Friday, 20 July 2018

US monetary policy works better, may unwind harder

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  • James Saft - June 2014

Faced with very low interest rates, corporations in Japan and the US have shown crucial differences in strategy, helping to explain where markets and the economy stand and where they may go.

While corporations in neither nation have shown especial willingness to invest and expand production, US corporations have racked up debt while peers in Japan piled up cash.

The upshot is that in the US growth may have gotten more of a boost from monetary policy, via the stock market, but may also have more to lose if, or when, things turn bad.

“The mechanisms by which BOJ and Fed money-printing find their way into the equity market appear similar, but they are not. The end game may have very different outcomes,” Andrew Lapthorne, quantitative strategist at Societe Generale in London, wrote in a note to clients.

In the US cheap central bank money led to greater corporate leverage, as companies issued bonds cheaply and used the money, not generally to build plants or hire people, but to buy back more shares. The big risk shift since the financial crisis in the US has been from household to corporate balance sheets.

In Japan, in contrast, corporate leadership has signally failed to take the bait of low-cost funds, at least as a means with which to lever shareholders to the bottom line. The Bank of Japan has, perhaps instead, engaged in massive outright purchases of shares, and now owns more than 60% of all ETFs issued in Japan. The BOJ is also one of the five largest shareholders in more than a third of the companies in the Nikkei 225 index.

“This difference is important. In a market downturn, equity market losses will lead to the BOJ having to mark to market its equity holdings at a lower price,” according to Lapthorne.

“In the US, lower equity markets will lead to balance-sheet disruption with the inevitable job losses and cuts in capital spending. In a low-growth world, debt is dangerous; in a deflationary world, debt is toxic. Japanese companies, through years of experience, probably understand this and have deleveraged as a result; US corporates, perhaps foolishly, have done the exact opposite.”

Net debt to total assets among corporations in Japan has dropped by a third since 2008, to 15%. In the US the same figure also dropped, but bottomed in 2011 and has since risen to 22%, higher than its pre-crisis peak.

Who is being born and who is getting paid

And while nominal capex by Japanese companies has increased since the introduction of Abenomics, it fell 0.1% in the most recent quarter. Japanese corporations are also carrying almost US$2.4trn in cash on their balance sheets, a record. Both figures show at best tepid animal spirits among businesspeople, and moreover reflect the fact that just sitting still imposes little penalty in terms of missing out on future growth.

To be sure, the underlying forces behind the divergence are complex, and include differing demographics, tax regimes and, crucially, executive compensation practices.

Japanese demographics are strongly negative, a fact not lost on corporate strategists. Their reaction has been, generally, to prioritize investment outside Japan, closer to current and future market growth. And while Japan is now at last getting a bit of wage pressure at home, the results of Abenomics have not been anything close to what was envisioned.

US demographics are more positive, thanks largely to immigration, and the puzzle remains as to why corporations have chosen leverage over expansion, even while enjoying historically high levels of profit.

Tax policy in the US has made it expensive for corporations to repatriate overseas gains, either to invest or to pay out to shareholders. At the same time, sluggish to non-existent revenue growth helped push companies to buy back shares to flatter their earnings figures.

Given that executives are paid on options, a policy of favouring near-term profitability over longer-term growth has emerged. Monetary policy has given this a boost, but the privileging of financial engineering over investment would likely have happened anyway.

Though economic expansions don’t die of old age, the current US one is 87 months long, the fourth longest since World War Two. Things may bubble along in the current way, supporting both modest investment and employment growth and strong equity valuations.

If a downturn hits in the US, it’s clear that corporations with high leverage will be quick to cut spending and employment, just as they were in 2007 and 2008.

If on the other hand inflation picks up and the Fed is able to push rates back to historically normal levels over the next couple of years that same debt will cost much more and may dictate similar cutbacks.

(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at

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