This commentary originally appeared on Real Money Pro on Nov. 18. Click here to learn about this dynamic market information service for active traders.
Could increased bank lending finally break the low rate/low inflation/low growth rut we've been stuck in? It is becoming an increasingly popular position, given why interest rates have been rising post-election.
Specifically, a repeal or rolling back of the Dodd-Frank act could loosen bank capital requirements, allowing them to lend more aggressively. It also appears to be a clear priority of both the incoming administration and Congress. I think conceptually this idea fits the combination of higher real rates, higher inflation expectations and a stronger dollar that we've seen since the election.
More lending could lead to more business investment, a key missing component during this tepid recovery. It could also increase the velocity of money, which could spark both faster overall growth and somewhat higher inflation. But the idea that there is scope for significantly more borrowing by companies doesn't fit the data. I'm afraid this is yet another example of the market trading with extreme confidence based on very shaky evidence.
First let's walk through how this narrative could plausibly be true. It hinges on the idea that if only it were easier for companies to borrow, there would be more capital investment spending. This breaks down into two questions:
- Is it hard for companies to borrow? Either because banks can't/won't lend or because the cost of funds is prohibitively high?
- If the funds were available, would companies spend it on capital investment?
Is It Hard for Companies to Borrow?
There is scant evidence for this -- whether we are talking about large or small businesses. From the borrower side, we could look at something like the National Federation of Independent Business Survey, which covers smaller businesses. In its October survey, only 4% of respondents reported that all their borrowing needs were not met. That has been steady between 3% to 5% over the last two years. The NFIB notes that "Record numbers of firms remain on the 'credit sidelines,' seeing no good reason to borrow."
Certainly for larger companies, the public markets have been wide open. Corporate bond issuance this year is running 3.5% ahead of 2015's pace -- and thus looks likely to set a new all-time high. For context, 2016's issuance should be more than double 2005's issuance.
We can also see it by looking at total corporate borrowing (i.e., loans plus bonds) as a percentage of GDP.
Source: Federal Reserve and Bureau of Economic Analysis
Total company debt stands at 45% of GDP, which equals the previous peak in 2000. I'm not pointing this out to sound alarm bells about companies being over-levered. Merely saying that this chart certainly does not indicate that corporate America can't get the debt funding it needs.
And it certainly isn't expensive for companies to borrow. The recent back up in rates notwithstanding, generally corporate borrowing terms and interest costs are still near all-time lows.
Would Companies Invest More if They Had More Capital to Invest?
This question may seem moot based on the analysis above, but it is worth considering anyway. Perhaps the additional capital doesn't come from more borrowing but rather repatriation. Regardless of source, if companies had the cash to spend, what would they do with it?
The last two years should make this abundantly obvious. Companies have been returning extra cash to shareholders. Not investing it in expanding. Look no further than the chart above. Companies are borrowing at a record pace, and yet business investment remains mediocre. Non-residential investment has grown at just a 0.3% annualized pace in 2015 and 2016. That compares with a 6.2% pace during the last expansion (2002 to 2007).
With rates having been so low for the last two years, and with general credit availability being so easy, companies have been borrowing. They just haven't been borrowing to fund capital spending. They've been doing M&A or returning cash to shareholders.
Hence, I argue that both sides of the narrative fail under scrutiny. Companies have plenty of access to capital. But unless it is to buy back stock or buy other companies, they aren't interested in expanding borrowing.
There's plenty about Dodd-Frank to dislike. And perhaps a better banking regulatory scheme would benefit the economy in the long run. But it is hard to make an immediate-term case that modifications to the regulations will unlock fresh capital. And if that doesn't happen, then there is no good reason to expect more inflation or more growth resulting from any changes in the law.