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Affluent Investor | June 23, 2017

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Zombies Threaten Growth in 2017

zombie

Most economists expect the economy to grow at its most rapid rate this year. One of my favorite economists wrote this:

“If the new Trump administration cuts taxes and deregulates the economy, expect higher economic growth and another good year on Wall Street. However, I also expect higher interest rates and more inflation. ‘King Dollar’ should continue its rise, which will make it difficult for gold and other commodities. Avoid bonds and gold — stay invested in the stock market.”

Let’s get the obvious problems with that forecast out of the way: higher interest rates and inflation are bad for the stock market and inflation is good for gold prices. And inflation means a lower dollar, not higher.

On the other hand, cutting regulations and taxes are good for the economy, ceteris paribus, or in theory, but in reality other things don’t remain the same. Take the problem of regulations. The Federal Register of new regulations grew by an average of 70,000 pages per year from 1970 through 2010. That adds up to over 3,000,000 pages of new regulations. Last year the Register grew by 90,000 pages. It will take decades to roll back enough regulations to have an impact on the economy.

I realize that some of our older readers will recall the massive boost to the economy that Carter’s and Reagan’s “deregulation” accomplished in the mid-1980s. But keep in mind that neither president deregulated anything. All they did was end federally imposed price controls. The problem of oppressive regulations today is much, much greater.

Tax cuts can provide a quick jolt to business if the cuts are deep enough. But they may not have the impact we have come to expect because of 1) the problem of regulations and 2) the drag of zombie businesses. Zombie businesses are the dead ones that banks keep alive through regular transfusions of cash and and the Fed helps through price inflation that boosts paper profits.

Every artificial expansion launched by cheap credit creates what Austrian economists call malinvestment, or bad investments. They’re bad because they’re out of line with what consumers want. Those are usually in the capital goods sectors of the economy. That’s why the greatest volatility in profits and employment happens in capital goods industries.

A good recession kills off the zombies as a cold winter exterminates bugs. Why is it important to get rid of zombie businesses? It’s important because they are tying up capital that is needed more urgently elsewhere in the economy and their competition sucks the life out of healthy companies.

Although this last recession was called “Great,” we didn’t allow it to do its healing work by getting rid of the zombies and freeing up their capital for use elsewhere. The federal government bailed out many of the banks and other businesses such as GM and AIG. And the Fed’s cheap interest policies made it easy for banks to keep zombies on the books in the hopes that they might magically transform someday into real businesses. That is especially true of many oil and gas producing companies.

The Big EZ (Euro Zone) has kept its southern conference, especially Greece and Italy, alive through transfusions. Japan’s millstone since 1990 has been zombie businesses that banks won’t let die.

That the economy needs recessions to kill zombie businesses is a paradox, not a contradiction. Austrian economists have been fond of saying that the expansion is the disease and the recession the cure, the opposite of conventional thinking. We need a recession to free up capital trapped in zombie businesses before the economy can grow again.

 

Article originally published on ABCT Investing.

 

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