Business·Analysis

Is U.S. Fed chair Janet Yellen creating a zombie economy?

As U.S. Fed chair Janet Yellen releases her latest statement today and Bank of Canada governor Stephen Poloz defends rate cuts, they must consider a new worry: that cutting interest rates and investor taxes may not be having the desired effect, and actually contribute to deflation, Don Pittis writes.

Low rates and low taxes are supposed to fight deflation. What if they're doing the opposite?

Zombie walks are a growing phenomenon as books, films and television shows popularize the genre. But now efforts by the world's central banks to keep interest rates too low for too long may be spreading the zombie plague to industry, says Don Pittis. (Francisco Seco/Associated Press)

Zombies are popular in TV, books and film. Now it seems that economics is imitating art. 

A new theory says that instead of stimulating the economy and getting the world back on track, bargain basement interest rates and handouts to investors in the form of lower taxes may be causing the opposite effect, creating a worldwide plague of walking undead companies.

Speaking to the House of Commons finance committee yesterday, Bank of Canada governor Stephen Poloz defended his surprise January cut in interest rates, saying that eventually it would help use up Canada's spare capacity. 

Janet Yellen, chair of the U.S. Federal Reserve, is expected to offer new clues today on when the U.S. central bank will begin to raise interest rates. (Andrew Harrer/Bloomberg)
But seen a different way, it may be that record low rates offered by central bankers like the U.S. Federal Reserve's Janet Yellen and Poloz are hurting, not helping. And it means that tax cuts in Canada's federal budget may be misguided.

As Poloz's comments indicate, the theory turns conventional economics upside down. Low rates are supposed to make deflation disappear as companies and consumers borrow and spend. 

But even a conventional pro-market publication like The Economist has observed the phenomenon happening in the past, specifically in Japan.

"The zombies make Japanese business look comedic," said The Economist in 2011. "Around two-thirds of all Japanese firms do not earn a profit (at least for tax purposes)." 

Dead firms walking

The phenomenon was something the magazine had been watching for a decade as explained in a 2004 article called Dead Firms Walking.

"Weak companies and wobbly banks clung to each other in mutual defiance of reality," reported The Economist. "Over time, this led to the emergence of so-called 'zombies' — companies that are competitively dead, but, sustained by their banks, continue to walk the Earth and give healthier firms nightmares."

In the new scenario, the role of Japan's wobbly banks has been taken by central bankers, creating a worldwide plague of companies that are the moaning, groaning walking dead. 

The financial website Zerohedge didn't use the Z-word, but its description of the global phenomenon was almost the same as the one The Economist used for Japan. 

"By keeping rates artificially suppressed," said Zerohedge, "the central banks of the world effectively make it impossible for the market to purge itself of inefficient actors and loss-making enterprises."

Just as in Japan, companies with access to cheap loans continue to borrow and add to output long after the world has enough of the product it is offering. The perfect example? The oil industry. 

So far, oil company results have reflected the boom times when oil prices were high and the market had nowhere to go but up. This week, we will see a more realistic picture as oil company financial results reflect plummetting prices.

Production glut

And yet despite low oil prices, those same oil companies continue to produce huge amounts, far more than world markets can absorb. The writers at Zerohedge make the case that financially weak companies, enabled by central banks offering artificially low interest rates, are to blame.

(Matthew Brown/Associated Press)
Oil producers large and small have access to dirt cheap lending. Tax breaks make the burden even lighter. So the producers keep filling up storage containers and tankers. New figures show the glut continues to grow.

Energy is only an obvious example. There are also record stockpiles of cotton, hitting their highest level since the U.S. government started counting. There are gluts of iron and steel.

It is harder to measure gluts in other products and services, but it is likely that access to cash far below natural market rates means companies everywhere are producing too much. 

In Japan, where The Economist first saw the problem emerging, it hasn't gone away. When the wobbly banks got into trouble, the Japanese government did the same thing for them that they had done for the zombie companies.

If The Economist was right about Japanese zombie companies more than a decade ago, then the entire country has now become a zombie economy. 

Wary consumers

This week, the rating agency Fitch downgraded Japan's credit rating again. It is now five notches below the AAA rating that rich stable countries like Canada normally expect. 

The danger is that Japan's problems may be a warning of what is beginning to happen in the wider world.

Despite that economy's huge capacity to produce goods and services, consumers are unwilling or unable to spend. And unlike companies, ordinary people are unwilling to borrow more.

In Japan, and increasingly everywhere else as well, the only way to get consumers to buy more is to push prices down. A general decline in prices has a name. It is called deflation, and it is supposed to be what banks are using low interest rates to fight.

This is not what most worry-warts had expected.

It is well-known that longer-term government interference in an economy causes distortions.The fear used to be that artificially low rates would create an overheated economy, sending inflation soaring and wiping out the value of money.

That may happen eventually. But in the meantime, those low rates may be having the opposite effect.

If so, we are creating a world economy swarmed with companies that just can't die, producing more than the world can consume. And if it continues, at some point, something's got to give. 

Follow Don Pittis on Twitter:@don_pittis.

About the Author

Don Pittis

Business columnist

Don Pittis was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.

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