Eurozone corporate liquidity squeeze intensifying
Simon Ward
1 Comment
The corporate liquidity ratio – companies’ holdings of short-term assets divided by their short-term borrowing – is a good leading indicator of the economic cycle. A falling ratio may indicate that corporate profits are weakening and / or companies are expanding their operations too rapidly. In either case, future retrenchment is more likely, involving cuts in investment and jobs.
In the UK, the ratio of private non-financial companies’ M4 money holdings to their bank borrowing – a proxy for the liquidity ratio – began to fall significantly as long ago as 2005. It has continued to decline in recent months, matching the low reached in the early 1990s recession. This signals ongoing business contraction at least through mid 2009.
Worryingly, a similar trend is now in place in the Eurozone. The chart shows the ratio of Eurozone companies’ M3 holdings to bank loans with an original maturity of up to five years. This began to decline significantly in early 2007 and is currently at its lowest since 2003.
The higher level of the Eurozone ratio compared with the UK is of limited comfort. Unlike their UK counterparts, Eurozone companies borrow significantly on a long-term basis from their banks – about half of outstanding loans have an original maturity of more than five years. Including these in the calculation would push the ratio well below the UK level.
As in the UK, the decline in the Eurozone ratio initially reflected rapid growth in borrowing but slowing monetary expansion has been the key driver more recently. The annual rate of change of non-financial companies’ M3 holdings fell from 13% in November 2007 to 3% a year later – the lowest on record since 2000.
The appropriate policy response to the corporate liquidity squeeze is Fed-style quantitative action to boost aggregate broad money supply growth. Such measures are required just as urgently in the Eurozone as the UK.
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Reader Comments (1)
Simon, I have a recollection of you saying back in the Autumn (Sept 12th) that the recession wasn't a done deal and the money supply was holding up. Obviously it wasn't?
I sometimes wonder if quantitative easing is based on Friedman or Idi Amin - the latter having been told by God that if the country was poor, Uganda's central bank needed to print more money.
It surely makes sense only if you subscribe to Friedman's view that a declining quantity of money is the cause of a depression - rather than being a symptom of a much needed correction to previous monetary excesses.
Quantitative easing might well in the short-term ease the problem of a $trillion of EU corporate debt needing refinancing in 2009. Especially given a backdrop of world Government's issuing $3trillion of sovereign bonds to fund balooning deficits, and even half-baked ideas to reflate mortgage lending by underwriting a £100bn of RMBS effectively at the expense of corporate paper. In oither words, it'll give some of the industry's funds a nice boost.
But it doesn't alter the fundamental weaknesses of US or UK economies, where neither labour nor capital are homogenous in the way so many macroeconomists seem to assume. "Mr Keynes' aggregates conceal the most fundamental mechanisms of change" - Hayek (1931).
Real Estate Agents will not be convinced to retrain. "Car" Companies who only sell cars when there's plenty of credit around, and then only make a profit if they sell that credit themselves, will not be liquidated and replaced by more efficient outfits. Malinvestments made on the back of the previous monetary expansion will not be liquidated as quickly and over-inflated asset prices will take longer to fall back.
As I see it, there are 3 choices. Let things run their course, as painful as this may be, so we can then hasten a real recovery. Or short-term fiscal and monetary stimulas that drags out the pain for years (a la Japan). Or longer-term reflation giving us a mild hyper-inflation, putting off the worst of it until the cholera outbreak... Personally, the first one looks the least worse of the options to me...