Thursday, April 9, 2015

America's Growing Corporate Debt-Profit Gap

As I've noted in previous postings, the growing level of corporate debt is something worth watching, particularly given that we live in a unique and rather lengthy period of ultra-low interest rates where even the most uncreditworthy of companies is able to issue bonds to unwary buyers who are seeking some sort of reasonable yield on their portfolios.

Until the mid-1970s, corporations kept debt and debt growth levels relatively low as you can see on this graph from FRED:

Until the mid-1970s, corporate earnings were adequate for covering investments in research and development, new equipment and plants and providing increasing compensation for their employees.  Companies basically used their own internal resources to expand their businesses.

Here is a graph that shows the dramatic increase in the debt-to-equity levels that occurred in the mid-1970s and lasted through to the early 1990s:

From its level of under 40 percent in the 1960s, overall debt-to-equity levels rose sharply to between 70 and 100 percent between 1974 and 1991.  In 1991, as the stock market took off, the value of equities rose much faster than the growth in corporate debt, pushing the debt-to-equity level down even though the level of debt continued to grow rapidly.  You will also note that during the 2001 and 2008 - 2009 market corrections, the debt-to-equity level rose dramatically as equities dropped in value far more quickly than debt levels dropped.

Let's look at another measure of corporate health, corporate profits.  Here is a graph from FRED showing total after tax corporate profits since 1947:

That looks pretty healthy doesn't it?  Corporate profits have grown quite rapidly, particularly over the last decade (excluding the Great Recession, of course).

Now, let's combine corporate debt (in red) and corporate profits (in blue) on the same graph:

That really puts the growth of corporate profits into perspective, doesn't it?

If we subtract corporate profits from corporate debt to give us a sense of how much faster corporate debt is growing compared to growth in corporate profits, here is what we end up with:

Right now, corporate debt is outstripping corporate profits by $5.51 trillion, the second highest level after the one-time (hopefully) readjustments of the Great Recession.  Let's call this difference between debt and profits the debt-profit gap, a gap that has grown substantially since 2011.  

Let's look at how much interest corporations are paying on their ever-rising debt loads since 1947 as shown here: 

Let's focus on the period since 2006:

We can see that the interest paid on corporate debt has dropped substantially from a peak of $605.7 billion in 2006 to $438.4 billion in 2013, a very substantial drop of $167.3 billion.  You'll also notice that the drop in interest paid by American corporations on their debt fell in tandem with interest rates on corporate bonds as shown here:

That's what life is like in our current interest rate environment; there are winners and there are losers and American corporations just happen to be one of the big beneficiaries of Ben Bernanke's generosity.

What lies ahead?  While no one knows when (or if) the Federal Reserve will allow interest rates to float back up to historical norms, one thing we can be certain of is that there will be a great deal of pain in overly indebted Corporate America as it tries to service its increasingly heavy debt load in a time when the debt-profit gap is rising.


  1. Reflecting back on how our economy arrived at this point is very important. Rewarding savers and placing a value on the allocation of financial assets is important. It should be noted that many Americans living today were not even born or too young to appreciate the historical ramifications of the events that took place starting in 1979.

    That was when then Fed chairman Paul Volcker hiked interest rates to over 20%. The impact of higher interest rates had a massive positive impact on corralling the growth of both credit and debt acting as an crucial reset to the economy for decades to come. Below is an article delving into the importance of this event and how it relates to the skewed and distorted economic landscape of today.

  2. Here is one of your graphs in logarithmic scale. Logarithmic is also useful in this field too.

    The distance between the two lines gives the log of the ratio. Also, since these things grow exponentially valued in dollars it shows what is going on in earlier times as comparison.