will magnify the next downturn.

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