There has been a lull in bankruptcy volumes globally during the pandemic due to relief measures and the deluge of near-free liquidity pumped into the global financial system by central banks, which have guaranteed cash flows for vulnerable businesses.

However, it has also increased the indebtedness of these companies within a global system that is now significantly more indebted.

If central banks are forced to engineer a recession to rein in four-decade high inflation rates, the zombie count could rise quite dramatically.

Global debt hit a record $303 trillion last year, according to the Institute of International Finance, $77 trillion more than in 2020 and the biggest one-year increase since World War II. . Investment manager Janus Henderson predicted a similar increase – around $72 trillion – this year.

If this access to cheap debt has kept some businesses afloat during the pandemic, then the rising interest and debt service charges and shrinking central bank liquidity that is happening now threatens to sink them. .

Over time, research by both the BIS and the OECD has shown that the proportion of zombie companies in listed company markets is increasing.

Between the end of the 1980s and 2017, it rose from around 4% of listed companies in the OECD to around 12%. In Australia, the proportion was estimated, before the pandemic, at around 12% (some estimates are much higher) and in the United States at around 16%.

It would seem reasonable to assume that after the traumas of the pandemic and with the tightening of fiscal and monetary taps, the number of zombies will increase. If central banks are forced to engineer a recession to rein in inflation rates that have been high for four decades, they could rise quite dramatically.

The historically cheap debt and equity environment that has prevailed since the financial crisis has helped keep frontier companies afloat and fueled the rise of “unicorns” (billion-plus tech companies) as well as a host of other technology and industrial companies whose values ​​have been secured more by expectations of eventual earnings than by actual earnings.

Stock markets are collapsing and the cost of servicing debt – debt that has risen quite significantly before and during the pandemic – is skyrocketing. Spreads on high-yield bonds, or junk bonds, in the United States are now 400 basis points higher than risk-free rates, which themselves have risen sharply.

The nadir in the US 10-year bond rate was 57 basis points in August 2020. It is now around 2.8%, having hit 3.13% earlier this month. In Australia, the 10-year rate was below 70 basis points at the start of the pandemic and is now around 3.3%.

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Rising interest rates and debt service charges and falling stock prices (and reduced access to stocks for companies with low cash generation) are a fading wave; probably the first time the tide has really turned since 2008.

As Warren Buffett so aptly put it, “It’s not until the tide goes out that you find out who’s been swimming naked.”

There are a few “ifs” here. Faced with the prospect of recessions, will central bankers and governments restrain their nerves and prioritize the need to control inflation over corporate meltdowns, rising unemployment and further explosions? of an already historically high public debt and deficit?

If they do, then zombie companies that were only alive before the pandemic, and some created by the pandemic, will be exposed and, to some degree at least, economies will be purged of their weaker companies.

That wouldn’t necessarily be a bad thing for economies at large.

The “whatever it takes” approach of central banks and governments after 2008 locked up a lot of valuable capital in unproductive and purely speculative activities.

They have stifled the pricing of risk and frustrated the forces of “creative destruction” that allow financial and human capital to be recycled and used more productively and may partly explain why productivity in major economies has stagnated since the financial crisis. . crisis.

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If central banks remain committed to fighting inflation and governments to reduce their pandemic-bloated leverage, the tide will go out for many zombie businesses and activities and being exposed to swim naked will be the least of their worries.

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