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The celebrated At 204,000 words, French economist Thomas Piketty's book Capital in the 21st Century is longer than Homer's Odyssey. But the book's central argument can be boiled down to his three-letter single expression: r>g. As Mr. Piketty calculated throughout the 20th century, inequality will likely increase as long as the real rate of return on capital, “r,'' exceeds the real economic growth rate, “g.''
Piketty was widely praised for the simplicity of his message. It also produced a resurgence in the popularity of economic expression. The influential one, i>g, is Piketty's variation on his rule. Applies when the nominal interest rate (or risk-free return) exceeds the nominal growth rate. A troubling conclusion from this equation also applies to debt. In the modern world, debtors' incomes, wages or tax revenues grow more slowly than the interest they accumulate on their borrowings, meaning debt levels can explode.
The world where i > g is foreign to America and most of the Western world. Nominal growth has exceeded nominal growth since the end of 2009 (with the exception of the first half of 2020, when the COVID-19 pandemic disrupted the economy). Now America is about to cross that line. In the first quarter of 2023, troublingly high inflation kept nominal economic growth at her 1.1% annual rate, even though real economic growth was only 1.1% annually. GDP It rose at an annual rate of 5.1%, roughly in line with today's federal funds rate. The median annualized growth forecast by professional forecasters surveyed by the Philadelphia Fed for the second quarter of this year was 1%. They also expect economy-wide inflation to be 3.3%, which means nominal growth will remain at just 4.3%, below the nominal growth rate of about 5.2%. become.
“Rubber is now on a cyclical path,” says Carl Riccadonna. bnp A bank called Paribas. “This is the point at which a company's revenue growth is slower than its cost of financing.” Wage growth lags debt growth. Government debt will rise faster than tax revenues. A quarter of this might be tolerable. Unfortunately, economists expect this situation to continue for more than a year.
The exact impact will depend on the extent to which debt is repriced as interest rates rise. The majority of American homeowners take out their 30-year fixed rate mortgage. This generous loan will protect them from the scissor-like combination of slower wage growth and higher interest payments. Nevertheless, consumers with other types of debt, such as credit card revolving balances or private student loans, will feel the pinch.
Many companies have a combination of fixed and variable interest rate debt, which creates some degree of isolation. However, their debt maturities tend to be much shorter than mortgage maturities. The bulk of corporate fixed-rate debt is scheduled to be rolled over into 2024, making companies preparing to refinance nervous. Rafael Bejarano of Jefferies, an investment bank, said many corporate treasurers have been spooked by the difficulty of issuing debt over the past year. “Many of them are looking at big redemptions in 2024 and are looking to pay off some of that debt a little earlier, even at higher interest rates,” he says. What they really fear is that they won't be able to repay their debts at all.
Many of the hottest companies include those recently acquired by private equity giants. Private credit loans undertaken by our portfolio companies tend to have variable interest rates. During the last major credit cycle in 2008, many private equity firms were able to maintain overleveraged acquisitions by negotiating with lenders, primarily banks. This time, they will be going head-to-head with private credit institutions, many of which employ strong teams in private equity and will be willing to take on even overleveraged companies.On May 16th, as a sign of what might happen, kkrEnvision Healthcare, the giant private asset firm, has allowed its portfolio company, Envision Healthcare, in which it invested $3.5 billion at a $10 billion valuation in 2018, to fall into bankruptcy and be foreclosed on by lenders. did.
Examining this situation, it is heartening to note that interest rates have been high for some time, the American economy is doing quite well, and even bank failures appear to represent physical wounds rather than fatal ones. But all this happened in different circumstances. It is much easier to accept a high cost of capital if it is balanced by a high return on that capital. And it won't last long. ■
Correction (May 26, 2023):This article originally misstated the title of Piketty's book and America's economic growth. sorry. The text and graph have been updated, and the source of future growth projections has been changed.
Read more from financial markets columnist Buttonwood:
How to invest in artificial intelligence (May 17)
Investors brace for a painful collapse in the US debt ceiling (May 10)
What the First Republic Agreement Means for American Banks (May 3)
Related article: Origin of the name Buttonwood Column
