Deleveraging is 'more of a myth than an issue'

Claims that the recovery is slowed by businesses deleveraging after they built up big debts before the crisis are unsupported, economist Andrew Smithers says

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“The problem is not that deleveraging is constraining demand, but that it is not happening and thus is maintaining a high risk of another financial crisis,” economist Andrew Smithers, the author of the book ‘Valuing Wall Street,’ wrote in a recent report.

The balance sheets of companies in the US and the UK are highly leveraged, but the firms are not seeking to deleverage, preferring to spend their cash on buying back shares rather than reducing debt, Smithers argues.

US non-financial debt is “higher than it was in 1929 and has barely shrunk since the financial crisis” while financial debt “has shrunk rather more but still remains extremely high by historic standards,” he wrote.

Historically high leverage seems to be a feature of UK companies as well, while in Japan business debt is low by domestic standards post-1975, but it is still high by international standards as the International Monetary Fund data show Japan non-financial corporate debt at 143% of gross domestic product in 2011, the highest in the world, Smithers added.

French corporate debt to GDP is 150%, UK corporate debt is 118%, US corporate debt is 90% and Germany’s is 80% according to the IMF data quoted by Smithers.

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“Companies are not seeking to deleverage. If they were, they would be repaying debt, not buying back equity,” he said, noting that the latest data available show that US non-financial firms are buying back equity at around $400 billion per year (or around 2.6% of GDP) while UK companies’ equity buyback represents around 3% of GDP.

Smithers argued early last year that linking bonuses for executives to short-term results encouraged resistance to cutting profit margins and increasing investment, thus creating a savings surplus in the business sector that can only be offset by high budget deficits.

In Friday’s report, he noted that the Japanese, UK and US budget deficits rose above 10% of GDP in recent years, while Germany currently has a balanced budget and yet the recoveries of these countries were very different, with the US and Germany growing and Japan and the UK lagging behind.

“The failure of current policies has been due to the structural nature of the current recession,” Smithers said.

“Attempts to achieve recovery by either more fiscal or more monetary stimulus are based on the structural problems being denied.”