In America, debt is on the rise for both large corporations and individual households. But what does any of that really mean for the country?
A certain amount of corporate debt is healthy, while a larger portion can be stifling. And though corporate debt has risen 60% since 2011, some analysts still believe that the outlook is good.
Why is Corporate Debt Considered Dangerous?
High levels of corporate debt make a business potentially vulnerable to economic hardship. If there is a recession, a large number of corporations may default on these debts, ultimately leaving banks and lenders in trouble. This cascades through the country’s economic backbone, ultimately leading to more businesses failing, lending becoming more difficult, and jobs being lost.
Corporate debt today is much higher than it has been in the past, which to many is a risk factor. If a recession does occur (which many people have been predicting), these companies may find themselves unable to pay their debts.
The Accelerated Accumulation of Debt
Yet even though corporate debt is largely considered dangerous, some might argue that America’s corporate debt is really a non-issue. Corporate debt is high in large part because borrowing is cheap. Interest rates are low. Debt is easy to repay. Thus, corporations are simply leveraging cheap money in order to grow and expand: something that can be seen as very good.
Most of the debts that corporations are taking on aren’t dangerous — not short-term debts, but rather lengthy debts that they have the ability to repay. Thus, the risk level of this corporate debt is lower than it has been historically, even if the amount of debt is larger than it has been in the past. And, even if there is a recession, the banks seem confident in their ability to weather the storm.
Collapse is STILL a Possibility
While economists as a whole seem optimistic, there are dissenting opinions. Part of this is due to the highly publicized, hotly discussed trade war. If companies are being made vulnerable due to the trade war, and further experience a recession, the combination of factors could lead to economic collapse. While the debt may be historically easier to repay than it has been in the past, there are also more confounding issues than there have been previously.
One need only look towards the recent IPOs to see many companies coming to market pre-revenue. This includes the infamous Lyft and Uber, but also a newcomer: Chewy. As companies are banking on their future profits more and more (and accumulating large amounts of debt), this could eventually lead to a dangerous scenario.
As Large Corporations Leverage, Small Businesses Decline
Another economic factor to consider is that many of these large companies are driving out smaller businesses, and smaller businesses have long formed the economic backbone of the country. Small businesses tend to bring money into local communities, while larger businesses tend to shift money out. By being able to over leverage and operate pre-revenue, these companies have made it so that the economy itself is more reliant upon them.
Ultimately, this could mean that America is in a “house of cards” situation. If the economy goes into recession, the trade war intensifies, and large companies find it difficult to continue paying off their loans, then companies may default and may need to downsize. This could lead to a loss of jobs, as well as a loss of products and services to the American public. 2019 has already seen some major companies shuttering locations.
A Halt to Corporate Debt
To stop corporate debt from continuing to rise, the country would need to pull back on its rate cuts, or even increase lending rates. Presently, as long as lending is affordable, it would be disadvantageous for companies to stop borrowing. While money is cheap, companies need to keep borrowing just to remain competitive.
Yet only time will tell how this situation will unfold, because if companies can remain agile and flexible, and can continue to pay off their debts, the affordable money is a boon to their growth. And while it is a risky situation, it may not be as risky as it initially seems.
Regards,
Ethan Warrick
Editor
Wealth Authority
