What has been the long-term impact of the zero interest rate policy (ZIRP) implemented by central banks in the wake of the 2008 financial crisis? Many economists worried about inflation, stagflation and currency devaluation, but who anticipated widespread gluts of just about everything from coffee, iron ore, oil, potash and copper, to aluminum, steel, excavating equipment and container ships? Yet this is exactly what has happened. While some companies borrowed to pursue buybacks or mergers and acquisitions, many others took on debt to expand output.
One could choose from a myriad of examples, but here are four companies in different industries and geographies to illustrate our point.
Cenovus Energy Inc. saw its total crude oil and natural gas liquids production increase from 121,838 barrels a day in 2009 to 206,647 barrels a day in 2015. Over that same period, long-term debt grew from $3.7-billion (U.S.) to $6.5-billion. Money was raised at very low rates: 3 per cent on $500-million due in 2022, 3.8 per cent on $450-million due in 2023, 4.45 per cent on $750-million due in 2042 and 5.2 per cent on $350-million due in 2043.
Oil and gas may be front and centre here in Canada, but in Brazil and Australia, it is the plummeting price of iron ore that attention is focused on. Between 2009 and 2015, miner BHP Billiton Ltd. saw its iron ore production soar from 114 million tons annually to 233 million, while its long term debt increased from $15.3-billion to $27.6-billion. As was the case with Cenovus, a lot of this debt was accumulated on the cheap. In fiscal year 2015, for example, BHP issued $1-billion Australian ($963-million Canadian) in new debt at 3 per cent due 2020 and €750-million ($1.4-billion Canadian) at an amazing 1.5 per cent due 2030.
Heavy-equipment manufacturers including Caterpillar Inc., Joy Global Inc. and Deere & Co. have fallen into the same trap. Deere has seen its debt load balloon from $17.4-billion (U.S.) in 2009 to $23.8-billion in 2015. Meanwhile, sales from the corporation's agriculture, construction and forestry equipment segments have grown from $20.8-billion to $25.8-billion. Although this is a sizable sales increase, revenue actually peaked in 2013 at $35-billion and has dropped off since as commodity prices and industrial demand have declined.
Shipping is another sector in which there has been massive oversupply. For example, Star Bulk Carriers Corp. had no debt prior to 2009 but as of its third quarter 2015, it owed $827-million. Since 2007, the company's fleet has expanded from four to 70 ships. Sadly, for its shareholders, the stock has fallen from an all-time highs of more than $228 in 2007 to about 63 cents today. It has also seen equity dilution take the share count from three million to 165 million. In the latest quarter, the enterprise sold some of its high-quality modern ships at fire-sale prices in an attempt to navigate the troubles. Strangely, Star Bulk Carriers is still in the game to grow its fleet through the rest of 2016.
Although one could draw many lessons from the application of a ZIRP, one we draw is that low interest rates seduced companies to pursue projects that would not have been profitable or feasible with higher-cost debt. This has contributed to a global oversupply in just about everything. Companies are not the only casualties; consumers here in Canada have extended themselves to buy ever more expensive houses, spurred on by artificially low interest rates.
For decades, academics have sparred over the conflicting economic prescriptions of John Maynard Keynes and Friedrich Hayek. Keynes's top-down application of monetary policy and fiscal stimulus was the "go-to" strategy for most national governments in 2009. This worked, to at least the extent that the economy was successfully resuscitated, but the shape and degree of the recovery has been disappointing.
Hayek argued that when central banks expand credit with low interest rates, the result is a misallocation of capital and a disruption to the balance of supply and demand.
In a hilarious YouTube video, Econstories imagines a Keynes/Hayek duel that is pugilistic, as well as intellectual. Given what we see of the global economy in 2016, we'll have to award this round to Mr. Hayek.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter.