January 3, 1999
ECONOMIC VIEW
The Joint Is Still Jumping, But the Floor Is Shaking
By LOUIS UCHITELLE
hese feel like such good times. People have jobs. Their pay is rising in many cases. The stock they own is gaining in value,
and so are their homes. They spend rather freely, and as the weeks pass they feel less threatened by the economic turmoil
elsewhere in the world. So it is hard to get people to focus on the precarious underpinnings, right here at home, of these boom
times.
One of the shaky supports is business debt. Everyone knows that consumers have borrowed up to their chins, a worry in its own
right. But now comes word from the Federal Reserve, which tabulates this sort of data, that companies have also been piling up
debt, though with less fanfare. Just as consumers have done, business borrowers have bet on a strong economy to give them
enough income to make their monthly installment payments. Lately, however, business debt has grown faster than profits.
"We are all getting caught up in euphoria, and a lot of good things are happening in this economy," said James Glassman, a senior
economist at Chase Manhattan Bank. "But you are never far from vulnerability, and business debt is now one of the vulnerable
areas."
Business debt, which includes the obligations of all types of business except banks, brokerage firms and other financial institutions,
stood at $5.13 trillion Sept. 30. That is a big number even for the big U.S. economy. And it keeps rising. While profit growth was
weakening in the third quarter, business debt was rising at a 10.4 percent annual rate, the fastest since the start of the economic
expansion nearly eight years ago.
The stock market makes all this debt seem unalarming. That's because stock prices are rising even faster than debt, so a company's
borrowings do not look high relative to its total market value. Such illusions help to explain how Amazon.com, its stock price
soaring, had little trouble borrowing $275 million last spring through a junk-bond offering, even though Amazon's earnings -- the
wherewithal to repay this debt -- were zero. For similar reasons, millions of Americans who own stock feel comfortable borrowing
faster than their incomes rise.
"Corporate balance sheets look fine," said William Dudley, chief economist at Goldman, Sachs, "as long as you focus your eye on
debt as a ratio of the market value of a company's stock. But when you look at debt as a percentage of book value -- the actual
value of a company's equipment, buildings and other assets -- it makes you sort of nervous."
There does not seem much danger of widespread defaults today, a contrast to the late 1980s, when shaky real-estate lending
accounted for much of the run-up in business debt. Interest rates are considerably lower now, making the repayment of loans less
burdensome. And if defaults come, the nation's lenders, particularly banks, are in better financial shape to weather trouble.
But not since the 1920s has the stock market played so big a role in a U.S. economic boom. And that is what makes rising business
debt so worrisome, though the public is paying little heed to the connection.
The economic expansion of the 1990s is largely built on borrowed money, as Wynne Godley, an economist at the Jerome Levy
Institute, has argued in various studies. Just as huge deficit spending by government financed the expansion in the 1980s, deficit
spending by consumers and, especially, businesses has carried the economy in this decade.
Companies have borrowed to pay for capital investment, a big source of economic growth. They have borrowed to stockpile
merchandise awaiting sale. They have borrowed to finance mergers. And companies have gone hundreds of millions of dollars into
debt to buy back their own stocks and give share prices a boost.
"For those who think the boom can continue, you really have to postulate that these borrowing flows will continue to rise at the old
pace," Godley said.
But how can they? Business has gone from repaying debt at an annual rate of $150 billion in 1991, as the last recession ended, to
borrowing at an annual rate of $522 billion in this year's third quarter -- a swing of nearly $700 billion. Profits are no longer
sufficient to keep adding to debt at that rate. And as business cuts back, the economy will inevitably slow.
That's where the stock market complicates matters. The slowing economy will eventually bring down stock prices; as they fall, the
ratio of business debt to equity will rise, alarming borrowers and lenders, who will then cut back debt even more.
Consumers will probably go through a similar process: If their stock-market wealth evaporates, they, too, will become more
reluctant borrowers -- and an orderly slowdown in the national economy could turn into a rout.
It may never happen that way. The U.S. economy is amazingly resilient, and some wonderful event, or series of events, may save
the day. But it's a realistic scenario, one that ought to dampen the current euphoria, and in doing so make the future less dangerous. |
